Ferro 2001 Annual Report - Letter to Shareholders

Hector R. Ortino, Chairman and Chief Executive Officer

While the year 2001 was a difficult and challenging one for our Company, the United States and much of the world, we at Ferro continued to execute the strategies we have identified to deliver strong growth over the long term. As the theme of this Annual Report indicates, we are moving Ferro in the right direction by maximizing our strengths and taking advantage of opportunities in world markets with solid long-term potential.

All of the actions we took during the year -- from the dmc² acquisition to our constant efforts to control costs and pay down debt -- helped position Ferro more favorably for profitable growth. Although we are disappointed by our 2001 results, we remain committed to our long-term financial goals of 6 to 8 percent annual sales growth and earnings per share growth of 12 percent.

To achieve these goals, we have focused on three strategic drivers:

• Portfolio management. We continue to improve our portfolio mix by achieving a higher potential balance of high-growth, moderate-growth and mature, cash-generating businesses. Our acquisition of certain businesses of dmc² in 2001 accelerates our strategy by creating critical mass in areas designated as high-growth.

• Geographic Expansion. We are broadening the geographic scope of many of our businesses to take advantage of growing markets, especially in Asia. Following the dmc² acquisition, international sales account for nearly half of our total sales.

• Acquisitions. Our acquisition strategy has been integral in our effort to reshape our Company for the future. Recent acquisitions complemented our existing strengths and expanded many of our businesses that have the greatest potential. Although we do not anticipate further acquisitions until we have reduced leverage to pre-dmc² levels, they remain a key element in our long-term strategy.

2001 FINANCIAL RESULTS
Our financial results for 2001 were affected by the economic recession in the United States and the resulting impact on the rest of the world, especially the European economy in the latter part of the year. Despite these challenging conditions, we made significant progress in achieving cost synergies, generating free cash flow and aggressively reducing debt.

Sales for the year were a record $1.50 billion, compared with $1.45 billion in 2000. Increased volume from acquisitions helped offset the slowdowns in our markets. Net income for the year was $39.2 million, or $1.04 per diluted share, compared with $73.1 million, or $1.92 per diluted share, in 2000. Earnings reflect lower production rates due to reduced demand.

Additional sales related to the acquisitions offset soft market demand in both of our business segments. Sales in the Coatings segment were $920.7 million in 2001, up from $878.5 million in 2000. Operating income was $71.1 million in 2001, compared with $99.5 million the prior year. The decline in operating income reflects the slowdown in the electronics industry and decreased demand for durable goods, building and renovation products, and household items.

The Performance Chemicals segment reported sales of $580.4 million in 2001, up from $568.8 million the prior year. Operating income for this segment was $39.1 million, compared with $54.9 million in 2000. Reduced sales volume resulted in lower manufacturing cost absorption for this segment, which was affected by a decline in activity in construction, durable goods and industrial markets, as well as an overall decrease in consumer spending.

ACQUISITIONS AND INTEGRATION
We have completed four acquisitions over the past two years and seven acquisitions over the past four years. Six of these acquisitions are now fully integrated into our overall business. The seventh, and our most strategic acquisition to date, was the dmc² businesses. Each of these acquisitions has played a major role in our strategic growth initiatives by expanding and strengthening our core businesses, providing significant synergies and allowing us to generate stronger cash flows from operations.

We are working diligently to integrate the dmc² acquisition, which was completed in September 2001, and we are pleased with the rapid progress we have made. By the end of 2001, we had achieved $20 million in annual cost synergies by eliminating duplicate facilities and reducing overhead. In 2002, we expect to achieve additional cost synergies related to the acquisition through further consolidation of functions and the manufacturing base, and capitalizing on our larger, combined purchasing base to save on raw material costs.

In addition to cost synergies, the dmc² acquisition has greatly improved Ferro's position for growth by broadening our geographic reach, adding complementary business lines to our product mix and increasing our technology and marketing capabilities in our worldwide businesses. The acquisition is a perfect strategic fit for Ferro and significantly strengthens three of our core businesses -- Electronic Material Systems, Color and Glass Performance Materials, and Tile Coating Systems.

In Electronic Material Systems, Ferro is now a worldwide technology leader in materials for passive electronic components. The acquisition expands our operations in the United States, Europe and Japan. The operation and increased presence in Asia Pacific is significant because it represents approximately 45 percent of the worldwide electronic materials market. This expanded geographic reach will enable us to serve these markets better, which are expected to grow significantly over the long term.

In Tile Coating Systems, the dmc² acquisition enhances our worldwide leadership position in decorative glass and colors. The dmc² operations in Asia and Southern Europe complement our manufacturing capabilities in these regions, providing significant cost-saving opportunities to this core business.

In addition, the acquisition doubled the size of our Color and Glass Performance Materials business. It expanded our product line, broadened the geographic base of our business and created a much stronger technology platform through complementary research and development activities.

FOCUSING ON WHAT WE CAN CONTROL
As we strategically reshape Ferro into a higher-growth-profile company, we are strengthening our position for long-term earnings growth by improving the balance sheet, cutting costs and focusing on factors that we can control. We will remain aggressive in our efforts to pay down our debt and restore the balance sheet to its pre-dmc² acquisition levels.

All of our businesses continued to implement aggressive cost containment measures in 2001, and our employees have responded tremendously to the challenges presented by the global economy. As evidence of our success, in the last half of 2001, we aggressively reduced working capital by approximately $139 million and generated roughly $149 million in free cash flow from operations for debt reduction, repaying more than 25 percent of the dmc² acquisition price.

On a worldwide basis, our focus is on developing and strengthening the successful niche products that we offer, taking them into high-growth geographic areas such as Asia, and expanding our manufacturing capabilities to serve those growing markets. On a region-by-region basis, 54 percent of our revenue now comes from North America, 32 percent from Europe, 8 percent from Asia and 6 percent from Latin America.

Our geographic and end-market diversification has helped offset the impact of regional economic and market downturns on our overall business. Our extensive global presence also allows us to leverage our technology expertise and product development skills to serve the needs of multinational customers better.

Innovative technology has been, and will continue to be, a key to Ferro's success. We encourage and fund creative ideas to develop new products throughout all of our businesses. We remain committed to investing wisely in research and technical development to ensure that new products and improved processes meet the dynamic needs of the market. As part of our effort to be more customer-focused, we now coordinate our sales and marketing efforts more closely with R&D. For example, we have centralized our labs to focus on specific business units, especially those that represent the greatest potential for higher growth.

BOARD OF DIRECTORS
A company with Ferro's geographic scope, strategic vision and commitment to innovation needs an experienced and insightful Board of Directors to guide it. We are privileged that two new directors with outstanding track records as technological innovators have joined our Board. Jennie Hwang, president of H-Technologies Group, Inc., which provides technology and manufacturing solutions for the electronics industry, was appointed to the Board midway through 2001. Padmasree Warrior, corporate vice president of Motorola, Inc. and general manager of its Thoughtbeam, Inc. subsidiary, joined the Board early in 2002. We welcome Ms. Hwang and Ms. Warrior to our Board and look forward to working with them. Their background and knowledge will help guide Ferro as we develop our growth businesses.

In addition, our thanks go to Dr. Glenn R. Brown and William E. Butler, who have retired from the Board, for their outstanding guidance and contributions to Ferro.

A COMMITMENT TO CORE VALUES
All of Ferro's successes of the past, present and future are the result of our employees' commitment to our strong core values, which include maximizing returns for shareholders. With a combined 14 percent ownership stake in the Company, our officers and employees are dedicated to operating excellence, serving the customer well and enhancing our Company's profitability in everything they do.

We will continue to move in the right direction by focusing our efforts on controlling the factors that we can control -- specifically, by reducing costs, strengthening our balance sheet, generating cash flow, selectively supporting new product development and marketing initiatives and expanding our geographic base. In doing so, we are positioning the Company to benefit greatly when economic recovery occurs.

Our strategies are solid and we have excellent prospects for achieving our long-term goals of revenue and earnings growth. The dmc² transaction was a major step in the process of reshaping Ferro into a stronger Company with a better balanced portfolio and greater capabilities to take advantage of exciting market opportunities worldwide.

I thank the senior management team and all of our employees for implementing the strategic plan that has changed the profile of our Company. Our thanks go also to the customers and shareholders of Ferro for their ongoing support.

Hector R. Ortino
Chairman and Chief Executive Officer