Ferro Corporation
Q2 2014 Earnings Call Transcript

Published: 31 Jul 2014

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Ferro Corporation 2014 Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Thursday, July 31, 2014. 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 2014 Second 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 comments, and Jeff will provide financial details for the quarter and 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 the 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 relating 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, 2013. Forward-looking statements reflect management's expectations as of today. The company undertakes no duty to update them to reflect future events, information or circumstances that arise after the date of this conference call, except as required by law. A dial-in replay of today's call will be available for 7 days. In addition, you may listen to or download a replay of the call through the Investor Information section at ferro.com. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Ferro is prohibited. I'd now like to call the turnover -- call over to Peter.

[Peter T. Thomas:]

Thanks, John. Good morning, everyone, and thank you for joining us today. As you read in our news release, we had another quarter of strong financial performance with adjusted EPS growth of 73%. The increase in profitability was primarily the result of lower selling, general and administrative expenses associated with our value creation strategy and continued expansion of gross profit margins. This performance enabled us to reach an operating margin of 11.2%, a level not seen in years. In addition, we continued to make progress on improving return on invested capital. On a continuing operations basis and adjusting the capital invested for the assets held for sale, our ROIC for the trailing 12 months was 9.7%. The progress we've made in transforming the company and our focus on shareholder value gives us confidence that we will achieve our target of 15% ROIC in 2015. Now since our last quarterly earnings call in April, we have achieved some significant milestones in executing our strategy to reposition Ferro as a higher-value, focused performance materials company. Now let me review those milestones with you. Today, we will close on our new $500 million secured credit facility. The new facility will reduce our debt cost and enhance our flexibility to pursue growth options. In addition, we are in the process of fully exiting the Performance Chemicals portion of our business portfolio. On July 1, we completed the asset sale of our Specialty Plastics business to A. Schulman for $88 million in net proceeds. And we remain on track with the marketing process for our Polymer Additives business. As you read in our release, we are now reporting the results of the Performance Chemical businesses as discontinued operations. With these dispositions, we are focusing on Ferro's true power alley [ph] in Performance Materials. Let me take a moment to review what the new, more focused Ferro does and how and where we do it. For the most part, we manufacture glass, and the majority of our manufacturing assets are related to smelting or the melting of inorganic materials to produce glass. We take the glass we produce and fracture it into pieces to create what is referred to as frit. Oftentimes, the frit is ground or milled into smaller particle sizes and/or powders. These products are the building blocks for a host of glass-based functional coatings. These coatings can be used on a variety of substrates, the most important for us being metal, as with porcelain enamel; ceramic tile; and glass surfaces, like containers and automotive windshields. We also excel in color science. Ferro is backward-integrated into the production of pigments and colors that can be used in our own glass-based coatings or sold directly into the market for several other non-glass applications such as paint, plastics and concrete. We capitalize on our formulation expertise by producing other types of coatings to the markets we serve, as with the inks we produce for digital printing in the tile industry. Our materials enhance the performance of our customers' products and end markets, including building materials and construction, automotive, packaging and consumer and industrial products. The new Ferro has an increased exposure to construction and automotive markets, and our geographic mix has also changed with increased exposure to Europe and emerging markets. We have moved from a relatively balanced North American and European model to one that is roughly 77% outside of North America. Europe accounts for approximately 45% of our business, while Asia Pacific and Latin America comprise 17% and 15%, respectively. For the quarter, value-added sales increased 6% in Asia Pacific, with higher sales across all product lines in that region. In Latin America, value-added sales increased 3%, primarily driven by a strong demand for container glass coatings and higher sales of digital inks for tile printing. We exceeded our regional GDP plus 1% growth benchmarks in both regions. Value-added sales declined in Europe by 1% and in the United States by 4%. The sales decline in Europe was primarily due to lower demand for porcelain enamel products and a shift in mix to lower-priced but higher-margin products in the Performance Colors and Glass segment. Volumes for European Performance Colors and Glass increased by approximately 9%, driving an 18% increase in gross profit, while value-added sales for this segment in Europe were nearly flat. The U.S. decline in value-added sales is primarily due to reduced sales of surface polishing products in Pigments, Powders and Oxides segment. Despite sales differences between the regions, all 4 regions experienced improved profitability in the quarter. We believe the shift in geographical mix away from North America to emerging markets will provide an important source of growth going forward. As the middle classes in these developing economies become more established, demand for our products tends to increase as demand for household-related products and automobiles accelerate. Nearly 20% of our sales are now generated by Eastern Europe, Turkey, North Africa and the Middle East. Our recent asset acquisition in Turkey from the reseller of our porcelain enamel products is one example of how we intend to expand our presence and increase sales in these countries. The investment represents a first step toward expanding sales in this fast-growing market, and it provides a base to support our commercial operations in that important region. While small, that acquisition illustrates that we are progressing from the cost reduction and business rationalization phase of our value creation strategy and moving ahead on growth initiatives, including several strategic opportunities to accelerate growth in emerging markets and expand capacity in our core frit-based businesses. Now let me provide some additional background on our organic and inorganic growth strategies. Now we believe we have considerable organic growth opportunities. Our commercial teams across the 3 business segments have developed a pipeline of more than 50 product development initiatives, which include product extensions, as well as new-to-Ferro opportunities. By our internal estimates, these initiatives in the aggregate have a nonprobability-adjusted value of about $700 million. Of course, only some of the initiatives will be successful and the products generated from these initiatives will be commercialized at different points in time. However, we are confident that these initiatives will add 1% to our core growth in each of the next several years. In terms of acquisitions, we've identified some 30 to 40 potential bolt-on targets across our 3 business segments that are closely aligned with our current business portfolio. These targets range in revenue from about $60 million up to $100 million. These opportunities provide for regional expansion, increased manufacturing capabilities, expansion into adjacent applications and improvements in our technology position. We are excited about the growth prospects associated with our core product lines, and we are actively pursuing multiple opportunities. I look forward to providing you with an update on our progress. So let me conclude my remarks with a brief overview of our outlook. As noted in the press release, based on a combination of the lower global GDP projections, particularly in Europe and the U.S., and weakness in our Pigments, Powders and Oxides segment, we have reduced our revenue outlook for 2014 as adjusted for dispositions in the second half of 2013. Value-added sales in the second half of 2014 are now expected to increase by approximately 2%. However, as a result of the strong earnings performance in the second quarter, we are revising our gross margin target up. As a result, we are increasing our guidance for 2014 adjusted EPS to $0.52 to $0.57 per diluted share, up from $0.48 to $0.53 per diluted share. We are also increasing our 2015 earnings target, expecting adjusted earnings per share to exceed $0.90 per diluted share, up from our prior guidance in excess of $0.80. This excludes the impact of any acquisitions we might make. So overall, we are pleased with our performance in the quarter. While we are disappointed that sales growth was below expectations, we continue to deliver improved earnings. We are on track with our strategic initiatives, we have strengthened our financial position with the new credit facility, and we are excited about our growth opportunities, particularly in emerging markets and our new product pipeline. We are confident that we can continue to improve shareholder value through prudent cost management and by investing in value-creating growth opportunities. And with that, I'll now turn the call over to Jeff.

[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 with information from period to period. As you are aware, we continue to address opportunities to enhance Ferro's value. So prior to getting into the detail of my remarks about our quarterly performance, I want to first briefly touch on a few topics, including the harvesting of the Specialty Plastics business, the marketing of our Polymer Additives business and its reporting as a discontinued operation and the refinancing of our debt. We closed the Plastics transaction on July 1 for approximately $88 million of net proceeds. The cash received was used primarily to repay debt, but will ultimately provide liquidity to fund growth opportunities. As a reminder, the disposed Plastics assets generated 2013 sales of $154 million and contributed direct EBITDA of $15.8 million. The results of the Specialty Plastics business are now reported in discontinued operations. The marketing of our Polymer Additives segment continues to proceed as planned, and we expect to complete the transaction by the end of the year. We are in active negotiations concerning the business, so we are not going to discuss specifics or speculate on potential proceeds. But as a reference point, this business had 2013 sales of $293 million and contributed direct EBITDA of $24.9 million. The Polymer Additives business is also now being reported as a discontinued operation. For the quarter, our discontinued operations generated a loss of $3.5 million. Included in the loss are the full quarter results of the sold Specialty Plastics business and the results of the Polymer Additives segment. The results of discontinued operations also include an impairment charge of $14.4 million associated with the impairment of our Antwerp, Belgium Polymer Additives assets. During the quarter, this facility and all of our Polymer Additives-related facilities were classified as assets held for sale. Accordingly, the Polymer Additives assets were tested for impairment, comparing the current fair value of the assets less the cost of selling to the then-current carrying value of the assets. The analysis supported the write-down of the Antwerp assets, as discussed in our 10-Q. As it pertains to the refinancing, we are closing today and expect funding on the new facility in repayment of the 7 7/8% notes. As previously disclosed, we have commenced a tender of those notes, and those not tendered will be redeemed. The new debt is a senior secured credit facility comprised of a 5-year $200 million revolving credit line and a 7-year $300 million term loan. Borrowings under the revolver will initially bear interest at LIBOR plus 275 basis points, though there will be no initial draw on the revolver at close. The term loan will bear interest equal to LIBOR plus 325 basis points subject to a 75-basis-point LIBOR floor. The proceeds from the new credit facility will be used to replace the current revolving credit facility and to repurchase all outstanding notes through our previously announced tender offer or through early redemption in accordance with the terms of the indenture. By the end of the day, we will have repurchased approximately $143 million through the tender offer, and we expect to redeem the remaining notes over the next 30 days. Now I'll turn to our results for the quarter on a continuing operation basis. For the second quarter of 2014, on a GAAP basis, we reported income of $0.11 per diluted share compared with a loss of $0.02 per diluted share for the same period last year. After recognizing Specialty Plastics and Polymer Additives as discontinued operations, we reported income from continuing operations of $0.15 per diluted share. This compares to a loss of $0.06 per diluted share last year. On an adjusted basis, diluted earnings per share were $0.19 in the current quarter versus $0.11 last year. There were a few notable adjustments which were reported as one-time items in the current quarter, including the following. First, in order to reduce operating costs, we entered into a transaction that allowed us to negotiate a new lease for our corporate offices, allowing us to downsize our corporate space and to get to a market cost per square foot. The effect of the transaction, we -- to effect the transaction, we incurred cash costs of $5.2 million and will generate annual savings of approximately $900,000. We recognize the total cash and noncash loss of $6.5 million associated with this transaction, the majority of which is recorded in other income and expense. Also included in other income and expense and included in the adjusted earnings table is a gain of $1.6 million associated with the sale of idled excess manufacturing properties. Finally, in SG&A, we had approximately $2 million of nonrecurring expenses. Further, it should be noted that income taxes have been adjusted to reflect a 36% effective tax rate. During the remainder of my remarks, I will refer to adjusted numbers, which will exclude the items 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. Excluding precious metal sales removes the volatility in our results associated with the significant movements in precious metal pricing. Value-added sales were $282 million in the second quarter of 2014 versus $291 million last year. Adjusted for the impact of business lines exited during 2013, including the North American and Asian metal powders assets, which accounted for approximately $10 million of sales in the second quarter of 2013, value-added sales were essentially unchanged. For the quarter, value-added sales in Performance Colors and Glass increased 3%, and we were basically unchanged in Performance Coatings. Adjusted for the exited Metal Powders business, as previously described, sales declined by 7% for the Pigments, Powders and Oxides segment. Adjusted gross profit, adjusting for charges, was $78 million in the second quarter of 2014 compared with $77 million last year. Adjusted gross profit as a percentage of value-added sales increased to 27.8% versus 26.4% last year. The primary drivers behind the increase in gross profit were increased production volumes and improved mix in Performance Colors and Glass and improved manufacturing performance in the Performance Coatings segment, partially offset by a reduction in volume and mix in Pigments, Powders and Oxides. Excluding special charges in both periods, adjusted SG&A was $47 million compared with $54 million in the prior period, representing a reduction of 14%. The reduction was primarily due to lower personnel costs associated with restructuring initiatives and lower incentive compensation. For the quarter, we achieved $39 million of adjusted EBITDA, resulting in an EBITDA margin of 13.8%. This compares to a second quarter 2013 adjusted EBITDA of $29 million or a 10.1% EBITDA margin. At June 30, 2014, net debt was $308 million, a decrease of $9 million from the first quarter of 2014 and an increase of $24 million year-to-date. As a reminder, during the first quarter, we paid all of our U.S. required quarterly pension contributions of $22 million, accounting for nearly all the year-to-date increase in net debt. As of June 2014, our U.S. pension plan is approximately 95% funded on a GAAP basis. At quarter end, our liquidity position was strong, and it will improve with the sale of Specialty Plastics and the refinancing of our debt. Based on where we ended the second quarter and adjusted for the recent transactions, but excluding any cash proceeds from our future Polymer Additives transaction, the company will have excess cash and revolver availability of approximately $275 million. The following significant cash flows occurred during the first half of the year as part of the $24 million increase in net debt. Note, these cash flows include the cash flows associated with discontinued operations. Working capital from continuing operations increased $21 million, primarily related to accounts receivable funding. Working capital investment of discontinued operations increased $29 million, specifically related to inventory build in Antwerp to support a manufacturing shutdown at the end of the third quarter of the plan to proceed with the dibenzoates manufacturing project. Capital expenditures for continuing operations was $20 million, $13 million for discontinued operations. Restructuring payments of $16 million, interest of $12 million, pension and retirement contributions globally of $24 million and other debt -- net cash inflows of approximately $13 million. Our precious metal consignment obligation was $29 million at quarter end, approximately equivalent to the level at year end 2013. We currently have no demands for cash collateral related to precious metal consignment program, and we have trimmed participation in the program back to adjust to our current level of precious metal requirements. And as a side note, I think we still have opportunity there. I would now like to provide a brief overview of our year-over-year second quarter results for our reporting segments. The analysis covers only continuing operations and is based on value-added sales. In Performance Coatings, sales were essentially flat quarter-over-quarter. Segment sales benefited from increased volumes, improved mix and favorable foreign currency fluctuations, partly offset by lowering price. Within the segment, sales of Tile Coating products increased by approximately 1%, offset by a 3% reduction in sales of porcelain enamel products. Within tile, demand for digital inks in frits and glazes was the largest contributor to the sales increase, partially offset by a reduction in demand for more commodity-oriented colors and related coatings. The digital inks product line continues to experience double-digit sales growth despite significant competitive pricing pressures. Porcelain enamel sales declined in the quarter, due principally to reduced demand in Europe. Segment gross profit increased by $2 million, with the gross profit margin increasing to 24.1% from 22.6% last year. Gross profit and the resulting margin increase were driven primarily by increased volumes, favorable raw material pricing and reduced manufacturing costs, partially offset by lower pricing. Regionally, Performance Coatings segment sales increased by approximately 5% in Asia Pac and 2% in Latin America, while sales in the U.S. were flat and declined by 3% in Europe. In the Performance Colors and Glass segment, value-added sales increased by $3 million or approximately 3% to $96 million. Increased volumes and favorable foreign currency fluctuations were the primary drivers of the revenue increase, partially offset by a shift in business mix to lower-priced products. Volumes increased by approximately 15%, driving a 13% increase in gross profit. Value-added sales increased in automotive and industrial applications, partially offset by reduced demand for decoration and electronic applications. Value-added sales increased in all regions, with particular strength in Latin America and the U.S. Gross profit improved by $4 million to approximately $35 million, with the gross profit margin improving to 37% from 33.6%. Gross profit increased primarily due to the higher volumes and improved manufacturing efficiencies, partially offset by higher raw material prices. In Pigments, Powders and Oxides, value-added sales and gross profit declined by 29% and 28%, respectively. Included in this change, however, is the impact of divesting the Metal Powders and Flakes product lines. Second quarter 2013 value-added sales from the dispositions were approximately $10 million, and the associated gross profit was approximately $1 million. Adjusted for those dispositions, sales declined by 7% and gross profit declined by nearly 17%. The sales decline is almost entirely attributable to a reduction in demand for our surface polishing product line, where sales were off by over 20%. The decline is primarily due to inventory control measures taken by a key customer as the customer continues to work off inventory built up at the end of 2013. On a regional basis, value-added sales declined in the U.S., primarily due to the loss of business in surface polishing. Sales also declined in Latin America, primarily for pigments. Value-added sales increased in Asia and Europe, partially offsetting the lower sales in the U.S. and Latin America. Segment gross profit declined in the quarter, primarily due to reduced volumes and unfavorable mix, partially offset by increased pricing and favorable raw material costs. I'll now provide some color on our outlook for 2014. Based on our second quarter performance, we now expect adjusted earnings for 2014 to be in the range of $0.52 to $0.57 per diluted share. Value-added sales for the second half of 2014 are expected to increase by approximately 2% versus 2013 levels as adjusted for dispositions in the second half of 2013 that represented value-added sales of approximately $12 million. We are lowering our revenue outlook as estimates of GDP growth in the regions where we participate have declined on average by approximately 1% since the beginning of 2014. And sales in our Pigments, Powders and Oxides segment are now expected to be below 2013 levels, as adjusted for exited businesses. The adjusted gross profit margin for the second half of 2014 expressed as a percentage of value-added sales is expected to be in the range of 27% to 27.5%. And SG&A expenses, excluding pension adjustments and other nonrecurring expense items, are expected to be $95 million to $100 million. For 2015, we are increasing our targeted adjusted EPS to exceed $0.90 per diluted share. Again, note that the 2014 and 2015 guidance exclude any benefit from the cash to be generated from the sales of Plastics and Polymer Additives. So the logical question we receive is, "What is the expected use of the $88 million of cash generated from the sale of Plastics and the cash to be generated from Polymer Additives?" What we have communicated previously is that our primary strategic use of this cash would be to invest in our fracture glass-based businesses, that is in glass, colors, tile and/or porcelain enamel. We have also stated the following relative to modeling of those potential investments. The investments will need to achieve return on invested capital of greater than 15% within an acceptable time period, but must have return on invested capital greater than weighted average cost of capital within 2 years of acquisition. Note that based upon our adjusted infrastructure, through the assistance of Capgemini and shared services and Accenture and indirect spend, we can be very confident in achievement of synergies to drive higher returns than would have been achievable historically for Ferro. To further the metrics for modeling acquisitions and assuming a near-term return on invested capital of 12%, which we need again to grow to greater than 15% to be acceptable, but at 12% return on invested capital for a $100 million acquisition, we would model the following

[John T. Bingle:]

Thank you, Jeff. Operator, we're now ready to begin the Q&A session. Please repeat the instructions to assist our guests, and we'll take the first question.

[Operator:]

[Operator Instructions] The first question comes from the line of John McNulty with Crédit Suisse.

[John P. McNulty:]

So I guess, with regard to your liquidity position, I think you highlighted you have about $270 million or so of flexibility, excluding any potential proceeds from the Polymer Additives sale. I guess, when you look at your M&A pipeline, do you feel that there's a reasonable chance that the bulk of that gets deployed say, in the next 12 to 18 months? Or is it a little bit tough to tell at this point?

[Jeffrey L. Rutherford:]

Well, I don't think we are necessarily going to use all of our liquidity. Obviously, we would -- it's very doubtful that we're going to leverage up totally on our revolver. What I would say is that we have opportunities. And obviously, as Peter mentioned, we're active, so we don't want to talk any specifics. But there is a good chance that we will utilize cash, the excess cash within the next 6 months.

[John P. McNulty:]

The next 6 months, okay, great. And then with regard to SG&A, you've taken a noticeable drop down yet again. Now when I look at kind of the level that you put out for the second quarter, if I just kind of straight-line that the rest of the year, it gets to below the kind of low end, the $195 million that you've guided to for the full year. So I guess, I'm wondering, are there any kind of lumps that we should be thinking about in 3 and 4Q, or are you just being conservative? Like I guess, how should we think about how SG&A progresses throughout the rest of the year?

[Jeffrey L. Rutherford:]

Here's what -- and we -- what we talk about internally -- I'll let you in on what we talk about internally. We always talk about -- without incentive comp. We're favorable to last year's incentive comp when we received 200% of incentive comp. But we're going to be above our budgeted number this year. We're not only exceeding external estimates, we're exceeding internal estimates. So there is an adjustment for incentive comp. So we talk about SG&A without incentive comp. And where we're running right now is we have a run rate, at the end of the second quarter, somewhere in the $45 million range for SG&A, excluding incentive comp. So where are we taking that? We're achieving the goals relative to our original estimates of $100 million reduction in total cost, both in cost of goods sold and SG&A. We're kind of there on that number. So we're setting new goals for ourselves. And what we've said is because we're selling PAD and because we're selling plastics, we set new goals of approximately additional $15 million reduction in SG&A, which wouldn't be reflected in that approximately $45 million run rate. So we have a lot of work ahead of us relative to achieving that goal. So you can do the math, right, that'll take us -- we're driving toward, on a comparable basis with the assets we have today, and this will change with acquisitions, but based on the assets we have today, we would drive the SG&A -- non-incentive comp SG&A to $40 million, and that's what our commitment is. How we're going to do that is we're doing a number of things. We're going to zero-based budgeting, and what does that mean for us? And what does that mean for the people of Ferro? We will budget, with the help of our partners, Accenture -- we've kind of created the team of rivals, right? We have Capgemini and Accenture helping us in cost reduction. We will build strategies by category, by subcategory. So what does that mean? F&A is a category, external audit fees is a subcategory, internal audit fees are a subcategory. So we will have a strategy by all categories greater than $100,000 of spend. And we will have a clear path as to how we're going to drive our SG&A below -- non-incentive comp SG&A below $40 million a quarter. So to answer your question, John, is that's our guidance. But we see opportunity, and we will continue to drive to opportunity. The only thing stopping us from achieving the numbers we're talking about is ourselves because what people don't like to do is impact other people. So now, we're talking about -- with Capgemini we've done shared services and outsourced shared services, and that's gone extremely well. And now, with Accenture, we're doing indirect spend and what -- this is a message to our employees is that we will drive toward those numbers and we -- and people will be impacted, both internally and externally. But we're doing this because we haven't done it historically. And we will get to those numbers, that by the end of '16, with the assets we have, we'll drive SG&A below $40 million a quarter.

[Operator:]

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

[Rosemarie J. Morbelli:]

I will start with my usual question, and then I will move on to the next one. Anything happening on manufacturing consolidation, except for Antwerp?

[Peter T. Thomas:]

Yes. So Rosemarie, as usual, when you ask that question, we'll give you a similar answer. We have identified where additional -- or potential consolidations can take place. And remember, we have certain timelines. And last year, we had a pretty exhaustive reduction that took place in Europe, for example, and we're limited by how often we can take actions in certain regions, if you will. So we do have plans. We are considering a range of options. And when the time is appropriate, we'll be able to speak to those and take those actions. But there are opportunities for us to reposition assets in the right place with the lowest cost structure to maintain our leadership positions and competitive advantage.

[Rosemarie J. Morbelli:]

Just following up on this. You made this acquisition in Turkey to add capacity really from what I am guessing and probably more efficient capacity than you have in Spain. Is the...

[Jeffrey L. Rutherford:]

No, Rosemarie, that was not a capacity addition. That was a -- let's define it as being a beachhead in an emerging market where we believe, with our strategies moving forward, that our presence in that region will be more significant. And right now, that is a position of an acquisition of a reseller of our higher-end porcelain enamel products. But we will have some capability, and we will put capability in to position ourselves with our inks business, as well as some of our higher-value tile business until we continue with our strategy of adding additional assets in emerging markets so that we can participate more cost-effectively in that region. So it's a building block. It's the first step of showing that there's a Ferro flag in that region.

[Rosemarie J. Morbelli:]

Are you planning in adding other smelters in Egypt since it is such a success story?

[Peter T. Thomas:]

Yes. So you bring up a good point. So let's discuss it because this is -- as it relates to our tile sales, for example, just to give you a perspective, all of our manufacturing smelters in what we would define as being in emerging markets and/or serving emerging markets, are now running greater than 90% and somewhere at the mid-90s. So we've done a very good job in the past 2 years of repositioning our frit and glazes capacity in a way that we're running at high utilization rates. Now what -- to your point in Asia, we've discussed this in the past, and we are really running full out at that facility, and we have been for quite some time. In fact, it's running so nicely that we've actually been able to upgrade the product mix and the margins because we do customer and product rationalization. So we have the best value coming out of all of our sites. And that gets back to the question as why our tile sales for frits and glazes may have been a little light because we can't take on every piece of business because it will dilute our gross profit whenever you have high utilization capacity. So it would be prudent for us, as the market leader, and making sure that we have the lowest cost production point in our space to add more assets in regions like Egypt.

[Jeffrey L. Rutherford:]

And we actually have talked about that we have approved a project and have preceding in Indonesia where we've had a need for capacity expansion for several years. What happened to the company is the company didn't invest in frit manufacturing for many, many years. I think the only real investment that was done over the last 10 years would have been in Egypt, right? And in fact, capacity probably was declined. So we have needs for capacity expansion, especially in emerging markets. And that's -- and we don't want to get too far into that because those are some of the opportunities we're looking at currently.

[Rosemarie J. Morbelli:]

Okay. And if I could ask Jeff a last question, okay, for the time being, could you talk about the amount of interest savings from your refinancing exercise?

[Jeffrey L. Rutherford:]

Right. Well, we're going to refinance today, and we're going to end up with $300 million of term debt effectively at 4%. So we're going to be -- on the term debt, it's obviously going to be $12 million. We've converted the 7 7/8% effectively to 4%. So it's that spread and the other $50 million -- John, we were borrowing at...

[John T. Bingle:]

About 3 1/4%.

[Jeffrey L. Rutherford:]

3 1/4%, so it's almost a wash on the other $50 million.

[Operator:]

The next question comes from the line of Mike Harrison from First Analysis.

[Michael J. Harrison:]

Just going back to the discussion you were just having over, maybe not taking on every piece of business in some of the places where you're running close to full capacity. Just trying to understand how much of the top line weakness -- or if we look at flattish value-added sales, how much of that is related to you guys either intentionally walking away from less profitable business or not taking on maybe more commodity or lower-margin business because you don't have the capacity? I mean, is that a 1% damp on your growth rate or is it higher than that?

[Peter T. Thomas:]

Yes. Mike, we do track that, and let me give you a perspective and I'll give you the components. As it relates to tile, part of the shortfall we have with tile is that raw material prices did come down and we did pass some on to our customers, although our margins, we kept more, and our margins have lifted. That's one piece. We also had a challenge with a couple of customers that are not financially as sound, and we decided not to do some business with them into -- in the second quarter until they straighten themselves out and such. And then there were also some, what we would define as walkaways or -- because of the margin wasn't attractive enough. And if you look at that combination of events without giving you a number for each one, it was about $5 million in the second quarter.

[Michael J. Harrison:]

And are there other segments where it's going on, or is it primarily a tile phenomenon?

[Peter T. Thomas:]

Well, since you're going in that direction, let's discuss some of the other segments. I think, for us, one of the little more disappointing businesses for a variety of reasons, which I'll get into, is our porcelain enamel business. We're really surprised that everybody called, we believe, it wrong in Europe around the turnaround in Europe and particularly in building construction because the building construction relative to where we participate has not actually improved year-over-year as it relates to porcelain enamel. In fact, the appliance market and the hot water tank market, if you will, is actually down about 2%. And that's exacerbated a bit with some -- a little bit of weakness we have in Eastern Europe, or let's call it the Ukraine and Russia, quite frankly, the year-over-year sales, it's about a $35 million to $40 million piece for us. And sales are a little soft there. So the porcelain enamel market is lovely in Asia Pacific, and in the emerging markets, things are doing well. But we're disappointed with Europe overall as it relates to either tile or even porcelain enamel because -- and based on our contacts with our customers, there isn't a lot of euphoria with the European customers that, that's going to turn around in the second half of the year, thus the comments we've made about softness in Europe. The Performance Color and Glass businesses is on fire. It's a wonderful business. And I hope everyone understands the perspective around how our volumes are up and our gross profits are up, but yet, our sales are flat because of lower price point products that are in demand from that product line. And let me give you a few examples so we're make -- we're clear on the clarity around those comments. For example, we have an industrial. If you look at our Performance Colors and Glass business, we have it broken up into 4 segments. One of them is industrial. Within the industrial sector, a big portion of our business is what we define as being colors for roofing tiles. And there's been a little bit of a change in the demand for the types of glazes and colors, then coatings that go on tiles. They used to be very colorful and very shiny, but there's been a consumer change in a bit, in more muted type of coatings and no shine. Now the good news for us, we happen to have those products in our portfolio that actually have higher gross margins, but the selling prices are quite a bit lower. So our customers are actually benefiting from getting good functionality and the aesthetics they need, but they're able to purchase at a lower price point while we have a lift in margins. That's one example. Another example would be in our decorations segment, and one of the drivers there would be dinnerware. And the demand for fancy or very intricate design china with the changing consumer is -- whether it's in Europe or in North America, the days of really complex coatings and designs are really gone. We see the change into, again, more earth tone colors, but durability is important and the intensity of the colors on the dinnerware are important, but not the designs. And there, again, we have products in our portfolio that are lower price points for the customers but our margins are higher. So that's what you've seen in Performance Colors and Glass. An interesting shift from really fancy and colorful and shiny types of coatings and colors to things that are more muted but good for us, we have them in our portfolio. The price points are lower for the customer, but our margins are higher. So that gives you a flavor of why our volume's up and the margins are up and our sales are flat in Performance Colors and Pigments -- Colors, if you will. Now in Pigments, Powders and Oxides, let's look at -- for what that's worth. That's the smallest segment. It represents about 12% of our revenue. 60% of that is Pigment-related, 40% is with the Polishing Materials that we're discussing. Of that 40%, a reasonable chunk of that is really to one customer who took a lot of product in -- actually in November and December of last year and is working it off. So we have a lull of small numbers around that business. But what we can tell you is that the Pigments part of that business is starting to pick up both in Europe and the U.S. So we just have that one little challenge in PPO. We have a mix shift in Performance Colors and Glass, and we have a little bit of customer and product rationalization in Performance Coatings and some capacity constraints. So when we put that all together, we feel actually very good about the quarter, even though we're disappointed in sales, but we are not losing share. In fact, one could argue we're gaining share. And I think as the next couple of quarters just go by, you'll see that change in consumerism or demand in some of those products that will show better results as it becomes more of an apples-and-apples comparison.

[Operator:]

The next question comes from the line of Kevin Hocevar with Northcoast Research.

[Kevin Hocevar:]

I was wondering if you could comment on the expectations for gross margins. It's been 28% here in the first half of the year. So just wondering why the expectation is for 27% to 27.5% in the back half?

[Jeffrey L. Rutherford:]

Generally speaking, in the back half of the year, due to the holidays in -- that are coming up here in August and then the holidays in December, we tend to have lower volume in the back half of the year, which has been factored into our guidance relative to back half gross profit being 27% to 27.5%.

[Kevin Hocevar:]

Okay. And then in terms of the digital inks, it sounds like there's quite a lot of pricing pressure going on in that business. So just wondering how you view it now? It sounds like sales are still growing very well, so volumes sound like they're very doing well. But how have the gross margins trended over time because I believe they used to substantially over that segment's average? So how have they trended over time? Are you still comfortable with the levels they're at? And kind of how do you view this business given the competitive environment kind of compared to how you used to, say, a year or 2 years ago?

[Peter T. Thomas:]

Good. Well, there were like 10 questions in there, so let me give an answer that may address all of those. So let's have some clarity around the business. Number one, we are still a market leader in that business. Number two, although pricing has gone down, our gross margins have essentially stayed the same. Why? Because of reformulation of those particular products and more efficient ways of manufacturing. The next piece is, the real competition is in China. We consciously -- being good market leaders in the space. We focus on advancing the technology and not be a me-too, and we're not really -- have not been interested in going into the areas where we know that there's going to be intense price competition, although you have to be in certain markets in order to understand the needs of the customers around the world. So let me give you an example. In 2009, we knew that the Chinese market was going to grow phenomenally, right? But we also have experience in the Chinese market to realize that it will, over time, become very intensive in terms of competition. So in 2009, there were probably only 2 equipment manufacturers for digital inks and probably only 1 or 2 players that were just starting in the inks. So now, we're sitting here 4 years later roughly after it's been established. China has 16 to 17 equipment producers and close to 16 or 17 ink producers. And we elected, as a market leader, not to put capacity in the area, a lot of capacity. But some, so we understand the dynamic, while a lot of our competitors decided to fall victim, quite candidly, into putting assets in place and trying to run up the market share and being victimized by a $40 a kilo type of market in the beginning to somewhere now that's around $18 in China. The good news for us, there is competition and pressure there, but we have elected not to go in a big way in that area like some of our competitors. What we've decided to do is keep on the market leadership position, being the only ink producer that's qualified with the majority of the ink machines, and introduce new technology like we have done with version 4 of inks, which are water-based, larger molecules, which will cannibalize some of the third, second and first generations as we discussed. And we are also exploiting new product lines like new digital glazes and top coats. So we're not only bringing on new technology in the inks, we're expanding the product line and we're focusing on the areas of the world where we can maintain margin and not get hammered on price, as some of our competitors are experiencing now. So the answer to your question, again, I know Jeff and I are going a long way around some of this today, but the bottom line is we're still the market leader. We're the leader in new technology and development. We have the best margins relative to the rest of the world, and we'll continue with that business model.

[Operator:]

[Operator Instructions] We do have a follow-up question from the line of Rosemarie Morbelli from Gabelli & Company.

[Rosemarie J. Morbelli:]

I was wondering if you could give us a feel as to the impact, if any, from the turmoil in the Middle East on your business? You vaguely talked about Russia and Ukraine. But what about the Middle East?

[Peter T. Thomas:]

Yes. We, quite frankly, I'll be candid with you. The Middle East is still very strong for us. We have good sales coming from Egypt into that area, so we're not seeing it. But in Ukraine and Russia, like, as I mentioned, we were $40 million a year in those 2 areas. And if you want to just average load it, it's about $10 million a quarter. But I'll very candid with you, we're down a couple of million dollars in that area. So that's the only spot where we see an issue. Now why would, you might ask, or what -- why is Egypt is still strong? Well, some of the good news there is the government change, with the army going into more direction and leading direction for the region, and that really helps our position. And a lot of our customers in Egypt are exporting more, so -- which means a lot of it's going to the Middle East. So we feel pretty good about Egypt and the Middle East and Turkey, and we're not seeing an issue there.

[Rosemarie J. Morbelli:]

If a sanction in Russia kind of goes through, can you lose the entire $40 million and -- of revenues? And is the margin similar to your overall margin there?

[Peter T. Thomas:]

Yes. So we, of course, look at things like that for our modeling. Part of the -- the short answer is we will -- we don't believe we'll lose it all. And the second point is, typically, the margin in those areas would be equivalent to Southern Spain. So they wouldn't be as high as Turkey or Egypt or the Middle East. But we won't lose it all, and it's not the highest margin. But yet, it's important for expansion. But we don't see like a real hit to the business because of that.

[Rosemarie J. Morbelli:]

Okay. And lastly, if I may, what are you seeing on the raw material cost trends? Because it sounded as though you benefited from some of the lower cost of raw material. So where are we going from here?

[Peter T. Thomas:]

Yes. So our forecast and with our suppliers, suggest that things will be pretty much business as usual for the second half of the year. And no one is really speaking too much about what's happening next year. But I know that over the next 1.5 months, as budgeting takes hold for a lot of companies, there will be more granularity from our suppliers as to what they believe will occur. So by the time we have the next call, we'll have a better handle. But right now, we're not -- it's pretty much business as usual. We've had a little bit of benefit from raw material declines, but there were a couple of metals that actually went up -- and the good news for us, it would have impacted our Performance, Colors and Glass business, particularly in the automotive segment, where one of the materials was pretty high, the good news for us, as our customers were unhappy, we just happened to have a product that could perform equal to or greater than the product that had that expensive material, and that's what they decided to buy instead of the other formula. So it saved them some money. They didn't have to deal with it, and we had a higher margin with that -- with those new set of products and everyone benefited. So that's one of the things we've been doing over the past couple of years, is trying to reformulate all of our businesses in a way we're not -- so that we won't be as victimized with raw material changes. And I really like to compliment the manufacturing groups and all these material businesses for paying attention to the benefits of reformulation. And that's been a big help at our COGS level.

[Operator:]

The last question comes from the line of David Begleiter from Deutsche Bank.

[David L. Begleiter:]

First, Jeff, on the tax rate, is there much more you can do going forward in 2015, 2016 to get a lower tax rate?

[Jeffrey L. Rutherford:]

Yes.

[Peter T. Thomas:]

Tell them, Jeff.

[Jeffrey L. Rutherford:]

Yes. Peter knows how I'm going to react to this, so that's why he's kidding me right now. We haven't done a good job historically, with tax planning. And that's why we model at 36%. I won't get into the detail of it, but we just aren't very good at it. And so what we're doing right now, David, is we're going through a project -- one of our problems is, generally speaking, foreign operating companies were direct subsidiaries of the U.S. operating company, which is a disaster from a tax perspective. So what we're doing as we speak is we're moving the ownership of our foreign operations to an Irish holding and financing corporations, 2 corporations in Ireland. And effectively, what we're going to do is manage our foreign taxes through our Irish holding companies. It still causes us some issues, mainly related to U.S. royalties for intellectual property and then our corporate facilities here in the U.S. So we're balancing all that out. Basically, here's what we're going to do. U.S. is going to end up being just slightly profitable, and then we'll optimize our European and Asian structure through inter-companies and dividend treaties and so forth through Ireland. We're going to drive down our effective tax rate. We're modeling currently and what -- we're going to go to 32% for modeling beginning in '15. There's still, David, there is still a lot of opportunity to take that number lower. It's going to take some time as we work through this structure and get the inter-companies and the intellectual property squared away. But we're very high at 36%. We're modeling at 32% for '15, and then we'll keep you posted where it's going to go from there.

[David L. Begleiter:]

Very good. And just one more thing, Jeff. Looking at the EPS -- the guidance increase for '15, can you just bridge us as to what drove that increase versus the prior guidance?

[Jeffrey L. Rutherford:]

It's, as we talked about, it's continued cost reductions. It's the change from greater than $80 million to greater than $90 million. In fact, we took down a little bit of the sales growth in our internal model. So it's not generated from sales. It's gross profit expansion and lower SG&A. And as -- and we had been modeling that 32% in our previous guidance from a tax rate. So it's all related to cost reductions.

[John T. Bingle:]

All right, 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 our website. I want to thank you for your time this morning and have a good day.

[Operator:]

Thank you. 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. Thank you and have a good day.