Ferro Corporation (NYSE:FOE)
Q4 2016 Earnings Conference Call
March 2, 2017 10:00 ET
Peter Thomas - President & CEO
Kevin Grant - Manager, IR
Benjamin Schlater - VP & CFO
John Bingle - Treasurer
Rosemarie Morbelli - Gabelli & Company
Mike Harrison - Seaport Global Securities
Dmitry Silverstein - Longbow Research
Yoyo Xie - JP Morgan
Good morning. Thank you for joining the Ferro Corporation's 2016 Fourth Quarter Earnings Conference Call. [Operator Instructions] An archived replay of this section of this teleconference will be available through the investor information section at ferro.com later today and will be available for approximately seven days.
I will now turn the call over Mr Kevin Corneous Grant, the Manager Investor Relations for Ferro Corporation. Please go ahead.
Thank you, operator. Good morning to everyone participating in the call and thank you for joining us. This morning we will be reviewing Ferro's financial results for the fourth quarter and the year ended December 31, 2016. I hope everyone had an opportunity to read the press release that we issued last night and through via the conference call presentation materials.
I am joined today by Peter Thomas, our Chairman, President and CEO; and Ben Schlater, our Vice President and Chief Financial Officer; along with John Bingle, Treasurer. After our comments this morning we will be pleased to take any questions that you have. I would like to remind everyone that our earnings release presentation supplemental slides are available on the Investor Information section of Ferro's website www.ferro.com.
Also some of the comments we are making today are forward looking statements and are based on our view of the world in our business as we see them today. Of course circumstances can change. Please refer to our forward looking statement disclosure on the earnings presentation and earnings release. Today's call will contain various operating results on both on reported and adjusted basis and will focus on our continued operations.
Those identified as adjusted exclude certain onetime items in charges that affect the comparability of reported results. When we refer to continued operations we are excluding discontinued operations as well as the results associated with us as well the operations which we divested in December 2015. Descriptions of these non-GAAP financial measures and reconciliations are included in the earnings release in the back of materials of earnings debt. It is now my pleasure to turn the call over to Peter.
Thank you Kevin and good morning everyone. Our fourth quarter was strong and we are pleased with the company's full year 2016 performance as well. During the course of the year the performance characteristics of what we call the Lucero became more visible across multiple financial metrics. Over the past four years we have executed a strategy that includes repositioning our portfolio, optimizing our operations and transforming into a focus functional totting's and power solutions business through strategic acquisitions and organic growth investments.
Our financial performance validated the hard work of our global team as they have executed our valued creation strategy. We delivered higher sales, higher gross margins, higher operating margins and higher earnings. I want to thank our associates around the world for their hard work. They have been executing our strategy with diligence, energy and enthusiasm. Without them our powerful transformation would not have occurred. And I should emphasize I believe we would have only just begun to see the potential of where we can take Ferro.
Our growth strategy is doing what we intended and we have momentum going into 2017 to continue the trajectory. Now let's take a look at some specifics from the quarter and full year. Please note the numbers I refer to are a non-GAAP adjusted basis. During the fourth quarter we grew sales by 11.7%. We generated a gross profit margin of 31.3%, and increase of 290 basis points from the 28.4% delivered in the prior year quarter.
Our adjusted operating profit margin expanded to 12.7% from 9.3% in the fourth quarter of 2015 and we grew adjusted EBITDA to $45.2 million. Turning to the full year, again on an adjusted basis using constant currency, we grew sales by 11.5%. We generated a gross margin of 31.4%, an increase of 250 basis points from the 28.9% delivered in 2015. We increased operating profit by nearly 220 basis points to 13.2% and we grew adjusted EBITDA to $194.6 million and finally we delivered $1.09 on adjusted earnings per diluted share.
As you can see the Ferro team delivered solid performance in 2016. We executed on growth projects and effectively managed costs and risks and of all the macro-economic environment driving improvement in both top and bottom line performance. Our teams also successfully completed five acquisitions during the year resulting in the investment of over $158 million in inorganic growth. Three of the acquisitions faired [indiscernible] were added to our Performance Colour and Glass business. And two of the acquisitions Delta and Capello were added to our PPO business.
Alongside these transactions our team continued to integrate our earlier acquisitions. We are especially pleased with the integration and the performance of the Nubiola and Al Salomi businesses which were strong contributors to our results in 2016. Across our acquisitions, our associates have recognized we expanded opportunity to provide our customers with high value products and services as a result of the strength and breadth of our combined companies.
As we previously recorded in February, we refinanced our outstanding debt. The refinancing increases our liquidity, increases our debt maturities and enhances our operating flexibility, providing us more financial resources to continue executing our growth strategy. The market interest and support for the transaction were satisfying and I believe that our strategy is being understood and valued by the financial community. We are looking forward to putting the liquidity to good work and maintaining the momentum of our growth programs into 2017.
Now let me provide a little more detail regarding our performance in the quarter. Typically fourth quarters are soft but this year the fourth quarter continued the momentum generated earlier in the year producing a strong finish to 2016. Turning to our conference call presentation deck you will see on Page 3, sales in the quarter increased to $281.3 million up from $251.9 million in the fourth quarter in 2015. As shown on this chart we continue to improve our gross profit margin while increasing power sales.
As I stated before, consolidated adjust to gross profit margin for the quarter increased by approximately 209 basis points to 31.3%. Contributing to the improvement in gross profit were increased sales volume, improve business mix, improving factory efficiencies and more profitable product reformulations as well as energy and raw material cost.
On a year-over-year basis all three segments generated higher fourth quarter sales and increased profitability. Our base business and recent acquisitions contribute to our improved performance. If you will turn to Slide 8 in our conference call deck, you will see the results for Performance Colors and Glass or PCG. As a reminder PCG is a market leading supplier in glass based code and some of our substrates. Key applications include automotive, decoration, industrial and electronic products.
For this business constant currency net sales increased to 10.9% to $94.6 million in the fourth quarter up from $85.3 million from the fourth quarter in 2015. The business delivered gross profit margins of 37.6%, an improvement of 450 basis points. Auto sales into Asia were strong two consecutive quarters providing a fourth quarter sales lift for our Auto glass enamel business. Strong sales in Asia set the slowdown experienced in Europe.
We also saw fourth quarter improvement in our sales into the electronics market with an increase of approximately 11.6% in organic sales. For the year PCG adjusted sales were $371.5 million off slightly from $378.5 million for 2015. Gross margin expanded to 36.7%, an increase of 270 basis points compared to prior year of 34%. Let me take a minute to explain the market dynamics that come into play for this segment. As you know PCG serves technology driven markets which aren't customers business are characterized by product campaigns with specific lifecycles.
These market dynamics can result in un-even demand as ramp up periods are followed by a half of sales for an off-cycle period. That is the nature of the business so we need to expect some fluctuation in demand as a result. The good news is that even as our sales might fluctuate, we continue to maintain and even build our margins. We do this by maintaining high touch relationships with customers who value our technical knowhow and our commitment to their commercial success.
The PCG team strategic focus is on continuously introducing higher value R&D driven products to these customers who rely on our innovation and technical expertise. We are confident that our proprietary pipeline of new products including both new to Ferro and new to the world products along with the acquisition of VSL [ph] provide attractive opportunities for the growth for the Performance Colors and Glass segment. Success for our PCG business in 2017 will be driven by new product introductions including high durable colors and silver paste for automotive applications, new floor hard especially if they are color pearls, low temperature coat fire deductive tapes and platinum materials for automotive oxygen sensors.
We also intend to leverage our recent acquisitions Pinturas Benicarlo for water borne coding on container glass and ESL for electronic packaging materials. Now let's move to pigments, powders and oxides. Please go to Slide 9 in the conference call deck. As a reminder, PPO is a leader in production of high value inorganic and organic pigments and colour solutions for a variety of substrates and in applications such as paints, plastics, automobiles, concrete and others. Beginning in the first quarter of 2017 we will refer to this segment as colour solutions.
This segment continues to generate strong volume growth. We are extremely pleased with the performance of Nubiola, the global inorganic pigments manufacturer which we acquired in 2015 and 2016 we also acquired Cappelle Pigments and Delta Performance products. With these acquisitions we have broadened our pigment portfolio and expanded our ability to develop specialized colour solutions that provide functional capabilities to our products for our customers.
PPO or colour solutions performed very well in the fourth quarter. This segment contributed $59 million in total net sales, an increase of 18.2% and generated 31.5% gross margin. This was up from $49.9 million and 30.6% in the prior year quarters. From the gross margin perspective margin expanded by nearly 90 basis points to 31.5%. The strong margin expansion was driven by all product lines within the pigments business as well as technology developments for higher value markets surge by our surface technologies business.
Organic sales in the surface technologies improved by over 50% with improved margin expansion driven by increased sales and volumes. Margins for this segment also benefitted from failed raw material costs. So for the year net sales for PPO or colour solutions were $246.8 million up from $164.4 million in 2015. Gross margin was 32.4% an increase of 300 basis points. Results for the year was driven by the added results of Nubiola and strong overall performance of the pigments business. We anticipate continued growth of PPO in 2017. We believe that the acquisition of Cappella provides us with exciting opportunities for cross-selling and geographic expansion. We also will continue to develop new pigments and our surface technology product line should benefit from additional memory chip applications and next generation automotive aftermarket polishes.
Now let's turn to our third segment Performance Coatings. Please turn to Slide 10 in our conference call deck. As a reminder Performance Coatings is a leading supplier of glass coatings and decorations systems for ceramic tiles which we sell through our tile coatings business and metal substrates which we sell through our personal ammo business. I will assume that everyone is familiar with ceramic tiles. The metal substrates in our porcelain ammo products coat are in applications such as appliances, water tanks and industrial storage vessels. Performance Coatings also had a nice quarter generated $127.8 million of sales revenue at a gross margin of 27% compared to $116.6 million in 2015 at a gross margin of 24.1%.
We saw strong volume growth of 20.3% in the [indiscernible] business driven by the sales in the Middle East emerging markets. Our Middle East sales have benefitted significantly from our 2015 acquisitions of Al Salomi in Egypt. We also saw higher volumes in Vietnam, Indonesia and China as our investments in infrastructure and marketing capability in the Asia Pac region had begun to take hold. We also are seeing improvements into our volumes in Italy and in the US. Porcelain ammo volume grew 5.2% in the fourth quarter coming largely from sales in the Europe and Asia Pac region. Organic sales grew by 3.6% and gross profit margin expanded 50 basis points to 30.7%
Performance coatings also performed well in the year. Net sales were $527 million up from $490.6 million in 2015. Gross margin was 26.5% up from 24.5% in 2015, an improvement of 200 basis points. Let me review our strategy for performance coatings. The Tile and PE are businesses in heavy price competitive markets. Our focus in the businesses is on driving volumes to gain share while enhancing margins as a result of providing higher value solutions for higher tears of the market. We are the global market leader in each business. In Tile we have turned our focus to the mid to high tiers of the market with Vetriceramici, the key supplier to the high end.
That acquisition has been a very good one for us. Our base operations have strategically realigned our operations to compete with the lower cost profile in emerging markets through our operations in Egypt and Turkey and by focusing R&D in technical resources and proactively regressively reformulating products that provided competitive edge to key customers. This customer focused commercial approach is allowing us to maintain higher volumes at stronger margins. The strategy has been quite successful for global tile business.
In Porcelain Ammo we are executing a similar model. There has been a leader in PE since our inception almost a century ago. We continue to innovate to drive production efficiencies for our customers. For example our R&D team is focused on new high tech products for appliance manufacturers. The same time we are investing and optimizing our global operations which will allow us to better serve our customers and compete more effectively in all regions.
We believe in strategy they have investments in positioning, performance coatings or another strong year in 2017. So, all in all another strong quarter and the year that demonstrates that with the business simplification and the portfolio evolution phases of our strategy substantially complete, we are advancing nicely into the growth phase of our strategy. The earlier phases of our strategy positioned us to improve those profits, improved earnings and improved free cash flow conversion.
Now we intend to build on the foundation we have set for growth in 2017 and beyond. So with that I will now turn the call over to Ben for his review of the financial performances of business in the fourth quarter and full year in 2016. Ben?
Thank you Peter, and good morning everyone. In keeping with the structure of the last several quarterly calls I will keep my prepared remarks to allow more time for Q&A. I will focus on the following four items. An overview of the onetime item that have been adjusted out of our fourth quarter and full year results. An overview of our SG&A expenses in the quarter. The components of our cash flow in the quarter and the full year and finally our guidance for the coming year.
For the quarter on a GAAP basis we recorded a loss from continuing operations of $0.25 per diluted share. However, adjusting for onetime items, our quarterly earnings from continuing operations were $0.27 per diluted share, an increase of 42% versus 2015. For the full year our adjusted diluted EPS from continuing operations was $1.09 exceeding our most recent guidance of $1.00 to $1.05 and our full year 2016 EBITDA was $195 million which was at the high end of our guidance.
The resulting EBITDA for the full year was 17% of sales. There are several onetime items which impacted earnings and have been adjusted out of the reported results. I will discuss each one on a pre-tax basis both from the context of impact of the fourth quarter as well as the full year. First in the quarter we took a $13 million charge related to the impairment of the good will associated in the tile business. While the tile business including the recent acquisitions is in good shape and performance is strong the valuation of the historical business and the associated assets requires us from a GAAP perspective to minimize carrying value of the goodwill and the base business.
Consequently, we require to write-off the goodwill associated with the Al Salomi business. There were no other impairments for the year. We also recorded a mark to market pension adjustment in the fourth quarter resulting in a $20 million non-cash charge related to our pension programs. Approximately $16 million of the charge was recorded in SG&A with the remaining $4 million included in cost of goods sold.
As with our impairment charges there were no other pension mark to market adjustments during the year. In the quarter we also recorded an additional $1 million of restructuring expenses while for the full year restructuring expenses amounted to approximately $3 million. Our restructuring activity for the year was primarily related to personal actions. Also in cost of goods sold, during the fourth quarter we reported approximately $4 million of cost principally related to acquisition, purchase price accounting adjustments primarily associated with the valuation of the purchased inventories.
The fourth quarter item was the only related charge for the full year. In SG&A for the quarter and mark to market adjustment previously discussed we insured approximately $7 million cash cost associated with non-recurring expense. For the full year our SG&A onetime items excluding the pension items in the fourth quarter totalled $18 million. The SG&A onetime for the quarter and for the year primarily related to business development activities and our ongoing operations, optimizations and reorganization projects.
Finally in other income and expense for the quarter we incurred a charge of approximately $10 million related primarily to the devaluation of the Egyptian Pound and the related impact on the valuation of monetary assets and liabilities. For the full year the charge dropped to $7 million comprised primarily of the charge recorded in the fourth quarter partially offset by $4 million gain associated with the disposal of the real estate property in Australia. Now turning to SG&A.
The global business teams did a great job managing SG&A expenses in the fourth quarter. For the quarter adjusted SG&A expenses was $52.3 million compared with $48.1 million last year as stated on a constant currency basis. Of the $4.2 million increase, newly acquired businesses accounted for the vast majority of the increase adding approximately $3 million. In additional incentive compensation programs for the fourth quarter were approximately $1.8 million higher while net pension expense for the quarter added another $800,000.
Excluding these items SG&A for the base business declined by approximately $1.4 million. While this performance was exemplary we do not anticipate base SG&A expenses will continue to decline in 2017. In fact we expect to invest further in SG&A in certain areas where we see opportunities to drive organic growth. The business also generated a significant amount of cash from continuing operations in the fourth quarter as well as for the full year.
As illustrated on Table 13 in the press release adjusted free cash flow from continuing operations for the fourth quarter was $52 million while for the full year was nearly $85 million. As a reminder adjusted free cash flow from continuing operations is defined as adjusted EBTDA from continuing operations less cash items used to operate the business including cash taxes and interest, investment modes and capital, capital expenditures and other cash items.
The significant components of the annual cash generation were as follows: EBITDA $195 million less cash items including interest of $18 million, taxes of $20 million, working capital of $33 million, capital spending of $24 million, pension contributions of $5 million and other cash items of $10 million. So I would like to conclude my remarks this morning with a brief overview of our 2017 guidance. We are optimistic of the growth established in the second half of 2016 will carry over in 2017 allowing us to generate modest organic growth to supplement the growth of our recent acquisition.
In addition, we expect continued growth profit margin expansion for the year which will set us up for continued, adjusted, diluted EPS growth. Results so far this year suggests our business appear to be performing in-line with these expectations. Having said that 2017 will not be without its own set of challenges, for example raw material costs have increased over the last several months and this trend is expected to continue. We expect to offset these cost increases through price actions, product reformulations and optimization actions. But we anticipate some lag between rising raw material prices and our ability to mitigate these increases which may put some pressure on gross margins quarter to quarter.
In addition, we expect FX rates will continue to be volatile and adversely impact reported results. For the full year 2017 we expect adjusted diluted EPS will be in the range of $1.12 to $1.17 per share and EBITDA will be approximately $207 million to $212 million. With these earnings we expect we will again generate adjusted free cash flow from continuing operations from $80 million to $90 million. This guidance assumes FX rates for 2017 will be approximately equivalent to year-end 2016 rates.
To put this in perspective we estimated that this FX assumption reduces our 2017 EBITDA and EPS guidance by approximately $7 million and $0.04 per diluted share respectively compared to our 2016 results on a constant currency basis. The major components of our guidance are as follows: nominal sales growth of 7% to 8%, consolidated gross profit margins of 31.4% to 31.9%, SG&A of 18.2% to 18.5% of sales, other expenses of approximately $4 million, interest of $26 million to $27 million and tax rate of 27% to 28%.
In addition we expect DNA of $45 million to $47 million, cash taxes of $30 million to $35 million, capital spending of approximately $35 million, working capital investment of $15 million to $20 million, pension contributions approximately equivalent to 2016 levels of $5 million and other cash expenditures of $5 million to $10 million. Please note our guidance does not include any new acquisitions or divestitures though it remains our target to invest between a $100 million to $150 million in inorganic growth opportunities and we believe our M&A pipeline is efficient enough to support this level of growth if not more.
Before turning it over to Q&A I would like to provide a quick walk from 2016 to our 2017 guidance both on an EBITDA and an EPS perspective. From an EBITDA perspective we start with 2016 EBITDA of $195 million. To this we add approximately $5 million to account for modest organic sales growth and margin expansion. Recently completed acquisitions will add $20 million to $25 million in additional EBITDA. However, we expect some SG&A inflation as well as additional investment to capitalize on recent growth momentum and this will reduce projected EBITDA by approximately $5 million.
And this puts up at $215 million to $220 million of EBITDA. Finally, the FX headwind which I have already discussed then reduces this amount by approximately $7 million. The remainder is EBITDA at roughly the mid-point of our range. From an EPS perspective, the walk would be as follows: you would start with our 2016 annual adjusted EPS of $1.09. That needs to be reduced by $0.03 to account for the benefit of a lower tax rate in 2016 versus 2017 and reduced to other expense due to more favourable than expected FX transaction expenses.
Relative to what we believe is the normalized level. To this we would add the impact of organic sales in gross margin expansion generating approximately $0.04 of incremental EPS. From there we would recognize the EPS contribution from our recent acquisition which we expect to be $0.10 to $0.15. The growth will be partially offset by increased investments in SG&A programs of $0.04. So if we stop there we suggest that the EPS would be in the range of $0.16 to $0.21 or a growth of approximately 7% to 11%. However we expect FX to be an additional headwind for us in 2017 trimming our EPS by $0.04 and putting us squarely in our guidance range.
With that I will now turn the call back over to Kevin for your questions. And again I would like to thank you for joining us this morning.
Thanks, Benefits. Operator we would be happy to take questions.
Thank you. [Operator Instructions] Our first question comes from the line of David [ph] from Deutsche Bank. Please go ahead.
Thank you. Peter can you talk about given the pressures from rising raw material cost and the lagging catching up to those that they take to running throughout the year by quarter?
Yes sure. This is Ben, I can go through it. So, with respect to 2017 I think the way to think about sales is our expectations look pretty similar to the quarters in 2016 as a percentage of the full year. From an EBITDA perspective I think you will find, you will see, typically what we have seen in the business. The second quarter will be the best followed closely by the third. And the fourth quarter will be roughly equal.
Got it and Ben, I may have missed some of the cash flow items, can you please go through it again, the items on the cash flow that you went through?
Sure, again, in terms of guidance, cash flow we would start with the mid-point of EBITDA, we would then have cash interest of roughly $20 million, capital spending of around $35 million, cash taxes of $30 million to $35 million, working capital of $15 million to $20 million and pension of about $5 million and then we would have other cash expenditures of $5 million to $10 million.
Thank you very much.
Our next question comes from the line of Rosemary Morbelli from Gabelli & Co. Please go ahead.
Thank you. Good morning everyone and congratulations on the strong end to 2016. However, with a slight disappointment to your expectations for 2017. Your breakdown then was really very helpful in order to figure out where the shortfall was versus my expectations. So I am just wondering if you could just talk about the environment in your existing markets and geographies. Is there anything out of the ordinary and I am not quite following why our Al Salomi needed to have impairment assets?
Okay. Good I will take the first part and then Ben will bring you up to date on the GAAP basis for the Al Salomi right down. As relates to where we are positioned and how we are reorganized and the new geographical expansion activity that we have undertaken in the past two years, what I can tell you where we sit today, everywhere where we are positioned today we would call the environment stable. Now this is the first time that we have seen this in about 24 months, so that is to tell you that Brazil for us on how we position our business model there is stable.
Argentine is stable, Indonesia is stable, even Russia believe it or not, with all the noise, actually performed quite well last year. We are up double digits in revenue and also in volume with some specific activity we have been developing and Turkey the same way. So right now for us we would call the stable environment from the macroeconomic perspective.
And so what about the different markets, I mean you talked about geographies and now if we look at Europe which is where you have the majority of your revenues, would you talk of the trends there and what you are seeing in the different markets?
Sure, of course I know you are up to date on the market segments and what the projections are for the key markets that we serve. Global automotive depending on which side you look I would suggest it is going to be up at about 1% this year. Construction globally up around the world of 3.4%. If you do a weighted average of those two market segments relative to our space you would like at our growth rate of about 2.7 from a macroeconomic perspective and what it would tell you is that our volume for 2017 is actually where we have talked about it being that 2.7% plus 1% to 2%. So like we mentioned with the repositioning of our business, as automotive goes up, we will do better, as it goes down we will not do as bad. Same is with construction and that's what you would be seeing with us in 2017. It's quite candidly the first quarter would also probably reflect that at this point.
So am I reading this properly and you are anticipating possibly a flat to down first quarter?
Okay. Could -- Al Salomi impairment charge?
Yes, hi Rosemarie, it's Ben. Sure, so in the fourth quarter what we do on an annual basis is as of October we test the goodwill in all of our segment. And in the tile business, we had a situation where the carrying value of the business was greater than the fair value. The fact that we brought Al Salomi on at the end of 2015 created that goodwill and so we consolidated the Al Salomi business with the base tile business that's what caused the accounting charge.
So no disappointment or any issue because of the economic -- I mean not economic, but political situation in the Middle East?
No, no. No, just the contrary in fact. I mean Al Salomi and as well as the base tile business are both performing well and their performance continues to improve.
Okay. And if I may ask one quick question regarding manufacturing efficiencies. I seem to recall that you expected $30 million to $35 million of savings from that particular project. Can you update us on where you stand?
Yes, sure. Rosemarie, what we can tell you is that project is on schedule, it's on budget and in some cases it's ahead of schedule on producing some additional margin enhancements. Again that particular project, when we introduced it I guess it was about almost a year ago. We mentioned that we would be a little more transparent with that at this call. However, due to some competitive reasons, we're going to be a little more judicious on how we impart competitive information around things like this.
But let us - what we can tell you is provide more of a framework on what we're doing. You should view this as a global manufacturing optimization program. Number two, it will involve new equipment, it will involve equipment upgrades. It will involve yield time, and cycle time improvements. It will involve capacity rightsizing around the world specific to target markets aligned with our application activities. And it will also involve a tighter supply chain and procurement efficiency activity. And it is underway and it is moving and we're already seeing some very interesting prospects.
In some cases where we can tell you that there are some opportunities for further enhancement. But again because of the competitive sensitivity on what we're doing, we don't want to be more specific other than the fact that going forward as we hit key milestone, we'll be able to share those with you. But we are definitely on schedule on track.
And actually, if I may; you acquired five, you made five acquisitions in 2016, investing let's say around $160 million. Are you targeting the same amounts for 2017 or are we going to see a slowdown or an acceleration of the project.
Yes, definitely not a slowdown. Again you're aware of our refinancing activities which puts us in a very, very strong flexible position to maintain the activity that we have enjoyed over the past two years been 9 acquisitions in 24 months. We've been public around the fact that we're heavily involved with five targets, we're in various discussions with 22 of them and we also just started or initiated discussions with another 16. So the waterfall cascading effect of that pipeline is very robust and we feel very good that we'll maintain what we've said over the past three years that our target is upwards of $150 million a year of investment in an organic activity. So we feel very good about those prospects again this year.
Thank you. Our next question comes from the line of Mike Harrison from Seaport Global Securities. Please go ahead.
Hi. Good morning.
Ben, I was hoping since you referred to the new credit agreement there. I was wondering, if you could talk a little bit about that 100% floating rate debt now in what's likely to be a rising interest rate environment. Is that the most appropriate capital structure for Ferro? Did you consider doing a portion of the deal at fixed rates and are you going to be entering in the swaps or any other credit derivatives to help insulate yourself from potential interest rate risk?
Yes, sure. So we did, we did look at doing a layer of bonds and as we consider both of that and the Term Loan B. It really might come down to sort of a cost perspective. The rate on the Term Loan B was lower, albeit variable. We will look at swaps from a fixed perspective. That was the biggest piece of decision. The Term Loan B market, when we look back even six weeks ago was really very, very attractive and so the arbitrage between that and the yield is what drove the decision.
Alright. And then just looking at the raw material headwinds; can you quantify how much headwind you are expecting year-on-year and what are some of the key raw materials that you're concerned about at this point?
Yeah. So I think Mike from a growth perspective, we'll sort of see mid-single digit headwinds. From a net perspective, again we will look to offset many of those and all of those within the year by combination of pricing and productivity actions. From a specific raw material perspective lithium, cobalt, zinc, zircon they would be the sort of the big ones that we see year-over-year increases on. Specifically though with respect to cobalt and lithium; while those raw materials are going up significantly year-over-year from at least what we saw in 16. We've got good ability inside the organization from both a reformulation perspective as well as the price perspective to mitigate nearly all of that.
And then, in terms of the SG&A investments to support growth. Can you give any color on the magnitude of those investments? And maybe what specific regions or markets are an area of focus. Then what would be the timeframe for starting to see return on those investments?
Okay. Mike here is where it's coming from. As you may recall, when we first started with this process. We have identified 55 RND platforms that will drive our organic growth programs and those particular programs have been contributing quite nicely to our success over the past two years. As an example in 2016, our three year new products sales which would include cannibalized and non-cannibalized was actually at a value of about $175 million worth of gross profit of 34%. Year before that in 15 it was $145 million also at about 33%.
So you can see that the turning over the past couple years that that organic pipeline is developing is actually contributing quite nicely to the improvement in the gross profit of the business. We expect this year to even be more significant in terms of the total of the three new product sales and even at a higher margin. So that's one point, now the second point is when we started with 55 programs and remember the framework we mentioned, we would not work on a program or invest in it unless it was tied to a customer and that there was at least an 80% percent probability that it would come to probation. So since then and with the acquisitions our new application program base is 12 to 72 programs with the 10 acquisitions if you look back over the 33 months. And those programs under the same framework will now require some additional support over the next couple of years and a magnitude it isn't what I would define significant with the type of contribution it could be somewhere between $2.5 million to $3.5 million over a period of time.
So we feel that that's a prudent investment could continue with the churn of three year new product sales in a way that it continues to levers and improve the gross margin profile.
Alright. Then the last one for me you mentioned volume up 20% in the tile business. How much was pricing down and can you talk about the competitive dynamics right now in tile?
I think you mentioned the competition would be an issue potentially in getting pricing to offset higher raw material costs?
Okay. So I think I would -- first of all, thank you for bringing this up because this is something that we really need to clear with this particular call. The tile business has been repositioned. We are now focusing on the upper mid-tier and the high-tier of the market with success. You've seen our gross margin has improved by almost 1000 basis points over the past 4 years, particularly with the acquisition of Vetriceramici.
The next point is before what you might remember, when we would talk about a competitive situation it was always a defensive move. Whereby somebody would go and cut a price, we would beat the price, maintain the volume, but the revenue would be down, but so would be corresponding gross profit. The situation is totally different. We had an interim period where as a defensive measure, we would reformulate to an equivalent price point. But we would do it in a way that it would improve the gross profit profile of the business as well as providing an enhancement of functionality to our customers.
Now what we have done now with Vetri over the past 18 months is because we're competing in the mid-tier and the high-tier with the knowledge and the cross functionality of both of the Vetri team and the Ferro team. What we're now able to do is to go and anticipate when a move might take place, and we formulate ourselves to a lower price point with a higher margin in a way to preserve our franchisee and keep competition out.
So let me give you another example of what that might mean. One way you check that is as a general statement out tile business may reformulate revenue by as much as $12 million to $15 million a year, which could be on the surface as much as 1% of Ferro's total revenue or almost as much as -- you can do the math 20% of the tile business. While what you have to check is the volume and the gross profit by the end is that we would reformulate lower price point our volume goes up and our gross profit goes up. So we lose the revenue because we reformulate it, but the profit dynamic is much in hand. So now we're doing that more in a proactive way instead of a reactionary way and it's proved to be a very, very good competitive position from us because we can sit here and tell you that we have not lost a customer and we have not lost share for the past 18 months.
Interesting. Thank you very much.
Our next question comes from the line of Dmitry Silverstein from Longbow Research. Please go ahead.
Good morning. And let me add my congratulations on a strong finish to the year. Couple of questions, if I may. First of all, you've talked about several times now and the PPO business about the surface polishing business doing very well I think he was up again 50% this quarter. You mentioned some electronic applications but also automotive polishing. Can you talk a little bit more about that business and how it got repositioned to the point where it's now a consistent rider of a pretty strong growth and sort of what the outlook for that business is and perhaps even size for us within the PPO division?
Okay. We got a couple of questions in there. So we'll answer them one at a time. It's too bad we were hoping someone would ask this question maybe next quarter too, but well since you asked it we'll discuss it. If you remember four years ago, when we set out PPO what we shared with everyone is that that was a collection of businesses that would serve as seeds for future development around the functional coatings and color solutions business. So embedded in PPO four years ago, what you had was a pigments business, small pigments business. You had what we would define as being a functionalized pigments business which was our Edison facility and we had this grouping of what we called surface technology, which would polish metals, which would polish glass, which would pose plastics and the like.
So over the past four years what we said is that business would turn into a color solutions platform. And what does that mean to you, and here's what it means and maybe this'll. Provide some insight for you. If you look at the acquisitions that we've made on the pigment side, there's a 2-fold strategy. The first is a horizontal strategy, whereby we would acquire high margin, high valued, minimal competition pigment businesses like Cappelle and UBL will complement our CICP business, that's the horizontal strategy.
The vertical strategy of that is that we'll take those pigments and we will add functionality and or alter them in a way that provides value to the customers. Whereby we would create a new value chain that really isn't - really well defined today, but we believe we can create a space there that's pretty significant by using all these high-end pigment. So that gives you the basis in PPO as the color solutions.
Now, you have to ask yourself the question like you just did. Why are these guys messing around with surface technology? Well if you really understand our strategy, we'll tell you we're about coating, we're about colors and we're about substrates. Don't you think it would be prudent for us to develop a surface technology's platform that would understand how to treat substrate, in a way that our coating with here and or add more functionality to them.
So this is what you're saying now as we build up the color piece, now the incubator for surface technology is gaining a lot of traction and you may find going forward that some of the opportunities that we're looking at would enhance and create more value for that business in a way that it will create another very unique fragmented high-end, high-margin profile business for us. And it's very much in line with our strategy of coatings colors substrate. And what this does is, it's treating substrates prior to the other applications I just mentioned. Does that make sense to you?
It does make sense. I was just looking to see what changed the guided business working from what I proceed could be kind of a new application to something that seems to be a consistent driver with its [indiscernible] of the PPO performance. Can you give us maybe an update that we are doing the PPO with the surface technology platform?
Haven't done that.
Yeah. We have not done that.
Yeah, we haven't done that. Give us a couple of more quarters before we share that information at this point.
Fair enough. And then my final question just a sort of take a broader look at the market whether you are talking about tile, whether you are talking about glass, coating or enamel any new trends emerging, anything that you are looking for that may not be impactful on 2017 but may change how the industry works or the market works how you will approach the market over the next three to five years and I'm thinking more along the lines of the digital printing of tile and things like that where a decade ago were a big driver of the market for you as well.
Yeah, I think that's a good question. So I'm going to answer it from out of, what I would define as our organic program perspective. And what you're referring to is what we will define his new applications. And in our pipelines what we've said, publicly is that as we sit today, we have about $600 million of probability adjusted revenue. That will on an additive basis, show itself within our business over the next three years.
Out of that $600 million about 30% of it is what we would define as being new to Ferro, which is about 180 that's the first time that you heard us talk about things that we can create that's new to the world because we just want in a position to do that that's part of the reason why we're looking for more resources. You should view these as being a cross fertilization of Ferro plus the nine or 10 acquisitions we've made in a way where all the RND brain power has come together and we are doing white space activities that figure out. What those things are that we can do that are new to the world that are different. And the first phase of that would be new little world type of products for each one of our segments.
For example, if you look at color solution. What you'll find is we're doing a lot of research and things are coming to fruition with heavy metal free pavements or anti-corrosion pigments or heat reflecting pigments. So those are new to the world activities with strong demand with smaller market right now, but we would use those to initiate an expansion of our addressable market.
If you look at PCJ, we've developed new resistant automobile enamels and you might say well, what in the world to be done with the black bend. Well, if you understood what a black bend and where its vulnerabilities are you will be pleased to know that within our black bends there could be as many as five different glass formulations that serve a different purpose. One glass may allow for bending of the glass in a way that would not cause force, stretch, cracks at the bendable parts of the glass or it could be that the cross fertilization of Nubiola and Ferro can produce a black bend that's even more dynamic on acid resistance to the atmosphere or you may end up having a combination of ESL and Ferro where the black bends beat the silver conductor paste line, you don't have silver migration into the black bend. So those are all new to Ferro, new to the world. Why do I bring that up is that's the point of differentiation that we're now able to bring to the marketplace by advancing the technology not just by one chasm by jumping it twice.
And what you'll find is as we've mentioned as automotive goes up, we go out better as it goes down we won't drop as much. And these are the types of things that allow us to make those statements because they're not high in the sky, the formulations are scattered throughout the market and they are gaining traction. And it's the same thing with our PCO business. With porcelain enamel we're developing new oven coatings that could be used at very, very low temperatures which were very efficient. We have anti-bacterial hypostyle coating that could be used in hospitals for applications or a nuclear centers for encapsulation. And we also have other types of decorative systems that again to your point will start to really be noticed in about three years.
So we have a lot of good white space activities that are going on and that's what's really exciting. We finally had an opportunity over the last 18 months to build that competency around these platforms. And I can tell you by having all those acquisitions and all that brainpower and RND coming together you would not believe the RNS sessions we have and the creativity is coming out of that group is phenomenal.
Thank you very much. It's very encouraging. Thank you.
Operator, we have time for one last question.
Thank you, sir. Our last question comes from the line of Jeff Zekauskas from JP Morgan. Please go ahead.
Hi this is Yoyo in for Jeff. Could you explain a little bit how much money or how much cash do you plan to spend relating to restructuring charge in 2017?
Yeah, so we've not yet been -- we've not yet been public with any type of restructuring charges we would have in 2017. What we have said inside the guidance's that we would have other cash expenditures of between somewhere in between $5 million to $10 million. So what we typically do is we add back cash flow from restructuring outside of guidance. So part of that might be used to cover that. But generally speaking, we've not yet given any guidance with respect to any anticipated cash for restructuring.
Okay, thank you.
If there is no more questions, we would like to thank everyone for attending our call today. We appreciate your interest and we look forward to discussing our results with you again next quarter. Have a great day, and best regards.
Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation. And now could you please disconnect your line.
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