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Ferro Corporation (NYSE:FOE)

Q3 2008 Earnings Call Transcript

November 6, 2008, 10:00 am ET

Executives

David Longfellow – Director, IR

Jim Kirsch – Chairman, President and CEO

Sallie Bailey – VP and CFO

Analysts

Michael Harrison – First Analysis

Jason Miner – Deutsche Bank

Robert Felice – Gabelli & Company

Mike Sison – KeyBanc

Dmitry Silversteyn – Longbow Research

Christopher Butler – Sidoti & Company

John McNulty – Credit Suisse

Operator

Good morning and welcome to the Ferro Corporation’s 2008 third quarter earnings conference call. All participants will be in listen-only mode until the question-and-answer session. (Operator instructions) This conference is being recorded. If there are any objections, you may disconnect at this time.

I would now like to turn the meeting over to your host, Mr. David Longfellow, Director of Investor Relations. Mr. Longfellow, you may begin.

David Longfellow

Thank you. Good morning and welcome to the Ferro Corporation’s third quarter earnings conference call. Today we will provide information about our financial results for the three-month period ended September 30th, 2008, and we will discuss our expectations for the fourth quarter.

Joining me on today’s call are Jim Kirsch, Chairman, President and Chief Executive Officer, and Sallie Bailey, Vice President and Chief Financial Officer. Jim will provide some thoughts on our third quarter performance, our view of the market environment, and how it is expected to impact our business, and third quarter business highlights. Sallie will follow with a more detailed discussion of the third quarter financial performance and our fourth quarter outlook. Following our prepared remarks, Jim and Sallie will take your questions.

I hope you have all had an opportunity to review the press release we issued yesterday. Copies of the press release are available on the ‘Investor Relations’ portion of Ferro’s website, which is located at www.ferro.com. Also available on our website is a reconciliation of reported results to non-GAAP amounts discussed on this conference call.

Before Jim begins, I want to remind you that statements made on this conference call about the future performance of the company may constitute forward-looking statements within the meaning of federal securities laws. These statements are subject to a variety of uncertainties, risks, and other factors related to the company’s operations and business environment that are listed on our earnings press release and in the company’s most recent quarterly report on Form 10-Q.

Forward-looking statements reflect management’s expectations as of today, November 6th, 2008. The company undertakes no duty to update them to reflect future events, information or circumstances that arise after the date of this conference call, except as required by regulations. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Ferro is prohibited.

A dial-in replay of today’s call will be available for seven days. In addition, you may listen to, or download, a replay of the call through the Ferro Investor Relations website.

I’d now like to turn the call over to Jim.

Jim Kirsch

Thank you, David, and welcome to everyone on this call this morning. It’s a real pleasure provide you with an update on our progress. Ferro continued to build on the momentum of the first half with another strong quarter. Despite a worsening economic environment, sales increased and we generated higher total segment income. We’ve made significant progress on the strategic initiatives that we began two years ago. We received the proceeds from the sale of the U.S. portion of our Fine Chemicals business, which will be used to reduce our borrowing levels. And despite the difficult environment, we continue to invest in new product development and the manufacturing facility expansion for our Electronic Materials business.

For the third quarter, net sales increased by 11% led by growth in Electronic Materials. Gross profit increased by 14% demonstrating the progress we’ve made on our cost structure despite the continuing need to cover higher raw materials costs. Total segment income increased 34% reflecting our strong product franchises in regions around the world. Reported earnings were lower by $0.01 a share, primarily as a result of non-recurring charges related to our bond refinancing.

In addition, our operating profit, excluding charges as a percent of sales and excluding precious metals, was 7% for the quarter, up from 5.9% in the third quarter of 2007. As a result of the work done within Ferro during the past two years we are positioned to weather a more uncertain and difficult business climate.

Over that time period, we have made great progress in our efforts to rationalize manufacturing assets in Europe, United States, and Latin America. We have confidence that we will continue to successfully execute the projects we have identified to complete our European restructuring. We continue to benefit from the progress we’ve made to improve our business processes and reduce our expenses. And we are taking additional steps to further reduce costs and lower our breakeven point.

During the course of the third quarter we saw deteriorating customer demand as the effects of worldwide credit tightness became evident in business activity. Demand softened in applications that had already shown weakness such as automotive, construction, and appliances. Western Europe, which normally has a seasonally slow month in August, was also weak in September. Because the issues in the credit markets were more acute at the end of the third quarter and during October, we all believe we have yet seen the full effect reflected in our customer orders.

In response to the uncertainty caused by the credit tightening we remain focused on a few key initiatives. We will continue to execute the restructuring programs that are already underway in order to improve our cost structure. We have an excellent track record of defining, planning, and delivering savings from these programs. We’ve began to realize benefits from three phases of our European manufacturing rationalization and we are finalizing plans for the fourth and final phase. We will continue to push forward as these initiatives are within our control to execute.

Second, we will continue to adjust our manufacturing resources to be in line with customer demand. We constantly evaluate our manufacturing capacity as compared to the orders and we make adjustments as necessary. Earlier this week, we informed the employees that we will close the United States pigments plant in our Color and Glass Performance Materials segment by the end of this year. In addition, we recently made further headcount reductions in our organics as a result of declining customer demand. We will take further actions as needed as we continue to evaluate business conditions.

We are also taking steps to control spending and reduce costs. These actions include significant reductions in discretionary spending and placing restrictions on hiring in any areas that are not directly supporting sales and earnings growth. One of the tenets we’ve adopted across Ferro as a part of our ‘Win from Within’ operating philosophy is velocity. Certainly, the months and quarters ahead will continue to demand that we act with velocity to adapt our business quickly to changing economic conditions. I am confident that we will meet this challenge.

We know what we are good at and how to translate those skills into cost effective application of our products in customers’ production lines. We have demonstrated an ability to find and cut excess costs from our operations and we continue to work closely with our customers to develop new and reformulated products that help them maintain or improve the functional properties of their products while managing their cost and helping them to grow.

Let me now briefly review the quarterly highlights from our three businesses. We had another strong quarter in Electronic Materials as shown by growth in sales and segment income.

Our metal powders and conductive pastes for solar cell applications continue to lead the way in this business. At the time of our last conference call we felt there was a possibility that we could see some negative effect from the Beijing Olympics on the demand for these products in China. However, demand continued to be strong and for the second straight quarter we delivered our target business model of 40% gross margins and 20% operating margins as a percent of sales excluding precious metals.

Progress on our new solar pasting facility in Suzhou continues on schedule and we plan to deliver our first production from this site to customers before the end of this year. I am looking forward to meeting with our Asia Pacific leadership team in China in a few days to get updates on operating plans and market conditions in this important growth region for Ferro. Our order pattern in Electronic Materials remains relatively strong and we expect this segment to deliver good results in the fourth quarter. Our multi-layer materials and surface finishing products have some exposure to consumer driven demand through the consumer electronics and eye glass lens polishing markets, respectively. These markets may be affected to some extent by slower economic growth.

Our Organic Specialties businesses, made up of the Polymer Additives, Specialty Plastics, and Other business segments, continued to manage their operations well in an increasingly difficult business climate. In total, the businesses delivered increased sales and increased segment income despite weaker customer demand and higher raw material costs.

Through the third quarter, our Polymer Additives business has successfully managed the relationship between its costs and product prices in order to keep the business relatively healthy during period of very volatile cost for soybean oil, tallow, and petrochemical based feedstocks. For the year, the businesses absorbed more than $30 million in increased raw material cost while at the same time delivering improved operating income.

As I mentioned earlier, we continue to take actions that keep our cost structure properly aligned with customer demand. In October, we reduced our manufacturing workforce in Specialty Plastics to lower costs and our breakeven point. These difficult actions are necessary to remain a healthy, long term supplier to our customers.

We had an improved third quarter in our Pharmaceutical operations as customer demand was higher than in the prior-year period. Demand is somewhat variable from quarter-to-quarter in this business, but we are pleased with the track record the business is establishing with respect to selecting new products, moving those projects to the development pipeline and delivering commercial production.

Last month, we announced the sale of our Fine Chemicals business. While this is a growing and profitable business, it could not fully leverage the technical skills we have in other parts of Ferro and growing Fine Chemicals substantially would have required capital that we would rather use to strengthen the core of our business. The sale is a part of a strategic review of our portfolio. As I have said many times, we will assess alternatives for businesses that either do not advance our ability to reach our long term financial goals or that do not leverage our core capabilities around particle engineering, color and glass science, product formulation, and applications understanding.

Our Inorganic Specialties business, including the Performance Coatings and Color and Glass Performance Materials segments improved both sales and segment income as a whole compared with the third quarter of 2007. However, this was also a quarter when we felt additional effects of the global economic slowdown particularly in our Color and Glass Performance Materials segment. Our geographic diversification continues to pay dividends in this business. While there has been weakness in North America and Western Europe, we have seen growth in Asia and Latin America along with the Middle East and Eastern Europe throughout the Inorganics business.

Our flat glass products and beverage bottle decorations business continued to hold up well. And our Spanish tile business continues to benefit from export markets as they service customers in North Africa, the Middle East and Eastern Europe.

During the third quarter, our Color and Glass Performance Materials business experienced reduced customer demand in Western Europe and the United States. This weaker demand was most evident in auto glass enamel sales. In previous quarters, our customer diversification in the North America automotive market helped to partially insulate us from the lower production rates of the U.S. domestic producers. However, as total U.S. auto production schedules declined during the third quarter, our business has been affected.

We continue to make progress in our European restructuring programs in the Inorganics business. In July, we successfully completed the transfer of our porcelain and enamel production from the Netherlands to Spain and we are generating significant manufacturing cost per unit savings, as planned. This was the third of four major phases of our manufacturing restructuring initiative that we started in 2006. We are currently in discussions with the local works council regarding the final phase of the European restructuring program. This phase is planned for completion in early 2010 when we expect to meet our original goal of cost – annual cost savings of $40 million to $50 million.

As I mentioned previously, we have initiated a new restructuring project in our Color and Glass business. We expect to generate $3 million to $4 million in annual cost savings by closing our Toccoa, Georgia pigments manufacturing site. Production at the site is expected to be finished by the end of this year. We will generate additional cost structure improvements through these programs in 2009, which will help to strengthen our business regardless of external economic conditions.

Sallie will provide our sales and earnings per share estimates for the fourth quarter, but I will provide some general comments on our outlook. Like most companies, we are cautious in our approach to the next several quarters. We are planning conservatively in terms of our cost and expense structure and we will act with velocity as economic conditions change. At the same time, we will continue to work closely with our customers and at every opportunity will provide them with product options to help them manage their businesses.

We’ve entered a difficult period for the worldwide economy, but Ferro is in a much improved position to weather the challenges. In August, we successfully refinanced our Senior Notes and thereby completed the recapitalization of the company that we started in the spring of 2006. We completed the restructuring project in our Electronic Materials business, and we have made significant progress on our European manufacturing rationalization. We’ve also found additional opportunities to reduce cost throughout our worldwide Inorganic Specialties operations.

In our Organic Specialties business, we’ve managed a very dynamic mix of raw material costs, expenses, and product prices. We’ve shown an ability to continue to generate profit and cash in a turbulent marketplace. Together, these actions have lowered our overall breakeven point and we have realized improved profitability as we have grown the company. Our results have been strong for the first three quarters of 2008 as evidenced by the 44% increase in our reported earnings per share. And our ability to stay on course despite external headwinds gives me confidence that our people are up to the challenges ahead.

We will continue to push forward with our efforts to improve business processes, leverage our worldwide buying power and build more effective and efficient manufacturing operations. We cannot completely insulate ourselves from changes in the global economy, but I have confidence that we have a team that is prepared to manage well in the interest of our shareholders, customers, and employees. I look forward to updating you on our efforts in the coming quarters.

Now, I would like to turn the call over to Sallie, who will review the financial results in more detail and discuss our fourth quarter estimates before we open up the call for your questions. Sallie?

Sallie Bailey

Thanks, Jim. This morning, I will begin my remarks with a recap of the third quarter results, and then I will discuss our current estimates for the fourth quarter.

Reconciliations of non-GAAP results discussed in my remarks are available on our website. Ferro’s earnings for the three months ended September 30th, 2008, were $0.11 per diluted share, including special charges. Included in the quarter were pre-tax charges of $17.9 million related primarily to restructuring, our bond refinancing, and corporate development activities.

Our net sales for the third quarter were $609 million, an 11% increase compared with net sales of $551 million in the third quarter of 2007. The sales increase for the quarter was driven by product price increases including pass-throughs for precious metal cost and favorable changes in foreign exchange rates.

Gross profit improved by 14% in the third quarter compared with the prior-year period. During the quarter, we recorded charges of $1.5 million in cost of sales related to asset write-offs and our manufacturing rationalization program.

Gross margin was 18.7% for the third quarter compared with 18.2% in the prior-year quarter. Adjusting our third quarter gross margin for precious metal sales and special charges, gross margin was 22% for the quarter, higher than our adjusted margin of 20.4% in the third quarter of 2007. This improvement was delivered in spite of raw materials cost that increased approximately $20 million from the third quarter of 2007.

SG&A expense for the third quarter of 2008 was $78.3 million. As a percent of sales, SG&A was 12.9%, flat with the third quarter of 2007. The 2008 third quarter SG&A expense included charges of $1.9 million, primarily related to corporate development activities, partially offset by insurance settlements. For the quarter, SG&A expense was increased by foreign exchange rates as a significant portion of our SG&A expenses are incurred in our non-U.S. facilities around the world.

Corporate SG&A expense increased primarily as a result of higher benefit and incentive compensation expenses. During the quarter, we also increased SG&A spending to support our Electronic Materials. Partially offsetting these increases were expense reduction actions taken by our business units in 2007 and 2008 particularly within our Organic Specialties Group.

Restructuring charges for the quarter were $9 million, up from $5.8 million in the third quarter last year. The primary driver of these charges continues to be the manufacturing rationalization project within our Inorganics business in Europe. During this quarter we recorded severance charges for employees at our Rotterdam facility, which closed at the end of July. We continue to be aggressive in realigning our cost and resources as market dynamics change.

Total segment income for the 2008 third quarter was $48.8 million, up 34% from the third quarter of 2007. Segment income increased in Electronic Materials as a result of increased sales volume of higher margin products, particularly advanced silver and aluminum pastes used in solar cells. Segment income also increased by double-digit percentages in our Performance Coatings, Polymer Additives and Other Business segments. The income increases were the result of a combination of aggressive actions to cover raw material cost increases, cost and expense control initiatives, and manufacturing cost improvements.

Income declined in the Color and Glass Performance Materials segment due to weakness in customer demand in auto glass enamel and dinnerware decorations. In addition, we recorded an increased debt reserve in this segment and we experienced some unexpected manufacturing cost during the quarter.

Income also declined in the Specialty Plastics segment as a result of continued weak demand from U.S. customers and automotive, construction, and appliance applications.

In our reconciliation of segment income to income from continuing operations before taxes, we reported unallocated corporate expenses of $13 million including special charges of $3.4 million. The corporate unallocated charges were up from the third quarter of 2007 as a result of higher special charges, increased benefit expenses and higher incentive compensation accruals.

For the 2008 third quarter, interest expense was $12.5 million, down from $14.5 million in the third quarter of 2007. The reduction was driven by lower interest rate, partially offset by the expense resulting from higher average level.

During the quarter, we successfully refinanced our 9 1/8% Senior Notes with a new five-year 6.5% convertible notes issuance. The new notes will result in improved cash flow as a result of the lower coupon. The refinancing completed the last piece of the new capital structure that we began putting in place in 2006.

Our refinancing resulted in a loss of extinguishment of debt of $5.5 million during the third quarter. The loss included call premiums and tender costs, including unamortized discounts and fees related to our 9 1/8% notes.

Bringing this all to the bottom line, we generated income from continuing operations of $0.11 per diluted share, including charges. Excluding the $17.9 million of special charges from our third quarter would result in pre-tax income of $24.4 million. Applying a tax rate of 36% would result in earnings of $0.35 per share on an adjusted basis.

Capital spending for the quarter was $17.2 million. Spending for the quarter included the continued build-out of our Spanish manufacturing site, investment in our new solar paste facility in Suzhou, China, and normal maintenance and productivity improvements in our facilities.

Depreciation and amortization for the quarter was $19.3 million. For the year, we have spent $51.8 million on capital expenditures. Our current forecast for capital spending for 2008 is approximately $75 million.

Total balance sheet debt on September 30th was $609 million, compared with $526 million at the end of 2007. In addition, at the end of the third quarter, we had net proceeds of $75 million from our off balance sheet U.S. asset securitization program and an additional $28.8 million of net proceeds from similar programs outside the U.S. The increase in debt for the third quarter was driven by the cost of our refinancing activity and our restructuring programs, which used $10.8 million and $13.2 million in cash, respectively.

We have now closed the U.S. portion of our Fine Chemicals business for $52 million in cash. An additional $8 million of purchase price is in escrow until an equity transfer of a Ferro subsidiary in China closes. We expect this will happen by the end of this year and we have used the net proceeds to pay down debt.

During the past two months we have seen a weakening in our customer demand, particularly in Western Europe and the U.S. As a result, our expectations of economic activity in the fourth quarter have been revised downward. We will continue to manage our cost and expense structure carefully with a mind towards controlling discretionary spending and aligning our production resources with the level of customer demand.

We expect fourth quarter sales to be in the range of $500 million to $550 million. With the volatility in exchange rates recently, the magnitude of changes in foreign exchange rates on reported sales is difficult to estimate. In addition, weaker customer demand is expected to continue to impact sales volume.

Earnings from continuing operations for the fourth quarter are expected in the range of $0.33 to $0.38 per share. Included in this estimate is a gain of $0.31 per share related to the sale of our Fine Chemicals business. Without this gain, the earnings estimate would be in the range to $0.02 to $0.07 per share. The fourth quarter estimate – earnings estimate also includes restructuring and other charges amounting to approximately $0.13 per share. Without the gain or the charges our non-GAAP earnings estimate equates to a range of $0.15 to $0.20 per share.

In the fourth quarter last year, we recorded a loss of $2.59 per share including charges of $2.71 per share resulting mainly from the goodwill impairment that was recorded in last year’s fourth quarter.

Thank you for participating in this morning’s call and your interest in Ferro, and I would like to turn the session back to Dave for questions and answers.

David Longfellow

Thank you, Sallie. Operator, we are now ready to begin the question-and-answer session. Can we have the first question please?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) The first question comes from Mike Harrison with First Analysis. Your line is open.

Michael Harrison – First Analysis

Hi, good morning.

Sallie Bailey

Good morning, Mike.

Jim Kirsch

Good morning, Mike.

Michael Harrison – First Analysis

I was hoping that you could walk me through the rationale for the Fine Chemicals divestiture. And also kind of curious if you could talk about what happened that made you decide to accept the lower price. As I look back historically, you guys tried to sell the plastics business and the buyer ended up cutting the price I know you walked away from that deal. So what made this different when the price was reduced?

Jim Kirsch

Okay, Mike, this is Jim. The – first of all, I’ve said for sometime that if you look at strategically where we are trying to go, where are trying to build sustainability as company it’s around a couple of key competencies where we believe we win in the marketplace. And those are around particle engineering. We – if you look across our Electronic Materials and Inorganics businesses they clearly give us competitive advantage. Those also are around our Color and Glass science capability and then formulation and application know-how at our customers’ place of business. We said for sometime that we are running the Organics businesses for cash and preserving the franchise. And the Fine Chemicals business, which we’ve built up over the last years into a good business in terms of margin and good business in terms of profitability, however, it doesn’t fit in our view long term where we are trying to go as a company. And second, the amount of capital we felt was needed to get that business to the size where it would move the needle for the company long term was better placed in businesses that we thought we get greater competitive advantage and greater value for our shareholders. So, strategically, that’s the rationale behind the sale.

With regards to price, at the end of the day every buy-sell is a negotiated activity. There was a substantive change in the world in terms of the economics of the world when we entered into that agreement as opposed to when we finalized that agreement. There is no question that the economic environment is significantly worse in October than it was when we entered into that agreement in the August timeframe. And fundamentally, at the end of the day we felt that the offering price – and our Board felt the offering price on a multiple and on a fairness basis was appropriate. So, we entered into and completed the negotiation.

To your point on the earlier activity, we obviously didn’t feel that way and so opted not to take a reduced price offer two years ago on a plastics divestiture opportunity. If you look at the plastics results, I will tell you that particularly compared with our peer group in the industry we made the right decision.

Michael Harrison – First Analysis

Now, that’s fair. That makes sense. I was wondering, Sallie, if you had any estimates on how much dilution we should expect in 2009 from the Fine Chemicals divestiture?

Sallie Bailey

Yes, Mike, I estimate it will be about $0.05 a share.

Michael Harrison – First Analysis

Okay. And then looking at the margin in Color and Glass, I was wondering how much of one-off is the increased bad debt expense or if that’s an expense that is may be there to stay for a few quarters or into the future.

Sallie Bailey

Yes, our view, Mike, is that it’s a one-off expense. We do a very thorough review as you can imagine of all our customers and in fact if you look at in the U.S. when we monitor our customers 90% of them are either current or within one to 15 days. So we really vie that as a one-off.

Michael Harrison – First Analysis

And how much was that additional expense.

Sallie Bailey

It’s about $800,000.

Michael Harrison – First Analysis

And then the last question I had for now is just looking at the currency headwinds you expect, obviously that’s going to impact you most on the top line –

Jim Kirsch

Right.

Michael Harrison – First Analysis

But do you guys have any rule of thumb that we could use for the impact of changes in the dollar-euro rate on operating income?

Sallie Bailey

Yes, Mike, we look at that for the whole of the company and through this year, foreign exchange has had almost no impact on operating profit as it’s gone up and so we would anticipate similarly as it comes down that it will have no impact on operating profit or minimal impact on operating profit.

Michael Harrison – First Analysis

Alright. Thanks very much.

Jim Kirsch

Thank you. Thanks.

Operator

Jason Miner with Deutsche Bank, your line is open.

Jason Miner – Deutsche Bank

Thank you, good morning.

Jim Kirsch

Good morning.

Sallie Bailey

Good morning.

Jason Miner – Deutsche Bank

Jim, as we look at Q4 and some of the demand pressures, I wonder if there is any way to get an end market view that would help us scale what sort of de-stocking we might be seeing versus overall weakening end market demand.

Jim Kirsch

If you looked at our individual businesses, the tile business, for instance, in Performance Coatings is driven externally to the U.S. First of all, let me start at the top. In geographic terms clearly the U.S. is the economy that we are seeing the most difficulties in. The businesses that are centered here for us are plastics, Polymer Additives, our Fine Chemicals business, and then to a lesser extent our pigments and Glass businesses and porcelain and enamel. The end users for those, if you think about porcelain and enamel, for instance, is appliance. If you just follow the trade journals or what you see in the Wall Street Journal or other trade rags, you’ll see that the big types of customers there, the Whirlpools of the world, et cetera, are continuing to cut output and continuing to cut cost by taking people out of their organizations. So, those businesses essentially tend to run with GDP type growth rates. So, if your anticipation of the GDP in U.S. is 1% or 2%, that wouldn’t be a bad marker for those businesses, Jason. The – we tend to run a little above GDPs, in Europe primarily because of our expansion into Eastern Europe, Africa, and Middle East, in our tile and porcelain and enamel businesses. So they are more GDP plus and typically what we have used in the past is about a point or so. And in Electronic Materials business, historically, if you look at the end markets, which tend to be either semiconductor or more clean technology or surface technologies, as a group they’ve tended to run at a compound growth rate in the 10% range – 9% range. The clean technology business or solar business has been much higher than that. It’s been in the 15% plus type of compound growth rate. But as I mentioned on our last call, we expected and called that that business would develop – I used a really technical term called ‘lumpiness’ because we expect the growth rate and the growth drivers to be maintained, but quarter-to-quarter we expect we are going to see much more significant volatility in those markets.

And then the final comment I am going to make is you asked about de-stocking. In the past we had seen significant de-stocking particularly in the fourth quarter as people managed their working capital. The supply chains are much more leaned out this year. And we think if there is de-stocking it will be having a lesser effect if you will on our business in the U.S.

Jason Miner – Deutsche Bank

Does that imply that the – I will call it late Q4 guidance is reflective of the fundamental demand environment rather than de-stocking?

Jim Kirsch

Yes, it does.

Jason Miner – Deutsche Bank

Right, Okay. That’s clear.

Jim Kirsch

It’s a – as I said in my comments, it’s a cautious outlook about the demand environment. We think – there is no question we’ve lowered our breakeven. We’ve taken tremendous chunks of cost and expense out of the company. We’ve improved our capital structure. This was a demand issue.

Jason Miner – Deutsche Bank

Okay. Just on the closure in Georgia is that demand that’s moved geographically overseas? Is there any likelihood that – what sort of utilization do you see on other plants after you closed that?

Jim Kirsch

This is a straightforward rationalization of manufacturing capacity. Its demand has not moved. It’s primarily a pigments plant and it is in our Color and Glass Performance Materials business. We’ll move all of that business – all of that manufacturing, rather, to our Washington, Pennsylvania facility, and we’ll enhance our capacity utilization substantially there. So, essentially you are taking two facilities that were under utilized and combining to one, and driving capacity utilization rates to a higher level.

Jason Miner – Deutsche Bank

That’s good.

Jim Kirsch

Hence, between that savings and the headcount reduction, we expect to see $3 million to $4 million cost savings.

Jason Miner – Deutsche Bank

Okay. Just two other quick ones and I will get back in queue. Did you guys scale the overall volume impact on sales growth?

Jim Kirsch

I am sorry, did we do what – ?

Jason Miner – Deutsche Bank

I am sorry, with sales were up 11%, what – how much was volume?

Jim Kirsch

Okay. If you look across the business, more of it in terms of sales growth was price, FX, the precious metals than volume. In fact, total volume in the quarter declined across the company. So, if price was about 20% of that, about a third was FX, and the remainder for the most part was the precious metal increases.

Jason Miner – Deutsche Bank

Okay. That’s helpful. And then my last quick one, sorry. There is a lot of moving parts in the tax rate. Just wondering may be, Sallie, what do you think the full year might be the tax rate at this point?

Sallie Bailey

Well, our best estimate for the full year tax rate on a GAAP basis is 41.6%, which you would calculate if you look at the nine months number. But, as you know, when we look at our non-GAAP numbers, we apply a 36% tax rate. And because of the volatility associated with our earnings as well as a number of discrete items and if you calculate the tax rate and you take out the $2 million we talked about last quarter the settlement we had in Brazil, you will see that we get very close to a 36% tax rate.

Jason Miner – Deutsche Bank

So, just looking more directly at Q4, are there other transitory impacts or true-ups that you expect or – I mean you think it would be close to 36%?

Sallie Bailey

Well, right now, our estimate for the fourth quarter would in fact be the 41.6%, which is our – which is the nine months calculation, as you know.

Jason Miner – Deutsche Bank

Okay.

Sallie Bailey

For each quarter you true up for the nine months what you anticipate your tax rate will be for the full year.

Jason Miner – Deutsche Bank

Okay. That’s fair. Thank you very much.

David Longfellow

Thank you. Could we get the next question, please?

Operator

Robert Felice with Gabelli and Company, your line is open.

Robert Felice – Gabelli & Company

Hi, most of my questions have been answered. Just a couple more. Could you remind the magnitude of the savings you realized year-to-date from the European restructuring, and as we look to ’09, the magnitude of the incremental savings you expect to realize?

Jim Kirsch

This year, it will be average of $15 million to $20 million and we are tracking towards the high end of that, Robert. And the expectation, incrementally next year would be about $20 million.

Robert Felice – Gabelli & Company

Okay. You know, obviously there is a lot of moving parts as we think about the Inorganics business and the world has changed quite a bit over the last couple of months, but as we look to ’09, could you help us balance what’s obviously become a very, very difficult external environment with the internal efforts to improve profitability, kind of your best guess as to how that will play out and whether – or to what magnitude of improvement we should expect at the bottom line next year within Inorganics?

Jim Kirsch

Yes, we historically don’t give forward-looking year-by-year guidance, as you know, Robert. But I will tell you that if you look at our activity to-date the – between raw material costs, which we’ve covered through a combination of pricing and productivity versus volumes across the company and the demand slowdown driven by these tremendous economic difficulties that the world is experiencing, we’ve managed to improve substantially over the nine months and if you take our guidance for the fourth quarter, we are going to have a much better year this year than last. And I would tell you that a combination of – and you can't point to one thing, but a combination of the savings I just mentioned in addition to additional restructurings like this opportunity to shutdown Toccoa and move that manufacturing over to Washington. It all is allowing us to stay ahead of the game. And my expectation from my management team is they are going to continue to deliver value by staying ahead of that game.

Robert Felice – Gabelli & Company

So, if I am reading into it correctly, it sounds confident that within – Inorganics next year should show improvement versus ’08, is that correct?

Jim Kirsch

I am not going to make a projection for you because the demand side of that is so volatile. I think if you could tell me what the demand side and economy side would like and say hey you are going to see a 3% growth rate GDP, I will have a lot of confidence in giving you a response to that. But I think all things being equal that if the demand side in the economies hold, we should be able to able to continue to execute against our restructuring, continue to take cost out and we’ve proven we can hold the line and price for raw material costs. So we should have a business that does okay.

Robert Felice – Gabelli & Company

Okay, well I guess stepping back and thinking about it broader for the entire company, do you still think Ferro is on tract to achieve 10% EBIT margin in 2010? I couldn’t help but notice that you didn’t mention that on the call and you’ve been pretty vocal about that on previous calls.

Jim Kirsch

I am glad you asked. If you think about ’07, and just for those who may not know, we’ve defined that as less our operating income margin less the restructuring and precious metal cost, it was at 6% at the end of 2007. If you look through the first three quarters of 2008, we are about 6.6% in the first quarter, this goes under 8% in the second quarter, and 7% in the third. It averages a little over 7% year-to-date through the first nine months. And then what I’ve said is we’ll get from 6% to 10% through three things we can control and one that we need a little help in the market. Those were 1% from improved manufacturing and procurement, half a point from SG&A reduction, and 1.5 through our restructuring. And so if you start from that 6%, what we have delivered is about 100 basis points to-date. And as I look out over the next 15-16 months my expectations we are going to deliver on restructuring, as I said in the call. So, we expect to get that full 1.5 from the basis of 6%. We’ve proven we can manage SG&A well. So I see no reason that we shouldn’t get that as well. And I think where we are going to struggle is we are going to need help on the economy on our 40:20:20 model in Electronic Materials in order to maintain the pace that we’ve set in the last two quarters.

So, I am not hedging my debt [ph]. We are basically still committed to delivering on 10%. And if things are in our control, we certainly expect to deliver on it.

Sallie Bailey

And, Rob, just we haven’t quoted on the website the reconciliation to the 7% that Jim mentioned in his comments and just referenced as well.

Robert Felice – Gabelli & Company

Okay. And then I guess lastly you mentioned the impact of the credit market on demand and I was hoping you can highlight where specifically you are seeing the greatest impact.

Sallie Bailey

Clearly the biggest hit is automotive. I mean it’s – if you look at the broad automotive and (inaudible) you look at the automotive or automotive enamels in our glass business in CGPM are impacted. Our plastics business is impacted. We have – in appliance, clearly a portion of the enamel business is impacted. And then as you look out further, and ripples of this as people slowdown in terms of redoing homes, et cetera, we are going to see that impact globally in our tiles business as well. So the net of it all is this isn’t good for anybody. And if you exposure to automotive, appliance, building and construction, you’ve got be very creative in ways to take cost out, consolidate your gains that we’ve accomplished and then make sure that you are little better in the next day, in the next day, in the next week than you were this week.

Robert Felice – Gabelli & Company

And I know it’s still early to determine the – how this is all going to play out over the next couple of quarters, but any sense as to the magnitude of the volume impact that you are seeing or you expect to see?

Jim Kirsch

Now, I think – I don’t think I can give you a projection at that point. I mean it’s – first of all, volume for us is a little bit, as we’ve tried to explain before, it’s a little unusual because we tend to try to sell smaller volume, higher value packages. Our lowest margin businesses tend to be things that are packed in 2000 pound bags, like frit. On the other hand, if you advance that frit into an (inaudible) or into a glass material that’s used in electronic application or automotive glass application, we get much higher value, but it’s packaged in a much smaller type of material and sold at a much lower volume. So, I actually want to maintain a certain base volume in our large volume frit plants, continue to absorb and deliver on our cost structures, et cetera, but we really try to sell more of the higher value-added, which net-net is a lower volume business for us.

Sallie Bailey

Rob, this is Sallie. I think if you want to think about how does Ferro manage through these types of economic circumstances, let’s think about how we’ve been managing our Organics business and in particular and in particular think about our plastics business. Clearly, that businesses had some pretty significant volume impact, and yet you can see that all-in we’ve done a pretty good job of continuing to keep our operating profit close to where it was in the prior year, certainly for the third quarter. And so what we are doing is we are continuing to try to look at and take action that align our cost structure both SG&A as well as within the plants with what the demand is. So I would point to that business in particular as an example of how we will manage thru the uncertainty that’s coming from volume demand. That’s basically end of [ph] 2009.

Robert Felice – Gabelli & Company

Okay, that’s helpful. I guess I have one or two other questions, but I will hop back in queue.

Jim Kirsch

Okay, thank you.

Operator

Mike Sison with KeyBanc, your line is open.

Mike Sison – KeyBanc

Hey, good morning guys.

Jim Kirsch

Good morning.

Sallie Bailey

Hi.

Mike Sison – KeyBanc

Jim, maybe just give us a quick comparison of how you feel about the business now. I know you weren’t here in 2001 during the last recession. Maybe just point out the – what you’ve done in total that maybe lessens the impact of a recession versus what we last time when Ferro went through it.

Jim Kirsch

Sure. Well, first off, we have about 40% fewer people here than we did in 2001, Mike. And we are (inaudible) 2000 people and we are down in the 6000 range right now, may be 6200 some number like that. Second, we have taken out by the end of next year virtually half of our manufacturing facilities that were part of that consolidation in ’01 in Europe and we’ll reduce from really 12 full manufacturing sites to six. We’ve lowered our breakeven substantially. We’ve put in a price cost culture such that people now understand how our customers make money and can assist them in doing so and at the same time we’ve shown we can extract values as evidenced by the higher gross margins we’ve delivered. And I think at the end of the day we have much better processes that are enablers for us to get better information and make better decision. So I don’t think the company other than the markets we serve and some of the fundamental core businesses we are in is very similar at all to what it was in 2001 at this point in time.

Mike Sison – KeyBanc

Okay, that’s helpful. And in terms of solar, how strong was it in terms of sales growth in the third quarter and to what degree will you see that grow in the fourth quarter?

Sallie Bailey

Could you ask the question again, Mike – ?

Mike Sison – KeyBanc

As far as the solar business in Electronic Materials –

Jim Kirsch

Oh solar, I am sorry just –

Mike Sison – KeyBanc

Yes, just I am sorry about that.

Jim Kirsch

It maintained pretty close to what we had seen in the prior – in the first six months of the year, Mike, where it was showing a growth rate roughly in the 14%-15% range. We saw a very similar type of growth in the third quarter and we expect certainly there to be some volatility month-to-month, quarter-to-quarter, but the underlying demand is still there. There is – there are tiering of customers in this business. You have kind of the top tier guys. These would be your VP [ph] solars and q-cells. Then you have the second tier, which are people that I think are much more dependant on financing and really entered the business in the last several years. And then you kind of have your third tier, which are startups. Certainly, the third tier has been impacted almost immediately by this economic issue and the second tier is beginning to be. Haven’t seen that as much in the third and our order books are, as I mentioned earlier, we expect a good fourth quarter. And I – we are managing the business closely. So I think you are going to see more volatility and it’s going to look a lot more like the semiconductor cycle that has a straight up solar cycle but the underlying growth fundamentals are still there.

Mike Sison – KeyBanc

How big will this business be by year-end and what are you hearing from your customers in terms of I guess general growth into 2009?

Jim Kirsch

Well, there is a lot of concern about things like starting [ph] the customer and things like tax subsidies and ability to access financing and so on and so forth. It – through the third quarter had not impacted our order book or our customers’ investment profile that we could see. I think in 2009 we will see some impact, but I am not going to predict how much that will be.

Mike Sison – KeyBanc

Okay. And it seems like conventional wisdom out there suggests that U.S. and Europe is going to be in a recession, so underlying that backdrop would you volume you think would be down in line with demand? Will it be a little bit better? Will it be up?

Jim Kirsch

No, I think that in – will be in line with general economic trends, Mike. The only difference I’d tell you is that clearly in some of our businesses, Electronic Materials, tile, glass business within CGPM, we’ve gained share. So, we are going to be running with the economies albeit from a higher base. If you go back a couple of calls ago, I talked about one of the differences in Ferro is by lowering our breakeven point so substantially we’ve raised a level, if you will, going into this. So, if we were having this conversation three years ago, I would be much more concerned about our ability to weather the storm than I am right now because our cost structure is substantially different and lower than it was three years ago or two years ago or one year ago. And our ability to rapidly act – the Toccoa, Georgia is an excellent example of that – to look at our business, understand the economy, understand what’s going on at play here, and take action rapidly to reduce manufacturing or shutdown a facility, and accelerate the move to a different facility to improve our overall capacity utilization will pay tremendous dividends to this company and our shareholders, moving forward.

Mike Sison – KeyBanc

Great. And last question, Sallie, when you think about interest expense using the proceeds to pay down debt, what’s the run rate look like for 2009 – ?

Sallie Bailey

Well, Mike, we would anticipate from a cash point of view that we’ll see $4 million to $5 million of improved cash flow due to the lower coupon. But as you may know, there is new GAAP pronouncement out there that you have to actually do some unconvertible. You basically have to treat the convertible as if a piece of it is debt and a piece of it is equity. So we believe our nominal interest expense in 2009 will be very close to – or our reported interest expense in 2009 will be close to the same run rate as we’ve had in ’08 from an effective interest rate point of view.

Mike Sison – KeyBanc

Okay. Thank you.

Jim Kirsch

Thanks, Mike.

Operator

Dmitry Silversteyn from Longbow Research, your line is open.

Sallie Bailey

Good morning.

Jim Kirsch

Dmitry?

Operator

Please check your mute button.

Dmitry Silversteyn – Longbow Research

Yes, hello, can you hear me.

Jim Kirsch

Yes.

Dmitry Silversteyn – Longbow Research

Okay, great, I am sorry. Most of my questions have been answered, but I do want to follow up on a couple of them. The closure of the Georgia plant and the $3 million to $4 million in incremental operating expense that you are hoping to eliminate as a result, that’s above and beyond what your Electronic and Inorganic restructuring program was going to accomplish, right? As you said, that’s something that you saw more recently and acted upon.

Jim Kirsch

That’s correct.

Dmitry Silversteyn – Longbow Research

Okay. And then secondly, you mentioned that a lot of your SG&A cost is in currencies outside of the U.S. so you’ve gotten a little bit of a benefit perhaps with the strengthening of the dollar in the third quarter. Should we expect the SG&A as a percentage of sales to continue to decline should the dollar continue to strengthen?

Jim Kirsch

Yes, and also as we continue to look for opportunities to size our organization to the demand that’s out there.

Dmitry Silversteyn – Longbow Research

Okay, alright. And then, just to get a better understanding of your revenue guidance for the fourth quarter, you are looking at – I am not sure – something in the neighborhood of 5% to 10% decline in revenues year-over-year. Part of that will be the divestiture of Fine Chemicals. Part of that would be – I am assuming your foreign exchange may be turning from positive to a negative or at least to an even year-over-year and then the rest would be volume. You still expect pricing to be fairly strong do you not for the fourth quarter?

Jim Kirsch

We do. It’s a good analysis, Dmitry.

Dmitry Silversteyn – Longbow Research

Okay. And then finally –

Jim Kirsch

If you go back last year, the – about this time, stretch my memory, but I think that the euro was in the $1.50 range, $1.48 range and it’s in the $1.30-$1.28 range.

Dmitry Silversteyn – Longbow Research

Okay. Okay, that’s helpful. And then finally on raw material, you guys have done a great job in getting pricing and getting mix improvements particularly in the polymer additives portion of the business to kind of offset what’s going on with raw material cost. We are hearing that – well, we are certainly the earlier chain or the material closer to the barrel of oil are already starting to roll over.

Jim Kirsch

Yes.

Dmitry Silversteyn – Longbow Research

A lot of metals and inorganics started to roll over. How is the raw material situation going to improve for you and given the relative magnitude of your raw material purchases versus what you would expect to see on the downturn and volumes, where do you see margins come out at the end of the day?

Jim Kirsch

Yes, I think that’s all going to rely on the execution of when to hang to pricing that’s been driven by raws going the other way. Right? And so historically in my younger days I – we saw that you tended to lose that fairly rapidly particularly in the petrochemical chain. I think the difference is in this particular situation is we have an outstanding price management organization in the Organics business and frankly both our Inorganics and EMS business – you asked specifically about the Organics business. And our expectation is that with some of the rapid declines in things like propylene and tallow and even soy oil has come down a bit, we are going to have to certainly give some of that back. But I would not expect to give it all back because of the value play and the move to some higher value markets that we’ve done in those industries and those sectors over the last two years. So I expect us to see some margin – I hate to use the word ‘stickiness,’ but some margin enhancement as a consequence in the short term.

Dmitry Silversteyn – Longbow Research

Okay. Alright and thank you very much.

Operator

Christopher Butler with Sidoti & Company, your line is open.

Christopher Butler – Sidoti & Company

Hi, good morning all.

Jim Kirsch

Good morning.

Sallie Bailey

Good morning.

Christopher Butler – Sidoti & Company

Following up on Dmitry’s question about the cost savings here in North America, any way you an give us a number much like you did for Rob and with the larger European restructuring.

Jim Kirsch

Yes, the – what’s going in Toccoa will be about $3 million to $4 million next year.

Christopher Butler – Sidoti & Company

But how about including what we’ve seen thus far from maybe even Electronics that you did last year and then the integration in the Organics business that’s been completed.

Jim Kirsch

Yes, the Electronics delivered about five. That’s done; that was completed in the last year. And you are seeing that in their results. And the Organics earlier actions in terms of headcount reductions and some of the capacity reductions that we took was about another $2 million to $3 million.

Christopher Butler – Sidoti & Company

And looking over to Europe, you’ve done a pretty good job of offsetting the weakness in the housing market in Western Europe over there by your focusing on sales in North Africa and Eastern Europe.

Jim Kirsch

Yes.

Christopher Butler – Sidoti & Company

Are you seeing any signs that these emerging economies are kind of following the developed regions at this point into a slowdown or recession?

Jim Kirsch

You know, a month ago I was the Italian Tiles Show for several days. And it was quite interesting because the people representing the Egyptian and Moroccan markets, for instance, are seeing very little impact and – as opposed to what we’ve seen in the rest of the world. But clearly, in Russia, which has been a significant growth market for us there has been an impact and a slowing. And in some other parts of Eastern Europe, yes, we are starting to see leakage, I will call it, of the banking issues in Western Europe impacting that part of the world. Haven’t seen in the Middle East and nor in the countries I mentioned a little earlier, so far.

Christopher Butler – Sidoti & Company

Thank you for your time.

Operator

John McNulty with Credit Suisse, your line is open.

John McNulty – Credit Suisse

Yes, good morning.

Jim Kirsch

Good morning, John.

Sallie Bailey

Hi.

John McNulty – Credit Suisse

With regard to the Georgia plant closure the coatings and glass or the Color and Glass businesses is a core business for you. This wasn’t a business that was going to shutdown originally. I guess I am wondering how can you be confident that shutting this plant down doesn’t compromise the growth in this – in what is normally a pretty decent growth business for you kind of through a full cycle? Have you not cut off the growth of the future in that business?

Jim Kirsch

It’s a good question, John. The way we’ve addressed that is we’ve improved our manufacturing capabilities and moved toward a manufacturing structure in Washington and others that’s enabling us to effectively put more pounds out with same or less headcount than we have in the past. More specifically, we’ve transitioned to rotary kilns for instance from (inaudible) kilns, which gives you more throughput in some of our businesses in the – in some of our market sectors and pigments. At net of it all is that Mike Murry’s shop has really set up a global manufacturing organization, which – within which you can pull from one area or another as need be driven by market needs. So we – I don’t have any concern at all that we won't have enough. Historically, in Ferro we’ve had way too many small facilities with very little scale and what we are building is scale and the ability to drive throughput, put in automation, and take both fixed and variable cost out of the equation.

John McNulty – Credit Suisse

So your overall capacity you assume is going to be roughly the same if not better, is that fair?

Jim Kirsch

Certainly be at least the same.

John McNulty – Credit Suisse

Okay. And then with that in mind, are there other plans throughout the Ferro network that haven’t been included in some of the restructuring plans that you’ve already outlined that because of manufacturing improvements you think there may be some potential to rationalize them as well going forward.

Jim Kirsch

In fairness, John, I wouldn’t tell you that if I hadn’t told some of my own organization that first. But I will tell you that what we do is constantly evaluate what’s the right supply-demand structure and what’s the right capacity to put in place over the next three to five years and then how do we get there quickly. And when you go through some large projects like we are doing in Europe, and I mentioned this in the last call, the Brazilian opportunity came out as a consequence of the dramatic lowering of our cost structure in Europe. This opportunity came out as a consequence of one, a slowdown in the economy, but two, improvements in our manufacturing and automation processes in our Washington facility that’s enabled us to look at that and say hey, we could put this together, improve capacity utilization, lower our cost structure, and it’s a win for our customers.

John McNulty – Credit Suisse

Great. Thanks for taking my question.

Jim Kirsch

You bet.

David Longfellow

Thank you, John. And we’ve run a little over our allotted time, so that we will conclude our Q&A session. I’d be happy to follow-up with anyone that has additional questions. Jim, would you like to make a few closing remarks?

Jim Kirsch

Yes, I’d like to make just one or two quick comments. First, I am very appreciative of the questions. There is a sense I think that, I hope, that you understand we prepared this company quite well moving forward into very, very uncertain economic times. And if we are all and the economic times are better than we expect then we’ll be even more prepared and better off than we’ve been. The third quarter results are evidence, I think – further evidence that what we started two years ago to rebuild the capital structure and reinvigorate our culture – and thank you Michael for the question about the difference between ’01 and ’08 because I think we were just really two different companies – and restructuring assets are not only generating results, they are generating good results. And the foundation of ‘Win from Within’ is velocity and I think the example of Toccoa, Georgia is an example of velocity with people taking accountability for their decisions to deliver value to our shareholders. So, we intend to continue to (inaudible) moving forward and I look forward to updating you on the progress at our next quarterly conference call and perhaps I may some of you and roll out and about. So, take care. David?

David Longfellow

For copies of our press release, replays of this call or access to our SEC filings, please go to our website at www.ferro.com and click on 'Investor Information.' Thank you and have a good day.

Operator

Thank you for participating in today’s conference. You may disconnect at this time.

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Source: Ferro Corporation Q3 2008 Earnings Call Transcript
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