Ferro Corporation
Q2 2020 Earnings Call Transcript
Published:
- Operator:
- Good morning and thank you for joining the Ferro Corporation's Second Quarter and Full Year 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 conference call over to Mr. Cornelius Grant, Director of Investor Relations and Corporate Communications.
- Kevin Grant:
- Thank you, and good morning, everyone. Welcome to Ferro's second quarter 2020 earnings conference call. This morning, we'll be reviewing Ferro's financial results for the second quarter ended June 30, 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 Web site. 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 today. However, those views may change as conditions and circumstances change. Please refer to the forward-looking statement disclosure in the earnings release and 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:
- Thanks, Kevin. Good morning, everyone. Thank you for joining us to discuss Ferro Corporation’s second quarter 2020 results. Ferro’s second quarter performance demonstrated the resilience of our portfolio and the value we provide to our customers. Despite a 20% decrease in sales volumes in the quarter, we increased gross profit margin to 32.1%, an increase of 30 basis points. We were able to do this in part because of our market leadership positions and the criticality of our products to essential industries. In addition, our focus on innovative product development and the actions we have taken to increase efficiency in our manufacturing facilities and optimized operations also contributed to the gross margin improvement. The quality of our business continues to improve, and we believe our second quarter performance demonstrated the power of our business to sustain and expand gross margin levels, especially as economies stabilize and recover. We achieved this performance while navigating through the challenges of the global COVID-19 pandemic and the difficult macroeconomic circumstances that resulted. We have no higher priority than the health and safety of our employees, and we recognize their dedication and professionalism during these challenging times. They have continued advancing our strategic priorities and delivering at the highest level to maintain our market leadership positions. We are grateful to our teams all around the world for what they have accomplished. As we said in the second quarter press release issued yesterday, our second quarter results, while down from the prior year, were in line with our expectations. Demand improved in the latter part of the second quarter relative to earlier in the quarter with a trajectory that was quite favorable as the second quarter ended. We are seeing signs that give us confidence that the third quarter will continue this favorable trajectory with meaningful sequential improvement in demand relative to the second quarter, albeit not yet up to the levels of last year. Although the timing and strength of the economic recovery around the world is unknown, we see no reason at this point to expect that we cannot continue with favorable momentum through the year. Let me give a little more explanation regarding the basis of our expectations for the third quarter. One thing we do to maintain our position as a market leader is to stay in close contact with our customers providing technical assistance based on our expertise in functional coatings to help them design new products. This is key to our market leadership positions. Conversations with our customers and order patterns we began to see in the second quarter from certain industries we serve indicate that our customers believe the macroeconomic trough is largely behind them, and they are on an upward trajectory. They are gaining a clearer picture of their needs for the second half of 2020, and we in turn are learning more about their inventory status and expected demand. This forms the basis for our confidence that the third quarter will track in the same favorable direction that we saw coming out of the second quarter. In addition, we are cautiously optimistic that we will see sequential improvement from the third quarter into the fourth quarter as customers work through inventories and ramp up production. In addition, the breadth of our product lines in the industry we serve provides a measure of protection against declines in demand for particular products or from particular industries in these uncertain times. We also are optimistic about the future because our portfolio and innovation initiatives are aligned with macro trends, which continue even in the current unsettled macroeconomic environment. We have previously explained that these macro trends create the opportunities for our innovation programs. Functional coatings and color solutions are at the core of our product innovation. Our functional coatings products are used in a wide range of applications across the automotive, industrial, decoration, construction and electronics markets. We have invested in technology platforms that position Ferro to play an essential role at the early stages of customers’ development of new products designed to address these emerging trends, leveraging our existing portfolio and prudently enhancing it with opportunities for additional growth. As an example, one of the macro trends that we are aligned with is electrification, which is driving increased demand for our pastes in sensors. Demand in the electronics sector was strong in the second quarter, resulting in double-digit sales growth. Our R&D efforts related to electrification are converging around materials for next-generation electronic applications, such as 5G, the Internet of Things, AVs, EVs, virtual communications and more. We also are well positioned for the continuing adoption of digital technologies. Our R&D in this area is focused on digital printing on a variety of substrates, with inorganic and organic inks as well as digital printing equipment. In our color solutions business, we offer a wide range of organic and inorganic specialty pigment products that support next-generation product applications. Our R&D for color solutions is directed toward continuing to modify individual pigments for customized functions in such areas as Infrared Reflection, food packaging and anticorrosives. Our market leadership positions and innovation programs have opened the door to relationships with well-known innovation leaders of today. These relationships offer significant scope for growth and value enhancement. We are a supplier of choice to these global and regional innovation leaders. Our strength in technology, global presence and focus on partnering with our customers enable Ferro to provide significant value to our customers and benefit from their growth. We’re very enthusiastic about our business model. We’re focused on high margin, essential products, cemented by innovation and optimization initiatives that are aligned with significant macro trends. With that, I’ll turn the call over to Ben for more insight into the second quarter results, and then I’ll discuss our segment performance. Ben?
- Benjamin Schlater:
- Thank you, Peter, and good morning, everyone. I’d like to start by echoing Peter’s comments on the resiliency of the business in the quarter, especially during the economic contraction due to the pandemic. During the second quarter, we continued to see the true performance of our continuing operations with two consecutive quarters of adjusted gross profit margins above 32%. We believe this is a good example of the quality of the business and the underlying portfolio to which all the Ferro associates have contributed. This also gives us the confidence, as Peter mentioned, about the momentum going forward. With that, I’ll move on to discuss our consolidated financial results for the second quarter of 2020 from continuing operations. Please note that the non-GAAP numbers I refer to are on an adjusted basis and growth rates mentioned are on a constant currency basis compared to the second quarter of 2019. The financial highlights and results for the second quarter can be reviewed on slides 3, 4 and 5 in the presentation accompanying today’s call, which you can find on ferro.com in the Investors section. Moving to Slide 4, in the second quarter. Net sales declined 19.6% to $204.8 million, adjusted gross profit declined 19% to $65.7 million, adjusted gross profit margins improved 30 basis points to 32.1%, adjusted SG&A expense declined by 6.9% to $45.2 million, adjusted EBITDA declined 29.5% to $30.9 million or 15.1% of net sales and adjusted EPS declined 50.5% to $0.12. Now moving to Slide 5. On a year-to-date basis, net sales declined 12.8% to $457.1 million, adjusted gross profit declined 7.1% to $147.6 million, adjusted gross profit margins improved 130 basis points to 32.3%, adjusted SG&A expense declined by 5.6% to $96.8 million, adjusted EBITDA declined 8.5% to $71.6 million, adjusted EBITDA margins improved 80 basis points to 15.7% and adjusted EPS declined 2.6% to $0.37. These results reflect certain non-GAAP adjustments for the second quarter, primarily related to costs associated with previously divested businesses, corporate development and optimization activities for both our Americas manufacturing optimization and global optimization programs. First, in cost of sales, we have adjustments of approximately $1.9 million, primarily due to costs related to our Americas manufacturing optimization initiative. In SG&A, we have one-time adjustments of $5.4 million in the quarter, $3.8 million of that consisting of costs for legal fees, professional fees and other expenses related to certain corporate development and optimization initiatives, including the Americas manufacturing optimization of $800,000 and $1.5 million related to divested businesses. And finally, turning to restructuring and impairment, there was an adjustment of approximately $8.6 million, reflecting actions to achieve our ongoing optimization initiatives and acquisition synergies, $800,000 of which related to the Americas manufacturing optimization and $7.8 million of which related to our global optimization program. Turning to adjusted gross margin. The business continues to show resiliency and has delivered adjusted gross profit margin above 32% for two consecutive quarters. In the second quarter, adjusted gross profit margins improved 30 basis points to 32.1% compared to the prior year second quarter. This was driven by lower raw material costs, better product sales mix and product pricing. As Peter mentioned, we expect to continue to see this momentum in adjusted gross profit margins. I’ll now move to SG&A. In the second quarter, adjusted SG&A expense was lower by 6.9% to $45.2 million or 22.1% of net sales compared with $48.5 million or 19.1% of net sales in the prior year quarter on a constant currency basis. This brings me to GAAP cash flow from operating activities. I will also discuss adjusted free cash flow 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 this metric by combining the following lines from our statement of cash flows, GAAP cash flow from operations less capital expenditures and plus cash collected under our securitization programs. This information can be found on Table 12 in our press release. In the second quarter, GAAP cash flow from operations was an outflow of $33 million. From that, we subtract $6.7 million of capital expenditures and then add cash received on other receivables of $33.8 million to arrive at $5.9 million of adjusted free cash flow used in the second quarter, the largest drivers being our cash earnings and changes in working capital, driven for the most part by inventory builds related to our Americas optimization program, which we expect to be temporary in nature. Continuing with our discussion on the balance sheet, Ferro is well positioned from a liquidity standpoint. As of June 30, 2020, we had liquidity of approximately $548.2 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. With that, I’ll 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:
- Thanks, Ben. Now I’ll take you through second quarter performance and our continuing operations reporting segments. As a reminder, earlier this year, we changed the name of our former performance colors and glass segment to functional coatings, which now also includes our porcelain enamel business. So let’s begin our discussion with the functional coatings segment. In the second quarter, functional coatings net sales on a constant currency basis were down 17.3%. Gross margins declined to 28.7% in the second quarter from 31.1% over the prior year period on a constant currency basis. Adjusted gross profit declined 23.6% from $49.6 million to $37.8 million. The vast majority of the decline in sales volume and gross profit resulted from weaker demand, due to the COVID-19 pandemic. This broadly impacted many of our end markets, such as automotive and industrial. Certain of our larger home appliance manufacturing customers also worked through inventories during the quarter. However, what we began to see through the second quarter is what we would call virus-proof growth brought on by the transition from workplace and schools to working from home. Examples in this space are high-end electronics that support virtual communication and memory devices. Our electronics materials business was up approximately 24% in the quarter compared to the prior year. Over the past several years, we have focused on investing in the electronics space to broaden our customer mix. Ferro’s electronics materials technology is found not only in the automotive sensors and high-end consumer electronics, but also in the electronics that enable people to do their jobs or schoolwork more efficiently away from their workplace or classroom. Our products also are critical elements in the devices being used to monitor and assist people using healthcare apps and telemedicine. As anticipated, during the second quarter, sales in the automotive sector declined significantly across the globe by approximately 50%. This was primarily due to automotive production shutdowns in the U.S. and Europe. However, we started to see some Asia Pac automotive production ramp up late in the second quarter, and as a result that region was down in the quarter, a comparatively modest 25%. Our decoration business was down approximately 30%, driven by lower demand in the U.S. as hobby distributors that are used by schools and retailers were closed for several months. There was also lower demand in Europe for luxury item bottles and decoration products, which resulted from closures in the hospitality segment of bars, hotels and restaurants. In both the industrial materials business and porcelain enamel business, sales were down approximately 20%. These declines were primarily due to commercial construction delays due to the COVID-19 pandemic and softer demand for digital printing equipment. As I mentioned, some larger home appliance manufacturers worked through their inventories early in the COVID-19 outbreak. This is causing some of them to have larger backlogs to deliver the finished appliances. We expect to see benefit from increased production by these customers during the second half of 2020. Now turning to our color solutions segment. In the second quarter, color solutions net sales on a constant currency basis were down 23.4%. Gross margins improved 510 basis points to 36.9% compared to the prior year quarter, which was at 31.8%. From a sequential quarter perspective, gross margins improved 200 basis points, primarily driven by lower raw material costs, price increases and plant utilization. Adjusted gross profit declined 11.2% to $27 million from $30.4 million in the prior year quarter. Like many of our end markets, our pigments segment was down in the high teens range, but we started to see a pickup in the latter part of the quarter with the do-it-yourself paint segment and consumer packaging. Viewed from a regional perspective, our pigments business in the U.S. was down mid-teens. In Europe, pigments were down 25%. And in the Asia Pac region, we had a mid-single digit decline. So, to sum it up, we managed through the second quarter and believe we are largely past the low point of the economic challenges that our customers have experienced. We expect increasing demand to continue to sequentially improve in the third quarter, and based on what we know today, are cautiously optimistic we will sustain the momentum in the fourth quarter. We anticipate ending the year at a point where we can begin to accelerate the growth potential of our business with the benefits from our major initiatives, including those related to the sale of our Tile Coatings Business. We also wanted to update you on the sale of our Tile Coatings Business to Lone Star and its affiliate, Esmalglass. Since the announcement of the transaction, we have been targeting a closing in the second half of 2020. Ferro and Lone Star are actively working so that the transaction can close according to its terms in a timely manner, which the parties currently expect to happen in October or November of this year. As we look at our business today, we have a more focused portfolio and more efficient operations. I’ve discussed the resiliency of our technology-led and innovation-driven business, our confidence for the third quarter and our cautious optimism for the fourth quarter. Although we acknowledge that conditions are fluid to some extent, we continue to execute on our innovation and optimization initiatives. Based on order patterns and customer insight, we expect a meaningful increase in sales in the second half of 2020 compared to the first two quarters of the year. In the first half, our RemainCo business performed to the level we have been telling you, we would expect from the portfolio with significant year-over-year improvements in gross margin and EBITDA margin as well as positive earnings, outperforming many of our peers. This gives us confidence that the second half has the potential to be even more positive. One factor contributing to our optimism is that the favorable mix we saw in electronics during the second quarter is starting to occur in our other businesses as well. Current volume levels can mask those projections. In fact, we see signs of a V-shaped recovery for Ferro as a result of the improvements made during the innovation and optimization phase of our strategy, which has enriched the mix of our entire portfolio. So we have good reasons to expect that when we are in a more normalized macroeconomic environment, we will see a return to pre-COVID volumes and the opportunity to grow both the top and bottom lines from there. So, thank you again for joining us today and we look forward to your questions.
- Kevin Grant:
- Thank you, Peter. With that, operator, let’s open up the call for our first question.
- Operator:
- Thank you. [Operator Instructions]. Our first question is from the line of Rosemarie Morbelli with G. Res. Please go ahead.
- Rosemarie Morbelli:
- Thank you. Good morning, everyone. Congratulations.
- Peter Thomas:
- Hi, Rosemarie.
- Benjamin Schlater:
- Good morning.
- Peter Thomas:
- Thank you.
- Rosemarie Morbelli:
- I apologize. I missed the beginning of the call as I had problems getting on. I was wondering if you have touched about how COVID has changed the way you are operating as a new company. And what we should be looking at in terms of the potential for RemainCo post the Tiles and post-COVID or even post Tiles and still with the uncertainty of COVID actually.
- Peter Thomas:
- Yes. Thanks, Rosemarie. I think – let’s address the COVID point because we teed [ph] something up during the last call, which the more we’ve looked into it, we are going to speak with more conviction about some of the indications regarding what our business is using COVID as an accelerant. And what we’re seeing, if you look at things like emerging structural changes as a result of COVID, there are maybe seven or eight key items that certainly investors – I know we do it as a team here, looking at the things we do personally on investment. And we do look around this concept of emerging structural changes. And of course, we apply it to our business. If you look at a handful of things that will structurally change, we’re looking at things like sustainability and recycling. And certainly, we have a lot of our products that would go into plastic bags where this concept of the single-use will become more prevalent again. We have pigments and inks that go into those spaces. Of course, health risks associated with all this multi-use type of a concept, not just bags but any type of foodware or dinnerware and the like, not to mention things like the higher carbon footprints that many single alternatives use. So if we look at the sustainability and recycling piece, we hit the spot in terms of post-COVID. Another piece that’s really important and I think you’ve heard it on the prepared remarks would be the concept of entertainment and leisure. And of course, the migration of large venue entertainment to smaller environments, certainly we see will drive an increase in consumer electronics and even in home remodeling, of course. You know our position with electronics between home improvement, construction, electronics and the like, that represents as much as 35% to 40% of our business. So we feel very good around that. We should – more germane to us, would show that a more positive and long-lasting impact on demand for things in our end markets like packaging, electronic chemicals, the new R&D work that we’re doing, which I’ll talk to in a bit, about selective types of polymers and the types of substrate printing that we’re applying on polymers and of course, the functionalization of our pigments in the architecture area with some of the major – the paint houses. So the concept of post COVID for us in entertainment and leisure is very high. How about the food value chain? We think that’s very important. Changes in food purchasing and consumption behaviors will certainly cause a structural shift in food packaging, and we’re starting to see it. We saw it at the tail end of the first quarter, sharply in the second quarter and emerging here in the third quarter, and we feel good about the fourth quarter in this space as well. And something that’s really served quite nicely for us and you’ve heard it in the prepared remarks, medical and healthcare industries. There’s significant investment in medical and healthcare industries and certainly will bolster the demand for our types of products that would go into that space, whether it’s ER electronics that we’ve mentioned that would go into telemedicine type of activities or even respirators or ventilators and any type of operating equipment. You’ll hear more going forward, that we have new product commercialization activities and what we’re defining is bio ceramics, which are both in and out of the body type of applications. And we’re starting to see a nice pull on demand for some of those new products. Also, even though the automotive industry is down when we talk about road travel and automotive sector, I’m sure everyone’s noticing the sharp demand in recreational vehicles. As people want to stay close as they’re traveling, they don’t want to miss the experience, but maybe they don’t want to fly, maybe they don’t want to stay in a hotel. And the demand for our types of products in transportation have moved up a bit here, certainly in the second and definitely into the third quarter as it relates to other than automotive applications. Because as many people know, automotive has been down but there is a bright story that we can discuss here in a little bit. So we do also see that the resulting increase in the use of private vehicles. And if you dig into automotive demand going forward, even though there’s a lot of negative, we always talk about our positive versus the market because when things get good, we can do better. When things are bad, we’re not as bad. And certainly that was the case in the first quarter and in the second. And of course, everyone knows if you read all the studies and you push COVID aside for a second, the demand for automotive, particularly with our type of products, we can see it in the third quarter and have some limited visibility, but good visibility in the fourth quarter. We’re all about context. So we can see a pickup in the order patterns for some of our product for the second half of the year. But also the concept is that many people don’t want to use public transportation, and we’re also seeing a pickup on some in-depth studies around how people that – late teens and early 20s, about 30% of that population, going back five years ago, didn’t feel the need to have to have a license to drive. And that was one of the challenges that the automotive dealers and the companies were trying to deal with, the lack of demand from millennials and a like for cars. However, what you’re seeing and what we’re reading is that there’s a demand – there’s a nice demand for those first generation drivers, again, much like I don’t know if you’ve noticed, but people are moving out of the urban area because of this and the first-time homebuyer situation is starting to pick up. And we’re positioned quite nicely in that space. So I think the concept of dense urbanization, road travel, medical and healthcare, food chain, entertainment, leisure, sustainability, recycling, based on our assessment and also using, by the way, an outside lens from some experts in this space, we can say that at least 85% of our portfolio fits the bill of using COVID as an accelerant to enhance our business model. Does that answer your question?
- Rosemarie Morbelli:
- All right. Thank you, Peter. Yes, in more ways than one. Peter, if you could just give a little more details and then I’ll get back on the queue. In terms – you mentioned new relationships with innovation leaders. Can you give us a little more on that to understand what you are actually doing and who with?
- Peter Thomas:
- We would really like to share some of that with you, but unfortunately we’re in some pretty heavy confidentiality agreements that we have to be. We’ve committed to be very cautious with that. But rest assured, if you think of all the nice novel things that are going out there, I would bet more than not that Ferro is involved with some of those exciting opportunities, albeit maybe some of them are very abstract. However, looking forward, those things could become functionally important and would certainly enhance our portfolio.
- Rosemarie Morbelli:
- Okay, great. Thanks.
- Peter Thomas:
- You’re welcome.
- Operator:
- Our next question is from the line of Mike Sison with Wells Fargo. Please go ahead.
- Michael Sison:
- Hi, guys. Nice quarter.
- Peter Thomas:
- Hi, Mike.
- Michael Sison:
- Peter, you mentioned that you felt there could be good sequential improvement into the third and maybe carrying some momentum in the fourth. Can you give us a little bit more color? Was that more on what you can control in terms of profitability or maybe walk us through some of the trends that you’re seeing in July in terms of sales to sort of give you the confidence that we’ll get that improvement in the second half?
- Peter Thomas:
- Okay, good. That’s a good question. It will give me an opportunity to underscore an important point that I’ve been making in the last three calls about how you need to view the RemainCo business in terms of order patterns. But as you know, many of our peers and many people have mentioned that April was the softest month for them. And for us, it was actually May. We had a reasonable April. And a lot of that has to deal with the framework of the order patterns for RemainCo. And what do I mean by that? And why is it important? When you look at more commoditized business, you may find that after 10 days in a month, 70% to 80% of the bookings are already made. So the order pattern for some of those to be every 10 days or so. But with RemainCo, we have eight MBUs that you all know of. Each one of those has a very interesting order pattern. For example, the more – the lower gross margin-type products in the eight MBUs in aggregate, we may see an order pattern every four to five weeks which seems to be an average. As you move up in gross margin, all the way maybe to an electronics piece relative to us, you may find that those order patterns can be 10, 12, 13, 14 weeks at a clip. And if you look at surface tech, maybe those are 8 to 12-week patterns. And the rest of performance colors and glass, functional coatings would be in that spot between 4 to 9 or 10 weeks. So we’re trying to be more predictable around how we’re going to talk through the order patterns. Because think of the first quarter for a second, how we had a really, really good first quarter. And we did mention that part of the reason why that quarter was good is because some of the sales that moved into the first quarter were actually ordered back in November and the likes, so they did come to fruition and people did take the orders. So I made the comment that maybe a good way of looking at RemainCo would be basically a trailing 15-month type of a pattern or a forward 15-month pattern to allow for the gestation of the portfolio or the MBUs to go through a full flush of a yearly order pattern as a minimum. So that’s one dimension, is understanding the dynamics of the order pattern, how it may come into the year as you think through your planning process like we are. That’s one part. The second part, why do we feel good about the third and fourth quarters? And what might that look like and what are we looking at? Okay, so back to the first part about the second quarter being light for many, many folks. For us, as you know, we were roughly, versus last year, down about 20%, let’s say. So when we talk about meaningful movement, it’s a lot of it is going from the second to the third quarter. Because when you look at the gap between last year and this year, the third quarter is going to be very meaningful as really tightening up that spread between last year and this year. We’re going to do a lot better from where we sit today than being down 20%. And that’s the meaningful piece. And we have very nice visibility into the third quarter. Now why is that? It gets back to the order pattern that I mentioned. Because going from the first quarter to the third quarter, we have some of those longer order patterns hitting in the third quarter because of the 12 weeks or 10 weeks period. So the third quarter makes us feel really, really good. Now you’ve also heard me make a comment that our business model resembles kind of a V. I know the global thing isn’t like that, but our business model is different. And what do we mean by that? Well, our – what visibility we have into the fourth quarter would suggest that gap, that delta between 2020 and 2019 even tightens up more going into the fourth quarter in a way that sequentially we could see a third quarter better than the second and a fourth quarter better than the third. And although we have limited visibility into what one argue as the first quarter of next year, if you think through what I just mentioned and you anticipate putting COVID aside that those longer lead time orders that are 10 to 16 weeks long with the highest margin, one might argue that would start to manifest itself into the first quarter. So that’s the comment around we see a resemblance of some sort of a V with the business model. And so we would expect, in addition to that concept, our margins because of the mix. Now you’ve heard us talk about, we had a nice electronics opportunity here in the second quarter, moving into the third quarter. Each one of our eight MBUs will perform equal to or better in the third and fourth quarters. We see that. And also understand that we talked about mix a lot in the second quarter. And that was in electronics. But what we can tell you, in every other MBU, because of the – whether it’s the new products that we’ve commercialized late last year and moving into this year with the type of ramp up, the mix enrichment within each MBU will start to manifest themselves into the third quarter. Not to mention the fact that we have a range of products that will be introduced in the third and fourth quarters that are very, very novel for us and some things like – let me give you a couple because I think it’s really important because this business model, we talk a lot about innovation and vitality index. And it will help to underscore why we feel pretty good about what we’re seeing. If you think about some of the new products that we haven’t commercialized yet, but you may see tailing into the second half of the year and surely going into the beginning of next year, not to mention the additional run rate of what we’ve already introduced that’s embedded within each of the product mixes of our sub MBUs and MBUs, you might have trends you’ve heard me talk about bioceramics for healthcare, food and cosmetics. That’s a very interesting platform, very novel and there are some very interesting applications. We have a new range of polymer conductive materials that would put us in the adhesive space in a very niche-oriented way that we view an adhesive as a coding. In our minds, the way we look at it, particularly where there’s extremely high, high temperatures involved. How about new enamels for food contact that are – actually have bioinspired [ph] properties or clean properties that can be cleansed off nicely without disrupting the types of finishes for a whole range of applications. We also have one of our dimensions on Megatrends as our echo-friendly organic colors, particularly substituting things like chrome and other materials, but still offering the marketplace very vibrant yellowish and oranges type pigments with functionality. Another very important thing that you’ll see moving forward, again, was some of these, let’s call them, innovation leaders around the world would be our glass enamels, the white coatings for solar cells that will improve transmission efficiencies. That’s a very interesting dynamic for us and we’re very excited to be working with certain individuals and companies with that because of the long-lasting and long-range types of applications for those products. And of course, you may remember, Mike, I think you brought it up maybe about four calls ago. And we were joking about Dip-Tech and how we said please understand this is the beginning of us digitally coloring the world. And with that acquisition, we now have an integrated solution with equipment, the heads, organic and inorganic inks in a way that now we would be able to color a plethora of substrates like PVC, concrete, wood, fiberboard and a whole range of others. So it’s this commercialization that’s already occurred embedded in the mix and then that which is coming out. And why else? I’m just going to echo again. You look at the automotive industry, which is a big piece for us. And if you look at it already, if you read the studies, you’ll find that moving into the fourth quarter – third quarter rather, the European auto business, although it’s been down almost 40% or 50%, it’s only projected to be down 10% in the third quarter. And then in the fourth quarter, it’s supposed to be flat. If you look at North America, down in the third quarter, up 2% in the fourth quarter and so on in a way that with the drastic drop, it will end around the world about 20%, 25%. But more importantly, in order for that to occur, you look at 2021 and the newest projections would be that the automotive space will be up 23%, which means we might see some of that impact a little bit earlier going into the year. So I gave you a lot of data, but I’m trying to provide you with some color around why we feel the way we do. And again, pushing COVID aside because everybody is using that and whatever, in the bottom line, it is there. We’re not ignoring it. But understand that in order to be thoughtful and move forward and not be contaminated with a constant ugly cloud of that impacting your business, we want to give some visibility in what we would think would be some normalized state. So when you add it all together, there’s your visibility of why we feel the way we do around the third quarter and moving into the fourth.
- Michael Sison:
- Great. Thanks. And then a quick follow up. Can you give us your degree of confidence of the close for Tile and the commitment to the buyer? And then your balance sheet is going to be in pretty good shape. What do you think the capital deployment priority will be once you get the cash? Thank you.
- Peter Thomas:
- Yes. So we’ll answer it in two parts, and I’ll do one and Ben will do the other. Understand because of the agreement we have, anything that we comment – make comments on, we do have to – we share that with Lone Star and we have to agree that whatever we say is a joint agreement. So we did provide some color more detailed this time around. But the color we can give you that both parties agree to, if you will, is that Ferro and basically Lone Star, we continue to certainly work together to close the transaction. I can tell you, and Ben will echo this and Mark, because everyone at this table we’re in constant conversations with virtually multiple times per week to discuss projects and next steps. And certainly, in particular, the parties have focused on two main key areas for this deal and it would be antitrust and the separation of Ferro’s tile and non-tile businesses. And certainly, we continue to support Lone Star as much as we possibly can and even more, in some cases, to obtain antitrust approval and substantial review of the transaction by the regulatory authorities. And as it relates to Ferro, how we’ve separated tile and non-tile businesses, we are doing that and all the related IT functions basically in July. And the Tile business is now running on its own IT system, which we plan to hand over to Lone Star at closing. So if you – the sale agreement is public. We made it public right away so everyone – that may – would’ve answered a lot of folks’ questions, I know it’s laborious maybe for everybody to get into it. But it was very nicely defined and everything was laid out. And so both parties are working very hard to get this deal done.
- Benjamin Schlater:
- Yes. Mike, with respect to capital deployment, obviously with the sale proceeds, we would expect to pay down long-term debt. And then beyond that, we’ll remain focused I think on leverage with also evaluating a number of different opportunities, as you’ve heard us talk in the past, for both continued optimization inside the facilities as well as looking at both organic and inorganic growth opportunities. But all the while, it’s – we’ve spent a lot of time getting leverage now to a place that post deal is going to be pretty good. We’ll stay pretty focused on that.
- Michael Sison:
- Got it. Thank you.
- Operator:
- Our next question is from the line of John McNulty with BMO Capital Markets. Please go ahead.
- John McNulty:
- Yes. Thanks for taking my question. So you had mentioned earlier just because of some of the optimization in the Americas side that inventory was maybe a little chunkier than you would have liked. And admittedly, the working capital was a little bit bigger of a use of funds as opposed to a source. So can you give us some color as to when we might see some of that working capital released and the cash flow picked back up again? Is it something that we could see in the second half or is it something that maybe drags on into 2021? How should we think about that?
- Benjamin Schlater:
- Yes. Hi, John. So if we look at working capital in the second quarter, and we have to remember we have to net what we collect on the AR securitizations against that, it was actually favorable by about $4 million or $5 million. And as we unpack that a little bit, if we look at both AR and AP, with respect to – as a percentage of sales, so we look at that in terms of leverage, those AR and AP actually performed as expected. In fact, a little bit better. If you look at the percentage of sales, we were actually better than we were in the first quarter on both accounts receivable as well as accounts payable, which makes sense given what volumes did in the second quarter. And we were also better on AR and AP than we were in the second quarter of last year as a percentage of sales. So we’re seeing real traction there from a working capital perspective. You’re correct. Switching over to inventory, where we see the headwind is inventory. And so that inventory relates to build that we’ve had to do because we’re shifting so much product down into lower-cost facilities. The magnitude of product that we’re shipping requires these large builds. And so a lot of this product is very high from a technology perspective. So we have to build up that inventory. And then we’ll release that over the course of this year and into the beginning of next year. But that will be temporary in nature. And like I said, we’ll expect to release that over the course of the next six to nine months.
- John McNulty:
- Got it. That’s helpful. And then, Peter, like when I look at the end markets that you serve, electronics looks like it’s still holding up solidly, autos is bouncing back neatly. So when we think about the magnitude of the improvement from 2Q to 3Q, are we at a point where realistically 3Q sales could be down high-single digits, something like that or is that too aggressive based on kind of the timing it actually takes for you to start to feel that demand pull? Is that the right way to think about it?
- Peter Thomas:
- The best way of looking at that, and I’ll keep it at this level of what we mentioned and think it through, if we were down 20% in the second quarter from last year, we made the comment that there’s going to be a meaningful improvement and tightening that gap between the third quarter of last year and this year, is the way you should look at it. And meaningful means meaningful.
- John McNulty:
- Got it. Fair enough. Thanks for the color.
- Peter Thomas:
- Okay.
- Operator:
- Our next question is from the line of David Begleiter with Deutsche Bank. Please go ahead.
- David Begleiter:
- Thank you. Good morning. Pete, just to follow up on John’s question, can you tell us what July volumes were versus June? How much have they improved?
- Peter Thomas:
- Yes. We won’t be specific. But we can tell you they were better. June was better – as I mentioned, May was our soft month. So June was better than May. July is better than June, and we like what we’re seeing in August. So definitely, we’re clear about where we see the trough. And then it gets back to how I answered John’s question. If you feel good about what we said about July, and maybe August, and of course, this meaningful gap closure between the second quarter this year versus last year and the third quarter, that tightening is meaningful.
- David Begleiter:
- Very good. And maybe, Ben, just the gross margin in color solutions in Q2 was quite impressive. Is that level sustainable going forward? And maybe a little more color on what drove that sequential increase versus sales being down sequentially?
- Benjamin Schlater:
- Yes, sure. Thanks, David. That’s an area obviously we feel really good about. I would say there’s three things with respect to color solutions. One, as you guys recall, last year in the second quarter of 2019, we had some headwinds from a manufacturing perspective that are behind us now. So the comps are better. The biggest single piece is the fact that the work that we’ve done on these manufacturing optimizations have really started to take hold in the second quarter. And the product that we moved into the lower cost facilities first was color solutions. And we saw that really have a significant impact in the second quarter. The other piece I would tell you is that much of color solutions from a manufacturing perspective, particularly in Western Europe and in Latin America, are in lower cost facilities that we can take cost out much more rapidly as volumes starts to move. So I would say those three things was the biggest piece being the impact of the optimization.
- David Begleiter:
- Thank you very much.
- Kevin Grant:
- Operator, we have time for one more question.
- Operator:
- Certainly. Our final question is from the line of Mike Harrison with Seaport Global Securities. Please go ahead.
- Michael Harrison:
- Hi. Good morning.
- Peter Thomas:
- Hi, Mike.
- Michael Harrison:
- Peter, looking at the Q3 EBITDA number, just kind of wondering, we did 31 million in the second quarter. We did a little over 40 million in the first quarter. Does the third quarter get back towards that first quarter number? Is that what you’re pointing toward with meaningful improvement?
- Peter Thomas:
- Yes. Mike, we haven’t said anything like that. And I think we should. Just go back to modeling a meaningful improvement from the second to the third quarter and see what you feel about that.
- Michael Harrison:
- All right. And then wanted to ask in the color business, can you give a little bit of additional detail about your exposure to the coatings space? You mentioned the DIY improvement. Yet, it still looks like your pigments business was down quite a bit. So how much of your business is architectural versus auto-related coatings versus other industrial coatings? And can you maybe talk about where you’re seeing customer inventory levels within the coatings space?
- Benjamin Schlater:
- Yes. Hi, Mike. It’s Ben. So actually within color solutions, if we look at what each of the businesses did, the pigments businesses were actually down the least. So we saw those businesses perform the best inside of color solutions, which makes sense with what we’re hearing and what you’re hearing from a do-it-yourself perspective. And then the larger fall offs would have been in the higher technology space, which goes back to some of the order patterns that Peter talked about earlier.
- Michael Harrison:
- All right. Thanks very much.
- Kevin Grant:
- We would like to thank you for joining us this morning. We appreciate your interest in Ferro, and we look forward to discussing our results with you next quarter.
- Operator:
- That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.
Other Ferro Corporation earnings call transcripts:
- Q4 (2020) FOE earnings call transcript
- Q1 (2020) FOE earnings call transcript
- Q4 (2019) FOE earnings call transcript
- Q3 (2019) FOE earnings call transcript
- Q2 (2019) FOE earnings call transcript
- Q1 (2019) FOE earnings call transcript
- Q4 (2018) FOE earnings call transcript
- Q3 (2018) FOE earnings call transcript
- Q2 (2018) FOE earnings call transcript
- Q1 (2018) FOE earnings call transcript