Ferro Corporation
Q2 2018 Earnings Call Transcript

Published: 27 Jul 2018

[Operator:]

Good morning and thank you for joining the Ferro Corporation 2018 Second Quarter 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 7 days. I would now like to turn the call over to Mr. Kevin Cornelius Grant, Head of Investor Relations for Ferro Corporation.

[Kevin Cornelius Grant:]

Thank you and good morning everyone. Welcome to Ferro's second quarter 2018 earnings conference call. This morning, we'll be reviewing Ferro's financial results for the second quarter ended June 30, 2018. I'm pleased to be joined today by Peter Thomas, our Chairman, President and CEO; and Ben Schlater, Vice President and Chief Financial Officer. The earnings release and the conference call presentation deck are available on the Investor 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 today. However, those views may change as conditions and circumstances change. Please refer to the forward-looking statement disclosure in our earnings release and presentation. Also today's call will contain various operating results on both the reported and adjusted basis. Description of these non-GAAP financial measures and reconciliations are included in the earnings release and the presentation deck. We encourage you to review that information in conjunction with today's discussion. We are modifying our presentation format slightly this quarter. We will begin with Peter's review of the Company's performance in the quarter and certain recent acquisitions activities. Ben will then comment on the Company's financial results and then pass it back to Peter. Peter will then summarize the credit performance of the three business units and comment on our full year 2018 guidance. As before, we will reserve most of the hour to address your question. It is now my pleasure to pass the call over to Peter.

[Peter Thomas:]

Thanks, Kevin, and good morning everyone. Ferro's global team delivered another quarter of strong performance. In fact, adjusted earnings per share in the second quarter were the highest in at least 10 years. Right across our business, we experienced continued strong demand for our functional coatings and power solutions products, technical service that we've provide alongside this price. Our associates are demonstrating back the dynamic innovation and optimization as they went in a combination. In the quarter, net sales increased almost 20% over the second quarter last year to $416.2. GAAP earnings per share increased 40% to $0.35 per diluted share and adjusted EPS increased 18.9% to $0.44 per diluted share. Without the headwind of transactional foreign currency losses amounting to a $0.02 per share, our business delivered $0.46 per share on an adjusted basis. The second quarter was Ferro's 8th consecutive quarter of organic growth. One reason for our extended run of organic growth is that our vitality index has continued to expand approximately 20% of our revenue in the second quarter came from new products. As we have said, we said how to build a robust innovation pipeline to drive organic growth and the results to date have been impressive. At the same time, we are supplementing the creative efforts of our teams concentrating on organic growth with innovative products acquired through acquisitions. These acquisitions should accelerate Ferro's technology leadership propelling growth and profitability both now and in the future. Regarding acquisitions, as we reported in our second quarter press release, we recently have completed or have pending agreements for acquisitions that provide Ferro's substantial innovation and optimization opportunities. The transactions brings to Ferro high margin products with advanced technology, expand our current addressable markets, enable us to enter new markets, extend our geographic reach and present us with opportunities for a commercial and operational synergies. They align with our growth strategy and are leveragable across all our businesses and are immediately accretive to earnings. It also is worth noting that each of our three business units will be home to at least one of these acquisitions. In other words, we are looking for acquisition targets to provide immediate financial benefit for Ferro and position us strategically for future growth. We are finding opportunities to execute on for each of the three business units. As you may notice, we are being somewhat protective of specific information regarding these recent acquisitions. From a competitive standpoint, the acquisitions have been implications from pathways to growth that we do not wish to disclose at this time. I am prepared to say that the acquisitions help to run out the technologies in our current price offers. In doing so, they extend our technology leading positions in attractive and fast growing niche markets, which should drive additional organic growth and expand our options for future acquisitions. I will also point out that a common thing to release the transaction is the opportunity they present Ferro to grow relationships with customers that values innovation, benefit from a global manufacturing footprint and appreciate a high such model of localized technical support. In the aggregate, the transactions we have close or that are in the process was signed definitive agreement subject to customary closing additions represent an investment of approximately $80 million. We expect them to accretive to earnings subject to the customary purchase accounting adjustments and to deliver on an annualized basis $50 million to $60 million in revenue $9 million to $11 million in adjusted EBITDA, $16 million to $18 million in synergy adjusted EBITDA, $0.6 to $0.08 of adjusted EPS per diluted share and $0.12 to $0.14 of synergy adjusted EPS per diluted share. Our acquisitions actively reflect our capital allocation priorities, which have remained consistent for some time. During the second quarter, however, we also allocated a certain amount of capital to the repurchase of Ferro shares acquiring approximately 280,000 shares of Ferro common stock. At this point, I would like to say a word about raw material price inflation. Our team has done an excellent job of offsetting raw material cost inflation increases with Ferro pricing and refund strategy. We typically are able to recover raw material price inflation within about two quarters and we continue to expect that going forward. We remain attentive to and intend to due diligence and managing raw material headwinds. We’re also are watching the tariff situation that is so much in the news these days. Our current analysis suggests that while there are certain puts and takes, the net direct economic impact our business of the tariffs being proposed would in fact be limited. To sum up, Ferro had another very good quarter. All three of our business units delivered strong performance resulting in double digit sales, gross profit and earnings growth. Our innovation pipeline is strong producing organic growth at a sustainable rate and we advanced on acquisitions to drive near and long-term growth and profitability. While far from complacent, we’re pleased with where we are in this the dynamic innovation and optimization phase of our strategy. I will now turn the call over to Ben to discuss our results in more detail. I will come back after Ben’s comments to talk about the individual business unit performance and Ferro's long range goals. Ben.

[Ben Schlater:]

Thank you, Peter, and good morning everyone. I would like to spend a few minutes to review the consolidated financial results from the second quarter 2018. Please note that the non-GAAP numbers I refer are on an adjusted basis using constant currency. All second quarter comparisons are versus the second quarter of 2017, the financial highlights and results can be reviewed on Slide 3, 4, 5 and 6 in the presentation accompanying today's press release, which you can find a ferro.com in the Investors section. Starting with the second quarter performance on Slide 4, we grew net sales 16.4% to $416.2 million with total volume increasing 12.3% and organic sales of 5.4%. Adjusted gross profit increased 12.3% to a $127.3 million. Adjusted SG&A expense was 65.6 million or 15.8% of net sales. We grew adjusted EBITDA by 17.9% to 75.2 million or 18.1% of net sales. GAAP earnings per diluted share improved 40% to $0.35 compared to $0.25 in the second quarter of 2017 and adjusted EPS increased 18.9% to $0.44. Now turning to Slide 5, I’ll quickly go through our year-to-date performance. We grew net sales 17.2% or $821.8 million. Adjusted gross profit increased 11.1% to $246.9 million. Adjusted gross profit margin was 30.6%, reflecting sequential quarter over quarter improvement of 110 basis points, helped by volume mix and our continued efforts related to offsetting raw material headwinds. We grew adjusted EBITDA by 16.3% to $139.2 million or 16.9% of net sales. GAAP earnings per diluted share improved 24% to $0.62 compared to $0.50 in the second quarter in 2017 and adjusted EPS increased 17.6% to $0.80. With that, I’ll review one-time adjustments for the second quarter of 2018 and provide an overview of SG&A expenses and other income and expense lines. For the second quarter of 2018, there were a few non-GAAP adjustments primarily related to our acquisition pipeline activity and optimization projects. First, we had adjustments of approximately 600,000 to cost of sales, primarily related to acquisitions and optimization projects. Turning to SG&A, we had one-time adjustment of 4.5 million consisting of legal, professional and other expenses related to certain corporate development activities as well as fees associated with certain optimization projects. Under restructuring and impairment, there was an adjustment of approximately 3.8 million in the second quarter related to action to advance our optimization initiatives and acquisition synergies. And finally, in other income and expense, we have an adjustment of about 1.69 million related to debt extinguishment charges and fees expense associated with the amended credit facility. Now turning to Slide 6, I’ll go through SG&A. The second quarter adjusted SG&A expense was 65.6 million or 15.8% of net sales, compared with 59.3 million or 16.6% of net sales in the prior year quarter as dated on a constant currency basis. Newly acquired business is accounted for most of the increase in absolute dollars. We continue to see good operating leverage as we grow the top line and feel good about the continued year-over-year results we are seeing there. That brings me to cash flow. For the second quarter adjusted free cash flow from continuing operations was a use of $5 million compared to an inflow of 8.4 million for the prior year. As a reminder we define adjusted free cash flow from continuing operations as GAAP operating cash flow less CapEx and other adjustments, primarily relating to M&A and optimization activities. So beginning with operating cash flow the most meaningful components are as follows. We start with GAAP net income of 29.9 million and we add 14.5 million of depreciation and amortization 6.3 million of other non-cash P&L items and then we subtract 49 million from our investment in working capital and 5 million of the change in other balance sheet items, to arrive at operating cash flow use of 3.4 million. From there we subtract 9.2 million of adjusted capital expenditures and then add back adjustments of 1.8 million for restructuring 4.2 million related to acquisition cost and 1.7 million related to optimization projects. This gets you to our adjusted free cash flow from continuing operations use of 5 million. As a reminder, the adjusted CapEx figures includes capital spend of 13.7 million related to the major optimization program we have referenced in the past, we continue to estimate a 30 million plus benefit to EBITDA by the end of 2020 related to this program. So I want to spend just a few more minutes on cash flow. Most of the variance versus prior year was driven by planned working capital increases and higher CapEx. The increased usage in working capital was driven primarily by growth in our business year-over-year, in addition to our typical seasonal working capital build based on year-end levels and strategic pre-buys of inventory in anticipation of some of our planned optimization and integration activities, as well as raw material prices. We anticipate both will reverse in the second half of the year consistent with our historical trends. So in summary, I would just reiterate that the adjusted cash flow from continuing operations was very consistent with our expectations for the second quarter, and does not change our outlook for the year. We still feel very confident about our full year guidance of 40% to 45% cash conversion. We feel good about the second quarter and our ability to continue to deliver consistent growth in our business model based on organic growth, driven by innovation and our new product programs, acquisitions and optimization throughout the Company. So, this concludes my prepared remarks from the second quarter for 2018. I'll now pass the call back to Peter to discuss the performance of the business units in the quarter and our outlook.

[Peter Thomas:]

Thanks, Ben. With that backdrop to our overall performance, I'll say a few words about each of our three business segments. Turning to Slide 7 in the presentation, you can see the second quarter 2018 summary of our business segments. So, let's begin with Performance Coatings, Performance Coatings is turning to another quarter of strong sales and profit growth. Net sales on a constant currency basis were up 25.2% and volumes were up 12.5%. Organic sales growth was 5.5%. Adjusted gross profit was 50.2 million. Gross profit margin was 26%, reflecting sequential quarter-over-quarter improvement of 230 basis points. We are optimizing our production to drive manufacturing efficiencies and we are optimizing our customer base to concentrate on segments of the market, but we can realize our margins are superior products and technical services. All those raw material costs have increased. The actions we have taking to maximize our value proposition by targeting the high end of the market and selecting business opportunities that are most profitable and are proving to be successful. We also are benefiting from China's increased attention to environmental, health and safety standards. As local manufacturers are pressured by the Chinese government to improve their environmental, health and safety performance, some are leaving the market. As a result, manufacturers with stronger environmental, health and safety performance such as Ferro are in fact experiencing higher demand. In Europe, we are seeing stable growth markets for our tile business particularly in Spain and Italy where growth is accelerating in the market segments with higher value materials and higher price points, where we are concentrating our efforts. In emerging markets around the world, we do anticipate more the growth for our Performance Coatings business as economy strengthened. Now, let's look at our Performance Colors and Glass business. You'll see that Performance Colors and Glass produced another quarter of solid sales growth well ahead of the market rates. Net sales report on a constant currency basis grew 14.3% with volumes up 28.1%. Organic sales increased 6.2%. Adjusted gross profit was $45.4 million and gross margin was 36%, essentially flat compared to last year's quarter. The automotive part of our business is delivering consistent high growth. Our sales to the automotive market grew low teens in the second quarter European and Asia Pacific while other market itself grew only 3%. We are taking market share from competitors because of the high quality of our products, our innovative initiatives, and high touch technical service. While in growth in Europe and Asia Pacific markets, was in double-digit, North America was less robust. Demand remained strong for our electronic packaging materials with sales up 11% over last year's second quarter. Decorations grew the mid single-digit as customer preferences showed a marked shift from white to more colors. On the horizon, we anticipate more growth from our Performance Colors and Glass business given our technical expertise. Ferro is a technology leader in class coatings, which positions us well to apply expertise to the emerging mega trends that we have talked about including LED, 5G smartcards, 3D printing and more. We’re at the forefront of innovative functional glass coatings and our position in multiple markets to take advantage of the opportunities created by these mega trends. Now turning to the Color Solutions business summary. Net sales growth in the second quarter for the business was all organic, reported on a constant currency basis net sales were up 4.2%. Adjusted gross profit was $31.9 million. Gross margin was 33%, reflecting a sequential quarter over quarter improvement of 40 basis points. Volumes were up low single digits to the second quarter 2017 primarily due to customer pre-buys in 2017 for Ultramarine blue, which is in short supply. Ferro recently announced that we are adding manufacturing capacity for Ultramarine blue by expanding our production facility in Columbia to meet the increased global demand. Overall sales for Color Solutions business advanced due in large part to continued strong growth in our surface technologies business not, only in the memory and chip market, but also in the markets for automotive polishes and plastic eyeglass lens polishes. Innovation is a strong driver of our Color Solutions business, as in our other businesses we are optimizing profitability by concentrating on opportunities to serve the higher end markets by improving mix and by pricing our products and services according to the value they provide our customers. On Slide 8, you will see year-to-date performance metrics for our three reported sectors. So again, Ferro delivered another strong quarter with all business units contributed. We are successfully executing our strategy of dynamic innovation and optimization. We are developing in-house and bringing into the Ferro portfolio through acquisitions, new products with technologies that immediately enhance our profitability and support future growth while we also pursuing initiatives that enhance our efficiency and effectiveness. In this comments, Ben mentioned CapEx related to our optimization program initiatives, including the major program is expected to yield 30 million of benefit to the business by 2020. But we want everyone to understand that we have made CapEx investments and have more opportunities in addition to that program that also include a much broader optimization effort made up of initiatives throughout the Company. For example, operating equipment, expanding in areas where a higher touch is needed to collaborate with our customers. We are adding capacity, such as the expansion we recently announced to increased production of Ultramarine blue. At any given time, there are many such sites specific optimization programs underway to increase efficiency, create additional value and position Ferro for future growth. Looking ahead to remainder of the year, we are reaffirming our 2018 guidance. We are reaffirming our guidance even though the change in the FX assumption in our guidance to reflect the U.S. dollar euro exchange rate of 116 rather than the 120 exchange rate in our prior guidance. Despite the FX change we reaffirm our full year 2018 guidance of adjusted EPS of a $1.55 to a $1.60, adjusted EBITDA of $270 million to $275 million, and adjusted cash flow from operations conversion of 40% to 45%. Please note that the acquisitions we just announced are not included in our guidance for the balance of the year. We have provided FX sensitivity in the guidance section of the earnings release that you can reference. Looking further ahead, we are very focused on achieving our Vision 2020 goals. As a reminder, these goals are gross margins of 33% to 34% EBITDA of about 20% plus and free cash flow conversion at 50% to 60%. We are making very good progress against these goals and building a stronger business in the process. And now, I'll turn the call back over to Kevin for the Q&A portion of our call.

[Kevin Cornelius Grant:]

Thanks Peter. With that, operator, let's open up the call for the first question.

[Operator:]

[Operator Instructions] And our first question comes from line of Rosemarie Morbelli with Gabelli & Company. Please go ahead.

[Rosemarie Morbelli:]

Good morning everyone and congratulations on a very good quarter. And last but not least on your ongoing projects, meaning the acquisitions, the pending acquisitions. And I was wondering if you could give us a little bit more Peter as to what we are looking for. Is it fair to assume that they will be opening markets in the mega trends that you are focusing on meaning smart cards, LED light, digital, et cetera?

[Peter Thomas:]

Yes, and thank you for the comment upfront. One of the things about acquisitions I think we want to set off right away. Certainly, you can see we are maintaining a certain proprietary perspective on this. And I think it's also in the best interest of our shareholders because as we move through these innovation things, one of the things that has developed as you know is that with innovation you have stickier customer relationships and you are -- once you own that position, you also not only in the current project but you're the first mover in the second and third generations. And what's important to note about that, in a lot of our higher end markets over the past year and 1.5 and 2 years with our repositioning, we've aligned ourselves as you know very strategically with those customers that sets the tone in the respective markets. And as a consequence, many of those opportunities again many in the high end that you've heard about and will hear more about, those programs last as long as 3 to 5 years where we can have a very solid position. And what the objective is that the jump the chasm twice and what I can tell you is that we are working on a lot of our revenue in the next 2 or 3 years are coming from those projects that say will end in 2020. But what we can tell you now as we have a lot of strong positioning in the next generation of products with those customers where we have visibility out to 2022 and 2023. So, as we migrate towards this innovation mode, think about it sequentially, we've targeted the right customers, we've cleaned up our operation, we started to grow the pipeline, we're adding innovation bolt-on to the complement our technology portfolio. We are in the new generation. We earned our way because we are performing those positions. Those same customers are giving us the opportunity on a lookout. So that gives you a perspective of what you're going to see and I know you're hearing through the last two years of this change in strategy. Now with these acquisitions, you are absolutely right, we've made, created the office of the technology group headed by Barry Misquitta and his team. We funded it with intake some new hires and they've identified a range of opportunities. We already have roughly seven rate programs with 35 different application areas. And you're right, with that each of the high-end businesses particularly in PCG, electronics and surface technologies, we have positioned ourselves with key innovative customers with those our products to support their new growth coming out over the next couple of years. So the acquisitions that we've made, you should think of it as best situation, not so much as acquisition, but they are buying technology pillars in our portfolio, which we know we will need because they're synergistic with what we've done in a way to put a fence around our customers, with that we are also buying technical expertise and the people that are part of that organization and of course there is an inherent pipeline to those deals that were speaking to. So, not only are those acquisitions at a high end of everything that we're doing within the three businesses, but they allow us to preserve the franchise, hence the customer and allow us to continue this longer-term growth. Does that help you?

[Operator:]

And our next question is from the line of John McNulty with BMO Capital Markets. Please go ahead.

[John McNulty:]

I guess I have two areas in areas in terms that I wanted to or hope to focus on. The organic growth rates kind of looking at each of the segments was probably better than what I would've expected. And certainly, I guess you guys target 1 to 2 points better than your end markets and each of these kind of implies that they are doing even better than that. So I guess I'm wondering where that -- where that outperformance is coming from? Are the end markets doing better? Is it more function of pricing? And that's something where you're getting some traction. I guess, how should we be thinking about where the -- where that outperformance relative to your longer-term expectations is coming from?

[Peter Thomas:]

Thanks, it's Peter. So, John, here's the way you should look at this. The first thing is the organic pipeline, if you just unfortunately listen to my long answer in the first question, you can see what that cluster customers at a high end. They require higher margin type products and again those projects have lay but we will continue to see filtering into the business each of the next three to four years. The second thing is the overall organic pipeline as you know is very robust. We hit a vitality index up 20% this quarter. We did not believe we would hit that till the end of the year and think about this. We first started in '13 and we're running at 2 or 3. So, we've made a lot of progress in a short period of time. And what happens with that pipeline, those projects are more sticky than just what we were doing in the past. So, the high end growth, the technology positioning has added to it, the base organic pipeline that typically is driving higher margin at the vitality index. This year as you know because I said it before is about 33% which is 300 basis points higher than the aggregate where we are today. And also we discussed that going forward expectations is that 300 to 400 will continue every year with that vitality index. And was also happy is yes, the pricing element is happening. If you remember the first quarter when there was some discussion about the tile business and I mentioned that we were doing customer optimization programs and remember not rationalization its optimization. Part of that optimization was that, we want to make sure everyone understands the value we bring to those customers and we want to be rewarded for it, not necessarily just in price, but if we beat things on business roles, if we beat thing on inventory management, its mix and alike. So that's also going to work with each business is and here is the definitive response to what happened in the first quarter with tile. Look at the organic growth of tile sequentially, look at that sequentially from the first quarter, it was up 7%. And even though volumes was flat, here is what you have to look at, embedded within that volume as part of the optimization our high end market volume grew in high single-digit. So you end up having this rationalization or optimization if you will, all facets of the value proposition that we felt were very germane for our success moving forward. So, we've done that in entitle and we also have been going on in Color Solutions and each of the businesses have that is a mandate going forward because we want to make sure that with all of our capacity that were also optimizing the value of every kilo or pound that goes off the door. So you’re right we are growing a bit faster in some cases, than the 1% to 2%. In fact, you know, if you look at the Ferro model, our GDP proxy based on where we sell waited to those areas was about 2.4, and we could see we’re tracking almost double of that. So, you’re right, we’re on the higher end of the 1 to 2. And my expectation and the team's expectation is that we’re committed to, is that somewhere along the line, we’re going to end up bumping that number up and we want to make sure that we have a strong foundation to bump that number up in order to make sure that we deliver what we say we are going to deliver. Does that help you?

[John McNulty:]

Yes, that’s hugely helpful. And then I guess the second question was more around capital allocation. So, I know you have got a target out there. You hope for M&A that’s in the $100 million to $150 million per year range. And I guess what kind of -- it sounds like we are at 80 million mark. Do you see an ability based on what you see in the pipeline an ability to hit that range? Or are things maybe a little bit slower? I noticed your buyback you are a maybe a little bit more aggressive than what we would have expected. How should we think about that and the balancing of the two?

[Ben Schlater:]

John, it's Ben. I think it's sort of more of the same from what you have seen in the first quarter. I mean we continue to feel good about the pipeline and getting to that 100 million to 150 throughout the balance of the year. And from a buyback perspective I think that we will continue to look at the stock the way we look at it now and balance that opportunistically with respect to what we are doing on the M&A side. So, I wouldn’t say that the buyback takes away from our view on our ability to get through the commitment from a deal perspective.

[Operator:]

And our next question is from the line of David Begleiter with Deutsche Bank. Please go ahead.

[Unidentified Analyst:]

This is David Bond [ph] here for David. I guess first question is that Performance Coatings volume, you mentioned in Q1 that you were expecting customer optimization initiatives to push some volume in Q2. So can you just discuss what happened there in Q2 and your outlook for organic volume growth in Q3 for Performance Coatings?

[Peter Thomas:]

Yes, in fact, I’m sorry I thought I might have highlighted that with the last answer, but let me do it again. There is part of our strategy here. Remember, dynamic optimization is exactly that we're looking at optimizing all facets in the business. In this case, what you're referring to again was relative to our customer optimization program based on value proposition analysis. So again what we have talked about in the first quarter was two things, not just the volume. But we were talking about as we understand the value proposition that we were working on a handful of things with targeted customers around, hey, we need more pricing maybe we need more a better mix, maybe want different business rules. We want to make sure that inventory management is where we think it should be. And that’s exactly what happened, if you look sequentially, the tile business was up 7.2% quarter-over-quarter. And as I mentioned, part of that business was that we wanted a more enrich mix at the higher end to solidify our position, which is exactly what we have got. We traded lower margin volume for higher margin volume in a way that the high end volume sequentially was also up 7%. So, we are going through a process of upgrading that before you can take a look at the tile margin. Sequentially, it was up a couple of hundred basis points. And our customers are in line with what we are doing and that model is working well enough that we are cascading it out through the rest of the businesses. And what's really important to understand as to why we are adjusting the volume, is our facilities right now in Europe are running very strongly. In fact, our Endeka acquisition that facility was running at about 45% before we bought it. We are up in the 80s. So our ability to utilize our facilities to maximize absorption and also once we get to that level, we want to optimize the value of that production. And we once have targeted at the higher end because that's what our strategy is. What's really important to understand as to why we are doing that now because over the past three years, we've become the market leader in the high-end of that business and the high-end of that business typically has margin that are 40% to 55%, and typically, the volume in that space actually grow, almost as much as we grew sequentially. And why is that important and why do we keep buying things to enhance that market position because, not only are we now the market leader, but in order to continue to win we had to keep buying high end opportunities, so that are relative market share goes beyond 1%. So what we've done with some of these acquisitions, you'll find that are relative market share in that space is now over 1.5 which means 1.5x greater than our newest competitor in a very short period of time. And that strategically is important because if you understand the cycle of this business over a long period as the tile companies in emerging markets, even now are going to take to China, they start all the majority of the Company started using the high-end materials in a way that we're already positioned, and we have long legs of growth opportunities with better margin. So, it's all part of a broader plan. Off course, we didn’t lay all that out before, but understand that there is a whole strategic rationale on how we are doing this, and I'll be very candid with you that is working extremely well. And thanks for asking questions.

[David Begleiter:]

And the second question is just on your gross margin compressed 90 bps in Q2, improved sequentially. Do you expect that to reflect in Q3 you're gross margin year-over-year basis?

[Peter Thomas:]

I guess we're not in a position to discuss that type of guidance, but the expectation is that everything that were doing including covering raw material price increases with pricing as well as reformulation activities that moving on it on a high-end, our expectations that we would continue to see that type of a pattern.

[Operator:]

And the next question comes from the line of Mike Sison with KeyBanc. Please go ahead.

[Mike Sison:]

In terms of the acquisitions to those close and I know it's not in your guidance, but it shouldn't affect the second half of if those have closed already?

[Peter Thomas:]

Here's you should you look at those. One, there were a handful of acquisitions and you know, there are at least three because we mentioned it was one for each business. And some have close and some haven't. And at the end of the day, if they do close like we believe they should, there may be something there.

[Ben Schlater:]

I think Mike it's right now the expectation that those are going to close sort of in the near term. And if they do, I think you can see a $0.01 or $0.02 sit in 2018 obviously that depends on when they close and purchase accounting. But, yes, there could be some accretion there.

[Mike Sison:]

And then when you think about the organic growth in Color Solutions see nice improvement there 2Q versus Q1, and that’s been, great business with last couple of years. What do you think the cadences for growth in the second half? And as you head into '19, is it accelerating again? Or is it kind of at the same level -- at this level?

[Peter Thomas:]

So, last year, we had a phenomenal year as the cross selling activities were really robust and we really did at that point, Mike, step change the business. There was a structural change where we moved up in the value chain with a lot of those companies and we secured a lot of additional business because of the triad of technology that we put together. So you can see with our growth rate we really look at it, if you adjust for the pre buy because of the pricing increase in the first quarter. Actually that growth was closer to 5% organically and closer to 2.5% to 3% on volume, which again if you just look at the revenue part, it's growing faster than actually payment space. The expectation is that our plans would suggest that we’re going to continue in the second half like we in the first half. What I can tell you is that there is strong demand globally for a lot of our individual pigments and that’s one of the reasons why we announced the Ultramarine blue expansion program. We also had another one in outside of the U.S. that we didn't really speak up, but the expectation is that we will continue to outpace the market growth rate for the pigments.

[Mike Sison:]

And then just one quick follow-up on acquisitions, you probably need some time to get the synergy and in place. So, when you think about these acquisitions in 19, it looks like it effectively ensures another year of double-digit type growth for the Company. Do more in integration synergies and EBITDA really flow into next year, if they close this year?

[Peter Thomas:]

Yes, I mean I think we were pretty clear about that. I think when you should look at is, on an annualize basis its roughly $0.07. But what we really want everyone to start doing is focusing on 2020, because you'll see the full impact of those acquisitions are adjusted EBITDA in 2020, much like everything that we're working towards now as you heard when I first started, we are looking to where 2020. Our visibility today is really, really good around where we are and where we expect to be and we’re all already moving into 2020. And as you heard, we're already planning for 2020 to 2023. So again you will see the full impact of those synergies in 2020.

[Operator:]

And our next question comes from line of Kevin Hocevar with Northcoast Research. Please go ahead.

[Kevin Hocevar:]

Question on just on the guidance, you maintained guidance, but you indicated that FX would be greater. So I guess I turn to a headwind, so wondering what the offset there was because if that you’re going to turn to a headwind at the back half of the year. What's offsetting that that allows you to maintain the guidance? To the acquisitions sounds like it's included in this point. So I guess what the offset?

[Ben Schlater:]

It’s just the underlying performing of the business, Kevin, I mean where business is performing well and we continue to expect to see strong performance in the second half of the year. So we’re able to maintain the guidance range of regardless of the headwinds in FX. So, we feel good about that from a fundamental instructional perspective.

[Kevin Hocevar:]

And then on the Ultramarine blue capacity, can you give us a sense for how much capacity this is adding for Ferro? How much is adding for the industry? And it sounds like things are pretty tight in that market. But when you add capacity like this, is there ever near-term pricing disruptions as a result. Just wondering, if you could comment on all that?

[Peter Thomas:]

Thanks for asking the question, but we are not in the position to discuss the magnitude of what our expansion is, other than the fact that we're doing it because we see demand for the next 24 months being very robust for us. And again, you'll hear us talk about relative market share and it's really important. There is another case where Ferro has a three -- relative three share in that space. So that means we are three times bigger than the nearest competitors. So we have a fiduciary responsibility of putting that capacity in because we satisfy all the major customers, that’s an expectation we put it in and we maintain our leadership position. And we will continue to do that around the globe.

[Kevin Hocevar:]

And then last one from me, on the 30 million of optimization savings you expect by 2020 timeframe. Could you remind us what the ramp of that would look like? Is it evenly do you get any in 2018? Is it more backend waited? How should we think of that flowing through the P&L?

[Peter Thomas:]

Yes, there is nothing in '18 at this point because we are at the tail end if you know if you remember when it was a couple of years ago we first mentioned this. We are at a point where, if you just hold on through the end of the year, it will be probably more obvious and more known. Well, nothing in '18, but what we want you to focus on is that in 2020 that $30 million is baked in 2020. And what's important to note is, if you remember, first, we said that was 20 million then we said it was 20 million to 30 million and then we have recently said it was 30 million plus, because as we are peeling the onion bag we keep finding other enhancements. So, the idea is focus on 2020 there will be some in '19. 2020 will be fully loaded. And what we will tell you is that it's 30 million plus for that big program. But now we are going to share something with you that we haven’t and I think it's important to you to understand it, as part of optimization phase, not only do we have a big one but I made references that we are constantly looking for often, this is the fourth, innovation optimization. We are constantly looking for way to becoming more efficient. Through that process, we have identified a greater than a couple of handful of optimization opportunity. And what we can tell you today based on where we are is that incremental to end of '18 but included in our 2020, which should make everyone feel better is there will be another $10 million to $15 million of optimization. So what's starting that, a couple years ago was 20 has now become as much as 40 plus in 2020. And we target that 2020 because that's our vision. We want 33% to 34% margins, strong cash flow, strong EBITDA. And now those are the building blocks and I hope by now, we hope by now that everyone understands that those are real and those are in 2020 and that's why we feel good about our Vision 2020.

[Operator:]

And the next question is from Dmitri Silversteyn with Longbow Research. Please go ahead.

[Dmitri Silversteyn:]

Couple of things, I just want to understand, actually, following up on Kevin's question, but the foreign exchange headwind that you expect in 2018 that kept your guidance constant. You've talk about experience maybe $0.02 or so headwind in the second quarter. Is that going through sort of increase to kind of the mid- single digit some range as we get into the back end of 2018 that's what you basically offsetting with your internal execution?

[Ben Schlater:]

Yes, I think it's in that $0.02 to $0.03 range.

[Dmitri Silversteyn:]

$0.02 to $0.03 range for the quarter okay so bottleneck of backend increase.

[Ben Schlater:]

It’s about $0.02 to $0.03 for the entire back half of the year.

[Dmitri Silversteyn:]

On the raw material outlook obviously a lot of your raw materials metals, and these notoriously volatile for reasons of their own, but of the stuff that tends to be -- that tends to have a cycle and tends to maybe not as much quarter to quarter for esoteric reasons, So, we are talking about cobalt, we are talking about nickel, titanium, dioxides, lithium. If you kind of look at those markets. How do you see sort of 2018 shaping up both sequentially and year-over-year as far as these costs are concerned and your ability to offset that in the second half of the year?

[Ben Schlater:]

Dmitri, it’s Ben. We feel good about I'll just start with the last piece of it first. I mean we feel good about our ability to offset that. We continue to sort of beyond this cadence of sort of a one to two quarter lag and we're starting to see the delta there get tighter. I mean the delta between price and raw materials in the first quarter through the second quarter really tightened up and so that's a really, really good sign for us to something that we obviously keep a pretty close eye on. With respect to what's happening in the underlying fundamental market, I mean, we are starting to see cobalt fall off. Lithium is sort of pushing sideways a little bit -- we've seen a little bit of relief there. We're still seeing headwinds in both the zinc and zirconium, but I would probably say that we have had more progress in those two with both the zinc and zirconium with the reformulation than anything else. The team has just done a really good job of offsetting those both with price and reformulation. Particularly the guys on this on the Performance Coatings side where we have Garcia and his team, have really got this figured out, we saw sequential quarter over quarter margins improve over 200 basis points, and they are getting hit with most of the raw materials. So we're pretty pleased with how we see that in the second quarter and expect more of the same from an offset perspective for the rest of the year.

[Dmitri Silversteyn:]

And then just a point of clarification I guess on the way you've presented the information for a couple of businesses you have sort of volumes being significantly higher than organic growth. I assuming volumes includes acquisition components the sale are meaningful and if that's the case if you just look at the organic growth that you have provided for each segment. Was it mostly driven by volume mix? Or was there a pricing action? And then I guess I'm trying to understand where your pricing momentum is versus your ability to reformulate and what Peter described the initiative of just moving out the kind of the margin later in terms of what volume you are taking what volume you are willing to give up?

[Peter Thomas:]

Yes, you're right, Dmitri, the volume numbers in a total number, which would include organic and inorganic activity. From an organic perspective, we were also up everywhere sort of across the board, we saw organic revenues up in all of the business is in mid-single digits or better and I would say that’s a pretty good mix of volume end price, you’re going to see a little bit more pricing in Performance Coatings than anywhere else but the balance of the business is we’re pretty balanced. We also saw really good mix, I mean the mix in Performance Coatings is really good this quarter as well, so is was pretty balanced between the two of those.

[Dmitri Silversteyn:]

And then the final question in working capital, you look at the kind of a trailing four quarter working capital to sales, its kind spiked up to the highest level which seems to the first quarter of 2017. I think it seems to be mostly an inventory, if this just, this function of a M&A, this function of building inventories in anticipation of a stronger second half of the year, kind of actually we think about the working capital impact on your business. And what should we expect our going forward as hopefully raw materials need to get a little bit more benign.

[Peter Thomas:]

All of the above, so I would say really split between right now it’s the high point proximal working capital perspective and we see that right forever. So that is sort of very much as expected. Normally, we would see working capital as a percent of sales somewhere around 30%. And we see sometimes between 4% and 6% deal through the middle of the year and that liquidates towards the end of the year. So this is all very, very typical. The other piece of it is just a growth in business, I mean when you’re averaging 6% or so organic growth in the business that obviously have an impact on our feet as well.

[Operator:]

And the next question is from Mike Harrison with Seaport Global Securities. Please go ahead.

[Mike Harrison:]

Maybe just continuing on kind of the cash flow related discussion here, just looking at maybe understand a little bit your thoughts on how GAAP free cash flow could compare to the adjusted free cash flow number that you're guiding to. I think we just trying to get a sense of how much real cash is going to be available for things like acquisitions, things like debt pay down as well as the optimization program that you give us some detail on?

[Peter Thomas:]

Yes, sure, no problem, and we outlined this in the press release, but just in summary, if you look at that delta for let's say the second quarter, you’re looking at a delta somewhere between around $25 million about $20 million and most of that Mike is the CapEx that we’re using for the optimization program, so again the delta between what we would call free cash flow or adjusted free cash flow and GAAP operating free cash flow about $20 million for the second quarter the vast majority of that is use on this optimization project. And so I think if you look at that number from a year-to-date perspective. It’s a little bit higher than that, it's closer to 30 million and so that we would expect that delta will obviously carry though for the balance of the year, so if you look at our guidance from an operating cash flow perspective and you take sort of that 40% to 45% of our EBITDA for that year that put you somewhere in the low hundreds the GAAP number would be about 30 million below that absence the adjustments we are making. So that’s kind of put you in these that 70 to 80 range from a GAAP perspective with considerations for more spend on the optimization project. But that’s kind of how we look at that bridge.

[Mike Harrison:]

And then, Peter, I was wondering if you could give a little more detail. You mentioned some of the Chinese competitors seeing regulatory or environmental issues that and being close. What segment in the market do they play in? And have you seen volume deems related to that yet? Or are we still in the early stages there?

[Peter Thomas:]

Yes, good. Actually we are seeing it in all of the businesses. And what we can see is we are already benefiting most of it. Let me give you a perspective. If you look at let's say -- let's start with tile first because that's where you are going to see the first tranche of it. As you know there are many small tile producers that’s why we never really took a position in China, if you will for the low end type of towel products. However, we are there with we call it a high end model includes high endings, and what we are going to find with that particular business in the Asia-Pacific region on a blended basis, we're realizing double-digit growth in the Performance Coatings business as it relates to those smaller companies shut downs. We are seeing it in the porcelain enamel business as well where that our Asian business where the porcelain enamel was up high single digit. We are seeing it in the pigments business. The blended, the triad of the three pigments businesses are growing in low -- upper single digits. In Performance Colors and Glass, we -- because of one of our major customers moved to China and drag us into there, into that region our glass business for auto is a good double-digit growth. And across each business we are seeing the impact of that. And also because of the shut down, there is more business for us in Indonesia because there was a lot of -- there were a lot of low end products moving into the Asian market that we -- into the Indonesian market where we had to address. But now that that’s gone in addition to the tariffs, we have a great double-digit growth profile for the first half of the year in Indonesia. So, it's funny, now just with the European and U.S. working on tariffs. When we do analysis we can tell you that look at the end of the day, if there were tariffs with China, Ferro would benefit. We probably be one of the only companies what that could stand it -- that would stand the game business from that tariffs concession. So, the whole Asian position is getting stronger for us as a result. The impact of those shut downs to the Chinese government's credit in order to clean the air and do everything that's right for all their constituencies. It's very, very helpful, for not only Ferro but I think a lot of other suppliers or competitors of ours.

[Operator:]

And our last question comes from the line of Rosemarie Morbelli with Gibelli & Company. It’s a follow-up. Please go ahead, Ms. Morbelli.

[Rosemarie Morbelli:]

So following up on the tariffs that was actually one of my questions while Ferro may not be directly impacted by it although you just said Peter that in China it would help. I was wondering about 80% of your revenues of from international operations. So, if you look at your customers, I mean could you be impacted in a major way, if you're customers are hit with the tariffs as they sale product back into the U.S.?

[Peter Thomas:]

Yes, we spend a lot of time on this and as you heard in the prepared remarks we go in this very, very limited and part of the reason is this. As we move through the heavy tough asset live approach and we've positioned ourselves with application in those regions that were faster growing over the past four years where we've build our more application center and the like, which follows those key customers that we've target in '14 and '15. We are so localized with those top customers that that's what limiting the potential impact for us. Because we're producing with our customers locally like in the Chinese market with the auto market that is fastest growing region and you know auto growth is 3% with our auto business is up double-digits. So, I think our model lend to self quite nicely in fact that where our key customer are and we are right there and they locally produced and we supply locally in the case of think about it in China. And the reasons I will made the comment around how we would benefit from China is anything that's imported into the U.S. that would be on the low end type of the spectrum. If there are tariffs what would happen is, all the North American producers of tile would suck up that demand and guess where Ferro is. We are right there as well, so not only do we get it, if there was an issue with Europe and the tile is coming in, we would offset that with local production with our local customers and would be limited. So, we are in a position where we to offset a lot of that. That's why we said it was very, very -- we did spend a lot of time on it. And off course now with what's going on between U.S. and Europe, I think it's a little news in here.

[Rosemarie Morbelli:]

Okay, so what you are saying is really that your customers are also supplying their domestic market as opposed to having a lot of exports?

[Peter Thomas:]

That's correct.

[Rosemarie Morbelli:]

And if I may ask two quick questions, I'm a little confused about this 30 million of savings from optimization. Is it 30 or is it 40 that you have included in your 2020 target?

[Peter Thomas:]

Yes, the major program that we mentioned awhile back where we first said it was 20 then 20 to 30 then 30 and now you hear us saying 30 plus. All that will be realized in 2020 that's why we are because we are not giving guidance for '19. There will be some obviously and will get to that whenever we provide guidance, but you should look at 2020 and feel that there is 30 plus million in there. From that major optimization program, but we were getting at this we wanted to address everyone's comfort level that I was doing things that are working on there are bunch of others. And what we have said is at the end of '18 on an incremental basis that is also included in our 2020 numbers is an additional 10 to 15 million of saving that were in off shoot of that major project, that's why we were saying it better than we thought it better than we thought. It allowed us to do certain things. That major project allowed us to do a bunch of other things that maybe you were little unexpected. We knew like we always do we start lower and we move up. But the way we're looking at it now is that all those projects together in 2020 amount to somewhere between 40 million and 45 million plus that are already baked into 2020, number and that’s where you said, everyone should start socializing around 2020 because we feel really comfortable as we keep supplying the building blocks why you should feel comfortable that and please give us consideration to that, even though it's a little far out there that were going to hit that. We’re trying to address the comfort level that people need to understand that we have a solid pathway that were executed towards to hit that number that is not aspirational like a lot of others that put out numbers 2 or 3 years out. We have a pathway. We're executing now we’re dosing out, the hit that you should build in so comfortable with. Does that help you?

[Rosemarie Morbelli:]

Yes, it does and it is fair to say that what we should add however to the 2020 number could be another 7 million or 8 million of synergies from the yet another acquisitions.

[Peter Thomas:]

Yes that's exactly why we mention the synergy adjusted EBITDA of 16 million to 18 million that’s correct.

[Unidentified Analyst:]

And lastly and very quickly SG&A ratio as a percentage of revenue, is at a sustainable level?

[Ben Schlater:]

Yes, I think that’s -- its' Ben. I think that's trending where we otherwise expected to be in terms of really leveraging the cost structure of the business at the top line.

[Peter Thomas:]

I think the other thing, Rosemarie, just worth mentioning on that. Certainly, it's just beyond SG&A, we’re seeing pretty good flow through, even if the gross margin level. Again, we keep a really close eye on how much of just -- we isolate volume as it relates to sales and how much of that is dropping through the margin. And that continues to be a really high percentage for us well in excess of our existing gross margin; and so, if those two together where we're really seeing the leverage so that continues to be important metric.

[Kevin Cornelius Grant:]

We would like to thank everyone for joining us on the call today. We appreciate your interest in Ferro and we look forward to discuss the results with you again in the next quarter. Enjoy the rest of your day.

[Operator:]

And ladies and gentlemen, that does conclude our call for today. We thank you for your participation. Everyone have a great rest of you day and you may disconnect your line.