Vince Morales - VP of IR
William Hernandez - SVP and CFO
PPG Industries Inc. (PPG) Q3 2008 Earnings Call October 16, 2008 8:30 AM ET
Good morning, this is Vince Morales, Vice President of Investor Relations for PPG Industries. Welcome to PPG's third quarter 2008 financial commentary. The financial commentary is provided by PPG's Senior Vice President and Chief Financial Officer, William Hernandez. These comments relate to the financial information released on Thursday, October 16, 2008. Visuals supporting this briefing may be accessed through the Investor Center on the PPG website at www.ppg.com.
As shown on slide number two, the following presentation contains forward-looking statements reflecting the company's current views about future events and their potential effect on PPG's operating and financial performance. These statements involve risks and uncertainties that could affect the company's operations and financial results and as discussed in PPG's filings with the SEC may cause actual results to differ from such forward-looking statements.
This presentation also contains certain non-GAAP financial measures. Pursuant to the requirements of Regulation G, the company has provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures presented on slide number five of the visuals supporting this briefing.
Now let me introduce PPG's Senior Vice President and CFO, William Hernandez.
Good morning and thank you for your time and interest in PPG. Today I will review PPG's third quarter 2008 operating performance and comment on various trends that impacted our results. Before I recap the quarter, let me quickly discuss a few strategic updates.
First, we completed the sale of our automotive glass and services business within our originally communicated timeline, despite challenging market conditions. I will discuss a few details on the deal later, but once again we are pleased to have followed through on our commitments.
Also, we recorded a business restructuring reserve in the third quarter, which focuses on adjusting the cost structure of our ongoing operations to reflect current market conditions, and will aid in achieving the year 2009 synergy targets that we set-forth for our SigmaKalon acquisition. We anticipate the restructuring will result in a $100 million cash outlay, and expect to achieve savings at a $100 million annual run-rate by the end of 2009.
Last, we repaid net debt of over $650 million, which puts us on pace to more than double our 2008 debt reduction target. Also, as you would expect from PPG, we remain financially disciplined, as we ended the quarter with cash of $500 million which exceeds our short-term commercial paper of about $175 million. We have been able to deliver these results due to our excellent cash generation, which is about $250 million or 50% ahead of a strong 2007 performance, including about $450 million of cash from operations in the third quarter.
Now let me discuss our ongoing operations. As we communicated toward the end of the third quarter, several of our businesses were hampered by non-recurring items including weather related events such as the two hurricanes, Gustav and Ike, which struck the US Gulf coast, and an employee work stoppage at The Boeing Company which is a large PPG Aerospace customer.
Additionally, overall economic conditions resulted in a significant drop in production levels in the automotive OEM industry and adjacent industries. Despite these challenges, we delivered double-digit percentage growth in both sales and segment earnings.
Our adjusted earnings per share, which include the negative impacts from weather, the considerably slower automotive OEM end-market, and continued cost inflation, was $1.37, which is comparable with a year ago.
Achieving these results despite the items I mentioned and in today's increasingly difficult economic climate, validates the strategic progress we have made in both transforming the company and making the company less prone to negative earnings shocks due to individual end-markets or regions.
Collectively, the weather related events and Boeing strike, negatively impacted our results this quarter by about $17 million pre-tax, or $0.07 per share. The negative weather impact to our financial results was less severe than we originally anticipated and communicated in September, due to better end-of-month performance in our commodity chemical business, as customer demand in the Gulf Coast region returned more quickly and stronger than we expected.
Meanwhile, the lower automotive OEM activity levels, which are primarily reflected in our Industrial Coatings reporting segment, combined with higher cost inflation, resulted in the majority of the substantial operating earnings decline for that segment versus last year as segment earnings fell 46%. And, although we sold the business at quarter-end, the third quarter automotive glass operating results were included in our reported earnings and also dropped versus last year.
Again, despite these notable headwinds, the company still delivered comparable results as the remainder of our business portfolio performed well despite slowing in the overall economy, and our results were aided by our largest quarterly selling price increase in at least a decade.
Our Commodity Chemical business, despite some negative impact from the weather related events, performed exceptionally well with year-over-year earnings up about 30%. Additionally, our Optical and Specialty Materials segment grew earnings by nearly 11% and our Performance Coatings segment despite the Boeing work stoppage in September still grew earnings by about 6%.
Finally, our SigmaKalon acquisition remains ahead of our financial targets supported by the continued growth of our Architectural EMEA segment, which consists of the majority of the SigmaKalon acquisition.
Third quarter year-over-year sales were up over 12% to $632 million as organic growth comprised of higher prices and stronger volumes accelerated further this quarter and were supplemented by currency gains. Segment earnings were $61 million, which includes a reduction of $30 million for depreciation and ongoing amortization stemming from acquisition accounting.
Let me conclude my recap of the quarter by stating once again the strong execution, which you have come to expect from PPG, our broad geographic reach and diverse end-markets, and our prudent approach toward managing our cash has once again, produced solid financial performance despite a variety of headwinds. Also with our recently announced restructuring, we are taking further action to adjust our cost structure to the shifts in the global markets we serve.
Now, if you turn to the next slide, let me review some of the details for the quarter. First, our reported sales exceeded $4.2 billion up 37% from last year, establishing a new PPG third quarter record. Despite the challenging economic backdrop, we delivered a year-over-year quarterly sales record for the 22nd consecutive quarter. Every one of our segments, except Glass, posted double-digit sales growth.
Our acquisitions primarily SigmaKalon added about 30% to PPG's total sales and increased the sales in our combined coatings segments by about 50%. We also delivered our best quarterly pricing results in at least a decade, as year-over-year selling prices added about $175 million to our sales.
Our volumes were down less than 1%. We experienced extremely weak US end market demand in automotive OEM, and lower demand in residential construction. We offset those volume declines with solid volume growth in several businesses including optical and aerospace, as well as continued growth in emerging regions. Currency was also slightly incremental, adding an additional 2% to sales.
Our segment earnings grew by over 10%, which is a result of the earnings of acquired businesses, the double-digit growth in the Commodity Chemicals and Optical and Specialty Materials segments, and the growth we delivered in emerging regions. Many of our business units delivered third quarter earnings records as well. Once again, we are proud of our growth and overall solid performance in today's economy.
Now let's review our earnings per share results. The next slide provides a reconciliation of our continuing operations reported earnings per share to our adjusted earnings per share for both this year and last, adjusting for unusual charges. Our reported earnings per share in the quarter were $0.70. We had unusual charges of $0.67 for business restructuring and $0.02 for our proposed asbestos settlement. We also had a one-time gain of $0.02 relating to our completed automotive glass divestiture.
Our third quarter adjusted earnings per share excluding the one-time and unusual items is $1.37. This compares with $1.40 last year. This performance provides both validation of the strength of our portfolio as well as a milepost on the progress of the company's transformation to a coatings, optical and specialty materials company.
Now let's review some of the details. Looking quickly at our sales results by region, our year-over-year sales in the United States and Canada grew by 6% in the third quarter, which is a much higher growth rate than last year despite volumes being hampered by weather related issues.
Pricing improved by 8% with every business, except our Automotive OEM businesses posting fairly solid pricing gains as we continue to work to offset cost inflation. Volumes in the region were down 2% including the negative weather and Boeing strike effects. As mentioned, the US automotive OEM industry weakened even further this quarter, while residential construction remained weak.
Many of our other business units did experience higher volumes in this region highlighted by optical and aerospace. We anticipate the fourth quarter to be equally challenging from an automotive OEM volume perspective, but we also expect to gain additional pricing.
Moving to the next slide, our European sales grew by about $850 million dollars, up more than 130%, primarily due to our SigmaKalon acquisition and currency. All SigmaKalon sales, including organic growth versus their 2007 performance, are classified as increases due to acquisition and thus not illustrated on this chart. As I mentioned SigmaKalon's organic growth rate accelerated during the quarter.
Excluding SigmaKalon, our selling prices increased by 2%, which offset slightly negative volumes, which were down 1%. As you can see on the graph, activity in the region has been fairly comparable all year. Also, with the last few quarters, our quarterly comparables from both 2007 and 2006 were exceedingly difficult, so maintaining these prior year gains is pleasing.
Regarding the fourth quarter, we are currently expecting additional slowing of general industrial growth in Western Europe, which will be partially offset by solid growth in Eastern Europe. We also expect to realize higher selling prices in this region.
Our Asian results are detailed on the next slide and our year-to-date sales in this region through September have already eclipsed, by about 20%, our full year sales from 2007 exemplifying our continued rapid growth in the region. During the quarter we still delivered double-digit organic growth despite lower activity levels around the 2008 Summer Olympics held in Beijing.
In the region, we have established a good market presence in each of our coatings businesses and our profitability remains at a high level, when compared with both overall coatings industry margins and even PPG's other regions. We expect similar growth rates to continue in this region in the fourth quarter.
Now before I discuss each of our individual business segments, let me discuss a few macro topics. As detailed on the next slide, during the quarter we continued to experience year-over-year inflationary increases in the cost of energy and raw materials.
In the quarter, our primary energy cost, natural gas, inflated to just above $9.50 per unit, compared with slightly under $7 in the third quarter of last year. Our cost did move down from the second quarter of this year, when it was about $10.50 per unit.
For those of you less familiar with PPG, we use 60 to 70 trillion BTUs of natural gas a year to generate power for the production of chlorine and caustic soda, and to produce glass and fiber glass. So, if natural gas unit costs change by $1 per million BTU, our pre-tax costs change by about $60 to $70 million on an annual basis.
Looking ahead we have about 40% of our fourth quarter gas needs hedged at about $8.75 per million BTU. As a reference point, our fourth quarter 2007 unit costs were about $7.50. We have also experienced inflation in our coatings raw material costs, which include petroleum based materials. Raw materials are the largest major component of production costs for coatings.
Our expectation at the outset of the third quarter was for year-over-year inflation in the range of 4% to 6% and our actual inflation was right at 6%. Our expectation for the fourth quarter is for year-over-year inflation in the range of 5% to 8%, but I will comment that it is a dynamic market today with both energy costs falling, but remaining very volatile, and our suppliers growing concerned about demand levels.
In addition to raw materials and direct energy costs, we also experienced higher year-over-year transportation costs and surcharges associated with higher gasoline and diesel costs. Our total transportation costs in the quarter increased by about $20 million versus last year.
Regarding inflation overall, we have continually increased efforts to identify and qualify new and more cost effective sources of raw materials. Also, as I mentioned earlier, our selling price was up about 6% this past quarter and our businesses are working to secure additional pricing to further offset the higher costs.
Now before I review our business results in more detail, I typically provide an update on our proposed asbestos settlement. For those not familiar with the details of the proposed settlement, please refer to the disclosures beginning on page 22 of our second quarter 2008 form 10-Q.
As we said in previous updates, we have filed motions asking the court to reconsider, alter or amend its ruling from December, 2006. Also, various parties, including PPG, are currently working toward an amended PPG settlement agreement to address issues the court raised in its ruling. We continue to believe we are close to a potential resolution. However, given the overall complexity of the issue we are not able to offer any time line upon, which any next step will be taken.
Now let's discuss the performance in each of our business segments. The next slide illustrates the results in our Performance Coatings segment. Third quarter sales grew by over $250 million or 28%. Acquisitions added 21% growth, currency added 3%, volumes were flat and price added 4%.
Our segment earnings were $148 million, up 6% versus the prior year. A few key elements driving the increased earnings were our pricing efforts, our continued growth in Aerospace despite the negative impact of the Boeing work stoppage, cost management in our US Architectural business and our Protective and Marine Coatings business results, which include a portion acquired in the SigmaKalon acquisition.
Let me review a few key items in our business units: In Aerospace, our sales grew 10%, resulting primarily from our volume and pricing gains. Volume growth outside the US was up double-digit percentages, with US growth up moderately despite the Boeing work stoppage which started in early September. This remains a solid business with continued growth prospects, but the level of growth next quarter will depend on the length of the Boeing work stoppage.
Our automotive refinish sales grew 12% supported by moderate gains in price, volumes, currency and acquisitions. Share gains are offsetting industry volume declines in the mature regions. Of note is the fact that we are delivering double-digit volume growth in Asia, and our quarter-end acquisition of the Chinese refinish paint company Bonny will further expand our offering into that rapidly growing market.
Our Architectural Coatings Americas and Asia business unit grew sales by 9%. Our non-US markets grew primarily as a result of a prior year acquisition and favorable currency. Our US and Canadian sales were flat. Volumes were down mid-single digits as volume in our national accounts rose, while company owned store and independent dealer volumes were down.
We did achieve price increases in most channels as we continue to work to offset raw material inflation. We remain at a very low activity level in the US, and we continue to aggressively manage costs in this business. Looking ahead we are continuing to seek further pricing to offset inflationary impacts, and do not expect any material changes in the overall activity level outside of the normal seasonal decline.
We continue to achieve high growth rates in our protective and marine coatings business unit. The SigmaKalon acquisition has more than doubled our sales into this end-market and the acquired business grew organically this quarter by mid-teen percentages, while our legacy business grew both pricing and volumes by mid-single digits. We expect end-market activity to remain strong for the foreseeable future.
To summarize the quarter for this segment, we offset lower activity levels in our US Architectural Coatings business with continued growth in aerospace, protective and marine and in all businesses in emerging regions. Also, we realized a notable portion of our initial pricing efforts which were intended to offset current year inflationary impacts. Finally, as I have mentioned all this year, the protective and marine portion of SigmaKalon has been nicely accretive and is performing ahead of our expectations both in end-market results and in synergies.
Moving to the next slide detailing our Industrial Coatings segment, our sales rose by about $120 million or 13%. The gain was due primarily to our acquisitions, including the SigmaKalon industrial coatings business. Favorable currency and price outpaced lower volumes.
Our segment earnings were down significantly, dropping from $89 million to $48 million. A major factor in this decline was the rapid deterioration in automotive OEM industry production levels. In the quarter, US auto OEM industry production declined by about (17%), a sizable downward shift from just last quarter.
Other impacts were from higher inflation and industrial sales in the mature regions which slowed slightly. Continued growth in emerging regions partially offset the slower end-markets and mature regions. Of note is that our sales in emerging regions of Asia, Latin America and Eastern Europe, are now collectively much larger than the sales in the US and Canadian region.
Let me quickly comment on each of the businesses comprising the Industrial Coatings segment: Our automotive OEM coatings sales were up 2% as volumes fell 2%, including a 15% drop in the US and Canadian market. The US and Canadian region represents about 30% of the business unit sales. Our combined non-US regions continued to grow by mid-single digit percentages, but growth rates in all these regions moderated. Looking ahead, we expect at a minimum, an equally challenging end-market in the fourth quarter.
Industrial Coatings business unit sales improved over 35%, as the SigmaKalon acquisition remained the main growth factor. Overall volumes were down 2% due to softer demand in mature regions, partially offset by growth in emerging regions which now account for over 40% of this business unit. Price gains accelerated to 2% for the business. We anticipate overall global activity levels to soften further in the fourth quarter.
Packaging coatings sales grew by 9% aided by currency and price, with slightly lower volumes. Overall our Industrial Coatings segment experienced a very difficult end-market decline. We are reacting quickly to this decline and announced a business restructuring late in the quarter which, in part, is targeted to lower this segment's ongoing cost structure in regions with lower ongoing activity levels. We will continue to focus on managing costs and will respond to as any other challenges that arise in the end-markets served.
Our next slide is Architectural Europe, Middle East and Africa or EMEA, and it represents about three quarters of the acquired SigmaKalon business. Segment sales in a seasonally strong quarter were $632 million. Organic sales growth accelerated to mid-single digit percentages versus pre-acquisition SigmaKalon results last year, reflecting continued growth in most regions. Earnings for the segment were $61 million. These earnings include $30 million each quarter in ongoing depreciation and non-cash amortization of intangibles stemming from the acquisition.
The business is performing well and is pacing well ahead of a solid 2007 financial performance. As I mentioned last quarter, we have minimal participation in several of the most negatively impacted construction markets in Europe, such as Spain, Italy and Ireland.
We do participate in the UK market and that was our only major market with negative growth, when compared with last year. However, solid pricing gains and strong positions in other, more stable regions and several Eastern European countries resulted in our accelerated organic growth.
Looking ahead, I will remind you that the fourth quarter is traditionally our slowest quarter seasonally in this business with about 20% of our annual sales in the fourth quarter versus roughly 27 to 29% in the second and third quarters.
As with last quarter, I will take this opportunity to provide you with an update on the overall SigmaKalon acquisition. This update includes our Architectural EMEA business, along with the SigmaKalon businesses, which we merged into our Industrial and Protective & Marine businesses.
As we mentioned previously, during the first quarter, we secured permanent debt financing within the interest rate guidance we set forth last November. Also, our integration efforts remain on schedule to achieve over $50 million of cost synergies this year.
On top of that we have achieved additional raw material cost mitigation through the first three quarters of the year, due to our enhanced purchasing power. This quarter, we announced business restructuring plans within the acquired businesses that will aid us in delivering our 2009 synergies.
Looking at the combined financial results from all the acquired SigmaKalon businesses, I am happy to report that we are exceeding our original 2008 financial targets due to stronger performance by all three business segments and this does not include the incremental raw material cost mitigation, I just mentioned. Obviously we are pleased with the acquisition results and the notable impact on our financial results this year.
Shifting to our Optical and Specialty Materials segment on the next slide, we achieved double-digit segment sales and earnings growth. This was a result of 10% volume growth in optical products, including Transitions. The growth rate accelerated versus the second quarter. Our Specialty Materials business delivered strong price gains, but posted volume declines reflecting lower automotive demand for our silica products in tires and batteries.
As we communicated last quarter, we increased, yet again, our marketing investments with notably higher selling and marketing costs. The investments continued to drive profitable growth as segment earnings grew 11% driven by optical volume gains.
Looking ahead, the rollout of our new generation Transition Optical lens product in certain European countries is now underway. As a result of this and continued strong demand in general, we anticipate further growth in this segment in a seasonally slower fourth quarter.
The next slide details our Commodity Chemicals segment. This segment was negatively affected by both US hurricanes Ike and Gustav, which resulted in two voluntary shutdowns of our largest facility, which is located in Louisiana. While our facility sustained minimal damage, production was curtailed by difficulties in securing critical raw materials and transportation equipment and similar issues for our customers including inability to secure energy to power their facilities.
Our facility returned to normal operating rates toward the end of September and the hurricane impacts on the business were not as severe, as we initially projected as customer demand returned sooner and stronger than anticipated. In the quarter our sales increased by 25% to a new all-time quarterly record. Pricing in response to industry supply and demand dynamics plus higher costs for both natural gas and ethylene, drove the majority of the sales gain. Segment earnings improved by 30%, which includes negative effects from the hurricanes.
As we look ahead, the fourth quarter is traditionally slower than the third quarter due to seasonality. As we exited the third quarter, several products remained on force majeure due to our low inventory position resulting from the outages and continued strong demand. Last price increases have been announced for select products for the fourth quarter
Our next business segment slide details our Glass segment. We sold the Automotive Glass and Services business on September 30th. So, our reported results for the quarter include the automotive glass business results. However, to aid in the understanding of the remaining glass businesses, we are providing financial figures both including and excluding the automotive glass business.
Looking at the businesses, which remain Performance Glazings, sales improved 8%. Pricing was favorable as higher prices in a few end-markets were combined with our energy surcharge. Volumes dropped slightly as volumes into the commercial construction segment were up, while residential construction volumes sagged.
Fiber Glass sales advanced 5% mostly due to pricing gains. Combined earnings from these two businesses declined by about $5 million versus last year as lower volumes and inflation more than countered the improved pricing and lower manufacturing costs. Looking ahead we anticipate some additional, moderate demand erosion in some industrial end-markets of these businesses in the fourth quarter.
Now let me quickly describe our automotive glass and services operating results. Automotive glass and services sales decreased 8%, stemming in part from lower end-market demand. Earnings were down by $13 million. The business sale was completed on September 30th, and on an ongoing basis, we will hold about a 40% minority share in the new entity.
Also, PPG retained liabilities for pension and retirement benefits, which were earned up to the business sale date, and we will recognize earnings and balance sheet impacts from these liabilities going forward based on GAAP requirements.
Now let's move to the company's cash results. The subsequent slide provides some details on our cash position and year-to-date cash uses. For the quarter, we generated about $450 million in cash from operations. On a year-to-date basis our cash from operations exceeds $800 million, and is more than $250 million, or about 50% ahead of last year's pace.
Our uses of cash through September are as follows: Year-to-date we have spent approximately $260 million on organic capital spending, excluding acquisitions, or about 2% of sales. Our dividend payments year-to-date totaled about $256 million, as dividends per share are up 3% versus last year.
Regarding debt, we assumed about $1.5 billion in the first quarter, as a result of our SigmaKalon acquisition. Year-to-date we have paid down net debt of over $650 million, which has already nearly doubled our debt reduction target for the entire year.
Regarding pensions, we made pre-tax contributions of about $100 million this year. Next are acquisitions, and outside of SigmaKalon we have made a few bolt-on acquisitions this year. Finally our share repurchases and through the third quarter our focus remained on offsetting dilution from options.
Let me conclude my cash discussion by reiterating what I stated in my opening comments. Our culture as a company, both historically and currently, is one of financial discipline. Given the recent issues in the credit markets our long-standing financial policies are providing us with an even larger benefit today. We currently have $500 million of cash, which well outpaces our commercial paper outstanding of about $175 million.
Additionally, the fourth quarter is traditionally a strong cash generation quarter for us. So, we remain extremely comfortable in our liquidity position and have actually been receiving interest on our excess cash at rates higher than our short-term debt interest rates
Now let me conclude my commentary on our third quarter results, by highlighting a few key takeaways from the quarter: As I mentioned at the outset, we are proud to deliver comparable year-over-year adjusted earnings per share, despite weather related issues and a generally more difficult economic environment.
Our SigmaKalon acquisition performance continues to demonstrate how successful that acquisition has been. We continue to execute on our transformation strategy with this quarter's highlight being the completion of the sale our automotive glass and services business.
We are managing some difficult end-markets and, as you would expect us to do, have reacted by quickly announcing business restructuring targeted at reducing our cost footprint serving those markets. A key measure of any company's success is cash generation, and the level of our year-over-year increase is providing us benefits and flexibility today and will do so into the future.
In conclusion, we are experiencing one of the most tumultuous economic environments in recent history. A time, where a broad business portfolio and extended geographic reach, traits that we have successfully built into PPG, are providing stability and continued growth potential.
Our performance this quarter and year-to-date confirms this, and we expect to continue our solid performance including our pace of record cash generation.
This concludes the third quarter 2008 financial commentary, featuring comments by William Hernandez, Senior Vice President and Chief Financial Officer.
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