Ferro Corporation
Q3 2013 Earnings Call Transcript

Published: 24 Oct 2013

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the 2013 third quarter earnings conference call. [Operator Instructions] As a reminder, this conference is being recorded, Thursday, October 24, 2013. I would now like to turn the conference over to John Bingle, Treasurer and Director of Investor Relations. Please go ahead, sir.

[John T. Bingle:]

Thank you. Good morning, and welcome to Ferro Corporation's 2013 Third Quarter Earnings Conference Call. Joining me on today's call is Peter Thomas, President and Chief Executive Officer; and Jeff Rutherford, Vice President and Chief Financial Officer. Peter will discuss how we're progressing with Ferro's value creation strategy and Jeff will follow with financial details for the quarter and he will discuss our guidance. We'll 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 a reconciliation of reported results to non-GAAP data that we'll 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 31, 2012. Forward-looking statements reflect management's expectations as of today, October 24, 2013. 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 7 days. In addition, you may listen to or download a replay of the call through the Investor Information section of ferro.com. Any redistribution, retransmission or rebroadcast of this call, in any form, without the express written consent of Ferro is prohibited. I'd now like to turn the call over to Peter.

[Peter T. Thomas:]

Thanks, John, and good morning, everyone. We appreciate your time this morning. It's been one year since we began the implementation of our value-creation strategy and I feel very good about the progress we are making and how that progress is reflected in our third quarter performance and increased guidance for the year. You'll recall that there are 3 components of our strategy. First, we're working to improve returns on invested capital. We are continuing to review all of our business assets and we will take necessary action, including divesting or investing, so that our portfolio generates value-creating returns. To this point, we've taken action throughout the year to enhance returns. We sold our solar pastes assets and our pharmaceuticals business, and we have initiated a project to convert from value-destroying phthalates to value-creating dibenzoates manufacturing capacity in Europe. In addition, we have a number of other activities underway as part of a disciplined approach to our portfolio management, and we'll report on them at the appropriate time. We are committed to taking action that supports our value-creation goals. The second piece of the value-creation strategy deals with the cost takeouts and improving the cost structure of the company. As we noted in our press release, we moved aggressively on cost reductions and currently expect to achieve $45 million in savings this year, with an annual savings run rate of $70 million entering into 2014. The progress we're making is evident in the reductions we've made in our SG&A expenditures. Year-to-date, through September, SG&A expenses have been reduced by more than $18 million versus the first 9 months of 2012. And once you adjust for special charges and the differences in incentive compensation referrals between the 2 periods, SG&A expenses have been reduced by approximately $33 million. Our current run rate for quarterly SG&A expenses is approximately $54 million, adjusting for special charges, normalized incentive compensation expenses and seasonal effects. Included in this improvement is the staffing reduction of 11% or 570 positions, inclusive of divested operations, since we announced our goal of a 10% reduction in force a year ago. Our future expense reductions relate directly to our programs with Capgemini, in global shared services and outsourcing, as well as with Procurian, an indirect spend strategic sourcing. We are confident these partnerships will yield the operational improvements and cost efficiencies that we've built into our model. Yes, I'd like to say that our value-creation strategy really breaks down into 3 phases

[Jeffrey L. Rutherford:]

Thank you, Peter, and good morning, everyone. As John mentioned at the start of the call, you will 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 adjusted information, to provide comparability of information from period to period. I'd like to cover 3 primary topics and then we'll get into your questions. First, I will provide a quick recap of the quarter. I will then give an overview with the performance of each of our reportable segments. And finally, I will conclude with a discussion of our outlook for the fourth quarter and the full year. First, our results. For the third quarter of 2013, on a GAAP basis, we reported net income of $0.15 per share. This compares to a loss of $3.66 per share last year. On an adjusted basis, diluted earnings per share from continuing operations were $0.14 in the current quarter versus a net loss of $0.02 last year. Adjustments in the current quarter include the following. The company incurred $3.8 million in restructuring costs associated with our ongoing cost-savings initiatives. We incurred approximately $600,000 of nonrecurring expenses and cost of goods sold, primarily related to inventory items associated with solar paste and additional cost associated with the flood that occurred at our Colditz, Germany manufacturing facility during the second quarter. SG&A expenses include approximately $2.3 million of special items associated with nonrecurring corporate expenses, including additional expenses associated with the 2013 proxy contest and corporate development expenses. And income taxes have been adjusted to a 36% tax rate. As I continue in my remarks of the quarterly results, I will refer to adjusted numbers, excluding the items I just noted. I will also focus on value-added sales and explain sales growth and then describing profitability measures, such as gross profit and EBITDA margins. As a reminder, value-added sales exclude precious metal sales, as precious metals sales, in general, are pass-through sales to our customers. Value-added sales were $387 million in the third quarter of 2013 versus $373 million last year. Adjusted for the impact of the -- exiting the solar paste product line and adjustment of approximately $4 million, value-added sales increased by 5%. It should be noted that we are comparing to a very weak third quarter last year when sales were adversely impacted by weak European economic conditions, particularly in Southern Europe, and reduced demand for products used in the Electronics industry, including both solar and nonsolar applications. On a regional basis, comparing the third quarter of this year to the same period last year, value-added sales, excluding divestitures, increased by approximately 14% in Europe, 7% in Asia, and 5% in Latin America. Sales declined by nearly 4% in the U.S. Weakness in the U.S. was primarily a result of reduced sales in the U.S. Polymer Additives business, which Peter described earlier and I will touch on again later. Adjusted gross profit was $85 million in the third quarter of 2013 compared with $67 million last year. Adjusted gross profit as a percentage of value-added sales increased to 21.9% versus 17.8% last year. The primary drivers behind the increase in gross profit were our cost-reduction initiatives, coupled with increased sales and production volumes and improved business mix, partially offset by lower sales in Polymer Additives and the impact of divesting the solar paste assets. Excluding special charges in both periods, SG&A expense declined 6.3% to $56.8 million from $60.6 million. Included in both periods are expenses associated with our annual incentive compensation accruals, including a charge of approximately $7 million in the third quarter of 2013 and a credit of approximately $4 million in the same quarter last year. As you may recall, as operations declined in the second half of 2012, we reversed our accrual for incentive compensation in the third quarter. Normalized incentive compensation for a quarter would be approximately $2.5 million. Excluding special charges and the impact of incentive compensation, SG&A expenses were reduced by more than $15 million on a year-over-year basis. Our current run rate for quarterly SG&A expense is approximately $54 million, adjusting for special charges, normalized incentive compensation expenses and seasonal effects. For the quarter, we achieved $38 million of adjusted EBITDA, resulting in an EBITDA margin of 9.8%. This compares to third quarter 2012 adjusted EBITDA of $17 million, or a 4.5% margin. Working capital in the period was the source of $5 million, and capital expenditures accounted for use of $5 million. Other cash payments included restructuring of $6 million, taxes of approximately $1 million, interest of $12 million and pension of $5 million. Other expenditures totaled approximately $8 million. At the end of the quarter, net debt was $302 million, a decrease of $6 million from the second quarter of 2013 and a decrease of $15 million from December 2012. Our liquidity remains strong. At the end of the quarter, we had approximately $225 million of availability on our $250 million revolving credit agreement, after retiring approximately $35 million remaining on our convertible notes that came due in August. Our precious metal consignment obligation was $90 million at quarter end compared to $189 million in the third quarter of last year. The net lease obligation has declined substantially over the last 12 months due to the solar paste asset divestiture, a decline in precious metal prices and our program to aggressively manage our precious metal manufacturing requirements, although we do believe there are opportunities to further reduce this obligation. We currently have no demands for cash collateral related to the precious metal consignment program, and there have been no recent changes in our precious metal leasing program participation. I would like -- now like to provide a brief overview of year-over-year third quarter results for our reporting segments. Again, the analysis is based on value-added sales. In Pigments, Powders and Oxides, value-added sales declined by 7%. Adjusting for the divested solar business line, value-added sales increased by 4%, primarily due to increased demand for metal powders and flakes for the electronic industry, and approximately $1 million of revenue from a tolling agreement entered into with a buyer of our solar paste assets. Excluding the divested solar operations, gross profit increased by approximately $3 million. Gross profit margin for the third quarter of 2013 was 23.6% compared with 18.9% in the same period last year. Adjusting for the divestiture, nearly $2 million of gross profit to 2012 third quarter margin was 15.9%. Gross profit improved due to cost savings initiatives and the positive impact of improved manufacturing volumes, particularly for metal powders. In the Performance Colors and Glass segment, value-added sales increased by $9 million or approximately 12%. Value-added sales increased in nearly all product lines, with the greatest gains coming in all 3 glass categories

[John T. 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'll then take the first question.

[Operator:]

[Operator Instructions] Our first question comes of the line of John McNulty with Credit Suisse.

[John McNulty:]

Just a couple of quick questions. So with regard to the cost cut run rate that you're looking at in 2013 right now, it's ahead of your original guidance, so I guess I'm wondering, is it that you're getting the cost cuts in that you expected but faster than you had expected or is it that the cost cuts are actually bigger than you were expecting?

[Peter T. Thomas:]

John, right now, what's happening is it's what we expected to happen. It's happening earlier than we expected it to happen. We're not lifting above our $100 million ultimate cost reductions. It's just happening earlier in '13 than we anticipated.

[John McNulty:]

Okay, great. And then in terms of the phthalate issues where you're -- I guess, it's falling off faster than you expected, can you size that business for us so we can kind of anticipate how bad it can potentially get? And then also, can you give us some color once the dibenzoate plant is up and running, what should that mean to revenues if it kind of starts out relatively at full rates?

[Peter T. Thomas:]

John, it's Peter. Here's how you should look at this. First of all, let me just, from a high-level, remind everybody that the deselection really started as part of reach in Europe about 3 years ago. And over the past 3 years, we have been steadily seeing the deselection take place at roughly somewhere between $6 million to $10 million a year. But recently, as of middle of last year, as result of Prop 65's labeling requirements in California, there has been a challenge in the legal system around whether or not some of the benzyl phthalate requiring price should be labeled according to Prop 65 legislation. And some of the flooring people who don't believe that that's the case, there isn't empirical evidence that our products actually are a threat to health or the environment. Well, we live in a world of perception and it was cheaper for the flooring folks to go ahead and reformulate away and that's something that we hadn't expected or the industry, we expected for at least 3 to 5 years. But it actually started late last year and it accelerated this year. So originally, I think we had mentioned in the first analyst call that we thought we would lose $30 million year-over-year. For total benzyl phthalate this year, it's roughly about $25 million. So when you look at our total business, the Polymer Additives business at about $310 million, roughly this year, it represents what we would define as being the targeted phthalates that we're referring to. It's about $65 million to $70 million. And looking forward, based on the acceleration of the flooring dynamic that we mentioned and what's going on in Europe as part of reach, we could see that decline, again next year, of maybe $25 million to $30 million.

[Jeffrey L. Rutherford:]

Yes, we're modeling at $30 million for '14. And then, the remainder of that targeted number would come out in '15 concurrent with the conversion to dibenzoates in '15.

[Peter T. Thomas:]

Yes. So the good point is, we're suggesting is the flooring deselection will be completed in '15.

[John McNulty:]

And in terms of the revenue that would be tied to that ramp up in '15, I mean, what kind of -- assuming you get to kind of a reasonable utilization rate for the business, what would that mean in revenues?

[Peter T. Thomas:]

You mean in terms of the startup of dibenzoates?

[John McNulty:]

Exactly.

[Peter T. Thomas:]

Yes. Here's how you should view that. We mentioned we'll be up and running in the fourth quarter of '14. Our expectation is in '15 that we should be somewhere between $40 million to $45 million. In '16, we should be anywhere between $50 million to $60 million. And by '17, we should hit full capacity utilization at $80 million. And what I should add at that point, at one time, our old benzyl phthalate business, in its prime, was $120 million. Yes, so you've heard us mention that there is additional room to grow, and the way we've designed our reaction train for that product is modular in design, so we can ramp up pretty quickly in terms of adding capacity.

[Jeffrey L. Rutherford:]

So, John, if you look at it from a modeling perspective, the $30 million decline in '14 will be real on the top line. There will -- when we look at '14 now, we look at it and we're still on our GDP plus 1% growth rate, but for '14, it will be GDP plus 1% less that $30 million of phthalates. So that decline will be real. When we get to '15, as dibenzoates come into the market and we're converting from phthalates into dibenzoates, so there isn't a net decline in sales modeled for '15. In '15, what we're looking at is GDP plus 1% because the decline in phthalates, which we're modeling at approximately somewhere between $40 million and $45 million is offset by the replacement in the dibenzoates. So they net due basically a flat run rate. And then the rest of the business grows at GDP plus 1%.

[Peter T. Thomas:]

And, John, it's Peter again. Let me add another piece. As it relates to the loss of the $30 million, just so we were clear with you, we have a mitigation plan to offset that lost gross profit and absorption for that volume and already developed and it will be implemented right away.

[John McNulty:]

Okay, great. No, that's very helpful. And then just one last question. On the Performance Coatings business and tile business, you indicated it was up actually really strong in Europe and then you actually saw some strength in Asia as well. I guess can you walk us through how that's happening because, I mean, from what we're hearing, we haven't exactly seen a robust recovery in kind of the construction-related markets in Europe or Asia for that matter. So if you can give us some maybe color as to what's driving that, that would be helpful.

[Peter T. Thomas:]

Okay. And so, as it relates to tile, I mean, you've heard us mention over the past 3 or 4 analyst calls that we're very excited about the strategy we implemented actually about 18 months ago as it relates to expanding our geographic presence into Eastern Europe, Turkey, North Africa and the Middle East. And then to complement that, we put our facility in Egypt to start feeding those areas. We've been very successful in that campaign, and particularly with the tile business, what I can tell you, if you look at Europe, as you have seen in our release, our European business collectively is up 9% in volume, about 14% revenue. But when you look at the areas in terms of the geographical expansion, what we call EMEA, we're up actually about 13% in volume and 18% in revenue. But on the positive side, we're actually up as well in the old traditional Europe, and we're actually up in volume by 4% and 8.9% in traditional Europe. Why is that? Is because of our inks business. So where Europe falls short, like you said in building construction, our new product development activities are actually helping in the old traditional Europe as well.

[Operator:]

Our next question comes of the line of Michael Harrison with First Analysis.

[Michael J. Harrison:]

Peter, I was hoping that you could maybe address the pricing versus raw material dynamics you alluded to in the -- I guess, Jeff alluded to in the Performance Coatings business. It sounds like pricing is lower, but that's a raw material driver. Are you guys net-net coming out ahead? How should we think about that?

[Peter T. Thomas:]

Yes, actually, raw material pricing coming out of last year, it's lower in the beginning of the year but it's pretty flat, it's actually been flat for the past several 7 or 8 months. And so we've been able to hold on to that price position and most of the reason has to do with the fact that we have a lot of lean initiatives as part of our cost-out programs that we've been talking about. Plus we've had a lot of reformulation activities, which actually is lower even with the flatness in pricing and reduction in pricing, we've been able to reformulate and lower cost and not have to pass on all the benefit of the price decrease to us. We've been actually able to up our margin because of that. So again, as it relates to raw materials, there is an advantage, but unlike maybe in the past when we had a lot of ramp up in raw materials, we had a hard time catching it because of our lean initiatives and our reformulation activities, we're able to pocket more of that money without giving it back.

[Michael J. Harrison:]

All right. Maybe sticking with Performance Coatings. We're hearing that appliance manufacturers are pretty strong right now. Can you talk about what you're seeing in that market, is the strength something that you're expecting to remain a driver in 2014?

[Peter T. Thomas:]

Yes. So if you look at our Porcelain Enamel business, which is really the driver for us in appliances, if you had a focus on a business. For the most part, it's up worldwide. And overall, year-over-year, we had volume growth of about 9% and revenue growth of about 17%. And we had a lift in gross profit by almost 1,000 basis points. So the answer is we're doing actually pretty well on the appliance sector globally. But it's interesting you mentioned about the robustness of appliances because some of our major customers, through our discussions recently with the sales organization, have suggested maybe there's a little bit of a slowing coming down. And I think you've read a couple of the major suppliers mentioning that they've seen a slowdown and they're not real sure what the first or second quarter may look like. Now some of it could be because on the conditions in Washington right now. I think everyone who's looking for a reason to explain some softness may be going that direction. I'm not sure that we see it, but it's out there and actually some of the customers are talking to it.

[Michael J. Harrison:]

All right. And then, I wanted to also ask, just in terms of the 2014 target for cost savings, the target was previously $70 million. You're now saying that you're already planning to be at that run rate heading into 2014. So what's a more realistic goal for where savings could eventually shakeout by year end?

[Jeffrey L. Rutherford:]

By year end 2014?

[Michael J. Harrison:]

That's right.

[Jeffrey L. Rutherford:]

Is that the question?

[Michael J. Harrison:]

Yes.

[Jeffrey L. Rutherford:]

What we've said, and only the guidance we provided -- updated guidance we provided on 2014 is the $70 million run rate at the beginning of 2014. And then we've also said that the ultimate cost reductions for the programs included in that scope would be $100 million.

[Michael J. Harrison:]

So the reasonable projects that you probably end up somewhere between $70 million and $100 million, but you won't give anymore guidance?

[Jeffrey L. Rutherford:]

We're going to give guidance, obviously, when we give '14 guidance. But here, let me just frame it a little bit, it's not going to be linear. The relationship from $70 million to $100 million is not going to be linear, it's going to ramp. And what's left in the cost-reduction programs are some higher-end programs, the next phases of global shared services and finance and accounting make up a portion of that. And then the other -- the largest piece is the reduction in indirect spend through our back office efforts with Capgemini related to the indirect spend of PO compliance and consulting negotiation from Procurian. Those -- that program will take a full cycle of spend to cycle through and it's in waves. So when you look at the next $30 million of cost, it's going -- it's not going to be a linear growth to that $30 million. It's going to ramp throughout 2014 to a higher point at the end of '14. So the bottom line is, it's going to be in that range, it's going to be under $80 million of cost reductions for '14 and then ramping up into '15. We're going to give guidance when we're ready on '14, we'll give you the direct numbers, but what I would say for modeling purposes, I would not model above $80 million of reductions in '14. Now what I will tell you is, what will happen is there's going to be adjustment in that bonus accrual. Remember, we're running at about a $20 million total accrual for '13. That's double what a normal accrual should be. We should be running at about -- a normalized incentive accruals should be $2.5 million a quarter, and we're going to run up toward $20 million. So that $10 million, from a modeling perspective, should normalize and that will reverse out in '14. So what you're going to have, as far as SG&A expenses, just to start the year, is a $70 million cost reduction run rate off of $45 million for this year, $10 million reduction in bonus provision. And then the beginning of a ramp-up of those 2 other projects in cost reductions.

[Operator:]

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

[Rosemarie J. Morbelli:]

I was wondering if you could talk a little bit about the issue on the manufacturing cost on your Specialty Plastics business. If I remember correctly, volume was up, revenues were up. Why is the manufacturing cost higher?

[Peter T. Thomas:]

It's Peter. Yes, you're right. The -- our volume was up at about 9%, our net sales were up 4%. And essentially, gross profit was flat. And there are really 3 pieces there. One, we did incur some higher manufacturing costs. The second is we had a little bit of a mix shift. We have a very nice thermoplastic elastomers business under the name of Alcryn that you're aware of. And we have a little bit of an order pattern shift in the third quarter then moving into the fourth quarter. And the, again, you know that a portion of our business is based on formula pricing as it relates to polypropylene. So when you just look at the net difference in what our formula price was to our customers with probably propylene quarter-over-quarter, year-over-year, that also had kind of a significant impact. So those were the 3 drivers. Nothing structurally or fundamental fundamentally wrong.

[Rosemarie J. Morbelli:]

All right. So those high manufacturing costs, do those -- do they include the raw material situation? Or is it something that is more tangible and that you can reduce over the next few months, let's say?

[Peter T. Thomas:]

Yes, that's -- most of that, if you -- basically, the manufacturing cost and formula pricing together, the manufacturing costs weren't as high as the formula pricing, but that, of course, adjusts over time, as you know, as each quarter goes by. Nothing structurally wrong. It's typical for the plastics business.

[Rosemarie J. Morbelli:]

Okay. All right. And then on your dibenzoates, however you pronounce it, manufacturing plant start up in Europe, you're only adding capacity or starting up a new plant in Europe. And yet, the demand is going to be here in the U.S. So are you planning in exporting from Europe those non-phthalate products? Or are you eventually going to build capacity here?

[Peter T. Thomas:]

Yes. So we actually have -- that's actually a good question, so let me take it pieces. Actually, the demand in Europe is strong, as you know. And I just want to remind you of the industry structure that exists. That particular product line is growing 6% to 8% a year, and it has margins which are actually almost 2.5 times better than typical benzyl phthalates. So that's one thing. And it's a -- the industry structure is such that there's an oligopoly. There are only 2 players and the demand-supply balance is extremely tight. So we already know of our phthalates will go away in Europe. In fact, there's a base load of somewhere between 12,000 and 15,000 metric tons that will stay and be converted. Plus there's another bucket of capacity of about 35,000 to 40,000 metric tons that we used to own prior to the dibenzoate conversion, which we have very good relationships with those customers and have expressed an interest of coming back to Ferro. So what we've done in designing our dibenzoate facility, as I mentioned, we're doing it in a modular form in a way that it will be easy for us to add capacity much quicker than we would be able to in a traditional benzyl phthalate type of formulation, which uses a lot more raw materials, if you will. The dibenzoates are basically a benzoic acid derivative, and it's not as intense as the benzyl phthalate production. So the demand is strong, and we'll continue to be strong in Europe and we can deal with that. We also, to your point, will see the North America market, where appropriate, with dibenzoates. However, we do have some alternate technology that we are producing in North America called our platinum series of plasticizers, which we've talked to everyone about in the past. And we've been reformulating and making that product more cost-effective, and so there's -- that particular product family is gaining momentum, so that, coupled with the dibenzoates from Europe and some other products that we're developing in North America to help offset that shortfall in volume, will be realized in a way that by 2015, it will be like we didn't have the benzyl phthalates down the river.

[Rosemarie J. Morbelli:]

Okay. And if I may ask, have you thought of looking at your manufacturing footprint and any thoughts on the potential savings there and when they could hit?

[Peter T. Thomas:]

Yes. We -- this is a good subject and we like talking about it every call because as part of our value-creation strategy, as we mentioned, we started off in a way that will be least disruptive to the customer and we're taking out our cost. We're in our transition phase of doing more new product development, as well as acquisitive growth. And what we wanted to do is save the footprint to the end. Because with the addition of organic growth, and potentially some acquisitive things, very small, be that as it may, that we have to be very careful on what we do with our footprint. But as we've mentioned before, there are some logical things that should be considered and we have talked about those in the past, and some of them would include that we make pigments in 6 different facilities, that should be addressed. We have maybe too many assets or too many plants in Europe, maybe we should have a mega-site. So we're addressing that. We have -- we're working on it, we do have plans and we're working through that. But we have to be careful that we don't disrupt our customer base and we don't make the wrong choice of where we should be at the end.

[Jeffrey L. Rutherford:]

But what we do have is, on a monthly basis, whenever we report, we now run and with all due respect to Ben and Stewart [ph], we run an EVA model on every site. And so, we do that by manufacturing sites, something the company hadn't historically done. So we know where our value is created and where value is being destroyed. So the focus for us is really on those sites, those sets of assets that are not creating value based upon our criteria relative to cost of capital, which for internal purposes, we're using a very high number. So there's a high hurdle rate for return internally. So we know what assets, to Peter's point, we know what assets need to be addressed. So those assets either have to be fixed and become value-creating, or they are a potential for other actions. We're not ready to announce what plants could be in that category. But we know internally, and to Peter's point, the manufacturing people and the plant operations people know what they are and the commercial people know and they know that it has to be addressed. We cannot -- a company our size cannot afford to have value destroying assets within its portfolio.

[Rosemarie J. Morbelli:]

While you cannot talk about which plants may go away, do you have a general feel for how much more savings about that $100 million you could get from that project?

[Jeffrey L. Rutherford:]

We do, but it's nothing that we've guided on at this time. But it -- and we wouldn't do it if it wasn't a substantial, a high return. Because each one of these would take an investment. Whenever you're adjusting footprint, it's going to take an investment, so there would have to be a very high return on that investment for us to undertake it. Or else we'd just harvest the asset.

[Operator:]

Our next question comes of the line of David Begleiter with Deutsche Bank.

[David L. Begleiter:]

Peter, on the dibenzoates reduction or issue and the phthalate reduction in 2014, of the $30 million reduction in sales you're modeling, I think you said there's a mitigation strategy in there. First, what is the earnings impact of the $30 million decline in phthalate sales, and what is your mitigation strategy to offset that decline?

[Jeffrey L. Rutherford:]

The good news on that $30 million decline is that it's a very, very low-margin.

[Peter T. Thomas:]

Yes. It's the commodity portion of the pad business which has the lowest gross margin.

[Jeffrey L. Rutherford:]

So with our model, there's $2 million gross profit attached to that $30 million reduction. So what we have is in that facility is we have -- I think the number is actually higher than the gross profit effect. So the end result is it's going to be neutral to slightly positive on gross profit relative to that $30 million reduction in sales.

[David L. Begleiter:]

Very good. And just when you bring on the new facility, what's the added depreciation you'll be incurring on annual basis?

[Peter T. Thomas:]

$3 million?

[Jeffrey L. Rutherford:]

Well, it's going to be approximately $1.5 million to $1.750 million a year.

[David L. Begleiter:]

Very good. And just -- you mentioned M&A as a potential -- as a focus going forward. How's the pipeline today? If you don't or are not able to make some transactions, where does the excess cash go over the near to medium term?

[Jeffrey L. Rutherford:]

Well, I can answer the second question first. The excess cash obviously goes to pay down any short-term debt we have and that's what we'll do. Right now, that's what we're doing with all our excess cash. And then the pipeline...

[Peter T. Thomas:]

Yes. In terms of our organic pipeline, actually, part of the reason why you see the Performance Coatings business and the Colored Glass business doing so well is because they are delivering hits against the pipeline that we set up last November. Actually, I'll be very candid, they're doing a wonderful job and it surprises me that it's coming out that quickly. So our pipeline is pretty robust. I think you've heard me mention in the past that it represents about 30% of our annual sales on a non-probability adjusted basis. And this year, we've actually swiped out of there about, on a run rate basis, of about $15 million of new business with really nice margins. So that pipeline is being add to. I mean, it's not stagnant, it's very fluent and it's being adhered to very strictly through our corporate development group. And weekly, it's updated. And it's getting -- it's becoming more rich in terms of our geographical expansions and focused on higher-margin opportunities. So we're real pleased with what's going on with that.

[David L. Begleiter:]

And last, Peter, I know you don't want to discuss the $100 million cost reduction target in terms of being on the upside, but is there any upside potentially longer term? Or is that -- the point is it's more of a growth story and investing for growth?

[Peter T. Thomas:]

Yes. At the end of the day, as we've said, a good robust cost reduction program that involves this not restructuring a company to get rid of it, but for sustainability, you have to be orderly methodical and surgical, which is what we're doing. And again, our methodology is always not doing it close to the customer, because through this whole process, we have not been disruptive to any of the customers and our customers are happy. But what you also have seen in the past from us is a very orderly and methodical transition from increasing the cost savings benefits. And as you get out there, they are farther and fewer between and the amounts are lower. But if we're doing our jobs, I mean, cost-reduction should not be a once in a 5-year thing, it's an ongoing process, and what's happening here with this new mindset is that we're constantly looking for ways of reducing cost and driving value. So the answer is, there's no doubt in my mind that this mindset and new cultural shift, we'll always be on the lookout for cost savings opportunities, and they will exist.

[Jeffrey L. Rutherford:]

Yes. I would add that the history of the company has not been to have a grassroots cultural expense reduction mindset and it's exemplified in a very poor way that the company historically budgeted and monitored SG&A expenses. And one of the biggest changes I believe we've made in the last year, 1.5 years, is that we put a focus on SG&A cost back to the source of the spending decision, which is the plant and the location. And that is going to be the cultural shift within the organization relative to who is responsible for spending and where. And it's very well mapped out. Our FP&A group has done a very good job of making those changes relative to budgeting and reporting on SG&A expenses. That, coupled with Procurian and a focus on when you spend money, you have to think about it, and you have to benchmark it, I think that's the biggest cultural shift we've had in this company from the day I came here to what I see today. In very simple areas, in every day spending now, the cultural shift is, is this the right amount and do I need to do something relative to verifying this cost? So as that occurs, to Peter's point, as that cultural shift occurs, within a disciplined approach relative to monitoring and reporting expenses, that number is going to go up.

[Operator:]

Our next question comes of the line of Mike Sison with KeyBanc.

[Michael J. Sison:]

In terms of the cost savings programs, you've done a nice job sort of bucketing it in 3 areas. But could you give us a little bit of color where gross margins would look like in Performance Materials, let's say by '15, assuming there's not a lot of growth, the economy really hasn't been helpful. But just on its own, where do you think the subsegments, in terms of gross margins, could get to?

[Peter T. Thomas:]

Just Performance Materials, Mike?

[Michael J. Sison:]

You could do both if you like.

[Peter T. Thomas:]

Just Performance Materials?

[Michael J. Sison:]

Sure.

[Jeffrey L. Rutherford:]

Yes. Performance Materials is running at mid-20s, 25% gross profit. And it should continue to grow at 20 to 30 basis points a year, from a leverage perspective.

[Michael J. Sison:]

Okay. And then when you think about the sales leverage potential, I mean, where are you now in terms of operating rates for each of the 2 segments? And then, I mean, is this a $2 billion business, if everything fills up?

[Peter T. Thomas:]

Yes, we measure our contribution value for each plant on incremental, either dollars or pounds. And what we can tell you, we want to be careful with this, but let's say that it's almost double, the contribution from where it was about 18 months ago. So we're -- to answer your question in a very oblique way without giving you the data, the map is really nice with incremental sales.

[John T. Bingle:]

Operator, we have time for one more question, please.

[Operator:]

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

[Dmitry Silversteyn:]

I just wanted to come back and touch a couple of points that have been addressed before. First of all, just help me understand the impact of the phthalate plasticizer. You've done a good job bracketing what it could be on the top line. But in terms of gross margin impact, as you go through the cost of changing to benzoates in the Netherlands, and you're not producing phthalates, should we look for headwind in gross margins? Or do you expect that to be -- is the margin low enough to where this business going away is not really going to impact your gross profit dollars?

[Peter T. Thomas:]

Yes. So what Jeff mentioned, on that $30 million that we're modeling for next year, we're not losing a lot of gross profit. Because it was the commodity portion of our business and it has been -- we've been losing volume over the past 3 years. So it just wasn't performing that well. And as I mentioned, if you took -- if you look back on the heyday of benzyl phthalates, whenever you may have gross margins in good periods of time, maybe 15% to 16%, now that may not sound good but when you have a business that's running SG&A of 4, it's not so bad. So I want to put it in perspective, a 16 or 17 gross profit, I don't know, for SG&A is -- the math seems pretty good to me. But when you look at...

[Jeffrey L. Rutherford:]

And low working capital.

[Peter T. Thomas:]

And very low working capital, by the way. Thanks, Jeff. And then you end up having the dibenzoate program. What I can do is speak to you in ranges because there is a mix with them, but the average gross profit in the industry right now on those products are anywhere between 22% and 28%, depending on the mix. And again, our SG&A is running at about 4.5%. So to answer question, we do expect greater profitability from that particular business. And again, it is an oligopoly, the demand-supply curve is very tight, it's growing at 8% a year and it's expensive to add capacity. So we did it and like I mentioned, we're not losing all of our benzyl phthalates. So a good portion of that 28,000 to 30,000 metric tons that we're going to produce, we already own a good chunk of it. And we know all the customers that can make up the difference in a way that we can sell that plant based on our model during mid-2017.

[Michael J. Sison:]

Okay. So if I understand you correctly, in 2014 you're probably going to see sort of low-single digit millions of dollars of a negative impact from gross profit, but that's going to come back strongly in 2015. And as you load up that plant, even more so in 2016 and '17.

[Peter T. Thomas:]

Yes. You can look at it but don't forget, this is important, we do have a mitigation planned to offset that $2 million, and to Jeff's point, it's higher than what we're going to lose.

[Jeffrey L. Rutherford:]

But in Europe, we will be running losses in Europe on phthalates through '14 until...

[Peter T. Thomas:]

Till we ramp up.

[Jeffrey L. Rutherford:]

Till we ramp up, yes.

[Peter T. Thomas:]

Yes, that's right.

[Dmitry Silversteyn:]

Fair enough. And then one last question before we end the call. You mentioned that you're seeing strong results in Europe, and obviously moving into the tile-centric regions of the continent in Middle East and North Africa and Eastern Europe are certainly helping. Are you seeing any benefit from the growth of the U.S. in terms of construction, whether housing or nonresidential in your tile and performance businesses, or is that still to come?

[Peter T. Thomas:]

Yes, that's a good -- actually, I'm glad you brought that up. As you know, the North American market is not one of the largest in the world for tile production. To put it in perspective, and I'll just pick one of our favorites, Turkey, it produces 250 million squares, if you will, of tile a year. The North American market runs at about 75,000, but, and this is a -- actually, thank you for bringing this up, it's something that I should highlight. In the North American market, because of the digital ink business, the aesthetics of tile are becoming so realistic that the North American market is starting to embrace it more. And we do see rapid growth in North America, but it's a lot of small numbers to start with. And what do I mean -- where is it going to happen? If you go to a flooring store and you look at tile that looks like pebbles or tile that looks like random wood plank flooring or even if you look at tile that looks like stacked stone, which also can go on the outside of a home for that aesthetic appeal, there is an increasing demand in North America. And again, thanks for bringing it up because our model shows over the next 3 years, that our business in North America has a -- will have a good growth spurt.

[Dmitry Silversteyn:]

Okay. But it sounds like it's not so much from the recovery and the end markets as it is from customer acceptance of the new technologies and the new printing effects that you could have on the tiles.

[Peter T. Thomas:]

Yes. So let me add to that. In North America, in old traditional Europe, that's the key. But as it relates to core tile growth, we're still in emerging market play where our base fritz [ph] and our colors and our income, those in the entire mix will have pretty significant growth in the emerging markets. So we're getting the benefit of the new markets with the core products and the old markets with the technology. So it's actually a nice scenario, and we'll take advantage of that over the next 3 to 5 years. I feel very, very good about where our Performance Coatings business is right now.

[John T. Bingle:]

All right. That concludes our call this morning...

[Jeffrey L. Rutherford:]

John, just before you conclude the call, just as a follow up to Mike Sison's question about operating leverage on the materials business. That's an -- you can pick it up out of our Q if you have a calculator. It's going to be around 15%. So the way we model the materials business from a growth perspective and a leverage perspective, we're starting with the mid-teens and operating profit and leveraging off that, the kind of numbers we talked about earlier relative to growth. So it starts -- materials is -- operating leverage is starting in the mid-teens at 15%. All right, now you can end the call, John.

[John T. Bingle:]

I appreciate it, thank you. My one task. That concludes our call for this morning. For copies of our press release, replays of this call or to access our SEC filings, please visit the website, www.ferro.com, and click on Investor Relations. Thank you for your time this morning and have a good day.

[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.