Ferro Corporation's (FOE) CEO Peter Thomas on Q1 2016 Results - Earnings Call Transcript

| About: Ferro Corporation (FOE)

Start Time: 10:00

End Time: 11:05

Ferro Corporation (NYSE:FOE)

Q1 2016 Earnings Conference Call

April 27, 2016, 10:00 AM ET

Executives

Peter T. Thomas - Chairman, President and CEO

Jeffrey L. Rutherford - VP and CFO

John Bingle - Treasurer and Director of IR

Analysts

David Begleiter - Deutsche Bank

Dmitry Silversteyn - Longbow Research

Mike Sison - KeyBanc Capital Markets

Rosemarie Morbelli - Gabelli and Company

Mike Harrison - Seaport Global

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Ferro Corporation 2016 First Quarter Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions]. As a reminder, this conference is being recorded on today’s date, Wednesday, April 27, 2016.

It is now my pleasure to turn the conference over to John Bingle, Treasurer and Director of Investor Relations. Please go ahead, sir.

John Bingle

Thank you. Good morning and welcome to the Ferro Corporation 2016 first quarter earnings conference call. Joining me on today’s call are Peter Thomas, Chairman, President and Chief Executive Officer; and Jeff Rutherford, Vice President and Chief Financial Officer.

Our quarterly earnings press release was issued last night. You can find the release, including reconciliations of reported results to non-GAAP data that we’ll discuss this morning, as well as supplemental slides for the call in the Investor Information portion of Ferro’s Web site, www.ferro.com.

Several of the charts contained in the supplemental slides posted on the Web site will be referenced in our comments today. 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, 2015.

Forward-looking statements reflect management’s expectations as of today. 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 law.

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 Investor Information section at ferro.com. Any redistribution, retransmission, or rebroadcast of this call in any form without the expressed written consent of Ferro is prohibited.

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

Peter T. Thomas

Thanks, John. Good morning everyone and thank you for joining us today. As you saw in our earnings press release, we delivered another solid quarter. We generated strong increases in key financial metrics and we’ve continued to transform our company to our value creation strategy. Our performance reflects the benefits of our disciplined approach to executing on our priorities and positions us well for the remainder of 2016 and beyond.

In the first quarter, we delivered a 13.4% increase in net sales on a constant currency basis. We delivered a 30.4% adjusted gross profit margin compared with 27.9% last year. We delivered an increase in the adjusted operating profit margin of 190 basis points to 11.9%. We delivered $44 million of adjusted EBITDA, a 28% increase versus last year. We delivered a 15.7% adjusted EBITDA margin and lastly, we delivered an 11.2% adjusted ROIC excluding acquisition owned less than one year.

Now with regard to the acquisitions we’ve made, I am pleased to say that they are contributing in a way we knew they could. In particular, our two largest acquisitions; Nubiola and Vetriceramici are performing at or ahead of our 2016 expectations. Our integration teams are focused on ensuring we realize the expected synergies from our transactions and refining our integration processes to support recent and future acquisitions.

Looking ahead, our M&A target is to invest on average $100 million per year in acquisitions that profitability extend our business. We are being strategic about what we add. Acquisitions don’t have to be large but they must be our criteria for high margin businesses that strengthen our product and technology portfolios, improve our market position, expand our global reach and generate shareholder value.

Before I turn to our segments, I’d like to provide some additional key takeaways from the quarter. First, the business segments met or exceeded our internal expectations in nearly all product lines and shipped from regions with the exception of high-end glass coatings within our Performance Colors and Glass segment. Demand for high-end glass coatings was lower across our electronics, decoration and industrial product lines.

We should note that this is not a result of Ferro losing market share to competitors but a result of certain product campaigns at the customer level having ended or moved out of the ramp up phase. We expect sales to normalize over the balance of the year but we do not expect the lower sales achieved in Q1 will be made up over the course of the year.

Second, as we anticipated, tile was rebounding from weakness experienced during 2015 with increased demand from Southern Europe, the Middle East and North Africa. Third, foreign currency continued to have an unfavorable impact in the quarter reducing net sales and operating income by approximately $18 million and $2 million, respectively.

Next, raw material costs have remained stable to slightly favorable and this coupled with lean initiatives and improved manufacturing efficiencies have positively impacted gross profit margins. Next, we continue to control cost with the goal of limiting SG&A increases. While we continue to invest in strategic programs where we can generate returns, our goal is to limit functional cost increases.

For the quarter on a constant currency basis, SG&A expenses increased by $6 million to 51 million. This increase was driven primarily by our recent acquisitions and a reduction in pension income. Our functional SG&A expenses, excluding the pension income change and functional costs with acquisition, declined slightly.

Next, two new frit production lines at Al Salomi in Egypt were brought up to operational levels during the quarter, which will increase our capacity to meet increased demand in Egypt and Turkey. And finally, beginning in the first quarter, we have migrated the value metric for our operating units from ROIC to economic value-added. Essentially, we are now charging a pre-tax cost of capital to each entity based upon the working capital and property.

We believe that this change will help local and regional management teams focus on the proper levers to increase value. It also provides a clear metric for us to speak to regional and plant level value creation. For example, our plant in Indonesia had a 2015 EVA margin of 5.5% and a first quarter 2016 EVA margin of 12.5%, clearly demonstrating the improvement in the Indonesian market.

And for Nubiola, the first quarter of 2016 EVA margin was also 12.5%, which is very good for an acquisition owned for less than 12 months. It should be noted that we have a partnership with EVA Dimensions and the expert on EVA, Bennett Stewart, who advises the Board and management.

Well, it’s only been two months since our last earnings conference call and while we had a good start to the year, we have not made significant changes to our full year expectations. Although we continue to face some economic headwinds and believe foreign currency will continue to be volatile, we are excited about our prospects that we will remain confident in our ability to deliver on the year.

On a consolidated basis, we continue to show higher sales and improved profitability. In the quarter, sales on a constant currency basis increased 13.4% to $277 million while the adjusted gross profit and operating profit margins improved to 30.4% and 11.9%, respectively.

Constant currency sales growth during the quarter was a bit higher than our expected annual growth of 10.5% to 11.5% for the full year. Due to the strong quarter, we now expect our full year consolidated gross margin will be a range of 29.5% to 30%, a 50 basis point improvement over prior guidance.

Turning to our segments, if you turn to Page 9 of the investor deck, you’ll see our results for Performance Colors and Glass. Even though sales declined by 8.8% on a constant currency basis, due to the timing of the end market product campaigns I alluded to previously, the gross profit margin continued to improve reaching a level of 36.1%.

For the remainder of three quarters of the year, we expect the segment to meet our prior net sales guidance of low single digit sales growth on a constant currency basis in line with global GDP expectations. For the full year, we expect constant currency sales for this segment to be relatively flat and that the segment’s annual gross profit margin will improve by 50 to 100 basis points compared to the level achieved for the full year in 2015.

On Page 10 of the investor presentation, we cover our Pigments, Powders and Oxides business. For the quarter, constant currency sales more than doubled to $61 million with Nubiola adding 33 million in the period. Excluding acquisitions on a constant currency basis, the PPO segment increased by 5% in line with prior guidance.

For the quarter, the adjusted gross profit percent improved to 33.2% compared with 29.7% last year. We expect the PPO segment full year gross margin will improve by 50 to 100 basis points compared with last year’s adjusted rate, which is in line with the guidance we provided on the last earnings call.

For the Performance Coatings segment as you can see on Page 11, constant currency sales for the quarter increased by 5% with Al Salomi adding nearly $6 million. Excluding acquisitions, constant currency sales increased by 1%. In tile coatings, constant currency sales, excluding Al Salomi, increased by 2.8%. For tile, this represents a nice rebound from what we experienced during 2015.

The segment adjusted gross profit margin also improved quarter-over-quarter increasing to 25.1%. For the remainder of the year, we expect constant currency sales growth, excluding Al Salomi, of low to mid-single digits with an improvement in gross margin of 25 to 50 basis points compared with the segment’s 2015 annual reported gross margin.

So to sum up, we are off to a very good start to 2016. Our global team produced strong results. We delivered increases in our key financial metrics. We are successfully integrating our recent acquisitions and benefitting from their contribution earnings. And we are growing while keeping a disciplined focus on expenses.

Based on the strong start, we are increasing our full year 2016 guidance by $0.03 as Jeff will describe. We are confident that we are well positioned to continue to successfully executing our strategy and driving increased value for our shareholders.

With that, I’ll turn the call over to Jeff.

Jeffrey L. Rutherford

Thank you, Peter, and good morning, everyone. Last quarter we implemented a different format for our quarterly conference call to reserve more time for your questions. We will continue with this format, so my comments this morning will be brief. I will discuss a few noteworthy items and then provide an overview of our increased 2016 guidance.

First the major adjustments in the quarter, which we reported as one-time items and have been excluded from adjusted earnings, including the following. During the quarter, we recorded $900,000 of restructuring charges associated with our Nubiola integration and 1.4 million in SG&A primarily associated with third-party M&A and acquisition integration costs.

In other income and expense, we recorded a $3.8 million gain related to the receipt of cash from the 2010 sale of excess property in Australia. It is our practice to exclude from adjusted earnings any gain or loss from the sale of excess real estate. Excluding this gain, other income and expense was an expense of approximately $1.8 million, which was primarily associated with foreign currency charges, the majority of which was associated with the devaluation of the Egyptian pound.

Finally, I’d like to comment briefly on our adjusted effective tax rate. Last year’s rate of 15.2% benefitted from the recognition of certain assets, which positively impacted the quarter’s rate and which will not repeat during 2016. This year, the first quarter rate was 29.1% above our full year guidance of 27% to 28%.

There are two primary factors accounting for the difference between the first quarter rate and our expectations for the full year. First, we recently concluded a tax planning project to consolidate our operations in Italy, which will allow us to more effectively utilize certain in-country tax assets.

This project will have a positive tax rate impact for the second quarter and remainder of the year. Second, for the quarter, we generated a greater percentage of our taxable income in higher tax jurisdictions than planned increasing the effective rate for the current quarter.

Now, I will turn to our 2016 guidance. For 2016, we expect constant currency net sales growth of 10.5% to 11.5% with recent acquisitions accounting for approximately $90 million of the growth and the base business providing low single digit constant currency sales growth. Net sales for 2016 are expected to be in the range of $1.14 billion to $1.155 billion.

If you refer to Page 5 in the investor deck, you will see the components of our sales growth. 2015 constant currency sales are shown at $1.033 billion composed of the base business at $974 million and $59 million associated with acquisitions owned less than 12 months. The base business of $974 million is expected to increase by 1.75% to 2.5% while the acquisitions will increase by $90 million to $95 million.

As stated in our press release, we are expecting the remainder of the income statement items for the full year to approximate the following. Gross profit margins of 29.5% to 30%, SG&A of approximately 17% to 17.5%, interest expense of $18.5 million to $19.5 million, other income and expense of approximately $5 million and an adjusted effective tax rate of 27% to 28%.

Based on the above and incorporating current 2016 currency exchange rates, we expect adjusted EPS will be in the range of $0.93 to $0.98 per share compared to prior guidance of $0.90 $0.95 per share. At this level, adjusted EBITDA is expected to be in a range of $180 million to $185 million.

We continue to expect that the business will generate free cash flow from continuing operations of between $80 million and $90 million. Free cash flow from continuing operations is equivalent to adjusted EBITDA less cash expenses associated with operating the business. Note we have included a table in the earnings release providing the detail of this cash flow metric for the quarter.

For modeling purposes we have also assumed the following. Depreciation and amortization will be approximately $45 million. Capital spending for the year will be approximately $35 million. Working capital will be a use of approximately $10 million. Cash taxes will be approximately $20 million. Cash interest will be approximately $19 million. And other cash uses, including pension contributions, will be $10 million to $15 million.

I’d like to conclude my remarks this morning with an update on our discontinued operations. As you know, we are in an active process to sell our dibenzoates manufacturing plant in Antwerp, Belgium. As such, the facility has been classified as an asset held for sale and is reported as a discontinued operation. For the quarter, the Antwerp facility generated an operating loss of $5 million.

The plant is now operational and we have begun converting customers to dibenzoates and recognizing commercial sales, and we are ramping up to commercial volumes. However, the time to complete the project has taken longer than anticipated again extending the forecasted cash flow through the project.

Consequently, we have recorded an additional asset impairment of $24 million reducing the net caring value of the Antwerp assets to approximately $12 million. The total loss for discontinued operations in the quarter was $29 million or $0.35 per diluted share.

As we actively marketing this property, we will not discuss the specifics of a potential transaction or speculate on potential proceeds or timing. Needless to say we are focused on moving forward to reach a conclusion on this matter.

With that, I’d like to turn the call back to Peter for an additional comment.

Peter T. Thomas

Thanks, Jeff. Before beginning Q&A, I would like to pause briefly to note one more item. As some of you are no doubt aware, FrontFour Capital Group publicly issued letters to Ferro’s Board of Directors on March 14 and April 21. We are in receipt of those letters and are aware of the contemporaneous rumors that are in the marketplace.

We have engaged in dialogue with FrontFour and our policy is to refrain from commenting on market rumors. Our focus for this call is our first quarter performance and our outlook for the remainder of the year. Thank you in advance for cooperating in this regard.

This concludes our prepared remarks. I’ll now turn it over to John for the question-and-answer session.

John Bingle

Thank you, Peter. Operator, we’re now ready to begin the question-and-answer session. Please repeat the instructions to assist our guests and then we’ll take the first question.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from the line of David Begleiter with Deutsche Bank. Please proceed.

David Begleiter

Thank you. Good morning. Pete, you mentioned tile demand picking up in certain regions. I’m not sure if you mentioned Asia. How is tile demand in that region progressing?

Peter T. Thomas

Dave, when we look at Asia we think of it in two parts, China and then the [indiscernible] areas. And as you know, frit and glazes, we don’t really participate in the Chinese market with those products but we do with our AcE business. So with our AcE business, I’m pleased to note that the price erosion was pretty much stabilized and with our new Vetri model, we are targeting the higher end customers whom appreciate our bundled products that we bring to them and they’re willing to pay a bit higher price for our in-products. So in China, no frits and glaze. The ink business is actually growing in volume at stabilized or even preferred pricing. When you talk about the [indiscernible] area, as you know we had a bit of a meltdown starting in the second and moving into the third quarter of last year in both Indonesia and Thailand. And the good news is, is both those areas actually either have done quite well in the first quarter. In fact, if you look at our Indonesian business, our volume which we use as a measurement for that type of business was actually flat to the first quarter of last year, which suggests or shows that the rebound is starting to occur. And if you remember, David, you asked a question on the last conference call, we did highlight that we did see demand picking up that the government intervened and announced that they would produce 100 million units, which is a nice driver for frit and glaze demand. Typically with those government projects, they use the top 5 or 10 top producers in the region, which we are the preferred supplier to each of those companies. So the good news is Indonesia is running back the top producers that we deal with, they are running now at about 80% capacity. They’re filling off their inventory levels and we see a nice start of the government project. The same holds true with Thailand. And as it relates to Thailand, we were actually up a little bit in volume. Again, the same conditions where the government has intervened, projects are moving, we’re exporting more to Vietnam, Sri Lanka, Burma and Bangladesh. There seems to be a lot of demand from those areas that I highlighted during the last quarter. So as it relates to Asia, quite candidly that area has performed better than we thought it would in the first quarter and the outlook quite candidly is pretty good in the second quarter based on our demand profile and we feel pretty optimistic that that trend will continue on an upward tick through the balance of the year.

David Begleiter

Very good. And just Pete or Jeff, how is the M&A pipeline looking for the remainder of the year?

Peter T. Thomas

Yes, the M&A pipeline, David, is very robust. In fact, as we mentioned during the last call, we have different phases on how we look at projects. Right now, we are engaged in different stages of a process with about 15 different people. As it relates to something that’s more near term, we have three or four opportunities that are moving quite well. And as we also mentioned during our last quarter, our target list has improved from 100 targets to 131. So the pipeline is robust. As we’re peeling back the onion with some of our acquisitions and bringing their acquisitions into our templates and in our pipeline, we have nice expansion of targets. We feel very, very good about that $100 million a year invested in acquisitions.

David Begleiter

Thank you very much.

Operator

Our next question comes from the line of Dmitry Silversteyn with Longbow Research. Please proceed.

Dmitry Silversteyn

Good morning, guys, and a couple of questions if I may. First of all in your PCG business division, you talked about the ramp up of customers on new programs waiting and that was the reason that you saw your revenues being down. Was that a channel fill type of a situation where you’re now comping against just basically building inventories for your customers? And should this lap in the next quarter or two so it can get back to some sort of a growth metric?

Peter T. Thomas

Yes, good question. So let me provide you with more detail. There were three situations that occurred during the first quarter of last year that were a bit different from this quarter. The first is the one you just mentioned which was a proprietary LTCC application, which was a military application that basically started in the first quarter last year. So there was significant demand. And there was inventory builds and the product was just rolling out. In fact, as you know with military applications, they may not be as accommodating providing you with demand for a path [ph]. So we had to use our own judgment. So the answer is with that particular program, our expectation is that will normalize through the course of the year. That’s a very good product and has a nice high margin profile. The second would be very similar with this business. Sometimes you have promotional activity. So last year during the first quarter, one of these major soda manufacturers that I can’t name at this point did a major program with tumblers and [indiscernible] to a bunch of tumblers around the world. And that program was very strong in the first two quarters of last year and now that promotional item is winding down. The third piece is what we would call our industrial application. Now what’s interesting is in the Middle East and countries with the slowdown in oil and pricing, the Middle Eastern countries use what we call a four heart [ph] color window in their commercial ability, which is a baked in type of a color versus a baked on. And for those areas it’s very important because it regulates the sun. It does a nice [indiscernible] job on the rays but it also provides a certain coloring entity. But that’s also two or three times the cost of a base on coating. So with that coating dynamic at the high end has throttle back a bit and we do have an expectation that moving forward, it will rebound over time.

Dmitry Silversteyn

Okay, all right. That’s helpful. Secondly, the Performance Coatings, your largest division, you talked about southern Europe and some of the Middle East and North Africa markets doing better for you in the first quarter. At the end of last year there was a lot of optimism particularly on the construction industry in Europe. When we’re starting to pick up a little bit of I guess moral cautious attitude on the balance of the year, construction so far seems to be excluded from that cautious attitude. How do you see sort of the sustainability of your growth in that region for the Performance Coatings business? Is there one or two things that you’re monitoring just sort of lets you know how the markets are doing or are you confident that what you saw in the first quarter is sustainable for the year, because of the projects you have on hand already?

Peter T. Thomas

Yes, so it’s the latter. We’re very comfortable and confident that what we experienced in the first quarter would be carried to the balance of the year. And let me provide you with a couple of data points and why that is. If you look at last year when we talked about meaning at this time, we were starting to see a bit of a slowdown in Egypt and Saudi. Just to give you a perspective, the meaner region in total was up 27% in volume over the first quarter of last year. Egypt by itself is up 38% and actually Saudi ordered three times the volume that it had during the first quarter. So we feel very good about that dynamic. And the reason why we feel good is that in these regions you have two types of production that occur. One would be what we define in emerging markets where there’s a government intervention or government construction around building homes for individuals and then versus what one would define as the public construction market. So right now what’s happening like in Indonesia and Thailand, in Egypt and even in Saudi which you’re finding and couple other North African countries that are smaller but there’s a lot of nice flow dynamics here that we have. The government spending in the construction project rolls out first. So we’re heavily involved in that and that will carry us through actually if you remember from last quarter’s call, we said we have enough growth around Egypt and Saudi and Turkey to last us for the next couple of years and enough volume and capacity to satisfy that. So what we’re seeing now and through the course of the year would be this construction build that could take as much as a year and a half or two years that we do have an expectation over that time that public construction will pick up. So that’s the Middle Eastern story; right place, right time, part of our strategy like we mentioned. That’s why we bought Al Salomi and now I think we’re starting to see the dynamic coming to fruition. Now what’s interesting is southern Spain and Italy or Spain and Italy are growing at 5% or 6% this year. Now the dynamic there is it’s one of export. And on the last call, you may even recall that we said that we positioned ourselves with our strategy where we’re going to take advantage of demand in the fastest growing high margin areas like North America, certain parts of Germany, Switzerland and Holland. And what you’re finding is those areas like the quality of Italian and Spanish production and some design, and a lot of that pickup in Spain and Italy with the exports to these areas as well as seeding new growth in North Africa and more importantly for us is the Nigerian market is starting to pick up. There is a dynamic, as you know, most of the town consumed is in warmer climates. Nigeria has a population of 150 million people and typically in that area, the average square meter per person demand would be about two as those economies develop. So right now Nigeria is a steaming spot for us and we’re feeding that area quite nicely and we believe that will continue through the balance of the year and next year. So we feel good about southern and north Turkey and Middle East and how we’re positioned. We’ve done it right.

Dmitry Silversteyn

That’s very helpful. Thank you for the granularity. And then one final question on foreign exchange, it’s looking to be about an 80% or somewhere around that guide for you in the first quarter. And as you move into the second and subsequent quarters, are we pretty much done with these types of foreign exchange headwinds? Should we be looking at sort of more like low single digits and potentially even positive comps as we get into the second half of the year? Sort of what’s your outlook? I know the major currencies but maybe there’s some of the secondary currencies that are still giving you headaches that you can highlight for us?

Jeffrey L. Rutherford

Dmitry, we should start to see a leveling off of that foreign currency pressure as we comp to rates that we’re more aligned with where we are towards the end of '15. But having said that, currencies remain volatile. Part of the charge that we had in other income to expense for the quarter that’s associated with the devaluation in the Egyptian pound, so we are anticipating that currencies continue to have a level of volatility in our results.

Peter T. Thomas

But the Egyptian pound issue was it’s a currency we cannot hedge.

Jeffrey L. Rutherford

Correct.

Peter T. Thomas

And that related to our cash that we have kept in Egypt as we have gone through the acquisition of Al Salomi and any inter-company debt associated with those acquisitions. So that’s what generated the loss from Egypt. Everything else where we cross actual currencies for the most part, we could hedge and we won’t recognize a loss like that in other income or expense. Specifically related to translation is we are guiding relative to what the FX rates are at the end of March and into April. And what we’ve experienced so far, you’re right, we’re experiencing favorable FX related to what we anticipated and we’ve built that into our guidance for the full year. And the effect we have relative to our model was relatively small but it was --

Dmitry Silversteyn

Got you. And I actually have one more question, I apologize. On your Pigments, Powders and Oxides business, you get 5% organic growth ex-acquisitions and foreign currency. Can you talk about what business units or what regions or what end markets are driving this robust level of growth? And given that, why are you only expecting 50 to 100 basis points improvement in margin. I would have thought this business would be a little bit more leveragable when it comes to profitability coming from volume growth?

Peter T. Thomas

Yes, so here’s what you have. You’ve heard us mention how very pleased we are with the Nubiola acquisition and how well it’s doing. And of course you know we have price increase initiatives which were successful. And our cross-selling dynamics between Nubiola and our Pigments business, particularly the CICPs, has been quite a bit better than we anticipated here in the first quarter of moving out to the balance of the year. So I think the Nubiola team have a very nice competency around salesmanship and technology and the way they go to market and their ability to take our CICPs particularly to their customers has been an overwhelming success and that team particularly really enjoys that having the extra product portfolio. And the same is true with the Ferro teams around the rest of the world in terms of the cross-selling activities. So what you’ll see in there is a combination of cross-selling activities doing a bit better than we had anticipated, which is a win with Nubiola pigments and Ferro CICPs and what you have is we’re being creative with some of our – I don’t want to get into the technical [indiscernible], it’s a bit of a competitive advantage, but the competency of blending Nubiola products with our products and creating new colors. And don’t forget Nubiola colors and our colors also add functionality to them whether they’re nonabrasive or anticorrosive. So we’re exploiting a little bit more around the functionality of the pigments rather than just the color. And that dynamic right now is what’s causing the gain and why we feel good about it for the balance of the year.

Dmitry Silversteyn

Okay. Thank you very much.

Operator

Our next question comes from the line of Mike Sison with KeyBanc. Please proceed.

Mike Sison

Hi, guys. Nice start to the year. Can you talk about the acquisition pipeline? Clearly acquisitions have been a nice positive for you guys for the last couple of years. Any thoughts there and maybe what areas you’re excited about potentially as the year unfolds?

Peter T. Thomas

So as we’ve mentioned earlier, our pipeline is very robust. It continues to expand. And as we’ve mentioned, each of our platforms has a certain type of an acquisition strategy. When it comes to Performance Coatings, it’s a strategy of adding higher value product lines like Vetri and also adding low-cost capacity in faster growing regions, emerging markets like we’ve done with Al Salomi. So you see now where those two acquisitions have complemented that business in a way that’s turned it around. In a way that not only we still are one of the market leaders but now we’ve differentiated ourselves both on the cost and technology. When you look at the Performance Colors and Glass business, that is more of a – less extends the technology portfolio. That’s why we bought TherMark. Even though it is small, what it does is it laser marks coatings on substrates particularly in glass but you also know that our strategy is we want to do the same with other substrates. So that’s more of a technology expansion kind of a play. Now as it relates to Pigments, Powders and Oxides, as you know we are developing the color solutions platform of that business and it’s twofold. One, what we said is that CICPs is one of the highest profile in margin and organic pigments in the pigment space. Our objective will be to go out and buy other type of pigments into high end that would allow us to increase our addressable market while maintaining a leadership position. So that’s why Nubiola was important. Now we have targeted two or three other type of high end colorings that we will be bringing into the business. Once that’s established with the color solutions portfolio, not only will we be backward integrated with our other coatings business but then we’re going to move up the value chain with those pigments to create additional differentiation both on how we develop a product form for those pigments, like a blend, a paste, a solution, a slurry, a polymeric delivery system, whatever the case is and we will move up the value chain with that product. And then we’ll also go after other substrates other than metals, glass and ceramics and we would move into things like concrete, asphalt and other natural substrates. So we have a whole mapping for each of those platforms and how we’re going to develop and expand the strategy. And again, as you see with Performance Coatings, it’s working. Color and glass, you’ll hear more about that shortly as you will with the color solutions platform.

Jeffrey L. Rutherford

And while we’re on the topic, Peter, we can talk about how they’re doing relative to value creation. Vetriceramici, which is in the second whole year of ownership is ahead of our internal models relative to value creation and will be in the low teens as far as return on invested capital. Nubiola is off the charts. Nubiola has not yet anniversaried its acquisition, so we really don’t measure it until this year. But we already know and Peter mentioned it from an EVA margin perspective, which is after the cost to capital and property and working capital that was already 12.5%, so that’s on top of the pre-tax charge of 15% on the capitalization. So Nubiola is doing extremely well. And then although it’s early on Al Salomi, Al Salomi as Peter mentioned is the right place, the right time relative to that market. And the availability of the excess capacity is key to that model and will generate the returns – all indications will be at or above our internal expectations relative to return.

Mike Sison

Great. And then curious, you’ve done a really nice job with Pigments, Powders and Oxides getting margins above 30%; Performance Colors and Glass, mid-30s. Is it possible to get Performance Coatings to that level or is that something that when you think about longer term as a possibility as you get that business turned around?

Peter T. Thomas

Yes, so that’s a good question and it’s one that we always put everyone to the test, but let’s take a little trip down into the past. In 2012, Performance Coatings or to say tile for example was about 17% gross profit. And with everything that we’ve done with the business, the right strategic actions on product and customer rationalization, optimizing the production that we have, the torture we’ve been put through because we were suckers. We couldn’t grow because we didn’t have the new capacity in place. But then now we bought Vetri and Al Salomi and all that’s molding together. You can see how that strategy is working. What we said is that the Performance Coatings business right now is sitting at 25.1%. So that’s been a significant move. Now if you think about the addition of another Vetri on that business, you could see another 60 basis points improvement. We absolute some of those out there and as we start moving into those low cost areas, like Al Salomi, the gross profit of the base products to the more commodity products are higher, then that would be in Spain, because it’s a low cost area. So we do have an aspirational model around that business and if we do another Al Salomi and Vetri, you can see that business lift another couple of hundred basis points. If there’s some other things that could be done but we can’t get into it at this point, we believe that we’re never going to end, no stop, trying to improve the gross margin of the business. So we feel that there is still more room.

Jeffrey L. Rutherford

The thing to remember though, Mike, is not only a huge point on mix into higher margin Vetri, like items but we gave extremely good leverage on our assets even where we’re at today. And the thing about Performance Coatings is it’s a very high positive cash flow business for us. It’s a low maintenance capital and fixed capital model, right. The return on an individual smelter, which is effectively what that business is, is smelting glass is extremely high and you’ll see that in Al Salomi where the margins are going to be in the mid-20s but the return is going to be extremely high on that investment.

Peter T. Thomas

Another thing, Mike, while we’re on this topic, I will underscore because I think there’s a lot of legacy dealings, a little bit of negative feeling happened in the business which is inappropriate. I think the days of the dog fight and new interest, low cost competitors coming in with the smelter and satisfying a customer, those days are over. And what it’s about now is you have to have the bundled products, you have to have the heavy customer touch, you need application in a region, you need production in a region. Your application people have to go to the customer site and help serve the customer both in manufacturing and in the laboratory. And we’re the only top producer that is doing that around the world. You have to look at what we’re doing and what we’re seeing and how we’re executing to show that we’re starting to differentiate ourselves from the other producers. You have producers – most of our competitors as you know are privately held or family owned. They’re not reinvesting the way we’re reinvesting. Some of those companies also are owned by private equity. It may not have the same investment profile, because they may want to sell the business. So we’re clearly with our strategy moving ourselves more into technology range and a lower cost range, and you’ll be hearing more about the low cost range moving forward.

Jeffrey L. Rutherford

Mike, I’m going to pile on you now. The other thing and Peter mentioned it in his statements is how good this model can be. Think of Indonesia. An Indonesian market couldn’t have been in worse shape than it was last year. That asset still returned after cost to capital 5.5%. So it created value even in a very down market. So that shows the model is a good model even in down markets, because of what the leverage is on the assets and what we can do with the model in the downward spiral like we had last year. Now that market is up 12.5% and it’s all relative to what the capitalization is and how we can control the capitalization. In the down market, we harvest working capital and we can still get an adequate return after applying cost capital. So we get asked that question a lot by investors about what the model does in a downturn, right? And Indonesia is the classic model for what this model can do in a downturn where you can control working capital and still get a return, still create value and come through it because of the low capitalization of [indiscernible], in particular Performance Coatings model. And that’s the beauty, Mike, of an asset light, heavy touch model which we’ve transformed this business into.

Mike Sison

Okay, great. And just one quick one. The M&A market for chemicals for the [indiscernible] got taken out. I think your strategy has been great but any thoughts around how you view this environment for Ferro in terms of strategic alternatives? Are you open to discussions with acquirers? How do you view the potential to maximize value given where you’re stocks at in this type of environment?

Peter T. Thomas

Mike, we’ve been singing the same song for the past year. We’re always into shareholder [ph] four years and we understand shareholder value. We understand our fiduciary responsibility. What we said is we’re not afraid of a transaction, we just don’t want another value transaction. We understand what the intrinsic value of this that this is worth. We look at tactical options. We look at strategic options. Our Board’s engaged. It’s not dysfunctional. We have hardcore robust discussions about every facet of the business. So we do appreciate that, but like you said we’re not concerned of a transaction. It’s an undervalued one. I’ll leave it there to talk about how we’re doing here in the quarter.

Mike Sison

Great. Thank you.

Operator

Our next question comes from the line of Rosemarie Morbelli with Gabelli and Company. Please proceed.

Rosemarie Morbelli

Thank you. So Mike asked my question in a different way. So I will move on to the quarter and --

Peter T. Thomas

Thank you, Rosemarie.

Rosemarie Morbelli

And I was wondering when you look at electronics, could you talk about the trends in the market and whether – I’m sorry, let me rephrase it, the trend during the quarter and what you see going forward for the balance of the year as well as your applications and in which categories of the electronic world?

Peter T. Thomas

So actually what’s interesting about the electronics piece, we had a broader portfolio back in the old days as you remember and we harvested all the non-core and we cherry-picked the applications in market segments that were truly what we would define as being glass, coating related. So as you know we settled in on multilayer materials and glass packaging materials. So you know those two markets. Now embedded within those two markets – by the way, just as the service, because they’re not tied mostly to consumer electronics for us, we’re mostly on industrial applications, which means we don’t have the volatile swings. In fact that market has the highest margin profile that has good growth opportunities moving forward and you may see us doing more in an inquisitive way relative to that space. So we’re real high on what we’ve done and what we’ve positioned and what we’re targeting. What’s exciting for us are a couple of areas. One, I can’t be real specific because of the applications but I’ll give you a flavor. The first is anything that has to deal with sensor applications for automobile application and other types of applications for the platinum product line as it relates to sensor applications is growing nicely. It will continue to be a nice spot for us. The next part would be you hear me talk about LTCC, which is low temperature co-fired ceramics. Now if you understand that market, you basically know what it is. They are monolithic ceramic devices and this is where the entire ceramics support structure and any conductive resistive dielectric materials are fired in a queue at the same time which saves a lot of energy and time for multi-firing applications for controlled devices in areas that would be like military applications, aircraft applications, space applications. And the devices that are produced from that type of technology would be capacitors, conductors, integrated circuits, resisters and transformers. And we’re the market leader in all that and that market has a nice growth profile with gross margins. So we’re focusing on that and that will continue to do well moving forward. The third piece that we really are targeting and we enjoy, and again I can’t be real specific but it has to deal with data storage capability and the types of products that we offer into that space in a way that companies can create more data storage in small spaces. And we have a very nice technical acumen in that area and that’s where some of our growth is coming from as well. So those are the three areas that we like. We’ve positioned ourselves as the go to for those types of applications and we like that area and you’ll hear more about that in terms of inquisitive approach [ph] later.

Rosemarie Morbelli

So are those areas more volatile that they declined year-over-year or is it that last year you had some big orders from one of your customers?

Peter T. Thomas

Yes, the only challenge that we referred to and it really wasn’t a big dollar value was that one ramp up of a military customer in this particular space, which is normalizing through the course of the year as a new product. So that area isn’t for us like really volatile. It’s pretty stable and it has a nice profile.

Rosemarie Morbelli

Okay, so it’s more of a year-over-year comparison. And when you touched on the high-end glass coatings on construction and you focused on the Middle East, is that the only region where they are used or are we using them as well in more temporary regions?

Peter T. Thomas

No, that’s where is the fight. If you saw the [indiscernible] profile of that product, which I can’t get into, it’s very expensive. Some of those products would be four to five times more expensive than our base baked on coating. And it is mostly the Middle East areas that can afford that type of a glass window. And that is where the market is. You don’t really see too many people messing around with that type of color glass. You may see in fact maybe you might see a bit in – Russia for a while was building it for some really high end buildings and you had some in Shanghai, but the market itself for that product is mostly in the Middle Eastern countries that can afford it.

Rosemarie Morbelli

So if you have 8% volume growth within that high demand type of applications such as automotive glass, I mean the rest has to be down substantially since your revenues were down 9.8% unless there was an enormous decline in price as well?

Peter T. Thomas

Yes, one thing we mentioned is automotive has been up on volume by 9%, so our automotive business around the world is doing quite well, particularly in every region but really nicely developed with certain applications in China. So our glass volume for auto is up by 9%.

Rosemarie Morbelli

And so price was down, Peter?

Peter T. Thomas

It’s mix related.

Rosemarie Morbelli

Okay, thanks. And can you talk generally, if you can, about the trends you saw during the first quarter, towards the end of the quarter, early in April versus what was going on at the beginning of the quarter?

Peter T. Thomas

Yes, in fact we have pretty good vision into April-May and the second quarter now which we feel very good about. And looking out beyond that based on our forecast and what visibility we have in certain regions, we feel pretty good about the balance of the year.

Rosemarie Morbelli

All right, thank you.

John Bingle

Operator, we have time for one more question.

Operator

Our next question comes from the line of Mike Harrison with Seaport Global Securities. Please proceed.

Mike Harrison

Hi. Good morning.

Peter T. Thomas

Hi, Mike.

Mike Harrison

Peter, you seem to be more optimistic on tile coatings demand in terms of the volume picture. Can you talk about what you’re seeing in terms of pricing in tile coatings overall and maybe specifically go through some of the market segments, the higher end Vetri piece, digital inks as well as the frits and glazes side?

Peter T. Thomas

Okay. So I see you have about five questions. I’m going to try to answer but I’m going to encompass all of it. Let’s talk about pricing generally around the world. And as you know, inks and frits and glazes have been under pressure over the past couple of years. And what we’ve done and you’ve heard us talk about this before as we are repositioning by taking advantage of the Vetri business and their model on serving the customers and how we’re positioning ourselves with low cost production to give us advantage at the high end as well as the low end in a way that overall we have the best blended cost position. What we’ve done is we moved ourselves kind of using the Vetri model away from a lot of the competitive intensity in a lot of the areas, like you heard me mention in China or in Asia in general. What we’re doing is we’re focusing on the higher end tile producers who produce good quality applications where we bring that bundle we can generally have a higher price point, like for inks. Our price point – I won’t be specific but I know that it’s higher than our competition, but we’ve been very selective and that competitive base likes to buy the fairer blend of products and the serviceability that goes with it. So you should think of it now is that we have a little bit more discipline in this business in terms of value pricing instead of competitive pricing with the addition of Vetri and that model. What we’ve done is we’ve adapted a high end model to our entire business in a way that if we mention to you that we selected we wanted to grow with and by using that model, as we were fighting over the last couple of years with pricing that we’ve moved to customers that we know are the best in class. And what we said to them is, hey, we might not have enough capacity now, so we want to optimize our tonnage and true-put and we don’t necessarily want your day-to-day business. What we want you to do is look at Ferro for the future. We’re going to service you with applications and please consider us in new applications and new product releases moving forward. So that’s what we’ve been doing over the past two years in terms of steering [ph] the future and the customers that we’ve picked by adding that capacity in Vetri has been such that they view us as the preferred, as at the high end, with good quality and the competitive intensity isn’t as great as it used to be. Where there’s still a tranche of business where we have lower end customers that don’t use all the high products but they like a nice mid cut, and what we’ve done there is that we’ve been able to use our low cost production instead of pricing, the cost to produce gives us that advantage without causing profit destruction and/or we reformulate our products in a way that we can meet pricing but still reserve the margin and not absolute gross profit dollars. So that’s the essence of what we’ve been able to transform that business and that’s what you’re going to see more of moving forward.

Mike Harrison

All right. And then the last one for me is on the Pigments business. You announced a price increase. I believe it was just on the Nubiola, Ultramarine business but maybe it was a broader increase. How much pricing did you realize on that and is there more to come or are those generally year-long contracts and it’s already baked into Q1 results?

Peter T. Thomas

Yes, we have to be careful with this. What I would tell you is that price increase was successful but I can’t be more specific for some contract reason.

Mike Harrison

Understood.

Peter T. Thomas

That would be because of the [ph] pricing, let me put it to you that way.

Mike Harrison

All right. Thanks very much.

John Bingle

Okay. Thank you very much. That concludes our call this morning. If you have need to get the press release or a copy of the presentation, you’ll find it on our Web site at ferro.com. And with that, I wish you good day. Thank you. Bye-bye.

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 lines. Have a great day, everyone.

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