Gates Industrial - Earnings Call - Q1 2018
May 2, 2018
Transcript
Operator (participant)
Good afternoon. My name is Sarah, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Gates Industrial Corporation Q1 2018 Earnings Release Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there'll be a question-and-answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, you may press the pound key. I will now turn the call over to Mr. Bill, Bill Waelke, Head of Investor Relations. Please go ahead, sir.
Bill Waelke (Head of Investor Relations)
Thank you for joining us on our Q1 2018 earnings call. With me today are our CEO, Ivo Jurek, and CFO, David Naemura. 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, which includes a reconciliation of non-GAAP to GAAP financial measures that we will use during this call and is also available on our website. Please refer now to slide two of the presentation, which provides a reminder that our remarks and answers 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 or implied by such forward-looking statements.
These risks include, among others, matters that we have described in our annual report on Form 10-K filed with the SEC and other filings we make with the SEC. We disclaim any obligation to update these forward-looking statements, which may not be updated until our next quarterly earnings call, if at all. With that, I will now turn the call over to Ivo.
Ivo Jurek (CEO)
Thanks, Bill. Good afternoon. Thank you for joining us today to review our first quarter 2018 results. Beginning on slide three of our presentation, we are pleased to report strong results for this first quarter of 2018. We generated revenues of $852 million, which represents a record quarterly revenue number for Gates. Our total revenue growth was 16.7% over the prior year quarter, driven by strong core growth of 6.2% and contribution from our prior year acquisitions of 4.7%, as well as a foreign currency translation benefit of 5.8%. We continue to execute on our growth initiatives and see a strong demand environment across the many end markets that we serve. Let me also note that we benefited from double-digit core revenue growth in emerging economies, where we have a terrific market presence. Our Q1 adjusted EBITDA of $183.9 million also stands as a quarterly record for Gates.
At 21.6% of sales, our adjusted EBITDA margin reflects 60 basis points of expansion over the prior year Q1. Excluding acquisitions on a comparable basis, our year-over-year adjusted EBITDA margin expansion was over 100 basis points, with an incremental margin of over 30%, reflecting solid performance in this environment. We continue to invest in the business during Q1 to advance our large organic growth initiatives, including investments in commercial capabilities, new product development, and incremental manufacturing capacity. As we have discussed previously, we are adding additional capacity in our fluid power segment, which will be coming online during the second half of this year. In addition to our organic investments, last week we announced the acquisition of Rapro in Turkey, which will further advance our fluid power business in Europe.
Rapro is primarily focused on the replacement market, for which it designs and manufactures molded and branched hoses and other products used in heavy-duty commercial and light vehicle engine applications. We have successfully manufactured these products in North America for some time, and through this acquisition, we'll now have that capability on the European continent. Rapro's products will fit seamlessly into our distribution network and will also provide further runway for growth in the industrial transportation markets. We are off to a good start in 2018 with solid Q1 results and another acquisition in our core markets completed. This builds further upon our exceptional momentum from 2017. Let me turn now to some segment details. Turning to slide four, beginning with power transmission. As a reminder, our power transmission business focuses on applications where belts, chains, and other devices transfer mechanical power.
We are gaining momentum through additional market penetration across most of these applications with our belt-based drive systems, in part due to their lighter weight, lower maintenance requirements, and energy-efficient performance, to name just a few of the advantages. Our power transmission segment delivered total revenue growth of 12.4% for the first quarter of 2018. On a core basis, power transmission revenue grew 5.8% over the prior year quarter. This growth was the result of a balanced performance across our end markets, with particular strength in emerging markets where we continue to invest and drive our organic growth initiatives. In terms of adjusted EBITDA margin, we delivered 80 basis points of expansion in Q1 on a year-over-year basis. This margin expansion was primarily the result of higher core revenue, continued productivity actions in our factories, and also more efficient R&D spending.
As we have previously stated, we remain in the early stages of rolling out our broader chain-to-belt conversion initiative, and we continue to pursue a number of conversion opportunities in target application verticals. From applications in the personal mobility markets to a number of manufacturing and industrial process applications, we are validating our value proposition with our customers and are optimistic about the long-term revenue generation opportunity this initiative offers to Gates. On slide five, our fluid power business offers customers fit-for-purpose products for a wide array of industrial applications in premium hydraulics, industrial hose, and other fluid power solutions. Our fluid power segment achieved another quarter of strong growth, with total revenue up 25.1% compared to the prior year quarter. On a core basis, fluid power revenue was up 7.2%. We are executing well on our organic growth initiatives.
Industrial and market demand remains healthy, and our fluid power acquisitions are all contributing to our growth. Our premium hydraulics product line, which is our largest within the fluid power segment, experienced strong revenue growth in a quarter, driven by solid demand in industrial and markets, and particularly in mobile applications. This robust demand in hydraulics has us basically maximizing our available capacity for these products, and as a result, we built a significant amount of hydraulic backlog in a quarter. Our hydraulics products grew low double digits, and if we were able to fulfill the demand at normalized rate, we would have grown in the high teens. Our upcoming incremental capacity, which is all hydraulics related, will help us return to our normal book and ship conditions by year-end.
The first increment of capacity will begin to come online in late Q2, with the remainder expected to at the end of Q3 and into Q4 of 2018. We believe that these capacity investments will position us well to execute on our hydraulics growth initiatives and expand our core addressable market, and are very timely in this capacity-constrained environment. Our fluid power revenue growth also contributed to an improved adjusted EBITDA margin. In this segment, the year-over-year expansion was over 50 basis points. We achieved this margin expansion while making investments to continue to strengthen our commercial presence and product development capabilities to help us deliver on the initiatives that I have referenced earlier. We remain very encouraged about the large underpenetrated core market opportunities that we have in fluid power in general and in hydraulics specifically. With that, I will now turn it over to David.
David Naemura (CFO)
Thanks, Ivo. I will now cover our Q1 financial performance, beginning on slide six, where, as Ivo mentioned earlier, you can see the record quarterly results that we delivered for revenue and adjusted EBITDA. Core revenue growth was 6.2% in the quarter, and adding to that increase were an additional 4.7 points of growth from acquisitions and 5.8 points from foreign currency, bringing total revenue growth to 16.7%. The core revenue growth primarily reflects strong demand in our industrial end markets, particularly at first-fit customers. We saw continued strong demand for mobile applications with double-digit revenue growth in the construction, agriculture, and industrial transportation end markets. More broadly, we experienced robust demand across a range of categories and saw significant growth in our hydraulics business in particular. As Ivo mentioned, we exited the quarter with a significant backlog, whereas we typically carry very little backlog as a book and ship business.
Our current hydraulics factory utilization is running at historically high rates, and we are pleased that we will have additional capacity coming online over the remainder of the year to address these increased demand levels. The first increments of capacity will be from the build-out of the remaining space in our existing China hydraulics facility, and that will begin to deliver products around the end of Q2. Our two new fluid power plants are scheduled to come online in late Q3 and early Q4. Our adjusted EBITDA of almost $184 million was an increase of $31 million, or 20%, over the prior year quarter. Our adjusted EBITDA margin was 21.6%, an improvement of 60 basis points over the prior year Q1. Excluding the impacts of acquisition, our adjusted EBITDA margin was 22.1%, an increase of 115 basis points over the prior year Q1.
We did see some continued inflation in the quarter, with raw materials increasing about $3.5 million over the prior year. These inflationary impacts were basically offset with continued procurement actions across our full spend base. We also had favorable pricing, which resulted in our price material dynamic being very favorable in the quarter. In the prior quarter, we discussed that the pricing that we implemented during the prior year was on about a one-quarter lag, and that we believed that we would be price material neutral to positive by the end of this first quarter of 2018. That, in fact, was the case. This contributed to gross margin expansion in the quarter of 15 basis points in total, and on a comparable basis, excluding the impact of acquisitions, gross margin expanded about 125 basis points.
We grew adjusted net income to $0.25 per share on a diluted basis compared to $0.18 in the prior year quarter, which was primarily the result of stronger operating performance in the quarter. Our effective tax rate in Q1 was approximately 28%, which is a bit higher than where we would anticipate the full year effective rate to be. The slightly higher effective rate is primarily due to non-operating expenses in Q1 for which there was no corresponding tax benefit, such as those related to our debt redemptions. Slide seven provides detail on key cash flow items and our focus on continued deleveraging of the business. Excluding the incremental trade working capital that we acquired with Atlas Hydraulics, our trade working capital improved over 80 basis points as a percentage of our last 12-month sales as compared to the prior year Q1.
As a reminder, our working capital has a seasonal trend whereby the end of the year is typically our low point, with working capital tending to be built in the first half of the year. We have presented last 12 months free cash flow as cash flow provided by operations, less CapEx, and reflected free cash flow conversion as a percentage of adjusted net income. While we improved last 12 months EBITDA and adjusted net income performance in Q1 over the prior year period, we had significantly higher CapEx during the current last 12-month period associated with the spend for our fluid power capacity build-out. Also, in the prior year last 12-month period, we had an inflow of approximately $40 million associated with a one-time tax refund.
Looking forward on CapEx, our underlying maintenance CapEx in 2018 is expected to be in line with our historic range of approximately 1.5% of net sales. However, our Q1 CapEx level was elevated due to the growth investments on our additional fluid power capacity. Total CapEx was $61 million in Q1 due to the timing of this capacity investment, and we would anticipate that total CapEx for the full year will be approximately $150 million - $170 million. Finally, on leverage, we ended Q1 with a net leverage ratio of 3.9x, reflecting our net IPO proceeds of $799 million, which we used along with additional cash on hand to repay approximately $914 million of outstanding debt.
Moving to our outlook on slide eight, the full year outlook for 2018 presented here is consistent with our previous guidance, with the exception of the impact from the acquisition of Rapro, which we completed at the end of April. For the remainder of the year, we would anticipate Rapro generating approximately $15 million in sales, which we expect to contribute to adjusted EBITDA at about the level of Gates' average margins. As I previously noted, we are introducing additional color on CapEx given the significant growth investment underway to expand our market opportunity. Further, despite the more uncertain tax environment that we are in, the previously communicated effective tax rate range of 27%± 150 basis points remains the current view for the full year. Finally, we know that inflation and tariffs are a very current topic.
As we have referenced earlier, we believe that we are well positioned to manage in this environment and would note that we experienced favorable price material again in Q1 as we did in Q4 of 2017. As it relates to the Section 232 tariff on imported steel and aluminum and Section 301 tariff on selected Chinese imports, we do not anticipate significant impacts at this time, primarily because of our in-region, for-region manufacturing strategy. I would also note that we believe these factors, along with appropriate offsetting actions, are already contemplated in our annual guidance. It is worth mentioning again that we will also be bringing up the additional fluid power capacity at three sites, two of which are brand new plants. Accordingly, there will be startup costs beginning in Q2 associated with bringing this capacity online, which were already factored into our full year guidance as well.
With that, I will hand it back over to Ivo to wrap up. Ivo.
Ivo Jurek (CEO)
Thanks, Dave. We are encouraged by our strong start to the year, which gives us confidence as we look forward to the remainder of 2018. Global industrial production continues to drive demand across our diversified end markets and geographies. Our presence in replacement channels is providing stable, recurring revenues across our segments, while our first-fit business is robust. We remain selective on opportunities where we can introduce differentiated products, or new technologies in first-fit applications, or advance our organic growth strategies. We believe we are taking the appropriate steps to position our business on a trajectory of long-term growth as a result of our strategic investments in commercial capabilities, new product development, and the necessary manufacturing capacity to deliver on resulting growth. We believe we have a compelling strategy, and our global teams are focused on executing on our large organic growth opportunities.
Q1 was a very good start to 2018, and our team will remain focused on execution as we move further into the year. I will now turn the call back over to the operator to open up the Q&A session. Sarah.
Operator (participant)
Ladies and gentlemen, as a reminder, to ask a question, press star and then the number one on your telephone keypad. Your first question comes from the line of Andrew Keplowitz from Citigroup. Please go ahead.
Andrew Kaplowitz (Managing Director and Research Analyst)
Good afternoon, guys.
Ivo Jurek (CEO)
Hello, Andrew.
David Naemura (CFO)
Andy.
Andrew Kaplowitz (Managing Director and Research Analyst)
Ivo, Dave, you mentioned that your hydraulics capacity limited fluid power growth in the quarter. If hydraulics were able to grow high teens, as you said, how much higher would the 7.2% in the segment have been the organic growth? As you know, there's been some increased concern regarding markets, really such as hydraulics peaking. Have you seen any evidence of slowing in any of your fluid power markets? Can you talk about your visibility, given that you've actually built backlog in the segment?
Ivo Jurek (CEO)
Yeah, this is a great question, right? Look, I'll stay away from whether and how the markets are behaving. I think that you guys are in a better position to judge that than we are. Look, we are very encouraged with the start to 2018. The markets are behaving very similarly to that we have exited 2017 with. We are very encouraged by the behavior. Our customers are doing really well. As we said, we are increasing our backlog. If we were able to manufacture all of the orders that we have received in a quarter, Andy, we would have probably printed another 5% of core growth or so in the fluid power segment. You were looking at somewhere north of 12% core.
We've told you on our last quarterly call that we have been running at pretty elevated levels, and we've just reached the levels where we just were not able to, frankly, to fulfill all of those incoming orders. We don't see any reduction in forecast as we are looking into the future period.
Andrew Kaplowitz (Managing Director and Research Analyst)
Okay, Ivo, that's really helpful. Then last quarter, you had mentioned that you thought your North American auto replacement business could pick up a bit in 2018. Depending on which industrial company we talk to, auto aftermarket was relatively lethargic in the first quarter. Did you see a pickup? Talk about your outlook in that part of your business, auto replacement maybe as a whole for the company.
Ivo Jurek (CEO)
Yeah, sure. I think that that's a really good question. Our total replacement business in Q1 was approximately, it was slightly under 5%. It was about 4.9%. The North America business grew slightly under 3%, so about 2.7%. As I said on the last update, we saw that the business is doing a little bit better. It's true. Again, as we've explained, I think on the last call, we see that the headwinds from 2008, 2009 are starting to dissipate. We are primarily focused on the seven-year-plus old fleet. We expect that that's a market that's going to replay, that's going to provide stability for us as we move forward into 2019 and beyond. Frankly, the emerging economies are behaving really well. I mean, there is a very robust growth in car fleets. Maybe just give you a number on China as an example.
Our AR business in China grew about 13% or so.
Andrew Kaplowitz (Managing Director and Research Analyst)
Got it. It sounds like steady shigos in the business and good growth in first fit as well.
Ivo Jurek (CEO)
In our first-fit auto business, we grew about 4% globally. It is not a big part of our business overall, but we continue to see growth with differentiated products. The growth in hybrids is doing really well.
Andrew Kaplowitz (Managing Director and Research Analyst)
Thanks, Ivo.
Ivo Jurek (CEO)
Thank you.
Operator (participant)
Your next question comes from Julian Mitchell from Barclays. Please go ahead.
Julian Mitchell (Equity Research Analyst)
Hi, good afternoon. Maybe just give a little bit of color on the overall sort of developed market growth rate in the quarter. I mean, I think one trend you've seen in general is emerging market growth very buoyant, developed markets weaker. I think you'd said emerging market growth was double digits. How was developed market growth in Q1, and what was it in the prior quarter? Thank you.
Ivo Jurek (CEO)
Good afternoon, Julian. Thank you. Yes, as we said, the emerging markets continue to perform really well for us. Again, we have a terrific presence there. We're spending quite a bit of resources to continue to grow our presence in those markets. I would say that the developed markets have grown kind of below single digits. They are doing reasonably well. We are not displeased. They are behaving the way that we've planned and we anticipated for 2018. I would maybe add, Julian, if I can, that if we had the capacity available in fluid power, we would have probably seen maybe another three points of core growth in the developed economies. We would probably be growing kind of mid-single digit. The demand is not an issue. It's our available capacity to support all the orders that we see coming in.
Julian Mitchell (Equity Research Analyst)
Understood. Thank you. My follow-up would just be around the circling back maybe to that price versus cost equation. As you pointed out, you had good adjusted gross margin increase in the first quarter. When you're thinking about that price-cost delta, is that becoming even more of a tailwind when you look at the back half of the year in terms of all the remaining nine months in terms of the gross margin impact, or do you think it will be fairly steady with what you saw in Q1?
David Naemura (CFO)
Julian it's Dave, I think the way we're thinking about it is that we'll maintain, we'll be probably price material neutral or materially so for the year. I think the compare gets a little tougher. We added a lot of price last year. I think we were well served to be proactive. Early in the year, we had some things that maybe were unique to our industry, like the impacts of inflation and due to dying, which didn't impact everyone, but it caused us to probably move a little earlier on price. Accordingly, I think we've carried good price into the year, and we'll begin to compare against that. I think the compare does get a little harder as the year goes on.
I think we're looking very favorable right now, and we anticipate being price material economics neutral, if not a little bit better than neutral for the full year.
Julian Mitchell (Equity Research Analyst)
Great. Thank you.
David Naemura (CFO)
You bet.
Operator (participant)
Your next question comes from the line of Jerry Rovich from Goldman Sachs. Please go ahead.
Corinne Jenkins (VP and Equity Analyst)
Hi, this is Corinne Jenkins on for Jerry Rovich. I understand the utilization story for fluid power. I was hoping you could talk about what you're seeing in your power transmission business and where you're seeing the tightest utilization for that across your global footprint.
Ivo Jurek (CEO)
Yeah. Good afternoon. I think we've updated that on the last quarter as well. Look, the demand remains quite solid for us. Again, emerging economies are growing very, very nicely. It's a very constructive market environment, particularly in the emerging economies. We're running higher capacity utilization rates in those emerging economies. We're not dramatically capacity constrained in power transmission, with the exception of a couple of product lines that we are rectifying, but they are not really giving us any headaches, so to speak. It is a very constructive environment, and I think we are well balanced with our capacity available to support further growth.
Corinne Jenkins (VP and Equity Analyst)
Okay. It sounds like you expect the hydraulic power demand to remain pretty elevated. Can you talk about how long you expect to take to work down the backlog that you have exiting this quarter and if we should think about any sort of catch-up in sales?
Ivo Jurek (CEO)
Look, I mean, my expectation is that let me give you a company-specific answer rather than try to opine on what I think the cycle of the business is going to be. Look, we see a very strong demand. We expect that demand to carry forward after, frankly, several years of very weak construction equipment, ag equipment, and mining equipment sales. My expectation is that the end market is going to be very supportive of further growth. The way that we are thinking about how we are positioning ourselves is that we have tremendous investments in new technology in fluid conveyance. We are already starting to demonstrate the technology with our third-party OE customers. They are quite excited about the technology. We believe that we have a significant opportunity to take incremental market share away.
We are putting capacity in support of this new technology and the opportunities that we have across the globe. We are a reasonably small player outside of North America. We believe with that capacity in Poland, the incremental capacity in China and in North America, we should continue to see pretty reasonable growth rates well into the future. Maybe the last piece of your question about that backlog, look, our expectation is that that backlog is going to be extinguished by the end of the calendar year 2018, where we expect to go back into our kind of normal operating mode of book and ship. We are not a big backlog business. We are more of a book and ship company, and we expect that by the end of the year, we will be there.
Corinne Jenkins (VP and Equity Analyst)
Good. Thank you.
Ivo Jurek (CEO)
Thanks, Corinne.
Operator (participant)
Your next question comes from Jamie Cook from Credit Suisse. Please go ahead.
Jamie Cook (Managing Director and Equity Research Analyst)
Hi, good evening. Two questions. First, you talked about demand being constrained by your own capacity issues, but were there any external factors impacting demand, whether it's labor, inability to ship product, or supply chain issues? My second question, just with regards to where the strength is coming from, in particular, first fit in the mobile equipment markets, does that have any impact on mix or profitability?
Ivo Jurek (CEO)
Yeah, Jamie, good afternoon. The first question, sorry, let me start with the second question first. We do not expect a significant impact to our results. I mean, the mix is slightly shifted towards OE, maybe two to three points overall. I mean, we have really not seen external factors to be impacting our ability to supply fluid power products. It has been all company-specific. We are just running extremely high rates of asset utilization, and that is why we have frankly seen an opportunity to make investments about a year and a half ago. That is where we started to stand up the capacity. It is coming in what we believe is good timing for those new assets to help us offset the capacity shortfalls that we are experiencing presently.
David Naemura (CFO)
Jamie, the.
Jamie Cook (Managing Director and Equity Research Analyst)
Sorry, go ahead.
David Naemura (CFO)
The negative impact of mix was under 30 basis points as we see some of that mix shift in the quarter. It was under 30 basis points at the gross margin level, of course.
Jamie Cook (Managing Director and Equity Research Analyst)
Okay. For the year, what's the expectation?
David Naemura (CFO)
I wouldn't give guidance for the year on that. We'll see how the revenues come out for the year. In the first quarter, we saw, as Ivo said, a two or maybe three-point shift in mix, and it had a 25%, 27% sorry, basis point impact at the gross margin level, which obviously was more than offset by a number of positive things.
Jamie Cook (Managing Director and Equity Research Analyst)
Okay. Great. Thanks.
David Naemura (CFO)
Thanks, Jamie.
Operator (participant)
Your next question comes from a line of Jeff Hammond from KeyBank Capital Markets. Please go ahead.
Jeff Hammond (Managing Director)
Hey, good afternoon, guys.
Ivo Jurek (CEO)
Hi, Jeff.
David Naemura (CFO)
Hey, Jeff.
Jeff Hammond (Managing Director)
Hey, just back on the fluid power ramp and supply chain, clearly, a lot of people are kind of feeling pressure and didn't seem to show up in your incrementals. As you look forward and you try to catch up some of the backlog and you ramp these new plants, are you anticipating any redundant costs or need for working capital build and any kind of negative impact on incrementals as we go forward?
David Naemura (CFO)
Yep. Good question. First, on incrementals, on the face of the income statement, Q1 reads at 25%, but that's negatively impacted by the acquisition. If we adjust for Atlas on an apples-to-apples basis, we would see about 32.5% incrementals. That's also negatively impacted by FX. If you thought about it on a core basis, you'd be quite a bit closer to 40%, if not at 40%, which would be a pretty good quarter for us. I think there are some startup costs. We don't see a huge working capital build. We're going to have to bring in some raw materials, but from a cost standpoint, we think there's a few million dollars, and we've contemplated that in kind of how we've guided people to the year. There'll be some inventory impact, but not meaningfully.
We think we've got it contemplated, and I don't think there would be a large impact to incrementals.
Jeff Hammond (Managing Director)
Okay. Great. Just as you look at some of your competition in fluid power, what do you how are you thinking about your lead times versus theirs? Is this an opportunity where you can capture some share even though you're building some backlog? Maybe just let me know what you're seeing from the comps. Thanks.
Ivo Jurek (CEO)
Yeah, Jeff, I think that you're spot on. I mean, we believe that that incremental capacity that we are standing up is going to give us tremendous opportunity to capture further market share. Frankly, the investment that we are making in NPI is also going to further accelerate our competitive position. We feel really well about where we stand presently in terms of our fluid power business.
Jeff Hammond (Managing Director)
Thanks, guys.
Ivo Jurek (CEO)
Thank you.
Operator (participant)
Your next question comes from Dean Drake from RBC Capital Markets. Please go ahead.
John Drake (Senior Director)
Thank you. Good afternoon, everyone.
Ivo Jurek (CEO)
Hey, Dean.
John Drake (Senior Director)
Hey, just want to stay on that very last point on Jeff's question regarding that build and backlog. Maybe this is the glass half-empty view, but is there any negative fallout in not being able to do the book and ship that your customers are usually expecting? Might any of this backlog go away? Any competitors picking up share because of your capacity constraint?
Ivo Jurek (CEO)
Dean, I think that that's a very thoughtful question that you raise. What we are dealing with is we are frankly dealing with a global capacity constraint. There are really no competitors that have the ability to just walk in and offer incremental supply because there's just simply none available. In terms of lots of the OE business that frankly we are doing everything that we can to support, you also need to go through a significant amount of qualifications, which is not something that you can just simply do overnight. We're working very diligently. We feel good about that backlog. We do not believe that that backlog is cancelable. Frankly, there are no inventories in a channel. It's kind of an interesting situation, and we feel very constructive about bringing the capacity online right now and taking advantage of the economics.
John Drake (Senior Director)
That's good to hear. Thanks for that clarification. How about some color on the acquisition, the Rapro deal? Some questions that immediately come to mind are what kind of manufacturing capacity are they operating at? Are there any kind of best practices that either they'll share with you or you share with them? Lastly, where are they on the branding side? It's all aftermarket, but you guys are on the good, better, best. Gates is all up there on the best and maybe a little bit of better, but where are they in that continuum on sort of premium brand?
David Naemura (CFO)
Yeah. Okay, Dean. Great question. The product that Rapro manufactures is something that we do very well here in North America. It's actually a very high-margin product for us. As we were looking at this opportunity, one of the big opportunities in this is bringing our know-how and expertise to them. We think we're going to have an ability to drive volumes as we drop this business into our aftermarket channels, as we said, if it fits seamlessly. As we're able to ramp volumes through our distribution base, we think we could probably come close to doubling the existing capacity out of their current manufacturing footprint. We're pretty bullish on that, us basically bringing the Gates operating system to what is already a very good company. From a brand perspective, they're a well-recognized brand in Europe.
We actually source a little bit of their product for European models ourselves. They are well-recognized, and I think they fit well into kind of the Gates tier of brand recognition here.
John Drake (Senior Director)
That's good to hear. Just the last one is, are there more Rapro deals in your pipeline?
David Naemura (CFO)
Yeah. It's highly fragmented global markets that we play in, and we like to believe that there will continue to be a good runway of accretive bolt-on acquisitions. We're always working on them, and I think we just got to find the right ones, and we'll kind of continue as part of our strategy.
John Drake (Senior Director)
Great. Thank you.
David Naemura (CFO)
Thanks, Dean.
Operator (participant)
Your next question comes from a line of Charlie Brady from SunTrust Robinson Humphrey. Please go ahead.
Charlie Brady (Managing Director and Senior Equity Analyst)
Hey, thanks. Just following on Dean's question on Rapro, just wondering, does Rapro bring to you any new customers or distribution that you don't have now that maybe you get and you can leverage that up?
Ivo Jurek (CEO)
Sure, Charlie. Good afternoon. Yes, they do. Obviously, they have a reasonably good presence. I mean, it's not a big business, but they have a good customer base in Eastern Europe and in the Middle East and some in Western Europe. They do bring customers to us where we believe we're going to be able to cross-sell our products that are core to us. Frankly, as they've indicated, we feel really positive about our ability to take those products and then funnel their products through our channels, particularly in the EMEA market space.
Charlie Brady (Managing Director and Senior Equity Analyst)
Thanks. Just on the background of the hydraulic, the backlog, and the capacity utilization issue you're facing right now, I'm just wondering, when you're running a plant flat out, you obviously run into some inefficiencies because you're making it as fast as you can make it. I'm wondering, from a margin perspective, can you put some color on maybe kind of the negative impact to margin that just being going flat out is having and how that pressure, when that pressure gets relieved, aside from startup costs on the new plants, how that might benefit margins in that part of the business?
David Naemura (CFO)
Yeah. Look, I think we mentioned a little of this in the last quarter, but for sure, we saw that in the fourth as we were ramping up fast. We've continued to see some of that in the first. It's there. It's not massive, right? I think at the total level, sure, there's kind of a million or two million dollars here and there as we've had to outsource certain products that we otherwise might make. To your point, just running a factory flat out is not as efficient as running it at an optimal level. We'll get more efficient. To your point, we have some inefficiencies of bringing these other plants up, but I think once we hit kind of more of a steady state next year, it's not going to be a big number at the total level here, I wouldn't think.
Charlie Brady (Managing Director and Senior Equity Analyst)
Thanks. Just the final one for me. Could you just give us the share count that you guys are using for the earnings this quarter? I just did not see it in the release.
David Naemura (CFO)
We're using 289,750. Let me see. 289,756,379.
Charlie Brady (Managing Director and Senior Equity Analyst)
Thank you.
Andrew Kaplowitz (Managing Director and Research Analyst)
Thank you.
Operator (participant)
Again, ladies and gentlemen, if you would like to ask a question, press star, then the number one on your telephone keypad. Your next question comes from a line of Steven Winoker from UBS. Please go ahead.
Steven Winoker (Managing Director)
Thanks. Good afternoon, guys.
Ivo Jurek (CEO)
Hi, Steve.
Steven Winoker (Managing Director)
Hey, just maybe backing up for a second on not Rapro, but just the whole point around the impact and how you're thinking about deleveraging. You mentioned the 3.9x post-IPO. You're still fitting in some of these smaller, very small bolt-ons occasionally. Any thoughts given also the performance in the business of accelerating the deleveraging, or how are you thinking about that now, Ivo?
David Naemura (CFO)
Steve, this is Dave. I'd say we've always said it's a balance, right? Deleveraging remains a focus area for us. We continue to think in the midterm here, we should be able to get to 3x or better, and we're focused on that. At the same time, we're trying to balance that with the investments for long-term growth. The increase in capital spend and doing a few bolt-ons that we think accelerate our strategy have been our approach. It remains top of mind, but we remain with kind of a balanced approach where we're going to keep investing in the business. Frankly, as you point out, that growth in EBITDA and our ability to continue to grow the business well and grow adjusted EBITDA will help us deleverage well quite a bit.
Steven Winoker (Managing Director)
You're not going to step up over these sort of smaller bolt-ons, most likely?
David Naemura (CFO)
I think what you saw from us last year was pretty reflective of where we're at. I think we deployed a little over $100 million in capital last year, and that was with doing a pretty good-sized deal with Atlas. Look, Rapro was not a big deal. We paid about eight-ish, a little over eight times EBITDA for it. We think post-synergies, it will be in the five range. Those are the kinds of deals when they're in our core business make a lot of sense for us. Again, small deal. I think what we've seen out of us last year and beginning this year with Rapro is kind of how we're thinking about bolt-ons. Never say never. There's a lot of opportunities out there to help us accelerate our strategy, but I think kind of indicates kind of how we're going about it.
Steven Winoker (Managing Director)
Right. You guys, since the IPO, it seems like I know I get a lot of calls where you're getting saddled with the auto first-fit label. To your point on this call, in addition to the growth that kind of blows that away, you've got, what, about 17% - 18% that's first-fit now in auto, and you're still growing that kind of, as you said, mid-single digits. Any kind of color about changes there and why that's kind of become a smaller part of the business?
David Naemura (CFO)
It's a great question. You're right. I think we've been saddled with a bit of a misnomer, and we're in the teens number. Over half of that, half or over half of that number is emerging market-based, where if you think of first-fit in emerging markets, we're growing at a good rate there. It's an important vehicle to establishing that aftermarket business that we want as the aftermarket guys. Relative to developed markets, we're very low, sub 2% of sales in North America, where I think people have concerns about registration rates. Frankly, we turn away as much business as we take. From that dynamic, we've put in a very strategic filter that, one, we got to get paid for it, and two, we want to be able to introduce innovative products. We're very, very highly selective.
I appreciate the question because I think it's an important point.
Steven Winoker (Managing Director)
Okay. And just a couple of cleanup questions. As we're sort of steering at second quarter, you've got a lot of the investment dynamics that everyone's been focused on for the call. Normally, I guess last year, you ran just under half of your sales in the first half, half in the just over in the second half. EBITDA was pretty close. Other than the, I guess, given the dynamics that you've talked about on the investment and capacity front, should we expect a very different second half, first half dynamic this year?
David Naemura (CFO)
I'm going to stay away from quarterly guidance, and I appreciate that's not exactly what you're asking, Steve, but it is a unique environment here with the capacity constraint on the fluid power side, having a little higher backlog than we otherwise would have and bringing up that capacity in the second half. I don't want to frankly kind of guide beyond the year here, but I acknowledge that that dynamic probably introduces a little nuances inconsistent with prior year. I mean, but I'll let you kind of quantify that.
Steven Winoker (Managing Director)
Okay. Yes. You did answer that. My last one is on the free cash flow in the quarter, not the trailing 12 months, that $87 million, of which $60 million was CapEx, $26.5 million CFO. That $26.5 million, was that can we maybe talk about the dynamics there? Was that anything unusual other than build on the growth?
David Naemura (CFO)
That's built on the growth. I think we got a little more efficient as a percent of sales, but we always build during this period as well, coming off a low point from year-end towards seasonally higher at the end of the second quarter. We grew at a faster rate, and we had to provide with that, right?
Steven Winoker (Managing Director)
Right. Okay.All right, guys. Thanks a lot.
David Naemura (CFO)
Thank you.
Operator (participant)
Your next question comes from a line of Sawyer Rice from Morgan Stanley. Please go ahead.
Sawyer Rice (Equity Analyst)
Yeah. Thanks. Good afternoon, guys.
Ivo Jurek (CEO)
Good afternoon.
Sawyer Rice (Equity Analyst)
Maybe staying a bit here on the fluid power side, can you maybe give us a little view of the level of capacity utilization post all of this capacity coming online? Then maybe asking Dean's question a little bit differently. Are there any regions, I guess, globally that you'll see more of a need for capacity introductions either organically or inorganically in the future?
David Naemura (CFO)
Dave, I guess we'll see. Capacity is going to ramp. We're at very high levels right now. I think we'll come down to a very healthy level, which will probably be in the 60% range, and then we'll ramp from there. As we noted, we're going to enter this new capacity with some backlog, and it's going to take time to come up. The new plants are only going to be one-third capacitized as it is. These are big plants we're building. We're going to lay out a third of the floor plate. As we get into future years, and frankly, the capacity we're putting in here will last us a while. As we get into future years, we'll have opportunity to grow into it more eloquently.
Your point around where we have opportunities, we're very well penetrated, although we still have a ton of opportunity. This is a $12 billion + market, of which we have $1 billion of share, but relatively more penetrated in North America currently. I would say internationally, in both EMEA and Asia-Pacific, we still have significant opportunities to take share, and I think that's consistent with where you see us bringing up the capacity.
Sawyer Rice (Equity Analyst)
Great. Maybe if I could just one follow-up on the PT side of the business, maybe just some incremental, any incremental data points on the chain development, if there's any positive reception as you go to market with that through the quarter. Thanks.
Ivo Jurek (CEO)
Hey, Sawyer. This is Ivo. Look, as we characterize, we are in very early stages of this initiative, but frankly, we are also very encouraged by what we see. A, we're validating that the market is very big, and we are continuing to unearth really interesting opportunities. Kind of anecdotally, we started to focus on this opportunity in North America last year, and we've identified a bunch of interesting opportunities, everything from mobility to grain silos, asphalt manufacturing facilities, lumber mills where we have helped, a couple of lumber processing facilities to significantly improve safety and reliability of operating those assets. I tasked my regional guys across the globe and said, "Hey, look, you guys go out there and start talking to your customers, and let's validate that this opportunity exists across the globe." Lo and behold, we're finding different types of applications.
In Asia-Pacific, it may be associated more with personal mobility. We are finding opportunities in oil and gas, if you can believe it, with opportunities there, as an example, mud pump drives in oil extractions. We are finding opportunities in EMEA in light manufacturing industrial complex, and we are finding opportunities in offshore marine where people are struggling with keeping chain from being rusted and maintaining servicing their equipment that is quite important in loading and offloading various payloads. We are validating actually directly with customers that the opportunity exists, and we are winning a number of applications. We are converting them, and we are realizing that once we convert one, we have an opportunity to convert 40-50-60 plants that those customers may be operating once they have gone through proof of concept.
I know it's a long-winded answer, but I think as you can sense, there's a general degree of enthusiasm about what this represents for Gates for the long term. Although we are early, we are quite bullish on the construct of that strategy.
Sawyer Rice (Equity Analyst)
Great. Thanks.
Operator (participant)
I'm showing no other questions at this time. I'll turn the call back over to Mr. Bill Waelke for closing comments.
Bill Waelke (Head of Investor Relations)
Thank you all for joining us on our call today and for your interest in Gates. We look forward to next speaking with you to report our Q2 results. In the interim, if you have further questions, please do not hesitate to contact me. Have a good evening, everyone.
Operator (participant)
This concludes today's conference call. Thank you for your participation. You may now disconnect.