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Ferro Corporation (NYSE:FOE)

Q1 2008 Earnings Call Transcript

May 7, 2008 10:00 am ET

Executives

David Longfellow – Director of IR

James Kirsch – Chairman, President and CEO

Sallie Bailey – VP and CFO

Analysts

Mike Sison – KeyBanc

David Begleiter – Deutsche Bank

Mike Harrison – First Analysis

Rosemarie Morbelli – Ingalls & Snyder

Robert Felice – Gabelli & Co.

Dmitry Silversteyn – Longbow Research

Christopher Butler – Sidoti & Co.

Operator

Good morning, and welcome to the Ferro Corporation's 2008 first quarter earnings conference call. The participants will be in listen-only mode until the question-and-answer session. (Operator instructions) This conference is being recorded. If there are any objections you may disconnect at this time. I'd like to introduce your host, Mr. David Longfellow, Director of Investor Relations. Mr. Longfellow, you may begin.

David Longfellow

Thank you. Good morning and welcome to the Ferro Corporation earnings conference call. Today, we will provide information about our financial results for the period ended March 31, 2008, and we will discuss our expectations for the second 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 first quarter performance, our view of the market environment, and highlights of our business unit results. Sallie will follow with a more detailed discussion of the first-quarter financial performance and our second-quarter outlook. Following our prepared remarks, Jim and Sally will take your questions.

I hope you have all had an opportunity to review the press release we issued yesterday. Copies of the press release are available on the Investor Relations portion of Ferro's web site, which is located at www.ferro.com. Also available on our web site is a reconciliation of reported results to non-GAAP amounts discussed from this conference call. 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 May 7, 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, retransmission 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, you may listen to or download a replay of the call through the Ferro Investor Relations web site.

I'd now like to turn the call over to Jim.

Jim Kirsch

Thank you, David, and thank you to everyone who has joined us this morning. Before I start, I also wanted to thank the Ferro people who may be listening. Your efforts and commitment to winning are bearing fruit and I'm proud of all you’re doing. That being said, on today's call, I'll provide some perspective on our 2008 first-quarter results, our view of the market environment, and what actions we are taking to continue building sustainable improvements in our operating results. Following my remarks, Sallie will provide additional details on the quarter's results and our outlook for the second quarter. We'll then open the call for your questions.

The first quarter showed improvement compared with the first quarter of 2007 and was better than the estimates we provided on our fourth -quarter 2007 conference call in February. Compared with a year ago, our first-quarter sales were 15% higher, SG&A expenses declined as a percent of sales, and income from continuing operations was more than 40% higher. All in all, a good start to the year. These results came in amidst of difficult macro-economic conditions in many of the markets we serve, particularly in the United States. The results are the product of a lot of hard work throughout Ferro, as we continue to focus on value creation by aggressively controlling costs and expenses, executing on our restructuring initiatives, pricing our products in a way that's consistent with the value we provide, while covering the escalating costs of raw materials, and improving operational execution across every facet of our business. Our plan for the coming quarters is to continue every one of these efforts. While we are pleased with the first-quarter results, there remains work to be done, and I'm confident that these initiatives will deliver sustainable progress toward our goal of 10% operating margins. Making consistent progress against our goals starts with the distinctive products, customer service, and operation support delivered by each of our operating groups.

I'll take the next few minutes to talk about what is happening in each of our three business groups. Then I'll discuss the actions we are taking more broadly across Ferro to keep in step with our view of global market conditions. Our organic specialties group, including the polymer additives, specialty plastics, and other business segments, continues to be the business most affected by weak customer demand in the United States. The demand for materials related to automotive parts, appliances, and residential construction has been depressed for a number of quarters and we, like others, expect the weak conditions to continue for several more. Because of these market conditions, we took actions to reduce our cost structure in late 2006 and in 2007. We are seeing the benefits of those actions now. By combining the market sell efforts in polymer additives and specialty plastics last year, we took a major step forward in productivity. This reorganization also helped us to reposition our product line into higher margin opportunities such as additives for concrete, oil fueled applications, and synthetic wood decking. This repositioning of our products has moderated the decline in our volumes over the past year to about half of the industry average by our estimation.

Specialty plastics income was down for the quarter as the benefits of cost cutting and product price increases were not enough to offset the combination of weak demand, lower volume, and raw material cost increases. Last month we made additional head count reductions in our specialty plastics business, primarily related to our manufacturing operations. We'll begin to see the benefits of these actions in our financial results for the second quarter.

As we forecasted during the earnings conference call in February, our first-quarter results in polymer additives were affected by additional cost related to the manufacturing issues at our Bridgeport, New Jersey, plant. Operating income in the segment was reduced by cost related to the remediation efforts required by the wastewater treatment incident at Bridgeport in December, 2007. Without these $3.3 million in costs, the polymer additive segment would have shown a strong improvement in income compared with the first quarter of 2007. This performance is due largely to the progress we have made in pricing our products to cover increases in raw material costs and our ability to reposition our products to a broader customer base beyond commodity PVC manufacturers.

Our pharmaceutical and fine chemicals business matched its strong performance in last year's first quarter. We continue to see a good pipeline of products in the pharmaceutical area and we currently have six commercial products in production, in addition to our fee-per-service and clinical trial support services. Our electrolyte products within the fine chemicals business continue to make progress as well, as we are now supplying electrolytes for lithium ion batteries in China from our plant in Suzhou. We are well positioned for opportunities in hybrid electric cars and ultracapacitors. The first quarter historically has been strong for our inorganic specialties group, including the performance coatings, and color and glass performance materials segments, and this year was no exception. The team delivered solid improvements in income on a sequential basis compared with the fourth quarter of 2007. Growth has been achieved in the business despite a slowing European economy and weakness in the United States. We see this particularly in slow U.S. auto production and appliance demand, as well as weaker orders from construction-related applications in southern Europe. However, we continue to do an excellent job of generating additional business in the Middle East, North Africa, Eastern Europe and Russia, offsetting slower growth in the traditional European markets. Stronger-than-expected results from our European tile business helped us beat our original income estimates for the first quarter. Growth in Asia remains healthy and we are in a good position to capitalize on that growth through our manufacturing capabilities for tile coatings in Indonesia and Thailand, and colors and pigments (inaudible) two facilities in China. Our Asian sales of auto glass enamels also did very well in the first quarter. Latin America was a positive contributor to the inorganics results in the first quarter as well.

Results in our electronic materials business were significantly improved over the first quarter of 2007, when supply chain adjustments reduced demand for our dielectric materials. The product mix in this business continues to move away from the dielectrics due to the growth of advanced metal pastes and powders. This successful mix shift is an important factor as we move toward the 40-20-20 operating model that we believe is appropriate for the business. Our metal paste for solar cells continued to lead the growth in the electronic materials segment. We are now suppliers to seven of the Top Ten solar cell producers, shown in the latest industry ranking by PHOTON International, a trade magazine that covers the photovoltaic industry. Our sales in Asia, particularly China, are growing rapidly and we are looking forward to supplying these customers from the manufacturing facility we are currently constructing in Suzhou. We expect the Suzhou plant will be delivering commercial product before the end of 2008. Another product line in our electronics business, our surface finishing products, also had a very good quarter. Sales growth was led by high-end ophthalmic polishing applications. Because the growth is being driven through higher margin products, income contribution from this business is improving.

To continue the positive momentum of the first-quarter results, we continue to take aggressive actions across Ferro. We need to make sure our resources are well aligned to the level of business activity, particularly in an environment like we have currently, where demand from certain customers or regions may be weak. Consequently, we continue to evaluate our businesses and find areas where we can be more productive. We have taken cost control actions in 2008 in our organics business, as I mentioned, and we have taken further actions in our inorganics business in addition to the ongoing European manufacturing restructuring. Our restructuring actions continue to be on schedule and on budget. We completed our electronic materials project in Niagara Falls, New York at the end of 2007, and we will achieve incremental savings of 3 to $4 million this year. We have closed our Italian color plant and we successfully transferred production to our new plant in Spain, where we continue to ramp up capacity. Our European operations team is progressing on schedule with the consolidation of our porcelain enamel facility in Rotterdam, and we expect to have all production transferred to Spain during the third quarter of this year.

Incremental savings during 2008 from our restructuring programs are forecasted to be $12 million to $15 million. All of these actions in the business units, along with more efficient corporate shared services, are designed to build a foundation of sustainable progress to our 10% margin goal. I am confident we are on the right path, and I'm pleased with the results we are sharing with you today provide evidence that we are making significant progress. We are determined no build on this success in the months ahead. However, because we are cautious about the macro-economic environment, we will continue to stress to all our team that we must remain keenly focused on continuous improvement, getting better at what we do every day and rigorously measuring our progress. In addition, we must be able to effectively manage those variables that are not within our direct control. We must anticipate and be ready to react with velocity to external surprises, so that we can deliver the consistent improvements in operating results to which we are committed.

I'll now turn the call over to Sallie who will review the financial results in more detail and discuss our second-quarter estimates before we open up the call for your questions. Sallie?

Sallie Bailey

Thanks, Jim. Today, I'll start with a recap of the 2008 first-quarter results, and I'll then discuss our current estimates for the second quarter. Our earnings for the three months ended March 31, 2008, were $0.21 per diluted share, including special charges, up 50% from the $0.14 per share we recorded in the first quarter of 2007. Our net sales for the first quarter were $607 million, an increase of 15% over the first three months of 2007. Sales increase for the quarter was driven by product price increases, including pass-throughs for precious metal costs and favorable changes in foreign exchange rates.

Sales volume was a positive contributor to the higher sales in performance coatings, and color and glass performance materials. Volume also increased in our metal pastes and powders in the electronic materials segment, although this was partially offset by the volume decline resulting from the sale of the industrial ceramics business in December of 2007. For the quarter, sales volume declined in the specialty plastic and polymer additive segment. These businesses were negatively impacted by weak demand in the U.S. markets for automotive parts, appliances and residential housing. Gross margin was 18.7% for the first quarter, compared with 20.2% in the first quarter of 2007. During the quarter, we recorded charges of $200,000 in cost of sales for accelerated depreciation related to our European manufacturing rationalization programs. In addition, we experienced approximately $2.3 million in higher manufacturing costs as a result of the plant interruption at our Bridgeport, New Jersey, organic chemicals plant, and an additional $1 million in higher absorption of manufacturing overhead at that plant. We do not expect any continuing costs from this incident.

Adjusting our first quarter gross margins for precious metal sales and accelerated depreciation charges, gross margins were 21.7% for the quarter, higher than our adjusted margins in the third and fourth quarters of 2007. These margins are lower than the first quarter of 2007, largely because of the increase in raw material costs, including precious metal pass-throughs. However, we believe we were successful in moving product prices during the 2008 first quarter sufficiently to cover raw material costs and to begin recovering some of the margin compression we experienced last year. SG&A expense for the first three months of 2008 was $78.7 million. As a percent of sales, SG&A declined to 13% from 14.9% in the first quarter of 2007. For the quarter, SG&A expense was higher as a result of changes in foreign currency exchange rates. Offsetting this increase were expense reduction actions taken by our business units in 2007, and lower-than-anticipated period health care claims and other benefit expenses.

Restructuring charges for the quarter were $4.2 million, as we continued our restructuring actions in our inorganics business in Europe. We are proceeding on schedule and on budget with our restructuring activities in Europe, and we will realize additional cost savings this year. We took additional cost reduction measures in our organics business in April to keep our cost and expense structure aligned with the deteriorating market conditions. Total segment income for the first three months of 2008 was $41.7 million, essentially flat with the first quarter of 2007. Segment income increased in electronic materials as our product mix continues to move towards higher margin products, particularly advanced metal paste and powders used in solar cells and plasma displays. Segment income also increased in our color and glass performance materials segment, driven by continued strong sales growth. Segment income declined in performance coatings, primarily due to the difficult market conditions in the U.S. construction market, which directly affects demand from our porcelain enamel customers. Income declined in the polymer additive segment as a result of cost to remediate the wastewater treatment issues that occurred in our Bridgeport, New Jersey, plant beginning in December of 2007. Without these costs, our polymer additive segment would have shown significantly improved profitability, as a result of cost reduction actions taken throughout 2007 and our success in recovering raw material cost increases through pricing actions. Income also declined in specialty plastics. Both specialty plastics and polymer additives were negatively affected by weak demand from U.S. customers in automotive, appliance, and residential housing applications.

In our reconciliation of segment income, income from continuing operations before taxes, we reported unallocated corporate expenses of $7.1 million in the first quarter of 2008. During the quarter, we benefited from favorable variations in health care and workers’ compensation claims. At this time, we are forecasting the 2008 full-year corporate unallocated expenses, net of any special charges, to be approximately $35 million. For the first quarter of 2008, we had interest expense of $14 million. In the first quarter of 2007, interest expense was $17.4 million, including a $2 million write-off of previously unamortized fees associated with an unused portion of our term loan facility. In addition, during the first quarter of 2008, our average loan balances and interest rates on our borrowings were lower than those in 2007. Miscellaneous expense was $1.9 million for the quarter, compared with miscellaneous income of $1.3 million in the first quarter of 2007. First quarter of 2007 included a gain of $1.9 million related to the sale of property. Our pre-tax income was $16.2 million for the first quarter, up 51% from pre-tax income of $10.8 million in the first quarter of 2007. Bringing this all to the bottom line, we generated income from continuing operations of $0.21 per diluted share, including special charges.

Let me summarize the special charges we recorded in the first quarter. Within cost of sales, we had charges of $200,000 related to accelerated depreciation. Our first-quarter SG&A expense included a benefit of $400,000, primarily related to favorable litigation development. We recorded a total of $4.2 million in restructuring charges for the quarter. Total of the pre-tax special charges in the first quarter of 2008 was $4 million. During the first three months of 2008, we generated $10.9 million of net cash from operating activities. Net working capital and requirements increased during the quarter, which is our normal seasonal pattern. Changing foreign currency exchange rates contributed to the increase in these working capital balances. Capital spending for the quarter was $15.3 million, driven primarily by the requirements of our restructuring programs, including the continued outfitting of our new color plant in Spain and normal upgrade in replacement capital spending. Depreciation and amortization for the quarter was $19 million. Our target for capital spending for 2008 continues to be about equal the depreciation/amortization expense for the year. Total balance sheet debt on March 31, 2008 was $538 million compared with $526 million at the end of 2007. In addition, at the end of the first quarter, we had net proceeds of $67.3 million from our off balance sheet U.S. asset securitization program, and an additional $42.5 million of net proceeds from similar programs outside the U.S.

Turning to our outlook for the second quarter, we expect net sales to be in the range of $600 million to $625 million, above the second quarter of 2007. Earnings per share from continuing operations for the second quarter are expected to be in the range of $0.11 to $0.16. Included in our estimate for earnings in the second quarter are restructuring and other special charges amounting to approximately $0.17 per share. Our earnings per share recorded in the second quarter of 2007 were $0.10, including approximately $0.16 per share of special charges.

Thank you for your participation this morning and your interest in Ferro, and I'll now turn the call back over to Dave.

David Longfellow

Thank you, Sallie. We are now ready for the question-and-answer session. Can we have the first question, please?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from Mike Sison with KeyBanc.

Mike Sison – KeyBanc

Hey, good morning guys, nice quarter. Just out of curiosity, did you generate any savings this quarter or could you sort of quantify how much savings you did generate from what you have accomplished in '07?

Jim Kirsch

Are you speaking to the restructuring?

Mike Sison – KeyBanc

Yes.

Jim Kirsch

I think it's fair to say that as you look at the incremental numbers we talked about, in electronics we talked about 3 to $4 million. That spaced out pretty evenly because it's fundamentally head count reduction, Mike. In the European side of that, we will get more in the second half versus the first because of the Rotterdam situation.

Mike Sison – KeyBanc

Okay. Then if I take a look at the electronics business, how much bigger is solar now in '08 versus '07? And was that the – you sort of had some margin improvement to 6.6 versus 5.9 excluding precious metals. So, my question is, soft of did solar's profitability really kick in because of mix. And the dielectrics, dilute that a little bit? Or was that mostly the cost savings of the improvement?

Jim Kirsch

The solar has been growing at about 15% on the material side. And the other side of the business that I mentioned in my call, which would be the surface finishing, also we showed nice double-digit growth. So, what is occurring is our higher margin, higher-growth product lines are outpacing the lower margin, lower-growth dielectric paste and powders.

Mike Sison – KeyBanc

Okay. And to get to your goal from where you are at now, what is sort of left to do, just to continue to grow? You have done most of the cost savings that you suggested. Is it just to fill up the plants and grow the business?

Jim Kirsch

Well, organically, you have to get electronics to that 40% gross margin. We are on our way to doing that.

We've got to, in terms of our inorganics business, that's got to deliver double-digit operating margins at the end of the day. So, it's a combination of finish the restructuring, continue to grind away on cost and expense, particularly shared services in our company, and also to continue on the path of growth that we've exhibited top line growth in the two businesses I mentioned.

The organics business has got to continue to be an excellent cash contributor for the company. And then finally, we are looking at filling the gap with bolt-on or tuck-under type acquisitions.

Mike Sison – KeyBanc

Right. And last question, for polymer additives, if I exclude the 3.3 million charge, looks like your operating margins are running at the 6% to 7% rate, going forward is that the run rate we should expect as those external costs will not sort of pop up?

Jim Kirsch

Yes, I've said in the past that both polymer additives and specialty plastics are kind of 5 to 7 run rate businesses in good economies. And we are not in a good economy.

So, I think if we can continue to contribute 5% to 7%, we will be outperforming most players in that sector. And we are doing that through a combination of repositioning away from commodity PVC as much as we can. Pricing cost and head count management, and making sure our efficiencies in our manufacturing operations are excellent.

So, at the end of the day, my expectation for that business is, on a normalized basis, 5% to 7%.

Mike Sison – KeyBanc

Great. Thank you.

David Longfellow

Hey, Mike, just to note. You said something about margins in the electronics business, ex precious metals. I've around 13% for the quarter. So, just don't know exactly where you calculated for that. But that's –

Mike Sison – KeyBanc

That's right. I apologize. It's 13. That was the total company, but yes, it was 13 versus 9.6.

David Longfellow

Yep. All right. Can we have the next question, please.

Operator

David Begleiter with Deutsche Bank.

David Begleiter – Deutsche Bank

Thank you, good morning.

Jim Kirsch

Good morning, Dave.

David Begleiter – Deutsche Bank

Jim, you highlight, in the electronic materials, the sequential margin decline. I think you did 18 or 17.9 ex precious metals in Q4. Why the decline in Q1 versus Q4?

Jim Kirsch

The Q4, in electronics, first off, third and fourth quarter are usually stronger quarters. In the first quarter, you have a combination of the Super Bowl hangover, meaning a lot of people do their procurement of things like plasma display panels and other large and electronic appliances, in anticipation of the Super Bowl, that actually has an impact on the business. And things like the holidays in Asia, Chinese New Year, et cetera. So, that usually has a dampening effect in the first quarter. More importantly, starting in about August, September, and we talked about this in some of our earlier calls, it really got white hot in not only solar but also dielectrics and so on. That industry tends to have, when it starts to get hot and over by mentality. And we saw that happening. We expected to see – the fourth quarter was an extraordinary one. We expected to see a dampening in the first, which we got. And we – yes, we prepared for it in terms of our supply chain.

David Begleiter – Deutsche Bank

Fair enough. Just on the – why were the volume declines in polymer additives and specialty plastics in Q1?

Jim Kirsch

Are you asking in terms of impact on profit? Or in terms of actual –

David Begleiter – Deutsche Bank

Actual, how much were the volumes down in those two businesses?

Jim Kirsch

On a percentage basis, they are down in the 5%, 6% range. Our estimate is the industry is down about 10.

David Begleiter – Deutsche Bank

And lastly, you detailed some slowing in Europe. Can you expand that comment?

Jim Kirsch

Mostly related to the same thing we are seeing in the U.S. is that the housing residential infrastructure, particularly in Spain, has slowed pretty significantly. That's the main activity in terms of slowing that we are seeing, Dave.

David Begleiter – Deutsche Bank

Thank you very much.

Operator

Mike Harrison [ph] with First Analysis.

Mike Harrison – First Analysis

Hi, good morning.

Jim Kirsch

Good morning, Mike.

Mike Harrison – First Analysis

I know it's still a little bit early in the restructuring process for the inorganics businesses but wondering if you could comment on how the savings are tracking relative to your expectations, and how your progress is tracking relative to your, maybe your timetable. And then also, talk about whether you expect to see any disruptions in the rest of the year as you shift some of these operations around.

Jim Kirsch

Let me answer the second part first. The answer is no, I don't expect to see any disruptions. The team, I mean we have a designated team of people that have done a magnificent job of moving hundreds and in some cases, several thousand product references, et cetera, from plant A to plant B without missing a beat. So, I'm really impressed with what they've done. And frankly, they get better every day because they have been doing this now for a year-and-a-half. On the first part, when we first started this process, we said over the three year time frame we'd deliver $40 million to $50 million by the end of '09 going to into '10 time frame. We are right on track to get that done. We had about $10 million roughly in '07. We said we'd get an additional incremental 12 to 15 out of the European numbers, three to four out of the Niagara Falls action. Call that 15 to 20 this year. We are going to get that. So, we are well on our way, which leaves us the last half as we get through '09 and into early '10 to deliver that last $10 million or $15 million. And I expect that to occur. One of the things that's terrific about this, in terms of grabbing those costs, particularly [ph] in the sense of being able to hang on to them, is a lot of this is driven by redundancy and head count. So at the end of the day, we will be a 500 to 600 person lighter organization in Europe, which if you look at our total European organization is in excess of 20-odd percent of our population.

Mike Harrison – First Analysis

Alright, and then in terms of the raw material outlook, I know last call you didn't want to share what your outlook was for the increase on a year-over-year basis. So, wanted to try to ask again, if you could talk about what your outlook is for this year. If you don't want to give us a specific number, could you let us know maybe where they are tracking relative to their expectations now that we are about a third of the way through the year?

Jim Kirsch

In aggregate, they are tracking – if you looked at last year, we had about $125 million in total raw material cost increases to the company. And in aggregate, what we were are seeing this year is different drivers, slightly below that across the corporation, but still a big number. Today it's – if I had to annualize from what I've seen, it's going to be 100 million-plus again.

Mike Harrison – First Analysis

All right. Any gap at all between higher raw material costs in Q1 and the pricing that you got?

Jim Kirsch

Gap meaning?

Mike Harrison – First Analysis

Meaning the cost succeeded the higher pricing. You believe you captured everything.

Jim Kirsch

In aggregate, I think we not only captured, we made progress in our margins. In fact, I know we did. So, individually I wouldn't make that same statement. But in aggregate in the company, we not only covered, we clawed back some margin, which is why you saw some improvement in gross margin on an adjusted basis as we described a little earlier.

Mike Harrison – First Analysis

All right. And then last question I wanted to ask is, you mentioned portfolio management and also talked about bolt-on acquisitions. Give us a better sense of what your strategic and financial criteria are for bolt-on acquisitions, and maybe what segments you are looking to add to.

Jim Kirsch

Clearly in terms of looking to acquire, we would be looking at enabling technologies, things that we can leverage given our geographic and/or customer base. What I might call one step adjacencies, things that have common cost base, common customer base, common geographies, common technologies – those sorts of things are what we use as our criteria. Certainly, we clearly look at financials, return on capital, rate of returns, et cetera. We've said in the past and we are very constant with this, we are looking very hard in our electronic materials and within pieces of our inorganics businesses, where we can find those enablers to accelerate growth. We've also said that we continue to run the organics business as a run for cash business, and we really only make targeted incremental investment there. An example would be, when Dow got out of the epoxidized soybean oil business a year or so back, we made an incremental investment in our facilities because there was additional opportunity to expand our customer base.

Mike Harrison – First Analysis

All right. Thanks very much.

Operator

Rosemarie Morbelli with Ingalls & Snyder.

Rosemarie Morbelli – Ingalls & Snyder

Good morning, all. I apologize. I was on another conference and missed the beginning. So, forgive me if I ask something you already talked about. Could you talk about the current size of the pharmaceutical business and then give us an idea of the potential size of the six new commercial products you mentioned in your comments?

Jim Kirsch

It's embedded within the other business segment, and it's a portion of that one, Rosemarie, but we really have never identified the revenue size of either of those businesses.

Rosemarie Morbelli – Ingalls & Snyder

Okay. When do you think – how long – since they are just newly commercialized, how long before they actually make an impact to both the top line and the bottom line?

Jim Kirsch

The businesses are small enough that they will make an impact immediately, quite frankly. So, as we go forward, the hope from our side of this is, we will take, a lot of this is somewhat contract manufacturing, if you will. If you think about it in that sense. And that's why you see lumpiness, as we've referred to it, in those businesses in the past. But as we try to accelerate growth, and develop and deliver products through the pipeline, the strategy is to try to take some of that lumpiness out and run these operations a little less like contract manufacturing, a little more like a more fluid operation, if you will.

Rosemarie Morbelli – Ingalls & Snyder

And as contract manufacturing, then you only – you don't really show a top line, do you?

Jim Kirsch

No, we do show top-line growth because I'm using that as an analogy. These are pure commercial contracts and we price for value and we typically receive high margins.

Rosemarie Morbelli – Ingalls & Snyder

Okay, and going – looking at the solar cells and plasma product lines, could you share with us the size today and where you see two year out since there is quite a bit of growth going on in those particular areas?

Jim Kirsch

Well, what I'll share, which we have shown in some presentations in the past, is that our dielectric paste and powder business is now about a third of our overall electronic materials segment. Our advanced materials, which is where solar materials are embedded, is close to half. And our surface finishing is remaining, call it 20%, 25%.

Rosemarie Morbelli – Ingalls & Snyder

And then going to – talking a little bit about the restructuring, will it be done, do you think you can do it before the end – I mean, finish it before the end of 2009, and regardless of when you end it, are there other areas which you are going to be concentrating on and which could generate another similar amount of savings? Or do you think that after this is done, it is mostly small incremental projects?

Jim Kirsch

The target is to be finished in late '09, early 2010. The gating item or works council negotiations and we typically budget, if I could put it that way, a certain time frame for those. Those are very much out of our control because there are a lot of legal issues surrounding those country by country. So far we've managed to stay on track and on budget because – and on schedule because our budgeting of that activity has either met the time frame that we've allowed or we've managed to catch up as a consequence of delays. So the short answer is, we expect to be done late '09, early '10 time frame.

Second part is, my belief is that as market structures change, you have to constantly re-evaluate your asset structure, and look for ways to make it more efficient and look for ways to make it leaner. I suspect we will continue to look for opportunities.

Rosemarie Morbelli – Ingalls & Snyder

And if I may and I apologize if you already talked about it, but could you give us a little detail if you haven't done so, on the reason why the first quarter results were better? Where did that new business come from and is that something that was a one-time event or will it recur every quarter going forward?

Jim Kirsch

Well, in a nutshell, revenues were up. Costs and expenses were down, and the portfolio has been shifting into more valuable segments. In addition, we had lower interest expense and better control of corporate unallocated expenses. The net of this was a 50% improvement in earnings on a GAAP basis and a substantial improvement of net income.

Sallie Bailey

And I think Rosemarie, if you look at the release we put out, in organics in particular, performed better than we had anticipated. And as Jim mentioned, our unallocated – corporate unallocated costs were lower than we'd expected. We think some of that may be timing related, but in fact we did have a 50% improvement in the earnings year-over-year.

Jim Kirsch

We gave some guidance for the second quarter that would suggest that we expect to see a second quarter that's better than our first quarter.

Rosemarie Morbelli – Ingalls & Snyder

Okay. And just going back again to that press release regarding the fact that you had some unexpected additional business, could you give us a little more detail as to where it is coming from?

Jim Kirsch

Yes, in the inorganic side, it's in our tile business in particular, it's not unexpected. We have been working very hard to expand that business geographically. And we have been successful. We have been talking for a year about gaining share in that business, both in Southeast Asia and in Eastern Europe. And we are accomplishing that.

Sallie Bailey

I'd add one more thing, that we talked about those two pieces of business. I think we also noted in our organics business that the team was able to overcome the real negative impact of the wastewater treatment interruption in the second and the third months of the quarter. And so as we began to see the strength of that group in both the productivity within the plant as well as in other parts of the business, we saw that we were getting improved results.

Rosemarie Morbelli – Ingalls & Snyder

Okay. Thanks a lot.

Jim Kirsch

You're welcome.

Operator

Robert Felice with Gabelli & Co.

Robert Felice – Gabelli & Co.

Hi, most of my questions have been answered. Just a couple more. I guess, on the color and glass side, excluding pass-throughs, you really had some nice underlying growth this quarter. First, I was hoping you could discuss the trends that you are seeing there and also break out your volume price mix contribution. And then second, despite the higher sales, it doesn't look like the growth translated into much higher profitability. In fact, margins were off, I want to say about 200 basis points year-over-year. So, I was wondering what the offsetting factors are that prevented the top line growth from translating into higher bottom line profit.

Jim Kirsch

There is, a lot of those sales are international and so there is an FX component in the top line. In addition, there is a fair amount of precious metal used in that business as well. So, you have some expansion of the top line due to FX when translated to the dollar and then precious metal inflation, if you will. That being said, the underlying fundamentals of the business are really sound. And I think that's a result of excellent geographic diversity in the business that is well positioned throughout Asia, throughout Latin America, the U.S. and Europe. And second, that we clearly are the market leader in the places we play. The preferred supplier at, whether it's automotive, flat glass or container, in the glass side. And/or in the specialty pigment side, we are the only player who can coat or bond to glass with both organic and inorganic in forehearth colors. And customers recognize that value and look to us for new application technology.

Robert Felice – Gabelli & Co.

And if we were to exclude pass-through of precious metals and also FX, what was the organic growth component?

Jim Kirsch

It exceeded GDP by a couple of points.

Robert Felice – Gabelli & Co.

Okay, and then I guess flipping to the other side of the question, we didn't really see the higher growth translate into higher profit. So, what were the offsetting factors there and do you expect those dynamics to continue through the balance of the year?

Jim Kirsch

Are you talking sequential now?

Robert Felice – Gabelli & Co.

Yes. I'm talking, what affected it both year-over-year, and then sequentially, what we should expect as the year progresses.

Jim Kirsch

Well, sequential, it had a very good move. So, my expectation in that business is that – see I've referred to it in the past as a flagship Ferro business. Our expectation is, in order for us to realize our 10% operating margin goal, it’s got to be well in excess of that, and we are continuing to work toward that.

Robert Felice – Gabelli & Co.

So, you would expect pretty nice sequential improvement as the year progresses?

Jim Kirsch

I'd expect over time that business to constantly get better.

Robert Felice – Gabelli & Co.

Okay. And then, Sallie, I think you touched on this earlier but I missed it. The quarter is really positively affected by lower corporate unallocated expense. I think you touched on the factors behind that. But I was hoping you could delve into that again.

And then also, is the amount we saw this quarter a fair run rate for the rest of the year?

Sallie Bailey

Let me answer the second question first. We believe our corporate unallocated recurrent will be about $35 million for the full year, net of any one time or special charges. And part of what we experienced this quarter was some benefit on some timing on workers’ compensation and health care claims that will probably come back in the second half of the year, which is why we think the run rate will be higher than the first quarter number.

Robert Felice – Gabelli & Co.

Okay. And then lastly, Jim, if I exclude the pass-through of precious metals, you have about 400 basis points to go to get to your 10% goal versus 2007. And I guess, I'm just wondering how much of that you would venture to guess comes in '08 versus '09 and 2010.

Jim Kirsch

I'm not going to give you that prediction Rob, other than to say I expect '08 to be better than last year. We have to be, in order to realize our goal. I want to come back to your earlier question on color and glass for a moment. I don't want to mislead you. When I talked about constant improvement, I'm talking about margins. That business has a very distinct cycle to it and the second half is typically not as strong as the first. That cycle is driven by, if you think about those markets, some are shutdowns in the automotive world, the holidays, in the Christmas time frame as well. So, there is a distinct cycle there.

Robert Felice – Gabelli & Co.

Given the fact that you will get some of the benefit of the restructuring, more heavily weighted to the back half of the year, would you expect that kind of seasonal pattern to hold up this year?

Jim Kirsch

I expect a seasonal pattern to hold up, what we are striving to do is to lift the seasonal pattern so it comes off a better base.

Robert Felice – Gabelli & Co.

Okay. And then I guess getting back to the previous question on the overall amount of underlying margin improvement we should expect this year, and I guess just by magnitude of ranges, should we expect that Ferro heading toward its goal of 10% should look more like a hockey stick or should we expect more of a linear path? Just any color as to the progression there would be helpful.

Jim Kirsch

I wouldn't call it a hockey stick or linear. It's a little more like a stepping stone or stair step approach, because if you think about it as you take down facilities and people leave in certain larger numbers, there is a larger impact at a point in time. So, I think what you are seeing in the first quarter and what our guidance in the second quarter is, we are starting to get the effect of a lower fixed cost base, and lower variable cost in the company.

Robert Felice – Gabelli & Co.

So, you are starting to feel that first step.

Jim Kirsch

Yes.

Robert Felice – Gabelli & Co.

Okay, great. Thanks so much.

Operator

Dmitry Silversteyn with Longbow Research.

Dmitry Silversteyn – Longbow Research

Good morning, gentlemen. Congratulations on getting the year off to a solid start. Couple of questions, a lot have been answered already. But I remember towards the end of 2007 as the consolidation in the European inorganics business was proceeding, you ran into some manufacturing issues and manufacturing inefficiencies. Have those been resolved and are you kind of happy with how the plants are operating right now in the region?

Jim Kirsch

Yes. None of those issues in manufacturing were in the inorganics business though, just to be clear. Two were in our – one was in our plastics operation, one was in our polymer additives operation and one was in electronic materials. All those were in the U.S. Electronic materials was a safety related issue at our South Plainfield, New Jersey plant. And the plant we restructured or shut down was Niagara Falls. So, they were distinct and discreet activities. Having said that, I'm very pleased with how things are going in Europe. Again, on time, on budget. Great team going after it and we are seeing the results.

Dmitry Silversteyn – Longbow Research

Okay, all right. Looking at the electronic materials results in the first quarter, you had a pretty significant increase in sequential revenues, and you talked about mix improving. But your margins have come down. Is that just a function of precious metal pass-throughs? Or is there more to it than that?

Jim Kirsch

Most of that is precious metal. A little bit of that is, very little of that, is volume. It's, the volume in that business is very difficult to track because you have such a wide disparity of products. But it's 99% of that difference is – that's an exaggeration, 90-plus % of that business is precious metals.

Sallie Bailey

Dmitry, were you talking from the fourth quarter of '07 to the first quarter of '08?

Dmitry Silversteyn – Longbow Research

Correct. Just looking at – because sequentially revenues were up, I believe, quarter-over-quarter in the electronics. But operating profitability has declined pretty dramatically. So, I just wanted to make sure there wasn't anything beyond –

Sallie Bailey

I think, Jim mentioned it earlier – a lot of it has to do with the seasonality associated with that business. There is a very, very strong fourth quarter. We think the first quarter was substantially improved results if we look at a comparison to last year's first quarter where we split into precious metals. We had segment margins of 9.6% in the first quarter of 2007, and now this quarter they are 13%. I think you can see the improvement in terms of the mix changes that we have been talking about.

Dmitry Silversteyn – Longbow Research

Okay.

David Longfellow

And ex precious metals, the revenues sequentially from the fourth quarter were down a little bit.

Dmitry Silversteyn – Longbow Research

Okay. So, the precious metal inflation and pass-through is really what drove both the top line improvement sequentially as well as the lower margin?

Sallie Bailey

Right.

Dmitry Silversteyn – Longbow Research

Can you give us an idea of what we can expect for the tax rate for the year, given that you started off the year with a fairly high tax rate?

Sallie Bailey

Yes, you know, because of the nature of our business and the dividends that we bring back from outside the U.S., that really – and all of the restructuring we are doing in Europe – that has a huge impact on our tax rate. The way we like to think about it is using a theoretical rate of 36%. And, which is pretty much the U.S. statutory rate of the 35%, plus 1% for state and local taxes. Because again, due to the geographical nature, you will see if you look at our tax rate through the course of 2007, there is a fair amount of volatility in the quarter-to-quarter rate. That's how I think about it is the theoretical 36%.

Dmitry Silversteyn – Longbow Research

Okay. But kind of given where you are in the first quarter and so far in the second quarter, would you expect the full year to be, this year at least, to be above that?

Sallie Bailey

I'd expect that the actual rate will be above this 36%, yes.

Dmitry Silversteyn – Longbow Research

Okay. All right. And final question, do you have any concrete plans for the amount of debt that you’re going to be paying down this quarter – this year? Is there anything coming up where you have to take down debt or is it more of a kind of an opportunistic thing for you?

Sallie Bailey

You mean do we expect our year-end debt levels to be what –

Dmitry Silversteyn – Longbow Research

Lower than year end.

Sallie Bailey

I think right now we would expect our year-end debt levels to be at or maybe perhaps a little bit higher than our debt levels at the end of 2007, as we are, primarily due to the investments that we are making into the restructuring programs and the other capital expenditures.

Dmitry Silversteyn – Longbow Research

Okay, so that doesn't even include potential acquisition. This is just on your organic business.

Sallie Bailey

Yes, I think organically, we've talked a lot about it. 2008 is a year that we are making a lot of investments in our restructuring programs. And in particular, we are doing a lot of restructuring in Europe, so there's a fair high number of severance expense associated with that.

Dmitry Silversteyn – Longbow Research

I got you. And then final question, just to get back on taxes real quick, the $4 million in special charges that you booked this quarter, should we be applying the same 43.5% tax rate to that or is that a different tax rate that we should be looking at?

Sallie Bailey

Well no. The way – again, Dmitry, the way I think about it is, I'd take the $4.2 million that we walked through of one-time charges and, or the $4 million in the restructuring, I'd exclude that from the income statement and then I'd apply a 36% tax rate.

Dmitry Silversteyn – Longbow Research

Okay. All right. Thank you.

Sallie Bailey

Thank you.

Operator

Christopher Butler with Sidoti & Co.

Christopher Butler – Sidoti & Co.

Hi, good morning. Looking at your inorganics business, it looks like the slowing that you are seeing in Europe is at least partially being offset by sales into Middle East, North Africa, Eastern Europe. Could you give us a little bit of color on what the business looks like going into these areas? How long you've had sales channels there and what your expectations are?

Jim Kirsch

Yes. We started expanding into those areas three years ago. We have a market sales structure in place. We produce and sell out of primarily Spain into those countries. Yes, we've seen the, what I might call first move advantage in terms of the growth driver. And I'd point out to you that within that business, the lagger, if you will, is primarily the issues in porcelain enamel, which is almost exclusively related to the appliance issues associated with housing and reconstruction.

Christopher Butler – Sidoti & Co.

And from the last conference call, you had stated that in light of the issue in New Jersey, if you were going to take a step back, look at different plants, the procedures that were in place. I’m not sure if this was a formal process that you were running but trying to get an idea where that stands, maybe a percentage of completion, something of that nature?

Jim Kirsch

We've actually done that. And it is a formal process. We actually started that process a little earlier. We have been through, under Tom Austin (inaudible), who's our VP of Operations and under various business leaders who are the directors of manufacturing, we have formal audits, health environmental safety, at all of our facilities. By March 31, they had to be at a certain compliance rate. By the end of the second quarter, they had to be at 100% compliance rate with higher standards that we have set in all of those areas.

I happened to be at four of our sites in Europe last week. I was really pleased to see the progress that's been made. Everything ranging from placarding into plants, the way to do things right, and the participation of the hourly work force in terms of their shift changes and tracking their progress, and being able to point to where our deficiencies are and what we are specifically doing to fix those. So, I'm very pleased. Each month I've a formal review of that, a full day with the operating and, operating Vice Presidents and their manufacturing leaders. And I know each of them has at least monthly reviews, as does Tom. I'm quite pleased with the progress that has been made.

Christopher Butler – Sidoti & Co.

Thank you. Appreciate the insight.

David Longfellow

I think we have time for one last question.

Operator

Mike Sison with KeyBanc.

Mike Sison – KeyBanc

Hi, just a couple of quick follow ups. On the raw materials that you alluded to Jim, does that exclude precious metals in terms of the upward pressure or does that include some of the precious metals.

Jim Kirsch

Excludes, Mike.

Mike Sison – KeyBanc

That excludes. Okay.

And then just for housekeeping purposes, could you give us a little bit more color on your sales growth in the quarter. Break it out from currency, pricing, volume. Just –.

Jim Kirsch

Yes. The big drivers on growth were price and FX. If you looked at the change from first quarter '07, first quarter '08, roughly FX was about 50% of that. Price is probably in terms of overall, is in the 30% range.

Mike Sison – KeyBanc

And that includes precious metals?

Jim Kirsch

Pardon me?

Mike Sison – KeyBanc

That includes precious metals?

Jim Kirsch

No. (inaudible), they are probably split half and half between precious metal and price. Half of it is FX, about half is price precious metal.

Mike Sison – KeyBanc

And then going forward then embedded in your second quarter guidance, that FX would be probably similar and your pricing would probably be similar, and your volumes would probably similar based on what we are seeing now?

Jim Kirsch

I think that's fair. If you just make the assumption that the Euro is going to stay roughly around where it is, that's the biggest driver in FX. There is some other, the Real and the BOB [ph] and so on have some impact but the biggest driver is the Euro.

Mike Sison – KeyBanc

And last question, in terms of semiconductor, electronics demand, some of your peers have suggested or lowered their outlook for, let’s say semiconductor shipments or wafer starts, so on and so forth, any change in your outlook for those markets excluding solar, heading into the rest of the year?

Jim Kirsch

I'd agree with their outlook on the semiconductor side, Mike. And one of the terrific things under Barry's leadership that's happened in our electronics materials and surface finishing, and I mentioned specifically high-end ophthalmic lenses, we have really worked hard to broaden our participation in polishing areas that are divergent, if you will from the semiconductor and wafer side. I don't disagree with any of the comments you're seeing in industry about the semiconductor side specifically.

Mike Sison – KeyBanc

Okay, great. Thank you.

David Longfellow

All right, that concludes our call for today. For copies of our press release, replays of this call or access to our SEC financial filings, please go to our web site at www.ferro.com and click on investor information. Thank you, and have a good day.

Jim Kirsch

Thank you.

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Source: Ferro Corporation Q1 2008 Earnings Call Transcript
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