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Executives

Jim Kirsch - Chairman, President and CEO

Sallie Bailey - VP and CFO

David Longfellow - Director of IR

Analysts

Mike Harrison - First Analysis

Rosemarie Morbelli - Ingalls and Snyder

David Begleiter - Deutsche Bank

Mike Sison - KeyBanc

Robert Felice - Gabelli & Company

Christopher Butler - Sidoti and Company

Ferro Corp. (FOE) Q4 2007 Earnings Call February 29, 2008 1:00 PM ET

Operator

Welcome to Ferro Corporation's 2007 fourth quarter Earnings Call. All participants will be in listen-only mode until the question-and-answer session. (Operator Instruction) This conference is being recorded, if you have any objections, please disconnect at this time.

Now I' like to turn the meeting over 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 and welcome to the Ferro Corporation Earnings Call. Today we will provide the information about our financial results for the period ended December 31, 2007 and we will discuss our expectations for the first quarter. Joining me on today's call are Jim Kirsch, Chairman, President, and Chief Executive Officer and Sallie Bailey, Vice President and Chief Financial Officer.

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

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

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

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

Jim Kirsch

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

2007 was a year of substantial progress within Ferro, but was also a year in which the evidence of that progress measured by our earnings was less than we had hoped. Nevertheless we took significant steps toward our goal of building a better Ferro. In 2007 we continued building a foundation for sustainable improvements in Ferro’s operations. Through the combined efforts of our team we were able to generate over $145 million in net cash flow from operating activities. Then we reduced our overall debt by more than $60 million.

Although, we still have a lot of work ahead of us to reach our profitability objectives, we are making progress in a number of important areas. First we are reshaping our manufacturing operations through our restructuring initiatives. We discontinued dielectric materials production at our Niagara Falls location, and electronic materials and transferred production to other existing sites in the US and Europe. We also sold the Niagara Falls site to an industrial ceramic business that operated there.

By completing this restructuring project on schedule we lowered our fixed costs, reduced headcount and improved the capacity utilization in our remaining manufacturing locations. This restructuring will deliver the $7 million to $8 million in annual cost savings that we had planned.

In Europe we made excellent progress on a number of restructuring projects, our new world class color plant began operations in Spain during September and in 2008, we will continue to consolidate additional element of our heavy manufacturing into this site.

We also kicked off a project to consolidate porcelain and enamel production from Rotterdam to our site in Spain.

We successfully transferred other production operations from Frankfurt to Colditz, Germany where we have a lower cost structure. Our European restructuring projects are progressing 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 new Vice President of Operations Tom Austin who is leading in number of important projects from lean manufacturing to procurement improvements.

Tom was instrumental in our efforts to improve safety and operating procedures at our South Plainfield, New Jersey, an electronic materials plant. While we absorbed some added cost from the interrupted manufacturing at the site in April, the benefits of these actions became apparent by the end of the year. By the fourth quarter, the employees at our South Plainfield plant were setting records for the amount of material processed and their overall productivity.

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

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

Our cost and expense reduction efforts are also making a difference. A year ago, we took action to reduce expenses 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 Additives products for PVC manufacturers. We've also extended and penetrated new markets such as Concrete Additives. As a result, even though, many of the key application markets for these products declined significantly during 2007, our combined Polymer Additives and Specialty Plastic segments increased sales during the year and delivered nearly the same segment income despite the unplanned manufacturing costs we experienced in the fourth quarter.

Our ability to deliver improved performance in tough market conditions will continue to be tested in 2008. Whether or not the overall US economy enters a recession, we know that many of the markets we serve will be difficult this year. However, we remain committed to improving our results. Our longer term goals have not changed and our resolve to reach those goals is unflinching.

On previous conference calls, we have discussed our goal to achieve 10% operating margins, defined by total segment income, less corporate and allocated charges as a percent of sales excluding 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 to improve the performance at levels that is competitive with our specialty material peers.

Our 2007 operating margins were of course affected by various charges for unusual items that are described in today's press release. However, if you adjust for those charges, our 2007 operating margin as a percentage of sales excluding precious medals was just under 6%.

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

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

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

In addition, we have made changes in our worldwide procurement organization and we believe we can reduce our cost as we address our $1.6 billion annual spend for goods and services. We expect these combined initiatives to eliminate unplanned cost, improve procurement effectiveness and manufacturing productivity, to deliver an incremental improvement of 1.5 points of operating margin by year-end 2009.

During 2007, we spoke publicly about our 40-20-20 business model objectives in our electronic materials segment. This means, we expect the business to achieve 40% gross margins and 20% operating margins, while we invest 20% of sales in SG&A and research and development. All of these percentages are relative to sales excluding precious 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 excluding precious metals..

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

Another opportunity for operating margin improvement comes from reduction in our SG&A expense. Through the broader implementation of shared services models in our corporate functions, it improved business processes in our operating groups. We believe we can continue to reduce SG&A as a percent of sales as we have done for the past two years and add another half point to operating margins.

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

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

We continue to see the internal targets for costs and expense improvements in excess of the amounts of outlined to strengthen our confidence in achieving our overall goals. As we move in to 2008 one priority is to aggressively address the key external issue that pressured our gross margins in 2007.

During the year, we experienced sharp and perhaps unprecedented increases in the cost of a number of raw materials that are essential to our specialty products. In the past year, we saw costs for raw materials affect the operations of all of our operating groups. That includes cobalt, chrome oxide, bismuth and nickel used in our inorganic specialties business; polypropylene, tallow and soybean oil are used in 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 nickel and bismuth also increased by a factor of three before coming off their peak prices recently. Price of tallow increased from around $0.22 per pound in early 2007 to $0.31 late in the year and continues to move upward.

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

We expected to make progress on the price versus raw material cost equation in 2007 fourth quarter. But because of some continued rapid price movements, we are only able to maintain the position we had in the third quarter. Therefore, while our gross margins excluding charges improved sequentially from the third quarter of 2007. They did not improve to the extent at which we had planned.

In 2008, we'll continue to work collaboratively with our customers to reformulate products where possible using less expensive raw materials. We have set aggressive targets to improve our manufacturing and conversion costs and we will set our prices, where we can earn a fair return on our investment. Through these actions, we expect to make progress in recovering gross margin that we lost over the past four quarters as a result of the extraordinarily rapid increase in raw materials.

At the beginning of 2008, we are facing 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, we announced additional reductions on our worldwide operations. Most of these reductions were incremental to our ongoing European restructuring.

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

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

Sallie Bailey

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

Our net sales for the year ended December 31, 2007 were $2.2 billion, an increase of 8% over 2006. Sales increase for the year was driven by product price increases and favorable foreign exchange rates. Price increases accounted for about two-thirds of the higher net sales. At an aggregate level, volume had a slightly negative impact on sales. Volume decline were primarily in our Porcelain and Enamel business and Performance Coating as well as in the Specialty Plastics and Polymer Additive segments.

These businesses were negatively impacted by weak demand in the US market for appliances and automobile. Volume was a positive driver for sales in our Color and Glass Performance Material segment. Volume was neutral in our Electronic Material segment as the business overcame weak demand for dielectric materials in the first half of the year, with improved volume in the second half of the year, particularly for our Solar Material and Metal Powders for plasma display.

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

In addition, we expensed approximately $10 million of unexpected manufacturing cost as a result of our quality issues in Evansville, Indiana, the intervention for safety in operating procedures in South Plainfield, New Jersey and the plants interruption at Bridgeport, New Jersey, Organics Chemicals plant.

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

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

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

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

Income from Electronic Materials was covered in the second half of the year due to a strong sales of our Advanced Materials for solar cells and plasma displays, the recovery, the demand for dielectric materials and a manufacturing productivity improvements resulting from actions taken in our South Plainfield facility..

In our reconciliation of segment income to income from continuing operations before taxes, we reported unallocated corporate expenses of $56.4 million in 2007. This amount includes approximately $20.1 million of one-time items. In 2008, we expect corporate unallocated expenses, net of these types of one-time items to be less than 2007. However, corporate unallocated expense is generally high in the first quarter as a result of the timing of audit fees.

2007, we recorded a loss from continuing operations as a result of the $128.7 million impairment charge we recorded in the fourth quarter. This charge, which we discussed in our press release on February 11th, was a non-cash write-down of goodwill on long-lived assets related to our polymer additives and pharmaceutical businesses. Details of the impairment charge, including the amount of goodwill and asset impairments by business unit are available on note 17 in our 2007 10-K report.

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

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

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

The 2007 cash contributions for US pension plan were $22.6 million and $8.7 million for non-US plans. We expect these 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 to the decline in balance sheet debt was the elimination of cash deposits for precious metals, which occurred in the first quarter of 2007. At the end of the year, we had net proceeds of $54.6 million from our off balance sheet US asset securitization program and an additional $42.1 million of net proceeds from similar programs outside the US.

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

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

Sales decline in other businesses was the result of declines in our pharmaceuticals products. These product sales continue to be affected by uneven demand as our customers enter and exit production cycles in various stages of their drug development program.

Reported gross margin for the quarter was 17.9% of sales, down from 19.7% in the fourth quarter of 2006 and 18.2% in the third quarter of 2007. The primary driver for the decline in gross margin from 2006 was our inability to increase product prices to compensate for higher raw material cost, sufficient enough to maintain gross margins.

Gross profit for the fourth quarter included $3.2 million in charges related to our manufacturing rationalization, including accelerated depreciation. Gross profit was also negatively impacted by the manufacturing disruption at our Bridgeport, New Jersey plant which added approximately $2 million in cost during the fourth quarter.

Considering the length of time required to reestablish steady-state operations in the biological waste water treatment at the Bridgeport plant, we expect approximately $2 million to $3 million in added cost during the first quarter of 2008. The plant is now operating in a normal production levels.

SG&A expenses in the fourth quarter 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 legal settlements during the quarter.

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

Our fourth quarter results include the $128.7 million impairment charge for goodwill and long life assets that I discussed earlier.

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

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

Total segment income for the quarter was $35.5 million, up from segment income of $33.3 million in the fourth quarter of 2006. Compared with the fourth quarter of 2006, income increased in the Electronic Material, Polymer Additives and Specialty plastic segments.

Increase in Electronic Material was driven by volume increases, particularly for metal paste and powders used in solar cells and plasma displays.

Income improved in Polymer Additives despite the issues in the Bridgeport Plant as a result of improved manufacturing volumes and price increases that were able to cover raw material cost increases

Income increased in Specialty Plastics, primarily as a result of product pricing increases and SG&A expense reductions.

Income declined from the prior year fourth quarter in our Performance Coatings, Color and Glass Performance Materials and other business segment. The primary factor on the decline was increased raw material costs that were not sufficiently match by price increases to maintain our gross margin percentages.

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

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

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

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

David Longfellow

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

Question-and-Answer Session

Operator

Yes. Thank you, sir. (Operator Instructions) Our first question comes from Mr. Mike Harrison with First Analysis. 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 materials segment, 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 in terms of demand for those three product areas in Q4? And maybe what your outlook is for 2008?

Jim Kirsch

Sure, Mike. Let me start at the bottom with CMP because CMP is really tiny. Let's talk more, if you will, about surface finishing because that's really our broader segment, polishing, okay? Because we're still quite small in CMP, specifically we continue to see growth and 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 growth in that particular area.

Dielectrics has been, was much stronger in the second half of '07 than it was in '08. Its return to what I would suggest would be more normalized levels, which is not unusual in the first 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 are claiming, we expect to see single-digit growth in that particular market segment.

Mike Harrison - First Analysis

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

Jim Kirsch

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

Mike Harrison - First Analysis

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

Jim Kirsch

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

In the metal side, in the base metals, here you are talking we are an oxide player in cobalt and we have talked 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 or so. Cobalt, chrome oxide, zinc, nickel those are drivers in our Performance Coatings 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 with pricing activities, raw material substitution activities, and utilized improvements in manufacturing, surcharges etc, to fight the good fight.

Mike Harrison - First Analysis

And then what about bismuth business, how significant is that in, remind me again what segment that shows up in?

Jim Kirsch

It ends up in our organic businesses and it is a significant raw material for us. It is one of the few metals where we really are, if you would, a world scale player. So, we are working hard to leverage our ability to buy on a market basis or relatively large quantities of bismuth and using that to leverage two additional suppliers and improve our price cost position if you will.

Mike Harrison - First Analysis

Oh, right. Then the, the last things I wanted to ask about is, you referred to an umbrella term unplanned manufacturing cost. You have stepped-up efforts to identify problems that need to be fixed. Can you talk about some of the costs that have been or they will be associated with these efforts to try to identify these problems. And I am just kind of curious if may be the Bridgeport problem is something that could have been identified prior or was it really sort of a one-time or completely changed event?

Jim Kirsch

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

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

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

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

At Bridgeport, again, I would tell you that the event that occurred was preventable. It was not a chance event. Our systems worked appropriately in terms of the warning that we had a manufacturing interruption occurring and we're moving product into our wastewater treatment facility at a rate that could potentially overwhelm the plant. And our people didn't react quickly or in diagnosing the problem appropriately or fasten up and then taking action once it was diagnosed.

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

Mike Harrison - First Analysis

All right. I appreciate color there. Thanks.

Operator

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

Rosemarie Morbelli - Ingalls and Snyder

Thank you, and good afternoon all. Following up on this topic, Jim, have you looked at all of your global manufacturing facilities to see if there are any similar problem growing there and 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 brought aboard was to assist us in enhancing not only things like productivity and our lean initiatives, but also recalibrating, if you will, the facilities themselves. In other words, within each of the business units, we've now have in place very good manufacturing directors, but we're not the same people that were running our global manufacturing operations two years ago.

Tom is highly experienced chemical operator. He has over 30 years of experience at Dow in running a variety of chemical processing facilities and their global maintenance and as a individual I have great confidence in him. In addition to that, I have great confidence in our three operating Vice Presidents in the manufacturing infrastructure they put in place with their people. It is interesting to note, if you think about where the problems have occurred, within the United States in chemical processing plants that have not necessarily been core to what this company was founded on as we have grown.

So I think that we have managed to step back, reexamine and reevaluate all of our procedure ,throughout our facilities, starting with safety and starting with environmental and making sure our environmental health and safety records are in compliance and we want our people to return home in the shape they came in. And I am very confident that the process improvements we are putting in place will enable us to diagnose early, make sure that we understand the potential problems we have and address them prior to them becoming very difficult issues for us or our shareholders.

Rosemarie Morbelli - Ingalls and Snyder

Thanks. That is very helpful. Is there a cost associated with this project, which will be more than standard in 2008 and will disappear in 2007?

Jim Kirsch

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

Rosemarie Morbelli - Ingalls and Snyder

I guess I did not phrase this properly. I meant that the fact that you are currently retraining people, looking at all of your manufacturing facilities, looking for those improvements, which will end up lowering your overall costs. So those costs kind 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 showing higher costs to look where the problems are and what can be fixed?

Jim Kirsch

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

Rosemarie Morbelli - Ingalls and Snyder

Okay and you had additional raw material 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've been wrong every year. I've prognosticated it because we didn't think we would see the run-up in '04 that we did. We didn't think, I don't think that many people in the industry thought that in '06 we would see or in '07 particularly in commodities. The extraordinary run-ups we've seen, I mean the rate of change and the slope of that curve has been something that, at the least is quite extraordinary. So, we have budgeted for some additional raw material cost in our operating budgets. But I am not going to make a prediction of what I think some of these metals or these other commodities will do.

Rosemarie Morbelli - Ingalls and Snyder

Will you share with us how much you have budgeted for?

Jim Kirsch

No. I can't. I don't want to share that with you.

Rosemarie Morbelli - Ingalls and Snyder

You wondered that -- okay. And in an environment -- my last question, if I may, in the somewhat recessionary environment raw material costs continuing to go up and your goal is to improve your mix and get paid for the value of your products and services. Do you think that you will continue to be able to raise those selling prizes, if the demand slows 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 the elasticity while it's not as elastic, I guess I'll say, as it was two years ago. Yes, I think we'll continue to be able to pass along cost to customers where we have used surcharges in the recent past. We will continue to call back and try to regain margin.

As I went into some detail on my remarks about operating margins, I think there are other tools that are disposal. Our improvements in procurement, our improvements in manufacturing operations, and I don't want to lose sight of the repositioning that's going on within our businesses to higher value markets is quite significant. We have substantially lowered our exposure to PVC in the polymer additives business, for instance. We have substantially increased our exposure in solar, in our electronic materials businesses, and as a consequence our exposure to dielectric 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. Your line is open.

David Begleiter - Deutsche Bank

Thank you. Good afternoon.

Jim Kirsch

Hi, David.

David Begleiter - Deutsche Bank

Jim, can you comment on recent demand trends in both the U.S. and Europe, any change in the delta from a volume standpoint?

Jim Kirsch

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

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

David Begleiter - Deutsche Bank

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

Sallie Bailey

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

David Begleiter - Deutsche Bank

Fair enough. And just Jim one more 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 cost basis David, in terms of the $125 million, so our GAAP is really the margin basis, if you will. And that's where between some of the manufacturing issues we had and that inability to cover margin is where we saw the compression and the gross margins.

David Begleiter - Deutsche Bank

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

Jim Kirsch

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

David Begleiter - Deutsche Bank

Right.

Jim Kirsch

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

David Begleiter - Deutsche Bank

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

Sallie Bailey

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

David Begleiter - Deutsche Bank

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

Sallie Bailey

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

David Begleiter - Deutsche Bank

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

Jim Kirsch

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

David Begleiter - Deutsche Bank

Thank you.

Operator

Thank you. Mr. Mike Sison with KeyBanc, your line is open.

Mike Sison - KeyBanc

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

Jim Kirsch

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

Mike Sison - KeyBanc

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

Jim Kirsch

I am sorry. I misunderstood your question. 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, you have to go out and get pricing?

Jim Kirsch

Right.

Mike Sison - KeyBanc

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

Jim Kirsch

We are doing that based on the businesses 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 that hit the '09, 1% from electronics and another 0.5% to get the SG&A. Any volume assumptions in there or basically if you have flat volumes till 2010 you would get there, I guess, right?

Jim Kirsch

If you calculate it, you capture all that exactly as I described then the answer would be yes. But I am not, I am naïve enough to think we are not going to have or have to have organic growth because we are going to get some linkage in some of there pieces somewhere.

Mike Sison - KeyBanc

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

Jim Kirsch

Yes.

Mike Sison - KeyBanc

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

Jim Kirsch

Looking back, there is no takedown. Well, that would be a pretty reasonable answer.

Mike Sison - KeyBanc

Okay. Great. Then how big is solar now?

Jim Kirsch

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

Mike Sison - KeyBanc

Right.

Jim Kirsch

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

Mike Sison - KeyBanc

Okay.

Jim Kirsch

Electronic materials for the year was 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 going to get the 1.5% from the cost savings, raw materials. It sounds like you took care of them in '07. Rising raw material shouldn't be an issue. It seems like you can get pricing. Interest expense should be lower, right. And then in volumes, I guess would be the major swing factor in determining whether your EPS is up or down.

Jim Kirsch

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

Mike Sison - KeyBanc

Okay.

Jim Kirsch

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

Mike Sison - KeyBanc

Okay.

Jim Kirsch

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

Mike Sison - KeyBanc

Okay. Final question, I guess for the fourth quarter, sort of, tough to get to the actual number. You had talked that EPS from operations was 12, in terms of your guidance. What was it if you sort 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 tax rates of 36%.

Mike Sison - KeyBanc

Okay. So, it did come into 12 for the fourth quarter.

Sallie Bailey

Yes.

Mike Sison - KeyBanc

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

Jim Kirsch

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

Mike Sison - KeyBanc

All right. Thanks guys.

Jim Kirsch

Thank you.

Sallie Bailey

Thank you.

Operator

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

Robert Felice - Gabelli & Company

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

Jim Kirsch

No, it should be a linear function 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 really excited about the mix shift going on there.

Robert Felice - Gabelli & Company

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

Jim Kirsch

This I'm going to answer that. I expect 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 in that business. So I expect to see improvement in 2008 over 2007 as we march down to path of delivering on 40-20-20 rule that we have put out in front of the world.

Robert Felice - Gabelli & Company

You think that fourth quarter margin is a new run-rate?

Jim Kirsch

I think the fourth quarter was white hot in terms of both solar and MLCC and I think in that industry sector when things get white hot, people over buy. They just can't seem to help themselves.

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

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

Robert Felice - Gabelli & Company

Okay. So it sounds like there is obviously some variation around that maybe the first and second quarter that will 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 and Glass. 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 over fourth quarter?

Robert Felice - Gabelli & Company

Yeah.

Jim Kirsch

In the fourth quarter of a year ago, 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 and we saw a pretty hard run on materials in the fourth quarter, particularly related 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 the fourth quarter of '07 was a bit more normalized particularly given the economic conditions around some of the end use markets i.e. automotive in particular that we were facing.

Robert Felice - Gabelli & Company

So, just specifically tougher comp year-over-year?

Jim Kirsch

Yes.

Robert Felice - Gabelli & Company

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

Jim Kirsch

Yes. I have not lowered our estimates, the $15 million to $20 million in corporate is the electronic materials, 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 in organics, and we expected to get $7 million to $8 million in the US out of the restructuring of electronic materials. We've gotten electronic materials done and we are already seeing that being delivered in to the business. And we expect in 2008 to realize $10 million, $12 million in inorganics and another $4 million, $5 million in electronics, which gives me that $15 million to $20 million range.

We have announced our restructuring shutdown of our Rotterdam facility, and as we roll into the second half of this year and into '09, we'll see the full benefit of that significant restructuring as well, which will give us, in my view, another kick-up in terms of incremental cost savings in Europe. So, we have not changed, in fact, we're on or ahead of schedule in all the restructuring activities we're doing in Europe.

Robert Felice - Gabelli & Company

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

Jim Kirsch

We have more in the second half than the first and the reasons behind that are as we are running out that new color plant that I mentioned we built in September. We will continue to move forward to consolidate into that facility. And in addition to that, we're consolidating from Rotterdam into Spain from our, in our porcelain enamel business. That will be complete in the Julyish timeframe, July-August. So I would expect in the second half to see more 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 of time 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 question please?

Operator

Thank you. Mr. Christopher Butler with 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 final questions 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 permanence involved whether or not if pricing goes up, are you going to have to put in more surcharges? Give us some color as to exactly what we're looking at?

Jim Kirsch

The simple answer is, I'd prefer direct pricing to surcharges, but if the rapidity of the metals increase maintains itself on the pace that it has been in the last 60 days you should expect to see more surcharges and that we will attempt to go back and negotiate and recover margin as we go through time.

Christopher Butler - Sidoti and Company

And from that it sounds as if the last 60 days here in the first quarter cost continue to go up. Is that something 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, yet working capital was basically flat year-over-year. This improvement that you are putting through -- remember that last year's working capital was up a little bit. Is this trimming that down? Can you give some idea of what's taking place there?

Sallie Bailey

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

Christopher Butler - Sidoti and Company

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

Sallie Bailey

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

Christopher Butler - Sidoti and Company

All right. Thank you. I will leave with that.

Jim Kirsch

Thank you very much.

David Longfellow

All right. Well, thank you very much. 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 at www.ferro.com and click on investor information. Thank you and have a good afternoon.

Operator

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

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Source: Ferro Corp. Q4 2007 Earnings Call Transcript
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