Ferro Corporation
Q4 2017 Earnings Call Transcript

Published: 1 Mar 2018

[Operator:]

Good morning. Thank you for joining the Ferro Corporation 2017 Fourth Quarter Earnings Conference Call. An archived replay of this teleconference will be available through the Investor Information section at ferro.com later today and will be available for approximately 7 days. I would now like to turn the call over to Mr. Kevin Cornelius Grant, Head of Investor Relations for Ferro Corporation.

[Kevin Cornelius Grant:]

Thank you, Operator. Good morning everyone. This morning, we'll be reviewing Ferro's financial results for the fourth quarter ended December 31, 2017. I'm pleased to be joined today by Peter Thomas, our Chairman, President and CEO; and Ben Schlater, Vice President and Chief Financial Officer. The earnings release and the conference call presentation deck are available on the Investor Relations section of our website. 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 our earnings release and presentation deck on Slide 2. Today's call will contain various operating results on both the reported and adjusted basis. Those identified as adjusted exclude certain onetime items and charges. Description of these non-GAAP financial measures and reconciliations are included in the earnings release and the presentation deck. It is now my pleasure to turn over the call to Peter.

[Peter Thomas:]

Thanks, Kevin. Good morning, everyone and thank you for joining us today. Well, we delivered another quarter of very good financial results finishing stronger year in which we saw for a full 12 months the impact of the transformation of our company. Ferro's 2017 performance demonstrates that our value creation strategy is generating the momentum and higher rate of growth we intended. We are particularly pleased with the sustained organic growth we experienced over the past 18 months. As we previously have discussed including at our Investor Day in November, innovation is driving our organic pipeline and the resulting growth is coming from product lines across our portfolio. We believe this organic growth together with strategic acquisitions and its [innovation] to optimization provides a winning combination that will deliver industry leading long-term sustainable performance. Our focus on product innovation has produced a vitality index that currently stands at 15%. This means that 15% of our revenue is coming from new development programs yielding products that are new to Ferro or new to the world in the last three years. Throughout 2017 including the fourth quarter, raw material price inflation had an impact on gross margins across our industry. We had a better story on raws than many of our peers because of our ability to cover cost increases through innovative product reformulations. Reformulated products often require less raw materials, perform better for our customers and command a higher margin. We are building a scalable business with a self-renewing business model that provides us with the ability to deliver faster and more profitable growth. Our ability to leverage linkages between our three operating segments that is our technology capabilities, our manufacturing processes, and our product platforms has enabled us to increase organic growth. Increase revenue and increased profitability in all segments against this quarter. Before we talk about segment performance, I will review some of the consolidated results from the fourth quarter and the full year 2017. Please note that the non-GAAP numbers I refer to are on an adjusted basis using constant currency. All fourth quarter comparisons are versus the fourth quarter of 2016 and all full year comparisons are against the full year of 2016. The financial highlights and results can be reviewed in Slides 3, 4 and 5 in the presentation, accompanying today's conference call. Starting with the fourth quarter performance on Slide 4. We grew net sales 34.2% to $377.5 million with total volume increasing 18.1% and organic sales growth was 9.2%. Adjusted gross profit increased 18.8% to $108 million. We grew adjusted EBITDA by 20.1% to $54.3 million or 14.4% of net sales. GAAP earnings per diluted share improved to a loss of $0.10 compared with a loss of $0.25 in the fourth quarter of last year and adjusted EPS increased 7.4% to $0.29. Now reviewing the full year 2017, please turn to Slide 5. We grew net sales 22% to $1.397 billion and our organic sales growth was 7.3%. Adjusted gross profit increased 17.9% to $424.4 million. We grew adjusted EBITDA 20.3% to $234.2 million or 16.8% of sales. GAAP EPS improved to $0.67 versus a loss of $0.25 and adjusted EPS increased 18.3% to $1.29. We delivered net income of $57.1 million compared to a loss last year of $20.8 million Very good results for 2017. We intend to carry forward last year’s momentum into 2018 and beyond. We have a high performance management team that understands what it takes to build a stronger company. I also want to emphasize how proud I am of the commitment and achievements of our associates around the world. They are justifiably proud of our company and of the work we do every day to help our customers win. I have every confidence that they can continue to deliver on our value creation strategy and look forward to reporting on our continued progress. Now I want to spend a little time reporting on the performance of our three segments. Turning to Slide 6 in the presentation, you can see a summary of fourth quarter performance from our three segments and on Slide 7, we do see full year 2017 results. Starting with Performance Coatings, a leading supplier of glass based coatings for metal substrates which we sell through our portion enamel business and decorative coatings for ceramic tile, which we sell through our tile coatings business. Performance Coatings represents about 43% of Ferro’s total sales. Performance Coatings generated double digit growth in net sales and volumes for the quarter and the year drivers for our growth include higher levels of cross-selling made possible by acquisitions as well as successive introductions and new products and a strong organic pipeline. As you recall we have repositioned this business to focus on the high end of the market in which demand is growing faster across the globe. For the fourth quarter net sales increased 28.4% to $169.5 million with volume up 17.8%. Organic sales growth was up 6.7%, adjusted gross profit was $38.7 million, and our gross profit margin was 22.8%. For the full year 2017, Performance Coatings net sales were up 13.7% to $594 million with volume up 11.9% and organic sales growth was up 5.5%. Adjusted gross profit increased year-over-year to $148.9 million, the gross profit margin for the year was 25.1%. Our Performance Coatings business has been the most impacted by 2017’s raw material price inflation. I'll speak more about how we are managing raw materials throughout our portfolio a little later. Despite those headwinds we see good opportunities for Performance Coatings in 2018 from organic and inorganic growth as well as optimization contributing to continued growth and profitability. Let me mention just a couple more points about Performance Coatings before we move to the next segment. First, one of the things we have really liked about Performance Coating is its ability to produce strong cash flow. This business is our largest segment provides very nice cash generation. And second, we are very pleased with the two acquisitions we made in 2017 Endeka and Gardenia to enhance our tile coatings business. As previously announced, these businesses expand our ceramics coatings business and provide key raw materials for the ceramic tile industry. We expect both businesses to be accretive return into 2018. They also provide us with substantial opportunities for product innovation and manufacturing optimization. Turning to Performance Colors and Glass you can see on Slide 6 and Slide 7 that the segment continued with double digit net sales growth. As a reminder Performance Colors and Glass is a global leader in glass-based coatings for glass substrates including automotive glass-based coatings for glass substrates, including automotive, decoration and industrial and electronics applications. We serve technology-driven markets,, for functional coatings that value to our customers products. The primary driver of our performance is product innovation, which we do in close coordination with our customers. In addition, our leadership in the digitalization of glass coatings is a growth driver. Performance Colors and Glass represents about 32% of total Ferro sales. For the fourth quarter, net sales in Performance Colors and Glass were up 26.1% to $123.9 million, with total volume up 26.3% and organic sales growth was 7%. Adjusted gross profit was $42.7 million, gross profit margin was 34.5%. For the full year 2017, net sales increased 18.9% to $444.7 million. Total volumes increased 7.9% and organic sales growth was 3.6%. Adjusted gross profit for the full year was $159.6 million and gross margin was an impressive 35.9%. Automotive glass volumes in Europe and Asia continue to outperform North America. Volumes in and decoration glass in Europe increased double digits and our electronics class business continues that sales and new opportunities through ESL. We had many growth initiatives underway throughout our Performance Colors in the last segment with new automotive glass products on order or in the test phase in Asia-Pacific, Latin America, North America and Europe. In decoration glass, we are adding new customers and increasing our business with existing customers, with one of the most complete product ranges available for the decoration of ceramics and glass which serves us well in this fragmented market. In electronic glass, we continue to innovate in the areas of electronic components and electronic packaging materials to enhance functionality. Now moving to Color Solutions, our smallest foot fastest growing business. The Color Solutions segment produces functional color pigments and surface finishing materials. The businesses that we acquired in recent years such as Nubiola, a global manufacturer of inorganic pigments, and Cappelle, a global manufacturer of both inorganic and organic pigments have increased our addressable market and they are making significant contributions toward the business. Color Solutions net sales for the fourth quarter of 2017 increased 39.1% to $84.1 million with volume up 16.3%. And organic sales growth was 17.5%, adjusted gross profit was $26.2 million with gross margin coming in at 31.1%. For the full year 2017 net sales were $358.1 million, up 44.3% with volume of 24.1%. And organic sales growth was 16.6%. Adjusted gross profit was $116.5 million with gross profit margin at a strong 32.5%. Demand continues to be strong for our pigments particularly in the construction business, innovation is a strong driver of new and expanding demand for this business also. Our deep expertise in formulation technology and ability to custom manufacturer and niche products for our customers differentiates us from others in the market. Color Solutions, as we previously have said, serves as a kind of incubator for businesses that we may want to develop such as our surface technology business. We remain excited about and continue to evaluate opportunities for building out our surface technology business into a more substantial platform. So as you can see it was another strong quarter and an impressive year for Ferro. It is worth repeating that we delivered this performance despite headwinds from raw material price inflation and it has had an impact on our entire industry. We have changed the focus for our business model and culture to one innovation and optimization. With this change we believe Ferro was better positioned than many other companies to continue to grow. We also believe we are a better positioned than many others to offset raw material price increases. In fact over the past year, new products and pricing initiatives almost completely offset raw materials price increases. We have embedded in our organization an ability to mitigate raw material price increases usually with a one-quarter to two-quarter lag. If you look at Slide 8 you'll see an overview of how Ferro has transformed to our dynamic innovation and optimization phase and how we intend to accelerate from here. We have shifted from 20% organic growth and 80% inorganic growth a couple of years ago to a more balanced 40% organic and 60% inorganic growth. Our innovation pipeline and focus on products and services targeted at high end of the market are our principal drivers of this shift. Across the bottom of this slide, we see our three levers and what we expect from them. We are expecting that our strategy will yield organic growth of 3% to 4% annually. We are expecting to continue to invest $100 million to $150 million per year and acquisitions which we expect will add $100 million in sales annually. And the final lever is optimization. Optimization involves looking throughout our business for ways to be more efficient and effective and including updating and upgrading facilities and enhancing the way we do things across our portfolio to drive our competitive advantage. We're very excited about our Vision 2020. Our 2020 vision is gross margins at 33% to 34%, EBITDA at 20% and free cash flow conversion at 50% to 60%. That's what we are working toward. We are confident in our strategy and the ability of our team to execute. We have a track record of delivering on our objectives and with the energized and entrepreneurial culture that is developing to Ferro, I believe we will continue to deliver including on our 2020 objectives. Now one more brief comment before I turn the call over to Ben. We are committed to sharing more information and of being accessible to the investment community. We've increased our efforts over the past year or so and are honored to be recognized as a finalist for the best overall Investor Relations Program in the small cap category by the analysts and investors who were surveyed by IR Magazine. And with that, I'll turn the call in Ben for his comments on the quarter and the year.

[Ben Schlater:]

Thank you, Peter and good morning, everyone. As Peter noted, we are very pleased with the fourth quarter and full-year 2017 results. And particularly with regard to the sixth consecutive quarter of organic growth, which coupled with our pricing and optimization activities including SG&A leverage allowed us to reach the high end of our guidance despite the headwinds our industry face from last year and what we expect to be transitory raw material price inflation. What we call our self-renewing business model allows us to improve operating leverage, while continuing to grow revenue, and we believe our strategy will has to continue to fund reinvestment in our core business growth areas and strategic acquisitions to achieve our vision 2020 targets. In my comments this morning, I’ll review one-time adjustments for the fourth quarter of 2017 and provide an overview of the SG&A expenses and other income and expense lines and income tax expense. Finally, I’ll touch on the components of our full year cash flow and cover our guidance for 2018. For the fourth quarter and full year, there were a few non-recurring adjustments primarily related to our active acquisition pipeline. First, we have had adjustments of $2.5 million and $8.2 million to cost of sales for the fourth quarter and full year 2017, respectively, primarily related to the amortization of purchase accounting adjustments associated with the valuation of purchased inventories for the acquisitions we closed in 2017. Turning to SG&A, we had one-time adjustments in the quarter of $3.9 million, there were two primary pieces to this adjustment. Income of $3.2 million related to pension and other post-retirement benefit mark-to-market adjustments and expense of $7.2 million associated with legal, professional and other expenses related to certain corporate development activities for the quarter. For the full year, one-time adjustments to SG&A were $18.3 million. This adjustment primarily consisted of $21.6 million associated with legal, professional and other expenses related to certain corporate development activities for the year, as well as fees associated with certain reorganization and optimization projects offset with the mark-to-market gain related to pension and other post-retirement benefits, I just mentioned. Turning to restructuring and impairment, there was an adjustment of approximately $3.7 million in the fourth quarter and $11.4 million for the full year to actually in the fourth quarter and $11.4 million for the full year due to actions to achieve our ongoing optimization initiatives and acquisition synergies. In other income and expense, we had an adjustment of about 400,000 related to acquisition costs in the quarter. From a full year perspective, adjustments in OIE were $3.5 million primarily related to the FX loss incurred on our euro denominated term loan. And lastly related to income tax expense, there was an adjustment of approximately $21.5 million primarily related to the re-measurement of our deferred tax assets as a result of the Tax Cut and Jobs Act legislation. I've also mentioned that our results do not reflect tax from the one-time deem repatriation that was also the result of the Tax Cut and Jobs Act as our initial calculations do not suggest any tax due. Now turning to Slide 9 in the fourth quarter earnings presentation. The fourth quarter adjusted SG&A expense was $67.7 million or 17.9% of sales compared with $54.2 million or 18.6% of net sales in the prior year quarter as stated on a constant currency basis. Newly acquired businesses accounted for the majority of the increase with the balance of the increase coming from stock-based compensation and incentive compensation plans. Adjusted SG&A for our base business was slightly favorable when compared to last year. On a constant currency basis, demonstrating the operating leverage, we are seeing at the SG&A level. For the year adjusted SG&A expense was $240.3 million or 17.2% of sales compared with $208.9 million or 18.2% of net sales in the prior year, again demonstrating the leverage improvement year-over-year. Here also our newly acquired businesses accounted for the majority of the increase, while the remaining increase came from stock-based compensation and incentive compensation plans. Adjusted SG&A for our base business was favorable to last year on a constant currency basis. That brings me to the breakdown of cash flow. Full-year adjusted free cash flow from continuing operations was $90.1 million with cash flow from conversion of approximately 39%, which compares to $85.4 million for the prior year. As a reminder, we define adjusted cash flow from continuing operations as adjusted EBITDA plus any charges for taxes, interest payments, investments and net working capital, capital spending and other cash operating items. The most meaningful components of adjusted cash flow from continuing operations are as follows. Starting with our adjusted EBITDA of $234.2 million, we subtract $26.9 million of interest, $25.7 million of cash taxes, $42.8 million from our investment and working capital, $34.2 million of capital spending, $12.2 million of incentive compensation payments, $4.5 million of pension payments and then add $2.2 million of other cash income. Now please turn to Slide 10 to review the 2018 guidance summary. Ferro expects to deliver consolidated sales growth in the range of 13% to 13.5%, adjusted gross profit margin within a range of 30.2% to 30.5%, adjusted SG&A as a percentage of sales of 16.4% to 16.6%. And we expect our tax rate to be between 26% and 27%. This reflects an approximate benefit of a 100 basis points annually as a result of the new tax legislation, which is our preliminary estimate. These metrics translates to 2018 full-year guidance of adjusted EBITDA in a range of $270 million to $275 million, adjusted EPS in the range of a $1.55 to a $1.60, adjusted free cash conversion between 40% and 45%. To be consistent with our previous practice, 2018 guidance reflects foreign exchange spot rates as of 12/31/2017, which reflect a euro to U.S. dollar exchange rate of a $1.20. We have provided FX sensitivity in the guidance section of the earnings release. Ferro generates approximately 35% to 40% of its revenue in euros and approximately 25% to 30% in U.S. dollars. We estimate that a 1% overall change in foreign currency exchange rates weighted for the countries where we do business with impact sales by approximately $8 million to $9 million and in operating profit by $1.2 million to $1.4 million. If you isolate for sensitivity, a 1% change in the euro would impact operating profit by about approximately $800,000 to $900,000. Now I would like to spend a few minutes bridging our adjusted EBITDA and EPS guidance. Starting from our reported adjusted EBITDA of $234 million, we add a tailwind of $7 million due to FX. Then we add expected organic growth contributions up approximately $16 $60 million. Then we subtract approximately $4 million to $5 million related to expected raw material headwinds and other items. And finally, we will add acquisitions made in 2017, which we estimate will contribute approximately $18 million to $22 million incrementally to EBITDA in 2018. With some of those pieces to the 2017 EBITDA of $234 million equals our guidance range of $270 million to $275 million. Now turning to our walk for EPS and starting at in our 2017 adjusted reported EPS of $1.29 We add a tailwind of $0.5 from FX, then we add $0.13 from organic growth, then we subtract $0.4 to $0.5 related to raw materials and other items. To that, we add $0.13 to $0.15 from acquisitions we've made in 2017. And finally, we are approximately $0.1 to $0.2 benefit from tax reform in 2018 to equal our guidance range of $1.55 to $1.60. To take it one step further, if the exchange rates stay approximately at current levels with the existing business mix, we could see approximately a $0.2 to $0.3 tailwind to our EPS guidance for the year. Okay, now I'd like to provide some additional detail to help everyone understand how our EPS guidance may look on our quarterly basis. We would expect to see the quarterly distribution of our full-year adjusted EPS 2018 guidance as follows. We expect the second quarter and the third quarter to be similar to our adjusted EPS distribution in the second quarter and third quarter in 2017 as a percentage of total adjusted 2018 EPS. However, when looking at the distribution in the first quarter and the fourth quarter of 2018, we would expect the first quarter to be slightly lower and the fourth quarter to be slightly higher than their respective quarters in 2017. All-in-all, we are pleased with Ferro’s current momentum. Backed by our strong performance in 2017 and our positive outlook for the year ahead, we feel good about how the company is positioned as a leading technology-based functional coatings and color solutions provider. And I'll now turn the call back over to Kevin for our Q&A session.

[Kevin Cornelius Grant:]

Operator, we'll take our first question.

[Operator:]

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

[Rosemarie Morbelli:]

Congratulations especially for your 2018 expectations. Peter, I was wondering if there was anything special in the fourth quarter organic growth, particularly when you look at color solution organic, meaning that you don't have acquisition I suppose in it. Was there a big order that will not be recurring next year? Can you give us a better feel for what happened?

[Peter Thomas:]

Let's start with how we might want to look at it for the whole year, Rosemarie, where we have base organic growth at about 7.4%. And this is important because as you know, we defined a new Ferro starting in second half of 2016. And there are a lot of new things happening in the business and of course overtime, we'll be able to have a placeholder of what you're referring to would be those off-cycle pits. So, let's think of the 7.4% reconciled this way if you don't mind. And of course you can use this data to modify your models as you see fit. But at 7.4%, what we’ve always said is that we’ll take starting - as a starting point, Ferro’s market growth rate last year which was about, let’s say 2.5% around the world relative to where we participate on a [shift] basis on a weighted average. To that, we made a commitment that we would add 1% to 2% from our organic pipeline. So let's state that we were pretty effective doing that last year and at least we’ll put 2. So that brings us up to 4.5. And then the delta between the 4.5 to the 7.4 would be something like this. One, we have increased absolute market share with new product development, the addition of additional technologies and moving to the innovative mode across every business unit. How did that remaining 3%, a portion of that is absolute share gain. And the second part of that, three would be what you're referring to are those items that are emerging out of our organic pipeline that we still might not have a handle on what the normalcy is of an order pattern because of the furtive nature. We're not sure how much of a pipeline fill is being drawn or we might not know whether or not there is an orderly and methodical way they're going to order. And we just might not have a handle on that. But that provides you I hope with enough of detail to get an idea, if you were modeling on how you might want to view the business because one, we're going to continue to have off-cycle activity I can assure you, we’ve a lot of it going on. And secondly, we will continue to gain share because of our innovation position in marketplace. Does that help you?

[Rosemarie Morbelli:]

Yes, it does. And so that brings me to your Vision 2020. So, we have organic growth of 3% to 4% than the market expectation of 1% to 2%. So now we are at - growing at 4% to 6%. And then I suppose we should add to that both new products, which could add 1% to 2% and then anything else that we should add to that?

[Peter Thomas:]

Yes. So the way you would want to look at that is that’s in total Rosemarie and you know we’re looking at a market, the base market around two over time as a relative market share for a portfolio and then we get to 2%, on the 1% to 2% from the organic pipeline. So remember what we’re doing here is and I think you’ve called it out at the Investor Day is that, is there conservatism. Well, certainly if you listen to how I answered the last question that’s why I brought it up you. You may want to try to decide how much the off cycle might be. You might want to decide how we’ll continue to gain market share, but as we’ve always done, we want to put things out there that we feel very, very comfortable that we can hit. And so if your question is there some conservatism in that, the answer is yes probably.

[Rosemarie Morbelli:]

And then if I may looking at M&A over the past two years, you invested about $256 million in acquisitions and that is 2016 and 2017 combined. Given your $100 million to $150 million target in terms of annual investments, what is the outlook for 2017, I mean 2018?

[Peter Thomas:]

So let’s go over a couple of points because I think it's important to really - this may help on understanding a little bit better what the core business is really doing, because I think what I’m going to share with you, you'll need to feel comfortable about the 2020 vision because there are a lot of things going on structurally with the business that may be somewhat masked by this raw material, right. Whether there have been some step changes structurally. So let me give you a couple of data points around the total acquisition environment that I think are really important. The first thing I want to mention is that there was a milestone at the end of last year for us on our acquisitive nature. We finally replaced in revenue what we sold within the second phase of our strategy. So we harvested $500 million of revenue and we bought $500 million of revenue. But listen to the difference structurally because you would look at this from a cascading perspective or a waterfall basis going forward. In terms of gross profit dollars, we sold $71 million, but what we bought synergy adjusted is about $210 million of gross profit. What we sold was $40 million of operating profit and synergy adjusted is about $130 million. So I just wanted to give you that perspective that a long time ago, we made the comment that once we recoup the revenue that we sold, that it should look something like I just mentioned. But as you can see it's a bit better. If you go back to 2013, when I first made that comment, we gave some guidelines and this is quite a bit better than we had anticipated. So that's one thing. The second thing that's an important that is the last two years, nothing has changed for us. We will continue to target $100 million to $150 million of invested capital, which translates into anywhere between $100 million to $120 million of revenue and about $30 million of synergy adjusted EBITDA. So that's basically a thing we've been doing that, we feel very comfortable about that. Our inorganic pipeline is loaded in a way that we will achieve that objective. If your question is, I’m sure it's coming as well, we haven't seen anything yet. And I think what you might want to go back and look is, the last couple of years they're usually backend loaded, usually something happened in April, or whatever they say is the starting point. And the reason why that is particularly now is, as we've mentioned we have maybe four or five things that we're working on. And we've modeled in a way that we have some flexibility of positioning those acquisitions in a way that would allow for synergy targets to come to fruition at a faster rate. So maybe if we're looking at five things, and we're looking at number five and we're looking at number one, but we're looking throughout that pipeline and maybe more prudent for us to move back in into number two, so we can you know wrap our hands around greater synergies in a shortest period of time. So, nothing has changed stay tuned and I'm sure you'll be hearing more around that. Does that help you?

[Rosemarie Morbelli:]

Yes it does. And then lastly if I may your net leverage is at about 2.9 times. How high are you willing to go for the right acquisition?

[Peter Thomas:]

We just had - good question, we had a board meeting around that of course everyone's feeling good about you know our performance over the last couple of years and our discipline around doing deals. And you know we are looking at different capital structures and things like that. So, the bottom line is the board would be okay with us for the most part maybe going over four as long as we can de-lever within the you know 24 months to where we are today.

[Operator:]

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

[David Begleiter:]

Peter and Ben, on raw materials, when do you expect to fully catch up to the raw material inflation and is it still - what materials are most impactful to you guys over the last quarter or two?

[Ben Schlater:]

I think as we’ve said in the past, we would expect to catch up over sort of a one to two quarter lag. So we would expect to cover anything from 2017 through the first half of 2018 and we still feel good about that from where we sit today. In terms of the raw materials, we're seeing probably the biggest headwinds from cobalt, lithium, zinc, and zircons. And those are primarily inside performance coatings, but the team has done a really good job keeping up with the raw material headwinds. As Peter said, it’s the top of the call. We feel pretty good about where we are with respect to both the trajectory and the level of the increase in pushing those through the market. So I would say with of course the first six months of 2018, you'll see that catch up with the 2017.

[David Begleiter:]

And Peter, just on Color Solutions, a very, very strong 2017, what’s your expectation for organic growth in this business in 2018?

[Peter Thomas:]

We would expect - I don't want to get into the level of detail, but let's say it will be we still expect that to be very strong. And let me let me show you why that is? Because I think it's important to grab the essence of that what's happening with that business. Number one, our cross selling activities, having those three businesses together is producing phenomenal results, I mean it far exceeds our expectation around how much leverage those three businesses offer us, as well as providing the right technology balance to the customers. The second important point is what it’s doing in terms of greater penetration into some of the markets that we really want too much involved with so as a base CIC business and also with Nubiola. But we're seeing greater penetration in the plastics and a plethora of clothing type of applications. Another important point is that, that Nubiola and compelling global market channel expansion strategy that we laid out for those business, businesses again coupled with the cross-selling, again that particular bullet point and we have in a value, assigned to it we've far exceeded, our business case to the board. The fourth point that's maybe a little surprising, but again I think a lot of it has to deal with the one stop shop of all the high end pigments that we offer, demand in India, Indonesia and Thailand is very strong where we had a very small base as individual components. Again, the idea of the three technology platforms is allowing us to gain market share from those who don't have the same mix. Another important point is that the ultra-marine technology that came with our acquisition is extremely robust and not only is it robust, but the derivatives of other types of ultra-Marine colors not just blues but I'm talking about violets and others, is that we’ve developed, the demand is very, very strong for new product development. And of course, we've also last year launched into our new infrared payments. So those handful of drivers will continue to drive know really strong year-over-year growth for further Color Solutions business, and our expectation would be moving forward, we have a strong desire to add more to that that business in the short-term. Does that help?

[Operator:]

Our next question comes from the line of Kevin Hocevar with the Northcoast Research. Your line is open. Please go ahead.

[Kevin Hocevar:]

What are these - on the 13% to 13.5% sales guidance, I was just wondering if you could just give us - is that 3% to 4% organic growth like long-term organic growth in your 2020 vision, is that what you're basing that on and the rest being acquisitions or wondering if you could just give us a little color on kind of the breakout there between acquisitions and organic?

[Ben Schlater:]

That's right. Of the 13% to 13.5%, we think 3% or 4% of that would be organic.

[Kevin Hocevar:]

And then another clarification too on the raw material headwinds there was a great EBITDA bridge, Ben that you provided. And you mentioned $4 million to $5 million - I think it was $4 million to $5 million of raw material headwinds that are baked into that. I was wondering if you could just clarify is that based on what it shows in the 10-K in terms of the raw material impacts and gross profit in 2017? This number is a lot smaller and so I was wondering if this is a gross number or is this net of price and net of the reformulations and all that stuff that you do to offset the raw material inflation.

[Ben Schlater:]

Yes, so a couple of things. One, first is net, that's a net number. So that's close to headwind less reformulations, less pricing. And just to be clear, the number that you're seeing in the case is a gross number. What's also there, you would see the reformulation piece and the pricing piece as well.

[Kevin Hocevar:]

Yes, perfect, okay.

[Peter Thomas:]

Kevin, do you mind if I interject as you bring up a good point. I think this year and we need to get it out. If you remember last year at this time, we were talking about the headwinds and we mentioned that we put a lot of mitigation programs together. There were about six or seven that we mentioned last year at this time like pre-buys, productivity, reformulation, price increases, volume increases from the organic pipeline and additional manufacturing kind of efficiencies. Now, I think when you add all those up, you'll find that we were of course, if you look at the simple math on the core business on a constant currency business, we were up $17 million gross profits. And certainly with all the headwinds, raw materials we far you know offset those. But here's what's really important, the sad reality of all this raw material kind of situation with us, is that when you look at the organic growth that we never, this is an important point, so please listen to it carefully. The organic growth, let’s say it was $75 million. It had 40% flow through, okay, which is an important number because what - why is that important. As raw materials normalize which they will and we move to a new level, which we have seen in the structural change that we’ve been delivering every year, but it’s been mitigated on the gross margin side and one might argue, it could be like 100 basis points around margin. That's like floating out there, but you need to grab that. Don’t let it float too far, so you grab it, look at it and ask yourself the question, of where we need to place that into the model. Does that help you?

[Kevin Hocevar:]

And just last question, and just really out of curiosity, in the press release that you guys gave in the full year 2018 guidance, you mentioned that that the guidance assumes no acquisitions, optimization program spend or divestitures in 2018 and just kind of that last part, I was just curious on the divestitures, because it sounded like in your - Peter you spent a lot of time divesting a lot of the non-core assets at the start of the turnaround for Ferro. And you know I don't think there's been anything for a while. So I was just curious, if there is any thoughts on divesting anything at this point or I was just kind of curious on that comment in there?

[Peter Thomas:]

We have nothing that we're looking at that we would find that we would need to the divest of anything. And that’s the comment but, look at the end of day, what I will say our business model has changed a lot. And we're very margin driven and innovative oriented. And who knows somewhere down the road. I mean, if we sat here and told you, we even didn't have discussions around things like that, it would be the wrong thing because that we have a fiduciary responsibility of constantly looking at optimizing our portfolio even greater. So look at the end of the day, there's nothing that we would look at, if we can create shareholder value and drive this business harder. And I'll tell you, once you get into this mode of delivering innovation and we haven’t even discussed and we’re prepared to we haven't even discussed them were prepared to talk about a couple of innovation points here. But you know between our base pipeline that we've been managing for three years or four years of which I heard at the Investor Day with our new corporate development R&D program, with all the megatrends, which is already delivering some very interesting green shoots and maybe a new order here, you know the feeling of really driving margins higher and higher with innovation and is really resonating nicely with the new culture. And why do I say that, think about it. You remember a few I guess was what three calls ago, we mentioned that our population about 45% of that was new. Well as we sit today with all the acquisitions it's now - so we have a 60% of organization is changed out, same with the board by the way. You know so we have a lot of new here. We have an entrepreneurial spirit from all the little companies that were entrepreneurial and everyone likes margin build and everyone is ought doing one another on driving R&D programs with the highest margin. And there's a lot of interesting things going on here that are putting a lot of interesting you know challenges on the table for us to find additional ways to support everybody who wants to drive higher margins. Yes, so I didn't want you to leave without having some of that color if that's helpful to you.

[Operator:]

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

[Dmitry Silversteyn:]

Thank you by the way, Peter for providing such detailed answers, I really appreciate it to previous questions. My question has to do with your Performance Coatings comment you made about you know this is one of your commodity businesses, but you’re repositioning towards, as you mentioned, higher value markets. Can you provide a little bit more detail of sort of which markets higher value markets, can you provide a little bit more detail of sort of which markets in the tile and metal coding areas are considered by you to be higher value, where the growth or the customers’ ability to pay or willingness to be for value is greatest?

[Ben Schlater:]

So I think a couple of things, just to remind everybody, in our view that performance coatings business is really segregated into two different markets. And over the last three years or four years, and as we sit here today, we are sort of squarely operating at what we view is in the more innovative and higher end of that market that really relies on sort of the design and the functionality, and the technology of the coatings. And so, don't view that as a commodity from our perspective. So, and going forward, where what we expect that to go is, let's just go by region. Right now, we feel really good about the demand both in Europe as well as in the Middle East. We're seeing traction there, we saw it last year and we expect that to continue into this year. From a North American perspective, this trend that we’ve seen around using tile to replace natural services whether it stack stone, the random length flooring et cetera, is continuing and that is buoyed by not just that trend, but also the general construction market in the United States. And then just sort of rounding up out the globe with Asia, we're making really, really good progress, Berry Miskit and his team in Asia are doing a great job sort of penetrating business, that the niche markets over there where we see high-end higher growth. So from our perspective both the volumes and the revenues in that business are good.

[Dmitry Silversteyn:]

So it's not so much any particular market segment, but the higher end markets in terms of more decorative, more I guess functional whether appearance or functionality wise markets. I noticed you did mention Latin America in your rundown of revenues. Is that just kind of opportunity for you longer term and kind of how do you see that market which should be amenable given the weather patterns there to tile sales and growth?

[Peter Thomas:]

Well actually, I'm glad, I'm glad you brought that up, Dmitry because you're right, there is a - if we were calling out positive items in the fourth quarter, Latin America would be one of those. And we're starting to see because of the depreciation of the currency in Argentina that how demand is picking up. As you know and heard us say before that in Brazil, we moved away from the commodity type frits where there was a lot of competition and put the battery high end of the market model there. And also we have a color - all three of our color product lines are, have application center there and we're driving the expansion through the channels in Latin America from there. So that combination, we're seeing you know delivering some pretty significant revenues. If I look at just base revenue and volume in those two areas, there are up double digits, actually last year, and we probably see something similar that this year. What’s been a little bit of a change is you've heard us talk a lot about Mexico because we really like Mexico for what it means to us, but there's been a little bit of a slowdown because of the upcoming elections. I think a lot of people are sitting back waiting to decide how the government may operate, what they’re going to invest in depending on what happens in July is the election. But one bright spot is that truck exports to the United States have picked up significant versus automobiles which has been the case for the prior year. So and you’re right, Latin America overall has a reasonable feel for it. In fact, we prepare what we call a global outlook feedback every month and we looked at that particular area, and we have it as a stronger color green than the prior period. So there could be some potentially some interesting upside potential there for us.

[Dmitry Silversteyn:]

And then my second and final question on the fourth quarter, your top line growth was significantly stronger than I think anybody expected. We certainly had the latest acquisitions in it, but you still surpassed our expectations. Was there anything that kind of drove that, that strong performance besides the foreign exchange contribution that may have been a pleasant surprise for you or the things just develop as you expected it to, but given your normal conservative guidance that, that's the reason for the strong outperformance?

[Peter Thomas:]

Here’s are a couple of data points that we're going to share with you that you may want to take away and look at it, a little bit harder. But part of the reason why we did have the core business growth for the year at 7%, and you're referring to the core business at 9%, is that the- it's interesting our organic pipeline that we've been representing over the past three years, in speaking to, came in a little bit better than we thought. I know that we used the vitality index. And actually the vitality index last year was a little bit better than the 15%. And what happened was roughly $230 million that a is gross margin of 34.4% find its way into our business, last year, as part of that vitality index. And so this is going to maybe tee you up for answering another question. And let's say that $226 million was skewed to the second half of the year and had a pretty nice pick up of new to the market, new to Ferro type of opportunities that will run rate into 2018. So I think, what you’ve seen is that, our pipeline delivered from a core business perspective a bit more than we expected. And to give you a perspective, when you look at what we showed as our guidance in that revenue, what we're showing is for 2018 is $307 million of that revenue is from our organic pipeline over three years and that has a higher gross margin than what I just mentioned. So what you're seeing is as we mature on delivering against that pipeline and more and more companies are added with their own pipelines, there's a cascading effect of how many programs, we're working on and what the three-year to five-year contribution would be. So what we're saying is, we should hit a vitality index of almost 20%, in 2018 which if you go back and look in the industry, it is starting to get in a very short period of time a tough quarter quartile performance.

[Kevin Cornelius Grant:]

Operator, we have time for one more question.

[Operator:]

Our final question comes from the line of Mike Harrison with Seaport Global Securities. Your line is open. Please go ahead.

[Mike Harrison:]

Peter you referred to the six or seven programs or levers that you had in place last year to help offset some of the raw material headwinds that you were seeing. I was just curious it sounded at that time like some of those were only going to be available temporarily. Just wondering how many of those arrows do you still have in the quiver right now as you guys continue to try to combat that higher raw material cost.

[Peter Thomas:]

Yes, as you may remember we had six of them and I mentioned them and right now reformulation is ongoing, price increases, both base price increase and what will define. We have smart price increases to be taken. We have different levels of pricing that we manage and you’ll see that. There will be additional volume increases as I mentioned from the organic pipeline. We’re always doing manufacturing initiatives around. So most of those with the exception of the pre-buys are probably still going to continue to contribute and what that should mean for you is, I think we mentioned this the headwind moving into - first of all, on an absolute basis, we did cover all those raw materials increases. If you look at the core business, I think we were $70 million over on gross profit dollars. So we did cover like we said, but targeting just price and reformulation, we had a headwind that we’re going to cover in 2018 and what you’re going to find is that that carry forward, and what’s new to the business for 2018 in terms of COBOL, lithium and others, will be significantly reduced by the end of the year in a way that there is something way less than 1% of our total raw material spend, that we would even consider thinking about beating to offset in 2019. So I think we're in a pretty good shape with all of everything that we've mentioned. Certainly on an absolute case, we're going to hit it out of part probably again on covering on the core business. But I think it's starting to wind on and that's the reason why I might not to underscore this again. I made the comment about the structural change and be careful not to forget that around the $75 million of organic opportunities with a 40% flow through. If you look at 18% again, and you use that kind of a math, kind of a situation just think about that total structural enhancement that will take place when this normalizes. And you can see that it you know very much supports the types of things we're targeting in 2020. Don't lose sight of the structural enhancement that's being matched.

[Mike Harrison:]

And then the other question I had is on the ESL business and you referenced the electronic packaging materials is having a lot of opportunities. Can you talk about what kind of growth you're seeing in that area and also maybe give us a sense of what the industry structure looks like? Is that consolidated, fragmented, are there more acquisition opportunities there and kind of what does Ferro’s position look like relative to the competition? Thanks.

[Peter Thomas:]

This is one area where we're going to be a little furtive for competitive reasons. But what I can tell you is, you should expect from ESL enhanced sales going forward that you know we grew double digits, I would suspect we may do that again. We have a lot of new opportunities both in the based pipeline plus, more importantly, the R&D pipeline that we introduced at the Investor Day in the five, six megatrends. So we have new opportunities in both areas, remember our core pipeline that we've been delivering against in the last three years is called our core pipeline and then the one we introduced at the Investor Day is the corporate pipeline. So we see lots of opportunities, remember these are smaller, high margin opportunities that are very proprietary in nature and there could be a limited competition, and that’s why we don’t want to be too specific. We are certainly the way we define the market, the market leader and one of the areas that we do talk to is the sensor market, whether its oxygen sensors or heat sensors. We do talk about that, and our sensor model grew very nicely last year; and we have the same expectations for it to grow this year. So the next question we can answer, as it relates to us being inquisitive in that area, the answer is we are certainly looking at a range of things that would enhance that technology portfolio of that business.

[Ben Schlater:]

So maybe just a couple of other points around guidance that we didn't mention, but we’ll close the call with. So we talked about our sales growth, our gross profit margin and SG&A. From an other income and expense perspective, we would expect that to be $5 million to $6 million for the year, interest expense, we would expect to be $29 million to $31 million. We think we again mentioned our tax rate of 26% to 27%. We would expect CapEx to be 40% to 45% and then our free cash flow conversion is also to be 40% to 45%.

[Peter Thomas:]

Thanks, Ben. We'd 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. Thank you.

[Operator:]

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