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FOE > SEC Filings for FOE > Form 10-Q on 29-Oct-2012All Recent SEC Filings

Show all filings for FERRO CORP

Form 10-Q for FERRO CORP


29-Oct-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

Market conditions were generally weaker in our key markets during the third quarter of 2012. Demand for our conductive pastes used in solar cells and metal powders used in a variety of electronic products declined from the second quarter of 2012 and remains significantly lower than prior-year periods. A reduced forecast for our solar pastes sales and a diminished outlook for our future opportunities in the solar market led to our decision to examine strategic options for the solar pastes business.

Demand from customers in Europe was also weaker during the 2012 third quarter as a result of deteriorating macroeconomic conditions in the region. Demand from customers in the United States was generally stronger than in Europe, but the level of customer demand varied by application market.

Net sales declined by 24% compared with the third quarter of 2011, driven by a decline in sales of Electronic Materials products and reduced demand in the European region. In aggregate, changes in product pricing and mix reduced our overall sales by approximately 12 percentage points. Lower sales volume reduced sales by an additional 9 percentage points, and changes in foreign currency exchange rates reduced sales by 3 percentage points. Lower sales in Electronic Materials, including reduced sales of precious metals, was the largest contributor to both the price/mix and sales volume declines during the quarter.

Gross profit declined in the 2012 third quarter compared with the third quarter of 2011. The decline in sales of Electronic Materials products, including high-margin solar pastes, metal powders and surface finishing materials, accounted for about two-thirds of the decline in consolidated gross profit. Raw material costs were little changed from the prior-year quarter, in aggregate, across the Company.

Selling, general and administrative ("SG&A") expenses declined in the 2012 third quarter, in comparison to the prior-year quarter. The primary driver of lower SG&A expenses was reduced incentive compensation expense, compared with the third quarter of 2011.

Restructuring and impairment charges increased during the quarter compared with the prior-year quarter as a result of goodwill and other asset impairments related to solar pastes and metal powders businesses within our Electronic Materials segment. In addition, an impairment charge was recorded to reflect the reduced value of property held for sale in connection with sites closed during earlier restructuring initiatives.

Interest expense was little changed in the 2012 third quarter compared with the third quarter of 2011. Average interest rates incurred on borrowings increased slightly, but this was largely offset by lower average borrowings during the quarter.

During the 2012 third quarter, income tax expense included a reserve against net deferred tax assets. As a result, income tax expense was substantially higher than in the prior-year period.

We recorded a net loss for the third quarter compared with net income in the 2011 third quarter primarily as a result of the increase in restructuring and impairment charges and additional income tax expense. In addition, lower net sales resulted in reduced gross profit that had a further negative impact on profitability compared with the prior-year quarter.

Outlook

Our ability to forecast future financial performance is limited because of uncertainty surrounding customer demand and economic conditions in a number of key markets and regions around the world. Customer demand for our solar pastes is difficult to forecast because of uncertainty in end-market demand, as well as uncertainty related to customers' responses to our announcement that we are exploring strategic options for the solar pastes business. We do not expect demand for solar pastes to improve meaningfully during the remainder of 2012.

Economic conditions in Europe have deteriorated over the past several quarters, and they may continue to deteriorate through the rest of 2012 due to sovereign debt issues and other macroeconomic drivers. The growth in economic activity in Asia-Pacific, including China, appears to be slowing from the rates experienced earlier in 2012. Weakening economic conditions in Europe and slower growth in Asia may affect demand for our products sold to customers in these regions, although the magnitude of these effects is difficult to estimate.

The assumptions we use in actuarial calculations for our defined benefit pension and other postretirement benefit plans have a significant impact on benefit obligations and annual net periodic benefit costs. We determine the discount rate for our U.S. pension and other postretirement benefit plans based on a bond model and for our non-U.S. plans we use a yield curve method. Given the volatility of market conditions and the interest rate environment, it is difficult to predict these factors. An


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increase in the discount rate would reduce future benefit expense, and a decrease in discount rate would result in an increase of future benefit expense. As of September 30, 2012, an increase or decrease in the discount rate of 1% on our U.S. pension and other postretirement benefit liabilities, holding all other assumptions constant, would result in a decrease or increase in our pre-tax loss and our benefit liability of approximately $50 million.

Factors that could adversely affect our future financial performance include those described under the heading "Risk Factors" in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2011.

Results of Operations

For the three and nine months ended September 30, 2011, amounts originally reported have been adjusted for the effects of applying retrospectively the refined allocations as described in Note 14, Reporting for Segments, and the change in accounting principle as described in Note 2, Recent Accounting Pronouncements and Change in Accounting Principle. Both notes are part of the condensed consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q.

Comparison of the three months ended September 30, 2012 and 2011

                                                Three months ended
                                                  September 30,
                                                              As adjusted
                                          2012                    2011                $ Change         % Change
                                          (Dollars in thousands, except per share amounts)
Net sales                            $      414,840        $          546,114        $ (131,274 )          (24.0 )%
Cost of sales                               352,501                   442,304           (89,803 )          (20.3 )%

Gross profit                                 62,339                   103,810           (41,471 )          (39.9 )%
Gross profit percentage                        15.0 %                    19.0 %
Selling, general and
administrative expenses                      65,109                    65,766              (657 )           (1.0 )%
Restructuring and impairment
charges                                     198,790                       869           197,921
Other expense (income):
Interest expense                              7,101                     7,030                71
Interest earned                                 (57 )                     (50 )              (7 )
Foreign currency losses, net                    869                     1,726              (857 )
Miscellaneous expense, net                      792                        64               728

(Loss) income before income taxes          (210,265 )                  28,405          (238,670 )
Income tax expense                          105,473                     9,057            96,416

Net (loss) income                    $     (315,738 )      $           19,348        $ (335,086 )

Diluted (loss) earnings per share    $        (3.66 )      $             0.22        $    (3.88 )

Net sales declined by 24.0% for the three months ended September 30, 2012, compared with the third quarter of 2011. The most significant driver of the net sales decline was reduced customer demand for our Electronic Materials products, including our solar pastes, metal powders and surface finishing materials. In addition, sales declined in Europe compared with the prior-year quarter due to weak economic conditions in the region. Lower sales of precious metals accounted for 49% of the overall sales decline, driven by reduced sales volume and lower prices for silver. In aggregate, changes in product pricing and mix reduced overall net sales by approximately 12 percentage points. Lower sales volume contributed an additional 9 percentage points to the sales decline and changes in foreign currency exchange rates reduced sales by approximately 3 percentage points.

Gross profit declined during the 2012 third quarter as a result of lower net sales and changes in product mix. Gross profit percentage declined to 15.0% of net sales from 19.0% in the prior-year quarter. In total, raw material costs were little changed from the prior-year quarter. Product price changes were generally more favorable than changes in raw materials, except in the Electronic Materials segment where product prices declined more quickly than raw material costs. Charges, primarily related to write-downs of solar pastes inventories and residual costs at closed manufacturing sites involved in earlier restructuring initiatives, reduced gross profit by $5.8 million during the third quarter. Gross profit was reduced by charges of $0.7 million during the third quarter of 2011, also primarily due to residual costs at closed manufacturing sites.

Selling, general and administrative ("SG&A") expenses decreased slightly compared with the prior-year quarter. Because of the decline in sales, SG&A expenses increased to 15.7% of net sales from 12.0% of net sales in the 2011 third quarter. The


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decline in SG&A expenses during the quarter included lower incentive compensation expense. Partially offsetting the lower SG&A expenses were higher special charges and additional reserves for bad debt. SG&A expenses in the 2012 third quarter included special charges of $3.2 million that were primarily related to a write-down of other tax assets, residual expenses at sites that were closed during earlier restructuring initiatives and severance costs. SG&A expenses in the 2011 third quarter included charges of $0.8 million sites closed as a result of earlier restructuring initiatives.

Restructuring and impairment charges increased to $198.8 million during the 2012 third quarter. The charges included a $147.3 million impairment of goodwill associated with the Electronic Materials segment. Impairment charges of $40.5 million were also recorded to reduce the value of long-lived assets, also related to the Electronic Materials segment. These impairments were the result of reduced forecasts for future profitability, primarily for our solar pastes and metal powders businesses within Electronic Materials. In addition, an impairment charge of $11.0 million was recorded to reduce the value of assets held for sale, primarily properties and buildings related to manufacturing sites that were closed as part of earlier restructuring activities.

Interest expense was little changed from the prior-year quarter. The impact of slightly higher average interest rates was largely offset by lower average borrowing during the quarter.

We are exposed to the impact of exchange rate fluctuations on foreign currency positions arising from our international sales and operations. We manage these currency risks principally by entering into forward contracts. The carrying value of the open contracts at each quarter-end are adjusted to fair value and the resulting gains or losses are charged to income or expense during the period, partially offsetting the effect of changes in foreign currency exchange rates on the underlying positions.

During the 2012 third quarter, we recognized tax expense of $105.5 million compared with income tax expense of $9.1 million in the 2011 third quarter. The higher income tax expense for the current period was primarily due to recording a charge of $112.3 million to reserve for a significant portion of our deferred tax assets. The reserve for the deferred tax assets was primarily driven by the significant impairment charges that were incurred during the third quarter. Additionally, we incurred pre-tax losses in jurisdictions already with full valuation allowances for which no tax benefit is recognized.

We recorded a net loss of $315.7 million in the quarter, compared with net income of $19.3 million in the prior-year quarter. The change was primarily the result of increased restructuring and impairment charges and higher income tax expense. In addition, reduced gross profit resulting from lower net sales contributed to the decline in profitability in the third quarter of 2011.

                                              Three months ended
                                                 September 30,
                                                          As adjusted
                                           2012              2011            $ Change         % Change
                                                    (Dollars in thousands)
Segment Sales
Electronic Materials                     $  66,188       $     156,081      $  (89,893 )          (57.6 )%
Performance Coatings                       137,229             153,365         (16,136 )          (10.5 )%
Color and Glass Performance Materials       84,262             100,525         (16,263 )          (16.2 )%
Polymer Additives                           79,881              85,634          (5,753 )           (6.7 )%
Specialty Plastics                          41,305              43,606          (2,301 )           (5.3 )%
Pharmaceuticals                              5,975               6,903            (928 )          (13.4 )%

Total segment sales                      $ 414,840       $     546,114      $ (131,274 )          (24.0 )%

Segment Income
Electronic Materials                     $  (6,311 )     $      16,463      $  (22,774 )             NM
Performance Coatings                         3,210              11,069          (7,859 )          (71.0 )%
Color and Glass Performance Materials        5,636               8,365          (2,729 )          (32.6 )%
Polymer Additives                            5,398               4,252           1,146             27.0 %
Specialty Plastics                           3,728               2,717           1,011             37.2 %
Pharmaceuticals                                 85               1,254          (1,169 )             NM

Total segment income                     $  11,746       $      44,120      $  (32,374 )          (73.4 )%

NM - Not meaningful


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Electronic Materials Segment Results. Sales declined in Electronic Materials primarily as a result of reduced demand for our conductive pastes used in solar cell manufacturing and metal powders used in other electronics applications. In addition, sales of polishing materials declined primarily due to lower product prices that reflected lower costs for a key raw material. Changes in volume reduced sales by approximately $35 million compared with the third quarter of 2011. Changes in product pricing and mix lowered sales by an additional $54 million and changes in foreign currency exchange rates reduced sales by $1 million. Sales of precious metals declined by $59 million due to lower sales volume of solar pastes and precious metal powders and as a result of lower precious metal prices. The costs of precious metals are passed through to our customers as an element of our product prices. Reduced sales of products produced in the United States and in Asia-Pacific accounted for most of the overall sales decline. Segment income declined due to a $24 million reduction in gross profit that was primarily the result of lower sales volume and reduced product prices. A $1 million decline in SG&A expense offset a portion of the gross profit decline.

Performance Coatings Segment Results. Sales declined in Performance Coatings, driven by changes in foreign currency exchange rates and changes in product pricing and mix. Changes in foreign currency exchange rates reduced sales by $9 million and changes in product pricing and mix accounted for $5 million of the sales decline. Reduced sales volume contributed an additional $2 million to the lower sales recorded during the quarter. Sales declined primarily in Europe-Middle East-Africa. Segment income declined primarily as a result of an $8 million decline in gross profit.

Color and Glass Performance Materials Segment Results. Sales declined in Color and Glass Performance Materials as a result of changes in sales volume, product pricing and mix, as well as changes in foreign currency exchange rates. Changes in sales volume reduced sales by $8 million during the quarter. Changes in product pricing and mix accounted for $4 million of the sales decline and changes in foreign currency exchange rates reduced sales by an additional $4 million. The sales decline was the most significant in Europe-Middle East-Africa, with smaller declines in the United States and Latin America. Segment income declined due to a $5 million decline in gross profit driven by the reduced sales, partially offset by a $2 million decline in SG&A expenses.

Polymer Additives Segment Results. Sales declined in Polymer Additives as a result of changes in product pricing and mix and changes in foreign currency exchange rates. Changes in product pricing and mix reduced sales by $4 million and changes in foreign currency exchange rates reduced sales an additional $2 million, compared with the third quarter of 2011. Reduced sales volume in the Europe-Middle East-Africa region was the primary driver of the sales decline, with a smaller reduction in United States sales. The sales decline in Europe-Middle East-Africa reflected reduced market demand resulting from a weak macroeconomic environment in Europe and reduced demand for certain plasticizer products due to changing environmental regulations. Segment income increased due to a $0.4 million increase in gross profit and a $0.7 million decline in SG&A expenses.

Specialty Plastics Segment Results. Sales declined in Specialty Plastics as a result of reduced sales volume and changes in foreign currency exchange rates, partially offset by changes in product pricing and mix. Lower sales volume reduced sales by $3 million and changes in foreign currency exchange rates reduced sales by an additional $1 million. Changes in product pricing and mix increased sales by approximately $2 million. Lower sales in Europe-Middle East-Africa were the primary driver of the sales decline. Segment income increased as a result of a $0.6 million increase in gross profit and a $0.4 million decline in SG&A expenses. The improvement in gross profit was primarily driven by changes in product pricing. The reduction in SG&A expenses was driven by cost reduction initiatives.

Pharmaceuticals Segment Results. Sales declined in Pharmaceuticals due to changes in product pricing and mix. Segment income declined primarily due to reduced gross profit resulting from higher manufacturing costs and lower sales.

                                Three months ended
                                   September 30,
                                2012          2011         $ Change        % Change
                                      (Dollars in thousands)
        Geographic Revenues
        United States         $ 179,623     $ 265,077     $  (85,454 )         (32.2 )%
        International           235,217       281,037        (45,820 )         (16.3 )%

        Total                 $ 414,840     $ 546,114     $ (131,274 )         (24.0 )%

Net sales declined in the United States and international regions compared with the prior-year quarter. In the 2012 third quarter, sales originating in the United States were 43% of total net sales, compared with 49% of net sales in the third quarter of 2011. The decline in U.S. sales was largely due to reduced sales of our solar pastes, metal powders and surface finishing products within the Electronic Materials segment. Sales originating in Asia-Pacific also declined primarily as a result of lower


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Electronic Materials sales. Sales in Europe-Middle East-Africa declined due to reduced customer demand resulting from a weakened macroeconomic environment in the region.

Comparison of the nine months ended September 30, 2012 and 2011

                                                Nine months ended
                                                  September 30,
                                                                As adjusted
                                          2012                     2011                 $ Change          % Change
                                          (Dollars in thousands, except per share amounts)
Net sales                           $      1,362,735         $       1,713,097         $ (350,362 )           (20.5 )%
Cost of sales                              1,124,228                 1,374,614           (250,386 )           (18.2 )%

Gross profit                                 238,507                   338,483            (99,976 )           (29.5 )%
Gross profit percentage                         17.5 %                    19.8 %
Selling, general and
administrative expenses                      206,306                   210,153             (3,847 )            (1.8 )%
Restructuring and impairment
charges                                      203,829                     4,044            199,785
Other expense (income):
Interest expense                              20,689                    21,208               (519 )
Interest earned                                 (192 )                    (193 )                1
Foreign currency losses, net                     792                     4,049             (3,257 )
Miscellaneous expense, net                     3,027                       458              2,569

(Loss) income before income
taxes                                       (195,944 )                  98,764           (294,708 )
Income tax expense                           113,618                    32,825             80,793

Net (loss) income                   $       (309,562 )       $          65,939         $ (375,501 )

Diluted (loss) earnings per
share                               $          (3.60 )       $            0.75         $    (4.35 )

Net sales declined by 20.5% for the nine months ended September 30, 2012, compared with the first nine months of 2011. The most significant driver of the sales decline was reduced customer demand for our Electronic Materials products, including our solar pastes, metal powders and surface finishing materials. In addition, sales declined in Europe compared with the prior-year quarter due to weak economic conditions in the region. Lower sales of precious metals accounted for 62% of the overall sales decline, driven by reduced sales volume and lower prices for silver. In aggregate, changes in product pricing and mix reduced overall net sales by approximately 10 percentage points. Lower sales volume reduced sales by an additional 8 percentage points and changes in foreign currency exchange rates contributed approximately 2 percentage points to the overall sales decline during the first nine months of 2012.

Gross profit declined as a result of reduced sales and a change in product mix due to the decline in Electronic Materials sales. Gross profit percentage declined to 17.5% of net sales from 19.8% of net sales in the first nine months of 2011. In total, raw material costs increased by approximately $7 million compared with the first three quarters of 2011 and these costs were offset by increased product prices. Gross profit was reduced by $7.2 million due to charges primarily related to write-downs of solar pastes inventory and residual costs at closed manufacturing sites involved in earlier restructuring initiatives. Gross profit was reduced by charges of $3.6 million during the first nine months of 2011, also as a result of residual costs at sites closed as a result of previous restructuring actions.

Selling, general and administrative ("SG&A") expenses declined by $3.8 million compared with the first nine months of 2011. Due primarily to reduced sales, SG&A expenses increased to 15.1% of net sales compared with 12.3% of net sales in the prior-year period. SG&A expenses declined primarily as a result of reduced incentive compensation expenses, depreciation expense, business travel costs and professional fees. Increased special charges, increased healthcare benefit expense for U.S. employees, higher reserves for bad debt and expenses related to an initiative to improve management information systems tools partially offset the decline in SG&A expenses during the first nine months of 2012. SG&A expenses during the first nine months of 2012 included charges of $6.0 million that were primarily related to a write-down of other tax assets, residual expenses at sites closed as a part of earlier restructuring initiatives and severance costs. SG&A expenses in the first nine months of 2011 included charges of $3.3 million, primarily related to expenses at sites closed as a result of earlier restructuring initiatives.


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Restructuring and impairment charges increased to $203.8 million during the first three quarters of 2012. The charges included a $147.3 million impairment of goodwill associated with the Electronic Materials segment. Impairment charges of $40.5 million were also recorded to reduce the value of long-lived assets, also in the Electronic Materials segment. These impairments were the result of reduced forecasts for future profitability, primarily for our solar pastes and metal powders businesses within Electronic Materials. In addition, an impairment charge of $11.0 million was recorded to reduce the value of assets held for sale, primarily properties and buildings related to manufacturing sites that were closed as part of earlier restructuring activities. Restructuring charges during the first nine months of 2012 also included charges of $4.6 million related to a restructuring initiative in our Performance Coatings business in Europe.

Interest expense declined by $0.5 million in the first nine months of 2012 compared with the first nine months of 2011. The lower expense primarily was a result of increased capitalized interest and lower average borrowings.

We are exposed to the impact of exchange rate fluctuations on foreign currency positions arising from our international sales and operations. We manage these currency risks principally by entering into forward contracts. The carrying value of the open contracts at each quarter-end are adjusted to fair value and the resulting gains or losses are charged to income or expense during the period, partially offsetting the effect of changes in foreign currency exchange rates on the underlying positions.

We recorded miscellaneous expense, net, of $3.0 million during the first nine months of 2012. Included in miscellaneous expense was a loss of $0.8 million related to the sale of a mining operation in Argentina.

During the first nine months of 2012, income tax expense was $113.6 million, or . . .

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