Ferro Corporation
Q3 2015 Earnings Call Transcript

Published: 8 Nov 2015

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Ferro Corporation 2015 Third Quarter Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards we will be conducting the question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded Thursday, November 5th, 2015. I would now like to turn the conference over to John Bingle, Treasurer and Director of Investor Relations. Please go ahead, sir.

[John Bingle:]

Thank you. Good morning and welcome to the Ferro Corporation 2015 third quarter earnings conference call. Joining me on today's call are Peter Thomas, Chairman, President, and Chief Executive Officer; and Jeff Rutherford, Vice President and Chief Financial Officer. Peter will open with a few brief comment, Jeff will provide financial details for the quarter and will discuss our guidance, we'll then address your questions at the end of the call. Our quarterly earnings press release was issued last night. You can find the release as well as the reconciliation of reported results to non-GAAP data that we discuss this morning in the Investor Information portion of Ferro's website www.ferro.com. Please note that statements made on this conference call about the future performance of the company may constitute forward-looking statements within the meaning of Federal Securities laws. These statements are subject to a variety of uncertainties, risks, and other factors related to the company's operations and business environment including those listed in our earnings press release and more fully described in the company's Annual Report on Form 10-K for December 31st, 2014. Forward-looking statements reflect the 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 expressed written consent of Ferro is prohibited. I'd now like to turn the call over to Peter.

[Peter Thomas:]

Thanks, John, and good morning to everyone. Thank you for joining us today. As most of you have seen from yesterday's earnings release, our sales and earnings for the quarter were in line with our expectations. Despite weak economic conditions across much of the globe and continuing challenges in certain markets where we do business, we were able to generate a 50% increase in adjusted diluted earnings per share for the quarter with adjusted EPS of $0.24 versus $0.16 last year. This marks our 11th consecutive year-over-year quarterly increase in adjusted EPS and it puts us in good shape to meet the full year adjusted EPS guidance of $0.82 to $0.87 per share that we provided previously. Value-added sales increased by approximately 2% and on a constant currency basis by 18% with the sales from recently acquired Vetriceramici and Nubiola being key drivers behind the increased sales. The integration of the two acquisitions continues and we're pleased with the results to date. We also continue to show improvement on other key financial metrics. Our adjusted gross profit margin increased to 30.5% excluding non-recurring purchase price accounting items associated with the Nubiola transaction. This compares to 27.5% last year. Our EBITDA margin improved to 17.3% from 12.7% last year and our ROIC increased to 12.8% compared with 11.1% for the period ending December 31st, 2014. We're pleased with the progress our teams around the world are making and we're excited about Ferro's future. From a strategic perspective, the acquisition pipeline remains robust and we continue to be very active. As you know, in July we completed the Nubiola transaction and in September we announced that we had entered into a definitive agreement to purchase Al Salomi, a leading manufacturer of tile coatings in Egypt. We continue to work on multiple M&A opportunities out of a portfolio of over 40 acquisition targets. The targets span across all three reportable segments with a typical size in the range of $60 million to $100 million in revenue. We are excited about our growth prospects and we intend to pursue opportunities aggressively while staying focused on investing for value creating growth. Now, turning to our business segments. Value-added sales for the quarter on a constant currency basis excluding the impact of acquisitions increased approximately 2% for Performance Colors and Glass and 7% for Pigments, Powders and Oxides; in line with our expectations. On the same basis, sales for the Performance Coatings segment declined by 6% due to weakness in the tile coatings business, which offset a modest sales increase in porcelain enamel. The tile business continues to be challenged by weak economic conditions and political disruptions in several countries where we participate, including Indonesia, China, Brazil, Russia, and Ukraine. In addition, the modest second half pick up we expected from Europe and the Middle East and North Africa has not yet materialized. As we have discussed in the past, we anticipate the difficulties in Indonesia, Russia, and Ukraine will be prolonged and take longer to be resolved as the fundamentals in these economies need to improve prior to seeing a substantial pick up in business. Conversely, in Europe and MENA, the issues are more transitory in nature and improvements are more within our control. We expect the business environment in these regions will begin to improve in the fourth quarter and expect that the actions we have taken to introduce new products in the region and to reformulate products to meet customer needs will provide a lift for tile sales over the next several months. We've begun to see signs of improvement in October based on our most current sales data. So, let me step back from the quarter for a moment and remind you where we are going with tile from a strategic perspective. First, I want to emphasize that we continue to regard tile as a good business with good cash generation capabilities. We are a market leader in an industry with modest growth and we should be participating in this growth. Despite troubles in some countries, tile is a construction material of choice in many markets around the world. However, due to past underinvestment, Ferro is not as well-positioned in certain markets as it should be. We have been operating at near capacity levels in several of our plants, which have prevented us from aggressively pursuing new business. We are taking action to change the situation with investments in both production capacity and commercial staffing in a number of attractive markets. We plan to make additional investments to ensure that we have low-cost manufacturing capacity supplying markets like Egypt, Turkey, Saudi Arabia, Eastern Europe, and North America that demonstrate the greatest growth and value creation opportunities. Here are a few of the investments that are helping us reach this goal for both tile and porcelain enamel businesses. First in 2014, we purchased certain commercial assets of a Turkish company that was acting as a reseller of our porcelain enamel products. This investment was all about acquiring the needed infrastructure to support commercial operations for both porcelain enamel and tile sales efforts in this attractive region. We have been building out this commercial operation this year and it will be a driver of Performance Coatings sales in the region in 2016. We have formed a JV in Indonesia with one of our local partners to build a new tile frit plant to provide additional smelting capacity to support growth in the region. We're targeting in-country demand as well as requirements for smaller faster growing markets in the ASEAN region and India. The plant is expected to be operational in the first quarter of 2016. Third, we're in the process of closing on our third deal to acquire Al Salomi, a leader in the manufacture of tile frits and glazes in Egypt. The acquisition of Al Salomi will bring us six low cost, high-tech smelters in Egypt with capacity to produce 55,000 metric tons of frits and glazes per year. An additional 12,000 metric tons per year of new capacity is slated to come online by the end of 2015. And at the site, there is an additional land and infrastructure to support future capacity expansion. And of course, our purchase of Vetriceramici is a major part of the growth solution. Not only is Vetri a higher margin business, it has enjoyed a higher level of growth over the last several years with its focus on the faster growing higher end segment of the market including the United States. In addition, Vetriceramici is providing an opportunity for enhancing sales growth via cross selling activities. And these are a few examples of how we are repositioning tile to restore growth. Our strategy is to continue to build up the tile business through internal initiatives, new product introductions, and acquisition. Having said that, it will take several quarters before our efforts and investments fully pay off, but we feel strongly that when global economic conditions turn around, we will be in an excellent position to accelerate growth for this mainstay Ferro business. All said, this was a good quarter and we're pleased with our continuing progress in executing our value creation strategy. Through acquisitions, divestitures, and internal optimization; we have improved adjusted gross profit margin from 17% three years ago to approximately 31% in the current quarter. We have upgraded the value of the enterprise by acquiring higher end businesses like Vetriceramici and Nubiola and high quality low cost producers like Al Salomi. Revenue growth has been constrained by market conditions and the strong dollar, but we continue to make progress on driving shareholder value. As I mentioned earlier, we are actively working on a number of acquisitions or joint venture opportunities in all three of our business segments and we have the cash flow and financial capacity to execute on them. We also have a healthy pipeline of innovative higher margin new products coming to market and in development. Despite the global uncertainties, we like our momentum going into 2016 and we will remain focused on delivering on our strategic objectives. And with that, I'll turn the call over to Jeff.

[Jeff Rutherford:]

Thank you, Peter, and good morning, everyone. As John mentioned at the start of the call, you'll find reconciliations of non-GAAP results discussed during this conference call in our press release and also in the supplemental financial data that is posted in the Investor Information portion of Ferro's website. My comments in general will focus on our continuing businesses as adjusted for restructuring and other one-time items to provide comparability of information from period-to-period. I will cover two primary topics and then we will get to your questions. First, I will provide a quick recap of the quarter and will then provide a discussion of our outlook for the fourth quarter. As you are aware, we have divested the majority of our performance chemicals business unit. We are currently in an active process to sell the remaining polymer additives assets, our dibenzoates manufacturing plant in Antwerp, Belgium. Because we are actively marketing this property, we will not discuss the specifics of a potential transaction or speculate on potential proceeds or timing. The Antwerp facility is reported as a discontinued operation and generated a loss of $19 million in the third quarter or a loss of $0.22 per diluted share. Included in this quarter's results for discontinued operations is a $12 million impairment charge relating to the assets held for sale in Belgium. As of the end of the third quarter, our investment in Antwerp is approximately $32 million. Now, I will turn to our results for the quarter on a continuing operations basis. On a GAAP basis, income from continuing operations was $0.17 per diluted share in the third quarter compared with a loss of $0.03 last year. On an adjusted basis, we reported income of $0.24 per diluted share compared with $0.16 per diluted share for the same period last year. We estimate that the foreign currency translation reduced our reported EPS by approximately $0.04 per diluted share. The major adjustments which were reported as one-time items in the current quarter included the following items. First, we incurred $4 million of additional restructuring charges mainly related to continued headcount reductions and the termination of a procurement contract and associated deferred costs. In addition, in SG&A we had approximately $5 million of non-recurring expenses primarily related to M&A activities. We then calculate the tax effect of these adjustments based upon their jurisdictional deductibility and statutory tax rates. Accordingly, the effective tax rate used in calculating adjusted EPS is our GAAP rate adjusted for the tax effect of restructuring and non-recurring expenses. For the third quarter of 2015, that adjusted effective tax rate was approximately 21%. We anticipate a full year adjusted effective tax rate of approximately 25%. This rate is impacted by the recognition of certain discreet tax benefits in the first and third quarters of 2015. Accordingly, the fourth quarter will have a higher adjusted effective tax rate of approximately 28%. During the remainder of my remarks, I will refer to adjusted numbers that exclude the adjustments I just noted. In addition, discussions about sales and sales related profitability measures such as gross profit margin will reference value-added sales. As a reminder, value-added sales exclude precious metal sales as precious metal sales in general are pass-through sales to our customers. Precious metal sales were $9 million and $11 million in the third quarters of 2015 and 2014. It should be noted and I would expect everyone will be happy to hear that the fourth quarter will be the last quarter where we discuss value-added sales. Precious metal sales have become a smaller component of our consolidated sales making this distinction less relevant. It is our intention to not report value-added sales or value-added sales metrics beginning in the first quarter of 2016. Having said that, value-added sales were $271 million in the third quarter of 2015 versus $265 million in the prior year. On a constant currency basis and including Vetriceramici and Nubiola, value-added sales increased by approximately 18%. Excluding the acquisitions and on a constant currency basis, value-added sales declined 2%. Adjusted gross profit was $77 million in the third quarter of 2015 compared to $73 million in 2014. Included in the current quarter is approximately $6 million in purchase accounting adjustments related to the purchase of Nubiola inventories. This step-up in inventory value was fully amortized in the third quarter reducing reported gross profit. Adjusting for this non-recurring item, the adjusted gross profit margin improved to 30.5% compared with 27.5% last year. Excluding special charges in both periods, adjusted SG&A was $44 million compared with $48 million in the prior year period. On a constant currency basis, adjusted SG&A increased by $2 million from $42 million in the prior year. Vetriceramici and Nubiola added approximately $7 million in SG&A during the quarter and this increase was partially offset by a reduction in incentive compensation. It should be noted that our SG&A level for the third quarter is seasonally low and contains virtually no expenses associated with incentive compensation. Our normalized level of SG&A at current FX rates and including Vetriceramici and Nubiola is in the range $47 million to $48 million. For the quarter, we achieved $47 million of adjusted EBITDA resulting in an EBITDA margin of 17.3%. This compares to third quarter 2014 adjusted EBITDA of $34 million or 12.7% EBITDA margin. At September 30, 2015, net debt was $357 million, an increase of approximately $154 million since year end 2014 with the increase driven by our $162 million acquisition of Nubiola. Our liquidity position remained strong. At quarter end, we had approximately $80 million of availability under the revolver and cash balances of $69 million. The following significant cash flows occurred during the first three quarters as part of the change in net debt. For continuing operations, we generated $119 million of EBITDA with the following items impacting cash and net debt. Restructuring payments of $6 million, interest of $11 million, cash taxes of $18 million, pension and other post retirement contributions of $5 million, capital expenditures of $14 million, working capital of $21 million as a use including the following components; receivables of $3 million, inventory of $12 million, and accounts payable $6 million. The 2014 bonus payments made in 2015 was $9 million, purchase of the common stock under the stock repurchase program of $7 million, and other net items of $15 million including $14 million of cash costs associated with one-time items not accounted for as restructuring, $7 million associated with the FX impact on cash balances, partially offset by other items including changes in accruals of $5 million. Acquisition activity consumed approximately $167 million of cash primarily associated with the purchases of Nubiola and TherMark. Discontinued operations used approximately $31 million in cash, $16 million of losses, and capital expenditures of $22 million offset by a working capital reduction of $7 million. Our precious metal consignment obligation was $23 million at quarter end and we currently have no demands for cash collateral related to the precious metal consignment program. I will now provide a brief overview of year-over-year third quarter results for our reporting segments. The analysis covers only continuing operations and is based on value-added sales. In Performance Coatings, sales declined by 11%. However, adjusting for the impact of foreign currencies, segment sales increased by 6%. Constant currency sales for both tile and porcelain enamel increased in the quarter by 8% and 2% respectively. Vetriceramici sales in the quarter were $14.3 million accounting for the sales gain in tile, partially offset by a reduction in sales for the legacy business. Sales in the legacy tile business were lower, primarily due to reduced sales volumes and lower average selling prices partially offset by favorable mix. Demand for the legacy tile business was weak in nearly all regions with the exception of Latin America. On a constant currency basis, segment gross profit increased by approximately $6 million with Vetriceramici accounting for the majority of the increase. The segment gross profit margin increased to 24.9% from 21.8%. In the Performance Colors and Glass segment, value-added sales on a constant currency basis increased by $2 million or 2% to $84 million. Vetriceramici accounted for approximately $300,000 of the value-added sales growth. Demand for automotive and decoration product categories were the primary drivers for increases in sales in the legacy business. Adjusting for FX, gross profit improved by $1 million to $32 million with the gross profit margin improving to 37.9% from 37.3%. In Pigments, Powders and Oxides constant currency value-added sales increased by $32 million due to the inclusion of Nubiola, which was acquired at the beginning of the quarter. Nubiola sales in the quarter were $30 million. Excluding the impact of acquisitions, constant currency value-added sales increased approximately 7%. Segment gross profit on a constant currency basis improved by $5 million, primarily due to the addition of Nubiola. As previously mentioned, included in cost of goods sold for the segment is approximately $6 million of amortization of purchase accounting adjustments associated with Nubiola's inventory. Excluding this non-recurring item, segment gross profit margins improved to 32.5% from 29.3% last year. I will now provide a brief overview of our outlook for the fourth quarter. We continue to be pressured by weakness in certain emerging markets and by unfavorable translation impact of weakening global currencies against the U.S. dollar. Despite these challenges, we expect continued revenue and earnings growth driven by the acquisitions of Vetriceramici and Nubiola. We expect full-year adjusted earnings per share to be in the mid to low range of our prior guidance of $0.82 to $0.87. The following are the components of our guidance. For sales, we're expecting continued growth mainly due to recent acquisition, but partially offset by the foreign currency translation. Value-added sales in the fourth quarter of 2014 were $248 million excluding the impact of acquisitions, but would have been approximately $28 million lower if recorded using our current foreign currency rate forecast. From this 2014 adjusted base of approximately $220 million, the legacy business is expected to decline by 1% to 2%. Vetriceramici and Nubiola will add $40 million to $45 million of sales to offset the legacy business sales decline. This would suggest a fourth quarter value-added sales target of $255 million to $263 million. Precious metal sales in the fourth quarter are expected to be in the range of $8 million to $10 million. Our underlying assumption for the euro is based on Bloomberg consolidated consensus estimates, which has the euro at an average of approximately $1.10 during the fourth quarter. We expect fourth quarter gross profit as a percentage of value-added sales to be in the range of 28.5% to 29% and operating profit is expected to be in the range of 10% to 10.5%. Interest expense is expected to be $4 million to $5 million in the fourth quarter based on an increase in debt required to complete the Al Salomi transaction and reduce capitalized interest as a result of the Antwerp, Belgium project reaching completion. Other expense will be in the range of $1 million to $2 million. The full year GAAP effective tax rate will be approximately 24%, while the adjusted effective tax rate will be approximately 25%, resulting in fourth quarter GAAP and adjusted effective tax rates of approximately 28%. For cash flow, we expect continuing operations to generate approximately $40 million to $50 million of cash flow during the full year excluding the requirements for M&A activity and the share repurchase program. In our release last night, we also announced that our Board of Directors approved a follow-on $25 million stock repurchase program. We continue to view funding growth as our top priority for capital allocation and do not believe the addition to our current repurchase program will prevent us from investing in acquisitions or grow capital. The timing and amount of shares repurchased has not been specified and will depend on our assessment of market condition, share price, projected cash flow, and other related factors. That concludes our prepared remarks. I will now turn it over to John for the Q&A session.

[John Bingle:]

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

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of David Begleiter with Deutsche Bank. Please proceed.

[Katherine Griffin:]

Hi, this is Katherine Griffin on for David actually. A couple of questions. First on Performance Coatings, have you seen any signs of rebound for tile demand in Asia and do you have confidence that growth will recover in 2016?

[Peter Thomas:]

Yes. What we're seeing and we mentioned in the last conference call that our expectation was in the fourth quarter that we would start to see a bit of a pickup particularly in Indonesia where we've had some challenges and we are seeing that. We're starting to see a little bit of an inventory build because most of our top customers have been reducing inventories for the past nine months. As we mentioned, we wanted to make sure we were clear that the pickup at this point would be more of replenishing inventories rather than domestic demand. But on the positive side, we're not seeing additional slowing. What we see is kind of a plateauing of the downturn and our expectations with our visibility with our customers as they share with us is that they see more of the second half of this year moving into the first half of next year and their expectation is that there should be an uptick coming out of the second quarter moving into the third quarter. And that's with Indonesia. As it relates to Thailand, Thailand is actually doing a bit better. They are now supplying some newer markets like Burma and Myanmar and Sri Lanka, which would be new business for us out of that area. And as relates to China where most of our tile business was centered around our digital ink business, since our distributor that we were using decided to get out of the business last year, most of our ink business was tied to them and we felt the negative impact through the course of the year. But putting them aside, we see just a small pickup in the inks business. But overall what we would say and what we're feeling is fundamentally, Asia as we view it, with our visibility has reached a trough or plateau and our expectation is that we'll see steady improvement, albeit slower in the first part of next year, but then starting to pick up.

[Katherine Griffin:]

Okay. And one more if I could on 2016 guidance, I know it's still early. But could you talk about how we should be thinking about EBITDA growth in 2016 either in terms of base business, cost savings, and acquisitions?

[Jeff Rutherford:]

Sure. We've talked about before and I think we talked about it on the last call, but we'll give an update on that. Basically where we're going to be on EBITDA for 2015 is we're going to be in the mid-150. And then when you look at 2016, what you need to do is you need to take Nubiola and a little bit of Vetri and Al Salomi and they're going to be the increase -- material increases to EBITDA for us in 2016 and that EBITDA is going to be approximately $30 million -- the high $20 million to $30 million. And then top of that what you'll have -- we're assuming in this discussion that there aren't any acquisitions between now and the end of next year which is highly probable that there's going to be something, but this is without any subsequent acquisition. We also believe that there is improvement in the base model that can continue. Our procurement group is very good now and they're doing a lot of things, both in direct and indirect spend and we expect some improvement from them. We have opportunities relative to functional non-strategic costs around the globe and we're pursuing those. What we model then is somewhere between $5 million and $10 million of improvement of the base. So mid-$150 million; high $20 million, $30 million of improvement of acquisitions already completed or soon to be completed, $5 million to 10 million in the base improvement, and then we're left with what's going to be the growth in those base legacy business. And as we've said before, a 4% growth and that's high now. We generally look at GDP plus 1% as our goal and what we model long-term in this base legacy business. It's probably down a little bit because of a decline in GDP. But at 4%, that EBITDA is approximately $11 million of incremental contribution.

[Katherine Griffin:]

Okay. Thank you so much.

[Jeff Rutherford:]

Sure.

[Operator:]

Our next question comes from the line of Mike Harrison with Seaport Global. Please proceed.

[Mike Harrison:]

Hi, good morning.

[Peter Thomas:]

Hey Mike.

[Mike Harrison:]

Peter, I was hoping you could give us a little bit further detail on the way you're thinking about tile coatings strategically given the outlook in Asia. I think I'm still struggling to understand why more capacity is the solution in Asia as you look to open another plant in Indonesia next year.

[Peter Thomas:]

Okay. First of all as you know strategy is not stagnant, it's fluid so everything we've been doing since 2012 is we have a vision of moving three years to five years out. Based on all of our projections, if you really understand the Asian markets as an emerging market, there are periods where there are ups and downs. Last time we were caught in this we had built 10 to 11 smelters and when the economy picked up three or four years ago in Indonesia when it was growing at 8%, we were at capacity and we couldn't sell more. We couldn't go out and aggressively get more business. So, it will turn and we're starting to see that based on our customers that we'll see an uptick in the business next year. And then you have to think about where it's positioned strategically. This is not in West Java, it's in Eastern Java which is almost like a separate environment and actually demand in Eastern Java is a little bit better if you will than Western. So, as the economy picks up, we're going to be at the right place at the right time. We're only putting two smelters in, each one of those smelters represents 6,000 metric tons on average and it will be enough to be the first mover and instead of somebody else moving in or the folks from China moving frits into that area, we'll be there with local production, we'll have an applications facility, and we'll be able to fence the customers, which is part of our new model. So, if you think about our strategy, what we said is we want to be at the right place at the right time, we want to put capacity in the low cost areas where the markets are growing faster and that's exactly what we've done with Al Salomi where we know moving forward that the faster growing markets for the tile business will be Egypt, the Middle East, Turkey, and Eastern Europe. In fact if you look at the third quarter, it's not all negative with tile. I mean as Jeff mentioned; Latin America, Mexico, and Argentina had a really, really good quarter versus last year. In Eastern Europe; Poland did well, Turkey did well. Unfortunately it's not enough to offset the impact of the softness if you will in the Middle East or Indonesia, but nonetheless we still have some positive signs there. So, again, think about the strategy and what we're saying. We want to be at the right place at the right time, low cost production, fast growing areas, and to top it off we want to expand the tile market with higher end product lines like the acquisition of Vetriceramici and as a way of adding higher value products, introducing cross-selling activities with our base business, with their customers and they have helped upgrade the margins in the tile business by 160 basis points. So, this is all about having a long-term vision being at the right place at the right time which is something we hadn't done in the past.

[Mike Harrison:]

And then in terms of the guidance for potentially seeing some customer downtime or some customer destocking in the fourth quarter, in the past you guys have had some fixed cost absorption issues if you need to take some downtime. So, can you talk about whether that's in the plan and if you are taking downtime, are there some maintenance costs or any new projects that might be taking place opportunistically in Q4?

[Peter Thomas:]

Okay. So, it all starts with our forecast, which the majority of our forecast comes from our customers. So, here's what we're seeing. In North America, the expectation is that customers particularly in the pigment space and the surface technology spaces have shared with us that they will whittle down inventory to manage cash through the fourth quarter, some of that we've built into our model. The question becomes whether or not they will do more, but we've built in a certain whittling down of inventory if you will and we've adjusted our manufacturing accordingly. So, anything that we can do to manage money effectively at the operations level, we have built in. What we're also hearing and I guess one of the other pieces of this isn't so much the inventory drain is as much in Europe where there will be an extended holiday shutdown. So, we've interviewed all of our customers and it's a big deal in Europe as you know whether it's a holiday in August or holidays in December, it's always a challenging time and the expectation is that the majority of our customers will go down the traditional two weeks. But considering that Europe is a bit sluggish, it hasn't fully turned around, it's not expanding there a lot, there could be some extra downtime. So, there is where some of our conservatism in our forecast is around whittling of inventory in North America and extended shutdowns in Europe.

[Mike Harrison:]

All right. And then the last thing I wanted to ask about is this $5.8 million Nubiola inventory step-up charge. You mentioned it's non-recurring and you call it a special item, but it sounds like it addressed product that was sold in Q3. So, if you're stepping up to what would be a normal price for that inventory, doesn't that pretty fairly represent what the ongoing profitability of that business should be or maybe give me a little bit more help understanding kind of what the ongoing gross margin and cost structure should look like there?

[Jeff Rutherford:]

Sure. First of all, we didn't exclude it in the $0.24. It's included in our adjusted gross profit, so it's not a special item. We just called it out. And what it is, is when we acquired Nubiola, basically in purchase accounting you're marking that inventory up to value based on what you're going to sell it at. So, you don't get any margin on that first turn. So -- by the way if that was our continuing margin, we'd really have a problem here because we would have no margin in Nubiola. So, basically in the first turn of inventory you get no gross profit and that's -- it is $5.8 million. So, it has stepped all the way up to value based on what it's going to be sold to, so in our mind it's a non-cash item and it amortizes through within the first turn of inventory.

[Mike Harrison:]

Okay. So, I guess I don't understand why it wasn't considered a special item then?

[Jeff Rutherford:]

Well, because we were trying to -- it's a special item. We just haven't excluded it from the adjusted basis because we basically have our pro forma adjustments down to two categories; restructuring, which we don't build into our guidance and M&A activities -- third-party M&A activities that are unpredictable on our end. It's all based on what we're looking at and where we're spending the money. Those two things are basic and when you look at the third quarter, those are our basic pro forma adjustments to get to adjusted numbers and then we tax effect those items. This item was built into our forecast and built into our modeling, so we didn't exclude it. I mean we could have, it certainly wasn't built into our guidance that way. Our guidance was based upon our models plus the acquisition of Nubiola and it was built into that. So, I think it would have been a little aggressive on our end if we had included this into pro forma adjusted numbers. You are welcome to do it and I think everyone should from a going basis is to build that end to what the margin is going to be going forward.

[Mike Harrison:]

Okay. So, just to be clear, this won't recur again and if we want to get a better sense of what the margin in that segment looks like, we should add that back going forward?

[Jeff Rutherford:]

That is correct. But I will say this; it will occur every time we do an acquisition and every time we do an acquisition, we'll call it out. But basically what it is, is when you go through your purchase accounting and you're writing your assets up to fair value for inventory, you're writing it up to what you're going to sell it at and then you don't get margin on the first turn.

[Peter Thomas:]

Just to be clear, so I'll just throw in. Our PPO business is doing extremely well with the 7% increase and the gross margin adjusted for that is about 30.5% and that business is doing very well. So, please take that into consideration because that business profile is a good margin.

[Mike Harrison:]

All right. Thanks very much.

[Jeff Rutherford:]

Sure.

[Operator:]

Our next question comes from the line of Ian Zaffino with Oppenheimer Funds. Please proceed.

[Ian Zaffino:]

Hi, thank you very much. Question would just be more on the M&A side and what are you targeting next year as far as number of deals. I know it's not in your guidance or what you had mentioned. But what are you targeting there? Is that going to be an increase? And then also what are you seeing in terms of multiples just given kind of where the business is right now and people lowering their selling price, what are you seeing there? Thank you.

[Peter Thomas:]

Yeah, we -- as we mentioned, we have what we define as pretty good momentum moving forward in our acquisition profiling and modeling and our capacity to handle deals. Right now as we've discussed in the past, we do handle multiple items; but at any point in time as we say, Jeff would be modeling out as many as seven or eight of them and we'll be in different stages of discussions with each of those. That seems to be a good capacity for us and we have a good track record again. However, we've had five acquisitions in about 15 or 16 months. So, right now we have multiple things going on. Right now you know that our model's been with the bolt-on acquisitions by Vetri and Nubiola. We're looking at I'll just round it up and say 7% with less than 5% after synergies. That could be a range for deals like that, but then again we have other things that we're looking at that would be more of an adjacent perspective and maybe more of a higher value type of a business that would maybe require a higher multiple. So, the bottom-line is we have multiple things going on. The deal flow is good. In terms of multiples, we like to keep our multiple that we framework with bolt-on acquisitions as I've mentioned and if there's anything else that's larger, we're looking at those and maybe the metrics may be a little different, but then of course they would have to be strategic and we spell that out.

[Jeff Rutherford:]

And then, Ian, from a modeling perspective, we don't model number of deals. We model invested capital and where we model that is it's based upon projected cash flows and we're now modeling it on an annual basis of an investment. Our normal model is an investment of approximately $150 million of incremental invested capital a year over the modeling period. And again what we do with those models, it's a base model and it's really a benchmark model for us. And what we do is in the first full year of the acquisition, so if the acquisition's in 2016, we'd be talking about it in 2017. But in the first full year of acquisition, our expectation is that after-tax return on invested capital for that incremental $150 million would be at 10% and we get to the 10% through non-strategic functional synergies and then direct and indirect purchasing synergies. And then the subsequent years so the $150 million we would model for 2016 would have a requirement of 10% after-tax return in 2017 growing over the next five years to 15% and that's where our expectation our operational and commercial synergies would move us from the 10% to the higher 15%. That's how we model it. Then what happens is in every given year as we bring models in, when we look at 2015's model today, it's specific to the acquisitions we're working on.

[Ian Zaffino:]

Okay, great. Thank you very much. That's very helpful.

[Peter Thomas:]

Ian, another thing. This is a good time for us to mention that we have hired a new Vice President of Strategy and Business Development. His name is Ben Schlater and he has a very, very strong M&A background and certainly the addition of having him on our team will help with the momentum and speed to market with some of the deals we have going on. So, we're pleased to have Ben on our team.

[Ian Zaffino:]

Okay, great. Thank you very much, guys.

[Operator:]

Our next question comes from the line of Rosemarie Morbelli with Gabelli & Company. Please proceed.

[Rosemarie Morbelli:]

Good morning everyone. So I was wondering since we are on the M&A front, Peter or Jeff actually, how much leverage are you comfortable with? Let's say you find a large acquisition, how high do you think it is prudent to go and how quickly can you get it done to what you can see a reasonable comfortable number?

[Peter Thomas:]

Sure. And we'll talk net debt to EBITDA, but we do use other metrics, but I'll talk net debt to EBITDA. We are comfortable in the two times to three times. Above three times we'd be concerned, John Bingle would need a psychiatrist in the whole thing. But above three times would become an issue, it's a red flag for us. Below two times is also a red flag for us, below two times says that we're probably underleveraged and then we'd have to do something relative to providing capital back to shareholders. So, it's in that two times to three times range. Now, there's nothing in what I just said relative to our modeling with $150 million of incremental invested capital over the modeling period, it takes us over three times. In fact you probably get in a position that bare risk would be we'd be under two times. So, that's our base model and we run a lot of models. So, we've looked at bigger models. We looked at models that would take us over the three times. Our expectation there is that it has to be a very, very clear path to go below three times and in those bigger deals then as we look at the financing opportunities and say is there a need for equity. If this is the right transaction versus leveraging too far up, would we look at equity? So, we run all those models. I can't say exactly what we would do until we are faced with the situation. But I will be clear that above three times we take very seriously and it would have to be a clear path to get below three times and we would shock that model to make sure that we didn't put the shareholders at risk.

[Rosemarie Morbelli:]

Okay. Thanks. And I was just wondering if you could talk about what is going on in the legacy business. I understand that there is a decline in demand on the tile side, but legacy seems overall at minus 1% to 2% doesn't seem to be doing quite well. Can you talk about volume and can you talk about what we can see in 2016 and what needs to happen in the outside environment in order to get to better results? And I'm not talking returns, returns are good, I'm talking growth.

[Peter Thomas:]

Yeah. Basically again, let's talk about the legacy business. You have Colors and Glass and everything else in it, which those businesses are doing well and have been doing well and you can see our PPO business is doing well so basically what we're kind of zeroing on in our legacy business which is soft is the tile business because the other two businesses are doing what we've expected them and they're growing relative to the market and so really we're talking about is the tile business. In the tile business if you look at it, you have to understand it. Ferro overall about 50% of our revenues are in emerging markets and about 60% of the tile business is in emerging markets, so obviously when emerging markets have a bit of a challenge so does that business. The issue with that business and we like that business, it's a good cash generation business. We have a strategy in place and there is no doubt in our minds that will improve the revenue profile of that business moving forward, but it's going to take time and when we've invested in Vetri. Again think about the tile business and what we have done there and let's go back to how we started to reignite this business. Back in 2012 actually our tile plants for the most part everywhere were running at full capacity because we hadn't invested in expanding those nor would we have in those areas for the most part, we would have moved into those markets where we're going now like with Al Salomi being in the low cost production areas and the faster growing markets. Faster growing markets are well known. If you look at the studies, you're talking about Egypt; you're talking about North Africa, the Middle East, the ASEAN countries, and Eastern Europe. So, everything we're doing right now is building out for the next three to five years so that we're at the right place at the right time with the right capacity level and making sure that we have application centers around there. So, we become the first mover and that's the extension of the strategy. So, you have a two-prong approach. One, we will continue to look for and acquire companies like Vetriceramici that bring new products at a higher level with higher level customers and in the expanding areas, so we can have higher margins and also cross-selling behaviors with our legacy business and we're going to keep moving in the low cost areas to supply the faster growing areas. While we're sitting in North Africa, which is for us the lowest cost production area; we can access and be more competitive moving into Eastern Europe, Turkey, and the Middle East. So, when the markets turnaround, which they will and they always do this is an emerging market play, we are and will be at the right place at the right time. It's just a matter of having some benefit from the macroeconomic conditions and that's what we're banking on.

[Jeff Rutherford:]

If you look at our segments individually, here's what you find and we've talked about this before when you break them down into their components. Colors and Glass is a good business. It's not only a high margin business, it's historically been a good growth business so maybe it wasn't in the third quarter, but overall it is. And if you look at the history of Color and Glass, it's growing at GDP plus. We say GDP plus 1% to 2%, it's actually maybe even a little higher than that over the last four to five years. So it's a good business, it will continue to grow in line with our modeling. PPO and with the addition of Nubiola is a GDP business that based upon investment whether it's R&D investment or whether it's capital investment will grow GDP plus 1%. So, we're comfortable, we have to continue to press those organizations to continue to grow, but they are performing in line with our expectations. And then to Peter's point when we get to Performance Coatings, that's where we get off track from that GDP plus 1%. Now, the good news is tile is a good industry and we would be more concerned from a strategic perspective if we didn't believe in tile and you can do your own research by looking at some of the public companies who are in the tile business. That business is growing and will continue to grow. It is the flooring of choice in a majority of the world and we should be participating in that so it's a strategic issue on our end. Our expectations are going to be that we get back into positive growth for that business in 2016. It may not be all the way up to GDP plus 1%, but we anticipate with Vetriceramici and the other -- Al Salomi and the other investments we're making, we're going to see positive growth in the Coatings business. Then our expectation is into 2017 and 2018 we're back on model with GDP plus 1% or greater. So, from our modeling perspective, we're as disappointed as anyone and in 2015 legacy growth. Our expectation -- and we have our operating meetings next week with each one of these segments, our expectations are we want to see the clear defined plans to get where we should be from a growth perspective and then from a strategic perspective, get back on that GDP plus 1% and then we'll hold that value within our own modeling relative to the value of the assets.

[Rosemarie Morbelli:]

Okay. Thanks. That is very helpful. And if I may ask two quick questions. One is about Egypt, I think it is being bombed at the moment or was, do you have any concern as to where the location of your facilities are both Ferro's and Al Salomi? And then how reliable are your customers' expectations? How were they in the past? I mean can you actually count on what they said they are going to do?

[Peter Thomas:]

Yeah, actually we're pleased with the strategic positioning of both Al Salomi and Fayoum. If you remember, they are well away from the epicenter of activity, which is Cairo and Al Salomi is on the Suez side and Fayoum would be 68 miles southwest of Cairo, both of those are positioned there what one might define as an industrial center. So, we are very pleased with the location. Right now we're very pleased with what we see as stability in the Egyptian market. There is demand there and as we've mentioned, our Fayoum plant is pretty much sold. Al Salomi we bought six smelters and we're completing two by the end of the year, those six are full. So, between our two plants, we have a very nice baseload and we're recognized now as the number one supplier in the region. So, the idea is when those smelters are up and running like we've talked about, we have low cost production in a fast growth area. And from that facility with the capabilities that we're putting in, we'll be able to satisfy the Turkish market, the new customers in Egypt because of the fact that we've been capacity constrained, we haven't gone out and aggressively secured new business because any customer that we take, we kind of are at a point that we want customers that buy everything not just one-offs and we have to make sure that once we take on a customer, we can satisfy their needs across the whole product profile. And with that additional capacity, that will do that. We've targeted customers in Egypt, Turkey, and Saudi Arabia. The other good thing about that facility as demand increases, that facility can almost double in capacity with the infrastructure that we have. So that pretty much, as Jeff was saying, it allows us position our self nicely in 2016, 2017, and 2018 as those markets continue to grow. So, overall strategically for us we've had actually good experience in Egypt and we expect another good experience with Al Salomi and we happen to really enjoy our customer base in Egypt.

[Rosemarie Morbelli:]

Okay. And the reliability of your customers' window type of thing?

[Peter Thomas:]

I'm sorry you're talking about the visibility of the forecast that they're giving us for the next quarter or so?

[Rosemarie Morbelli:]

Right. And how on target were they in the past so can you count on what they say?

[Peter Thomas:]

Yeah, you can count on what they say, but it's a lot of what's going on in the area. Like if Tunisia has a problem, Libya may have a problem that could be unknown to them where maybe the tile customers in Egypt would shift there. There's a challenge in one of the -- what we call the challenge there is whether it's political or whatever you want to call it, it may have a consequence that they didn't predict. But right now the demand in Egypt locally is pretty good. Saudi Arabia if you look through the third quarter is starting to come around, in fact October we actually saw some nice positive signs in the Middle East. MENA overall and also Eastern Europe by the way; again as I mentioned Poland, Turkey, Egypt, and Saudi Arabia produced a nice October and it looks like we may see a little bit of a pick up through the fourth quarter going into the new year. So, the visibility from those customers, we also not only from the studies, but we have building reports that come out of those areas that are three year to five-year planning documents and all those areas show a lot of commercial activity, which by the way tile is used a lot commercially there as well. But there's a lot of growth expectations in those areas and we have to have the capacity at the right place at the right time to maintain our leadership position and that's what we're doing.

[Rosemarie Morbelli:]

Okay, great. Thank you.

[Peter Thomas:]

Operator, we have time for one more question.

[Operator:]

We'll have a question from the line of Dmitry Silversteyn with Longbow Research. Please proceed.

[Dmitry Silversteyn:]

Thank you for taking my call before the end of the conference call. Wanted to dig in a little bit into the strength that you saw in Latin America that you mentioned in your tile business, obviously not an area that a lot of companies are pointing to as a source of strength. So, can you talk about what is it in Latin America in respect to your position or the market that's driving the strength in the third quarter and is that sustainable through the balance of this year and into next year? And then second is a follow-up. Can you just provide a little bit of granularity on the growth in your Powders and Oxides as well as the Glass business as far as which markets are driving the mid to high single-digit growth or the low to mid-single-digit growth organically you're seeing in these divisions?

[Peter Thomas:]

Sure. Let's take the first question because it's good one because it's going to allow us to talk about Mexico, which we're really actually excited about. So, when we talk about Latin America if you look at tile first, Argentina has been doing extremely well and so is Mexico. Mexico actually has picked up. Now you've heard me mention before the Mexican government had imposed some extra income taxes in a way that over the past 18 months or so has hurt that domestic economy a bit and that was also exacerbated with low oil prices where the government wasn't spending. But now that the oil price situation seems to have equilibrated, the government has let go, let up on the income tax situation, but they've also implemented some favorable tax positions in terms of supporting the construction market particularly residential. So, what we're seeing first in Mexico is a pickup in tile. We're seeing a bit of a pickup in porcelain enamel which is good. What's been good for the past 12 to 18 months, is auto. The auto glass business, in fact all the autos that are produced in Mexico as you know for the most part comes from the North American market and that's been a very good business and it continues to be a good business out of Mexico. And we also have again a situation where you may recall we lost a large commodity glass customer, Corona Beer I think we had mentioned it, and what we did there is that we retuned our manufacturing capabilities and scaled it down to adjust for that loss of business. But in the meantime, we've been able to pick up a new piece of business in a way that's actually a higher margin business and we haven't added back at the manufacturing level. So, right now Mexico is a bright spot for us and I would tell you that through the fourth quarter and going into next year, Mexico is going to be a bright spot for us basically across all of our businesses. In Argentina not only is the tile business good there, but it's also the key area for us covering Argentina and Brazil and some of the other areas for porcelain enamel. Now we've been fortunate in that we're getting a lot of new business there from new models appliances that are coming out of the Argentinian customers and we're the supplier choice and there seems to be an expansion of appliance products. So, Latin America has been pretty good for us in the third quarter. Our expectation relative to glass, tile for the most part that moving into next year, we feel pretty optimistic.

[Jeff Rutherford:]

And then to answer the question regarding PPO and Color and Glass growth. PPO is basically a North American business with smaller businesses in Asia and Western Europe. It's up on a rounded basis 2% in North America, but in Asia it's up in the low 20%s and in Western Europe it's up about 5%. And then Color and Glass, Color and Glass is everywhere but where it's really grown for us is Eastern Europe and Middle East and it's up 12% in Asia.

[Dmitry Silversteyn:]

Okay. So, it sounds like it's the automotive markets as well as some regional strength in Mexico and Asia-Pacific that you are having those businesses?

[Peter Thomas:]

Yeah. Don't forget there's another important piece. Our flat glass business is in there, so that's also doing quite well in North America. In fact you probably have heard there is a flat glass shortage so a lot of flat glass is coming out of Europe into the North American market and that's helping us a bit in Europe. So, the flat glass market is good, the automotive market is still good, and in certain areas our container glass may be good particularly in the Middle East.

[Dmitry Silversteyn:]

Got it. Okay. Thank you, gentlemen.

[John Bingle:]

All right. Thank you. That concludes our call this morning. For copies of our press releases, replay of this call, or to access our SEC filings; please visit our website at ferro.com and click on the Investor Information button. Thank you for your time this morning and have a good day. Bye, bye.

[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. Have a great day, everyone.