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Ferro 10-K 2014
10-K
Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

(Mark One)

  x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2013

or

 

  ¨ 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)

 

Ohio   34-0217820
(State of Corporation)   (IRS Employer Identification No.)

6060 Parkland Blvd.

Mayfield Heights, OH

  44124
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: 216-875-5600

Securities Registered Pursuant to section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, par value $1.00   New York Stock Exchange

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ¨        NO  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    YES  ¨        NO  x

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x        NO  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained here, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ¨

  Accelerated filer  x   Non-accelerated filer  ¨   Smaller reporting company  ¨
  (Do not check if a smaller reporting company)                

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    YES  ¨        NO  x

The aggregate market value of Ferro Corporation Common Stock, par value $1.00, held by non-affiliates and based on the closing sale price as of June 30, 2013, was approximately $595,503,000.

On January 31, 2014, there were 86,718,915 shares of Ferro Corporation Common Stock, par value $1.00 outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for Ferro Corporation’s 2014 Annual Meeting of Shareholders are incorporated into Part III of this Annual Report on Form 10-K.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

   PART I   

Item 1

   Business      Page       3   

Item 1A

   Risk Factors      Page       8   

Item 1B

   Unresolved Staff Comments      Page     16   

Item 2

   Properties      Page     17   

Item 3

   Legal Proceedings      Page     17   

Item 4

   Mine Safety Disclosures      Page     17   
   PART II   

Item 5

   Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities      Page     19   

Item 6

   Selected Financial Data      Page     20   

Item 7

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      Page     21   

Item 7A

   Quantitative and Qualitative Disclosures about Market Risk      Page     42   

Item 8

   Financial Statements and Supplementary Data      Page     44   

Item 9

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      Page     97   

Item 9A

   Controls and Procedures      Page     97   

Item 9B

   Other Information      Page     99   
   PART III   

Item 10

   Directors, Executive Officers and Corporate Governance      Page   100   

Item 11

   Executive Compensation      Page   100   

Item 12

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      Page   100   

Item 13

   Certain Relationships and Related Transactions, and Director Independence      Page   101   

Item 14

   Principal Accountant Fees and Services      Page   101   
   PART IV   

Item 15

   Exhibits and Financial Statement Schedules      Page   102   

 

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PART I

Item 1 — Business

History, Organization and Products

Ferro Corporation was incorporated in Ohio in 1919 as an enameling company. When we use the terms “Ferro,” “we,” “us” or “the Company,” we are referring to Ferro Corporation and its subsidiaries unless we indicate otherwise. Today, we are a leading producer of specialty materials and chemicals that are sold to a broad range of manufacturers who, in turn, make products for many end-use markets. We operate approximately 39 facilities around the world that manufacture the following types of products:

 

   

Performance Materials — Frits, porcelain and other glass enamels, glazes, stains, decorating colors, pigments, inks, polishing materials, specialty dielectrics, electronic glasses, and other specialty coatings; and

 

   

Performance Chemicals — Polymer additives, engineered plastic compounds, and pigment dispersions.

We refer to our products as performance materials and chemicals because we formulate them to perform specific functions in the manufacturing processes and end products of our customers. The products we develop often are delivered to our customers in combination with customized technical service. The value of our products stems from the benefits they deliver in actual use. We develop and deliver innovative products to our customers through our key strengths in:

 

   

Particle Engineering — Our ability to design and produce very small particles made of a broad variety of materials, with precisely controlled characteristics of shape, size and size distribution. We understand how to disperse these particles within liquid, paste and gel formulations.

 

   

Color and Glass Science — Our understanding of the chemistry required to develop and produce pigments that provide color characteristics ideally suited to customers’ applications. We have a demonstrated ability to provide glass-based coatings with properties that precisely meet customers’ needs in a broad variety of applications.

 

   

Surface Chemistry and Surface Application Technology — Our understanding of chemicals and materials used to develop products and processes that involve the interface between layers and the surface properties of materials.

 

   

Product Formulation — Our ability to develop and manufacture combinations of materials that deliver specific performance characteristics designed to work within customers’ particular products and manufacturing processes.

 

   

Polymer Science/Organic Synthesis — Our ability to develop and produce polymers and supporting additives by utilizing organic synthesis expertise to create and modify materials with a variety of innovative characteristics and desired capabilities. We understand how to craft and transform resin systems to fulfill customer requirements.

We deliver these key technical strengths to our customers in a way that creates additional value through our integrated applications support. Our applications support personnel provide assistance to our customers in their material specification and evaluation, product design and manufacturing process characterization in order to help them optimize the efficient and cost-effective application of our products.

 

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We divide our operations into six business units, which comprise five reportable segments. We have grouped these units by their product group below:

 

Performance Materials

  

Performance Chemicals

• Tile Coating Systems(1)

  

• Polymer Additives

• Porcelain Enamel(1)

  

• Specialty Plastics

• Performance Colors and Glass

  

• Pigments Powders and Oxides

  

 

  (1) Tile Coating Systems and Porcelain Enamel are combined into one reportable segment, Performance Coatings, for financial reporting purposes.

Financial information about our segments is included herein in Note 19 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

Markets and Customers

Ferro’s products are used in a variety of product applications in markets including:

 

• Appliances    • Household furnishings
• Automobiles    • Industrial products
• Building and renovation    • Packaging
• Electronics     

Many of our products are used as coatings on our customers’ products, such as glazes and decorations on tile, glass and dinnerware. Other products are supplied to customers as powders that are used to manufacture electronic components and other products. Still other products are added during our customers’ manufacturing processes to provide desirable properties to their end product. Often, our products are a small portion of the total cost of our customers’ products, but they can be critical to the appearance or functionality of those products.

Our leading customers include manufacturers of ceramic tile, major appliances, construction materials, automobile parts, glass, bottles, and wall coverings. Many of our customers, including makers of major appliances and automobile parts, purchase materials from more than one of our business units. Our customer base is well diversified both geographically and by end market.

We generally sell our products directly to our customers. However, a portion of our business uses indirect sales channels, such as agents and distributors, to deliver products to market. In 2013, no single customer or related group of customers represented more than 10% of net sales. In addition, none of our reportable segments is dependent on any single customer or related group of customers.

Backlog of Orders and Seasonality

Generally, there is no significant lead time between customer orders and delivery in any of our business segments. As a result, we do not consider that the dollar amount of backlogged orders believed to be firm is material information for an understanding of our business. We also do not regard any material part of our business to be seasonal. However, customer demand has historically been higher in the second quarter when building and renovation markets are particularly active, and this quarter is normally the strongest for sales and operating profit.

 

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Competition

In most of our markets, we have a substantial number of competitors, none of which is dominant. Due to the diverse nature of our product lines, no single competitor directly matches all of our product offerings. Our competition varies by product and by region, and is based primarily on price, product quality and performance, customer service and technical support, and our ability to develop custom products to meet specific customer requirements.

We are a worldwide leader in the production of glass enamels, porcelain enamels, and ceramic tile coatings. There is strong competition in our markets, ranging from large multinational corporations to local producers. While many of our customers purchase customized products and formulations from us, our customers could generally buy from other sources, if necessary.

Raw Materials and Supplier Relations

Raw materials widely used in our operations include:

 

Metal Oxides:    Other Inorganic Materials:

• Aluminum oxide(1)

  

• Boron acid(2)

• Cobalt oxide(1)(2)

  

• Clay(2)

• Nickel oxide(1)(2)

  

• Feldspar(2)

• Titanium dioxide(1)(2)(3)

  

• Fiberglass(3)

• Zinc oxide(2)

  

• Lithium(2)

• Zirconium dioxide(2)

  

• Silica(2)

  

• Zircon(2)

  
Precious and Non-precious Metals:    Other Organic Materials:(4)

• Aluminum(1)

  

• Butanol

• Bismuth(1)

  

• Phenol

• Chrome(1)(2)

  

• Phthalic anhydride

• Copper(1)

  

• Soybean oil

• Gold(1)

  

• Tallow

• Silver(1)

  

• Toluene

  
Polymers:(3)    Energy:

• Polyethylene

  

• Electricity

• Polypropylene

  

• Natural gas

• Polystyrene

  

• Unsaturated polyester

  

 

  (1) Primarily used by Performance Colors and Glass (PCG) and Pigments, Powders and Oxides (PPO).
  (2) Primarily used by Performance Coatings.
  (3) Primarily used by Specialty Plastics.
  (4) Primarily used by Polymer Additives.

These raw materials make up a large portion of our product costs in certain of our product lines, and fluctuations in the cost of raw materials may have a significant impact on the financial performance of the related businesses. We attempt to pass through to our customers raw material cost increases.

 

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We have a broad supplier base and, in many instances, multiple sources of essential raw materials are available worldwide if problems arise with a particular supplier. We maintain many comprehensive supplier agreements for strategic and critical raw materials. We did not encounter raw material shortages in 2013 that significantly affected our manufacturing operations, but we are subject to volatile raw material costs that can affect our results of operations.

Environmental Matters

As part of the production of some of our products, we handle, process, use and store hazardous materials. As a result, we operate manufacturing facilities that are subject to a broad array of environmental laws and regulations in the countries in which we operate, particularly for plant wastes and emissions. In addition, some of our products are subject to restrictions under laws or regulations such as California Proposition 65 or the European Union’s (“EU”) chemical substances directive. The costs to comply with complex environmental laws and regulations are significant and will continue for the industry and us for the foreseeable future. These routine costs are expensed as they are incurred. While these costs may increase in the future, they are not expected to have a material impact on our financial position, liquidity or results of operations. We believe that we are in substantial compliance with the environmental regulations to which our operations are subject and that, to the extent we may not be in compliance with such regulations, non-compliance will not have a materially adverse effect on our financial position, liquidity or results of operations.

Our policy is to operate our plants and facilities in a manner that protects the environment and the health and safety of our employees and the public. We intend to continue to make expenditures for environmental protection and improvements in a timely manner consistent with available technology. Although we cannot precisely predict future environmental spending, we do not expect the costs to have a material impact on our financial position, liquidity or results of operations. Capital expenditures for environmental protection were $2.5 million in 2013, $0.9 million in 2012, and $2.0 million in 2011.

We also accrue for environmental remediation costs when it is probable that a liability has been incurred and we can reasonably estimate the amount. We determine the timing and amount of any liability based upon assumptions regarding future events, and inherent uncertainties exist in such evaluations primarily due to unknown conditions, changing governmental regulations and legal standards regarding liability, and evolving technologies. We adjust these liabilities periodically as remediation efforts progress, the nature and extent of contamination become more certain, or as additional technical or legal information become available.

Research and Development

We are involved worldwide in research and development activities relating to new and existing products, services and technologies required by our customers’ continually changing markets. Our research and development resources are organized into centers of excellence that support our regional and worldwide major business units. We also conduct research and development activities at our Posnick Center of Innovative Technology in Independence, Ohio. These centers are augmented by local laboratories that provide technical service and support to meet customer and market needs in various geographic areas.

Total expenditures for product and application technology, including research and development, customer technical support and other related activities, were $30.0 million in 2013, $39.5 million in 2012, and $42.4 million in 2011. These amounts include expenditures for company-sponsored research and development activities of approximately $26.9 million in 2013, $30.0 million in 2012, and $30.4 million in 2011.

Patents, Trademarks and Licenses

We own a substantial number of patents and patent applications relating to our various products and their uses. While these patents are of importance to us and we exercise diligence to ensure that they are valid, we do not believe that the invalidity or expiration of any single patent or group of patents would have a material adverse

 

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effect on our businesses. Our patents will expire at various dates through the year 2032. We also use a number of trademarks that are important to our businesses as a whole or to a particular segment. We believe that these trademarks are adequately protected.

Employees

At December 31, 2013, we employed 4,364 full-time employees, including 3,159 employees in our foreign consolidated subsidiaries and 1,205 in the United States (“U.S.”). Total employment decreased by 201 in our foreign subsidiaries and by 383 in the U.S. from the prior year end due to reductions made in areas where sales activity declined net of additions related to new business opportunities.

Collective bargaining agreements cover approximately 22% of our U.S. workforce. Approximately 11% of all U.S. employees are affected by labor agreements that expire in 2014, and we expect to complete renewals of these agreements with no significant disruption to the related businesses. We consider our relations with our employees, including those covered by collective bargaining agreements, to be good.

Our employees in Europe have protections afforded them by local laws and regulations through unions and works councils. Some of these laws and regulations may affect the timing, amount and nature of restructuring and cost reduction programs in that region.

Domestic and Foreign Operations

We began international operations in 1927. Our products are manufactured and/or distributed through our consolidated subsidiaries and unconsolidated affiliates in the following countries:

 

Consolidated Subsidiaries:          

• Argentina

  

• France

  

• Malaysia

  

• Taiwan

• Australia

  

• Germany

  

• Mexico

  

• Thailand

• Belgium

  

• India

  

• Netherlands

  

• United Kingdom

• Brazil

  

• Indonesia

  

• Portugal

  

• United States

• China

  

• Italy

  

• Russia

  

• Venezuela

• Egypt

  

• Japan

  

• Spain

  
Unconsolidated Affiliates:      

• Italy

  

• Spain

  

• South Korea

  

Financial information for geographic areas is included in Note 19 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K. More than 50% of our net sales are outside of the U.S. Our customers represent more than 30 industries and operate in approximately 100 countries.

Our U.S. parent company receives technical service fees and/or royalties from many of its foreign subsidiaries. As a matter of corporate policy, the foreign subsidiaries have historically been expected to remit a portion of their annual earnings to the U.S. parent company as dividends. To the extent earnings of foreign subsidiaries are not remitted to the U.S. parent company, those earnings are indefinitely re-invested in those subsidiaries.

Available Information

Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K, including any amendments, will be made available free of charge on our Web site, www.ferro.com, as soon as reasonably practical, following the filing of the reports with the U.S. Securities and Exchange Commission

 

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(“SEC”). Our Corporate Governance Principles, Legal and Ethical Policies, Guidelines for Determining Director Independence, and charters for our Audit Committee, Compensation Committee, Strategy Committee and Governance and Nomination Committee are available free of charge on our Web site or to any shareholder who requests them from the Ferro Corporation Investor Relations Department located at 6060 Parkland Blvd., Mayfield Heights, Ohio, 44124.

Forward-looking Statements

Certain statements contained here and in future filings with the SEC reflect our expectations with respect to future performance and constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are subject to a variety of uncertainties, unknown risks and other factors concerning our operations and the business environment, which are difficult to predict and are beyond our control.

Item 1A — Risk Factors

Many factors could cause our actual results to differ materially from those suggested by statements contained in this filing and could adversely affect our future financial performance. Such factors include the following:

We sell our products into industries where demand has been unpredictable, cyclical or heavily influenced by consumer spending, and such demand and our results of operations may be further impacted by macro-economic circumstances.

We sell our products to a wide variety of customers who supply many different market segments. Many of these market segments, such as building and renovation, major appliances, transportation, and electronics, are cyclical or closely tied to consumer demand. Consumer demand is difficult to accurately forecast and incorrect forecasts of demand or unforeseen reductions in demand can adversely affect costs and profitability due to factors such as underused manufacturing capacity, excess inventory, or working capital needs. Our forecasting systems and modeling tools may not accurately predict changes in demand for our products or other market conditions.

Our results of operations are materially affected by conditions in capital markets and economies in the U.S. and elsewhere around the world. Concerns over fluctuating prices, energy costs, geopolitical issues, government deficits and debt loads, and the availability and cost of credit have contributed to economic uncertainty around the world. Our customers may be impacted by these conditions and may modify, delay, or cancel plans to purchase our products. Additionally, if customers are not successful in generating sufficient revenue or are precluded from securing financing, they may not be able to pay, or may delay payment of, accounts receivable that are owed to us. A reduction in demand or inability of customers to pay us for our products may adversely affect our earnings and cash flow.

We have undertaken cost-savings initiatives, including restructuring programs, to improve our operating performance, but we may not be able to implement and/or administer these initiatives in the manner contemplated and these initiatives may not produce the desired results.

We have undertaken cost-savings initiatives, including restructuring programs, and may undertake additional cost-savings initiatives in the future. These initiatives involve, among other things, restructuring programs that involve plant closures and staff reductions. Although we expect these initiatives to help us achieve incremental cost savings and operational efficiencies, we may not be able to implement and/or administer these initiatives, including plant closures and staff reductions, in the manner contemplated, which could cause the initiatives to fail to achieve the desired results. Additionally, the implementation of these initiatives may result in impairment charges, some of which could be material. Even if we do implement and administer these initiatives

 

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in the manner contemplated, they may not produce the desired results. Accordingly, the initiatives that we have implemented and those that we may implement in the future may not improve our operating performance and may not help us achieve cost savings. Failure to successfully implement and/or administer these initiatives could have an adverse effect on our financial performance.

We are subject to a number of restrictive covenants under our credit facilities and the indenture governing our senior notes, which could affect our flexibility to fund ongoing operations and strategic initiatives, and, if we are unable to maintain compliance with such covenants, could lead to significant challenges in meeting our liquidity requirements.

Our credit facilities and the indenture governing our senior notes contain a number of restrictive covenants, including those described in more detail in Note 6 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K. These covenants include customary operating restrictions that limit our ability to engage in certain activities, including additional loans and investments; prepayments, redemptions and repurchases of debt; and mergers, acquisitions and asset sales. We are also subject to customary financial covenants under our credit facilities, including a leverage ratio and an interest coverage ratio. These covenants under our credit facilities restrict the amount of our borrowings, reducing our flexibility to fund ongoing operations and strategic initiatives. These facilities and our senior notes are described in more detail in “Capital Resources and Liquidity” under Item 7 and in Note 6 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

The most critical of these ratios is the leverage ratio. As of December 31, 2013, we were in compliance with our maximum leverage ratio covenant of 4.00x as our actual ratio was 2.57x, providing $43.8 million of EBITDA, as defined within our credit facilities and senior notes indenture, cushion on the leverage ratio. Our leverage ratio covenants decrease in the second and third quarters of 2014 to 3.75x and in the fourth quarter of 2014 and thereafter it will be 3.50x. To the extent that economic conditions in key markets deteriorate or we are unable to meet our business projections and EBITDA falls below approximately $100 million for a rolling four quarters, based on reasonably consistent debt levels with those as of December 31, 2013, we could be unable to maintain compliance with our leverage ratio covenant, in which case, our lenders could demand immediate payment of outstanding amounts and we would need to seek alternate financing sources to pay off such debts and to fund our ongoing operations. Such financing may not be available on favorable terms, if at all.

We depend on external financial resources, and the economic environment and credit market uncertainty could interrupt our access to capital markets, borrowings, or financial transactions to hedge certain risks, which could adversely affect our financial condition.

At December 31, 2013, we had approximately $311.7 million of short-term and long-term debt with varying maturities and approximately $40.9 million of off balance sheet arrangements, including consignment arrangements for precious metals, bank guarantees, and standby letters of credit. These arrangements have allowed us to make investments in growth opportunities and fund working capital requirements. In addition, we may enter into financial transactions to hedge certain risks, including foreign exchange, commodity pricing, and sourcing of certain raw materials. Our continued access to capital markets, the stability of our lenders, customers and financial partners and their willingness to support our needs are essential to our liquidity and our ability to meet our current obligations and to fund operations and our strategic initiatives. An interruption in our access to external financing or financial transactions to hedge risk could adversely affect our business prospects and financial condition. See further information regarding our liquidity in “Capital Resources and Liquidity” under Item 7 and in Note 6 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

We strive to improve operating margins through sales growth, price increases, productivity gains, and improved purchasing techniques, but we may not achieve the desired improvements.

We work to improve operating profit margins through activities such as growing sales to achieve increased economies of scale, increasing prices, improving manufacturing processes, and adopting purchasing techniques that lower costs or provide increased cost predictability to realize cost savings. However, these activities depend

 

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on a combination of improved product design and engineering, effective manufacturing process control initiatives, cost-effective redistribution of production, and other efforts that may not be as successful as anticipated. The success of sales growth and price increases depends not only on our actions but also on the strength of customer demand and competitors’ pricing responses, which are not fully predictable. Failure to successfully implement actions to improve operating margins could adversely affect our financial performance.

We rely on information systems to conduct our business and interruption, or damage to, or failure or compromise of, these systems may adversely affect our business and results of operations.

We rely on information systems to obtain, process, analyze and manage data to forecast and facilitate the purchase and distribution of our products; to receive, process, and ship orders on a timely basis; to account for other product and service transactions with customers; to manage the accurate billing and collections for thousands of customers; to process payments to suppliers; and to manage data and records relating to our employees, contractors, and other individuals. Our business and results of operations may be adversely affected if these systems are interrupted, damaged, or compromised or if they fail for any extended period of time, due to events including but not limited to programming errors, computer viruses and security breaches. Information privacy and security risks have generally increased in recent years because of the proliferation of new technologies and the increased sophistication and activities of perpetrators of cyber attacks, and prevention of information and privacy security breaches cannot be assured. We may be required to expend additional resources to continue to enhance our information privacy and security measures and/or to investigate and remediate any information security vulnerabilities. In addition, third-party service providers are responsible for managing a significant portion of our information systems, and we are subject to risk as a result of possible information privacy and security breaches of those third parties. The consequences of these risks could adversely impact our results of operations, financial condition, and cash flows.

We depend on reliable sources of energy and raw materials, including petroleum-based materials, minerals and other supplies, at a reasonable cost, but the availability of these materials and supplies could be interrupted and/or their prices could escalate and adversely affect our sales and profitability.

We purchase energy and many raw materials, including petroleum-based materials and other supplies, which we use to manufacture our products. Changes in their availability or price could affect our ability to manufacture enough products to meet customers’ demands or to manufacture products profitably. We try to maintain multiple sources of raw materials and supplies where practical, but this may not prevent unanticipated changes in their availability or cost and, for certain raw materials, there may not be alternative sources. We may not be able to pass cost increases through to our customers. Significant disruptions in availability or cost increases could adversely affect our manufacturing volume or costs, which could negatively affect product sales or profitability of our operations.

The global scope of our operations exposes us to risks related to currency conversion rates, new and different regulatory schemes and changing economic, regulatory, social and political conditions around the world.

More than 50% of our net sales during 2013 were outside of the U.S. In order to support global customers, access regional markets and compete effectively, our operations are located around the world. We may encounter difficulties expanding into additional growth markets around the world. Our operations have additional complexity due to economic, regulatory, social and political conditions in multiple locations and we are subject to risks relating to currency conversion rates. Other risks inherent in international operations include the following:

 

   

New and different legal and regulatory requirements and enforcement mechanisms in local jurisdictions;

 

   

U.S. and other export licenses may be difficult to obtain and we may be subject to export duties or import quotas or other trade restrictions or barriers;

 

   

Increased costs, and decreased availability, of transportation or shipping;

 

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Credit risk and financial conditions of local customers and distributors;

 

   

Risk of nationalization of private enterprises by foreign governments or restrictions on investments;

 

   

Potentially adverse tax consequences, including imposition or increase of withholding and other taxes on remittances and other payments by subsidiaries; and

 

   

Local political, economic and social conditions, including the possibility of hyperinflationary conditions, deflation, and political instability in certain countries.

We have subsidiaries in Venezuela, a country that has established rigid controls over the ability of foreign companies to repatriate cash, and in Egypt, a country with recent political instability. Such conditions could potentially impact our ability to recover both the cost of our investments and earnings from those investments. While we attempt to anticipate these changes and manage our business appropriately in each location where we do business, these changes are often beyond our control and difficult to forecast.

The consequences of these risks may have significant adverse effects on our results of operations or financial position, and if we fail to comply with applicable laws and regulations, we could be exposed to civil and criminal penalties, reputational harm, and restrictions on our operations.

We have a presence in regions of the world where it can be difficult for a multi-national company such as Ferro to compete lawfully with local competitors, which may cause us to lose business opportunities.

We pursue business opportunities around the world and many of our most promising growth opportunities are in developing markets and the Asia-Pacific region, including the People’s Republic of China. Although we have been able to compete successfully in those markets to date, local laws and customs can make it difficult for a multi-national company such as Ferro to compete on a “level playing field” with local competitors without engaging in conduct that would be illegal under U.S. or other countries’ anti-bribery laws. Our strict policy of observing the highest standards of legal and ethical conduct may cause us to lose some otherwise attractive business opportunities to competitors in these regions.

Regulatory authorities in the U.S., European Union and elsewhere are taking a much more aggressive approach to regulating hazardous materials and other substances, and those regulations could affect sales of our products.

Legislation and regulations concerning hazardous materials and other substances can restrict the sale of products and/or increase the cost of producing them. Some of our products are subject to restrictions under laws or regulations such as California Proposition 65 or the EU’s chemical substances directive. The EU “REACH” registration system requires us to perform studies of some of our products or components of our products and to register the information in a central database, increasing the cost of these products. As a result of such regulations, customers may avoid purchasing some products in favor of less hazardous or less costly alternatives. It may be impractical for us to continue manufacturing heavily regulated products, and we may incur costs to shut down or transition such operations to alternative products. These circumstances could adversely affect our business, including our sales and operating profits.

Our businesses depend on a continuous stream of new products, and failure to introduce new products could affect our sales, profitability and liquidity.

One way that we remain competitive is by developing and introducing new and improved products on an ongoing basis. Customers continually evaluate our products in comparison to those offered by our competitors. A failure to introduce new products at the right time that are price competitive and that provide the features and performance required by customers could adversely affect our sales, or could require us to compensate by lowering prices. In addition, when we invest in new product development, we face risks related to production delays, cost over-runs and unanticipated technical difficulties, which could impact sales, profitability and/or liquidity.

 

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We may not be able to complete or successfully integrate future acquisitions into our business, which could adversely affect our business or results of operations.

As part of our strategy, we intend to pursue acquisitions. Our success in accomplishing growth through acquisitions may be limited by the availability and suitability of acquisition candidates and by our financial resources, including available cash and borrowing capacity. Acquisitions involve numerous risks, including difficulty determining appropriate valuation, integrating operations, technologies, services and products of the acquired product lines or businesses, personnel turnover and the diversion of management’s attention from other business matters. In addition, we may be unable to achieve anticipated benefits from these acquisitions in the time frame that we anticipate, or at all, which could adversely affect our business or results of operations.

Our strategy includes seeking opportunities in new growth markets, and failure to identify or successfully enter such markets could affect our ability to grow our revenues and earnings.

Certain of our products are sold into mature markets and part of our strategy is to identify and enter into markets growing more rapidly. These growth opportunities may involve new geographies, new product lines, new technologies, or new customers. We may not be successful capitalizing on such opportunities and our ability to increase our revenue and earnings could be impacted.

Sales of our products to certain customers or into certain industries may expose us to different and complex regulatory regimes.

We seek to expand our customer base and the industries into which we sell. Selling products to certain customers or into certain industries, such as governments or the defense industry, requires compliance with regulatory regimes that do not apply to sales involving other customers or industries and that can be complex and difficult to navigate. Our failure to comply with these regulations could result in liabilities or damage to our reputation with customers, which could negatively impact our business, financial condition, or results of operations.

We have limited or no redundancy for certain of our manufacturing facilities, and damage to or interference with those facilities could interrupt our operations, increase our costs of doing business and impair our ability to deliver our products on a timely basis.

If certain of our existing production facilities become incapable of manufacturing products for any reason, we may be unable to meet production requirements, we may lose revenue and we may not be able to maintain our relationships with our customers. Without operation of certain existing production facilities, we may be limited in our ability to deliver products until we restore the manufacturing capability at the particular facility, find an alternative manufacturing facility or arrange an alternative source of supply. Although we carry business interruption insurance to cover lost revenue and profits in an amount we consider adequate, this insurance does not cover all possible situations. In addition, our business interruption insurance would not compensate us for the loss of opportunity and potential adverse impact on relations with our existing customers resulting from our inability to produce products for them.

The markets for our products are highly competitive and subject to intense price competition, which could adversely affect our sales and earnings performance.

Our customers typically have multiple suppliers from which to choose. If we are unwilling or unable to provide products at competitive prices, and if other factors, such as product performance and value-added services do not provide an offsetting competitive advantage, customers may reduce, discontinue, or decide not to purchase our products. If we could not secure alternate customers for lost business, our sales and earnings performance could be adversely affected.

 

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If we are unable to protect our intellectual property rights or to successfully resolve claims of infringement brought against us, our product sales and financial performance could be adversely affected.

Our performance may depend in part on our ability to establish, protect and enforce intellectual property rights with respect to our products, technologies and proprietary rights and to defend against any claims of infringement, which involves complex legal, scientific and factual questions and uncertainties. We may have to rely on litigation to enforce our intellectual property rights. In addition, we may face claims of infringement that could interfere with our ability to use technology or other intellectual property rights that are material to our business operations. If litigation that we initiate is unsuccessful, we may not be able to protect the value of some of our intellectual property. In the event a claim of infringement against us is successful, we may be required to pay royalties or license fees to continue to use technology or other intellectual property rights that we have been using or we may be unable to obtain necessary licenses from third parties at a reasonable cost or within a reasonable time.

Our operations are subject to operating hazards and, as a result, to stringent environmental, health and safety regulations, and compliance with those regulations could require us to make significant investments.

Our production facilities are subject to hazards associated with the manufacture, handling, storage, and transportation of chemical materials and products. These hazards can cause personal injury and loss of life, severe damage to, or destruction of, property and equipment and environmental contamination and other environmental damage and could have an adverse effect on our business, financial condition or results of operations.

We strive to maintain our production facilities and conduct our manufacturing operations in a manner that is safe and in compliance with all applicable environmental, health and safety regulations. Compliance with changing regulations may require us to make significant capital investments, incur training costs, make changes in manufacturing processes or product formulations, or incur costs that could adversely affect our profitability, and violations of these laws could lead to substantial fines and penalties. These costs may not affect competitors in the same way due to differences in product formulations, manufacturing locations or other factors, and we could be at a competitive disadvantage, which might adversely affect financial performance.

If we are unable to manage our general and administrative expenses, our business, financial condition or results of operations could be negatively impacted.

We may not be able to manage our administrative expense in all circumstances. While we attempt to effectively manage such expenses, including through projects designed to create administrative efficiencies, increases in staff-related and other administrative expenses may occur from time to time. Recently, we have made significant efforts to achieve general and administrative cost savings and improve our operational performance. As a part of these initiatives, we have and will continue to consolidate business and management operations and enter into arrangements with third parties offering additional cost savings. It cannot be assured that our strategies to reduce our general and administrative costs and improve our operating performance will be successful or achieve the anticipated savings.

Our multi-jurisdictional tax structure may not provide favorable tax efficiencies.

We conduct our business operations in a number of countries and are subject to taxation in those jurisdictions. While we seek to minimize our worldwide effective tax rate, our corporate structure may not optimize tax efficiency opportunities. We develop our tax position based upon the anticipated nature and structure of our business and the tax laws, administrative practices and judicial decisions now in effect in the countries in which we have assets or conduct business, which are subject to change or differing interpretations. In addition, our effective tax rate could be adversely affected by several other factors, including: increases in expenses that are not deductible for tax purposes, the tax effects of restructuring charges or purchase accounting for acquisitions, changes related to our ability to ultimately realize future benefits attributed to our deferred tax assets, including those related to other-than-temporary impairment, and a change in our decision to indefinitely

 

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reinvest foreign earnings. Further, we are subject to review and audit by both domestic and foreign tax authorities, which may result in adverse decisions. Increased tax expense could have a negative effect on our operating results and financial condition.

We have significant deferred tax assets, and if we are unable to utilize these assets, our results of operations may be adversely affected.

To fully realize the carrying value of our net deferred tax assets, we will have to generate adequate taxable profits in various tax jurisdictions. At December 31, 2013, we had $22.0 million of net deferred tax assets, after valuation allowances. If we do not generate adequate profits within the time periods required by applicable tax statutes, the carrying value of the tax assets will not be realized. If it becomes unlikely that the carrying value of our net deferred tax assets will be realized, the valuation allowances may need to be increased in our consolidated financial statements, adversely affecting results of operations. Further information on our deferred tax assets is presented in Note 8 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

We may not be successful in implementing our strategies to increase our return on invested capital.

We are taking steps to generate a higher return on invested capital. There are risks associated with the implementation of these steps, which may be complicated and may involve substantial capital investment. To the extent we are unsuccessful in achieving these strategies, our results of operations may be adversely affected.

We are subject to stringent labor and employment laws in certain jurisdictions in which we operate, we are party to various collective bargaining arrangements, and our relationship with our employees could deteriorate, which could adversely impact our operations.

A majority of our full-time employees are employed outside the U.S. In certain jurisdictions where we operate, labor and employment laws are relatively stringent and, in many cases, grant significant job protection to certain employees, including rights on termination of employment. In addition, in certain countries where we operate, our employees are members of unions or are represented by works councils. We are often required to consult and seek the consent or advice of these unions and/or works councils. These regulations and laws, coupled with the requirement to consult with the relevant unions or works councils, could have a significant impact on our flexibility in managing costs and responding to market changes.

Furthermore, approximately 22% of our U.S. employees as of December 31, 2013, are subject to collective bargaining arrangements or similar arrangements, and approximately 11% are subject to labor agreements that expire in 2014. While we expect to complete renewal of these agreements without significant disruption to our business, there can be no assurance that we will be able to negotiate labor agreements on satisfactory terms or that actions by our employees will not be disruptive to our business. If these workers were to engage in a strike, work stoppage or other slowdown or if other employees were to become unionized, we could experience a significant disruption of our operations and/or higher ongoing labor costs, which could adversely affect our business, financial condition and results of operations.

Employee benefit costs, especially postretirement costs, constitute a significant element of our annual expenses, and funding these costs could adversely affect our financial condition.

Employee benefit costs are a significant element of our cost structure. Certain expenses, particularly postretirement costs under defined benefit pension plans and healthcare costs for employees and retirees, may increase significantly at a rate that is difficult to forecast and may adversely affect our financial results, financial condition or cash flows. Declines in global capital markets may cause reductions in the value of our pension plan assets. Such circumstances could have an adverse effect on future pension expense and funding requirements. Further information regarding our retirement benefits is presented in Note 10 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

 

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Our implementation of business information systems and processes could adversely affect our results of operations and cash flow.

We have been implementing information systems and related business processes to standardize and streamline our business operations. Implementation of information systems and related processes involves risk, including risks related to programming and data transfer. Costs of implementation also could be greater than anticipated. In addition, we may be unable or decide not to implement such systems and processes in certain locations. Inherent risks, decisions and constraints related to implementation could result in operating inefficiencies and could impact our ability to perform business transactions. These risks could adversely impact our results of operations, financial condition, and cash flows.

There are risks associated with the manufacture and sale of our products into the pharmaceutical industry.

The manufacture and sale of products into the pharmaceutical industry involves the risk of injury to consumers, as well as commercial risks. Injury to consumers could result from, among other things, tampering by unauthorized third parties or the introduction into the product of foreign objects, substances, chemicals and other agents during the manufacturing, packaging, storage, handling or transportation phases. Shipment of adulterated products may be a violation of law and may lead to an increased risk of exposure to product liability or other claims, product recalls and increased scrutiny by federal and state regulatory agencies. Such claims or liabilities may not be covered by our insurance or by any rights of indemnity or contribution that we may have against third parties. In addition, the negative publicity surrounding any assertion that our products caused illness or injury could have a material adverse effect on our reputation with existing and potential customers, which could negatively impact our business, operating results or financial condition.

We are exposed to lawsuits in the normal course of business, which could harm our business.

We are from time to time exposed to certain legal proceedings, which may include claims involving product liability, infringement of intellectual property rights of third parties and other claims. Due to the uncertainties of litigation, we can give no assurance that we will prevail on claims made against us in the lawsuits that we currently face or that additional claims will not be made against us in the future. We do not believe that lawsuits we currently face are likely to have a material adverse effect on our business, operating results or financial condition. Future claims or lawsuits, if they were to result in a ruling adverse to us, could give rise to substantial liability, which could have a material adverse effect on our business, operating results or financial condition.

We are exposed to intangible asset risk, and a write down of our intangible assets could have an adverse impact to our operating results and financial position.

We have recorded intangible assets, including goodwill, in connection with business acquisitions. We are required to perform goodwill impairment tests on at least an annual basis and whenever events or circumstances indicate that the carrying value may not be recoverable from estimated future cash flows. As a result of our annual and other periodic evaluations, we may determine that the intangible asset values need to be written down to their fair values, which could result in material charges that could be adverse to our operating results and financial position. See further information regarding our goodwill and other intangible assets in “Critical Accounting Policies” under Item 7 and in Note 5 to the consolidated financial statements under Item 8 of this Form 10-K.

Interest rates on some of our borrowings are variable, and our borrowing costs could be adversely affected by interest rate increases.

Portions of our debt obligations have variable interest rates. Generally, when interest rates rise, our cost of borrowings increases. We estimate, based on the debt obligations outstanding at December 31, 2013, that a one percent increase in interest rates would cause interest expense to increase by $0.5 million annually. Continued

 

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interest rate increases could raise the cost of borrowings and adversely affect our financial performance. See further information regarding our interest rates on our debt obligations in “Quantitative and Qualitative Disclosures about Market Risk” under Item 7A and in Note 6 to the consolidated financial statements under Item 8 of this Form 10-K.

Many of our assets are encumbered by liens that have been granted to lenders, and those liens affect our flexibility to dispose of property and businesses.

Certain of our debt obligations are secured by substantially all of our assets. These liens could reduce our ability and/or extend the time to dispose of property and businesses, as these liens must be cleared or waived by the lenders prior to any disposition. These security interests are described in more detail in Note 6 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

We may not pay dividends on our common stock at any time in the foreseeable future.

Holders of our common stock are entitled to receive such dividends as our Board of Directors from time to time may declare out of funds legally available for such purposes. Our Board of Directors has no obligation to declare dividends under Ohio law or our amended Articles of Incorporation. We may not pay dividends on our common stock at any time in the foreseeable future. Any determination by our Board of Directors to pay dividends in the future will be based on various factors, including our financial condition, results of operations and current anticipated cash needs and any limits our then-existing credit facility and other debt instruments place on our ability to pay dividends.

We are exposed to risks associated with acts of God, terrorists and others, as well as fires, explosions, wars, riots, accidents, embargoes, natural disasters, strikes and other work stoppages, quarantines and other governmental actions, and other events or circumstances that are beyond our control.

Ferro is exposed to risks from various events that are beyond our control, which may have significant effects on our results of operations. While we attempt to mitigate these risks through appropriate loss prevention measures, insurance, contingency planning and other means, we may not be able to anticipate all risks or to reasonably or cost-effectively manage those risks that we do anticipate. As a result, our operations could be adversely affected by circumstances or events in ways that are significant and/or long lasting.

The risks and uncertainties identified above are not the only risks that we face. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial also may adversely affect us. If any known or unknown risks and uncertainties develop into actual events, these developments could have material adverse effects on our financial position, results of operations, and cash flows.

We Are Subject To Risks Associated With Outsourcing Functions To Third Parties.

We have entered into outsourcing agreements with third parties, and rely on such parties, to provide certain services in support of our business. One such vendor provides a number of business services related to our information systems and finance and accounting activity. Arrangements with third party service providers may make our operations vulnerable if vendors fail to provide the expected service or there are changes in their own operations, financial condition, or other matters outside of our control. If these service providers are unable to perform to our requirements or to provide the level of service expected, our operating results and financial condition may suffer and we may be forced to pursue alternatives to provide these services, which could result in delays, business disruptions and additional expenses.

Item 1B — Unresolved Staff Comments

None.

 

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Item 2 — Properties

We lease our corporate headquarters offices, which are located at 6060 Parkland Blvd., Mayfield Heights, Ohio. The company owns other corporate facilities, including a centralized research and development facility, which is located in Independence, Ohio. We own principal manufacturing plants that range in size from 29,000 sq. ft. to over 800,000 sq. ft. Plants we own with more than 250,000 sq. ft. are located in Spain; Germany; Cleveland, Ohio; Penn Yan, New York; and Mexico. The locations of these principal manufacturing plants by reportable segment are as follows:

Pigments, Powders and Oxides-U.S.: Penn Yan, New York. Outside the U.S.: China and Brazil.

Performance Colors and Glass-U.S.: Washington, Pennsylvania, and Orrville, Ohio. Outside the U.S.: Brazil, China, France, Germany, Mexico, Spain, and the United Kingdom.

Performance Coatings-U.S.: Cleveland, Ohio. Outside the U.S.: Argentina, Brazil, China, Egypt, France, Indonesia, Italy, Mexico, Spain, Thailand and Venezuela.

Polymer Additives-U.S.: Bridgeport, New Jersey; Cleveland, Ohio; Walton Hills, Ohio; and Fort Worth, Texas. Outside the U.S.: Belgium and the United Kingdom.

Specialty Plastics-U.S.: Evansville, Indiana; Plymouth, Indiana; Edison, New Jersey; and Stryker, Ohio. Outside the U.S.: Spain.

Ferro’s revolving credit facility has a security interest in the real estate of the parent company and its domestic material subsidiaries.

In addition, we lease manufacturing facilities for the Performance Colors and Glass segment in Germany, Japan, Italy, and Vista California; and for the Specialty Plastics segment in Carpentersville, Illinois. In some instances, the manufacturing facilities are used for two or more segments. Leased facilities range in size from 18,000 sq. ft. to over 100,000 sq. ft.

Item 3 — Legal Proceedings

There are various lawsuits and claims pending against the Company and its consolidated subsidiaries. We do not currently expect the resolution of such matters to materially affect the consolidated financial position, results of operations, or cash flows of the Company.

Item 4 — Mine Safety Disclosures

Not applicable.

 

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Executive Officers of the Registrant

The executive officers of the Company as of February 24, 2014, are listed below, along with their ages and positions held during the past five years. The year indicates when the individual was named to the indicated position. No family relationship exists between any of Ferro’s executive officers.

Peter T. Thomas — 58

President and Chief Executive Officer, 2013

Interim President and Chief Executive Officer, 2012

Vice President, Polymer and Ceramic Engineered Materials, 2009

Vice President, Organic Specialties, 2006

Mark H. Duesenberg — 52

Vice President, General Counsel and Secretary, 2008

Executive Director, Legal and Government Affairs, Lenovo Group Ltd., a global manufacturer of personal computers and electronic devices, 2008

Legal Director — Europe, Middle East and Africa, Lenovo Group Ltd., 2005

Ann E. Killian — 59

Vice President, Human Resources, 2005

Jeffrey L. Rutherford — 53

Vice President and Chief Financial Officer, 2012

Vice President and Chief Financial Officer, Park-Ohio Holdings Corp., an industrial supply chain logistics and diversified manufacturing business, 2008

Senior Vice President and Chief Financial Officer, UAP Holding Corp., an independent distributor of agricultural inputs and professional non-crop products, 2007

 

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PART II

 

Item 5 — Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

Our common stock is listed on the New York Stock Exchange under the ticker symbol FOE. On January 31, 2014, we had 1,253 shareholders of record for our common stock, and the closing price of the common stock was $12.58 per share.

The chart below compares Ferro’s cumulative total shareholder return for the five years ended December 31, 2013, to that of the Standard & Poor’s 500 Index and the Standard & Poor’s MidCap Specialty Chemicals Index. In all cases, the information is presented on a dividend-reinvested basis and assumes investment of $100.00 on December 31, 2008. At December 31, 2013, the closing price of our common stock was $12.83 per share.

COMPARISON OF FIVE-YEAR

CUMULATIVE TOTAL RETURNS

 

LOGO

The quarterly high and low intra-day sales prices and dividends declared per share for our common stock during 2013 and 2012 were as follows:

 

     2013      2012  
           High                  Low                  Dividends                  High                  Low                  Dividends        

First Quarter

   $ 6.99       $ 3.60       $       $ 7.50       $ 4.84       $   

Second Quarter

     7.26         6.39                 5.96         4.02           

Third Quarter

     9.35         6.19                 5.06         2.65           

Fourth Quarter

     14.17         9.12                 4.28         2.38           

The restrictive covenants contained in our credit facility limit the amount of dividends we can pay on our common stock. For further discussion, see Management’s Discussion and Analysis of Financial Condition and Results of Operations under Item 7 of this Annual Report on Form 10-K.

 

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The following table summarizes purchases of our common stock by the Company and affiliated purchasers during the three months ended December 31, 2013:

 

     Total Number
of Shares
Purchased(1)
     Average
Price Paid
per Share
     Total Number
of Shares
Purchased as
Part of
Publicly
Announced
Plans or
Programs
     Maximum
Number of
Shares that
May Yet Be
Purchased
Under the
Plans or
Programs
 
     (In thousands, except for per share amounts)  

October 1, 2013 to October 31, 2013

           $                   

November 1, 2013 to November 30, 2013

                               

December 1, 2013 to December 31, 2013

                     —                     —                 —   

Total

                 —                             

 

(1) Consists of shares of common stock surrendered by employees to meet minimum tax withholding obligations under current and previous long-term incentive plans.

Item 6 — Selected Financial Data

The following table presents selected financial data for the last five years ended December 31st:

 

     2013      2012     2011      2010      2009  
     (Dollars in thousands, except per share data)  
Net sales    $   1,635,406       $   1,744,613      $   2,130,853       $   2,077,989       $   1,635,570   
Income (loss) from continuing operations      80,866         (374,190     2,958         14,960         (8,125
Basic earnings (loss) per share from continuing operations attributable to Ferro Corporation common shareholders      0.93         (4.35     0.02         0.15         (0.22
Diluted earnings (loss) per share from continuing operations attributable to Ferro Corporation common shareholders      0.92         (4.35     0.02         0.15         (0.22
Cash dividends declared per common share                                     0.01   
Total assets      1,008,192         1,079,103        1,440,651         1,434,355         1,526,355   
Long-term debt, including current portion, and redeemable preferred stock      268,637         298,177        300,769         303,269         409,231   

In 2013, we sold our Pharmaceuticals business, which is presented as discontinued operations in 2009 through 2013.

In 2012, we changed our method of recognizing defined benefit pension and other postretirement benefit expense. Under the new method, we recognize actuarial gains and losses in our operating results in the year in which the gains or losses occur. All prior periods have been adjusted to apply the new method retrospectively.

In 2008, we sold our Fine Chemicals business, which is presented as discontinued operations in 2009.

 

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Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

During 2013, we have made considerable progress against our value creation strategy. During the first quarter, we sold our solar pastes assets, generating approximately $11 million of cash, and sold the stock of our Pharmaceuticals business, generating approximately $17 million of cash. During the fourth quarter, we completed the sale of our North American and Asian metal powders product lines, which generated additional cash of approximately $13 million, and was the primary driver of the reduction in our precious metals consignment obligations of 73% compared with the prior year.

Further, we continued to streamline our operations and reduce operating costs through various cost reduction activities in 2013. We have taken actions that have a full year cost savings impact exceeding $47 million. Overall cost savings are estimated to be greater than $100 million by the end of 2015 after executing against remaining identified opportunities.

Outlook

For the full year 2014, we expect revenue growth to be approximately 3.5% to 4.0%, or global GDP plus 100 basis points, after considering the impact of businesses and product lines that were divested in 2013, and the impact of the plasticizer product that has been driving the underperformance in our Polymer Additives segment. We expect continued deterioration in the demand for this product in 2014, which we estimate will negatively impact sales by approximately $30 million. As previously announced, we have an active capital project to convert plasticizer production capabilities at our Antwerp, Belgium facility, to directly address this challenge, and we expect that this capacity will be online late 2014. We base our overall growth expectations on our underlying markets, and capital projects that are currently in process.

We expect continued competitive pressures in 2014, including pricing in multiple segments, most significantly in Performance Coatings. Despite the pressures, we anticipate being able to manage gross profit margins to be equal to, or slightly ahead of 2013 levels.

With respect to selling, general and administrative expenses (“SG&A”), we expect additional progress on our value creation strategy through further cost reductions, and normalized incentive compensation, to drive increased cost savings and profitability in 2014.

Results of Operations — Consolidated

For the years ended December 31, 2012 and 2011, amounts originally reported have been adjusted for the effects of applying retrospectively the discontinued operations of Ferro Pfanstieh Laboratories, Inc. (“FPL”) as described in Note 16, Discontinued Operations, and the changes in our reportable segments as described in Note 19, Reporting for Segments. Both notes are part of the consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

Comparison of the years ended December 31, 2013 and 2012

For the year ended December 31, 2013, Ferro net income was $72.4 million, compared with net loss of $373.0 million in 2012. For the year ended December 31, 2013, Ferro net income attributable to common shareholders was $71.9 million, or $0.83 per share, compared with Ferro net loss attributable to common shareholders of $374.3 million, or $4.34 per share in 2012.

 

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Net Sales

 

     2013     2012     $ Change     % Change  
     (Dollars in thousands)        

Net sales excluding precious metals

   $   1,538,684      $   1,571,863      $ (33,179     (2.1 )% 

Sales of precious metals

     96,722        172,750        (76,028     (44.0 )% 

Net sales

     1,635,406        1,744,613          (109,207     (6.3 )% 

Cost of sales

     1,305,682        1,455,043        (149,361     (10.3 )% 

Gross profit

   $ 329,724      $ 289,570      $ 40,154        13.9  % 

Gross profit as a % of net sales excluding precious metals

     21.4     18.4    

Net sales decreased by $109.2 million, or 6.3%, in the year ended December 31, 2013, compared with the prior year. Net sales excluding precious metals decreased $33.2 million, driven by decreased sales in our Pigments, Powders and Oxides segment, primarily due to the exit of solar pastes during the first quarter of 2013, and decreased sales in our Polymer Additives segment that are being driven by changing environmental regulations. Partially mitigating these decreases were increased sales in our Performance Colors and Glass and Performance Coatings segments. Sales of precious metals were down compared with the prior year due to the exit of solar pastes, and lower sales in our North American and Asian metal powders product lines prior to being sold during the fourth quarter.  

Gross Profit

Gross profit increased $40.2 million, or 13.9%, in 2013 to $329.7 million, compared with $289.6 million in 2012. The significant drivers of the increased gross profit are strong performance in our Performance Coatings and Performance Colors and Glass segments.

Selling, General and Administrative Expense

The following table presents our segments summarized into their respective operating groups, with Pigments, Powders and Oxides, Performance Colors and Glass, and Performance Coatings comprising Performance Materials, and Polymer Additives and Specialty Plastics comprising Performance Chemicals. Corporate SG&A expenses exclude the impact of the annual mark-to-market adjustment on our pension and other postretirement benefit plans, as the volatility in this adjustment does not allow for a meaningful comparison of underlying Corporate SG&A costs between periods. In conjunction with the changes to segments, we also changed the profitability metric utilized by management to evaluate segment performance, as discussed in Note 19. The metric that was utilized historically was segment income, which included SG&A expenses that were directly incurred by each segment, as well as certain allocated costs. Segment gross profit is the metric that is now utilized. Further, we have refined our approach to managing SG&A expenses and are intensely focused on analyzing expenses at the individual site level, and also across functional areas within the Company, as opposed to the segment level, and will evaluate performance in this manner.

 

     2013     2012      $ Change     % Change  
     (Dollars in thousands)        

Performance Materials

   $       150,572      $       155,517       $ (4,945     (3.2 )% 

Performance Chemicals

     22,713        26,380         (3,667     (13.9 )% 

Corporate

     72,793        92,705         (19,912     (21.5 )% 

Pension and other postretirement benefits mark-to-market adjustment

     (69,796     23,153         (92,949     NM   

Selling, general and administrative expenses

   $ 176,282      $ 297,755       $       (121,473     (40.8 )% 

 

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The following represent the components with significant changes between 2013 and 2012:

 

     2013     2012      $ Change     % Change  
     (Dollars in thousands)        

Personnel expenses

   $       144,761      $       173,927       $ (29,166     (16.8 )% 

Incentive compensation

     18,459        646         17,813        NM   

Stock-based compensation

     6,890        2,677         4,213        157.4

Pension and other postretirement benefits

     (71,845     29,065         (100,910     NM   

Idle sites

            2,077         (2,077     NM   

Bad debt

     4,074        5,202         (1,128     (21.7 )% 

Other

     73,943        84,161         (10,218     (12.1 )% 

Selling, general and administrative expenses

   $ 176,282      $ 297,755       $       (121,473     (40.8 )% 

SG&A expenses were $121.5 million lower in 2013 compared with the prior year. As a percentage of net sales excluding precious metals, SG&A expenses decreased 740 basis points from 18.9% in the prior year to 11.5% in 2013. The most significant driver of the decline in SG&A expenses in 2013 was the mark-to-market gain on our defined benefit pension plans and postretirement health care and life insurance benefit plans of $69.8 million, and is included within the pension and other postretirement benefits line above. In 2012, the mark-to-market adjustments resulted in an actuarial loss of $23.2 million. Excluding the impact of the mark-to-market adjustment, SG&A expenses decreased 150 basis points from 17.5% in the prior year to 16.0% in 2013. Various restructuring activities executed in 2013 drove the decrease in personnel expenses. Our expenses related to idle sites have decreased in 2013 as a result of selling the majority of our idle sites during the year. The decreases were partially offset by higher incentive compensation of approximately $18 million, or 120 basis points, due to strong performance in 2013. Incentive compensation in 2012 was less than $1 million, driven by not meeting respective performance targets. Strong performance in 2013 was the primary driver of increased stock-based compensation expense.

Restructuring and Impairment Charges

 

     2013      2012      $ Change     % Change  
     (Dollars in thousands)        

Goodwill

   $       $ 153,566       $ (153,566     NM   

Amortizable intangible assets

     2,102                 2,102        NM   

Property, plant and equipment

     7,484         46,800         (39,316     NM   

Assets held for sale

             14,913         (14,913     NM   

Corporate plane

     1,242         3,214         (1,972     NM   

Restructuring

     30,905         7,231         23,674        NM   

Restructuring and impairment charges

   $   41,733       $   225,724       $   (183,991     (81.5 )% 

 

NM — Not meaningful

Restructuring and impairment charges decreased significantly in 2013 compared with 2012. The primary drivers of the decrease were the 2012 impairment charges of $153.6 million taken against goodwill related to our legacy Electronic Materials reporting unit and $46.8 million related to property, plant and equipment associated with solar and metal powders related assets in 2012. Restructuring charges increased $23.7 million in 2013 when compared to 2012 driven by various restructuring activities executed during the year.

 

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Interest Expense

Interest expense in 2013 increased compared to the prior year, primarily due to the write-off of deferred financing fees resulting from amending our revolving credit facility and the commitment amount being reduced from $350.0 million to $250.0 million, and reduced capitalization of interest costs. The components of interest expense are as follows:

 

     2013     2012     $ Change     % Change  
     (Dollars in thousands)        

Interest expense

   $     25,345      $     25,396      $       (51     (0.2 )% 

Interest capitalization

     (917     (780     (137     17.6

Amortization of bank fees

     2,905        1,845        1,060        57.5

Interest expense

   $ 27,333      $ 26,461      $ 872        3.3%   

Income Tax Expense

In 2013, income tax expense was $14.9 million or 15.5% of income before income taxes, compared to an income tax expense of $108.9 million, or 41.0% of loss before income taxes in 2012. The 2013 effective tax rate was less than the statutory income tax rate of 35% primarily as a result of a $27.2 million benefit for the release of the valuation allowances related to deferred tax assets that were utilized in the current year, the reduction to deferred tax assets related to uncertain tax positions and the expiration of fully valued tax credits offset by a $6.8 million charge related to the expiration of the fully valued tax credits. The 2012 effective tax rate was a significant negative effective tax rate compared to the statutory income tax rate primarily as a result of a $182.7 million charge to increase the valuation allowances, a $4.1 million charge related to the expiration of certain tax credits, and the tax impact of the book goodwill impairment.

Comparison of the years ended December 31, 2012 and 2011

For the year ended December 31, 2012, Ferro net loss was $373.0 million, compared with net income of $5.1 million in 2011. For the year ended December 31, 2012, Ferro net loss attributable to common shareholders was $374.3 million, or $4.34 per share, compared with Ferro net income attributable to common shareholders of $4.2 million, or $0.05 per share in 2011.

Net Sales

 

     2012      2011      $ Change     % Change  
     (Dollars in thousands)        

Net sales excluding precious metals

   $     1,571,863       $     1,731,782       $     (159,919     (9.2 )% 

Sales of precious metals

     172,750         399,071         (226,321     (56.7 )% 

Net sales

     1,744,613         2,130,853         (386,240     (18.1 )% 

Cost of sales

     1,455,043         1,728,048         (273,005     (15.8 )% 

Gross profit

   $ 289,570       $ 402,805       $ (113,235     (28.1 )% 

Gross profit as a % of net sales excluding precious metals

     18.4%         23.3%        

Net sales decreased by 18.1% in the year ended December 31, 2012, compared with the prior year. Lower sales volumes in Pigments, Powders and Oxides, specifically for solar pastes and metal powders, in combination with unfavorable price and mix, and weakness in Europe due to macro-economic conditions, were the primary drivers of the decrease. Further, as a result of the decrease in Pigments, Powders and Oxides volumes, precious metals sales decreased 56.7% from 2011, or 58.6% of the overall decrease in net sales in 2012. Across our

 

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segments, changes in product prices and mix accounted for approximately 8% of sales decline, lower sales volumes reduced sales by approximately 8% and changes in foreign currency exchange rates reduced sales an additional 2%.

Gross Profit

Gross profit decreased 28.1% in 2012 to $289.6 million, compared with $402.8 million in 2011. The most significant driver was the performance of the Pigments, Powders and Oxides segment, which accounted for approximately 80% of the total decline. Weakness in Europe also contributed to the reduction in gross profit, particularly in the Performance Colors and Glass, Performance Coatings and Polymer Additives segments. Gross profit percentage declined to 18.4% of net sales excluding precious metals from 23.3% in 2011.

Selling, General and Administrative Expense

The following table presents our segments summarized into their respective operating groups, with Pigments, Powders and Oxides, Performance Colors and Glass, and Performance Coatings comprising Performance Materials, and Polymer Additives and Specialty Plastics comprising Performance Chemicals. Corporate SG&A expenses exclude the impact of the annual mark-to-market adjustment on our pension and other postretirement benefit plans, as the volatility in this adjustment does not allow for a meaningful comparison of underlying Corporate SG&A costs between periods. In conjunction with the changes to segments, we also changed the profitability metric utilized by management to evaluate segment performance, as discussed in Note 19. The metric that was utilized historically was segment income, which included SG&A that were directly incurred by each segment, as well as certain allocated costs. Segment gross profit is the metric that is now utilized. Further, we have refined our approach to managing SG&A expenses and are intensely focused on analyzing expenses at the individual site level, and also across functional areas within the Company, as opposed to the segment level, and will evaluate performance in this manner.

 

     2012      2011      $ Change     % Change  
     (Dollars in thousands)        

Performance Materials

   $         155,517       $         174,559       $         (19,042     (10.9 )% 

Performance Chemicals

     26,380         27,284         (904     (3.3 )% 

Corporate

     92,705         77,815         14,890        19.1

Pension and other postretirement benefits mark-to-market adjustment

     23,153         50,792         (27,639     (54.4 )% 

Selling, general and administrative expenses

   $ 297,755       $ 330,450       $ (32,695     (9.9 )% 

The following represent the components with significant changes between 2012 and 2011:

 

     2012      2011      $ Change     % Change  
     (Dollars in thousands)        

Personnel expenses

   $         173,927       $         177,515       $         (3,588     (2.0 )% 

Incentive compensation

     646         2,808         (2,162     (77.0 )% 

Stock-based compensation

     2,677         6,201         (3,524     (56.8 )% 

Pension and other postretirement benefits

     29,065         57,611         (28,546     (49.5 )% 

Idle sites

     2,077         2,841         (764     (26.9 )% 

Bad debt

     5,202         2,349         2,853        121.5

Other

     84,161         81,125         3,036        3.7

Selling, general and administrative expenses

   $ 297,755       $ 330,450       $ (32,695     (9.9 )% 

 

NM — Not meaningful

 

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SG&A expenses were $32.7 million lower in 2012 compared with the prior year. As a percentage of net sales excluding precious metals, SG&A expenses decreased 20 basis points from 19.1% in the prior year to 18.9% in 2012. The most significant driver of the decline in SG&A expenses in 2012 was a lower mark-to-market loss on our defined benefit pension plans and postretirement health care and life insurance benefit plans compared to the prior year. In 2012, the mark-to-market adjustments resulted in an actuarial loss of $23.2 million, compared to an actuarial loss of $50.8 million in 2011. Excluding the impact of the mark-to-market adjustment, SG&A expenses increased 140 basis points from 16.1% in the prior year to 17.5% in 2012, due to lower net sales excluding precious metals compared with the prior year. Lower personnel expenses and stock-based compensation expense compared with the prior year were the result of certain personnel actions during the year. Lower incentive compensation was driven by not meeting respective performance targets. Partially offsetting the favorability was higher bad debt expense and certain other corporate expenses.

Restructuring and Impairment Charges

 

     2012      2011      $ Change      % Change  
     (Dollars in thousands)         

Goodwill

   $     153,566       $ 3,881       $ 149,685         NM   

Property, plant and equipment

     46,800         4,436         42,364         NM   

Assets held for sale

     14,913         3,809         11,104         NM   

Corporate plane

     3,214                 3,214         NM   

Restructuring

     7,231         4,904         2,327         NM   

Restructuring and impairment charges

   $ 225,724       $   17,030       $     208,694         NM   

 

NM — Not meaningful

Restructuring and impairment charges increased significantly in 2012 compared with 2011. The primary driver of the increase was impairment charges taken against goodwill and property, plant and equipment in 2012 related to our legacy Electronic Materials reporting unit, and solar and metal powders related assets. Additionally, we continued to aggressively liquidate our portfolio of real estate related to idled facilities that were classified as held for sale, which drove incremental impairment charges during the year. Our idled facilities were principally located in Europe, which continued to experience difficult economic conditions. Idled assets in France, the Netherlands and the U.S. were sold in 2012. The restructuring charges incurred in 2012 primarily related to Performance Coatings in Europe and the disposal of the leased corporate plane.

Interest Expense

Interest expense in 2012 did not change significantly from 2011. The components of interest expense are as follows:

 

     2012     2011      $ Change     % Change  
     (Dollars in thousands)        

Interest expense

   $ 25,396      $ 25,887       $ (491     (1.9 )% 

Interest capitalization

     (780     (499)         (281     56.3

Amortization of bank fees

     1,845        1,802         43        2.4

Interest expense

   $     26,461      $   27,190       $     (729     (2.7 )% 

Income Tax Expense

In 2012, income tax expense was $108.9 million, or 41.0% of loss before income taxes, compared to an income tax expense of $18.1 million, or 86.0% of income before income taxes in 2011. The effective tax rate was a significant negative effective tax rate compared to the statutory income tax rate of 35% primarily as a result of

 

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a $182.7 million charge to increase the valuation allowances to more accurately measure the portion of the deferred tax assets that more likely than not will be realized, a $4.1 million charge related to the expiration of certain tax credits, and the tax impact of the book goodwill impairment. The 2011 effective tax rate was greater than the statutory income tax rate of 35% primarily as a result of an $11.3 million charge to increase the valuation allowances.

Results of Operations — Segment Information

Comparison of the years ended December 31, 2013 and 2012

Pigments, Powders and Oxides

 

     2013     2012     $ Change     % Change  
     (Dollars in thousands)        

Net sales excluding precious metals

   $       137,185      $      156,672      $ (19,487     (12.4 )% 

Precious metal sales

     53,141        122,353        (69,212     (56.6 )% 

Segment net sales

     190,326        279,025        (88,699     (31.8 )% 

Segment gross profit

     34,225        31,780                2,445        7.7  % 

Segment gross profit as a % of net sales excluding precious metals

     24.9     20.3    

Sales in Pigments, Powders and Oxides decreased primarily due to the exit of solar pastes during the first quarter of 2013, which comprised approximately $18 million of the decrease in net sales excluding precious metals from the prior year. Additionally, sales decreased approximately $1 million in our North American and Asian metal powders product lines from the prior year until they were sold during the fourth quarter of 2013. Regionally, the United States drove the decrease in sales, due to the exit of solar pastes. Gross profit increased from the prior year, primarily due to favorable raw material costs.

Performance Colors and Glass

 

     2013     2012     $ Change     % Change  
     (Dollars in thousands)        

Net sales excluding precious metals

   $       346,426      $      336,141      $       10,285        3.1

Precious metal sales

     43,581        50,397        (6,816     (13.5 )% 

Segment net sales

     390,007        386,538        3,469        0.9

Segment gross profit

     112,825        101,847        10,978        10.8

Segment gross profit as a % of net sales excluding precious metals

     32.6     30.3    

Net sales excluding precious metals increased compared with the prior year, primarily driven by sales of our glass products. Sales of our glass products increased over the prior-year same period by approximately $9 million, with the remainder of the increase primarily comprised of our electronics products. Net sales were favorably impacted by volume and price. Regionally, Europe and Latin America drove the majority of the increase. Gross profit increased from the prior year as a result of favorable raw material costs, product pricing, and lower manufacturing costs.

 

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Performance Coatings

 

     2013     2012     $ Change      % Change  
     (Dollars in thousands)         

Segment net sales

   $     591,975      $     587,698      $     4,277         0.7

Segment gross profit

     132,695        111,609        21,086         18.9

Segment gross profit as a % of net sales

     22.4     19.0     

Sales increased in Performance Coatings primarily due to increased sales of our porcelain enamel products, comprising approximately $6 million of the increase, which was partially offset by a decline of approximately $2 million in overall sales of tile products. The primary driver of the sales increase was favorable mix of our porcelain enamel products. Regionally, Europe and Asia Pacific increased approximately $9 million and $5 million, respectively, partially offset by decreased sales in Latin America of approximately $11 million. Gross profit increased from the prior year primarily due to increased volume in our tile products, favorable mix in our porcelain enamel products, and favorable manufacturing costs.

Polymer Additives

 

     2013     2012     $ Change     % Change  
     (Dollars in thousands)        

Segment net sales

   $     292,568      $     320,635      $ (28,067     (8.8 )% 

Segment gross profit

     27,139        29,951            (2,812     (9.4 )% 

Segment gross profit as a % of net sales

     9.3     9.3    

Sales decreased in Polymer Additives primarily due to the continued decline in sales volume of certain plasticizer products that is being driven by changing environmental regulations. Regionally, this drove a decrease in United States sales of approximately $24 million and Europe sales of approximately $5 million, which were partially mitigated by increased sales in Latin America of approximately $2 million. Gross profit decreased from the prior year as a result of the reduced sales volume and unfavorable raw material costs, partially mitigated by favorable pricing impacts.

Specialty Plastics

 

     2013     2012     $ Change     % Change  
     (Dollars in thousands)        

Segment net sales

   $     170,530      $     170,717      $ (187     (0.1 )% 

Segment gross profit

     28,366        29,186            (820     (2.8 )% 

Segment gross profit as a % of net sales

     16.6     17.1    

Sales decreased slightly in Specialty Plastics compared with the prior year. Regionally, the United States drove the majority of the decrease, approximately $4 million, which was partially mitigated by increases in Europe and Latin America that totaled approximately $4 million. Gross profit decreased from the prior year, primarily due to unfavorable pricing impacts and manufacturing costs, partially mitigated by favorable raw material costs and mix, and increased volume.

 

     2013      2012      $ Change     % Change  
     (Dollars in thousands)        

Geographic Revenues

          

United States

   $ 644,354       $ 740,578       $ (96,224     (13.0 )% 

International

     991,052         1,004,035             (12,983     (1.3 )% 

Total geographic revenues

   $     1,635,406       $     1,744,613       $ (109,207     (6.3 )% 

 

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Net sales declined in the United States and international regions compared with the prior year. Sales originating in the United States were 39% of total net sales in 2013, compared with 42% of net sales in the prior year. Approximately $66 million of the decline in sales in the United States was driven by the exit of solar pastes, including sales of precious metals, and approximately $20 million was due to reduced demand for certain plasticizer products, which is being driven by changing environmental regulations. International sales decreased approximately $13 million, primarily due to a $16 million decline associated with the exit of solar pastes during the first quarter, approximately $7 million of lower sales of metal powders products prior to the product line being sold during the third quarter, approximately $2 million of lower sales of certain plasticizer products being driven by changing environmental regulations and approximately $3 million in sales related to a mine that was sold in 2012. The lower sales were partially mitigated by increased sales across in other products totaling approximately $15 million.

Comparison of the years ended December 31, 2012 and 2011

Pigments, Powders and Oxides

 

     2012     2011     $ Change     % Change  
     (Dollars in thousands)        

Net sales excluding precious metals

   $     156,672      $     261,364      $ (104,692     (40.1 )% 

Precious metal sales

     122,353        340,178        (217,825     (64.0 )% 

Segment net sales

     279,025        601,542        (322,517     (53.6 )% 

Segment gross profit

     31,780        119,173            (87,393     (73.3 )% 

Segment gross profit as a % of net sales excluding precious metals

     20.3     45.6    

Sales declined in Pigments, Powders and Oxides primarily as a result of reduced demand for conductive pastes used in solar cells and metal powders used in other electronics applications. Further, sales of our polishing materials declined in 2012 compared with 2011 due to significantly lower costs for the key raw material used in the manufacture of the products. Unfavorable product pricing and mix and lower volumes were the primary drivers of the decrease. Sales of precious metals also declined significantly in 2012, in line with the overall reduction in volumes year over year, as the costs of precious metals are passed through to our customers. Pigments, Powders and Oxides operates principally in North America and Asia-Pacific, and both regions experienced significant declines in performance during 2012.

Performance Colors and Glass

 

     2012     2011     $ Change     % Change  
     (Dollars in thousands)        

Net sales excluding precious metals

   $     336,141      $     358,859      $ (22,718     (6.3 )% 

Precious metal sales

     50,397        58,893        (8,496     (14.4 )% 

Segment net sales

     386,538        417,752        (31,214     (7.5 )% 

Segment gross profit

     101,847        111,187            (9,340     (8.4 )% 

Segment gross profit as a % of net sales excluding precious metals

     30.3     31.0    

Performance Colors and Glass sales were affected by unfavorable impacts on volume which declined most significantly in Europe, with Asia-Pacific and Latin America also down, and foreign currency exchange. Partially offsetting the volume and foreign currency impacts were favorable price and mix. In addition to reduced sales, gross margin was also impacted unfavorably by higher costs of raw materials in 2012 compared with 2011.

 

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Performance Coatings

 

     2012     2011     $ Change     % Change  
     (Dollars in thousands)        

Segment net sales

   $     587,698      $     602,566      $ (14,868     (2.5 )% 

Segment gross profit

     111,609        120,752            (9,143     (7.6 )% 

Segment gross profit as a % of net sales

     19.0     20.0    

Sales in Performance Coatings declined in 2012 primarily due to unfavorable foreign currency exchange impacts of approximately $24 million. This was partially offset by increased volume impacts of approximately $6 million and slightly favorable price and mix of approximately $3 million. We experienced volume growth in Europe and Latin America. However, price was adversely impacted in Europe by overall European economic conditions and the highly price-competitive end markets into which Performance Coatings sells. This was partially mitigated by favorable pricing in Latin America. Gross margin declined in 2012 compared with 2011, and in addition to the unfavorable impacts on net sales, higher raw material costs also significantly impacted the Performance Coatings segment.

Polymer Additives

 

     2012     2011     $ Change     % Change  
     (Dollars in thousands)        

Segment net sales

   $     320,635      $     336,965      $ (16,330     (4.8 )% 

Segment gross profit

     29,951        33,829            (3,878     (11.5 )% 

Segment gross profit as a % of net sales

     9.3     10.0    

Sales in Polymer Additives were significantly impacted by declines in volume and price compared with 2011. The lower volume was primarily in Europe and North America, which are the principal markets for our Polymer Additives products, and driven by reduced demand for certain plasticizer products resulting from changing environmental regulations, as well as overall economic conditions in Europe.

Specialty Plastics

 

     2012     2011     $ Change     % Change  
     (Dollars in thousands)        

Segment net sales

   $     170,717      $     172,028      $ (1,311     (0.8 )% 

Segment gross profit

     29,186        25,043             4,143            16.5

Segment gross profit as a % of net sales

     17.1     14.6    

Sales in Specialty Plastics were relatively flat in 2012 compared with 2011. Reduced volumes in North America and Europe lowered sales by approximately $7 million, however we were able to mitigate the majority of the shortfall through pricing actions, which were favorable by approximately $6 million. Partially offsetting the favorable impact of price on gross margin were slightly higher raw material costs in 2012 compared with 2011.

 

     2012      2011      $ Change     % Change  
     (Dollars in thousands)        

Geographic Revenues

          

United States

   $ 740,578       $ 997,181       $ (256,603     (25.7 )% 

International

     1,004,035         1,133,672             (129,637     (11.4 )% 

Total geographic revenues

   $     1,744,613       $     2,130,853       $ (386,240     (18.1 )% 

 

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The primary driver of the decrease in net sales, both in the United States and in international regions, was the under-performance of Pigments, Powders and Oxides. Pigments, Powders and Oxides net sales were down approximately $323 million in 2012 compared with 2011. The decline in Pigments, Powders and Oxides in the United States was partially mitigated by higher sales in Performance Colors and Glass. In addition to the impact of Pigments, Powders and Oxides, the balance of the international sales decline was due to lower sales emanating from Europe in other segments. Sales that are recorded in each region include products exported to customers located in other regions.

Summary of Cash Flows for the years ended December 31, 2013, 2012, and 2011

 

     2013     2012     2011  
     (Dollars in thousands)  

Net cash provided by operating activities

   $ 18,464      $ 23,658      $ 53,233   

Net cash provided by (used for) investing activities

     17,168            (55,308         (65,127

Net cash (used for) provided by financing activities

         (36,715     36,457        5,904   

Effect of exchange rate changes on cash

     (165     1,778        (54

Increase (decrease) in cash and cash equivalents

   $ (1,248   $ 6,585      $ (6,044

Operating activities. Cash flows from operating activities decreased $5.2 million in 2013 compared to 2012. While net income was higher in 2013 when compared to 2012, the increase was primarily offset with noncash adjustments from impairment charges in the prior year as well as cash payments for restructuring activities in 2013 of $18.3 million compared to $3.4 million in 2012. Also contributing to the decrease was a decline in accounts payable balances which were partially offset by decreases in receivable balances.

Investing activities. Cash flows from investing activities increased approximately $72.5 million from 2012 to 2013. The increase was driven primarily through cash proceeds from the sales of our metal powders, solar paste operations, and our pharmaceuticals business. Capital expenditures decreased $24.5 million from 2012 to 2013.

Financing activities. Cash flows from financing activities decreased $73.2 million from 2012 to 2013. The primary driver of the decrease is the substantial decrease in net borrowing on our credit facilities and receivables programs as well as payment of our 6.5% convertible bonds of $35.1 million upon maturity in the third quarter of 2013.

We had a net use of cash from all credit facilities of $34.3 million in 2013 and net proceeds of $34.8 million in 2012.

Proceeds associated with the sale of our Pharmaceuticals reporting segment were $16.9 million and are included within investing activities. The impact of the impairment associated with the fixed assets of the reportable segment of $8.7 million has been included within operating activities as a reconciling item between net income and cash provided by operating activities.

We have paid no dividends on our common stock since 2009. Dividends paid on our preferred stock totaled $0.2 million in 2011.

 

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Capital Resources and Liquidity

Major debt instruments that were outstanding during 2013 are described below.

7.875% Senior Notes

In 2010, we issued $250 million of 7.875% Senior Notes due 2018 (the “Senior Notes”). The Senior Notes were issued at par and bear interest at a rate of 7.875% per year, payable semi-annually in arrears on February 15 and August 15 of each year. The Senior Notes mature on August 15, 2018, and are unsecured. The principal amount outstanding was $250.0 million at December 31, 2013. At December 31, 2013, we were in compliance with the covenants under the Senior Notes’ indenture.

6.50% Convertible Senior Notes

In 2008, Ferro issued $172.5 million of 6.50% Convertible Senior Notes due 2013 (the “Convertible Notes”). The Convertible Notes bear interest at a rate of 6.5% per year, payable semi-annually in arrears on February 15 and August 15 of each year. The Convertible Notes matured on August 15, 2013.

The 6.50% Convertible Notes were repaid at maturity on August 15, 2013. The principal amount outstanding at maturity was $35.1 million.

Revolving Credit Facility

In 2010, we entered into the Third Amended and Restated Credit Agreement with a group of lenders for a five-year, $350 million multi-currency senior revolving credit facility (the “2010 Credit Facility”). In 2012, we amended the 2010 Credit Facility (the “2012 Amended Credit Facility”) primarily to provide additional operating flexibility.

In March 2013, we again amended the 2010 Credit Facility (the “2013 Amended Credit Facility”) to provide additional operating flexibility. The primary effects of the 2013 Amended Credit Facility were to:

 

   

Decrease the Revolving Loan Commitment Amount from $350.0 million to $250.0 million;

 

   

Amend the calculation of EBITDA to provide for a restructuring expense add-back attributable to the Company’s restructuring programs of $30.0 million in 2013, $20.0 million in 2014 and $10.0 million in 2015, with no aggregate limit on restructuring expense;

 

   

Increase the maximum permitted leverage ratio to the levels stated below.

 

   

Amend the requirements for Permitted Acquisitions such that for the Company to consummate a Permitted Acquisition the Company must have minimum liquidity of $100.0 million and the Company’s Secured Leverage Ratio must be less than 1.50.

The 2013 Amended Credit Facility matures on August 24, 2015, and is secured by substantially all of Ferro’s assets. After reductions for borrowings and outstanding letters of credit secured by these facilities, we had $235.3 million of additional borrowings available at December 31, 2013, and $343.2 million at December 31, 2012. The interest rate under the 2013 Amended Credit Facility is the sum of (A) either (1) LIBOR or (2) the higher of the Federal Funds Rate plus 0.5%, the Prime Rate, or LIBOR plus 1.0% and (B) a variable margin based on the Company’s leverage. At December 31, 2013, the interest rate was 3.4%.

 

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Under the 2013 Amended Credit Facility, we are subject to a number of financial covenants, including limitations on the payment of common stock dividends. The covenants include requirements for a leverage ratio, an interest coverage ratio, and capital expenditures as follows:

 

   

The leverage ratio must be less than (i) 4.25 to 1.00 the first, second and third quarters of 2013 and (ii) 4.00 to 1.00 in the fourth quarter of 2013 and first quarter of 2014, (iii) 3.75 to 1.00 in the second and third quarters of 2014, and (iv) 3.50 to 1.00 thereafter. In the leverage ratio, the numerator is total debt, which consists of borrowings and certain letters of credit outstanding on the 2013 Amended Credit Facility and our international facilities, the principal amount outstanding on our senior notes, capitalized lease obligations, and amounts outstanding on our domestic and international receivables sales programs. The denominator is the sum of earnings before interest, income taxes, depreciation, and amortization (“EBITDA”), and adjusted for certain special charges over the last four fiscal quarters.

 

   

The interest coverage ratio must be not less than (i) 3.00 for the first quarter of 2013 and thereafter. In the interest coverage ratio, the numerator is EBITDA and the denominator is cash paid for interest expense and certain other financing expenses.

 

   

Capital expenditures are limited to (i) $65.0 million for the twelve months ended March 31, 2013, and (ii) $65.0 million for the 2013 fiscal year and each fiscal year thereafter. Certain unused capital expenditures from prior measurement periods are permitted to be carried forward to the following fiscal year.

Our ability to meet these covenants is primarily driven by our EBITDA; our total debt; our interest payments; and our capital expenditures. Our total debt is primarily driven by cash flow items, including net income before amortization, depreciation, and other noncash charges; our cash payments for restructuring; our capital expenditures; requirements for deposits from participants in our precious metals consignment program; our customers’ ability to make payments for purchases and the timing of such payments; and our ability to manage inventory and other working capital items. Our interest payments are driven by our debt level, external fees, and interest rates, primarily the Prime rate and LIBOR. Our capital expenditures are driven by our desire to invest in growth opportunities, to maintain existing property, plant and equipment, and to meet environmental, health and safety requirements. At December 31, 2013, we were in compliance with the covenants of the 2013 Amended Credit Facility.

Our ability to pay common stock dividends is limited by certain covenants in our 2013 Amended Credit Facility and the bond indenture governing the Senior Notes. The covenant in our 2013 Amended Credit Facility is the more limiting of the two covenants and limits our ability to make restricted payments, which include, but are not limited to, common stock dividends and the repurchase of equity interests. We are not permitted to make restricted payments in excess of $30 million in any calendar year. However, if we make less than $30 million of restricted payments in any calendar year, the unused amount can be carried over for restricted payments in future years, provided that the maximum amount of restricted payments in any calendar year does not exceed $60 million.

Domestic Receivable Sales Program

We have an asset securitization program for Ferro’s U.S. trade accounts receivable. This program accelerates cash collections at favorable financing costs and helps us manage the Company’s liquidity requirements. We sell undivided variable percentage interests in our domestic receivables to various purchasers, and we may obtain up to $50.0 million in the form of cash or letters of credit. Advances received under this program are accounted for as borrowings secured by the receivables and included in net cash provided by financing activities. The purchasers have no recourse to Ferro’s other assets for failure of payment of the receivables as a result of the lack of creditworthiness, or financial inability to pay, of the related obligor. In May 2013, we extended the maturity of this credit facility through May 2014. At December 31, 2013, we had borrowed $41.0 million under this facility. After reductions for non-qualifying receivables, we had $0.6 million of additional borrowings available under the program at December 31, 2013. During the third quarter 2013,

 

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agreement to account for changes in the underlying funding source for the securitization process. The interest rate under the amended agreement is the sum of (A) either (1) LIBOR rates or (2) the federal funds rate plus 0.5% or the prime rate and (B) a fixed margin. At December 31, 2013, the interest rate was 0.6%.

International Receivable Sales Programs

We have several international programs to sell with recourse trade accounts receivable to financial institutions. Advances received under these programs are accounted for as borrowings secured by the receivables and included in net cash provided by financing activities. During the fourth quarter 2013, the international factoring programs expired and were not renewed.

Off Balance Sheet Arrangements

Consignment and Customer Arrangements for Precious Metals. We use precious metals, primarily silver, in the production of some of our products. We obtain most precious metals from financial institutions under consignment agreements (generally referred to as our precious metals consignment program). The financial institutions retain ownership of the precious metals and charge us fees based on the amounts we consign and the period of consignment. These fees were $3.0 million for 2013. At December 31, 2013, we had on hand $30.8 million worth of precious metals owned by participants in our precious metals consignment program, measured at fair value based on market prices for identical assets. We also process precious metals owned by our customers.

The consignment agreements under our precious metals program involve short-term commitments that typically mature within 30 to 90 days of each transaction and are typically renewed on an ongoing basis. As a result, the Company relies on the continued willingness of financial institutions to participate in these arrangements to maintain this source of liquidity. On occasion, we have been required to deliver cash collateral. While no deposits were outstanding at December 31, 2013, we may be required to furnish cash collateral in the future based on the quantity and market value of the precious metals under consignment and the amount of collateral-free lines provided by the financial institutions. The amount of cash collateral required is subject to review by the financial institutions and can be changed at any time at their discretion, based in part on their assessment of our creditworthiness.

Bank Guarantees and Standby Letters of Credit. At December 31, 2013, the Company and its subsidiaries had bank guarantees and standby letters of credit issued by financial institutions that totaled $10.1 million. These agreements primarily relate to Ferro’s insurance programs, foreign energy purchase contracts and foreign tax payments.

Other Financing Arrangements

We maintain other lines of credit to provide global flexibility for Ferro’s short-term liquidity requirements. These facilities are uncommitted lines for our international operations and totaled $17.1 million at December 31, 2013. We had $10.1 million of additional borrowings available under these lines at December 31, 2013.

Liquidity Requirements

Our primary sources of liquidity are available cash and cash equivalents, available lines of credit under the revolving credit facility, and cash flows from operating activities. As of December 31, 2013, we had $28.3 million of cash and cash equivalents. Substantially all of our cash and cash equivalents were held by foreign subsidiaries. Cash generated in the U.S. is generally used to pay down amounts outstanding under our revolving credit facility. If needed, we could repatriate the majority of cash held by foreign subsidiaries without the need to accrue and pay U.S. income taxes. We do not anticipate a liquidity need requiring such repatriation of these funds to the U.S.

 

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Our liquidity requirements primarily include debt service, purchase commitments, labor costs, working capital requirements, restructuring expenditures, capital investments, precious metals cash collateral requirements, and postretirement obligations. We expect to meet these requirements in the long term through cash provided by operating activities and availability under existing credit facilities or other financing arrangements. Cash flows from operating activities are primarily driven by earnings before noncash charges and changes in working capital needs. In 2013, cash flows from investing and operating activities were used to fund our financing activities. We had additional borrowing capacity of $235.3 million at December 31, 2013, under our revolving credit facility.

Our credit facilities and the indenture governing our senior notes contain a number of restrictive covenants, including those described in more detail in Note 6 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K. These covenants include customary operating restrictions that limit our ability to engage in certain activities, including additional loans and investments; prepayments, redemptions and repurchases of debt; and mergers, acquisitions and asset sales. We are also subject to customary financial covenants under our credit facilities, including a leverage ratio and an interest coverage ratio. These covenants under our credit facilities restrict the amount of our borrowings, reducing our flexibility to fund ongoing operations and strategic initiatives. These facilities and our senior notes are described in more detail in “Capital Resources and Liquidity” under Item 7 and in Note 6 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

The most critical of these ratios is the leverage ratio for the revolving credit facility. As of December 31, 2013, we were in compliance with our maximum leverage ratio covenant of 4.00x as our actual ratio was 2.57x, providing $43.8 million of EBITDA cushion on the leverage ratio, as defined within our credit facilities and senior notes indenture. Our leverage ratio covenants decrease in 2013 to 3.50x. To the extent that economic conditions in key markets deteriorate or we are unable to meet our business projections and EBITDA falls below approximately $100 million for rolling four quarters, based on reasonably consistent debt levels with those as of December 31, 2013, we could become unable to maintain compliance with our leverage ratio covenant. In such case, our lenders could demand immediate payment of outstanding amounts and we would need to seek alternate financing sources to pay off such debts and to fund our ongoing operations. Such financing may not be available on favorable terms, if at all.

We may from time to time seek to retire or repurchase our outstanding debt through open market purchases, privately negotiated transactions, or other means. Such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions, and other factors. The amounts involved may be material.

Difficulties experienced in global capital markets could affect the ability or willingness of counterparties to perform under our various lines of credit, receivable sales programs, forward contracts, and precious metals program. These counterparties are major, reputable, multinational institutions, all having investment-grade credit ratings, except for one, which is not rated. Accordingly, we do not anticipate counterparty default. However, an interruption in access to external financing could adversely affect our business prospects and financial condition.

We assess on an ongoing basis our portfolio of businesses, as well as our financial and capital structure, to ensure that we have sufficient capital and liquidity to meet our strategic objectives. As part of this process, from time to time we evaluate the possible divestiture of businesses that are not critical to our core strategic objectives and, where appropriate, pursue the sale of such businesses and assets such as our completed sales in 2013. We also evaluate and pursue acquisition opportunities that we believe will enhance our strategic position. Generally, we publicly announce divestiture and acquisition transactions only when we have entered into definitive agreements relating to those transactions.

 

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The Company’s aggregate amount of contractual obligations for the next five years and thereafter is set forth below:

 

    2014     2015     2016     2017     2018     Thereafter     Totals  
    (Dollars in thousands)  

Loans payable(1)

  $ 43,062      $      $      $      $      $      $ 43,062   

Long-term debt(2)

    1,168        10,600        1,131        992        250,855        3,891        268,637   

Interest(3)

    19,688        19,688        19,688        19,688        19,688               98,440   

Operating lease obligations

    13,739        8,116        5,768        4,957        4,516        21,061        58,157   

Purchase commitments(4)

    19,302        8,544        6,484        4,498        1,495               40,323   

Taxes(5)

    1,135                                           1,135   
Retirement and other postemployment benefits(6)     33,457        31,032                                    64,489   
    $     131,551      $     77,980      $     33,071      $     30,135      $     276,554      $     24,953      $     574,243   

 

(1) Loans Payable includes our loans payable to banks as well our domestic accounts receivable program.
(2) Long-term debt excludes imputed interest and executory costs on capitalized lease obligations.
(3) Interest represents only contractual payments for fixed-rate debt.
(4) Purchased commitments are noncancelable contractual obligations for raw materials and energy.
(5) We have not projected payments past 2014 due to uncertainties in estimating the amount and period of any payments. We have $38.7 million in gross liabilities related to unrecognized tax benefits, including $2.3 million of accrued interest and penalties that are not included in the above table since we cannot reasonably predict the timing of cash settlements with various taxing authorities.
(6) The funding amounts are based on the minimum contributions required under our various plans and applicable regulations in each respective country. We have not projected contributions past 2015 due to uncertainties regarding the assumptions involved in estimating future required contributions.

Critical Accounting Policies

When we prepare our consolidated financial statements we are required to make estimates and assumptions that affect the amounts we report in the consolidated financial statements and footnotes. We consider the policies discussed below to be more critical than other policies because their application requires our most subjective or complex judgments. These estimates and judgments arise because of the inherent uncertainty in predicting future events. Management has discussed the development, selection and disclosure of these policies with the Audit Committee of the Board of Directors.

Revenue Recognition

We recognize sales typically when we ship goods to our customers and when all of the following criteria are met:

 

   

Persuasive evidence of an arrangement exists;

 

   

The selling price is fixed or determinable;

 

   

Collection is reasonably assured; and

 

   

Title and risk of loss has passed to our customers.

In order to ensure the revenue recognition in the proper period, we review material sales contracts for proper cut-off based upon the business practices and legal requirements of each country. For sales of products

 

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containing precious metals, we report revenues gross along with their corresponding cost of sales to arrive at gross profit. We record revenues this way because we act as the principal in the transactions into which we enter.

Restructuring and Cost Reduction Programs

In recent years, we have developed and initiated several restructuring programs across a number of our business segments with the objectives of leveraging our global scale, realigning and lowering our cost structure, and optimizing capacity utilization. The programs are primarily associated with North America, Europe and Asia-Pacific. Management continues to evaluate our businesses, and therefore, there may be additional provisions for new plan initiatives, as well as changes in estimates to amounts previously recorded, as payments are made or actions are completed.

Restructuring charges include both termination benefits and asset writedowns. We estimate accruals for termination benefits based on various factors including length of service, contract provisions, local legal requirements, projected final service dates, and salary levels. We also analyze the carrying value of long-lived assets and record estimated accelerated depreciation through the anticipated end of the useful life of the assets affected by the restructuring or record an asset impairment. In all likelihood, this accelerated depreciation will result in reducing the net book value of those assets to zero at the date operations cease. While we believe that changes to our estimates are unlikely, the accuracy of our estimates depends on the successful completion of numerous actions. Changes in our estimates could increase our restructuring costs to such an extent that it could have a material impact on the Company’s results of operations, financial position, or cash flows. Other events, such as negotiations with unions and works councils, may also delay the resulting cost savings.

Accounts Receivable and the Allowance for Doubtful Accounts

Ferro sells its products to customers in diversified industries throughout the world. No customer or related group of customers represents greater than 10% of net sales or accounts receivable. We perform ongoing credit evaluations of our customers and require collateral principally for export sales, when industry practices allow and as market conditions dictate, subject to our ability to negotiate secured terms relative to competitive offers. We regularly analyze significant customer accounts and provide for uncollectible accounts based on historical experience, customer payment history, the length of time the receivables are past due, the financial health of the customer, economic conditions, and specific circumstances, as appropriate. Changes in these factors could result in additional allowances. Customer accounts we conclude to be uncollectible or to require excessive collection costs are written off against the allowance for doubtful accounts. Historically, write-offs of uncollectible accounts have been within our expectations.

Goodwill

We review goodwill for impairment each year using a measurement date of October 31st or more frequently in the event of an impairment indicator. We annually, or more frequently as warranted, evaluate the appropriateness of our reporting units utilizing operating segments as the starting point of our analysis. In the event of a change in our reporting units we would allocate goodwill based on the relative fair value. We estimate the fair values of the reporting units associated with these assets using the average of both the income approach and the market approach, which we believe provides a reasonable estimate of the reporting units’ fair values, unless facts and circumstances exist that indicate more representative fair values. The income approach uses projected cash flows attributable to the reporting units over their useful lives and allocates certain corporate expenses to the reporting units. We use historical results, trends and our projections of market growth, internal sales efforts and anticipated cost structure assumptions to estimate future cash flows. Using a risk-adjusted, weighted-average cost of capital, we discount the cash flow projections to the measurement date. The market approach estimates a price reasonably expected to be paid by a market participant in the purchase of similar businesses. If the fair value of any of the reporting units were determined to be less than its carrying value, we would proceed to the second step and obtain comparable market values or independent appraisals of its assets and liabilities to determine the amount of any impairment.

 

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The significant assumptions and ranges of assumptions we used in our impairment analyses of goodwill at October 31, 2013 and 2012, were as follows:

 

Significant Assumptions

   2013     2012  

Weighted-average cost of capital

     12.0% - 12.5     12.0% - 15.5

Residual growth rate

     3.0     3.0

Our estimates of fair value can be adversely affected by a variety of factors. Reductions in actual or projected growth or profitability at our reporting units due to unfavorable market conditions or significant increases in cost structure could lead to the impairment of any related goodwill. Additionally, an increase in inflation, interest rates or the risk-adjusted, weighted-average cost of capital could also lead to a reduction in the fair value of one or more of our reporting units and therefore lead to the impairment of goodwill.

Based on our 2013 annual impairment test performed as of October 31, 2013, the fair values of the remaining reporting units tested for impairment exceeded the carrying values of the respective reporting units by amounts ranging from 35% to 166% at the 2013 measurement date. The lowest cushion relates to the Pigments, Powders and Oxides reporting unit, which had a goodwill balance of $9.5 million at December 31, 2013. A future potential impairment is possible for any of these reporting units if actual results are materially less than forecasted results. Some of the factors that could negatively affect our cash flows and, as a result, not support the carrying values of our reporting units are: new environmental regulations or legal restrictions on the use of our products that would either reduce our product revenues or add substantial costs to the manufacturing process, thereby reducing operating margins; new technologies that could make our products less competitive or require substantial capital investment in new equipment or manufacturing processes; and substantial downturns in economic conditions.

Long-Lived Asset Impairment

The Company’s long-lived assets include property, plant and equipment, and amortizable intangible assets. We review property, plant and equipment and amortizable intangible assets for impairment whenever events or circumstances indicate that their carrying values may not be recoverable. The following are examples of such events or changes in circumstances:

 

   

An adverse change in the business climate or market price of a long-lived asset or asset group;

 

   

An adverse change in the extent or manner in which a long-lived asset or asset group is used or in its physical condition;

 

   

Current operating losses for a long-lived asset or asset group combined with a history of such losses or projected or forecasted losses that demonstrate that the losses will continue; or

 

   

A current expectation that, more likely than not, a long-lived asset or asset group will be sold or otherwise significantly disposed of before the end of its previously estimated useful life.

The carrying amount of property, plant and equipment and amortizable intangible assets is not recoverable if the carrying value of the asset group exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset group. In the event of impairment, we recognize a loss for the excess of the recorded value over fair value. The long-term nature of these assets requires the estimation of cash inflows and outflows several years into the future and only takes into consideration technological advances known at the time of review.

Income Taxes

The breadth of our operations and complexity of income tax regulations require us to assess uncertainties and make judgments in estimating the ultimate amount of income taxes we will pay. Our income tax expense,

 

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deferred tax assets and liabilities, and reserves for unrecognized tax benefits reflect management’s best assessment of estimated current and future taxes to be paid. The final income taxes we pay are based upon many factors, including existing income tax laws and regulations, negotiations with taxing authorities in various jurisdictions, outcomes of tax litigation, and resolution of disputes arising from federal, state and international income tax audits. The resolution of these uncertainties may result in adjustments to our income tax assets and liabilities in the future.

Deferred income taxes result from differences between the financial and tax basis of our assets and liabilities. We adjust our deferred income tax assets and liabilities for changes in income tax rates and income tax laws when changes are enacted. We record valuation allowances to reduce deferred income tax assets when it is more likely than not that a tax benefit will not be realized. Significant judgment is required in evaluating the need for and the magnitude of appropriate valuation allowances against deferred income tax assets. The realization of these assets is dependent on generating future taxable income, our ability to carry back or carry forward net operating losses and credits to offset tax liabilities in a prior year, as well as successful implementation of various tax strategies to generate tax where net operating losses or credit carryforwards exist. In evaluating our ability to realize the deferred income tax assets, we rely principally on the reversal of existing temporary differences, the availability of tax planning strategies, and forecasted income.

We recognize a tax benefit from an uncertain tax position when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Our estimate of the potential outcome of any uncertain tax positions is subject to management’s assessment of relevant risks, facts, and circumstances existing at that time. We record a liability for the difference between the benefit recognized and measured based on a more-likely-than-not threshold and the tax position taken or expected to be taken on the tax return. To the extent that our assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made. We report tax-related interest and penalties as a component of income tax expense.

Derivative Financial Instruments

We use derivative financial instruments in the normal course of business to manage our exposure to fluctuations in interest rates, foreign currency exchange rates, commodity prices, and precious metal prices. The accounting for derivative financial instruments can be complex and can require significant judgment. Generally, the derivative financial instruments that we use are not complex, and observable market-based inputs are available to measure their fair value. We do not engage in speculative transactions for trading purposes. Financial instruments, including derivative financial instruments, expose us to counterparty credit risk for nonperformance. We manage our exposure to counterparty credit risk through minimum credit standards and procedures to monitor concentrations of credit risk. We enter into these derivative financial instruments with major, reputable, multinational financial institutions. Accordingly, we do not anticipate counter-party default. We continuously evaluate the effectiveness of derivative financial instruments designated as hedges to ensure that they are highly effective. In the event the hedge becomes ineffective, we discontinue hedge treatment. Except as noted below, we do not expect any changes in our risk policies or in the nature of the transactions we enter into to mitigate those risks.

We manage foreign currency risks in a wide variety of foreign currencies principally by entering into forward contracts to mitigate the impact of currency fluctuations on transactions arising from international trade. Our objective in entering into these forward contracts is to preserve the economic value of nonfunctional currency cash flows. Our principal foreign currency exposures relate to the Euro, the British Pound Sterling, the Japanese Yen, and the Chinese Yuan. We mark these forward contracts to fair value based on market prices for comparable contracts and recognize the resulting gains or losses as other income or expense from foreign currency transactions.

Precious metals (primarily silver, gold, platinum and palladium) represent a significant portion of raw material costs in our electronic products. When we enter into a fixed price sales contract at the customer’s

 

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request to establish the price for the precious metals content of the order, we also enter into a forward purchase arrangement with a precious metals supplier to completely cover the value of the precious metals content. Our current precious metal contracts are designated as normal purchase contracts, which are not marked to market.

We also purchase portions of our energy requirements, including natural gas and electricity, under fixed price contracts to reduce the volatility of cost changes. Our current energy contracts are designated as normal purchase contracts, which are not marked to market.

Pension and Other Postretirement Benefits

We sponsor defined benefit plans in the U.S. and many countries outside the U.S., and we also sponsor retiree medical benefits for a segment of our salaried and hourly work force within the U.S. The U.S. pension plans represent approximately 83% of pension plan assets, 75% of benefit obligations and 101% of net periodic pension income.

The assumptions we use in actuarial calculations for these plans have a significant impact on benefit obligations and annual net periodic benefit costs. We meet with our actuaries annually to discuss key economic assumptions used to develop these benefit obligations and net periodic costs.

We determine the discount rate for the U.S. pension and retiree medical plans based on a bond model. Using the pension plans’ projected cash flows, the bond model considers all possible bond portfolios that produce matching cash flows and selects the portfolio with the highest possible yield. These portfolios are based on bonds with a quality rating of AA or better under either Moody’s Investor Services, Inc. or Standard & Poor’s Rating Group, but exclude certain bonds, such as callable bonds, bonds with small amounts outstanding, and bonds with unusually high or low yields. The discount rates for the non-U.S. plans are based on a yield curve method, using AA-rated bonds applicable in their respective capital markets. The duration of each plan’s liabilities is used to select the rate from the yield curve corresponding to the same duration.

For the market-related value of plan assets, we use fair value, rather than a calculated value that recognizes changes in fair value in a systematic and rational manner over several years. We calculate the expected return on assets at the beginning of the year for defined benefit plans as the weighted-average of the expected return for the target allocation of the principal asset classes held by each of the plans. In determining the expected returns, we consider both historical performance and an estimate of future long-term rates of return. The Company consults with and considers the opinion of its actuaries in developing appropriate return assumptions. Our target asset allocation percentages are 35% fixed income, 60% equity, and 5% other investments for U.S. plans and 75% fixed income, 24% equity, and 1% other investments for non-U.S. plans. In 2013, investment returns on average plan assets were approximately 15% within U.S. plans and 6% within non-U.S. plans. In 2012, investment returns on average plan assets were approximately 14% within U.S. plans and 14% within non-U.S. plans. Future actual pension expense will depend on future investment allocation and performance, changes in future discount rates and various other factors related to the population of participants in the Company’s pension plans.

All other assumptions are reviewed periodically by our actuaries and us and may be adjusted based on current trends and expectations as well as past experience in the plans.

 

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The following table provides the sensitivity of net annual periodic benefit costs for our pension plans, including a U.S. nonqualified retirement plan, and the retiree medical plan to a 25-basis-point decrease in both the discount rate and asset return assumption:

 

     25-Basis-Point Decrease in
Discount Rate
    25-Basis-Point Decrease in
Asset Return Assumption
 
     (Dollars in thousands)  

U.S. pension plans

   $ (369   $ 887   

U.S. retiree medical plan

     (39       

Non-U.S. pension plans

     (56     198   

Total

     $    (464   $     1,085   

The following table provides the rates used in the assumptions and the changes between 2013 and 2012:

 

             2013                     2012                     Change          

Discount rate used to measure benefit cost:

      

U.S. pension plans

     4.30     5.10     (0.80 )% 

U.S. retiree medical plan

     3.85     4.85     (1.00 )% 

Non-U.S. pension plans

     4.00     5.01     (1.01 )% 

Discount rate used to measure benefit obligations:

      

U.S. pension plans

     5.25     4.30     0.95

U.S. retiree medical plan

     4.90     3.85     1.05

Non-U.S. pension plans

     4.12     4.00     0.12

Expected return on plan assets:

      

U.S. pension plans

     8.20     8.20    

Non-U.S. pension plans

     4.45     4.86     (0.41 )% 

Our overall net periodic benefit income for all defined benefit plans increased $100.9 million to $71.8 million in 2013 from net periodic benefit cost of $29.1 million in 2012. The change is the result of higher mark to market actuarial net gains and returns on plan assets than in the prior year.

For 2014, assuming expected returns on plan assets and no actuarial gains or losses, we expect our overall net periodic benefit income to be approximately $4.5 million, compared with income of approximately $2.5 million in 2013 on a comparable basis. The change is the result of higher expected returns from a larger asset base, partially offset by higher interest costs due to higher discount rates.

Inventories

We value inventory at the lower of cost or market, with cost determined utilizing the first-in, first-out (FIFO) method. We periodically evaluate the net realizable value of inventories based primarily upon their age, but also upon assumptions of future usage in production, customer demand and market conditions. Inventories have been reduced to the lower of cost or realizable value by allowances for slow moving or obsolete goods. If actual circumstances are less favorable than those projected by management in its evaluation of the net realizable value of inventories, additional write-downs may be required. Slow moving, excess or obsolete materials are specifically identified and may be physically separated from other materials, and we rework or dispose of these materials as time and manpower permit.

 

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Environmental Liabilities

Our manufacturing facilities are subject to a broad array of environmental laws and regulations in the countries in which they are located. The costs to comply with complex environmental laws and regulations are significant and will continue for the foreseeable future. We expense these recurring costs as they are incurred. While these costs may increase in the future, they are not expected to have a material impact on our financial position, liquidity or results of operations.

We also accrue for environmental remediation costs when it is probable that a liability has been incurred and we can reasonably estimate the amount. We determine the timing and amount of any liability based upon assumptions regarding future events. Inherent uncertainties exist in such evaluations primarily due to unknown conditions, changing governmental regulations and legal standards regarding liability, and evolving technologies. We adjust these liabilities periodically as remediation efforts progress or as additional technical or legal information becomes available.

Impact of Newly Issued Accounting Pronouncements

Refer to Note 2 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K for a discussion of accounting standards we recently adopted or will be required to adopt.

Item 7A — Quantitative and Qualitative Disclosures about Market Risk

The primary objective of the following information is to provide forward-looking quantitative and qualitative information about our exposure to instruments that are sensitive to fluctuations in interest rates, foreign currency exchange rates, and costs of raw materials and energy.

Our exposure to interest rate risk arises from our debt portfolio. We manage this risk by controlling the mix of fixed versus variable-rate debt after considering the interest rate environment and expected future cash flows. Our objective is to limit variability in earnings, cash flows and overall borrowing costs caused by changes in interest rates, while preserving operating flexibility.

We operate internationally and enter into transactions denominated in foreign currencies. These transactions expose us to gains and losses arising from exchange rate movements between the dates foreign currencies are recorded and the dates they are settled. We manage this risk by entering into forward currency contracts that substantially offset these gains and losses.

We are subject to cost changes with respect to our raw materials and energy purchases. We attempt to mitigate raw materials cost increases through product reformulations, price increases, and other productivity improvements. We enter into forward purchase arrangements with precious metals suppliers to completely cover the value of the precious metals content of fixed price sales contracts. These agreements are designated as normal purchase contracts, which are not marked to market, and had purchase commitments totaling $2.8 million at December 31, 2013. In addition, we purchase portions of our natural gas and electricity requirements under fixed price contracts to reduce the volatility of these costs. These energy contracts are designated as normal purchase contracts, which are not marked to market, and had purchase commitments totaling $33.2 million at December 31, 2013.

 

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The notional amounts, carrying amounts of assets (liabilities), and fair values associated with our exposure to these market risks and sensitivity analysis about potential gains (losses) resulting from hypothetical changes in market rates are presented below:

 

             2013                     2012          
     (Dollars in thousands)  

Variable-rate debt and utilization of asset securitization program:

    

Change in annual interest expense from 1% change in interest rates

   $ 516      $ 543   

Fixed-rate debt:

    

Carrying amount

         253,617            289,148   

Fair value

     269,238        270,240   

Change in fair value from 1% increase in interest rate

     (10,061     (10,113

Change in fair value from 1% decrease in interest rate

     10,546        10,668   

Foreign currency forward contracts:

    

Notional amount

     244,921        250,680   

Carrying amount and fair value

     (2,255     (4,758

Change in fair value from 10% appreciation of U.S. dollar

     12,867        13,205   

Change in fair value from 10% depreciation of U.S. dollar

     (15,727     (16,140

 

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Item 8 — Financial Statements and Supplementary Data 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Ferro Corporation

Cleveland, Ohio

We have audited the accompanying consolidated balance sheets of Ferro Corporation and subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive income (loss), equity, and cash flows for each of the three years in the period ended December 31, 2013. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Ferro Corporation and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

As discussed in Note 16 to the consolidated financial statements, the Company sold its Pharmaceuticals business in the first quarter of 2013. The operations prior to the sale are included in (loss) income from discontinued operations in the accompanying consolidated financial statements.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2013, based on the criteria established in Internal Control — Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 24, 2014 expressed an unqualified opinion on the Company’s internal control over financial reporting.

/s/ Deloitte & Touche LLP

Cleveland, Ohio

February 24, 2014

 

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FERRO CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Years Ended December 31,  
     2013     2012     2011  
     (In thousands, except per share amounts)  

Net sales

   $   1,635,406      $   1,744,613      $   2,130,853   

Cost of sales

     1,305,682        1,455,043        1,728,048   

Gross profit

     329,724        289,570        402,805   

Selling, general and administrative expenses

     176,282        297,755        330,450   

Restructuring and impairment charges

     41,733        225,724        17,030   

Other expense (income):

      

Interest expense

     27,333        26,461        27,190   

Interest earned

     (271     (311     (285

Losses on extinguishment of debt

                   45   

Foreign currency losses, net

     4,183        2,186        4,758   

Miscellaneous (income) expense, net

     (15,269     3,095        2,527   

Income (loss) before income taxes

     95,733        (265,340     21,090   

Income tax expense

     14,867        108,850        18,132   

Net income (loss) from continuing operations

     80,866        (374,190     2,958   

(Loss) income from discontinued operations, net of income tax

     (8,421     1,156        2,176   

Net income (loss)

     72,445        (373,034     5,134   

Less: Net income attributable to noncontrolling interests

     503        1,234        730   

Net income (loss) attributable to Ferro Corporation

     71,942        (374,268     4,404   

Dividends on preferred stock

                   (165
Net income (loss) attributable to Ferro Corporation common shareholders      71,942        (374,268     4,239   

Amounts attributable to Ferro Corporation:

      

Income (loss) from continuing operations, net of income tax

     80,363        (375,424     2,228   

(Loss) income from discontinued operations, net of income tax

     (8,421     1,156        2,176   

Income (loss) attributable to Ferro Corporation

   $ 71,942      $ (374,268   $ 4,404   

Weighted-average common shares outstanding

     86,484        86,288        86,119   
Incremental common shares attributable to convertible preferred stock, performance shares, deferred stock units, and stock options      1,013               659   

Weighted-average diluted shares outstanding

     87,497        86,288        86,778   
Earnings (loss) per share attributable to Ferro Corporation common shareholders:       

Basic earnings (loss) per share:

      

From continuing operations

   $ 0.93      $ (4.35   $ 0.02   

From discontinued operations

     (0.10     0.01        0.03   
     $ 0.83      $ (4.34   $ 0.05   

Diluted earnings (loss) per share:

      

From continuing operations

   $ 0.92      $ (4.35   $ 0.02   

From discontinued operations

     (0.10     0.01        0.03   
     $ 0.82      $ (4.34   $ 0.05   

See accompanying notes to consolidated financial statements.

 

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FERRO CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

 

    Years Ended December 31,  
            2013                     2012                     2011          
    (Dollars in thousands)  

Net income (loss)

  $     72,445      $       (373,034   $       5,134   

Other comprehensive income (loss), net of tax:

     

Foreign currency translation

    (7,459     (4,253     (3,473

Postretirement benefit liabilities

    (705     (910     (220

Other

    7        (25       

Other comprehensive income (loss), net of income tax

    (8,157     (5,188     (3,693

Total comprehensive income (loss)

    64,288        (378,222     1,441   

Less: Comprehensive income attributable to noncontrolling interests

    732        3,295        930   

Comprehensive income (loss) attributable to Ferro Corporation

  $ 63,556      $ (381,517   $ 511   

See accompanying notes to consolidated financial statements.

 

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FERRO CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

      December 31,  
     2013     2012  
     (Dollars in thousands)  
ASSETS   

Current assets

    

Cash and cash equivalents

   $ 28,328      $ 29,576   

Accounts receivable, net

     287,925        306,463   

Inventories

     190,216        200,824   

Deferred income taxes

     6,584        7,995   

Other receivables

     25,775        31,554   

Other current assets

     16,561        10,802   

Current assets of discontinued operations

            6,289   

Total current assets

     555,389        593,503   

Other assets

    

Property, plant and equipment, net

     297,104        309,374   

Goodwill

     63,473        62,975   

Amortizable intangible assets, net

     13,027        14,410   

Deferred income taxes

     19,451        21,554   

Other non-current assets

     59,748        61,941   

Other assets of discontinued operations

            15,346   

Total assets

   $ 1,008,192      $ 1,079,103   
LIABILITIES and EQUITY   

Current liabilities

    

Loans payable and current portion of long-term debt

   $ 44,230      $ 85,152   

Accounts payable

     153,877        182,024   

Accrued payrolls

     44,509        31,643   

Accrued expenses and other current liabilities

     71,115        76,384   

Current liabilities of discontinued operations

            1,300   

Total current liabilities

     313,731        376,503   

Other liabilities

    

Long-term debt, less current portion

     267,469        261,624   

Postretirement and pension liabilities

     120,527        216,167   

Other non-current liabilities

     32,622        18,135   

Total liabilities

     734,349        872,429   

Equity

    

Ferro Corporation shareholders’ equity:

    

Common stock, par value $1 per share; 300.0 million shares authorized and 93.4 million shares issued at December 31, 2013 and 2012; 86.7 million and 86.5 million shares outstanding at December 31, 2013 and 2012, respectively

     93,436        93,436   

Paid-in capital

     318,055        321,652   

Accumulated deficit

     (14,664     (86,606

Accumulated other comprehensive income

     8,493        16,650   

Common shares in treasury, at cost

     (143,802     (151,605

Total Ferro Corporation shareholders’ equity

     261,518        193,527   

Noncontrolling interests

     12,325        13,147   

Total equity

     273,843        206,674   

Total liabilities and equity

   $     1,008,192      $     1,079,103   

See accompanying notes to consolidated financial statements.

 

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FERRO CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EQUITY

 

    Ferro Corporation Shareholders              
    Common Shares
In Treasury
    Common
Stock
    Paid-in
Capital
    Retained
Earnings
(Deficit)
    Accumulated
Other
Comprehensive
Income (Loss)(a)
    Non-
controlling
Interests
    Total Equity  
    Shares     Amount              
    (In thousands, except per share data)  

Balances at December 31, 2010

    7,242      $ (164,257   $ 93,436      $ 323,015      $ 283,423      $ 27,792      $ 10,771      $ 574,180   

Net income

            4,404          730        5,134   
Other comprehensive (loss) income               (3,893     200        (3,693
Cash dividends on preferred shares(b)             (165         (165
Stock-based compensation transactions     (377     10,640          (2,133           8,507   
Distributions to noncontrolling interests                                                     (1,469     (1,469

Balances at December 31, 2011

    6,865        (153,617     93,436        320,882        287,662        23,899        10,232        582,494   

Net (loss) income

            (374,268       1,234        (373,034
Other comprehensive (loss) income               (7,249     2,061        (5,188
Stock-based compensation transactions     97        2,012          770              2,782   
Distributions to noncontrolling interests                                                     (380     (380

Balances at December 31, 2012

    6,962        (151,605     93,436        321,652        (86,606     16,650        13,147        206,674   

Net income

            71,942          503        72,445   
Other comprehensive (loss) income               (8,157     229        (7,928
Stock-based compensation transactions     (232     7,803          (3,597           4,206   
Distributions to noncontrolling interests                                                     (1,554     (1,554

Balances at December 31, 2013

    6,730      $ (143,802   $ 93,436      $ 318,055      $ (14,664   $ 8,493      $ 12,325      $ 273,843   

 

(a) Accumulated translation adjustments were $6,621, $14,080, and $20,394 and accumulated postretirement benefit liability adjustments were $1,942, $2,647, and $3,557 at December 31, 2013, 2012, and 2011, respectively, all net of tax.
(b) Dividends per share of convertible preferred stock were $0.8125 in 2011.

See accompanying notes to consolidated financial statements.

 

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FERRO CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Years Ended December 31,  
     2013     2012     2011  
     (Dollars in thousands)  

Cash flows from operating activities

      
Net income (loss)    $ 72,445      $ (373,034   $ 5,134   
Adjustments to reconcile net income (loss) to net cash provided by operating activities:       

(Gain) loss on sale of assets and businesses

     (15,604     505        (244

Depreciation and amortization

     50,028        57,384        63,493   

Restructuring and impairment charges

     20,581        221,596        7,472   

Losses on extinguishment of debt

                   45   

Provision for allowance for doubtful accounts

     4,074        5,217        2,349   

Retirement benefits

     (97,053     339        8,337   

Deferred income taxes

     7,853        107,575        20,575   

Non-cash foreign currency (losses) gains

     (13,028     (6,815     12,443   

Changes in current assets and liabilities, net of effects of acquisitions:

      

Accounts receivable

     16,224        (5,258     (13,444

Inventories

     18,056        22,287        (29,790

Deposits for precious metals

                   28,086   

Other receivables and other current assets

     (826     13,192        (19,673

Accounts payable

     (27,963     (18,359     4,715   

Accrued expenses and other current liabilities

     (6,939     4,409        (31,205

Other operating activities

     (9,384     (5,380     (5,060

Net cash provided by operating activities

     18,464        23,658        53,233   

Cash flows from investing activities

      
Capital expenditures for property, plant and equipment and other long-lived assets      (34,220     (58,685     (72,713
Proceeds from sale of assets and businesses      50,173        3,043        6,441   

Other investing activities

     1,215        334        1,145   

Net cash provided by (used for) investing activities

     17,168        (55,308     (65,127

Cash flows from financing activities

      

Net (repayments) borrowings under loans payable(1)

     (5,884     39,934        8,661   

Proceeds from revolving credit facility

     449,268        395,576        646,834   

Payments on revolving credit facility

     (442,659     (400,687     (639,128

Extinguishment of Convertible Senior Notes

     (35,066            (725

Redemption of convertible preferred stock

                   (9,427

Cash dividends

                   (165

Proceeds from exercise of stock options

     666        107        1,053   

Other financing activities

     (3,040     1,527        (1,199

Net cash (used for) provided by financing activities

     (36,715     36,457        5,904   

Effect of exchange rate changes on cash and cash equivalents

     (165     1,778        (54

(Decrease) increase in cash and cash equivalents

     (1,248     6,585        (6,044

Cash and cash equivalents at beginning of period

     29,576        22,991        29,035   

Cash and cash equivalents at end of period

   $ 28,328      $ 29,576      $ 22,991   

Cash paid during the period for:

      

Interest

   $ 26,775      $ 26,468      $ 25,920   

Income taxes

     5,815        4,657        22,060   

 

(1) Includes cash flows related to our domestic accounts receivable program, international accounts receivable sales programs as well as loans payable to banks.

See accompanying notes to condensed consolidated financial statements.

 

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FERRO CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2013, 2012 and 2011

 

1. Our Business

Ferro Corporation (“Ferro,” “we,” “us” or “the Company”) produces performance materials for a broad range of manufacturers in diversified industries throughout the world. Our products are classified as performance materials, rather than commodities, because they are formulated to perform specific and important functions both in the manufacturing processes and in the finished products of our customers. We use inorganic and organic chemical processes, polymer science and materials science to develop and produce these performance materials. Performance materials require a high degree of technical service on an individual customer basis. The value of our products stems from the results and performance they achieve in actual use. We manage our diverse businesses through six business units that are differentiated from one another by product type. We have grouped these units by their product group below:

 

Performance Materials

  

Performance Chemicals

•  Tile Coating Systems

  

•  Polymer Additives

•  Porcelain Enamel

  

•  Specialty Plastics

•  Performance Colors and Glass

  

•  Pigments, Powders and Oxides

  

We produce our products primarily in the United States (“U.S.”), Europe-Middle East-Africa, the Asia-Pacific region, and Latin America.

We sell our products directly to customers and through the use of agents or distributors throughout the world. Our products are sold principally in the U.S., Europe, the Asia-Pacific region, and Latin America. Our customers manufacture products to serve a variety of end markets, including building and renovation, electronics, automobiles, appliances, household furnishings, packaging, and industrial products.

 

2. Significant Accounting Policies

Principles of Consolidation

Our consolidated financial statements include the accounts of the parent company and the accounts of its subsidiaries. When we consolidate our financial statements, we eliminate intercompany transactions, accounts and profits. When we exert significant influence over an investee but do not control it, we account for the investment and the investment income using the equity method. These investments are reported in the other non-current assets section of our balance sheet. We consolidate five legal entities in which we do not own 100% of the equity interests, either directly or indirectly through our subsidiaries. These entities have non-controlling interest ownerships ranging from 5% to 49%.

When we acquire a subsidiary, its financial results are included in our consolidated financial statements from the date of the acquisition. When we dispose of a subsidiary, its financial results are included in our consolidated financial statements until the date of the disposition. In the event that a disposal group meets the criteria for discontinued operations, prior periods are adjusted to reflect the disposition.

Use of Estimates and Assumptions in the Preparation of Financial Statements

We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States, which requires us to make estimates and to use judgments and assumptions that affect the timing and amount of assets, liabilities, equity, revenues and expenses recorded and disclosed. The more significant estimates and judgments relate to revenue recognition, restructuring and cost reduction programs, goodwill, asset impairment, income taxes, pension and other postretirement benefits, inventories, and

 

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FERRO CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2013, 2012 and 2011 — (Continued)

 

environmental liabilities. Actual outcomes could differ from our estimates, resulting in changes in revenues or costs that could have a material impact on the Company’s results of operations, financial position, or cash flows.

Foreign Currency Translation

The financial results of our operations outside of the U.S. are recorded in local currencies, which generally are also the functional currencies for financial reporting purposes. The results of operations outside of the U.S. are translated from these functional currencies into U.S. dollars using the average monthly currency exchange rates. We use the average currency exchange rate for these results of operations as a reasonable approximation of the results had specific currency exchange rates been used for each individual transaction. Foreign currency transaction gains and losses are recorded as incurred as other expense (income) in the consolidated statements of operations. Assets and liabilities are translated into U.S. dollars using exchange rates at the balance sheet dates, and we record the resulting foreign currency translation adjustment as a separate component of accumulated other comprehensive loss in equity.

Revenue Recognition

We typically recognize sales when we ship goods to our customers and when all of the following criteria are met:

 

   

Persuasive evidence of an arrangement exists;

 

   

The selling price is fixed or determinable;

 

   

Collection is reasonably assured; and

 

   

Title and risk of loss has passed to our customers.

In order to ensure the revenue recognition in the proper period, we review material sales contracts for proper cut-off based upon the business practices and legal requirements of each country. For sales of all products, including those containing precious metals, we report revenues gross along with their corresponding cost of sales to arrive at gross profit. We record revenues this way because we act as the principal in the transactions into which we enter.

The amount of shipping and handling fees invoiced to our customers at the time our product is shipped is included in net sales. Credit memos issued to customers for sales returns, discounts allowed and sales adjustments are recorded when they are incurred as a reduction of sales.

Additionally, we provide certain of our customers with incentive rebate programs to promote customer loyalty and encourage greater product sales. We accrue customer rebates over the rebate periods based upon estimated attainments of the provisions in the rebate agreements using available information and record these rebate accruals as reductions of sales.

Research and Development Expenses

Research and development expenses are expensed as incurred and are included in selling, general and administrative expenses. Expenditures for company-sponsored research and development activities were approximately $ 26.9 million for 2013 and $30.0 million for 2012, and $30.4 million for 2011.

Restructuring Programs

We expense costs associated with exit and disposal activities designed to restructure operations and reduce ongoing costs of operations when we incur the related liabilities or when other triggering events occur. After the appropriate level of management having the authority approves the detailed restructuring plan and the

 

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FERRO CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2013, 2012 and 2011 — (Continued)

 

appropriate criteria for recognition are met, we establish accruals for employee termination costs. The accruals are estimates that are based upon factors including statutory and union requirements, affected employees’ lengths of service, contract provisions, salary level, and health care benefit choices. We also analyze the carrying value of affected long-lived assets for impairment and reductions in their remaining estimated useful lives. In addition, we record the fair value of any new or remaining obligations when existing operating lease contracts are terminated or abandoned as a result of our exit and disposal activities.

Asset Impairment

The Company’s long-lived assets include property, plant and equipment, goodwill, and amortizable intangible assets. We review property, plant and equipment and amortizable intangible assets for impairment whenever events or circumstances indicate that their carrying values may not be recoverable. The following are examples of such events or changes in circumstances:

 

   

An adverse change in the business climate or market price of a long-lived asset or asset group;

 

   

An adverse change in the extent or manner in which a long-lived asset or asset group is used or in its physical condition;

 

   

Current operating losses for a long-lived asset or asset group combined with a history of such losses or projected or forecasted losses that demonstrate that the losses will continue; or

 

   

A current expectation that, more likely than not, a long-lived asset or asset group will be sold or otherwise significantly disposed of before the end of its previously estimated useful life.

The carrying amount of property, plant and equipment and amortizable intangible assets is not recoverable if the carrying value of the asset group exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset group. In the event of impairment, we recognize a loss for the excess of the recorded value over fair value. The long-term nature of these assets requires the estimation of cash inflows and outflows several years into the future and only takes into consideration technological advances known at the time of review.

We review goodwill for impairment annually using a measurement date of October 31st, primarily due to the timing of our annual budgeting process, or more frequently in the event of an impairment indicator. The fair value of each reporting unit that has goodwill is estimated using the average of both the income approach and the market approach, which we believe provides a reasonable estimate of the reporting unit’s fair value, unless facts or circumstances exist which indicate a more representative fair value. The income approach is a discounted cash flow model, which uses projected cash flows attributable to the reporting unit, including an allocation of certain corporate expenses based primarily on a proportional sales method. We use historical results, trends and our projections of market growth, internal sales efforts and anticipated cost structure assumptions to estimate future cash flows. Using a risk-adjusted, weighted-average cost of capital, we discount the cash flow projections to the measurement date. The market approach estimates a price reasonably expected to be paid by a market participant in the purchase of the reporting units based on a comparison to similar businesses. If the fair value of any of the reporting units were determined to be less than its carrying value, we would obtain comparable market values or independent appraisals of its net assets.

Derivative Financial Instruments

As part of our risk management activities, we employ derivative financial instruments, primarily foreign currency forward contracts, to hedge certain anticipated transactions, firm commitments, or assets and liabilities denominated in foreign currencies. We also purchase portions of our energy and precious metal requirements under fixed price forward purchase contracts designated as normal purchase contracts.

 

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FERRO CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2013, 2012 and 2011 — (Continued)

 

We record derivatives on our balance sheet as either assets or liabilities that are measured at fair value. For derivative instruments that are designated and qualify as cash flow hedges, the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified from accumulated other comprehensive income into earnings when the hedged transaction affects earnings. As of December 31, 2013, we did not have any derivative instruments classified as cash flow hedges. The ineffective portion, if any, in the change in value of these derivatives is immediately recognized in earnings. For derivatives that are not designated as hedges, the gain or loss on the derivative is recognized in current earnings. We use derivatives only to manage well-defined risks and do not use derivatives for speculative purposes.

Postretirement and Other Employee Benefits

We recognize postretirement and other employee benefits as employees render the services necessary to earn those benefits. We determine defined benefit pension and other postretirement benefit costs and obligations with the assistance of actuarial calculations performed by third parties. The calculations and the resulting amounts recorded in our consolidated financial statements are affected by assumptions including the discount rate, expected long-term rate of return on plan assets, the annual rate of change in compensation for plan-eligible employees, estimated changes in costs of healthcare benefits, and other factors. We evaluate the assumptions used on an annual basis.

Income Taxes

We account for income taxes in accordance with Accounting Standards Codification (“ASC”) Topic 740, Income Taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax effects of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

We record deferred tax assets to the extent we believe these assets will more likely than not be realized. In making such determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future income, tax planning strategies, and recent financial operations.

We recognize a tax benefit from an uncertain tax position when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits.

We recognize interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying consolidated statements of operations.

Cash Equivalents

We consider all highly liquid instruments with original maturities of three months or less when purchased to be cash equivalents. These instruments are carried at cost.

Accounts Receivable and the Allowance for Doubtful Accounts

Ferro sells its products to customers in diversified industries throughout the world. No customer or related group of customers represents greater than 10% of net sales or accounts receivable. We perform ongoing credit evaluations of our customers and require collateral principally for export sales, when industry practices allow and as

 

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FERRO CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2013, 2012 and 2011 — (Continued)

 

market conditions dictate, subject to our ability to negotiate secured terms relative to competitive offers. We regularly analyze significant customer accounts and provide for uncollectible accounts based on historical experience, customer payment history, the length of time the receivables are past due, the financial health of the customer, economic conditions and specific circumstances, as appropriate. Changes in these factors could result in additional allowances. Customer accounts we conclude to be uncollectible or to require excessive collection costs are written off against the allowance for doubtful accounts. Historically, write-offs of uncollectible accounts have been within our expectations. Detailed information about the allowance for doubtful accounts is provided below:

 

     2013      2012      2011  
     (Dollars in thousands)  

Allowance for doubtful accounts

   $     12,428       $     14,353       $     10,443   

Bad debt expense

     4,074         5,202         2,349   

We have receivables sales programs in place for the U.S. where we sell our receivables to various purchasers. Due to the terms of such programs, these programs are recorded similar to secured borrowings on our balance sheet. The underlying receivables are derecognized when collection occurs, at which time repayment of the borrowings is made to the purchasers. The cash flows for the underlying receivables are categorized as operating activities. The related cash flows for the secured borrowings are categorized as financing activities and presented net as the turnover of such activities is quick, the amounts are large, and the maturities are short, generally three months or less. These programs accelerate cash collections at favorable financing costs. In December 2013, the international factoring program expired and was not renewed.

Inventories

We value inventory at the lower of cost or market, with cost determined utilizing the first-in, first-out (FIFO) method. We periodically evaluate the net realizable value of inventories based primarily upon their age, but also upon assumptions of future usage in production, customer demand and market conditions. Inventories have been reduced to the lower of cost or realizable value by allowances for slow moving or obsolete goods.

We maintain raw m