COVID-19 leads to Gates sales drop in Q1

DENVER—Gates Industrial Corp. might consider the first quarter of 2020 as a tale of two economies.

In every geographic market segment served by the global provider of power transmission and fluid power solutions—North America, South America, Europe, the Middle East, Africa, China, India and East Asia—the first quarter of 2020, which concluded March 28, started well and ended poorly, impacted by the coronavirus pandemic in the waning months.

Gates disclosed May 5 that the company saw net sales decline 11.8 percent in the first quarter of 2020, with $710.1 million versus $804.9 million in the first quarter of 2019.

This represented a core revenue decline of 10.1 percent compared to one year ago, with 7 percent of that core revenue decline "directly due to COVID-19," Gates CEO Ivo Jurek said.

"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," Jurek said during a May 5 webinar on the first quarter results.

The uncertainty of the pandemic, driven by rough estimates of a timeline for a normalized economy, means the second quarter results—and likely year-end results—do not look any better.

"While we continue to operate around the world, we expect the sharp reductions in economic activity, and the uncertain timing of the recovery will have a substantial impact on our Q2 results, as well as those for the full year," Jurek said.

As a result, Gates has withdrawn its previously issued guidance for 2020 core revenue and adjusted EBITDA.

Jurek said proactive measures taken by Gates in China in February, such as a mobilized response team to design countermeasures to combat the COVID-19 pandemic, have produced models and protocols for reopening other Gates plants across the world.

The problem for Gates, and most others in the rubber industry, is that efforts put forth in Asia began much sooner than those on other continents, pushing the unknown recovery timeline for those off-Asia sites past the end of July.

So while China can serve as a barometer for the pandemic's reach and effects, much about the economic impact remains unknown, Jurek said.

"Methods used in China have informed our approach in other regions," Jurek said. "Because of this we have seen no significant disruption in service for our customers, and we have maintained a proper capacity of raw materials."

While supply has not been the problem, plummeting customer demand has been realized in industrial and automotive market end-use manufacturers.

Sales into replacement channels outperformed those into first-fit channels during the first quarter, Gates said, the latter of which were negatively impacted by temporary suspensions of production by some customers.

Jurek did note that Gates is navigating the current environment in a "strong financial position," with more than $1 billion in liquidity and no debt principal payments until 2024. The company said it expects to continue its strong free cash flow generation, reported at $16.2 million for the first quarter.

"Where appropriate, we are reducing production capacity and taking actions to reduce our controllable costs and discretionary spending," Jurek said. "Further, we have contingency plans in place for a variety of scenarios and, as this fluid situation continues to evolve, will respond accordingly. While COVID-19 is a developing situation, we believe our business is prepared for the challenges ahead and well-positioned to emerge stronger as the crisis abates."

Power transmission segment

The drop in core revenue and net sales for Gates' power transmission segment mirrored the overall numbers for Gates, as the segment saw $441.2 million in net sales in the first quarter of 2020, compared to $499.5 million in net sales in the first quarter of 2019, a drop of 11.7 percent in net sales year-over-year and a 9.8 percent decline in core revenue.

"The power transmissions business was significantly impacted by COVID-19 in China and related temporary customer shutdowns before only recently showing signs of recovery," Jurek said.

Modest gains in Europe, led by automotive end markets, were offset by a deceleration in North America led by industrial end markets.

In research and development, Gates did see a successful launch of what Jurek called "a next generation V-belt," which is based on ethylene elastomer compounds that eliminate chloroprene from belt construction.

"This represents another step in the revitalization of our entire power transmission product portfolio," Jurek said. "We believe our focus on innovation will differentiate us and offer future growth when markets return to normal."

Fluid power segment

And as the power transmission segment went, so went Gates' fluid power segment. The fluid power segment saw $268.9 million in net sales in the first quarter of 2020, compared to $305.4 million in first quarter sales for 2019, a 12 percent drop in net sales year-over-year and a 10.6 percent decline in core revenue.

In North America, core revenue is in the industrial end use market, which was down, Gates said. In Europe, core growth in the automotive end market was offset by weakness in the industrial end-use market.

And in China, fluid power was down in the first quarter of 2020 due to "weakness in customer activity in the construction end-use markets, driven by the COVID-19 pandemic."

But Jurek said there existed a focus on innovation in the fluid power segment as well, with a modular hose series for heating and cooling released for heavy trucks and passenger vehicles.

"Our focus on new products will continue to differentiate us during this exceptional environment and the regional nature of this pandemic," he said.

A regional glance

Gates' markets were affected by the resulting safety regulations implemented by the many different governments and local communities where their plants are located.

In North America, which has 19 plants, net sales were down 9 percent in the first quarter, driven by slowing mobile hydraulic sales in industrial markets. The automotive market saw a decline in North America as well, Gates reported.

South America, with two plants, saw net sales drop 14 percent, driven by a decline in automotive end markets.

The Europe, Middle East and Africa region, which has 10 plants, saw net sales fall 3 percent. One plant in Spain closed for more than half a month due to the pandemic, and two closed in Turkey for three weekends in April.

China, which has five facilities, started with solid growth in the fourth quarter of 2019, however all manufacturing facilities closed for several weeks, driving net sales down 30 percent in the first quarter of 2020, with weakness in all end markets.

In East Asia and India, which have seven factories, net sales were down due to weakness in industrial end-use markets. Four of the plants were forced to close for more than a month each.

"During these unprecedented times driven by the COVID-19 pandemic, our primary objective is the health and safety of our employees, as well as the communities in which we operate," Jurek said. "The vast majority of our production facilities are currently operational, and we are focused on serving our customers, many of whom operate in essential industries. We believe that we have a resilient business in a strong position to withstand the uncertainty, given the critical applications we support and our business model that is focused on replacement channels."