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Ferro Corp. (NYSE:FOE)

Q4 2007 Earnings Call

February 29, 2008 1:00 pm ET

Executives

Jim Kirsch - Chairman, Presidentand CEO

Sallie Bailey - VP and CFO

David Longfellow - Director of IR

Analysts

Mike Harrison - First Analysis

Rosemarie Morbelli - Ingalls andSnyder

David Begleiter - Deutsche Bank

Mike Sison - KeyBanc

Robert Felice - Gabelli &Company

Christopher Butler - Sidoti andCompany

Operator

Welcome to Ferro Corporation's2007 fourth quarter Earnings Call. All participants will be in listen-only modeuntil the question-and-answer session. (Operator Instruction) This conferenceis being recorded, if you have any objections, please disconnect at this time.

Now I' like to turn the meetingover to your host, Mr. David Longfellow, Director of Investor Relations. Mr.Longfellow, you may begin.

David Longfellow - Director of Investor Relations

Thank you. Good morning andwelcome to the Ferro Corporation Earnings Call. Today we will provide theinformation about our financial results for the period ended December 31, 2007and we will discuss our expectations for the first quarter. Joining me ontoday's call are Jim Kirsch, Chairman, President, and Chief Executive Officerand Sallie Bailey, Vice President and Chief Financial Officer.

Jim will speak first and give youhis perspective on our 2007 performance, our long term goals and our path toachieve those goals. Sallie will follow with a more detailed discussion of the2007 results and our first quarter outlook. Following the prepared remarks, Jimand Sallie will take your questions.

I hope you have had all had anopportunity to review the press release we issued today. Copies of the pressrelease are available on the investor relations portion of Ferro's web site,which is located at www.ferro.com.

Before Jim begins, I want toremind you that statements made on this conference call about the futureperformance of the company may constitute forward-looking statements within themeaning of federal securities laws. These statements are subject to a varietyof uncertainties, risks and other factors related to the company's operationsand business environment that are listed in our earnings press release and inthe company's 2007 annual report on Form 10-K.

Forward-looking statementsreflect management's expectations as of today, February 29, 2008. The companyundertakes no duty to update them, to reflect future events, information, orcircumstances that arise after the date of this conference call, except asrequired by regulations. Any redistribution, re transmission or rebroadcast ofthis call in any form without the expressed written consent of Ferro isprohibited. A dial-in replay of today's call will be available for seven days.In addition, the replay will be available on Ferro's web site. I would now liketo turn the call over to Jim.

Jim Kirsch

Thank you, David. Good afternoonand thank you to everyone who is participating on today's call. My remarks ontoday’s call are intended to give you my perspective on our 2007 resultsincluding the progress we made during the year and the actions we are taking toimprove, discuss how we intend to reach our long-term operating margin goals,our efforts to manage increasing raw material costs and price per value andfinally our view of the global business conditions.

2007 was a year of substantialprogress within Ferro, but was also a year in which the evidence of thatprogress measured by our earnings was less than we had hoped. Nevertheless wetook significant steps toward our goal of building a better Ferro. In 2007 wecontinued building a foundation for sustainable improvements in Ferro’soperations. Through the combined efforts of our team we were able to generateover $145 million in net cash flow from operating activities. Then we reducedour overall debt by more than $60 million.

Although, we still have a lot ofwork ahead of us to reach our profitability objectives, we are making progressin a number of important areas. First we are reshaping our manufacturingoperations through our restructuring initiatives. We discontinued dielectricmaterials production at our Niagara Fallslocation, and electronic materials and transferred production to other existingsites in the US and Europe. We also sold the Niagara Falls site to an industrial ceramicbusiness that operated there.

By completing this restructuringproject on schedule we lowered our fixed costs, reduced headcount and improvedthe capacity utilization in our remaining manufacturing locations. Thisrestructuring will deliver the $7 million to $8 million in annual cost savingsthat we had planned.

In Europe we made excellentprogress on a number of restructuring projects, our new world class color plantbegan operations in Spain during September and in 2008, we will continue toconsolidate additional element of our heavy manufacturing into this site.

We also kicked off a project toconsolidate porcelain and enamel production from Rotterdamto our site in Spain.

We successfully transferred otherproduction operations from Frankfurt to Colditz, Germany wherewe have a lower cost structure. Our European restructuring projects areprogressing on track and on budget and we expect them to deliver approximately$10 million to $12 million in incremental cost savings during 2008.

During 2007, we brought in a newVice President of Operations Tom Austin who is leading in number of importantprojects from lean manufacturing to procurement improvements.

Tom was instrumental in ourefforts to improve safety and operating procedures at our South Plainfield, New Jersey, anelectronic materials plant. While we absorbed some added cost from theinterrupted manufacturing at the site in April, the benefits of these actionsbecame apparent by the end of the year. By the fourth quarter, the employees atour South Plainfield plant were settingrecords for the amount of material processed and their overall productivity.

In South Plainfield and across the company, we have been aggressively lookingfor finding and fixing operational issues. We have brought in capable newleadership from the top level executives to new plant managers and first levelsupervisors.

We are measuring our performanceagainst tough standardized operational metrics that connect the goals ofindividual shift workers to manufacturing plant metrics in business unit goals.And we've replaced employees who did not showed our commitment to our win fromwithin operating principles and the values that support them. I believe thesechanges are producing sustainable improvements that will help Ferro reach amuch higher level of performance.

Our cost and expense reductionefforts are also making a difference. A year ago, we took action to reduceexpenses in our combined Polymer Additives and Specialty Plastics businesses.By combining the businesses, we're able to generate new sales opportunities,such as compounding our Specialty Plastics colors with our Polymer Additivesproducts for PVC manufacturers. We've also extended and penetrated new marketssuch as Concrete Additives. As a result, even though, many of the keyapplication markets for these products declined significantly during 2007, ourcombined Polymer Additives and Specialty Plastic segments increased salesduring the year and delivered nearly the same segment income despite theunplanned manufacturing costs we experienced in the fourth quarter.

Our ability to deliver improvedperformance in tough market conditions will continue to be tested in 2008.Whether or not the overall USeconomy enters a recession, we know that many of the markets we serve will bedifficult this year. However, we remain committed to improving our results. Ourlonger term goals have not changed and our resolve to reach those goals isunflinching.

On previous conference calls, wehave discussed our goal to achieve 10% operating margins, defined by totalsegment income, less corporate and allocated charges as a percent of salesexcluding precious metals. We remain committed to achieving this goal in 2010.Our efforts throughout our business continue to be directed toward this goal,which I believe is a tough but realistic one. And one that is required toimprove the performance at levels that is competitive with our specialtymaterial peers.

Our 2007 operating margins wereof course affected by various charges for unusual items that are described intoday's press release. However, if you adjust for those charges, our 2007operating margin as a percentage of sales excluding precious medals was just under6%.

The completion of ourrestructuring programs in Europe along with the full benefit of our NiagaraFalls restructuring, is expected to generate savings that will contributed anadditional 1.5 point of operating margin. We expect to realize approximately$15 million of these incremental savings in 2008. Savings from restructuringare significant but they are not the only contributors to reaching our overalloperating margin goals.

In addition to restructuring, weare in the midst of other efforts to improve profitability.

Tom Austin is spearheading aneffort to improve our cost, through a combination of improved productivity,lean manufacturing, better procurement at lower cost from unplannedmanufacturing cost, such as we experienced in the fourth quarter in Bridgeport,New Jersey. These unplanned manufacturing interruptions reduced our operatingincome by $8 million to $10 million in 2007. We believe there is opportunity toimprove our manufacturing operations through the broader adoption of lean manufacturingand aggressive productivity targets that we have established on a site-by-sitebasis.

In addition, we have made changesin our worldwide procurement organization and we believe we can reduce our costas we address our $1.6 billion annual spend for goods and services. We expectthese combined initiatives to eliminate unplanned cost, improve procurementeffectiveness and manufacturing productivity, to deliver an incrementalimprovement of 1.5 points of operating margin by year-end 2009.

During 2007, we spoke publiclyabout our 40-20-20 business model objectives in our electronic materialssegment. This means, we expect the business to achieve 40% gross margins and20% operating margins, while we invest 20% of sales in SG&A and researchand development. All of these percentages are relative to sales excludingprecious metals..

In the fourth quarter of 2007,the Electronic Materials business showed that this is not an unrealistic goal,as it achieved 36% gross margins and 18% operating margins on sales excludingprecious metals..

Continued favorable changes inproduct mix to growth in higher margin products such as our solar materials,execution of our new product pipeline and attention to manufacturingproductivity will help us achieve our 40-20-20 goal during the next two yearsand will contribute about an additional 1% to our overall corporate operatingmargins.

Another opportunity for operatingmargin improvement comes from reduction in our SG&A expense. Through thebroader implementation of shared services models in our corporate functions, itimproved business processes in our operating groups. We believe we can continueto reduce SG&A as a percent of sales as we have done for the past two yearsand add another half point to operating margins.

Through a combination of all ofthese efforts, we believe we have a difficult but realistic and achievable planto deliver 10% operating margins in 2010.

Most of the work we are doing toachieve our profitability targets is internal to our own organization andtherefore, under our control. However, we understand that we cannot controlexternal business conditions and are likely to be bumps along the road.

We continue to see the internaltargets for costs and expense improvements in excess of the amounts of outlinedto strengthen our confidence in achieving our overall goals. As we move in to2008 one priority is to aggressively address the key external issue thatpressured our gross margins in 2007.

During the year, we experiencedsharp and perhaps unprecedented increases in the cost of a number of rawmaterials that are essential to our specialty products. In the past year, wesaw costs for raw materials affect the operations of all of our operatinggroups. That includes cobalt, chrome oxide, bismuth and nickel used in ourinorganic specialties business; polypropylene, tallow and soybean oil are usedin our organics products; and precious metals used in our electronic materials.

Just to give you a few examples,the price of cobalt more than doubled during the year and the price of nickeland bismuth also increased by a factor of three before coming off their peakprices recently. Price of tallow increased from around $0.22 per pound in early2007 to $0.31 late in the year and continues to move upward.

In total, increases in rawmaterial costs added roughly $125 million to our manufacturing costs in 2007compared to 2006. In this period of sharply increasing raw material costs, werelied more heavily than normal on surcharges and other mechanisms to reactquickly to changing costs. While these methods were generally effective inmatching price increases to raw material cost changes, we were not able tomaintain our normal gross margins.

We expected to make progress onthe price versus raw material cost equation in 2007 fourth quarter. But becauseof some continued rapid price movements, we are only able to maintain theposition we had in the third quarter. Therefore, while our gross marginsexcluding charges improved sequentially from the third quarter of 2007. Theydid not improve to the extent at which we had planned.

In 2008, we'll continue to workcollaboratively with our customers to reformulate products where possible usingless expensive raw materials. We have set aggressive targets to improve our manufacturingand conversion costs and we will set our prices, where we can earn a fairreturn on our investment. Through these actions, we expect to make progress inrecovering gross margin that we lost over the past four quarters as a result ofthe extraordinarily rapid increase in raw materials.

At the beginning of 2008, we arefacing some uncertainty in forecast for the world market growth. As a result,we are taking steps to further reduce our cost and expenses. In December, weannounced additional reductions on our worldwide operations. Most of thesereductions were incremental to our ongoing European restructuring.

We will continue to takeproactive cost and expense actions to manage our business as we go through thenext several quarters. I believe that we have a very capable team in place andthat the building blocks for improvement that we put in place during 2007 willprove their value this year.

Sallie will talk about ourspecific estimates for the first quarter shortly. Then I'll look forward toupdating you on our progress as we go through the rest of 2008. I would like toturn the call over to Sallie, who will review the financial results in moredetail and discuss our first quarter estimates before we open up the call foryour questions. Sallie?

Sallie Bailey

Thank you, Jim. Today, I'll startwith a brief recap of the 2007 full year results and then I'll discuss thefourth quarter income statement.

Our net sales for the year endedDecember 31, 2007 were $2.2 billion, an increase of 8% over 2006. Salesincrease for the year was driven by product price increases and favorableforeign exchange rates. Price increases accounted for about two-thirds of thehigher net sales. At an aggregate level, volume had a slightly negative impacton sales. Volume decline were primarily in our Porcelain and Enamel businessand Performance Coating as well as in the Specialty Plastics and PolymerAdditive segments.

These businesses were negativelyimpacted by weak demand in the USmarket for appliances and automobile. Volume was a positive driver for sales inour Color and Glass Performance Material segment. Volume was neutral in ourElectronic Material segment as the business overcame weak demand for dielectricmaterials in the first half of the year, with improved volume in the secondhalf of the year, particularly for our Solar Material and Metal Powders forplasma display.

Gross margin was 18.9% for theyear, compared with 20.4% in 2006. Raw material price increases continue to putpressure on gross margins. During 2007, we recorded expenses of $7.9 million incost of sales, primarily for accelerated depreciation and other cost related toour manufacturing rationalization programs.

In addition, we expensedapproximately $10 million of unexpected manufacturing cost as a result of ourquality issues in Evansville, Indiana,the intervention for safety in operating procedures in South Plainfield, New Jersey and theplants interruption at Bridgeport, New Jersey, Organics Chemicalsplant.

SG&A expense for the year was$319.1 million. As a percentage of sales SG&A declined to 14.5% from 15% in2006. The 2007 SG&A expense included $12.2 million in expense primarilyrelated to legal settlement and divestment activities. In 2006, SG&Aexpense included $8.2 million primarily from expenses associated withaccounting restatement and a settlement loss from a nonqualified benefit plan,which was partially offset by a benefit from changes in our postretirementbenefit programs.

Restructuring charges for theyear was $16.9 million, as we completed the restructuring project in Niagara Falls, New Yorkthe Electronic Materials site and continue to work related to restructuring ourinorganic business in Europe.

Total segment income for year was$154 million, up slightly from $152.6 million in 2006. Increased income in ourColor and Glass Performance Materials and other business for segment waslargely offset by income declines in our Performance Coatings and ElectronicMaterials segment.

Color and Glass continue to be astrong business for us in 2007. This has expanded it leading brand position inautomotive enamel, architectural glass coatings, pigments and then enamels andcolors for glass bottles and dinnerware. The combined Polymer Additives andSpecialties Plastic segment slightly exceeded their 2006 income performance,despite a very difficult market environment in the US where the bulk of their productsare sold.

Income from Electronic Materialswas covered in the second half of the year due to a strong sales of ourAdvanced Materials for solar cells and plasma displays, the recovery, thedemand for dielectric materials and a manufacturing productivity improvementsresulting from actions taken in our South Plainfieldfacility..

In our reconciliation of segmentincome to income from continuing operations before taxes, we reportedunallocated corporate expenses of $56.4 million in 2007. This amount includesapproximately $20.1 million of one-time items. In 2008, we expect corporateunallocated expenses, net of these types of one-time items to be less than2007. However, corporate unallocated expense is generally high in the firstquarter as a result of the timing of audit fees.

2007, we recorded a loss fromcontinuing operations as a result of the $128.7 million impairment charge werecorded in the fourth quarter. This charge, which we discussed in our pressrelease on February 11th, was a non-cash write-down of goodwill on long-livedassets related to our polymer additives and pharmaceutical businesses. Detailsof the impairment charge, including the amount of goodwill and assetimpairments by business unit are available on note 17 in our 2007 10-K report.

Let me summarize the variousone-time charges we recorded in 2007. Within cost of sales, we recorded $7.9million related to manufacturing rationalization activities. Our 2007 SG&Aexpense included $12.2 million related to various legal settlements indivestment activities. We recorded a total of $16.9 million in restructuringand $128.7 million in impairment charges. In addition, we recorded charges of$2 million as part of interest expense for the write-off of previouslyunamortized fees and discounts associated with an unused portion of our termloan.

During 2007, we generated $144.6million of net cash from operating activities. Contributors to the increasedcash flow include the elimination of cash deposits for precious metalconsignment, lower inventories and increased payables. Capital spending for theyear was $67.6 million, an increase of $17 million from 2006 driven primarilyby the requirements of our restructuring programs including the construction ofour new color plant in Spain.

Depreciation and amortization forthe year was $87.5 million. Our target for capital spending for 2008 is to beabout equal to the depreciation and amortization for the year. We continue toinvest in capital for growth and productivity improvement, and to fund thecapital investment requirements of our restructuring program.

The 2007 cash contributions for USpension plan were $22.6 million and $8.7 million for non-US plans. We expectthese contributions to decline to a total of approximately $25 million in 2008.Total balance sheet debt on December 31, 2007 was $526 million compared with$592 million at the end of 2006.

The most significant driver tothe decline in balance sheet debt was the elimination of cash deposits forprecious metals, which occurred in the first quarter of 2007. At the end of theyear, we had net proceeds of $54.6 million from our off balance sheet US assetsecuritization program and an additional $42.1 million of net proceeds fromsimilar programs outside the US.

Turning to the fourth quarterresults. Net sales were $570.7 million, a 14.8% increase from the fourthquarter of 2006. The increase was due to a combination of product priceincreases, favorable exchange rate and volume increases. The volume increasewas primarily the result of the strong quarterly sales in electronic materials.

First quarter sales compared withthe prior year increase in all segments except other businesses. Percentagegrowth in sales was the greatest in the Color and Glass, Polymer Additives andElectronic Material segment. Each of which grew about 20% compared with thefourth quarter of 2006.

Sales decline in other businesseswas the result of declines in our pharmaceuticals products. These product salescontinue to be affected by uneven demand as our customers enter and exitproduction cycles in various stages of their drug development program.

Reported gross margin for thequarter was 17.9% of sales, down from 19.7% in the fourth quarter of 2006 and18.2% in the third quarter of 2007. The primary driver for the decline in grossmargin from 2006 was our inability to increase product prices to compensate forhigher raw material cost, sufficient enough to maintain gross margins.

Gross profit for the fourthquarter included $3.2 million in charges related to our manufacturingrationalization, including accelerated depreciation. Gross profit was alsonegatively impacted by the manufacturing disruption at our Bridgeport, New Jerseyplant which added approximately $2 million in cost during the fourth quarter.

Considering the length of timerequired to reestablish steady-state operations in the biological waste watertreatment at the Bridgeportplant, we expect approximately $2 million to $3 million in added cost duringthe first quarter of 2008. The plant is now operating in a normal productionlevels.

SG&A expenses in the fourthquarter were $84.9 million or 14.9% of sales. Included in the fourth quarter,SG&A expense were $3.9 million in charges, primarily related to legalsettlements during the quarter.

We continue to address ourexpense structures as we go forward in an uncertain macroeconomic environment.We announced additional cost and expense reductions in December and we'verecently notified a smaller group of employees at our UK plastic operations of plant costcutting actions. We expect SG&A expense as a percentage of sales tocontinue to trend down overtime.

Our fourth quarter resultsinclude the $128.7 million impairment charge for goodwill and long life assetsthat I discussed earlier.

Restructuring charges were $9.2million for the quarter, all related to our manufacturing rationalizationprograms in the Inorganic Specialty and Electronic Material business unit..

Interest expense was $13.5million in the fourth quarter, down from $16.3 million in the prior yearperiod. The decline was largely of the result of lower borrowing levelsresulting from the elimination of cash deposits for precious metals thatoccurred in 2007 and lower average interest rates on our term loans.

Total segment income for thequarter was $35.5 million, up from segment income of $33.3 million in thefourth quarter of 2006. Compared with the fourth quarter of 2006, incomeincreased in the Electronic Material, Polymer Additives and Specialty plasticsegments.

Increase in Electronic Materialwas driven by volume increases, particularly for metal paste and powders usedin solar cells and plasma displays.

Income improved in PolymerAdditives despite the issues in the Bridgeport Plant as a result of improvedmanufacturing volumes and price increases that were able to cover raw materialcost increases

Income increased in SpecialtyPlastics, primarily as a result of product pricing increases and SG&Aexpense reductions.

Income declined from the prioryear fourth quarter in our Performance Coatings, Color and Glass PerformanceMaterials and other business segment. The primary factor on the decline wasincreased raw material costs that were not sufficiently match by priceincreases to maintain our gross margin percentages.

Let me take a minute to summarizethe fourth quarter charges as I did the full year charges. Within cost ofsales, we had charges of $3.2 million for manufacturing and rationalizationactivities. Our fourth quarter SG&A expense included $3.9 million incharges primarily related the various legal settlements and divestmentactivities. We record total of $9.2 million in restructuring expense and the$128.7 million impairment charge.

Now, turning to our outlook forthe first quarter. We expect sales to be in the range of $550 million to $575million. This input sale is above the first quarter of 2007. Earnings per sharefrom continuing operation for the first quarter are expected to be in the rangeof $0.12 to $0.17.

Included in our estimates forearnings in the first quarter, our restructuring and other charges amounting toapproximately $0.05 per share, also included in our first quarter estimates,our $2 to million $3 million in cost related to our Bridgeport, New Jerseyplant disruption. Our earning recorded in the first quarter of 2007 were $0.14per share including approximately $0.08 per share of one-time items.

Thank you for attention and I'llturn the call back over to Dave.

David Longfellow

Thank you, Sallie. And if theoperator could you please proceed with the question-and-answer session now.

Question-and-Answer Session

Operator

Yes. Thank you, sir. (OperatorInstructions) Our first question comes from Mr. Mike Harrison with FirstAnalysis. Your line is open.

Mike Harrison - First Analysis

Hi. Good afternoon, everyone.

David Longfellow

Good afternoon, Mike.

Jim Kirsch

Hi, Mike.

Sallie Bailey

Hi.

Mike Harrison - First Analysis

In the electronic materialssegment, as you look at the three makeup points of that segment being dielectrics,photovoltaic materials and CMP, can you talk about what you've been seeing interms of demand for those three product areas in Q4? And maybe what youroutlook is for 2008?

Jim Kirsch

Sure, Mike. Let me start at thebottom with CMP because CMP is really tiny. Let's talk more, if you will, aboutsurface finishing because that's really our broader segment, polishing, okay?Because we're still quite small in CMP, specifically we continue to see growthand expansion in that particular business, albeit, more relatively small base.And photovoltaic or advance materials, we have continued to see robust demand.And our expectation as we go through 2008 is that we'll see double-digit growthin that particular area.

Dielectrics has been, was muchstronger in the second half of '07 than it was in '08. Its return to what Iwould suggest would be more normalized levels, which is not unusual in thefirst quarter after the Christmas season and the Chinese New Year and so on.So, as I look at the year and we read about what to prognosticators areclaiming, we expect to see single-digit growth in that particular marketsegment.

Mike Harrison - First Analysis

When you see double-digit growthin photovoltaic materials or advanced materials, are we talking in sort of themid-teens range or are we talking 20% possibly?

Jim Kirsch

Well by definition of materialsguys typically have a  lesser growthrate, if you will, than the parts players or the solar panel people. So from amaterial standpoint we would expect to see something in the 12% to 14% growthrate which would be very similar to what 2007 showed.

Mike Harrison - First Analysis

All right. Great and then isthere any way that you can give us some more detail on what your raw materialpurchases are in terms of your actual financial needs or volume needs forcertain raw materials. It seems like every quarter there is sort of a differentraw that is giving you guys trouble?

Jim Kirsch

Well let me address the back halfof that question. We have said pretty consistently that tallow and soybean oilin our organics businesses are the big drivers. And it wasn’t too long alongthat tallow’s market pricing was in the $0.14, $0.15 range. So the delta isvery significant in that it is in the mid thirties or so now. Soy oil is aconsequence of what’s happened in biofuels in a move to planting more cornetcetera, the restricted acreage has rocketed and we at large are a significantconsumer for raw material for our organic materials business. And we have beentalking about that one for over a year now.

In the metal side, in the basemetals, here you are talking we are an oxide player in cobalt and we havetalked about the volatility in the cobalt oxide business for some time as well.That remains volatile. It has got very, very expensive in the last 90 days orso. Cobalt, chrome oxide, zinc, nickel those are drivers in our PerformanceCoatings businesses, have been forever and have been very volatile in the last,really the last two and half years and we have battled through those withpricing activities, raw material substitution activities, and utilizedimprovements in manufacturing, surcharges etc, to fight the good fight.

Mike Harrison - First Analysis

And then what about bismuthbusiness, how significant is that in, remind me again what segment that showsup in?

Jim Kirsch

It ends up in our organicbusinesses and it is a significant raw material for us. It is one of the fewmetals where we really are, if you would, a world scale player. So, we areworking hard to leverage our ability to buy on a market basis or relativelylarge quantities of bismuth and using that to leverage two additional suppliersand improve our price cost position if you will.

Mike Harrison - First Analysis

Oh, right. Then the, the lastthings I wanted to ask about is, you referred to an umbrella term unplannedmanufacturing cost. You have stepped-up efforts to identify problems that needto be fixed. Can you talk about some of the costs that have been or they willbe associated with these efforts to try to identify these problems. And I amjust kind of curious if may be the Bridgeportproblem is something that could have been identified prior or was it reallysort of a one-time or completely changed event?

Jim Kirsch

Okay. Let me address that. Let meaddress all the three of the events that occurred last year, because I wouldthink that some people listening might wonder if we've got a systemic problemwithin manufacturing, if you will. At Evansville,we had a people/quality/ raw material problem. We identified that within ourbusiness unit at our Evansvillesite, people were taking poor decisions about quality of raw material and howto process it appropriately.

Our action after we did thoroughinvestigation was effectively to dismiss that entire management team at thatsite, put in improved processes particularly around quality and procurement.And we found that we've resolved that issue at that particular site. So thatwas more that I would call a people related issue.

At South Plainfield, we were very proactive in examining the safetyorientation not only of our employees, but also, of our processes and could weenhance and improve the safety in the facility by changing people's behaviors,also changing product flows we thought we could improve productivity. Thestep-up that you saw in our electronic materials business in the second half,particularly during the fourth quarter, was in a great part related tomanufacturing it effectiveness and efficiencies that were generated as aconsequence of that intervention.

That's where most of our preciousmetal materials are processed, if you will. And that's a significant plant forus in all our related precious metal and used markets. So as these excellentmarkets for us ranging from shielding to solar et cetera, grow our ability tocontinue to drive efficiency in that plant is paying great dividends.

At Bridgeport, again, I would tell you that theevent that occurred was preventable. It was not a chance event. Our systemsworked appropriately in terms of the warning that we had a manufacturinginterruption occurring and we're moving product into our wastewater treatmentfacility at a rate that could potentially overwhelm the plant. And our peopledidn't react quickly or in diagnosing the problem appropriately or fasten upand then taking action once it was diagnosed.

So we've gone through a series ofsteps of the fixing the problem, diagnosing the root cause of the problem,replacing people, retraining where we need to and then identifying from hereforward appropriate manufacturing and operational procedures that we're quiterigid in that people follow. So I don't think it an issue that we should expectto see in.

Mike Harrison - First Analysis

All right. I appreciate colorthere. Thanks.

Operator

Thank you. Rosemarie Morbelliwith Ingalls and Snyder, your line is open.

Rosemarie Morbelli - Ingalls and Snyder

Thank you, and good afternoonall. Following up on this topic, Jim, have you looked at all of your globalmanufacturing facilities to see if there are any similar problem growing thereand just waiting to explore that one point or another?

Jim Kirsch

Yeah. That's a great question,Rosemarie. Yes, we have. In fact, one of the reason Tom Austin was broughtaboard was to assist us in enhancing not only things like productivity and ourlean initiatives, but also recalibrating, if you will, the facilitiesthemselves. In other words, within each of the business units, we've now havein place very good manufacturing directors, but we're not the same people thatwere running our global manufacturing operations two years ago.

Tom is highly experienced chemicaloperator. He has over 30 years of experience at Dow in running a variety ofchemical processing facilities and their global maintenance and as a individualI have great confidence in him. In addition to that, I have great confidence inour three operating Vice Presidents in the manufacturing infrastructure theyput in place with their people. It is interesting to note, if you think aboutwhere the problems have occurred, within the United States in chemicalprocessing plants that have not necessarily been core to what this company wasfounded on as we have grown.

So I think that we have managedto step back, reexamine and reevaluate all of our procedure ,throughout ourfacilities, starting with safety and starting with environmental and makingsure our environmental health and safety records are in compliance and we wantour people to return home in the shape they came in. And I am very confidentthat the process improvements we are putting in place will enable us todiagnose early, make sure that we understand the potential problems we have andaddress them prior to them becoming very difficult issues for us or ourshareholders.

Rosemarie Morbelli - Ingalls and Snyder

Thanks. That is very helpful. Isthere a cost associated with this project, which will be more than standard in2008 and will disappear in 2007?

Jim Kirsch

Actually, Rosemarie, I wouldthink it is the opposite. I think there is cost improvement available to us asa consequence to running facilities more effectively and safer. We won't haveas much downtime in terms of employees who are out and the compensating costassociated with that. And I think as we raise the bar, the standard of what weexpect out of the values and behaviors of our people, and we raise the bar onthe efficiencies with which we expect our raw materials to be processed, weshould expect to see enhancements in everything from our maintenance spendingto our during the productivity cost to our labor cost as we move forward.

Rosemarie Morbelli - Ingalls and Snyder

I guess I did not phrase thisproperly. I meant that the fact that you are currently retraining people,looking at all of your manufacturing facilities, looking for thoseimprovements, which will end up lowering your overall costs. So those costskind of booked in 2007 and you are now done with the process and therefore in’08 we are beginning to see some of the lower cost as opposed to '08 showinghigher costs to look where the problems are and what can be fixed?

Jim Kirsch

I will tell you that the work weare doing is build in to our budgets. We expect to have lower manufacturing ofoverall total costs in '08 primarily as a consequence of the restructuring weare doing in taking out fixed assets. And my expectation and the goals we havestructured on each our operating units are very specific to what we call netproductivity improvements. So we expect to find between 3% and 5% of netproductivity improvements out of each of our manufacturing unitsyear-over-year, as a consequence of their in-house, within the four wallsimprovements. I will put it that way.

Rosemarie Morbelli - Ingalls and Snyder

Okay and you had additional rawmaterial costs of, if my memory serves me right, but I am sure that Sandy will correct me?

Jim Kirsch

About $125 million I said.

Rosemarie Morbelli - Ingalls and Snyder

Right, okay. Thanks. Are you,what kind of raw material cost increase in '08 versus '07 are you expecting?

Jim Kirsch

That's a great question. And I'vebeen wrong every year. I've prognosticated it because we didn't think we wouldsee the run-up in '04 that we did. We didn't think, I don't think that manypeople in the industry thought that in '06 we would see or in '07 particularlyin commodities. The extraordinary run-ups we've seen, I mean the rate of changeand the slope of that curve has been something that, at the least is quiteextraordinary. So, we have budgeted for some additional raw material cost inour operating budgets. But I am not going to make a prediction of what I thinksome of these metals or these other commodities will do.

Rosemarie Morbelli - Ingalls and Snyder

Will you share with us how muchyou have budgeted for?

Jim Kirsch

No. I can't. I don't want toshare that with you.

Rosemarie Morbelli - Ingalls and Snyder

You wondered that -- okay. And inan environment -- my last question, if I may, in the somewhat recessionaryenvironment raw material costs continuing to go up and your goal is to improveyour mix and get paid for the value of your products and services. Do you thinkthat you will continue to be able to raise those selling prizes, if the demandslows down substantially?

Jim Kirsch

I am a big price believer, Rosemarie.I've been from the day I started my career as a sales rep. So, I think theelasticity while it's not as elastic, I guess I'll say, as it was two yearsago. Yes, I think we'll continue to be able to pass along cost to customerswhere we have used surcharges in the recent past. We will continue to call backand try to regain margin.

As I went into some detail on myremarks about operating margins, I think there are other tools that aredisposal. Our improvements in procurement, our improvements in manufacturingoperations, and I don't want to lose sight of the repositioning that's going onwithin our businesses to higher value markets is quite significant. We havesubstantially lowered our exposure to PVC in the polymer additives business,for instance. We have substantially increased our exposure in solar, in ourelectronic materials businesses, and as a consequence our exposure todielectric materials, which is a lower business has been decreased.

Rosemarie Morbelli - Ingalls and Snyder

Okay. Thanks a lot.

Jim Kirsch

You bet.

Operator

Thank you. David Begleiter with Deutsche Bank. Yourline is open.

David Begleiter - Deutsche Bank

Thank you. Good afternoon.

Jim Kirsch

Hi, David.

David Begleiter - Deutsche Bank

Jim, can you comment on recentdemand trends in both the U.S.and Europe, any change in the delta from avolume standpoint?

Jim Kirsch

Yes. I don't know how much youmean recently. Let's talk, maybe about fourth quarter or the throughout thecourse of 2007, David. It certainly slowed, particularly in specialty plastic-- specialty plastics as we went through the year. Any of the polymer relatedbusinesses into appliance packaging, automotive, building and construction inthe U.S.clearly slowed throughout 2007. And we expect in 2008 that it's going to be atough year.

I think the overall, maybe, twomonths ago I would have told you we were expecting maybe a 2% kind of GDP inthe U.S.Today, I would tell you that our view is that it's lower than that. In theEuropean continent, in the Euro zone, in our view couple of months ago, wasprobably that we would expect to see 3% type growth in the Euro area, today. Ithink its less than that but certainly better than what we're seeing here in U.S.

David Begleiter - DeutscheBank

Okay. Looking more for as you mentioned the first two months of theyear, I think you gave us an insight. FX, what was the benefit in Q4 and '07from FX and what's your expectation in '08?

Sallie Bailey

David, its Sallie. When we lookat the whole of the Company, the benefit from FX is really pretty minimumyear-over-year because we are pretty naturally hedged that to the extent thatwe have higher sales, let just say, to the appreciation of Euro relative to thedollar. By the time, we also have higher costs because those are also in Eurosand higher [SME]. So, bottom line the impact really is pretty minimal and thattrend would be somewhere in 2008.

David Begleiter - DeutscheBank

Fair enough. And just Jim onemore thing on the raw materials, what was the GAAP versus price increases in'07 and do you expect the GAAP to close in '08 and get positive in '09?

Jim Kirsch.

We pretty much covered the costbasis David, in terms of the $125 million, so our GAAP is really the marginbasis, if you will. And that's where between some of the manufacturing issueswe had and that inability to cover margin is where we saw the compression andthe gross margins.

David Begleiter - DeutscheBank

So to be clear, you recovered theentire 125 of high raw material cost?

Jim Kirsch

Yes, we did. What we didn't coverwas the margin on top of that. If you do the arithmetic for instance, broadlyto have a 20% or 25% gross margin business, you need to raise your prices tokeep track 30%, 35% right?

David Begleiter - DeutscheBank

Right.

Jim Kirsch

So, we were covering firstportion of that and not necessarily the second.

David Begleiter - DeutscheBank

Understood. And lastly Sallie,'08 you mentioned CapEx equal in the D&A, what is the actual number?

Sallie Bailey

I think David, for thesepurposes, if you wanted, use the $90 million, which is -- what are ourdepreciated D&A was. With that what you see there is the starting point.

David Begleiter - DeutscheBank

Is that's the case, why theincrease in CapEx in 2008?

Sallie Bailey

I say, I am sorry David. Can youask the question again?

David Begleiter - DeutscheBank

If CapEx is 90 in 2008, what isthe -- what accounts for the increase?

Jim Kirsch

What we have been looking atcontinued investments in to our, in particular in our capital -- in ourprograms in Europe and our restructuring programs in Europewould be the biggest piece of this.

David Begleiter - DeutscheBank

Thank you.

Operator

Thank you. Mr. Mike Sison withKeyBanc, your line is open.

Mike Sison - KeyBanc

Hey. Good morning. Goodafternoon. In terms of the raw materials of 125, how much of that is taken careby the pass-throughs or surcharges on an average?

Jim Kirsch

I will have to go back and do acalculation, Mike. But off the top of my head, I would tell you it would be inthe neighborhood of 25% on surcharges.

Mike Sison - KeyBanc

Okay. So the remaining 75% isyour value-added pricing you had to go out and actually get the price increase?

Jim Kirsch

I am sorry. I misunderstood yourquestion. Did you talk about precious metals pass-through?

Mike Sison - KeyBanc

Yeah. Of the 125, does that --that includes precious metals going up, right?

Jim Kirsch

No. It does not.

Mike Sison - Key Banc

Oh. It does not.

Jim Kirsch

No.

Mike Sison - Key Banc

Okay. So the 125 is pure, youhave to go out and get pricing?

Jim Kirsch

Right.

Mike Sison - KeyBanc

Right. Then when you think aboutthe 10% goal that you alluded to get there, you can do that with the businessesthat you have, no divestitures needed, no acquisition?

Jim Kirsch

We are doing that based on thebusinesses we have. That’s correct.

Mike Sison - KeyBanc

When you think about the three,the sort of four buckets you talked about, 1.5% coming from the '07 programs,you have got another 1.5% from the, for what you are going to do in '08 thathit the '09, 1% from electronics and another 0.5% to get the SG&A. Anyvolume assumptions in there or basically if you have flat volumes till 2010 youwould get there, I guess, right?

Jim Kirsch

If you calculate it, you captureall that exactly as I described then the answer would be yes. But I am not, Iam naïve enough to think we are not going to have or have to have organicgrowth because we are going to get some linkage in some of there piecessomewhere.

Mike Sison - KeyBanc

I got you. So you did a littlebit of organic growth to get there assuming some leakage in certain areas.

Jim Kirsch

Yes.

Mike Sison - KeyBanc

Okay. Then I mean other way tolook at it then, if you think about 2007, the precious metals sales beforeprecious metals, 10% of that is about $200 million. So, maybe one way to lookat is that $200 million Op income is sort of a target number?

Jim Kirsch

Looking back, there is notakedown. Well, that would be a pretty reasonable answer.

Mike Sison - KeyBanc

Okay. Great. Then how big issolar now?

Jim Kirsch

We don't define it in that way,Mike.

Mike Sison - KeyBanc

Right.

Jim Kirsch

It's a substantial part of ouradvanced products business within electronic materials and that today is abouthalf of our overall precious metal value added sales in electronic materials.

Mike Sison - KeyBanc

Okay.

Jim Kirsch

Electronic materials for the yearwas 268, I believe.

Mike Sison - KeyBanc

Okay. Then when you think about'08, maybe just talk through the levers to get some growth here, you're goingto get the 1.5% from the cost savings, raw materials. It sounds like you tookcare of them in '07. Rising raw material shouldn't be an issue. It seems likeyou can get pricing. Interest expense should be lower, right. And then involumes, I guess would be the major swing factor in determining whether yourEPS is up or down.

Jim Kirsch

We would expect as we look outthat over the course of our planning period, we expect our electronic materialsbusiness to grow at a compound growth rate of about 10%.

Mike Sison - KeyBanc

Okay.

Jim Kirsch

Industry typically on a materialside grows in the neighborhood of 9, 8 to 9 at least historically. A lot ofnoise in there quarter-to-quarter, sometimes half-to-half, but if you look atthe business and the cycles, it should grow at a compound growth rate around9%. We think we can beat that. We think we can beat that because of thetechnology product offerings we have, particularly in the advanced materialsand surface furnishing. In the inorganics business, our goal is to beat GDP.

Mike Sison - KeyBanc

Okay.

Jim Kirsch

With the GDP driven business andour goal is to as a consequence again integration of capabilities and servicesat our customer's place of business to beat GDP. So, if global GDP is 3%, wewould expect that business to grow at 3.5% or 4%.

Mike Sison - KeyBanc

Okay. Final question, I guess forthe fourth quarter, sort of, tough to get to the actual number. You had talkedthat EPS from operations was 12, in terms of your guidance. What was it if yousort back everything out for the fourth quarter?

Sallie Bailey

Mike, the way that we look at it,it was in fact 12.

Mike Sison - KeyBanc

It was 12, okay.

Sallie Bailey

So, let me just...

Mike Sison - KeyBanc

And so the tax rate was?

Sallie Bailey

Yeah. We use this normalized taxrates of 36%.

Mike Sison - KeyBanc

Okay. So, it did come into 12 forthe fourth quarter.

Sallie Bailey

Yes.

Mike Sison - KeyBanc

And then, I guess when you do themath, Jim, again, I know you don't want to give full await outlooks, butinterest expense is going to be lower. You have some cost savings, tax rates, Iguess, Sallie would be about the same. You have a lot going for you where EPSshould make an improvement in '08 versus '07 directionally?

Jim Kirsch

You have a really good modelsbecause I've seen it before, Mike. And I am going to let you come to your ownconclusions about that.

Mike Sison - KeyBanc

All right. Thanks guys.

Jim Kirsch

Thank you.

Sallie Bailey

Thank you.

Operator

Thank you. Mr. Robert Felice withGabelli & Company. Your line is open.

Robert Felice - Gabelli & Company

Hi. Just a couple of quickquestions, most have been answered though. You talked about the 40, 20, 20 rolein electronic materials getting to that 20% margin over the next two years. AndI guess what I am wondering is how much progress you expect to make in 2008 andwhether that improvement should come as a linear function or whether it wouldbe backend waited toward 2009?

Jim Kirsch

No, it should be a linearfunction and I would tell you that because it's, if you look at what we did in'05 and '06, you'd see we had made substantial improvement and I'm reallyexcited about the mix shift going on there.

Robert Felice - Gabelli & Company

Okay. So in terms of themagnitude of improvement we should expect in '08 or we talking, I mean if stripeverything out, it looks like you are at about 12.5% for the full yearexcluding precious metals. Should I think that you improved by 200 basispoints, just a relative magnitude of improvement would be helpful?

Jim Kirsch

This I'm going to answer that. Iexpect to be at 20% operating margins in that business as we are under 20-10.And we demonstrated particularly in the fourth quarter an excellent return inthat business. So I expect to see improvement in 2008 over 2007 as we marchdown to path of delivering on 40-20-20 rule that we have put out in front ofthe world.

Robert Felice - Gabelli & Company

You think that fourth quartermargin is a new run-rate?

Jim Kirsch

I think the fourth quarter waswhite hot in terms of both solar and MLCC and I think in that industry sectorwhen things get white hot, people over buy. They just can't seem to helpthemselves.

And in addition to that we hadsome really excellent drivers. That's a great season because of the Christmasseason and believe it or not with the Super Bowl right behind it, the largescreen particularly plasma display panels TVs is a big driver.

You get into the first quarterand you have Chinese New Year, and post Super Bowl hangover you tend to see inthat business, softening is a wrong word, but a reduction in demand and ittends to level in second quarter and build again in the third and fourth. So Iwould be hesitant to call the fourth quarter a run-rate for that industry.

Robert Felice - Gabelli & Company

Okay. So it sounds like there isobviously some variation around that maybe the first and second quarter thatwill be a little bit lower but you will slowly work back up to that level?

Jim Kirsch

I think that's a fair assessment.

Robert Felice - Gabelli & Company

Okay.. And then, shifting gears,I guess, I was little surprise at the year-over-year Op decline in Color andGlass. This does seem to be progressing pretty well throughout the entire year.I just hope, you can just touch on what cause the fourth quarter decline?

Jim Kirsch

Do you mean fourth quarter overfourth quarter?

Robert Felice - Gabelli & Company

Yeah.

Jim Kirsch

In the fourth quarter of a yearago, there was a new German tax coming in to play for the first quarter of '07.And we saw a pretty hard run on materials. So there was about a 3% VAT tax andwe saw a pretty hard run on materials in the fourth quarter, particularlyrelated to the automotive glass. Then it was sort of interesting in retrospect,the first quarter '07 was a very strong quarter, even as a consequence of that-- though that VAT tax had been implemented. So I would tell you that thefourth quarter of '07 was a bit more normalized particularly given the economicconditions around some of the end use markets i.e. automotive in particularthat we were facing.

Robert Felice - Gabelli & Company

So, just specifically toughercomp year-over-year?

Jim Kirsch

Yes.

Robert Felice - Gabelli & Company

Okay. And then if I remembercorrectly, within the inorganic business, you would have expected $15 millionto $20 million in incremental saving during '08, and if I heard correctly, Iknow you had mentioned $10 million to $12 million. I guess what caused you tolower those estimates and do you still expect $40 million to $50 million intotal savings?

Jim Kirsch

Yes. I have not lowered ourestimates, the $15 million to $20 million in corporate is the electronicmaterials, restructuring in Niagara Falls as well. So, just to be clear, we expect to get$40 million to $50 million in total out of our European restructuring inorganics, and we expected to get $7 million to $8 million in the US outof the restructuring of electronic materials. We've gotten electronic materialsdone and we are already seeing that being delivered in to the business. And weexpect in 2008 to realize $10 million, $12 million in inorganics and another $4million, $5 million in electronics, which gives me that $15 million to $20million range.

We have announced ourrestructuring shutdown of our Rotterdam facility, and as we roll into thesecond half of this year and into '09, we'll see the full benefit of thatsignificant restructuring as well, which will give us, in my view, anotherkick-up in terms of incremental cost savings in Europe. So, we have notchanged, in fact, we're on or ahead of schedule in all the restructuringactivities we're doing in Europe.

Robert Felice - Gabelli & Company

And what are the timing of thosesavings as we move throughout 2008?

Jim Kirsch

We have more in the second halfthan the first and the reasons behind that are as we are running out that newcolor plant that I mentioned we built in September. We will continue to moveforward to consolidate into that facility. And in addition to that, we'reconsolidating from Rotterdam into Spainfrom our, in our porcelain enamel business. That will be complete in theJulyish timeframe, July-August. So I would expect in the second half to seemore of those savings in the first.

Robert Felice - Gabelli & Company

Okay. That's helpful. And I guess--

Jim Kirsch

Thanks. We're just about out oftime and we have got one more person on the queue, if we could -- I am sorry.

Robert Felice - Gabelli & Company

Yeah. Of course.

Jim Kirsch

Can we have the last questionplease?

Operator

Thank you. Mr. Christopher Butlerwith Sidoti and Company. Your line is open..

Christopher Butler - Sidoti and Company

Hi. Good afternoon.

Jim Kirsch

Hi, Christopher..

Sallie Bailey

Hi Chris..

Christopher Butler - Sidoti and Company

Thanks for taking my finalquestions here.

Jim Kirsch

You bet..

Christopher Butler - Sidoti and Company

First off, on the surcharges,could you give me an idea of what we're looking at here, what the permanenceinvolved whether or not if pricing goes up, are you going to have to put inmore surcharges? Give us some color as to exactly what we're looking at?

Jim Kirsch

The simple answer is, I'd preferdirect pricing to surcharges, but if the rapidity of the metals increasemaintains itself on the pace that it has been in the last 60 days you shouldexpect to see more surcharges and that we will attempt to go back and negotiateand recover margin as we go through time.

Christopher Butler - Sidoti and Company

And from that it sounds as if thelast 60 days here in the first quarter cost continue to go up. Is thatsomething that you have embedded in your guidance for the first quarter?

Jim Kirsch

Yes we have.

Christopher Butler - Sidoti and Company

And similarly costs are going up.Your prices are going up. You are shifting to more value-based products, yetworking capital was basically flat year-over-year. This improvement that youare putting through -- remember that last year's working capital was up alittle bit. Is this trimming that down? Can you give some idea of what's takingplace there?

Sallie Bailey

Well I think, Christopher, if youlook on the cash flow season and perhaps what we should do is wait until deferthat question until the K. Actually, you got a chance to look at the K. Becausewhen you look at the K, you'll be able to see the various components of workingcapital. We did generate cash from inventory in the year especially in thesecond half of the year.

Christopher Butler - Sidoti and Company

It sounds like, on the inventoryside that you're doing a pretty good job of keeping volumes down there?

Sallie Bailey

Right. I know you can't see itbecause it doesn't show up on the cash flow that we put out with the pressrelease also it doesn't show up -- you can't see it on the balance sheetbecause, of course, you do cash flows you have to take out the impact of theinventory -- I am sorry, of the foreign exchange. But when you get a chance tolook at the 10-K, what you'll see is that in 2006 we used about $30 million ofcash from inventory and in 2007, we generated cash of about $21 million.

Christopher Butler - Sidoti and Company

All right. Thank you. I willleave with that.

Jim Kirsch

Thank you very much.

David Longfellow

All right. Well, thank you verymuch. That concludes today's conference call. For copies of our press release,replays of this call or access to our SEC filings, please go to our website atwww.ferro.com and click on investor information. Thank you and have a goodafternoon.

Operator

Thank you. That concludes today'sconference call. You may disconnect at this time.

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Source: Ferro Corp. Q4 2007 Earnings Call Transcript

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