Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Ferro Corp. (NYSE:FOE)

Q2 2008 Earnings Call Transcript

August 6, 2008 10:00 am ET

Executives

David Longfellow - Director, IR

Jim Kirsch - Chairman, President and CEO

Sallie Bailey - VP and CFO

Analysts

David Begleiter - Deutsche Bank

Rosemarie Morbelli - Ingalls & Snyder

Mike Harrison - First Analysis

Mike Sison - KeyBanc

Dmitry Silversteyn - Longbow Research

Christopher Butler - Sidoti & Company

John McNulty - Credit Suisse

Operator

Good morning and welcome to the Ferro Corporation’s 2008 Second Quarter Earnings Conference Call. All participants will be in a listen-only mode until the question-and-answer session. (Operator Instructions). This conference is being recorded. If there are any objections, please disconnect at this time.

Now, I’d like to turn the meeting over to your host, Mr. David Longfellow, Director of Investor Relations. Mr. Longfellow, you may begin.

David Longfellow

Good morning and welcome to the Ferro Corporation’s second quarter earnings conference call. Today we will provide information about our financial results for the three month period ended June 30th, 2008, and we will discuss our expectations for the third 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 he will provide some thoughts on our second 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 second quarter financial performance and our third quarter outlook. Following our prepared remarks, Jim and Sallie 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 website, which is located at www.ferro.com. Also available on our website is a reconciliation of reported results to non-GAAP amounts discussed on this conference call.

Before Jim begins, I want to remind you that all 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 most recent quarterly report on Form 10-Q and other SEC filings.

Forward-looking statements reflect management’s expectations as of today, August 6th, 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 website.

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

Jim Kirsch

Thank you, David, and good morning to everyone who has joined us. We delivered a strong second quarter, resulting in earnings that were well ahead of the second quarter of 2007, and ahead of the estimates we provided during our conference call in May.

Our second quarter earnings were $0.21 per share, more than double the earnings in the 2007 second quarter, driven by a 17% increase in sales. The improvement in our profitability came despite weaker economic climate and a sharp increase in the cost of the number of raw materials. Our geographic diversity with over 55% of our sales outside the United States continues to help us whether the current US economic weakness.

We are expanding sales in Asia, the Middle East, Northern Africa, Central Europe and Russia by leveraging our worldwide manufacturing assets. We expect international sales to continue to have a positive effect on our results in the second half of the year.

As we said three months ago when we announced the first quarter’s results, the steps we are taking to improve our business operations and restructure our manufacturing assets are gaining traction, and the second quarter results are further evidence of our progress. The results are also evidence that our management team continues to work hard to control costs, and maintain pricing discipline in order to affectively manage those external forces that are not completely within our control.

The changes we have made in Ferro are building a solid foundation that is helping us progress toward our goal of 10% operating margins. Our second quarter profitability was significantly higher than in the prior year period with segment operating income, net income and earnings per share, all showing excellent improvement. And we are on track to continue delivering substantial year-over-year improvement in our third quarter financial performance.

A lot of hard work over the past two years has gone into achieving these results. Our efforts have been and will continue to be focused on sustainable improvements in the value we deliver to shareholders and winning in the marketplace. This is what win from within is all about.

We understand that we need to remain dedicated to continuous improvement as we move forward. We are determined to build on the momentum we have generated by executing on our restructuring initiatives around the world, pricing our products in a way that is consistent with the value we provide while covering the escalating costs of raw materials, aggressively controlling costs and expenses throughout our operations, and continually improving in our operational execution including manufacturing, procurement and our corporate functions.

This has been our consistent massage, both within our organization and to our shareholders, and we are committed to staying on this path as we move towards our long-term performance goals. Progress toward our goals begins in the operating groups, so I will take the next few minutes to discuss the second quarter highlights from our three business groups.

Our Electronic Materials team delivered outstanding results in the second quarter, driven by strong demand for our conductive pastes for solar applications. We have talked for some time about our efforts to achieve a 40-20-20 business model through sales growth of higher margin products, restructuring, and operational improvements.

During the second quarter, we delivered on this business model for the first time. Segment income as a percent of Electronic Materials sales excluding pressure metals reached nearly 24% as we’re seeing the full benefits of last year’s restructuring in Niagara Falls, the improved operations in our South Plainfield manufacturing location as a result of the intervention we did one year ago, and excellent growth in sales of higher margin products.

Clearly, the robust market for our solar conductive paste was a significantly drive of the quarter’s performance. We are seeing continuing strong demand around the world, particularly in Asia. We believe that some Chinese producers may be buying ahead then producing their products early in anticipation of possible production interruptions during the Beijing Olympic Games. So, there is a possibility that the growth in this business could be tempered in the next quarter or two, however, the degree of any Olympic effect is difficult to forecast.

The longer term outlook for our solar products continues to be good as demand is expected to remain on an upward trend. However, the rapid expansion of capacity among solar cell manufacturers could lead to some increased demand volatility in the future due to short-term supply and demand imbalances and supply chain rebalancing. We view this as an overlay of relatively normal electronics markets volatility on top of strong underlying growth trend.

To support our growing solar business in Asia, we’re continuing construction of our new metal paste facility in Suzhou, China. We are on track to deliver production to customers from this plant by year-end, both in terms of our plant construction activities and our qualification of locally sourced raw materials.

In July, we expanded our surface technologies portfolio with a number of grinding fluid products purchased Fluid Logic LLC. These materials are used in a production of precision optics, ophthalmic lenses and flat glass, as well as ceramic and quartz substrates used in electronics. While past sales of these products have been modest, we see growth opportunities available through leveraging our existing broad customer base and our global sales and support capabilities.

We expect these products to help us continue the growth we’re seeing in our surface technologies business within Electronic Materials. We will continue to look for bolt-on acquisitions like these surface technology products that complement our existing product development pipeline and build on our customer relationships as we develop platforms for future profitable growth.

While we are not expecting the second quarter’s level of performance to continue each quarter for the remainder of 2008, we are focused on taking steps necessary to reach a sustainable 40-20-20 business model. These second quarter results give us additional confidence that this goal in achievable with our present strategy and our product portfolio.

Our Organic Specialties group including the polymer additives, specialty plastics, and other businesses segments continues to be affected by weak demand, particularly from customers in the US, automotive, appliance and construction industries. Our goal for these businesses is to generate cash and perform better than our markets and competitors, and we believe we are accomplishing these goals.

We continue to enrich our polymer specialties product mix, and thereby, decrease our dependence on sales and PVC applications. We are doing this through the introduction of products for a number of specialty applications, such as oilfield mud drilling fluids, sanitizing household cleaners, and concrete additives.

We realized that our organic customers demand had peaked in late 2006 and we began curtailing our own spending early in this economic cycle. We combined resources in polymer additives and specialty plastics in order to reduce costs and as a result we also managed to generate additional opportunities to add value for our customers by combining products and capabilities.

We continue to reduce our cost structure to help deal with a difficult demand environment. In April, we have reduced manufacturing headcount in plastics manufacturing operations. In addition, we continue to adjust our prices to cover the cost increases related to tallow, soybean oil and petrochemical based feed stocks. These are the latest of a number of actions we have taken across the organics group to keep our cost at an appropriate level relative to current customer demand. Our fine chemical sales in Asia were a highlight of the quarter. Sales of electrolytes from our manufacturing facility in Suzhou, China are up sharply as we have captured growing customer demand in China to our new product introductions.

Our inogranics group which includes our performance coatings and color and glass performance material segments reported another very solid quarter. Sales were higher in both segments by double digit percentages compared to the second quarter last year.

Perhaps more importantly, segment income grew faster than sales in both businesses. This shows that the efforts we were making to adjust product prices to cover raw material cost increase and to lower our cost structure through aggressive restructuring are delivering results. Our improved results were obtained despite difficult economic conditions in the quarter, including continuing volatile raw material cost weaker demand in southern Europe and a trucking strike that affected our Spanish operations for several days in June.

Our restructuring efforts continue in Europe and around the world. We ended the porcelain enamel manufacturing at our site in Rotterdam at the end of July, and we will begin to generate savings from this action in the third quarter. In addition, in June we announced restructuring activities in Brazil that will lower our cost structure in the second half of 2008. In the second quarter, our inorganic sales also benefited from geographic diversity. Sales volume increased in the inorganics group partly because of our strength in markets such as Indonesia, North Africa, Eastern Europe, Russia and the Middle East which helped compensate for relatively weak demand in other countries including the US. Across Ferro, our restructuring programs continue on schedule and on budget, and we continue to look forward execute additional cost and expense reduction activities throughout our businesses. These actions will remain an important part of our operating approach not only to make progress toward our long-term profitability goals but also to keep our cost controlled in a very uncertain economy. Many of the applications we serve, such as the automotive, housing and appliance markets, have experienced weak demand for a number of quarters.

Sallie will provide our sales and earnings estimates for the third quarter, but I will provide some general comments on our outlook for the second half. We continue to carefully monitor the outlook for future customer demand as the effects of increased energy and commodity prices and tightening credit continue to work their way through various regional economies. Despite the external outlook, I am very excited about what we are doing within Ferro. The things that we can control such as our restructuring programs, our improved procurement systems and our business and manufacturing process improvement initiatives will continue to benefit our business and our shareholders. These should result in continued improvement in our earnings in the second half compared to the same period in 2007. These actions will strengthen the foundation necessary to support sustained progress for our 10% operating margin goal.

However, given the weakness in a number of our regional markets, our year-over-year improvement in the second half of 2008 earnings may not match the year-over-year increase was generated in the first half. I look forward to updating you on our progress in the coming quarters. Now, I would like to turn the call over Sallie who will review the financial results in more detail and discuss our third quarter estimates before we open up the call for your questions. Sallie?

Sallie Bailey

Thanks, Jim. This morning I will begin my remarks with a recap of the 2008 second quarter results, and then I will discuss our current estimates for the third quarter. Our earnings for the three months ended June 30, 2008 were $0.21 per share including special charges, more than double the $0.10 per share we have reported in the second quarter of 2007.

Our net sales for the second quarter were $650 million, an increase of over 17% compared with sales in the second quarter of 2007. The sales increase for the quarter was driven by product price increase, including pass through for precious metal cost, favorable changes in foreign exchange rates and the benefit of increased sales volume.

Gross profit improved by 15% in the second quarter compared with the prior year. During the quarter, we reported charge of $1.4 million in cost of sales related to asset write-offs and our manufacturing rationalization program. Gross margin was 19% for the quarter compared with 19.4% from the prior year quarter. Adjusting our second quarter gross margin for precious metal sales and special charges the gross margin was 22.3% for the quarter, higher than our adjusted margin in the second quarter of 2007 and the third consecutive quarterly improvement.

SG&A expense for the second quarter of 2008 was $81.2 million. As a percent of sales, SG&A declined to 12.5% from 15.2% in the second quarter of 2007. The 2008 second quarter SG&A included charges of $2.4 million primarily related to corporate development activities asset write-offs and employee severance expense. For the quarter SG&A expenses impacted by foreign exchange rate, is a significant portion of our SG&A expenses are incurred in our non-US facilities around the world. Offsetting this increase were expense reduction actions taken by our business units in 2007 and early 2008 including headcount reductions in Europe, the United States, Latin America and Asia. Restructuring charges for the quarter were $9 million. The primary driver of these charges continues to be the manufacturing rationalization projects within our inorganic business in Europe. During this quarter, we reported severance charges for a number of employees at our Rotterdam facility which caused at the end of July.

The consolidation of the porcelain and enamel manufacturing into Spain will result in cost savings that will begin by the end of the third quarter. During the second quarter, we took additional actions to reduce cost in our specialty plastics business and to lower costs in our inorganic operations in Latin America. We will continue to be aggressive in realigning our cost and resources as market dynamics change.

Total segment income for the 2008 second quarter was $54.8 million, up 36% from the second quarter of 2007. Segment income increased in electronic materials as our product mix continues to move towards higher margin products, particularly advance metal pastes and powders used in solar cells. In addition the 2007 second quarter results in electronic material included the cost of a temporary interruption of manufacturing that was necessary to address safety and operational issues at our South Plainfield site.

Segment income also increased by double-digit percentages in our color and glass performance materials and performance coatings segment driven by higher average selling prices and sales volume growth. Income in polymer additive increased slightly compared with the prior year period primary as a result of product price and product mix improvements which offset raw material cost increases. Income declined in the specialty plastics segment as a result of continued weak demand from US customers in automotive, residential housing, and appliance applications.

Income also was lower in our other business segment primarily driven by product mix changes as we sold fewer pharmaceutical products and more lower margin industrial solvents during this 2008 second quarter. In our reconciliation of segment income, to income from continuing operations before taxes, we reported unallocated corporate expenses of $12.6 million in the second quarter of 2008, including special charges of $3.8 million. This amount is consistent with the 2008 full-year estimate of corporate unallocated expenses of approximately $35 million, excluding special charges which we provided during our May conference call.

For the 2008 second quarter, we had interest expense of $13.2 million, down from $14.3 million in the second quarter of 2007. The reduction was driven by lower interest rates, partially offset by expenses resulting from higher average borrowings. Miscellaneous expense of $2.1 million for the second quarter compared with $900,000 in the second quarter of 2007. The 2008 second quarter included a charge of $1 million for environmental contingencies at a previously closed manufacturing property.

Our pre-tax income was $17.4 million for the second quarter up from $7.4 million in the second quarter of 2007. Brining this also the bottom-line, we generated income from continuing operations of $0.21 per diluted share including charge.

Let me summarize the various special charges that include in our second quarter results. Within cost of sales we have charge of $1.4 million related to asset write-off of manufacturing rationalization activity. Our second quarter SG&A expense included charge of $2.4 million primarily related to corporate development activities, asset write-off and severance expense.

We recorded a total of $9 million in restructuring charges for the quarter and finally we recorded a $1 million charge in miscellaneous expense or an increased environmental reserve. Total pre-tax charges in the second quarter of 2008 were $13.8 million. During the second quarter of 2008 we used $4.2 million of net cash operating activities. That working capital requirements defined as a sum of receivables plus inventory less payables, increased during the period which is our normal seasonal pattern.

Capital spending for quarter was $19.3 million driven primarily by our restructuring programs in Europe. Depreciation and amortization for the quarter was $19.2 million. Our target for capital spending for 2008 continues to be about equal to depreciation and amortization for the year. Total balance sheet debt on June 30 was $571 million compared with $526 million at the end of 2007. In addition, at the end of the second quarter we had net proceeds of $75 million from our off-balance sheet US Asset Securitization program and an additional $41.2 million of net proceeds for similar programs outside the U.S. The increase in debt at June 30, was driven by increase in working capital requirements resulting from a higher level of sales.

Now turning to our estimates for the third quarter. We expect sales to be in the range of $600 million to $625 million. This would result in sales that are higher than the third quarter of last year, but lower than our just completed second quarter. Consistent with our normal seasonal pattern, our seasonality in the third quarter is driven by our exposure to the European market where vacations in Europe particularly have an effect in economic activity.

This year there also maybe a negative effect on sales on China from interruptions in our customers production due to the Olympic games, although the magnitude of this effect if any is difficult to forecast. Earnings from continuing operations for the third quarter are expected to be in the range from $0.08 to $0.13 per share, included in this estimate our restructuring other charges amounting to approximately $0.20 per share. Earnings in the third quarter of 2007 was $0.12 per share including approximately $0.11 per share charges.

Our third quarter estimates are consistent with our view of the economic outlook. As higher energy and commodity prices, higher lending standards, and credit market volatility all work their way through the customer demand. Regardless of our view of the macroeconomic conditions, we continue to drive the restructuring initiatives, cost containment activities and business process improvement that have helped us achieve the results that we have discussed today.

Thank you for your participation and your interest in Ferro. And now I will turn the call over to Jim.

Jim Kirsch

Thanks Sallie. I would just like to say a final word about the quarters results and our outlook. Obviously we are pleased with the second quarter performance. We believe the results are evidenced of the efforts we are making to improve our operations, restructuring our assets and strengthen our businesses to gain traction.

We are beginning to realize the benefits of win from within across our entire company. And we are confident that we can meet our commitments to our shareholders in the third quarter and generate year-over-year profitability improvements in the second half of 2008.

I am looking forward to updating you on our process during our next conference call in November. David.

David Longfellow

Thank you, Jim. Operator we are now ready to begin the question-and-answer session. Can we have the first question please?

Question-and-Answer Session

Operator

Thank you. Our first question comes from David Begleiter. Your line is open.

David Begleiter - Deutsche Bank

Thank you. Good morning.

Sallie Bailey

Good morning.

Jim Kirsch

Good morning, David.

David Begleiter - Deutsche Bank

Jim, can you quantify the pre-volume you think occurred in the solar conductive pastes, and the impact in both sales and operating profit.

Jim Kirsch

As I mentioned it's really difficult to forecast the what I call the Beijing Olympic effect and it's been such a robust market for the last nine-months. We are anticipating giving some of the closures to factories and what not that the Chinese government has taken, that some customers have pulled forward orders, but we have not been able to ascertain the quantity to add if you will. I don’t think it's a major issue by any stretch of the imagination. I just think, I think they were probably some there.

David Begleiter - Deutsche Bank

And how is the pricing in that product line up well as down?

Jim Kirsch

In the solar conductor paste in general?

David Begleiter - Deutsche Bank

Yes.

Jim Kirsch

We continue to price for value and push it hard, there’s a lot of elasticity there.

David Begleiter - Deutsche Bank

Which means –

Jim Kirsch

We have maintained or improved.

David Begleiter - Deutsche Bank

Okay. And can you say what’s the year-over-year growth was in that product line on sales and operating profit?

Jim Kirsch

On a percentage basis, we have been saying consistently for a while now, that the material side is growing about a 15% compound growth rate and the cell manufacturer side of that is probably closer to 25 and if you look at it in terms of actual megawatts of production, you would see that it was up 40% to 50% year-over-year meaning ’07 over ’06 and ’08 projection over ’07. Then if you look at electronic materials in total, if you take a look in the Q you can figure and do the arithmetic and see what the year-over-year revenue and segment profitability is.

David Begleiter - Deutsche Bank

Fair enough. And Sallie, just on the charges, what is the tax rate you apply to the charges.

Sallie Bailey

Couple of things, you will notice in the Q we talked about one-time items -- discreet items, particularly in Brazil, that caused the quarters tax rate to go up quite substantially. So, when we look at it we apply a 36% hypothetical rate, which would be in the 35% statutory rate in the US plus an additional 1% for sate and local taxes.

David Begleiter - Deutsche Bank

Okay. Jim just seeing your guidance, you did say fixed cap earnings will be below the prior year level?

Jim Kirsch

Just the opposite. Second half ’08 would be an improvement over second half ’07.

David Begleiter - Deutsche Bank

Okay, but the rate of growth will be less than the first half?

Jim Kirsch

That’s correct.

David Begleiter - Deutsche Bank

Okay. Thank you very much.

Operator

Our next question comes from Rosemarie Morbelli with Ingalls & Snyder.

Rosemarie Morbelli - Ingalls & Snyder

Good morning all.

Sallie Bailey

Good morning.

Jim Kirsch

Good morning, Rosemarie.

Rosemarie Morbelli - Ingalls & Snyder

Congratulations on a very good quarter.

Jim Kirsch

Thank you.

Rosemarie Morbelli - Ingalls & Snyder

Sallie, can you do the math first I haven’t had a chance to get onto your website, and once you have -- you know, tax effected the charges, what could have been the earnings per share which would compare to the $0.25 last year on the same basis.

Sallie Bailey

Yes. There is $1.4 million in cost of sales, $2.4 million in SG&A, $1 million in other expense, $9 million restructuring, which totaled to $13.8 million, applying a 36% tax rate takes us to $0.46 a share. And that applies if we look at for example EBITDA margin we would look at income from continuing operations of $9.4 million adding back income taxes of $8 million, interest expense of $13.2 million, depreciation and amortization of $19.2 million, the EBITDA number as reported is $49.8 million adding back the one-time charges we would get to adjusted EBITDA of $63.2 million.

Rosemarie Morbelli - Ingalls & Snyder

Okay. So that $0.21 turn into $0.46?

Sallie Bailey

That’s correct.

Rosemarie Morbelli - Ingalls & Snyder

Okay. Alright. And you really had quite a big improvement in margin sequentially, I am not talking about versus ’07, sequentially in all of your businesses except for other. Do you anticipate given the seasonality in the third quarter, I apologize, do you anticipate continuing sequential margin improvement of this seasonality also hit you on the margin?

Jim Kirsch

Rosemarie, this is Jim. It's certainly our goal to show sequential improvement. And if you talk on the gross margin line –

Rosemarie Morbelli - Ingalls & Snyder

I was looking at the segments, Jim, and the operating margin.

Jim Kirsch

Right. And I'm going to get down to that in a second.

Rosemarie Morbelli - Ingalls & Snyder

Okay. Sorry.

Jim Kirsch

First starting at the gross margin line, the continuing work to take cost structure out of the organization should enable us to continue -- if we are successful with pricing, to continue to work toward improving in gross margin. In -- if you get into the segments then, a little bit more difficult because historically third quarter is a tougher quarter for us for a variety of reasons. One, traditionally Europe second half of August, you know, starting about second week of August, lot of vacations, a lot of slowdown, and so on and so forth. With the US economy, particularly in automotive you had extended shutdowns, reductions in car builds, etcetera, will impact our U.S. based businesses. So it's a little more difficult to project, but, you know, my expectation is that we'll continue to make progress toward our overall goal of 10% operating margins, which would suggest to you that for the year, we have to continue to make improvement. I'm frankly not as concerned quarterly, quarterly if you will, as long as we're driving this yearly toward where we need to be in order to make the step changes in the company that we're trying to deliver.

Rosemarie Morbelli - Ingalls & Snyder

Okay. And in the -- given the strong margin in the second quarter, were there some costs which were somehow not hitting you fully in the second quarter, but are going to have a full impact in Q3, or --

Jim Kirsch

No. No, I think it's just the opposite, actually. If you think back to a year ago, we put that intervention in South Plainfield, which was a very significant cost of about $4 million and that will hit directly $3 million, hit directly in the bottom-line of the electronic materials business. During the second quarter we also had some costs associated with the cost of quality in Evansville. That hit the bottom-line of our plastics business. So those were nonrecurring. Those are issues that we fixed, and I think -- you know, what you are seeing is the strength in the businesses -- the facilities running well, a lot of absorption going on, and our ability to cover raw material energy with pricing, and product substitution, and then finally taking chunks of costs out of the company is -- you know, you are seeing good results.

Rosemarie Morbelli - Ingalls & Snyder

And if I may ask one last question. Sallie, the $13.8 million of one-time charge, let's call it. Could you allocate that within -- in each of the segments, so we have a better feel for what the margins really were there?

Sallie Bailey

No, we don't provide that. We -- information, Rosemarie.

Rosemarie Morbelli - Ingalls & Snyder

Okay. Too bad. Thanks.

Sallie Bailey

Thank you.

Jim Kirsch

Thank you.

Operator

Our next question comes from Mike Harrison, First Analysis.

Mike Harrison - First Analysis

Hi, good morning.

Jim Kirsch

Good morning, Mike.

Mike Harrison - First Analysis

Not to harp on the guidance, and sort of what you're looking at for next quarter and for the second half, but you talked about sustainable improvements in the business, and looking at this quarter versus what your guidance is for next quarter, even considering the seasonality, you know, shouldn't we assume that the restructuring benefits are actually increasing as the year progresses?

Jim Kirsch

Yes, you should.

Mike Harrison - First Analysis

Then -- then I guess maybe if you could help me understand, maybe -- you know, aside from electronics, are there other segments where you are concerned that you might see a slowdown on the top line, or some kind of margin compression versus what you have seen this quarter?

Jim Kirsch

The way I would answer that, Mike, is if you think about our broad exposures to market segments, we have about a 10% exposure to the automotive world. We have about a 30% or so exposure to broad construction and -- you know, both commercial and residential industries around the world. I don't know any prognosticator in the last two and a half years that has forecasted those correctly, frankly. So -- yes, I think that we're being appropriately cautious in our outlook. We recognize the things that we can control, and as we said over the last year we're on time, on schedule, on budget, etcetera. We're performing very well.

And I think that we will continue to perform well, and I think we have put out a guidance estimate that in our view is a solid estimate that should reflect the uncertain economic times we're in, and our ability to take control and continue to move on price versus raw materials and energy. The net of it all, I think -- if you have had a look at this over the last several years in particular, is we have had some low lows in this company the last several years, and I think what we have done by taking costs out and improving the pricing mentality and the value proposition for the customers, and then finally by improving the product mix substantially, is we have lifted the base. So we're operating off of a higher platform than we have in years gone by, and we expect that to continue.

Mike Harrison - First Analysis

Alright then -- your sales in the appliances market, does that get lumped in to the way you look at construction broadly, or that would be separate?

David Longfellow

We look at that separately. If you looked at some of the past pie charts that we have done on sales by our customer’s application, Mike, we -- we call that out as a separate slice of the part.

Jim Kirsch

It’s about 7% to 8% of sales Mike.

Michael Harrison - First Analysis

And is that roughly half in half U.S. and international or is it more heavily in North America?

Jim Kirsch

It’s more heavily in North America, but it is not dmoninated by that. We are talking probably in the 55% to 60% in North America. Our Asia business in that sector is growing nicely. But it's certainly North America. But it’s certainly North America and Europe for the most part.

Michael Harrison - First Analysis

Got it. Got it. Jim, you spoke at your Analysts Day about acquisitions. I know the Fluid Logic acquisition was a fairly small deal. But can you talk about what that deal means to Ferro in terms of, so to speak, returning to the acquisition game? And then as you look at your management team, how would you rate your experience in finding and successfully integrating acquisitions?

Jim Kirsch

Yes, it is a modest deal, no question about it. But first off from an extension of value-added products, it's a very nice fit with our surface finishing technology and extends us in the value chain And in fact a significant number of our customers that we deal with in both electronics and in organics are customers that they were dealing with this product line. So, it will, we believe we will be able to leverage at substantially and rapidly growth of sales. And so, from that standpoint, technology, couple of key people, process et cetera, same kind of criteria I outlined in New York at our Analysts Day, it made a nice fit, easy to make sense of it, and it's been a seamless integration, fairly rapidly. In terms of the individuals we have, if you look at the operating people, all of them are pretty seasoned, and all of them have participated in both acquisitions and divestitures.

So I would tell you that today our process capability is such that we're now engaged in and looking at the acquisition field much more seriously than we were a year ago. Because if you remember, maybe a year ago I made some comments to this effect saying, hey, we've got to build our infrastructure, meaning our information systems, our accounting and finance, our market sale, as well as manufacturing. And when we get to that levels that we think are not only sustainable but are able to acquire and bring things in non-disruptively, we'll go do that. So I think you should look at this action as our beginning.

Michael Harrison - First Analysis

All right. Great, and then the last question I had was for Sallie. It sounds like between the impact of FX and the precious metal pass-throughs that organic growth was something around 4.5%, and I was wondering within that organic growth number, can you give me a rough estimate of how much of that was pricing outside of the precious metals, versus volume and mix component?

Sallie Bailey

Yes, Mike, it's hard to -- it's hard for us within the complexity of the businesses to differentiate among – at that level of granularity among the volume and the price and mix.

Michael Harrison - First Analysis

Was volume and mix positive?

Sallie Bailey

Well, it really depends on which business, you know, you are talking about.

Jim Kirsch

Let me help out, Mike. In terms of -- first off, in terms of volume mix, I have talked about this before, we sell frit for instance in 2,000-pound bags, and we sale materials in the same business by the kilo or in some cases by the gallon or the quart-type container. So as move toward higher-value products, such as metals and pastes, for instance , and electronics, there's much less total volume in terms of weight and so on going out the door, and in fact, you know, we consider ourselves more successful on the higher-value end if we're selling less frit and more of the value-added products in tile or PE, and more of the value-added products in electronics and PAD.

So, in general, if you look at it from an operating profit basis, volume mix was positive, and price was positive. Okay? But price was a greater percentage of the positive, if I can put it that way, than volume mix was. If you looked at it on a revenue basis, you would find that volume mix was negative and price was positive. And that's mostly driven by the plastics business in the U.S., where we did very well on price, but the volume is down considerably over the last several years and continuous to decline based on where that ends up, automotive appliance etcetera.

Michael Harrison - First Analysis

All right, thanks very much.

Operator

The next question comes from Mike Sison with KeyBanc. Your line is open.

Mike Sison - KeyBanc

Hey, good morning, congrats on a very very nice quarter.

Jim Kirsch

Thank you.

Mike Sison - KeyBanc

In terms of electronics, just wanted to get a better feel for the profitability improvement, 24% pre-precious metal versus 8, how much of that was sort of the cost savings, and I'm trying to see if there's sort of a base profitability level that you are at, that maybe total might fluctuate depending on demand?

Jim Kirsch

Let’s break the cost savings into pieces. If you go back to the Niagara Falls shutdown?

Mike Sison - KeyBanc

Right.

Jim Kirsch

We said, we get about $3.5 million this year.

Mike Sison - KeyBanc

In that business, right? We had about 3.5 last year.

David Longfellow

Although we didn’t see any of that in the second quarter of last year.

Jim Kirsch

Right. Right. So in the – second piece of that would be the -- primarily the drivers would be the conductive metal pastes and surface finishing businesses and the driver there has been volume and price, and expanding our market and customer positions. So our overall improvement in the business has been dominated by price, volume and customer expansions, if you will, followed by the significant cost improvement in South Plainfield, you remember there was a $3 million hit in the second quarter. So you could do an apples to apples , second quarter to second quarter and look at $3 million in difference, okay?

Mike Sison - KeyBanc

Right. Okay. I got you.

Jim Kirsch

So you can add back 3, if you will, to of more apples to am

Mike Sison - KeyBanc

Yes.

Jim Kirsch

Those would be the three pieces.

Mike Sison - KeyBanc

Okay. Good. And then, in total for the company, you have sort of an estimate of how much the improvement of how much the improvement was, you know, cost savings in total for the quarter?

Jim Kirsch

I haven’t broken it down that way, because I have been looking at the total for the year, but again, if you go back to the quarter-over-quarter look, you got about $3 million from South Plainfield, and about $1 million to $1.5 million in plastics from the Evansville action last year.

Mike Sison - KeyBanc

Yes.

Jim Kirsch

In addition to that, we have some savings that we generated last year from the overall restructuring effort, which we said annualized – this year would in the $15 million to $20 million range.

Mike Sison - KeyBanc

Okay.

Jim Kirsch

I wouldn’t tell you could quarter-ize that so to speak, because more of that is going to happen in the second half than the first, but we are seeing it.

Mike Sison - KeyBanc

Okay. So that -- so if I did that math, the -- the improvements in profitability does continue to increase the third and fourth quarter , relative to what -- what could have been seen in the second?

Jim Kirsch

No, didn't say -- I'm not sure what you mean in terms of improvements in profitability, if you are [corporately] or you're asking about our cost savings. But I would expect your cost savings that we're generating in the second half to be the greater than the cost-savings we generated in the first half.

Mike Sison - KeyBanc

The impact on your results, that is?

Jim Kirsch

Correct.

Mike Sison - KeyBanc

Okay, great.

Jim Kirsch

What that doesn’t speak to what happens with raw materials, energy, pricing, et cetera, et cetera. So I wouldn't tie them necessarily directly to profitability.

Mike Sison - KeyBanc

Okay. And in terms of raw materials, it doesn't sound like there was much of a squeeze this quarter, in total. It sounded – you got most of your pricing to offset it?

Jim Kirsch

Yes, that’s correct. We had, by our calculation, about a $30 million impact of raw materials and energy into the company in the second quarter.

Mike Sison - KeyBanc

That’s great. And that $30 million was it mostly petro, or a very small portion petro.

Jim Kirsch

No, it was more -- again, you have got to look at the volume we take. It was widely spread, but petrochemical, tallow, soy oil were very significant to us in the organics businesses; in the inorganics business chrome went out of sight. We’re seeing some improvement in cobalt, a little bit in zinc, so it’s a real mixed bag. But both metals, meaning non-precious metals and then the tallow, soy bean oil and petro would be the kind of the buckets.

Mike Sison - KeyBanc

This has been effectively the second quarter in a row that you have been able to offset changes in raw materials pretty quickly in terms of pricing. Going forward, do you think that’s sustainable in the third and fourth quarter? May be just step back real quick and give us an idea what has really changed fundamentally, because we see most companies being squeezed pretty significantly, you know, on the raw material front.

Jim Kirsch

I don’t want to sound egotistical, but we started earlier, Mike

Mike Sison - KeyBanc

Right

Jim Kirsch

Frankly. I mean, if you went back to a comment made by one of the operating guys in NewYork, there was a big splash about one of our peer companies, who shall remain unnamed but got recently bought, talking about all the things you doing on pricing. We started that stuff in 2005. Product substitutions, reformulations, surcharges, FX surcharges, freight surcharges, straight prices, TVAs working with our customers will give them options. And I frankly think that we understand our customer base as well or better than our competitor still. And we understand how they make money and how to help make them successful, and their sustainability is critical to our success. We have been working on this for three years.

Mike Sison - KeyBanc

Great. Thank you.

Operator

Your next question comes from Dmitry Silversteyn Longbow Research.

Dmitry Silversteyn - Longbow Research

Good morning, and let me add my congratulatory comments to your very fine quarter here.

Jim Kirsch

Thank you.

Dmitry Silversteyn - Longbow Research

Couple of questions. First of all, just to follow-up on Mike Sison's question earlier, and I think you answered it partially, but I just want to make sure that I understand the answer completely. The polymer additives performance on the margin was to say the least surprising on a good side and in the sense despite all the headwinds that you are facing for raw materials and from weaker demand you are able to maintain your margin aside from pricing initiative that you have just talked about, is there anything else in terms of productivity gains or high approach to business or the cost structure or the markets that you’re in that would account for the success you are having from preserving margin in this tough environment?

Jim Kirsch

Well, there's two factors it, you know -- or three, rather, productivity, clearly as we continued to adjust our work force, and continued to up the operating rates at our facilities, we run the business for cash. We're very, very selective in our investment into business. Pricing has been the premier tool that has been used. That business started two and half years ago to restructure and resize itself. We talked about combining the sales and marketing efforts with plastics and polymer additives. Take costs and better serve out to it's better service customers. But the third we talked about off and on that we treat as very, very critical to the success, that business has had a tremendous effort in moving away from PVC. Now you can't completely divorce yourself from it, but they moved a significant amount of their revenues away from PVC into higher-value products like personal care, home sanitizers, oil field down-hole mud drilling materials, and so on and so forth. And those carry with them more value in terms of price relationship to the customer.

Dmitry Silversteyn - Longbow Research

So it would be almost incorrect these days to call this a polymer additives segment, you would call it some sort of functional additives segment then?

Jim Kirsch

We'll stay with polymer additives because it's too tough to change names around here.

Dmitry Silversteyn - Longbow Research

Alright, fair enough. The double-digit growth you delivered in that business in the first half of the year, I understand part of it is foreign exchange and pricing, but to be getting [14%] and [15%] growth on a year-over-year basis in this environment, is there a significant mix improvement and volume that goes along with the shift to non-PVC markets, and is that sustainable in the second half year of the year, as you're coming up against some difficult comps?

Jim Kirsch

Yes, it's value, in other words we have moved, as I said a substantial more than 20%, 25% of that business out PVC-dominated end-uses, as a consequence you get a much higher price for the product. Second, we have some very unique chemistry capabilities in our operating units in that business, and we're able to do some things in terms of combining chemistries and capabilities that others can't. And we price for that. It's not volume.

Dmitry Silversteyn - Longbow Research

Excellent, and just to follow-up on the electronic materials improvement in the profit margin, now that you have achieved double-digit levels of profitability, even including the precious metal costs just on a reported basis of 11% this quarter, should we expect this run-rate to continue allowing for some seasonal softness in the third quarter because of just typical seasonality in the electronics market?

Jim Kirsch

Yes, I believe so. In other words, you know, we have said this 40/20/20. 40% gross margins, 20% reinvestment in our people, and 20% operating margins what we want to deliver ex-precious metals. We did that for the very first time; on that basis it was about a 24% operating margin, and my expectation of that business is they are going to continue to drive that process and, you know, we expect to continue to see those kinds of returns consistently.

Dmitry Silversteyn - Longbow Research

Excellent. Final question. In terms of raw material costs, you talked about being little bit ahead of the curve in some of your actions that you're taking, but in strict price increase terms, are you seeing the overall material costs going up at a faster rate, slower rate, in the second half of the year versus the second half of the year? You think the worse is kind of behind you and you are catching up, or do you feel that you have to run really hard to just keep up with what you expect from the second half of the year?

Jim Kirsch

Those who are familiar with me that have seen me a lot in the last three years know that every time I try to prognosticate that, and I have said this publicly a number of times, I'm wrong. I'm not going to take a shot at that, because it's just way too volatile out there. I'm not surprised by anything anymore in terms of energy and raw materials. The turnover in some of the key commodities like cobalt is certainly helpful to us; on the other, hand the extraordinarily fast and high rise in chrome hurts us. So I think the key is to be adroit, adept, very fast, act with velocity, take your decisions quickly, stay close and work with your customers, and constantly anticipate what is going to happen, and we are working very hard at all of those and have a group that is pretty good at it.

Dmitry Silversteyn - Longbow Research

Okay. Thank you very much, and congratulations again.

Jim Kirsch

Thank you.

Sallie Bailey

Thank you.

Operator

Christopher Butler with Sidoti & Company.

Christopher Butler - Sidoti & Company

Hi, good morning. Thank you for taking my call.

Jim Kirsch

Good morning, Chris.

Sallie Bailey

Good morning, Chris.

Christopher Butler - Sidoti & Company

Just wanted to clarify something you were saying to Mike Sison on the costs saving side, I know you said that for the most part the inorganic savings is going to be the second half of his year. Did you say that you saw anything in the second quarter from that?

Jim Kirsch

Yes, we did. You have got to really look at -- we started this process in late '05 early '06, and we set out a target of $40 million to $50 million of total cost savings in the inorganics business through restructuring in Europe. We said we got some of that, $10 million, $12 million in '07, and we get 15 to 20 this year, and that we would capture the remain at the end of '09, first quarter '10. We're on time and on budget to do that. So we have seen savings, and when you get those, they stick, right? So we have seen some of that in the first half.

Christopher Butler - Sidoti & Company

And staying in inorganics, could you give us an update on -- you know, what we're looking at for the housing market in Europe, the news seems to be getting worse and worse there, but it sounds like you continued to offset that with North Africa, Eastern Europe, Russia, some of these other geographies.

Jim Kirsch

That’s exactly right, I mean, clearly in the Euro zone particularly Italy, Spain, the housing activity has slowed considerably. On other hand, Egypt for instance remains an extremely high growth market. So, we continue -- I have got to give the guys in the tile business all the credit in the world. They started this program in 2001, again, chunks of cost in that. Our goal is to hang on to that margin and not pass that along, but it also makes us that much more competitive as we extend into these markets.

Christopher Butler - Sidoti & Company

And shifting gears to business in Asia, you had mentioned on the electronics side that you may see things slow a little bit in the second half of the year due to possible pre-buying from China – are you seeing any sort of slowdown in general in Asia due to slowing global conditions, anything from that?

Jim Kirsch

You know, as evidenced by our second quarter, I would have to tell you no to that answer because as I looked at our regional results, Asia, and -- you know, the US was the weakest region and in terms of percentages and Asia was just fine.

Christopher Butler - Sidoti & Company

Thank you for your time.

Jim Kirsch

Yeah.

Operator

John McNulty with Credit Suisse

John McNulty - Credit Suisse

Good morning, just a few quick questions, first of all can you give us -- I realize you are in kind of deep investment mode between ramping up some new facilities and also tied to your restructuring program, can you give us some color or your thoughts on where your cash flow may come out at the end of the year with regard to your free cash generation? I know in past years you kind of been just barely breaking even a little bit below or so, can you give us kind of your thoughts on that?

Sallie Bailey

Yes, sure John. We’d be in that same mode, may be some usage of cash for 2008 because of the investment we’re making, investments in three forms actually, hard investments in terms of our color plant in Spain, hard investments in terms of the Suzhou electronics materials plant, and then the continued payouts associated with severance with our restructuring plant.

John McNulty - Credit Suisse

And should we expect that to turnaround in 2009, I know obviously there are lot of moving parts, but?

Sallie Bailey

Yes, absolutely, I mean as those programs begin -- you know, we have built the plants, and we complete our restructuring programs, we would anticipate our free cash flow beginning to improve. I think, if you look at the adjusted EBITDA for the -- for the quarter that I went through, it's a big improvement over what we saw in the first quarter. And the quality of our earnings is improving, and we would anticipate if the quality in earnings continues to improve, that that would continue to generate strong free cash flow, particularly as we again begin -- as ''09 begins.

John McNulty - Credit Suisse

Okay, great, as far as the cost cutting plan and the 15 million to 20 million that you’re looking for 2008, given the strength that you have seen in some of the numbers that you’re putting up in the first half of the year. Do you have any conviction that you comment, may be above that range at this point?

Jim Kirsch

I am sticking with our guidance John.

John McNulty - Credit Suisse

Okay, thanks. Fair enough, last question in the electronics business, if I remember correctly, at your '07 Investor day, advance materials was about half of the revenue excluding pressure metals, can you give us an update as to where that stands right now given kind of how fast some of your business are growing and some are, may be not growing?

Jim Kirsch

It’s because of the growth in surface finishing. It is still in that 50%-55% range.

John McNulty - Credit Suisse

Okay.

Jim Kirsch

So, if you looked at what way updated at the Analyst call in New York, I think it was May – I am losing track of my months here.

David Longfellow

June.

Jim Kirsch

June, we still show that around to 50% to 55% range John, and that’s a pretty accurate number.

John McNulty - Credit Suisse

Okay great, thanks for the update.

Sallie Bailey

Thank you.

David Longfellow

I don’t see any more questions in the queue, so that concludes today’s conference call. For copies of our press release, replays of this call or access to our SEC-financial filings please go to our website at www.ferro.com and click on investor information. Thank you and have a good day.

Operator

Thank you for participation in today’s conference call. You may disconnect at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Ferro Corp. (FOE) Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts