Ferro Corporation

Good morning. Thank you for joining the Faro Corporation first quarter and full year 2020 earnings conference call. An archived replay of this teleconference will be available through the investor information section at faro.com later today and will be available for approximately seven days. I would now like to turn the call over to Mr. Kevin Cornelius Grant, Director, Investor Relations and Corporate Communications. Please go ahead.

Thank you and good morning, everyone. Welcome to Farrow's first quarter 2020 earnings conference call. This morning, we'll be reviewing Farrow's financial results for the first quarter ended March 31st, 2020. I am pleased to join today by Peter Thomas, our Chairman, President, CEO, and Ben Schlater, Group Vice President and Chief Financial Officer. The earnings release and conference call presentation deck are available in 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 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.

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

Thank you, Peter, and good morning, everyone. I would like to echo Peter's comments of how proud and grateful we are for our associates globally for their efforts during this time. The safety and status of our teams around the world remains our top priority. Our associates have really stepped up and remain committed to our strategy. Ferro delivered strong first quarter earnings, driven primarily by improvements to margins versus the first quarter of last year. We believe these margins are more characteristic of the profile of our businesses in the portfolio that comprises our continuing operations. This benefit was driven primarily by two factors. First, more efficient operations in our facilities versus the first quarter of last year. And second, raw material tailwinds. On the manufacturing side, as you may recall, in the first half of last year, we made comments on certain manufacturing headwinds due to several reasons, including the process around optimizing our facilities and the locations where products are produced. As we advance these optimization efforts, and with some of this friction behind us, we are uncovering the underlying and inherent margins of our continuing operations portfolio, which are in line with our expectations. Further, as our work on our optimization activities progresses, our expectation is there will be additional long-term structural margin enhancements, as you have heard us mention. Our teams have worked hard on these efforts, as you know, and we are pleased to see some of the benefits manifest themselves in our results. Our progress in this regard remains a key strategic focus this year, as Peter has mentioned, and we are excited about the additional benefits yet to be realized from these efforts. Touching a bit more on raw materials, one of the characteristics of this portfolio is a greater ability to maintain a favorable price to raw materials balance in periods of raw material inflation and deflation. We have seen this historically in these businesses, and it was made evident yet again in the first quarter. In addition, some of these benefits were the result of focused actions within our optimization programs to structurally lower these costs. With that, I'll move on to discuss our consolidated financial results for the first quarter of 2020 from continuing operations. Please note that the non-GAAP numbers I refer to are on an adjusted basis and growth rates mentioned are on a constant currency basis compared to the first quarter of 2019. Also, beginning with this call and going forward, we are reporting and commenting on free cash flow used in operations. We will no longer report free cash flow on an adjusted basis. The financial highlights and results for the first quarter can be seen on slides 3, 4, and 5 in the presentation materials accompanying today's call, which you can find on faro.com in the investor section. Moving to slide four in the first quarter, net sales declined 2.4% to $252.3 million. Adjusted gross profit improved 5.4% to $81.9 million. Adjusted SG&A expense declined by 4.6% to $51.7 million. Adjusted EBITDA improved 18.2% to $40.7 million, or 16.1% of net sales. and adjusted EPS increased 73.3% to 26 cents. As we noted, the first quarter was stronger than the prior year quarter, with margin expansion across most of the business compared to the first quarter of last year. Adjusted gross profit margin improved 240 basis points to 32.5% compared to the first quarter of last year, and we saw further benefits from SG&A. These results reflect certain non-GAAP adjustments for the first quarter primarily related to professional fees associated with previously divested businesses, corporate development, and optimization activities. First, in cost of sales, we have adjustments of approximately $1.2 million, primarily due to costs related to optimization initiatives. In SG&A, we have one-time adjustments of $4.4 million in the quarter, $2.7 million of that, consisting of costs for professional fees and other expenses related to corporate development and optimization initiatives, including the North American manufacturing optimization, and $1.7 million related to divested businesses. And finally, turning to restructuring and impairment, there was an adjustment of approximately $1.2 million, reflecting actions to achieve our ongoing optimization initiatives and acquisition synergies. Having already discussed gross margin, I'll now move to SG&A. In the first quarter, adjusted SG&A expense was lower by 4.6% to $51.6 million, or 20.5% of net sales. compared with $54.1 million or 20.9% of net sales in the prior year quarter on a constant currency basis. This brings me to GAAP cash flow. As I mentioned earlier, we will no longer report free cash flow on an adjusted basis. Going forward, we will focus on GAAP cash flow from operating activities. We will also discuss free cash flow from operations are 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 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 10 in our press release. In the first quarter, GAAP cash flow from operations was an outflow of $71.5 million. I'll spend a few more minutes walking through the details. The most meaningful components for the quarter are as follows. Starting with GAAP net income attributed to Farrell Corporation of $16.1 million, we add $11.4 million of depreciation and amortization, then subtract $101.5 million for working capital, $13.5 million of change and other balance sheet items, and then add $15.6 million of other non-cash P&L items. And finally, add $300,000 of restructuring impairments to arrive at cash used in operating activities of $71.5 million on a GAAP basis. Then we subtract $8.3 million of capital expenditures and add cash received on other receivables of $28.8 million to arrive at $51 million of cash flow used in the first quarter, which reflects the earnings benefits we mentioned, and changes in working capital for normal seasonality, but also for certain optimization initiatives. Continuing with our discussion on the balance sheet, FARO is well positioned from a liquidity perspective to manage through the near-term effects of the COVID-19 pandemic. As of May 5th, 2020, we had liquidity of approximately $550 million, consisting of cash and availability under our various credit facilities, primarily FARO's revolving credit facility. We have no significant debt maturities prior to February of 2023. Although the first quarter was strong, we know that the pandemic is going to have an impact in the second quarter and potentially into the second half of 2020. Unfortunately, we can't predict the duration or the severity of any potential economic weakness, nor can we predict the shape of the recovery. And because of that, we have withdrawn our full year guidance. Further, as you might expect, we have taken measures to reduce spending CapEx where possible and appropriate and have further plans in place should there be a need for those steps. We will continue to prioritize cash flow and leverage. However, even while obvious macroeconomic challenges exist, so do opportunities. We think the current circumstances might provide an opportunity to expand our market leadership positions, increase market share, and align our existing technologies with areas in which there may be enhanced growth due to potential changes as behaviors and markets evolve in these changing times. I would reiterate that we are very focused on what we can control and on keeping the business agile to adapt to economic changes, all the while maintaining efforts to be well-positioned for when markets do recover. With that, I'll now turn the call back over to Peter to walk through each of the business units and add his final comments before we take questions. Peter?

Continuing operations. reporting segments. As a reminder, during the first quarter, we changed the name of our former performance colors and glass segment to functional coatings, which we think better reflects the product lines within that segment, which now also includes our porcelain and enamel business. We'll begin our discussion with the functional coating segment. So in the first quarter, functional coatings net sales on a constant currency basis were down 5%. Despite the lower sales, Gross margin improved by 240 basis points in the first quarter over the prior year period on a constant currency basis, increasing from 29% to 31.4%. Adjusted gross profit increased 2.9% from $47.5 million to $48.9 million. As we have seen through the prior quarters, the part of our business that serves the automotive industry continued to experience weak global demand, falling approximately 10%. However, despite lower sales, we were able to improve gross margins in this part of our business by more than 500 basis points through our optimization initiatives. Our glass decoration business was up low single digits in the quarter compared to the prior year as we benefited from initiation of a project by a large global restaurant chain. We would characterize this kind of project is off-cycle and not indicative of a general trend in the business. Without this off-cycle demand, our glass decoration business would have been flat. Our electronics materials business was up mid-single digits in the quarter compared to the prior year. During the quarter, we saw increased demand from a large global appliance manufacturer. In addition, we generated additional sales as we resumed production for some customers following our shift of production from from one location to another. In our industrial materials business, we saw a mid-single-digit decline, driven primarily by softer printer equipment demand for digital printing and continued weaker automotive demand. Turning to our porcelain and enamel business, we saw low double-digit declines due to lower sales demand from U.S. appliance manufacturers. Despite lower demand, we again were able, through our optimization programs, to improve gross margins in this business by more than 500 basis points. Now, turning to our color solution segment. In the first quarter, color solutions net sales on a constant currency basis were up 2.1%. Gross margins improved 420 basis points to 34.9% compared to the prior year quarter at 30.7%. Adjusted gross profit increased 16.1% to $33.8 million from $29.2 million in the prior year quarter. In our pigments business, we saw strong demand from the paint sector along with strong demand for our ultramarine blue, basic chrome sulfate, and anti-corrosive products. Viewed from a regional perspective, our pigments business generated in the U.S. high double-digit growth. In Europe, high single-digit growth, and in the Asia-Pacific region, mid-single-digit growth. Demand for our pigments used in master batches and auto production, however, remained weak. The overall higher demand for our pigments helped offset lower demand in surface technology. This lower demand was anticipated. As we previously said, the strong demand we experienced in 2019 for our surface technology products as chip makers built up inventory started to reverse in the fourth quarter of 2019 and is expected to continue through 2020 as chip makers transition to next-generation chip production. So, to bring our comments together this morning, let me emphasize a few key points. We had a strong first quarter. The COVID-19 pandemic did not have a significant impact on our business in the first quarter. We expect a greater impact on our business from COVID-19 in the second quarter due to softened demand with the impact to our business being in the same range as that of our peer group. We don't have clarity about the macroeconomic impact of COVID-19 for the remainder of the year. However, we expect continuing benefits during the year from manufacturing efficiencies, optimization, and favorable raw material expenses. And with our business model, we are confident that we can withstand the current market turbulence, and we are enthusiastic about the opportunities that lie ahead once markets normalize. So we have worked hard to transform Faro to create a highly focused, efficient, and high-value specialty chemical company. We have simplified operations, harvested underperforming assets, invested in higher value assets, and driven innovation and optimization. After the sale of the Tau Coding System business, we will have a company with lower capital intensity, reduced financial leverage, and lower working capital. We will have a more balanced portfolio, both geographically and by end market, with reduced exposure to cyclical markets and a greater concentration on end markets with higher growth. I trust you can see why we are optimistic about our business. When we emerge from the current COVID-19 circumstances, we believe Ferrell will be very well positioned to thrive and create additional value. Finally, before we take your questions, I want to once again recognize and express my pride in our employees. Their dedication and teamwork have given our company a very, very good start to the year. Then with that, Kevin, we are ready to take questions.

Oh, thank you. If you'd like to register a question, please press the 1 followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the 1 followed by the 3. Once again, that's 1-4 to register for a question. One moment, please, for the first question. And we do have a question from the line of Rosemary Morabelli from GE Research. Please go ahead.

Thank you. Good morning, everyone.

Good morning.

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

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

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

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

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

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

Thank you. We have a question from Mike Harrison with Seaport Global Securities. Please go ahead. Hi, good morning.

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

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

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

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

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

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

All right. Thanks very much.

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

Thank you. Good morning. Peter, can you just comment actually what April sales were actually down year over year?

No, we can't do that.

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

Yeah, so, David, I would again point you to the sensitivities that are in the press release. But when we came out with our guidance originally that obviously we've since withdrawn, FX was right around $1.08. which is pretty close to where it sits now. So there was a little bit of FX benefit actually in the first quarter, but with where exchange rates sit now, that's pretty consistent with what was otherwise contemplated at the beginning of the year.

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

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

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

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

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

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

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

Got it. Thanks very much for the caller.

Operator, we have time for one last question.

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

Hey, guys. Nice start to the year. Hey, Mike. I was wondering if you could maybe give us your general thoughts on who the right peer group is for the new FARO. And then when I look at the broad sort of basket of chemical coatings, materials companies, you know, I'm seeing EBITDA down in 2Q, you know, pretty wide range, right, 15%, 20%, some are down 50%. Can you sort of just talk about where you think, you know, you would be in that range? And then do you have what 2Q19 pro forma EBITDA is? I apologize if I missed that.

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

Great. And just sort of comment on sort of the range for 2Q and what your suggested use out was for 2Q19?

Yeah, Mike, for the continuing operations, the second quarter EBITDA was in the low 40s is sort of our estimate, and that would be on an adjusted basis, obviously.

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

Yeah, Mike. So let's go back to what we said quite candidly back in our 2017 Investor Day. I don't know if we can maybe tick it up a bit. I think that You know, we said back then that gross margins would be 33% to 34%. Right now, we can tell you it's probably going to be higher than that. Of course, you know that. You're starting to see the basis of 32%. Understand that our new vitality index with RemainCo is at a very high level, and I can tell you right now our five-year pipeline has a gross margin average of 44%. where we're sitting at 32 today. You can see the contribution that the innovation will bring and that coupled with the optimization programs that you're already seeing the benefit. There will be more, don't forget. We have stranded costs that come out after harvesting or signing the tile business or closing it. Gross margins, I mean, I think we've made comments that we could see them at the 35, 36 range. EBITDA margins, there's no reason to believe that we won't see approaching 20 as we go through the tile deal and moving into next year with the remaining of one, the optimization initiatives, which would be 60% of the 30 we committed to. And secondly, you know, we do have the $10 to $12 million of stranded costs that we spoke of. And three, again, we have a reorganization design about the way Maine code goes to market that's going to be more technology, sales, and marketing and strategically oriented rather than a product regional type of dimension. When you do that, there will be some, you know, cost benefits from that. So, again, the profile of this business is, is one that we think is very, very attractive. Again, 35, 36, 37 gross margins, EBITDA margins approaching 20. And you have the math that will get you there. And I think Ben very, very distinctly outlined an EBITDA framework for a starting position for RemainCo next year. If you listen to all that, you'll have a basis of what we think this business is as a starting point, which is certainly more attractive than it is safe. Why? Because I just outlined all the cost benefits and what Ben talked about during the last call really didn't have a lot of growth in it either. So even if you want to be optimistic and put some level of growth in and add that to the mix, you'll see a very, very attractive RemainCo business moving into the middle part of 2021. So we're very excited about this business today and the first quarter. And Mike, there's something very interesting, and we've discussed this before, and I think it's prudent for us to kind of end it on this note. We've been working for six years, as you know, to try to create something very special. And that's something very special, was taking what we had that was very attractive, that it was a coherent portfolio, bringing it together and leveraging both technology innovation optimization as well as inorganic growth to build a very unique business. And what we say, going back six years if you get your notes, what was very important to us is that our end result would be to create a performance special needs business that really had all the characteristics of what the good companies are. And we laid that out for everybody. We said that there has to be portfolio coherence. We said there has to be leadership positions in the products and the sectors. We said there has to be an attractive market segment structure. We said there has to be... very, very strong technology and innovation capabilities. There has to be good dynamic growth, and there has to be cycle resiliency. So if you listen to our prepared remarks, we laid all that out. So over the past years with what we have with Manko, by following our strategy of simplifying our operations, reducing the cost, harvesting underperforming assets, investing in higher growth value opportunities, which are the 55 technology platforms that we've built into the company. And then we have the dynamic innovation optimization phase, which is really focused on streamlining, optimizing, improving the cost efficiency, which you're seeing now, much like the Viagrant situation, much like the European asset consolidation program we spoke of, and all the other little things that we're doing, stranded cost, reorganizing RemainCo, putting this business at a very streamlined, very, very attractive and strong financial position. And of course, you know what phase five is. It's all about shifting the center of gravity to high margin and high value portfolio. So you can see how we brought all that together. And when you look specifically at those six characteristics, then you have to ask yourself the question, How do we fit in with those six characteristics that I've mentioned? And you've heard us talk about, certainly you can see that we have higher margins and we're telling you that they're sustainable. You can see that the portfolio is less cyclical. You can see that we have a more balanced and marketed regional mix. You see that we have stronger underlying market growth. We have less raw material intensive positions. We are streamlining our manufacturing footprint, and we certainly have a more technology-led, innovation-driven company. So when you think of the six characteristics, what's the end game? We strung out five phases over the past six years to create that model. I've just delineated the top key focus points that are aligned with those six characteristics. of good companies, and then your next question should be, because we think this is a big deal, and here's what excites us, which actually gets to answering one of Rosemary's questions. What happens after COVID-19? Well, one thing I think everyone understands is that there will be structural changes with COVID-19. You know, one of the most important things, I think, as an investor, which we all are, is the lens that you look at each of the companies we're all investing in, whether it's ours or anybody else's. You want to know what the fundamental structural changes in the performance and attractiveness of the end markets that are served by the companies, like us and others, that are focused on. And they're going to be very wide-ranging, and they're going to include some of the most important things where we are strong and we're starting to see it now with RemainCo. Sustainability and recycling is going to be very important. You know, the one package concept and everything that we have that goes into it. You're talking about entertainment and leisure. Well, what about our electronics business? And what about all the 5G applications that we have? You're talking about food and value chain. All of our products go into beverage bottles. They go into the color. They go into a lot of food packaging types of products. The medical and health industries, look at all the electronics. Look at all the specialty pigment products. They are going into all those applications. So what's really interesting is RemainCo has really done well in the first quarter, pretty much aligned with the six characteristics of what we would define strong performing companies, what we've established aligned with those six characteristics, and of course, how are they aligned to post-COVID? And hopefully you can put the dots together to see, Sparrow is in a very, very strong position, not only now with what we've created, but post-COVID. We can see that we are very, very well positioned with post-COVID activities.

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

That does conclude the call for today. We thank you for your participation, and I say please disconnect your line.