Earnings Call Transcript
Gates Industrial Corp plc (GTES)
Earnings Call Transcript - GTES Q1 2020
Operator, Operator
Thank you for joining us for the Gates Industrial Q1 2020 Earnings Conference Call. All participants are currently in a listen-only mode. Following the speakers' presentation, there will be a session for questions and answers. I will now turn the call over to Bill Waelke, Head of Investor Relations. Please proceed.
Bill Waelke, Head of Investor Relations
Thanks, Josh, and thanks, everyone for joining us on our first quarter 2020 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 CFO, Brooks Mallard. After the market closed today, we published our first quarter 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, including our quarterly report on Form 10-Q that will be filed this week. We disclaim any obligation to update these forward-looking statements, which may not be updated until our next quarterly earnings call, if at all. I will now hand things over to Ivo.
Ivo Jurek, CEO
Thank you, Bill. Good afternoon, and thanks for joining us today. The first quarter marked the beginning of an unprecedented environment for the global economy as governments, companies, and communities implemented strict measures to minimize the spread of the COVID-19 pandemic. Let me provide a brief overview of how we are responding to the spread of the virus before I cover the Q1 business results. In early February, as our business in China was being impacted, we've mobilized a centralized crisis response team that developed and is tactically engaged in the implementation of countermeasures across our global footprint. While we are prioritizing the health and safety of our employees and the communities around the world in which we operate, we have also been able to maintain operational continuity in support of our global customer base. We're adhering to government mandates and guidance provided by the health authorities and have implemented remote work policies where possible. Additionally, we have enhanced protective measures in our plants to ensure we are able to safely supply our mission-critical components. In particular, the methods we used in China to manage through the COVID-19 impact have informed the approach we are successfully taking in our other regions. Our in-region, for-region manufacturing strategy is supported largely by local supply chains. We have taken the necessary steps to protect our raw material supply to ensure we are able to maintain continuity, and we have not experienced any significant disruption of our service today. Before we move to Slide 4 and jump into more detail on the quarter, I would like to take a moment to thank our global team of associates for their perseverance and dedication during these challenging times, particularly those in our manufacturing and logistics facilities, whose essential jobs necessitate an on-site presence. I appreciate their commitment, which has allowed us to continue to be a trusted and reliable supplier to our customers during this challenging time for everyone. Now moving to Slide 4 and a brief overview of our first quarter results, Q1 got off to a solid start with steady sequential improvement from where we exited 2019. Our core revenue in the quarter ultimately declined by 10%, which includes an approximate 7% negative impact from COVID-19. I would also note that we experienced significant revenue deceleration in our businesses in North America and Europe, primarily over the last two weeks in March as stay-at-home orders took hold across numerous jurisdictions and geographies. First quarter adjusted EBITDA was $121 million, representing a margin of 17%. The margin decline was broadly in line with the expectations communicated on our Q4 earnings call and represents an improved decremental margin relative to Q4 and full-year 2019, a result of the progress we have made in rightsizing the business. On a percentage basis, our adjusted earnings per share of $0.21 represented a decline similar to that in our adjusted EBITDA. Our liquidity position is strong, with over $1 billion available and no meaningful debt maturities until 2024. We also continue to expect to generate strong free cash flow in 2020, which will further strengthen our liquidity position. Moving now to our segments on Slide 5. Our Power Transmission business in Q1 was notably impacted by COVID-19 in China, where core revenue declined over 30%. In Europe, our business had modest growth, the result of growth in the automotive replacement channel. In North America, the trajectory we saw in the fourth quarter decelerated modestly in Q1, primarily a result of weakness in the last two weeks of March. Despite the uncertain business environment, we saw solid design wins activity from our global customer base in Q1. Our chain-to-belt initiative had design wins in intralogistics, material handling, food processing and health service applications. We also recently launched our next-generation V-belt, representing another step in revitalizing our entire Power Transmission product portfolio. This new V-belt family delivers superior performance for industrial applications while eliminating chloroprene from the belt construction. We believe our focus on innovation will differentiate us in the market and will enable future growth as our end markets return to a more normal state, and we anticipate continuing to fully support our investment in innovation throughout 2020. Moving now to Slide 6. Our Fluid Power core revenue represented a 10.6% decline year-over-year but a mid-single-digit sequential improvement. In North America, core revenue in industrial end markets remained down compared to the prior year period primarily due to the weakness in the mobile hydraulics market, but improved notably from Q4. Our Fluid Power business in Europe declined year-over-year with core growth in the automotive end market, offset by weakness in industrial end markets. In China, our Fluid Power segment was impacted by weakness in the construction end market, a trend that began to turn, however, with significant new orders in March. The solid pipeline of opportunities we have been building with our revitalized product portfolio resulted in Q1 being our MXT hose family’s best revenue-generating quarter since its launch. Similar to Power Transmission, we believe our focus on innovation differentiates us, and we expect our new products will continue to build momentum when the current COVID-19 uncertainty subsides. Slide 7. We don't plan to provide the information on this slide on a quarterly basis going forward. But given the exceptional environment and regional nature of COVID-19 pandemic, we thought it would be useful to provide additional color this quarter. Beginning with China, our core revenue began the quarter with continuation of the solid growth trajectory we saw in Q4 before being significantly impacted by the measures taken to limit the spread of the virus. From a demand perspective, March appears to have been the bottom in China. We expect the general trend of improvement we saw in April to continue over the remaining two months of the present quarter. In Europe, we have proactively managed our production levels in line with demand, and most of our plants have remained operational, with the exception of a brief government-mandated suspension of operations at our plant in Spain. The automotive replacement business saw a slightly lower growth rate in March but performed well throughout the quarter before declining in April as shelter-in-place orders took a firm hold across the EU. Our first-fit businesses experienced a notable decline in March and, subsequently, April as many of our largest customers temporarily suspended production. In North America, our business improved sequentially but industrial end markets remained weak, as anticipated. Similar to Europe, our business was not meaningfully impacted by the effects of COVID-19 until the last two weeks of March when larger customers began temporarily suspending production and replacement channel activity notably declined, trends that accelerated in April. I would note that in April, we experienced a significant decline in India, where our operations were temporarily shut down, in line with a broad government mandate. We began the process of reopening our manufacturing facilities there on May 4 and are employing the same tactics used in China to safely bring our operations in India back online. I won't spend a lot of time on Slide 8, but hopefully, it illustrates some of the recent complexity involved with managing our global businesses. We have laid out a high-level timeline of when the regions we operate in began to be impacted by shelter-in-place and a rough estimate of what their path to improvement could look like on a relative basis through the second quarter. The majority of our regions began to be adversely affected by these restrictions around mid-March and are now experiencing the significant impact that hit China in February and March. Although we do not expect the rest of the world to behave exactly the same way, we view the trends of demand recovery in China as informative and a potential model for what we could experience in other geographies. Of course, we are very focused on being responsive to the changes in business trends and are ready to react to those changes as they come. I will now turn the call over to our new CFO, Brooks Mallard, for some additional details on the financials. Brooks?
Brooks Mallard, CFO
Thank you, Ivo. Starting on Slide 9, our total Q1 revenue of $710.1 million declined 11.8% year-over-year, which includes the negative impacts of 1.7% from FX and an estimated 7% from the effects of the COVID-19 pandemic. Adjusted EBITDA was $121 million or 17% of sales compared to $166 million or 20.6% of sales in Q1 of 2019. The decrease in earnings and adjusted EBITDA margins was driven by lower revenues, partly from expected lower volumes and partly from the impact of COVID-19. Our adjusted EBITDA decrementals in Q1 of 2020 were 47% when compared against the same quarter in 2019. This is a sequential improvement to our Q4 2019 year-over-year adjusted EBITDA decrementals, a result of the work done in the latter half of 2019 to lower our overall operating cost structure. Our adjusted earnings per share were $0.21 compared to $0.28 in the same quarter one year ago. This is attributable to lower earnings in Q1 of 2020, partially offset by an improvement in our effective tax rate. Moving now to Slide 10, which provides detail on key balance sheet and cash flow items, first quarter operating working capital declined 140 basis points as a percentage of sales, primarily driven by reductions in accounts receivable and inventory. Accounts receivable reductions were driven by lower revenues, while lower inventories are a result of the efforts to optimize our inventory levels in the back half of 2019. As we expect revenue to decline for an intermediate period of time, we anticipate positive cash flow, driven primarily by lower operating working capital requirements. With respect to free cash flow, Q1 typically results in a cash outflow for the business as we build working capital for peak seasonal revenue in Q2 and Q3. In Q1 of this year, we generated $16 million of free cash flow, driven by reduced investment in working capital, lower cash interest due to timing of interest payments following our Q4 bond refinancing and lower cash taxes. The significant improvement in LTM free cash flow was driven primarily by improvements in operating working capital compared to Q1 of last year. Moving now to capital spending. Typically, our business has a low maintenance CapEx requirement of around 1.5% of sales. To preserve liquidity, we have limited new capital spending to initiatives deemed essential to our business. We will continue to manage our capital spending based on the prevailing market conditions. As a result of our lower adjusted EBITDA, net leverage in the first quarter increased 4.1 times from 3.6 times in Q1 of last year. Although we expect the attainment of our 3 times leverage target to be pushed out due to the current economic environment, cash generation and deleveraging remain a priority. Turning now to Slide 11, this provides a detail on our available liquidity, financial covenants, and debt maturities. As of May 1, our total liquidity was over $1 billion, consisting of $616 million in cash and $440 million in revolver availability. We do not have financial covenants unless our ABL or revolving credit facility is drawn more than 90% or 30%, respectively. As long as these credit facilities remain undrawn, we would not have any material debt maturities until March 2024. We believe our solid liquidity position will allow us to withstand the uncertainty associated with COVID-19 and its impact on our end markets. And we do not currently envision tapping into either our ABL or revolving credit facility this year.
Ivo Jurek, CEO
With that, I will now turn it back to Ivo. Thanks, Brooks. So in lieu of providing full-year guidance in this environment, on Slide 12, we have tried to provide some context of how we are currently thinking about the year. Our two largest regions of Europe and North America did not begin to see an impact of COVID-19 until the latter part of March. Accordingly, we expect the second quarter to be the most difficult of the year, with core revenue likely to decline in the range of 15% to 25% sequentially. I would note that April sales came in largely in line with our expectations, underlying how the second quarter will develop. As shelter-in-place restrictions ease and the level of business activity at our customers improve, we expect the second half of the year to get progressively better, given the magnitude of the decline we anticipate to see in the first half of the year. And thereafter, the varied rates of demand recovery we will see across different end markets and geographies, we do expect the full year to result in revenue decline. Reflecting the progress we have made last year in rightsizing the business, we would expect the full year decremental margins to be an improvement from what we saw in 2019, despite the relatively unexpected and significant decline in revenue as a result of the pandemic. We are undertaking incremental actions that we expect will further reduce our compressible cost and discretionary spend by approximately $50 million this year. Additionally, we are continuing to execute the restructuring plan we announced and then upsized last year to ultimately address $40 million of cost by the end of 2021. With respect to CapEx, we plan to maintain a flexible posture, but presently expect to spend approximately $70 million this year to support our business with maintenance and growth capital, but we'll react to any changes to business conditions and align our investment accordingly. We anticipate working through this difficult market environment and generating significant free cash flow this year while still funding some of our key initiatives to enhance our competitive position in the market and allow us to emerge from this downturn even stronger. So wrapping things up on Slide 13, the COVID-19 pandemic has clearly created an unprecedented evolving environment, and we are taking measures around the world to prudently manage the business. While the timing and trajectory of the recovery are unclear at this time, we look to our experience in China as a guide to manage through the near-term challenges. We remain focused on what we can control while being mindful that demand for our mission-critical components will recover. In addition to tightly controlling discretionary spending, we will continue to manage our compressible cost to prevailing demand conditions and have contingency plans in place, should they become necessary. Being cognizant of the potential magnitude of the COVID-19 impact, we are certain about the Company's ability to operate in this challenging environment. Our mission-critical components, which we sell across a wide range of end markets and geographies, need to be replaced. Our focus on innovation and recently introduced new products have strengthened our competitive position and we believe will allow us to take market share during this downturn. Focused on replacement channels, our business is resilient and has historically responded well after significant downturns. This was most notably evident in 2010 when core revenue grew 21% and recovered the declines of 5.5% and 15% in 2008 and 2009, respectively. In addition to the strength and flexibility of our liquidity position, our business has demonstrated the ability to generate solid free cash flow when revenues contract. We have begun to see green shoots in China and believe it is only a matter of time before we see them in our other regions. Until then, we believe we are well prepared to not only manage through the uncertainty but also emerge a stronger company when more normal operating conditions return. Thank you. And I will now turn the call back over to the operator to begin the Q&A.
Operator, Operator
And your first question comes from Andy Kaplowitz of Citigroup.
Andrew Kaplowitz, Analyst
Hey, good evening guys.
Ivo Jurek, CEO
Hi, Andy.
Andrew Kaplowitz, Analyst
Ivo, so you're guiding to a 60% year-over-year drop in Q2 revenue. We obviously know that auto builds around the world will likely be down, close to that. So could you give us more color on whether, for instance, your replacement businesses are outperforming that drop? And how much of the drop is due to either your customers that you're being shutting down, as you said, versus destocking or just end market demand being weaker?
Ivo Jurek, CEO
Well, in Q1, the replacement market significantly outperformed the first-fit market. Again, this was predominantly the result of what we have experienced in China, Andy. Obviously, in Greater China, the automotive first-fit market, in particular, has taken quite a substantial hit. And so we anticipate that the replacement channels are going to rebound before the first-fit channels will. And that is what we have seen in April as well. And so we anticipate we will see that as the quarter progresses.
Andrew Kaplowitz, Analyst
That's helpful, Ivo. You still have a considerable amount of production capacity that is currently shut down. Considering the guidance for the full year, how do you plan to approach decrementals in Q2? Have you noticed any supply chain issues easing up?
Ivo Jurek, CEO
So let me answer the last question first. And from a supply chain perspective, our supply chain issues are very limited or non-existent, Andy. We have been pretty proactive early on when we started seeing the issues in China to ensure that our supply chain certainly doesn't hamper our ability to support our customers. And our team has done a terrific job to do so. Now, as to decrementals, we anticipate the decrementals to be kind of mid-40s in Q2, which is, as you may recall, quite a substantial improvement from 2019.
Andrew Kaplowitz, Analyst
That's good to hear. I mean, you do have the same decrementals, Ivo, for the year sort of modeled. So is it possible, as sales declines ease, that you could see better decrementals as you go into the second half of the year? Are you being conservative in your sort of guide for the year?
Ivo Jurek, CEO
The situation is very fluid, Andy. While we expect Q2 to be the worst quarter of the year, which suggests that decrementals should improve, it is currently hard to predict how the second half will perform in relation to demand. If demand improves as we expect, we foresee better leverage in the second half.
Andrew Kaplowitz, Analyst
Great. Thank you. Well, be well.
Ivo Jurek, CEO
Thank you.
Operator, Operator
Your next question comes from Julian Mitchell with Barclays. Please go ahead.
Julian Mitchell, Analyst
Hi, good afternoon.
Ivo Jurek, CEO
Good afternoon, Julian.
Julian Mitchell, Analyst
Afternoon, Ivo. Maybe just a first question on the top line. I just wanted to clarify something. I think the first question just now had talked about a 60% sales drop year-on-year in Q2. I was getting near a 30% year-on-year at the midpoint for Q2 based on the comments in the slides. So I just wondered if you could confirm what kind of year-on-year revenue change is implied in Q2? And also within that, just to clarify, how much your orders or sales in April were down? And if there's any sort of color you could give on regions or segments within that, please?
Ivo Jurek, CEO
Your statement about the Q2 revenue is accurate. Our decline is in the 30s, which aligns with our expectation of a sequential decline between 15% and 25%. I apologize for missing Andy's earlier comment. For April, we observed results in the mid-to-high 30s, providing reasonable support for our anticipated deceleration in the second quarter of 15% to 25%. Specifically, China showed significant improvement, with a decline in the high-30s to mid-40s during February and March dropping to the teens in April. We expect conditions to progressively improve as May and June unfold. In North America and Europe, we experienced a decline in the high 30s.
Julian Mitchell, Analyst
That's very helpful, Ivo. Thank you. And then maybe just one quick follow-up. If we look at the cost savings, let's say, that $50 million of discretionary spending this year, maybe just help us understand the weighting of that and how that impacts the P&L. And any sort of longer-term fixed cost reduction measures you may be thinking about? Or those are kind of on ice, unless you see the sales outlook get even worse in the second half?
Ivo Jurek, CEO
So the $50 million, we anticipate to realize in the calendar year 2020, Julian. So that is compressible costs that we anticipate to be managing through the rest of the year, SG&A, predominantly, obviously. The fixed cost reductions, we have announced a $40 million fixed cost reduction plan in the latter part of 2019, which we continue to execute against well, despite even some of the difficulties, as you can imagine, that you see from lack of ability to travel and some of these impediments that we have all encountered presently over the last eight weeks. We continue to proceed reasonably well with those and we anticipate to be on track to attain as we have outlined those in the second half of the year. Should the business get worse than what we anticipate, we have a number of other projects sitting on the shelf that we would enact. We believe that we would just have the management capacity to go and execute those incrementally. So we are, I think, reasonably well positioned to potentially seeing a further deterioration. We don't certainly anticipate that that's what's going to happen. But at the end of the day, there is an unprecedented lack of visibility and we have a number of scenarios on a shelf to be able to go and execute. We're not going to shy away from structural improvements of this business. As you know, we have spoken about that quite substantially, and we believe that we have a number of these projects that we will be able to continue to execute on.
Julian Mitchell, Analyst
Perfect. Thank you.
Ivo Jurek, CEO
Thank you.
Operator, Operator
Your next question comes from Jamie Cook with Credit Suisse. Please go ahead.
Jamie Cook, Analyst
Hi, good evening, and I hope everyone is doing well. My first question is regarding the inventory in the channel and how long it typically takes to correct. I apologize for joining late due to overlapping calls. Additionally, could you provide insight into the market demand for April, particularly comparing the auto sector to other mobile equipment markets? I'm trying to understand where the demand is weakest. I suspect it’s in the auto sector, but any additional information would be appreciated. Thank you.
Ivo Jurek, CEO
In April, the auto sector was significantly affected, about twice as much as the industrial OEMs, which makes sense given that most auto OEMs were closed throughout that month. We've noticed a considerable number of auto OEMs beginning to resume operations, so we expect improvement in the coming months, although it won't be drastic. The industrial OEMs had earlier shutdowns and many are now restarting, so we also foresee better conditions for them in the remaining quarter. The main challenge for these OEMs is to stabilize their supply chains. While we are prepared to supply, they need to ensure they have all necessary components to manufacture their machinery and equipment. Did I cover everything? I feel like I might have missed something.
Jamie Cook, Analyst
Yes, I was inquiring about your channel inventory and if you could provide any insight on that.
Ivo Jurek, CEO
Yes, sorry about that, Jamie. So, as you know, we have discussed the reduction of channel inventory, particularly in the industrial sector and the normalization of channel inventory in automotive replacement. We believe that some of the improvement we've observed in the first quarter, especially in North America for industrial, is linked to our supply being better aligned with the demand. We think that inventory in the industrial channel has stabilized in North America, and we do not expect significant challenges from this moving forward.
Jamie Cook, Analyst
Thank you. I appreciate your help.
Ivo Jurek, CEO
Thank you.
Operator, Operator
Your next question comes from Jerry Revich with Goldman Sachs. Please go ahead.
Jerry Revich, Analyst
Hi, Ivo, and good evening everyone.
Ivo Jurek, CEO
Hi, Jerry.
Jerry Revich, Analyst
Ivo, what we're hearing from some of the other companies with construction end market exposure is essentially a really painful start to April and then reduced year-over-year pain, if you will, as we got through the latter parts of April. Have you seen that type of improvement in any parts of your business, particularly on the replacement side outside of China? As you mentioned, that was the cadence there. But I'm wondering, any other regions or any other parts of your business that may have followed a similar pattern as we went through the month?
Ivo Jurek, CEO
Yes. The OEMs faced a challenging April as many of them took shelter-in-place orders seriously, resulting in limited machinery production. However, we observed a decent recovery in demand from China during April, although the industrial original equipment sector was down in high-single digits. India experienced a full month decline, which was quite difficult for us. In Europe and the Americas, we saw a similar situation with an average decline in the high-30s. On the other hand, the replacement markets performed better globally in the industrial sector, achieving approximately 30% stronger performance compared to the original equipment side.
Jerry Revich, Analyst
Okay. Thank you. And then as we think about what incremental margins look like whenever the markets are recovering, hopefully in '21, can you talk about whether there are any levers you can pull to drive higher incremental margins coming out of the cycle? Because at the peak, we've got hit by supply shortages. And then, obviously, the market deteriorated over the past two years that made decremental margins, I think, tougher than it otherwise would. I'm wondering does that all translate to better incremental margins in a recovery compared to what we've seen in prior cycles for this business?
Ivo Jurek, CEO
I would really like to discuss when we expect growth to return. Thank you for the positive outlook—I'm confident it will happen. I believe we are significantly improving the business. I've mentioned before that the slowdown we faced due to COVID-19 has not changed my view that our incremental margins should outperform the decremental margins from 2019. While I can't give you an exact figure, I fully expect our incremental margins to be considerably better than those decremental margins we experienced in 2019. We are all eager to show the rebound and profitability of the business once that happens. For now, our primary focus is on managing the next few quarters effectively and minimizing the impact on our business to best position ourselves for the eventual recovery that we anticipate.
Jerry Revich, Analyst
I appreciate that. Thanks.
Ivo Jurek, CEO
Thank you.
Operator, Operator
Your next question comes from Jeff Hammond with KeyBanc. Please go ahead.
Jeffrey Hammond, Analyst
Hi, good morning or good afternoon, guys.
Ivo Jurek, CEO
Hi, Jeff.
Jeffrey Hammond, Analyst
Just on the auto aftermarket. I know this is kind of a unique situation where people are driving less. But if you just take kind of normal economic recessions and then that dynamic, how do you think that impacts kind of the pace of snapback or recovery? I know you said aftermarket has been holding up better.
Ivo Jurek, CEO
I think everyone is focusing on the miles driven, which is definitely a good metric to track. Various reports indicate that there has been a significant rebound in miles driven. While there was a noticeable decline in early April, we have started to see a steady increase since then. We do expect that miles driven may still be lower in May due to ongoing shelter-in-place requirements. However, we anticipate a sequential improvement in demand for our products from April to May to June, primarily because the fundamentals of the automotive replacement market are strong. The average age of vehicles is at a near-record high. Once consumers return, we believe they will be more inclined to drive rather than use public transport or airplanes for trips, especially with low gasoline prices. This should favor driving over other transportation modes. Our products are essential; if you experience issues like a blown hose or belt in your vehicle, replacement is necessary, not optional. Thus, we are optimistic about recovery as stability returns to the market. O'Reilly has recently reported that their decline bottomed out at around 15% in mid-April, with signs of improved store performance. We expect a similar trend to influence our business if they begin needing to replenish their inventory. I believe that in about 45 to 60 days, we should see a similar performance trend from our larger customers. To summarize, we are confident that the market will rebound positively, and the demand for our essential products will recover well.
Jeffrey Hammond, Analyst
That's very helpful. Regarding working capital, it seems there was a seasonal use in the first quarter and certainly last year. You achieved a good year-end that somewhat balances it out. However, how do you view the cash generation potential from working capital amid these declines?
Brooks Mallard, CFO
Hi. This is Brooks. We believe that in Q2, which is likely to be the lowest point for revenues, we will experience solid cash generation from our working capital. As the year progresses, the speed of recovery will significantly influence the cash we generate from working capital. Based on Ivo's earlier framework, we expect it to be a good cash source for 2020. As for the recovery in 2021, that may present a different scenario. If the rebound happens sooner than anticipated, it might not serve as a cash source to the extent we expect, but that would be a positive issue to navigate.
Jeffrey Hammond, Analyst
Okay. Excellent. Thanks guys.
Ivo Jurek, CEO
Thank you, Jeff.
Operator, Operator
Your next question comes from Josh Pokrzywinski with Morgan Stanley. Please go ahead.
Josh Pokrzywinski, Analyst
Hi, good evening, guys.
Ivo Jurek, CEO
Hi, Jeff.
Josh Pokrzywinski, Analyst
So Hammond's a wise and handsome man, I'm going to ask his question a slightly different way, though. Ivo, if I just kind of normalize your OE customers having the lights on, so obviously, a lot of auto OEMs shut down here in the interim, going back to work fairly soon, normalized miles driven. I don't know what the new normal is, but probably something better than April. What does that imply for the sequential improvement into perhaps 3Q? Calling the individual months is probably a little too fine a point, but thinking about the step down and then the step back up, how are you guys thinking about it? How are you calibrating the cost base?
Ivo Jurek, CEO
Yes, Josh, I apologize for the confusion. Our expectation is that we have likely reached the lowest point in the automotive replacement market, which we believe will stabilize around mid to late April. We have observed some improvement in order rates as we moved out of April, and we anticipate continued progress as we finish the second quarter. However, we are not projecting a dramatic recovery in the second half of the year. While we are using the situation in China as a reference, we do not expect a similar outcome in North America or Europe. In China, we have seen a reasonable recovery in the automotive replacement sector after a significant drop in activity due to widespread shutdowns. Activity levels improved significantly in March and further in April, although they were still not favorable. I believe we will see a bottoming out in April, with improvements in May and June, leading to a better situation in the third quarter. While I do not expect a significant rebound in demand, I am not forecasting a continued drop like we experienced in April. I agree that it is difficult to define what normalization will look like. My impression is that more people will probably choose to drive their cars rather than use alternative transportation options. If we had clearer visibility, we might provide guidance for revenue in the third and fourth quarters, but we really want to see how the second quarter unfolds before giving insights on the latter half of the year.
Josh Pokrzywinski, Analyst
Got it, understood. I guess, the other part of that question, I missed the answer to if you gave it, was on the OE side, the customers coming back to work, obviously, a lot of shutdown in the interim. How much would you say that is worth on kind of a consolidated Gates basis?
Ivo Jurek, CEO
April was significantly worse than March, mainly because the majority of the global automotive plants were shut down, with China just beginning to restart its operations. In April, China had a notably late restart in the automotive first-fit sector. I anticipate that the declines in the auto first-fit business for the quarter will be in the mid-40s percentage range. This is likely to represent the most challenging market situation we expect to face in the second quarter.
Josh Pokrzywinski, Analyst
Got it. Appreciate it. If I can just squeeze in another one here. Competitive dynamics, I mean, obviously, with a lot of market volatility waging for a couple of years now, in some cases, in some markets, how do you see the competitive landscape? Is there an opportunity to kind of selectively invest, either commit capacity, working capital, etc., and maybe capture some opportunity where some of your competitors are in a more challenged position, smaller, etc.? Are you seeing that? Are you acting on that? Any color would be helpful.
Ivo Jurek, CEO
From my perspective, Gates is in a favorable position. We have continued to operate through Q1 and are actively supporting our customers. We're also selectively offering assistance to some potential clients that we hope will become long-term customers. Some competitors are likely to face challenges in maintaining uninterrupted operations in the mid-term due to significant shutdowns, making it difficult for them to restart, as we've seen in China even though we managed to resume operations smoothly there. The competitive landscape appears to favor companies like Gates, which have strong liquidity and available inventory. We have been investing heavily in innovation and R&D, positioning ourselves to launch a large number of new products and revitalize our product lineup. We are well-positioned to emerge as a leader in our manufacturing sector, which may open up additional opportunities for M&A or acquiring customers we previously could not reach. I’m optimistic about our situation. While we have much work ahead, we are focused on navigating the short-term turbulence without retreating from long-term investments in innovation and supporting our capital needs. Overall, I feel confident about our current standing.
Josh Pokrzywinski, Analyst
Great. Thanks for the Ivo. Best of luck to you.
Ivo Jurek, CEO
Thanks, Josh.
Operator, Operator
Your next question comes from Deane Dray with RBC Capital Markets. Please go ahead.
Deane Dray, Analyst
Good afternoon, everyone.
Ivo Jurek, CEO
Hello, Deane.
Deane Dray, Analyst
Maybe we can stay with the competitive dynamic question. And do you see any changes, balance of power, whatever, for the sale of Eaton's Hydraulics business? How does that impact Gates?
Ivo Jurek, CEO
I don't believe it impacts Gates at all. We continue to innovate and launch new products. Our MXG product portfolio had its best quarter since launch, driving significant revenue and gaining volume from new customers and market share from competitors. If we focus on managing our business effectively, the rest will sort itself out. However, this is a challenging time for large-scale mergers and acquisitions. Honestly, if I were in their position, I wouldn't be sure what to focus on with all the demand destruction related to COVID-19 and the complexities of integration. It's tough on their end. I'm confident they will manage it, but we are concentrating on what we can control: innovation, supporting our customers, and fulfilling our obligations.
Deane Dray, Analyst
That's good to hear. And then in the prepared remarks, it sounded like you had some meaningful wins in chain-to-belt. Anything you can share there? What's the pipeline look? And when do those convert to revenue?
Ivo Jurek, CEO
I would say that Q1 was a particularly strong quarter for us regarding design wins. It was one of our larger design win quarters in the last three or four quarters, which is noteworthy given the challenges everyone has faced, especially in the second half of the quarter. We secured some excellent new design wins in the industrial and personal mobility areas related to chain-to-belt. Our pipeline for chain-to-belt is nearly $100 million. We believe we can achieve significant growth despite the difficult business environment related to the chain-to-belt initiative in 2020, which looks promising for us in 2021.
Deane Dray, Analyst
So when you say $100 million, is that an increase in a market that was previously served by chain? Or is that actually a revenue opportunity?
Ivo Jurek, CEO
There is a revenue opportunity pipeline that we are converting presently that we anticipate is going to start ramping up through 2021 and beyond. But it's an incremental opportunity taking away chain.
Deane Dray, Analyst
Great to hear. Thank you and best of luck.
Ivo Jurek, CEO
Thank you, Deane.
Operator, Operator
There are no further questions at this time. I'll turn the call back to Bill Waelke for closing remarks.
Bill Waelke, Head of Investor Relations
Okay. Thanks, everyone. As always, we appreciate the interest, and we look forward to updating you again, which should be in August. Have a good evening.
Ivo Jurek, CEO
Thank you. Stay safe.
Operator, Operator
This concludes today's conference call. Thank you for joining. You may now disconnect.