Ferro Corporation
Q1 2020 Earnings Call Transcript

Published: 12 May 2020

[Operator:]

Good morning and thank you for joining the Ferro Corporation's First Quarter 2020 Earnings Conference Call. An archived replay of this teleconference will be available through the investor information section at ferro.com later today and will be available for approximately seven days.I would now like to turn the call over to Mr. Kevin Cornelius Grant, Director of Investor Relations and Corporate Communications. Please go ahead.

[Kevin Grant:]

Thank you, and good morning, everyone. Welcome to Ferro's First Quarter 2020 Earnings Conference Call. This morning, we'll be reviewing Ferro's financial results for the first quarter ended March 31, 2020. I am pleased to be joined today by Peter Thomas, our Chairman, President and CEO; and Ben Schlater, Group Vice President and Chief Financial Officer.The earnings release and conference call presentation deck are available in the Investors section of our website. I'd like to remind everyone that some of the comments we are making today are forward-looking statements and are based on our view of conditions and circumstances as we see them. However, those views may change as conditions and circumstances change. Please refer to the forward-looking statement disclosure in the earnings release and the earnings presentation.Also, today's call will contain various operating results on both a reported and adjusted basis. Descriptions of these non-GAAP financial measures and reconciliations are included in the earnings release and presentation deck. We encourage you to review that information in conjunction with today's discussion.It is now my pleasure to pass the call over to Peter.

[Peter Thomas:]

As you may have seen in the press release we issued yesterday, Ferro delivered strong earnings growth in the first quarter. Lower raw material cost and the actions we took over the past year to improve operational efficiency at our manufacturing facilities were key factors in these results. We were able to maintain our prices even as raw material costs declined, which we believe shows the value of our market leadership position and our constant commitment to developing innovative products for our customers.Looking at the first quarter numbers, gross margin expanded to 32%. Net income improved 18.5%. Adjusted EBITDA improved 18.2%. Adjusted EBITDA margin improved 300 basis points to 16.1% and adjusted earnings per share from continuing operations increased 73.3%. There is a lot to be pleased in these results.By the way, 32% gross margin is a level that we expect to sustain over the long-term. In fact, we think we can drive it higher through additional optimization initiatives and smarter sales and marketing. So we had a very good quarter. I believe the first quarter gives a glimpse of the kind of profitability that our business can generate as we reap the benefits of our strategic priorities.So now I'd like to comment on what we anticipate for our business in 2020 beyond the first quarter. Here's the essence of my message. We intend to continue executing on our strategic priorities even in these turbulent macroeconomic circumstances brought on by the COVID-19 pandemic, just as we have through this point in the year. We are confident we can do this for several reasons.First, we sell our products and services in the multiple markets and into geographies around the world which limits our exposure to any one industry or region. Second, Ferro has leading positions in the market niches it serves and we have the resources to continue developing innovative products for our customers to main our leadership. Third, many of our products and services support critical industries which government authorities around the world have generally allowed to operate even during the pandemic.Let me amplify this point. Along with the construction, automotive and appliance markets, which we discuss a lot, Ferro also sells its products and services into industries such as healthcare, food and beverage, information technology, energy and defense. And fourth, we believe we have ample liquidity to weather the current market turbulence. That in our opinion is a business model with resilience.As some indication of Ferro's resilience, it is worth noting that nearly all of our facilities have continued to operate with no or only brief suspensions of activity since early March when the World Health Organization declared the spread of COVID-19 a pandemic.Now, I want to say a word about our employees. Ferro employees have been hard at work supporting our customers throughout this period. They have done a tremendous job all around the world and I am very proud of them. There is no greater priority than the well-being of our employees and we have implemented heightened health and safety protocols at our facilities consistent with recommendations of the public health authorities.So, what are we focused on even as COVID-19 agitates the markets? Through 2019 we talked about redefining our manufacturing footprint. There were many opportunities for transforming capacity, optimizing logistics to align with our network of facilities and streamlining sourcing, procurement and raw material consumptions. We have been very active on this front with the objectives of driving down cost of goods sold, improving gross margins and enhancing our capital efficiency.One of the most significant manufacturing footprint optimization issues is our previously discussed North American project. We are making good progress on this project. We have moved a significant portion of our basic material production from the U.S. to our newly expanded state-of-the-art facility in Villagran, Mexico, which significantly improves our operational efficiency and cost position.Although COVID-19 has created challenges such as international travel restrictions and limitations on our physical engagement with business partners, the program is generating benefits now and we continue to expect it deliver the full scope of anticipated benefits when it is completed.Another significant initiative is our footprint optimization program in Europe, which was mentioned previously. We are advancing with this project and we will talk more about that initiative in upcoming quarters.Another key strategic objective, as we previously said is to shift Ferro's center of gravity to higher growth markets that generate higher margins. We want to provide products and services that are essential to our customers as they innovate to address trends in their markets. We also are successfully executing on this objective. We are right there with our customers as they develop their next-generation products, providing critical functional coatings and color solutions for them.So here are some examples of what I mean. First, electrification, where there is increasing demand for our paced [ph] use processors. Digital technologies which rely on our digital [indiscernible], eco friendly materials as preferences shift to organic pigments and organic colors [indiscernible], electronic packaging in component materials which incorporate our multilayer insulating materials and surface polishing and finishing which use Ferro materials for the automotive, precision optics and semiconductor markets among other markets.These are just a few examples of the high growth markets in which Ferro's innovation and know-how make us an attractive partner for our customers. We have established leadership positions about 95% of our sales and markets in which we hold leadership positions and we continue to innovate and invest to maintain our customer relationships and protect these leadership positions.We are executing from a position of strength with a strong and diversified portfolio and we are leveraging our expertise to growth with macro trends and to expand our opportunities with new applications and next-generation products.Inorganic growth also remains part of our strategy. We will continue to selectively consider bolt-on acquisitions to fill in technology gaps and to complement and expand our product portfolio in high-margin, high-growth areas. We also would consider larger transactions if the right opportunities were presented. We are maintaining our pipeline of potential transactions, both bolt-on and larger while being mindful of the current unsettled macroeconomic conditions.We also are making progress on the activities necessary to complete the sale of our tile coatings systems business. We continue to expect the transaction to be completed as planned in the second half of 2020. As a reminder, the divestiture of the tile coating systems business will result in Ferro having more attractive underlying financial and operational metrics including higher sustainable margins, less exposure to cyclical markets including the construction industry, a more balanced end market and regional mix, stronger underlying market growth, less raw material consumption, a more streamlined manufacturing footprint and greater focus on technology and innovation aligned with megatrends.So to sum up, we believe our business model will enable us to get through the current economic conditions brought on by COVID-19 that is to not say we have clear visibility for the remainder of the year. Macroeconomic circumstances are just too uncertain, but we do believe we are positioned to manage through the current macroeconomic circumstances. And then once we get through the current circumstances we believe that Ferro can try the enviable characteristics of our business that give us confidence for the near-term, give us enthusiasm about the opportunities ahead over the longer term.And with that, I'll turn the call over to Ben for his report on Ferro's financial performance.

[Benjamin Schlater:]

Thank you, Peter, and good morning, everyone. I would like to echo Peter's comments of how proud and grateful we are for our associates globally, for their efforts during this time. The safety and status of our teams around the world remains our top priority. Our associates have really stepped up and remain committed to our strategy.Ferro delivered strong first quarter earnings, driven primarily by improvements to margins versus the first quarter of last year. We believe these markets are more characteristic of the profile of our businesses in the portfolio that comprises our continuing operations. This benefit was driven primarily by two factors; first, more efficient operations in our facilities versus the first quarter of last year, and second raw material tailwinds.On the manufacturing side, as you may recall, in the first half of last year we made comments on certain manufacturing headwinds due to several reasons, including the process around optimizing our facilities and the locations where products are produced. As we advance these optimization efforts and with some of this friction behind us, we are uncovering the underlying and inherent margins of our continuing operations portfolio which are in line with our expectations.Further, our work on our optimization activities progresses, our expectation is there will be additional long-term, structural margin enhancements as you have heard us mention. Our teams have worked hard on these efforts as you know and we are pleased to see some of the benefits manifest themselves in our results. Our progress in this regard remains a key strategic focus this year as Peter has mentioned and we are excited about the additional benefits yet to be realized from these efforts.Touching a bit more on raw materials, one of the characteristics of this portfolio is a greater ability to maintain a favorable priced raw materials balance in periods of raw material inflation and deflation. We have seen this historically in these businesses and it was made evident yet again in the first quarter. In addition, some of these benefits were the results of focused actions within our optimization programs to structurally lower these costs.With that, I'll move on to discuss our consolidated financial results for the first quarter of 2020 from continuing operations. Please note that the non-GAAP numbers I will refer to are on an adjusted basis and growth rates mentioned on a constant currency basis compared to the first quarter of 2019. Also beginning with this call and going forward, we are reporting and commenting on free cash flow used in operations. We will no longer report free cash flow on an adjusted basis.The financial highlights and results for the first quarter can be seen on Slides 3, 4, and 5 in the presentation materials accompanying today's call, which you can find on ferro.com in the Investors Section.Moving to Slide 4 and the first quarter, net sales declined 2.4% to $252.3 million. Adjusted gross profit improved 5.4% to $81.9 million. Adjusted SG&A expense declined by 4.6% to $51.7 million, adjusted EBITDA improved 18.2% to $40.7 million or 16.1% of net sales. And adjusted EPS increased to 73.3% to $0.26.As we noted, the first quarter was stronger than the prior year quarter with margin expansion across most of the business compared to the first quarter of last year. Adjusted gross profit margin improved 240 basis points to 32.5% compared to the first quarter of last year and we saw further benefits from SG&A.These results reflect certain non-GAAP adjustments for the first quarter primarily related to professional fees associated with previously divested businesses, corporate development and optimization activities. First, in cost of sales we adjustments of approximately $1.2 million primarily due to costs related to optimization initiatives.In SG&A we have one-time adjustments of $4.4 million in the quarter, $2.7 million consisting of costs for professional fees and other expenses related to corporate development and optimization initiatives, including the North American manufacturing optimization and $1.7 million related to divested businesses.And finally, turning to restructuring and impairment, there was an adjustment of approximately $1.2 million reflecting actions to achieve our ongoing optimization initiatives and acquisition synergies.Having already discussed gross margin, I'll now move to SG&A. In the first quarter adjusted SG&A expense was lower by 4.6% to $51.6 million or 20.5% of net sales, compared with $54.1 million or 20.9% of net sales in the prior year quarter on a constant currency basis.This brings me to GAAP cash flow. As I mentioned earlier, we will no longer report free cash flow on an adjusted basis. Going forward we will focus on GAAP cash flow from operating activities. We will also discuss free cash flow from operations or what we would view as cash flow available for items including, but not limited to strategic investments, debt service, and shareholder returns.We calculate as free cash flow measure by combining the following lines from our statement of cash flows. GAAP cash flow from operations, capital expenditures, and cash selected under securitization programs. This information can be found on table 10 in our press release. In the first quarter GAAP cash flow from operations was an outflow of $71.5 million.I'll spend a few more minutes walking through the details. The most meaningful components for the quarter are as follows, starting with GAAP net income attributed to Ferro Corporation of $16.1 million we add $11.4 million of depreciation and amortization, then subtract $101.5 for working capital, $13.5 million of change in other balance sheet items, and then add $15.6 million of other non-cash P&L items.And finally add $300,000 of restructuring impairments to arrive at cash used in operating activities of $71.5 million on a GAAP basis. Then we subtract $8.3 million of capital expenditures and add cash received on other receivables of $28.8 million to arrive at $51 million of cash flow used in the first quarter which reflects the earnings benefits we mentioned and changes in working capital for normal seasonality, but also for certain optimization initiatives.Continuing with our discussion on balance sheet, Ferro is well positioned from a liquidity perspective to manage through the near-term effects of the COVID-19 pandemic. As of May 5, 2020 we had liquidity of approximately $550 million consisting of cash and availability under our various credit facilities, primarily Ferro's revolving credit facility. We have no significant debt maturities prior to February of 2023.Although the first quarter was strong, we know that the pandemic is going to have an impact in the second quarter and potentially into the second half of 2020. Unfortunately we can't predict the duration or the severity of any potential economic weakness, nor can we predict the shape of the recovery. And because of that we have withdrawn our full-year guidance.Further, as you might expect, we have taken measures to reduce spending CapEx where possible and appropriate and have further plans in place should there be a need for those steps. We will continue to prioritize cash flow and leverage. However, even while obvious macroeconomic challenges exist, so do opportunities.We think the current circumstances might provide an opportunity to expand our market leadership positions, increase market share, and align our existing technologies with areas in which there may be enhanced growth due to potential changes as behaviors and markets evolve in these changing times.I would reiterate that we are very focused on what we can control and on keeping the business agile to adapt to economic changes, all while maintaining efforts to be well-positioned for when markets do recover.With that, I'll now turn the call back over to Peter to walk through each of the business units and add his final comments before we take questions. Peter?

[Peter Thomas:]

Continuing operations, we reported segments. As a reminder, during the first quarter we changed the name of our former performance colors and glass segment to Functional Coatings which we thinks better reflects the product lines within that segment, which now also includes our porcelain enamel business.We will begin our discussion with the Functional Coatings segment. So in the first quarter, Functional Coatings net sales on a constant currency basis were down 5%. Despite the lower sales, gross margin improved by 2040 basis points in the first quarter over the prior year period on a constant currency basis increasing from 29% to 31.4%. Adjusted gross profit increased 2.9% from $47.5 million to $48.9 million.As we have seen through the prior quarters, the part of our business that serves the automotive industry continued to experience weak global demand totaling approximately 10%. However, despite lower sales we were able to improve gross margins in this part of our business by more than 500 basis points through our optimization initiatives.Our Glass Decoration business was up low single digits in the quarter compared to the prior year as we benefited from initiation of a project by a large global restaurant chain. We would characterize this kind of project as off cycle and not indicative of a general trend in the business. Without this off cycle demand, our glass decoration business would have been flat.Our Electronics Materials business was up mid-single digits in the quarter compared to the prior year. During the quarter we saw increased demand from a large global appliance manufacturer. In addition, we generated additional sales as we resumed production for some customers following our shift of production from one location to another.In our Industrial Materials business we saw a mid single digit decline driven primarily by softer printer equipment demand for digital printing and continued weaker automotive demand.Turning to our Porcelain Enamel business we saw low double-digit declines due to lower sales demand from U.S. appliance manufacturers. However, despite lower demand, we again were able through our optimization programs to improve gross margins in this business by more than 500 basis points.Now turning to our Color Solutions segment, in the first quarter color solutions net sales on a constant currency basis were up 2.1%. Gross margins improved 420 basis points to 34.9% compared to the prior year quarter of 30.7%. Adjusted gross profit increased 16.1% to $33.8 million from $29.2 million in the prior year quarter.In our pigments business we saw strong demand from the paint sector along with strong demand for our Ultramarine Blue, Basic Chrome Sulfate, and anticorrosive products. Viewed from a regional perspective, our pigments business generated in U.S. high double-digit growth, in Europe high single digit growth and in the Asia-Pacific region mid-single digit growth.Demand for our pigments used in master batches in our production however remained weak. The overall higher demand for our pigments helped to offset lower demand in surface technology. This lower demand was anticipated. As we previously said, the strong demand we experienced in 2019 for our surface technology products as chipmakers buildup inventory started to reverse in the fourth quarter of 2019 and is expected to continue through 2020 as chipmakers transition to next-generation chip production.So to bring our comments together this morning, let me emphasize a few key points. We had a strong first quarter. The COVID-19 pandemic did not have a significant impact on our business in the first quarter. We expect a greater impact on our business from COVID-19 in the second quarter due to the softening demand with the impact to our business being in the same range as that of our peer group.We don't have clarity about the macroeconomic impact of COVID-19 for the remainder of the year. However, we expect continuing benefits during the year from manufacturing efficiencies, optimization, and favourable raw material expenses. And with our business model, we are confident that we can withstand the current market turbulence and we are enthusiastic about the opportunities that lie ahead once markets normalize.So we have worked hard to transform Ferro to create a highly focused, efficient and high value specialty chemical company. We have simplified operations, harvested underperforming assets, invested in higher value assets and driven innovation and optimization.After the sale of the tile coatings system business, we will have a company with lower capital intensity, reduced financial leverage and lower working capital. We will have a more balanced portfolio, both geographically and by end market with reduced exposure to cyclical markets and a greater concentration on end markets with higher growth.I trust you can see why we are optimistic about our business. When we emerged from the current COVID-19 circumstances, we believe Ferro will be very well positioned to drive and create additional value.Finally, before we take your questions, I want to once again recognize and express my pride in our employees. Their dedication and teamwork have given our company a very, very good start to the year.Then with that, Kevin, we are ready to take questions.

[Operator:]

Thank you. [Operator Instructions] And we do have a question from the line of Rosemarie Morbelli from G. Research. Please go ahead.

[Rosemarie Morbelli:]

Thank you. Good morning everyone.

[Peter Thomas:]

Good morning.

[Benjamin Schlater:]

Good morning.

[Rosemarie Morbelli:]

Glad to see you out all alive and this was really a very good quarter. Was there anything, in this quarter, Peter that exceeded your expectations, anything pulled from the second quarter for example, and what do you see happening when we come out of the confinement?You did mention that you expected the second quarter to be similar to peers, which we are more or less looking at a top line decline of about 15%. So if you could address that and the incremental margin that comes along with a declining topline. I realized there was a lot.

[Peter Thomas:]

That's okay. I'll get – and you just gave me an excuse to talk about, that's all. Let's first start on your first question which was our expectations of things that exceeded our expectations. And although, we have realized over quite some time through the execution of strategy, we would get to the point where we are with remainco and you would start to see, let's call it the gestation of remainco with all that we've done with building technology platforms, all the optimization programs and just really starting to bring it all together.And what I would highlight for the first quarter is a handful of what we would define positives. And although what I'm going to mention to you we realized would occur, these things seem to be a little bit better than we anticipated. And there are about eight of those things. And one thing we can emphatically tell you is that we have gained market share. Again, all of the market share is coming from two areas. One would be with our new technology programs with the leaders and them introducing new products.And there is another kind of interesting dimension here. As you know, we're the leader in high-end fragmented applications. And strangely enough, even though we're $1 billion in remainco, we do have scale in a fragmented world. And there are a lot of smaller companies around the world that may not be faring very well during the pandemic and I suspect that we have gained some share from those smaller competitors, as we're able to outperform them in this environment.Another key point is our ability to hold pricing. We've heard that through both of our prepared remarks. Another key point that strangely enough, we were able to strategically raise prices in certain higher-end end markets. I think you could see through the uptick in a lot of the different product lines with the basis points improvement in gross margin, that our optimization initiatives are gaining traction and maybe a bit more than we anticipated.One thing we can tell you is that even in this environment where a lot of companies are pulling back in R&D and working with their customers on new opportunities, what we can share is, our working activities with our major suppliers have continued in the innovation booked. So we do have and have been working with our customers in preparation for next generation type of product launches. That has not stopped.And of course, and not only that we experienced favorability in all ranges of optimization of sub-segment of course would be the lower cost position, particularly coming out of our Mexican site and targeted areas through the rest of the world that maybe we haven't been too specific about for competitive reasons, but not only is in the movement from the U.S. to Mexico, but throughout the world, there are things that we have been doing better now coming to fruition. So that's the answer to expectations and these things being a little bit better than we had anticipated and of course, we have no reason to believe in a normalized world that this would go away. So that's, that's the first part.The second part of your question has to deal with the second quarter. And we do want to underscore that our performance in the second quarter is very, very much in line with that of our peers. And we've been pretty clear about that in the scripts. And just to be very crisp, I think the whole world didn't do very much in the month of April.However, incremental build in May and June is surfacing and with many of our larger customers, particularly in the automotive space, you can see that their startup is progressing in a very uniformed and orderly kind of way in that as we try to establish our S&OP process, we are really counting on them to give us enough information, because those customers don't want to build excess inventory. We are not going to deal with building excess inventory.So we are in communication with them on a very, very regular basis because that really drives the business, the automotive piece right now. But what we can tell you there is an incremental build through May and June, of course, anticipating no further pandemic challenges. But we are starting to feel very candidly, maybe a little bit better about the third quarter. So in the second quarter is pretty much in line, but understand that what we established in terms of the gross margin performance and the continuation of optimization and all the other positives I mentioned, will theme throughout the second quarter and should manifest themselves nicely in the third quarter.

[Rosemarie Morbelli:]

Yes, to a certain degree, I was wondering if Ben could touch on the incremental margin as volume or revenues dropped 15%, which I understand is my number, but it is in line with what other companies have said.

[Benjamin Schlater:]

Yes, hi, Rosemarie. I think the gross profit line, the sensitivity around a 15% revenue drop would be somewhere between 25% and 30% of that sales number.

[Rosemarie Morbelli:]

Okay, thank you. That is very helpful. And then Peter, I understand you - I mean you fill in your presentation and in the press release said that you expect the tile coatings transaction to close in the second half. Can you update us on what you can still prepare while there is - travel is eliminated, can you still talk to the potential buyer? Can they still do some due diligence or was that done before? Can you give us a little more on that project?

[Peter Thomas:]

Yes, sure. Here is what we can say, and I think you captured it all. I think if you - you would not believe how much due diligence was done prior to signing. So we did do a lot, and that's one of the reasons why we feel so good. One thing we can't tell you, because I know everyone wants a little more color on this, what we can say is, first we know that we're still targeting the second half of the year. And what we can say to add some more color is that, we are continuing to work together to make progress and both companies are checking off boxes that we need in order to get to closing. And you know, there is momentum behind it. Things are getting done. Lots of communication, obviously with the TSRs and things like that, that we have to go through. And so I think it's, hey, we still continue to target.

[Operator:]

Thank you. And we have a question from Mike Harrison with Seaport Global Securities. Please go ahead.

[Michael Harrison:]

Hi, good morning.

[Peter Thomas:]

Hi Mike.

[Benjamin Schlater:]

Hi Mike.

[Michael Harrison:]

Congratulations on the progress you're showing. It's definitely encouraging. I was wondering if you can give us a little bit more detail on the portion of your business that in some of these more, defensive markets or critical markets. If I had to put your business into buckets where you're expecting sales in Q2 to hold up pretty well and be down slightly and be down significantly, can you help us size those buckets in terms of the percentage of sales that go into more resilient markets versus markets that are being significantly impacted here?

[Benjamin Schlater:]

Yes, sure, sure, sure. Mike. So, look I think with respect to - as we talk about right industrial and electronics, which are a couple of the businesses that have shown some resiliency, obviously is as you know, both of those big businesses fit in the segment that we used to call PPG [ph] and now call Functional Coatings.So with respect to electronics, that's around 15% of the current portfolio that sits in continuing operations. With respect to industrial, that's around 10% again with respect of that continuing operations business. As we think about more of our surface tech businesses and some of the higher end pigment businesses, again the combination of those would be right around between 8% and 10% of the total business. And then much of what I would say, Mike, of the remaining higher end payments.So if you look at our payments versus CITPs [ph] as well as the Ultramarine Blues and then a portion of the [indiscernible] businesses as well, when you sum all of those businesses up in total, you're looking at roughly another 20% of the business. Now those are the - that's the complete, those are the complete business, but the diversity around the amount of markets that those go into and that's what we're going to see food and beverages, healthcare and those types of things. And that's really where we saw the diversity happen in the first quarter. I would tell you that pigments was an area, a significant area of strength for us year-over-year and part of it is obviously due to that.

[Michael Harrison:]

All right, got it. And then, I was also wondering if you could give a little bit more detail on what you're seeing in the electronics related businesses. You mentioned in surface technologies that you're coming off a very strong year there, and expecting some customer changeover to happen. Are you guys positioned in the next generation slurries that are needed in those semiconductor customers to kind of pick back up as we get into 2020, 2021 and forward?

[Peter Thomas:]

Yes, we are, Mike. In fact, that's one of the items that we mentioned in our prepared remarks. As we have established our position in those particular markets and we were in a generation of products. Usually as you know as well as I do, I know, the space there could be a three to five-year product life cycle. And what we're learning is that, we were in the first round, which took us up to last year.We are in the second round, but what is new for us is that a lot of these companies will take a lot of inventory right at the end of a product's life cycle, and use that through the course of the year and then we start to ramp up on the next generation. Such was the case in the fourth quarter of '19, as you know, where we had a lot of sales relative to those products and the company, those companies will be draining that inventory probably through the third quarter. And then you'll start to see a ramp up of the next generation of those particular products that you are referring to.But that's basically when you look - let me answer the question around electronics. You know, we do feel good about all of our electronic applications, although we can't be very specific. But if you think about things like high frequency communications with our low temperature profile ceramics, there are prep, there are lots of pressure sensors, there's oxygen sensors, there's nitrogen sensors, there's in the appliance area, there's a lot of printed circuit boards that are going on metal that we cut. You know, so we have a lot of novel and very interesting applications that we've been developing for the past four years that are starting to hit a certain stride. And you're seeing that performance because as we've mentioned in the prepared remarks, that business is up about 7% year-over-year.So we feel really good about those particular applications. Why? Because the growth rate, although starting from a small number is growing pretty significantly and there is more, you're going to hear us use a lot of the concepts that we – there is a lot more content that's driving our business, whether it like even in the automotive business, which is a perfect example, which report you want to read. Automotive was down as much as 15% year-over-year and we were done just under 10%. So like we've always said when things are good, we'll be up higher. When things are bad, we won't be as bad. And a lot of that has to deal with more content of our products.

[Michael Harrison:]

All right. And then last question I wanted to ask is on the raw material outlook. It looks like you saw some benefits in the first quarter. Could we see some more benefits flowing through in the second quarter or are there some timing issues that we should think of raws is maybe being more of a benefit in Q3 and Q4?

[Benjamin Schlater:]

Hey Mike, this is Ben. No, look I think we should – we would continue to expect to see raw material benefits in Q2 as well as in the back half of the year. For the most part, those raw materials have stabilized within a certain band.

[Michael Harrison:]

All right, thanks very much.

[Operator:]

We have a question from David Begleiter with Deutsche Bank. Please go ahead.

[David Begleiter:]

Thank you, good morning. Peter and Ben, can you just comment actually what April sales were actually down year-over-year?

[Peter Thomas:]

No, we can't do that.

[David Begleiter:]

Okay. and Ben, just looking at FX, what are your expectations for the rest of Q2 and the second half given current exchange rates?

[Benjamin Schlater:]

Yes, so, David, I would again point you to the sensitivities that are in the press release, but when we came out with our guidance originally that obviously we've sent withdrawn FX was right around a dollar eight, which is pretty close to where it sits now. So there was a little bit of FX benefit actually in the first quarter, but with where exchange rates sit now, that's pretty consistent with what was otherwise contemplated at the beginning of the year.

[David Begleiter:]

And lastly, Peter, are there additional costs, actions, temporary actions you're taking to offset the impact of the current crisis?

[Peter Thomas:]

Not really. I think that we're still on target with what we committed to for this year, roughly being about 40% of the $30 million that we committed to, and we're still on very much on task with that program. Maybe there is a bit more, quite candidly, some SG&A, Ben went over that, but at the end of the day, that's not going to move the needle in a way that you might feel comfortable, but it does contribute. And so, we are seeing certain things, but mostly at the SG&A level and it's again, it's not a real problem [ph].

[David Begleiter:]

Thank you.

[Operator:]

And we have a question from the line of John McNulty with BMO Capital Markets. Please go ahead.

[John McNulty:]

Yes, good morning. Thanks for taking my question. So this one may be for Ben. On the gross margin detrimental that you spoke about the 25% to 30%. Is that inclusive of some of the cost initiatives that you're taking or would we want to be adding that back in? And maybe a little bit of color on where some of those initiatives we can expect them to come through, because it looks like a lot are coming on the gross margin line, but at the same time your SG&A seems like it's coming in on the lighter side as well. So maybe a little color there would be helpful?

[Benjamin Schlater:]

Sure. So the short answer is yes, the 25% to 30% would include sort of all the costs optimization programs. And the way to think about that is those are basically offsetting a headwind in absorption. Right? So if you think normal margins are low-30s that would have been made worse by lower absorption, and then made better by initiatives. So that's sort of the first part of the question.If the gross profit line, we would expect margin benefit in both Color Solutions and Functional Coatings. We've got optimization initiatives including the North American piece that would impact both of those product lines and we would expect to see benefits in both places. On the SG&A front John. I think this is a focused effort on our part to make sure that as we get into a period where there's more economic uncertainty, that we're being prudent and judicious with the spending and that's just what you're seeing.

[John McNulty:]

Got it, fair enough. And then maybe to that, when you look at the working capital that you're running through the P&L, what can you adjust in terms of the cash flow as you're looking out through the rest of the year? How much should we be able to see as a release given the downturn that we're looking at or is it just that some of your growth opportunities prevent that release? Like how should we think about that?

[Benjamin Schlater:]

Generally speaking, John, it's 30%, right? I mean, so roughly 30% of volumes are sales fallout in the context of working capital. With the remaining businesses and continuing operations, our working capital is a little bit better, so we run a little lighter. So in certain circumstances, putting seasonality aside, you can see it down into the 25% range. The only thing that's happening sort of outside of the ordinary course of business with respect to working capital right now is we do have some strategic inventory builds as we're moving product around the world to get it into the right facility, but beyond that, not much.

[John McNulty:]

Got it. Thanks very much for the color.

[Peter Thomas:]

Operator, we have time for one last question.

[Operator:]

Thank you. We have a question from Mike Sison with Wells Fargo. Please go ahead.

[Michael Sison:]

Hey guys, nice start to the year.

[Peter Thomas:]

Hi, Mike.

[Benjamin Schlater:]

Hi there.

[Michael Sison:]

I was wondering if you could maybe give us your general thoughts and who the right peer group is for the new Ferro? And then, when I look at the broad sort of basket of chemicals, coatings, com materials companies, you know, I'm seeing EBITDA down in 2Q, you know, pretty wide range, right? 15% and 20%, some are down 50%. Can you sort of just talk about where you think you would be in that range and then do you have what 2Q 2019 pro forma EBITDA is? I apologize if I missed that?

[Peter Thomas:]

Yes, let me – let's break it up in a couple of different parts. The first part, let me make sure that we underscore something that I think is really, really germane to what we've been able to accomplish with remainco, as it relates to industry structure. Because I think that's where it all starts. And we do have, and I think I've mentioned this before, we have I think remainco sub-end to use. And when you break the industry structure out that way relative to each one of those sub-end to use, we have what we would define very, very limited type of competition in terms of the numbers of players.And for example, if you look at coatings, our definition of coatings may be different than just a [indiscernible], our coatings are glass coatings. They're colored, functional, pigmented, slurry coatings and the type of competitors that you would hear in that environment would not be big - those big names, they would be smaller type specialty companies and of course the biggest one that you may know, when we talked about decoration, PPG is in there.But, our decoration is at a higher application level, that is higher margin, but smaller volumes. So where we might compete with some of those big names we've carved out a niche at the higher end where the margins are higher, and there is less competitive intensity. So kind of like we've said, our sustainable gross margins are sustainable because of the positioning within each of those sub-end to use at the higher end.The whole strategy of the company, including the tile business as you know, has been to put each one of our platform in a mode where it drives towards the higher end with limited competition where the innovation is more important, pricing is stickier, and we end up jumping the CASM one or two times as we move down sequential new product introductions and that is what you're starting to see right now in the business, it's starting to present itself that way.

[Michael Sison:]

Great. And just sort of the comment on sort of the range for 2Q and what your adjusted EBITDA was for 2Q '19?

[Benjamin Schlater:]

Yes, Mike on a - for the continuing operations, the second quarter EBITDA was in the low 40s. It's sort of our estimates, and that would be on an adjusted basis, obviously.

[Michael Sison:]

Okay. And then I guess as a follow-up, Peter what's the right way to think about sort of a normalized EBITDA or sort of the EBITDA, you could get to post the pandemic, and added into the cost savings, and just sort of rebuilding some of the EBITDA potential once we get through this pandemic?

[Peter Thomas:]

Yes, Mike. So let's go back to what we said quite candidly back in our 2017 Investor Day, and then only we can maybe tick it up a bit. I think that we said back then that gross margins would be 33% to 34% right now. We can tell you, it's probably going to be higher than that. Of course you know that. You're starting to see the base is at 32. Understand that our new vitality index, with remainco is that a very high level and I can tell you right now our five-year pipeline has a gross margin average of 44%, where we're sitting at 32% today. So you can see the contribution that the innovation will bring and that coupled with the optimization programs that you're already seeing the benefit.And there will be more, don't forget we have stranded cost that come on after harvesting our signed the tile business or closing it. So gross margins, I mean I think we have made comments that we could see them at the 35% to 36% range, EBITDA margins. There is no reason to believe that we won't see approaching 20 as we go through the tile deal and moving into next year with the remaining of one, the optimization initiatives, which would be 60% of the 30 we generated [ph].And secondly, we do have the $10 million to $12 million of stranded costs that we spoke of. And three, again we have a reorganization designed about the way remainco goes to the market that's going to be more technology sales and marketing and strategically oriented rather than our product regional type of dimension. When you do that, there will be some cost benefits from that.So again, the profile of this business is one that we think is very, very attractive, again 35%, 36%, 37% gross margins, EBITDA margins approaching 20 and you have the math that will get you there. And I think Ben very, very distinctly outlined an EBITDA framework for our starting position for remainco next year, we listened to all that. You'll have a basis of what we think this business is as a starting point, which is certainly more attractive let us say. Why? Because I just outlined all the cost benefits and well Ben talked about during the last call, really didn't have a lot of growth and it either. So even if you want to be optimistic and put some level of growth and then add that to the mix, you will see a very, very attractive remainco business moving into the middle part of '20 and '21. So we're very excited about this business today and the first quarter.And Mike, there is something very interesting and we've discussed this before, and I think it's prudent for us that kind of end it on this note. We've been working for six years as you know trying to create something very special. And that something very special was taking what we had, that was very attractive, that it was a coherent portfolio, bringing it together and leveraging both technology innovation optimization, as well as inorganic growth to build a very unique business. And what we said going back six years, if you get, you know so it was very important to us, is that our end result would be to create a performance specialties business that really have all the characteristics of what a -- the good companies are. And we laid that out for everybody.We said that there has to be portfolio coherence. We said there has to be leadership positions in the products in the sectors. We said there has to be an attractive market segment. Our structure, we said there has to be stripped very, very strong technology and innovation capabilities. There has to be good dynamic growth, and there has to be cycle resiliency.So if you listen to our prepared remarks, we laid all of that out. So over the past years with what we have with remainco, by following our strategy of simplifying our operations, reducing the cost, harvesting underperforming assets, investing in higher growth value opportunities, which were the 55 technology platforms that we've built into the company.And then we have the dynamic innovation, optimization phase, which is really focused on streamlining, optimizing, improving the cost efficiency what you're seeing now, much like the Villagran situation, much like the European assets consolidation program that we spoke of, and all the other little things that we're doing, stranded cost, reorganizing remainco, putting this business at a very streamlined very, very attractive and strong financial position.And of course you know, so it is five, it is all about shifting the center of gravity to high-margin and high value portfolio. So you can see how we've brought all of that together. And when you look specifically at those six characteristics, then you have to ask yourself the question, how do we fit in with those six characteristics that I've mentioned? And you've heard us talk about certainly, you can see that we have higher margins and we're telling you that are sustainable.You can see that the portfolio is less cyclical. You can see that we have a more balanced end market and regional mix. You see that we have stronger underlying market growth. We have less raw material incentive positions. We are streamlining our manufacturing footprint and we certainly have a more technology led innovation-driven company.So when you think of the six characteristics was the end game, we strung out five phases over the past six years to create that model. I've just eliminated the top key focus points that are aligned with those six characteristics of good companies, and then your next question should be, because we think this is a big deal. And here's what excites us, which actually gets to answering one of Rosemarie's questions. What happens after COVID-19? Well, one thing I think everyone understands is that there will be structural changes with COVID-19.One of the most important things I think as an investor, which we are, is the lens that you look at each of the company’s wherein all investing in, whether it's ours or anybody else's, you want to know what's the fundamental structural changes in the performance and attractiveness of the end markets that are served by the companies like us and others that are focused on. And they're going to be very wide-ranging, and those would include some of the most important things where we are strong and we're starting to see it now with remainco. Sustainability and recycling is going to be very important. You know the one package concept that everything that we have that goes into it.You're talking about entertainment and leisure, well what about our electronics business? And what about all of the 5G applications that we have? You're talking about food and value chain. You know all of our products go into beverage bottles, they go into the coloring , they go into a lot of food packaging types of products. The medical and health industry, look at all the electronics, look at all the specialty pigment products, they are going into all those applications.So what is really interesting is remainco has really done well in the first quarter, pretty much aligned with the six characteristics of what we would define strong performing companies, what we've established aligned with those six characteristics and of course how are they aligned to post-COVID, and hopefully you can put the dots together to see Ferro is in a very, very strong position, not only now but what we phrased as post-COVID. We can see that we are very, very well positioned with post-COVID activities.

[Kevin Grant:]

Thank you, Peter. We would like to thank everyone for joining us on the call today. We appreciate your interest in Ferro and we look forward to discussing our results with you again next quarter.

[Operator:]

That does conclude the call for today. We thank you for your participation and ask that you please disconnect your line.