Ferro Corporation
Q3 2016 Earnings Call Transcript

Published: 5 Nov 2016

[Operator:]

Ferro Corporation's 2016 Third Quarter Earnings Conference Call. [Operator Instructions] Now, a quick reminder, today's event is being recorded, Thursday, November 3rd, 2016. It is now my pleasure to introduce Peter Thomas, Chairman and Chief Executive Officer of Ferro Corporation. Please go ahead sir.

[Peter Thomas:]

Good morning, everyone. Before we begin our discussion of the quarter, I would like to take a couple of minutes to comment on recent management appointments. We recently changed the leaders of our Finance and Corporate Development teams to capitalize on growth opportunities and this growth stage of our value creation strategy. Joe Vitale re-joined our company last month to lead Corporate Development. It is a great benefit to bring the aboard someone who already knows our strategy and pipeline. We haven't lost a step in the transition of Corporate Development leadership from Ben Schlater to Joe, as demonstrated by the transactions we recently announced. Ben, of course, was named Vice President and Chief Financial Officer, and I am delighted to have him with me on the call today. Kevin Grant is also on the call in his new role as Head of Investor Relations. At this stage in Ferro's strategy, it was appropriate for us to have someone focused on communicating our investment story on a full time basis. In addition, Andrew Ross and Allen Spizzo have joined Ferro's Board of Directors. We are extremely pleased to have Andrew and Allen bring to Ferro their exceptional knowledge of the specialty chemical industry and their deep business experience. Also John Bingle who will remain in his role as Treasurer will be joining us on the call as well. So with those introductions, I'll turn the call over to Kevin.

[Kevin Grant:]

Thank you, Peter. Good morning to everyone and thank you for joining our 2016 third quarter earnings call. Our quarterly earnings press release was published last night. The release including reconciliations of reported results to non-GAAP data that we'll discuss this morning, as well as supplemental slides for the call are on the Investor Information section of Ferro's website www.ferro.com. Please note that the statements made on this conference call about the future performance of the company may constitute forward-looking statements within the meaning of Federal Securities Laws. These statements are subject to a variety of uncertainties, risks and other factors related to the company's operations and business environment, including those listed in our earnings press release and more fully described in the company's Annual Report on Form 10-K for December 31, 2015. Forward-looking statements reflect management's expectations as of today. The company undertakes no duty to update them to reflect future events, information or circumstances that arise after the date of this conference call, except as required by law. A dial-in replay of today's call will be available for seven days. In addition, you may listen to or download a replay of the call through the Investor Information section at ferro.com. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Ferro is prohibited. Please also note that in our Q3 earnings press release, we have added language under a section titled Adjusted Guidance. Under SEC rules, non-GAAP numbers that we use in public disclosures generally are to be reconciled to the most directly comparable GAAP numbers. With respect to forward-looking numbers like estimated adjusted EBITDA, the SEC provides an exception to the general requirement to reconcile to GAAP. If the reconciliation cannot be done without unreasonable effort in reliance on this exception is disclosed, clearly it is for this reason that we have added this statement. I will now turn the call back over to Peter Thomas.

[Peter Thomas:]

Thank you, Kevin. Ferro delivered another quarter of strong results, with solid sales growth and margin expansion. We maintain the momentum of our growth strategy and the strategy is clearly doing what we intended, upgrading the business with high quality, value portfolios of products and services that lead to strong customer relationships and stronger margins. Our fifth acquisition of the year, which we announced on Tuesday is another example of our strategy at work. The addition of Electro-Science Laboratories is going to be great platform in the electronic material space for our Performance Colors and Glass business. You can expect to hear more from us as we continue to execute on our strategy. Now, let's take a closer look at the quarter's performance. Here are some highlights from a constant currency perspective in the third quarter. We delivered a 5.7% increase in net sales, and we remain on track to meet our 2016 revenue targets. We generated 30.8% adjusted gross profit margin, up from 27.5% in the third quarter last year. We increased the adjusted operating profit margin by nearly 120 basis points to 13%. We delivered EBTDA of $49 million compared to $47 million in 2015. Further, we produced 11.4% adjusted ROIC excluding acquisitions owned less than one year, and we completed the sale of our in Antwerp, Belgium based dibenzoates manufacturing assets. So, it was another solid quarter. And, although, we see traces of economic uncertainties in the fourth quarter, we are confident in our prospects for the remainder of the year and are affirming our adjusted earnings per share guidance of $1 to $1.05 per diluted share and adjusted EBITDA guidance of $190 million to $195 million. Now, let me provide a little more detail regarding our performance in the quarter. Turning to our conference call presentation deck, you will see on page three, sales in the third quarter increased to $289 million, up from $272 million from the third quarter last year. As shown on this chart, we continue to improve our profitability, which again demonstrates that our strategy is delivering results. Part of the increase in profitability is being driven by higher gross profit margins in all of our reportable segments. As I stated before, consolidated adjusted gross profit margin improved by approximately 330 basis points to 30.8%. In the quarter, we benefited from increased sales volume, improved manufacturing efficiencies, product reformulations and lower energy and raw material costs. It is worth noting that included in the third quarter of 2015 was a non-recurring purchase accounting adjustment of approximately $6 million related to the acquired Nubiola inventory. Now, turning our attention to our segments, if you will turn to page eight on the conference call deck, you will see our results for Performance Colors and Glass. Performance Colors and Glass sales increased 1.3% on a constant currency basis in the third quarter. This segment delivered gross profit margin of 34.8%, up 50 basis points. Sales in Asia were strong, growing at 10.6%, which offset sales weakness in the U.S., primarily for the enamels used in automobiles. During the second quarter, we acquired Pinturas Benicarló, a market leader in organic paints for container glass, which strengthened our coatings portfolio and expanded our addressable market. And earlier this week, as I noted earlier, we announced the acquisition Electro-Science Laboratories, or ESL, which adds to our capabilities in electronics packaging materials and provides a platform for growth in markets where we had little prior presence. We're feeling really positive about the prospects of this business, given both the operational and commercial synergies that are in our plans. Turning to page nine in the conference call deck, you will see our results for Pigments, Powders and Oxides. PPO was our strongest performing segment this quarter, with net sales up 11.9% on a constant currency basis and gross profit improving 300 basis points to 35.5%. Nubiola and double-digit sales growth in both the pigments and surface technologies product lines drove the overall increase. Nubiola increased net sales year-over-year by 9.4%. In PPO, we are adding to our pigment portfolio and expanding our capabilities to combine and manipulate pigment to produce specialized color solutions that provide functional attributes for our customers and products. Last month, we announced the acquisitions of Cappelle Pigments and Delta Performance Products, both of which increased our PPO portfolio of products and technical capabilities and also expand our addressable market. Cappelle once completed will provide us with an expansion into the high performance specialty organic pigment market and complement our inorganic pigments product families. The addition of the assets purchased from Delta Performance gives us additional manufacturing technology in engineered colorants and custom blends. If you will turn to page 10 of the conference call deck, you will see our results for Performance Coatings. Looking at Performance Coatings, net sales for the third quarter improved 7.6% on a constant currency basis and gross profit margin increased 100 basis points to 25.8%. Our tile business experienced strong volume growth in the third quarter, up 16.9% over last year's quarter. Frits and glazes volumes increased 27.3% in the quarter, primarily driven by our acquisition of Al Salomi. In Performance Coatings, we are pursuing a strategy of expanding sales into new geographic markets and increasing our position at the top end of the markets we serve. We continue to see improvement in Mexico, China, Indonesia and Egypt compared to prior third quarter of 2015 when we experienced sluggish growth. For the year, we expect constant currency sales growth excluding Al Salomi, in the mid single-digit range, and anticipate that Al Salomi will contribute approximately $23 million to $25 million. This higher growth for the Performance Coatings segment in the second half of 2016 depends on a continuation of a rebound in Asia and North Africa. Overall, it was another strong quarter, demonstrating that the continued successful acquisition of our value creation strategy. Our global teams are producing sustainable results and delivering on our key metrics. Going forward, we intend to continue to enrich our portfolio with businesses that provide high value solutions to the customers, both products and services that our customers need to be successful and when. We intend to invest in our businesses and to maintain a disciplined approach in acquiring the right mix of businesses that meet our model of being asset light and building heavy touch customer relationships that sustain loyalty and translate over time into higher margins. We have structured our organization to optimize the growth opportunities ahead of us, and we are having good success in integrating the companies we've added through acquisition over the past few years. We're excited about the great companies we've added, and I am proud of the excellent work our joint teams are doing across all areas, from manufacturing to product development and technical sales support to strengthening customer relationships until fortifying Ferro's market presence and market share. With that, I will now turn the call over to Ben Schlater for his comments.

[Benjamin Schlater:]

Thank you Peter and good morning everyone. In an effort to stay consistent with our recent past practice, I will keep my remarks today brief to allow more time for Q&A. My goal will be to provide some color to the financial results in the press release, which as Peter mentioned illustrate the progress we're making in growing Ferro and the fantastic efforts of Ferro associates around the world. My comments will cover adjustments to our earnings, cash flow, guidance and our recent acquisitions. To that end, the one adjustment we made in the quarter was $4.1 million in SG&A, associated with expenses related to the strategic alternative review process and for third-party M&A. This amount was reported as a one-time item and has been excluded from adjusted earnings. Turning to our cash flow, as noted in the press release, free cash flow from continuing operations was $25.1 million for the quarter bringing the year-to-date total to $35.1 million. The significant drivers of this figure for the quarter are adjusted EBITDA of $49.2 million, offset most significantly with working capital, which I will come back to in a moment. Now turning to guidance. As Peter mentioned, we are affirming our guidance for adjusted diluted EPS of $1 to $1.05 and an adjusted EBITDA range of $190 million to $195 million, with lower cash generation of $70 million to $80 million. This lower cash generation guidance from our prior guidance is primarily driven by our growth in emerging markets and most notably in the Middle East, North Africa and Latin America, where longer receivable days are more common. I will quickly highlight the key assumptions to our full year guidance as we did during the second quarter earnings release. Net sales of 10.5% to 11.5%, gross profit margins of 30.5% to 31.0%, SG&A of approximately 17.5% to 18.0%, interest expense of $20 million to $21 million, other income and expense of approximately $5 million, and adjusted effective tax rate of 27% to 28%. Based on the above and incorporating current 2016 currency exchange rates, we expect adjusted diluted EPS will be in the range of $1 to $1.05. At this level, adjusted EBITDA is expected to be in the range of $190 million to $195 million as I have stated previously. Finally, I would like to briefly touch on the three transactions we announced over the last several weeks. As Peter mentioned, these are very attractive businesses that are highly complementary, and we are excited to bring them into the Ferro team. In addition, each will be accretive to earnings in their first year of operations. While we have not completed all of the accounting work required to fully analyze the impact of purchase price allocations and the impact on each firm's financials, we are confident that the three will add to our earnings in 2017. For Delta, the smallest of the three, we estimate EPS accretion of $0.01 to $0.02, while Cappelle will add somewhere in the range of $0.06 to $0.08, depending on the timing of close, our ability to capture the expected synergies and the results of the purchase accounting analysis. For ESL, EPS will be modest in 2017 in the range of $0.03 to $0.06 and will ramp nicely from there, as we capture more of the $10 million plus in expected synergies. That concludes our prepared remarks. I will turn the call back to Kevin for the question-and-answer session.

[Kevin Grant:]

Thank you, Ben. Operator, we're ready to begin the question-and-answer session. Please repeat the instructions to assist our guests and we will take the next question.

[Operator:]

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

[Rosemarie Morbelli:]

Thank you. Good morning, everyone and congratulations.

[Peter Thomas:]

Thank you, Rosemarie.

[Rosemarie Morbelli:]

I was wondering Peter, you are definitely on a role regarding acquisitions and they all seem to be accretive to the margin, to the bottom line in Ferro here. Given the successful acquisitions so far, what would be the top leverage you would be willing to take in order to actually make a large one and is that more likely in the picture.

[Peter Thomas:]

Yeah, we're just going to -- I just repeat what we've said over the last quarter is where we feel comfortable somewhere between 3.5 to four times with a quick delevering within 18 months to 24 months somewhere to where we are today at around three, 2.8 and that range would be sufficient for us at this point. We feel comfortable in that range.

[Rosemarie Morbelli:]

And you are talking about total debt to EBITDA, not net, right?

[Peter Thomas:]

Net.

[Rosemarie Morbelli:]

Net. Okay. And then I was surprised by the organic -- what seems to be the organic growth of Performance Coatings of 5%. My understanding was that you were capacity constraint in every region and were accounting on Al Salomi's new facility or new smelter rather in order to be able to support the market growth. So, could you give us a feel what is happening there and where -- and how you are able to provide that additional volume?

[Peter Thomas:]

Yeah, as you know, we have essentially filled Al Salomi and that wasn't originally part of our plan, but that plant has been filled up pretty quickly. We also have the other Egyptian facility. They had some capacity left, so we've utilized that because the Egyptian market as you know, for the past year has grown year roughly, in terms of volume, at about 22% for the year. So, Egyptian facilities have been able to accommodate that indigenous growth. We also have rationalized the Italy and Spanish facilities, meaning our old [indiscernible] with our Vetriceramici facilities in a way that we were able to produce more frits and glazes and other types of products. We also, as you know, had the shortfall in Indonesia, which took our capacity down a lot last year. And this year we're up 10% in volume for the year. So, the puts and takes around the world have provided enough capacity on the take side to accommodate the new business model for growth attacking the higher ends of the markets.

[Rosemarie Morbelli:]

Could you give us a feel for what you see in terms of market demand in different categories for 2017?

[Peter Thomas:]

Yeah. Sure. So, Rosemarie, would you like to -- our feelings for each of the regions first? Will that make sense to you or--?

[Rosemarie Morbelli:]

Yes. The regions and your different segments.

[Peter Thomas:]

Okay. So, let's start with North America. And again, all of our products are sold in North America. But generally what we see in North America is somewhat of a slowdown like everyone else. You have that macroeconomic environments -- I mean, we are faced with the same as everyone else. What I will tell you though, year-to-date our volume in North America is up about 31% and that would include, of course, Nubiola, but aside from that the legacy business is up double-digits in volume. We are having strong demand with our colorants, with the acquisition of Nubiola and the combination with our CICPs and, of course, that's one of the reasons why we're excited with Cappelle, because now we have the triad of the high margin businesses coming together in a very unique way. So, we still expect North America for us, as it relates to pigments to be pretty good even though the market is slowing down. You're hearing from Valspar and Sherwin-Williams has slowed down, and some pigment manufactures will be hit with that. But the fact that we're adding new customers and applications provides a good platform for us to continue to grow again with a lot of small numbers with our business. The Auto segment is certainly slowing down. We have a big position in Mexico. And Mexican automotive sales are down about 15%, and we expect that to continue moving into next year. If you look at the most current economic reports and, as you know, we've offshore economics as one of our major sources. And what they'll tell you is that as it relates to the United States, they are projecting a decrease of about 2.1% next year in automotive applications. However, again because of our repositioning with applications in the regions as part of our asset light heavy touch model, we probably would do a little better that, because we are gaining market share in the automotive market, because we are delivering and producing organically new black enamels that are more resistant to temperature, to acids and many other type of resistant application. So, again, even though markets are down, because we are the market leader in gaining share in product development, we will probably do a little bit better. But again North America, we do see a slowdown. We also see in North America construction -- the commercial construction seems to be somewhat slower than it has been in the first part of the year and the latter part of last year. But we think that's a bit of an anomaly. We are already starting to see some pick-up in orders for the first and second quarters of next year. So, the commercial side of construction in North America although slow in commercial applications, will be picking up. Again and as it relates to construction, again from the data, it would suggest that North America would have an increase in construction year-over-year. So, we feel pretty good about the commercial aspects of our North American operations. So all in all, slowdown North America. We feel good. We will probably do better again because of the strategy and how we're executing. Mexico, we would like to single that, because we really feel good about Mexico. We have felt good about Mexico for the past 18 months as we're communicating. Even though auto -- automotive is down, that really doesn't matter, because the rest of the businesses are up for us. In fact, Mexico for the year is up roughly 18% in revenue. And for the third quarter it was up about 22%. And again that's what sluggish automotive, but that's because the Mexican government is subsidizing housing and there's appliance growth, the true emerging a middle-class in Mexico is actually helping our results. So, we feel very, very good about Mexico in terms of construction in our Pigments business and increased government spending. Now, here is some good news. I think you asked us the question in the last quarter that you had heard that people were starting to feel that Brazil and Argentina maybe at the bottom. And I think this is the first indication that we would share with you that we too now believe at this point that Brazil and Argentina are at the bottom. And we do see some positive spots, particularly in Brazil because we changed our business model. In fact in Brazil, although, it's a small number, our revenue increased in the third quarter by double-digits, as well as in Argentina, because we've changed the business model to one of a more of a high end type of an application, rather than just selling enamel products and tile, we've converted Brazil to more of a high end, a distributor of all of our products globally, whether it's pigments, Nubiola's pigments. In fact, we eliminated the Nubiola distribution base in a way that Brazil is picking that up. So, again, we have Glass products, we have high end [indiscernible] types, we have Colors and we're changing the business model of Brazil in a very favorable way. So, we think Brazil and Argentina are -- have hit the bottom, and our strategy seems to be working on our repositioning activity. Moving to Europe, as we are -- as you know is a big part of our business, we see that it's softening, and we see that -- it is stagnant at this point. And in fact you probably have read that the IMF has reduced the growth rate to 1.5%. And again, construction and automotive are very important for us, even the Oxford economics data suggest that it will decrease and move to about 1.8%. So, we see that either Europe is going to be flat for the most part, but for us because again of the strategy of adding new applications and new customers, we feel a bit better and then we believe we will perform better in the construction area and the automotive applications, as well as the declaration part of our business where we have leadership positions. But overall, construction remains weak. The appliance sector is weak. And, of course, there is collateral damage due to the activities in Syria, and alike that we see continuing to play that particular region. What we're really feeling positive about is MENA. And again, as I mentioned earlier, China -- Egypt for the year in terms of volumes up about 22% and high single-digits in revenue, so that area is performing quite well. And for the first time in that area, we see that Saudi is starting to pick-up. In fact, part of the reason why it was slow in the tile business, in the glass business was because of the price of oil. When it was floating around $40 and $45, it throttle the economy back on some of the high end products, but when it hit $50, and as the customers in that region would tell us that somewhere between $50 and $60 is a sweet spot that will spur demand, when they did hit that $50, $52 range, we did have some orders in some of the higher end applications that we serve. And the customers they are cautious, but they feel that the business will be better in those areas next year versus this year. We see that Turkey stable -- as you know, we've taken a pretty big position in Turkey. We feel very good about our ability to gain share there, well, particularly with our tile and porcelain enamel applications. As you know, we are building more smelters in Al Salomi to serve the porcelain enamel frit market. We're the first international producer of -- will be the first international producer of porcelain enamel frit for the Eastern Europe market, as well as the Middle Eastern market. As you know, our porcelain enamel business was up all -- throughout the year. In fact on the legacy business it's somewhere between 2% and 3%, and it looks typically a flat market. So, we still feel good about the strategic orientation to the business serving in those areas. So we're still good with Turkey. Strangely enough even though we had lot of comments last year about Romania and Russia being down, for us this year, we are seeing a double-digit growth in both of those areas, albeit very small numbers. But for us and how we're positioned the demand for particularly our porcelain enamel products and our glass products seem to be picking up in that area and we have no reason to believe that that will go backwards here in the fourth quarter and moving into next year. And one of the most important things that I want to mention, Rosemarie, about Egypt. I guess you are aware that there was a big gas line of about 30 trillion cubic feet in the Mediterranean. And the Egyptian government is hooked up with any out of Italy to grab that gas. And what we're hearing from our customers is the belief that we may see a benefit of that gas extraction as soon as the third quarter of next year which there is a belief it will improve even further our cost structure in Egypt, that's why we feel -- again another reason why we feel so good. Moving to Asia-Pacific -- and what I will tell you in Asia-Pacific through the year, our Chinese volume is up about 56% and revenue is up 18%. Indonesia is up in revenue about 9%, as percent well as volume, the turnaround and you will be able to see. And as you heard me talk about seeding of Vietnam is something that was really important, because we do see that as a growth region, and we were up significantly in Vietnam. So as it relates to Asia-PAC, overall, we're up about 21% in volume and 9% in revenue. Now we are in China where that revenue and increase is coming is not from commodity applications. Again, what we've done -- like we've done in Brazil was turn China into a high and especially kind of all of Ferro distribution center. So that mean our pigments are being produced and sold there. There is cross-selling activities with all of our Color. And we're introducing the [indiscernible] model. We've repositioned our Ink business only at the high end customers in a way that our Ink business is actually up in China, and volume by about 27%. And our margins are -- in that business are around 30% or 32%. So, again, we're in the emerging markets where -- we know that it's not good for commodities. We are repositioning those locations to be high end distribution type facilities for all of our products. And, again, that model seems to be working quite nicely. Also in China, what you will see is automotive. As you know, automotive growth has been pretty rampant there over the past couple of years. And in the past, we never had a pasting facility in China. And as you know, our new strategy is asset light heavy touch, so every region where we know there is significant demand, we have now put an application center for all of our high end products in a way to serve that market. And as I have announced over the past two quarters, we actually have hit with one of the major windshield producers on the smaller vehicles that are being subsidized by the Chinese government. So, the fact is that, although, there is a deceleration in growth in China and actually growth next year is projected to be only 2%, again, lot of small numbers benefit us where we weren't participating before, but now we've had a couple of hits, and we're serving with good applications. We have a pretty strong growth, and we expect that to continue next year. And, of course, you know that the Indonesian economy has turned around, I gave you the data for that. Thailand is doing well. Vietnam is doing well. So, for us Asia-Pacific, although, it has its challenges because of this strategy and how we are implementing and repositioning ourselves, we're doing a bit better.

[Rosemarie Morbelli:]

That is very helpful. Thank you, Peter. Good luck on continuing this process.

[Peter Thomas:]

Thank you.

[Operator:]

[Operator Instructions] And there appears to be no further questions on the phone lines -- actually we have just a question popped in the queue. Wait for a moment. And there are on questions on the phone lines at this time.

[Kevin Grant:]

Thank you, operator. That concludes our call this morning. For copies of our press release, replays of this call or to access our SEC filings, please visit our website at www.ferro.com. Thank you again for joining us this morning.

[Operator:]

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