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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003,
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-584
---------------
FERRO CORPORATION
(Exact name of registrant as specified in its charter)
AN OHIO CORPORATION, IRS NO. 34-0217820
1000 LAKESIDE AVENUE CLEVELAND, OH 44114
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE:
216/641-8580
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES [X] NO [ ]
At July 31, 2003 there were 40,772,045 shares of Ferro common stock, par
value $1.00, outstanding.
================================================================================
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FERRO CORPORATION AND SUBSIDIARIES
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2003 2002 2003 2002
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
------------ ------------ ------------ ------------
(dollars in thousands- except per share amounts)
Net Sales ................................................ $ 416,178 $ 408,416 $ 817,948 $ 773,439
Cost of Sales ............................................ 318,114 301,666 618,783 573,379
Selling, Administrative and General Expenses ............. 77,425 74,043 152,877 143,162
Other Charges:
Interest Expense ...................................... 8,915 11,596 17,699 23,611
Foreign Currency Transactions, Net .................... 1,204 900 2,393 1,676
Miscellaneous Expense - Net ........................... 3,067 2,245 4,591 5,695
------------ ------------ ------------ ------------
Income Before Taxes ................................ 7,453 17,966 21,605 25,916
Income Tax Expense ....................................... 1,593 6,202 6,292 9,240
------------ ------------ ------------ ------------
Income from Continuing Operations ........................ 5,860 11,764 15,313 16,676
Discontinued Operations
Income/(Loss) from Discontinued Operations, Net of Tax (854) 2,243 (923) 4,551
Gain on Disposal of Discontinued Operations, Net of Tax 2,417 -- 2,417 --
------------ ------------ ------------ ------------
Net Income ............................................... 7,423 14,007 16,807 21,227
Dividend on Preferred Stock .............................. 534 611 1,081 1,281
------------ ------------ ------------ ------------
Net Income Available to Common Shareholders .............. $ 6,889 $ 13,396 $ 15,726 $ 19,946
============ ============ ============ ============
Per Common Share Data:
Basic Earnings
From Continuing Operations ......................... $ 0.13 $ 0.30 $ 0.35 $ 0.42
From Discontinued Operations ....................... 0.04 0.06 0.04 0.13
------------ ------------ ------------ ------------
$ 0.17 $ 0.36 $ 0.39 $ 0.55
Diluted Earnings
From Continuing Operations ......................... $ 0.13 $ 0.29 $ 0.34 $ 0.42
From Discontinued Operations ....................... 0.04 0.05 0.04 $ 0.12
------------ ------------ ------------ ------------
$ 0.17 $ 0.34 $ 0.38 $ 0.54
------------ ------------ ------------ ------------
Shares Outstanding:
Average Outstanding ................................... 40,730,581 37,662,108 40,661,723 36,151,656
Average Diluted ....................................... 40,961,716 40,687,074 40,856,950 39,160,598
Actual End of Period .................................. 40,754,825 40,254,273 40,754,825 40,254,273
See Accompanying Notes to Condensed Consolidated Financial Statements
2
CONDENSED CONSOLIDATED BALANCE SHEETS
FERRO CORPORATION AND SUBSIDIARIES
JUNE 30, DECEMBER 31,
2003 2002
(UNAUDITED) (AUDITED)
---------- ----------
(dollars in thousands)
ASSETS
Current Assets:
Cash and Cash Equivalents ...................... $ 11,869 $ 14,942
Accounts and Trade Notes Receivable ............ 168,123 154,533
Inventories .................................... 199,016 183,055
Assets of Businesses Held for Sale ............. -- 27,046
Other Current Assets ........................... 178,060 106,009
---------- ----------
Total Current Assets ........................ $ 557,068 $ 485,585
Net Property, Plant & Equipment ................... 605,262 577,754
Unamortized Intangible Assets ..................... 420,232 421,274
Other Assets ...................................... 127,669 119,860
---------- ----------
$1,710,231 $1,604,473
========== ==========
LIABILITIES and SHAREHOLDERS' EQUITY
Current Liabilities:
Notes and Loans Payable ........................ $ 11,190 $ 7,835
Accounts Payable ............................... 232,460 207,873
Liabilities of Businesses Held for Sale ........ -- 12,518
Other Accrued Expenses/Other Current Liabilities 176,789 175,941
---------- ----------
Total Current Liabilities ................... $ 420,439 $ 404,167
Long-Term Debt, Less Current Portion .............. 510,075 443,552
Other Non-Current Liabilities ..................... 274,517 284,258
Shareholders' Equity .............................. 505,200 472,496
---------- ----------
$1,710,231 $1,604,473
========== ==========
See Accompanying Notes to Condensed Consolidated Financial Statements
3
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FERRO CORPORATION AND SUBSIDIARIES
SIX MONTHS ENDED
JUNE 30,
2003 2002
(UNAUDITED) (UNAUDITED)
--------- ---------
(dollars in thousands)
Cash Flow from Operating Activities
Net Cash Provided by Continuing Operations ............ $ 3,283 $ 70,285
Net Cash Provided by (Used for) Discontinued Operations (923) 16,689
--------- ---------
Net Cash Provided by Operating Activities ..................... 2,360 86,974
Cash Flow from Investing Activities
Capital Expenditures for Plant and Equipment
of Continuing Operations ......................... (16,893) (16,096)
Capital Expenditures for Plant and Equipment
of Discontinued Operations ....................... (381) (165)
Divestitures, Net of Cash ............................. 23,875 --
Acquisition, Net of Cash .............................. (8,478) --
Buy Out of Operating Lease ............................ (25,000)
Other Investing Activities ............................ (802) (2,428)
--------- ---------
Net Cash Used for Investing Activities ........................ (27,679) (18,689)
Cash Flow from Financing Activities
Issuance of Common Stock .............................. -- 131,571
Net Borrowings (Payments) under Short Term Facilities . 3,355 (3,232)
Proceeds from (Repayment of) Long Term Debt ........... 66,127 (207,434)
Net Proceeds (Payments) from Asset Securitization ..... (36,658) 26,108
Purchase of Treasury Stock ............................ -- (424)
Cash Dividends Paid ................................... (12,730) (11,350)
Other Financing Activities ............................ 1,437 2,390
--------- ---------
Net Cash Provided by (Used for) Financing Activities .......... 21,531 (62,371)
Effect of Exchange Rate Changes on Cash ............. 715 3,514
--------- ---------
Increase/(Decrease) in Cash and Cash Equivalents .............. (3,073) 9,428
Cash and Cash Equivalents at Beginning of Period .............. $ 14,942 $ 15,317
--------- ---------
Cash and Cash Equivalents at End of Period .................... $ 11,869 $ 24,745
========= =========
Cash Paid During the Period for
Interest, Net of Amounts Capitalized .................. $ 18,173 $ 12,919
Income Taxes .......................................... $ 5,375 $ 2,750
See Accompanying Notes to Condensed Consolidated Financial Statements
4
FERRO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
These condensed consolidated financial statements should be read in conjunction
with the consolidated financial statements and notes thereto included in the
Company's annual report on Form 10-K for the fiscal year ended December 31,
2002. The information furnished herein reflects all adjustments (consisting of
normal recurring adjustments), which are, in the opinion of management,
necessary for fair presentation of the results of operations for the interim
periods. Certain amounts in the 2002 financial statements and accompanying notes
have been reclassified to conform to the 2003 presentation. The results for the
three and six months ended June 30, 2003, are not necessarily indicative of the
results expected in subsequent quarters or for the full year.
2. COMPREHENSIVE INCOME
Comprehensive income represents net income adjusted for foreign currency
translation adjustments, minimum pension liability adjustments and the costs
associated with natural gas forward contracts. Comprehensive income was $23.5
million and $36.7 million for the three months ended June 30, 2003, and 2002,
respectively. Comprehensive income was $44.3 million and $38.2 million for the
six months ended June 30, 2003, and 2002, respectively. Accumulated other
comprehensive loss at June 30, 2003, and December 31, 2002, was $103.4 million
and $130.9 million, respectively.
3. INVENTORIES
Inventories consisted of the following:
JUNE 30, DECEMBER 31,
(dollars in thousands) 2003 2002
(UNAUDITED) (AUDITED)
--------- ---------
Raw Materials .... $ 46,655 $ 42,177
Work in Process .. 25,681 17,755
Finished Goods ... 137,208 133,328
--------- ---------
209,544 193,260
LIFO Reserve ..... (10,528) (10,205)
--------- ---------
Inventories ...... $ 199,016 $ 183,055
========= =========
4. FINANCING AND LONG-TERM DEBT
Long-term debt as of June 30, 2003, and December 31, 2002, was as follows:
JUNE 30, DECEMBER 31,
(dollars in thousands) 2003 2002
(UNAUDITED) (AUDITED)
-------- --------
Senior Notes, 9.125%, due 2009 $196,629 $196,324
Debentures, 7.625%, due 2013 . 24,848 24,843
Debentures, 7.375%, due 2015 . 24,956 24,954
Debentures, 8.0%, due 2025 ... 49,492 49,480
Debentures, 7.125%, due 2028 . 54,480 54,469
Revolving credit ............. 158,700 91,900
agreements
Other ........................ 2,276 2,464
-------- --------
511,381 444,434
Less current portion (A) ..... 1,306 882
-------- --------
Total ........................ $510,075 $443,552
======== ========
(A) Included in notes and loans payable.
5
At June 30, 2003, the Company had $355.0 million principal amount outstanding
under debentures and senior notes, which had an estimated fair market value of
$377.9 million.
In September 2001, the Company entered into new unsecured senior credit
facilities. The senior credit facilities included a $373.0 million five-year
revolving credit facility. Using the net proceeds from the sale of the Powder
Coatings business in September 2002, the Company repaid $132.0 million of the
five-year facility and effectively reduced the maximum borrowings thereunder to
$300.0 million. The Company had $158.7 million outstanding under the five-year
revolving credit facility as of June 30, 2003.
At the Company's option, borrowings under the five-year credit facility bear
interest at a rate equal to (1) LIBOR, or (2) the greater of the prime rate
established by National City Bank, Cleveland, Ohio, and the Federal Funds
effective rate plus 0.5% (Prime Rate); plus, in each case, applicable margins
based upon a combination of the Company's index debt rating and the ratio of the
Company's total debt to EBITDA (earnings before interest, taxes, depreciation
and amortization). The weighted average interest rate in effect at June 30,
2003, for the revolving credit facility was 2.98%, and that in effect at
December 31, 2002, was 2.54 %.
The Company's credit facility contains customary operating covenants that limit
its ability to engage in certain activities, including significant acquisitions.
Several of the covenants contain additional restrictions based upon the ratio of
total debt to EBITDA or in the event the Company's senior debt ceases to be
rated investment grade by either Moody's Investor Service (Moody's) or Standard
& Poor's Rating Group (S&P). The credit facilities also contain financial
covenants relating to minimum fixed charge coverage ratios over certain periods
of time. In December 2002, the Company renegotiated these financial covenants to
provide greater flexibility and strengthen the Company's liquidity profile. The
Company's ability to meet these covenants in the future may be affected by
events beyond its control, including prevailing economic, financial and market
conditions and their effect on the Company's financial position and results of
operations. The Company does have several options available to mitigate these
circumstances, including selected asset sales and the issuance of additional
share capital.
Obligations under the revolving credit facility are unsecured; however, if the
Company's debt ceases to be rated as investment grade by either Moody's or S&P,
the Company and its material subsidiaries would be required to grant, within 30
days from such a rating downgrade, security interests in their principal
manufacturing facilities, pledge 100% of the stock of domestic material
subsidiaries and pledge 65% of the stock of foreign material subsidiaries, in
each case, in favor of the lenders under the senior credit facility. In that
event, liens on principal domestic manufacturing properties and the stock of
domestic subsidiaries would be shared with the holders of the Company's senior
notes and debentures.
The Company's level of debt and debt service requirements could have important
consequences to the Company's business operations and uses of cash flows. In
addition, a reduction in overall demand for the Company's products could
adversely affect the Company's cash flows from operations. However, the Company
has available a $300.0 million revolving credit facility, under which
approximately $141.3 million was available as of June 30, 2003. This liquidity,
along with liquidity from the Company's asset securitization program and the
available cash flows from operations, should allow the Company to meet its
funding requirements and other commitments.
In 2000, the Company initiated a $150.0 million five-year program to sell
(securitize), on an ongoing basis, a pool of its trade accounts receivable.
Under this program, certain of the receivables of the Company are sold to a
wholly-owned unconsolidated qualified special purpose entity, Ferro Finance
Corporation (FFC). FFC can sell, under certain conditions, an undivided
fractional ownership interest in the pool of receivables to a multi-seller
receivables securitization company (Conduit). Additionally, under this program,
receivables of certain European subsidiaries are sold directly to other
conduits. At December 31, 2002, $85.7 million had been advanced to the Company,
net of repayments, under this program. In the second quarter of 2003, $50.6
million, net of advancements, had been repaid to the conduits, resulting in
total advances outstanding of $49.0 million. During the quarter ended June 30,
2003, $312.3 million of accounts receivable were sold under this program and
$362.9 million of receivables were collected and remitted to the conduits,
resulting in a net reduction in borrowings of $50.6 million. In the first six
months of 2003, $36.7 million, net of advancements, had been repaid to the
conduits, resulting in total advances outstanding of $49.0 million. During the
six months ended June 30, 2003, $632.2 million of accounts receivable were sold
under this program and $668.9 million of receivables were collected and remitted
to the Conduits, resulting in a net reduction in borrowings of $36.7 million.
The Company and certain European subsidiaries on behalf of FFC and the Conduits
provide service, administration and collection of the receivables. FFC and the
Conduits have no recourse to the Company's other assets for failure of debtors
to pay when due. The accounts receivable securitization facility contains a
provision under which the agent can terminate the facility if the Company's
senior credit rating is downgraded below BB by S&P or Ba2 by Moody's.
The Company retains interest in the receivables transferred to FFC and Conduits
in the form of a note receivable to the extent that
6
receivables transferred exceed advances. The note receivable balance was $113.2
million as of June 30, 2003, and $23.8 million as of December 31, 2002, and is
included in other current assets in the condensed consolidated balance sheets.
The Company and certain European subsidiaries, on a monthly basis, measure the
fair value of the retained interests at management's best estimate of the
undiscounted expected future cash collections on the transferred receivables.
Actual cash collections may differ from these estimates and would directly
affect the fair value of the retained interests.
The maintenance of minimum cash balances is informally agreed to with certain
banks as a result of loans, commitments and services rendered. Cash balances
maintained to meet operating needs on a daily basis are sufficient to satisfy
these informal agreements. These balances are available for use by the Company
and its subsidiaries at all times and do not contain legal restrictions. Cash in
excess of such operating requirements may be invested in short-term securities
or applied against short-term debt.
5. EARNINGS PER SHARE COMPUTATION
Basic earnings per share is computed as net income available to common
shareholders divided by average basic shares outstanding. Diluted earnings per
share is computed as net income adjusted for the tax effect associated with
assumed conversion of preferred stock and common stock options to common stock
divided by average diluted shares outstanding.
Information concerning the calculation of basic and diluted earnings per share
is shown below:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
------------ ------------ ------------ ------------
Net Income ........................ $ 7,423 $ 14,007 $ 16,807 $ 21,227
Tax effect on assumed conversion of
convertible preferred stock ..... -- (115) -- (240)
------------ ------------ ------------ ------------
Adjusted Net Income ............... $ 7,423 $ 13,892 $ 16,807 $ 20,987
============ ============ ============ ============
Average Basic Shares
Outstanding ...................... 40,730,581 37,662,108 40,661,723 36,151,656
Adjustments for Assumed
Conversion of Convertible
Preferred Stock and
Common Stock Options ............. 231,135 3,024,966 195,227 3,008,942
------------ ------------ ------------ ------------
Average Diluted Shares .................... 40,961,716 40,687,074 40,856,950 39,160,598
============ ============ ============ ============
For the three and six month periods ended June 30, 2003, there were common
equivalents of 1,707,949 shares for convertible preferred stock that were
excluded from the computation of diluted EPS as they had anti dilutive impact.
6. ACQUISITIONS
On September 7, 2001, the Company acquired from OM Group, Inc. (OMG) certain
businesses previously owned by dmc2 Degussa Metals Catalysts Cerdec AG (dmc2)
pursuant to an agreement to purchase certain assets of dmc2, including shares of
certain of its subsidiaries. The Company paid $8.5 million in cash for the
settlement of certain pre acquisition contingencies with dmc2 in the first
quarter of 2003 that resulted in a corresponding increase in goodwill recorded
on acquisition.
7
7. REALIGNMENT AND COST REDUCTION PROGRAMS
The following table summarizes the activities relating to the Company's reserves
for realignment and cost reduction programs:
OTHER
(dollars in thousands) SEVERANCE COSTS TOTAL
--------- ------- -------
(AUDITED)
Balance, December 31, 2002 $ 13,867 $ 132 $ 13,999
(UNAUDITED) 1,310 28 1,338
Gross charges ............ (467) 0 (467)
Adjustments ..............
Cash Payments ............ (3,413) (132) (3,545)
Balance, June 30, 2003 ... $ 11,297 $ 28 $ 11,325
Charges in the six months ended June 30, 2003, relate to the Company's ongoing
cost reduction and integration programs. These programs include employment cost
reductions in response to a slowdown in general economic conditions and
integration synergy plans relating to the acquisition of certain businesses of
dmc2. Total gross charges, for the three months ended June 30, 2003, of $0.5
million were included in selling, administrative and general expenses. Total
gross charges, for the six months ended June 30, 2003, of $0.5 million and $0.8
million were included in cost of sales and selling, administrative and general
expenses, respectively. No charges for discontinued operations were incurred in
2003.
Through June 30, 2003, the amount of severance costs paid under these
realignment and cost reduction programs was $21.6 million and 1,012 employees
had actually been terminated.
The utilization of charges associated with realignment and cost reduction
programs for the remaining balance of $11.3 million is expected to be completed
by the fourth quarter of 2004. The Company will continue to evaluate further
steps to reduce costs and improve efficiencies. If fully implemented, these
actions may result in pretax charges of $10.0 million to $12.0 million during
the second half of 2003.
8. DISCONTINUED OPERATIONS
On September 30, 2002, the Company completed the sale of its Powder Coatings
business unit, previously part of its Coatings segment, in separate transactions
with Rohm and Haas Company and certain of its wholly-owned subsidiaries and
certain wholly-owned subsidiaries of Akzo Nobel NV, for an aggregate selling
price of $132.0 million.
On June 30, 2003, the Company completed the sale of its Petroleum Additives
business, previously part of its Performance Chemicals segment, to Dover
Chemicals for an aggregate selling price of $17.0 million of which $9.0 million
is in the form of a note receivable and will be settled by December 31, 2005.
On June 30, 2003, the Company completed the sale of its Specialty Ceramics
business, previously part of its Coatings segment, to CerCo LLC for an aggregate
selling price of $22.0 million of which $2.0 million is in the form of a note
receivable and will be settled by June 30, 2004.
Selling prices are subject to certain post-closing adjustments with respect to
assets sold and liabilities assumed by the buyers. Powder Coatings, which was
divested in September 2002, and the Petroleum Additives and Specialty Ceramics
businesses, which were divested in June 2003, have been reported as discontinued
operations since the third quarter of 2002. Previously reported results in the
Condensed Income Statement for the three months and six months ended June 30,
2002, have been reclassified to conform with the presentation for the three
months and six months ended June 30, 2003.
Sales from discontinued operations were $14.2 million and $67.4 million for the
quarters ended June 30, 2003, and 2002, respectively, and were $30.0 million and
$129.1 million for the six months ended June 30, 2003, and 2002, respectively.
Earnings/(loss) net of tax from discontinued operations were $(0.9) million and
$2.2 million for the quarters ended June 30, 2003, and 2002 respectively. Pretax
earnings/(loss) from discontinued operations were $(1.4) million and $3.3
million for the quarters
8
ended June 30, 2003, and 2002 respectively. Earnings/(loss) net of tax from
discontinued operations were $(0.9) million and $4.6 million for the six months
ended June 30, 2003, and 2002 respectively. Pretax earnings/(loss) from
discontinued operations were $(1.5) million and $6.6 million for the six months
ended June 30, 2003, and 2002 respectively. The results of discontinued
operations include the operating earnings of the discontinued units as well as
interest expense, foreign currency gains and losses, other income or expenses
and income taxes directly related to, or allocated to, the discontinued
operations. Interest was allocated to discontinued operations assuming debt
levels approximating the estimated or actual debt reductions upon disposal of
the operations, and the Company's actual weighted average interest rates for the
first half of 2003 and 2002, respectively. The financial statements for all
periods presented have been revised to reflect the discontinued operations.
Consequently, much of the information previously filed in the prior year will
not be directly comparable to the revised numbers.
9. CONTINGENT LIABILITIES
There are various lawsuits and claims pending against the Company and its
consolidated subsidiaries. In the opinion of management, the ultimate
liabilities (if any) and expenses resulting from such lawsuits and claims will
not materially affect the consolidated financial position, results of operations
or liquidity of the Company.
In February 2003, the Company was requested to produce documents in connection
with an investigation by the United States Department of Justice into possible
antitrust violations in the heat stabilizer industry. Subsequently, the Company
received several class action lawsuits alleging civil damages and requesting
injunctive relief as a result of this investigation. The Company has no reason
to believe that it or any of its employees engaged in any conduct that violated
the antitrust laws. The Company is cooperating with the Department of Justice in
its investigation and is vigorously defending itself in the class action
lawsuits. Management does not expect this investigation to have a material
effect on the consolidated financial position, results of operations or
liquidity of the Company.
10. STOCK PLANS
The stock option plan provides for the issuance of stock options at no less than
the then current market price. Stock options have a maximum term of 10 years and
vest evenly over four years on the anniversary of the grant date.
The Company continues to account for stock-based compensation in accordance with
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees," (APB 25), and related interpretations as permitted under FASB
statement No. 148, "Accounting for Stock-Based Compensation-Transition and
Disclosure." Compensation cost for the Company's stock option plan of $0.1
million (after tax basis) in the second quarter of 2003 has been determined in
accordance with APB 25 and the Company's net income and earnings per share
reflect this expense. On a pro forma basis, had compensation cost for the
Company's stock option plan been determined based on the fair value at the grant
date under the fair value recognition provisions of FASB Statement No. 123
"Accounting for Stock-Based Compensation," the Company's net income and earnings
per share for the three months and six months ended June 30, 2003, would have
been reduced to the pro forma amounts shown below:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
(dollars in thousands, except per share data) 2003 2002 2003 2002
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
----------- ----------- ----------- -----------
Income from continuing operations less preferred dividends--as reported $ 5,326 $ 11,153 $ 14,232 $ 15,395
Deduct: Total stock-based employee compensation expense
determined under fair value methods for all awards, net
of tax ......................................................... (784) (967) (1,402) (1,667)
Income from continuing operations--pro forma .......................... $ 4,542 $ 10,186 $ 12,830 $ 13,728
Basic earnings per share from continuing operations--as reported ...... $ 0.13 $ 0.30 $ 0.35 $ 0.42
Basic earnings per share from continuing operations--pro forma ........ $ 0.11 $ 0.27 $ 0.32 $ 0.37
Diluted earnings per share from continuing operations--as reported .... $ 0.13 $ 0.29 $ 0.34 $ 0.42
Diluted earnings per share from continuing operations--pro forma ...... $ 0.11 $ 0.27 $ 0.31 $ 0.38
9
There was no impact from discontinued operations on the pro forma expense for
the second quarters and first six months of 2003 and 2002.
11. REPORTING FOR SEGMENTS
In determining reportable segments, the Company considers its operating and
management structure and the types of information subject to regular review by
its chief operating decision-maker. The Company has two reportable segments
consisting of coatings and performance chemicals. Coatings products include tile
coating systems, porcelain enamel, color and glass performance materials and
electronic materials systems. Performance chemicals consist of polymer
additives, pharmaceuticals, fine chemicals and plastics.
The accounting policies of the segments are consistent with those described for
the consolidated financial statements in the summary of significant accounting
policies. The Company measures segment profit for reporting purposes as net
operating profit before interest and taxes. Net operating profit excludes
unallocated corporate expenses. A complete reconciliation of segment income to
consolidated income before tax is presented below. Sales to external customers
are presented in the following table. Inter-segment sales are not material.
FERRO CORPORATION AND SUBSIDIARIES
SEGMENT DATA
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
Net sales 2003 2002 2003 2002
(dollars in thousands) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
----------- ----------- ----------- -----------
Coatings.................... $275,039 $263,492 $535,015 $496,332
Performance Chemicals....... 141,139 144,924 282,933 277,107
------- ------- ------- -------
Total.............................. $416,178 $408,416 $817,948 $773,439
======== ======== ======== ========
Income and reconciliation to segment income (loss) before taxes from continuing
operations follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
(dollars in thousands) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
----------- ----------- ----------- -----------
Coatings ................. $22,391 $25,891 $46,592 $46,260
Performance Chemicals 8,176 13,310 17,164 22,719
------- ------- ------- -------
Segment income .................... $30,567 $39,201 $63,756 $68,979
Less
Unallocated expenses ....... 9,928 6,494 17,468 12,081
Interest expense ........... 8,915 11,596 17,699 23,611
Foreign currency loss ...... 1,204 900 2,393 1,676
Miscellaneous - net ........ 3,067 2,245 4,591 5,695
------- ------- ------- -------
Income before taxes from
continuing operations ............. $ 7,453 $17,966 $21,605 $25,916
======= ======= ======= =======
Geographic information follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
Net sales 2003 2002 2003 2002
(dollars in thousands) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
----------- ----------- ----------- -----------
United States................ $198,254 $200,612 $395,477 $385,782
International................ 217,924 207,804 422,471 387,657
-------- -------- -------- --------
Total.............................. $416,178 $408,416 $817,948 $773,439
======== ======== ======== ========
10
Geographic revenues are based on the region in which the customer invoice
originates. The United States of America is the single largest country for the
origination of customer sales. No other single country originates more than 10%
of consolidated sales.
12. NEW ACCOUNTING POLICIES
In July 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." Statement No. 146 applies to costs
from activities such as eliminating or reducing product lines, terminating
employees and contracts, and relocating plant facilities or personnel. The
Company adopted FASB Statement No. 146 as of January 1, 2003, and accordingly,
records exit or disposal costs when they are "incurred" and can be measured at
fair value. The adoption of Statement No. 146 did not have a material impact on
the Company's results of operations or financial position for the three months
and six months ended June 30, 2003.
In December 2002, the FASB Issued Statement No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which amends Statement No. 123
"Accounting for Stock-Based Compensation." Statement No. 148 provides
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock based employee compensation. In addition,
Statement No. 148 amends the disclosure requirements of Statement No. 123 to
require more prominent and more frequent disclosures in financial statements
about the effects of stock-based compensation. The transition guidance and
annual disclosure provisions of Statement No. 148 were effective for fiscal
years ended after December 15, 2002, with earlier application permitted in
certain circumstances. The Company continues to account for stock-based
compensation expense in accordance with Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees," and related interpretations, as
permitted under Statement No. 148. The Company adopted the annual disclosure
provisions of Statement No. 148 as of December 31, 2002, and accordingly, has
included the required disclosure for the interim periods ended on June 30, 2003,
and 2002 in note 10 to the condensed financial statements.
In April 2003, the FASB issued statement No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." Statement No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities accounted
for under Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities." The adoption of Statement No. 149 will not have a material impact
on the Company's results of operations or financial position.
In May 2003, the FASB issued statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity."
Statement No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. Some of the provisions
of this Statement are consistent with the current definition of liabilities in
FASB Concepts Statement No. 6, "Elements of Financial Statements." The remaining
provisions of this Statement are consistent with the Board's proposal to revise
that definition to encompass certain obligations that a reporting entity can or
must settle by issuing its own equity shares, depending on the nature of the
relationship established between the holder and the issuer. While the Board
still plans to revise that definition through an amendment to Concepts Statement
6, the Board decided to defer issuing that amendment until it has concluded its
deliberations on the next phase of this project. That next phase will deal with
certain compound financial instruments including puttable shares, convertible
bonds, and dual-indexed financial instruments. This Statement concludes the
first phase of the Board's redeliberations of the Exposure Draft, Accounting for
Financial Instruments with Characteristics of Liabilities, Equity, or Both. The
adoption of Statement No. 150 will not have a material impact on the Company's
results of operations or financial position.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure requirements for Guarantees, Including Indirect Guarantees of the
Indebtedness of Others." Interpretation 45 expands on the accounting guidance of
Statements No. 5 "Accounting for Contingencies," No. 57, "Related Party
Disclosures," and No. 107, "Disclosures about Fair Value of Financial
Instruments" and incorporates without change the provisions of Interpretation
No. 34, "Disclosure in Indirect Guarantees of Indebtedness of Others, an
Interpretation of FASB Statement No. 5" which is being superceded.
Interpretation 45 elaborates on the existing disclosure requirements for most
guarantees, including loan guarantees such as standby letters of credit. It also
clarifies that at the time an entity issues a guarantee, the entity must
recognize an initial liability for the fair value, or market value, of the
obligations it assumes under that guarantee and must disclose that information
in its interim and annual financial statements. The initial recognition and
measurement provisions of Interpretation 45 apply on a prospective basis to
guarantees issued or
11
modified after December 31, 2002, regardless of an entity's year-end. The
disclosure requirements of Interpretation 45 are effective for financial
statements of interim or annual periods ended after December 15, 2002.
Accordingly, the Company adopted the disclosure requirements of Interpretation
45 for the year ended December 31, 2002, and the interpretation in its entirety
as of January 1, 2003. The adoption of Interpretation 45 did not have a material
impact on the Company's results of operations or financial position.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." Interpretation 46 addresses consolidation by
business enterprises of variable interest entities and requires existing
unconsolidated variable interest entities to be consolidated by their primary
beneficiaries if the entities do not effectively disperse risk among parties
involved. It is based on the concept that companies that control another entity
through interests other than voting interests should consolidate the controlled
entity. The Company bought out its asset defeasance program in June of 2003 and
therefore the adoption of Interpretation 46 will not have a material impact on
the Company's results of operations or financial position.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
In September 2002, the Company completed the sale of its Powder Coatings
business and in June 2003, the Company completed the sales of its Petroleum
Additives and Specialty Ceramics business units, and accordingly, as of June 30,
2003, and for all periods presented, these businesses have been reported as
discontinued operations. The discussions presented below under "Results of
Operations" focus on the Company's results from continuing operations.
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2003, AND 2002
Second quarter 2003 net sales from continuing operations of $416.2 million were
1.9% higher than the $408.4 million of sales for the comparable 2002 period.
Sales increased 4.4% in the Coatings segment and declined by 2.6% in the
Performance Chemicals segment.
The strengthening of the European currency had a favorable impact on sales of
$24.3 million or 5.8 percentage points of total sales in the second quarter,
2003. Volume unfavorably impacted sales by 8.0% for the quarter as compared to
the prior year period as demand softened in North America and Europe. This was
partially offset by higher selling prices in the polymer additives and plastics
businesses. Market conditions improved for electronics, pharmaceuticals and
container glass, but there was not the typical seasonal demand for the building
and renovation markets. European demand has not rebounded after several soft
quarters and the North American recovery has been very inconsistent. The
Asia-Pacific region has faced some challenges as well, but demand growth has
been fairly resilient.
Gross margins from continuing operations were 23.6% of sales compared with 26.1%
for the comparable 2002 period. The lower gross margins compared to the prior
year primarily stemmed from the absorption impact of lower volumes in the tile
and polymer additives businesses and raw material cost increases in the
Performance Chemicals segment. The gross margins for the second quarter were
unfavorably impacted by a loss of $1.4 million related to the buy out of a $25.0
million off-balance sheet operating lease for certain land, buildings and
machinery.
Selling, administrative and general expenses from continuing operations were
$77.4 million in the second quarter of 2003 compared with $74.0 million in the
second quarter of 2002. Of the $3.4 million increase in selling, administrative
and general expenses, $4.4 million was caused by the strengthening of the euro
against the dollar and higher pension expense and research & development
spending in our electronics and pharmaceuticals businesses increased these
expenses by an additional $2.3 million. These increases were partially offset by
integration savings and other expense reduction initiatives.
Interest expense from continuing operations was $8.9 million for the second
quarter of 2003, compared with $11.6 million for the second quarter of 2002. The
decline is the result of a debt reduction program that included the sale of five
million common shares through a public offering on May 15, 2002, the divestment
of the Powder Coatings business in September 2002 and lower interest rates.
Income tax as a percentage of pre tax income for the quarter ended June 30,
2003, was 21.4% compared with 34.5% in the same period of 2002. Contributing to
this decline in the effective tax rate were tax benefits realized from export
sales, utilization of net operating loss carry-forwards that were fully reserved
and a higher proportion of earnings in jurisdictions having lower statutory
12
tax rates and other tax benefits.
Income from continuing operations for the second quarter of 2003 was $5.9
million or 50.2% below the prior year period. Diluted earnings per share for the
second quarter of 2003 from continuing operations totaled $0.13 as compared to
$0.29 in 2002.
Income/(loss) from discontinued operations was ($0.9) million for the second
quarter of 2003 as compared with $2.2 million in the prior year period. Prior
year results included the Powder Coatings business unit, which was divested in
September 2002, and the Petroleum Additives and Specialty Ceramics business
units, which were divested in June, 2003. Income from the discontinued Powder
Coatings operations was $1.9 million for the second quarter of 2002. The
disposal of the Petroleum Additives and Specialty Ceramics business units netted
a gain of $2.4 million in the second quarter of 2003. Diluted earnings per share
for discontinued operations totaled $0.04 compared to $0.05 in 2002.
Net Income for the second quarter of 2003 totaled $7.4 million or a decrease of
47.0% compared with the prior year period. Earnings per diluted share were $0.17
in the second quarter of 2003 versus $0.34 in 2002.
QUARTERLY SEGMENT RESULTS
Sales in the Coatings segment were $275.0 million in the second quarter,
compared with second quarter 2002 sales of $263.5 million. The increase in sales
is primarily due to the effect of the strengthening European currency. There was
also improved global market demand for electronics and continued strong demand
in the container glass market in North America. This was offset by lower end
market demand for appliances and building and renovation products in Europe and
the United States. Operating income was $22.4 million in the second quarter
2003, compared with $25.9 million in the prior year quarter. The impact of lower
volume was minimized by the capture of cost synergies and improved manufacturing
efficiencies.
Sales in the Performance Chemicals segment were $141.1 million in the second
quarter, compared with second quarter 2002 sales of $144.9 million. The decline
was the result of lower demand for durable goods and the building and renovation
end markets, offsetting improved conditions for pharmaceuticals and fine
chemicals. The polymer additives business experienced higher raw material costs
and customers in the PVC industry suffered volume declines as high as 15 percent
during an industry wide inventory correction in the second quarter. Plastics
also experienced higher raw material costs and the impact of soft end market
conditions, especially appliances. Operating income was $8.2 million in the
quarter, compared with $13.3 million in the prior year quarter. The lower
operating income was due primarily to the impact of reduced sales volume and
higher raw material costs in the polymer additives and plastics business units.
GEOGRAPHIC SALES
Sales in the United States were $198.3 million for the three months ended June
30, 2003, compared with $200.6 million for the three months ended June 30, 2002.
The decline in the United States was primarily related to lower sales in the
Performance Chemicals segment. International sales were $217.9 million for the
three months ended June 30, 2003, compared with $207.8 million for the three
months ended June 30, 2002. The international sales increase occurred in Europe
and was primarily due to the strengthening of the euro against the dollar.
RESULTS OF OPERATIONS
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2003, AND 2002
Sales from continuing operations for the first six months of 2003 of $817.9
million were 5.8% higher than the $773.4 million of sales for the comparable
2002 period. Sales increased 7.8% in the Coatings segment and 2.1% in the
Performance Chemicals segment.
The strengthening of the European currency had a favorable impact on sales of
$51.1 million or 6.2 percentage points of total sales for the six months ended
June 30, 2003. Volume unfavorably impacted sales by 4.8% for the quarter as
compared to the prior year period. Several key end markets contributed to lower
volumes including durable goods, automotive and the building and renovation
market. This was partially offset by an improvement in the semiconductor
industry and higher selling prices in the polymer additives and plastics
business units to offset raw material increases.
Gross margins from continuing operations were 24.3% of sales compared with 25.9%
for the prior year period. The reduced gross margins compared to the prior year
primarily stemmed from lower volumes and raw material cost increases in the
Performance
13
Chemicals segment. The gross margins for the first half of 2003 were unfavorably
impacted by a loss of $1.4 million related to the buy out of a $25.0 million
off-balance sheet operating lease for certain land, buildings and machinery.
Selling, administrative and general expenses from continuing operations were
$152.9 million for the first six months of 2003 compared with $143.2 million for
the same period in 2002. Of the $9.7 million increase in selling, administrative
and general expenses, $9.4 million was caused by the strengthening of the euro
against the dollar and higher pension expense and research & development
spending in our electronics and pharmaceuticals businesses increased these
expenses by an additional $4.4 million. The increases were partially offset by
integration savings and other expense reduction initiatives.
The first half 2003 earnings included pretax charges of $0.9 million related
primarily to severance and integration costs and the first half of 2002 included
approximately $3.3 million of similar charges.
Interest expense from continuing operations was $17.7 million for the first six
months of 2003, compared to $23.6 for the first six months of 2002. This is the
result of a debt reduction program that included sale of five million common
shares through a public offering on May 15, 2002, the divestment of the Powder
Coatings business in September 2002 and lower interest rates.
Income tax as a percentage of pre tax income for the six months ended June 30,
2003, was 29.1% compared with 35.7% in the same period of 2002. Contributing to
this decline in the effective tax rate were tax benefits realized from export
sales, utilization of net operating loss carry-forwards that were fully reserved
and a higher proportion of earnings in jurisdictions having lower statutory tax
rates and other tax benefits.
Income from continuing operations for the first half of 2003 was $15.3 million
or 8.2% lower than the prior year period. Diluted earnings per share for
continuing operations totaled $0.34 as compared to $0.42 in 2002.
Income/(loss) from discontinued operations was ($0.9) million for the first half
of 2003 as compared to $4.6 million in the prior year period. Prior year results
included the Company's Powder Coatings business unit, which was divested in
September 2002, and the Petroleum Additives and Specialty Ceramics business
units, which were divested in June 2003. Income from the discontinued Powder
Coatings operations was $3.5 million for the first half of 2002. The disposal of
the Petroleum Additives and Specialty Ceramics business units netted a gain of
$2.4 million in the second quarter of 2003. Diluted earnings per share for
discontinued operations totaled $0.04 for the six months ended June 30, 2003
compared to $0.12 for the same period in 2002.
Net Income for the second quarter 2003 totaled $16.8 million or a decrease of
20.8% over the prior year period. Earnings per diluted share were $0.38 in the
first half of 2003 versus $0.54 in 2002.
FIRST HALF SEGMENT RESULTS
Sales in the Coatings segment were $535.0 million in the first half of 2003,
compared with first half 2002 sales of $496.3 million. The increase in sales is
primarily due to the effect of currency exchange rates. Improved demand for
electronics and the glass markets was partially offset by sluggish building and
renovation activity. Operating income was $46.6 million in the first half,
compared with $46.3 million in the first half of the prior year. Improved
earnings are due primarily to the capture of cost synergies.
Sales in the Performance Chemicals segment were $282.9 million in the first half
of 2003, compared with first half 2002 sales of $277.1 million. The
year-over-year increase in sales was primarily due to the effect of currency
exchange rates, higher prices and improved conditions for pharmaceuticals and
fine chemicals which more than offset the impact on volume of lower demand for
durable goods and the building and renovation end markets. Operating income was
$17.2 million in first half, compared with $22.7 million in the first half of
the prior year. The lower operating income was due primarily to the impact of
reduced sales volume and higher raw material costs in the polymer additives and
plastics business units.
GEOGRAPHIC SALES
Sales in the United States were $395.5 million for the six months ended June 30,
2003, compared with $385.8 million for the six months ended June 30, 2002. The
increase was related to higher sales in the Coatings segment. International
sales were $422.5 million for the six months ended June 30, 2003, compared with
$387.7 million for the six months ended June 30, 2002. The majority of the
international sales increase occurred in Europe was primarily due to the
strengthening of the euro against the dollar.
14
CASH FLOWS
Net cash provided by operating activities of continuing operations was $3.3
million for the six months ended June 30, 2003, compared with cash provided of
$70.3 million for six months ended June 30, 2002. The largest factors impacting
the change were increased pension contributions and higher working capital
reductions in the first half of 2002 than in the first half 2003. Cash used for
investing activities of continuing operations was $27.3 million for the first
half of 2003 versus $18.5 million for the first half of 2002. The higher cash
usage from investing activities this year resulted primarily from the $25.0
million buy out of an operating lease agreement along with purchase price
settlements (payments) of approximately ($8.5) million related to the dmc2
acquisition. These were partially offset by the proceeds from the sales of
petroleum additives and specialty ceramics businesses less a purchase price
settlement (payments) of ($3.1) million related to the divestment of the powder
coatings business. Net cash provided by financing activities for the first half
of 2003, was $21.5 million compared with cash used by financing activities for
the first half of 2002 of $62.4 million. The year-over-year change was primarily
due to increases in borrowing during the first half of 2003 as compared to the
repayment of debt in the prior year period.
Net cash used for operating activities of discontinued operations was $0.9
million for the first half of 2003, compared with cash provided of $16.7 million
for the same period of 2002. The difference is due primarily to the inclusion of
the results of the Powder Coatings business, which was sold in September 2002,
in the cash flow for the first half of 2002. Net cash used for investing
activities of discontinued operations was $0.4 million for the first half of
2003, and $0.2 million for the first half of 2002.
OUTLOOK
After experiencing a rebound in demand in the first quarter 2003, the second
quarter did not show sequential improvement. Lower sales volumes due to soft
market conditions in Europe and North America, combined with higher raw material
and energy costs, are impacting our ability to increase earnings. Despite these
challenging conditions, the Company continued to make progress lowering our debt
levels, helped in part by the divestiture proceeds. Until there are clear signs
an economic recovery is underway, the Company will be aggressive in management
of working capital, discretionary spending and debt. The Company remains
convinced that the strategic and operational initiatives undertaken during the
past eighteen to twenty-four months position Ferro for significant revenue and
earnings growth going forward.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity requirements include primarily debt service, working
capital requirements, capital investments, post-retirement benefits and
dividends. The Company expects to be able to meet its liquidity requirements
from a variety of sources, including cash flow from operations and use of its
credit facilities or long-term borrowings. The Company has a $300.0 million
revolving credit facility, of which $141.3 million was available as of June 30,
2003. See further information regarding the Company's credit facilities included
in Note 4 to the Company's condensed consolidated financial statements.
The Company also has an accounts receivable securitization facility under which
the Company may receive advances of up to $150.0 million, subject to the level
of qualifying accounts receivable. At December 31, 2002, $85.7 million had been
advanced to the Company, net of repayments, under this program. As of June 30,
2003, $49.0 million had been advanced to the Company, net of repayments, under
this program. Under FASB Statement No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities - a replacement
of FASB Statement No. 125" neither the amounts advanced nor the corresponding
receivables sold are reflected in the Company's consolidated balance sheet. See
further information regarding the securitization facility included in Note 4 to
the Company's condensed consolidated financial statements.
Obligations under the revolving credit facilities are unsecured; however, if the
Company's debt ceases to be rated as investment grade by either Moody's or S&P,
the Company and its material subsidiaries would be required to grant security
interests in its principal manufacturing properties, pledge 100% of the stock of
material domestic subsidiaries and pledge 65% of the stock of material foreign
subsidiaries, in each case, in favor of the Company's lenders under such
facilities. In that event, liens on principal domestic manufacturing properties
and the stock of domestic subsidiaries would be shared with the holders of the
Company's senior notes and debentures. The accounts receivable securitization
facility contains a provision under which the agent can terminate the facility
if the Company's senior credit rating is downgraded below BB by S&P or Ba2 by
Moody's. Ferro does not believe that the termination of this facility would
reasonably be expected to have a material adverse effect on the Company's
15
liquidity or the Company's capital resource requirements.
The rating agencies may, at any time, based on various factors including
changing market, political or socio-economic conditions, reconsider the current
rating of the Company's outstanding debt. Based on rating agency disclosures,
Ferro understands that ratings changes within the general industrial sector are
evaluated based on quantitative, qualitative and legal analyses. Factors
considered by the rating agencies include: industry characteristics, competitive
position, management, financial policy, profitability, capital structure, cash
flow production and financial flexibility. S&P and Moody's have disclosed that
the Company's ability to improve earnings, reduce the Company's level of
indebtedness and strengthen cash flow protection measures, whether through asset
sales, increased free cash flows from acquisitions or otherwise, will be factors
in their ratings determinations going forward.
The Company's credit facility contains customary operating covenants that limit
its ability to engage in certain activities, including significant acquisitions.
See further information regarding these covenants in Note 4 to the Company's
condensed consolidated financial statements. The Company's ability to meet these
covenants in the future may be affected by events beyond its control, including
prevailing economic, financial and market conditions and their effect on the
Company's financial position and results of operations. The Company does have
several options available to mitigate these circumstances, including selected
asset sales and the issuance of additional capital. In December 2002, the
Company renegotiated these financial covenants to provide greater flexibility
and strengthen the Company's liquidity profile.
The Company enters into precious metal leases (primarily gold, silver, platinum
and palladium), which are consignment inventory arrangements under which banks
provide the Company with precious metals for a specified period for which the
Company pays a lease fee. The lease terms are generally less than one year, and
the Company maintains sufficient quantities of precious metals to cover the
lease obligations at all times. The leases are treated as operating leases, and
expenses were approximately $0.3 million for the quarter ended June 30, 2003,
compared with $0.5 million for the three months ended June 30, 2002. As of June
30, 2003, the fair value of precious metals under leasing arrangements was $60.9
million. Management believes it will continue to have sufficient availability
under these leasing arrangements so that it will not be required to purchase or
find alternative financing or sourcing arrangements for its precious metal
inventory requirements. However, factors beyond the control of the Company, or
those that management currently believes are unlikely, could result in
non-renewal of the leases, which could impact the liquidity of the Company to
the extent of the fair value of the precious metals leased. The Company uses
derivative financial instruments to manage the price risk for a portion of our
annual requirements for natural gas. In compliance with FASB Statement No. 133,
the Company recorded these contracts on its balance sheet at June 30, 2003. The
offset was to Stockholders' Equity and there was no impact to income. These
instruments, that have maturity dates that coincide with the Company's expected
purchases of the natural gas, allow the Company to effectively establish its
cost for gas at the time the Company enters into the instrument. To the extent
the Company has not entered into derivative financial instruments, our cost of
natural gas will increase or decrease as the market prices for the commodities
rise and fall.
Ferro's level of debt and debt service requirements could have important
consequences to its business operations and uses of cash flow. In addition, a
reduction in overall demand for the Company's products could adversely affect
cash flows from operations. However, the Company has a $300.0 million revolving
credit facility of which approximately $141.3 million was available as of June
30, 2003. This liquidity, along with the liquidity from the Company's asset
securitization program of $101.0 million and available cash flows from
operations, should allow the Company to meet its funding requirements and other
commitments.
CRITICAL ACCOUNTING POLICIES
There were no significant changes to critical accounting policies since December
31, 2002. Please refer to the 2002 10-K filing for a detailed description of
Critical Accounting Policies.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's exposure to market risks is primarily limited to interest rate and
foreign currency fluctuation risks. Ferro's exposure to interest rate risk
relates primarily to its debt portfolio including off balance sheet obligations
under the accounts receivable securitization program. The Company's interest
rate risk management objective is to limit the effect of interest rate changes
on earnings, cash flows and overall borrowing costs. To limit interest rate risk
on borrowings, the Company maintains a portfolio of fixed and variable debt
within defined parameters. In managing the percentage of fixed versus variable
rate debt, consideration is given to the interest rate environment and
forecasted cash flows. This policy limits exposure from rising interest rates
and allows the Company to benefit during periods of falling rates. The Company's
interest rate exposure is generally limited
16
to the amounts outstanding under the revolving credit facility and amounts
outstanding under its asset securitization program. Based on the amount of
variable-rate indebtedness outstanding at December 31, 2002, a 1% change in
interest rates would have resulted in a $2.1 million increase in expense for the
year 2002. A 1% change in interest rates would have resulted in a $0.5 million
in expense for the second quarter of 2003 and $1.1 million for the first half of
2003.
At June 30, 2003, the Company had $350.4 million of fixed rate debt outstanding
with a weighted average interest rate of 8.4%, all maturing after 2007. The fair
market value of these debt securities was approximately $377.9 million at June
30, 2003.
Ferro manages its currency risks principally through the purchase of put options
and by entering into forward contracts. Put options are purchased to protect the
value of euro-denominated earnings against a depreciation of the euro versus the
U.S. dollar. Forward contracts are entered into to mitigate the impact of
currency fluctuations on transaction and other exposures.
At June 30, 2003, the Company held forward contracts to manage its foreign
currency transaction exposures, which had a notional amount of $63.2 million,
and held other contracts of a non-transactional nature, which had a notional
amount of $6.5 million. The Company also held put options to sell euros for U.S.
dollars with a notional amount of $7.6 million and an average strike price of
$1.03/euro. At June 30, 2003, these forward contracts and options had an
aggregate fair value of $(0.3) million.
A 10% appreciation of the U.S. dollar would have resulted in a $0.4 million and
$1.6 million increase in the fair value of these contracts in the aggregate at
June 30, 2003, and December 31, 2002, respectively. A 10% depreciation of the
U.S. dollar would have resulted in a $0.3 million and $1.5 million decrease in
the fair value of these contracts in the aggregate at June 30, 2003, and
December 31, 2002, respectively.
ITEM 4. CONTROLS AND PROCEDURES
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Chairman and Chief
Executive Officer of the Company and the Chief Financial Officer of the Company,
of the effectiveness of the design and operation of the Company's disclosure
controls and procedures pursuant to Exchange Act Rule 13a-15 (e) as of the end
of the period covered by this report. Based upon that evaluation, the Chairman
and Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures are effective in timely alerting
them to material information relating to the Company (including its consolidated
subsidiaries) required to be included in the Company's periodic SEC filings.
There has been no significant change in our internal control over financial
reporting that occurred during the period covered by this report that has
materially affected, or that is reasonably likely to materially affect, our
internal control over financial reporting.
17
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Legal proceedings were reported in the Company's Form 10-K for the year
ended December 31, 2002, and are also covered in Footnote 9 to the Condensed
Consolidated Financial Statements contained herein.
ITEM 2. CHANGE IN SECURITIES AND OF USE OF PROCEEDS.
No change.
ITEM 3. DEFAULT UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the Annual Meeting of Shareholders held on April 25, 2003, there
were a total of 37,336,672 shareholders voting either in person or by proxy.
The shareholders:
A. Elected three directors to the Ferro Corporation Board of Directors,
Jennie S. Hwang, Ph.D., Hector R. Ortino and Padmasree Warrior, to serve on the
Board until the meeting in the year 2006.
The results of the voting for directors were as follows:
Number of Votes - For Withheld Authority
--- ------------------
Jennie S. Hwang, Ph.D. 36,545,200 791,471
Hector R. Ortino 36,163,623 1,173,048
Padmasree Warrior 36,532,991 803,681
The terms of office for Michael H. Bulkin, Sandra Austin Crayton,
William B. Lawrence, Michael F. Mee, William J. Sharp, Dennis W.
Sullivan and Alberto Weisser continued after the meeting.
B. Approved a proposal to ratify the designation of KPMG LLP as the independent
auditors of the books and accounts of the Company for the current year ended
December 31, 2003. The holders of 36,059,441 shares of Ferro Common and
Preferred Stock voting together as a class voted in favor of the proposal. The
holders of 1,139,843 shares of Ferro Common and Preferred Stock voted against
the proposal. The holders of 137,388 shares of Ferro Common and Preferred Stock
abstained from voting on the issue.
C. Approved a proposal to adopt the 2003 Long-Term Incentive Compensation Plan.
The holders of 29,606,557 shares of Ferro Common and Preferred Stock voting
together as a class voted in favor of the proposal. The holders of 5,074,949
shares of Ferro Common and Preferred Stock voted against the proposal. The
holders of 235,380 shares of Ferro Common and Preferred Stock abstained from
voting on the issue.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) The exhibits listed in the attached Exhibit Index are filed pursuant to
Item 6(a) of the Form 10-Q.
(b) The following reports on Form 8-K have been furnished to the SEC during
the second quarter:
Current Report on Form 8-K (item 12), dated April 22, 2003
Current Report on Form 8-K (item 12), dated April 14, 2003
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FERRO CORPORATION
(Registrant)
Date: August 14, 2003
/s/ Hector R. Ortino
----------------------------------------
Hector R. Ortino
Chairman and Chief Executive Officer
Date: August 14, 2003
/s/ Thomas M. Gannon
----------------------------------------
Thomas M. Gannon
Vice President and Chief Financial Officer
19
EXHIBIT INDEX
The following exhibits are filed with this report or are incorporated here by
reference to a prior filing in accordance with Rule 12b-32 under the Securities
Exchange Act of 1934. (Asterisk denotes exhibits filed with this report.)
Exhibit:
(3) Articles of Incorporation and by-laws
(a) Eleventh Amended Articles of Incorporation. (Reference is made to
Exhibit (3)(a) to Ferro Corporation's Quarterly Report on Form 10-Q for
the three months ended June 30, 1998, which Exhibit is incorporated here
by reference.)
(b) Certificate of Amendment to the Eleventh Amended Articles of
Incorporation of Ferro Corporation filed December 28, 1994. (Reference
is made to Exhibit (3)(b) to Ferro Corporation's Quarterly Report on
Form 10-Q for the three months ended June 30, 1998, which Exhibit is
incorporated here by reference.)
(c) Certificate of Amendment to the Eleventh Amended Articles of
Incorporation of Ferro Corporation filed January 19, 1998. (Reference is
made to Exhibit (3)(c) to Ferro Corporation's Quarterly Report on Form
10-Q for the three months ended June 30, 1998, which Exhibit is
incorporated here by reference.)
(d) Amended Code of Regulations. (Reference is made to Exhibit (3)(d) to
Ferro Corporation's Quarterly Report on Form 10-Q for the three months
ended June 30, 1998, which Exhibit is incorporated here by reference.)
(4) Instruments defining rights of security holders, including indentures
(a) Amended and Restated Shareholder Rights Agreement between Ferro
Corporation and National City Bank, Cleveland, Ohio, as Rights Agent,
dated as of December 10, 1999. (Reference is made to Exhibit 4(k) to
Ferro Corporation's Form 10-K for the year ended December 31, 1999,
which Exhibit is incorporated here by reference.)
(b) The rights of the holders of Ferro's Debt Securities issued and to be
issued pursuant to a Senior Indenture between Ferro and J. P. Morgan
Trust Company, National Association (successor-in-interest to Chase
Manhattan Trust Company, National Association) as Trustee, are described
in the Senior Indenture, dated March 25, 1998. (Reference is made to
Exhibit 4(c) to Ferro Corporation Quarterly Report on Form 10-Q for the
three months ended March 31, 1998, which Exhibit is incorporated here by
reference.)
(c) Form of Security (7-1/8% Debentures due 2028). (Reference is made to
Exhibit 4(a-1) to Ferro Corporation's Form 8-K filed March 31, 1998,
which Exhibit is incorporated here by reference.)
(d) Officer's Certificate dated December 20, 2001, pursuant to Section 301
of the Indenture dated as of March 25, 1998, between the Company and J.
P. Morgan Trust Company, National Association (the successor-in-interest
to Chase Manhattan Trust Company, National Association), as Trustee
(excluding exhibits thereto). (Reference is made to Exhibit 4.1 to Ferro
Corporation's Form 8-K filed December 21, 2001, which Exhibit is
incorporated here by reference.)
(e) Form of Global Note (9-1/8% Senior Notes due 2009). (Reference is made
to Exhibit 4.2 to Ferro Corporation's Form 8-K filed December 21, 2001,
which Exhibit is incorporated here by reference.)
The Company agrees, upon request, to furnish to the Securities and Exchange
Commission a copy of any instrument authorizing long-term debt that does not
authorize debt in excess of 10% of the total assets of the Company and its
subsidiaries on a consolidated basis.
*(11) Computation of Earnings Per Share.
*(31.1) Certification of Principal Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)
*(31.2) Certification of Principal Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)
*(32.1) Certification of Principal Executive Officer Pursuant to 18 U.S.C. 1350.
*(32.2) Certification of Principal Financial Officer Pursuant to 18 U.S.C. 1350.
*(99.1) Condensed Consolidated Statements of Income for Twelve Months Ended June 30, 2003.
20