Gates Industrial Corporation PLC

NYSE:GTES

Earnings Call Transcript 2018-Q2

[Operator]

Good afternoon. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Gates Industrial Corporation Q2 earnings release. [Operator Instructions]

Mr. Bill Waelke, Head of Investor Relations, you may begin your conference.

[Bill Waelke, executive]

Thanks, Rob. Thank you, everyone, for joining us on our Q2 2018 earnings call. With me today are our CEO, Ivo Jurek; and CFO, David Naemura.

After the market closed today, we published our second 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. A reconciliation of these non-GAAP financial measures is 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 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 you 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'll hand things over to Ivo.

[Ivo Jurek, executive]

Thanks, Bill. Good afternoon. Thank you for joining us today to review our second quarter 2018 results.

Beginning on Slide 3 of our presentation material. We are pleased to report another strong quarter of performance. We generated revenues of $875 million, which represents a record quarterly revenue level for Gates. Our total revenue growth was 13.8% over the prior year quarter, driven by accelerating core growth of 6.7% and contribution from acquisitions of 4.9% as well as foreign currency translation benefit of 2.1%.

We continue to execute on our growth initiatives and see strong demand environment across many end markets we serve. We saw continued double-digit growth in industrial end markets, led by construction, agriculture and heavy-duty trucks. We also experienced good demand in automotive, driven by our aftermarket presence, which grew high single digits globally and was strong in both developed and emerging markets. Let me also note that we benefited from double-digit core revenue growth overall in emerging economies, in both the replacement and first-fit channels.

Our Q2 adjusted EBITDA of $205 million also represents a quarterly record for Gates. At 23.4% of sales, our adjusted EBITDA margin is also a record and reflects 15 basis points of expansion over the prior year Q2. Excluding acquisitions, adjusted EBITDA margin expanded by 60 basis points.

We continued to invest in the business during the quarter to advance our large, organic growth initiatives, including investments in commercial capabilities, new product development and incremental manufacturing capacity. Building on the company's commitment to product development and material science, we've recently announced the global launch of our MXT premium hydraulic hoses family for both the first-fit and replacement markets. We believe MXT is truly a differentiated product that will offer the end user benefit, such as lighter weight, better flexibility and improved ease-of-use with the same level of performance that Gates' products are known for.

So we are off to a good start to 2018 with solid Q2 results and a record first half for the company.

Now let's turn to the segment detail. Starting on Page 4, beginning with Power Transmission. Our Power Transmission segment delivered total revenue growth of 7.6% and core revenue growth of 5% in the second quarter. We grew revenue across all of our end markets with particular strength in the construction and heavy-duty truck end markets. We also saw very strong performance in our automotive replacement business globally. In addition, the trend of emerging markets outperforming continued in the second quarter as we generated total Power Transmission core growth of 7% in these faster-growth economies and had over 9% growth in China alone.

During the quarter, we continued to advance our chain-to-belt initiative. As a reminder, we are targeting a focused set of end markets and applications which collectively represents a significant market opportunity. During the quarter, we had key wins in lumber, food and beverage applications, packaging as well as personal mobility applications where we had both e-bike and e-scooter wins in Europe and Asia. Although we remain in early stages, the feedback that we continue to receive remains very positive and validates that we are on the right path and that our product value proposition is well understood by our customers. The Power Transmission adjusted EBITDA margin expanded by 70 basis points in Q2 compared to the prior year. This margin expansion was primarily the result of higher revenues and ongoing productivity actions in our factories.

Moving to Slide 5. Our Fluid Power segment achieved another quarter of strong growth, with total revenue increasing by 26% compared to the prior year quarter. On a core basis, Fluid Power revenue was up 10.1%. We are executing well on our organic growth initiatives. Industrial end market demand remains healthy, and our Fluid Power acquisitions are contributing well to our growth.

Our premium hydraulics product line, which is our largest within the Fluid Power segment, experienced mid-teen core revenue growth in the quarter, driven by solid demand in industrial end markets, particularly in mobile applications. Our Fluid Power revenue growth, along with manufacturing initiatives configured to an improved adjusted EBITDA margin. In this segment, the year-over-year expansion was 50 basis points when excluding recent acquisitions. We achieved this margin expansion while making investments to continue to strengthen our commercial presence, application engineering as well as product development capabilities.

As mentioned on our last call, the strong demand in hydraulics has resulted us fully utilizing our available capacity for these products. And as a result, we've built a significant amount of hydraulics backlog in the first quarter. During the second quarter, our hydraulics backlog remained relatively unchanged from where we exited Q1. The first increment of our increased hydraulics capacity began to come online in late Q2 in China, with the remainder expected to come online in late Q3 and Q4 in accordance with our previously discussed time lines.

Our new plants in Mexico and Poland also remain on track relative to our previously discussed time lines. We did incur some incremental start-up costs in Q2 and will have additional costs in the second half, particularly Q3, which we believe is normal when bringing this level of capacity online, and it is contemplated in our guidance. The total impact of these costs was about $1 million in Q2 and is expected to be around $4 million to $6 million in the second half of the year.

Further, our recent acquisitions are progressing well, and we are seeing early-stage benefits at Rapro from the implementation of the Gates Operating System in the manufacturing facility.

Finally, our fluid -- in Fluid Power, I want to once again touch briefly on our launch of MXT. This is a new product innovation that combines material science and manufacturing process advancements to introduce a truly differentiated product line. Hydraulic hose that weighs less provides advantages of fuel efficiency when placed on mobile equipment. And hose that is more flexible is much easier to thread through equipment in complex industrial environments. We are very excited to bring this new product to both our Original Equipment customers as well as our replacement channel partners.

With that, I'll now turn it over to David, for some additional details on the financials. David?

[David Naemura, executive]

Thanks, Ivo. I will now cover our Q2 financial performance beginning on Slide 6, where, as Ivo mentioned earlier, you can see the record quarterly results that we delivered for revenue and adjusted EBITDA. Core revenue growth was 6.7% in the quarter. And adding to that increase were an additional 4.9 points from acquisitions and 2.1 from foreign currency, bringing total revenue growth to 13.8%. The core revenue growth reflects continued strong demand in our industrial end markets across both of our segments, particularly at industrial first-fit customers. We saw continued strong demand for mobile applications with double-digit revenue growth in the construction, agriculture and heavy-duty truck end markets. We also experienced strong growth in our automotive replacement channel which grew globally by about 8%, a function of strong growth in emerging and developed markets, particularly in China and North America where we see increased end user demand through our channel partners. Overall, we experienced broad range in growth, and we continue to benefit from our high emerging market exposure where we had total core growth of almost 12%.

Our adjusted EBITDA of $205 million was an increase of $26 million or 14.5% over the prior year quarter. Our adjusted EBITDA margin was 23.4%, a record and an improvement of 15 basis points over the prior year Q2. Excluding the impact of acquisitions, our adjusted EBITDA margin was 23.9%, an increase of 60 basis points over the prior year Q2. We did see continued raw material inflation in the quarter. But these inflationary impacts were more than offset with price, manufacturing initiatives and other procurement actions across our full spend base. For Q2, we saw our incremental fall-through on a core basis in the high 30s.

As we have stated previously, our approach to pricing is to price for inflation and we believe we are well positioned to do that with our strong brand and replacement channel presence. We believe that we remain on track to be price-material positive for the year. And although we anticipate inflation to increase in the second half, we have been out in front of it with pricing actions in the first half of the year and expect to be able to continue to respond to market conditions as needed.

We grew adjusted net income to $0.38 per share on a dilutive basis compared to $0.26 per share in the prior year quarter, which was the result of better operating performance and lower effective tax rate and reduced interest expense. Our GAAP effective tax rate in Q2 was 11% as compared with 35% in the prior year as a result of benefits associated with clarifications on U.S. tax reform implementation as well as a few discrete items, and we will touch more on the tax rate going forward in the outlook section.

Slide 7 provides detail on key cash flow items and our focus on continued deleveraging of the business. Our net working capital as a percentage of revenue, excluding acquisitions for comparability purposes, improved 190 basis points compared to Q2 of last year, reflecting continued progress in improving our working capital efficiency. Our free cash flow for the last 12-month period reflects the higher spend on the Fluid Power capacity expansion, which, given the timing of the build-out, was most significant in the first half of the year. We also typically build working capital in the first half of the year, which in 2018 has also included us providing for working capital associated with our revenue growth. Also, the prior year reflects a nonrecurring tax refund of about $40 million.

Within our elevated CapEx spending, underlying maintenance CapEx is in line with our historic range of approximately 1.5% of net sales and consistent with our expectation for 2018. On leverage, we ended Q2 with a net leverage of 3.7x, reflecting our progress on deleveraging the business while continuing to invest both organically and inorganically.

Slide 8 contains our updated outlook for 2018. Based on our results in the first half of the year, we are increasing outlook for the full year. We are increasing our total revenue growth range by 150 basis points at the midpoint and increasing our core revenue growth range by 100 basis points. For adjusted EBITDA, we have increased the midpoint of the range by $7 million. As we look to our performance in the second half, we have considered that we will continue to experience certain inefficiencies from operating our existing Fluid Power plants at maximum capacity and that we will experience incremental start-up costs to bring our new capacity online.

We would anticipate that these negative headwinds will impact Q3 the most. And therefore, the second half is expected to reflect better margin performance in Q4 than in Q3. We have also increased our capital expenditure outlook to around $180 million, reflecting our intention in the latter half of the year to accelerate certain planned organic investments. I will note that we are also performing a bit better than expected in working capital and believe that we will be offsetting a reasonable portion of the additional capital expenditure with increased improvement in full year working capital.

Finally, on our tax rate. We previously communicated an underlying GAAP effective tax rate of 27% plus or minus 150 basis points. We are now seeing an underlying rate closer to 25% for the year as a result of clarification of certain items related to U.S. tax reform. We would also anticipate that infrequent or nonrecurring items could take the effective rate closer to 20%.

With that, I will now hand it back to Ivo.

[Ivo Jurek, executive]

Thanks, Dave. We are encouraged by the terrific results we delivered in the first half of the year and the continued strength in our end markets. We delivered a major new product launch with MXT, and our growth initiatives continued to move forward on track. And we are pleased with the progress we have made with our recent acquisitions, which are also adding to our growth. We continue to invest in the business, including our investments in additional Fluid Power capacity. This capacity is beginning to come online, and we believe that this is well timed with the current market backdrop.

I would also like to thank the global Gates team for their commitment and performance in delivering another outstanding set of results. We remain focused on executing our growth strategies in order to capitalize on the significant core market opportunities we have in front of us. This is an exciting time for Gates, and we look forward to updating you on our progress in the upcoming quarters.

We will now turn the call back over to the operator to open up Q&A.

[Operator]

[Operator Instructions] And your first question comes from the line of Jamie Cook from Crédit Suisse.

[Jamie Cook, analyst]

I guess, a couple of questions. Can you just talk by end market where you're seeing the most strength in China and what your assumptions are for the back half of the year? Just because there's been some concerns in China, that we're [indiscernible] with China heavy-duty truck sales letting down 15% for June this month. So just wondering on that first. And then can you just talk about what your assumptions on -- are on price cost in the back half of the year relative to the first half?

[David Naemura, executive]

Okay. Jamie, it's Dave. China, we saw growth of 11.6% core in the quarter. It was pretty broad ranged, double-digit in automotive, in energy, really high in construction. The only place we saw some headwinds is maybe agriculture which is reasonably, actually a very small market for us in China. So it was -- our growth in China was reasonably broad. Transportation, which we would consider industrial transportation, was kind of mid- to high single digits. So we continue to have pretty good growth. On the second half price cost side, we continue to -- we believe we will continue to have positive price in the second half as we did in the first and even on a tougher compare. So we began to take price really second half of last year, and we'll carry -- we carried a lot of that into the year. We've continued to take price in face of increasing inflation, and we'll continue to have positive price in the second half. We anticipate raw material inflation will pick up in the second half, but would anticipate price still outpacing that.

[Operator]

And your next question comes from the line of Andrew Kaplowitz from Citi.

[Andrew Kaplowitz, analyst]

Ivo, maybe you could give us some more color regarding the improvement in the global auto replacement market and your business growing 8% in the quarter. I think you grew less than 5% last quarter. At the beginning of the year, you did mention that you've had an improvement, especially in North America. So what did North America grow at in Q2? I think it was less than 3% in Q1. And then is it really just the headwind stating from 2008 and '09 as you've been talking about, anything special you're doing in your product portfolio this year to enhance the growth?

[Ivo Jurek, executive]

Thanks, Andy. I think that's a great question. So first of all, let me start with the fact that I think that the weather is helping us out a lot. I mean, it is pretty hot everywhere. And we like hot weather. And I think that the AR channel likes hot weather. So let me start with that. Our North America AR business grew about 8.4%. So this is very, very strong results in North America. I think that you're right as well. We are starting to see that the headwinds from 2009 are turning into tailwinds, and so we expect that the market is going to continue to recover. But honestly, we've had very, very nice performance across the globe. As well as we performed in the developed markets. We've performed even better in the developing markets. And China is doing quite well as well. So we are very bullish about what's happening in the AR market.

[Andrew Kaplowitz, analyst]

That's helpful. And Dave, I think we understand the start-up costs that you sort of mentioned for the quarter and for 3Q. And my question around Fluid Power is just even if we exclude the $1 million that you mentioned at the start, you did mention a step-up in investments. So I think that's what you mentioned. And it looks like the incrementals came down a bit ex acquisitions from last quarter. So maybe you can talk about sort of what you're doing there in investments? The kind of incremental that we saw ex acquisitions in 2Q, is that what we should expect excluding the extra cost in the start-ups going forward?

[David Naemura, executive]

Yes, I think what you saw in the second quarter was some of the headwinds from the start-up cost kicking in. So we experienced just over $1 million of that, plus some increased inefficiencies that we think will abate over time, Andy, as we bring the new capacity online. So we think that we'll get back to kind of more of a fleet average, more similar to what you saw in Q1 as we get in. We're also benefiting quite a bit at price. At Fluid Power, given the constraints in the environment is a place we're taking a lot of price and that has a very favorable impact on incrementals, as you can imagine. Ivo, do you have any thoughts?

[Ivo Jurek, executive]

Yes. And maybe the only thing that I would also add, Andy, is that as we mentioned, we launched this major new product line and that also requires obviously cutting into production capacity to be able to run all the trials that you need to run and do all the validation so that you can actually conduct a product launch. So outside of that, that's probably the only other supplemental item.

[Andrew Kaplowitz, analyst]

And is it possible, guys, to quantify that start-up of the product line and/or the inefficiencies without adding sort of another $1 million or $2 million to the cost in 2Q?

[David Naemura, executive]

Yes, we -- the start-up cost were $1 million. The inefficiencies were at least that, maybe a little more. We see those inefficiencies continuing. And so the start-up cost alone we think, another, for -- kind of $4 million to $6 million, as Ivo mentioned. And we're going to continue to have some of these inefficiencies at the back half of the year as we just run flat out.

[Operator]

Your next question comes from the line of Julian Mitchell from Barclays.

[Julian Mitchell, analyst]

Maybe a first question around the free cash flows. So you had an outflow of about $20 million in the first half. Understood that the CapEx is obviously being hiked, and your operating cash flow was about flat in the first half. But is there any color you could give on your full year free cash flow expectations? And maybe how you see working capital trending in particular from here given the comments around backlog work through?

[David Naemura, executive]

Yes. So generally speaking, Julian, we tend to build a lot of working capital in the first half, and that tends to abate itself. And by the end of the year, it's our low working capital point of the year. So we look to increase our percentage of sales with -- frankly, our goal entering the year was about 50 basis points. We now see that being a little bit better, and that's kind of what I was referring to when thinking about full year working capital performance. Beyond that -- I'm sorry, what was the second part of the question?

[Julian Mitchell, analyst]

Just what do you think your free cash flow is, let's say, for the year as a whole? I mean, after doing minus $20 million in the first half?

[David Naemura, executive]

So look, we weren't giving full year free cash flow guidance. But I think we've given the pieces. And I think the working capital performance efficiency is -- and the increased strength that should go into the calculation. Look, we think working capital will be strong in the second half. And then you also got to factor that the majority of the CapEx will occur in the first half. We're talking about $180 million for the year, and I think we're $112 million or $115 million here through the first half, and that has to do with the timing of the planned spend.

[Julian Mitchell, analyst]

And then my second question, just trying to sort of pin it down a little bit more on margin. So the gross margin was down about 50 bps year-on-year in Q2, even with the sort of 7% organic sales growth. So it's a little unusual. I understand there are some of those inefficiencies and maybe new product launch costs you've mentioned. But is the assumption that the gross margin will rebound year-on-year in the second half?

[David Naemura, executive]

Yes. A big part of that minus 50 bps here, Julian, is the inclusion of acquisitions, primarily Atlas, which is significantly lower gross margin business that we think will improve over time. If you had a comparable basis and excluded the acquisitions, you'd be plus 50 basis points, which I think is more indicative of the underlying performance.

[Operator]

And your next question comes from the line of Jeff Hammond from KeyBanc Capital Markets.

[Jeffrey Hammond, analyst]

So just on the guide. Is it fair to say that Fluid Power strength is guiding it? Or would you say that the PT business is also exceeding expectations?

[David Naemura, executive]

It's really broad strength. I think the Fluid Power, clearly, we have a lot of momentum in the end market environment there. But I think you also see a lot of momentum on the automotive aftermarket and a few key business. So I think the strength we see in the first half is broad, and I think -- we're thinking that continuously.

[Jeffrey Hammond, analyst]

Okay. And then I think you mentioned backlog in Fluid Power flat sequentially. Can you just give us the updated backlog year-on-year on a core basis?

[David Naemura, executive]

We don't report backlog, Jeff, to be honest. We haven't talked about it before. And the only real reason we talked about it the last quarter was because we had such a significant move. But to be frank, we are not a backlog business. Of course, we have unfulfilled orders like everyone else, but we don't run the business on a backlog basis. We run it on a book-ship basis, and we really stay away from reporting backlog. And so we haven't measured it that way, so to speak.

[Jeffrey Hammond, analyst]

And then just on that point, on the new plants coming in, do you see 4Q kind of the early time frame? Or are you starting to eat into that backlog as these new plants ramp?

[Ivo Jurek, executive]

Yes, look. We will -- the facilities are going to start slowly coming online from this quarter onwards. So our expectation is that we should start seeing an ability to eat up into that backlog as we exit Q4. And really meaningfully in Q1 of next year.

[Jeffrey Hammond, analyst]

Okay. And then just last. Interest expense was a little bit lower. Can You just update us on how you're thinking about interest expense for the year second half?

[David Naemura, executive]

Yes, I think for the full year I think interest expense, $170 million cash full year. Prior year interest expense included some recognitions in deferred financing fees associated with refinancing some of the debt. So year-over-year comparative can look tricky. And then we've also lowered rates a couple of times since over the course of last year. So lower rates and lower debt as a result of IPO paydown and some higher items in last year given some of the refinancing, some of the recognition, some of the deferred fees, so $170 million cash for the full year.

[Operator]

Your next question comes from the line of Steven Winoker from UBS.

[Steven Winoker, analyst]

So can we just go back to China for a minute, and actually, the tariff question. And as tariffs have expanded in reality and then the potential, maybe just talk about the potential impact on Gates, how you guys are thinking about it from a broad perspective and risk mitigation?

[Ivo Jurek, executive]

Look, Steve, as we stated, we're kind of in-region, for region manufacturing organization. So our primary focus in China is to support our customers in China that consume the products in China. That being said, our expectation is that it will start to a degree filter through some economic psyche. And I think that the customers will be all watching very carefully about what that will result in from kind of the macro economic sense. If you think about what it means in dollars and cents, our expectation is that the presently announced 301 tariffs are going to be $10 million to $15 million headwind for us and our expectation is that we have very good position to be able to offset that without any major difficulties.

[Steven Winoker, analyst]

Okay, that's helpful. And then going to the growth investments, both capital and operating expense. The capital side on the additional $10 million at the high end. Just maybe chalk through that in a little more detail, what kind of things that is tied to so we have a better idea of where -- what kind of spending that is. And then there's a broader question, maybe more on the R&D and other line that we've talked about in the past, which is these growth rates are obviously quite strong. Some part of that is just market strength. Some part of that is you guys outgrowing the market and you've got these initiatives across the business. How are you thinking about that, Ivo, in terms of what's what and how we might think about sustainability of these things and the cost for you to get there?

[David Naemura, executive]

Okay. Steve, I'll take the first piece on capital and then kick it over to Ivo. So some of the new things we're talking about, the incremental $10 million that you've referred to are items that we frankly would have been executing the in first half of next year that we're trying to accelerate, one thing I'll talk about is the new design of coupling that we haven't necessarily brought to the market yet, but we're looking to bring some of that capacity into emerging markets. And that will be dovetailing off the Fluid Power hydraulics growth that we're seeing in the market today. We also have a very large VAVE project. That I won't going to do much of the details but it's ending improving gross margin. And then finally, we have some projects around the highest end of Fluid Power capacity. So we are adding a lot of Fluid Power capacity. But the biggest demand is of highest levels. So we haven't fully capacitized these plants but we're going to bring it into what we call spiral wrapped hose we may bring in some more capacity for that or few lines because we just having such a hard time keeping up with that level of demand.

[Ivo Jurek, executive]

Yes. And so Steve, maybe I can take that growth piece of it. And look, I mean, when we decided to build these manufacturing facilities, none of us really could predict what is going to happen with the market and when the market is going to recover. So we didn't necessarily spend the CapEx to time it with the market recovery. I guess it was probably a smart decision, and it was about time from that perspective. But we've invested the CapEx so that we can expand into these bigger markets with, frankly, what we feel is very exciting set of new high-pressure premium hydraulics product portfolio. We started with the MXT that I have talked about earlier a little bit, and we believe that it is a very differentiated product that's going to allow us to continue to -- the trajectory of performing above market growth rates and start taking market share away from some of our major competitors out there. And we have a ton of supplemental innovation that is coming online towards kind of the second half of this year beginning of next year where we believe that's going to further help us reposition our hydraulics business on that much more firmer footings where we again believe that we are going to be extremely well positioned to take advantage of the capacity we stood up and differentiate ourselves in the marketplace with very, very differentiated innovative products. So we're pretty bullish about what's happening at Gates. And as Dave said, we're also investing a ton of VAVE activities that are going to help us to continue on a trajectory of continuing to expand our gross margins. And so we are reasonably bullish about what's ahead of us.

[Operator]

Your next question comes from the line of Jerry Revich from Goldman Sachs.

[Jerry Revich, analyst]

I'm wondering if you could talk about how you're thinking about CapEx decisions on a multiyear basis. As you pointed out, you're opportunistically accelerating CapEx programs here near term. But some of the longer lead time decisions as you pointed out take 1 to 2 years to play out. So how's your thinking evolved around capacity broadly? Can you just give us an update how you're thinking about the '19, '20 CapEx outlook and the buckets of opportunities that you folks are thinking about?

[David Naemura, executive]

Yes, great. Look, Jerry, I think directionally, I would explain it like this. I think we will see the high CapEx year being 2018. And I think over the course of '19 and '20, we will get back to a more normalized rate for the business, which historically has been closer to that 3% of sales. I think we will continue to invest in Fluid Power related activities. But clearly, the big capacity piece we've put in is the large investment. We believe we'll have investments around certain new VAVE projects as we've discussed. I think there will be some PT related items that are building new plants that are building more efficient lines within existing footprints. So I think we will see it abate over time and come back over the next couple of years to a more normalized level. Ivo, do you have anything to add to that?

[Ivo Jurek, executive]

The other thing I would add is, Jerry, I think we started a discussion about some of the exciting programs that we have with Fluid Power. We see the next evolution of our product portfolio in Power Transmission. And we will be very open and forthcoming about investment that we need to make, if we need to make them. And they will be made keeping in mind that we need to generate premium returns for shareholders. And so again, we are quite excited about what's on the table. But we think that continuing to invest in our business is the right thing to do for the long-term of the company.

[Jerry Revich, analyst]

Okay. And in terms of -- in Fluid Power, you mentioned the backlog was about flat sequentially. David, can just give us some context by region in terms of how orders have shaped up over the course of the quarter? I guess, we're seeing pockets of capital equipment and order growth slowing and I'm wondering if you're seeing that flowing through into your order rates when you piece out the individual components of the backlog?

[David Naemura, executive]

Well, look, Jerry, we'll talk about demand as it came through in revenue. Again, I don't think -- we don't necessarily run it on a typical kind of booking bill in order type business. But we saw continued Fluid Power strength in China significantly, double-digit, low 20s. North America was kind of high single digits. Globally obviously, the core of growth of 10% that we talked about. South America is a small business for us, but had very high growth. And then EMEA was low teens which was pretty robust as well. So I would characterize our Fluid Power growth as broad-based and strong in emerging markets.

[Operator]

Your next question comes from the line of Deane Dray from RBC Capital Markets.

[Deane Dray, analyst]

Sticking in Fluid Power, and it was good to hear the new capacity is coming on as planned. One of your competitors in Fluid Power was talking recently about bringing on new capacity in Turkey. And I was wondering might that change any of the competitive dynamics in the second half? Because what they saw is they similarly had built it all those backlog and then -- because customers were double ordering just to anticipating the capacity issues. And then as capacity comes on, that backlog begins to shrink. Is that, just for expectation purposes, do you think it's going to play out similarly for you?

[Ivo Jurek, executive]

Deane, I don't -- I can't completely comment about what they are seeing. What I would suggest to you is that we continue to see strong demand across all the regions. I listened to that call I think as well yesterday. But my sense was that the capacity addition was reasonably limited to what they have added. And again, what I would just kind of keep coming back to is that we're adding capacity to support our growth with highly differentiated products that we are launching where we believe we have tremendous opportunity to take market share. And that is the foremost reason why we put the capacity online, and we certainly believe that, that remains to be at the front and center and the market backdrop is just an incremental benefit for us that we see today.

[Deane Dray, analyst]

Got it. That's really helpful. And then since it's come up a couple of different times, the new launch of the MXT product. Does that -- will that represent incremental growth for you, increase the market share? Or will it cannibalize any of your high-end products do you believe?

[Ivo Jurek, executive]

Our expectation, Deane, is that this is going to bring an incremental growth to us over the midterm.

[Deane Dray, analyst]

Could you size for that? And then also, has it already been launched? Are you already shipping? And where are you making it?

[Ivo Jurek, executive]

Yes. So the answer to that is yes, we are already shipping to several of our OEM customers. Our expectation is that as we progress over the course of this quarter into the next, we will start fully launching globally across all of the replacement markets. So far, the response to that launch was very positive. And we are manufacturing in all 3 regions this new product line.

[Operator]

And your next question comes from the line of Charlie Brady from SunTrust.

[Charles Brady, analyst]

Just on the growth question. I guess maybe a larger macro picture, I'm [indiscernible] saying I understand, it's probably hard to analyze this. But given that you're capacity constrained, some underlying market growth seems very strong. I'm just wondering, do you have any sense, is the capacity constraint may be causing you not to get book sales that you otherwise would book? And then once that capacity comes on, you could potentially see an acceleration in the underlying growth rate because now you're freed up to have to take more orders that you could otherwise taken and customers not having to go somewhere else?

[David Naemura, executive]

Good question, Charlie. I think it's not quite as it ever is that black-and-white. But I would tell you that we have not been as adamant about generating demand given the constraints that we have. Now that we're adding capacity and, frankly, bringing new product introduction out with MXT, we will be looking to generate more demand than what we have otherwise would. We have always believed that our capacity with coming into market, it was well-timed with the market strength, which should give us some opportunities to continue to grow share. But I don't think that -- again, we don't run this by backlog. I'm not looking at some large backlog reduction opportunity that's fundamentally going to bring this kind of huge step function. But I think we will have opportunities to continue to grow our Fluid Power business greater than the fleet average of the business and stronger than the market backdrop. And the new products we think we're well positioned through the rest of this year and into next year at a minimum.

[Charles Brady, analyst]

That's helpful. And then just one more on the MXT product. From a profitability standpoint, I'm assuming that, David, you have a better profit -- more profitable product or kind of in line and is that sort of sliding scale as you continue to ramp production, initially maybe not as much as the full rate production when you rolled out you're at a better margin profile.

[David Naemura, executive]

Yes. On average at a standard level, it will have a better margin profile than the existing premium products of -- I think it's been developed as a combination of manufacturing process innovation as well as material science, and it's a very innovative product. And it will have a better margin profile. So as it gets adopted slowly over the coming quarters and years, that should be accretive to the fleet average.

[Operator]

And your next question comes from the line of Sawyer Rice from Morgan Stanley.

[Sawyer Rice, analyst]

Maybe just a question on the chain development initiatives. Can you maybe size some of the opportunities you're seeing here in the quarter? It sounds like that trend is pretty in line with your expectations. And then may be just an update on the mix impact of that? How that's -- whether that's market accretive to the overall business.

[Ivo Jurek, executive]

Yes, so we are. A good question. Look, all of the opportunities outside in my prepared remarks are kind of north of $0.5 million in size. We expect that they're going to start ramping up kind of during the course of Q4, Q1, Q2 next year, kind of in total, kind of $10 million annually in scope. And we remain quite bullish about the response to this technology and working very diligently on our business model, scaling up our marketing resources and field application resources to be able to support the demand of this type of conversions. But it's very, very exciting, especially since a couple of these opportunities are with large multinational companies that are running these pilots and conversions of their broader footprint. So pretty good response to this initiative.

[David Naemura, executive]

On the margin front, Sawyer, I think it will vary will be the answer. When we're doing a lot of items in the emerging markets, that can have different implications. But ultimately, I think chain-to-belt will generally be a premium product and have a lot of carbon drive in it. And so when we are selling that product and Poly Chain, I think those are typically premium products which carry higher than fleet average margin which we would expect.

[Sawyer Rice, analyst]

Got it, makes sense. And then maybe just one more in the quarter. Can you give us a little insight into the cadence of growth in the quarter? Did you see any particular trends as a whole and then maybe by region as well?

[David Naemura, executive]

Look. I think for the quarter, it was continuation of the good environment that we had been seeing. We're continuing to see strong first-fit demand. But frankly, demand in the replacement markets overall was very good as well. So I would say it was a lot of kind of what we have seen. With some increased momentum in automotive aftermarket business and we like that, right? We're the aftermarket guys. So I think we've seen a very good environment kind of continue through the first half of the year.

[Operator]

There are no further questions at this time. I will turn the call back over to Mr. Bill Waelke for some closing remarks.

[Bill Waelke, executive]

All right. Thanks, everyone, for joining and for your interest in Gates. We look forward to keeping you apprised on our progress over the next call. And as usual I'm available for any follow-up questions. Have a good evening.

[Operator]

This concludes today's conference call. You may now disconnect.