Q3 2020 Ferro Corp Earnings Call
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Please stand by the Gulf Wishful thinking voluntarily. Thank your for your patience when I say please remain on the line. If you look to register for a question Express one four on your telephone.
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Hello. Good morning, Thank you for joining the Ferro Corporation third quarter and full year 2020 earnings conference call. An archived replay of this teleconference will be available through the investor information section at Faro Dot Com later today and will be available.
<unk> approximately seven days sales calls because being recorded Thursday November five 2020, and now I'd like to turn the call over to Mr., Kevin Corneal described director Investor Relations and corporate Communications. Please go ahead.
Thank you and good morning, everyone. Welcome to Faro is third quarter Twentytwenty earnings Conference call. This morning, we will be reviewing service finance results for the third quarter ended September Thirtyth 2020.
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 conference call presentation deck are available in the investors section of our website.
I'd like to remind everyone that some of the comments we are making today are forward looking statements and are based on our view of conditions and circumstances as we see them 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 view that information in conjunction with today's discussion.
It's now my pleasure to pass the call over to Peter.
Thanks, Kevin Good morning, everyone. Thank you for joining us to discuss Ferro Corporation third quarter 2020 results.
We were pleased with Taros third quarter results, we experienced a significant recovery in demand driven by our leadership positions in markets that have been recovering nicely from the low point of macroeconomic conditions brought on by the COVID-19 pandemic.
Last quarter, we said that we were seeing what we thought could be beginning of a V shape recovery in demand for care products.
That V shape recovery became more pronounced in the third quarter as demand for our high margin products is critical to growing industries continued its upward trend.
Although down as compared to the pre pandemic third quarter 2019 sales in the third quarter increased by 18.1% over the second quarter 2020.
Sales increased in almost all market categories.
Margins in the third quarter were affected by product mix. However, we expect margins in the fourth quarter to rebound as we work through inventory and realize additional benefits from our North American optimization program. We continue to carefully manage expenses in the quarter, reducing SGN, a even as sales volumes.
Increased.
Looking ahead, we are seeing signs that the positive momentum in demand for our products experienced in the third quarter will extend into the fourth quarter and early 2021.
Our customers do not appear to be de stocking in the fourth quarter to the degree they sometimes do order patterns for the fourth quarter and early in the new year suggest that our customers are preparing for continued expansion of the recovery in their markets.
Accordingly, we are optimistic for the fourth quarter and early 2021, even as we recognize that the strength of global macroeconomic conditions remains uneven and uncertain.
Of course, the Kogut pandemic continues to challenge economies around the world and while we.
We do not anticipate a significant impact from the second wave of Coca cases, we are mindful of the situation and positioning the company to address circumstances as they evolve.
I should add here that our employees have been exemplary dealing with the many challenges brought on by the co that pandemic.
It bears repeating especially during these times that there is nothing more important than the health and safety of our employees.
And we continue to utilize practices such as remote working and facility protocols to keep our people healthy and safe.
So, let's now step back for a minute from the immediacy of the last quarter and the next few months to consider our long term strategy as you will recall the core of our focus is innovation and optimization. The strategic decisions. We made to focus on high margin innovative functional coatings and color. So.
Solutions aligned with Mega trends are proving beneficial and providing the foundation for additional growth and our optimization initiatives are enabling us to more comfortably manage through macroeconomic downturns.
And further expand profitability during economic upswing.
The Mega trends that we discussed three years ago at our Investor day are creating new product development opportunities in industries that we have targeted for our nation programs.
The innovation and quality of Ferro products together with our technical expertise and functional coatings and color solutions enable us to play a critical role for our customers as their markets recover and demand for technically advanced products accelerates.
Furthermore, many of the Mega trend related product development opportunities. We are working on are in early stages, and we are right there alongside our customers position to be the supplier of choice.
There are many examples that illustrate the value we provide to our customers in connection with the products. They developed to address the Mega trends, we identified such as Fiveg, the internet of things AB ease in virtual communications among others.
Faro is well positioned with existing products technical expertise and continuing investment in R&D to support our customers.
We mentioned some of these last quarter, namely digital printing with organic and inorganic game Sunbury substrates.
Pigments for customized functions, such as infrared reflection food contact packaging anti grosses and paste and sensors used in electronics.
As we look forward to 2021, we are encouraged by a number of market dynamics, reflecting mega trends, especially in healthcare automotive electronics and decoration all areas in which we have invested in technology platforms to support our customers.
The breadth of our product portfolio and markets also provides us resilience to withstand weaknesses that bites arise from time to time in one sector or another the benefits of such diversity are starkly apparent in the current context, when we compare ferros V shape recovery to the ongoing challenges for.
Basic many businesses that have a more narrow focus and continued to be hit hard by the cobot pandemic.
Along with the value of a diverse product portfolio and customer base. The cobot pandemic also has brought another interesting dynamic to light.
Good related behavior changes are accelerating demand for certain products, especially those used by industry supporting mobility, such as people one.
Individuals' smart and energy saving transportation and entertainment and personal technology as people continue to work from home and limit attendance at large events.
In addition demand for our products to go into appliances also is growing as consumers seek new smart appliances.
And construction also is picking up as people renovator homes and move away from urban environments as a consequence of the pandemic.
It is worth noting here that residential construction is picking up around the world construction is often a bellwether for changes more broadly in the macro economy as global residential construction has strengthened we are seeing demand increase in our tile coatings business. Another indicates her of recovery.
Now these drivers of our business are complemented by the cost management and optimization programs that have increased the efficiency of our company we.
We are seeing the benefits from our North American optimization program, and we will have more opportunities for efficiency as we remove stranded cost following the sale of our tile coatings business.
To a modest degree there has been some impact on our optimization initiatives from factors related to co that such as the additional time needed to complete transfers of certain assets and these factors also have affected inventory levels for Faro and our customers, but we are working through these.
Improving productivity and efficiency is a core element of our strategy and fundamental to the quality of our business and we are addressing these issues.
Paul This is to say that we are doing what we told you we would do and generating positive results.
With that I'm now going to turn the call over to Ben for his comments on the quarter and our outlook for the remainder of 2020 that I will talk about progress in our functional coatings and color solutions segments and provide some final thoughts on our expectations for 2021.
Ben.
Okay.
Thank you Peter and good morning, everyone I would like to Echo Peters comments on how pleased we are with the Companys performance in the third quarter. Despite the continuing challenges of the covet pandemic. The business had deliberate substantial revenue growth from the second to the third quarter and improved adjusted gross profit margins year to date.
All while low managing to lower our SGN today.
Moving onto discuss our consolidated financial results for the third quarter of 2020 from continuing operations. Please note that the non-GAAP numbers I referred to earlier on an adjusted basis and growth rates mentioned are on a constant currency basis compared to the third quarter of 2019.
As a reminder, I'll also review free cash flow used in operations.
The financial highlights and results for the third quarter can be viewed on slides three four and five in the presentation accompanying todays call, which you can find on Ferro dotcom and the investors section.
Moving to slide four in the third quarter net sales declined 2.1% to $241.9 million.
Adjusted gross profit declined 7.4% to $72.2 million adjust.
Adjusted gross profit margin declined 172 basis points to 29.8%.
Adjusted EBITDA expense was down approximately 1% at $45.1 million adjusted EBITDA declined 14% to $36.9 million or 15.2% of net sales and adjusted EPS declined 29.6% to 19 cents.
Now moving on to slide five year to date through September Thirtyth net sales declined 8.2% to $699 million adjusted gross profit declined 7.2% to $219.8 million.
Adjusted gross profit margins improved 29 basis points to 31.4%.
Adjusted SGN expense declined by 4.1% to $142 million adjusted EBITDA declined 9.1% to $108.5 million adjusted EBITDA margins were flat at 15.5% and adjusted EPS declined 13.8% to 56 cents.
These results reflect certain non-GAAP adjustments for the third quarter, primarily related to legal costs associated with previously divested businesses corporate development and optimization activities.
First in cost of sales, we have adjustments of approximately $2 million, primarily due to costs related to optimization initiatives of $1.5 million and 500000 related to other costs.
NSG, ne we have onetime adjustments up $2.7 million in the quarter $1.9 million that consisting of costs for legal fees professional fees and other expenses related to certain corporate development and optimization initiatives, including the north American manufacturing optimization and $800000 related to divested businesses.
Turning to restructuring and impairment there was an adjustment of approximately $2.4 million, reflecting actions to achieve our ongoing optimization initiatives and acquisition synergies.
And finally in other expense there was $1.2 million related to divestitures.
I will now move to ask DNA in the third quarter adjusted SGN expense declined approximately 1% to $45.1 million or 18.7% of net sales compared with $45.5 million or 18.4% of net sales in the prior year quarter on a constant currency basis.
We've managed to reduce SGN expenses, even while growing our revenue substantially from the second to the third quarter and saw the resulting benefits from that reduce spending in our SGN a leverage for the quarter.
This brings me to GAAP cash flow from operating activities.
We'll also discuss adjusted free cash flow from operations or what we define as cash flow available for items, including but not limited to strategic investments debt service and shareholder returns.
We calculate this adjusted free cash flow metric by combining the following lines from our statement of cash flows GAAP cash flow from operations capital expenditures and cash collected under securitization programs. This information can be found on table 12 in our press release and the third quarter GAAP cash flow from operations was an outflow of 1.9.
$9 million.
Then we subtract $6.7 million of capital expenditures and added cash received on other receivables of $34.7 million to arrive at $26.1 million of adjusted free cash flow in the third quarter, which reflects the earnings benefits, we mentioned and changes in working capital for seasonality, but also for certain optimization.
Initiatives.
I would like to wrap up my comments by reintroducing guidance for 2020 as you may recall during the first quarter 2020 earnings call. We withdrew our 2020 full year guidance as the cobot pandemic began to affect economies around the world and challenge visibility although.
Although we recognize there remains a level of uncertainty in the macro economic landscape related to the cobot pandemic. We believe we've gained sufficient visibility and confidence with respect to certain metrics through the end of 2020 to re establish guidance for 2020, we now expect full year adjusted EPS to be 71% to 76.
Sense, and EBITDA to be $141 million to $146 million for continuing operations.
With that I'll now turn the call back over to Peter to walk through each of the business units and that his final comments before we take questions Peter.
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Thanks, Ben now I take you through highlights of third quarter performance and our continuing operations reporting segments. As a reminder, earlier this year, we changed the name of our formal performance colors and glass segment to functional coatings, which includes the porcelain enamel business.
We'll begin our discussion with the functional coatings segment.
In the third quarter functional coatings net sales on a constant currency basis were down 1% compared to the third quarter 2019, However on a sequential basis net sales increased 17.1% from the second quarter of 2020 adjusts.
Adjusted gross margins declined to 27.8% in the third quarter from 31% over the prior year period on a constant currency basis, adjusted gross profit declined 11.4% from $48.2 million to $42.9 million.
Now the vast majority of the decline in sales volume gross profit resulted from weaker demand in end markets that have been impacted significantly by the coated pandemic. This includes end markets, such as automotive and decoration, which serves the hospitality and travel industry and industrial commercial construction.
Hi.
In addition, we saw some sure capture in this space in Latin America.
Our declaration business was down approximately 10% due to lower demand and hospitality and travel. This business segment too is off its lows improving from the second quarter by approximately 17%.
We have every expectation at the business will return as the hospitality industry eventually recovers from the pandemic.
In the industrial materials business important enamel business sales increase low single digits. The commercial construction landscape continues to look week due to the pandemic.
On the other hand, we are seeing strong volume demand in Asia from two of the largest solar manufacturers for our glass enamel, which provides higher efficiency and power generation and solar panels.
As I mentioned last quarter home appliance manufacturers largely depleted their inventories in the wake of the Covid outbreak.
Harpy business grew in the third quarter by approximately 30% from the lows in the second quarter as customer demand surged because of the strong demand for replacement in remodeling occurring in the appliance market as people spend more time at home many of our customers now carry a very very long backlog.
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We expect this to translate into continuing strong demand for pharaoh products used in appliances.
Now turning to our color solution segment.
And the third quarter color solutions net sales on a constant currency basis were down for 2% compared to the third quarter of 2019. However on a sequential basis net sales increased 19, 90% from the second quarter of 2020.
Adjusted gross margins increased 111 basis points to 33% in the third quarter from 31.9% over the prior year period on a constant currency basis.
Adjusted gross profit declined approximately 1% from $29 $2 million to $28 $90 million.
And the quarter the majority of the decline compared to the prior year quarter was attributable to pigments used an automotive and industrial coatings, however, coming out of the second quarter of 2020, we saw strong demand for angst utilized in single Houston disposable packaging applications. Another consequence of the.
Covid pandemic.
Also we are seeing strong demand for our surface technology products utilize demand applications.
In addition demand has been strong for surface technology products used an eyeglass polishes as these businesses are now getting back to normal after long shutdowns of I wear stores due to the pandemic.
And finally, we are seeing strong demand for our pigments and coatings as automotive manufacturers now are back in operation.
So we had a strong third quarter canned we are confident that farrow is position to continue the momentum in the fourth quarter and into the new year.
At this point, we also wanted to update you on the sale of our town business to Lone Star and its affiliate asthma glass. The transaction is subject to customary closing conditions, including regulatory approvals Farrell Lone star have made substantial progress on the transaction and are working with the regulatory.
Sorry agencies to obtain the remaining approvals while a definitive closing date cannot yet be determined that parties are advancing with plans to be able to close the transaction by December 15th 2020. According to the purchase agreement terms 15 days.
After satisfaction or the relative.
Conditions or as the parties otherwise agree.
Anticipating that additional time may be required the parties have already expressed the intention to discuss an extension if necessary.
Again from a longer term perspective, our leadership positions in markets align with Mega trends in our innovation initiatives focused on these markets will we believe continue to contribute to attractive growth going forward.
When this growth is combined with our commitment to optimizing our business. We believe we have a winning formula for attractive sustainable and profitable growth.
Now I'll turn the call over to Kevin to open the call to our first question.
Kevin.
Thanks, Peter with that operator, let's open up for the call for our first question.
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And we have a question from divine.
Rosemary more belly with GE research. Please go ahead you lines helpful. Thank you good morning, everyone.
Rosemary clinic.
Hi, I was wondering if Peter you could give us a little more on the child's clothing coating transaction.
Why is it taking that long and I didn't realize that it is regulators, but are they taking this long because it's usually how it happens, let's say in Spain, and Portugal, which is my best guess is where it is.
Since it is with where it's my glass is space that or do you think that they are going to be asking you. It's my glass to to.
Diverse to some pieces of the business in order to approve it can you give us.
To the extent that you can let them more on what is actually going on.
The way you see it.
Yeah sure I think you you answered it yourself quite nicely when you first opened.
Certainly the regulatory process in Europe, as a regulatory process in Europe.
It's their timing their schedule quest.
Questions that are asked in lone star and sparrow or responding.
As necessary to answer questions, but I think it's more of those on the call and everyone who have done.
Understand that the regulatory agencies are what they are we have no control over them asthma glass has no control over there, but we continued to speak all the time and so that's basically basically the answer you're right. It's just the timing city.
Situation.
Okay and looking at.
The results for the quota you mentioned in the press release that Rachels, who are better than you anticipated could you talk about the areas, which actually perform better than your.
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Yeah sure I think you might remember in the first and second quarter cause we did mention in our modeling that we we're starting to see as we look forward that we would have some kind of these.
V shaped recovery and certainly I think you'll see more of that not only with us, but a lot of other companies, but our modeling suggested back then that we would be kind of where we thought would be on the last call, which I also made the comment that we would be materially better than the second quarter moving into the third quarter, which which.
Happening.
So from that perspective from our visibility.
Custom orders through our eight a M to use we could even see in the second quarter that sales were coming into the third and even fourth quarters at that time.
The automotive business itself has picked up a bit faster than we anticipated even though we're in daily contact with our top customers the appliance market picked up a bit better than we thought.
And.
Our electronics business continues to do well for the reasons that we mentioned in our prepared remarks.
We see.
Different types of pigments for different types of applications doing a little bit better than than we had thought particularly in the third quarter may be the new Bill was high range of products were a bit better based on the application, but I think we did discuss it in the in the prepared remarks, how the ink for.
Packaging.
One way usage versus.
Reusable type of applications.
That segment did.
A bit better or surface technologies business did better as I mentioned around plastic polishing has picked up both and the consumer end and also in the industrial types of applications. So far.
Five out of the ATM to use that we had.
Outperformed what we thought and the good news is those not only.
Five abuse.
Are also showing.
Good performance now in the fourth quarter, and maybe moving into the first quarter of next year and the only MDU that that's a lagging a bit we actually getting a bit better wood.
Would be the declaration piece out of all eight of them. That's the one that's tied mostly the hospitality.
And travel and although it is picking up I picked up nicely from the second to the third quarter.
Still the lagger, but the other seven empty use as I mentioned about the v-shaped recovery.
And I think we mentioned last quarter that by the end of the year, we will see a run rate that would solidify the b position and I think we are definitely in that camp that that's going to occur so.
Hopefully that.
And to your questions. It does just one last question if I may with your electronics business at double digit.
Do you see any inventory build that at your customers that is going to Imped shit. Your gross a case of that the short term or they they are inventories. So depleted that it is actually we filling it as opposed to wheel cause.
Consumer demand.
Good question actually it's all of the above it depends on the customer depends on the application because.
All of our market segments as you know, we have hundreds and hundreds of applications. So.
Let me, let me answer it this way because I think we're seeing something that's very interesting and.
I think it's important and maybe something that may be a lot of.
Our peers are seeing but I haven't heard too much of what I am going to say and a lot of the script. So let me lay it out there.
What you're seeing is one the pandemic has caused an <unk> sketch moment and everybody supply chain. So.
It's sort of like we joke around here because of the pandemic everyone is remodeling cleaning out their closets and doing this and that I suspect that all of that's going on in companies as well. So the pandemic is from our perspective.
Through our lens in discussions with our customers everyone is kind of cleaning house and their companies, they're doing what they can to be more efficient.
Draining inventories.
And and the light and so now what you're seeing.
Is there is a pretty strong demand on I think everybody and and different degrees, but let's just talk for us for a moment so for them to use that I mentioned that did better than we thought.
Interestingly enough when we speak with our customers I think our customers enjoy.
The tightness of the supply and demand scenario not that we're going to get into an economics review here, but you know as well as I do when demand and supplies tight what happens maybe the consumers doesn't benefit from it but I think a lot of people like the idea that managed to supply change tightly they.
Been doing it for five or six months.
They're carrying maybe the minimum amount of inventory that's needed I don't think anyone's, becoming very ambitious about billing inventory on field of dreams, where they anticipate stronger goes I think no one's really interested in having phantom sales skewing, what's real and demand and again.
I believe that a lot of our customers, which are market leaders by the way is over 95% of our sales are with market leaders and we're very close to them. We have nice fences around those the customers and their concept is this is like working okay. We liked the way our plants are running we'd like that.
Tighter supply chain.
Helped with business rules customers are giving us borders with longer lead times, which is helping and allows us to have more visibility going forward last quarter I mentioned that we had orders and the third and fourth quarter and maybe intention the first and I can sit here today and say we are seeing an order pattern and we have.
Visibility on our order books going into the first quarter in some cases, where touching the second quarter and also a lot of our customers.
Are saying not only do we like.
Kind of the help manage this tightness and supply and demand.
But it's also a period, where we can reduce our S. K us.
It's sort of like let that rather than having 15 different variants with this pandemic why don't we try to focus on a narrower kind of.
And offering in a way that.
It would help us be more efficient and help with inventory and your life. So.
So I think conceptually.
This concept of keeping.
Keeping supply and demand as tight as possible is everyone's conservative way in view of managing through the pandemic, probably going through next year from our perspective.
Thank you and our next question is from Mike Tyson with Wells Fargo. Please go ahead. Your line is open.
Hey, guys Nice Carter.
Excellent Peter when you think about 21 and and maybe.
Look at a bridge for next year.
Have some cost savings.
What type of leverage on growth do you think you'll get.
And it just might be early to give specific guidance, but are there sort of variables you could help us think about as we head into 21 fair for Pharaoh.
Yeah. So.
At this point.
Let's just tea up what we've said in the past and what we're saying already.
We we are feeling that's V recovery.
And hopefully that puts us back on a normal cadence that we've had I think we've been pretty specific around the optimization Act we have.
Again the act.
Cost savings, we continue to see those.
We'll be working on our stranded costs, which were already that plans are already developed and we're already starting to March down that path and again, we mentioned somewhere between 10 to 12 million for those next year. We gave ranges for hacked, we see no real deviation from any of that.
And the only big question is what happens with the revenue and we're not in a position now to discuss that but I think the starting point would be your basic hey, let's have a V recovery and then tried to look at some normalcy.
Remain covid normally do for a year as a starting point and I think that's.
Now, we're starting to see it and again, we do see some indications with our order book that we're seeing some some orders in the first quarter received some touches and the second and I'll remember why that is remember what I mentioned about remain calm in the past. Unlike a lot of commodity companies, where maybe 70% of the business.
Is already booked out within the first seven or eight days of a month.
All of those investors in and we specifically they adopted our strategy over multiple phases would deliver a company contained six very important characteristics of a leading performer whether that.
Portfolio coherence or leadership positions in chosen products or sectors very attractive market structure, you'll have gotten into that with each of our <unk>, we have no more than than two or three major competitors and anything that we do we certainly have strong technology and innovation capable.
<unk> is evidence of the.
What we would define our common technology competencies are leading to a plethora of technology platforms with a broad range of programs that are emanating from them leading to this.
Almost 20, 20% vitality index all of that is real and we've delivered against it and we now have a good growth dynamic I think you're going to see like we've discussed we've moved from GDP to market growth plus one to two because mark that growth for us is higher than GDP and I think if you take a look.
The broad range of potential opportunities, we could look at and as we get into next year.
We'll definitely be looking at those.
Our next question is from David Big later with Deutsche Bank. Please go ahead you lines open.
Thank you good morning Pete.
Peter and Ben what are the assumptions underlying the low end of your implied Q4 EBITDA guidance.
Sorry, David.
You broke up in the last part of that can you repeat the question lately.
What are the assumptions underlying the low end of your implied Q4 EBITDA guidance yeah sure. So.
So let's start with Q3 <unk> three was much better than expected right. So we had a very strong Q3.
And the view for Q4 is that Q4 will be much the same as Q3 so.
We expected originally some lift from from Q3 two four.
We've now recovery that we anticipated is actually accelerated meeting we saw more of a benefit in Q3 than anticipated. So we know sort of C. A very similar quarter between Q3 and Q for I would say the only difference will be some administrative things that we typically see at the end of the year around health care and that sort of thing that way.
Come into SG&A, but beyond that the quarters will look will look pretty similar so with that as the baseline.
Trinity's for capital deployment can.
Can you speak to the M&A pipeline in terms of where the bid asks RF. There I know earlier. This year. They were they are pretty wide you see them narrowing and do you see opportunities that realistically.
Realistically you may push across the finish line as we look to 2021, obviously after the the the tile coating sale.
Things will be as they are forecasting and it has been mentioned we feel really good about it I think what's happened again much in line. The second part of my comment around our customers enjoying managing a very tight supply and demand position for obvious reasons. The second part of that is.
Everyone in our manufacturing facilities around the world.
I am not going to take the slightly but Ah kind of are kind of accepting that it is what it is in the protocol that we've put in place in a lot of our customers are very strong and wood.
Low for the type of demands that we see against their products in our products to continue through the fourth quarter and into the first even with the second wave as you are saying it. So I think it's sort of like everyone is adjust from a manufacturer in perspective I know we have.
In our discussions with customers suggest that they have and it's sort of like.
That's one of the reasons why I think that as we continue this product move from North America into Latin America that will continue into 2021, a lot of that is customer base and lead time based so our sense was is that's going to continue into 2021.
When we get through that a lot of this will be based on customer mix as well as demand in 2021, and we can get.
Into that more when we when we talk after the first of the year, but no. The short answer. Your question is that it will certainly continue in the fourth quarter and likely continue into 2021.
And the yesterday costs, how much of the <unk> that was temporary.
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