Ferro Management Discusses Q4 2013 Results - Earnings Call Transcript

Feb.25.14 | About: Ferro Corporation (FOE)

Ferro (NYSE:FOE)

Q4 2013 Earnings Call

February 25, 2014 10:00 am ET

Executives

John T. Bingle - Director of Investor Relations and Treasurer

Peter T. Thomas - Chief Executive Officer, President and Director

Jeffrey L. Rutherford - Chief Financial Officer, Principal Accounting Officer and Vice President

Analysts

John P. McNulty - Crédit Suisse AG, Research Division

Kevin Hocevar - Northcoast Research

David L. Begleiter - Deutsche Bank AG, Research Division

Rosemarie J. Morbelli - G. Research, Inc.

Eugene Fedotoff - Longbow Research LLC

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Ferro Corporation 2013 Fourth Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Tuesday, February 25, 2014. I would now like to turn the conference over to Mr. John Bingle, Treasurer and Director of Investor Relations. Please go ahead, sir.

John T. Bingle

Good morning, and welcome to Ferro Corporation's 2013 Fourth Quarter Earnings Conference Call. Joining me on today's call is Peter Thomas, President and Chief Executive Officer; and Jeff Rutherford, Vice President and Chief Financial Officer. Peter will comment on our 2013 performance, progress against our value creation strategy, and he will discuss how we see 2014 unfolding. Jeff will provide financial details for the quarter and will discuss our guidance. We'll address your questions at the end of the call.

Our quarterly earnings press release was issued last night. You can find the release, as well as a reconciliation of reported results to non-GAAP data that we'll discuss this morning in the Investor Information portion of the Ferro's website at www.ferro.com.

Please note 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, including those listed in our earnings press release and more fully described in the company's annual report on Form 10-K for December 31, 2013.

Forward-looking statements reflect management's expectations as of today, February 25, 2014, and the company undertakes no duty to update them to reflect future events, information or circumstances that arise after this date of the conference call, except as required by law. A dial-in replay of today's call will be available for 7 days. In addition, you may listen to or download a replay of the call through the Investor Information at ferro.com. Any redistribution, retransmission or rebroadcast of this call, in any form, without the express written consent of Ferro is prohibited.

I now like to turn the call over to Peter.

Peter T. Thomas

Thanks, John. Good morning, everyone, and thank you for joining us. I'd like to start by commending the employees of Ferro for their contributions to our progress and strong performance in 2013. As we executed the company's value creation strategy, we called on to our teams to closely examine their work processes to identify opportunities for efficiency, adapt to changes and take on additional responsibilities, and in many cases, to make some very difficult decisions. I'm extremely proud of the way our team has responded and of their commitment to our success as we work together to drive value for Ferro shareholders.

The pace of change and progress certainly is not waning as we move into 2014. We are committed to and are taking actions to meet our 2015 target of delivering adjusted EPS in excess of $1 per share. Our sites are implementing plans to improve return on invested capital by attacking cost, by vesting excess or non-performing assets and driving for increased sales. We continue to reduce cost to lower our SG&A expenses. Our quarterly run rate for SG&A expense is currently at about $55 million, adjusting for special charges and normalized compensation expense. And we expect to have a sustained quarterly SG&A of lower than $50 million by the end of 2015, as our business process outsourcing and indirect procurement strategies are further implemented.

We made very good progress in the portfolio management component of our value creation strategy last year, completing divestitures of 3 underperforming businesses and trimming our customer and product portfolios where returns were not sufficient. Our focus on portfolio management continues along 2 paths: to repair or exit underperforming assets, as well as to expand in areas where we create value. We're actively exploring strategic opportunities to expand in growing geographies and to add businesses that complement our technical capabilities. And we look forward to sharing our progress with you.

Now I'd like to give you an overview of business conditions for 2014. I'll start with Performance Materials, where we have approximately $600 million of invested capital, and which includes Ferro's legacy core technologies.

Before I start, I'd like to review for everyone that one of our core technologies is glass science. Our Performance Materials group, for the most part, manufactures glass, and the majority of our manufacturing assets are related to smelting or the melting of inorganic materials to produce glass. We take the glass we produce and fracture glass into pieces, which we refer to as frit. Oftentimes, the frit is ground or milled into smaller particle sizes or powders. These products are then the building blocks for a host of glass-based functional coatings. These coatings can be used on a variety of substrates, the most important for us being metal, as with porcelain enamel, ceramic tile and other glass surfaces like containers and automotive windshields.

We also excel in color science, Ferro's backward integrated into production of pigments and colors that can be used in our own glass-based coatings or sold directly into the market for a host of other non-glass applications. We capitalize on our formulation expertise by producing other types of coatings to the markets we serve, as with the inks we produce for digital printing in the tile industry. We have a number of opportunities across the Performance Materials portfolio that build off these core Ferro Technologies.

In the Performance Coatings segment, we have just launched our fourth generation Ferro Inks product line, which features water-based ceramic tile colors, special effect inks and glazes. The products are seeing excellent acceptance in the market due to improved color intensity, a wider spectrum of design capabilities and the savings and environmental benefits associated with water-based media. We're bullish about the commercial success of this new product suite and our continuing global market leadership position.

Product innovation and value technical and design services continue to differentiate Ferro in the increasingly price competitive ceramic tile market. Incidentally, an example of product innovation, the 4.0 Ferro Inks product, which earned the highest honor for innovation 2 weeks ago at the International CEVISAMA Ceramics Fair in Valencia, Spain.

2013 was a very good year for the Porcelain Enamel team and we are attracting the attention in the market. While the Porcelain Enamel business is now experiencing pricing pressure in many regions, we continue to win in the market. Strong fourth quarter sales in Asia are carrying over into the first half, as we are enjoying strong demand, partially driven by the growing water heater market in China.

In the Performance Colors and Glass segment, coatings for automobile and container glass are off to a strong start. We're projecting nice growth in North America and Asia for auto glass products and strong business for our glass container decoration products in Latin America. In addition, sales into Turkey, the Middle East and Africa are providing growth opportunities for our automotive, decoration and industrial glass products. We see good growth potential for products such as forehearth color pearls, a high-demand, low-dust producing glass coloring product that we built capacity for in France. And we're excited about the growing market interest in our Specialty Glasses in dental, automotive and industrial applications. For example, we are producing sub micron ultrapure dental preparation fillers, which are gaining commercial success and have strong growth potential.

Now our Pigments, Powders and Oxides segment. We sold various precious metal powder assets in this business last October. The segment now primarily comprises complex inorganic color pigments, or CICPs sold into plastics, paint and concrete markets and surface-finishing materials for precision polishing of autos and lenses. We're expecting modest top line growth for the CICP business as we move into 2014, but we think there's upside potential for further strengthening of the North America and European building and construction industries.

We also are developing sales in Eastern Europe, Turkey and South Africa where we experienced good sales penetration last year. Excellent cost controls are expected to deliver good margins for the product line.

In surface finishing, the continuing strength of alumina polishes for the auto aftermarket and plastic lens polishes in the U.S. market are key growth drivers. A challenge for us is the devaluation of the Japanese yen, which is providing Japanese competitors with price advantage throughout Asia for alumina-based auto polishes.

I'll now comment on our Performance Chemicals group, which includes the Plastics and Polymer Additives reporting segments and represents approximately $120 million of invested capital. Let me touch briefly on what we do in the Performance Chemicals group. Our manufacturing assets in this group are quite different from our Performance Materials group, and our focus is on organic chemistry. Here, you will find more traditional chemical operations, including vessels and mixers for chemical reactions, distillation columns and extruders for the blending of plastic resins. Our raw materials are organic-based, with major inputs coming from agricultural, animal or petrochemical feedstocks. Products sold in our Specialty Plastics segment include filled and reinforced plastic compounds, plastic colorants and thermoplastic elastomers. These product offerings are used in applications such as appliance and auto parts, building construction materials and packaging.

Polymer Additives products include heat stabilizers, polymer modifiers, benzyl chloride and stearate lubricants. These products are commonly used in vinyl applications, sealants and cogs and wire and cable applications.

For Specialty Plastics, we are seeing a recovery in the Color Concentrates business, particularly in Africa and South America, and early year demand for our gel coats has been strong. We expect to have good sales into the U.S. auto industry, even as auto sales contract from 2013 levels. And we should benefit from the decision of certain appliance companies to bring manufacturing back to North America.

In the Polymer Additives segment, as we've previously stated, we will continue to experience the effect of product deselection of phthalates. We expect this trend will adversely impact 2014 sales by approximately $30 million. Excluding this loss, we project sales in the segment will increase at GDP plus 1%.

Our dibenzoates capacity project in Belgium is on track and we continue to expect to launch production of this phthalate replacement product family by year's end. However, we may continue to sell phthalates for an additional 6 months due to customer conversion cycles.

In North America, metallic stearates used in the manufacture of PVC pipe, signing and window profiles are off to a solid start as building construction markets strengthen. We're also seeing growth for our mixed metal stabilizers used in building and construction and consumer goods, and for benzyl chloride that we sell for industrial cleaner and oilfield applications.

We are currently experiencing soft pricing environments in nearly all regions. We're managing through these pressures to protect our market positions and gross margins. Smart pricing strategies, delivery of superior product solutions and technical support and tight cost controls across our operations is the focus. Despite a more challenging pricing environment, we expect 2014 gross profit margins will be maintained at the current level of approximately 22%.

Raw material prices generally are stable, although we're seeing increases in certain materials such as praseodymium, impacting our ceramic colors and Specialty Plastics seeing upward pressure on resin. In addition, our U.S.-based manufacturing operations are facing higher costs associated with natural gas and electricity.

Currency volatility in Latin America and Turkey, and political circumstances in Thailand, Indonesia and India could create market uncertainty and hinder growth for us in the first half. Thus far, demand has not been significantly affected. Likewise, our operations in Egypt are stable. Business out of our Egypt facility remains robust, and we're reviewing various opportunities for increasing capacity to drive growth for our functional coatings businesses in the region.

We gained good momentum in 2013 and are carrying it into 2014. Initial business reports covering the first 2 months are favorable, and we're excited about our prospects. As I said earlier, we're pushing ahead aggressively in executing our value creation strategy. We're confident in our 2014 guidance, and I believe the Ferro management team and our employees will deliver on our 2015 targets.

From a strategic perspective, here's what you should keep in mind. For 2014, it's paramount that we continue to execute on the value creation strategy we laid out a year ago.

Our plan to reshape the company and significantly reduce cost was a multi-year plan, so in 2014, you can expect more of the same. We will continue to focus on cost takeouts to drive improved earnings. Now the progress we're making to streamline the company and reduce cost is opening up opportunities to pursue strategic actions previously out of reach due to our cost structure. We will continue to evaluate our portfolio with the focus on making acquisitions that will enhance our market positions and delivering -- divesting operations where value creation opportunities are limited.

Further, in conjunction with our continued study of strategic options, we also will evaluate our capital structure, particularly debt capital, in light of the credit debt market environment and with our improving credit profile. And with that, I will now turn the call over to Jeff.

Jeffrey L. Rutherford

Thank you, Peter, and good morning, everyone. As John mentioned at the start of the call, you will find reconciliations of non-GAAP results discussed during this conference call in our press release and also in the supplemental financial data that is posted in the Investor Information portion of Ferro's website. My comments, in general, will focus on adjusted information to provide comparability of information from period to period.

I will cover 3 primary topics and then we'll get into your questions. First, I'll provide a quick recap of the quarter. I will then give an overview of the performance of each of our reportable segments. And finally, I will conclude with a discussion of our outlook for 2014.

Now turning to our results for the quarter. For the fourth quarter 2013, on a GAAP basis, we reported net income from continuing operations of $0.69 per diluted share. This compares to a loss of $0.74 per share last year. On an adjusted basis, diluted earnings per share from continuing operations were $0.09 in the current quarter versus a net loss of $0.07 last year. There are several adjustments in the current quarter, which can be grouped into 4 categories. First, a $70.1 million noncash mark-to-market gain recorded in SG&A for our pension and other post-retirement benefit programs to account for the impact of the year-end revaluation of our post-retirement liabilities and pension assets. It should be noted that on a GAAP basis, our U.S. pension plans are now approximately 92% funded.

Secondly, a $5.4 million restructuring charge associated with our ongoing cost savings initiative. Third, a $9.6 million charge for asset impairments, primarily related to a $7.5 million write-down of a building in China, which was originally built for solar paste manufacturing, and a $2.1 million impairment associated with intangible assets of our grinding fluids operation.

And fourth, other items that resulted in a net gain of $3.5 million. The net gain is composed of a few items, the largest of which is a $13.3 million gain associated with the October sale of our North American and Asian metal powders and flakes assets. This gain was partially offset by charges, including an $8.3 million charge for an exposure in Argentina related to a mining operation, which was divested in early 2012. Further, it should be noted that income taxes have been adjusted from our GAAP rate of 15% to a pro forma effective rate of 36%.

During the remainder of my remarks, I will refer to adjusted numbers, which will exclude the items I just noted. In addition, discussions about sales and sales-related profitability measures, such as gross profit margin, will reference value-added sales. As a reminder, value-added sales exclude precious metal sales, as precious metal sales, in general, are pass-through sales to our customers. Excluding the precious metal sales removes the volatility in our results associated with any significant movements in precious metal pricing.

Value-added sales were $357 million in the fourth quarter of 2013 versus $360 million last year. Adjusted for the impact of business lines exited during the year, including solar and the North American and Asian metal powders assets, which accounted for approximately $3 million and $9 million in the fourth quarter 2013 and 2012 sales, value-added sales increased by 1%. In the quarter, sales were adversely impacted by continued product deselection of phthalates in the Polymer Additives segment, driving an approximately $6 million reduction in sales for that segment. Adjusted for this loss, sales for the company's underlying businesses increased by approximately 3%.

On a regional basis, comparing the fourth quarter of this year to the same period last year, value-added sales, excluding divestitures which were essentially flat in Europe, increased 9% in Asia and 7% in Latin America. Sales declined by nearly 3% in the U.S., driven primarily by the deselection trend in Polymer Additives.

Excluding the impact of phthalate deselection in the U.S., nearly all of the $6 million previously referenced, company sales in the U.S. increased by approximately 2%.

Adjusted gross profit, adjusting for charges and excluding the impact of precious metal sales, was $79 million in the fourth quarter of 2013 compared with $63 million last year. Adjusted gross profit as a percentage of value-added sales increased to 22.1% versus 17.5% last year. The primary drivers behind the increase in gross profit were our cost-reduction initiatives, coupled with increased sales and production volumes and improved business mix. Excluding special charges in both periods, adjusted SG&A was $61 million compared with $63 million in the prior period. Included in both periods are expenses associated with accruals for incentive and stock-based compensation, including a charge of approximately $7 million in the fourth quarter of 2013 and a credit of approximately $2 million in the same quarter last year. As discussed on our prior call, as operations declined in the second half of 2012, we reversed incentive-oriented compensation.

Excluding the charges and the incentive compensation accruals, SG&A expenses were reduced by nearly $12 million on a year-over-year basis, including approximately $4 million of SG&A reduction associated with the exit of the solar asset. Our current run rate for quarterly SG&A expense is approximately $55 million, adjusting for special charges and normalized incentive compensation expense.

For the quarter, we achieved $31 million of adjusted EBITDA, resulting in an EBITDA margin of 8.6%. This compares to fourth quarter 2012 adjusted EBITDA of $12 million or a 3.2% EBITDA margin. Total EBITDA for 2013 was $138 million compared with $90 million for 2012.

At December 31, 2013, net debt was $283 million, a decrease of $34 million from December 2012. Our liquidity continues to remain strong. At the end of the year, we had approximately $235 million of availability on our $250 million revolving credit facility.

The following significant cash flows occurred during the year as part of the $30 million reduction in net debt. Net proceeds from asset dispositions of $34 million; restructuring payments of $30 million; capital expenditures of $34 million; interest of $27 million; cash taxes of $6 million, offset by a tax refund of $6 million, netting to 0; pension and retirement contributions of $22 million; and excluding divested working capital impact, working capital was flat year-over-year.

Our precious metal consignment obligation at $31 million at quarter end compared with $112 million in the fourth quarter of last year. The net lease obligation has declined substantially over the last 12 months due to the solar paste asset divestiture and a more recent sale of our precious metal-based powders and flakes product line in North America and Asia.

We continue to be diligent with respect to our program to aggressively manage our precious metal manufacturing consignment requirement and believe there are opportunities to further reduce this obligation. We currently have no demands for cash collateral related to precious metal consignment and we have trimmed participation in the program back to adjust to our current level of precious metal requirements.

I would now like to provide a brief overview of year-over-year fourth quarter results for our reporting segments. Again, the analysis is based on value-added sales. In Pigments, Powders and Oxides, value-added sales declined by 16% while gross profit more than doubled. Included in this change, however, is the impact of divesting the solar and metal powders assets. The sales from these dispositions were approximately $3 million in the fourth quarter of 2013 compared with $9 million in 2012. While the associated gross profit in the same periods was $2 million for 2013 and a loss of $1 million in 2012.

Excluding the dispositions from both periods, sales increased by 3% and gross profit improved by nearly $2 million. Increased volumes for pigments and surface polishing products offerings drove the majority of improvement in sales, partially offset by a lower average pricing and a weaker business mix. Increased volumes, in addition to lower manufacturing cost, contributed to higher level of profitability, partially offset by lower pricing.

Excluding the effect of the asset disposition, the segment gross margin for the fourth quarter was 26%.

In the Performance Colors and Glass segment, value-added sales increased by $2 million or approximately 3% to $82 million. Volume increased nearly 14%, though it's offset by a less favorable product mix. Value-added sales increased in all product categories, with the greatest gains coming in the decorating group, which is composed of container glass and dinnerware products. Value-added sales increased in all regions, with the exception of the U.S., where sales were off on lower volume. Gross profit improved by $1 million or 4% to approximately $26 million, with the gross profit margin improving to 31.4% from 31.1%. Gross profit increased primarily due to higher volumes and favorable raw material cost, partially offset by a reduction in plant inventories and higher plant cost.

In Performance Coatings, sales increased by 4% or approximately $5 million on a quarter-over-quarter basis. Sales in Porcelain Enamel accounts for the entire change, with sales improving by 14%, including increases of approximately 25% in the U.S. and 25% in Asia Pacific and a 9% increase in Europe.

Strong sales gains in the Porcelain Enamel product lines were only slightly offset by 1% reduction for tile coating. Demand for tile frits, glazes and inks remained strong, with sales increases in excess of 5%, while product sales for more commodity-oriented colors and related coatings declined. Reduced pricing was a significant drag in tile sales. Average selling prices have declined in relation to lower raw material costs, in addition to lower average selling prices for digital inks associated with increasing competitive pressures. Despite the lower selling prices and increased competitive environment for digital inks, profit margins for the tile product line have improved by over 200 basis points.

In total, Performance Coatings segment sales benefited from increased volumes and improved business mix, partially offset by lower pricing, primarily due to lower raw material cost. Segment gross profit increased by $6 million, with gross profit margin increasing to 22.2% from 18.8% last year. Gross profit and the resulting margin increase were driven primarily by increased volumes and reduced manufacturing costs, including the benefit of restructuring activities.

Sales in Polymer Additives declined by 9%, and sales have been adversely impacted by changes in environmental regulations pertaining to phthalate, which have resulted in product replacement by certain customers in the United States and Europe.

Regionally, sales declined in the United States by approximately $7 million, accounting for nearly the quarter-over-quarter sales decline. The deselection process in the United States accelerated last year as the U.S. flooring industry moved away from the use of phthalate-containing materials. This change over is attributable to California EPA's Proposition 65 and associated legal challenges in California. We believe the deselection of our products by flooring producers has run its course, and the primary impact on our 2014 result is the annualization of sales reductions experienced in 2013, which I'll discuss in my outlook comment.

Gross profit from the Polymer Additives segment increased by $3 million from the fourth quarter of 2012, with gross profit margins improving to 10.3% from 4.4%. The increase in gross profit and the gross profit margin is the result of favorable mix, particularly, the decline of the low-margin phthalate business, manufacturing improvements and manufacturing cost reductions. As previously announced, we are in the process of converting our European phthalate plant to dibenzoates and benzoic acid production capabilities, providing an alternative for the phthalate products offering. Production of dibenzoates in Europe is expected to begin in late 2014.

Sales in the Specialty Plastics increased 3%, reflecting higher global volumes, primarily in the filled and reinforced plastic product line, partially offset by unfavorable pricing mix. The impact of lowering average selling prices adversely affected sales in the quarter, with the lower prices primarily as a result of lower raw material cost.

Regionally, sales increased in the U.S. and Latin America, while sales in Europe declined. Gross profit for the quarter was approximately equal to last year's level at $6 million. Gross profit margin, improved slightly year-over-year to 15.9% from 15.6%. Increased volumes and favorable raw material costs, which declined more than average selling prices, were the primary cause for the improvement in gross profit margin, partially offset by higher manufacturing cost.

Finally, I'd like to provide some color on our outlook for 2014. We expect adjusted earnings for 2014 to be in the range of $0.65 to $0.70 per diluted share. The expected increase in earnings is primarily a result of increased value-added sales, continued cost savings during the year, and normalization of incentive compensation expenses. As we have discussed in the past, we expect value-added sales growth to approximate global GDP plus 1%. We are expecting global real GDP weighted for the markets we serve to be approximately 2.6%. Therefore, we would expect our Performance Materials business, which had 2013 value-added sales of $1.05 billion, as adjusted for dispositions, to grow at a rate of approximately 3.6%.

For the Performance Chemicals group, we believe the effect of deselection of phthalate will continue through the year, resulting in lost sales of approximately $30 million off of the group's 2013 sales base of $463 million. Excluding this loss, however, we expect sales growth of the underlying sales for the group, including the sales of other Polymer Additives product lines to also be in the range of 3.6%.

The actions we are taking to reduce cost will continue. In 2013, cost savings exceeded $47 million, and for 2014, we expect the savings level to exceed $75 million. We should exit 2015 at a savings run rate -- I'm sorry, we should exit 2014 at a savings run rate of $80 million to $85 million.

Gross profit margins are expected to be approximately equal to the levels attained in the fourth quarter of 2013 in the range of 22%, and SG&A should approximate 14% of value-added sales. We are also reaffirming our longer-term 2015 adjusted earnings target of EPS in excess of $1 per diluted share.

Other targets for 2015 include the following: value-added sales growth of GDP plus 1%; gross profit margin of greater than 22.5%; quarterly SG&A declining to less than $50 million by the end of the quarter; I'm sorry -- by the end of the year; EBITDA margin of 12.5%; maintenance CapEx of $25 million; and ROIC of approximately 15%. That includes our prepared remarks.

I'll now turn it over to John for the Q&A session.

John T. Bingle

Thank you, Jeff. Operator, you may now start the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes of the line of John McNulty with Crédit Suisse.

John P. McNulty - Crédit Suisse AG, Research Division

So a question regarding some of the headwinds that you were talking about in terms of like the pricing issues in the Porcelain Enamel business, can you quantify what you think some of the bigger headwinds that you're going to be seeing in 2014 might be?

Peter T. Thomas

John, it's Peter. Let's -- we keep, on an ongoing basis, a collection, not to bore you with analyticals, but the risks and opportunities matrices. And out of the risks, there's a handful of what we might define are headwinds that are coming out of the each of the different regions. So what you may find is raw materials have been dropping, prices have been dropping. But the good news for us, our prices haven't dropped as much as raw materials have, which is a change from prior years. And a lot of that has to do with our reformulation activities that we've been talking to over the past 3 or 4 quarters. You also have things like currency devaluation, right? You're seeing it in Indonesia, which happens to be one of our hottest spots in Asia, even stronger than China, actually. And you have devaluation issues in Turkey, devaluation challenges, potentially, in India, and you've read it, you know the story, so devaluation is also a headwind for us. Pricing pressure is a headwind. And what happens in this environment when particularly raw materials start to stabilize, and until the markets, like in Europe, for example, everyone knows that building construction and automotive should be up ticking. But we're talking about markets that contracted again last year. So just as the markets are starting to move up, you will see competitive pressure with competitors trying to jockey for volume to get ahead of the ramp-up in those market segments. So those would be the major type of headwinds, we would say. You may -- and we were -- you may ask hey look, what about Egypt and the case like that, there's a case where the business is phenomenal, very robust, we're adding capacity and we're looking for ways to increase that. So it's very regionally defined. But the headwinds are mostly on, let's call them, developing economy challenges and pricing pressures. Those are the 2 larger ones.

John P. McNulty - Crédit Suisse AG, Research Division

Okay, great. And then just, I guess, as a followup to that, when I look at your guidance for 2014, and I make the assumptions that you're continuing your cost-cut program, which it looks like is going well, and we give you credit for the management comp maybe being down a little bit in 2014. I'm already getting towards the middle to high end of the range of guidance that you've put out. And that's not making any assumptions for macro improvement or anything like that, so l guess, I'm wondering if the risks that you just highlighted will completely offset any macro headwind -- or macro tailwinds that you're expecting to see this year? Or am I just missing something else in regards to the math?

Peter T. Thomas

No, I think you're right. That's a good comment. What we've been doing over the past 1.5 years is try to be as laser-like as we can on what we see at a point in time. And right now, there is, as I mentioned, in addition to those risks, there are opportunities. So let me give you some equal weight on the opportunities because I gave you some on the risks. So here are the opportunities. One, we do have a robust organic pipeline that's been developing, quite frankly. I mentioned to you in the past, it represents about 30% of our annualized sales on a non-probability adjusted basis. And we see, from that pipeline, anywhere between $25 million and $30 million coming from that. Could there be more, could it -- and the answer is yes. So, there could be an upside on more cascading of those new projects into the business. The second thing is, there are pricing initiatives on certain product lines that we're working on. The third thing is you heard us talk about the new suite of inks we produce that are water-based. Those products have higher margins and they could have a quick runup in the market. So there's an opportunity. We do see and track share gain from competitive substitution. We've -- since we've had a real strong focus on the customer as a result of us, where Jeff and I talked about last year, where the commercial folks are 100% on the customer, focused on the customer, that's it. We have an increasing tendency towards having more opportunities to substitute our competitors out. So those are the major areas where we see opportunities. So when we show those, we run those through models that we have, and we look at them and opportunities and risks, net it out at a probability basis of 60% or 80% NOI, and what we can tell you, is like we've said here, we have bias to the upside moving into the year.

Operator

Our question comes on the line of Kevin Hocevar with Northcoast Research.

Kevin Hocevar - Northcoast Research

I had a question on -- so when you ran through the 2015 guidance GDP plus 1%, gross profit margin, 22.5%, I was wondering, I think that gross profit margin before was 21.5% and I think everything else stayed constant. So does that -- is there anything else offsetting, keeping the guidance at $1 plus EPS or -- just wondering why, I guess, the floor of that didn't move up with the gross profit margin.

Jeffrey L. Rutherford

No, nothing -- Kevin, this is Jeff. Nothing did change other than the gross profit did go up. And our guidance for '15 is greater than $1. So as you can imagine, it went up higher than where it was previously.

Kevin Hocevar - Northcoast Research

Okay. And I wonder if you could -- you talked about saving more than $100 million in 2015. So I'm wondering if you could kind of talk about what hasn't been done yet, what could still be done to potentially drive that number higher.

Jeffrey L. Rutherford

What's in our models is essentially what we've already identified and are acting upon. And that's why the number has changed over time. And as we identify incremental opportunities and we're ready to launch those activities, we add it into our $100 million. So things are happening as we speak. As we've talked about historically, these things have been sequential. There are incremental activities occurring. And when those additional activities are solidified and we're acting on it, we'll add it on to the $100 million. So the answer to the question is, that's what we're acting on today and that number will go up. And when we're ready to tell about you it, we'll announce it on the quarter that we've increased our target.

Kevin Hocevar - Northcoast Research

Okay. And just one final question. I believe, and I think you mentioned earlier on the call, one of the initiatives then to review your product lines and consider either pruning or divesting or what have you, so you have alternatives for businesses that aren't generating profitability where you think is appropriate. So wondering, has there been some pruning of businesses outside of the divested businesses that you've announced, what type of impact that had in 2013? And is that pruning of business baked into your 2014 sales guidance of GDP plus 1%?

Jeffrey L. Rutherford

Are you talking about -- Kevin, if you're talking about site-specific analysis, we do multiple analysis. And Peter can talk about customer analysis and SKU analysis. Let's talk about site analysis first. As we've told people previously, we maintain a model by location. And in fact, I just pulled it up when you asked this question. So we have model by location running out for 5 years and a projection on return on invested capital by location for those 5 years. And I can look at it and I could tell you -- and we don't give that level of granular guidance, but I could tell you I know and management knows and Peter knows and the board knows which locations aren't performing adequately to our expectations as return on invested capital is the metric we are measuring these locations on. I could tell you that there are locations around the world that are not meeting our requirements relative to performance. Those sites are being evaluated by the commercial teams and our operating teams to determine if they can be brought to the proper level of value creation or do we have to do something else with them. And it's gone both ways. We have a site, and I won't tell you where the site is, but Peter is laughing. There is a site I had targeted that we should do something with, if not close. And to the credit of the commercial and operational group, they found a way to improve the operating results of that location to bring it to where its return on invested capital for 2013 was 32%. So that's what we want people to do. We want -- we're giving the commercial and the operational teams a chance. They know what sites have to be improved. So it's not built -- I mean, the plan they have is built into '14. If those sites don't perform -- and we had another one that we closed and we took the impairment charge on the building. We had a joint venture in China that didn't pan out that was supposed to use that building that was built for solar production. We closed the joint venture and we impaired the asset. So there are other sites that are on the list. We're not prepared to tell you what they are. And then I won't say that closing of any of those sites is not built into the guidance that we just provided.

And Peter, as far as customer and product rationalization?

Peter T. Thomas

Yes. That's another important piece. We have a fairly robust customer and product rationalization program. Just like Jeff mentioned that we measure ROIC by site, what we have is a fairly detailed gross margin analysis cut very many, many ways, whether it's by product, whether it's by tonnage, whether it's by customer, whether it's by region or the like. And we look at the total gross margin coming from those facilities and we put plans against the bad margin businesses. And quite frankly, that initiative last year was pretty productive. It represented a nice portion of our gross profit over our budget, if you will. I won't be specific, but it was a very, very nice number. And we did walk -- as you heard us say in the first and second quarters last year of customers who walked away from us. But they came back. And when they came back, they paid the price that we wanted them to pay, so it gave everyone a chance to resharpen the business rules up for each customer by product, by location and gave everyone a chance to have a fresh set of eyes on what the financial returns should be, not only on the site, but on the product family. So it's a very comprehensive program that we've laid out both at the hard asset site and at the customer interface. And we've been more successful than not. And again I will mention this, one of the most important things that I like to talk to is that we have not had customer interference or disappointment as part of this restructuring process, which has been pretty impactful for the company in all the changes we've made and all the cost reductions. And you can see on the financial metrics that we're executing on those key components.

Operator

Our next question comes from the line of David Begleiter with Deutsche Bank.

David L. Begleiter - Deutsche Bank AG, Research Division

Peter, Jeff, I may be a little off here, but it looks like for 2014, x cost saves and lower incentive comp, you're not projecting much of any growth in the base business. But for '15 to reach your $1 plus target, you are projecting pretty significant growth in the base business. So between '14 and '15, what changes in the base business and in your confidence in that base business picking up?

Peter T. Thomas

We probably have 2 answers. So let me take one perspective and Jeff will do the other. We have a defined strategy in Ferro. And because we have that defined strategy within Ferro, the value creation strategy and all the nuances around the target focus where we're moving, our invested capital clearly is in Performance Materials, $600 million. We have a good return on that, mid-teens return on that business. The gross margins are in excess of 25%. And we've mentioned that we have a very nice organic pipeline and an inorganic pipeline around where we have all of our invested capital. And because of that focus, the whole organization is clear on where we're moving the company and which projects we're selecting and how we're moving geographically throughout the world with our expansion. All that coming together with new product development and converging, that's what you're going to see in '14 and '15 as it relates to the sales growth. Now some of it is in our models and some of it isn't. We've been focused on cost-outs in 2013 and '14. '14 -- at the end of '13 and moving into '14, we have a push now on organic growth execution, and there's upside to that. And then we also discussed in our script here that we're looking at inorganic opportunities that will complement our technical capabilities, give us reach into emerging markets and will deliver the returns that we've profiled on our acquisition criteria. So having said all that, there is organic and inorganic growth opportunity that we have not built into this model. The reason why is that we've been very careful over the past 1.5 year, targeting on cost-outs, defining what they are, scrubbing them and getting everyone to sign up on them. And because we've used that methodology, we doing the same now that we're start shifting into the growth side, where they're defined, they're vetted, they're presented. And as we accept them and as we fund them and agree to them, then we'll bring that to everyone's attention. But there is upside potential there.

Jeffrey L. Rutherford

Yes. And Dave, let me help from a modeling perspective. So if you take the '13 adjusted results, and then pro forma out metal powders, which sales were approximately $25 million, and then take out the reduction that we talked about in benzyl phthalate, which will be approximately $30 million, and make that your starting point for sales, and then follow our guidance relative to GDP plus 1%, and that should be your basis for '14 sales. And then we talked about where gross profit was going to on an adjusted basis, taking out metal powders, which is low margin, you're going to get to just under 22% as your base. And we talked about through '15, that's going to increase to greater than 22.5%. And then incentive comp, let me just give you some color on incentive comp. We ended '13, it was approximately $19.4 million for the bonus piece of incentive comp. And you should cut that in half to get back to this plan for '14. We were double bonus in '13. And then from a cost -- obviously, in cost of goods sold, those numbers, those percentages include continued cost reductions. But there's going to be continued SG&A reductions. We're moving toward, as I said, by the end of '15, the fourth quarter of '15, to be at of a 55 -- or less than a $50 million run rate. Our run rate in the fourth quarter adjusted was $55 million, so you could see what we need to do over the next 2 years as we need to reduce another annualized $20 million in SG&A. Let me get you to the -- walk you through how you get to that $55 million run rate. If you look at the Table 5 in our release, you could see that our adjusted SG&A for the fourth quarter was $60.5 million. Here's what's in there that we adjust out to get to the run rate. As I said earlier, the bonus. So that was running at just a little under $2.5 million excess a quarter. There's other performance compensation, stock-based performance compensation that was an adjustment in the fourth quarter of '13 that picked up another $1.5 million above normalized stock compensation. And then we had $2.4 million of bad debt in the fourth quarter of '13. Normal bad debt for us is somewhere around $750,000 to $1 million a quarter. We run -- bad debt runs somewhere around $3 million to $4 million a year for us. We had some bankruptcies in Europe related to the tile business and some negotiations relative to some of the restructurings. But there was some excess bad debt in the fourth quarter. If you adjust for that, and you're going to get to a $55 million run rate. So to get to that -- from that $55 million run rate in the fourth quarter of '13 to a less than $50 million run rate by the end of fourth quarter of '15, it's going to be a little choppy. It's not going to be linear. But we have actions, as we've talked, we have actions to get it there and beyond as far as cost reductions.

David L. Begleiter - Deutsche Bank AG, Research Division

That's very helpful. Maybe just one more thing on modeling. On '14, what are the 2 biggest earnings headwinds in '14 you're facing? If you could just quantify maybe just FX and price, if that's possible.

Peter T. Thomas

Yes. Like we mentioned on the other question, the 2 major headwinds would be pricing pressure and what we might define as being disruptions or challenges in the developing economies, like around the currency challenges in Indonesia, India, Turkey and the likes, as we do business in those areas and there are some challenges there. But we haven't seen anything significant yet. Like I said, what we do is we develop matrices around risks and opportunities, but those were the 2 headliners from all the regions. If you poll everybody from each region, they'll say pricing pressures and this challenging developing economies, kind of potential headwind. But again, we did outline that there are a lot of other opportunities and that the opportunities leading in for the first 2 or 3 months are more positive than not.

Jeffrey L. Rutherford

And I think that one of the headwinds you can get into when you go through a restructuring, a cost reduction, like we're in is complacency. And that's not going to happen. The biggest risk when you have -- we had a tough -- obviously everybody knows, we had a tough 2012. Not much could've gone on beyond what we experienced in 2012, then we have a good 2013. And so what we can't let happen -- and this is on Peter and on me, what we can let happen is people to become complacent because we had a good year and we've got bonuses because that's not the way it's going to be. We have got about 15 minutes to enjoy 2013. And my staff knows this because I told them that this morning, "You have 15 minutes to enjoy '13 and let's get going on '14 because we all have goals and we're going to exceed those goals." And so -- and there's still tough decisions to be made. In fact, the decisions to be made now, maybe tougher than last year's decisions because now we're getting very, very granular. We're getting -- it's not the big bulk of cost we're taking out. It's very, very -- it's not a shotgun, it's a rifle now and we need to stay very focused. So that's been the message to all of our people, too, that do not become complacent because we still have a lot of work to do.

Operator

Our next question comes from the line of Rosemarie Morbelli with Gabelli & Company.

Rosemarie J. Morbelli - G. Research, Inc.

If I read between the lines, Peter, it sounds to me as though you are getting ready to make some divestitures and acquisitions. I was wondering if you could give us a feel, help us with the timing of what you are planning and doing? Is it something that could occur in the first half of 2014, by year end? Can you share some of your thoughts on that?

Jeffrey L. Rutherford

No, we really can't do that. I'm going to hold Peter back on that. When we're prepared, when something is prepared to be announced, it will be announced. What you can take away though is that there are things that are available to us now that for the company wouldn't have been available before. Not because of size, but specifically, we now have a leverageable model. And so what we can look at is bringing in assets and leveraging those assets into the model and taking something that normally when we look at it, it may have an okay return that we can make it a very good return. So those are the things we're looking at. And a lot of that has to do with negotiations. So we don't want to get ahead of ourselves in negotiations both in assets that we want and assets that maybe we don't want. So we're not going to get ahead of ourselves. But we are active and we are going to be strategic about what assets fit and what assets don't fit.

Peter T. Thomas

We have a carefully laid out plan that we're executing against, Rosemarie.

Rosemarie J. Morbelli - G. Research, Inc.

Okay. No, that is helpful. And I was wondering, you talk about the competitive environment in digital inks. And that used to be one of your big developments, so to speak. So has the market changed? Is your success in that category opened the door to a lot of competitors? Is there something else behind the new competitive environment?

Peter T. Thomas

No. Good question, too. On the contrary, that business is still growing at 20% to 25% a year. That business has been around now for -- believe it or not, if you remember, we used to talk about this at Analyst Day, Rosemarie. It's been around for 4 years already. In that 4 years, it has drawn a lot of attention from competitors, all the major tile competitors are participating. It's been globalized throughout the world. And as you know, we have -- we're the only producer of inks that have globalized the manufacturing footprint. We're in 4 or 5 regions around the world. It's in China. Once it went to China, then everybody's into it, whatever. Now the difference between us, since we were the pioneers, we're on our fourth generation, and this is what we're talking to. So there are 4 different generations that make up the market. And the newest generations typically have the highest gross profit. We're the incumbent. We substitute ourselves or other people out. And we're keeping a bigger part of another expanding market in a way that we stay ahead of the curve, maintain our leadership position and typically have the highest margins in the space. So we're very good on product development. One of the good points, very exciting points about us with the new 4.0 Ferro Inks that we introduced at the show a couple of weeks ago in Valencia is that the customers are really embracing this technology change because the robustness and intensity of the colors. And it's water-based and it's friendly to the environment. And that expansion on that shift will probably be pretty quick. And what's good about that is we're doing it, we're selling it, we're already in the space, we already have the footprint. And strangely enough, and I quite frankly haven't - I don't recall ever seeing this in my career. But by shifting to a new product, by default, the capacity that we have can be expanded without investment because the water-based products are larger molecules and, by default, from going to small but large molecules, without getting into the detail, we actually have built-in capacity as we expand the market. We're not going to have to add a lot in the short to near term.

Rosemarie J. Morbelli - G. Research, Inc.

And what is the revenue size? What is the size of this particular business?

Peter T. Thomas

Yes. To put it in perspective because you we are aware of it, about 3 or 4 years ago, I remember making presentations that said that by the end of 2013, it would probably be $150 million. It's close to about $300 million to $325 million today. It's growing at 20% to 25%. And we are maintaining our market share between 30% and 35%. But we have the highest margins in the space and we have the newest products and the more specialized products. And don't forget, we have a few derivatives, remember, like our digital glazes, which are another form of a digital -- digitally applied topcoat that adds strength or other aesthetics to the tile. So not only are there inks, there are glazes, there are topcoats. The product line is proliferated into 3 or 4 entries and each 1 of those has a new generation. So we're the competitor to target because of all the technology we have and we have the depth and breadth of product lines.

Rosemarie J. Morbelli - G. Research, Inc.

So if your technology is so much better than the competition, and then you have this environmentally friendly ink, why would price go down? Shouldn't most customers want it without you having to lower the cost or at least not lower your margin?

Peter T. Thomas

Yes. So we have 3 different versions plus the new one, right? So every customer around the world is in a different stage of accepting digital inks. There are some customers that are in first generation, some are in second, some are in third, some are in fourth. The fourth has just started. And typically, the market movers in the space will move to that first, which we will enjoy for a long period of time, like we have in the past. We will get the sales, we will get the margins. And over time, the competitors will go from 1 to 2. The competitors that are in second generation move to third, and the ones in the third will go into the fourth. It's just the way of the world in the tile space. You have to keep reinventing yourself, which we do to stay ahead of the curve. And you could see our margins in the tile business because of what I just discussed. You could see we're holding them and maintaining. We've gone from 18% to 22% in just a very short period of time for the global business for tiles. You're right, nobody is messing with the price on the fourth generation yet. But give it time, within a year, 2 years, it will start there, too. But by then, we would have gone to the fifth generation.

Rosemarie J. Morbelli - G. Research, Inc.

Okay. That is very helpful. And if I may ask one last question. You talked about Egypt operating at full capacity, so you acquired 2 smelters there. You added another 4, if my memory serves me right, so you have 6 or maybe 8.

Peter T. Thomas

8.

Rosemarie J. Morbelli - G. Research, Inc.

Right. And it looks as though you could use some additional low-cost capacity. So is it a question of adding more smelters in Egypt? Or would you -- or do think it makes more sense to build a new facility somewhere else that could also be advantageous?

Peter T. Thomas

Yes. Our strategy with the asset footprint, which gets into the question that you typically ask, and you haven't yet, around our footprint, when does it change? One of the things that's very important for our business, which we are clearly a developing nation, emerging market play with our frit business is to make sure that we are positioned with the lowest-cost production available throughout the world. So right now, like Egypt is there. It is the lowest cost, Indonesia as well, Turkey as well. We're already in Indonesia. But because Egypt is the lowest and because we've done a superb job there and we brought international quality to the marketplace, if we -- I'll just be very candid with you and Jeff can chime in on this, too. If we would have tripled our capacity when we did, we would be sold out today. So that gives you an idea of the demand because in Turkey, you can reach -- I'm sorry, in Egypt, you can reach Turkey, you can reach the Middle East. You can even go to Poland, you can go to Russia with good economics and because we have the quality in Egypt with the, what we call, our international Spanish quality in Egypt. What the Egyptians are doing now, a lot of the top producers, 60% of the products that they're making now are exported out of Egypt because we've brought new quality or high levels of quality in a way that they can expand their export business. So that position was very strategic 3 or 4 years ago and it will continue to be strategic, and we will do something there.

Operator

Our final question comes of the line of Eugene Fedotoff with Longbow Research.

Eugene Fedotoff - Longbow Research LLC

First of all, I just wanted to make sure that you're not seeing any weather impact on first quarter results.

Jeffrey L. Rutherford

Yes. We're asked this question occasionally. Our energy cost in the U.S. in particular, I think you're probably asking, is less than 3% of cost of goods sold. And there has been impact. We're not going to say there hasn't, but it's only been a couple hundred thousand dollar impact relative to energy cost in the U.S. for the first couple of months.

Eugene Fedotoff - Longbow Research LLC

Okay. And then just a follow-up on cost, you're expecting a run rate of $80 million to $85 million at the end of the year. And you said it's going to be choppy. Can you provide a little bit more guidance on that? Are you expecting the cost savings to be back-end loaded or any guidance on that?

Jeffrey L. Rutherford

Yes. From a quarterly guidance perspective, I'd back end them.

Eugene Fedotoff - Longbow Research LLC

Okay. And then the last question, I guess, to follow up on Performance Coatings business. Your porcelain enamel growth was pretty strong in U.S. and in Asia. I wanted to understand a little bit better, what's driving that business? I think you mentioned that you expected some slow growth at customer level and some customers actually said that they're expecting a softer first quarter. So both trying to understand what drove the business in fourth quarter and your outlook for first quarter.

Peter T. Thomas

Yes, this is Peter. What we've seen -- let me give you the lay of the land regionally because I think that's -- since our business is, that business is global. We had 2 hotspots for porcelain enamel. Porcelain Enamel was strong throughout the year in Asia because of market expansion. When you look at our porcelain enamel business, you have appliances, hot water tanks and what we call cookware and then the third is architectural, which would be things that are metal substrates that we coat that would have an architectural appeal or design. So in the Asian market, we were mostly focused on hot water tanks. But we've been able to branch out in Asia into not only hot water tanks but other application areas. So that market expansion was important. And that was the case also in North America. It's about taking -- as we refocus the business -- and actually, I'm glad you're asking this question, so we can talk to this substrate thing because you've heard us talk to it in the script and you're going to hear more of it. One of our competitive advantages is that not only do we make glass coatings, but we understand the dynamic of making glass coatings that are applied to substrates. And our most important substrates are metal, ceramic and also glass, glass on glass. So as we stay more focused on the customer and in that space, the functional coatings and color solutions, it's allowing everyone in the R&D groups to look for new, novel ways to take our glass or porcelain enamel or tile products. And what's happening is that we're expanding the market with porcelain enamel. And that's what you're seeing in Asia and North America. It's just like our glass business. I mean, you've heard us talk to making ultra micro-pure, if you will, particles for dental fillers. I mean, we're looking -- our products are in some toothpastes. We have nuclear encapsulated glass coatings. We have -- there are people that are looking at replacing hips with glass. So there are a lot of interesting things going on in our technology and with the substrates that we could use to decorate those 2 product lines. And you're starting to see that traction take place.

Operator

Mr. Bingle, as there are no further questions at this time, I'll now turn the call back to you.

Peter T. Thomas

Yes. Before we end the call, I just want to -- I want to make a few points. I mean, I'd like to close by saying that we are on track and our momentum is strong with the business. We're focused on delivering shareholder value. And our programs are certainly gaining traction, as if you heard us in Q&A and through our script. We did end the year at a return on invested capital of 8.9%, a substantial improvement over 2012. And as the questions are out, we do anticipate that sometime during 2014, we will cross the 10% return on invested capital threshold, a level that we haven't seen for a very, very long time here at Ferro. So we want to thank you for your time today and have a good day.

John T. Bingle

Thank you, operator.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.

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