FERRO CORPORATION 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For
the quarterly period ended June 30, 2005
or
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o |
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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)
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Ohio
(State of Corporation)
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34-0217820
(IRS Employer Identification No.) |
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1000 Lakeside Avenue
Cleveland, OH
(Address of Principal executive offices)
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44114
(Zip Code) |
216-641-8580
(Telephone Number)
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 o NO þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). YES o NO þ
At September 29, 2006, there were 42,758,302 shares of Ferro Common Stock, par value $1.00,
outstanding.
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Ferro Corporation and Consolidated Subsidiaries
Condensed Consolidated Statements of Income
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Three months ended |
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Six months ended |
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June 30, |
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June 30, |
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2005 |
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2004 |
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2005 |
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2004 |
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(Dollars in thousands, except per share amounts) |
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Net sales |
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$ |
496,626 |
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$ |
482,630 |
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$ |
958,300 |
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$ |
944,213 |
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Cost of sales |
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392,160 |
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375,483 |
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760,876 |
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735,392 |
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Selling, general and administrative expenses |
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78,794 |
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76,906 |
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162,355 |
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158,185 |
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Other expense (income): |
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Interest expense |
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11,678 |
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10,212 |
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22,706 |
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20,347 |
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Foreign currency transactions, net |
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219 |
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1,192 |
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986 |
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2,951 |
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Gain on sale of businesses |
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(5,195 |
) |
Miscellaneous expense (income), net |
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1,785 |
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1,633 |
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(43 |
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1,411 |
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Income before taxes |
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11,990 |
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17,204 |
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11,420 |
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31,122 |
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Income tax expense |
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3,913 |
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5,352 |
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2,760 |
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10,272 |
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Income from continuing operations |
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8,077 |
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11,852 |
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8,660 |
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20,850 |
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Discontinued operations: |
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Loss on disposal of discontinued operations,
net of tax |
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(154 |
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(33 |
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(219 |
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(71 |
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Net income |
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7,923 |
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11,819 |
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8,441 |
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20,779 |
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Dividends on preferred stock |
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375 |
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438 |
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762 |
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888 |
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Net income available to common shareholders |
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$ |
7,548 |
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$ |
11,381 |
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$ |
7,679 |
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$ |
19,891 |
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Per common share data |
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Basic earnings: |
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From continuing operations |
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$ |
0.18 |
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$ |
0.27 |
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$ |
0.19 |
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$ |
0.48 |
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From discontinued operations |
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0.00 |
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0.00 |
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(0.01 |
) |
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0.00 |
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$ |
0.18 |
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$ |
0.27 |
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$ |
0.18 |
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$ |
0.48 |
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Diluted earnings: |
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From continuing operations |
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$ |
0.18 |
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$ |
0.27 |
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$ |
0.19 |
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$ |
0.47 |
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From discontinued operations |
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0.00 |
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0.00 |
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(0.01 |
) |
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0.00 |
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$ |
0.18 |
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$ |
0.27 |
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$ |
0.18 |
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$ |
0.47 |
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Dividends |
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$ |
0.145 |
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$ |
0.145 |
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$ |
0.29 |
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$ |
0.29 |
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See accompanying notes to Condensed Consolidated Financial Statements
2
Ferro Corporation and Consolidated Subsidiaries
Condensed Consolidated Balance Sheets
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June 30, |
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December 31, |
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2005 |
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2004 |
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(Dollars in thousands) |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
19,352 |
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$ |
13,939 |
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Accounts and trade notes receivable, net |
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200,183 |
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184,470 |
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Notes receivable |
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126,960 |
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114,030 |
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Inventories |
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227,891 |
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220,126 |
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Deferred income taxes |
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46,264 |
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45,647 |
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Other current assets |
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22,439 |
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34,137 |
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Total current assets |
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643,089 |
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612,349 |
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Property, plant & equipment, net |
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556,321 |
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598,719 |
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Intangibles, net |
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412,962 |
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412,507 |
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Deferred income taxes |
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47,932 |
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46,696 |
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Other non-current assets |
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58,935 |
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63,166 |
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Total assets |
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$ |
1,719,239 |
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$ |
1,733,437 |
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LIABILITIES and SHAREHOLDERS EQUITY |
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Current liabilities: |
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Loans payable and current portion of long-term debt |
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$ |
11,499 |
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$ |
9,674 |
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Accounts payable |
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246,152 |
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260,215 |
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Income taxes |
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2,129 |
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3,609 |
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Accrued payrolls |
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28,793 |
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31,468 |
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Accrued expenses and other current liabilities |
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95,283 |
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96,017 |
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Total current liabilities |
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383,856 |
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400,983 |
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Long-term debt, less current portion |
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538,202 |
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497,314 |
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Post-retirement and pension liabilities |
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245,507 |
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247,132 |
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Other non-current liabilities |
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39,958 |
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42,914 |
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Total liabilities |
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1,207,523 |
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1,188,343 |
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Series A convertible preferred stock |
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21,406 |
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22,829 |
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Shareholders equity |
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490,310 |
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522,265 |
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Total liabilities and shareholders equity |
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$ |
1,719,239 |
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$ |
1,733,437 |
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See accompanying notes to Condensed Consolidated Financial Statements
3
Ferro Corporation and Consolidated Subsidiaries
Condensed Consolidated Statements of Cash Flows
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Six months ended |
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June 30, |
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2005 |
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2004 |
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(Dollars in thousands) |
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Cash flows from operating activities |
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Net cash (used for) provided by continuing operations |
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$ |
(3,884 |
) |
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$ |
26,971 |
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Net cash used for discontinued operations |
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(551 |
) |
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(267 |
) |
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Net cash (used for) provided by operating activities |
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(4,435 |
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26,704 |
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Cash flows from investing activities |
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Capital expenditures for plant and equipment |
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(19,015 |
) |
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(16,197 |
) |
Cash adjustment to purchase price of prior acquisition |
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8,505 |
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Acquisitions, net of cash acquired |
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(798 |
) |
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Proceeds from the sale of assets and businesses |
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617 |
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6,434 |
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Other investing activities |
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101 |
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1,503 |
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Net cash (used for) provided by investing activities |
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(19,095 |
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245 |
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Cash flows from financing activities |
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Net borrowings (payments) under short term facilities |
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1,825 |
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(716 |
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Proceeds from revolving credit facility |
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456,166 |
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350,873 |
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Principal payments on revolving credit facility |
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(414,990 |
) |
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(374,185 |
) |
Cash dividends paid |
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(13,035 |
) |
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(13,034 |
) |
Other financing activities |
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(533 |
) |
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6,789 |
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Net cash provided by (used for) financing activities |
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29,433 |
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(30,273 |
) |
Effect of exchange rate changes on cash |
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(490 |
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45 |
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Decrease in cash and cash equivalents |
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5,413 |
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(3,279 |
) |
Cash and cash equivalents at beginning of period |
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13,939 |
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23,381 |
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Cash and cash equivalents at end of period |
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$ |
19,352 |
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$ |
20,102 |
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Cash paid during the period for: |
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Interest |
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$ |
21,325 |
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$ |
19,259 |
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Income taxes |
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$ |
2,288 |
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$ |
14,249 |
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See accompanying notes to Condensed Consolidated Financial Statements
4
Ferro Corporation and Consolidated Subsidiaries
Notes to Condensed Consolidated Financial Statements
1. Basis of presentation
These unaudited condensed consolidated financial statements of Ferro Corporation and its
consolidated subsidiaries (Company) have been prepared in accordance with accounting principles
generally accepted in the United States of America (U.S. GAAP) for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by U.S. GAAP for complete financial
statements, and therefore should be read in conjunction with the consolidated financial statements
and notes thereto included in the Companys Annual Report on Form 10-K for the year ended December
31, 2005, which was previously filed. The preparation of financial statements in conformity with
U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in
the condensed consolidated financial statements. Actual amounts could differ from these estimates.
In the opinion of management, all adjustments that are necessary for a fair presentation have been
made and are of a normal recurring nature unless otherwise noted. The results for the three and
six months ended June 30, 2005, are not necessarily indicative of the results expected in
subsequent quarters or for the full year.
2. Accounting pronouncements adopted in the six months ended June 30, 2005
FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations,
(Interpretation No. 47) was issued in March 2005 and is effective for fiscal years ending after
December 15, 2005. Interpretation No. 47 clarifies that the term conditional asset retirement
obligation as used in FASB Statement No. 143, Accounting for Asset Retirement Obligations,
refers to an unconditional legal obligation to perform an asset retirement activity in which the
timing or method of settlement are conditional on a future event. This obligation should be
recognized at its fair value, if that value can be reasonably estimated. The Company adopted
Interpretation No. 47 as of January 1, 2005, and recorded additional conditional asset retirement
obligations of $0.9 million. The effect of Interpretation No. 47 on the Companys net income and
earnings per share for the three and six months ended June 30, 2004, is not material.
3. Newly issued accounting pronouncement
In September 2006, the FASB issued Statement No. 158, Employers Accounting for Defined
Benefit Pension and Other Postretirement Plans an amendment of FASB Statements No. 87, 88, 106,
and 132(R), (FAS No. 158). This statement will require the Company to:
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Recognize the overfunded or underfunded status of defined benefit post retirement plans
as an asset or liability in its consolidated balance sheets and to recognize changes in
that funded status through comprehensive income in the year in which the changes occur; |
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Recognize as a component of other comprehensive income, net of tax, the actuarial gains
or losses and prior service costs or benefits that arise during the period but are not
recognized as components of net periodic cost; |
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Measure defined benefit plan assets and obligations as of the balance sheet date; and |
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Disclose additional information concerning the delayed recognition of actuarial gains or
losses and prior service costs or benefits. |
The Company will be required to adopt the recognition and disclosure provisions of FAS No. 158
as of December 31, 2006. Upon adoption of the recognition provisions of FAS No. 158, the Company
anticipates adjustments to increase the accrued benefit liability by approximately $26.0 million
and increase the accumulated other comprehensive loss, net of tax, by approximately $16.9 million.
The Company will be required to adopt the measurement provisions of FAS No. 158 as of December
31, 2008. The Company is currently evaluating the requirements of the measurement provisions of
FAS No. 158 and has not yet determined the impact, if any, this may have on its consolidated
financial statements.
5
4. Shareholders equity
Comprehensive income (loss) represents net income adjusted for foreign currency translation
adjustments, minimum pension liability adjustments, and unrealized gain (loss) adjustments
associated with investments in marketable equity securities that are available for sale.
Comprehensive income (loss) was $(8.9) million and $6.0 million for the three months ended June 30,
2005 and 2004, respectively. Comprehensive income (loss) was $(21.6) million and $12.4 million for
the six months ended June 30, 2005 and 2004, respectively. Accumulated other comprehensive loss at
June 30, 2005, and December 31, 2004, was $97.7 million and $67.7 million, respectively.
Transactions involving benefit plans increased shareholders equity by $0.7 million and $2.9
million for the three months ended June 30, 2005 and 2004, respectively, and by $2.8 million and
$10.2 million for the six months ended June 30, 2005 and 2004, respectively.
5. Inventories
Inventories are comprised of the following:
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June 30, |
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December 31, |
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2005 |
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2004 |
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(Dollars in thousands) |
|
Raw materials |
|
$ |
64,224 |
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|
$ |
61,249 |
|
Work in process |
|
|
40,242 |
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|
35,091 |
|
Finished goods |
|
|
135,537 |
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|
135,541 |
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FIFO cost (approximates replacement cost) |
|
|
240,003 |
|
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|
231,881 |
|
LIFO reserve |
|
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(12,112 |
) |
|
|
(11,755 |
) |
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|
|
|
|
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Total |
|
$ |
227,891 |
|
|
$ |
220,126 |
|
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6. Financing and long-term debt
Long-term debt consists of the following:
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|
June 30, |
|
|
December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
|
(Dollars in thousands) |
|
$200,000 Senior notes, 9.125%, due 2009 (a) |
|
$ |
197,856 |
|
|
$ |
197,549 |
|
$25,000 Debentures, 7.625%, due 2013 (a) |
|
|
24,870 |
|
|
|
24,864 |
|
$25,000 Debentures, 7.375%, due 2015 (a) |
|
|
24,963 |
|
|
|
24,961 |
|
$50,000 Debentures, 8.0%, due 2025 (a) |
|
|
49,538 |
|
|
|
49,526 |
|
$55,000 Debentures, 7.125%, due 2028 (a) |
|
|
54,522 |
|
|
|
54,511 |
|
Revolving credit agreement |
|
|
178,800 |
|
|
|
137,400 |
|
Capitalized lease obligations |
|
|
7,666 |
|
|
|
8,161 |
|
Other notes |
|
|
1,640 |
|
|
|
1,857 |
|
|
|
|
|
|
|
|
|
|
|
539,855 |
|
|
|
498,829 |
|
Less current portion |
|
|
1,653 |
|
|
|
1,515 |
|
|
|
|
|
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|
|
Total |
|
$ |
538,202 |
|
|
$ |
497,314 |
|
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(a) Net of unamortized discounts
Revolving Credit and Term Loan Agreement
At June 30, 2005, the Company had borrowed $178.8 million under a $300 million revolving
credit facility that was scheduled to expire in September 2006 (Prior Revolving Credit Facility).
The average interest rates for borrowings against the Prior Revolving Credit Facility at June 30,
2005, and December 31, 2004, were 5.3% and 4.0%, respectively.
The Prior Revolving Credit Facility contained financial covenants relating to total debt,
fixed charges and EBITDA, cross default provisions with other debt obligations, and customary
operating covenants that limited the Companys ability to engage in certain activities, including
significant acquisitions. In addition, when the Companys senior credit rating was
6
downgraded below Ba2 by Moodys in March 2006, the Company and its domestic material
subsidiaries were required to grant security interests in their tangible and intangible assets
(with the exception of the receivables sold as part of the Companys asset securitization program),
pledge 100% of the stock of domestic material subsidiaries and pledge 65% of the stock of foreign
material subsidiaries, in each case, in favor of the lenders under the Prior Revolving Credit
Facility. This lien grant and pledge of stock was substantially completed in April 2006. Liens on
principal domestic manufacturing properties and the stock of domestic subsidiaries were also
granted to and shared with the holders of the Companys senior notes and debentures, as required by
their indentures.
In March 2006, the Company accepted a commitment from a syndicate of lenders to underwrite a
$700 million credit facility (the New Credit Facility) and, in June 2006, finalized the
agreement. The New Credit Facility is comprised of a five year, $250 million multi-currency senior
revolving credit facility and a six year, $450 million senior delayed-draw term loan facility.
Under the terms of the New Credit Facility, the Company can request that the revolving credit
facility be increased by $50 million at no additional fee.
The New Credit Facility was entered into to replace the Prior Revolving Credit Facility that
was scheduled to expire in September 2006. In addition, the financing, through the term loan
facility, provided capital resources sufficient to refinance the $200 million of senior notes and
$155 million of debentures that could have become immediately due and payable due to defaults
associated with the Companys delayed SEC financial filings for 2005. Because one of the purposes
of the term loan facility is to fund the potential acceleration of the senior notes and debentures,
the term facility contains certain restrictions including, but not limited to, the following:
|
|
|
$355 million of the facility is reserved to repay the senior notes and
debentures; |
|
|
|
|
$95 million of the facility is immediately available for refunding indebtedness
other than the senior notes and debentures; |
|
|
|
|
The Company may access up to $55 million of the $355 million reserved to repay
the senior notes and debentures if these obligations have not already been paid in
full and no event of default for these obligations exists and is continuing; and |
|
|
|
|
The Company may draw on the delayed-draw facility for up to one year with any
unused commitment under the term facility terminating on June 6, 2007. |
At the close of the New Credit Facility in June 2006, the Company drew $95 million of the term
loan facility to partially repay the Prior Revolving Credit Facility. In addition, during the
third quarter of 2006, the Company drew down another $155 million of the term loan facility to
repay $155 million of outstanding debentures, as bondholders accelerated payment on these
obligations due to the previously mentioned 2005 SEC financial reporting delays. See further
discussion under Senior Notes and Debentures below.
The New Credit Facility bears interest at a rate equal to, at the Companys option, either (1)
LIBOR or (2) the Alternate Base Rate which is the higher of the Prime Rate and the Federal Funds
Effective Rate plus 0.5%; plus, in each case, applicable margins based on the Companys index debt
rating. The New Credit Facility is secured by substantially all of the Companys assets, including
the assets and 100% of the shares of the Companys material domestic subsidiaries and 65% of the
shares of the Companys first tier foreign subsidiaries, but excluding trade receivables sold
pursuant to the Companys accounts receivable sales programs. These liens are shared with the
holders of the Companys senior notes, as required under the respective indenture.
The New Credit Facility contains customary operating covenants that limit the Companys
ability to engage in certain activities, including limitations on additional loans and investments;
creation of additional liens; prepayments, redemptions and repurchases of debt; and mergers,
acquisitions and asset sales. The Company is also subject to customary financial covenants
including a leverage ratio and a fixed charge coverage ratio. Additional covenants of the New
Credit Facility require the Company to file its 2006 Forms 10-Q by December 29, 2006. Failure to
satisfy certain of these covenants, either immediately or after a brief period allowing the company
to satisfy the covenant, would result in an event of default. If any event of default should occur
and be continuing and a waiver not have been obtained, the obligations under the New Credit
Facility may become immediately due and payable at the option of providers of more than 50% of the
credit facility commitment.
7
Senior Notes and Debentures
At June 30, 2005, the Company had $355.0 million principal amount outstanding under debentures
and senior notes, which had an estimated fair market value of $367.1 million. Fair market value
represents a third partys indicative bid prices for these obligations. In the second quarter of
2005, the Companys senior credit rating was downgraded from Baa3 to Ba1 by Moodys Investor
Service, Inc. (Moodys) and from BB+ to BB by Standard & Poors Rating Group (S&P). In March
2006, Moodys further lowered its rating to B1 and then withdrew its ratings, and S&P further
lowered its rating to B+. See further information regarding this matter in Note 17.
The indentures under which the senior notes and the debentures were issued contain operating
covenants that limit the Companys ability to engage in certain activities, including limitations
on consolidations, mergers, and transfers of assets; and sale and leaseback transactions. The
indentures contain cross-default provisions with other debt obligations that exceed $10 million of
principal outstanding. In addition, the terms of the indentures require, among other things, the
Company to file with the Trustee copies of its annual reports on Form 10-K, quarterly reports on
Form 10-Q and an Officers Certificate relating to the Companys compliance with the terms of the
indentures within 120 days after the end of its fiscal year. The Company has been in default on
these reporting requirements since it delayed filing its Form 10-Q for the second quarter of 2004
due to the restatement of its 2003 and first quarter 2004 results. As the Company anticipated and
planned for, in March and April 2006, the Company received notices of default from a holder and the
Trustee of the senior notes and debentures of which $355 million was outstanding. The notices of
default related only to reporting requirements and the related Officers Certificate. Under the
terms of the indentures, the Company had 90 days from the notices of default in which to cure the
deficiencies identified in the notices of default or obtain waivers, or events of default would
have occurred and the holders of the senior notes or debentures or the Trustee could declare the
principal immediately due and payable. At the end of these periods, the deficiencies had not been
cured and waivers had not been obtained. During July and August 2006, the bondholders accelerated
the payment of the principal amount of the debentures, of which $155 million was outstanding, and
the Company financed the accelerated repayments by use of the aforementioned $450 million term loan
facility.
As of the date of this filing, the $200 million senior notes currently remain outstanding,
although they could be declared immediately due and payable at any time. In the event the
bondholders of the senior notes provide a notice of acceleration prior to the Company curing the
existing reporting default, the Company believes it has sufficient liquidity resources, primarily
through the term loan facility, to fully satisfy any potential acceleration. In addition, the
senior notes are redeemable at the option of the Company at any time for the principal amount of
the senior notes then outstanding plus the sum of any accrued but unpaid interest and the present
value of any remaining scheduled interest payments. The senior notes are redeemable at the option
of the holders only upon a change in control of the Company combined with a rating by either
Moodys or S&P below investment grade as defined in the indenture. Currently, the rating by S&P of
the senior notes is below investment grade.
Asset Securitization Program
The Company has a $100 million program to sell (securitize), on an ongoing basis, a pool of
its U.S. trade accounts receivable. This program serves to accelerate cash collections of the
Companys trade accounts receivable at favorable financing costs and helps manage the Companys
liquidity requirements. In June 2005, the Company amended the program to resolve issues related to
a credit rating downgrade and delayed SEC filings and to extend the program through June 2006. In
June 2006, the Company amended the program to extend it up to June 2, 2009, to cure a default
resulting from a credit rating downgrade, and to modify the reporting requirements to more closely
match those in the New Credit Facility. While the Company expects to maintain a satisfactory U.S.
asset securitization program to help meet the Companys liquidity requirements, factors beyond the
Companys control such as prevailing economic, financial and market conditions may prevent the
Company from doing so.
Under this program, certain of the Companys receivables are sold to Ferro Finance Corporation
(FFC), a wholly-owned unconsolidated qualified special purpose entity (QSPE), as defined by
Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, (FAS No. 140). FFC finances its acquisition
of trade accounts receivable assets by issuing financial interests to multi-seller receivables
securitization companies (commercial paper conduits). At December 31, 2004, $3.6 million had been
advanced to the Company, net of repayments, under this program. During the three months ended June
30, 2005, $243.0 million of accounts receivable were sold under this program and $243.0 million of
receivables were collected and remitted to FFC and the
8
commercial paper conduits. During the six months ended June 30, 2005, $469.1 million of
accounts receivable were sold under this program and $471.7 million of receivables were collected
and remitted to FFC and the commercial paper conduits, resulting in a net decrease in advances of
$2.6 million and total advances outstanding at June 30, 2005, of $1.0 million.
The Company on behalf of FFC and the commercial paper conduits provides normal collection and
administration services with respect to the receivables. In accordance with FAS No. 140, no
servicing asset or liability is reflected on the Companys consolidated balance sheet. FFC and the
commercial paper conduits have no recourse to the Companys other assets for failure of debtors to
pay when due as the assets transferred are legally isolated in accordance with the bankruptcy laws
of the United States. Under FAS No. 140 and FASB Interpretation No. 46R, Consolidation of Variable
Interest Entities, neither the amounts advanced nor the corresponding receivables sold are
reflected in the Companys consolidated balance sheet as the trade receivables have been
de-recognized with an appropriate accounting loss recognized in the Companys consolidated
statements of income.
The Company retains a beneficial interest in the receivables transferred to FFC in the form of
a note receivable to the extent that cash flows collected from receivables transferred exceed cash
flows used by FFC to pay the commercial paper conduits. The note receivable balance was $124.1
million as of June 30, 2005, and $108.5 million as of December 31, 2004. The Company, on a monthly
basis, measures the fair value of the retained interests using managements best estimate of the
undiscounted expected future cash collections on the transferred receivables. Actual cash
collections may differ from these estimates and would directly affect the fair value of the
retained interests.
Liquidity
The Companys level of debt and debt service requirements could have important consequences to
its business operations and uses of cash flows. In addition, a reduction in overall demand for the
Companys products, as well as the potential requirement to repay the senior notes due to the
Companys delayed SEC filings, could adversely affect cash flows. As of September 30, 2006, the
Company had borrowed $157.7 million against its $250 million revolving credit facility and drawn
$64.5 million on the $100 million asset securitization program. In addition, the Company had drawn
$250 million on the $450 million term loan facility, although the $200 million remaining
availability is reserved for the repayment of the 9 1/8% senior notes should they be accelerated by
the bondholders.
9
7. Earnings per share computation
Information concerning the calculation of basic and diluted earnings per share is shown below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
Six months ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
|
(In thousands, except per share amounts) |
|
Basic earnings per share computation: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income available to common shareholders |
|
$ |
7,548 |
|
|
$ |
11,381 |
|
|
$ |
7,679 |
|
|
$ |
19,891 |
|
Add back: Loss from discontinued operations |
|
|
154 |
|
|
|
33 |
|
|
|
219 |
|
|
|
71 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
7,702 |
|
|
$ |
11,414 |
|
|
$ |
7,898 |
|
|
$ |
19,962 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average common shares outstanding |
|
|
42,296 |
|
|
|
41,941 |
|
|
|
42,288 |
|
|
|
41,889 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share from continuing operations |
|
$ |
0.18 |
|
|
$ |
0.27 |
|
|
$ |
0.19 |
|
|
$ |
0.48 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share computation: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income available to common shareholders |
|
$ |
7,548 |
|
|
$ |
11,381 |
|
|
$ |
7,679 |
|
|
$ |
19,891 |
|
Add back: Loss from discontinued operations |
|
|
154 |
|
|
|
33 |
|
|
|
219 |
|
|
|
71 |
|
Plus: Convertible preferred stock |
|
|
|
|
|
|
357 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
7,702 |
|
|
$ |
11,771 |
|
|
$ |
7,898 |
|
|
$ |
19,962 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average common shares outstanding |
|
|
42,296 |
|
|
|
41,941 |
|
|
|
42,288 |
|
|
|
41,889 |
|
Assumed conversion of convertible preferred stock |
|
|
|
|
|
|
1,414 |
|
|
|
|
|
|
|
|
|
Assumed exercise of stock options |
|
|
27 |
|
|
|
381 |
|
|
|
41 |
|
|
|
405 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average diluted shares outstanding |
|
|
42,323 |
|
|
|
43,736 |
|
|
|
42,329 |
|
|
|
42,294 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share from continuing operations |
|
$ |
0.18 |
|
|
$ |
0.27 |
|
|
$ |
0.19 |
|
|
$ |
0.47 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The convertible preferred shares were anti-dilutive for the three months ended June 30, 2005,
and the six months ended June 30, 2005 and 2004, and thus not included in the diluted shares
outstanding for those periods.
8. Restructuring and cost reduction programs
The following table summarizes the activities relating to the Companys reserves for
restructuring and cost reduction programs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other |
|
|
|
|
|
|
Severance |
|
|
costs |
|
|
Total |
|
|
|
(Dollars in thousands) |
|
Balance, December 31, 2004 |
|
$ |
4,897 |
|
|
$ |
976 |
|
|
$ |
5,873 |
|
Gross charges |
|
|
5,465 |
|
|
|
|
|
|
|
5,465 |
|
Non-cash items |
|
|
(255 |
) |
|
|
|
|
|
|
(255 |
) |
Cash payments |
|
|
(3,877 |
) |
|
|
(706 |
) |
|
|
(4,583 |
) |
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2005 |
|
$ |
6,230 |
|
|
$ |
270 |
|
|
$ |
6,500 |
|
|
|
|
|
|
|
|
|
|
|
Charges in the three months and six months ended June 30, 2005, relate to the Companys
ongoing restructuring and cost reduction programs. Total gross charges for the three months ended
June 30, 2005, were $1.0 million of which $0.8 million were included in cost of sales and $0.2
million were included in selling, general and administrative expenses. Total gross charges for the
six months ended June 30, 2005, were $5.5 million of which $2.0 million and $3.5 million were
included in cost of sales and selling, general and administrative expenses, respectively.
The remaining reserve balance for restructuring and cost reduction programs primarily
represents cash payments expected to be made over the following twelve months except where certain
legal or contractual restrictions on the Companys ability to complete the program exist. The
Company will continue to evaluate further steps to reduce costs and improve efficiencies.
10
9. Discontinued operations
Discontinued operations relate to the Powder Coatings, Petroleum Additives and Specialty
Ceramics businesses that were sold in 2002 and 2003. There were no sales, income before taxes, or
related tax expense from discontinued operations in the three or six month periods ended June 30,
2005 or 2004. In connection with certain divestitures, the Company has continuing obligations with
respect to environmental remediation. The Company accrued $3.1 million as of June 30, 2005, and
December 31, 2004, for these matters. These amounts are based on managements best estimate of the
nature and extent of soil and/or groundwater contamination, as well as expected remedial actions as
determined by agreements with relevant authorities, where applicable, and existing technologies.
Disposal of discontinued operations resulted in pre-tax losses of $253,000 and $360,000 for
the three and six months ended June 30, 2005, respectively, and $51,000 and $110,000 for the three
and six months ended June 30, 2004, respectively. The related tax benefits were $99,000 and
$141,000 for the three and six months ended June 30, 2005, respectively, and $18,000 and $39,000
for the three and six months ended June 30, 2004, respectively. Selling prices are subject to
certain post-closing adjustments with respect to assets sold to and liabilities assumed by the
buyers. The loss on disposal of discontinued operations includes such post-closing adjustments to
the selling prices and ongoing legal costs and reserve adjustments directly related to discontinued
operations.
There were no cash flows from investing or financing activities related to discontinued
operations for the three or six months ended June 30, 2005 or 2004.
10. Contingent liabilities
In February 2003, the Company was requested to produce documents in connection with an
investigation by the United States Department of Justice into possible antitrust violations in the
heat stabilizer industry. In April 2006, the Company was notified by the Department of Justice that
the Government had closed its investigation and that the Company was relieved of any obligation to
retain documents that were responsive to the Governments earlier document request. Before closing
its investigation, the Department of Justice took no action against the Company or any current or
former employee of the Company. The Company was previously named as a defendant in several
lawsuits alleging civil damages and requesting injunctive relief relating to the conduct the
Government was investigating. The Company is vigorously defending itself in those actions and
believes it would have a claim of indemnification by the former owner of its heat stabilizer
business if the Company were found liable. In any case, management does not expect the pending
lawsuits to have a material effect on the consolidated financial position, results of operations,
or cash flows of the Company.
In a July 23, 2004, press release, Ferro announced that its Polymer Additives business
performance in the second quarter of 2004 fell short of expectations and that its Audit Committee
would investigate possible inappropriate accounting entries in Ferros Polymer Additives business.
A consolidated putative securities class action lawsuit arising from and related to the July 23,
2004, announcement is currently pending in the United States District Court for the Northern
District of Ohio against Ferro, its deceased former Chief Executive Officer, its Chief Financial
Officer, and a former operating Vice President of Ferro. This claim is based on alleged violations
of Federal securities laws. Ferro and the named executives consider these allegations to be
unfounded, are vigorously defending this action and have notified Ferros directors and officers
liability insurer of the claim. Because this action is in its preliminary stage, the outcome of
this litigation cannot be determined at this time.
Also, following the July 23, 2004, announcement, two derivative lawsuits were commenced in the
United States District Court for the Northern District of Ohio on behalf of Ferro against Ferros
Directors, its deceased former Chief Executive Officer, and Chief Financial Officer. Two other
derivative actions were subsequently filed in the Court of Common Pleas for Cuyahoga County, Ohio.
The state court actions were removed to the United States District Court for the Northern District
of Ohio and all of the derivative lawsuits were then consolidated into a single action. The
derivative lawsuits alleged breach of fiduciary duties and mismanagement-related claims. On March
21, 2006, the Court dismissed the consolidated derivative action without prejudice. On April 8,
2006, plaintiffs filed a motion seeking relief from the judgment dismissing the derivative lawsuit
and seeking to further amend their complaint following discovery, which was denied. On April 13,
2006, plaintiffs also filed a Notice of Appeal to the Sixth Circuit Court of Appeals. The Directors
and named executives consider the allegations contained in the derivative actions to be unfounded,
have vigorously defended this action and will defend against the new filings. The Company has
notified Ferros directors and officers liability insurer of the claim. Because this appeal is in
the preliminary stage, the outcome of this litigation cannot be determined at this time.
11
On June 10, 2005, a putative class action lawsuit was filed against Ferro, and certain former
and current employees alleging breach of fiduciary duty with respect to ERISA plans. The Company
considers these allegations to be unfounded, has vigorously defended this action, and has notified
Ferros fiduciary liability insurer of the claim. In October 2006, the parties reached a
settlement in principle that would result in the dismissal of the lawsuit with prejudice in
exchange for the settlement amount of $4.0 million, which would be paid by the Companys liability
insurer subject to the Companys satisfaction of the remaining retention amount under the insurance
policy. The Company and the individual defendants expressly deny any and all liability. Several
contingent events must be satisfied before the settlement becomes final, including preliminary and
final approval by the United States District Court where the matter is pending. Management does
not expect the ultimate outcome of the lawsuit to have a material effect on the financial position,
results of operations or cash flows of the Company.
On October 15, 2004, the Belgian Ministry of Economic Affairs Commercial Policy Division (the
Ministry) served on Ferros Belgian subsidiary a mandate requiring the production of certain
documents related to an alleged cartel among producers of butyl benzyl phthalate (BBP) from 1983
to 2002. Subsequently, German and Hungarian authorities initiated their own national investigations
in relation to the same allegations. Ferros Belgian subsidiary acquired its BBP business from
Solutia Europe S.A./N.V. (SOLBR) in August 2000. Ferro promptly notified SOLBR of the Ministrys
actions and requested SOLBR to indemnify and defend Ferro and its Belgian subsidiary with respect
to these investigations. In response to Ferros notice, SOLBR exercised its right under the 2000
acquisition agreement to take over the defense and settlement of these matters, subject to
reservation of rights. In December 2005, the Hungarian authorities imposed a de minimus fine on
Ferros Belgian subsidiary, and the Company expects the German and Belgian authorities also to
assess fines for the alleged conduct. Management cannot predict the amount of fines that will
ultimately be assessed and cannot predict the degree to which SOLBR will indemnify Ferros Belgian
subsidiary for such fines.
In October 2005, the Company performed a routine environmental, health and safety audit of its
Bridgeport, New Jersey facility. In the course of this audit, internal environmental, health and
safety auditors assessed the Companys compliance with the New Jersey Department of Environmental
Protections (NJDEP) laws and regulations regarding water discharge requirements pursuant to the
New Jersey Water Pollution Control Act (WPCA). On October 31, 2005, the Company disclosed to the
NJDEP that it had identified potential violations of the WPCA and the Company commenced an
investigation and committed to report any violations and to undertake any necessary remedial
actions. In September 2006, the Company entered into an agreement with the NJDEP under which the
Company paid the State of New Jersey a civil administrative penalty of $0.2 million in full
settlement of the violations.
There are various other lawsuits and claims pending against the Company and its consolidated
subsidiaries. In the opinion of management, the ultimate liabilities, if any, and expenses
resulting from such lawsuits and claims will not materially affect the consolidated financial
position, results of operations, or cash flows of the Company.
11. Stock-based compensation
The following table shows pro forma information regarding net income and earnings per share as
if the Company had accounted for stock options based on the fair value at the grant date under the
fair value recognition provisions of FASB Statement No. 123 Accounting for Stock-Based
Compensation. The fair value for these options was estimated at the date of grant using a
Black-Scholes option-pricing model.
12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
Six months ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
|
(Dollars in thousands, except per share amounts) |
|
Income available to common shareholders from continuing
operationsas reported |
|
$ |
7,702 |
|
|
$ |
11,414 |
|
|
$ |
7,898 |
|
|
$ |
19,962 |
|
Add: Stock-based employee compensation expense included in
reported income, net of tax |
|
|
36 |
|
|
|
36 |
|
|
|
72 |
|
|
|
72 |
|
Deduct: Total stock-based employee compensation expense
determined under fair value methods for all awards, net of tax |
|
|
(844 |
) |
|
|
(887 |
) |
|
|
(1,633 |
) |
|
|
(1,694 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income available to common shareholders from continuing
operationspro forma |
|
$ |
6,894 |
|
|
$ |
10,563 |
|
|
$ |
6,337 |
|
|
$ |
18,340 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share from continuing operationsas reported |
|
$ |
0.18 |
|
|
$ |
0.27 |
|
|
$ |
0.19 |
|
|
$ |
0.48 |
|
Basic earnings per share from continuing operationspro forma |
|
$ |
0.16 |
|
|
$ |
0.25 |
|
|
$ |
0.15 |
|
|
$ |
0.44 |
|
|
Diluted earnings per share from continuing operationsas reported |
|
$ |
0.18 |
|
|
$ |
0.27 |
|
|
$ |
0.19 |
|
|
$ |
0.47 |
|
Diluted earnings per share from continuing operationspro forma |
|
$ |
0.16 |
|
|
$ |
0.24 |
|
|
$ |
0.15 |
|
|
$ |
0.43 |
|
There was no impact from pro forma expense on discontinued operations for any period
presented.
Compensation expense (reduction of expenses) for the Companys stock performance plan was $0.5
million and $0.6 million for the three months ended June 30, 2005 and 2004, respectively, and $0.7
million and $(0.1) million for the six months ended June 30, 2005 and 2004, respectively.
12. Retirement benefits
Information concerning net periodic benefit costs of the pension and other postretirement
benefit plans of the Company is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension benefits |
|
|
Other benefits |
|
|
Pension benefits |
|
|
Other benefits |
|
|
|
Three months ended |
|
|
Three months ended |
|
|
Six months ended |
|
|
Six months ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
June 30, |
|
|
June 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Components of
net periodic cost: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service cost |
|
$ |
3,850 |
|
|
$ |
3,613 |
|
|
$ |
200 |
|
|
$ |
226 |
|
|
$ |
7,823 |
|
|
$ |
7,278 |
|
|
$ |
400 |
|
|
$ |
451 |
|
Interest cost |
|
|
6,526 |
|
|
|
6,286 |
|
|
|
790 |
|
|
|
840 |
|
|
|
13,180 |
|
|
|
12,625 |
|
|
|
1,580 |
|
|
|
1,681 |
|
Expected return on
plan assets |
|
|
(5,503 |
) |
|
|
(5,416 |
) |
|
|
|
|
|
|
|
|
|
|
(11,109 |
) |
|
|
(10,876 |
) |
|
|
|
|
|
|
|
|
Amortization of
prior service cost |
|
|
25 |
|
|
|
49 |
|
|
|
(140 |
) |
|
|
(140 |
) |
|
|
49 |
|
|
|
101 |
|
|
|
(280 |
) |
|
|
(279 |
) |
Net amortization
and deferral |
|
|
1,658 |
|
|
|
1,486 |
|
|
|
(58 |
) |
|
|
(24 |
) |
|
|
3,327 |
|
|
|
2,971 |
|
|
|
(116 |
) |
|
|
(48 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic
benefit cost |
|
$ |
6,556 |
|
|
$ |
6,018 |
|
|
$ |
792 |
|
|
$ |
902 |
|
|
$ |
13,270 |
|
|
$ |
12,099 |
|
|
$ |
1,584 |
|
|
$ |
1,805 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In February 2006, the Company announced changes to certain of its postretirement benefit
plans. See additional information regarding this matter in Note 17.
13. Income taxes
Income tax expense as a percentage of pre-tax income for the six months ended June 30, 2005,
was 24.2% compared with 33.0% in 2004. The lower 2005 rate reflects the Companys tax benefit in
the first quarter, when a combination of a pre-tax loss coupled with a higher proportion of losses
in jurisdictions having higher effective tax rates and a relatively low level of dividends
repatriated resulted in a $1.2 million tax benefit, combined with an effective rate of 32.6% for
the three months ended June 30, 2005.
13
14. Reporting for segments
The Company has six reportable segments: Performance Coatings, Electronic Materials, Color and
Glass Performance Materials, Polymer Additives, Specialty Plastics and Other, which is comprised of
two business units, Pharmaceuticals and Fine Chemicals, which do not meet the quantitative
thresholds for separate disclosure. The Company uses the criteria outlined in Statement of
Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related
Information, to identify segments which management has concluded are its seven major business
units. Further, the Company has concluded that it is appropriate to aggregate its Tile and
Porcelain Enamel business units into one reportable segment, Performance Coatings, based on their
similar economic and operating characteristics.
The accounting policies of the segments are consistent with those described for the Companys
consolidated financial statements in the summary of significant accounting policies contained in
the Companys Annual Report on Form 10-K for the year ended December 31, 2005, which was previous
filed. Net sales to external customers are presented in the following table. Inter-segment sales
were not material.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
Six months ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
Performance Coatings |
|
$ |
130,044 |
|
|
$ |
117,443 |
|
|
$ |
248,760 |
|
|
$ |
231,185 |
|
Electronic Materials |
|
|
92,646 |
|
|
|
110,658 |
|
|
|
170,814 |
|
|
|
209,669 |
|
Color and Glass Performance
Materials |
|
|
95,994 |
|
|
|
92,813 |
|
|
|
188,613 |
|
|
|
183,551 |
|
Polymer Additives |
|
|
78,570 |
|
|
|
71,036 |
|
|
|
154,878 |
|
|
|
141,090 |
|
Specialty Plastics |
|
|
72,456 |
|
|
|
65,762 |
|
|
|
143,318 |
|
|
|
134,061 |
|
Other |
|
|
26,916 |
|
|
|
24,918 |
|
|
|
51,917 |
|
|
|
44,657 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total consolidated sales |
|
$ |
496,626 |
|
|
$ |
482,630 |
|
|
$ |
958,300 |
|
|
$ |
944,213 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company measures segment income for reporting purposes as net operating profit before
interest and taxes. Net segment income also excludes unallocated corporate expenses and charges
associated with employment cost reduction programs. Reconciliation of segment income (loss) to
income before taxes from continuing operations follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
Six months ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
Performance Coatings |
|
$ |
9,334 |
|
|
$ |
8,061 |
|
|
$ |
17,130 |
|
|
$ |
14,717 |
|
Electronic Materials |
|
|
4,427 |
|
|
|
12,748 |
|
|
|
4,190 |
|
|
|
23,923 |
|
Color and Glass
Performance Materials |
|
|
11,948 |
|
|
|
11,933 |
|
|
|
22,871 |
|
|
|
24,072 |
|
Polymer Additives |
|
|
5,582 |
|
|
|
396 |
|
|
|
10,402 |
|
|
|
(187 |
) |
Specialty Plastics |
|
|
3,271 |
|
|
|
3,401 |
|
|
|
6,864 |
|
|
|
7,467 |
|
Other |
|
|
1,230 |
|
|
|
2,288 |
|
|
|
2,044 |
|
|
|
2,139 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment income |
|
|
35,792 |
|
|
|
38,827 |
|
|
|
63,501 |
|
|
|
72,131 |
|
Unallocated expenses |
|
|
(10,120 |
) |
|
|
(8,586 |
) |
|
|
(28,432 |
) |
|
|
(21,495 |
) |
Interest expense |
|
|
(11,678 |
) |
|
|
(10,212 |
) |
|
|
(22,706 |
) |
|
|
(20,347 |
) |
Foreign currency |
|
|
(219 |
) |
|
|
(1,192 |
) |
|
|
(986 |
) |
|
|
(2,951 |
) |
Gain on sale of businesses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,195 |
|
Miscellaneous net |
|
|
(1,785 |
) |
|
|
(1,633 |
) |
|
|
43 |
|
|
|
(1,411 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before taxes from
continuing operations |
|
$ |
11,990 |
|
|
$ |
17,204 |
|
|
$ |
11,420 |
|
|
$ |
31,122 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14
Geographic revenues are based on the region in which the customer invoice is generated. The
United States of America is the single largest country for customer sales. No other single country
represents more than 10% of the Companys consolidated sales. Net sales by geographic region are
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
Six months ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
United States |
|
$ |
240,053 |
|
|
$ |
252,888 |
|
|
$ |
466,115 |
|
|
$ |
491,542 |
|
International |
|
|
256,573 |
|
|
|
229,742 |
|
|
|
492,185 |
|
|
|
452,671 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total sales |
|
$ |
496,626 |
|
|
$ |
482,630 |
|
|
$ |
958,300 |
|
|
$ |
944,213 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15. Financial instruments
The Company consigns, from various financial institutions, precious metals (primarily silver,
gold, platinum and palladium, collectively metals) used in the production of certain products for
customers. Under these consignment arrangements, the financial institutions provide the Company
with metals for a specified period of one year or less in duration, for which the Company pays a
fee. Under these arrangements, the financial institutions own the metals, and accordingly, the
Company does not report these consigned materials as part of its inventory on its consolidated
balance sheet. These agreements are cancelable by either party at the end of each consignment
period, however, because the Company has access to a number of consignment arrangements with
available capacity, consignment needs can be shifted among the other participating institutions.
At June 30, 2005, the Company had 7.6 million troy ounces of metals (primarily silver) on
consignment for periods of less than one year with a market value of $92.8 million. At December
31, 2004, the Company had 9.4 million troy ounces of metals on consignment for periods of less than
one year with a market value of $106.4 million. Beginning in the fourth quarter of 2005, certain
participating institutions required cash deposits to provide additional collateral beyond the
underlying precious metals.
16. Property, plant and equipment
Property, plant and equipment is reported net of accumulated depreciation of $583.6 million at
June 30, 2005, and $574.4 million at December 31, 2004.
17. Subsequent events
Credit Ratings Downgrade
In March 2006, the Companys senior credit rating was downgraded to B1 by Moodys. Moodys
then withdrew its ratings. Moodys cited the absence of audited financials for a sustained period
of time and the concern that there may be additional delays in receiving audited financial
statements for 2005. Moodys also noted that the Companys business profile is consistent with a
rating in the Ba category, according to Moodys rating methodology for the chemical industry.
Moodys indicated it could reassign ratings to the Company once it has filed audited financials for
2004 and 2005 with the Securities and Exchange Commission. Also in March 2006, S&P lowered its
rating to B+. S&P cited delays in filing, a recent absence of transparency with regard to current
results and near term prospects, and a diminished business profit that resulted in weak operating
margins and earnings. Although there are negative implications to these actions, the Company
anticipates that it will continue to have access to sufficient liquidity, albeit at higher
borrowing costs.
Moodys rating downgrade triggered the springing lien in the Companys prior revolving credit
facility. Under the terms of that agreement, the lenders became entitled to security interests in
the Companys and its domestic material subsidiaries tangible and intangible assets (with the
exception of the receivables sold as part of the Companys asset securitization program) and the
pledge of 100% of the stock of the Companys domestic material subsidiaries and 65% of the stock of
the Companys foreign material subsidiaries. This lien grant and pledge of stock was substantially
completed in April 2006. Under the terms of the Companys senior unsecured notes and debentures,
the holders of the Companys notes became equally secured with the revolving credit lenders with
security interests in the Companys principal domestic manufacturing facilities and the pledge of
100% of the stock of the Companys domestic subsidiaries. The Company obtained a waiver from the
lenders in the revolving credit facility in place at the time (Prior Revolving Credit Facility)
to extend reporting
15
requirements through June 2006 for the 2004, 2005 and 2006 periods. The extension gave the
Company time to put in place the New Credit Facility as described below.
New Credit Facility
In March 2006, the Company accepted a commitment from a syndicate of lenders to underwrite a
$700 million credit facility (the New Credit Facility) and, in June 2006, finalized the
agreement. The New Credit Facility is comprised of a five year, $250 million multi-currency senior
revolving credit facility and a six year, $450 million senior delayed-draw term loan facility.
Under the terms of the New Credit Facility, the Company can request that the revolving credit
facility be increased by $50 million at no additional fee.
The New Credit Facility was entered into to replace the Prior Revolving Credit Facility that
was scheduled to expire in September 2006. In addition, the financing, through the term loan
facility, provided capital resources sufficient to refinance the $200 million of senior notes and
$155 million of debentures that could have become immediately due and payable due to defaults
associated with the Companys delayed SEC financial filings for 2005. Because one of the purposes
of the term loan facility is to fund the potential acceleration of the senior notes and debentures,
the term facility contains certain restrictions including, but not limited to, the following:
|
|
|
$355 million of the facility is reserved to repay the senior notes and
debentures; |
|
|
|
$95 million of the facility is immediately available for refunding indebtedness
other than the senior notes and debentures; |
|
|
|
The Company may access up to $55 million of the $355 million reserved to repay
the senior notes and debentures if these obligations have not already been paid in
full and no event of default for these obligations exists and is continuing; and |
|
|
|
The Company may draw on the delayed-draw facility for up to one year with any
unused commitment under the term facility terminating on June 6, 2007. |
At the close of the New Credit Facility in June 2006, the Company drew $95 million of the term
loan facility to partially repay the Prior Revolving Credit Facility. In addition, during the
third quarter of 2006, the Company drew down another $155 million of the term loan facility to
repay $155 million of outstanding debentures, as bondholders accelerated payment on these
obligations due to the previously mentioned 2005 SEC financial reporting delays. See further
discussion under Accelerated Repayment of Debentures below.
The New Credit Facility bears interest at a rate equal to, at the Companys option, either (1)
LIBOR or (2) the Alternate Base Rate which is the higher of the Prime Rate and the Federal Funds
Effective Rate plus 0.5%; plus, in each case, applicable margins based on the Companys index debt
rating. The New Credit Facility is secured by substantially all of the Companys assets, including
the assets and 100% of the shares of the Companys material domestic subsidiaries and 65% of the
shares of the Companys first tier foreign subsidiaries, but excluding trade receivables sold
pursuant to the Companys accounts receivable sales programs. These liens are shared with the
holders of the Companys senior notes, as required under the respective indenture.
The New Credit Facility contains customary operating covenants that limit the Companys
ability to engage in certain activities, including limitations on additional loans and investments;
creation of additional liens; prepayments, redemptions and repurchases of debt; and mergers,
acquisitions and asset sales. The Company is also subject to customary financial covenants
including a leverage ratio and a fixed charge coverage ratio. Additional covenants of the New
Credit Facility require the Company to file its 2006 Forms 10-Q by December 29, 2006. Failure to
satisfy certain of these covenants, either immediately or after a brief period allowing the company
to satisfy the covenant, would result in an event of default. If any event of default should occur
and be continuing and a waiver not have been obtained, the obligations under the New Credit
Facility may become immediately due and payable at the option of providers of more than 50% of the
credit facility commitment.
Accelerated Repayment of Debentures
As the Company anticipated and planned for, in March and April 2006, the Company received
notices of default from a holder and the Trustee of the senior notes and debentures of which $355
million was outstanding. The notices of default
16
related only to reporting requirements and the related Officers Certificate. Under the terms of
the indentures, the Company had 90 days from the notices of default to cure the deficiencies
identified in the notices of default or obtain waivers, or events of default would have occurred
and the holders or the bondholders of the senior notes or debentures could declare the principal
immediately due and payable. At the end of these periods, the deficiencies had not been cured and
waivers had not been obtained. During July and August 2006, the bondholders accelerated the
payment of the principal amount of the debentures, of which $155 million was outstanding, and the
Company financed the accelerated repayments by use of the aforementioned $450 million term loan
facility.
Asset Securitization Program
In June 2006, the Company amended the asset securitization program to extend it up to June 2,
2009, to cure a default resulting from a credit rating downgrade, and to modify the reporting
requirements to more closely match those in the New Credit Facility. While the Company expects to
maintain a satisfactory U.S. asset securitization program to help meet the Companys liquidity
requirements, factors beyond the Companys control such as prevailing economic, financial and
market conditions may prevent the Company from doing so.
Pension and Other Postretirement Benefits
On April 1, 2006, the Company froze retirement benefit accumulations for its largest defined
benefit pension plan, which covers certain salaried and certain hourly employees in the United
States. The affected employees now receive benefits in the Companys defined contribution plan
that previously covered only U.S. salaried employees hired after June 30, 2003. The new plan
supports a diverse and mobile workforce with a competitive, flexible and portable retirement
benefit, while lowering and providing greater predictability to the Companys cost structure.
These changes do not affect current retirees or former employees.
Additionally, the Company limited eligibility for the retiree medical and life insurance
coverage for all eligible nonunion employees. Only employees age 55 or older with 10 or more years
of service as of December 31, 2006, will be eligible for post-retirement medical and life insurance
benefits. Moreover, these benefits will be available only to those employees who retire by
December 31, 2007, after having advised the Company of their retirement plans by March 31, 2007.
These changes do not affect current retirees.
The Company estimates that the changes in these retirement plans will reduce expenses by $30
to $40 million in total over the upcoming five years. Ferro expects its overall annual net
periodic cost (U.S. pension, U.S. retiree medical, and non-U.S. pension) to decrease approximately
$5.2 million from 2005 to 2006, primarily due to $10.0 million in expense reductions relating to
the aforementioned changes in the pension and retiree medical programs, offset by $4.2 million in
charges primarily relating to a lump sum payment to the beneficiary of its deceased former Chief
Executive Officer from a nonqualified defined benefit retirement plan.
Legal Proceedings
In February 2003, the Company was requested to produce documents in connection with an
investigation by the United States Department of Justice into possible antitrust violations in the
heat stabilizer industry. In April 2006, the Company was notified by the Department of Justice
that the Government had closed its investigation and that the Company was relieved of any
obligation to retain documents that were responsive to the Governments earlier document request.
Four derivative lawsuits were commenced in 2004 and subsequently consolidated into a single
action in the United States District Court for the Northern District of Ohio. These lawsuits
alleged breach of fiduciary duties and mismanagement-related claims. On March 31, 2006, the Court
dismissed the consolidated derivative action without prejudice. On April 8, 2006, plaintiffs filed
a motion seeking relief from the judgment dismissing the derivative lawsuit and seeking to further
amend their complaint following discovery, which was denied. On April 13, 2006, plaintiffs also
filed a Notice of Appeal to the Sixth Circuit Court of Appeals.
In October 2005, the Company disclosed to the New Jersey Department of Environmental
Protection (NJDEP) that it had identified potential violations of the New Jersey Water Pollution
Control Act and the Company commenced an investigation and committed to report any violations and
to undertake any necessary remedial actions. In September 2006,
17
the Company entered into an agreement with the NJDEP under which the Company paid the State of
New Jersey a civil administrative penalty of $0.2 million in full settlement of the violations.
On June 10, 2005, a putative class action lawsuit was filed against Ferro, and certain former
and current employees alleging breach of fiduciary duty with respect to ERISA plans. In October
2006, the parties reached a settlement in principle that would result in the dismissal of the
lawsuit with prejudice in exchange for the settlement amount of $4.0 million, which would be paid
by the Companys liability insurer subject to the Companys satisfaction of the remaining retention
amount under the insurance policy. Several contingent events must be satisfied before the
settlement becomes final, including preliminary and final approval by the United States District
Court where the matter is pending.
Specialty Plastics
In May 2006, the Company announced that it had entered into a non-binding letter of intent to
divest its Specialty Plastics business unit and had entered into negotiations with a potential
buyer. In October 2006, the Company announced that it had discontinued negotiations with the
potential buyer and will continue to operate the Specialty Plastics business.
18
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Overview
Net income for the three months ended June 30, 2005, decreased to $7.9 million from $11.8
million for the three months ended June 30, 2004. Earnings declined in the current quarter
primarily due to increased raw materials prices, increased expenses for the accounting
investigation and restatement and higher interest expenses.
Outlook
Due to the timing of this filing, it is not meaningful to provide an outlook for the remainder
of calendar year 2005. Refer to the Companys Annual Report on Form 10-K for the year ended
December 31, 2005, which was previously filed.
Results of Operations
Comparison of the three months ended June 30, 2005 and 2004
Second quarter 2005 net sales of $496.6 million were 2.9% higher than net sales of $482.6
million for the comparable 2004 period. The revenue increase was driven by increased sales in
Performance Coatings, Polymer Additives, Specialty Plastics, and Color and Glass Performance
Materials, partially offset by weak sales in Electronic Materials. The strengthening of foreign
currencies, particularly the Euro, contributed slightly less than two percentage points to the
revenue growth rates. Higher average selling prices and an improved product mix also contributed to
the increased sales, but these positive effects were largely offset by lower volume.
Gross margins (net sales less cost of sales) from continuing operations were 21.0% of sales
compared with 22.2% for the comparable 2004 period. The modest decline was driven by increased
costs of raw materials and lower volumes, particularly in the Electronic Materials segment.
Improved pricing had a positive effect on gross margins, but not enough to offset the factors
listed above.
Selling, general and administrative (SG&A) expenses were $78.8 million in the second quarter
of 2005 compared with $76.9 million in the second quarter of 2004. Expenses related to
restructuring and the accounting investigation and restatement process increased SG&A by $3.1
million in the second quarter of 2005, compared to the same period in 2004. All other SG&A
expenses declined by $1.2 million in the current period, compared to 2004, due to continuing cost
control initiatives.
Interest expense was $11.7 million for the second quarter of 2005 compared with $10.2 million
in the same period of 2004. Interest expense increased primarily due to higher average interest
rates on the Companys variable rate borrowings and, to a lesser extent, from an increase in
average outstanding borrowing levels.
Net foreign currency loss for the quarter ended June 30, 2005, was $0.2 million as compared to
$1.2 million for the quarter ended June 30, 2004. The Company has and continues to use certain
foreign currency instruments to offset the effect of changing exchange rates on foreign subsidiary
earnings and short-term transaction exposures. The carrying values of such contracts are adjusted
to market value and resulting gains or losses are charged to income or expense in the period.
Miscellaneous expense, net, for the three months ended June 30, 2005, was $1.8 million as
compared to expense of $1.6 million for the same period in the prior year. In 2005 the Company
realized $0.8 million in losses associated with marked-to-market valuation of natural gas contracts
versus a loss of $0.1 million in 2004.
Income tax expense as a percentage of pre-tax income from continuing operations for the
quarter was 32.6%, consistent with 31.1% in the same period in 2004.
There were no businesses reported as discontinued operations in the quarter ended June 30,
2005. The Company, however, recorded a loss of $0.2 million, net of tax, in 2005 related to certain
post-closing matters associated with businesses sold in prior periods.
19
Income from continuing operations for the second quarter of 2005 was $8.1 million compared to
$11.9 million for the same period in 2004. Diluted earnings per share from continuing operations
for the quarter totaled $0.18 compared to $0.27 in 2004.
Performance Coatings Segment Results. Net sales for the Performance Coatings segment increased
10.7% to $130.0 million as compared to $117.4 million in the second quarter of 2004. Segment income
increased to $9.3 million from $8.1 million in 2004. The revenue increase was driven primarily by
volume increases for tile coating products and favorable currency exchange rates related to the
strong Euro, partially offset by slightly lower revenues in porcelain enamel products. Revenue
increased in all regions around the world, with the largest increase in Europe. The increase in
segment income reflects improved pricing and lower SG&A expenses, offset partially by higher raw
material costs and less productive manufacturing performance.
Electronic Materials Segment Results. Net sales for the Electronic Materials segment declined
16.3% to $92.6 million as compared to $110.7 million in the second quarter of 2004. Segment income
was $4.4 million, down from $12.7 million in 2004. The revenue decline was driven by weak demand
for dielectric materials and metal powders and pastes from manufacturers of multilayer capacitors.
The reduction in segment income was driven largely by sharply lower manufacturing volume that
reduced the Companys ability to absorb fixed manufacturing costs.
Color and Glass Performance Materials Segment Results. Net sales for the Color and Glass
Performance Materials segment were $96.0 million, an increase of 3.4% versus $92.8 million in the
second quarter of 2004. Segment income of $11.9 million in the second quarter of 2005 was
substantially unchanged from the same period in 2004. Revenue grew as the result of increased
volumes and the favorable impact of foreign currency exchange rate differences, primarily related
to the Euro. Partially offsetting the growth was a less favorable combination of price and product
mix. Sales growth was the strongest in Asia.
Polymer Additives Segment Results. Net sales for the Polymer Additives segment were $78.6
million, an increase of 10.6% versus $71.0 million in the second quarter of 2004. Segment income
increased to $5.6 million from $0.4 million in the second quarter of 2004. The revenue increase was
driven by improved economic conditions in North America, which allowed pricing increases that
outpaced the effect of a decline in volume. The improved segment income was due primarily to
increased product pricing and lower SG&A expenses that more than offset increases in raw material
costs and volume declines.
Specialty Plastics Segment Results. Net sales for the Specialty Plastics segment were $72.5
million, an increase of 10.2% versus $65.8 million in the second quarter of 2004. Segment income
declined to $3.3 million from $3.4 million in 2004. The revenue increase was driven primarily
through improvements in pricing, which was partially offset by declines in volume. Segment income
was slightly lower as increased prices were more than offset by higher raw material costs.
Other Segment Results. Net sales in the Other segment were $26.9 million for the second
quarter of 2005, an increase of 8.0% versus $24.9 million in the prior year. Segment income
declined to $1.2 million from $2.3 million in the second quarter of 2004.
Geographic Sales. Net sales in the United States were $240.1 million for the second quarter of
2005 compared with $252.9 million in the same period of 2004. The lower sales were primarily due to
lower sales in Electronic Materials. International net sales were $256.6 million in the current
quarter compared to $229.7 million in 2004. This increase was primarily due to increased sales in
Latin America and Asia-Pacific as well as the strength of the Euro, relative to the U.S. dollar.
Comparison of the six months ended June 30, 2005 and 2004
Net sales from continuing operations for the first six months of 2005 of $958.3 million were
1.5% higher than the $944.2 million recorded in 2004. The revenue increase was the result of
increased sales in Performance Coatings, Polymer Additives, Specialty Plastics and Color and Glass
Performance Materials. This growth was offset by a sharp decline in sales in Electronic Materials
where there was weak demand, particularly in materials sold to makers of multilayer capacitors.
Changes in foreign exchange rates, particularly the strengthening Euro, contributed approximately
two percentage points to the sales increase. Higher average selling prices also contributed to the
higher reported net sales.
20
Gross margins were 20.6% of sales compared to 22.1% in 2004. The increased cost of raw
materials and the effects of lower volumes in Electronic Materials more than offset the
improvements from higher selling prices in other businesses.
Selling, general and administrative (SG&A) expenses were $162.4 million for the first six
months of 2005 versus $158.2 million for 2004. Increases of $7.2 million in expenses for
restructuring and the accounting investigation and restatement during the first half of 2005 more
than offset declines in other SG&A expenses, compared to the first half of 2004. SG&A as a
percentage of net sales was largely unchanged at 16.9% for the first six months of 2005 compared
with 16.8% for the first six months of 2004.
Interest expense from continuing operations increased to $22.7 million for the first six
months of 2005 from $20.3 million for the same period in 2004. This change was driven by an
increase in the average interest rates paid on the Companys variable rate borrowings and, to a
lesser extent, increased borrowing levels in the second quarter.
Net foreign currency loss for the six months ended June 30, 2005, was $1.0 million compared to
$3.0 million for the same 2004 period. The 2004 period includes a $1.0 million loss associated with
the liquidation of a joint venture company. The Company has and continues to use certain foreign
currency instruments to offset the effect of changing exchange rates on foreign subsidiary earnings
and short-term transaction exposure. The carrying values of such contracts are adjusted to market
value and resulting gains or losses are charged to income or expense in the period.
A pre-tax gain of $5.2 million was recognized in the first half of 2004 for the sale of the
Companys interest in Tokan Material Technology Co. Limited, an unconsolidated affiliate. There
were no similar gains or losses in the first six months of 2005.
Miscellaneous income, net, for the six months ended June 30, 2005, was $0.0 million as
compared to expense of $1.4 million for the same period in the prior year. In 2005 the Company
realized $1.6 million in gains associated with marked-to-market valuation of natural gas contracts
versus a loss of $0.0 million in 2004.
Income tax expense as a percentage of pre-tax income for the six months ended June 30, 2005,
was 24.2% compared with 33.0% in 2004. The lower 2005 rate reflects the Companys tax benefit in
the first quarter, when a combination of a pre-tax loss coupled with a higher proportion of losses
in jurisdictions having higher effective tax rates and a relatively low level of dividends
repatriated resulted in a $1.2 million tax benefit, combined with an effective rate of 32.6% for
the three months ended June 30, 2006.
There were no businesses reported as discontinued operations for the six-month period ended
June 30, 2005. The Company, however, recorded a loss of $0.2 million, net of tax, in 2005 related
to certain post-closing matters associated with businesses sold in prior periods, including Powder
Coatings and Specialty Ceramics. The reported loss from discontinued operations, net of tax, for
the six months ended June 30, 2004, was $0.1 million.
Income from continuing operations for the first half of 2005 was $8.7 million versus $20.9
million in 2004. Diluted earnings per share from continuing operations were $0.19 in the first six
months of 2005 compared to $0.47 in 2004.
Performance Coatings Segment Results. Net sales in the Performance Coatings segment were
$248.8 million for the six months ended June 30, 2005, compared with net sales of $231.2 million
for the six months ended June 30, 2004. Segment income in the first half of 2005 was $17.1 million,
an increase of 16.4% from the same period in 2004. Volume increases contributed to the sales
increase coupled with a benefit from favorable currency exchange rates, primarily related to the
strong Euro. This increase was partially offset by a less favorable product mix. The increase in
segment income reflects the increased volume and lower SG&A expenses offset partially by higher raw
material costs.
Electronic Materials Segment Results. Net sales in the Electronic Materials segment were
$170.8 million for the six months ended June 30, 2005, compared with net sales of $209.7 million
for the six months ended June 30, 2004. Segment income in the first half of 2005 was $4.2 million,
compared with income of $23.9 million in the same period in 2004. The revenue decrease was driven
primarily by weak demand among manufacturers of multilayer capacitors, particularly in the first
quarter of 2005. The decline in segment income reflects sharply lower volumes and lower
manufacturing utilization rates relative to 2004.
21
Color and Glass Performance Materials Segment Results. Net sales for the Color and Glass
Performance Materials segment were $188.6 million, an increase of 2.8% versus $183.6 million in the
first half of 2004. Segment income declined to $22.9 million from $24.1 million in 2004. Net sales
benefited from increased volumes, but this improvement was offset to a large degree by lower
average selling prices. Revenues also increased due to the favorable impact of foreign currency
exchange rate differences. Segment income declined due to increased raw material costs and lower
average selling prices.
Polymer Additives Segment Results. Net sales in the Polymer Additives segment were $154.9
million for the six months ended June 30, 2005, compared with net sales of $141.1 million for the
six months ended June 30, 2004. Segment income was $10.4 million for the period, compared with a
loss of $0.2 million for the prior year. The 9.8% increase in revenue for the six-month period was
driven by improved pricing, particularly in North America, partially offset by lower volume.
Improved pricing also accounted for the increased segment income as higher prices more than offset
raw materials cost increases and declining volume.
Specialty Plastics Segment Results. Net sales in the Specialty Plastics segment were $143.3
million for the six months ended June 30, 2005, compared with net sales of $134.1 million for the
six months ended June 30, 2004. Segment income was $6.9 million for the six months ended June 30,
2005, compared with $7.5 million for the six months ended June 30, 2004. The revenue increase of
6.9% for the period was driven by improved pricing in North America, coupled with a slightly
positive impact from foreign exchange rate differences. Segment income declined as a result of raw
material cost increases that were not fully recovered through price increases or expense
reductions.
Other Segment Results. Net sales in the Other segment were $51.9 million for the six-month
period ended June 30, 2005, an increase of 16.3% versus $44.7 million in the prior year. Segment
income declined to $2.0 million from $2.1 million in the same period of 2004.
Geographic Sales. Net sales in the United States were $466.1 million for the six months ended
June 30, 2005, compared with net sales of $491.5 million for the six months ended June 30, 2004.
The decrease in revenue was due to lower U.S. sales into the electronics sector. Sales into other
markets, including those in the pharmaceuticals, consumer packaging, automotive and construction
sectors, grew during the first half of 2005 compared to the first six months of 2004.
International net sales were $492.2 million for the six months ended June 30, 2004, compared with
net sales of $452.7 million for the six months ended June 30, 2004. Increased market demand in the
Asia-Pacific region coupled with the positive impact of foreign currency exchange rate differences
contributed to the international sales increase.
Cash Flows. Net cash used for operating activities of continuing operations for the six months
ended June 30, 2005, was $3.9 million, compared with net cash provided by operating activities of
continuing operations of $27.0 million for the same period in 2004. The increase in net cash used
for operating activities of continuing operations is primarily due to lower net income and
increases in the amount of cash used for working capital.
Net cash used for investing activities was $19.1 million for the six months ended June 30,
2005, compared with cash provided by investing activities of $0.2 million for the same period in
2004. The capital expenditures in 2005 were $19.0 million and these expenditures accounted for most
of the cash used for investing activities. During the first six months of 2004, capital
expenditures were $16.2 million, but these expenditures were offset by proceeds from the sale of a
business and equipment and cash received as an adjustment to the purchase price of a prior
acquisition.
Net cash provided by financing activities was $29.4 million in the six months ended June 30,
2005, compared with net cash used for financing activities of $30.3 million during the same period
in 2004. Cash provided by financing activities in 2005 primarily reflects debt increases, less
dividends paid to the Companys shareholders.
Net cash used for operating activities of discontinued operations was $0.6 million during the
six months ended June 30, 2005, compared with $0.3 million of net cash used for discontinued
operations for the same period in 2004.
Liquidity and Capital Resources
The Companys liquidity requirements include primarily debt service, working capital
requirements, capital investments, post-retirement obligations and dividend payments. The Company
expects to be able to meet its liquidity requirements from a variety of sources, including cash
flow from operations and use of its credit facilities. At June 30, 2005, the Company had a $300
million revolving credit facility that was scheduled to expire in September 2006, as well as $200
million of senior notes
22
due in 2009 and $155 million of debentures with varying maturities beyond 2012. The Company
also had an accounts receivable securitization facility under which the Company could receive
advances of up to $100 million, subject to the level of qualifying accounts receivable. The
accounts receivable securitization facility was due to mature in June 2006.
Subsequent to June 30, 2005, the Company replaced and/or modified its existing facilities to
secure future financial liquidity. The $300 million revolving credit facility was replaced by a
$700 million credit facility, consisting of a $250 million multi-currency senior revolving credit
facility expiring in 2011 and a $450 million senior delayed-draw term loan facility expiring in
2012. See further discussion under Revolving Credit and Term Loan Facility below. In addition,
the Company extended its $100 million accounts receivable securitization facility for up to three
additional years. See further discussion under Off Balance Sheet Arrangements below. For
further information regarding the Companys credit facilities, refer to Note 6 to the Companys
Condensed Consolidated Financial Statements under Item 1 herein.
In the second quarter of 2005, the Companys senior credit rating was downgraded from Baa3 to
Ba1 by Moodys Investor Service, Inc. (Moodys) and from BB+ to BB by Standard & Poors Rating
Group (S&P). In March 2006, Moodys further lowered its rating to B1 and then withdrew its
ratings, and S&P further lowered its rating to B+. The rating agencies may, at any time, based on
various factors including changing market, political or economic conditions, reconsider the current
rating of the Companys outstanding debt. Based on rating agency disclosures, Ferro understands
that ratings changes within the general industrial sector are evaluated based on quantitative,
qualitative and legal analyses. Factors considered by the rating agencies include: industry
characteristics, competitive position, management, financial policy, profitability, capital
structure, cash flow production and financial flexibility. Moodys and S&P have disclosed that the
Companys ability to improve earnings, reduce the Companys level of indebtedness and strengthen
cash flow protection measures, whether through asset sales, increased free cash flows from
operations or otherwise, will be factors in their ratings determinations going forward.
Revolving Credit and Term Loan Facility
In March 2006, the Company accepted a commitment from a syndicate of lenders to underwrite a
$700 million credit facility (the New Credit Facility) and, in June 2006, finalized the
agreement. The New Credit Facility is comprised of a five year, $250 million multi-currency senior
revolving credit facility and a six year, $450 million senior delayed-draw term loan facility.
Under the terms of the New Credit Facility, the Company can request that the revolving credit
facility be increased by $50 million at no additional fee.
The New Credit Facility was entered into to replace the prior revolving credit facility that
was scheduled to expire in September 2006. In addition, the financing, through the term loan
facility, provided capital resources sufficient to refinance the $200 million of senior notes and
$155 million of debentures that could have become immediately due and payable due to defaults
associated with the Companys delayed SEC financial filings for 2005. Because one of the purposes
of the term loan facility is to fund the potential acceleration of the senior notes and debentures,
the term facility contains certain restrictions including, but not limited to, the following:
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$355 million of the facility is reserved to repay the senior notes and
debentures; |
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$95 million of the facility is immediately available for refunding indebtedness
other than the senior notes and debentures; |
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The Company may access up to $55 million of the $355 million reserved to repay
the senior notes and debentures if these obligations have not already been paid in
full and no event of default for these obligations exists and is continuing; and |
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The Company may draw on the delayed-draw facility for up to one year with any
unused commitment under the term facility terminating on June 6, 2007. |
At the close of the New Credit Facility in June 2006, the Company drew $95 million of the term
loan facility to partially repay the old revolving credit facility. In addition, during the third
quarter of 2006, the Company drew down another $155 million of the term loan facility to repay $155
million of outstanding debentures, as bondholders accelerated payment on these obligations due to
the previously mentioned 2005 SEC financial reporting delays. See further discussion under Senior
Notes and Debentures below.
23
The New Credit Facility is secured by substantially all of the Companys assets, including the
assets and 100% of the shares of the Companys material domestic subsidiaries and 65% of the shares
of the Companys first tier foreign subsidiaries, but excluding trade receivables sold pursuant
to the Companys accounts receivable sales programs (see below). These liens are shared with the
holders of the Companys senior notes, as required under the respective indenture. The New Credit
Facility contains customary operating covenants that limit the Companys ability to engage in
certain activities, including limitations on additional loans and investments; creation of
additional liens; prepayments, redemptions and repurchases of debt; and mergers, acquisitions and
asset sales. The Company is also subject to customary financial covenants including a leverage
ratio and a fixed charge coverage ratio. Additional covenants of the New Credit Facility require
the Company to file its 2006 Forms 10-Q by December 29, 2006. Failure to satisfy certain of these
covenants, either immediately or after a brief period allowing the company to satisfy the covenant,
would result in an event of default. If any event of default should occur and be continuing and a
waiver not have been obtained, the obligations under the New Credit Facility may become immediately
due and payable at the option of providers of more than 50% of the credit facility commitment.
Senior Notes and Debentures
The indentures under which the senior notes and the debentures were issued contain operating
covenants that limit the Companys ability to engage in certain activities including limitations on
consolidations, mergers, and transfers of assets; and sale and leaseback transactions. The
indentures contain cross-default provisions with other debt obligations that exceed $10 million of
principal outstanding. In addition, the terms of the indentures require, among other things, the
Company to file with the Trustee copies of its annual reports on Form 10-K, quarterly reports on
Form 10-Q and an Officers Certificate relating to the Companys compliance with the terms of the
indenture within 120 days after the end of its fiscal year. The Company has been in default on
these reporting requirements since it delayed filing its Form 10-Q for the second quarter of 2004
due to the restatement of its 2003 and first quarter 2004 results. As the Company anticipated and
planned for, in March and April 2006, the Company received notices of default from a holder and the
Trustee of the senior notes and debentures of which $355 million was outstanding. The notices of
default related only to reporting requirements and the related Officers Certificate. Under the
terms of the indentures, the Company had 90 days from the notices of default to cure the
deficiencies identified in the notices of default or obtain waivers, or events of default would
have occurred and the holders or the Trustee of the senior notes or debentures could declare the
principal immediately due and payable. At the end of these periods, the deficiencies had not been
cured and waivers had not been obtained. During July and August 2006, the bondholders accelerated
the payment of the principal amount of the debentures, of which $155 million was outstanding, and
the Company financed the accelerated repayments by use of the aforementioned $450 million term loan
facility.
As of the date of this filing, the $200 million senior notes currently remain outstanding,
although they could be declared immediately due and payable at any time. In the event the
bondholders of the senior notes provide a notice of acceleration prior to the Company curing the
existing reporting default, the Company believes it has sufficient liquidity resources, primarily
through the term loan facility, to fully satisfy any potential acceleration. In addition, the
senior notes are redeemable at the option of the Company at any time for the principal amount of
the senior notes then outstanding plus the sum of any accrued but unpaid interest and the present
value of any remaining scheduled interest payments. The senior notes are redeemable at the option
of the holders only upon a change in control of the Company combined with a rating by either
Moodys or S&P below investment grade as defined in the indenture. Currently, the rating by S&P of
the senior notes is below investment grade.
Off Balance Sheet Arrangements
Asset Securitization Program. The Company has a $100 million program to sell (securitize), on
an ongoing basis, a pool of its trade accounts receivable. This program serves to accelerate cash
collections of the Companys trade accounts receivable at favorable financing costs and helps
manage the Companys liquidity requirements. In June 2005, the Company amended the program to
resolve issues related to a credit rating downgrade and delayed SEC filings and to extend the
program through June 2006. In June 2006, the Company amended the program to extend it up to June 2,
2009, to cure a default resulting from a credit rating downgrade, and to modify the reporting
requirements to more closely match those in the New Credit Facility. While the Company expects to
maintain a satisfactory U.S. asset securitization program to help meet the Companys liquidity
requirements, factors beyond the Companys control such as prevailing economic, financial and
market conditions may prevent the Company from doing so.
24
Under this program, certain of the Companys receivables are sold to Ferro Finance Corporation
(FFC), a wholly-owned unconsolidated qualified special purpose entity (QSPE), as defined by
Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, (FAS No. 140). FFC finances its acquisition
of trade accounts receivables assets by issuing financial interests to multi-seller receivables
securitization companies (commercial paper conduits). At December 31, 2004, $3.6 million had been
advanced to the Company, net of repayments, under this program. During the three months ended June
30, 2005, $243.0 million of accounts receivable were sold under this program and $243.0 million of
receivables were collected and remitted to FFC and the commercial paper conduits. During the six
months ended June 30, 2005, $496.1 million of accounts receivable were sold under this program and
$471.1 million of receivables were collected and remitted to FFC and the commercial paper conduits,
resulting in a net decrease in advances of $2.6 million and total advances outstanding at June 30,
2005, of $1.0 million.
Consignment Arrangements. The Company consigns, from various financial institutions, precious
metals (primarily silver, gold, platinum and palladium, collectively metals) used in the
production of certain products for customers. Under these consignment arrangements, the financial
institutions provide the Company with metals for a specified period of one year or less in
duration, for which the Company pays a fee. Under these arrangements, the financial institutions
own the metals, and accordingly, the Company does not report these consigned materials as part of
its inventory on its consolidated balance sheet. These agreements are cancelable by either party at
the end of each consignment period, however, because the Company has access to a number of
consignment arrangements with available capacity, consignment needs can be shifted among the other
participating institutions. At June 30, 2005, the Company had 7.6 million troy ounces of metals
(primarily silver) on consignment for periods of less than one year with a market value of $92.8
million. Beginning in the fourth quarter of 2005, certain participating institutions required cash
deposits to provide additional collateral beyond the underlying precious metals. At September 30,
2006, the Company had outstanding deposits of $93.3 million. The Company anticipates that the
majority of these cash deposits will be returned by December 31, 2006.
Other Financing Arrangements
In addition, the Company maintains other lines of credit and receivable sales programs to
provide global flexibility for the Companys liquidity requirements. Most of these facilities,
including receivable sales programs, are uncommitted lines for the Companys international
operations.
Liquidity
Ferros level of debt and debt service requirements could have important consequences to its
business operations and uses of cash flows. In addition, a reduction in overall demand for the
Companys products, as well as the potential requirement to repay the senior notes due to the
Companys delayed SEC filings, could adversely affect cash flows. Despite these potential
constraints on cash flows, the Company maintains considerable resources. At June 30, 2005, the
Company had a $300.0 million revolving credit facility of which $121.2 million was available. This
liquidity, along with the liquidity from the Companys asset securitization program of which $99.0
million was available as of June 30, 2005, other financing arrangements, available cash flows from
operations, asset sales, and the New Credit Facility, should allow the Company to meet its funding
requirements and other commitments. However, factors beyond the Companys control such as
prevailing economic, financial and market conditions may prevent the Company from doing so. As of
September 30, 2006, the Company had borrowed $157.7 million against its $250 million revolving
credit facility and drawn $64.5 million on the $100 million asset securitization program. In
addition, the Company had drawn $250 million on the $450 million term loan facility, although the
$200 million remaining availability is reserved for the repayment of the 9 1/8% senior notes should
they be accelerated by the bondholders.
Critical Accounting Policies
Please refer to the Companys Annual Report on Form 10-K for the year ended December 31, 2005,
which was previously filed, for a detailed description of Critical Accounting Policies.
Risk Factors
Certain statements contained here and in future filings with the Securities and Exchange
Commission reflect the Companys 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
25
amended. These statements are subject to a variety of uncertainties, unknown risks and other
factors concerning the Companys operations and business environment, which are difficult to
predict and are beyond the control of the Company. Please refer to the Companys Annual Report on
Form 10-K for the year ended December 31, 2005, which was previously filed, for a detailed
description of such uncertainties, risks and other factors under the heading Risk Factors.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Companys exposure to market risks is primarily limited to fluctuations in interest rates,
foreign currency exchange rates, and costs of raw materials and natural gas.
Ferros exposure to interest rate risk relates primarily to its debt portfolio including
obligations under the accounts receivable securitization program. The Companys interest rate risk
management objective is to limit the effect of interest rate changes on earnings, cash flows and
overall borrowing costs. In managing the percentage of fixed versus variable rate debt,
consideration is given to the interest rate environment and forecasted cash flows. This policy
limits exposure from rising interest rates and allows the Company to benefit during periods of
falling rates. The Companys interest rate exposure is generally limited to the amounts outstanding
under the revolving credit facility and amounts outstanding under its asset securitization program.
Based on the amount of variable-rate indebtedness outstanding at June 30, 2005, a 1% increase or
decrease in interest rates would have resulted in a $1.9 million corresponding change in annual
interest expense. At June 30, 2005, the Company had $353.4 million carrying value of fixed rate
debt outstanding with an average effective interest rate of 8.6%, substantially all maturing after
2008. The fair market value of these debt securities was approximately $368.7 million at June 30,
2005. During July and August 2006, the bondholders accelerated the payment of the principal amount
of the Companys fixed-rate debentures, of which $155 million was outstanding. The debentures were
repaid through use of the term loan facility (see further information included under Liquidity and
Capital Resources under Item 2 of this Form 10-Q), which increased the level of floating-rate debt.
Ferro manages its currency risks principally by entering into forward contracts to mitigate
the impact of currency fluctuations on transaction and other exposures. At June 30, 2005, the
Company held forward contracts with a notional amount of $112.7 million and an aggregate fair value
of $0.5 million. A 10% appreciation of the U.S. dollar would have resulted in a $0.2 million
increase in the fair value of these contracts in the aggregate at June 30, 2005. A 10%
depreciation of the U.S. dollar would have resulted in a $0.3 million decrease in the fair value of
these contracts in the aggregate at June 30, 2005.
The Company is also subject to cost changes with respect to its raw materials and natural gas
purchases. The Company attempts to mitigate raw materials cost increases with price increases to
the Companys customers. In addition, the Company purchases portions of its natural gas
requirements under fixed price contracts, over short time periods, to reduce the volatility of this
cost. At June 30, 2005, contracts for 1.2 million MMBTUs of natural gas had a fair value of $0.7
million. A 10% increase or decrease in the forward prices of natural gas would have resulted in a
$1.0 million corresponding change in the fair value of the contracts as of June 30, 2005.
Item 4. Controls and Procedures
For a discussion of the Companys Controls and Procedures, see Item 9A in the Companys Annual
Report on Form 10-K for the year ended December 31, 2005, which was previously filed. Item 9A in
the Companys Annual Report on Form 10-K for the year ended December 31, 2005, is incorporated
herein by reference.
Evaluation of Disclosure Controls and Procedures
The Companys management, under the supervision and with the participation of the Chief
Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and
operation of the Companys disclosure controls and procedures as of June 30, 2005. Based on that
evaluation, management concluded that the disclosure controls and procedures were not effective as
of June 30, 2005.
Procedures were undertaken in order for management to conclude that reasonable assurance
exists regarding the reliability of the Condensed Consolidated Financial Statements contained in
this filing. Accordingly, management believes that the Condensed Consolidated Financial Statements
included in this Form 10-Q present fairly, in all material respects, the financial position,
results of operations and cash flows for the periods presented.
26
Changes in Internal Control over Financial Reporting
As disclosed in the Companys Annual Report on Form 10-K for the year ended December 31, 2005,
which was previously filed, the Company initiated a number of remediation activities during 2005
that materially improved, or were reasonably likely to improve, the Companys internal control over
financial reporting. During the quarterly period ended June 30, 2005, the following remediation
activities were taken in response to the material weaknesses identified by management:
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Initiated an analysis of the global accounting organization to assess whether any
additional resources are needed; resulting in the addition of several positions; |
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Further refinement, expansion and communication of the Accounting Policies and
Procedures manual; and |
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Migration of two international sites of the Companys various stand-alone
information systems to the global SAP platform with the objective of having one
integrated system with improved corporate oversight. |
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PART II OTHER INFORMATION
Item 1. Legal Proceedings
The information regarding legal proceedings included in Note 10 and Note 17 to the Condensed
Consolidated Financial Statements is incorporated herein by reference.
Item 1A. Risk Factors
There are no changes to the risk factors disclosed in the Companys Annual Report on Form 10-K
for the year ended December 31, 2005, which was previously filed.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
The Companys prior revolving credit agreement required the Company and its material
subsidiaries, as the result of Moodys rating downgrade in March 2006, to grant, within 30 days
from the rating downgrade, security interests in their tangible and intangible assets (with the
exception of the receivables sold as part of the Companys asset securitization program), pledge
100% of the stock of domestic material subsidiaries and pledge 65% of the stock of foreign material
subsidiaries, in each case, in favor of the lenders under the senior credit facility. This lien
grant and pledge of stock was substantially completed in April 2006. Liens on principal domestic
manufacturing properties and the stock of domestic subsidiaries were also granted to and shared
with the holders of the Companys senior notes and debentures, as required by their indentures. In
June 2006, the Company replaced the prior revolving credit agreement with a new credit facility.
In March and April 2006, the Company received notices of default from a holder and the Trustee
of the Companys senior notes and debentures, listed below, with an aggregate principal amount of
$355 million. The carrying value of the notes and debentures was not materially different from the
principal amounts originally issued. Under the terms of the indentures, the Company had 90 days
from the notices of default to cure the deficiencies identified in the notices of default or obtain
waivers, or events of default would have occurred and the holders of the senior notes or debentures
or the Trustee could declare the principal immediately due and payable. At the end of these
periods, the deficiencies had not been cured and waivers had not been obtained. During July and
August 2006, the bondholders accelerated the payment of the principal amount of the debentures, of
which $155 million was outstanding, and the Company financed the accelerated repayments by use of
the term loan portion of the aforementioned new credit facility.
Notes and debentures included in the notices of default:
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$200 million 9.125% Senior Notes due January 1, 2009 |
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$25 million 7.625% Debentures due May 1, 2013 |
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$25 million 7.375% Debentures due November 1, 2015 |
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$50 million 8.0% Debentures due June 15, 2025 |
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$55 million 7.125% Debentures due April 1, 2028 |
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
None.
Item 6. Exhibits
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The exhibits listed in the attached Exhibit Index are filed pursuant to Item 6(a) of Form 10-Q. |
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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FERRO CORPORATION
(Registrant)
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Date: November 3, 2006
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/s/ James F. Kirsch
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James F. Kirsch |
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President and Chief Executive Officer
(Principal Executive Officer) |
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Date: November 3, 2006
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/s/ Thomas M. Gannon
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Thomas M. Gannon |
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Vice President and Chief Financial Officer
(Principal Financial Officer) |
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29
EXHIBIT INDEX
The following exhibits are filed with this report or are incorporated here by reference to a
prior filing in accordance with Rule 12b-32 under the Securities and Exchange Act of 1934.
Exhibit:
(3) Articles of Incorporation and by-laws
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(a) |
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Eleventh Amended Articles of Incorporation. (Reference is made to Exhibit 3(a) to
Ferro Corporations Annual Report on Form 10-K for the year ended December 31, 2003,
which Exhibit is incorporated here by reference.) |
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(b) |
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Certificate of Amendment to the Eleventh Amended Articles of Incorporation of Ferro
Corporation filed December 28, 1994. (Reference is made to Exhibit 3(b) to Ferro
Corporations Annual Report on Form 10-K for the year ended December 31, 2003, which
Exhibit is incorporated here by reference.) |
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(c) |
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Certificate of Amendment to the Eleventh Amended Articles of Incorporation of Ferro
filed June 19, 1998. (Reference is made to Exhibit 3(c) to Ferro Corporations Annual
Report on Form 10-K for the year ended December 31, 2003, which Exhibit is incorporated
here by reference.) |
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(d) |
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Amended Code of Regulations. (Reference is made to Exhibit 3(d) to Ferro
Corporations Annual Report on Form 10-K for the year ended December 31, 2003, which
Exhibit is incorporated here by reference.) |
(4) Instruments defining rights of security holders, including indentures
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(a) |
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The rights of the holders of Ferros Debt Securities issued and to be issued
pursuant to a Senior Indenture between Ferro and J. P. Morgan Trust Company, National
Association (successor-in-interest to Chase Manhattan Trust Company, National
Association) as Trustee, are described in the Senior Indenture, dated March 25, 1998.
(Reference is made to Exhibit 4(b) to Ferro Corporations Annual Report on Form 10-K
for the year ended December 31, 2003, which Exhibit is incorporated here by reference.) |
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(b) |
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Officers Certificate dated December 20, 2001, pursuant to Section 301 of the
Indenture dated as of March 25, 1998, between the Company and J. P. Morgan Trust
Company, National Association (the successor-in-interest to Chase Manhattan Trust
Company, National Association), as Trustee (excluding exhibits thereto). (Reference is
made to Exhibit 4.1 to Ferro Corporations Current Report on Form 8-K filed December
21, 2001, which Exhibit is incorporated herein by reference.) |
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(c) |
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Form of Global Note (9-1/8% Senior Notes due 2009). (Reference is made to Exhibit
4.2 to Ferro Corporations Current Report on Form 8-K filed December 21, 2001, which
Exhibit is incorporated here by reference.) |
The Company agrees, upon request, to furnish to the Securities and Exchange Commission a
copy of any instrument authorizing long-term debt that does not authorize debt in excess of
10% of the total assets of the Company and its subsidiaries on a consolidated basis.
(31.1) Certification of Principal Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).
(31.2) Certification of Principal Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).
(32.1) Certification of Principal Executive Officer Pursuant to 18 U.S.C. 1350.
(32.2) Certification of Principal Financial Officer Pursuant to 18 U.S.C. 1350.
30