UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________________________
Form 10-K
___________________________________________
(Mark One)
For the fiscal year ended December 31, 2021
or
For the transition period from _________ to __________
Commission file number 1-584
(Exact name of registrant as specified in its charter)
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||
| (Address of principal executive offices) | (Zip Code) | |||||||
Registrant’s telephone number, including area code (216 ) 875-5600
Securities Registered Pursuant to section 12(b) of the Act:
| Title of Each Class | Trading Symbol(s) | Name of Each Exchange on Which Registered | ||||||||||||
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
| ☒ | Accelerated filer | ☐ | Non-accelerated filer | ☐ | Smaller reporting company | Emerging growth company | |||||||||||||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(c)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
The aggregate market value of Ferro Corporation Common Stock, par value $1.00, held by non-affiliates and based on the closing sale price as of June 30, 2021, was approximately $1,749,665,504 .
On January 31, 2022, there were 83,629,399 shares of Ferro Corporation Common Stock, par value $1.00 outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
TABLE OF CONTENTS
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PART I
Item 1 — Business
History, Organization and Products
Ferro Corporation is a leading producer of specialty materials that are sold to a broad range of manufacturers who, in turn, make products for many end-use markets. When we use the terms “Ferro,” “we,” “us” or “the Company,” we are referring to Ferro Corporation and its subsidiaries unless indicated otherwise.
Ferro’s products fall into two general categories: functional coatings, which perform specific functions in the end products and manufacturing processes of our customers; and color solutions, which provide performance and aesthetic characteristics to our customers’ products. Our products are manufactured in approximately 48 facilities around the world. They include frits, porcelain and other glass enamels, glazes, stains, decorating colors, pigments, inks, polishing materials, dielectrics, electronic glasses, and other specialty coatings.
Ferro develops and delivers innovative products to our customers based on our strengths in the following technologies:
•Particle Engineering — Our ability to design and produce very small particles made of a broad variety of materials, with precisely controlled characteristics of shape, size and particle distribution. We have proven expertise in dispersing these particles within liquid, paste and gel formulations.
•Color and Glass Science — Our understanding of the chemistry required to develop and produce pigments that provide color characteristics ideally suited to customers’ applications. We have a demonstrated ability to manufacture glass-based and certain other coatings with properties that precisely meet customers’ needs in a broad variety of applications.
•Surface Chemistry and Surface Application Technology — Our understanding of chemicals and materials used to develop products and processes that involve the interface between layers and the surface properties of materials.
•Formulation — Our ability to develop and manufacture combinations of materials that deliver specific performance characteristics designed to work within customers’ particular products and manufacturing processes.
We differentiate our Company in our industry by innovation, development of new products and services, the consistent high quality of our products, combined with delivery of localized technical service and customized application technology support. Our value-added technology services assist customers in their material specification and evaluation, product design, and manufacturing process characterization in order to help them optimize the application of our products.
Ferro’s operations are divided into the four business units, which comprise two reportable segments, listed below:
•Tile Coating Systems(1)
•Porcelain Enamel(2)
•Functional Coatings
•Color Solutions
(1)Tile Coating Systems was historically a part of the Performance Coatings reportable segment. As of December 31, 2019, the results of the Tile Coatings business portion of Tile Coating Systems are reported as discontinued operations, for financial reporting purposes.
(2)Porcelain Enamel, previously a part of the Performance Coatings reportable segment, is integrated into the Functional Coatings reportable segment, for financial reporting purposes.
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During the fourth quarter of 2019, substantially all of the assets and liabilities of our Tile Coatings business were classified as held-for-sale in the consolidated balance sheets. We entered into a definitive agreement to sell our Tile Coatings business, which has historically been a part of our Performance Coatings reportable segment. Therefore, the associated operating results, net of income tax, have been classified as discontinued operations in the accompanying consolidated statements of operations for all periods presented.
On February 25, 2021, we completed the sale of our Tile Coatings business to Pigments Spain, S.L., a company of the Esmalglass-Itaca-Fritta group (the “Buyer”), which is a portfolio company of certain Lone Star Funds, for $460.0 million in cash, subject to post-closing adjustments. The transaction resulted in net proceeds of approximately $402.1 million after expenses and a gain of $94.8 million, which is recorded within Income (loss) from discontinued operations, net of income taxes in our consolidated statement of operations for the period ended December 31, 2021. During the fourth quarter of 2021, we finalized our post-closing adjustments with the Buyer for $13.1 million. We entered into a Transition Services Agreement (“TSA”) with the Buyer, which is designed to facilitate an orderly transfer of business operations. The services provided under the TSA will terminate at various points in times between six to twelve months from the completion of the sale. Except for transition services, we have no continuing involvement with the Buyer subsequent to the completion of the sale. Refer to Note 4 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K for a discussion of the sale of the Tile Coatings business. Throughout this Annual Report on Form 10-K, unless otherwise indicated, amounts and activity are presented on a continuing operations basis.
Financial information about our segments is included herein in Note 20 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K.
Markets and Customers
Ferro’s products are used in a variety of product applications, within the following markets:
| Appliances | Electronics | ||||||||||
| Automotive | Industrial products | ||||||||||
| Building and renovation | Packaging | ||||||||||
| Consumer products | Sanitary | ||||||||||
Many of our products are used as functional or aesthetic coatings for a variety of different substrates on our customers’ products, such as metals, ceramics, glass, plastic, wood and concrete. Other products are used to manufacture electronic components and other technology products. Still other products are added during our customers’ manufacturing processes to provide desired properties to their end product. Often, Ferro materials are a small portion of the total cost of our customers’ products, but they can be critical to the functionality or appearance of those products.
Our customers include manufacturers of ceramic tile, major appliances, construction materials, automobile parts, automobiles, architectural and container glass, and electronic components and devices. Many of our customers, including makers of major appliances and automobile parts, purchase materials from more than one of our business units. Our customer base is well diversified both geographically and by end market.
We generally sell our products directly to our customers. However, a portion of our business uses indirect sales channels, such as agents and distributors, to deliver products to market. In 2021, no single customer or related group of customers represented more than 10% of net sales. In addition, none of our reportable segments is dependent on any single customer or related group of customers.
Seasonality
Although not seasonal, in certain of our technology-driven markets, our customers’ business is often characterized by product campaigns with defined life cycles, which can result in uneven demand as product ramp-up periods are followed by down-cycle periods. As our innovation activity increases in line with our value creation strategy, we expect this type of business also to increase. This type of market operates on a different cycle from the majority of our business. We do not regard any material part of our business to be seasonal. However, customer demand has historically been higher in the second quarter when building and renovation markets are particularly active, and the second quarter has also normally been the strongest for sales and operating profit.
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Competition
In most of our markets, we have a substantial number of competitors, none of which is dominant. Due to the diverse nature of our product lines, no single competitor directly matches all of our product offerings. Our competition varies by product and by region, and is based primarily on product quality, performance and functionality, as well as on pricing, customer service, technical support, and the ability to develop custom products to meet specific customer applications.
We are a worldwide leader in the production of specialty coatings and enamels for glass enamels, porcelain enamel, and ceramic tile coatings. There is strong competition in our markets, ranging from large multinational corporations to local producers. While many of our customers purchase customized products and formulations from us, our customers could generally buy from other sources, if necessary.
Raw Materials and Supplier Relations
Raw materials widely used in our operations include:
| Metal Oxides: | Other Inorganic Materials: | ||||||||||
Aluminum oxide(2) | Boron(1) | ||||||||||
Antimony oxide(2) | Clay(1) (2) | ||||||||||
Bismuth oxide(1) | Feldspar(1) | ||||||||||
Chrome oxide(1) (2) | Lithium(1) | ||||||||||
Cobalt oxide(1) (2) | Silica(1) | ||||||||||
Copper oxide(1) (2) | Soda ash(1) (2) | ||||||||||
Iron oxide(2) | Zircon(1) | ||||||||||
Lead oxide(2) | |||||||||||
Nickel oxide(1) (2) | |||||||||||
Titanium dioxide(1) (2) | |||||||||||
Zinc oxide(1) (2) | |||||||||||
Zirconium dioxide(1) (2) | |||||||||||
| Precious Metals: | Energy: | ||||||||||
Gold(1) | Electricity | ||||||||||
Silver(1) | Natural gas | ||||||||||
Platinum(1) | |||||||||||
(1)Primarily used by the Functional Coatings segment.
(2)Primarily used by the Color Solutions segment.
These raw materials make up a large portion of our product costs in certain of our product lines, and fluctuations in the cost of raw materials can have a significant impact on the financial performance of the related businesses. We attempt to pass through raw material cost increases to our customers.
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We have a broad supplier base and, in many instances, multiple sources of essential raw materials are available worldwide if problems arise with any particular supplier. We maintain many comprehensive supplier agreements for strategic and critical raw materials. We did not encounter raw material shortages in 2021 that materially affected our manufacturing operations, but we are subject to volatile raw material costs or material availability that can affect our results of operations.
Environmental Matters
We handle, process, use and store hazardous materials as part of the production of some of our products. As a result, we operate production facilities that are subject to a broad array of environmental laws and regulations in the countries in which we operate, particularly for wastes, wastewater discharges and air emissions. In addition, some of our products are subject to restrictions under laws or regulations, such as California’s Proposition 65, the Toxic Substances and Control Act and the European Union’s (“EU”) chemical substances directive. The costs to comply with the complex environmental laws and regulations applicable to our operations are significant and will continue for the industry and us for the foreseeable future. These routine costs are expensed as they are incurred. While these costs may increase in the future, they are not expected to have a material impact on our financial position, liquidity or results of operations. We believe that we are in substantial compliance with the environmental laws and regulations applicable to our operations. We also believe that, to the extent that we may not be in compliance with such regulations, such non-compliance will not have a materially adverse effect on our financial position, liquidity or results of operations.
Our policy is to operate our plants and facilities in a manner that protects the environment and the health and safety of our employees and the public. We intend to continue to make expenditures for environmental and health and safety protection and improvements in a timely manner consistent with available technology. Although we cannot precisely predict future environmental, health and safety spending, we do not expect the costs to have a material impact on our financial position, liquidity or results of operations. Capital expenditures for environmental, health and safety protection were $5.7 million in 2021, $2.6 million in 2020, and $4.5 million in 2019. We also accrue for environmental remediation costs when it is probable that a liability has been incurred and we can reasonably estimate the amount. We determine the timing and amount of any liability based upon assumptions regarding future events, and inherent uncertainties exist in such evaluations primarily due to unknown conditions or circumstances, changing governmental regulations and legal standards regarding liability, and evolving technologies. We adjust these liabilities periodically as remediation-related efforts progress, the nature and extent of contamination becomes more certain, or as additional technical or legal information becomes available.
Research and Development
We are involved worldwide in research and development activities relating to new and existing products, services and technologies required by our customers’ continually changing markets. Our research and development resources are organized into centers of excellence that support our regional and worldwide major business units. These centers are augmented by local laboratories that provide technical service and support to meet customer and market needs in various geographic areas.
Total expenditures for product and application technology, including research and development, customer technical support and other related activities, were $32.6 million in 2021, $35.6 million in 2020, and $41.0 million in 2019.
Patents, Trademarks and Licenses
We own a substantial number of patents and patent applications relating to our various products and their uses. While these patents are of importance to us and we exercise diligence to ensure that they are valid, we do not believe that the invalidity or expiration of any single patent or group of patents would have a material adverse effect on our businesses. Our patents will expire at various dates through the year 2039. We also use a number of trademarks that are important to our businesses as a whole or to particular segments of our business. We believe that these trademarks are adequately protected.
Human Capital
We provide employee benefits and programs in recruiting, retention, performance management, and training that aim to enable us to develop, create and fully leverage the strengths of our workforce to help exceed customer expectations and ongoing growth objectives.
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At December 31, 2021, we employed 3,585 full-time employees, including 3,153 employees in our foreign consolidated subsidiaries and 432 in the United States (“U.S.”). At December 31, 2021, 0 of our employees in our foreign consolidated subsidiaries were associated with the Tile Coatings business. Total employment decreased by 1,967 in our foreign subsidiaries and decreased by 63 in the U.S. from the prior year end primarily due to the sale of our Tile Coatings business and our cost optimization initiatives.
Collective bargaining agreements cover 6.3% of our U.S. workforce. Approximately 4.6% of all U.S. employees are affected by a labor agreement that expires in 2024. We consider our relations with our employees, including those covered by collective bargaining agreements, to be good.
Our employees in Europe have protections afforded them by local laws and regulations through unions and works councils. Some of these laws and regulations may affect the timing, amount and nature of restructuring and cost reduction programs in that region.
Domestic and Foreign Operations
We began international operations in 1927. Our products are manufactured and/or distributed through our consolidated subsidiaries and unconsolidated affiliates in the following countries:
Consolidated Subsidiaries:
| Argentina | France | Malaysia (1) | Taiwan | ||||||||||||||||||||
| Australia | Germany | Mexico | Thailand | ||||||||||||||||||||
| Belgium | India | Netherlands | Turkey | ||||||||||||||||||||
| Brazil | Indonesia | Poland (1) | United Kingdom | ||||||||||||||||||||
| Canada | Ireland | Portugal | United States | ||||||||||||||||||||
| China | Israel | Romania | Vietnam (1) | ||||||||||||||||||||
| Colombia | Italy | Russia | |||||||||||||||||||||
Egypt (1) | Japan | Spain | |||||||||||||||||||||
Unconsolidated Affiliates:
| China | Egypt (1) | South Korea | |||||||||||||||||||||
Ecuador (1) | Spain | ||||||||||||||||||||||
(1)Indicates operations associated with the Tile Coatings business which were discontinued with the completion of the sale during the first quarter of 2021.
Financial information for geographic areas is included in Note 20 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K. More than 60.0% of our net sales are outside of the U.S. We sell products into approximately 96 countries.
Our U.S. parent company receives technical service fees and/or royalties from many of its foreign subsidiaries. As a matter of corporate policy, the foreign subsidiaries have historically been expected to remit a portion of their annual earnings to the U.S. parent company as dividends. To the extent earnings of foreign subsidiaries are not remitted to the U.S. parent company, those earnings are indefinitely re-invested in those subsidiaries.
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Available Information
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K, including any amendments, will be made available free of charge on our website, www.ferro.com, as soon as reasonably practical, following the filing of the reports with the U.S. Securities and Exchange Commission (“SEC”). Our Corporate Governance Principles, Code of Business Conduct, Guidelines for Determining Director Independence, and charters for our Audit Committee, Compensation Committee and Governance and Nomination Committee are available free of charge either on our website or to any shareholder who requests them from the Ferro Corporation Investor Relations Department located at 6060 Parkland Blvd., Suite 250, Mayfield Heights, Ohio, 44124.
Forward-Looking Statements
Certain statements contained here and in future filings with the SEC reflect our expectations with respect to future performance and constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are subject to a variety of uncertainties, unknown risks and other factors concerning our operations and the business environment, which are difficult to predict and are beyond our control.
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Item 1A — Risk Factors
Many factors could cause our actual results to differ materially from those suggested by statements contained in this filing and could adversely affect our future financial performance. Such factors include the following:
Risks Related to Our Business and Strategy
We sell our products into industries where demand has been unpredictable, cyclical or heavily influenced by consumer spending, and such demand and our results of operations may be further impacted by macro-economic circumstances.
We sell our products to a wide variety of customers who supply many different market segments. Many of these market segments, including building and renovation, major appliances, transportation, and electronics, are cyclical or closely tied to consumer demand. Consumer demand may change and is difficult to accurately forecast. Change in demand and incorrect forecasts of demand or unforeseen reductions in demand can adversely affect costs and profitability due to factors, including but not limited to underused manufacturing capacity, excess inventory, or working capital needs. Our sales and operations planning processes and forecasting systems and modeling tools may not accurately predict changes in demand for our products or other market conditions.
Our results of operations are materially affected by conditions in capital markets and economies in the U.S. and elsewhere around the world. Concerns over fluctuating prices, energy costs, geopolitical issues, inflation, supply chain issues, government deficits and debt loads, and the availability and cost of credit have contributed to economic uncertainty around the world. Our customers may be impacted by these conditions and may modify, delay, or cancel plans to purchase our products. Additionally, if customers are not successful in generating sufficient revenue or are precluded from securing financing, they may not be able to pay, or may delay payment of, accounts receivable that are owed to us. A reduction in demand or inability of customers to pay us for our products may adversely affect our earnings and cash flow.
We strive to improve operating margins through sales growth, price increases, new products, productivity gains, optimization initiatives, and improved purchasing techniques, but we may not achieve the desired improvements.
We work to improve operating profit margins through activities such as growing sales, increasing economies of scale, raising prices, introducing new products, improving manufacturing processes, reformulating products, reducing the use of raw materials, and adopting purchasing techniques that lower costs or provide increased cost predictability. However, these activities depend on a combination of factors, including improved product design and engineering, effective manufacturing process control initiatives, cost-effective redistribution of production, and other efforts that may not be as successful as anticipated. Likewise, the success of sales growth and price increases depends not only on our actions but also on the strength of customer demand and competitors' pricing responses, which are not fully predictable. Failure to successfully implement actions to improve operating margins could adversely affect our financial performance.
The global scope of our operations exposes us to risks related to currency conversion rates, new and different regulatory schemes and changing economic, regulatory, social and political conditions around the world.
More than 60% of our net sales during 2021 were outside of the U.S. In order to support our customers, access regional markets and compete effectively, our operations are located around the world. Our operations are subject to multiple and changing economic, regulatory, social and political conditions and we are subject to risks relating to currency conversion rates. We also may encounter difficulties expanding into additional growth markets around the world. Other risks inherent in our operations include the following:
•New, different and unpredictable legal and regulatory requirements and enforcement mechanisms in the U.S. and other countries;
•Challenges related to obtaining export licenses, import or export duties or import quotas, export controls and restrictions administered by, for example, the Office of Foreign Assets Control or other trade restrictions or barriers;
•Increased costs, and decreased availability, of transportation or shipping;
•Credit risks and financial conditions of local customers and distributors;
•Risk of nationalization of private enterprises by governments, or restrictions on investments;
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•Potentially adverse tax consequences, including imposition or increase of withholding and other taxes on remittances and other payments by subsidiaries; and
•Political, economic and social conditions, including political instability and organized crime in certain countries, the possibility of inflationary or hyperinflationary conditions, deflation and public health crises, such as pandemics and epidemics.
We have subsidiaries in Israel, Turkey, Mexico and Colombia, which are located in or near regions that are politically volatile or subject to high levels of crime and violence. Such conditions could potentially impact our ability to operate and to recover both the cost of our investments and earnings from those investments. While we attempt to anticipate these circumstances and manage our business appropriately in each location where we do business, these circumstances are often beyond our control and difficult to forecast.
The consequences of these risks may have significant adverse effects on our results of operations or financial position, and if we fail to comply with applicable laws and regulations, we could be exposed to civil and criminal penalties, reputational harm, and restrictions on our operations.
Our businesses depend on a continuous stream of new products and services, and failure to introduce new products and services could affect our sales, profitability and liquidity.
We strive to remain competitive through innovation, including by continually developing and introducing new and improved products and services. Customers evaluate our products and services in comparison to those offered by our competitors. A failure to introduce new products and services at the right time that are price competitive and that meet the needs of our customers could adversely affect our sales or could require us to respond by lowering prices. In addition, when we invest in new product development, we face risks related to production delays, cost over-runs and unanticipated technical difficulties, which could impact sales, profitability and/or liquidity.
Certain of the markets for our products and services are highly competitive and subject to intense price competition, which could adversely affect our sales and earnings performance.
Our customers typically have multiple suppliers from which to choose. If we are unwilling or unable to provide products and services at competitive prices, and if other factors, such as product performance and value-added services, do not provide an offsetting competitive advantage, customers may reduce, discontinue, or decide not to purchase our products. If we could not secure alternate customers for lost business, our sales and earnings performance could be adversely affected.
We are subject to a number of restrictive covenants under our credit facilities, which could affect our flexibility to fund ongoing operations and strategic initiatives, and, if we are unable to maintain compliance with such covenants, could lead to significant challenges in meeting our liquidity requirements.
Our Amended Credit Facility, entered into on April 25, 2018, contains a number of restrictive covenants, including those described in more detail in Note 8 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K. These covenants include limitations on use of loan proceeds, limitations on the Company’s ability to pay dividends and repurchase stock, limitations on acquisitions and dispositions and limitations on certain types of investments. The Amended Credit Facility also contains standard provisions relating to conditions of borrowing and customary events of default, including the non-payment of obligations by the Company and the bankruptcy of the Company. Specific to the 2018 Revolving Facility, the Company is subject to a financial covenant regarding the Company’s maximum leverage ratio. If an event of default occurs, all amounts outstanding under the Amended Credit Facility may be accelerated and become immediately due and payable. The Amended Credit Facility is described in more detail in Note 8 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K.
Our strategy includes seeking opportunities in new growth markets, and failure to identify or successfully enter such markets could affect our ability to grow our revenues and earnings.
Certain of our products are sold into mature markets and part of our strategy is to identify and enter into markets growing more rapidly. These growth opportunities may involve new geographies, new product lines, new technologies, or new customers. We may not successfully exploit such opportunities and our ability to increase our revenue and earnings could be impacted as a result.
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If we are unable to protect our intellectual property rights, including trade secrets, or to successfully resolve claims of infringement brought against us, our product sales and financial performance could be adversely affected.
Our performance may depend in part on our ability to establish, protect and enforce intellectual property rights with respect to our products, technologies and proprietary rights and to defend against any claims of infringement, which involves complex legal, scientific and factual questions and uncertainties. We may have to rely on litigation to enforce our intellectual property rights. The intellectual property laws and practice of some countries may not protect our interests to the same extent as the laws and practices of the U.S. In addition, we may face claims of infringement that could interfere with our ability to use technology or other intellectual property rights that are material to our business operations. If litigation that we initiate is unsuccessful, we may not be able to protect the value of some of our intellectual property. In the event a claim of infringement against us is successful, we may be required to pay royalties or license fees to continue to use technology or other intellectual property rights that we have been using or we may be unable to obtain necessary licenses from third parties at a reasonable cost or within a reasonable time.
We may not be able to complete or successfully integrate previous or future acquisitions into our business, which could adversely affect our business or results of operations.
We have pursued and we may continue to pursue acquisitions. Our success in accomplishing growth through acquisitions may be limited by the availability and suitability of acquisition candidates and by our financial resources, including available cash and borrowing capacity. Acquisitions involve numerous risks, including difficulty determining appropriate valuation, integrating operations, information systems, technologies, services and products of the acquired product lines or business, personnel turnover, and the diversion of management’s attention from other business matters. In addition, we may be unable to achieve anticipated benefits from these acquisitions in the timeframe that we anticipate, or at all, which could adversely affect our business or results of operations.
We may not be successful in implementing our strategies to increase our return on invested capital, internal rate of return, or other return metrics.
We have taken steps to generate a higher return on our investments. There are risks associated with the implementation of these steps, which may be complicated and may involve substantial capital investment. To the extent we fail to achieve these strategies, our results of operations may be adversely affected.
Many of our assets are encumbered by liens that have been granted to lenders, and those liens affect our flexibility to dispose of property and businesses.
Certain of our debt obligations are secured by substantially all of our assets. These liens could reduce our ability and/or extend the time to dispose of property and businesses, as these liens must be cleared or waived by the lenders prior to any disposition. These security interests are described in more detail in Note 8 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K.
Risks Related to Our Operations
We depend on reliable sources of energy and raw materials, minerals and other supplies, at a reasonable cost, but the availability of these materials and supplies could be interrupted and/or their prices could change and adversely affect our sales and profitability.
We purchase energy and many raw materials to manufacture our products. Changes in their availability or price could affect our ability to manufacture enough products to meet customers’ demands or to manufacture products profitably. We try to maintain multiple sources of raw materials and supplies where practical, but this may not prevent changes in their availability or cost and, for certain raw materials, there may not be alternative sources. We may not be able to pass cost increases through to our customers. Significant disruptions in availability or cost increases could adversely affect our manufacturing volume or costs, which could negatively affect product sales or profitability of our operations.
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We have undertaken and continue to undertake optimization initiatives, to rationalize our operations and improve our operating performance, but we may not be able to implement and/or administer these initiatives in the manner contemplated and these initiatives may not produce the desired results.
We have undertaken, may continue undertaking, optimization initiatives to rationalize our operations to improve our operational performance. These initiatives may involve, among other things, changes to the operations of recently acquired business, the transfer of manufacturing to new or existing facilities, the divestiture of certain assets, and restructuring programs that involve plant closures and staff reductions, which could be material in their nature with respect to the investments, costs and potential benefits. These initiatives also may involve changes in the management and delivery of functional services. Although we expect these initiatives to help us achieve operational efficiencies and cost savings, we may not be able to implement and/or administer these initiatives in the manner contemplated, which could cause the initiatives to fail to achieve the desired results. In addition, transfer and consolidation of manufacturing operations may involve substantial capital expenses and the transfer of manufacturing processes and personnel from one site to another, with resultant inefficiencies and other issues at the receiving site as it starts up, the need for requalification of our products and for ISO or other certifications of our products. We may experience shortages of affected products, delays and higher than expected expenses. Changes in functional services may prove ineffective, inefficient and disruptive. Accordingly, the initiatives that we have implemented and those that we may implement in the future may not improve our operating performance and may not help us achieve cost savings. Failure to successfully implement and/or administer these initiatives could have an adverse effect on our financial performance.
We rely on information systems to conduct our business and interruption, or damage to, or failure or compromise of, these systems may adversely affect our business and results of operations.
We rely on information systems to obtain, process, analyze and manage data to forecast and facilitate the purchase of raw materials and the distribution of our products; to receive, process, and ship orders on a timely basis; to run and operate our facilities; to account for our product and service transactions with customers; to manage the accurate billing and collections for thousands of customers; to process payments to suppliers; and to manage data and records relating to our employees, contractors, and other individuals. Our business and results of operations may be adversely affected if these systems are interrupted, damaged, or compromised or if they fail for any extended period, due to events including but not limited to programming errors, aging information systems infrastructure and software and required maintenance or replacement, computer viruses and security breaches. Information privacy and cyber security risks have generally increased in recent years because of the proliferation of new technologies and the increased sophistication and activities of perpetrators of cyber-attacks. We may incur significant costs to implement the security measures that we feel are necessary to protect our information systems. However, our information systems may remain vulnerable to damage despite our implementation of security measures that we deem to be appropriate.
In addition, third-party service providers are responsible for managing a significant portion of our information systems, and we are subject to risk because of possible information privacy and security breaches of those third parties. Any system failure, accident or security breach involving our or a third-party’s information system could result in disruptions to our operations. A breach in the security of our information systems could include the theft of our intellectual property or trade secrets, negatively impact our manufacturing operations, or result in the compromise of personal information of our employees, customers or suppliers. While we have, from time to time, experienced system failures, accidents and security breaches involving our information systems, these incidents have not had a material impact on our operations. To the extent that any system failure, accident or security breach results in material disruptions to our operations or the theft, loss or disclosure of, or damage to, material data or confidential information, our reputation, business, financial condition, and results of operations could be materially adversely affected.
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We have limited or no redundancy for certain of our manufacturing operations, and damage to our facilities or interference with our operations could interrupt our business, increase our costs of doing business and impair our ability to deliver our products on a timely basis.
If certain of our existing production facilities become incapable of manufacturing products for any reason, including through interruption of our supply chain, we may be unable to meet production requirements, we may lose revenue and we may not be able to maintain our relationships with our customers. Without operation of certain existing production facilities, we may be unable or limited in our ability to deliver products until we restore the manufacturing capability at the particular facility, find an alternative manufacturing facility or arrange an alternative source of supply. Although we carry business interruption insurance to cover lost revenue and profits in an amount we consider adequate, this insurance does not cover all possible situations or expenses. We may not be able to recover from or be compensated for the loss of opportunity and potential adverse impact on relations with our existing customers resulting from our inability to produce and deliver products for them.
If we are unable to attract and retain key personnel, our business could be materially adversely affected.
Our business substantially depends on the continued service of key members of our management. The loss of the services of a key member of our management could have a material adverse effect on our business. Our future success will also depend on our ability to attract and retain highly skilled personnel, such as engineering, marketing and senior management professionals. Competition for these employees is intense, and we could experience difficulty from time to time in hiring and retaining the personnel necessary to support our business. If we do not succeed in retaining our current employees and attracting new skilled employees, our business could be materially adversely affected.
Our multi-jurisdictional tax structure may not provide favorable tax efficiencies.
We conduct our business operations in a number of countries and are subject to taxation in those jurisdictions. While we seek to minimize our worldwide effective tax rate, our corporate structure may not optimize tax efficiency opportunities. We develop our tax position based upon the anticipated nature and structure of our business and the tax laws, administrative practices and judicial decisions now in effect in the countries in which we have assets or conduct business, which are subject to change or differing interpretations. In addition, our effective tax rate could be adversely affected by several other factors, including: increases in expenses that are not deductible for tax purposes, the tax effects of restructuring charges or purchase accounting for acquisitions, changes related to our ability to ultimately realize future benefits attributed to our deferred tax assets, including those related to other-than-temporary impairment, and a change in our decision to indefinitely reinvest foreign earnings. Further, we are subject to review and audit by both domestic and foreign tax authorities, which may result in adverse decisions. Increased tax expense could have a negative effect on our operating results and financial condition.
If we are unable to manage our general and administrative expenses, our business, financial condition or results of operations could be negatively impacted.
We may not be able to effectively manage our administrative expense in all circumstances. While we attempt to effectively manage such expenses, including through projects designed to create administrative efficiencies, increases in staff-related and other administrative expenses may occur from time to time. We have made significant efforts to achieve general and administrative cost savings and improve our operational performance. As a part of these initiatives, we have and will continue to consolidate business and management operations and enter into arrangements with third parties offering cost savings. It cannot be assured that our strategies to reduce our general and administrative costs and improve our operating performance will be successful or achieve the anticipated savings.
We are subject to risks associated with outsourcing functions to third parties.
We have entered into outsourcing agreements with third parties, and rely on such parties, to provide certain services in support of our business. One such vendor provides a number of business services related to our information systems and finance and accounting activity. Arrangements with third-party service providers may make our operations vulnerable if vendors fail to provide the expected service or there are changes in their own operations, financial condition, or other matters outside of our control. If these service providers are unable to perform to our requirements or to provide the level of service expected, our operating results and financial condition may suffer and we may be forced to pursue alternatives to provide these services, which could result in delays, business disruptions and additional expenses.
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Our implementation and operation of business information systems and processes could adversely affect our results of operations and cash flow.
We implement and operate information systems and related business processes for our business operations. Implementation and operation of information systems and related processes involves risk, including risks related to programming and data transfer. Costs of implementation also could be greater than anticipated. In addition, we may be unable or decide not to implement such systems and processes in certain locations. Inherent risks, decisions and constraints related to implementation and operation of information systems could result in operating inefficiencies and could impact our ability to perform business transactions. These risks could adversely impact our results of operations, financial condition, and cash flows.
Legal and Regulatory Risks
We operate in regions of the world where it can be difficult for a multi-national company, such as Ferro, to compete lawfully with local competitors, which may cause us to lose business opportunities.
We pursue business opportunities around the world and many of our most promising growth opportunities are in markets such as, the People’s Republic of China, Latin America, the Asia Pacific region, India and the Middle East. Although we have been able to compete successfully in those markets to date, local laws and customs can make it difficult for a multi-national company, such as Ferro, to compete on a “level playing field” with local competitors without engaging in conduct that would be illegal under U.S. or other countries’ anti-bribery laws. Our strict policy of observing the highest standards of legal and ethical conduct may cause us to lose some otherwise attractive business opportunities to competitors in these regions.
Regulatory authorities in the U.S., European Union and elsewhere are taking a more aggressive approach to regulating hazardous materials and other substances, and those regulations could affect sales of our products.
Legislation and regulations concerning hazardous materials and other substances can restrict the sale of products and/or increase the cost of producing them. Some of our products are subject to restrictions under laws or regulations such as California’s Proposition 65 and the EU’s chemical substances directive. The EU “REACH” registration system requires us to perform studies of some of our products or components of our products and to register the information in a central database, increasing the cost of these products. As a result of such regulations, our ability to sell certain products may be curtailed and customers may avoid purchasing some products in favor of less regulated, less hazardous or less costly alternatives. It may be impractical for us to continue manufacturing heavily regulated products, and we may incur costs to shut down or transition such operations to alternative products. These circumstances could adversely affect our business, including our sales and operating profits.
Our operations are subject to operating hazards and to stringent environmental, health and safety regulations, and compliance with those regulations could require us to make significant investments.
Our production facilities are subject to hazards associated with the manufacture, handling, storage, and transportation of chemical materials and products. These hazards can cause personal injury and loss of life, severe damage to, or destruction of, property and equipment and environmental contamination and other environmental damage and could have an adverse effect on our business, financial condition or results of operations.
We strive to maintain our production facilities and conduct our manufacturing operations in a manner that is safe and in compliance with all applicable environmental, health and safety regulations. Compliance with changing regulations, or other circumstances, may require us to make significant capital investments, incur training costs, make changes in manufacturing processes or product formulations, or incur costs that could adversely affect our profitability, and violations of these laws could lead to substantial fines and penalties. These costs may not affect competitors in the same way that they affect us due to differences in product formulations, manufacturing locations or other factors, and we could be at a competitive disadvantage, which might adversely affect financial performance.
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Our business could be adversely affected by safety, environmental, social and product stewardship issues.
We may be impacted by and may not be able to adequately address safety, human health, social, product liability and environmental risks associated with our current and historical products, product life cycles, and production processes and the obligations that follow from them. This could adversely impact employees, communities, stakeholders, the environment, our reputation and our business, financial condition, and the results of our operations. Public perception of the risks associated with our current or past products, their respective life cycles, and production processes could impact product acceptance and influence the regulatory environment in which we operate.
Our business is subject to a variety of domestic and international laws, rules, policies and other obligations regarding data protection.
The processing and storage of certain information is increasingly subject to privacy and data security regulations and many such regulations are country-specific. The interpretation and application of data protection laws in the U.S., Europe and elsewhere, including but not limited to the California Consumer Privacy Act and the General Data Protection Regulation (the “GDPR”), are uncertain, evolving and may be inconsistent among jurisdictions. Complying with these various laws may be difficult and could cause us to incur substantial costs or require us to change our business practices in a manner adverse to our business. We may be required to expend additional resources to continue to enhance our information privacy and security measures, investigate and remediate any information security vulnerabilities and/or comply with regulatory requirements.
Changes in U.S. and other governments’ trade policies and other factors beyond our control may adversely impact our business, financial condition and results of operations.
Tariffs, retaliatory tariffs or other trade restrictions on products and materials that we or our customers and suppliers export or import could affect demand for our products. Direct or indirect consequences of tariffs, retaliatory tariffs or other trade restrictions may also alter the competitive landscape of our products in one or more regions of the world. Trade tensions or other governmental action related to tariffs or international trade agreements or policies has the potential to negatively impact our business, financial condition and results of operations.
Sales of our products to certain customers or into certain industries may expose us to different and complex regulatory regimes.
We seek to expand our customer base and the industries into which we sell. Selling products to certain customers or into certain industries, such as governments or the defense industry, requires compliance with regulatory regimes that can be complex and difficult to navigate. Our failure to comply with these regulations could result in liabilities or damage to our reputation, which could negatively impact our business, financial condition, or results of operations.
We are exposed to lawsuits, governmental investigations and proceedings relating to current and historical operations and products, which could harm our business.
We are from time to time exposed to certain lawsuits, governmental investigations and proceedings relating to current and historical operations and products, which may include claims involving product liability, environmental compliance, hazardous materials, infringement of intellectual property rights of third parties, work place safety, employment and other claims. Due to the uncertainties of litigation, we can give no assurance that we will prevail on claims made against us in the lawsuits that we currently face or that additional claims will not be made against us in the future. Lawsuits or claims, if they were to result in a ruling adverse to us or otherwise result in an obligation on the part of the Company, could give rise to substantial liability, which could have a material adverse effect on our business, financial condition, or results of operations.
15
We are subject to stringent labor and employment laws in certain jurisdictions in which we operate, we are party to various collective bargaining arrangements, and our relationship with our employees could deteriorate, which could adversely impact our operations.
A majority of our full-time employees are employed outside the U.S. In certain jurisdictions where we operate, labor and employment laws are relatively stringent and, in many cases, grant significant job protection to certain employees, including rights on termination of employment. In addition, in certain countries where we operate, our employees are members of unions or are represented by works councils. We are often required to consult with and seek the consent or advice of these unions and/or works councils. These regulations and laws, coupled with the requirement to seek consent or consult with the relevant unions or works councils, could have a significant impact on our flexibility in managing costs and responding to market changes.
Furthermore, approximately 6.3% of our U.S. employees as of December 31, 2021, are subject to collective bargaining arrangements or similar arrangements. Approximately 4.6% of all U.S. employees are affected by a labor agreement that expires in 2024. While we expect to be able to renew these agreements without significant disruption to our business when they are scheduled to expire, there can be no assurance that we will be able to negotiate labor agreements on satisfactory terms or that actions by our employees will not be disruptive to our business. If these workers were to engage in a strike, work stoppage or other slowdown or if other employees were to become unionized, we could experience a significant disruption of our operations and/or higher ongoing labor costs, which could adversely affect our business, financial condition and results of operations.
There are risks associated with the manufacture and sale of our materials into industries that make products for sensitive applications.
We manufacture and sell materials to parties that make products for sensitive applications, such as medical devices. The supply of materials that enter the human body involves the risk of illness or injury to consumers, as well as commercial risks. Injury to consumers could result from, among other things, improper use, tampering by unauthorized third parties, or the introduction into the material of foreign objects, substances, chemicals and other agents during the manufacturing, packaging, storage, handling or transportation phases. Shipment of adulterated materials may be a violation of law and may lead to an increased risk of exposure to product liability or other claims, product recalls and increased scrutiny by federal and state regulatory agencies. Such claims or liabilities may not be covered by our insurance or by any rights of indemnity or contribution that we may have against third parties. In addition, the negative publicity surrounding any assertion that our materials caused illness or injury could have a material adverse effect on our reputation with existing and potential customers, which could negatively impact our business, operating results or financial condition.
General Risks
The impact of the novel coronavirus (“COVID-19”) may exacerbate the risks discussed therein, any of which could have a material effect on the Company.
Since the first quarter of 2020, there has been a world-wide impact from the COVID-19 pandemic, including in Asia, Europe, the Middle East, and North and South America, all of which are regions in which Ferro has operations. Authorities have implemented numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter in place orders, and business shutdowns. The measures taken by the authorities have impacted and may further impact certain of our workforce and operations, the operations of our customers, and those of our vendors and suppliers. Although certain jurisdictions have eased restrictions, because of recurring outbreaks and new variants of the virus there still is considerable uncertainty regarding measures that authorities may implement in the future, which may restrict our operations and those of our suppliers and customers and disrupt logistics and other supply and distribution service providers. The spread of COVID-19 has caused us to modify certain of our business practices with respect to certain products (including site operations, employee workplace practices, travel, and participation in meetings, events, and conferences), and we may take further actions as required or recommended by authorities or deemed to be in the best interests of our employees and business partners. There is no certainty that such measures will be sufficient to mitigate the risks posed by the virus, and our ability to perform critical functions could be adversely affected. These circumstances could negatively impact our business, results of operations, financial condition and cash flows.
16
The degree to which COVID-19 will impact our results in the future depends on many factors, which are highly uncertain and cannot be predicted, including, but not limited to, the duration of the pandemic, actions to contain the virus or limit its impact, the availability, administration and effectiveness of vaccines, and the speed and extent to which normal economic and operating conditions resume. Even after the COVID-19 outbreak has subsided, we may experience material adverse impacts to our business as a result of the potential sustained economic impact and any recession or other macroeconomic weakness that may occur.
We depend on external financial resources, and the economic environment and credit market uncertainty could interrupt our access to capital markets, borrowings, or financial transactions to hedge certain risks, which could adversely affect our financial condition.
At December 31, 2021, we had approximately $260.3 million of short-term and long-term debt with varying maturities and approximately $99.9 million of off-balance sheet arrangements, including consignment arrangements for precious metals, bank guarantees, receivables sales programs and standby letters of credit. These arrangements have allowed us to make investments in growth opportunities and fund working capital requirements. In addition, we may enter into financial transactions to hedge certain risks, including foreign exchange, commodity pricing, interest rates, and sourcing of certain raw materials. Our continued access to capital markets and the stability of our lenders, customers and financial partners, and their willingness to support our needs, are essential to our liquidity and our ability to meet our current obligations and to fund operations and our strategic initiatives. An interruption in our access to external financing or financial transactions to hedge risk could adversely affect our business prospects and financial condition. See further information regarding our liquidity in “Capital Resources and Liquidity” under Item 7 and in Note 8 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K.
In addition, on July 27, 2017, the Financial Conduct Authority (FCA) in the U.K. announced that it would phase out LIBOR as a benchmark by the end of calendar year 2021. The expected discontinuation of LIBOR may require us to amend certain agreements governing our debt and, although the U.S. and other jurisdictions are working to replace LIBOR with alternative reference rates, we cannot predict what alternative index, margin adjustments and related terms would be negotiated with our counterparties. As a result, our interest expense could increase.
Interest rates on some of our borrowings are variable, and our borrowing costs could be adversely affected by interest rate increases.
Portions of our debt obligations have variable interest rates. Generally, when interest rates rise, our cost of borrowings increases. We estimate, based on the debt obligations outstanding at December 31, 2021, that a one percent increase in interest rates would cause interest expense to increase by $1.4 million annually. Although interest rates have remained relatively stable over the past few years, future increases could raise our cost of borrowings and adversely affect our financial performance. See further information regarding our interest rates on our debt obligations in “Quantitative and Qualitative Disclosures about Market Risk” under Item 7A and in Note 8 to the consolidated financial statements under Item 8 of this Form 10-K.
Employee benefit costs, including postretirement costs, constitute a significant element of our annual expenses, and funding these costs could adversely affect our financial condition.
Employee benefit costs are a significant element of our cost structure. Certain expenses, particularly postretirement costs under defined benefit pension plans and healthcare costs for employees and retirees, may increase significantly at a rate that is difficult to forecast and may adversely affect our financial results, financial condition or cash flows. Changes in the applicable discount rate can affect our postretirement obligations. Declines in global capital markets may cause reductions in the value of our pension plan assets. Such circumstances could have an adverse effect on future pension expense and funding requirements. Further information regarding our retirement benefits is presented in Note 12 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K.
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We are exposed to intangible asset risk, and a write down of our intangible assets could have an adverse impact on our operating results and financial position.
We have recorded intangible assets, including goodwill, in connection with business acquisitions. We are required to perform goodwill impairment tests on at least an annual basis and whenever events or circumstances indicate that the carrying value may not be recoverable from estimated future cash flows. As a result of our annual and other periodic evaluations, we may determine that the intangible asset values need to be written down to their fair values, which could result in material charges that could be adverse to our operating results and financial position. See further information regarding our goodwill and other intangible assets in “Critical Accounting Policies” under Item 7 and in Note 7 to the consolidated financial statements under Item 8 of this Form 10-K.
We are exposed to risks associated with acts of God, terrorists and others, as well as fires, explosions, wars, riots, accidents, embargoes, natural disasters, strikes and other work stoppages, quarantines and other governmental actions, and other events or circumstances that are beyond our control.
Ferro is exposed to risks from various events that are beyond our control, which may have significant effects on our results of operations. While we attempt to mitigate these risks through appropriate loss prevention measures, insurance, contingency planning and other means, we may not be able to anticipate all risks or to reasonably or cost-effectively manage those risks that we do anticipate. As a result, our operations could be adversely affected by circumstances or events in ways that are significant and/or long lasting.
The risks and uncertainties identified above are not the only risks that we face. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial also may adversely affect us. If any known or unknown risks and uncertainties develop into actual events, these developments could have material adverse effects on our financial position, results of operations, and cash flows.
Item 1B — Unresolved Staff Comments
None.
Item 2 — Properties
We lease our corporate headquarters, which is located at 6060 Parkland Blvd., Mayfield Heights, Ohio. The Company owns other corporate facilities worldwide. We own principal manufacturing plants that range in size from 16,000 sq. ft. to over 764,000 sq. ft. Plants we own with more than 250,000 sq. ft. are located in Belgium; China; Colombia; France; Germany; Mexico; Cleveland, Ohio; and Penn Yan, New York. The locations of principal manufacturing plants by reportable segment are as follows:
Functional Coatings — U.S.: King of Prussia, Pennsylvania and Orrville, Ohio. Outside the U.S.: Brazil, China, France, Germany, Mexico, Portugal, Spain, and the United Kingdom.
Color Solutions — U.S.: Penn Yan, New York and Norcross, Georgia. Outside the U.S.: Belgium, China, Colombia, France, India, Romania and Spain.
In addition, we lease manufacturing facilities for the Functional Coatings reportable segment in the United Kingdom; Germany; Japan; Israel; and Turkey; We also lease manufacturing facilities in Taiwan for Color Solutions. In some instances, the manufacturing facilities are used for two or more segments. Leased facilities range in size from 1,000 sq. ft. to over 100,000 sq. ft.
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Item 3 — Legal Proceedings
In November 2017, Suffolk County Water Authority filed a complaint, Suffolk County Water Authority v. The Dow Chemical Company et al., against the Company and a number of other companies in the U.S. Federal Court for the Eastern District of New York with regard to the product 1,4 dioxane. The plaintiff alleges, among other things, that the Suffolk County water supply is contaminated with 1,4 dioxane and that the defendants are liable for unspecified costs of cleanup and remediation of the water supply, among other damages. The Company has not manufactured 1,4 dioxane since 2008, denies the allegations related to liability for the plaintiff’s claims, and is vigorously defending this proceeding. Since December 2018, additional complaints were filed in the same court by 25 other New York water suppliers against the Company and others making substantially similar allegations regarding the contamination of their respective water supplies with 1,4 dioxane. An additional complaint also was filed by the Hicksville Water District against the Company and others in New York State Supreme Court making substantially similar allegations and seeking damages of $900.0 million. The Company is likewise vigorously defending these additional actions. The Company currently does not expect the outcome of these proceedings to have a material adverse impact on its consolidated financial condition, results of operations, or cash flows, net of any insurance coverage. However, it is not possible to predict the ultimate outcome of these proceedings due to the unpredictable nature of litigation.
In addition to the proceedings described above, the Company and its consolidated subsidiaries are subject from time to time to various claims, lawsuits, investigations, and proceedings related to products, services, contracts, environmental, health and safety, employment, intellectual property, and other matters, including with respect to divested businesses. The outcome of such matters is unpredictable, our assessment of them may change, and resolution of them could have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows. We do not currently expect the resolution of such matters to materially affect the consolidated financial position, results of operations, or cash flows of the Company.
Item 4 — Mine Safety Disclosures
Not applicable.
Information about our Executive Officers
The executive officers of the Company as of February 24, 2022, are listed below, along with their ages and business experience during the past five years. The year indicates when the individual was named to the indicated position with Ferro, unless otherwise indicated.
Peter T. Thomas — 66
Chairman of the Board of Directors, 2014
President and Chief Executive Officer, 2013
Mark H. Duesenberg — 60
Vice President, General Counsel and Secretary, 2008
Benjamin J. Schlater — 46
Group Vice President and Chief Financial Officer, 2019
Vice President and Chief Financial Officer, 2016
Vice President, Corporate Development and Strategy, 2015
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PART II
Item 5 — Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Our common stock is listed on the New York Stock Exchange under the ticker symbol FOE. On January 31, 2022, we had 776 shareholders of record for our common stock, and the closing price of the common stock was $21.80 per share.
The chart below compares Ferro’s cumulative total shareholder return for the five years ended December 31, 2021, to that of the Standard & Poor’s 500 and Standard & Poor’s 400 Specialty Chemicals Indexes, on which the Company was formerly listed, and the Standard & Poor’s 600 Material Sector and Standard & Poor’s Small Cap 600 Indexes, on which the Company is currently listed. In all cases, the information is presented on a dividend-reinvested basis and assumes investment of $100.00 on December 31, 2016. At December 31, 2021, the closing price of our common stock was $21.83 per share.
The Company's Board of Directors have not declared any dividends on common stock during 2021 or 2020. The Company’s Amended Credit Facility restricts the amount of dividends we can pay on our common stock. Any future dividends declared would be at the discretion of our Board of Directors and would depend on our financial condition, results of operations, cash flows, contractual obligations, the terms of our financing agreements at the time a dividend is considered, and other relevant factors. For further discussion, see Management’s Discussion and Analysis of Financial Condition and Results of Operations under Item 7 of this Annual Report on Form 10-K.
In October 2018, the Company’s Board of Directors approved a new share repurchase program under which the Company is authorized to repurchase up to an additional $50 million of the Company’s outstanding common stock on the open market, including through Rule 10b5-1 plans, in privately negotiated transactions, or otherwise. This new program is in addition to the $100 million of authorization previously approved and announced.
The Company made no repurchases during 2021 and 2020. The Company repurchased 1,440,678 shares of common stock at an average price of $17.35 per share for a total cost of $25.0 million during 2019. As of December 31, 2021, $46.2 million remains authorized under the program for the repurchase of common stock.
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The following table summarizes purchases of our common stock by the Company and affiliated purchasers during the three months ended December 31, 2021:
| (Dollars in thousands, except for per share amounts) | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Share Purchased as Part of Publicly Announced Plans or Programs | Maximum Dollar Amount that May Yet Be Purchased Under the Plans or Programs | |||||||||||||||||||
| October 1, 2021 to October 31, 2021 | — | $ | — | — | $ | 46,192,535 | |||||||||||||||||
| November 1, 2021 to November 30, 2021 | — | $ | — | — | $ | 46,192,535 | |||||||||||||||||
| December 1, 2021 to December 31, 2021 | — | $ | — | — | $ | 46,192,535 | |||||||||||||||||
| Total | — | — | |||||||||||||||||||||
Item 6 — Selected Financial Data
[Reserved]
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Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
During the year ended December 31, 2021, net sales increased $167.3 million, or 17.4%, compared with 2020. Net sales increased by $123.9 million and $43.4 million in Functional Coatings and Color Solutions, respectively. Gross profit increased $50.9 million compared with 2020; as a percentage of net sales, it remained unchanged at 30.6%. The increase in gross profit was primarily attributable to increases of $43.0 million and $9.3 million in Functional Coatings and Color Solutions, respectively.
For the year ended December 31, 2021, selling, general and administrative (“SG&A”) expenses increased $15.4 million, or 7.6%, compared with 2020. As a percentage of net sales, SG&A expenses decreased 180 basis points from 21.1% in 2020 to 19.3% in 2021.
For the year ended December 31, 2021, net income was $150.5 million, compared with net income of $44.0 million in 2020, and net income attributable to common shareholders was $148.8 million, compared with net income attributable to common shareholders of $42.8 million in 2020. Income from continuing operations was $73.3 million for the year ended December 31, 2021, compared with $30.0 million in 2020.
As previously disclosed on January 17, 2019, the Company has been expanding its production facility in Villagran, Mexico, which has become the Company’s Manufacturing Center of Excellence for the Americas. The expansion of the Villagran facility is expected to significantly increase the revenue generated from products manufactured at that facility. With the expanded capacity in Villagran, the Company has discontinued the production of glass enamels, other industrial specialty products, such as architectural glass coatings, and pigments at its Washington, Pennsylvania facility over the course of 2021 and (ii) discontinued production of porcelain enamel products at its Cleveland, Ohio facility. As part of this optimization initiative, the Company expanded its King of Prussia, Pennsylvania facility. Conductive glass coatings production was discontinued at the Washington, Pennsylvania facility and will be produced at the King of Prussia, Pennsylvania facility, and the Company’s operations at its Vista, California facility have been transferred to the King of Prussia, Pennsylvania facility. In addition, the Company has moved its Americas research and development center for glass products to its technology center in Independence, Ohio, where the Company has expanded laboratory facilities. The Washington, Pennsylvania facility discontinued operations during the fourth quarter of 2021. Production of specialty glasses for electronics applications will continue at the Cleveland, Ohio facility, and the Company is investing in the facility to equip it to serve as a logistics center. The Cleveland, Ohio facility also will serve as the Americas research and development center for the porcelain enamel business.
Outlook
Ferro experienced higher demand across all business segments in 2021, continuing the trend established as customer markets have improved from 2020. The impact of the COVID pandemic through 2022 is unknown, even with the global availability of vaccines. Ferro expects to continue to benefit from strategic actions taken prior to and during the pandemic to optimize our business, invest in technology platforms, align with macrotrends, and focus on higher-margin, higher-growth markets.
Ferro provides products and services that are essential to our customers as they innovate to address trends in their markets and develop next generation products. We sell our products and services in multiple markets and geographies around the world, which limits exposure to any one industry or region. In addition, we serve a diverse set of industries, including automotive, construction, appliances, healthcare, food and beverage, information technology, energy and defense. COVID-related behavior changes have accelerated demand for certain products, especially those in industries supporting mobility, entertainment and personal technology, smart appliances, construction, and sustainable product packaging.
Ferro continues to maintain protocols for the safety and well-being of our personnel. We monitor the impact of COVID-19 on our business, including how it may impact our customers, employees, supply chain and distribution network and take action, as appropriate, to address these circumstances. In some areas around the world, government mandates have been changed and economic conditions have improved in certain sectors of the economy relative to 2020. Recently, some regions have experienced increasing numbers of COVID-19 cases, and if this continues and if public authorities intensify efforts to contain the spread of COVID-19, normal business activity may be further disrupted, and economic conditions could weaken.
22
In 2021, following the completion of the sale of our Tile Coatings Business, we are transitioning to a smaller, more agile and more streamlined global business with a more coherent and focused portfolio aligned with evolving megatrends. As previously announced, on May 11, 2021, Ferro Corporation entered into a definitive agreement to be acquired by an affiliate of Prince International Corporation ("Prince"), a portfolio company of American Securities LLC. We anticipate the transaction to close in the first half of the second quarter of 2022, subject to satisfaction of customary closing conditions, including receipt of regulatory approvals.
The outlook for 2022 may be affected by the rise of inflation, which could impact raw material and supply chain. Foreign currency rates may continue to be volatile through 2022 and changes in interest rates could adversely impact reported results. We continue to expect cash flow from operating activities to be positive for 2022.
Factors that could adversely affect our future performance include those described under the heading “Risk Factors” in Item 1A of Part I of this Annual Report on Form 10-K for the year ended December 31, 2021.
Results of Operations - Consolidated
Comparison of the years ended December 31, 2021 and 2020
For the year ended December 31, 2021, net income from continuing operations was $73.3 million, compared with $30.0 million in 2020. For the year ended December 31, 2021, net income attributable to common shareholders was $148.8 million, or $1.78 earnings per share, compared with $42.8 million, or $0.52 earnings per share in 2020.
Net Sales
| (Dollars in thousands) | 2021 | 2020 | $ Change | % Change | |||||||||||||||||||
| Net sales | $ | 1,126,264 | $ | 958,954 | $ | 167,310 | 17.4 | % | |||||||||||||||
| Cost of sales | 781,645 | 665,198 | 116,447 | 17.5 | % | ||||||||||||||||||
| Gross profit | $ | 344,619 | $ | 293,756 | $ | 50,863 | 17.3 | % | |||||||||||||||
| Gross profit as a % of net sales | 30.6 | % | 30.6 | % | |||||||||||||||||||
Net sales increased by $167.3 million, or 17.4%, in the year ended December 31, 2021, compared with 2020, with increased sales in Functional Coatings and Color Solutions of $123.9 million and $43.4 million, respectively.
Gross Profit
Gross profit increased $50.9 million, or 17.3%, in 2021 to $344.6 million, compared with $293.8 million in 2020 and, as a percentage of net sales, it remained unchanged at 30.6%. The increase in gross profit was attributable to increases in Functional Coatings and Color Solutions of $43.0 million and $9.3 million, respectively. The increase in gross profit was primarily attributable to higher sales volumes and mix of $46.3 million, favorable product pricing of $14.9 million and favorable foreign currency impacts of $5.7 million, partially offset by higher raw material and manufacturing costs of $14.6 million and $1.4 million, respectively.
Geographic Revenues
The following table presents our sales on the basis of where sales originated.
| (Dollars in thousands) | 2021 | 2020 | $ Change | % Change | |||||||||||||||||||
| Geographic Revenues on a sales origination basis | |||||||||||||||||||||||
| EMEA | $ | 486,842 | $ | 396,263 | $ | 90,579 | 22.9 | % | |||||||||||||||
| Americas | 472,218 | 421,743 | 50,475 | 12.0 | % | ||||||||||||||||||
| Asia Pacific | 167,204 | 140,948 | 26,256 | 18.6 | % | ||||||||||||||||||
| Net sales | $ | 1,126,264 | $ | 958,954 | $ | 167,310 | 17.4 | % | |||||||||||||||
The increase in net sales of $167.3 million, compared with 2020, was driven by higher sales in all regions. The increase in sales from EMEA was attributable to higher sales in Functional Coatings and Color Solutions of $75.4 million and $15.2 million, respectively. The increase in sales from the Americas was attributable to higher sales in Color Solutions and Functional Coatings of $26.3 million and $24.2 million, respectively. The increase in sales from Asia Pacific was attributable to higher sales in Functional Coatings and Color Solutions of $22.2 million and $4.1 million, respectively.
23
Selling, General and Administrative Expense
The following table includes SG&A components with significant changes between 2021 and 2020:
| (Dollars in thousands) | 2021 | 2020 | $ Change | % Change | |||||||||||||||||||
| Personnel expenses (excluding R&D personnel expenses) | $ | 84,772 | $ | 81,852 | $ | 2,920 | 3.6 | % | |||||||||||||||
| Research and development expenses | 32,587 | 35,616 | (3,029) | (8.5) | % | ||||||||||||||||||
| Business development | 22,323 | 9,051 | 13,272 | 146.6 | % | ||||||||||||||||||
| Incentive compensation | 15,828 | 7,379 | 8,449 | 114.5 | % | ||||||||||||||||||
| Stock-based compensation | 4,785 | 7,998 | (3,213) | (40.2) | % | ||||||||||||||||||
| Intangible asset amortization | 5,187 | 5,926 | (739) | (12.5) | % | ||||||||||||||||||
| Pension and other postretirement benefits | 1,662 | 2,094 | (432) | (20.6) | % | ||||||||||||||||||
| Bad debt | 692 | 255 | 437 | 171.4 | % | ||||||||||||||||||
| All other expenses | 49,973 | 52,242 | (2,269) | (4.3) | % | ||||||||||||||||||
| Selling, general and administrative expenses | $ | 217,809 | $ | 202,413 | $ | 15,396 | 7.6 | % | |||||||||||||||
SG&A expenses were $15.4 million higher in 2021 compared with 2020. As a percentage of net sales, SG&A expenses decreased 180 basis points from 21.1% in 2020 to 19.3% in 2021. The higher SG&A expenses compared with the prior year were primarily driven by higher personnel expenses, business development, and incentive compensation, partially offset by lower research and development expenses and stock based compensation.
The following table presents SG&A expenses attributable to sales, research and development, and operations costs as strategic services and presents other SG&A costs as functional services.
| (Dollars in thousands) | 2021 | 2020 | $ Change | % Change | |||||||||||||||||||
| Strategic services | $ | 101,847 | $ | 94,357 | $ | 7,490 | 7.9 | % | |||||||||||||||
| Functional services | 95,349 | 92,679 | 2,670 | 2.9 | % | ||||||||||||||||||
| Incentive compensation | 15,828 | 7,379 | 8,449 | 114.5 | % | ||||||||||||||||||
| Stock-based compensation | 4,785 | 7,998 | (3,213) | (40.2) | % | ||||||||||||||||||
| Selling, general and administrative expenses | $ | 217,809 | $ | 202,413 | $ | 15,396 | 7.6 | % | |||||||||||||||
Restructuring and Impairment Charges
| (Dollars in thousands) | 2021 | 2020 | $ Change | % Change | |||||||||||||||||||
| Employee severance | $ | 10,471 | $ | 9,690 | $ | 781 | 8.1 | % | |||||||||||||||
| Other restructuring costs | 3,939 | 7,735 | (3,796) | (49.1) | % | ||||||||||||||||||
| Restructuring and impairment charges | $ | 14,410 | $ | 17,425 | $ | (3,015) | (17.3) | % | |||||||||||||||
Restructuring and impairment charges decreased $3.0 million in 2021, compared with 2020. The decrease primarily relates to costs associated with our Global Optimization and Organizational Optimization Plans, compared with the prior-year same period. Refer to Note 14 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K for a discussion of our optimization plans and related costs.
Interest Expense
| (Dollars in thousands) | 2021 | 2020 | $ Change | % Change | |||||||||||||||||||
| Interest expense | $ | 28,385 | $ | 22,303 | $ | 6,082 | 27.3 | % | |||||||||||||||
| Amortization of bank fees | 2,090 | 3,974 | (1,884) | (47.4) | % | ||||||||||||||||||
| Interest swap amortization | (947) | (1,263) | 316 | (25.0) | % | ||||||||||||||||||
| Interest capitalization | (1,362) | (3,134) | 1,772 | (56.5) | % | ||||||||||||||||||
| Interest expense | $ | 28,166 | $ | 21,880 | $ | 6,286 | 28.7 | % | |||||||||||||||
Interest expense in 2021 increased $6.3 million compared with 2020. The increase in interest expense was primarily due to the settlement of several swap terminations, partially offset by a decrease in the average interest rate and average long-term debt balance during 2021.
24
Income Tax Expense
In 2021, we recorded an income tax expense of $39.2 million, or 34.8% of income before income taxes, compared to an income tax expense of $14.9 million, or 33.1% of income before income taxes in 2020. The 2021 effective tax rate is greater than the statutory income tax rate of 21% primarily as a result of the net effect of a $8.8 million expense related to foreign tax rate differences and a $4.7 million expense related to foreign tax withholding. The 2020 effective tax rate is greater than the statutory income tax rate of 21% primarily as a result of the net effect of a $3.2 million expense related to foreign tax rate differences and a $2.0 million expense related to disallowed expenses.
Comparison of the years ended December 31, 2020 and 2019
For the year ended December 31, 2020, net income from continuing operations was $30.0 million, compared with $34.8 million in 2019. For the year ended December 31, 2020, net income attributable to common shareholders was $42.8 million, or $0.52 earnings per share, compared with $6.0 million, or $0.07 earnings per share in 2019. The increase in net income attributable to shareholders is primarily due to impairment charges of $42.5 million associated with the Tile Coatings business, recorded within Net income (loss) from discontinued operations, during the prior year
Net Sales
| (Dollars in thousands) | 2020 | 2019 | $ Change | % Change | |||||||||||||||||||
| Net sales | $ | 958,954 | $ | 1,014,457 | $ | (55,503) | (5.5) | % | |||||||||||||||
| Cost of sales | 665,198 | 706,481 | (41,283) | (5.8) | % | ||||||||||||||||||
| Gross profit | $ | 293,756 | $ | 307,976 | $ | (14,220) | (4.6) | % | |||||||||||||||
| Gross profit as a % of net sales | 30.6 | % | 30.4 | % | |||||||||||||||||||
Net sales decreased by $55.5 million, or 5.5%, in the year ended December 31, 2020, compared with 2019, with decreased sales in Functional Coatings and Color Solutions of $36.6 million and $18.9 million, respectively.
Gross Profit
Gross profit decreased $14.2 million, or 4.6%, in 2020 to $293.8 million, compared with $308.0 million in 2019 and, as a percentage of net sales, it increased 20 basis points to 30.6%. The decrease in gross profit was attributable to a decrease in Functional Coatings of $17.1 million, partially mitigated by an increase in Color Solutions of $4.1 million. The decrease in gross profit was primarily attributable to lower sales volumes and mix of $30.8 million, unfavorable foreign currency impacts of $2.1 million and higher manufacturing and product costs of $1.1 million, partially mitigated by lower raw material costs of $15.7 million and favorable product pricing of $4.1 million.
Geographic Revenues
The following table presents our sales on the basis of where sales originated.
| (Dollars in thousands) | 2020 | 2019 | $ Change | % Change | |||||||||||||||||||
| Geographic Revenues on a sales origination basis | |||||||||||||||||||||||
| EMEA | $ | 396,263 | $ | 432,132 | $ | (35,869) | (8.3) | % | |||||||||||||||
| Americas | 421,743 | 443,319 | (21,576) | (4.9) | % | ||||||||||||||||||
| Asia Pacific | 140,948 | 139,006 | 1,942 | 1.4 | % | ||||||||||||||||||
| Net sales | $ | 958,954 | $ | 1,014,457 | $ | (55,503) | (5.5) | % | |||||||||||||||
The decrease in net sales of $55.5 million, compared with 2019, was driven by lower sales in the EMEA and Americas regions, partially mitigated by higher sales in the Asia Pacific region. The decrease in sales from EMEA was attributable to lower sales in Functional Coatings and Color Solutions of $28.2 million and $7.7 million, respectively. The decrease in sales from the Americas was attributable to lower sales in Color Solutions and Functional Coatings of $13.9 million and $7.6 million, respectively. The increase in sales from Asia Pacific was attributable to higher sales in Color Solutions of $2.7 million, partially offset by lower sales in Functional Coatings of $0.8 million.
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Selling, General and Administrative Expense
The following table includes SG&A components with significant changes between 2020 and 2019.
| (Dollars in thousands) | 2020 | 2019 | $ Change | % Change | |||||||||||||||||||
| Personnel expenses (excluding R&D personnel expenses) | $ | 81,852 | $ | 94,544 | $ | (12,692) | (13.4) | % | |||||||||||||||
| Research and development expenses | 35,616 | 40,962 | (5,346) | (13.1) | % | ||||||||||||||||||
| Business development | 9,051 | 4,989 | 4,062 | 81.4 | % | ||||||||||||||||||
| Incentive compensation | 7,379 | 2,459 | 4,920 | 200.1 | % | ||||||||||||||||||
| Stock-based compensation | 7,998 | 7,406 | 592 | 8.0 | % | ||||||||||||||||||
| Intangible asset amortization | 5,926 | 6,949 | (1,023) | (14.7) | % | ||||||||||||||||||
| Pension and other postretirement benefits | 2,094 | 1,422 | 672 | 47.3 | % | ||||||||||||||||||
| Bad debt | 255 | 455 | (200) | (44.0) | % | ||||||||||||||||||
| All other expenses | 52,242 | 53,179 | (937) | (1.8) | % | ||||||||||||||||||
| Selling, general and administrative expenses | $ | 202,413 | $ | 212,365 | $ | (9,952) | (4.7) | % | |||||||||||||||
SG&A expenses were $10.0 million lower in 2020 compared with 2019. As a percentage of net sales, SG&A expenses increased 20 basis points from 20.9% in 2019 to 21.1% in 2020. The lower SG&A expenses compared with the prior year were primarily driven by lower personnel and research and development expenses, partially offset by higher incentive compensation and business development expenses.
The following table presents SG&A expenses attributable to sales, research and development, and operations costs as strategic services and presents other SG&A costs as functional services.
| (Dollars in thousands) | 2020 | 2019 | $ Change | % Change | |||||||||||||||||||
| Strategic services | $ | 94,357 | $ | 103,603 | $ | (9,246) | (8.9) | % | |||||||||||||||
| Functional services | 92,679 | 98,897 | (6,218) | (6.3) | % | ||||||||||||||||||
| Incentive compensation | 7,379 | 2,459 | 4,920 | 200.1 | % | ||||||||||||||||||
| Stock-based compensation | 7,998 | 7,406 | 592 | 8.0 | % | ||||||||||||||||||
| Selling, general and administrative expenses | $ | 202,413 | $ | 212,365 | $ | (9,952) | (4.7) | % | |||||||||||||||
Restructuring and Impairment Charges
| (Dollars in thousands) | 2020 | 2019 | $ Change | % Change | |||||||||||||||||||
| Employee severance | $ | 9,690 | $ | 7,163 | $ | 2,527 | 35.3 | % | |||||||||||||||
| Other restructuring costs | 7,735 | 3,792 | 3,943 | 104.0 | % | ||||||||||||||||||
| Restructuring and impairment charges | $ | 17,425 | $ | 10,955 | $ | 6,470 | 59.1 | % | |||||||||||||||
Restructuring and impairment charges increased $6.5 million in 2020, compared with 2019. The increase primarily relates to costs associated with our Global Optimization and Organizational Optimization Plans, compared with the prior-year same period. Refer to Note 14 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K for a discussion of our optimization plans and related costs.
Interest Expense
| (Dollars in thousands) | 2020 | 2019 | $ Change | % Change | |||||||||||||||||||
| Interest expense | $ | 22,303 | $ | 24,888 | $ | (2,585) | (10.4) | % | |||||||||||||||
| Amortization of bank fees | 3,974 | 3,755 | 219 | 5.8 | % | ||||||||||||||||||
| Interest swap amortization | (1,263) | (1,263) | — | — | % | ||||||||||||||||||
| Interest capitalization | (3,134) | (3,078) | (56) | 1.8 | % | ||||||||||||||||||
| Interest expense | $ | 21,880 | $ | 24,302 | $ | (2,422) | (10.0) | % | |||||||||||||||
Interest expense in 2020 decreased $2.4 million compared with 2019. The decrease in interest expense was primarily due to a decrease in the average interest rate, partially offset by an increase in the average long-term debt balance during 2020.
26
Income Tax Expense
In 2020, we recorded an income tax expense of $14.9 million, or 33.1% of income before income taxes, compared to an income tax expense of $8.0 million, or 18.6% of income before income taxes in 2019. The 2020 effective tax rate is greater than the statutory income tax rate of 21% primarily as a result of the net effect of a $3.2 million expense related to foreign tax rate differences and a $2.0 million expense related to disallowed expenses. The 2019 effective tax rate is less than the statutory income tax rate of 21% primarily as a result of a net effect of a $7.6 million net benefit related to the release of valuation allowances related to deferred tax assets that were utilized in the current year and which are deemed no longer necessary based upon changes in the current and expected future years of operating profits and a $4.3 million net expense related to foreign tax rate differences.
Results of Operations - Segment Information
Comparison of the years ended December 31, 2021 and 2020
Functional Coatings
| Change due to | |||||||||||||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | 2021 | 2020 | $ Change | % Change | Price | Volume / Mix | Currency | Other | |||||||||||||||||||||||||||||||||||||||
| Segment net sales | $ | 732,063 | $ | 608,192 | $ | 123,871 | 20.4 | % | $ | 8,762 | $ | 104,797 | $ | 10,312 | $ | — | |||||||||||||||||||||||||||||||
| Segment gross profit | 218,619 | 175,601 | 43,018 | 24.5 | % | 8,762 | 34,791 | 2,986 | (3,521) | ||||||||||||||||||||||||||||||||||||||
| Segment gross profit as a % of segment net sales | 29.9 | % | 28.9 | % | |||||||||||||||||||||||||||||||||||||||||||
Net sales increased $123.9 million compared with the prior year, primarily driven by higher sales in porcelain enamel, electronics, decoration, industrial and automotive products of $31.0 million, $29.8 million, $29.5 million, $18.9 million, and $14.7 million, respectively. The increase in net sales was driven by favorable volume and mix of $104.8 million and favorable foreign currency impacts of $10.3 million and higher product pricing of $8.8 million. Gross profit increased from the prior year, primarily due to higher sales volume and mix of $34.8 million, higher product pricing of $8.8 million, favorable foreign currency impacts of $3.0 million and favorable manufacturing costs of $1.8 million, partially offset by higher raw material costs of $5.4 million.
| (Dollars in thousands) | 2021 | 2020 | $ Change | % Change | |||||||||||||||||||
| Segment net sales by Region | |||||||||||||||||||||||
| EMEA | $ | 342,396 | $ | 267,041 | $ | 75,355 | 28.2 | % | |||||||||||||||
| Americas | 266,745 | 240,424 | 26,321 | 10.9 | % | ||||||||||||||||||
| Asia Pacific | 122,922 | 100,727 | 22,195 | 22.0 | % | ||||||||||||||||||
| Net sales | $ | 732,063 | $ | 608,192 | $ | 123,871 | 20.4 | % | |||||||||||||||
The net sales increase of $123.9 million was driven by higher sales from all regions. The increase in sales from EMEA was primarily attributable to higher sales of decoration, industrial, porcelain enamel, electronic and automotive products of $21.3 million, $18.2 million, $16.2 million, $13.7 million and $6.0 million, respectively. The increase in sales from the Americas was primarily attributable to higher sales of electronic, porcelain enamel, automotive and decoration products of $15.0 million, $9.9 million, $3.1 million and $1.6 million, respectively, partially offset by lower sales of industrial products of $3.3 million. The increase in sales from Asia Pacific was primarily attributable to higher sales of decoration, automotive, porcelain enamel, industrial and electronic products of $6.6 million, $5.6 million, $4.9 million, $4.0 million and $1.1 million, respectively.
27
Color Solutions
| Change due to | |||||||||||||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | 2021 | 2020 | $ Change | % Change | Price | Volume / Mix | Currency | Other | |||||||||||||||||||||||||||||||||||||||
| Segment net sales | $ | 394,201 | $ | 350,762 | $ | 43,439 | 12.4 | % | $ | 6,165 | $ | 30,993 | $ | 6,281 | $ | — | |||||||||||||||||||||||||||||||
| Segment gross profit | 128,356 | 119,071 | 9,285 | 7.8 | % | 6,165 | 11,489 | 2,663 | (11,032) | ||||||||||||||||||||||||||||||||||||||
| Segment gross profit as a % of segment net sales | 32.6 | % | 33.9 | % | |||||||||||||||||||||||||||||||||||||||||||
Net sales increased $43.4 million compared with the prior year primarily due to higher product sales of pigments, dispersions and colorants, and surface technology of $38.8 million $4.0 million and $0.6 million, respectively. The increase in net sales was driven by favorable volume and mix and foreign currency impacts of $31.0 million and $6.3 million, respectively, and higher product pricing of $6.2 million. Gross profit increased from the prior year primarily due to favorable sales volume and mix of $11.5 million, higher product pricing of $6.2 million, and favorable foreign currency impacts of $2.7 million, partially offset by higher raw material and manufacturing costs of $9.2 million and $1.8 million, respectively.
| (Dollars in thousands) | 2021 | 2020 | $ Change | % Change | |||||||||||||||||||
| Segment net sales by Region | |||||||||||||||||||||||
| Americas | $ | 205,473 | $ | 181,319 | $ | 24,154 | 13.3 | % | |||||||||||||||
| EMEA | 144,446 | 129,222 | 15,224 | 11.8 | % | ||||||||||||||||||
| Asia Pacific | 44,282 | 40,221 | 4,061 | 10.1 | % | ||||||||||||||||||
| Net sales | $ | 394,201 | $ | 350,762 | $ | 43,439 | 12.4 | % | |||||||||||||||
The net sales increased of $43.4 million was driven by higher sales from all regions. The increase in sales from the Americas was primarily driven by higher sales of pigment, dispersions and colorants and surface technology products of $17.8 million, $3.2 million and $3.2 million, respectively. The increase in sales from EMEA was primarily attributable to higher sales of pigment and dispersions and colorants products of $14.5 million and $0.7 million, respectively. The increase in sales from Asia Pacific was primarily attributable to higher sales of pigment products of $6.5 million, partially offset by surface technology products of $2.5 million.
Comparison of the years ended December 31, 2020 and 2019
Functional Coatings
| Change due to | |||||||||||||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | 2020 | 2019 | $ Change | % Change | Price | Volume / Mix | Currency | Other | |||||||||||||||||||||||||||||||||||||||
| Segment net sales | $ | 608,192 | $ | 644,783 | $ | (36,591) | (5.7) | % | $ | 4,280 | $ | (37,771) | $ | (3,100) | $ | — | |||||||||||||||||||||||||||||||
| Segment gross profit | 175,601 | 192,668 | (17,067) | (8.9) | % | 4,280 | (16,544) | (2,172) | (2,631) | ||||||||||||||||||||||||||||||||||||||
| Segment gross profit as a % of segment net sales | 28.9 | % | 29.9 | % | |||||||||||||||||||||||||||||||||||||||||||
Net sales decreased $36.6 million compared with the prior year, primarily driven by lower sales in industrial, decoration and automotive products of $18.9 million, $15.8 million, and $13.3 million, respectively, partially mitigated by higher sales of electronics products of $18.7 million. The decrease in net sales was driven by unfavorable volume and mix of $37.8 million and unfavorable foreign currency impacts of $3.1 million, partially offset by higher product pricing of $4.3 million. Gross profit decreased from the prior year, primarily due to lower sales volume and mix of $16.5 million, unfavorable manufacturing costs of $12.1 million and unfavorable foreign currency impacts of $2.2 million, partially offset by lower raw material costs of $9.4 million, higher product pricing of $4.3 million.
28
| (Dollars in thousands) | 2020 | 2019 | $ Change | % Change | |||||||||||||||||||
| Segment net sales by Region | |||||||||||||||||||||||
| EMEA | $ | 267,041 | $ | 295,198 | $ | (28,157) | (9.5) | % | |||||||||||||||
| Americas | 240,424 | 248,064 | (7,640) | (3.1) | % | ||||||||||||||||||
| Asia Pacific | 100,727 | 101,521 | (794) | (0.8) | % | ||||||||||||||||||
| Net sales | $ | 608,192 | $ | 644,783 | $ | (36,591) | (5.7) | % | |||||||||||||||
The net sales decrease of $36.6 million was driven by lower sales from all regions. The decrease in sales from EMEA was primarily attributable to lower sales of industrial, decoration and automotive products of $19.2 million, $10.7 million and $4.7 million, respectively, partially mitigated by higher sales of electronic products of $5.5 million. The decrease in sales from the Americas was primarily attributable to lower sales of automotive, porcelain enamel, industrial and decoration products of $6.9 million, $4.9 million, $4.5 million and $1.1 million, respectively, partially offset by an increase in sales of electronic products of $12.7 million. The decrease in sales from Asia Pacific was primarily attributable to lower sales of decoration and automotive products of $4.0 million and $1.7 million, respectively, partially mitigated by higher sales of industrial products of $4.8 million.
Color Solutions
| Change due to | |||||||||||||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | 2020 | 2019 | $ Change | % Change | Price | Volume / Mix | Currency | Other | |||||||||||||||||||||||||||||||||||||||
| Segment net sales | $ | 350,762 | $ | 369,674 | $ | (18,912) | (5.1) | % | $ | (217) | $ | (18,429) | $ | (266) | $ | — | |||||||||||||||||||||||||||||||
| Segment gross profit | 119,071 | 114,939 | 4,132 | 3.6 | % | (217) | (13,019) | 82 | 17,286 | ||||||||||||||||||||||||||||||||||||||
| Segment gross profit as a % of segment net sales | 33.9 | % | 31.1 | % | |||||||||||||||||||||||||||||||||||||||||||
Net sales decreased $18.9 million compared with the prior year primarily due to lower sales of surface technology products of $12.7 million, pigment products of $5.1 million and dispersions and colorants of $1.1 million. The decrease in net sales was driven by lower volume and mix of $18.4 million and unfavorable foreign currency impacts. Gross profit increased from the prior year primarily due to lower manufacturing costs of $11.0 million and lower raw material costs of $6.3 million, partially offset by unfavorable sales volume and mix of $13.0 million and lower product pricing of $0.2 million.
| 2020 | 2019 | $ Change | % Change | ||||||||||||||||||||
| Segment net sales by Region | |||||||||||||||||||||||
| Americas | $ | 181,319 | $ | 195,255 | $ | (13,936) | (7.1) | % | |||||||||||||||
| EMEA | 129,222 | 136,934 | (7,712) | (5.6) | % | ||||||||||||||||||
| Asia Pacific | 40,221 | 37,485 | 2,736 | 7.3 | % | ||||||||||||||||||
| Net sales | $ | 350,762 | $ | 369,674 | $ | (18,912) | (5.1) | % | |||||||||||||||
The net sales decrease of $18.9 million was driven by lower sales from the EMEA and Americas regions, partially mitigated by higher sales from the Asia Pacific region. The decrease in sales from EMEA was primarily attributable to lower sales of pigment products of $6.5 million and dispersions and colorants of $1.2 million. The decrease in sales from the Americas was primarily driven by lower sales of surface technology products of $12.7 million and pigment products of $1.3 million, partially mitigated by higher sales of dispersions and colorants of $0.1 million. The increase in sales from Asia Pacific was primarily attributable to higher sales of pigment products of $2.7 million.
29
Summary of Cash Flows for the years ended December 31, 2021, 2020 and 2019
| (Dollars in thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Net cash provided by (used for) operating activities | $ | (61,303) | $ | (13,192) | $ | 17,710 | |||||||||||
| Net cash provided by investing activities | 490,659 | 98,993 | 21,303 | ||||||||||||||
| Net cash used for financing activities | (538,052) | (10,048) | (39,195) | ||||||||||||||
| Effect of exchange rate changes on cash and cash equivalents | (2,088) | 2,122 | 283 | ||||||||||||||
| (Decrease) increase in cash and cash equivalents | $ | (110,784) | $ | 77,875 | $ | 101 | |||||||||||
Operating activities. Cash flows from operating activities decreased $48.1 million in 2021 compared to 2020. The decrease in cash from operating activities was primarily due to higher cash outflows for other current assets and liabilities of $22.5 million, net working capital of $3.2 million, and a decrease in net income, excluding noncash items and the gain on the sale of the Tile Coatings business.
Cash flows from operating activities decreased $30.9 million in 2020 compared to 2019. The decrease was primarily due to higher cash outflows for net working capital of $36.4 million which was offset by lower cash payments for incentive compensation of $5.1 million and lower pension contributions of $2.4 million.
Investing activities. Cash flows from investing activities increased $391.7 million in 2021 compared to 2020. The increase was primarily due to proceeds from the sale of our Tile Coatings business of $402.1 million, and lower cash outflows for capital expenditures of $1.8 million, partially offset by lower collections of financing receivables of $11.9 million and lower sales of assets of $0.4 million.
Cash flows from investing activities increased $77.7 million in 2020 compared to 2019. The increase was primarily due to higher collections of financing receivables of $45.4 million and lower cash outflows for capital expenditures of $33.2 million.
Financing activities. Cash flows from financing activities decreased $528.0 million in 2021 compared with 2020. The decrease is primarily attributable to increased principal payments on the Amended Credit Facility of $535.0 million and decreased other financing activities of $4.6 million, partially offset by increased proceeds from the exercise of stock options of $10.8 million and increased net proceeds from loans payable of $0.8 million.
Cash flows from financing activities increased $29.1 million in 2020 compared with 2019. The increase is primarily attributable to decreased cash outflows for the purchase of treasury stock of $25.0 million and decreased cash outflows for acquisition-related contingency payments of $5.2 million.
We have paid no dividends on our common stock since 2009.
Capital Resources and Liquidity
Refer to Note 8 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K for a discussion of major debt instruments that were outstanding during 2021.
Off Balance Sheet Arrangements
Consignment and Customer Arrangements for Precious Metals. We use precious metals, primarily silver, in the production of some of our products. We obtain most precious metals from financial institutions under consignment agreements. The financial institutions retain ownership of the precious metals and charge us fees based on the amounts we consign and the period of consignment. These fees were $2.8 million, $2.9 million, and $3.1 million for 2021, 2020, and 2019, respectively. We had on hand precious metals owned by participants in our precious metals consignment program of $95.4 million at December 31, 2021 and $87.2 million at December 31, 2020, measured at fair value based on market prices for identical assets and net of credits.
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The consignment agreements under our precious metals program involve short-term commitments that typically mature within 30 to 90 days of each transaction and are typically renewed on an ongoing basis. As a result, the Company relies on the continued willingness of financial institutions to participate in these arrangements to maintain this source of liquidity. On occasion, we have been required to deliver cash collateral. While no deposits were outstanding at December 31, 2021 or December 31, 2020, we may be required to furnish cash collateral in the future based on the quantity and market value of the precious metals under consignment and the amount of collateral-free lines provided by the financial institutions. The amount of cash collateral required is subject to review by the financial institutions and can be changed at any time at their discretion, based in part on their assessment of our creditworthiness.
Bank Guarantees and Standby Letters of Credit.
At December 31, 2021, the Company and its subsidiaries had bank guarantees and standby letters of credit issued by financial institutions that totaled $4.5 million. These agreements primarily relate to Ferro’s insurance programs, foreign energy purchase contracts and foreign tax payments.
Liquidity Requirements
Our primary sources of liquidity are available cash and cash equivalents, available lines of credit under the Amended Credit Facility, and cash flows from operating activities. As of December 31, 2021, we had $71.5 million of cash and cash equivalents. Cash generated in the U.S. is generally used to pay down amounts outstanding under our 2018 Revolving Facility and for general corporate purposes, including acquisitions. If needed, we could repatriate the majority of cash held by foreign subsidiaries without the need to accrue and pay U.S. income taxes. We do not anticipate a liquidity need requiring such repatriation of these funds to the U.S.
During the fourth quarter of 2019, we entered into a definitive agreement to sell our Tile Coatings business which has historically been a part of our Performance Coatings reportable segment. We used the proceeds of the sale to settle long-term obligations. On February 25, 2021, we completed the sale of our Tile Coatings business to Pigments Spain, S.L., a company of the Esmalglass-Itaca-Fritta group, which is a portfolio company of certain Lone Star Funds. Proceeds from the close of the transaction, in addition to current cash balances, were used to pay down our term loan facility in the amount of $435.0 million on February 25, 2021. The Company paid down and additional $100.0 million of the Term Loan Facility during the fourth quarter of 2021, and $50.0 million in January 2022.
Our liquidity requirements primarily include debt service, purchase commitments, labor costs, working capital requirements, restructuring expenditures, acquisition costs, capital investments, precious metals cash collateral requirements, and postretirement benefit obligations. We expect to meet these requirements in the long term through cash provided by operating activities and availability under existing credit facilities or other financing arrangements. Cash flows from operating activities are primarily driven by earnings before noncash charges and changes in working capital needs. Additionally, we used the borrowings available under the Amended Credit Facility for other general business purposes. We had additional borrowing capacity of $521.1 million at December 31, 2021, available under various credit facilities, primarily our revolving credit facility.
Our Amended Credit Facility contains customary restrictive covenants, including those described in more detail in Note 8 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K. These covenants include customary restrictions, including, but not limited to, limitations on use of loan proceeds, limitations on the Company’s ability to pay dividends and repurchase stock, limitations on acquisitions and dispositions, and limitations on certain types of investments. Specific to the 2018 Revolving Facility, we are subject to a financial covenant regarding the Company’s maximum leverage ratio. This covenant under our Amended Credit Facility restricts the amount of our borrowings, reducing our flexibility to fund ongoing operations and strategic initiatives. This facility is described in more detail in Note 8 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K.
As of December 31, 2021, we were in compliance with our maximum leverage ratio covenant of 4.00x as our actual ratio was 1.03, providing $171.7 million of EBITDA cushion on the leverage ratio, as defined within the Amended Credit Facility. To the extent that economic conditions in key markets deteriorate or we are unable to meet our business projections and EBITDA falls below approximately $59.4 million for a rolling four quarters, based on reasonably consistent net debt levels with those as of December 31, 2021, we could become unable to maintain compliance with our leverage ratio covenant. In such case, our lenders could demand immediate payment of outstanding amounts and we would need to seek alternate financing sources to pay off such debts and to fund our ongoing operations. Such financing may not be available on favorable terms, if at all.
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Difficulties experienced in global capital markets could affect the ability or willingness of counterparties to perform under our various lines of credit, forward contracts, and precious metals program. These counterparties are major, reputable, multinational institutions, all having investment-grade credit ratings. Accordingly, we do not anticipate counterparty default. However, an interruption in access to external financing could adversely affect our business prospects and financial condition.
We assess on an ongoing basis our portfolio of businesses, as well as our financial and capital structure, to ensure that we have sufficient capital and liquidity to meet our strategic objectives. As part of this process, from time to time we evaluate the possible divestiture of businesses that are not critical to our core strategic objectives and, where appropriate, pursue the sale of such businesses and assets. We also evaluate and pursue acquisition opportunities that we believe will enhance our strategic position such as the acquisitions we completed in 2018. Generally, we publicly announce material divestiture and acquisition transactions only when we have entered into a material definitive agreement or closed on those transactions.
The Company’s aggregate amount of contractual obligations for the next five years and thereafter is set forth below:
| (Dollars in thousands) | 2022 | 2023 | 2024 | 2025 | 2026 | Thereafter | Totals | ||||||||||||||||||||||||||||||||||
Long-term debt (1) | $ | 9,056 | $ | 8,977 | $ | 238,645 | $ | 758 | $ | 624 | $ | 3,499 | $ | 261,559 | |||||||||||||||||||||||||||
Interest (2) | 254 | 254 | 254 | 254 | 254 | 2,785 | 4,055 | ||||||||||||||||||||||||||||||||||
| Operating lease obligations | 5,129 | 3,325 | 2,337 | 1,823 | 1,422 | 1,804 | 15,840 | ||||||||||||||||||||||||||||||||||
Purchase commitments (3) | 2,939 | 1,897 | 79 | 81 | 84 | 86 | 5,166 | ||||||||||||||||||||||||||||||||||
Taxes (4) | 18,275 | — | — | — | — | — | 18,275 | ||||||||||||||||||||||||||||||||||
Retirement and other postemployment benefits (5) | 4,274 | — | — | — | — | — | 4,274 | ||||||||||||||||||||||||||||||||||
| $ | 39,927 | $ | 14,453 | $ | 241,315 | $ | 2,916 | $ | 2,384 | $ | 8,174 | $ | 309,169 | ||||||||||||||||||||||||||||
(1)Long-term debt excludes imputed interest and executory costs on capitalized lease obligations and unamortized issuance costs on the term loan facility.
(2)Interest represents only contractual payments for fixed-rate debt.
(3)Purchase commitments are noncancelable contractual obligations for raw materials and energy, and exclude capital expenditures for property, plant and equipment.
(4)We have not projected payments past 2022 due to uncertainties in estimating the amount and period of any payments. The amount above relates to our current income tax liability as of December 31, 2021. We have $10.0 million in gross liabilities related to unrecognized tax benefits, including $0.8 million of accrued interest and penalties that are not included in the above table since we cannot reasonably predict the timing of cash settlements with various taxing authorities.
(5)The funding amounts are based on the minimum contributions required under our various plans and applicable regulations in each respective country. We have not projected contributions past 2022 due to uncertainties regarding the assumptions involved in estimating future required contributions.
Critical Accounting Policies
When we prepare our consolidated financial statements we are required to make estimates and assumptions that affect the amounts we report in the consolidated financial statements and footnotes. We consider the policies discussed below to be more critical than other policies because their application requires our most subjective or complex judgments. These estimates and judgments arise because of the inherent uncertainty in predicting future events. Management has discussed the development, selection and disclosure of these policies with the Audit Committee of the Board of Directors.
Restructuring and Cost Reduction Programs
In recent years, we have developed and initiated global cost reduction programs with the objectives of leveraging our global scale, realigning and lowering our cost structure, and optimizing capacity utilization. Management continues to evaluate our businesses, and therefore, there may be additional provisions for new optimization and cost-savings initiatives, as well as changes in estimates to amounts previously recorded, as payments are made or actions are completed.
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Restructuring charges include both termination benefits and asset writedowns. We estimate accruals for termination benefits based on various factors including length of service, contract provisions, local legal requirements, projected final service dates, and salary levels. We also analyze the carrying value of long-lived assets and record estimated accelerated depreciation through the anticipated end of the useful life of the assets affected by the restructuring or record an asset impairment. In all likelihood, this accelerated depreciation will result in reducing the net book value of those assets to zero at the date operations cease. While we believe that changes to our estimates are unlikely, the accuracy of our estimates depends on the successful completion of numerous actions. Changes in our estimates could increase our restructuring costs to such an extent that it could have a material impact on the Company’s results of operations, financial position, or cash flows. Other events, such as negotiations with unions and works councils, may also delay the resulting cost savings.
Goodwill
We review goodwill for impairment each year using a measurement date of October 31st or more frequently in the event of an impairment indicator. We annually, or more frequently as warranted, evaluate the appropriateness of our reporting units utilizing operating segments as the starting point of our analysis. In the event of a change in our reporting units, we would allocate goodwill based on the relative fair value. We estimate the fair values of the reporting units associated with these assets using the average of both the income approach and the market approach, which we believe provides a reasonable estimate of the reporting units’ fair values, unless facts and circumstances exist that indicate more representative fair values. The income approach uses projected cash flows attributable to the reporting units and allocates certain corporate expenses to the reporting units. We use historical results, trends and our projections of market growth, internal sales efforts and anticipated cost structure assumptions to estimate future cash flows. Using a risk-adjusted, weighted-average cost of capital, we discount the cash flow projections to the measurement date. The market approach estimates a price reasonably expected to be paid by a market participant in the purchase of similar businesses. If the fair value of any reporting unit was determined to be less than its carrying value, we would recognize an impairment for the difference between fair value and carrying value.
The significant assumptions we used in our impairment analyses of goodwill at October 31, 2021 and 2020 are the weighted average cost of capital and revenue growth rates.
Our estimates of fair value can be adversely affected by a variety of factors. Reductions in actual or projected growth or profitability at our reporting units due to unfavorable market conditions or significant increases in cost structure could lead to the impairment of any related goodwill. Additionally, an increase in inflation, interest rates or the risk-adjusted, weighted-average cost of capital could also lead to a reduction in the fair value of one or more of our reporting units and therefore lead to the impairment of goodwill.
Future potential impairments are possible for any of the Company’s remaining reporting units if actual results are materially less than forecasted results. Some of the factors that could negatively affect our cash flows and, as a result, not support the carrying values of our reporting units are: new environmental regulations or legal restrictions on the use of our products that would either reduce our product revenues or add substantial costs to the manufacturing process, thereby reducing operating margins; new technologies that could make our products less competitive or require substantial capital investment in new equipment or manufacturing processes; and substantial downturns in economic conditions.
Long-Lived Asset Impairment
The Company’s long-lived assets include property, plant and equipment, and intangible assets. We review property, plant and equipment and intangible assets for impairment whenever events or circumstances indicate that their carrying values may not be recoverable. The following are examples of such events or changes in circumstances:
•An adverse change in the business climate of a long-lived asset or asset group;
•An adverse change in the extent or manner in which a long-lived asset or asset group is used or in its physical condition;
•Current operating losses for a long-lived asset or asset group combined with a history of such losses or projected or forecasted losses that demonstrate that the losses will continue; or
•A current expectation that, more likely than not, a long-lived asset or asset group will be sold or otherwise significantly disposed of before the end of its previously estimated useful life.
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The carrying amount of property, plant and equipment and intangible assets is not recoverable if the carrying value of the asset group exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset group. In the event of impairment, we recognize a loss for the excess of the recorded value over fair value. The long-term nature of these assets requires the estimation of cash inflows and outflows several years into the future and only takes into consideration technological advances known at the time of review.
Income Taxes
The breadth of our operations and complexity of income tax regulations require us to assess uncertainties and make judgments in estimating the ultimate amount of income taxes we will pay. Our income tax expense, deferred tax assets and liabilities, and reserves for unrecognized tax benefits reflect management’s best assessment of estimated current and future taxes to be paid. The final income taxes we pay are based upon many factors, including existing income tax laws and regulations, negotiations with taxing authorities in various jurisdictions, outcomes of tax litigation, and resolution of disputes arising from federal, state and international income tax audits. The resolution of these uncertainties may result in adjustments to our income tax assets and liabilities in the future.
Deferred income taxes result from differences between the financial and tax basis of our assets and liabilities. We adjust our deferred income tax assets and liabilities for changes in income tax rates and income tax laws when changes are enacted. We record valuation allowances to reduce deferred income tax assets when it is more likely than not that a tax benefit will not be realized. Significant judgment is required in evaluating the need for and the magnitude of appropriate valuation allowances against deferred income tax assets. The realization of these assets is dependent on generating future taxable income, our ability to carry back or carry forward net operating losses and credits to offset tax liabilities, as well as successful implementation of various tax strategies to generate tax where net operating losses or credit carryforwards exist. In evaluating our ability to realize the deferred income tax assets, we rely principally on the reversal of existing temporary differences, the availability of tax planning strategies, and forecasted income.
We recognize a tax benefit from an uncertain tax position when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Our estimate of the potential outcome of any uncertain tax positions is subject to management’s assessment of relevant risks, facts, and circumstances existing at that time. We record a liability for the difference between the benefit recognized and measured based on a more-likely-than-not threshold and the tax position taken or expected to be taken on the tax return. To the extent that our assessment of such tax positions change, the change in estimate is recorded in the period in which the determination is made. We report tax-related interest and penalties as a component of income tax expense.
Derivative Financial Instruments
We use derivative financial instruments in the normal course of business to manage our exposure to fluctuations in interest rates, foreign currency exchange rates, and precious metal prices. The accounting for derivative financial instruments can be complex and can require significant judgment. Generally, the derivative financial instruments that we use are not complex, and observable market-based inputs are available to measure their fair value. We do not engage in speculative transactions for trading purposes. The use of financial derivatives is managed under a policy that identifies the conditions necessary to identify the transaction as a financial derivative. Financial instruments, including derivative financial instruments, expose us to counterparty credit risk for nonperformance. We manage our exposure to counterparty credit risk through minimum credit standards and procedures to monitor concentrations of credit risk. We enter into these derivative financial instruments with major, reputable, multinational financial institutions. Accordingly, we do not anticipate counter-party default. We continuously evaluate the effectiveness of derivative financial instruments designated as hedges to ensure that they are highly effective. In the event the hedge becomes ineffective, we discontinue hedge treatment. Except as noted below, we do not expect any changes in our risk policies or in the nature of the transactions we enter into to mitigate those risks.
Our exposure to interest rate changes arises from our debt agreements with variable interest rates. To reduce our exposure to interest rate changes on variable rate debt, we entered into interest rate swap agreements. These swaps are settled in cash, and the net interest paid or received is effectively recognized as interest expense. We mark these swaps to fair value and recognize the resulting gains or losses as other comprehensive income.
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We have executed cross currency interest rate swaps to minimize our exposure to floating rate debt agreements denominated in a currency other than functional currency. These swaps are settled in cash, and the net interest paid or received is effectively recognized as interest expense as the interest on the debt is accrued. These swaps are designated as cash flow hedges and we mark these swaps to fair value and recognize the resulting gains or losses as other comprehensive income.
To help protect the value of the Company’s net investment in European operations against adverse changes in exchange rates, the Company, from time-to-time, uses non-derivative financial instruments, such as its foreign currency denominated debt, as economic hedges of its net investments in certain foreign subsidiaries. In addition, we have executed cross currency interest rate swaps to help protect the value of the Company’s net investment in European operations. These swaps are settled in cash, and the net interest paid or received is effectively recognized as interest expense. We mark these swaps to fair value and recognize the resulting gains or losses as cumulative translation adjustments (a component of other comprehensive income).
We manage foreign currency risks in a wide variety of foreign currencies principally by entering into forward contracts to mitigate the impact of currency fluctuations on transactions arising from international trade. Our objective in entering into these forward contracts is to preserve the economic value of nonfunctional currency cash flows. Our principal foreign currency exposures relate to the Euro, the Turkish Lira, the Taiwan Dollar, the Colombian Peso, the Australian Dollar, the Indian Rupee, the Thailand Baht, the Indonesian Rupiah, the Japanese Yen, the Chinese Renminbi and the Romanian Leu. We mark these forward contracts to fair value based on market prices for comparable contracts and recognize the resulting gains or losses as other income or expense from foreign currency transactions.
Precious metals (primarily silver, gold, platinum and palladium) represent a significant portion of raw material costs in our electronics products. When we enter into a fixed price sales contract at the customer’s request to establish the price for the precious metals content of the order, we may enter into a forward purchase arrangement with a precious metals supplier to completely cover the value of the precious metals content. Our current precious metals contracts are designated as normal purchase contracts, which are not marked to market.
We also purchase portions of our energy requirements, including natural gas and electricity, under fixed price contracts to reduce the volatility of cost changes. Our current energy contracts are designated as normal purchase contracts, which are not marked to market.
Pension and Other Postretirement Benefits
We sponsor defined benefit plans in the U.S. and many countries outside the U.S., and we also sponsor retiree medical benefits for a segment of our salaried and hourly work force within the U.S. The U.S. pension plans and retiree medical plans represent approximately 86% of pension plan assets, 71% of benefit obligations and 84% of net periodic pension expense as of December 31, 2021.
The assumptions we use in actuarial calculations for these plans have a significant impact on benefit obligations and annual net periodic benefit costs. We meet with our actuaries annually to discuss key economic assumptions used to develop these benefit obligations and net periodic costs.
We determine the discount rate for the U.S. pension and retiree medical plans based on a bond model. Using the pension plans’ projected cash flows, the bond model considers all possible bond portfolios that produce matching cash flows and selects the portfolio with the highest possible yield. These portfolios are based on bonds with a quality rating of AA or better under either Moody’s Investor Services, Inc. or Standard & Poor’s Rating Group, but exclude certain bonds, such as callable bonds, bonds with small amounts outstanding, and bonds with unusually high or low yields. The discount rates for the non-U.S. plans are based on a yield curve method, using AA-rated bonds applicable in their respective capital markets. The duration of each plan’s liabilities is used to select the rate from the yield curve corresponding to the same duration.
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For the market-related value of plan assets, we use fair value, rather than a calculated value. The market-related value recognizes changes in fair value in a systematic and rational manner over several years. We calculate the expected return on assets at the beginning of the year for defined benefit plans as the weighted-average of the expected return for the target allocation of the principal asset classes held by each of the plans. In determining the expected returns, we consider both historical performance and an estimate of future long-term rates of return. The Company consults with and considers the opinion of its actuaries in developing appropriate return assumptions. Our target asset allocation percentages are 35% fixed income, 60% equity, and 5% other investments for U.S. plans. Non-U.S. plan allocations are primarily comprised of fixed income securities. In 2021, our pension plan assets incurred gains of approximately 12% within the U.S. plans and 2% within non-U.S. plans. In 2020, our pension plan assets incurred gains of approximately 11% within the U.S. plans and 7% within non-U.S. plans. Future actual pension expense will depend on future investment allocation and performance, changes in future discount rates and various other factors related to the population of participants in the Company’s pension plans.
All other assumptions are reviewed periodically by our actuaries and us and may be adjusted based on current trends and expectations as well as past experience in the plans.
The following table provides the sensitivity of net annual periodic benefit costs for our pension plans, including a U.S. nonqualified retirement plan, and the retiree medical plan to a 25-basis-point decrease in both the discount rate and asset return assumption:
| (Dollars in thousands) | 25 Basis Point Decrease in Discount Rate | 25 Basis Point Decrease in Asset Return Assumption | |||||||||
| U.S. pension plans | $ | (500) | $ | 580 | |||||||
| U.S. retiree medical plan | (18) | — | |||||||||
| Non-U.S. pension plans | (138) | 26 | |||||||||
| Total | $ | (656) | $ | 606 | |||||||
The following table provides the rates used in the assumptions and the changes between 2021 and 2020:
| 2021 | 2020 | Change | |||||||||||||||
| Discount rate used to measure the benefit cost: | |||||||||||||||||
| U.S. pension plans | 2.55 | % | 3.35 | % | (0.80) | % | |||||||||||
| U.S. retiree medical plan | 2.40 | % | 3.25 | % | (0.85) | % | |||||||||||
| Non-U.S. pension plans | 1.14 | % | 1.76 | % | (0.62) | % | |||||||||||
| Discount rate used to measure the benefit obligation: | |||||||||||||||||
| U.S. pension plans | 2.85 | % | 2.55 | % | 0.30 | % | |||||||||||
| U.S. retiree medical plan | 2.80 | % | 2.40 | % | 0.40 | % | |||||||||||
| Non-U.S. pension plans | 1.43 | % | 1.29 | % | 0.14 | % | |||||||||||
| Expected return on plan assets: | |||||||||||||||||
| U.S. pension plans | 7.48 | % | 7.70 | % | (0.22) | % | |||||||||||
| Non-U.S. pension plans | 1.55 | % | 2.04 | % | (0.49) | % | |||||||||||
Our overall net periodic benefit credit for all defined benefit plans was $31.1 million in 2021 and a cost of $8.4 million in 2020. In the U.S., the net periodic benefit credit for all defined benefit plans was $26.3 million in 2021 and a cost of $2.2 million in 2020. This is primarily caused by the increase in discount rates and higher asset returns in 2021. In non-U.S. countries, the net periodic benefit credit for all defined benefit plans was $4.9 million in 2021 and a cost of $6.3 million in 2020. This is also primarily caused by the increase in discount rates in 2021.
For 2022, assuming expected returns on plan assets and no actuarial gains or losses, we expect our overall net periodic benefit income to be approximately $4.6 million, compared with income of approximately $4.9 million in 2021 on a comparable basis.
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Environmental Liabilities
Our manufacturing facilities are subject to a broad array of environmental laws and regulations in the countries in which they are located. The costs to comply with complex environmental laws and regulations are significant and will continue for the foreseeable future. We expense these recurring costs as they are incurred. While these costs may increase in the future, they are not expected to have a material impact on our financial position, liquidity or results of operations.
We also accrue for environmental remediation costs and other obligations when it is probable that a liability has been incurred and we can reasonably estimate the amount. We determine the timing and amount of any liability based upon assumptions regarding future events. Inherent uncertainties exist in such evaluations primarily due to unknown conditions and other circumstances, changing governmental regulations and legal standards regarding liability, and evolving technologies. We adjust these liabilities periodically as remediation efforts progress or as additional technical or legal information becomes available.
Impact of Newly Issued Accounting Pronouncements
Refer to Note 2 to the consolidated financial statements under Item 8 of this Annual Report on Form 10-K for a discussion of accounting standards we recently adopted or will be required to adopt. In November 2020, the SEC issued Final Rule Release No. 33-10890, Manag