UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2007

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

For the transition period from                      to                     

FERRO CORPORATION

(Exact name of registrant as specified in its charter)

Ohio		34-0217820
(State of Corporation)		(IRS Employer Identification No.)
1000 Lakeside Avenue		44114
Cleveland, OH		(Zip Code)
(Address of Principal executive offices)

216-641-8580
(Telephone Number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o

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

Large accelerated filer þ      Accelerated filer o      Non-accelerated filer o

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

At July 31, 2007, there were 43,508,944 shares of Ferro Common Stock, par value $1.00, outstanding.

 

 

TABLE OF CONTENTS

		PART I
Item 1		Financial Statements (Unaudited)		Page 3
Item 2		Management’s Discussion and Analysis of Financial Condition and Results of Operations		Page 27
Item 3		Quantitative and Qualitative Disclosures about Market Risk		Page 38
Item 4		Controls and Procedures		Page 40
		PART II
Item 1		Legal Proceedings		Page 41
Item 1A		Risk Factors		Page 41
Item 2		Unregistered Sales of Equity Securities and Use of Proceeds		Page 41
Item 3		Defaults Upon Senior Securities		Page 41
Item 4		Submission of Matters to a Vote of Security Holders		Page 41
Item 5		Other Information		Page 41
Item 6		Exhibits		Page 41
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

Ferro Corporation and Consolidated Subsidiaries
Condensed Consolidated Statements of Income

		Three months ended								Six months ended
		June 30,								June 30,
						Adjusted								Adjusted
		2007				2006				2007				2006
		(Dollars in thousands, except per share amounts)
Net sales		$	553,658			$	538,492			$	1,083,363			$	1,043,645
Cost of sales			446,131				427,586				869,056				824,905
Gross profit			107,527				110,906				214,307				218,740
Selling, general and administrative expenses			84,386				78,735				163,143				157,839
Restructuring charges			332				—				1,863				—
Other expense (income):
Interest expense			14,286				18,087				31,732				31,337
Interest earned			(189	)			(1,026	)			(1,154	)			(1,770	)
Foreign currency transactions, net			423				219				934				540
Miscellaneous expense (income), net			883				(758	)			(386	)			2,642
Income before taxes			7,406				15,649				18,175				28,152
Income tax expense			2,808				5,137				7,342				9,244
Income from continuing operations			4,598				10,512				10,833				18,908
Loss on disposal of discontinued operations, net of tax			58				341				214				467
Net income			4,540				10,171				10,619				18,441
Dividends on preferred stock			259				317				545				645
Net income available to common shareholders		$	4,281			$	9,854			$	10,074			$	17,796
Per common share data
Basic earnings:
From continuing operations		$	0.10			$	0.24			$	0.24			$	0.43
From discontinued operations			0.00				(0.01	)			0.00				(0.01	)
		$	0.10			$	0.23			$	0.24			$	0.42
Diluted earnings:
From continuing operations		$	0.10			$	0.24			$	0.24			$	0.43
From discontinued operations			0.00				(0.01	)			0.00				(0.01	)
		$	0.10			$	0.23			$	0.24			$	0.42
Cash dividends declared		$	0.145			$	0.145			$	0.29			$	0.29

See accompanying notes to condensed consolidated financial statements.

Ferro Corporation and Consolidated Subsidiaries
Condensed Consolidated Balance Sheets

						Adjusted
		June 30,				December 31,
		2007				2006
		(Dollars in thousands)
ASSETS
Current assets
Cash and cash equivalents		$	17,795			$	16,985
Accounts and trade notes receivable, net			248,630				220,899
Note receivable from Ferro Finance Corporation			30,199				16,083
Inventories			291,833				269,234
Deposits for precious metals			—				70,073
Deferred income taxes			12,593				12,291
Other current assets			29,718				25,877
Total current assets			630,768				631,442
Other assets
Property, plant and equipment, net			525,335				526,802
Goodwill and other intangible assets, net			405,710				406,340
Deferred income taxes			91,388				94,490
Other non-current assets			104,577				82,528
Total assets		$	1,757,778			$	1,741,602
LIABILITIES and SHAREHOLDERS’ EQUITY
Current liabilities
Loans payable and current portion of long-term debt		$	22,790			$	10,764
Accounts payable			253,589				237,018
Income taxes			—				8,951
Accrued payrolls			28,695				33,164
Accrued expenses and other current liabilities			92,820				91,150
Total current liabilities			397,894				381,047
Other liabilities
Long-term debt, less current portion			536,394				581,654
Postretirement and pension liabilities			188,459				194,427
Deferred income taxes			18,267				11,037
Other non-current liabilities			58,452				21,599
Total liabilities			1,199,466				1,189,764
Series A convertible preferred stock			14,602				16,787
Shareholders’ equity
Common stock			52,323				52,323
Paid-in capital			161,112				158,504
Retained earnings			586,309				600,638
Accumulated other comprehensive loss			(54,662	)			(65,138	)
Common shares in treasury, at cost			(201,372	)			(211,276	)
Total shareholders’ equity			543,710				535,051
Total liabilities and shareholders’ equity		$	1,757,778			$	1,741,602

See accompanying notes to condensed consolidated financial statements.

Ferro Corporation and Consolidated Subsidiaries
Condensed Consolidated Statement of Shareholders’ Equity and Comprehensive Income

																						Accumulated				Total
		Common Shares																				Other				Share-
		in Treasury								Common				Paid-in				Retained				Comprehensive				holders’
		Shares				Amount				Stock				Capital				Earnings				Income (Loss)				Equity
		(In thousands, except per share data)
Balances at December 31, 2006 - Adjusted			9,458			$	(211,276	)		$	52,323			$	158,504			$	600,638			$	(65,138	)		$	535,051
Net income																			10,619								10,619
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment																							12,742				12,742
Postemployment benefit liability adjustments																							(3	)			(3	)
Raw material commodity swap adjustments																							(1,512	)			(1,512	)
Interest rate swap adjustments																							(751	)			(751	)
Total comprehensive income																											21,095
Cash dividends:
Common																			(12,496	)							(12,496	)
Preferred																			(545	)							(545	)
Income tax benefits																			26								26
Transactions involving benefit plans			(571	)			9,904								2,608												12,512
Adjustment to initially apply FIN No. 48 as of January 1, 2007																			(11,933	)							(11,933	)
Balances at June 30, 2007			8,887			$	(201,372	)		$	52,323			$	161,112			$	586,309			$	(54,662	)		$	543,710

See accompanying notes to condensed consolidated financial statements.

Ferro Corporation and Consolidated Subsidiaries
Condensed Consolidated Statements of Cash Flows

		Six months ended
		June 30,
						Adjusted
		2007				2006
		(Dollars in thousands)
Cash flows from operating activities
Net income		$	10,619			$	18,441
Depreciation and amortization			43,992				38,892
Precious metals deposits			70,073				(58,000	)
Accounts and trade notes receivable, inventories, and accounts payable			(26,190	)			(59,501	)
Note receivable from Ferro Finance Corporation			(14,116	)			67,735
Other changes in current assets and liabilities, net			(7,367	)			5,957
Other adjustments, net			(7,149	)			5,814
Net cash provided by continuing operations			69,862				19,338
Net cash used for discontinued operations			(45	)			(766	)
Net cash provided by operating activities			69,817				18,572
Cash flows from investing activities
Capital expenditures for property, plant and equipment			(30,921	)			(20,829	)
Proceeds from sale of assets and businesses			1,964				5,606
Cash investment in affiliate			859				(25,000	)
Other investing activities			—				62
Net cash used for investing activities			(28,098	)			(40,161	)
Cash flows from financing activities
Net borrowings under short term facilities			10,850				1,136
Proceeds from revolving credit facility			410,295				774,000
Proceeds from term loan facility			55,000				95,000
Principal payments on revolving credit facility			(507,649	)			(823,200	)
Principal payments on term loan facility			(1,525	)			—
Debt issue costs paid			(2,086	)			(14,402	)
Proceeds from exercise of stock options			8,233				2,196
Cash dividends paid			(13,041	)			(12,955	)
Other financing activities			(1,325	)			(1,658	)
Net cash (used for) provided by financing activities			(41,248	)			20,117
Effect of exchange rate changes on cash			339				(432	)
Increase (decrease) in cash and cash equivalents			810				(1,904	)
Cash and cash equivalents at beginning of period			16,985				17,413
Cash and cash equivalents at end of period		$	17,795			$	15,509
Cash paid during the period for:
Interest		$	28,680			$	28,081
Income taxes		$	6,774			$	4,397

See accompanying notes to condensed consolidated financial statements.

Ferro Corporation and Consolidated Subsidiaries
Notes to Condensed Consolidated Financial Statements

1. Basis of Presentation

     Ferro Corporation (“Ferro,” “we,” “us” or “the Company”) prepared these unaudited condensed consolidated financial statements of Ferro Corporation and its consolidated subsidiaries in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements and, therefore, should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2006. The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the timing and amount of assets, liabilities, equity, revenues and expenses reported and disclosed. Actual amounts could differ from our estimates, resulting in changes in revenues or costs that could have a material impact on the Company’s results of operations, financial position, or cash flows. In our opinion, we made all adjustments that are necessary for a fair presentation, and those adjustments are of a normal recurring nature unless otherwise noted. Due to differing business conditions, our various initiatives, and some seasonality, the results for the three and six months ended June 30, 2007, are not necessarily indicative of the results expected in subsequent quarters or for the full year.

     Interest earned in the three and six months ended June 30, 2006, of $1.0 million and $1.8 million, respectively, was reclassified from miscellaneous (income) expense, net, and is shown separately in the condensed consolidated statements of income.

2. Accounting Methods Adopted in the Six Months Ended June 30, 2007

     On January 1, 2007, we elected to change our costing method for our inventories not already costed under the lower of cost or market using the first-in, first-out (“FIFO”) method, while in prior years, these inventories were costed under the lower of cost or market using the last-in, first-out (“LIFO”) method. The percentage of inventories accounted for under the LIFO method at December 31, 2006, was 13.8% for U.S. inventories and 6.2% for consolidated inventories. We believe the FIFO method is preferable as it conforms the inventory costing methods for all of our inventories to a single method and improves comparability with our industry peers. The FIFO method also better reflects current acquisition cost of those inventories on our consolidated balance sheets and enhances the matching of future cost of sales with revenues. In accordance with Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Correction, all prior periods presented have been adjusted to apply the new method retrospectively. The effect of the change in our inventory costing method includes the LIFO reserve and related impact on the obsolescence reserve. This change increased our inventory balance by $13.7 million and increased retained earnings, net of income tax effects, by $8.5 million as of January 1, 2006.

     On January 1, 2007, we also changed our accounting method of accruing for major planned overhauls. Financial Accounting Standards Board (“FASB”) Staff Position No. AUG AIR-1, Accounting for Planned Maintenance Activities, (“AUG AIR-1”), prohibits our prior policy of accruing for major planned overhauls in advance of when the actual costs are incurred. Under our new policy, the costs of major planned overhauls are expensed when incurred. All prior periods presented have been adjusted to apply the new method retrospectively. Adoption of this accounting pronouncement decreased our accrued expenses and other current liabilities by $2.2 million and increased retained earnings, net of income tax effects, by $1.5 million as of January 1, 2006.

     On January 1, 2007, we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, (“FIN 48”). FIN 48 clarifies what criteria must be met prior to recognition of the financial statement benefit of a position taken or expected to be taken in a tax return. This interpretation also provides guidance on de-recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods, and income tax disclosures. The adoption of this interpretation decreased the opening balance of retained earnings by $11.9 million as of January 1, 2007. We have elected to continue to report interest and penalties as income tax expense.

     On January 1, 2007, we also adopted Statement of Financial Accounting Standards No. 156, Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140, (“FAS No. 156”). This statement requires an entity to recognize at fair value a servicing asset or liability each time it undertakes an obligation to service a financial asset by

entering into a servicing contract. We provide “collection agent” services for our U.S. and certain international receivable sales programs. The “collection agent” fees received by the Company approximate adequate compensation. Therefore, the adoption of FAS No. 156 did not have an effect on our consolidated financial statements.

     We have presented the effects of the changes in accounting principles for inventory costs and for major planned overhauls for 2007 and 2006 below. We have combined certain financial statement line items if they were not affected by the changes in accounting principles.

Condensed Consolidated Statements of Income

		Three months ended June 30, 2007
		Computed				Change to				Reported
		under LIFO				FIFO				under FIFO
		(Dollars in thousands, except per share amounts)
Net sales		$	553,658			$	—			$	553,658
Cost of sales			446,663				(532	)			446,131
Gross profit			106,995				532				107,527
Selling, general and administrative expenses			84,386				—				84,386
Restructuring charges			332				—				332
Other expense			15,403				—				15,403
Income before taxes			6,874				532				7,406
Income tax expense			2,612				196				2,808
Income from continuing operations			4,262				336				4,598
Loss on disposal of discontinued operations, net of tax			58				—				58
Net income			4,204				336				4,540
Dividends on preferred stock			259				—				259
Net income available to common shareholders		$	3,945			$	336			$	4,281
Per common share data
Basic earnings:
From continuing operations		$	0.09			$	0.01			$	0.10
From discontinued operations			0.00				0.00				0.00
		$	0.09			$	0.01			$	0.10
Diluted earnings:
From continuing operations		$	0.09			$	0.01			$	0.10
From discontinued operations			0.00				0.00				0.00
		$	0.09			$	0.01			$	0.10

		Six months ended June 30, 2007
		Computed				Change to				Reported
		under LIFO				FIFO				under FIFO
		(Dollars in thousands, except per share amounts)
Net sales		$	1,083,363			$	—			$	1,083,363
Cost of sales			869,687				(631	)			869,056
Gross profit			213,676				631				214,307
Selling, general and administrative expenses			163,143				—				163,143
Restructuring charges			1,863				—				1,863
Other expense			31,126				—				31,126
Income before taxes			17,544				631				18,175
Income tax expense			7,107				235				7,342
Income from continuing operations			10,437				396				10,833
Loss on disposal of discontinued operations, net of tax			214				—				214
Net income			10,223				396				10,619
Dividends on preferred stock			545				—				545
Net income available to common shareholders		$	9,678			$	396			$	10,074
Per common share data
Basic earnings:
From continuing operations		$	0.23			$	0.01			$	0.24
From discontinued operations			0.00				0.00				0.00
		$	0.23			$	0.01			$	0.24
Diluted earnings:
From continuing operations		$	0.23			$	0.01			$	0.24
From discontinued operations			0.00				0.00				0.00
		$	0.23			$	0.01			$	0.24

		Three months ended June 30, 2006
		Originally				Change to				Adoption of
		Reported				FIFO				AUG AIR-1				Adjusted
		(Dollars in thousands, except per share amounts)
Net sales		$	538,492			$	—			$	—			$	538,492
Cost of sales			427,602				56				(72	)			427,586
Gross profit			110,890				(56	)			72				110,906
Selling, general and administrative expenses			78,735				—				—				78,735
Other expense			16,522				—				—				16,522
Income before taxes			15,633				(56	)			72				15,649
Income tax expense			5,142				(21	)			16				5,137
Income from continuing operations			10,491				(35	)			56				10,512
Loss on disposal of discontinued operations, net of tax			341				—				—				341
Net income			10,150				(35	)			56				10,171
Dividends on preferred stock			317				—				—				317
Net income available to common shareholders		$	9,833			$	(35	)		$	56			$	9,854
Per common share data
Basic earnings:
From continuing operations		$	0.24			$	0.00			$	0.00			$	0.24
From discontinued operations			(0.01	)			0.00				0.00				(0.01	)
		$	0.23			$	0.00			$	0.00			$	0.23
Diluted earnings:
From continuing operations		$	0.24			$	0.00			$	0.00			$	0.24
From discontinued operations			(0.01	)			0.00				0.00				(0.01	)
		$	0.23			$	0.00			$	0.00			$	0.23

		Six months ended June 30, 2006
		Originally				Change to				Adoption of
		Reported				FIFO				AUG AIR-1				Adjusted
		(Dollars in thousands, except per share amounts)
Net sales		$	1,043,645			$	—			$	—			$	1,043,645
Cost of sales			824,848				234				(177	)			824,905
Gross profit			218,797				(234	)			177				218,740
Selling, general and administrative expenses			157,839				—				—				157,839
Other expense			32,749				—				—				32,749
Income before taxes			28,209				(234	)			177				28,152
Income tax expense			9,280				(87	)			51				9,244
Income from continuing operations			18,929				(147	)			126				18,908
Loss on disposal of discontinued operations, net of tax			467				—				—				467
Net income			18,462				(147	)			126				18,441
Dividends on preferred stock			645				—				—				645
Net income available to common shareholders		$	17,817			$	(147	)		$	126			$	17,796
Per common share data
Basic earnings:
From continuing operations		$	0.43			$	0.00			$	0.00			$	0.43
From discontinued operations			(0.01	)			0.00				0.00				(0.01	)
		$	0.42			$	0.00			$	0.00			$	0.42
Diluted earnings:
From continuing operations		$	0.43			$	0.00			$	0.00			$	0.43
From discontinued operations			(0.01	)			0.00				0.00				(0.01	)
		$	0.42			$	0.00			$	0.00			$	0.42

Condensed Consolidated Balance Sheets

		June 30, 2007
		Computed				Change to				Reported
		under LIFO				FIFO				under FIFO
		(Dollars in thousands)
ASSETS
Current assets
Inventories		$	276,481			$	15,352			$	291,833
Deferred income taxes			18,443				(5,850	)			12,593
Other current assets			326,342				—				326,342
Total current assets			621,266				9,502				630,768
Other assets			1,127,010				—				1,127,010
Total assets		$	1,748,276			$	9,502			$	1,757,778
LIABILITIES and SHAREHOLDERS’ EQUITY
Current liabilities		$	397,894			$	—			$	397,894
Other liabilities			801,572				—				801,572
Total liabilities			1,199,466				—				1,199,466
Series A convertible preferred stock			14,602				—				14,602
Shareholders’ equity
Retained earnings			576,807				9,502				586,309
Other shareholders’ equity			(42,599	)			—				(42,599	)
Total shareholders’ equity			534,208				9,502				543,710
Total liabilities and shareholders’ equity		$	1,748,276			$	9,502			$	1,757,778

		December 31, 2006
		Originally				Change to				Adoption of
		Reported				FIFO				AUG AIR-1				Adjusted
		(Dollars in thousands)
ASSETS
Current assets
Inventories		$	254,513			$	14,721			$	—			$	269,234
Deferred income taxes			18,175				(5,615	)			(269	)			12,291
Other current assets			349,917				—				—				349,917
Total current assets			622,605				9,106				(269	)			631,442
Other assets
Deferred income taxes			94,662				—				(172	)			94,490
Other non-current assets			1,015,670				—				—				1,015,670
Total assets		$	1,732,937			$	9,106			$	(441	)		$	1,741,602
LIABILITIES and SHAREHOLDERS’ EQUITY
Current liabilities
Income taxes		$	8,732			$	—			$	219			$	8,951
Accrued expenses and other current liabilities			93,206				—				(2,056	)			91,150
Other current liabilities			280,946				—				—				280,946
Total current liabilities			382,884				—				(1,837	)			381,047
Other liabilities			808,717				—				—				808,717
Total liabilities			1,191,601				—				(1,837	)			1,189,764
Series A convertible preferred stock			16,787				—				—				16,787
Shareholders’ equity
Retained earnings			590,136				9,106				1,396				600,638
Other shareholders’ equity			(65,587	)			—				—				(65,587	)
Total shareholders’ equity			524,549				9,106				1,396				535,051
Total liabilities and shareholders’ equity		$	1,732,937			$	9,106			$	(441	)		$	1,741,602

Condensed Consolidated Statements of Cash Flows

		Six months ended June 30, 2007
		Computed				Change to				Reported
		under LIFO				FIFO				under FIFO
		(Dollars in thousands)
Cash flows from operating activities
Net income		$	10,223			$	396			$	10,619
Depreciation and amortization			43,992				—				43,992
Precious metals deposits			70,073				—				70,073
Accounts and trade notes receivable, inventories, and accounts payable			(25,559	)			(631	)			(26,190	)
Note receivable from Ferro Finance Corporation			(14,116	)			—				(14,116	)
Other changes in current assets and liabilities, net			(7,367	)			—				(7,367	)
Other adjustments, net			(7,384	)			235				(7,149	)
Net cash provided by continuing operations			69,862				—				69,862
Net cash used for discontinued operations			(45	)			—				(45	)
Net cash provided by operating activities			69,817				—				69,817
Cash flows from investing activities			(28,098	)			—				(28,098	)
Cash flows from financing activities			(41,248	)			—				(41,248	)
Effect of exchange rate changes on cash			339				—				339
Increase in cash and cash equivalents			810				—				810
Cash and cash equivalents at beginning of period			16,985				—				16,985
Cash and cash equivalents at end of period		$	17,795			$	—			$	17,795

		Six months ended June 30, 2006
		Originally				Change to				Adoption of
		Reported				FIFO				AUG AIR-1				Adjusted
		(Dollars in thousands)
Cash flows from operating activities
Net income		$	18,462			$	(147	)		$	126			$	18,441
Depreciation and amortization			38,892				—				—				38,892
Precious metals deposits			(58,000	)			—				—				(58,000	)
Accounts and trade notes receivable, inventories, and accounts payable			(59,735	)			234				—				(59,501	)
Note receivable from Ferro Finance Corporation			67,735				—				—				67,735
Other changes in current assets and liabilities, net			6,094				—				(137	)			5,957
Other adjustments, net			5,890				(87	)			11				5,814
Net cash provided by continuing operations			19,338				—				—				19,338
Net cash used for discontinued operations			(766	)			—				—				(766	)
Net cash provided by operating activities			18,572				—				—				18,572
Cash flows from investing activities			(40,161	)			—				—				(40,161	)
Cash flows from financing activities			20,117				—				—				20,117
Effect of exchange rate changes on cash			(432	)			—				—				(432	)
Decrease in cash and cash equivalents			(1,904	)			—				—				(1,904	)
Cash and cash equivalents at beginning of period			17,413				—				—				17,413
Cash and cash equivalents at end of period		$	15,509			$	—			$	—			$	15,509

3. Newly Issued Accounting Pronouncement

     In June 2007, the Emerging Issues Task Force of the FASB reached a consensus on Issue No. 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards, (“EITF No. 06-11”). EITF No. 06-11 requires that the income tax benefit from dividends that are charged to retained earnings and paid to employees for nonvested equity shares be recognized as an increase to paid-in capital. Currently, we recognize this income tax benefit as an increase to retained earnings. EITF No. 06-11 is to be applied prospectively in fiscal years beginning after December 15, 2007. Beginning in 2008, we will report this income tax benefit as an increase to paid-in capital.

4. Inventories

     As noted in Note 2, effective January 1, 2007, we elected to change our costing method for selected inventories. We applied this change in accounting principle by adjusting all prior periods presented retrospectively. Inventories consisted of the following:

						Adjusted
		June 30,				December 31,
		2007				2006
		(Dollars in thousands)
Raw materials		$	84,902			$	74,160
Work in process			44,919				44,658
Finished goods			162,012				150,416
Total		$	291,833			$	269,234

     In the production of some of our products, we use precious metals, some of which we obtain from financial institutions under consignment agreements with terms of one year or less. The financial institutions retain ownership of the precious metals and charge us fees based on the amounts we consign. These fees were $1.0 million and $0.9 million for the three months ended June 30, 2007 and 2006, respectively, and $2.0 million and $1.4 million for the six months ended June 30, 2007 and 2006, respectively, and were charged to cost of sales. In November 2005, the financial institutions renewed their requirement for cash deposits from us to provide additional collateral beyond the value of the underlying precious metals. Outstanding collateral deposits were $70.1 million at December 31, 2006. These requirements were eliminated during the first half of 2007. We had on hand $113.7 million at June 30, 2007, and $120.9 million at December 31, 2006, of precious metals owned by financial institutions, measured at fair value.

5. Property, Plant and Equipment

     Property, plant and equipment is reported net of accumulated depreciation of $733.0 million at June 30, 2007, and $691.4 million at December 31, 2006.

6. Financing and Long-term Debt

     Long-term debt consists of the following:

		June 30,				December 31,
		2007				2006
		(Dollars in thousands)
$200,000 Senior Notes, 9.125%, due 2009 *		$	199,454			$	199,273
Revolving credit facility			30,599				127,953
Term loan facility			303,475				250,000
Capital lease obligations			6,410				6,744
Other notes			841				1,008
			540,779				584,978
Less current portion			(4,385	)			(3,324	)
Total		$	536,394			$	581,654

Credit Rating

     In May 2007, Moody’s Investor Services, Inc. (“Moody’s”) reassigned a senior credit rating to the Company after withdrawing its rating in March 2006 due to delays in the filing of financial statements for 2005 and quarterly statements for 2004 through 2006. At June 30, 2007, the Company’s senior credit rating was B1, with a positive outlook, by Moody’s and B+, with a stable outlook, by Standard & Poor’s Rating Group (“S&P”).

Revolving Credit and Term Loan Facilities

     In 2006, we entered into an agreement with a group of lenders for a $700 million credit facility. At that time, the credit facility consisted of a five-year, $250 million multi-currency senior revolving credit facility and a six-year, $450 million senior term loan facility.

     In June 2007, we amended the credit facility (the “Amended Credit Facility”) primarily to increase the size of the revolving credit facility by $50 million to $300 million, reduce interest expense, and increase operating flexibility. We had $260.7 million at June 30, 2007, and $109.3 million at December 31, 2006, available under the revolving credit facility, after reductions for standby letters of credit secured by this facility. In addition, we can request an increase of $50 million in the revolving credit facility. With the amendment, we reduced the margins for borrowings under both the revolving credit and the term loan facilities as compared with the margins that were in effect prior to the amendment. For the revolving credit facility, as amended, the variable margin is based on the Company’s leverage ratio. Previously, the variable margin was based on the Company’s credit ratings as determined by S&P and Moody’s. In addition, the amendment increased our operating flexibility by increasing the amount of restructuring and manufacturing rationalization programs permitted, relaxing restrictions on the use of proceeds from asset dispositions, and modifying covenants related to Ferro’s leverage ratio and fixed charge coverage ratio.

     In January 2007, we borrowed $55 million of our term loan facility and used the proceeds to reduce borrowings under our revolving credit facility. We also cancelled the remaining unused term loan commitment of $145 million, which was reserved to finance the potential accelerated payment of the senior notes, since the default under the senior notes was no longer continuing. As a result of canceling the remaining commitment, we wrote off to interest expense $2.0 million of deferred fees related to the term loan facility in the first quarter of 2007. In the second quarter of 2007, we began making periodic principal payments on the term loans. At June 30, 2007, we had borrowed $303.5 million in term loans. The Company is required to make quarterly principal payments of $0.8 million from July 2007 to July 2011 and $72.6 million from October 2011 to April 2012 and a final payment of $72.6 million in June 2012.

     The interest rates under the Amended Credit Facility are the sum of (A) either (1) LIBOR or (2) the higher of the Federal Funds Rate plus 0.5% or the Prime Rate and (B) for the revolving credit facility, a variable margin based on the Company’s

leverage, or for the term loan facility, a fixed margin. As part of the June 2007 amendments, $175 million of borrowings under the term loan facility were restricted to using three-month LIBOR in determining their interest rates. This change was made in connection with interest rate swap agreements executed in June 2007. These swap agreements effectively fixed the interest rate through June 2011 on $150 million of borrowings under the term loan facility. At June 30, 2007, the average interest rate for revolving credit borrowings was 6.8%, and the effective interest rate for term loan borrowings after adjusting for the interest rate swaps was 7.5%. At December 31, 2006, the average interest rate was 8.1% for revolving credit borrowings and 8.1% for term loan borrowings.

Senior Notes and Debentures

     The senior notes are redeemable at our option at any time for the principal amount then outstanding plus the present value of unpaid interest through maturity. The senior notes are redeemable at the option of the holders only upon a change in control of the Company combined with a rating by either Moody’s or S&P below investment grade as defined in the indenture. Currently, the ratings by Moody’s and S&P of the senior notes are below investment grade.

Receivable Sales Programs

     We have several programs to sell, on an ongoing basis, pools of our trade accounts receivable. These programs accelerate cash collections at favorable financing costs and help us manage the Company’s liquidity requirements. In our largest program, we sell substantially all of Ferro’s U.S. trade accounts receivable to Ferro Finance Corporation (“FFC”), a wholly-owned unconsolidated qualified special purpose entity (“QSPE”). FFC finances its acquisition of trade receivable assets by issuing beneficial interests in (securitizing) the receivables to multi-seller receivables securitization companies (the “Conduits”) for proceeds of up to $100.0 million. FFC had received net proceeds of $61.3 million at June 30, 2007, and $60.6 million at December 31, 2006, for outstanding receivables. FFC and the Conduits have no recourse to Ferro’s other assets for failure of debtors to pay when due, as the assets transferred are legally isolated in accordance with the U.S. bankruptcy laws. Ferro, on behalf of FFC and the Conduits, provides normal “collection agent” services with respect to the trade accounts receivable sold. In June 2007, we amended the program primarily to reduce its fees and to make Ferro’s leverage ratio the basis for these fees.

     Activity from this program for the six months ended June 30 is detailed below:

		2007				2006
		(Dollars in thousands)
Trade accounts receivable sold to FFC		$	497,358			$	528,834
Cash proceeds from FFC			482,838				596,288
Trade accounts receivable collected and remitted to FFC and the conduits			482,138				513,388

     In addition, we maintain several international programs to sell trade accounts receivable, primarily without recourse. The commitments supporting these programs can be withdrawn at any time and totaled $61.2 million and $49.2 million at June 30, 2007, and December 31, 2006, respectively. The amount of outstanding receivables sold under the international programs was $39.3 million and $33.7 million at June 30, 2007, and December 31, 2006, respectively.

Other Financing Arrangements

     In June 2007, we entered into two international variable-rate credit facilities secured by specific accounts receivable. At June 30, 2007, the commitments under these facilities, which can be withdrawn at any time, totaled $22.3 million, and the borrowings totaled $14.9 million.

7. Financial Instruments

     The carrying amounts of borrowings under the Amended Credit Facility approximate their fair values, due to their variable market interest rates. To reduce our exposure to interest rate changes on variable-rate debt, we entered into interest rate swap agreements. These swaps effectively converted $150 million of our variable-rate debt to a fixed rate.

     The carrying amount of the senior notes was $199.5 million at June 30, 2007, and $199.3 million at December 31, 2006. The fair value of the senior notes was $205.5 million at June 30, 2007, and $205.5 million at December 31, 2006. The fair value of Ferro’s senior notes is based on a third party’s estimated bid price.

     We manage foreign currency risks principally by entering into forward contracts to mitigate the impact of currency fluctuations on transactions. We hedge a portion of our exposure to changes in the pricing of certain raw material

commodities principally using swap arrangements that allow us to fix the price of the commodities for future purchase. When we enter into fixed price sales contracts for products with precious metal content, we also enter into a forward purchase arrangement with a precious metals supplier to completely cover the value of the fixed price sales contract. We also purchase portions of our natural gas requirements under fixed price contracts to reduce the volatility of cost changes. For gas contracts entered into prior to April 2006, we marked these contracts to fair value and recognized the resulting gains or losses as miscellaneous income or expense, respectively. Beginning April 2006, we designated new natural gas contracts as normal purchase contracts, which are not marked-to-market. Our purchase commitment for natural gas under normal purchase contracts was $7.4 million at June 30, 2007.

     The notional amounts, carrying amounts of assets (liabilities), and fair values of these derivative instruments were as follows:

		June 30,				December 31,
		2007				2006
		(Dollars in thousands)
Interest rate swaps:
Notional amount		$	150,000			$	—
Carrying amount and fair value		$	(1,231	)		$	—
Foreign currency forward contracts:
Notional amount		$	157,018			$	121,430
Carrying amount and fair value		$	(281	)		$	(640	)
Raw material commodity swaps:
Notional amount (in metric tons of base metals)			1,564				2,004
Carrying amount and fair value		$	(1,047	)		$	1,939
Precious metals forward contracts:
Notional amount (in troy ounces)			206,403				183,264
Carrying amount and fair value		$	124			$	192
Marked-to-market natural gas forward purchase contracts:
Notional amount (in MBTUs)			—				120,000
Carrying amount and fair value		$	—			$	(442	)

8. Income Taxes

     Income tax expense for the six months ended June 30, 2007, was $7.3 million or 40.4% of pre-tax income compared with $9.2 million or 32.9% of pre-tax income in the first half of 2006. The primary reasons for the increase in the effective tax rate were a change in the mix of income by country and a relatively high level of current year earnings repatriated from outside the United States.

     On January 1, 2007, we adopted FIN 48. For further information regarding the adoption of FIN 48, refer to Note 2.

     As of January 1, 2007, we had unrecognized tax benefits of $47.4 million, which, if recognized, would have a favorable impact of $23.5 million on income tax expense. We have recorded accrued interest and penalties related to unrecognized tax benefits totaling $3.7 million at January 1, 2007. During the first half of 2007, there were no significant changes in the amount of unrecognized tax benefits. We do not anticipate any significant increase or decrease in the amount of unrecognized tax benefits within the next twelve months.

     The Company conducts business globally, and, as a result, the U.S. parent company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. In the normal course of business, the U.S. parent company and its subsidiaries are subject to examination by taxing authorities. With few exceptions, we are not subject to federal, state, local or non-U.S. income tax examinations for years before 2000.

9. Contingent Liabilities

     In February 2003, we were requested to produce documents in connection with an investigation by the United States Department of Justice into possible antitrust violations in the heat stabilizer industry. In April 2006, we were notified by the Department of Justice that the Government had closed its investigation and that the Company was relieved of any obligation to retain documents that were responsive to the Government’s earlier document request. Before closing its investigation, the Department of Justice took no action against the Company or any of its current or former employees. The Company was previously named as a defendant in several lawsuits alleging civil damages and requesting injunctive relief relating to the conduct the Government was investigating. We entered into a verbal agreement in June 2007 and a definitive written settlement agreement in July 2007 with the direct purchasers in one of these class action civil lawsuits related to alleged antitrust violations in the heat stabilizer industry. Although the Company decided to bring this matter to a close through settlement, the Company did not admit to any of the alleged violations and continues to deny any liability. The settlement agreement must be approved by the United States District Court for the Eastern District of Pennsylvania. During the quarter ended June 30, 2007, and as a result of the settlement agreement, the Company recorded a reserve of approximately $6.3 million for a settlement payment of $5.5 million to the direct purchasers and a settlement payment of approximately $0.8 million to PolyOne Corporation, which opted out of the class of direct purchasers and entered into a separate settlement agreement with the Company. The Company is vigorously defending the remaining two civil actions alleging antitrust violations in the heat stabilizer industry. In addition, the Company believes that it has a claim for indemnification by the former owner of the Company’s heat stabilizer business for the defense of these lawsuits and any resulting payments by the Company, including the payments of approximately $6.3 million to the class of direct purchasers and PolyOne Corporation. The remaining two actions are in their preliminary stages; therefore, we cannot determine the outcomes of these lawsuits at this time.

     In a July 2004 press release, we announced that our Polymer Additives business performance in the second quarter of 2004 fell short of expectations and that our Audit Committee would investigate possible inappropriate accounting entries in the Polymer Additives business. We were later sued in a series of putative securities class action lawsuits related to this July 2004 announcement. Those lawsuits were consolidated into a single case in the United States District Court for the Northern District of Ohio against the Company, our deceased former Chief Executive Officer, our former Chief Financial Officer, and a former Operating Vice President of the Company. This claim was based on alleged violations of Federal securities laws. We considered these allegations to be unfounded and defended this action vigorously. In June 2007, the Court dismissed the consolidated case without prejudice. While the plaintiffs may appeal this decision, we do not expect the ultimate outcome of the case to have a material effect on the financial position, results of operations or cash flows of the Company.

     Also following this July 2004 press release, four derivative lawsuits were filed and subsequently consolidated in the United States District Court for the Northern District of Ohio. These lawsuits alleged breach of fiduciary duties and mismanagement-related claims. In March 2006, the Court dismissed the consolidated derivative action without prejudice. In April 2006, the plaintiffs filed a motion seeking relief from the judgment that dismissed the derivative lawsuit and seeking to amend their complaint further following discovery. The plaintiffs’ motion was denied. Later in April 2006, plaintiffs filed a Notice of Appeal to the Sixth Circuit Court of Appeals. The Directors and named executives consider the allegations contained in the derivative actions to be unfounded, have vigorously defended this action and will defend against the new filing. We have notified Ferro’s directors and officers liability insurer of the claim. This appeal is currently under consideration by the Sixth Circuit Court of Appeals; therefore, we cannot determine the outcome of this litigation at this time.

     Finally, in June 2005, a putative class action lawsuit was filed against the Company and certain former and current employees alleging breach of fiduciary duty with respect to ERISA plans in connection with the matters announced in the July 2004 press release. In October 2006, the parties reached a settlement in principle that would result in the dismissal of the lawsuit with prejudice in exchange for a settlement amount of $4.0 million, which would be paid by the Company’s liability insurer subject to our satisfaction of the remaining retention amount under the insurance policy. The Company and the individual defendants have expressly denied any and all liability. The United States District Court granted preliminary approval of the settlement in November 2006. Several conditions must be met before the settlement becomes final. We do not expect the ultimate outcome of the lawsuit to have a material effect on the financial position, results of operations or cash flows of the Company.

     In October 2004, the Belgian Ministry of Economic Affairs’ Commercial Policy Division (the “Ministry”) served on our Belgian subsidiary a mandate requiring the production of certain documents related to an alleged cartel among producers of

butyl benzyl phthalate (“BBP”) from 1983 to 2002. Subsequently, German and Hungarian authorities initiated their own national investigations related to the same allegations. Our Belgian subsidiary acquired its BBP business from Solutia Europe S.A./N.V. (“SOLBR”) in August 2000. Ferro promptly notified SOLBR of the Ministry’s actions and requested SOLBR to indemnify and defend Ferro and its Belgian subsidiary with respect to these investigations. In response to our notice, SOLBR exercised its right under the 2000 acquisition agreement to take over the defense and settlement of these matters. In December 2005, the Hungarian authorities imposed a de minimis fine on our Belgian subsidiary, and we expect the German and Belgian authorities also to assess fines for the alleged conduct. We cannot predict the amount of fines that will ultimately be assessed and cannot predict the degree to which SOLBR will indemnify Ferro’s Belgian subsidiary for such fines.

     In February 2007, we discovered that some of the values shown on certificates of analysis provided to customers by a plant in our Specialty Plastics segment were inaccurate. We are working with the customers of the Specialty Plastics business to provide those customers with products that meet their performance requirements and are accurately described on the corresponding certificates of analysis. While it is possible some customers may not accept products with new specifications or otherwise assert claims relating to this issue, we cannot predict at this time the financial effects of any resulting lost business or claims.

     There are various other lawsuits and claims pending against the Company and its consolidated subsidiaries. In our opinion, the ultimate liabilities, if any, and expenses resulting from such lawsuits and claims will not materially affect the consolidated financial position, results of operations, or cash flows of the Company.

     The Company had bank guarantees and standby letters of credit issued by financial institutions, which totaled $17.0 million at June 30, 2007, and $20.8 million at December 31, 2006. These agreements primarily relate to Ferro’s insurance programs, natural gas contracts, potential environmental remediation liabilities, and foreign tax payments. If the Company fails to perform its obligations, the guarantees and letters of credit may be drawn down by their holders, and we would be liable to the financial institutions for the amounts drawn.

10. Retirement Benefits

     Information concerning net periodic benefit costs of our U.S. pension plans (including our unfunded nonqualified plans), non-U.S. pension plans, and postretirement health care and life insurance benefit plans for the three months ended June 30 is as follows:

		U.S. Pension Plans								Non-U.S. Pension Plans								Other Benefit Plans
		2007				2006				2007				2006				2007				2006
		(Dollars in thousands)
Components of net periodic cost:
Service cost		$	315			$	2,586			$	1,633			$	1,792			$	152			$	191
Interest cost			5,029				5,144				2,318				1,874				859				831
Expected return on plan assets			(5,129	)			(4,852	)			(1,837	)			(1,473	)			—				—
Amortization of prior service cost			39				27				28				35				(293	)			(158	)
Net amortization and deferral			1,473				1,686				145				233				—				—
Curtailment and settlement effects			—				2,415				—				—				—				(2,453	)
Net periodic benefit cost		$	1,727			$	7,006			$	2,287			$	2,461			$	718			$	(1,589	)