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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 SEPTEMBER 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 October 31, 2003 there were 41,276,951 shares of Ferro common stock, par
value $1.00, outstanding.
===============================================================================
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FERRO CORPORATION AND SUBSIDIARIES
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
------------ ------------ ------------ ------------
(dollars in thousands- except per share amounts)
Net Sales ................................................ $ 397,010 $ 388,807 $ 1,214,958 $ 1,162,246
Cost of Sales............................................. 307,427 293,577 926,210 866,956
Selling, Administrative and General Expenses.............. 78,864 69,937 231,741 213,099
Other Charges:
Interest Expense....................................... 9,014 9,571 26,713 33,182
Foreign Currency Transactions - Net, (Gain) Loss ...... (36) (1,327) 2,357 349
Miscellaneous Expense - Net ........................... 2,819 3,811 7,410 9,506
------------ ------------ ------------ ------------
Income (Loss) Before Taxes ......................... (1,078) 13,238 20,527 39,154
Income Tax Expense (Benefit) ............................. (321) 3,221 5,971 12,461
------------ ------------ ------------ ------------
Income (Loss) from Continuing Operations ................. (757) 10,017 14,556 26,693
Discontinued Operations
Income (Loss) from Discontinued Operations, Net of Tax -- 2,039 (923) 6,590
Gain on Disposal of Discontinued Operations, Net of Tax -- 32,465 2,417 32,465
Net Income (Loss) ........................................ (757) 44,521 16,050 65,748
Dividend on Preferred Stock .............................. 517 594 1,598 1,875
Net Income (Loss) Available to Common Shareholders ....... $ (1,274) $ 43,927 $ 14,452 $ 63,873
============ ============ ============ ============
Per Common Share Data:
Basic Earnings (Loss)
From Continuing Operations ......................... $ (0.03) $ 0.23 $ 0.31 $ 0.66
From Discontinued Operations ....................... -- 0.86 0.04 1.04
------------ ------------ ------------ ------------
$ (0.03) $ 1.09 $ 0.35 $ 1.70
Diluted Earnings (Loss)
From Continuing Operations ......................... $ (0.03) $ 0.23 $ 0.31 $ 0.65
From Discontinued Operations ....................... -- 0.80 0.04 0.97
------------ ------------ ------------ ------------
$ (0.03) $ 1.03 $ 0.35 $ 1.62
------------ ------------ ------------ ------------
Shares Outstanding:
Average Outstanding ................................... 40,953,873 40,347,707 40,759,106 37,550,340
Average Diluted ....................................... 40,953,873 43,010,001 40,943,904 40,443,732
Actual End of Period .................................. 41,290,954 40,381,678 41,290,954 40,381,678
See Accompanying Notes to Condensed Consolidated Financial Statements
2
CONDENSED CONSOLIDATED BALANCE SHEETS
FERRO CORPORATION AND SUBSIDIARIES
SEPTEMBER 30, DECEMBER 31,
2003 2002
(UNAUDITED) (UNAUDITED)
------------- ------------
(dollars in thousands)
ASSETS
Current Assets:
Cash and Cash Equivalents .......................... $ 19,001 $ 14,942
Accounts and Trade Notes Receivable ................ 174,021 154,533
Notes Receivable ................................... 95,768 23,800
Inventories ........................................ 179,939 183,055
Assets of Businesses Held for Sale ................. -- 27,046
Other Current Assets ............................... 104,188 82,209
---------- ----------
Total Current Assets ............................ $ 572,917 $ 485,585
Net Property, Plant & Equipment ....................... 599,882 577,754
Unamortized Intangible Assets ......................... 421,012 421,274
Other Assets .......................................... 130,769 119,860
---------- ----------
$1,724,580 $1,604,473
========== ==========
LIABILITIES and SHAREHOLDERS' EQUITY
Current Liabilities:
Notes and Loans Payable ............................ $ 9,329 $ 7,835
Accounts Payable ................................... 212,490 207,873
Liabilities of Businesses Held for Sale ............ -- 12,518
Other Accrued Expenses, Other Current Liabilities .. 175,113 175,941
---------- ----------
Total Current Liabilities ....................... $ 396,932 $ 404,167
Long-Term Debt, Less Current Portion .................. 540,678 443,552
Other Non-Current Liabilities ......................... 271,092 284,258
Shareholders' Equity .................................. 515,878 472,496
---------- ----------
$1,724,580 $1,604,473
========== ==========
See Accompanying Notes to Condensed Consolidated Financial Statements
3
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FERRO CORPORATION AND SUBSIDIARIES
NINE MONTHS ENDED
SEPTEMBER 30,
2003 2002
(UNAUDITED) (UNAUDITED)
----------- -----------
(dollars in thousands)
Cash Flow from Operating Activities
Net Cash Provided by Continuing Operations ............ $ 43,904 $ 125,407
Net Cash Provided by (Used for) Discontinued Operations (923) 13,087
--------- ---------
Net Cash Provided by Operating Activities ..................... 42,981 138,494
Cash Flow from Investing Activities
Capital Expenditures for Plant and Equipment
of Continuing Operations ......................... (23,524) (25,026)
Capital Expenditures for Plant and Equipment
of Discontinued Operations ....................... (381) (519)
Divestitures, Net of Cash ............................. 19,685 132,491
Acquisition, Net of Cash .............................. (8,478) --
Buy Out of Operating Lease ............................ (25,000) --
Other Investing Activities ............................ 393 (2,404)
--------- ---------
Net Cash Provided by (Used for) Investing Activities .......... (37,305) 104,542
Cash Flow from Financing Activities
Issuance of Common Stock .............................. -- 131,540
Net Borrowings (Payments) under Short Term Facilities . 1,495 (114,330)
Proceeds from (Repayment of) Long Term Debt ........... 96,627 (280,752)
Net Proceeds from (Payments to) Asset Securitization .. (82,614) 25,434
Sale of Treasury Stock ................................ 1,977 10,324
Cash Dividends Paid ................................... (19,162) (17,796)
Other Financing Activities ............................ (515) (478)
--------- ---------
Net Cash Used for Financing Activities ........................ (2,192) (246,058)
Effect of Exchange Rate Changes on Cash ............. 575 3,583
--------- ---------
Increase in Cash and Cash Equivalents ......................... 4,059 561
Cash and Cash Equivalents at Beginning of Period .............. $ 14,942 $ 15,317
--------- ---------
Cash and Cash Equivalents at End of Period .................... $ 19,001 $ 15,878
========= =========
Cash Paid During the Period for
Interest, Net of Amounts Capitalized .................. $ 10,602 $ 28,775
Income Taxes .......................................... $ 3,968 $ 9,343
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. As indicated below, 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 nine months ended September 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
unrealized gain (loss) adjustments associated with natural gas forward
contracts. Comprehensive income was $6.3 million and $38.7 million for the three
months ended September 30, 2003, and 2002, respectively. Comprehensive income
was $50.6 million and $76.9 million for the nine months ended September 30,
2003, and 2002, respectively. Accumulated other comprehensive loss at September
30, 2003, and December 31, 2002, was $96.4 million and $130.9 million,
respectively.
3. INVENTORIES
Inventories as of September 30, 2003, and December 31, 2002, consisted of the
following:
SEPTEMBER 30, DECEMBER 31,
(dollars in thousands) 2003 2002
(UNAUDITED) (AUDITED)
--------- ---------
Raw Materials ................ $ 42,658 $ 42,177
Work in Process .............. 24,466 17,755
Finished Goods ............... 123,476 133,328
--------- ---------
190,600 193,260
LIFO Reserve ................. (10,661) (10,205)
--------- ---------
Inventories .................. $ 179,939 $ 183,055
========= =========
4. FINANCING AND LONG-TERM DEBT
Long-term debt as of September 30, 2003, and December 31, 2002, was as follows:
SEPTEMBER 30, DECEMBER 31,
(dollars in thousands) 2003 2002
(UNAUDITED) (AUDITED)
------------ ------------
Senior Notes, 9.125%, due 2009......... $196,784 $196,324
Debentures, 7.625%, due 2013 .......... 24,850 24,843
Debentures, 7.375%, due 2015 .......... 24,957 24,954
Debentures, 8.000%, due 2025 .......... 49,498 49,480
Debentures, 7.125%, due 2028 .......... 54,485 54,469
Revolving credit agreement ............ 189,200 91,900
Other ................................. 2,239 2,464
-------- --------
542,013 444,434
Less current portion (A) .............. 1,335 882
-------- --------
Total ................................. $540,678 $443,552
======== ========
(A) Included in notes and loans payable.
5
At September 30, 2003, the Company had $355.0 million principal amount
outstanding under debentures and senior notes, which had an estimated fair
market value of $371.1 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 $189.2 million of borrowings under the five-year
revolving credit facility as of September 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 September 30,
2003, for the revolving credit facility was 2.80%, 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 is downgraded
below Ba2 by Moody's Investor Service (Moody's) or BB by 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 September 2003, the Company renegotiated the fixed charge, leverage and
spring lien 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 senior credit rating is downgraded below BB by S&P or Ba2 by Moody's,
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 a $300.0 million revolving credit facility, under which approximately $110.8
million was available as of September 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. During the nine months ended September
30, 2003, $842.4 million of accounts receivable were sold under this program and
$925.0 million of receivables were collected and remitted to the conduits,
resulting in a net reduction in borrowings of $82.6 million and total advances
outstanding at September 30, 2003 of $3.1 million. During the quarter ended
September 30, 2003, $210.2 million of account receivable were sold under this
program and $256.2 million of receivable were collected and remitted to the
conduits, resulting in a net reduction in borrowings of $46.0 million and total
advances outstanding at September 30, 2003 of $3.1 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 receivables transferred
exceed advances. The note receivable balance was $95.8 million as of September
30, 2003, and $23.8 million
6
as of December 31, 2002. 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 taxes associated with assumed
conversion of preferred stock to common stock and exercise of common stock
options divided by average diluted shares outstanding.
Information concerning the calculation of basic and diluted earnings per share
is shown below:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
------------ ------------ ------------ ------------
Net Income (Loss) .................... $ (757) $ 44,521 $ 16,050 $ 65,748
Tax effect on assumed conversion of
convertible preferred stock ........ -- (111) -- (351)
----------- ----------- ----------- -----------
Adjusted Net Income .................. $ (757) $ 44,410 $ 16,050 $ 65,397
=========== =========== =========== ===========
Average Basic Shares
Outstanding ......................... 40,953,873 40,347,707 40,759,106 37,550,340
Adjustments for Assumed
Conversion of Convertible
Preferred Stock and exercise of
Common Stock Options ................ -- 2,662,294 184,798 2,893,392
----------- ----------- ----------- -----------
Average Diluted Shares ....................... 40,953,873 43,010,001 40,943,904 40,443,732
=========== =========== =========== ===========
For the three and nine month periods ended September 30, 2003, there were common
equivalents of 1,674,571 shares and 1,726,526 shares, respectively, for
convertible preferred stock that were excluded from the computation of diluted
EPS as they had anti-dilutive impact. For the three month period ended September
30, 2003, there were common equivalents of 163,940 shares for exercise of stock
options 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 the 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
--------- ----- -----
Balance, December 31, 2002 $ 13,867 $ 132 $ 13,999
(UNAUDITED)
Gross charges -
First Quarter, 2003 ....... 781 28 809
Second Quarter, 2003 ...... 529 -- 529
Third Quarter, 2003 ....... 10,873 409 11,282
Adjustments -
Second Quarter, 2003 ...... (467) -- (467)
Non Cash Items ............ -- (197) (197)
Cash Payments ............. (5,743) (344) (6,087)
-------- -------- --------
Balance, September 30, 2003 $ 19,840 $ 28 $ 19,868
======== ======== ========
Charges in the nine months ended September 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 September
30, 2003, were $11.3 million of which $2.8 million and $8.5 million were
included in cost of sales and selling, administrative and general expenses,
respectively. Total gross charges, for the nine months ended September 30, 2003,
were $12.6 million of which $3.3 million and $9.3 million were included in cost
of sales and selling, administrative and general expenses, respectively. No
charges for discontinued operations were incurred in 2003.
Through September 30, 2003, the amount of severance costs paid under these
realignment and cost reduction programs was $23.9 million and 1,140 employees
had actually been terminated.
The utilization of reserves associated with realignment and cost reduction
programs for the remaining balance of $19.9 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.
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.
On June 30, 2003, the Company completed the sale of its Petroleum Additives
business, previously part of its Performance Chemicals segment, to Dover
Chemicals.
On June 30, 2003, the Company completed the sale of its Specialty Ceramics
business, previously part of its Coatings segment, to CerCo LLC.
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.
Sales from discontinued operations were $0.0 million and $60.6 million for the
quarters ended September 30, 2003, and 2002, respectively, and were $30.0
million and $189.7 million for the nine months ended September 30, 2003, and
2002, respectively. Earnings (Loss), net of tax, from discontinued operations
were $0.0 million and 2.0 million for the quarters ended September 30,
8
2003, and 2002, respectively. Pretax earnings (loss) from discontinued
operations were $0.0 million and $3.1 million for the quarters ended September
30, 2003, and 2002 respectively. Earnings (loss), net of tax, from discontinued
operations were $(0.9) million and $6.6 million for the nine months ended
September 30, 2003, and 2002 respectively. Pretax earnings (loss) from
discontinued operations were ($1.5) million and $9.7 million for the nine months
ended September 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
respective periods.
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 matter to have a material effect on
the consolidated financial position, results of operations or liquidity of the
Company.
10. STOCK PLANS
The Company's stock option plan provides for the issuance of stock options at no
less than the then current market price. Stock options have a maximum life 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 Financial
Accounting Standards Board (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 (net of tax) for the nine months ended
September 30, 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 nine
months ended September 30, 2003 and September 30, 2002, would have been reduced
to the pro forma amounts shown below:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
(dollars in thousands, except per share data) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
---------- ---------- ---------- ----------
Income (Loss) from continuing operations less preferred dividends--
as reported $ (1,274) $ 9,423 $ 12,958 $ 24,818
Less: Total stock-based employee compensation expense ..................... $ (1,152) $ (948) $ (2,555) $ (2,615)
determined under fair value methods for all awards, net
of tax
Income (Loss) from continuing operations--pro forma ....................... $ (2,426) $ 8,475 $ 10,403 $ 22,203
Basic earnings (loss) per share from continuing operations--as reported .... $ (0.03) $ 0.23 $ 0.31 $ 0.66
Basic earnings (loss) per share from continuing operations--pro forma ...... $ (0.06) $ 0.21 $ 0.26 $ 0.59
Diluted earnings (loss) per share from continuing operations--as reported.. $ (0.03) $ 0.23 $ 0.31 $ 0.65
Diluted earnings (loss) per share from continuing operations--pro forma .... $ (0.06) $ 0.21 $ 0.25 $ 0.59
There was no impact from discontinued operations on the pro forma expense for
all periods presented.
9
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 in
the 2002 10-K filing under 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 charges for cost
reduction and integration programs and unallocated corporate expenses. A
complete reconciliation of segment income to consolidated income before tax is
presented below.
Sales from continuing operations to external customers are presented in the
following table. Inter-segment sales are not material.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
Net sales 2003 2002 2003 2002
(dollars in thousands) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
----------- ----------- ----------- ------------
Coatings ................. $ 262,587 $ 249,975 $ 797,602 $ 746,307
Performance Chemicals..... 134,423 138,832 417,356 415,939
---------- ---------- ---------- ----------
Total .......................... $ 397,010 $ 388,807 $1,214,958 $1,162,246
---------- ---------- ---------- ----------
Income and reconciliation to segment income (loss) before taxes from continuing
operations follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
(dollars in thousands) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
----------- ----------- ----------- -----------
Coatings .................. $ 22,575 $ 26,315 $ 69,167 $ 72,568
Performance Chemicals ..... 5,341 9,410 22,505 32,130
-------- ------- -------- ---------
Segment income ..................... $ 27,916 $ 35,725 $ 91,672 $104,698
-------- -------- -------- --------
Less:
Unallocated expenses ........ 17,197 10,432 34,665 22,507
Interest expense ............ 9,014 9,571 26,713 33,182
Foreign Currency -
(Gain) Loss ................. (36) (1,327) 2,357 349
Miscellaneous - net ......... 2,819 3,811 7,410 9,506
-------- -------- -------- --------
Income (Loss) before taxes from
continuing operations .............. $ (1,078) $ 13,238 $ 20,527 $ 39,154
======== ======== ======== ========
Geographic information follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
Net sales . 2003 2002 2003 2002
(dollars in thousands) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
----------- ---------- ----------- ----------
United States ........ $ 192,325 $ 196,240 $ 587,802 $ 582,022
International ........ 204,685 192,567 627,156 580,224
---------- ---------- ---------- ----------
Total ..................... $ 397,010 $ 388,807 $1,214,958 $1,162,246
========== ========== ========== ==========
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.
10
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 FASB Statement No. 146 did not have an impact on the
financial statements because the Company did not have any termination benefits
as defined by the Statement. During the third quarter of 2003, the Company
recorded restructuring and integration charges as summarized in Footnote 7 of
the consolidated financial statements using the guidance under FASB Statement
No. 88, "Employers' Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits" and FASB Settlement No. 112,
"Employers' Accounting for Postemployment Benefits."
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 September 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 did 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 did 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 of 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 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.
11
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" and in October 2003 published a proposed
Interpretation for public comment by December 1, 2003. The proposed
clarifications and modifications would apply in financial statements for the
period ending after December 15, 2003. 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 adoption of FASB Interpretation No. 46 should not have a material
impact on the Company's results of operations or financial position. In June of
2003, the company bought out its asset defeasance program that would have
required consolidation on adoption of FASB Interpretation No. 46.
The Company uses derivative financial instruments to manage the price risk for a
portion of its forecasted requirements for natural gas. These are termed as cash
flow hedges in accordance with FASB Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities." The Company records these
contracts on its balance sheet at fair market value. Unrealized gains or losses
on the effective portion of such hedges are accounted for as a component of
other comprehensive income in accordance with FASB 133. As of September 30,
2003, no portion of such contracts was considered ineffective.
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
September 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 SEPTEMBER 30, 2003,
AND 2002
Third quarter 2003 net sales from continuing operations of $397.0 million were
2.1% higher than the $388.8 million of sales for the comparable 2002 period.
Sales increased 5.0% in the Coatings segment and declined by 3.2% in the
Performance Chemicals segment. The strengthening of the European currency had a
favorable impact on sales of $17.4 million or 4.5 percentage points of total
sales in the third quarter, 2003. Volume, price, product mix and other currency
movements negatively impacted sales by $9.2 million or 2.4 percentage points.
Gross margins from continuing operations were 22.6% of sales compared with 24.5%
for the comparable 2002 period. The lower gross margins compared to the prior
year primarily stemmed from lower operating rates, lower average product pricing
and higher raw material costs.
Selling, administrative and general expenses from continuing operations were
$78.9 million or 19.9% of sales in the third quarter of 2003 compared with $69.9
million or 18.0% of sales in the third quarter of 2002. The increase in selling,
administrative and general expenses was primarily due to a $3.3 million impact
from a stronger euro, increased restructuring charges of $6.6 million compared
to the year ago period and higher pension and insurance expenses.
Interest expense from continuing operations was $9.0 million for the third
quarter of 2003, compared with $9.6 million for the third quarter of 2002. The
decline is the result of a debt reduction program and lower interest rates.
Income tax as a percentage of pre tax income for the quarter ended September 30,
2003, was 29.8% compared with 24.3% in the same period of 2002. The third
quarter of 2002 tax rate was favorably impacted by tax benefits realized from
export sales, utilization of net operating loss carry-forwards that were fully
reserved, the impact of equity in earnings of non-consolidated entities reported
net of tax, and increased earnings in lower tax rate jurisdictions.
The loss from continuing operations was $(0.8) million for the third quarter of
2003, compared with income of $10.0 million in the corresponding period of 2002.
Diluted earnings (loss) per share from continuing operations for the third
quarter of 2003 totaled $(0.03) as compared to $0.23 in 2002.
12
Income from discontinued operations was $0.0 million for the third quarter of
2003, compared with $2.0 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. A gain on the disposal of the Company's Powder
Coatings business of $32.5 million, net of income taxes of $22.7 million, was
recorded in the quarter ended September 30, 2002. Diluted earnings per share
from discontinued operations totaled $0.00 for the third quarter 2003, compared
with $0.80 in 2002.
Net (loss) totaled $(0.8) million for the third quarter of 2003 compared with
net income of $44.5 million in the prior year period. Diluted earnings (loss)
per share were $(0.03) in the third quarter of 2003 versus $1.03 in 2002.
QUARTERLY SEGMENT RESULTS
Sales in the Coatings segment were $262.6 million in the third quarter, 2003
compared with third quarter, 2002 sales of $250.0 million. The increase in sales
was driven primarily by favorable foreign currency exchange rates and increased
global end market demand for electronics. Segment income was $22.6 million in
the third quarter 2003, compared with $26.3 million in the prior year quarter.
Segment income in the quarter reflects an unfavorable mix and lower volumes
related to key European end markets for color and glass, tile coatings and
porcelain enamel. This was partially offset by cost reduction actions taken
throughout the year.
Sales in the Performance Chemicals segment were $134.4 million in the third
quarter, compared with third quarter 2002 sales of $138.8 million. Lower sales
reflect soft end market conditions that developed in the second quarter 2003 and
persisted into July and August before showing some improvement in September. The
primary drivers were appliances, packaging and the non-residential construction
markets for specialty plastics and polymer additives. Polymer additives was
negatively affected by very weak demand in the PVC market. The pharmaceutical
and fine chemicals business continued to deliver strong revenue growth. Segment
income was $5.3 million in the quarter, compared with $9.4 million in the prior
year quarter. The lower operating income for the segment was due primarily to
the impact of reduced sales volume and further raw material cost increases in
the polymer additives and plastics business units.
GEOGRAPHIC SALES
Sales in the United States were $192.3 million for the third quarter ended
September 30, 2003, compared with $196.2 million for the third quarter ended
September 30, 2002. The decline in the United States was primarily related to
lower sales in the Performance Chemicals segment. International sales were
$204.7 million for the third quarter ended September 30, 2003, compared with
$192.6 million for the third quarter ended September 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 NINE MONTHS ENDED SEPTEMBER 30, 2003,
AND 2002
Sales from continuing operations for the nine months ended September 30, 2003 of
$1,215.0 million were 4.5% higher than the $1,162.2 million of sales for the
comparable 2002 period. Sales increased 6.9% in the Coatings segment and 0.3% in
the Performance Chemicals segment.
The strengthening of the European currency had a favorable impact on sales of
$70.5 million or 6.1 percentage points of total sales for the nine months ended
September 30, 2003. Volume unfavorably impacted sales for the nine months ended
September 30, 2003 compared with 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 23.8% of sales compared with 25.4%
for the prior year period. The reduced gross margins compared with the prior
year primarily stemmed from lower volumes and raw material cost increases in the
Performance Chemicals segment. The gross margins for the nine months ended
September 30, 2003 were also unfavorably impacted by a pre tax loss of $1.4
million related to the second quarter, 2003, 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
$231.7 million for the nine months ended September 30, 2003 compared with $213.1
million for the same period in 2002. Of the $18.6 million increase in selling,
administrative and general expenses, $13.7 million was caused by the
strengthening of the euro against the dollar, increased restructuring charges of
$4.4 million, and higher pension expense of $4.5 million. In addition, research
& development spending in our electronics and pharmaceuticals
13
businesses increased these expenses by another $2.1 million. The increases were
partially offset by integration savings and other expense reduction initiatives.
Earnings for the nine months ended September 30, 2003 included pre-tax charges
of $12.6 million related primarily to severance and integration costs and for
the nine months ended September 30, 2002 included $8.8 million of similar
charges.
Interest expense from continuing operations was $26.7 million for the nine
months ended September 30, 2003, compared to $33.2 for the nine months ended
September 30, 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,
other debt reduction initiatives and lower interest rates.
Income tax as a percentage of pre-tax income for the nine months ended September
30, 2003, was 29.1% compared with 31.8% in the same period of 2002. Contributing
to this decline in the effective tax rate were tax benefits realized due to a
higher proportion of earnings in jurisdictions having lower statutory tax rates.
Income from continuing operations for the nine months ended September 30, 2003
was $14.6 million or 45.5% lower than the prior year period. Diluted earnings
per share from continuing operations totaled $0.31 compared with $0.65 in 2002.
The loss from discontinued operations was $(0.9) million for the first nine
months of 2003 compared with income of $6.6 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. A gain on the
disposal of the Company's Powder Coatings business of $32.5 million, net of
income taxes of $22.7 million, was recorded in the quarter ended September 30,
2002. The disposal of the Petroleum Additives and Specialty Ceramics business
units netted a gain of $2.4 million in the quarter ended June 30, 2003. Diluted
earnings per share for discontinued operations totaled $0.04 for the nine months
ended September 30, 2003 compared to $0.97 for the same period in 2002.
Net Income for the nine months ended September 30, 2003 totaled $16.1 million
compared with $65.7 million in the prior year period. Diluted earnings per share
were $0.35 in the nine months ended September 30, 2003 versus $1.62 in 2002.
SEGMENT RESULTS FOR NINE MONTHS ENDED SEPTEMBER 30, 2002 and 2003
Sales in the Coatings segment were $797.6 million in the nine months ended
September 30, 2003, compared with nine months ended September 30, 2002 sales of
$746.3 million. The increase in sales is primarily due to the effect of currency
exchange rates. Improved demand for electronics and glass products was partially
offset by sluggish building and renovation activity. Operating income for the
segment was $69.2 million in the nine months ended September 30, 2003, compared
with $72.6 million in the nine months ended September 30, 2002. The capture of
cost synergies was offset by reduced operating rates in the tile coatings and
color and glass businesses.
Sales in the Performance Chemicals segment were $417.4 million in the nine
months ended September 30, 2003, compared with nine months ended September 30,
2002 sales of $415.9 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 for the segment was $22.5 million in
the nine months ended September 30, 2003, compared with $32.1 million in the
nine months ended September 30, 2003 of the prior year. The lower segment 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 $587.8 million for the nine months ended
September 30, 2003, compared with $582.0 million for the nine months ended
September 30, 2002. The increase was primarily due to higher sales in the
Coatings segment. International sales were $627.2 million for the nine months
ended September 30, 2003, compared with $580.2 million for the nine months ended
September 30, 2002. The majority of the international sales increase occurred in
Europe due to the strengthening of the euro against the dollar.
14
CASH FLOWS
Net cash provided by operating activities of continuing operations was $43.9
million for the nine months ended September 30, 2003, compared with cash
provided of $125.4 million for nine months ended September 30, 2002. The largest
factors impacting the change were lower income and increased pension
contributions for the nine months ended September 30, 2003 and higher working
capital reductions in the nine months ended September 30, 2002 as compared to
the same period in 2003.
Cash provided by (used for) investing activities of continuing operations was
($56.6) million for the nine months ended September 30, 2003 versus $(27.5)
million the nine months ended September 30, 2002. The cash usage from investing
activities this year resulted primarily from the $25.0 million buy out of an
operating lease agreement, capital expenditures of $23.5 million and purchase
price settlements (payments) of approximately ($8.5) million related to the dmc2
acquisition.
Net cash provided by (used for) financing activities for the nine months ended
September 30, 2003 was ($2.2) million compared with cash used by financing
activities for the nine months ended September 30, 2002 of ($246.1) million. The
year-over-year change was primarily due to increases in borrowing for the nine
months ended September 30, 2003 as compared to the repayment of debt in the
prior year period.
Net cash provided by (used for) operating activities of discontinued operations
was ($0.9) million for the nine months ended September 30, 2003, compared with
cash provided of $13.1 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.
Net cash provided by (used for) investing activities of discontinued operations
was $19.3 million for the nine months ended September 30, 2003 and $132.0
million for the nine months ended September 30, 2002. Cash provided from
investing activities for the nine months ended September 30, 2003 includes
proceeds of $19.7 million from the sales of the petroleum additives and
specialty ceramics businesses less purchase price settlements (payments) related
to the divestment of the powder coatings business. Cash provided from investing
activities for the nine months ended September 30, 2002 includes the proceeds
from the sale of the Powder Coatings business of $132.5 million.
OUTLOOK
Economic conditions are gradually improving but will likely remain difficult at
least through the rest of 2003. There are some encouraging signs, particularly
within the electronic materials business, where increased volumes and stronger
orders compared with the year ago period are being experienced. Going forward,
Ferro will continue to evaluate options to reduce costs, including the potential
for further facility rationalization. Ferro management will also continue to
place emphasis on strengthening the balance sheet and further positioning the
Company for long-term growth.
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, under which $110.8 million was available as of
September 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 September
30, 2003, $3.1 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 senior credit rating is downgraded below BB by S&P or Ba2 by Moody's,
the Company and its material subsidiaries would be required to grant security
interests in its principal
15
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 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 share capital. In September 2003, the
Company renegotiated the fixed charge, leverage and spring lien 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
lease expenses were approximately $0.5 million for the quarters ended September
30, 2003 and 2002. For the nine months ended September 30, 2003, lease expenses
were approximately $1.1 million and for the nine months ended September 30, 2002
lease expenses were approximately $1.5 million. As of September 30, 2003, the
fair value of precious metals under leasing arrangements was $69.3 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.
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 $110.8 million was available as of
September 30, 2003. This liquidity, along with the liquidity from the Company's
asset securitization program of $146.9 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 to the amounts outstanding under
16
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 corresponding change in expense for the year 2002. A
1% change in interest rates would have resulted in a $0.5 million corresponding
change in expense for the third quarter of 2003 and $1.6 million for nine months
ended September 30, 2003.
At September 30, 2003, the Company had $350.6 million of fixed rate debt
outstanding with a weighted average interest rate of 8.5%, all maturing after
2008. The fair market value of these debt securities was approximately $371.1
million at September 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 September 30, 2003, the Company held forward contracts to manage its foreign
currency transaction exposures, which had a notional amount of $67.2 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 $3.7 million and an average strike price of
$1.03/euro. At September 30, 2003, these forward contracts and options had an
aggregate fair value of $(1.0) million.
A 10% appreciation of the U.S. dollar would have resulted in a $1.6 million
increase in the fair value of these contracts in the aggregate at September 30,
2003, and December 31, 2002. A 10% depreciation of the U.S. dollar would have
resulted in a $1.9 million and $1.5 million decrease in the fair value of these
contracts in the aggregate at September 30, 2003, and December 31, 2002,
respectively.
The Company uses derivative financial instruments to manage the price risk for a
portion of its forecasted requirements for natural gas. In compliance with FASB
Statement No. 133, the Company records these contracts on its balance sheet at
fair market value. 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 commodity rises and falls. The fair value of the contracts for
natural gas was a loss of approximately $0.5 million (pre tax ) at September 30,
2003. A 10% change in the forward prices of natural gas from the September 30,
2003 level would have resulted in a $0.6 million corresponding change in the
fair market value of the contracts as of September 30, 2003.
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. As of September 30, 2003, the fair value of precious
metals under leasing arrangements was $69.3 million. A 10% change in the lease
rate of precious metals from the September 30, 2003 level would have resulted in
a $0.1 million corresponding change in lease expense in the third quarter of
2003.
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.
Not applicable
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 third quarter:
Current Report on Form 8-K (item 12), dated July 11, 2003
Current Report on Form 8-K (item 12), dated July 29, 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: November 13, 2003
/s/ Hector R. Ortino
------------------------------------
Hector R. Ortino
Chairman and Chief Executive Officer
Date: November 13, 2003
/s/ Thomas M. Gannon
------------------------------------------
Thomas M. Gannon
Vice President and Chief Financial Officer
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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 September 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 September 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 September 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 September 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.
(10) Material Contracts
*(a)Second Amendment to Credit Agreement dated as of September 30, 2003,
between Ferro Corporation and the Lenders, National City Bank as
administrative agent and Credit Suisse First Boston as syndicate first
agent.
20
*(10) Second Amendment to Credit Agreement
*(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.
21