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PPG Industries (NYSE:PPG)

Q2 2009 Earnings Call

July 16, 2009 1:30 pm ET

Executives

Charles Bunch – CEO

William Hernandez – CFO

David Navikas – VP

Vincent Morales – VP IR

Analysts

Sergey Vasnetsov - Barclays Capital

David Begleiter - Deutsche Bank

Kevin Mccarthy - BAS-ML

Robert Koort - Goldman Sachs

John Roberts – Buckingham Research

PJ Juvekar – Citi

Silke Kueck – JPMorgan

Don Carson – UBS

Dmitry Silversteyn - Longbow Research

Frank Mitsch - BB&T Capital Markets

Operator

Good afternoon ladies and gentlemen and welcome to the second quarter 2009 PPG Industries financial results conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Vince Morales.

Vince Morales

Hello, this is Vince Morales, Vice President of Investor Relations for PPG Industries. Welcome to PPG's second quarter 2009 financial teleconference. Joining me on the call from PPG is Charles Bunch, Chairman and Chief Executive Officer, Bill Hernandez, Senior Vice President of Finance and Chief Financial Officer, and David Navikas, Vice President and Comptroller.

Our comments relate to financial information released on Thursday, July 16, 2009. 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, our prepared remarks and comments in the subsequent question-and-answer session, may contain forward-looking statements reflecting the company's view 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 Industries filings with the SEC may cause actual results to differ from such forward-looking statements. The company is under no obligation to provide subsequent updates on these forward-looking statements.

This presentation also contains certain non-GAAP financial measures. Pursuant to the requirements of Regulation G, the company has provided in the Appendix of the presentation materials reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures.

Now let me introduce PPG's Chairman and CEO, Charles Bunch.

Charles Bunch

Thank you Vince and welcome everyone. I will provide a brief overview of PPG’s performance in the second quarter. William Hernandez will then review some of the financial details and then I will add some closing remarks before we field questions.

In the second quarter we experienced a traditional seasonal sales increase versus the first quarter. Our total sales this quarter remained fairly consistent month to month with some slight strengthening in June and were also steady within each major region.

This gives us a degree of confidence that most markets have stabilized albeit at considerably lower level than prior years. However we continue to experience very challenging conditions in several markets such as the US automotive OEM sector and certain general industrial OEM markets.

In these industries there was little improvement from the extremely difficult environment we saw in the first quarter. In other markets such as those for European and US architectural coatings we did see some improvement versus the late fourth quarter 2008 and first quarter levels even though demand was still down in comparison with the prior year’s second quarter.

As for earnings our results are still down considerably versus last year but were pleased our profitability improved substantially versus the previous two quarters despite weaker results in our commodity chemicals business.

Clearly the improved bottom line results in our coatings businesses reflect the very aggressive cost cutting measures we’ve taken combined with increased savings from restructuring actions. This is particularly evident in our industrial coatings segment where global demand levels have remained depressed.

Yet we delivered substantial segment earnings improvements of $68 million and $44 million versus the fourth and first quarters respectively on a relatively similar sales base. A major factor in the quarter that negatively impacted sales and earnings was currency conversion.

In the second quarter of 2008 the euro peaked versus the US dollar. As a result year over year currency translation in this year’s second quarter was a significant headwind. In architectural coatings EMEA and performance coatings specifically the negative impact from currency translation nearly equaled the year over year earnings decline.

So in local currency these segments had nearly flat year over year earnings performance, a very noteworthy achievement given the volume headwinds related to the weakened economy. Lastly we remained focused on cash.

We generated nearly $400 million in cash from operations this quarter, up 25% versus last year driven by improvements in our businesses working capital levels. As a result we once again ended the quarter with a very solid cash position with over $1 billion of cash on hand.

While our cash position is high compared to historic PPG standards, we have been and intend to remain very prudent in our uses of cash. Now here is William to review some of the financial details.

William Hernandez

Thanks Charles, I will start by reviewing our sales results which are detailed on slide five, overall sales for the company were down nearly $1.4 billion versus the second quarter of last year which includes the reduction of just over $250 million stemming from our third quarter 2008 divestiture of a majority interest in the automotive glass and services business.

Demand remained weak resulting in a decline of about $825 million in sales volumes. Volumes declined year over year in each region with Asia down the least dropping 7% driven by weak Asian exports offset by strong consumption within China.

Our United States and Canadian volumes fell by over slightly more than 20% driven by weak automotive and industrial activity levels. Our European volume was down 18% with drops well in excess of 30% in many industrial markets combined with mid single-digit declines in our architectural coatings.

I will remind you that the Easter holiday shifted into the second quarter this year but was in the first quarter in 2008. Also as Charles mentioned negative currency translation was sizable resulting in a headwind of over $300 million.

Turning to the next slide, you will see that one key benchmark of the currency headwinds is the euro which peaked against the dollar in the second quarter of 2008 with the exchange rate 13% lower this year. This translation impact also hits earnings.

Our year over year earnings fell by about $22 million versus last year due to currency translation or about $0.09 per share. I will also point out that we were facing a similar but smaller headwind in the third quarter based on current exchange rates.

Also on this slide is our seasonal sales index trend for the past several years between our first and second quarters. The second quarter is typically our best quarter seasonally and as illustrated we experienced fairly comparable sequential sales growth this year compared with last.

However as Charles mentioned this is from a much lower absolute sales level. We typically experience a single-digit percentage volume drop due to seasonality between the second and third quarters and we are expecting that trend to continue.

The next slide details our sales by segment and I will review each segment in detail later. In summary total sales were down about 25% excluding the impact of our automotive glass divestiture late last year.

Sales in all of our segments were down with more pronounced declines in excess of 35% in industrial coatings, commodity chemicals, and glass. Similar to the first quarter our industrial coatings segment drop was driven by continued end use market weakness for light vehicles and for general industrial products.

As I will discuss shortly many of these markets remained at similar depressed activity levels in comparison with the first quarter. Also lower industrial production dampened our commodity chemicals and glass results and a slumping US commercial construction market also contributed to the glass decline.

As I mentioned previously currency conversion was a large factor in the overall company results and specifically in the architectural coatings EMEA segment where currency was easily the largest single factor in the reduction of sales accounting for just over $100 million of the $140 million difference.

Both the performance coatings and optical and specialty material segments experienced mid teen percentage declines. In specialty materials our silicas business experienced volume drops of about 35% in comparison with last year which was even worse than the first quarter reflecting weakness of the automotive and general industrial markets that it serves.

Volumes in our performance coating segment which has a notable after market component faired somewhat better and this segment was also negatively impacted by currency. Our segment earnings are detailed on the next slide.

These results reflect a significant impact of the global economic downturn has had on our sales volumes. In aggregate our second quarter segment earnings fell by about 35% versus last year and while this is a fairly steep drop, its important to note that our first quarter segment results were down about 50%.

This improvement was primarily in our coating segments and reflects the progress we made in implementing our cost and restructuring actions. I will review all our segments in further detail later but the largest earnings decline was in industrial coatings, again reflecting the severe deterioration in industrial production including automotive OEM.

The segment was down over $80 million in the quarter and represented over 40% of the corporation’s total decline. Equally important to mentioned however is the segment was solidly profitable this quarter after incurring losses in the previous two quarters.

Earnings in both performance coatings and architectural coatings EMEA would have been flat but for the negative impacts of currency translation. The next slide presents our adjusted earnings per share, a reconciliation of these amounts to our reported earnings per share is included in the Appendix of today’s presentation materials which is available at the Investor Center on our website at www.ppg.com.

In the quarter our adjusted earnings per share was $0.91. This is down from $1.66 in 2008 and which results from the impact of volume from a continued sluggish global economy partly offset by our cost actions. One takeaway from our results this quarter is illustrated on our trend chart on the right side of the slide.

As you can see our second quarter performance while down over 40% year over year easily outpaced similar comparisons for both the fourth quarter of 2008 and first quarter this year. To add further perspective the sequential earnings improvement is despite a nearly equal year over year sales decline this quarter versus last.

As Charles noted, our aggressive cost management in addition to the savings we are yielding from our restructuring actions are important factors in our improving the relative earnings performance. Our restructuring savings are detailed on the next slide.

Depicted on the slide is the anticipated annual run rate of our cumulative savings from the restructuring actions. As detailed we expect to achieve about a $250 million annual savings run rate by the end of 2010 when our restructuring programs will be fully implemented. This annual savings level at completion equals nearly $1.00 in earnings per share accretion.

The restructuring actions are generally structural in nature as we are permanently modifying the way we conduct business. To date we have achieved about 20% of the targeted savings which puts us slightly ahead of our original schedule. But obviously we still have a sizable portion of savings that will be accretive in future quarters.

Moving to our business segment review on the next slide, the impact of our cost management and restructuring actions are most apparent in our industrial coatings segment. This segment has business units serving the global automotive OEM, general industrial and packaging end use markets. As detailed on this slide while we are still at a very low earnings level we have dramatically improved this segment earnings performance the past few quarters despite consistently low sales levels.

Our sales are still below our fourth quarter sales level, but our quarterly earnings have improved by a dramatic $68 million in comparison. Also reviewing results on a monthly basis, we have been solidly profitable for the past four consecutive months and are now approaching monthly profit levels we last achieved early in the fourth quarter of 2008 despite sales this quarter being 30% lower.

Some additional details on our industrial coatings segment are included in the next slide. Sales in the quarter totaled about $740 million, down 36% versus last year. Lower volumes accounted for the lion share of the decline but currency was also a sizable headwind. As displayed on the segment volume chart second quarter volume declines nearly matched the steep first quarter drops.

Global industrial demand remained very weak although Asia primarily China, easily outperformed the other major regions. The global industrial weakness was most intense in the United States automotive OEM market where year over year production dropped a remarkable 50% for the second consecutive quarter.

This is also where we have instituted the most significant cost actions. In our September 2008 restructuring announced before the severe end use market collapse, was focused on this segment and is now delivering positive earnings results.

Also as illustrated on the bottom graph North American vehicle production is actually running well below the depressed level of US auto sales. We expect production to move closer to sales levels in future quarters as had been the case early last year. That being said, the end use markets in this segment are still likely to remain some of our most challenging and we will continue to execute on our announced cost reduction actions to incrementally improve profitability and position this business to benefit when market demand recovers.

Performance coating segment results are detailed on the next slide, sales were down about $200 million or 16% from last year’s sales level but reflect normal seasonal gains versus the first quarter. Earnings declined slightly, slipping $13 million which is equal to the negative impact of currency translation.

As Charles mentioned we are pleased with this segment’s ability to achieve earnings parity in local currencies in light of today’s economic climate. Segment volumes fell low double-digit percentages which is much less than most of our other segments and in part reflects the important after market component of the businesses in this segment.

Operating margins improved as aggressive cost management helped to offset the volume declines. Looking individually at each of our business units, our architectural coatings Americas and Asia business had volume declines of low double-digit percentages. This was a solid improvement over the past several quarters led by our US results where volumes improved versus the previous two quarters but were down high single-digit percentages.

Our stores and dealer channels were down more while our national accounts or do-it-yourself channel delivered growth in the low double-digit percentage range. Asia volumes were down mid single-digits while Latin American volumes were down 30%.

Our automotive refinish business continue to experience lower sales volumes falling double-digit percentages as a result of the continued distributor destocking and less collision repairs which are due in part to fewer miles driven versus last year.

Our volume results this quarter were only moderately different than the first quarter. Both protective and marine coatings and aerospace sales were down mildly excluding currency impacts. These businesses support end use markets which have a sizable after market and both still have considerable OEM backlogs.

Also the protective coatings market supports global infrastructure projects and while aerospace is doing fine overall, the business jet market is experiencing extreme volume declines. Results for our architectural coatings Europe, Middle East and Africa or EMEA business, are on the next slide.

Sales were about $525 million, down $140 million versus last year with over $100 million of the decline related to currency conversion. Sales were down only about 5% in local currencies. Earnings declined $16 million due largely to the impact of currency. From a seasonal perspective the second quarter is traditionally our highest sales quarter and we did experience a typical seasonal bounce versus the first quarter.

Also our year over year volume results improved nicely in comparison to the first quarter. Volumes in the entire segment declined mid single-digit percents and were partially offset by price gains. Volumes in the first quarter were down double-digit percents. As is customary volume results differ greatly throughout the various regions with all major regions down year over year but some less so than others.

As with the first quarter exclusive of currency there was minimal earnings erosion compared to last year due in large part to very strong cost management. Also illustrated on this slide are the earnings before interest, taxes, depreciation and amortization, or EBITA. And our EBITDA margins were flat.

We believe EBITDA is a relevant measure for this business given the ongoing non-cash amortization stemming from the acquisition. We estimate between 75% and 80% of architectural coatings in many of our major regions are related to recurring maintenance applications which are less sensitive to economic swings and allow this segment to deliver more stable financial results.

Looking ahead, we expect currency to remain a headwind in the third quarter but to a lesser degree. Also we anticipate a similar stable business profile in the coming quarters. And anticipate normal seasonal sales patterns.

Our optical and specialty material segment results are detailed on the next slide. Sales were $255 million, down $55 million from last year. Earnings were about $60 million, about 20% lower year over year. Segment operating margins remained [inaudible] year over year. Year over year declines in this segment financial results were very similar to the first quarter.

I will remind you that our year over year comparables are very difficult as the optical products business experienced record sales and earnings in the first half of 2008 due largely to our generation six transitions product introduction and pipeline fill in North America. Looking individually at the businesses in the quarter, silicas which is a raw material used in the production of tires and car batteries, experienced even steeper volume declines than in the first quarter, with volumes falling nearly 35% based on collapsing demand in both the automotive OEM and auto after markets.

Our optical product sales were impacted by both negative currency and the lower volume impacts I mentioned earlier along with continuing difficult economic conditions in our major regional markets. Glancing ahead, we expect the year over year volume declines in silicas to lessen somewhat due to improved automotive production and easier comparables from the second half of 2008.

Also we anticipate year over year sales declines in the second half of 2009 in our optical products business to moderate based on a less significant effect in the second half of 2008 from our next generation transitions lens product introduction. On the next slide are our commodity chemicals segment results.

Sales declined about $175 million versus last year driven by both lower volumes and pricing. Earnings fell by $26 million due to lower volumes and the related impact of lower capacity utilization on our manufacturing costs. Our operating rate this past quarter was in the low 80% range, down from the low to mid 90% range last year.

This lower utilization is a reflection of lower market demand driven primarily by similar declines in the rate of US industrial production which is the economic statistic that serves as a good measure for caustic soda market demand.

Segment operating margins remain fairly consistent with the prior year as lower pricing was offset by lower input costs including natural gas. Our natural gas cost in the quarter was about $6.00 per million BTU. This included the impact from our natural gas hedge position as we had half of our normal purchases hedged at about $8.00 per unit in the quarter pricing decline versus the prior year as a result of weaker demand.

As we look ahead caustic soda pricing fell by double-digit percentages in each month during the quarter. So our second quarter results did not fully reflect an entire quarter’s impact from the lower pricing. Separately we announced three pouring price increases totaling $300.00 per ton which will be implemented in the second half of the year.

Also the business would benefit in both sales volume and capacity utilization from an increase in US industrial production. Our glass segment details are on the following slide. As was the case last quarter we included 2008 results both with and without the automotive glass and service business we divested late in 2008.

My comparison comments will be against the 2008 results excluding auto glass. Sales this quarter were $207 million, down about $120 million or 37% from last year. Fiberglass sales were down nearly 50% due to severely lower global industrial demand. Performance glazings sales dropped by over 30% due to continued weakness in US residential construction and a deteriorating US commercial construction market.

Earnings dropped $27 million year-over-year to a loss of $7 million driven by the lower volumes

and related lower manufacturing utilization. We continue to execute on our restructuring and cost reduction actions, and achieved total year over year cost reductions approaching $10 million.

Our second quarter earnings results were $20 million better than our first quarter results despite

only a slight seasonal sales increase. Although we are seeing a slight improvement in demand, market conditions remain very difficult. We will continue to aggressively pursue cost savings in these businesses.

Let me conclude my remarks by reviewing cash which is detailed on the next slide. We ended the quarter with over $1.0 billion of cash on hand. In the quarter we generated just under $400 million from cash from operations, which was up about 25% from last year’s second quarter driven by strong working capital results.

Our ending cash balance includes about $235 million of cash from a $400 million multi-year term loan we obtained in late June at favorable interest rates. We immediately used about $165 million of the loan proceeds to repay existing debt, and intend to use the remainder in the third quarter for similar purposes.

Excluding the excess cash from the term loan, our cash balance is still up about a $0.50 billion

dollars from the prior years’ second quarter levels. As with the past several quarters, we

maintained about $240 million of commercial paper outstanding. Based on our anticipated strong second half cash generation, we will likely pay down a good portion of this commercial paper.

We remain on or favorable to our full year targets in our uses of cash and let me discuss a few of them. We originally targeted $200 million in full year capital spending, excluding acquisitions, and we have spent $100 million through the first half of the year. Relative to acquisitions, we will likely remain cautious in that area.

Regarding other cash uses, we have about $115 million of term debt maturing in the third quarter with no other maturities of size this year. And last, we have already made pension contributions of nearly $200 million for the year, most of which are voluntary and have actually decreased our full year funding projection from $350 million to $250 million. I will remind you that the pension contribution figures are pre-tax, and we do receive a tax benefit.

We are pleased with our cash performance and growth year-over-year, particularly in light of

today’s economy. Given today’s economic times, we intend to continue our focus on managing

our cash and will likely maintain a larger than normal cash balance for the financial flexibility it

provides in the current environment.

With that I now will turn it back over to Charles for some closing comments.

Charles Bunch

Thanks William. Let me summarize the quarter by recapping a few key items. In most markets, demand levels remain depressed in comparison with the past several years and improved only mildly from the first quarter. However demand was stable during the second quarter and our businesses’ earnings performance improved.

Our coatings and optical and specialty materials segments, which combined accounted for 90% of the company’s segment earnings during the quarter, delivered improved earnings performance versus the first quarter in absolute dollars and in year over year percentage change.

Conversely our commodity chemicals business, while still performing solidly, experienced

declines from what were truly excellent results the past several years. In total, I was pleased with the partial recovery in earnings back towards last year’s level in light of the continuing difficulties in the economy.

And as I mentioned at the outset, this was a result of our strong execution, and aggressive cost-cutting and restructuring actions we are taking across all of our businesses. We believe that because of these actions, we are well positioned and will have excellent operating leverage which will enable us to fully capitalize as economic conditions and demand improve.

In the third quarter, excluding the impacts of a normal seasonal drop, we expect overall market

conditions to improve but only mildly. And, as William mentioned, the direction and magnitude of change will differ among the various pieces of our portfolio.

For example, we expect sequential improvement in US automotive OEM, but anticipate the opposite for commodity chemicals. I will assure you that we will continue to execute on our cost-reduction actions and the relating benefit will grow again next quarter.

Also, because it deserves mentioning again, we intend to remain very prudent in how we manage our cash position. That concludes our prepared remarks. We are now ready for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Sergey Vasnetsov - Barclays Capital

Sergey Vasnetsov - Barclays Capital

Could you comment on such a big difference between the European and US decorative coatings results, we know that your business [inaudible] housing bubble but nonetheless I think the difference is huge.

Charles Bunch

I would say that performance in our architectural coatings business in Europe was very good. Obviously the demand is weaker but I think we offset that with some aggressive cost actions and so the performance was very solid. Here in North America the volume is actually even weaker than in Europe but I think there too our team did a very good job in reducing their costs and their performance although weaker in volume, was solid.

Sergey Vasnetsov - Barclays Capital

And could you comment what you see Asia broadly and China specifically when it comes to industrial and [inaudible] coatings.

Charles Bunch

Our performance in Asia Pacific in coatings in the second quarter was very good. Volume was down. Sales were down but it was a record pre-tax, pre-interest earnings performance in the second quarter despite that. It was led by our businesses in China. They offset what I would consider weaker results in countries like Korea or Australia.

And I would say that the businesses in China especially the automotive OEM business, they benefited from some of the Chinese stimulus plans. Our protective and marine coatings business, our packaging coatings businesses, these businesses in China all had very solid quarters and we’re very pleased with the results there.

Industrial coatings, because some of the industrial end use markets are more tied to the Chinese export markets weren’t quite as strong but we had many of the domestic Chinese businesses were among our strongest.

Operator

Your next question comes from the line of David Begleiter - Deutsche Bank

David Begleiter - Deutsche Bank

Can you comment on the trends you’re seeing in raw material costs as well as selling price increases in your coatings businesses.

Charles Bunch

Let’s talk about raw material costs, I would say that after some weakness at the end of last year in raw material input costs for us, pricing environment has stabilized. If you remember during the first quarter oil prices got down to below $40.00 a barrel then they started moving up late in the first quarter and through the second quarter. We therefore had a lot of suppliers who were attempting to get prices up in the second quarter.

And so far what I would say is that its bit of a standoff in terms of raw material input. The biggest benefit we’re still experiencing is the natural gas prices which have remained weak and that is helping us. That is the unhedged portion so that’s been the biggest positive story. The other raw material prices are now let’s call it stable.

Similar for pricing, we have I think a more stable pricing environment if oil prices and raw materials remain stable so at this point I would say our pricing actions are modest at this point either positive or negative.

David Begleiter - Deutsche Bank

Is your pricing ahead of or equal to your raw material cost.

Charles Bunch

Well I think what you saw last year we as we’ve talked, we usually have a little bit of a lag both in absorbing the cost and being able to move those through to our customers so we were probably a little bit behind the curve at this time last year then we were able to get some modest price increases in some markets and so I would say now, the situation for the last several quarters has been stable.

Prices for our raw materials not going up although our suppliers are attempting to discuss those with us and by and large our pricing actions are neutral with our customers.

Operator

Your next question comes from the line of Kevin Mccarthy - BAS-ML

Kevin Mccarthy - BAS-ML

I heard you say that you expect to remain pretty cautious as it relates to acquisitions and of course watch cash carefully, understandable given the last nine months, but on a forward looking basis I guess you could also argue it’s a buyers market right now. You’ve got a year and a half of Sigma-Kalon behind you and end use markets in architectural and industrial are pretty fragmented. So I guess my question is what sort of conditions would you be looking for to accept a little bit more risk in terms of adding to the portfolio here in the coatings side.

Charles Bunch

What I would say is that the market for coatings acquisition opportunities is a little slow right now. We have not seen very many companies or properties being offered. We have been fairly inactive but I think in many cases you’re seeing companies that are focusing on execution on improving their returns and so we have not seen a lot of opportunities and certainly last year and earlier this year the discussions that we did have, there was still an expectation on the part of the sellers that the valuations should be similar to what the market was in 2007 or early 2008 when the earnings were stronger.

So I think there’s still a little bit of a dislocation there so we’re going to obviously look at opportunities. We haven’t seen anything yet that we would regard as a real bargain opportunity. We also have as you know a stock price at PPG that we think has room to move on the upside so that would be an alternative if we continue to see this level of excess cash and our operating performance and cash flow continue strongly, I think we would also look to modestly have share buybacks as part of our program.

Kevin Mccarthy - BAS-ML

Follow-up if I may on slide six, you show a seasonal sales growth index comparing 2Q to 1Q, I was wondering if you could comment on the outlook in coatings for 3Q versus 2Q and what sort of sequential pattern you might foresee there.

Charles Bunch

I would say that we’re looking for a still a decline versus the third quarter of 2008 but if you’re looking from a let’s call it a seasonal standpoint I think that its going to be in coatings a little favorable in the third quarter to what would traditionally be a second quarter to third quarter fall off anyway so I think the volume declines that we would normally see from second to third quarter historically will be a little less and one of the reasons there is we think there’ll be a little more strength in the automotive OEM and industrial markets.

I think a lot of the destocking has already taken place. We see here in North America that General Motors and Chrysler who have you know, were virtually out of the car production business in the second quarter, we do look for them to start production here later this month and through the rest of the quarter.

Operator

Your next question comes from the line of Robert Koort - Goldman Sachs

Robert Koort - Goldman Sachs

In terms of the savings benefit you’re talking about in $250 million on the run rate basis, how much of this target of savings benefit is sensitive to the underlying economic conditions. In other words if we see some improvement in this economic environment will you still be able to produce that $1.00 per share savings benefit. Or probably you have to give back some.

Charles Bunch

At this point our view would be that these reductions that we’ve made, these structural cost reductions are somewhat transparent to our customers. We intend to be able to by reorganizing our supply chain we would not anticipate these types of cost savings would be shared with our customers as you know in the businesses that have been most impacted by this downturn such as our automotive coatings or our glass businesses, these are businesses that are still struggling and as William indicated we’re still losing money in our glass segment.

So at this point we need these cost reductions to return to solid levels of profitability for PPG.

Operator

Your next question comes from the line of John Roberts – Buckingham Research

John Roberts – Buckingham Research

With GM and Chrysler now out of bankruptcy are they more interesting customers to you now that they’re balance sheets are in better shape and they’ve shed some of the legacy liabilities.

Charles Bunch

I would think as stand alone companies these are healthier. They have better balance sheets. We feel that they represent, they’ve always been good customers although the outlook in the longer-term was always somewhat cloudy. Now I think there’s a little more certainty and so they’re certainly attractive customers for us.

We intend to continue the position that we have had before their bankruptcy in terms of supply so we think we will be able to start back up with them as they ramp up production and we think they represent good opportunities for us to grow with them and in the case of General Motors, their businesses outside of North America that weren’t as touched by these bankruptcy challenges, we see them continuing to do well in markets like China, like Korea, like Latin America.

So we think they present a very solid opportunity to grow.

John Roberts – Buckingham Research

Are you concerned at all that Europe’s auto production may be propped up here by their cash for clunkers program and that there’ll be an uncharacteristic drop later this year when that comes off.

Charles Bunch

I think there is obviously a risk that this has pulled forward some of the demand and that will probably mean that the continued improvement that you’d like to see at the bottom of a recession won’t be as strong in 2010 in Europe. So I think that is a valid point. We won’t get the kind of growth that maybe we would have had if we’d gone down to the depths this year.

But I think especially in the case of Europe where it takes you a little longer to implement restructuring actions, to close plants, I think its given all of us the car manufacturers and the automotive suppliers, the dealers and the like a little more time to adjust to these economic conditions. But I think we’ll see some of that same phenomena here in North America. The scrappage program will I think bring forward some sales and I think that we’re already hearing that its bringing interest into the dealers lots.

There’s more inquiries and we hope that in the case here, that it will restart the industry and that even though it may steal a few sales from next year, I think the sales have been so depressed at this point that eventually you will get stronger pent up demand as we go forward.

Operator

Your next question comes from the line of PJ Juvekar – Citi

PJ Juvekar – Citi

You talked about this automotive OEM ramp up in the US is that a third quarter event or more like a fourth quarter event and if we think production is running at seven million units or so where do you think that could go.

Charles Bunch

I think its, you’re going to see improvement here in the third quarter. If you remember last year in North America production levels started being taken down dramatically in the third quarter. We are going to see a restart especially at Chrysler and General Motors in this quarter. So we think you’ll see some impact here in the third quarter and it will continue on into the fourth quarter.

Because we have really been producing in North America at lower than these depressed sales levels, so right now inventories are healthier from that standpoint that they have been in a number of years. So I think we’ll see some improvement here in the third quarter and that should continue on into the fourth quarter.

PJ Juvekar – Citi

And then quickly on chlor-alkali, spot caustic prices have come down so contract prices are likely to come down, but you talked about chlorine price increases, natural gas is down, if you look at all those moving parts do you think you can hold your margins in that 13% to 14% range in the second half.

Charles Bunch

I think in the third quarter we’ll have I think a challenge to hold the margins that we saw in the fourth quarter. The prices were coming down through the quarter so we ended up in, at the end of the quarter certainly not at the same pricing level or profitability. Yes we are helped by what’s happening in natural gas or ethylene, but I think it will be a challenge for us to maintain this level of profitability in the third and fourth quarters.

Operator

Your next question comes from the line of Silke Kueck – JPMorgan

Silke Kueck – JPMorgan

I have two questions, one is a question of clarification on the US architectural business, did I hear correctly that you said that the US architectural stores business was down double-digit but that the do-it-yourself business was up double-digit.

Charles Bunch

Yes, that was correct. The stores business in the second quarter was off, low double-digits from the previous year and our national accounts business and dealer business were slightly positive.

Silke Kueck – JPMorgan

What’s slightly positive.

Charles Bunch

They were in mid single-digits volume gain.

Silke Kueck – JPMorgan

And I have a question on the cost savings, the annualized run rate of $50 million in cost savings can you tell which areas of your income statement benefit, I saw that SG&A costs were down more than $200 million in the quarter on a year over year basis and also your gross margin improved nicely by a couple of hundred basis points so can you tell where these cost savings are more noticeable.

Charles Bunch

I would say they are split between let’s call it supply chain improvements or manufacturing. We closed a number of factories there at the end of 2008 and here recently in the second quarter so some of that will flow directly to the margins as part of our variable cost reduction but we also took out significant overhead costs so that is why you’re seeing some improvement in the RS & GA so I would say its probably a mix between the two.

And that trend will continue.

Operator

Your next question comes from the line of Don Carson – UBS

Don Carson – UBS

Just a couple of housekeeping items first I don’t know if you went over this but the corporate expense was down sequentially and just wondering what drove that and what you think a sustainable corporate expense level is and then just also wondering about the year over year depreciation decline, what’s driving that.

William Hernandez

Let’s talk depreciation first, a lot of the things we’ve closed down have eliminated depreciation since we no longer have them. We’ve also gotten rid of our automotive glass business so that’s closed down quite a bit of our depreciation as well.

In terms of the corporate expense, part of that is equity earnings.

Vincent Morales

The biggest change in corporate expense this quarter really was a currency conversion, the rate shifted sequentially. We had a currency conversion gain this quarter. If you recall back to the first quarter we had actually had a currency conversion loss versus again the fourth quarter rates.

So if you look on a run rate basis, corporate was running about, its running on constant items of about $30 million exclusive of the stock options and the currency gain was $8 million this quarter. The currency loss last quarter was an equivalent $8 million.

Don Carson – UBS

And then on the chlor-alkali, you’re talking rates in the low 80’s which is quite a bit above the industry rate which has been around the 72% range, I’m just wondering what’s driving your higher rates and can you just talk a bit about sort of the average ECU for the quarter and where you ended the quarter.

Charles Bunch

I would say on our capacity utilization we were a little stronger outside of our US plants. We have four plants, two in the US, two outside the US. Our operating rates were stronger and historically are outside the US so those are running above kind of US industry averages. I would say our two US plants have been running maybe slightly ahead of industry operating rates but as we looked at the last half of the second quarter those operating levels came down a little bit.

And in terms of the ECU we don’t give out prices on specific prices on ECU levels. We’ve said that they were coming down through the second quarter and we finished the second quarter arguably 25% below where we had been in the first quarter and the trends right now in the third quarter are mixed. Obviously caustic prices are still weak. There is spot prices that have been leading the contract prices down, but there are a number of actions in pricing on chlorine including some that we have announced that we hope will stabilize the ECU pricing environment in the second half.

Operator

Your next question is a follow-up from the line of David Begleiter - Deutsche Bank

David Begleiter - Deutsche Bank

I know that question has been addressed or asked somewhat but on your cost actions how much of these costs are variable in nature that may come back as volumes ramp up whether its in R&D or SG&A.

Charles Bunch

I would say that our intent is to make sure that the cost, especially the cost of where we’ve taken these restructuring actions, that we are making let’s say a long-term adjustment in our cost and ability to deliver services so that at this point we have talked maybe in one case in our glass furnaces where we’ve said we’ve actually idled the furnace with the opportunity to bring it back at a later date.

But if you look at most of the rest of our cost actions in manufacturing typically we’re closing plants such as the one we closed in the second quarter in automotive coatings in Canada. Our intent would not be to bring that production back at that location and consolidate it in our other facilities.

And likewise with our overhead costs we’re looking at opportunities or ways to do things more efficiently, more productively so I would say that we are not looking to add these costs back at a later date. We are looking for new ways to do business under the kinds of collapses in demand that we’ve seen, we understand now that we have really had to challenge ourselves on the way we do business and so we intend for these changes to be longer-term.

Operator

Your next question comes from the line of Dmitry Silversteyn - Longbow Research

Dmitry Silversteyn - Longbow Research

I have a follow-up question on raw material costs, can you quantify the delta on raw material costs year over year.

Vincent Morales

If you remember last year oil ran up in the second quarter, in early third quarter and we typically lag oil inflation so we didn’t really see a sizable inflationary impact in coatings raw materials until the second half of the year. So our year over year deflation from raw materials is fairly benign in the second quarter.

Dmitry Silversteyn - Longbow Research

Then on domestic architectural market, particularly on your store paint sales, sales are down double-digits and your competitor announced price declines in the channel. Just wondering what is your stand on pricing in that channel.

Charles Bunch

Are you referring to the Sherwin Williams announcement on retail prices in their stores business.

Dmitry Silversteyn - Longbow Research

That’s correct.

Charles Bunch

Our stores channel is more focused on the professional painter. We have at this point not tried to compete aggressively in what I would call retail or DIY paint from our stores channel and we would view Sherwin Williams as competing with our customers and I can’t comment on whether those pricing actions on their part are designed to get them competitive at those levels.

So our pricing to the professional segment through our stores has been stable this year. We have taken a number of actions to reduce costs. We have lowered our store count in the face of this weaker economic and construction environment and we actually feel that we are stabilizing in that business and our performance is improving despite the fact that volume is still showing a decline in the second quarter.

Dmitry Silversteyn - Longbow Research

On chlorine, price increases, given weak demand do you think those price increases will stick and do you expect them in the third quarter or fourth quarter.

Charles Bunch

We certainly hope that these price increases will stick. We would see some of that benefit starting in the third quarter although if there were all implemented the full benefits would be seen in the fourth quarter.

Operator

Your next question comes from the line of Frank Mitsch - BB&T Capital Markets

Frank Mitsch - BB&T Capital Markets

Sorry if I missed it but did you quantify on an EPS basis what the foreign exchange negative impact was and if not, is it around 10%.

Vincent Morales

Nine to $0.10.

Frank Mitsch - BB&T Capital Markets

And if currencies stay where they are right you’d anticipate that that might be a little bit less in the third quarter, is that fair.

William Hernandez

It would probably be about half of that I think in the third quarter.

Frank Mitsch - BB&T Capital Markets

And then I caught the part where your nat gas unfortunately was hedged at $8.00 per MM BTU in the second quarter where does that stand for the third and fourth quarters right now.

Charles Bunch

It will be very similar. We’ve been hedging actually three years out for a third and then we have a little more of that hedged now especially with the volume declines so the hedge position will be similar in the third and fourth quarters.

Operator

Your next question is a follow-up from the line of PJ Juvekar – Citi

PJ Juvekar – Citi

I just had a quick follow-up question, first on the raw material benefit, your raw materials typically tend to lag the commodity market by one to two quarters, so we saw a big benefit in 2Q, do you expect that benefit to narrow as we go ahead because oil prices have gone up.

Charles Bunch

I would say the raw material prices are fairly stable right now. As you know the prices have gone up and the suppliers would like to pass some increases on but at this point I think given the weak economic environment we think that raw material prices appear stable here in the near-term.

PJ Juvekar – Citi

And on the European architectural business, your volumes held up but margins are still below the US margins, can you comment about the cost structure there and what have you done in the last 18 months in terms of improving that cost structure.

Charles Bunch

What I would say is actually again, we’re very pleased with the performance of the architectural business in Europe and the margins were very solid. As you can see they were double-digit margins in the second quarter. That’s obviously the strongest point of the season. But if you look at the comparison to our US or North American architectural business or other architectural businesses that we have around the world, this is actually a better performance.

If you look at our business here in North America it is in the performance coatings segment, the performance coatings segment has higher margins than what you see in the architectural Europe segment but we also have some very strong businesses in that segment as well so I would say like for like the European performance is very good in architectural.

Operator

Your next question is a follow-up from the line of Robert Koort - Goldman Sachs

Robert Koort - Goldman Sachs

For your North America architectural paint business the volumes at the store channel has been up and underperforming the national [inaudible] distribution channel dramatically and heading to the second half of the year, would you expect that the volume trends at your stores just to stabilize the weak level or we should expect some sequential improvement or even some sequential deterioration.

Charles Bunch

I think that the volume, if you look at the stores, our stores business, its more exposed to the commercial segment. Its more exposed to new home construction, both of which have been weaker than what we would consider the DIY channel where I think you’re seeing a little better performance on the part of the consumer.

Repainting is a low end or a low cost way to make home improvements and so I would say that at this point we don’t look for any further declines in volume for our store channel but some of the trends where we haven’t seen significant improvement in new home construction and commercial is sluggish out there.

I’m saying that volume shouldn’t improve significantly and the improvements that we have seen in that channel have been from or own cost reduction initiatives.

Robert Koort - Goldman Sachs

In Europe and obviously your architectural paint volume is much better than a lot of people would have expected and just wondering is there any particular regions that represent a big benefit for PPG or you take market share from some of your major competitors in some product lines or areas.

Charles Bunch

I would say that as we’ve been talking about the former Sigma-Kalon architectural business is very well positioned. They had a lot of momentum over the last couple of years in the marketplace. They control a lot of their own distribution so that gives us, I think we’re not as subject to the vagaries of the retailers in some cases in Europe.

We have a little more control. I think we’ve done a good job in positioning the business. Share has been stable to slightly positive and although we’ve been exposed in the UK to a weak construction market, we have missed some of the weakest markets in Europe like Spain, or Italy and I think with our focus on the repaint market, the smaller painters, in Northern Europe, in France, that has given us a more stable business profile.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Charles Bunch

Thank you very much for joining us and we look forward to continuing our dialogue with you in October for our third quarter results. Thank you.

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Source: PPG Industries Q2 2009 (Qtr End 06/30/09) Earnings Call Transcript
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