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Ferro Corporation (NYSE:FOE)

Q3 2009 Earnings Call Transcript

October 27, 2009 10:00 ET

Executives

James F. Kirsch - Chairman, President and Chief Executive Officer

Sallie B. Bailey - Vice President and Chief Financial Officer

David Longfellow - Director of Investor Relations

Analysts

Jason Miner from Deutsche Bank

Michael Harrison - First Analysis Securities Corporation

Michael Sison - KeyBanc Capital Markets

Jeffrey Zekauskas - JPMorgan

Rosemarie Morbelli - Ingalls & Snyder

Dmitry Silversteyn - Longbow Research

David Sachs - Hockey Capital

Operator

Good morning and welcome to Ferro Corporation’s third quarter 2009 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, please disconnect at this time.

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

David Longfellow

Good morning and welcome to the Ferro Corporation 2009 third quarter earnings conference call. Today, we will provide information about our financial results for the three month period ended September 30th, 2009.

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 related to our third quarter results and current business conditions.

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

In addition to the earnings release, we issued a press release this morning, announcing a follow-on equity offering. We will not be discussing the equity offering on this call due to securities rules and regulations. The preliminary prospectus supplement for the offering is available on the SEC website at www.sec.gov.

In addition, this morning, we announced the execution of an amendment to our credit facility. The effectiveness of which is contingent on the successful completion of the equity offering. Information related to the credit facility amendment was filed with the SEC on Form 8-K. Copies of the 8-K can be obtained on Ferro’s or the SEC’s websites.

Before I turn the call over to Jim, 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 31st, 2008.

Forward-looking statements reflect management’s expectations as of today, October 27th, 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 express 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.

James F. Kirsch

Thank you, David. And welcome to everyone on the call. I will focus my remarks this morning on our third quarter results in the current business conditions. I’m pleased to report that we made excellent progress in the third quarter. The efforts to reduce cost and expense, lower our breakeven sales level, and manage the business in an environment of sharply lower customer demand, as we’ve discussed during the past several conference calls are having a substantial effect. Our third quarter performance provides the evidence.

Gross margins in the third quarter were better than in the third quarter of 2008, despite a net sales decline of 25%. On an adjusted basis, excluding precious metals and one-time charges, gross margins were 24.7% or 260 basis points above the prior year quarter and 800 basis points above their trough in the 2008 fourth quarter.

Our 2009 third quarter segment income more than doubled to $41.5 million from $19.3 million in the 2009 second quarter. Segment income as a percent of sales was higher than in the third quarter a year ago. We generated income in the quarter demonstrating our improved operating leverage.

The third quarter financial performance is result of actions taken by our team around the world. The actions demonstrate the core tenets of the winning culture that we’ve been building within Ferro, a culture that emphases the following. First, making decisions with velocity. During the past seven quarter, worldwide staffing has been reduced by more than 20% and four manufacturing sides have been closed. Our teams around the world have taken decisive action in a very difficult and uncertain environment.

Second, accountability for decisions, we have faced the current economic challenges head on, as a result we executed restructuring actions on time and on budget. We delivered more than $77 million in cash through inventory reductions during 2009 to provide essential liquidity. And we maintained compliance with our financial performance covenants through a period of significant marketplace disruptions.

And third our team remains focus on continuous improvement in the way we do business from the manufacturing floor to the way we execute our corporate support functions. A reorganization of our product line structure that we announced earlier this month is an example of this continuous improvement. We streamlined the organization into two business group from our previous three. And we continue to reduce the number of levels from top to bottom in the company. While we are pleased with the progress shown in the quarter’s financial performance, we understand there is more work to be done. We’re continuing many cost and expense improvement efforts around the world.

Our manufacturing rationalization program in Europe continues to progress as planned. We expect to realize annual saving of approximately $14 million per year from the consolidation of manufacturing from our site in Limoges, France into other existing sides. This project is on track and we expect to close the site in the first half of 2010. We also expect to realize additional annual savings of two to $3 million from suspending our operations at our Nules, Spain manufacturing site last June. In addition at the beginning of October we initiated new cost and expense reduction initiatives that are expected to generate incremental savings in 2010.

These savings will be the result of a combination of two manufacturing site closures, SG&A expense reductions and consolidation of certain sales support operations. In total these initiatives will reduce our worldwide staffing by approximately 230 positions. The total cash expenditures for these latest actions are forecast to be approximately $19 million including $3 million of capital expenditures. The estimated payback period for these projects is approximately 13 months which is consistent with our track record of our previous cost and expense reduction programs which have generated annual savings approximately equal to our cash costs. As we continue to execute on these programs we expect to make progress in lowering our sales breakeven level and improve our operational cash flow. This will help maintain the momentum that we have built during the past two quarters when our positive cash flow resulted in lower GAAP.

As you may know we announced a reorganization of our operating business in a release we issued on October 5th. We are now organized into two business Groups; the Electronics, Color and Glass Materials Group, then the Polymer and Ceramic Engineered Materials Group. It has helped us take another step in streamlining and flattening the organization while increasing decision-making velocity. The Polymer and Ceramic Engineered Materials Group combines our Performance Coatings, Polymer Additives, Specialty Plastics and Pharmaceuticals segments.

Within this new group we have for the first time combined our high-volume businesses into one worldwide organization. These businesses are focused on maintaining a world-class cost structure while generating positive cash flow to be invested in high margin growth opportunities across Ferro.

The Electronics, Color and Glass Materials operating group combines our Electronics Materials and Color and Glass Performance Materials reporting segments. This business group is focused on high margin, high growth, speciality materials that leverage our core capabilities at particle engineering, color and glass science, product formulation and surfaced chemistries. With that introduction let me now review the performance of our two operating groups and the current economic environment.

During the quarter we experienced a continuation of the stabilization and modest sequential improvements in the global business environment that we reported on in our second quarter conference call. Our Polymer and Ceramic Engineered Materials Group delivered excellent results in the third quarter. In total, segment income increased with flat or increased segment income in Polymer Additives, Specialty Plastics and performance coatings on a year-over-year basis. This performance was achieved despite a sales decline of 25% compared with the third quarter of 2008.

Performance in our Porcelain Enamel business was strong as it benefited from the consolidation of European manufacturing operations into Spain. Continued cost improvements at facilities around the world and improved manufacturing volume. Our tile business benefited from suspending operations that are Nules Spain, site at the end of the second quarter. In total, the performance coating segment reported segment income that was 20% better than in the third quarter of 2008.

Segment income in our Polymer Additives business match the prior year quarter, and increase in the Specialty Plastics business. This was due in large measure to that team’s relentless attention to reducing their cost and expense structure. In addition we continue to generate benefits from product repositioning toward higher margin derivatives and new products developed to provide customers with alternatives for materials under regulatory pressure. These new products include Low-VOC gel coats that can help our customers avoid significant capital cost in the manufacturing facilities while providing superior product performance.

At the same time, we have penetrated new application segments with these products such as coating wind turbine blades which has helped insulate our sales from some of the downturn in more traditional application markets. During the third quarter, our Electronics, Color and Glass Materials Group delivers sequential improvements in sales and segment income. The Electronic Materials business exceeded its 20% target for segment income as a percent of sales excluding precious metals for the first time this year. Demand for conductive metal pastes for solar cell applications was relatively strong in Asia and weaker in Europe continuing the pattern we saw in the second quarter.

During the quarter, we took the first production orders for solar pastes made at our new Suzhou, China manufacturing facility. We expect the aluminum paste manufactured in Suzhou will help us broaden our penetration of the Asian solar market. Demand for metal powders also increased, driven by improvement in the consumer electronics end market. Our metal powders are used in a variety of electronic based applications including conductive adhesives, plasma displays and touch screen cell phones. Sales of polishing materials also increased sequentially, driven by automotive aftermarket sales of paint finishing products.

Results in Color and Glass Performance Materials improved compared with the 2009 first half through sequential increases in sales volume combined with cost and expense control. Sales of auto glass enamels began to recover as our customers’ inventory de-stocking declined from the high levels experienced earlier in 2009. This was combined with some beneficial effect from Cash for Clunkers programs in Europe and the United States. Sales of pigmented inks used in digital tile printing applications also continued to perform well.

Turning now to the outlook, as was the case in previous quarters in 2009, we will not provide specific fourth quarter sales or earnings per share expectations because of the uncertainty in near term customer demand. Visibility to future customer orders has improved modestly but it does remain limited. Sales increased sequentially during the third quarter which is better than our normal seasonal pattern. Historically our sales have often declined from the second quarter to the third due to our exposure in Europe where August holidays reduced demand. While our august sales were lower than July as expected, September sales returned to the positive growth trend we have seen for a number of months.

We are encouraged by this performance, but it is still difficult to forecast future quarterly performance with certainty. While we believe the stabilization in end market demand around the world is likely to continue along with modest growth in selective regions, we remain cautious for the fourth quarter. Customers remain very focused on cash flow and liquidity and they have indicated that inventories are likely to be held to very low levels at the end of the year. However, if end market demand remains steady then conditions would be favorable for sales of our products as we begin 2010.

If customer demand is better than our base line expectations, we are confident that we have the flexibility in our manufacturing capacity, as well as the resources, to respond well if sales increase more than expected. However regardless of the level of future sales we will continue to pursue actions to realize permanent savings in our cost and expense structure as I’ve discussed on today’s call.

Before I turn the call over to Sallie to review the details of our third quarter performance, I’d like to thank our employees around the world for their efforts to maintain liquidity and improve operations through extraordinarily challenging global economic conditions and severe disruptions in our markets. They have responded with velocity to deliver improvements in our gross margins and segment margins despite lower sales. I’m convinced we are building an excellent foundation for future growth and profitability.

I’m confident that Ferro will continue to respond aggressively and positively to market conditions over the next several quarters. We do not know the future pace of worldwide recovery and end market demand. However, our profit improvement plans are not dependent on a quick rebound to a customer demand level of a year ago. Instead we are preparing for an extended period of modest recovery in which our reduced cost structure and expense control discipline can generate improved operating leverage.

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 B. Bailey

Thanks, Jim. This morning I’ll discuss our 2009 third quarter result in comparison with both the 2008 third quarter and our performance in the first half of 2009. The sequential comparisons are important as we evaluate both changes in the external economic environment and the progress we are making to improve our cost and expense structure. Reconciliation with non-GAAP results discussed in this conference call are available on our website in our supplementary financial results package.

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 third quarter are included in discontinued operations as a result of the sale of the business in the fourth quarter of last year.

Ferro recorded income from continuing operations of $0.04 per diluted share for the third quarter of 2009. Included in the results were pre-tax charges of 14.1 million dollars primarily related to a goodwill impairment charge and to manufacturing rationalization activities and other cost reduction actions. Excluding these charges non-GAAP earnings were $0.17 per share.

Net sales for the quarter were $442 million, a decline of 25% compared with net sales of $590 million in the 2008 third quarter. Net sales increased by 11% from the second quarter of 2009. The sales decline from the prior year period was driven by reduced sales volume resulting from the global economic downturn.

Reduced precious metal pass-throughs contributed approximately three percentage points to the sales decline and foreign currency rates accounted for approximately one percentage point.

Cost of sales declined by 27% from the prior year quarter to $349 million, primarily as a result of the lower sales volume. Manufacturing related staff costs and other cost reduction activities also contributed to our ability to drive down the cost of sales faster than the decline of sales.

Gross profit margin increased to 21.1% of sales from 18.7% in the prior year quarter. Gross profit in the 2009 third quarter was reduced by special charges of approximately $300,000. Gross profit in the 2008 third quarter included approximately $1.5 million with special charges.

Adjusting our third quarter gross margin parentages for special precious – for precious metal sales and special charges, gross margin was 24.7%. The equivalent adjusted gross margins were 22.1% in the third quarter of 2008. Adjusted gross margins increased 470 basis points sequentially from the second quarter of 2009. The improvements in gross margin percentage were primarily the results of manufacturing staff reductions and other cost containment initiatives and sales increases. In addition, raw material cost declined approximately $26 million compared to the prior year quarter, which was in excess of the product price decline.

SG&A expense for the third quarter was $65.9 million, a decline of $11 million from the third quarter of 2008. The SG&A reduction was driven by lower staffing, suspension of payments under our annual incentive compensation program and reductions in other employee benefits and other expense control initiatives. Partially offsetting the decline in the quarterly SG&A expense was an increase of approximately $5 million in pension expense.

The 2009 third quarter SG&A also included approximately $2.7 million in special charges, primarily related to severance cost associated with staffing reduction. The 2008 third quarter SG&A expense included net charges of $1.9 million. During the quarter we reported an impairment charge of $8.2 million related to our Pharmaceuticals business. The impairment was triggered by changed assumptions used to determine the unit’s market-based valuation. In addition, we recorded restructuring charges of $2.8 million during the 2009 third quarter, primarily related to our European manufacturing rationalization.

Total segment income for the 2009 third quarter was $41.5 million, or 9.4% of sales, compared with $46.8 million, or 7.9% of sales, in the prior year quarter. Segment income increased by $22.2 million compared with the segment income recorded in the second quarter of 2009.

For the quarter, Performance Coatings and Specialty Plastics recorded higher segment income than in the prior year quarter, while Polymer Additives segment income was about flat. Segment income declined in Electronic Materials and Color and Glass Performance Materials compared with the third quarter of 2008.

In our reconciliation of segment income to income from continuing operations before taxes, we reported unallocated corporate expenses of $14.3 million for the 2009 third quarter, including non-restructuring special charges of $3 million. In the 2008 third quarter, unallocated corporate expense was $13.4 million, including non-restructuring special charges of $3.4 million. The primary driver of the increase in unallocated corporate expense was approximately $5 million in additional pension expense. Excluding the special charges of $3 million and the added pension expense of $5 million, the 2009 third quarter unallocated corporate expense was $6.3 million.

Interest expense was $17.9 million for the third quarter, up from $12.4 million in the 2008 third quarter. The increase was driven by increased borrowing levels and higher average interest rates. The increased interest rates were primarily the result of amendments to our credit facility and receivable securitization program that were signed in March and June 2009 respectively.

In the 2008 third quarter, we refinanced our senior notes with a convertible bond issue. In connection with the retirement of the senior notes, we recorded a loss on extinguishment of debt of $5.5 million. The loss did not recur in 2009.

For the quarter, our income from continuing operations was $0.04 per share including charges. Excluding $14.1 million in special charges from our third quarter performance would result a pre-tax income of $13.1 million. Applying a tax rate of 36% would result in income $0.17 per share on an adjusted basis.

Capital spending for the quarter was $7.7 million. We expect the full-year capital spending to be approximately 35 to $40 million. Depreciation and amortization was $22.1 million for the quarter.

Total balance sheet debt on September 30 was $621 million. In addition, we had net proceeds of $13.2 million from off balance sheet international receivables factoring. Total financing was $634.2 million on September 30, including receivables factoring an increase of $47 million since December 31, 2008. The increase was driven by a requirement to collateralize our least precious metals.

Total collateral on deposits related to (ph) leased metals was $92.3 million at the end of the third quarter. Total financing declined by $32.8 million in the three months ended September 30 despite an increase of $11.9 million in collateral on deposit during the quarter.

While our quarterly net sales continue to be effected by reduced costumer demand resulting from the worldwide economic slowdown we have made significant progress in reducing our costs and expenses. As a result both gross margin percentage and segment income as a percent of sales increased compared with the prior quarter. Continued progress and the execution of ongoing manufacturing rationalization program and the new cost and expense reduction initiatives that began in early October are expected to make a positive contribution to gross profits and segment income in the coming quarters. So lower breakeven sales resulting from these savings will strengthen our operating leverage as worldwide customer demand recovers in the coming quarters.

Thank you for your participation in this morning’s call, and I would like to turn the call back to Dave to begin the question and answer session.

David Longfellow

Thank you, Sallie. I would like to remind you that today’s question and answer session will be limited to topics related to our third quarter results and the current business climate. We will not take any questions related to the equity offering on this morning’s call. I appreciate your understanding of the constraints required by securities regulations and your cooperation this morning.

Operator we are now ready to take the first question.

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from Jason Miner from Deutsche Bank.

Jason Miner - Deutsche Bank

Hi, good morning.

James F. Kirsch

Good morning Jason.

Sallie B. Bailey

Good morning.

Jason Miner - Deutsche Bank

Congratulations on a solid quarter.

James F. Kirsch

Thank you.

Sallie B. Bailey

Thank you.

Jason Miner - Deutsche Bank

Just a question on the offering – no I’m kidding, I’m kidding. On – really on electronic materials I wanted to ask, rather spend a little chatter about there’s some weakening of support for some of the subsidies specifically in Germany, and I know that we had faced some headwinds in the past when Spain had eased its subsidy for solar, so putting this together with the knowledge that margins might be a little higher on the Europe solar materials, Jim could you just address whether you can (ph) see there any headwinds to the strong margins as we go forward both on the risks politically and then just on the shifting mix toward Asia?

James F. Kirsch

Yeah, I think the – you will identify appropriately a risk in the solar industry which is politics and there is chatter in the German parliament about some care of easing in the – or subsidy easing as we get into the new year, I don’t believe that’s been (ph) despited yet and there is a lot of debate about what happens there.

Part of that debate is centered on their concern about the Chinese play because as the Chinese have become more of a world force in the cell manufacturing and moved up the quality line pretty substantially there is a fight going on between the German manufacturers and Chinese manufacturers in the European marketplace. My personal view and that of a number of consultants will use in this industry sector view the overall growth rate of megawatts as produced by solar energy over the next five years to grow at a 15 to 20% compound growth rate.

So whether that happens in Germany, China, and/or North America, which I expect will occur as we get into the 2012, 2013, 2014 timeframe is – I’m neutral on. Why am I neutral; because I’ve got manufacturing locations and distribution and sales and application of technology in all of those areas.

So we’re excited about our new facility in Suzhou. I want to remind you we have one in California, in Vista, California, which is a primary growth area for this industry as well. And as we look out over the next several years, our anticipation is though it’s an aluminum based facility for the most part today in penetrating the Chinese marketplace, will also continue to have good success with silver materials.

And candidly, though there is a difference in margin on the two, they are both very high margin products and our expectation moving out is that the over photovoltaic industry will continue to be a high growth one for Ferro albeit it may have some lumpy quarters along the way over the next three to five years.

Jason Miner - Deutsche Bank

That’s very helpful. Thank you. Second question just to recap some of the savings, I did take note that 7.5 million this quarter was from lower salaries and it made me think about the sustainability of some of these things. Maybe if you could just look back over the last two years and address how much we have done and how much might come back as volumes hopefully rise in the coming year.

James F. Kirsch

Yeah, let me first address the, let’s call it, the non-sustainable expense reduction, things 401(k) contributions that we suspended earlier this year, salary freezes, we had a – we took a mandatory furlough in the second quarter which we did not do in the third and won’t do in the fourth in the U.S. as well as suspending incentive compensation.

If you roll all of that together, it’s in the neighborhood of 20 to $25 million total expense. As we look at and as we think about our company, we think there is going to be modest growth economically. Therefore, we’ve prepared plans and put actions in place that will continue to lower our sales breakeven level.

And we continue to demonstrate the ability to return about $1 to the EBITDA line for every dollar of cost take-out that we implement. And we believe that the actions we took particularly once announced in the 1st of October, which I referenced with 230 heads coming out and two facilities being closed will more than make up for that particular non-sustainable expense, particularly when you play into that the carry-forward of the other activities that we’ve put in place over the last several years.

Jason Miner - Deutsche Bank

Okay, thank you very much.

Operator

The next question is from Mike Harrison from First Analysis.

Michael Harrison - First Analysis Securities Corporation

Hi, good morning.

Sallie B. Bailey

Good morning.

James F. Kirsch

Good morning, Mike.

David Longfellow

Good morning, Mike.

Michael Harrison - First Analysis Securities Corporation

If I do the math correctly, incremental margin compared to last quarter this is a sequential incremental margin calculation was north of 50% which I think is a little bit higher than people would have though. Obviously, some of that’s related to this $7.5 million of sort of unsustainable cost savings. But I guess maybe if you could help us understand a little bit better really how much of that is related to the incremental cost savings that came through the quarter and then what might be a sustainable incremental margin number to use as your underlying demand levels improve and we see that come through in the topline.

James F. Kirsch

Sure. It’s – first off, we had a terrific product mix in the third quarter. And we saw a build in our electronic materials – and I referenced in the last call that we were moving away from the dielectrics, which are lower margin, lower growth, extraordinarily competitive marketplace, mostly frankly because of our cost structure.

Our cost structure is not going to enable us to win. Therefore, I am not terribly interested in banging my head against that wall. So we’ve moved resources steadily in the last couple of years in that business sector into more of the clean energy (ph) polishing type materials, which are a much richer mix for us than the dialectrics.

In addition to that, we haven’t talked a lot about it, but pigmented inks in our tile business are high margin, high growth materials that are inkjet-applied if you will onto tie lines. That’s opening up and broadening the addressable market for us, and again, it’s a very high margin business. And the reason it broadens the market is it allows a tile producer to put a non-repeating pattern onto a tile, which then allows them to compete with natural materials such as wood or stone, marble, et cetera, in floor tile and wall tile applications.

Then when you take a look at the mix and you take a look at our cost reduction, what we’ve said before is a normalized rate, 25 to 40% contribution margin, Mike, and clearly we were on the high end of this, this time. A portion of that was certainly due to the continued decline in our staff in front of our staff reductions and so on. But overall, I’m very comfortable saying that in a normalized timeframe, without any special savings reductions related to salaries, expense, et cetera, that we have now moved the company with our break-even situation where it is into this 25 to 40% mode. And the reason it’s that wide is it’s very dependent on mix. And there are certain times of the year when the mix is different and richer than other times of the year.

Michael Harrison - First Analysis Securities Corporation

All right, and you touched a little bit on the electronics business and you got some areas you’d like to get bigger in and some areas that maybe you’d like to get out of. Can you talk strategically about how you’d like to move forward there and maybe how you’d like to see that segment evolve over the next two to three years as you grow businesses where you need to stay ahead of the technology curve?

James F. Kirsch

Let me broaden that a little bit, and let’s talk about the organizational structure you have today. On the one side of the company, if you will, we have performance coatings, polymer additives, plastics. They’ve done a great job of growing organically, and they’ve done a terrific job of growing regionally, particularly in the performance coatings business as we have extended into Eastern Europe, Russia, the Middle East. Egypt’s been a terrific market for us. In Southeast Asia, Vietnam has become a very good tile coating market, for instance. In porcelain enamel, we’ve had wonderful success throughout China.

So those businesses have done a good job of extending their reach, taking costs out, and you see the results in the segment income and performance coatings. In addition, those businesses have been delivering more than $2 cash for every dollar of EBIT that they have provided to the company.

So over the course of the next several years, a significant investment in those businesses will be cost reduction related, continuous improvement related, and the expectation is those businesses will deliver cash to reinvest in the company. The reinvestment will take place in the electronics, color and glass businesses, where we will lever off of our core competencies.

And when we think about electronics, when you think about it, we’ve really positioned ourselves a bit away from semiconductors and more into the energy related markets. In the end, our glass coatings business and our color business, we have a variety of energy related pigments, for instance, infrared and UV type pigments used in everything from camouflage type paints to other types of coatings.

So those businesses are significantly higher margin, have greater opportunity for growth, and our expectation is what we just delivered in electronic materials, which was excess of 40% gross margins and 20% operating margins. And we expect to continue that success moving forward and extend that throughout our business through both organic growth and then over time, given the timeframe you’ve adopted, we’ll certainly look for bolt-ons or tuck-under type acquisitions.

Michael Harrison - First Analysis Securities Corporation

And then the last question I had is really the exposure of your business to the automotive end market. And I was hoping you could comment to what extent Cash For Clunkers may have given any of your businesses, a temporary boost, or do you think you’re seeing more sustained improvement and demand from the auto side?

James F. Kirsch

I’m glad you brought that up, because I’m a (ph) contrarian. I think auto’s a growth opportunity for this company. Why do I say that? If you look where the automotive markets are moving, they’re clearly Asia, the BRIC countries, Brazil, India, China, are becoming very significant players in the world stage of automotive production. And in fact I think this is correct, I believe China is today the world’s largest producer of automobiles. We are very well positioned throughout Asia. India is – we have a presence albeit a small one there but we are the world’s leader in glass coating is certain automotive applications and we have terrific opportunities as auto continues to build in those growing and emerging economies to parley that into a growth story for Ferro. Cash (indiscernible) had an impact. It wasn’t huge. I can’t quantify that for you but clearly I think like other companies, both in our plastics business and our glass business, we saw some impact from it. I will tell you that I said in the last call that August and September, excuse me, July and August for the third quarter we’re maintaining what we saw from the second quarter in terms of our expectations of revenue. And as I look out, we aren’t going to talk much about the fourth quarter but I will make one comment. We are seeing the early look at October as it’s continuing the momentum we saw coming through the third quarter in terms of revenue.

Michael Harrison - First Analysis Securities Corporation

All right, thanks very much, Jim.

Operator

The next question is from Mike Sison from KeyBanc.

Michael Sison - KeyBanc Capital Markets

Hey, good morning, great quarter.

James F. Kirsch

Thank you, Mike. Good morning.

Michael Sison - KeyBanc Capital Markets

In terms – Jim, you’ve done a lot of 2005. Can you summarize maybe quickly in terms of how many plans do you have now, sort of the number of employees you have reduced and maybe there – is there sort of a tick we’ve saved this much type of number since then, reduced cost?

James F. Kirsch

Yeah, I will put it to you this way, Mike. We have about 7,400 employees when I came to Ferro. We have around 5,200 today. We have closed for suspended operations in eight facilities around the world. We talked today on the call about two additional facilities. We delivered over $150 million in fixed cost reduction as a consequence of those actions over the last couple of years which has lowered our breakeven, a topic you like to ask questions about a lot. So I try to get ahead of that one for a change, Mike. It’s lowered our breakeven sales by $80 million a quarter.

So in summation if you think about it, quite candidly that was a company in crisis in ’05. We had a lot of issues. And it was all about getting some stability, personal or capital structure creating sustainability and turning our attention to growth. As we get into the 2008 timeframe, we thought we were going to be opportunity to start turning our attention to growth, and all along the way we were looking to find ways to de-lever our balance sheet. Yeah, the recession clearly set us back, but it also gave us a great opportunity to accelerate cost takeout, accelerate staff reductions, accelerate the opportunity to realign the company so that the numbers of levels between me and entry level are about five or six depending upon which side of the business you are on whereas three years ago it was around 11.

So all of that is permanent change in the cost structure of the company to take advantage of what we think would be a modestly and hopefully improving upon the modest recovery over the next couple of years.

Michael Sison - KeyBanc Capital Markets

Great, and then as a follow-up, when you think about – you sort of – your sale sort of peaked, excluding precious metals, at 2 billion. I3t will be somewhere around 1.4. There’s sort of 600 million in, let’s say, sales volume that’s recoupable over time – talk about incremental margin. So if you – how much of that 600 million is recoupable and, I think at one point we had – that was a thought you can get to a 10% operating margin before precious metals. Is that still a target longer term?

James F. Kirsch

Let’s start at the end of that equation. It clearly is a target. In fact, if you look at our third quarter, you will see that our operating margins excluding precious metal were little over 8% and that’s actually better than if you look at the 2008 quarter. We are actually improved and that’s because of this cost takeout activity we have embarked upon several years ago, and we are seeing the benefit of that.

In term of the $600 million of what you can recruit, that’s a really hard question to answer, Mike, because you’re trying to – you asked me to pinpoint what year do we think that will come back based on the global economy. So I can’t predict that. What I will tell you is our planning in terms of enhancing the profitability and the shareholder value for this company is based on our abilities to maintain and sustain these permanent cost reductions to appropriately staff the company, in the right places, in right geographies behind the right businesses to invest in higher margin, higher growth businesses. All things are not equal at Ferro and then they won’t be treated that way. Then as the economies around the world recover, if they win those volumes come back we will be the beneficiary of that.

I can’t tell you that if we had those volumes today, we’d be generating an extra 70, $75 million of income as a consequence of it, based on the cost structure we put in place.

Michael Sison - KeyBanc Capital Markets

Great. And last question for Sallie. You’ve done nice job generating some cash and working capital, second and third quarter. Are most of those structural and will you get some more cash from that strategy in the fourth quarter in 2010?

Sallie B. Bailey

Yeah. Mike, we are continuing to look at our liquidity and we do believe that we’ll be able to manage our company at the lower levels of working capital that we have. I think you know, as we go out and as economy begins to improve we’ll see some increases in our accounts payable which will help the offset – the increases that we need to fund the receivable.

Michael Sison - KeyBanc Capital Markets

Great. Thank you.

Operator

Next question is from Jeff Zekauskas from JPMorgan.

Jeffrey Zekauskas - JPMorgan

Hi. Good morning.

Sallie B. Bailey

Good morning.

James F. Kirsch

Good morning, Jeff.

Jeffrey Zekauskas - JPMorgan

For the fourth quarter can you talk about what might be the level of unallocated corporate expense? Would it be consistent with the previous three quarters or would there be something unusual that goes on into the fourth quarter or next year for that matter because of your restructuring?

Sallie B. Bailey

Jeff, I think it will be pretty consistent with what we’ve seen so far this year and likewise next year.

Jeffrey Zekauskas - JPMorgan

Secondly, can you talk about what seasonal factors will probably affect you in the fourth quarter of ’09 versus the third quarter of ’09.

James F. Kirsch

Sure the biggest one Jeff, are holidays. Typically what we see in the fourth quarter particularly December is an awful lot of closers and customers taking advantage of the holiday season to manipulate, if you will, their closure schedules to have as clean a balance sheet as they can going into the first quarter of the new year.

That’s what is so concerning if you will as I look at December that sort of that Thanksgiving to the end of the year timeframe. Will that de-stocking occur; because we believe our customer base has pretty much been through all the de-stocking they can be – they can go through. We don’t think the improvement, if you l look at our revenue side, the improvement was nice but modest.

We don’t believe that’s going in the inventories, we think it’s reflective of demand. On the other hand from the seasonal standpoint or electronic materials business, typically the third and fourth quarter are stronger quarters. And a couple of things drive that. On the [indiscernible] side, people are trying to get installations done before the winter sets in, both in Europe and in some parts of Asia. So that’s a significant driver for a very high margin business for us.

Second, metal powders which go into things like flat panel displays and to cellphones, touchscreens et cetera, yes, there is often between the Christmas season and believe it or not Super Bowl season, a significant uptick and production builds going on in the October, November, December timeframe.

So there’s sort of some counter-cyclical actions that occur and the good news for us is the positive tend to be higher margin products than the negative. The bad news for us is the negative tend to be higher volume products than the positive. So that’s why the fourth quarter in this environment is so difficult to call, but having said that I’ll tell you that I am very confident that our ability to manage through that is quite good. We are going to continue to drive down the path of cost and expense reduction. We are going to continue to maintain very tight operating parameters where I want 45 days or less total inventory on the floor of any of our factories around the world that most if not all of them are at or below that level. And that’s why you see cash generation out of working capital even in an improved – improving economy in the third quarter we generated cash out of working capital and certainly our goal to continue to do that as we look forward. I hope that’s helpful to you.

Jeffrey Zekauskas - JPMorgan

Yes, that’s helpful, and then lastly for Sallie, how much debt comes due in July of 2012 under your amended agreement?

Sallie B. Bailey

$448 million.

Jeffrey Zekauskas - JPMorgan

Okay. Thank you very much.

James F. Kirsch

Thank you.

Operator

The next question is from Rosemarie Morbelli of Ingalls & Snyder.

Rosemarie Morbelli - Ingalls & Snyder

Good morning all.

Sallie B. Bailey

Good morning.

James F. Kirsch

Good morning, Rosemarie.

Rosemarie Morbelli - Ingalls & Snyder

And congratulations for a terrific quarter.

Sallie B. Bailey

Thank you.

James F. Kirsch

Thank you.

Rosemarie Morbelli - Ingalls & Snyder

Could you talk about the – well you did give us a dollar amount Sallie, regarding the help from raw material cost coming down, it looks as though your selling prices also went down. Could you give us a feel as to what the trend is currently in war material cost with oil going up and whether you would be able in this demand environment to get those selling prices back half?

James F. Kirsch

Rosemarie, I’ll take that. It’s really mixed. With oil going up we are seeing some impact in the smaller piece of the business in plastics certainly. On the other hand utilities, natural gas in particular, remains at nice levels and we are at a fairly significant utility use for us.

Then as you go across the board, yes, it’s a real mixed bag. As you know we have a very, very broad raw material base and whether it’s tallow or bean oil on the polymer additives side or if you go into the non-precious metals like cobalt and zircons and so on for the tile and porcelain enamel side, in general it looks to us like across the board, a fairly stable environment at the moment as opposed to one that’s in reduction, and second I’ll tell you that while our prices did come down, we were able to maintain a positive price over raw materials which we’ve consistently done for the last couple of years.

So I think our guys have demonstrated a very good capability to manage price over raw materials. We have a nice enhanced margin because sometimes they have risen so rapidly we use things like surcharges but as we go through a time as demonstrated in our gross margins we tend to continue to fight that battle and a lot of our products, as consequence of their functional performance in a relatively low part of this customer system, have demonstrated price elasticity and frankly we take advantage of that.

Rosemarie Morbelli - Ingalls & Snyder

Okay, that is helpful. And could you give us a feel as to the difference behind the lower sales volume for tile coatings but up for porcelain enamels, if there is a question of they were small inventory deflation in one then the other, are they in different – or if one more in new construction the other one in remodeling. Could you help me understand what is going on there?

James F. Kirsch

Yes, we had a significant and – over the course of the year, let’s start there in tile; we’ve really moved a lot of inventory out, all right. But second tiles markets are clearly softer than the porcelain enamel market particularly in Spain and Italy where the building and construction industry has been probably some of the most severely impacted globally.

Porcelain enamel on the other hand, primary end-use market appliance and hot water tanks, both renovation and building and construction and again I mentioned on the call a significant improvement in our Chinese operations; there had been some quality changes and some drives toward a regulatory improvements or code improvements, they like to put it that way believe it or not in our Chinese markets which have enabled us to compete more effectively given a lower cost which has helped to drive volume. So in general, porcelain enamel volumes are going up in a better end use demand environment as opposed to tiles volume which has come down a bit as a consequence primarily of what’s occurred in Spain and in Italy.

Rosemarie Morbelli - Ingalls & Snyder

Okay. That is helpful. And if I may, you talked about your breakeven level being down 80 million in revenues, so if I make the revenues in the third quarter of 442 is it correct to estimate that at 362 million in revenue which is just about the first quarter level, a little more but not much, you actually would break even or do better than that?

James F. Kirsch

I’m not sure I followed all of that math, but the last time we were on a call we talked about our breakevens; were around a 125 or $130 million a month value added sales and so if you look on a value added basis, if that’s the way you are thinking about it, that would suggest that’s around the breakeven for the profit before tax level for the company.

Rosemarie Morbelli - Ingalls & Snyder

Okay, all right. So I had forgotten those numbers. Thank you.

James F. Kirsch

You bet.

Rosemarie Morbelli - Ingalls & Snyder

Thanks.

James F. Kirsch

Thank you.

Operator

The next question is from Dmitry Silversteyn from Longbow Research.

Dmitry Silversteyn - Longbow Research

Good morning. Just I have a couple of questions to follow up on everything that’s been asked before. You’ve talked about electronics materials, the business depending more on the solar cells than semi-conductor industry, but we did a see a very nice growth in semi-conductors and related products over the last couple of quarter. So is that benefiting business in a meaningful way or have you repositioned away from semi-conductors to the point where growth in that industry really doesn’t have much bearing on the performance of the electronic segment.

David Longfellow

No, we haven’t gone that far away, we still have polishing materials for wafers and that sort of application.

Dmitry Silversteyn - Longbow Research

Okay.

David Longfellow

And our dielectric materials, multilayer ceramic capacitors are still is – is still a portion of that overall portfolio. So we are actually if you look at electronic materials, if I broke it down by region for you as difficult as dielectrics were in the first half. Well electronic materials certainly made money in the segment basis. It was slightly better than breakeven in Europe and that’s our main manufacturing area for dielectrics, but that’s much better than what it had been a couple of quarters ago and that’s a consequence of some of the improvements you are talking about.

Dmitry Silversteyn - Longbow Research

Okay. Okay, that’s helpful. Now you in response to Rosemarie’s question you talked a little about the Thailand porcelain market. If you look at the – all the colors and glazes and kind of all the, what used to be called the inorganic market or business unit as well as the polymer additives and engineered plastics business, when we think about the company and kind of where it fits in a cycle, are you – are your markets more U.S. and European driven or emerging markets driven and also are they more driven by residential construction recovery or by commercial construction recovery or does it vary by geography?

David Longfellow

It’s a complicated question. Let me try to answer it in a relatively short manner. European revenues are about a third and you have got about 45 or so percent out of the America’s and you have got about 20, let’s call it 25% out of greater Asia and that’s total company.

James F. Kirsch

Total company I am speaking to you now.

Dmitry Silversteyn - Longbow Research

Right.

David Longfellow

That gives you a little bit of the balance. If you look at total company the – we have about in this broader sense of building and construction about a 35 plus, 35 to 40% exposure to the broadest view of building and construction, whether it is roof tile glazes or whether that is PVC related and polymer additives or whether that is on building and construction for floor tiles and wall tiles or appliances that might be from both our plastics and our porcelain enamel business.

Dmitry Silversteyn - Longbow Research

Got you.

David Longfellow

It, we historically have had more impact by municipality and commercial in the states and then to an extent more residential in Europe and then if we go into the emerging markets, as we think about China and really we, if you think about these particular products we are referring to. You’ve got to think about Southeast Asia because we had a very large presence in Singapore, Thailand, Vietnam and Vietnam. And Vietnam has become one of the world’s leading tile producer nations. In fact if you go to Home Depot you’ll start seeing Vietnamese manufactured tiles now. So it’s a difficult question to answer cleanly, but in the Southeastern Asian market more residential building and construction, although a fair amount of tile is used in commercial. And frankly in the Chinese market it is much more driven by our colors business, our automotive business and glass and our electronics businesses.

Dmitry Silversteyn - Longbow Research

Got you. That’s very helpful. Thank you very much. And then, you reorganized the company into what’s basically going to be a cash generating business and a growth business.

David Longfellow

That’s right.

Dmitry Silversteyn - Longbow Research

The cash generating business, particularly the organics portion of it at one time were going to be divested, is that still the plan or is this reorganization basically means that you are going to keep the businesses and just use the cash to grow the rest of the company?

David Longfellow

Certainly in this environment, with this economy we would keep the businesses and continue to run it for cash, because they are much more valuably to me as a cash generator then they are trying to sell a business at some depressed multiple. Over time as we look at both that we look to do some other things we will certainly always look at the opportunity to monetize certain assets that are non-strategic to the company, if they make more sense in somebody else’s portfolio versus ours. But I wouldn’t see it happening anytime soon.

Dmitry Silversteyn - Longbow Research

Okay, okay that makes sense and then finally you took a big write-down in goodwill on the pharmaceutical part of your business, is that still – what are your long-term plans for this business, I mean, are you – when the M&A market improves are you looking to sell it or this business is going to continue to operate within the company for the foreseeable future?

David Longfellow

That’s the business that’s been turned around nicely by the guys running it. It’s also a business that require – will require over time significant investment. That would certainly be a business that today we are optimizing it, running it in the best way we know how. We have had good success with certain hits in or certain APIs in both cancer and asthma drugs fields and as we go through time, as the economy gets better if we have the opportunity to look at monetization of that because it would make more sense in somebody else’s portfolio than ours, we would listen to that.

Dmitry Silversteyn - Longbow Research

Okay, so one thing we can probably say with some degree of confidence is you are not looking to improve this business through acquiring and getting it bigger?

David Longfellow

I think you can say with confidence I am not looking to be a pharmaceutical player.

Dmitry Silversteyn - Longbow Research

Got you and then one final question. What was the foreign exchange impact on profitability this quarter and how much it will lower dollar help you in terms of margin in 2010 assuming it stays at current exchange rates?

Sallie B. Bailey

You know, Dmitry, as we talk about in the past we’re not really operationally hedged so whilst that impacts us on sales level when you get to the operating – by the time you get to the operating income line it really has offset itself so and that’s true this quarter and will be true in quarters going forward.

Dmitry Silversteyn - Longbow Research

Ok so you’re basically self-hedged as far as where you are making cash and where you sell in terms of currencies.

Sallie B. Bailey

That’s right.

Dmitry Silversteyn - Longbow Research

Okay, okay, that’s helpful. Thank you very much.

James F. Kirsch

All right. We are just about – we are really running very short on time. We will try to get one more – one last quick question in if we could please.

Operator

The last question is from David Sachs from Hockey Capital.

David Sachs - Hockey Capital

A quick question on the precious metals financing. If there is an opportunity given that the credit market’s proved a little too – not double collateralized going forward or have you explored the opportunity of going back to your traditional financing mechanisms there?

Sallie B. Bailey

Yes, we have. We continue to explore what opportunities that come to us and think that with an improving credit profile we will give these metals become uncollateralized.

David Sachs - Hockey Capital

And have you been able to get more money for the precious metals that you – because you have had this extra financing cost or is that something you had eat via incremental expense?

Sallie B. Bailey

I am sorry I don’t really understand the question.

David Sachs - Hockey Capital

You had to borrow the incremental $90 million in cash against your precious metal inventories so there’s a interest expense tied to that if you were able to recover the 90 million as [indiscernible] deposit but if you have been able to charge your customers more just because it’s cost you more to hold the metals?

Sallie B. Bailey

No, no, no we haven’t passed through the added interest expense.

David Sachs - Hockey Capital

So in two fronts here we could either pick up 90 million and reduce interest expense if we could refinance through that product or we could as well save the interest expense?

Sallie B. Bailey

Well, it doesn’t better the possibility. It doesn’t exactly work that way because the least prices are lower because of the precious metals collateralization so to some extent as the precious metals collateralization decreases there will be some increase in the least fees.

David Sachs - Hockey Capital

And just in your conversations with the banks is there a likelihood in your mind that in 2010 this double collateralization could reverse?

Sallie B. Bailey

Yes, as we – as I said before as our credit profile begins to improve and the we would have the expectations that over time we will have the precious metals deposits released.

David Sachs - Hockey Capital

Last quick question. Capital spending for 2010, any initial thoughts?

James F. Kirsch

Yeah, we are going to spend between 35 and $40 million this year and as we look out next year we are evaluating what we think the economy will do. We are going to be very cautious with it. Yeah and we are not going to unleash the pocket book until we know that we are on very solid ground moving forward.

David Longfellow

Well, thank you very much. I think we are just about out of time today. So that concludes our Q&A session for this call. For copies of our third quarter earnings press release, replays of this call or access to our SEC financial filings, please go to our website at www.ferro.com and click on investor information. Thank you and have a good day.

Operator

That concludes today’s conference. You may disconnect at this time.

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Source: Ferro Corporation Q3 2009 Earnings Call Transcript
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