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Ferro Corp. (NYSE:FOE)

Q1 2009 Earnings Call

May 19, 2009 10:00 am ET

Executives

Jim Kirsch - Chairman, President and CEO

Sallie Bailey - VP and CFO

David Longfellow - Director of IR

Analysts

Mike Sison - KeyBanc

Rosemarie Morbelli - Ingalls & Snyder

Dmitry Silversteyn - Longbow Research

Tiffany Teitel - Credit Suisse

Robert Felice - Gabelli & Company

Operator

(Operator Instructions). Mr. Longfellow, you may begin.

David Longfellow

Good morning and welcome to the Ferro Corporation's 2009 first quarter Earnings Call. Today, we will provide information about our financial results for the three month period ended March 31, 2009 and actions Ferro is taking to address current economic challenges.

Joining me on today's call are Jim Kirsch, Chairman, President and Chief Executive Officer; and Sallie Bailey, Vice President and Chief Financial Officer. Following their prepared remarks, Jim and Sallie will take your questions.

I hope you have 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 in 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 in our earnings press release and in the company's annual report on Form 10-K for December 31, 2008.

Forward-looking statements reflect management's expectations as of today, May 7, 2009. 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 the call this morning. I will focus my remarks this morning on three key topics. First, a brief review of first quarter results, concentrating on our cash management initiatives. Second a summary of the current economic climate that we see in each of our business groups and how it has changed over the past few months. Third, I will then discuss the actions we are taking to address the economic challenges and reduce our cost structure.

The 2009 first quarter was a challenging three months for Ferro. Customer demand remained at low levels that we experienced in December of 2008. Destocking continued throughout the supply chain as our customers and our customers' customers consumed inventory.

The result was a short reduction in our sales compared to the first quarter of 2008, driven predominantly by decline in our sales volumes. However, our cost containment efforts are having a beneficial effect. As indicated by the fact that although sales and volume were lower than in the fourth quarter of 2008 gross margins were up sequentially by approximately 60 basis points.

The difficult economic environment required extraordinary efforts related to cost and expense control and cash management, as well as quick decisions by our management team to respond to very dynamic changes in customer demand. The global Ferro team delivered excellent performance in a number of these areas during the quarter.

Our SG&A expense declined by 12% in the first quarter compared to the first quarter of 2008. Despite approximately $5 million in additional non-cash pension expense and $2 million in added healthcare claims.

Our cost of sales reduction in percentage terms, virtually matched the decline in our sales. This is evidence that we have reacted quickly to reduce variable and fixed manufacturing costs to very nearly match the abrupt decline in customer orders.

Our capital spending for the quarter was under our target of 50% reduction from our 2008 spending and we continue to carefully examine every spending request. In addition, we delivered $47 million in cash from reductions in inventory during the first quarter. While this reduction in inventory had a negative effect on our earnings for the quarter, it was an appropriate action as we manage our cash resources.

In order to maintain access to liquidity, we completed an amendment to our credit facility that provided additional flexibility in our debt covenants, while maintaining the size of our revolving credit facility. In addition, changes in the covenants allow additional borrowing needed to satisfy requirements for cash collateral related to our precious metal leasing.

These results required aggressive action to cut costs and many difficult decisions at our sites around the world. I know our team is dedicated to continuing these efforts as we move forward.

Let me now turn to review of the current market conditions that we see in each of our business groups, and then I will discuss the regional issues to which we are responding. In our Inorganic Specialties business, including our Performance Coatings and Color and Glass Performance Material segments, orders continue to be impacted by weakness in construction, automotive and appliance markets.

Destocking in these markets has continued longer than anticipated. Sales of our Tile Coating products were particularly impacted by the economic slowdown in Continental Europe during the first quarter as demand from both residential and commercial construction applications declined.

Sales in the Color and Glass Performance Materials segment declined in the first quarter, driven by a sharp reduction in the worldwide demand for auto glass enamels and weakness in construction markets.

Customer destocking was a significant issue in this application segment as well. However, we believe our market share remained strong and we've recently won additional business for new models at two German automakers. In addition, the German government's effort to stimulate car sales appears to be having a positive impact, which could generate incremental orders in the current quarter.

It appears that sales in our Inorganic's group have bottomed out and in fact April sales were slightly improved compared with March. We remained cautious in our outlook, which is prudent given that the world economic is and will continue to be in a recessionary environment throughout 2009.

In our Organic Specialties business, including Polymer Additives, Specialty Plastics, Pharmaceutical segments, our cost and expense reduction efforts have helped to mitigate the affects of weak demand in US and Europe. This is especially true in the Specialty Plastic segment, where segment income was nearly flat compared with the first quarter of 2008, despite the negative effects of lower sales volume.

As in the Inorganic's business, the decline in customer demand within the organics businesses appears to have slowed and monthly sales have stabilized. Pricing remains competitive, but relatively stable and we've been able to benefit from lower raw material costs. We believe most customers have completed their inventory reductions based on their current forecasted demand.

However, we think our best opportunity for sales growth in the next several months will come from new product areas, such as our specialized lubricants for high-end polyolefin's and additional penetration of our liquid color products in PVC applications.

We expect demand in the United States will begin to show improvement earlier than in Europe. We anticipate a slow and gradual recovery in the US during the next two quarters, with Europe following the same pattern in late 2009 and early 2010.

There may be some near-term benefit for our Polymer Additives products due to government stimulus spending on infrastructure and commercial construction. We will further utilize our European manufacturing capacity to penetrate Asian markets, which we expect to show modest growth.

Our Electronic Materials segment has experienced a sharp drop in demand for commodity dielectric materials. This decline coincides with the drop in the overall semiconductor and electronics markets and it has been made more severe by significant channel inventory of multilayer ceramic capacitors.

The $2.4 million segment income that was recorded in electronic materials during the quarter, despite the severe issues in the dielectrics and semiconductor markets is a result of successfully reducing our reliance on the commodity dielectric materials market, and our decision several years ago to focus product development resources on higher margin products like conductive pastes and powders.

Sales of conductive pastes and powders, including materials we sell to solar cell producers have experienced less significant declines than our dielectric materials. Regionally, sales of our solar pastes have been impacted less in Europe and more in Asia.

There is a shift in our product mix somewhat towards aluminum pastes and away from silver pastes. Because of this mix shift and a decline in silver prices, our sales of precious metals declined compared with the first quarter 2008. We do expect some modest recovery in solar materials in China over the next several months.

We are beginning to see gradual improvement in demand for conductive pastes and surface finishing materials. And we are reinforcing our leading market positions as we win qualification of our materials in next-generation solar technologies and we get traction on new applications for our advanced packaging materials.

It is important to note that in the first quarter each Ferro Business Group was profitable on a segment income basis in all regions of the world except for Europe. We made money in North America, Latin America and Asia Pacific. Our problem area is Europe, and specifically the dielectrics business in Uden, The Netherlands and the tile and color and glass business within Europe. The portion on enamel business was profitable in Europe due in large part to the closing of our Holland facility in 2008.

In dielectrics, our Uden facility supplies major customers in Taiwan who manufacture multilayer ceramic capacitors for consumer products and other electronic devices. Our manufacturing for dielectrics has been virtually shut down since December as the industry works off its excess inventory.

In our color and glass products in Europe, precipitous declines in auto builds and construction spending, primarily due to the global recession and credit issues, reduced volumes by approximately 50%, which is below our breakeven production level.

A good news is that this is a high contribution margin product line that will deliver substantial improvements in profitability with modest volume recovery as a result of restructuring efforts that we began back in 2006. These efforts have reduced headcount by over 300 across our European inorganics organization and a restructuring initiative that we initiated in January will reduce staffing by approximately 100 additional positions.

As I look at Ferro's businesses around the world, I see reasons for cautious optimism. The Asia Pacific economies are growing albeit at a slower rate. In Latin America, we have a streamline cost structure that enables us to be profitable even in today's lower volumes. Brazil's volumes are slightly improved, and if Mexico returns to normalcy soon, we think we can remain profitable in the region. In the US we believe we have seen the bottom of the current recession and even some very slight improvements in sectors related to municipal spending, probably due to government stimulus programs.

That brings us back to Europe. It appears that the December to March downturn in Europe was more severe than economists had forecast and our first quarter results certainly support that conclusion. However, we believe our business has bottomed as government stimulus efforts are beginning to have some effects and as consumer confidence improves. In fact, April sales volumes across our inorganics businesses are slightly better than volumes in March. However, we do not expect throughout 2009 any significant recovery in Europe.

In addition, we are considering a number of actions to further address our European cost structure, including additional restructuring, staffing reductions and product repositioning. Because we are not counting on a rapid rebound in global customer demand across our product portfolio, our efforts in 2009 will continue to be tightly focused on liquidity and cash management. Consistent with this focus, we are taking actions to further reduce Ferro's cost and expense structure to better align with market demand.

During the 2009 first quarter we worked to improve our future cost structure and manage our cash by implementing an additional 5% reduction of our global workforce. This reduction is in addition to the 12% reduction in 2008, initiating a mandatory furlough program for all US-based salary personnel that will involve a week of unpaid leave taken before the end of June. This program is expected to save approximately $1.5 million by the end of the second quarter.

Suspending the company match on US employees' 401(k) contribution, the furlough program and the 401(k) contribution suspension will save approximately $4 million this year. This is an addition to the $4 million to $5 million savings from our earlier decision to freeze salaries for this year, suspending payments under our short term incentive compensation programs for 2009, lowering the common stock dividend and reducing capital spending.

Elimination of the dividend as now required by our credit facility amendment will reduce cash outlays by approximately $25 million on an annual basis. As I mentioned previously, our first quarter capital spending is well within our reduced CapEx budget for 2009, which is expected to reduce cash outlays by approximately $35 million compared with 2008.

Shutting plants temporarily and reducing work hours at manufacturing sites around the world as we align our production capacity with customer demand. Launching a new phase of our European restructuring that will result in closing our Limoges, France manufacturing site. The project is expected to generate annual cost savings of $14 million when it is completed at the end of next year.

These actions are improving our global cost and expense structure in order to improve short term financial performance and to provide additional earnings leverage as the worldwide demand recovers. We estimate that our current cost structure and product prices if applied to the product mix and volume we actually experienced in 2006, 2007 and 2008 would have resulted in approximately $60 million a year in incremental segment income.

We spent the last three years building the culture of win from within inside Ferro. As the organization response to the current challenges, I can clearly see the benefits of this effort. The organization understands our goals and the commitments we have made and our employees continue to take direct accountability for their results through aggressive and timely action in response to a very dynamic and difficult business environment.

Our employees are confronting challenges and living change to improve our business, and I have confidence they will continue to do so as we position the company to benefit directly from any recovery in global demand.

Now I'd like to turn the call over to Sallie who will review the financial results in more detail before we open up the call for your questions. Sallie.

Sallie Bailey

This morning I'll begin my remarks with a recap of the 2009 first quarter results. I'll then discuss some of the factors that are expected to drive our performance during the second quarter of 2009. Reconciliations of non-GAAP results discussed in this conference call are available on our website.

Please note that the prior period results and our press release, SEC filings and on the call today have been adjusted for the sale of our fine chemicals business. The fine chemicals results for the 2008 first quarter are included in discontinued operations as a result of the sale of that business in the fourth quarter last year.

Ferro reported a loss from continuing operations of $0.46 per diluted share for the first quarter of 2009. Included in the results were pre-tax charges of $3.3 million, primarily related to restructuring charges and corporate development activities.

Our net sales for the quarter were $358 million, a decline of 39% compared with net sales of $591 million in the 2008 first quarter. The sales decline was primarily driven by reduced sales volume, resulting from the global economic slowdown.

Lower precious metal costs and foreign currency effects also contributed to the sales decline. Reduced precious metal cost pass-throughs contributed appropriately 8 percentage points to the sales decline and changes in foreign currency exchange rate accounted for an additional 4 percentage point reduction.

Cost of sales declined by 37% for the quarter to $303 million as a result of the lower volume. This impact was partially offset by staffing reductions and other cost reduction activities.

Gross profit declined to $55 million and gross profit percentage declined to 15.4% of sales from 18.5% of sales in the first quarter of last year. The change was driven by the sharp drop in manufacturing volume and the reduction in inventory.

Adjusting our 2009 first quarter gross margin for precious metal sales and special charges, the gross margin was 17.3% compared with 21.6% in the prior year period. The equivalent adjusted gross margin was 16.7% in the fourth quarter of 2008.

SG&A expense for the first quarter was $68.1 million, a decrease of $9.4 million from the first quarter of 2008. SG&A was 19% of sales for the quarter, an increase from the prior year period as a result of the decline in sales.

The SG&A expense decline was driven by staffing reductions, limitations and discretionary spending, and lower incentive compensation accruals. Partially offsetting the decline were increases of $4.8 million of pension expense and $1.7 million of healthcare claims.

The 2009 first quarter SG&A included approximately $1.3 million in charges primarily related to corporate development activities. The 2008 SG&A expense included net charges of $3.9 million, primarily related to corporate development charges that were offset partially by insurance settlements and litigation proceeds.

Restructuring charges for the quarter were $1.4 million, a decline from $4.2 million in the first quarter of 2008. The primary driver for these charges continues to be the manufacturing rationalization project in our Inorganics business in Europe.

We expect restructuring charges in the coming quarters as we continue work related to closing our Limoges, France manufacturing site and as we undertake other restructuring efforts around the world to reduce costs. Total segment income during the first quarter was $2.8 million down from $39 million during the first quarter of 2008.

The Performance Coatings and Color and Glass Performance Materials segments recorded operating losses for the quarter. Lower volume was the primary driver of the losses. In addition, inventory in these segments declined by approximately $35 million increasing the cost of goods sold.

All other segments recorded operating income during the quarter. Lower sales and the associated lower manufacturing volumes coupled with higher cost absorptions and inventory liquidation were the primary reasons for the decline in segment income compared to the prior year period.

As part of our reconciliation of segment income to income from continuing operations before taxes, we reported unallocated corporate expenses of $15.7 million for the 2009 first quarter including non-restructuring special charges of $1.9 million.

In the prior year period, unallocated corporate expense was $7.4 million. The primary drivers of the increase in corporate unallocated charges were $4.8 million in additional pension expense and $1.7 million in higher healthcare claims.

Interest expense was $11.2 million for the first quarter down from $13.6 million in 2008. The reduction was driven by lower interest rates compared with the prior year quarter. On March 11, we completed an amendment to our credit facility. As a result interest rates on our term loans and revolving credit lines will increase. This increase will result in higher interest expense in future quarters.

For the quarter our loss from continuing operations was $0.46 per share, including charges. Excluding the $3.3 million in special charges from our first quarter 2009 financial performance would result in a pre-tax loss of $24.2 million. Applying a tax rate of 36% would result in a loss $0.35 per share on an adjusted basis.

Capital spending in the first quarter was $2.6 million, despite the low level of spending in the first quarter, we continue to expect the full year capital budget to be approximately $35 million or about half our spending during 2008.

Depreciation, amortization was $18.6 million for the quarter. Total balance sheet debt on March 31, 2009 was $664.6 million. In addition we had net proceeds of $8.7 million from off balance sheet international receivables factoring. Total financing was $673.3 million on March 31, including the receivables factoring, an increase of $86.1 million since December 31, 2008.

The increase was driven by our requirement to provide $65.5 million in collateral related to our precious metal leases, a decline in payables and the cash costs of our credit amendments.

In conclusion, the first quarter was characterized by very week demand particularly from European markets. However, we are cautiously optimistic that sales reached a bottom in the quarter.

Our gross margins increased sequentially compared with the 2008 fourth quarter and in addition we delivered period-over-period savings in our expense structure despite the increase in our pension expense.

We are able to reduce inventory significantly, which offset much of the decline in payables that we experienced during the quarter. And we are able to execute the amendment to our credit facility.

Looking forward, we plan continued tight costs and expense management as we continue to put in place our cost structure that will improve our earnings leverage when markets recover.

Thank you for participating in this morning's call and I'd like to turn the call back to Dave to begin the question and answer session.

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

(Operator Instructions). Mike Sison from KeyBanc.

Mike Sison - KeyBanc

Jim when you think about several longer-term outlook, in 2008 your sales for precious metals is about $2 billion. You earned close to a $1 per share, you've got more cost savings in the pipeline, you did a nice job particularly in the first quarter getting back to breakeven in plastics. To sort of get back to that dollar range which you, that sales number is probably lower. Any feel for what that is, would it be more like $1.8 billion, $1.9?

Jim Kirsch

Yes, let me leave you with a couple of thoughts, Mike. Couple of key thoughts, markets seem to have stabilized and although we don't expect a large recovery. We're seeing some slight improvements in April as I mentioned. We're working the European issue, and the reason Porcelain Enamel was profitable on a segment basis or an EBIT basis was because we've taken out the Holland facility.

So, our Limoges facility is 100% in the glass business. So, as you think about $14 million of cost savings being generated when that facility comes out, you'll see because of the operating leverage, a substantial upturn with any volume that comes along over the next couple of years in that particular business.

So I think the answer to your question is, and I am not an economic prognosticator. Our breakeven's continue to come down, that's evidenced by the operating leverage, example I gave with what '06, '07 and '08 would have look like with our current cost structure, and we continue to drive to bring that cost structure to lower levels. Gross profit on an adjusted basis, as I said fourth quarter to first was slightly better 60 basis points. Again, more evidence that the fixed cost reductions are sticking.

So I am not going to prognosticate when volumes will return and we'll be able to achieve $1.8 billion or $2 billion in sales again. But I will tell you that the operating level is substantial and we are seeing a pretty significant increase in the contribution margin in the businesses. And as we realized and we've shown we can deliver on the cost reductions in Europe, which is where we are putting a lot of focus right now. I would expect to see that breakeven come down and our ability to return to reasonably good earnings rates a very doable goal.

Mike Sison - KeyBanc

Okay. Then on a sequential basis, with April being better generally across the board, would you expect that second quarter sales would sequentially improve, maybe more in line with what you've seen historically? And if that sequential improvement continues throughout the year, with the cost savings would you think you can get to breakeven at some point this year?

Jim Kirsch

I don't think we are going to see in the second quarter. What you say, what we've seen historically. If you mean by that are we going to return to sales level we saw in '08 and '07 and the second quarter of '09, my answer would be no.

Mike Sison - KeyBanc

No, I meant, sequentially, your sales tends to improve 5% to 10% on a historical basis.

Jim Kirsch

Yes, and I think, when I talked about we're seeing slight improvement, it's in that 5% to 10% kind of range in the businesses.

Mike Sison - KeyBanc

Okay.

Jim Kirsch

Again April was sort of an odd month because although it's a long month the Easter Holiday was in there and we had a number of customers take advantage of the Easter Holiday in different areas of the world to shutdown for an extended time frame, 4, 5, 6 days, as opposed to the typical Thursday night to Monday kind of shutdown.

So it's a little difficult to get your arms around exactly what's occurred, but we saw some improvement in April with what amounted to a shorter work month than what we would normally see in April. If we continue to see that slight improvement in May-June and yes, I think that, that would give us a signal that this bottoming that we think we're at is actually there.

Mike Sison - KeyBanc

Okay and last question. On a quarterly basis, I think in the last call, you suggested that somewhere around 475 get to the EPS breakeven, is any thoughts there now with the more cost savings that is made for the quarter, 4 to 50.

Jim Kirsch

It's clearly coming down Mike. Again it's evidenced I think that seeing slight improvement in gross margin is a good thing. I'd prefer to focus on the operating leverage side of this based on the cost reductions and what we're looking at now in terms of balancing our liquidity and cash flows and EBIT is how aggressive we can be in taking out more cost and then keeping a balance so we're comfortable with our liquidity.

Operator

Rosemarie Morbelli from Ingalls & Snyder.

Rosemarie Morbelli - Ingalls & Snyder

How comfortable, well I guess you kind of answer that question right now. I was wondering, how comfortable you were that you have hit bottom, but it sounds as though May and June are going to be the tell-tale?

Jim Kirsch

I think that's a fair assessment.

Rosemarie Morbelli - Ingalls & Snyder

Now Sally, you talked about additional restructuring in Europe and elsewhere in the world. Is that in addition to Limoges, as far as Europe is concerned and what else do you have in mind with ballpark what kind of savings and timings?

Jim Kirsch

It is in addition to Limoges, yes. We haven't gone public internally with specifics, Rosemarie on what sites, and what business sectors, and so on. So, I prefer not to do that on this call. But, I will tell you that in terms of ranges it's very problematic, because if it's a sight restructuring, you typically see savings in the $10 million plus range, if it is a just headcount reduction you might see savings in the neighborhood of $1 million or $2 million or $3 million, and as a combination of both we are engaged in.

Rosemarie Morbelli - Ingalls & Snyder

Okay. So, that's something to look forward to. You also talked about focusing on new applications for advance packaging. Could you give us a better feel for that, the size of that business profitability or like thereof and where you are going?

Jim Kirsch

Yes. In the past what I have really talked about is, in our Polymer Additives business, repositioning the business into more non-PVC and non-commercial construction applications and we talked about things like down-hole muds in to drilling applications.

That business, that what I would call non-traditional markets for our Polymer Additives is approaching roughly a third of our overall business today in that particular sector and we continue to try to grow that. And if you would ask me that question six months ago I would have told you it was in 20% to 25% range.

So you can see that the overall revenues in that business enhance the ability to maintain profitability in the business are being driven by newer applications that are higher margin.

Rosemarie Morbelli - Ingalls & Snyder

If I may ask one last quick question, are we expecting $17 million of interest expense a good number to look at for the next three quarters?

Sallie Bailey

Yes. Rosemarie, that's a very good number.

Operator

Dmitry Silversteyn from Longbow Research.

Dmitry Silversteyn - Longbow Research

I just want to make sure I understand the dynamic behind the Inorganic business losing money and the Organic business despite what looks like a greater decline in revenue still maintaining performance and positive performance. All of your restructuring efforts have been aimed at the Inorganics business side. I would have thought that it would have been better able to withstand lower volumes.

Can you give us an idea, obviously very good news that you're able to keep positive margin on the organic side of the business, but why was it different from inorganics where you couldn't keep positive margin?

Jim Kirsch

First of all let me start with organic side, if you go back and think about some of the conference calls we've had, we started talking in late '06 early '07 that we were transitioning the way we ran organics to a run for cash mentality. And that we were resizing the business capacities, people and so on because we saw a decline in the US automotive and packaging markets starting in the '07 timeframe.

The ability in that business to take out cost and expense has been extraordinary and in essence over this '07, '08, '09 timeframe have effectively managed to stay pretty much with or ahead of the curve and manage very well through volatile raw material swings, through pricing and so on and so forth.

The second thing I'll tell you is quite candidly it is. I don't mean is disrespectfully to the inorganic efforts. It's easier to take cost out in the US than it is in Europe. It's less expensive, you don't have to deal with works councils for the most part and often times in those businesses we can take capacity out by shutting down an extruder line for instance as opposed closing a facility.

In the inorganic side, again I'll remind you, we made money in every part of the world in that business with the exception of Europe. Europe is where our restructuring action is taking place and the decline in revenue is driven by very precipitous volume declines, left us unable to keep up in terms of taking out additional costs and expense.

In addition, we pushed that business very hard to reduce inventories in the first quarter, in terms of running for cash. So a combination of heavy inventory reduction, we had a very significant destocking issue going on in slower volumes and in the business for color and glass specifically we are in what we call Phase IV of our restructuring and a majority of that cost reduction is associated with this Limoges shutdown.

If you look at PE, which was in Phase II, Phase III where we shutdown Holland, we made money in Europe in Porcelain Enamel, where we have taken significant cost out. So I think what we got catch with if this global meltdown had happened at the end of '09 as supposed at the end '08. I think we would have seen a better performance frankly at these lower volumes at the Inorganics business.

Having said that, it is what it is and so we are dealing with it and taking the actions I noted in my comments to continue to accelerate cost and expense restructuring while balancing that with our liquidity situation.

Dmitry Silversteyn - Longbow Research

Can you update us on what the percentage of sales in Europe is for Inorganics? How big Europe is for that business? Whether you want to talk about the whole business overall or Performance Coatings versus Color and Glass if there is a big difference?

Jim Kirsch

Yes. In Inorganics globally if you look at total business, over 55% of revenue is in Europe.

Dmitry Silversteyn - Longbow Research

Okay. So that explains it. Okay. The other thing that I wanted to follow-up on the level of improvement that you've seen in April versus, I guess December through March timeframe. If we continue to run at that run rate, will that be enough to with the cost savings that you are going to get incremental in your second and third quarter versus which you are able to get in the first quarter. Is that going to be enough to get you to a breakeven in the Inorganics business or do you need to see further improvement in May and June versus April to be able to get there?

Jim Kirsch

If you are asking on an [EBIT], segment income level?

Dmitry Silversteyn - Longbow Research

Yes.

Jim Kirsch

It will be very close. I think if we maintain 5% to 10% improvement over the next months. And we continue to be successful with cost and expense reduction, and one assumes there is not a huge raw material displacement that I am optimistic that we can get that breakeven.

Dmitry Silversteyn - Longbow Research

Can you remind us what the new covenants are for your renegotiated debt?

Jim Kirsch

There is leverage coverage and EBITDA.

Dmitry Silversteyn - Longbow Research

Okay.

Jim Kirsch

Or you are asking specifically about the numbers?

Dmitry Silversteyn - Longbow Research

I was asking about the number, but I can look it up, its leverage and EBITDA right?

Sallie Bailey

And fix charge.

Jim Kirsch

Yes.

Sallie Bailey

Dmitry, why don't you call Dave and he can give you all the specifics after the call.

Silversteyn - Longbow Research

Sounds good, thank you guys.

Operator

John McNulty from Credit Suisse.

Tiffany Teitel - Credit Suisse

Hi this is Tiffany Teitel on behalf of John McNulty. Based on your new covenants, how comfortably are you over the next few quarters and being in compliance and do you think that's going to be done strictly on cost cutting or would you entertain possibly an equity offering or any asset sale?

Sallie Bailey

Yes, Tiffany, we're constantly looking at our capital structure, as well as portfolio management, so we certainly are looking at all alternatives to manage both of those things and manage our liquidity. In terms of the forward look, we're compliant in the first quarter and because of the limited visibility that we have, we're not providing performance estimates for the second quarter or out further in the year. I think Jim's gone through issues that we really are looking at in terms of managing the company. We're looking for the market to stabilize. We're seeing some improvements. We're going after as much cost take outs as we can and look for continued cost management and we're managing around liquidity and cash flow.

Tiffany Teitel - Credit Suisse

What was your leverage ratio for the credit agreement at the end of 1Q?

Sallie Bailey

We don't provide that information.

Tiffany Teitel - Credit Suisse

One last thing on your current spread on the term loan?

Sallie Bailey

Its 600.

Tiffany Teitel - Credit Suisse

Okay.

Sallie Bailey

Overall.

Operator

Robert Felice from Gabelli & Company.

Robert Felice - Gabelli & Company

Hi. Most of my questions have been answered, just a couple more. I guess first, Jim, could you give us an update on the actions and steps you are taking to reduce debt and if I remember correctly on last quarter's call, you mentioned the asset sales as a potential means to delever. Could you elaborate on that dynamic as well as the size and potential timing of any divestitures you are targeting?

Jim Kirsch

Sure. As Sallie mentioned portfolio management and that's been a plank in our strategy for sometime now, clearly in post August timeframe in the credit markets of last year it got much more difficult to buy or sell, if one was utilizing leverage. And that we managed to close on our fine chemicals business at the end of October as you know which is in the settlement of $60 million, which were used to pay down debt.

When I am looking at our parts and pieces of our businesses now there, if there is an opportunity to place a part or a piece of a business elsewhere that's non-strategic or non-core to us, we would do so. They are relatively small Rob, I mean we are not looking at multi hundreds of millions of dollars anything like that.

So, I think if you are thinking about things that are like fine chemicals or smaller, you are much closer to the range. And, those are conversations that we have periodically and a lot of it frankly depends on how the twist and turns of the economy are going and how the twist and turns in some other different credit markets are going.

Robert Felice - Gabelli & Company

Then, I guess staying with the debt reduction front. Can you give us an update on where things stand on the precious metal front? Whether you are seeing an opportunity to reduce that $65 million of dual collateralization?

Jim Kirsch

Yes. Rob, we actually have seen our precious metal collateralization increase in the second quarter. And I think until we begin to see markets improve we should anticipate will have a level of that type of level of cash collateralization. So what we're doing is we are focusing on taking this down the amount of troy ounces that we need within our Suzhou facility, so that we can manage and that's the way that we will be able to manage the decreased exposure on the cash collateralization.

Jim Kirsch

Let me add little more color to that Rob, if I may. If you went back to the last time we were in this situation we had to collateralize several ago. We started a program then, which was late '06 time frame mid to late '06 to change the way we operate our refinery in South Plainfield, New Jersey. Under the manufacturing leadership of the group there in the Barry Russell's shop, they've been able to reduce the amount of troy ounces in our system by over 35%.

So as a consequence of that our lease lines have been less problematic in terms of how much we need to lease. And we're trying to manage things we can control because we currently can't control silver price or market demand. But if we can reduce we're used to use at a neighborhood of 8 million to 9 million troy ounces at any point of time in that facility.

Today we've been able to 5 million to 5.50 million troy ounces in that facility and we've been able to stabilized at that level even with the very high and hot markets we have in our Conductive Materials businesses in the third quarter, second, third quarter of last year. As we went through in the fourth quarter, first quarter of this year that's clearly has slowed somewhat. We've been able to combat the issue of silver pricing and market demand with more efficient operations.

Robert Felice - Gabelli & Company

Okay, so I guess finally, as I wrap all of these dynamics up and I think about your net debt and your cash flow for the year. Do you have any net debt targets we should think about for the second quarter, the third quarter, the fourth quarter, that we can measure your progress against?

Jim Kirsch

Well I think, I'd say a right measure of our progress against is on cash flow. Our expectation is to be neutral or positive in cash flows moving forward.

Sallie Bailey

Ex-precious metals. So, I think Rob the way to add a little bit more color to what Jim said, you should look at our ex-precious metals, cash flows as being neutral to positive and then measure the precious metals separately, because as Jim mentioned so much of that relates to what the price of the silver is off of the use of the troy ounces.

I think if you really, you can really tell by this quarter, because our fourth quarter results as well as our first quarter results, the emphasis is that we have been placing on cash flow. If you think about it, we generated [$70 million] in cash flow from accounts receivable, another $47 million from inventories, then we used $67 million of cash for payables.

So, I mean net working capital was the use of cash at $6 million, but most of that really related to the payables balance coming down. We saw a fair amount of cash payments in the beginning of the quarter, and we have seen those payables actually stabilize in the latter part of the quarter. We would anticipate if there's some pickup in demand that we would some improvement in the payables balances as provider of working capital

Operator

Rosemarie Morbelli from Ingalls & Snyder.

Rosemarie Morbelli - Ingalls & Snyder

Thanks. Can you take down, following up on Rob question. Can you think down the volume of silver that you or precious metals that you are using or is 5 million to 5.5 million troy ounces the bottom of what you need to have in order to operate efficiently?

Jim Kirsch

Well, that's a very interesting question, Rosemarie. There is actually a team at the plant today examining that very issue in terms of as we leaned out that facility. The next question, is okay, we think we are optimized, let's call this 5 million troy ounce range, is there a way to take another 10% out. And let's reexamine the value and value map all the various processes in the plant and see if there is another opportunity and it literally went out last night.

Rosemarie Morbelli - Ingalls & Snyder

Based on what is going on in the marketplace, based on the steps you are taking the savings trickling into the system, even if you had, let says, that April you saw a pick up but none of your customers sold whatever they bought, and therefore, May and June are going to be flat with April or maybe even a little down. Can you still see some sequential gross margin improvements quarter-over-quarter?

Jim Kirsch

We could, it depends a bit on mix. For instance, an important example, I have mentioned using more aluminum paste versus silver paste in our solar business. There is a margin difference that is not in consequential in those two types of product mix. So, if as we expect China starts to get a little bit better in the second quarter we'll see more silver paste being consumed.

If that's the case, we'll see an enhancement even if the volumes were flat we would see an enhancement in margin as a consequence. The other thing I think, your questions is very astute, because earlier somebody asked about organics and the improvements and so on. And I talked about what we started doing in '07 and '08.

As we've taken those costs out, and as you hang on to some or all of them, you get the cumulative role forward effect. So, while volumes are down in plastics and pad for instance and we've managed to maintain profitability or be profitable. A significant portion of that is due to things like reductions in force that we took over the course of 2008 and we are continuing where we can to very proactively utilize that particular tool.

Rosemarie Morbelli - Ingalls & Snyder

I'm going down my list if you don't mind. You took down your inventory by $40 million. Are you satisfied with this inventory level, do you think that it is going to come down some more even if you see your customers inventory leveling off at this particular point?

Jim Kirsch

Yes, it's another good question. The reason it's come down so much obviously was the precipitous slowdown in demand. So one of the metric we watch is quarter-over-quarter and year-over-year sales decline at points in time and the same for your inventory decline so for instance I look at March '08 versus March '09 sales decline or March '09 versus March '08 sales decline and then I look at the corresponding inventory decline.

What I want to see is that that inventory decline matches the revenue or sales decline, and where it doesn't then that's a target area for you to go and drive that harder to get ahead of the curve. What's happened is inventory typically lags and particularly as rapidly as the volume decline hit. So, each month of that $47 million, we got more of it in March than we did in January or February.

So, we are much closer to a balance now than we were as we went into the first quarter. So yes, I would expect to see a continued inventory reduction but not to the extent that we had in the fourth quarter and the first quarter, because, the sales have started to bottom at a level and even have a very, very slight up tick, we have kind of caught up in many of our businesses, and there's a couple of spots, where we have got a more work to do. And, we will continue to take inventory out there, but it won't be at the same rate.

Rosemarie Morbelli - Ingalls & Snyder

Okay. And on the SG&A, even if revenues go up, do you think you can continue to operate at the $68 million, which is high as a percentage of sales, but in dollar terms is that a good number to look at to going forward for the next three quarters?

Jim Kirsch

Yes. It's a good number, but our intention to continue to bring that down. So I mean for modeling proposes that's fine. I think it's appropriate to take a conservative view, but our intent is clearly to continue to drive that down.

Operator

Mike Sison from KeyBanc.

Mike Sison - KeyBanc

Hey. I wanted to take one more stab at the earnings potential here. Jim, I think when I thought about Ferro historically, if you got incremental dollars worth of sales you tend to bring about $0.30 to the bottom-line. Does that leverage move up to like $0.35 or $0.40 without the cost savings that you have seen?

Jim Kirsch

I think that's a very good number, Mike.

Mike Sison - KeyBanc

Okay. Great.

Jim Kirsch

In terms of contributions.

Mike Sison - KeyBanc

Right, in terms of contributions.

Jim Kirsch

Yeah.

Mike Sison - KeyBanc

Great. Then in terms of solar the first quarter was the first quarter we've seen that business not down as much. Could you just give us a little feel for what's happening in the industry?

Jim Kirsch

Yeah.

Mike Sison - KeyBanc

Near-term and was there any inventory destocking there or was it just demand was little bit late?

Jim Kirsch

It's very interesting and complex view. Let's start in China, it virtually shutdown in the first quarter why because about 95% or 98% of all the solar panels produced in China get exported to places like Spain. Spain as you know, was over built as they went through '07, '08 and had a very significant decline in consumption. Germany on the other hand has been relatively stable and kind of other places sort of that are burgeoning Turkey, Greece et cetera have picked up some of the slack but not all.

So on a year-over-year basis our first quarter revenues in solar were not very different than our first quarter '08 revenues in that area. What was very different was the mix. The aluminum was a much heavier mix than the silver in '09 versus '08 as much of what was produced out of China was silver based if you will versus what was produced in Europe was aluminum based.

I was in Germany visiting solar customers in January, and the day I was there, one particular customer had told me they had a 40% reduction in panel prices. Yet their production was running and maintained its run through the first six weeks on the year on a seven day work schedule.

So I'm sure some of that was going into inventory. There my expectation is solar has bottomed somewhat, we believe we're seeing some small recovery I commented that we expect China over the next several months and quarters to begin to build again. Some of that is due to stimulus that's going on in China. But I don't think you're going to see as, if you recall last year, it was the second and third quarter that were wide hot in solar and then it really tapered particularly in November and December really December last year. So, I don't think you're going to see that wide hot look again, but I do think we are going to see improvement over the next couple of quarters in that business.

Mike Sison - KeyBanc

Okay, great. Then in the semiconductor part, there has been several companies suggesting that inventories have or the destocking has certainly ended and that the outlook looks for some sequential improvement into the second half of the year. Is that what you're thinking as well from what you've heard from your customers?

Jim Kirsch

Yes it is Mike, but let me give a little more color for you and those on the phone in that business. That's our dielectrics business for multi-layer ceramic capacitors and our major commodity production point is Uden in the Netherlands.

We are examining every option, because that's just not a business that it's very attractive. It's highly cost competitive, very depressed margins. You run through these cycles all the time whether its boom and bust cycles in inventories. It is no fun. So, what we have really looked at over the last three years is moving the business away from that semiconductor cycle into more of the clean technology and packaging.

I think somebody asked an earlier question about packaging I did mentioned this, but insulating glass in MEMS technology for instance is another example, where we have extended and are expanding in our electronic packaging businesses. We're really good at specialty glasses, they are higher margin and more consistent, they are higher growth. That's where we belong.

So, over time our intent has clearly been to reduce our exposure to that business or continuing to reduce our exposure to it, and longer term or strategically it's just not a real exciting place to be for Ferro.

David Longfellow

I think we have time for one more quick question. We could have the last question, please.

Operator

Robert Felice from Gabelli & Company.

Robert Felice - Gabelli & Company

Just a quick follow-up, and I apologize I may have missed this from earlier in the call. But, what was the magnitude of the impact on inorganics profitability from the reduction of your inventories?

Jim Kirsch

In terms of a profitability basis Rob, I would tell you that we would have been much closer to breakeven if we hadn't pushed inventory as hard even in Europe.

Robert Felice - Gabelli & Company

So, would you expect that dynamic to go away in the second quarter?

Jim Kirsch

It will be mitigated, but we are going to continue to push some inventory out of that business.

Robert Felice - Gabelli & Company

Okay.

Jim Kirsch

That's one of one that hasn't got up yet with that revenue drop, because it was so precipitous.

Robert Felice - Gabelli & Company

Okay. But when I factor in that dynamic as well as a modest pick up in April volumes versus the first quarter, fairly reasonable to assume that the Inorganic business are likely or hopefully turn positive in the second quarter?

Jim Kirsch

Well, I am cautiously optimistic that that business will improve. I won't go so far as to give you a number or forecast, but I tell you that I had a conference call very early this morning with that group in Europe and that was the crux of the call.

David Longfellow

That concludes the time we have this morning for our Q&A session. Jim, would you like to make a few closing comments?

Jim Kirsch

I'd just close by reminding you of three thoughts I guess. Market seems to stabilize, we are very cautiously optimistic, but prudent says we're still in global recession. Yes and we've still got people like GM shutting down for nine weeks, and so on and so forth. This is going to be a tough slog. But we are seeing albeit slight and from a low level, obviously with our revenues, slight volume improvement in April and we're hopeful we'll continue to see that trend in next several months.

Second, we're working the European issue. We know what the problems are, we know where the problems are and we're working them hard in terms of structural costs and in terms of effectiveness and efficiency of our people and our expenses.

And third, our focus in 2009 is on liquidity and cash, number one. That is a fair amount of importance to myself and the management team, and we want to be absolutely certain that our liquidity cushion is appropriate and that we can weather any other storms that may come at us as we move forward.

So I appreciate your time and your attention. Hope we've answered your questions thoroughly and we certainly have tried to the best of our ability to do so. I look forward to seeing some of you between now and the end of the quarter.

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

This concludes your conference call. You may now disconnect. Thank you.

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Source: Ferro Corp. Q1 2009 Earnings Call Transcript
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