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

Executives

David Longfellow - Director of Investor Relations

James F. Kirsch - Executive Chairman, Chief Executive Officer and President

Jeffrey L. Rutherford - Chief Financial Officer

Analysts

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Abhiram Rajendran - Crédit Suisse AG, Research Division

Kevin Hocevar - Northcoast Research

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Michael J. Harrison - First Analysis Securities Corporation, Research Division

David L. Begleiter - Deutsche Bank AG, Research Division

Dmitry Silversteyn - Longbow Research LLC

Ferro (FOE) Q3 2012 Earnings Call October 30, 2012 10:00 AM ET

Operator

Good morning, and welcome to Ferro Corporation's Third Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Tuesday, October 30, 2012. 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 2012 Third Quarter Earnings Conference Call. Today, we will discuss our financial results for the 3-month and 9-month periods ended September 30, 2012, and provide a current outlook for our financial performance for the full year. Joining me on today's call are Jim Kirsch, Chairman, President and Chief Executive Officer; and Jeff Rutherford, Vice President and Chief Financial Officer. Following their prepared remarks, Jeff -- Jim and Jeff will take your questions.

Our quarterly earnings press release was issued yesterday and is 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 we begin, 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, including those listed in our earnings press release and more fully described in the company's Annual Report on Form 10-K for December 31, 2011.

Forward-looking statements reflect management's expectations as of today, October 30, 2012. The company undertakes no duty to update them to reflect future events, information or circumstances that arise after the date of this conference call except as required by law. A dial-in replay of today's call will be available for 7 days. In addition, you may listen to, or download a replay of the call through the Ferro Investor Relations website. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Ferro is prohibited.

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

James F. Kirsch

Thank you, David, and good morning to those of you on the call. Let me first comment that our thoughts are with those on the East Coast dealing with the devastation of Hurricane Sandy. On today's call, I will focus my remarks on the actions we're taking to create value for our shareholders, including the decision we announced earlier this month to explore strategic options for our solar pastes business and the organizational and business process changes we are making to drive expense reduction.

First, however, let me say a few words about our overall results for the quarter. We reported an adjusted loss of $0.02 per diluted share for the third quarter and adjusted income of $0.15 per diluted share through the first 9 months of 2012. The results are in line with the guidance we provided on October 9 when we announced our intent to explore strategic options for our solar paste business. The paste business continues to be a drag on our performance, reducing earnings by approximately $0.04 per share during the quarter. We also experienced further weakening of customer demand in Europe during the third quarter in several of our businesses as the economic climate continues to deteriorate, especially in Southern Europe.

The decline in the market for solar pastes, coupled with a lack of adequate progress in our efforts to qualify new products at major solar cell manufacturers, led to our decision to seek strategic alternatives for our solar paste business. Our objective is to eliminate the negative impact from this business on earnings and cash flow and to focus more of our efforts on higher potential opportunities related to Ferro's strong Coatings and Colors businesses.

We're determined to complete a review of the available options for the solar paste business quickly and to take any necessary actions without delay. We are having discussions about the paste business with a number of third parties at this time, and we have engaged financial advisors to help us complete this process as quickly as possible.

I'll now focus the remainder of my remarks on additional steps we are taking within Ferro to improve profitability and create shareholder value. Our efforts are anchored around expense reduction, targeted capital spending and profitable growth from both the internal programs and acquisitions. We're undertaking efforts to reduce operating expenses with added urgency because of the macroeconomic headwinds that we are experiencing around the world, particularly in Europe.

As we've indicated previously, we expect to reduce the annual operating expenses run rate by $15 million by the end of 2013 and an additional $15 million by the end of 2014. The actions to implement these expense reductions have already begun and will continue through the next several quarters. Achieving these goals will require streamlining our organization at all levels. We also intend to make changes in the organizational structure of our commercial groups and support organizations. Our changes will be aimed at driving additional accountability for each organization to optimize our worldwide financial performance, whether in sales growth, production costs or global support expenses.

In addition, we are currently analyzing the potential closure of some smaller facilities, particularly in Europe, consolidating our operations to our existing major manufacturing locations. We expect all these cost reduction actions will reduce worldwide headcount by approximately 10% over the next 2 years. As we go forward, our capital spending will be targeted on the areas that offer the best opportunity for profitable growth. We will continue to invest in businesses that earn their cost of capital and deliver their growth targets, such as our pigmented inks business within Performance Coatings. Return on invested capital is a key metric used to evaluate every business in our portfolio. We require a minimum return of greater than our cost of capital on any growth capital project proposed. Projects meeting this minimum threshold are selected based on a prioritized ranking, comparing all proposed projects.

We believe there are growth opportunities within our core businesses over the next several years. We are well-positioned to benefit from any future cyclical recovery in the worldwide building and construction markets. These markets have been challenging recently, but we have been able to expand our position in regions such as North America and the Middle East, and we have opportunities to grow as construction markets improve over the next 3 to 5 years. We expect automotive markets to provide growth opportunities as well, particularly with North American and German customers where we have strong market positions and good customer relationships.

In addition, we believe there are good opportunities to expand our available markets and supplement our organic revenue growths through synergistic acquisitions in the Coatings and Colors markets. We are continuing to evaluate possible acquisitions and we believe there will be opportunities to act while maintaining a strong balance sheet.

Let me summarize my remarks. The economic climate is likely to remain challenging in the coming quarters, particularly in Europe. However, we have a portfolio of strong core businesses that return their cost of capital and generate positive cash flow that can be reinvested in the business. We are taking decisive actions to address the levers that drive improved return on invested capital, gross profit, operating expenses, working capital and capital spending. In addition, we're taking action to achieve $30 million in cost and expense reductions, and we are moving forward with headcount reductions and expect to reduce overall headcount significantly. We are looking at further plant consolidations in Europe, and we are working to resolve our issues with the solar paste business in the near term. I expect these actions to make significant contributions to our profitability and allow us to leverage any future recovery in global business conditions.

Now I'd like to turn the call over to Jeff Rutherford, who will detail our financial results and discuss our outlook for 2012 before we open the call for your questions. Jeff?

Jeffrey L. Rutherford

Thank you, Jim. In my comments this morning, I will briefly review the key drivers of our third quarter performance, including the charges we recorded. I will finish with a discussion of our current 2012 guidance. The details of our reported results can be found in our quarterly report on Form 10-Q that was filed yesterday. Additional information is available in our earnings press release, also filed yesterday, and in the supplemental information available on our website. Reconciliations of non-GAAP results discussed during this conference call are contained in our press release and the posted supplemental financial data that can be accessed from the Investor Information portion of Ferro's website.

Our reported loss attributable to common shareholders was $316 million, or $3.66 per diluted share during the 2012 third quarter. Excluding impairments, restructuring and other special charges, the adjusted loss per share was $0.02. Pre-tax charges totaling $208 million were excluded from our adjusted results, including impairments of goodwill, along with assets and property held for sale and solar paste inventory write-downs. In addition, and largely as a consequence of the impairment charges, we recorded a noncash reserve against our deferred tax assets that increased income tax expense by $112 million. The income statement line item detail for these charges is shown in the reconciliation contained in our earnings press release and posted on our website.

Net sales were $415 million during the third quarter, down from $514 million in the third quarter of 2011. Lower sales of solar paste, metal powders and surface finishing materials in our Electronic Materials business were the largest contributors to the decline in sales. Reduced sales of precious metals accounted for $64 million of the net sales decline. Outside of the Electronic Materials segment, sales in our other 5 businesses declined by $41 million compared with the prior year quarter. Changes in foreign currency exchange rates were responsible for $16 million of that decline, while changes in sales volume and price mix each contributed approximately $13 million to the total sales decline. From a regional perspective, the bulk of the sales decline in the nonelectronics businesses was due to the weak economic environment in Europe.

Gross profit was $62 million during the third quarter compared with $104 million in the third quarter of 2011. As with sales, the majority of the decline was driven by reduced sales of Electronic Materials products. The third quarter gross profit was reduced by approximately $5.8 million of special charges due mainly to inventory write-downs and silver reclamation costs associated with solar paste and residual costs at manufacturing sites closed during earlier restructuring actions.

SG&A expense for the 2012 third quarter was $65 million, a decline of $1 million from the prior year quarter. The third quarter SG&A expense includes special charges of $3.2 million primarily related to an increased reserve for other tax assets and residual expenses at sites that were closed during prior period restructuring actions.

Both the 2012 third quarter and the prior period SG&A expenses reflect a change to a preferred method of accounting for pension and post-retirement benefits. Under this method, actuarial gains and losses associated with these benefits are recognizing in the year in which they occur. And therefore, periodic benefits expense no longer includes the amortization of deferred gains and losses. This change is expected to reduce our full year 2012 pension and post-retirement benefits expense by approximately $19 million. We have adjusted the prior period results reported in our 10-Q and press release for this accounting methodology change. In addition, we have posted supplemental information on the Ferro Investor Relations website showing reported and adjusted results for the 4 quarters in 2011 and the first 3 quarters of 2012 so that you can see the effect of the change in pension accounting.

The noncash mark-to-market charge that we expect to record in the fourth quarter will not be included in our adjusted earnings, nor is it included in our earnings per share guidance for the year. The amount of the change will be dependent on the market performance of the pension plan assets during the year, in combination with the effect of changes in our discount rate and other assumptions on the post-retirement benefit liabilities. Given the current interest rate environment, we expect the discount rate assumption used in the annual measurement of our benefit liabilities will decline resulting in the fourth quarter charge.

Restructuring and impairment charges were $199 million during the third quarter. The charges include $147 million goodwill impairment and a $41 million impairment of property, plant and equipment, both related to our Electronic Materials business. In addition, we recorded an $11 million impairment of property held-for-sale related to manufacturing sites that were closed in prior restructuring actions.

Our liquidity remains strong. At the end of the third quarter, we had $335 million of availability in our $350 million revolving credit agreement and we had an additional $30 million in liquidity available through our U.S. receivable securitization facility. Our net precious metal leases were $189 million at the end of the third quarter. Our net leases are the total leases outstanding less any unapplied credits which we have generated through our third-party precious metal sales.

Subsequent to the end of the third quarter, we have reduced our net leased balance to $152 million as of October 26. Included in the $152 million, there's approximately $15 million of metal at third parties being processed back to bullion, which will reduce our

[Audio Gap]

additional $15 million or approximately $137 million. We currently have no demands for cash collateral related to our precious metal leases. We have not had any recent changes in our precious metal leasing program participants. We are currently in compliance with all of our debt covenants and based on our current forecast, expect to remain in compliance.

We reported improved cash flow during the third quarter compared with the prior year quarter. For the third quarter, our adjusted EBITDA was $17.3 million, as shown in our supplemental financial data posted to our website. In addition, we generated cash through a reduction in net working capital of $15.2 million driven by a reduction in receivables. During the quarter, we consumed cash with cash income taxes of $1 million, cash interest of $12.1 million, pension contributions of $7 million and FPS cash cost, including both expenses and capital, of $2.9 million. All of the capital spending was $10.9 million during the quarter. Other miscellaneous sources of cash were approximately $5.2 million. As a result, our reduction in net debt was $3.8 million during the third quarter.

Year-to-date, our cash flow is a negative $26 million. We are currently forecasting that full year 2012 cash flow will be negative $10 million to $15 million. Note, we have already paid a majority of our taxes, cash taxes, cash interest and cash pension contributions for the year.

Finally, I'd like to review our current 2012 outlook, which is unchanged from the forecast we provided in our press release on October 9. Total sales for 2012, excluding precious metal sales, are expected to be down 8% to 10% compared with 2011. Sales of precious metals are expected to decline due to lower volume and lower average prices. Adjusted earnings for 2012, excluding special charges, are expected to be in the range of $0.07 to $0.12 per diluted share. The adjusted earnings per share are estimated using a pro forma tax rate of 36%. Additional assumptions that are part of our 2012 outlook include: capital spending of approximately $55 million to $60 million. Interest expense is expected to total $28 million for 2012, or about the same as in 2011. Cash taxes are expected to be approximately $4 million for the year.

Worldwide, pension cash contributions are forecasted approximately $28 million in 2012, a decline in $2 million from 2011. Year-to-date pension contributions through September 30 were $27 million and depreciation and amortization expense of approximately $55 million. That concludes our prepared remarks for this morning's call. So I'd like to turn the call back to Dave Longfellow so we can take your questions.

David Longfellow

Thank you, Jeff. Operator, we're now ready to begin the question-and-answer session.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Rosemarie Morbelli with Gabelli & Company.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Jim, could you touch on your silver exposure after you disposed of solar, one way or another?

James F. Kirsch

Well, if one were to assume we weren't in the solar paste business, which is the basis of your question, we'd would be reduced by another $30 million -- $40 million.

Jeffrey L. Rutherford

$40 million. We'd be at -- based on today's metal levels, we'd be at approximately $100 million of precious metal.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

$130 million, you said?

Jeffrey L. Rutherford

Well, today we're around $140 million after all the credits and all the metal we have out. So we would reduce that another $40 million if solar paste were sold. And so, our remaining metal for our powders business in the U.S. and in Europe would be approximately $100 million, based on today's metal prices.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Sure, I understand. I am assuming that you can't really give us a feel for what is really going on, but if you look at the likelihood of getting some money for that solar business as opposed to just shutting it down, do you have some kind of a prognosis?

James F. Kirsch

Not one that I care to speculate on, Rosemarie.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Okay, and we have seen the housing to a certain degree, recover in North America, or it is beginning to recover. Could you give us a feel for how much of your housing exposure is in the different regions because I thought that you would have benefited more?

James F. Kirsch

Yes, the predominate exposure would be in North America. And it would be through our Polymer Additives and our Plastics businesses. The broad exposure in Europe would be Southern Europe, Middle East, Africa. That would be primarily through the Tile business and in Porcelain Enamel, both in Europe and in North America. In Asia, the exposure is through the Tile, Porcelain Enamel businesses, primarily. So as you look at the revenue generation the majority of pad and plastics revenues is generated here in North America. And off the top of my head, I'd have to come back to you on exactly what the housing subsegment of building construction is, Rosemarie. But it's significant in each of them.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Okay, and lastly, if I may. Are you considering any strategic options for any other of your businesses?

James F. Kirsch

Again, not at this time that I'd want to comment on.

Operator

And our next question comes of the line of John McNulty with Credit Suisse.

Abhiram Rajendran - Crédit Suisse AG, Research Division

This is Abhi Rajendran calling in for John. So your options for solar, I guess, could you touch a little bit on how much of this is being driven by just general oversupply conditions in the industry versus geographic shifts in demand or versus simple share shifts that you might be seeing?

James F. Kirsch

It's a little bit of all of the above. Let me just give you kind of our backdrop, anyways. When the industry consumption shifted dramatically to China, there was a real by bifurcation of the size of accounts based on government support, local support in communities and so on. We found ourselves much stronger in rear silver materials at Tier 2 and Tier 3 accounts. When went we went through 2010 and the first half of '11, from a volume standpoint, that was probably okay, but our work to transition to the Tier 1 accounts proved to be more difficult than, frankly, we had anticipated. We have good product, we've had a number of qualifications, we've been more successful in rear silver than front or aluminum at the Tier 1 accounts but their run rates are down in the 30% kind of operating capacity rates. And any overflow that they had in sending off to the Tier 2s and 3s really disappeared as they pulled that production back in-house. That exacerbated our issues a bit. And we found that the qualifications we've received, because of the low run rates, really haven't translated into the kinds of revenues that we had anticipated.

In addition to that, our outlook on the industry, while we think, certainly I believe the industry is one that will be here in the next several years, 3, 4, 5 years out, it will be a mainstay of production of electrical power although in a niche segment, I think the next couple of years are going to be extraordinarily difficult. There's going to be, in my mind, consolidation in the industry all through the chain. There continues to be a large amount of overcapacity at virtually every part of the chain, starting from polysilicon materials all the way through to modules. And from a materials player's standpoint, I think one has to take a strategic decision of participating in that consolidation and being more integrated in that overall solar industry, or not participating. And as we examine those opportunities and the cost of doing that, and the opportunities we had in other businesses, our view was, we'd be better off not participating in that consolidation over the next several years, weathering the difficulties that, that took place and the risks that brought with it and looking at other better opportunities for the company.

Abhiram Rajendran - Crédit Suisse AG, Research Division

And just a quick follow up. So it appears to be the nonsolar Electronics part of the business also lost some money in the quarter and going into a weak 4Q, will likely continue to be modestly unprofitable. Is that the right way to think about things? And are you expecting the nonsolar area to return to profitability in early 2013?

Jeffrey L. Rutherford

We would've been slightly profitable without solar in the third quarter and we'd be at $0.02 and that's going to continue. We're going to be probably in the fourth quarter -- we're already down, from a seasonality perspective, a little bit in the fourth quarter and I think we're going to be, if you back in into the numbers, about breakeven for the nonsolar business in the fourth quarter.

James F. Kirsch

Our outlook on 20 -- go ahead.

Abhiram Rajendran - Crédit Suisse AG, Research Division

Is that the -- does that include the nonsolar Electronics, that was also profitable in the quarter or...

Jeffrey L. Rutherford

Yes.

James F. Kirsch

Yes. As we look into 2013, at least the prognosticators in the nonsolar Electronic Materials, our expectation is that we'll see some modest recovery of those businesses. And given our positioning and the contribution margin of those businesses, it won't take a lot of recovery to show some fairly significant improvements. So if the industry in the semiconductor consumer products side improves in the 5% or 10% range next year, which would be actually a fairly modest improvement, 5%, 6%, then we would expect to see improvement -- corresponding improvement in our business.

Operator

And our next question comes from the line of Kevin Hocevar with Northcoast Research.

Kevin Hocevar - Northcoast Research

Could you comment on the Performance Coatings business? Of kind of the 3 pieces, there's the tile coatings, the Porcelain Enamel and the digital inks, which ones of those kind of saw the bigger declines during the period? And also, did digital inks grow during the period?

James F. Kirsch

Let me start on the bottom. Digital inks grew during the period. It continues to perform very well. We are running at high utilization rates and we'll continue to invest as the first mover branded advantage with that particular business. In the third quarter, the biggest downdraft was the Tile business and it was primarily the issues we experienced in Southern Europe. Beyond the downdraft in revenue, we also reserved a couple of million dollars for bad debt in anticipation of some difficulty we may well have in Europe, Middle East Africa region as a consequence of all the things going on in the economies of the Eurozone. So the issues in Performance Coatings primarily were Europe, were primarily volume related. As a consequence, we saw some pricing behaviors that depressed profitability. And then again, to reiterate, the inks business performed quite well and continues on its growth path.

Kevin Hocevar - Northcoast Research

Okay, and then in terms of the Specialty Plastics, has been performing really well for several quarters now. Is that -- has there been any changes there that -- because it's been around 9% EBIT margins here for a couple of quarters now. So has anything changed in there that -- and is that a sustainable margin going forward?

James F. Kirsch

Well we've talked about this in both Polymer Additives and Plastics. They're niche businesses, they're not large scale in that industry businesses. Both of them had been very focused on positioning themselves with higher value customers in higher value end-use segments. In Plastics, specific to your question, we've gained some position at some of those types of customers. Pricing has been advantageous, raw materials have been relatively benign and we've improved in terms of -- the guys do a great job of managing SG&A. So over the years, what we've experienced in that business is anywhere from 7% to 9% kind of margins. And so, when we experienced pricing raw material environment like we have right now, we tend to push to 9% or even 10% returns. And when you see things like polypropylene or styrene going crazy, then you tend to see us more in that 7-ish percent, 6%, 7-ish percent kind of range.

Kevin Hocevar - Northcoast Research

Okay. And then finally, you touched on the nonsolar part of Electronic Materials. Can this get back to the 25% type profit margins that we saw in the 2010, 2011 timeframe? Is all it means is that recovery in demand or has anything else changed in that industry?

James F. Kirsch

What we -- from our perspective, we need is, we need recovery in demand, particularly in the semiconductors side of this. And we need a little bit of volume uptick and particularly in metal powders. So as metal powders, which really go into, I'll say broadly general electronics applications. It's a high fixed-cost manufacturing facility. So as we trip over that breakeven, it's contribution margins tend to be quite high. We're operating fairly close to that level now in that business. And so as we see some uptick, then my expectation is, we'll see very healthy contribution margins from those businesses. In addition to that, our expectations are that in the part of our surface finishing businesses, the JV we've put in place in China, we think will be a positive contributor to margins in 2013 where it really was just started up here in the past couple of months. So I think we've got not only industry recovery going our way, assuming that, that occurs next year, but we've also introduced it through this JV, some enhanced products into the Chinese market that I think will benefit us.

Operator

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

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

In terms of the solar business, if you had time, which doesn't sound like time is sort of on your side, and you've done it in the past, do you feel pretty good that the technology that you have would ultimately sort of win the commercial contracts that you need to rebuild the earnings power for this business?

James F. Kirsch

That's a tough question, Mike. But I would tell you that if you looked at history, we've done very, very well, and there's been some years when we've been out-of-favor, if you will, and some years when we've clearly been the leader. Certainly, in the rear silver, we're the leader today. In aluminum and front silver, we're not. Is a bit of an open-ended question given time, resources, money, et cetera. Yes, I think we have very capable people and we have very, very good technology, and we have a track record of would suggest, over time, we would be capable of that.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Right, okay. And then if I try to rebuild some of your earnings power here, you guided $0.07 to $0.12 this year, includes the $0.14 to $0.17 loss from solar. And then you talked about $30 million in cost savings and if I tax effect that, it's $0.20, $0.25, so if you were able to find a solution for solar and execute well on your cost savings, it would seem to me with no fundamental improvement in demand that earnings power should be in that $0.40 to $0.50 range, is that one way to look at it?

James F. Kirsch

Yes, it is.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Okay, and then when you think about the leverage of the base business, any thoughts there and how we sort of build that earnings power going forward?

James F. Kirsch

Well, let's talk about our business from a -- our core businesses are solid businesses that generate cash and positive return on invested capital. They're not in market end-use applications that have high, high growth rates, right. You might suggest this year, automotive would be an exceptional to that. But in general, appliance packaging, building and construction and so on are GDP, or GDP-plus. What I think the guys -- I think plastics is an excellent example of that when they have changed the business model over the last several years to take advantage of higher value customers so we actually have a business that is generating terrific returns in that industry sector and yet is a smaller business than it was a few years ago. I'm not trying to suggest our businesses were all going to get smaller. What I'm am suggesting is that these businesses are going to have to continue to look for ways to generate higher margins in tough markets. Part of the way to do that is reposition yourself with better customers and make sure that all of our customers are generating a certain gross margin. And in addition to that, we have to be much more efficient below that gross margin line. And as I think about these businesses and where we're going, fundamentally, most of our business is coat or color substrates. We're looking at metals, ceramics, glass, and we're relatively a low part of the system cost. We've taken advantage of that with tremendous price elasticity, particularly in our Glass coatings businesses over the years, but we have limited headroom in terms of the size of the addressable markets and the technologies we practice. So we intend to use things like development, pigmented inks is a good example of that. And we've introduced organic materials in our automotive glass business as well. That's been very widely accepted in the market. And we also intend to acquire some opportunities through relatively modest size acquisitions to essentially add to our chemistry portfolio and change that addressable market. I think when we get those things done and we focus on these cost reductions, we take care of the solar issue that we've talked about, we maintain an excellent return on invested capital or enhance that through our working capital and other elements of it, we'll have an opportunity to lever our earnings. And if we perform and execute, you'll see that.

Operator

Our next question comes from the line of Jeffrey Zekauskas with JP Morgan.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

What's happening to your capital expenditures run rate per quarter going forward? Is that moving down or staying the same?

Jeffrey L. Rutherford

Yes, what we're doing now is we're running off some open capital projects, Jim mentioned one in China and other projects we have. And that's what you're seeing running right now. What we've done is we created a more robust capital process and what we're going to do going forward is we're going to have a fixed number relative to maintenance capital. The way we look at this is health safety of our employees is of priority in capital spending, public safety, obviously also environmental. But we're going to have a number relative to maintenance capital that's going to be a ceiling of what we can spend in maintenance capital. We're not ready to give you a number for '13, but it's probably something approximating half of our depreciation cost. And then what we have left over is going to -- well dependent upon cash flows, there's no limit of growth capital in my mind if it has adequate returns. We're going to have a high standard for a return on invested capital on incremental capital spending. And as Jim said, when those projects come forward, we have the liquidity but we're going to be very stringent about where we spend that money. So the answer to your question is, maintenance capital is going to come down from the levels that we're spending today, but we're not ready to make any commitment on growth capital yet other than to say, anything above that maintenance capital level will have an extremely high return. And that's how we're going to spend our money going forward.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Okay. And how big is your workforce after the solar business goes

[Audio Gap]

Of your workforce? When you think about...

James F. Kirsch

Around [ph] 500 people, Jeff.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

I'm sorry, how many?

James F. Kirsch

Our total workforce is a little over 5,000, so it would be around 500.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

What are the cash costs of reducing your workforce by another 10%?

James F. Kirsch

It's, on average, it's dollar for dollar for the type of savings you see generated.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

And what's the timeframe under which you'll reduce the 10%?

James F. Kirsch

Over the course of the next 2 years.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Two years. Is that front-end loaded or equally spaced?

James F. Kirsch

That's [indiscernible] Pardon me?

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Is it front-end loaded or equally spaced over the 2-year period?

James F. Kirsch

I mentioned that we had begun our cost reductions. And over the past quarter, we've reduced about 100 that are, I'll say, being phased out between now and the end of the year. So we've taken a big step forward already. But because, as you go through this process, there were a variety of legal activities and hurdles one has to overcome, negotiations with a variety of unions, works counsels et cetera. It will be phased and on the other side of this is that a lot of our back-office activities were centralizing and globalizing, and it'll take us I think the better part of 2013 to get those processes in place and to get that activity either outsourced or co-sourced as appropriate or globally resourced here in Ohio. So I would expect a significant portion will be late next year and then into 2014. So I can't give you an exact schedule other than to say we're about 20% of the way there right now.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

And then lastly, when you contemplate acquisitions, are these tuck-in additions to current businesses, or these diversification acquisitions?

James F. Kirsch

They would be tuck-in to current, but the critical element is that they not have the same product lines or chemistries we practice. Let me give you an example. Within our CGPM business, our pigments business, if we were to procure or buy another company that practice the same inorganic chemical process we do for pigments, it wouldn't do anything for our addressable market size, and we actually have a sizable share in that addressable market. If we were to, on the other hand, acquire a business that brought with it certain organic pigment chemistries, luminescent or fluorescent-type pigment chemistries, those are in the same realm of what we do but are different chemistries than what we practice. That type of activity could well change the size of the addressable market by a factor of 10. The overall global pigments universe is about $14 billion. Yes, what we want to do is change the size of that addressable market, leverage the global footprint and the facilities we have and participate in larger pieces of the pigments market.

Operator

And our next question is from the line of Mike Harrison with First Analysis.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Just was hoping to follow up a little bit further on the silver metal powders business. I guess I'm just surprised that you're not seeing better demands for touch screen applications, given the continued growth in tablets and smartphones. And I was wondering if you could talk about that and also talk about what kind of opportunities you might be seeing in touch screen monitor applications as we get into Windows 8, which is more of a touchscreen type of operating systems?

James F. Kirsch

Yes, we provide conductive inks into those applications specifically, Mike. We are a fairly far down in that supply chain. The -- you don't use a lot of them in any particular product line, if it's in a smartphone or a tablet and so on. The business is growing, it's growing at a fairly robust rate, but is coming from a relatively small base within our overall metal powders business. But it's one that we're focused on and continue to put resources against.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

And so as I think about maybe some the other non-solar pieces of electronic materials, I mean what is it that where you're really seeing weakness? Obviously, semiconductor is not great but it hasn't fallen off a cliff, probably same type of scenario for the flat panel display. Where is the weakness and kind of what's your outlook, what's your view on customer order patterns and inventory levels?

James F. Kirsch

From a profitability standpoint, we've seen a big decline in Surface Technologies, which are polishing materials. And it's as much related and I talked about this on a call once before, it's as much related to this price decline in ceria as it is to volume change. So there's been a dramatic change in ceria pricing that we took advantage of on the way up a year ago and as it's declined, pricing has changed pretty significantly in those related polishing materials. So volume's not bad, but pricing has come down pretty substantially and the customer order book is actually pretty solid in that business. In metal powders, we have materials that not only go into conductive inks, but go into general electronic applications, anything from shielding applications and also solar applications. So that has had, clearly, a dampening effects on the metal powders business. But broadly, we've seen outside of solar is a fairly steady customer demand rate, but folks are clearly managing inventories tightly. We're seeing that in all of our businesses. Some of the reduction in volume, in revenue we saw at pad and plastics was clearly a result of customers have started the destocking early. And I think in Electronic Materials business, what we've seen as well is very tight inventory control by customers, and yet relatively solid book to bills, but not one that's in a growth mode yet.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Okay, and on the CGPM business, I was hoping that maybe you can kind of talk us through the 16% top line decline, how much of that was driven by FX and maybe talk about what you're seeing in sort of the different markets there in automotive construction, packaging, et cetera?

James F. Kirsch

It's 3 elements, it's mix, volume and Europe. The mix has particularly in the PPC side of CGPM, so the non-glass materials, has not been as robust as it had been in the last year or so, particularly 2011. So as, in Southern Europe, as the volumes have declined, we've -- in the past year, we've been working very hard to continue to run those plants at rates. And it's our mix has declined, if you will. So if you put all those 3 pieces together more of this downturn is in the PPC, which is dinnerware colors, industrial specialties and into pigments. And most of that is in Europe. The glass business, while we've had some softening, primarily in flat class, the container and automotive sides have both held up pretty well.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

All right. And then last question a little bit around strategy. You've talked in the past, I think particularly when you guys did the secondary, talked about Ferro being a growth company. I understand that it's been a challenging environment here on a variety of fronts. But it does seem like the focus for the last several years and sort of as we look over the next couple of years, it has been much more on restructuring and on cost cutting than on growth. Going forward, how do you switch gears and position this company to grow and leverage the reduced manufacturing base that you've clearly done some very good work on and then sort of related question, how do you go about rightsizing this business in an uncertain environment and do you get concerned that you maybe end up cutting too far?

James F. Kirsch

Let me answer the second one first. I think on the second one, what we're -- what I'm focused on is what I would call perhaps less productive activities that we've been spending a lot of time and effort on and we're going to utilize things like our Ferro Business Systems initiative to get at those inefficiencies. My expectation is -- will have very -- or will have less impact the closer one gets to the customer. And as you're impacting your customer, our goal here is to further embed ourselves with them and meet or exceed their knees and you need to do that with the appropriate resources in the right places. However, you have to do that with the right customers and I think we've got some work to do there. With regards to how do we grow, I want to go back to the comment I made a little bit earlier. We have relatively high shares in most of our businesses in the addressable markets we participate in. So what we have to do is change the scale of those addressable markets. And you're seeing some of that with pigmented inks, but what we need to do is through bolt-ons is acquire some additional technologies, and we need to develop some as well, that will allow us to create more opportunity for Ferro moving forward. We thought, several years ago and made a pretty substantial resource investment, that solar would be volatile but not like we've seen it. And we thought that as a consequence of some of the improvements in our cost structure, in our core businesses, that we would be able to weather the volatility and dampen that volatility.

[Audio Gap]

So did the global economies. So as we look at those and how they've changed, that bumper, if you will, or that buffer, the degradation in our solar businesses went right through it, and obviously, it's had pretty negative impact on the performance the company. So I think our goal here if I look at our market structures, again, for the most part, they're not structures that are going to grow at 10% compound growth rates. I mean they're business that are going to grow at GDP or GDP plus 1 or GDP plus 2 kind of things. So our goal is as we look at these is be positioned in the right geographies with the right customers that can exceed those growth rates and can deliver added value. We'll do that by being more particular at where we invest our growth capital. We'll do that by enlarging the scale of the addressable markets we participate in. And we'll do that by rewarding the groups, businesses and people who would deliver on those very specific KPIs related to contribution margins, related to revenue growth, related to return on capital. So those are the activities that we're pursuing. And doing that in an environment once we get post our solar experience, then I suspect will be much less volatile than it's been in the past.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

And then last question is for Jeff, just on around the pension accounting change, in Q2 you guys reported and there were some unusual costs in there associated with pension, associated with some unusual health care benefits. Does the accounting change get rid of that kind of variability altogether or do we still see some puts and takes around the healthcare costs?

Jeffrey L. Rutherford

Yes, this -- the accounting change doesn't affect the healthcare costs. That's -- you got to go back and think about what our pension plans are. In the U.S., they're effectively dead plans. There are participants, but there are very, very little service cost in there. So what we have in our U.S. pension plans, effectively, is we need to fund those plans over time to meet the future obligations that we made to past employees. So we believe that pension accounting change is the best way to reflect that and takes that amortization cost of which can cloud our earnings and then we have to reconcile that out because really what you should be interested in relative to our U.S. pension is how much we're going to contribute. Because it's all about how much we're going to contribute and how are the assets performing. And we think this accounting change makes that much clearer everyone. Not only that, but it's the preferred method of accounting. On the -- to answer your question though about healthcare, that doesn't have did anything to do in the about this accounting change. Healthcare here, our issues in the second quarter were related to our current employees and we had a blip in our healthcare cost. As it turns out, it's come back into a more normal state in the third quarter, we didn't have a like adjustment in the third quarter.

Operator

Our next was also the line of David Begleiter from Deutsche Bank.

David L. Begleiter - Deutsche Bank AG, Research Division

Jim, with your liquidity larger than your current market capitalization, why wouldn't you look to buy back some stock at these hopefully depressed levels here?

James F. Kirsch

Well, we never say never, right? But right now, we're addressing some of our operating issues. We have to address our solar issue and then we would determine whether a buyback of stock or an investment in other businesses is in the best interest of our shareholders and that's what will continue to do. As of right now, we have not made a decision relative to buying back any shares.

David L. Begleiter - Deutsche Bank AG, Research Division

Okay, and Jim, just on Europe, which has been a key source of weakness. Is your sense that Europe has -- is getting worse, is stabilizing, that there's any potential of improvement next year? What's your sense from your business perspective?

James F. Kirsch

Well, I just got back from 11 days in Europe and the last 1.5 day was spent at a show called glasstec, which happens every other year in Düsseldorf. And Europe's of a tale of 3 cities, it sort of depends whether you're in the Southern part of Eurozone or Northern part of Eurozone or you're in Eastern Europe. But in our businesses, I'm very comfortable that we are very well positioned with our Glass business and CGPM. I think we're quite well and I think that business, because we have extended and enhanced our capabilities in Asia, I expect that business to show improvements as we move through the next year. The PPC side of that business is having a little tougher time primarily because the pigments part of the business wherein the addressable markets we operate in Europe are struggling. And if you look at some of our peers in that business, mostly were down about 15% in terms of their volume or revenue. But my sense is, our positioning again into some other parts of Eastern Europe, Middle East and so on, will enhance us. So I don't think the Eurozone is getting any better. I think our positioning in those businesses is getting better. The tile business is going to continue to struggle because you're got an awful lot of Europe -- excuse me, Spain and Italy, engaged in terms of consumption and the business has done a very nice job of moving product outside of that zone, but we are operating at very, very high operating capacity rates, 95-plus percent, whereas the industry is operating at closer to 50%. And it's led to really poor pricing discipline throughout the markets. And I think we're doing quite well and positioned with the -- in the right places in Egypt, Eastern Europe, Middle East, Northern Africa. But the pricing environment there, based on the market structures, is going to continue to be a difficult one to navigate.

David L. Begleiter - Deutsche Bank AG, Research Division

And Jim just lastly in solar, if you were to -- if you could not sell a business, what would the actual cash -- cash shutdown cost be for solar?

James F. Kirsch

We haven't gone public with that to date. It's a relatively modest number. It's -- it will be less than $5 million, Dave.

Operator

Our last question comes from the line of Dmitry Silversteyn with Longbow Research.

Dmitry Silversteyn - Longbow Research LLC

A couple of -- it's actually a 3-part question related to solar. First of all, on the -- you mentioned that in the third quarter, you took about $2 million in bad debt expense and the Tile business for some expected or realized customer bankruptcies. We've seen in the solar business, certainly, a lot of businesses -- the upstream of you and downstream of you going out of business, I am not -- I don't remember you taking or increasing bad debt reserves in the solar business. Is that because the customers you're exposed are still pretty liquid or is that still to come?

Jeffrey L. Rutherford

No, they're the opposite of liquid. What we do is we only sell to them through bank guarantees.

James F. Kirsch

Or cash with order.

Dmitry Silversteyn - Longbow Research LLC

Okay, there's no -- so you're not in a hook for any accounts receivables or any bad debt?

Jeffrey L. Rutherford

No. If we don't get paid, we draw on the bank guarantees and get paid.

Dmitry Silversteyn - Longbow Research LLC

Excellent. Secondly, how much over the last, let's say, how do -- how much does this grow in, let's say over the last 5 years, can you give me a ballpark of how much CapEx has been invented in the solar business?

Jeffrey L. Rutherford

Very little.

James F. Kirsch

Very little. It's not been a capital-intense business with the exception of our South Plainfield facility. And that's services solar and other electronics so specific to just solar, it's been a relatively modest number.

Jeffrey L. Rutherford

$10 million, maybe a little over $10 million.

James F. Kirsch

That's probably a good ballpark.

Dmitry Silversteyn - Longbow Research LLC

Okay, $10 million. And then final question. You sort of -- the industry dynamic that you've described with maturation, not maturation but acceleration of growth to a certain level and then the Chinese competitors come in and sort of drive the volume and drive down the pricing. We've seen this and I'm sure you've.

[Audio Gap]

Industries, from your point of view of 5 years ago and how you are looking at this business, what went differently from your expectation to get you to the point where you're at where you have to make a decision whether to continue with this business or whether to get vertically integrated like you talked about the industry might have to do? Was it lack of demand in the U.S. that this market never really took off or was it lack of funding in Europe, given the political struggles and budget struggles there? What didn't play out according to the way it's played out in every other industry that took you by surprise in solar?

James F. Kirsch

Well, I think sort of all of the above. I think the struggles and the sovereign debt in Europe really bounced around who was in and who was out. We really believed, as did others, that the technology center would remain between some of the European companies and university and government consortiums. That's really not occurred. If anything, a huge change was solar powered being one of the platform planks of the 5-year plan in the Chinese government. And that put enormous funds into localized startups that they just didn't have access to. And then I think probably the third thing in our shoulders is technologically, whereas I mentioned earlier, in real silver, I think we still have a global leadership role in technology. On front silver, where we've been the leader in the past, we currently are clearly not. And so, we have I think a product today that we've just introduced that is a very, very good product. It remains to be seen whether it becomes #1 or not in the industry. So I think the industry structure changed dramatically, you had a tremendous number of competitors from Korea, to Japan, to China, to Taiwan, enter the market that weren't there 5 years ago. Many of them are funded by government dollars. Technology transitioned to Asia and I'd go so far as to say a lot of technology was reengineered, in Asia. And it became very, very difficult to protect one's intellectual property and then to I think crack those Tier 1 accounts who clearly prefer to buy from localized suppliers, if they can do so.

David Longfellow

Thank you, that concludes our Q&A session for today's call. For copies of our press release, replays of this call or access to our SEC filings, please go to our website at www.ferro.com. And click on the investor information. Thank you for participating in the Ferro Corp. Third Quarter Earnings Conference Call.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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 Management Discusses Q3 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts