Ladies and gentlemen, thank you for standing by, and welcome to the Gates Industrial Q1 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]I would now like to hand the call over to your speaker today, Bill Waelke, Head of Investor Relations. Please go ahead.

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.

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,…

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…

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…

[Operator Instructions] And your first question comes from Andy Kaplowitz of Citigroup.

Hey, good evening guys.

Hi, Andy.

Ivo, so you're guiding to 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?

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.

That's helpful, Ivo. And then, obviously, you still have a fair amount of production capacity that is in some form of shutdown. So when you think about decrementals in Q2, given the guidance for the full year, to the extent you want to talk about it, how would you think about decrementals? And have you seen, at this point, supply chain -- any supply chain issues that you've had sort of ease out as well?

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 start seeing the issues in China to ensure that our supply chain certainly don'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.

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?

What we -- the situation is very fluid, Andy. And although we do anticipate that Q2 will be the worst quarter of the year, and thus, you could extrapolate from that statement that decrementals should improve, it is very difficult presently to say how the second half will perform vis-a-vis demand. So if the demand improves as we anticipate, we anticipate to have little better leverage in second half.

Great. Thank you. Well, be well.

Thank you.

Your next question comes from Julian Mitchell with Barclays. Please go ahead.

Hi, good afternoon.

Good afternoon, Julian.

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?

So your statement was correct about the Q2 revenue, Julian. So it's in -- our decline is in the 30s. That's what we anticipated for the sequential decline of 15% to 25% would imply. So you're correct. I apologize. I didn't catch Andy's comment there earlier. What I would say about April is that April came in kind of in the mid-to-high 30s. So that would give us a reasonably good support to what we anticipate is going to be a second quarter deceleration sequentially, 15% to 25%.I would say that maybe from a regional color, China got significantly better. China went from kind of that high-30s, mid-40s, February, March to kind of teens in April, and we anticipate that, that will progressively get better as May and June come into books. Europe and North America were kind of high-30s deceleration.

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?

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.

Perfect. Thank you.

Thank you.

Your next question comes from Jamie Cook with Credit Suisse. Please go ahead.

Hi, good evening, and hope everyone is well. I guess, just first question, and I'm sorry, I hopped on a little late because I had multiple calls going on, but can you just distinguish what you're seeing in the channel in terms of inventory and how long that sort of takes to correct? And then second question, just by end market, have you given any color in terms of like how much -- what you're seeing in April in terms of auto versus some of the other mobile equipment markets? I'm just trying to see where demand is most weak. I assume it's auto. But if you could give any color, that would be helpful. Thank you.

Sure. So on the channel side, Jamie, in April, auto was the most dislocated, about 2x of the industrial OEs, certainly makes sense as vast majority of auto OEMs have been shut down throughout the month of April. We have seen a significant number of notices of auto OEMs coming back. So we certainly anticipate that although not terrific, it will get better over the next two months of the present quarter.The industrial OEMs, they have started shutting down earlier than the other OEMs, Jamie, and many of them are restarting. So we anticipate that, that also will start get -- will start getting a little better for the remainder of the quarter. I think that the biggest challenge that these OEMs are facing is to ensure that their supply chain is not dislocated.Now although we are ready to supply, I think that they have to make sure they have all the components that they require to be able to build their own machinery and equipment in itself. I hope I -- did I miss something? I feel like I have...

Yes, because I was asking -- hey, sorry, too. I was just asking about sort of what your channel inventory, if you could make any commentary on that.

Yes, sorry about it, Jamie. Yes. So as you know, over the second half of last year, we have talked quite a bit about the compression of channel inventory, both industrial, in particular, and the normalizing channel inventory in automotive replacement side. We certainly believe that some of the improvement that we have seen in Q1 on the industrial in North America, in particular, has been associated with the fact that we have seen our supply more aligned with the demand environment. So we believe that the inventory has stabilized in the channel -- in the industrial channel, certainly, and particularly in North America. And we don't anticipate a dramatic headwind coming from that, if that makes sense.

Thank you. I appreciate your help.

Thank you.

Your next question comes from Jerry Revich with Goldman Sachs. Please go ahead.

Hi, Ivo, and good evening everyone.

Hi, Jerry.

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?

Yes. So the OEMs, I think you've correctly stated, it was a pretty painful April. Obviously, they all -- if not all, but a substantial amount of the OEMs have taken a shelter-in-place order pretty seriously and did not produce a lot of machinery. We did see a reasonably good return of demand in China in April. So that was kind of down high-single digits in China on the OE -- industrial OE side. India was down, obviously, full month, so that was quite painful for us there. Europe and Americas were kind of fleet average, kind of high-30s down for us. And the replacement markets performed better everywhere for us across the globe on the industrial side, kind of maybe a 30% better performance than the OE side.

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 translated to better incremental margins in a recovery compared to what we've seen in prior cycles for this business?

Well, I'd love to have a discussion on when the growth returns. So thank you for putting a positive spin on -- it will come. Look, I mean, I think that we are making the business substantially better. And I think that I have been pretty forthright before we have experienced this deceleration associated with this COVID-19 situation that our incremental margins should be better than our decremental margins were in 2019. And absent of giving you an absolute number, I certainly am anticipating incremental margins to be nicely better than the decremental margins that we have experienced in 2019.So I think that we're all looking to be able to demonstrate the rebound and the profitability of the business when that occurs. But frankly, right now, we are simply focused on ensuring that we can manage through the next couple of quarters and minimize the impact on our business and position the business in the best possible situation to be prepared for that eventual rebound that will come.

I appreciate that. Thanks.

Thank you.

Your next question comes from Jeff Hammond with KeyBanc. Please go ahead.

Hi, good morning or good afternoon, guys.

Hi, Jeff.

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.

Yeah. So look, I think that everybody is focused on the miles driven, right? I mean that certainly is a good metric. And there's lots of reports that you can look at. And what I would tell you is that when we do some of these analytics, you see a really nice rebound actually in the miles driven. You'll see that the miles driven have declined in early part of April pretty dramatically, and then they started to increase nicely.We certainly anticipate that miles driven are still going to be down in May as the wide ranging shelter-in-place requirements stay in place, more or less. But what we anticipate is that the demand for our products is going to sequentially start improving from April to May to June, predominantly because the automotive replacement market fundamentals remain very solid.The age of the fleet is at near-record high. Look, the consumer, when they start coming back, I think the consumer will be much more inclined to drive than take a public transportation or taken an airplane to take a trip. Gasoline prices are very low. So certainly, we believe that the influence on driving versus selecting other modes of transportations will be favorable for driving.And then look, our products are critical in nature. If you're going to have a blown hose on your HVAC, a blown belt on your car, you will need to replace it. It is not a discretionary item. It is a necessary item to operate your vehicle. So we are reasonably positive on the recovery when things starting to at least -- when we start seeing some stability in the market.I believe that if you look back at some of the things that O'Reilly has announced most recently, they've been announcing that they have seen a decline kind of bottoming out of -- at about 15% plus or minus in mid-April and then start to see a little better performance in their store performance. And we certainly anticipate that, that's going to start filtering through our business as well if they start having a need for inventory replenishment.So my view is that kind of 45 days to 60 days out, you should start seeing the same trend as you would have seen with some of the -- some of our large customers seeing presently. So I know that I've given you a pretty long-winded, convoluted answer, but in a short synopsis, we believe that this market is going to rebound nicely. The demand for our products is going to rebound nicely, simply because it is an essential set of products, not a discretionary product.

That's very helpful. Just on working capital, it looks like it was a bit of a use seasonally in the first quarter and certainly last year. You put together a nice year-end that kind of bring it back. But how are you thinking about -- in this kind of declines, how much cash you can generate from working capital?

Hi. This is Brooks. Yeah, I mean, certainly, we think in Q2, when you're going to see probably the trough in revenues, we're going to see nice cash generation from working capital. I think as the year goes on, the rate of rebound is really going to determine how much cash we generate from working capital.Based on the framework that Ivo laid out earlier, we think it should be a good source of cash for 2020. And then as the rebound comes in 2021, obviously, that will be a little bit of a different story. But then if the rebound comes sooner, right, it may turn and be not as much of a source as we think, right? But that would be a good problem to have, so -- if the rebound comes sooner than we anticipate.

Okay. Excellent. Thanks guys.

Thank you, Jeff.OperatorYour next question comes from Josh Pokrzywinski with Morgan Stanley. Please go ahead.

Hi, good evening, guys.

Hi, Jeff [ph].

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?

Yes, Josh, sorry there. Look, our anticipation is that we've kind of seen the bottom -- we anticipate to seeing a bottom in the AR, on the automotive replacement side, kind of mid to latter part of April. We definitely have seen some improvements in order rates as we exited April, and we certainly anticipate to see a progression as we exit Q2. But we are really not counting on a very dramatic second half recovery. We are using China as a guideline, but we, by no means, believe that we're going to see a carbon copy in North America or in Europe.And so, if you look at China as a guide, China has been recovering reasonably nicely in the AR side, right, going from nearly no activity with vast majority of the country shutdown, a condition that you didn't have in North America nor in Europe. But then going up and stepping up pretty dramatic improvement in activity in March, although still at a very unfavorable rate, and in April, yet another dramatic improvement or significant improvement in activity.So my sense is that AR, you're going to see bottoming out in April, you're going to see some improvements in May and June. And then sequentially, it should be significantly better in Q3. Now significantly to be flat to up, I don't think so. But I don't certainly expect that you're going to see the -- a significant demand destruction that we have seen in April with this market.So I agree with you, you can argue what normalization will look like. My sense is that we will probably be all driving our automobiles more than taking alternate modes of transportation. But I think if we had a better visibility, we would probably, at least, offer some guide posts on revenue in Q3 and Q4. And we really want to see Q2, how it develops before we are able to provide a better insight on the second half of the year.

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?

April was worse than March, obviously, because -- in the automotive first-fit side, predominantly because vast majority of the globe was shut down with the auto plants activity, and China was just restarting. I think China had a very late restart in a first-fit auto side in April. And so my sense is that you're going to kind of see declines of in the mid-40s for the quarter in auto first-fit business. That's probably going to be the most unfavorable market dynamic that we will -- that we're anticipating to be exposed to in Q2.

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.

Yeah. Look, my sense is that from my -- from where I sit today, Gates is sitting in a pretty enviable position. We have been able to operate throughout Q1, we continue to operate and support our customers as we speak today. We have been selectively picking up some support for some clients that are not our present customers, that we anticipate we'll have an opportunity to turn over to become Gates customers on more permanent basis. There are some competitors that I think are going to have some difficulties to continue to operate uninterrupted over, certainly, the mid-term period of time. Lots of our competitors have gone through a reasonably substantial shutdowns, and they'll have to restart. And that's how -- that's very, very challenging as we have certainly experienced in China despite the fact that we have been able to start up reasonably flawlessly there.So the competitive dynamics, I think, is going to be rewarding companies like Gates that have a strong liquidity, that have inventory available to supply customers. And frankly, we have continued to invest pretty significantly in innovation and R&D. And we're on a trajectory to continue to launch a dramatic amount of new products and fully revitalize our product portfolio, as we have discussed in prior calls or prior conferences. So we feel that we are very well positioned to be able to emerge, frankly, in a leading position in the products that we manufacture.Now that ultimately will also offer incremental opportunities, potentially for whether or not it is M&A or, frankly, for acquisition of substantial amount of customer base that we would have historically not been able to do. So I like where we sit. We have lots of work to do. We are predominantly focused managing through the turbulence in the short term. But we, by no means, are retrenching from making investments for the long term, whether or not it is in innovation or in supporting our capital needs with some incremental capacities or incremental tooling that can help some of our global customers. So I feel pretty good where we sit.

Great. Thanks for the Ivo. Best of luck to you.

Thanks, Josh.

Your next question comes from Deane Dray with RBC Capital Markets. Please go ahead.

Good afternoon, everyone.

Hello, Deane.

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?

Gosh, I do not believe that it impacts Gates, frankly, at all. I mean I think that, again, I'll borrow a little bit from what I said to Josh, we continue to innovate, Deane. We continue to launch new products. Our MXG product portfolio has had probably the best quarter since we launched it in terms of driving revenue generation and taking incremental volume from customers that we have not supported in the past or taking market share away from our competitors. And so I believe that if we stay focused on managing our business well, the rest of the dynamics are going to work themselves out.Now, I would say that this is a very difficult time to do a large scale M&A. And I -- frankly, if I was in those shoes, I'm not quite sure exactly what we would be focused on because you have all of these dynamics associated with the demand destruction, associated with COVID-19, and then trying to figure out how you're going to be driving integration, just very challenging, I think, on their side. I'm sure they're going to figure it out. But meanwhile, we are focused on what we can control, and that is innovation, supporting those customers and making sure that we fulfill our requirements to those that we are obligated to do.

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?

Yes. So I would say that -- I would actually say that Q1 was interestingly a terrific quarter for us in terms of design wins. It was one of the bigger design win quarters that we have had, probably in three or four quarters, which is unusual taking into an account what everybody has been dealing with, particularly in the second half of the Q.We've gotten some terrific new design wins across industrial and personal mobility landscape on chain-to-belt. A pipeline on chain-to-belt is, frankly, near $100 million. We believe that we're going to be able to deliver nice growth despite the very challenging business environment with chain-to-belt initiative in 2020, and that bodes really well for 2021 for us, Deane.

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?

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.

Great to hear. Thank you and best of luck.

Thank you, Deane.

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

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.

Thank you. Stay safe.

This concludes today's conference call. Thank you for joining. You may now disconnect.