Ferro Corporation
Q3 2017 Earnings Call Transcript

Published: 2 Nov 2017

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Ferro Corporation 2017 Third Quarter Earnings Conference Call. During the presentation, all participants will be in a listen-only mode, after which we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded Thursday, November 2, 2017. An archive replay of this teleconference will be available through the Investor Information section at ferro.com later today. It will be available for approximately seven days. I would now like to turn the call over to Kevin Cornelius Grant, Head of Investor Relations. Please go ahead, sir.

[Kevin Cornelius Grant:]

Thank you, operator. Good morning, everyone. This morning, we'll be reviewing Ferro's financial results for the third quarter ended September 30, 2017. The earnings release and conference call presentation deck are available on the Investor Relations section of our website. I'm joined today by Peter Thomas, our Chairman, President and CEO; and Ben Schlater, Vice President and Chief Financial Officer. After our comments this morning, we'll be happy to take your questions. I'd like to remind everyone that some of the comments we are making today are forward-looking statements and are based on our view of the world and our businesses as we see them today. Of course, circumstances can change. Please refer to the forward-looking statement disclosure in the earnings release and presentation. Today's call will contain various operating results on both a reported and adjusted basis. Those identified as adjusted exclude certain onetime items and charges. Descriptions of these non-GAAP financial measures and reconciliations are included in the earnings release and presentation deck. It is now my pleasure to turn the call over to Peter.

[Peter Thomas:]

Good morning, everyone and thank you for joining us today. It is my privilege to report another quarter of strong performance by Ferro. In light of the challenges that the third quarter brought to our industry, the Ferro team again delivering impressive results. This is our fifth consecutive quarter of organic volume and sales growth and our seventh consecutive quarter of adjusted gross margins of 30% or higher. These and other performance metrics demonstrate that our value creation strategy, now supported by a culture of continuous innovation and optimization, continues to build on the foundation established in the earlier phases of the strategy. In the third quarter, sales for all three of our reportable segments increased by double digits, with profitability increasing across the board as well. Growth has been both organic and inorganic and is coming from product lines across our entire portfolio. The 14 strategic acquisitions that we completed over the past 33 months, certainly have contributed to this growth, but so have our legacy businesses. We have invested in our people as well as our portfolio, with training and development programs focused in particular on growth and innovation. We are moving away from a product based orientation to solution centric thinking. This reorientation is contributing to the thought leadership that our customers value most, strengthening our portfolio, deepening our customer relationships, and generating demand for our products and services. This reorientation is at the heart of what we describe as our self-renewing business. It provides us with the ability to deliver on our commitments to value creation in multiple ways. We have been working to construct a scalable business that can sustainably build upon itself, not just to get bigger but to get better. Better means to grow faster and more profitably through organic growth, strategic acquisitions and shared product and service capabilities, and continually optimize all facets of the company so that operating leverage expands as we grow revenue. We intend to capitalize on the opportunities for self-renewing growth and profitability offered by our model and believe we are well positioned in our markets to outperform consistently and significantly. As previously discussed, we are currently in the dynamic innovation and optimization phase of our value creation strategy. We are leveraging the linkages between our three operating segments and our technology capabilities and shared manufacturing platforms and processes. We have made a concentrated effort to invest in technology that will keep us at the forefront of our industry and make Ferro a more valued technology partner for our customers. Already, we are reaping benefits from these investments, both expected and unexpected. These experiences add to our confidence that we are on the right path. Now I’ll review some of the results from the third quarter. Please note that the non-GAAP numbers I refer to are on an adjusted basis using constant currency. All the comparisons are to the third quarter of 2016. During the third quarter, we grew net sales by 19.7% to $350 million, with organic sales increasing by 5% on a constant currency basis. Total volume increased 8.9%, with organic volume increasing 4%. As I noted earlier, this is the fifth consecutive quarter of organic sales and volume growth. We grew gross profit by 15.9% to $105 million, compared to $90.5 million in the third quarter prior year. We produced our seventh consecutive quarter of adjusted gross profit margin of 30% or higher, notwithstanding raw material headwinds. We grew adjusted EBITDA by 19.2% to $59.2 million, or 16.9% of net sales. And finally, we delivered GAAP earnings per diluted share of $0.27 compared to a loss of $0.11 in the prior year and we delivered adjusted EPS of $0.33, an improvement of 22.2% compared to the prior year. On the basis of our performance year to date, we have updated our full year guidance as Ben will discuss shortly. We have built considerable momentum and are confident that we would - we have built a strong, sustainable, innovation driven business. We have leadership positions in the vast global markets and we intend to innovate and optimize to produce sustainable long term growth and profitability. Now, before we get into segment performance for the quarter, please turn to the conference call presentation deck. On slide number three, you can see the third quarter sales increased to $350 million, up from $292.4 million in the prior year quarter. Slide number five shows the consolidated adjusted gross profit margin was 30% for the third quarter, notwithstanding raw material headwinds. Let me pause for a minute on gross margins. As I noted earlier, this is our seventh consecutive quarter generating an adjusted gross margin of 30% or higher. There will be transitory impacts on margins as raw material prices change, but we have levers to pull to manage such circumstances. Earlier this year for example, we said that we took measures to mitigate raw material price increases beginning in the fourth quarter last year, including product price increases, product reformulation that provide higher returns, and other measures. These measures have blunted the impact of raw material price increases this year. From today's vantage point, our current view is that pricing for many raw materials will continue to provide a headwind. However, we feel comfortable that we will be able to offset them through price actions, product reformulations and optimization actions. Turning to slide number eight in the conference call deck, you'll see the results for our Performance Colors & Glass or PCG, which were quite strong for the quarter. As a reminder, PCG is a market leading supplier of glass based coatings for glass substrates. Our products add value in automotive, decoration and industrial and electronics applications. PCG serves technology driven markets. As technology for coatings and decoration continues to advance, we see opportunities to attract customers with innovative technology, and to reinforce our market leadership. Net sales in PCG increased by 16.7% to $110.6 million, up from $94.8 million in the 2016 third quarter. Organic sales were down slightly by 1%. Gross profit was $38.6 million, compared to $32.9 million last year. And gross profit margin was 34.9%, up from 34.7% in the third quarter of 2016. Within the automotive market, we saw sales improvement within certain geographic markets. For example, we continue to see weak automotive demand in the US, but offset by increases in Europe and Asia Pacific. At the end of the day, we still remain the first choice for automotive customers with our lead free enamel solutions. Our acquisition of ESL continues to add to sales gains in our electronics business in the US. We anticipate continued growth in next generation electronic packaging technology, and we expect our electronics business to grow with it. Our decoration business continues to expand with additional market share capture in the Americas, and strong dinnerware and container growth in Europe. Moving to Color Solutions, formerly called Pigments, Powders and Oxides, please turn to slide number nine. As a reminder, Color Solutions is a leader in the production of high value inorganic and organic pigments and color solutions for a variety of substrates and in applications such as paints, plastics and construction materials like concrete, roofing and siding. The Color Solutions segment continues to perform very well. The businesses that we have acquired, such as Nubiola, a global manufacturer of inorganic pigments, and Cappelle, a global manufacturer of inorganic and organic pigments, have increased the addressable market and are making significant contributions to our business. Cross selling activity and sales to new customers and new markets continue to expand. Color Solutions met sales for the third quarter increased by 40.9% to $93.2 million. Sales and volumes increased in all geographic markets. Those profits grew to $31 million and gross margin improved to 33.3%. Organic sales increased 14.2% to $74.7 million and margins came in at 36.3%. Within Color Solutions, we have both pigments and Surface Technology product lines. In the pigments line of products, we are particularly pleased with the sales and volumes increase in the building and construction industry in the Americas. By the way, none of our operations were seriously impacted by any of the recent hurricanes or the earthquake in Mexico. Looking forward, we expect rebuilding after the hurricanes and the earthquake to ramp up over the next year, which could have a positive impact on our sales. Turning to our Surface Technology product line, we continued to see strong growth in the third quarter, with sales growth of over 30% driven by precision polishing sales for certain high tech applications. Our surface polishing technology is a preferred choice in this market and we continue to deliver market leading products and services for our customers. Now let's turn to our third segment, Performance Coatings on slide number 10. As a reminder, Performance Coatings is a leading supplier of glass based coatings for metal substrates, which we sell through our porcelain enamel business and decorative coatings for ceramic tile, which we sell through our Tile Coatings business. Performance Coatings generated double digit growth in volume and sales in the third quarter. Volume increased 8.7%, while net sales increased by 11.2% to $146.2 million. Gross profit was $35.9 million at a gross profit margin of 24.5%. In the US, porcelain enamel sales through appliance makers, contributed to the increase in volumes. Volumes and sales increased significantly in Europe and in the Asia Pacific region. In Tile Coatings, we leveraged our technology, market knowledge and customer relationships to drive growth and mitigate raw material cost through product reformulations. Because of our deep knowledge of coatings technology, we can reformulate our products so that they have equal or better functional performance at a lower cost to our customers. From an inorganic growth perspective, we recently announced two acquisitions that expand our ceramic coatings business and provide key raw materials for the ceramic tile market. In early October, we acquired a majority interest in Gardenia. And yesterday we completed the acquisition of Endeka Group. Both businesses are located near Ferro's facilities in Castellón, Spain, a major hub of the worldwide ceramics market. We expect both to be accretive to earnings in 2018 and to provide multiple opportunities for optimizing manufacturing operations, while also providing opportunities for further innovation within our ceramics coatings portfolio. So again, our global team delivered another strong quarter, with a record of quarter over quarter of improving financial performance and a fundamentally stronger business to work with. We are confident that we have a business model for delivering higher levels of growth on a sustainable basis. And with that, I will turn the call over to Ben for his comments on the quarter.

[Ben Schlater:]

Thank you, Peter, and good morning everyone. As Peter stated, Ferro delivered yet another quarter of strong results. We are really pleased with the financial performance for the quarter and year to date. It’s an indication that we are delivering according to the expectations we set, despite the headwinds that are broadly affecting our industry, including raw material cost increases we had discussed in the past. As we said in a press release, we are improving operating leverage, while growing revenue. And we believe our strategy will allow us to continue to fund reinvestment in our core business growth areas and strategic acquisitions. In my comments this morning, I’ll review one-time adjustments for the third quarter of 2017, and provide an overview of the SG&A expenses and other income and expense lines. Finally, I’ll touch on the components of our year to date cash flow and cover our updated guidance for the year. For the third quarter, there were a few non-recurring adjustments primarily related to our active acquisition pipeline. First, a $1.4 million adjustment to cost of sales, primarily related to the amortization of purchase accounting adjustments associated with the valuation of purchased inventories for the acquisitions we closed in the second and third quarter of 2017. Second, an adjustment of $6.9 million to SG&A. This adjustment primarily related to third party legal, professional and other expenses relating to certain corporate development activities for the quarter. Finally, there was an adjustment of approximately $1.5 million in restructuring and impairment charges related to actions to achieve our ongoing optimization initiatives. Now turning to SG&A. for the third quarter, adjusted SG&A expense was $58.6 million, or 16.8% of net sales, compared with $52.3 million or 17.9% of net sales in the prior year quarter as stated on a constant currency basis. Newly acquired businesses drove the increase as adjusted SG&A for our base business was slightly favorable the last year on a constant currency basis. That brings me to the breakdown of cash flow. As you can see on table 13 in our press release, year to date adjusted free cash flow from continuing operations was $35 million, which compares to $35.7 million for the prior year to date. As a reminder, we define adjusted cash flow from continuing operations as adjusted EBITDA, less cash outflows for taxes, interest payment, investments in networking capital, capital spending and other cash operating items. The most meaningful components of the cash flow year to date are as follows. Starting with adjusted EBITDA of $179.9 million, we subtract $20.6 million of interest, $16.6 million of cash taxes, $75.8 million from our investment in working capital, $22.3 million of capital spending, $12.2 million of incentive compensation payments, $2 million of pension payments, and then add $4.6 million of other cash inflows. So finally, before we take your questions, I'll just spend a few minutes on the updated guidance we provided in the press release. For the full year 2017, we expect consolidated sales growth to be in a range of 17% to 17.5%, up from our previous guidance of 12% to 13%. Adjusted EPS to be in a range of $1.26 to $1.29 per share, up from $1.22 to $1.27 per share. Adjusted EBITDA to be approximately $228 million to $231 million, up from $223 million to $228 million. And we are holding guidance for adjusted cash flow constant in a range of $90 million to $100 million. So let me take a minute to explain the components within these ranges. We see gross margins in the range of 30.5% to 31% for the year, which reflects raw material headwinds, which we would expect to cover on a dollar basis with some lag. In addition, we expect lower SG&A as a percent of sales of 17% to 17.5%. This expectation reflects maintaining our cost base as the business grows, which is a key part of the optimization strategy. Other Expense between $4 million and $5 million. Interest expense remains between $26 million and $27 million. And finally, we are maintaining our tax guidance between 27% and 28%. To be clear, our guidance reflects actual adjusted results at nominal currency for year to date September and foreign exchange rate as of 12/31 2016 for the fourth quarter, in an effort to be consistent with the previous guidance assumptions we have provided through the year. As I have reminded everyone in prior calls, Ferro’s original guidance assumed an average exchange rate of $1.05 for the Euro. Ferro generates approximately 30% to 40% of its revenue in Euros, and approximately 25% to 30% in US dollars. We estimate that a 1% overall change in foreign currency exchange rates, weighted for the countries where we do business, would impact operating profit by approximately $1.2 million to $1.4 million. If you isolate for sensitivity, a 1% change in the Euro would impact operating profit by approximately $600,000 to $800,000. So to take it one step further, if rates stay at the level they are at today with the existing business mix, we could see approximately a $0.01 to $0.02 tailwind to our EPS our guidance for the year. Looking at the remainder of 2017, we expect to continue the momentum we have generated for the first three quarters of the year. Our global team is working diligently to deliver the results we have laid out in our updated guidance and we feel comfortable with our view on the balance of the year. We are proud of where we are today, but we are not about to become complacent. From our perspective, things are just getting started and our dynamic innovation and optimization strategy would deliver a faster rate of growth at a higher level. As Peter mentioned, we are looking forward to taking on a deeper dive into our business and prospects during our Investor Day. And I’ll now turn the call back over to Kevin for our Q&A session. Operator, we’ll be happy to take the first question.

[Operator:]

Thank you. [Operator Instructions] And our first question comes from the line of Rosemarie Morbelli with Gabelli & Company. Please go ahead.

[Rosemarie Morbelli:]

Thank you. Good morning everyone and congratulations. Peter, I was wondering if you could touch on the trends in the different markets you serve and give us some details on the areas where you see most of the growth potential. And then I’ll ask my second question now. And wondered if you could also touch on your M&A pipeline and what you see going forward.

[Peter Thomas:]

Good. Thanks, Rosemarie. And again, thank you for the confidence in your comments. As it relates to regional performance, I can tell you, we are really, really pleased on what we’ve seen so far year to date. Let me give you an example to put some color on it. When you look at our revenue growth, and it all starts with our organic growth that's been augmented with our acquisitions. But if you look at some of the emerging areas that we're focusing on, Eastern Europe year to date is up 9%. Mean is up close to 10%. Asia Pac is up 13%. Latin America, even with all the turmoil in those areas with us readjusting our business model, is up 8%. Western Europe, the heart areas of Europe, which are typically flat in that area between 1.8% to 2%, we’re up 4%. So our strategy around inorganic growth and organic growth are certainly working in those regions that help lift that organic growth percent in terms of revenue and volume. Now, more importantly, let's take a look at some very interesting cases. If you look at Asia Pac and you know, we only deal with high end type of applications there, and as I mentioned, it's up about 13%. But more importantly in China, we’re up - and here's what's going on that we really feel good about, particularly the high technology companies in those areas will benefit, is the fact that the government is cracking down on compliance and EH&S activities in a way that a lot of smaller ankle biters if you will in the region are going by the wayside and it's presenting a nice opportunity for those of us that have good international type of compliance and EHS standards. And that is actually helping our business actually for the, I guess past six months. And then when you start looking at Indonesia as part of the Asian Pac, that economy is picking up and because of the change in the currency, they're now exporting products. So and as the market leader, we’re advantaged in both domestically consume materials, as well as exports. Then you move to Thailand. Vietnam itself is up in high double digits and we're able to supply that market very effectively from Thailand. Then if you move on to Latin America, Mexico, great middle class story for us. It’s up 8% and it's all across the board, whether it's indigenous automotive applications, appliances, building and construction, everywhere you look, where we participate with the high end materials, that business is doing quite well. Even Argentina that has all its problems, do you know in Argentina, we're actually up high double digits in revenues. Same with Brazil. We’re seeing a pickup in Brazil on automotive, as well as the tile market is picking up, particularly at the high end. And again with our new colorants Ferro Pigments presentation in Brazil satisfying the areas of one colors group, that particular model is actually helping from a revenue point. And even when you look at Europe, if you look at Italy, Italy even by itself, is up almost double digits, because that's where all the high end activity is, whether it's in tiles, whether it's in porcelain enamel and other decorative things. So whether it's local consumption and or export is up. Spain is up 7% both domestically and exports to areas where there's an advantage with the currency. So from our perspective, every region, every application that we have is really, really doing well, not to mention the fact that the flow through of our organic pipeline is probably going to hit about 18% of this year's revenue with a gross margin of about 33.75%. So the idea that the regions are moving in an advantage way, the fact that our pipeline is hitting, we just announced a couple more of acquisitions. And I'll take you in for the next question. Again, we're maintaining that we have that $150 million year of invested capital that will generate $120 million to $150 million of acquisitions revenue, with synergy adjusted EBITDA of 20% to 30%. Yes, $30 million. So everything right now for us is like the perfect storm coming through the end of the year and going into ’18. And the only negative that we see is that automotive in North America seems to be the only thing that's a bit, troubling but everything else (indiscernible).

[Rosemarie Morbelli:]

And actually if I may ask one last question. Since you are dependent to a certain degree to building and construction, what is the size of your exposure companywide to that particular market?

[Peter Thomas:]

Yes. 20% to 35%. But you know, I'm glad you asked that question because what's really exciting, Rosemarie, and again thank you for that, is that with our new technology that we’ve added, whether it's Pinturas or whether it's Dip-Tech, the digital application in construction moving forward is going to be very, very interesting for us because you would not believe the number of secrecy agreements that we've engaged in this year versus prior years. I would probably say this year it’s more than the prior high in terms of the technology that we bring to the market relative even to that space, whether it's automotive or construction. But you know, the construction market are looking for advanced material performance. Now, let me tell you what that is. Whether it's blown concrete polymeric siding that could be enhanced with digital application or moving away from certain types of ceramic roof tiles that could be a similar type of a composite, that that would be enhanced in a very decorative way with digital applications. And it goes on and on with the types of companies that are reaching out to us, both in the automotive and the construction markets, high tech companies that want future types of product development that would use our materials. And if you think about what we're good at, whether it's a siding application or roofing application, the fact that our materials provide adhesive properties with conductivity, you can just really think about what those applications are. And if you want to look at the automotive application, I would just ask you to get on the BMW site, look at their new X-7. Take a look at that vehicle. The whole roof is glass and just take note of all the different enamels and conductive paints that are on that. And if you speak with those customers, they'll tell you, within the next three to five years, there will be as much as 30% to 35% more glass on a vehicle because of the self-driving application. And look, more glass means more work for Ferro. It means conductivity. It means enameling. It means sensors and the - as I said, the new innovation model we have, the reach out from a broad breadth of customers, is just so different and it really stages a nice even for ’18 and ’19 for us.

[Rosemarie Morbelli:]

Thank you.

[Operator:]

Our next question comes from the line of David Begleiter with Deutsche Bank. Please go ahead.

[David Begleiter:]

Thank you. Good morning. Peter and Ben, just on raws versus selling prices, can you say where you are in terms of that dynamic and what you expect in 2018? Thank you.

[Ben Schlater:]

Yes, sure. Hey David. So from a raws perspective, let's just talk year to date now, 2017. So we are through September, sort of I would say mid - we’ve seen gross headwinds in kind of the mid-single digits as a percentage of total costs. And after pricing reformulation and sort of our optimization activity, that would be sort of very low single digits from a net perspective. So we have offset nearly all of them on a year to date basis. We would expect still some lag. And I think the way to think about this is, and that’s most of what we're seeing from a margin perspective. Now, we would expect that to be transitory. All of that pressure we would expect us to offset. We’ve said in the past over a one to two quarter lag. I think that that’s still the case. As raw materials continue to go up, we’ll continue to operate on that lag. And then as they start to stabilize, we’ll recover that from a margin perspective. But it's been very, very minimal from a dollars perspective.

[David Begleiter:]

Very good. I know it's also early 2018, but early look on 2018, could you achieve a similar earnings per share growth next year as you are achieving this year?

[Ben Schlater:]

So I think David, you'll hear more about that in a week, right? So we've got our Investor Day on the ninth and I think what we’ll probably do is get into that more then and then obviously as we wrap up the year.

[David Begleiter:]

Very good. Thank you.

[Operator:]

Our next question comes from the line of Mike Sison and with KeyBanc. Please go ahead.

[Mike Sison:]

Hey guys, nice quarter there. Peter, when you think about the outlook for ’17, 17% sales growth, pretty impressive there, particularly with organic growth. When you look at acquisition contribution in ’18 that is already completed, it seems to me, if I’m doing the right math that you will continue to have double - pretty strong double digit sales growth next year.

[Peter Thomas:]

Yes. We will.

[Mike Sison:]

Great, and then when - just a quick question on Color Solutions. That business has been very - four quarters of double digit growth. When you think about the fourth quarter, that was your first quarter you have a pretty tough comp. Do you still have enough momentum to put up some pretty good growth there in the fourth?

[Peter Thomas:]

What we can say is that the demand is very, very strong for our Color Solutions business. Again it's the ongoing us increasing the addressable market with those acquisitions and the reach out for not only current customers, but existing customers around the world has been phenomenal, because what's happened is that we've been able to harmonize a very strong international quality and supply chain and reliability basis with all those businesses together, and it's just creating actually enormous demand for us. We have - that's a very good problem to have for us if you will. We are debottlenecking facilities and we’re optimizing other facilities so we can accommodate the additional volume. So we feel really good about the balance of the year and certainly again moving into next year with that business.

[Mike Sison:]

Okay, great. And since my first question was too easy for you, I’m just going to add one more. In terms of acquisition, when we think about, in terms of the types of acquisitions, can you - are you going to stay within your core or are there opportunities to bring in maybe new technologies or add another segment? Or is it basically within these three businesses you’re going to continue to focus the acquisition growth/

[Peter Thomas:]

Yes. The thesis behind our acquisition model hasn't changed obviously, and I think that one of the reasons why we’ve been so successful with 14 deals over 33 months, with the type of discipline and the financial metrics we put around our deals. So what you will see is our mission is to continually focus our line of sight on the 100 to 150 per year that will generate the 120 to 150 in acquisition revenue, with $20 million to $30 million of synergy adjusted EBITDA as a first wave. Now, what I can tell you a little bit different than the past, we are currently in discussions with 10 targets. In the past, we've always said five or six, and we're in various discussions with 20, which used to be in 15 and 16. So as we're moving and we're seeing more discipline, our ability to move a little faster on deals is getting better. And that would be in your line of sight type of deals, that $150 million of invested capital. Now, because we've been doing this for three years and I think everyone knows that we’re in acquisition mode. There are a lot of things that are being brought to us. We have a lot of privately held companies that are reaching out to us, wanting to be part of Ferro. And again, I make this comment the last couple of calls that strangely enough, a lot of our competitors that are smaller, looking at Ferro as the market leader, they like the idea of their family legacy being with a market leader. And we still continue to see that. But the key is we are at a point, as you mentioned, if we want to - we have some seedlings that are buried in our business, Mike that could emerge as a new definite related type of a platform that we could build on. And we're pretty excited because the one or two particular platforms we're thinking about have really, really strong margins and their competitive intensity is pretty light. And the fact that we have the new seeding with the technology. We have a lot of technology folks coming to us, is presenting a lot of those types of opportunities for us to expand the platform. Four, your other point was, we do know what the technology gaps are in each of our three businesses, and each one of those businesses has the dimensions of their individual strategies around seeking out adjacent type of bolt-ons or weld-ons that will continually expand our technology base. And that's why you hear us talk about this concept of self-renewing business model, because every time we do something, you could see the proliferation of things that take place. Our organic pipeline goes up by 10 programs. Our acquisition pipeline, Mike, is up 270. Everything just keeps blossoming as the seeds are planted. And again, just look at the addressable market and ask yourself the question. In 2012, our addressable market was $3.2 billion and now it's $8.5 billion. And just the fact that we have that headspace with all those different adjacencies, and we have a technology reach to get it, it's really adding all that extra activity on our pipelines and that's where all the excitement is coming from, and that's why we're calling this the dynamic innovation and optimization phase. And another thing is that we have not lost sight of where we came from. This company will never get out of hand of cost. So you can just see that with the SG&A leverage that it's been maintained. And you asked the question two years ago if we were successful at this point. Are we going to have to just add people? The answer is no. We're growing into our new skin of innovation here with all these acquisitions. We have very, very competent people in the acquisitions that we've made, unbelievable R&D and marketing prowess in those 14 companies. And it just makes it easier for us to keep on the path we are.

[Mike Sison:]

Great. Look forward to seeing you next week.

[Operator:]

Our next question comes from the line of Mike Harrison with Seaport Global Securities. Please go ahead.

[Mike Harrison:]

Good morning. Was wondering if we can talk a little bit, Ben, about some of the components of SG&A. it looks like the incentive comp number has been increasing throughout all three quarters this year. Wondering if the Q4 level is going to continue to increase from Q3 or if it levels off or comes down. And then kind of similar question on the functional services piece that has increased over the course of the year as you’ve done some acquisitions. Is that a number that could come lower over 2018 as you realize some of the acquisition synergies? Or do you see a need to maintain those functional services expenses related - presumably related to the acquired businesses?

[Ben Schlater:]

Yes. Thanks, Mike. Yes. I would say the SG&A performance throughout the year is something we feel pretty good about. I mean with the leverage that we've seen there year to date has been really, really good. From a dollar perspective, the increases that you've seen are really all related to acquisitions, let's say what we would call base company SG&A, both at the strategic, as well as at the functional level is actually slightly down for the year. So all the increases you're seeing from an SG&A perspective would be from the deals. We do think that that will - that there is opportunity as we move into ‘18 to realize some of that, yes, from a synergy perspective. And we've been - we've talked about that as we've announced those deals. And then an incentive comp perspective, you pointed that out. Yes, that is predominantly due to the performance of the business and the stock price throughout the year.

[Mike Harrison:]

And the incentive comp, should that be kind of level to the Q3 number or could it go higher in Q4?

[Ben Schlater:]

No. I think that the level that we're seeing now is sort of what we would expect to see from an expectations perspective. Again, it all - from a - let’s say from a quarterly accrual perspective. Having said that, obviously that will move around as the share pricing performance does.

[Mike Harrison:]

I suppose you hope that it goes higher in Q4.

[Ben Schlater:]

That’s the idea.

[Mike Harrison:]

Looking at the gross margin performance, specifically in Performance Coatings and in the Color & Glass businesses, was wondering if you could help us quantify whether there's any dilution in the margin related to recent acquisitions, specifically the SPC business within Performance Coatings or Dip-Tech within PC&G. I know that sometimes you see like an inventory step up or maybe just some mix differences or some integration costs that can impact the margin in the first quarter or two.

[Ben Schlater:]

Yes. So let me start with Performance Coatings. I would say no. from an SPC perspective, we've said a number of times that the targets we look at from a margin perspective need to be higher than the portfolio where they will reside. That's true for both SPC as well as for Dip-Tech. from an inventory step up perspective, we take those add backs as I mentioned in the call on a reported to and as adjusted basis. And then this would reflect the amortization of intangibles from purchase price accounting perspective. But no, both those deals are equal to or greater than the portfolios.

[Mike Harrison:]

All right. Then last question is just on the Tile Coatings business, and was wondering if you could talk in a little bit of detail on what you're seeing in the remodel market. And I think you mentioned the rebuilding process post the disasters that we saw in the US and Mexico and Puerto Rico. Is remodeling and rebuilding a big enough driver to see growth in Tile Coatings, or do we need to see new construction pick up in order to really see that growth be driven higher in North America?

[Peter Thomas:]

No, Mike. I think we'll see growth because of both of those. It’s new build as well as remodeling. And we’ve seen that so far from a year to date perspective. And so we would continue to expect to see that. And the tile market as driven by the construction market in North America, has been strong. A lot of that is due to the recent trends in tile let’s say over the last couple of years, moving to sort of these natural services. So we are benefiting a lot from that and we're seeing volume increases all over North America because of that. With respect to the natural disasters, specifically the hurricanes and some of the earthquakes that happened earlier this year, from a supply chain perspective, we didn't really see much of a hiccup at all. We were fortunate enough to go through that. We do expect that there will be a rebuilding effort over the next six to nine months. And that's not just on construction, but also from an automotive perspective, from an appliance perspective. We think that that will be fairly broad. And so our sense is there'll be some benefit in the next six to nine months because of that.

[Mike Harrison:]

All right. Thank you very much.

[Operator:]

Our next question comes from the line of Dmitry Silversteyn with Longbow Research. Please go ahead.

[Dmitry Silversteyn:]

Good morning guys and graduations on another strong quarter. Just, a lot of my questions have been answered, but I just want to sort of to get a little bit into the price reaction. That seems to be varied by your businesses. Pricing sort of in the Color Solutions and Performance Coatings are up 2% to 4%, but it looks like pricing in Performance Colors & Glass is still sort of in the 0.5% range, year over year improvement. Can you talk about sort of the dynamics that's keeping that price realization in that market below expectations? Or maybe it is within expectations, but below what you can achieve in other markets.

[Ben Schlater:]

Yes. I think - thanks Dmitry. I think it's actually pretty straightforward. With respect to Performance Colors & Glass, the pricing expectations there I would say are at or above expectations. We’ve just seen less headwinds from a broad perspective in that business. And so if we - when we look at pricing rise, we sort of look at the net and that business is where it needs to be from a net perspective. So that's why you're not seeing the pricing just because the raw exposure in that business hasn’t been significant.

[Dmitry Silversteyn:]

Okay. And then to follow up with that division, it's the only one where you've seen organic volumes declining for the last three quarters. Can you talk a little bit about, is it just a process of weeding out unprofitable customers or is there something going on there beyond that?

[Peter Thomas:]

Dmitry, what you’re seeing here is basically North American automotive growth or lack thereof, and that's basically the driver of what you're seeing there, versus last year.

[Dmitry Silversteyn:]

Got it. So that business is big enough for you where, even though it's growing internationally, your exposure to the North American automotive companies is basically causing you to lose modest volume?

[Peter Thomas:]

Yes. that would be - one thing that's important to note though, as it relates to the demand in automotive, like if you look at versus last year or even two years ago, because of our application model of moving the heavy touch approach around automotive, the demand in Europe is two times the market growth for automotive. And if you go in Asia Pac for us where we’re now pasting and providing application services, that particular market is up high single digits. And strangely enough, even the Brazilian market for us is picking up. So the business model change around making sure that we are at the right place at the right time, has really helped us out. And basically what you're seeing in North America is the demand for cars and trucks coming out of Mexico into North America, is with the issuers. But even Mexico itself, which is more of a truck environment, that particular automotive market is up. So Mexico, Europe, Asia Pac and Brazil are actually pretty strong. And it's just North American itself.

[Ben Schlater:]

Yes. maybe Dmitry, the one other thing I would mention to that is sometimes it’s easier to look at that on a year to date basis because the quarters sort of ebb and flow and actually on a year to date basis, that - the Performance Colors & Glass business is actually up organically. And so …

[Peter Thomas:]

Yes, 2%.

[Ben Schlater:]

Yes, just to put it sort of into perspective. So what we saw in the third quarter, it sort of smooths itself out throughout the year, if you will.

[Dmitry Silversteyn:]

Got it. Okay, thank you very much.

[Kevin Cornelius Grant:]

Operator, we have time for one more question.

[Operator:]

Very well, sir. We do have a follow up question from Rosemarie Morbelli with Gabelli & Company. Please go ahead.

[Rosemarie Morbelli:]

Thank you. I was wondering if you could touch on the contribution you are expecting in 2018 from the Endeka acquisition which you just closed.

[Ben Schlater:]

Yes. Hi Rosemarie.

[Rosemarie Morbelli:]

And both on the revenues and EBITDA and potentially EPS contribution.

[Ben Schlater:]

Hi Rosemarie. Yes. So what we've said is that we expect that business to do $1 million to $14 million of EBITDA in the first year. That does not include any - so again that’s at the EBITDA line. We would have obviously depreciation and then some portion of purchase price accounting that would happen in ’18. We’re finalizing that now. So probably the best we have is still sort of that $1 million to $14 million for next year from an EBITDA perspective. From a revenue perspective, we expect that to be somewhere between $85 million and $90 million in 2018.

[Rosemarie Morbelli:]

If my memory serves me right, when you mentioned the $13 million to $14 million of EBITDA, that includes synergies.

[Ben Schlater:]

It does.

[Rosemarie Morbelli:]

So while you did not give us the synergy amount, can you actually get them during the 2018 year and we will have the full $13 million to $14 million?

[Ben Schlater:]

Yes. So good question. The synergies for Endeka we actually think are greater than that. And what we've said is that $13 million to $14 million just includes the 2018 portion. We would expect additional synergies actually from that deal into 2019.

[Rosemarie Morbelli:]

Okay. Thank you.

[Kevin Cornelius Grant:]

We would like to thank everyone for joining us on the call today. We appreciate your interest in Ferro and we look forward to discussing our results with you again next quarter. Have a great day and thank you.

[Operator:]

Ladies and gentlemen, that concludes today’s call. We thank you for your participation and ask you to please disconnect your lines.