Vince Morales - VP, IR
William Hernandez - Senior VP and CFO
PPG Industries, Inc. (PPG) Q1 2008 Earnings Call April 17, 2008 8:00 AM ET
Good morning. This is Vince Morales, Vice President of Investor Relations for PPG Industries. Welcome to PPG’s first 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 financial information released on Thursday, April 17 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 2, the following presentation contains forward-looking statements reflecting on the company's current 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.
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 on Slide number 9 of the visuals supporting this briefing.
And 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. I will review PPG’s first quarter 2008 performance, and comment on various industry and economic trends that are impacting our performance. If you turn to Slide 3, let me quickly recap the quarter.
Our sales from continuing operations were $3.7 billion, up over 40% from last year, easily establishing a new PPG record for any quarter in the company’s history. For 20 consecutive quarters, or five years in a row, we have delivered a year-over-year quarterly sales record. Our acquisition of SigmaKalon represented a sizable portion of our sales gain, but volumes, pricing, and currency were all positive contributors as well.
We delivered solid overall volume growth of over 2% in the quarter. As a result of slower economic activity, our US and Canadian volumes were flat. European volumes were down 1%, reflecting, in part, strong comparables last year and a slowing in some European economic segments or regions. We more than offset these slightly lower volume results with very robust growth in Asia and Latin America, each advancing by about 18%.
Pricing was an additional positive of 3%, which was our largest quarterly sales price increase since mid-2006. Also, currency added about 6% to sales.
Regarding the SigmaKalon acquisition, integration is going very well and the business has continued to grow. Although we report all the 2008 SigmaKalon sales as acquisition gains for PPG, on a year-over-year basis, excluding currency gains, overall sales were up low-to-mid single digit percentages. Also, as we communicated earlier during the quarter, we recognized $117 million in pre-tax, non-recurring acquisition related costs, and we finalized our long-term financing of the deal. I will discuss specifics regarding the acquisition in a few moments.
Our earnings per share from continuing operations for the quarter were $0.53, which included a $0.54 reduction related to the non-recurring acquisition costs I just mentioned. First quarter 2007 earnings per share from continuing operations were $1.06, which included a $0.03 reduction relating to our proposed asbestos settlement.
Our adjusted earnings per share from continuing operations were $1.07 in 2008 versus $1.09 in 2007. Of note when comparing these figures is a net unfavorable impact of $0.07 in 2008 due to non-recurring tax items in both years. A key measure of our business growth is our total segment earnings, which increased by 17% versus last year.
Regarding cash; our cash from operations increased by about a $150 million versus the first quarter of 2007. To quickly recap our performance, we are very pleased with our organic growth and double-digit segment earnings growth, especially in the light of today's economic backdrop.
This performance provides a clear measure of the success of our prior actions taken to expand our geographic footprint and broaden our end market served, which has resulted in a stronger, more resilient company. Also, we are delivering on our commitments relative to the SigmaKalon acquisition. Finally, we remain focused on increasing even further our historically strong cash generation with a primary use of this cash in the near term to grow our earnings through the paying down of our debt.
Now, let's review some of the details. The next slide illustrates our new geographic mix of sales. As displayed, we have excellent geographic diversity. Of note is that our sales in the United States and Canada have segued from nearly 75% of our total reported just two years ago, to about 45% today. Our total coatings sales are even more diverse with the US and Canada accounting for about 30% percent of our total. Western Europe accounts for about 40%, and combined the emerging regions of Asia, Eastern Europe, and Latin America now account for about 30%.
Our past strategic actions have provided us with this broad geographic distribution, which enables us to take advantage of regional growth and also minimize the impact of economic slowing in any individual region. The next slide provides details on PPG’s organic volume trend. This was our ninth consecutive quarter of positive volume growth, but our growth slowed from the prior year’s trend. Factored into the slower rate of growth were a variety of headwinds this past quarter, including the weakening US economy, a major supplier strike which impacted General Motors production in the United States, and a shift of the Easter holiday into the first quarter this year.
Our strong growth in the Asian and Latin American regions, and in businesses such as Optical and Aerospace, more than offset the impact of these headwinds. The following slide shows our volume trend in Europe. Volumes were down slightly this year due to some slowing in Western Europe combined with some difficult comparables from solid growth in several businesses the past two years as evidenced by the chart. These comparables included strong 2007 results in Automotive Refinish, bolstered by customer conversions to our new water-based product last year, following government regulations eliminating solvent-based product.
Our SigmaKalon results are not included in this chart, as all their sales are classified as acquisition sales. However, as noted earlier, our Architectural EMEA business, which represents the major portion of the acquired SigmaKalon business, enjoyed low-to-mid single-digit percentage growth versus 2007, exclusive of currency gains. Next is a slide detailing our Asian volume performance. Once again, our comparables were exceedingly difficult, and once again we have grown by double-digit percentages.
Our 18% growth was our best performance in the past four years, despite a much larger sales base and frankly excellent performance in many of the previous quarters. Our total sales in this region are more than three times what they were just two years ago, and are now a very meaningful portion of both sales and earnings for PPG.
Now let’s review our overall segment results detailed on the next slide. I will discuss each segment in further detail later, but let me summarize a few key items. Total sales grew over 40%, driven by a 30% gain due to our acquisitions. Favorable currency added about 6% to sales. Despite various headwinds, organic growth was achieved in every segment except Glass, which was down slightly. We established sales records in several segments and most of our individual business units. Segment earnings improved by $56 million, or 17%. Earnings in Performance and Industrial Coatings were level with last year, as growth outside the United States offset lower US results, due to a difficult U.S. economy.
Architectural EMEA earnings are all incremental and reflect results for a seasonally slower period for the business. These earnings also include the majority of the $20 million in intangible amortization expense stemming from the acquisition. Optical & Specialty Materials posted a 17% improvement in net earnings, based on strong sales growth stemming from introduction in the United States of our new generation Transitions Optical product. Chlor-Alkali delivered meaningful earnings growth driven by higher pricing, while glass earnings were aided by better Fiber Glass results.
Now let’s review our earnings per share results. As depicted on Slide number 9, we reported first quarter earnings per share of $0.61 comprised of earnings from continuing operations, net of tax of $0.53, and earnings from discontinued operations; net of tax of $0.08. The reported net earnings from continuing operations include a reduction of $89 million after-tax, or $0.54 per share, related to non-recurring acquisition-related costs from the flow through cost of sales of the step-up to fair value of the inventory acquired in the SigmaKalon acquisition, and the write-off of in-process research and development costs.
The impact of our proposed asbestos settlement on our first quarter results was not material. As noted earlier, our adjusted earnings per share from continuing operations was $1.07, which was achieved due to our double-digit segment earnings growth. Last year, our reported first quarter earnings per share from continuing operations was $1.06. This figure included a $0.03 charge related to the asbestos settlement. Our tax rate on continuing operations in the first quarter last year was 23%, and is about 30% in the first quarter of 2008.
Tax rates in both years included adjustments due to non-recurring items. The net unfavorable impact of these non-recurring tax items on 2008 earnings-per-share is $0.07, when comparing results versus last year. Income from discontinued operations, net of tax was $13 million or $0.08 per share in the first quarter this year, compared with $18 million and $0.11 per share a year ago. Please refer to Slide number 9 of this presentation on the investor center section of our website for a reconciliation of these adjusted earnings amounts to the comparable GAAP financial measures.
Let me now discuss some relevant economic statistics. The next slide provides an overview of either our or Global Insight’s current estimates of relevant economic statistics. I will also provide our outlook for the coming quarter. Year-over-year US GDP growth is estimated to be about 2%, but activity has softened throughout the quarter. This figure differs from the well documented GDP comparison versus the last quarter of 2007, which is expected to be flat or possibly even negative. However, we have historically utilized the year-over-year figure as it is a better proxy for sales comparisons versus last year’s first quarter.
Year-over-year GDP growth in Western Europe was also estimated to be about 2%, with Emerging Europe growth estimated to be three times that figure. Meanwhile, GDP in China advanced by about 11%, while Latin America grew by mid single-digit percentages. In the second quarter, we expect growth in the North American economy to slow even more. Exports should continue to provide an economic boost, offset by the drag from higher energy costs, lower consumer spending, and tighter credit markets.
We anticipate the economy in Western Europe will continue at a level consistent with the first quarter. Unemployment in Western Europe is at one of its lowest levels in the past decade, but higher inflation and flattening-to-declining results in some sectors continue to mitigate growth advances. Solid growth will continue in Emerging Europe supported by growing infrastructure needs and continued manufacturing expansions. We expect other emerging economies, including China and Latin America, to continue to experience rapid growth.
Last, we continue to closely watch two US economic statistics, employment and consumer spending, which at present are close to but not at levels signaling a US recession. Over the past several months, these statistics have continued to drift downward, which has created a contraction of the overall growth rate. We continue to believe these will remain the two most relevant economic figures in today’s economy.
Next is automotive production, which, on a global basis continued to advance with mid-single digit percentage gains. In the quarter, North American light vehicle production is estimated to have declined about 6%, due in part to a General Motors supplier strike. Total European vehicle production is estimated to have increased by about 3%, with a 2% decline in Western Europe offset by growth exceeding 15% in Eastern Europe. Asian growth is estimated to have exceeded 20%.
Our global automotive OEM coatings business grew organically once again, posting mid-single digit percentage volume gains despite negative US volumes. Our growth is a result of both the global reach of our business and our excellent customer relationships supported by innovative technologies and services. Looking ahead, we again expect global vehicle production growth next quarter, but still anticipate a decline in the US market.
Shifting to overall industrial production, we continue to see and benefit from the continued globalization of the industrial base. North American industrial production improved by about 1% year-over-year. Western Europe is estimated to have produced growth of about 3%. China is expected to have grown by nearly 15%. I will remind you that both a shift in the Easter holiday and, specific to the US, the GM supplier strike weighed on the quarter’s results. Our industry projections in the US for next quarter are for slower growth year-over-year, but up slightly sequentially.
Finally, in the construction markets, the US commercial and residential construction markets moved once again in drastically opposite directions. Residential construction softened even further, contracting by about 30% year-over-year. Conversely, commercial construction has grown by more than 10% over the same period. Looking ahead, we are not anticipating any recovery in the US housing market in the near term.
Regarding commercial construction, there is anecdotal evidence of certain sub-segments hitting a plateau, while other sub-segments continue to grow nicely. While our organic North American architectural business results have outpaced the combined market, this has, and will remain, a very challenging environment. Let me conclude our economic discussion by mentioning that we have evidenced notable contraction in several US economic sectors, including residential housing and automotive production. Both of these US segments are already in recession, and have been for some time.
We are working hard to effectively manage our businesses serving these markets. At the same time, we have continued to benefit from growth in other economic segments such as Aerospace, along with broad industrial growth supporting higher exports. There is no question that the US economy is, at a minimum, flirting with an overall recession. However, our past strategic actions to significantly change our geographic footprint and broaden our end-markets served, have allowed PPG to continue to grow despite the US economic slowdown.
While there will likely be some contagion in other regions from the weakening US economy, for PPG we expect continued growth in these other regions to more than offset any negative US impacts. We have years of experience managing the ups and downs of the business cycle. If the US economy does slip into a potentially prolonged recession, we will manage our businesses appropriately, with the intent of minimizing any impacts to PPG and our shareholders.
Now, moving to Slide 11 let me discuss a few other key topics. Energy costs remain a focal issue. In the quarter, our primary energy cost, natural gas, inflated to $8.50 per unit, up from a comparative of $7.50 in both the first and fourth quarters of last year. For those of you less familiar with PPG, we use 60 trillion 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 changed by about $60 million to $70 million on an annual basis.
We have also experienced increases in our coatings raw material costs, which includes petroleum-based materials, and is by far the largest component of production costs for coatings. Our expectation at the outset of the quarter was for inflation in the range of 2% to 4%, and our actual inflation was right at 2%. In addition, we also experienced rapid inflationary impacts in freight costs due primarily to direct costs and surcharges associated with rising gasoline costs. Our total freight cost in the quarter increased by approximately $20 million versus last year, an increase of more than 15%.
As we look ahead, the energy markets remain volatile due in part, in our opinion, to speculation. Accordingly, we expect no relief in our energy or freight costs. Regarding natural gas costs, based on pricing at the beginning of the quarter, we have about 30% of our second quarter costs hedged at about $8.75 per million BTU. As a reminder, comparable per unit costs were $8.50 in the first quarter of 2008 and $7.70 in the second quarter of 2007.
With respect to coatings raw materials, feedstock pressures will remain, but we expect second quarter inflation to remain within our previously communicated range of 2% to 4%. Our substantial organic growth and acquisitions, geographic diversity, broadening of our supplier base, and ability to reformulate our products have continued to aid us in minimizing these inflationary impacts. As I mentioned earlier, our selling pricing was up 3% this past quarter, which was our largest increase in a few years. But, we did not fully offset these higher costs. Our businesses will continue to work to secure pricing to offset these inflationary items.
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 58 of our 2007 form 10-K. 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 a third amended plan of reorganization to address issues the court raised in its ruling. Given the overall complexity of the issue, we are not able to offer any timeline upon which any next step will be taken.
Now, let’s discuss our businesses performance. Slide 12 illustrates the results in our Performance Coatings segment. First quarter sales grew by slightly more that $250 million, or about 30%. Acquisitions added about 21% growth, currency added 6%, volumes grew 1% and price added 2%. Our segment earnings were $120 million, comparable to last year. As I will discuss shortly, earnings were negatively impacted by lower volumes in certain regions or businesses, offset by favorable growth elsewhere. Also, the favorable impact of currency offset higher future growth focused costs in certain business, including Protective & Marine Coatings and Automotive Refinish.
Let me review a few key items in our business units. Our Architectural Coatings Americas and Asia business unit grew sales by 16%. This growth was principally due to acquisitions and currency, as our total US volumes were down mid-single digits, where we experienced sharp volume declines in our professional channels, both in our company-owned stores and in independent dealers. These lower volumes were partially offset by volume gains in our national accounts or “big-box” channel.
Looking ahead, we are not projecting any improvement, and actually may see some further deterioration in this business in the second quarter based on continued end market weakness. We have been, and will remain, diligent on managing our costs, and are focused on pricing to offset raw material increases. In Aerospace, our excellent double-digit growth continued with sales improving by 12%, supported by volume and pricing gains, and currency. This is one of our strongest end-markets, and we expect it to remain strong in the foreseeable future.
Our Automotive Refinish sales grew by 14%, driven by both currency and acquisitions. Pricing was also up, offsetting slight volumes declines. These volume declines were driven by lower European volumes, based on a strong comparable from last year. We anticipate this business will deliver both positive pricing and volumes in the second quarter. We added this year our Protective & Marine Coatings business unit to this segment, as the SigmaKalon acquisition more than doubled our sales into this end-market.
In addition to the acquisition gains, we also experienced organic growth from our base business with pricing gains and double-digit volume gains. Similar to Aerospace, sizable growth opportunities remain due to the robust end-markets served by this business. To summarize the quarter for this segment, our organic growth in Aerospace and Protective & Marine allowed us to absorb and offset the impacts of lower activity levels elsewhere. Additionally, we were able to invest in future growth initiatives, which will begin to provide benefits as early as next quarter. Last, our acquisitions are meeting our expectations and also provide another basis for additional growth in the future.
Moving to the next slide detailing our Industrial Coatings segment; our sales rose by just under $190 million, or 22%. About half of the gain was due to the acquisition of SigmaKalon’s Industrial Coatings business. The remainder of the increase was due to favorable currency and positive volume growth in all businesses. This segment has our greatest geographic diversity. We continue to experience headwinds in the US and Canada, with volumes declining high-single digits, but that region now accounts for less than 30% of the segment total.
We more than offset these negative impacts with very strong organic growth in Europe, Asia, and Latin America. Combined, these regions averaged a robust 10% volume growth, and account for 70% of the segment. Our segment earnings were flat, reflecting the impact of the weaker US market and higher inflation, offset by strong results in our Non-US regions and positive acquisition related earnings.
Let me quickly comment on each of the businesses comprising the Industrial Coatings segment. Our Automotive OEM Coatings business grew by 13%, and set a new first quarter sales record, despite the negative impact of the US General Motors supplier strike and the calendar impact of the Easter holiday. Volume increases of 4%, once again validated the growth potential of this business, supporting global growth in this end-market.
Industrial Coatings business unit sales improved by 41%, with the SigmaKalon acquisition contributing about three-fourth of that growth. Overall volumes grew slightly, despite US volumes which were down by about 10%, as double-digit percentage growth was achieved in emerging regions. Packaging Coatings sales grew by 14% with currency the main factor, although volumes and price also contributed.
Overall our Industrial Coatings segment results truly reflect the geographic diversity of this segment, as we were able to offset appreciably lower US market results. Looking ahead, we expect a continuation of the current market conditions in all of these regions.
Our next segment 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 slow quarter were $536 million. Excluding positive currency impacts, sales grew by low-to-mid single digit percentages versus SigmaKalon results last year, reflecting continued organic growth in several regions.
Earnings for the segment were $9 million, which included a reduction of earnings associated with the majority of the $20 million non-cash intangible amortization stemming from the acquisition. We mentioned previously that the first quarter was a seasonally slow quarter for this segment, with 15% to 20% of annual sales and about 10% to 15% of the annual earnings in this quarter. Historically, the second quarter represents 30% to 35% of the annual totals, which will result in a material sales and earnings increase versus the first quarter.
Also, I will quickly comment on the overall SigmaKalon integration which is going extremely well. I have been very impressed with the energy and enthusiasm exhibited by both our existing and our new colleagues. And, despite a fairly volatile credit market, we were successful during the quarter in placing our permanent financing within in the interest rate range we previously stipulated upon announcing the deal last July.
Last, we remain on target to achieve our full year 2008 cost synergy target of $25 million to $75 million, with measurable progress already achieved this past quarter despite this being the first quarter of integration.
Shifting to our Optical and Specialty Materials segment on Slide 15, we once again delivered record sales supported by the introduction of our new generation Transitions Optical product. Segment earnings improved 17%, driven by volume growth in Optical which offset lower earnings in our Specialty businesses due to higher raw material costs. Segment operating margins remained in the mid-20s. Looking ahead, we will likely experience additional increases in our Specialty businesses input costs, but are very pleased with the excitement and growth rates driven by our new Transitions technology and anticipate this carrying forward into next quarter.
Shifting to the next slide detailing our Commodity Chemicals segment, sales increased by about 14% to a new first quarter record. Most of the sales gain was due to positive pricing, which has been on an upward trend since the beginning of 2007, as customer demand remained strong. Earnings in the segment improved by over 50%, with favorable manufacturing performance adding to the price gains. Meanwhile, natural gas, ethylene, and freight costs experienced significant year-over-year inflation, which acted to moderate the earnings improvement.
Price increases have been announced for select products for the second quarter. Also, we are planning on some minor maintenance outages, which will impact our production volumes. Slide 17 details our Glass segment. During the quarter, our sales grew by 3%, driven primarily by currency gains. Positive pricing did not fully offset volumes which were down 2%. Earnings in this segment improved by $13 million, driven by improved manufacturing. The absence of our prior year joint venture write-down was offset by higher inflation, including natural gas.
Looking at results by business unit. Performance Glazings sales improved 5% due to positive volumes, price, and currency. Volume growth continued as weaker sales to the residential market were more than offset by higher commercial construction market sales. Fiber Glass sales advanced slightly as favorable currency offset weaker volumes. This segment continues to face challenging market conditions and higher input costs. As our improved manufacturing results indicate, we have, and will continue, to manage costs in this business very aggressively.
Now, let’s move to our cash uses during the quarter. Slide 18 details our prioritized cash uses, which most of you have heard us discuss for some time. We generated roughly $50 million in cash from operations this quarter, which is an increase of $150 million versus last year. Our prioritized use of cash remains balanced, and are as follows: First, is prudently funding our businesses through organic capital spending necessary to keep the businesses healthy and competitive.
We spent $90 million, excluding acquisitions, in the quarter. Our annual target remains about 4% of sales. Next, we once again rewarded shareholders in the form of dividends and our payout was up 4% over last year. Regarding debt, our debt-to-capital is about 50%, reflecting the increased debt related to the SigmaKalon acquisition. The total debt at the end of the quarter associated with the final acquisition financing is about $3.1 billion. This includes the $1.5 billion related to our senior note issuance completed during the quarter. Our intentions remain to pay down an average of $250 million to $450 million per year in 2008 through 2010. Debt payments this year will occur later in the year. With respect to pensions, it is likely we will make contributions ranging from $100 million to $200 million this year.
Next on our list are acquisitions, and while we are reviewing potential acquisitions, any we make this year will likely be fairly small. Our last prioritized use of cash is share repurchases, and it is likely any buybacks completed this year will be done with the intention of offsetting dilution. Let me conclude our cash discussion by reiterating that our overriding goals for our cash deployment remain to strengthen our businesses and provide for sustainable earnings growth opportunities for the benefit of our shareholders.
Now, let me conclude my commentary on our first quarter results by highlighting a few key takeaways. We have substantially increased our penetration into the Global Coatings market, with an increase in total coatings sales of 57%. Also, our Optical and Specialty Materials segment grew sales by 18%. This is significant growth in our core business segments, which has, and will, continue to benefit PPG. Our past strategic actions to build a globally diverse Coatings and Optical and Specialty Materials company are now paying dividends. We have increased our share of the coatings market in each major region of the world, which makes us a more resilient company as evidenced this quarter.
Equally important is that these sizable beachheads outside of North America also provide for future growth. We remain focused on continuing to solidify our portfolio. Obviously, the successful integration and delivering of value from our recent acquisitions, including SigmaKalon, remains a focal point. Additionally, our intentions remain to sell our Automotive Glass and Services business this year.
Last, we are not resting on our heritage of strong cash generation. We have sharpened our focus in this area once again, and expect even further improvements in this hallmark of PPG performance. The additional cash we generate will be utilized to grow earnings, initially through the payment of debt.
In conclusion, given the economic backdrop, we are pleased to deliver sales and double-digit segment earnings growth, supplemented by the positive performance of our acquisitions. Our geographic diversity and broad customer and end-market coverage have been and will remain key contributors despite slowing economic sectors or regions and high inflation rates. We remain confident in our ability to grow in today’s environment due to our past actions, while concurrently laying the foundation and investing for tomorrow.
This concludes the first quarter 2008 financial commentary featuring comments by William Hernandez, Senior Vice President and Chief Financial Officer.