Vince Morales - Vice President, Investor Relations
William Hernandez - Senior Vice President and Chief Financial Officer
PPG Industries (PPG) Q2 2008 Earnings Call July 17, 2008 8:00 AM ET
Good morning, this is Vince Morales, Vice President of Investor Relations for PPG Industries. Welcome to PPG’s second 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, July 17, 2008. Visuals supporting this briefing may be accessed through the investor center on PPG’s website at www.PPG.com.
As shown on slide 2, the following presentation contains forward looking statements reflecting 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 in the Appendix of the visuals supporting this briefing.
Now let me introduce PPG’s Senior Vice President and CFO, William Hernandez.
Today I will review PPG’s second quarter 2008 performance and comment on various trends that are impacting our results. Let me quickly recap the quarter.
First, let me state that we are very proud to deliver strong financial performance this quarter. We achieved double digit percentage growth in sales, segment earnings and adjusted earnings per share, despite a higher inflationary environment and overall slower economic conditions including severe recessions in US residential construction and US automotive production.
We were able to deliver this performance due to the strength and diversity of our business portfolio. Some of the main contributors were our growth drivers of Aerospace, Optical, Protective and Marine Coatings and our coatings businesses in Asia, Latin America and Eastern Europe, which continued to grow at very high rates. Our commodity chemical business had yet another solid quarter. Also, across all our businesses, we achieved one of our largest selling price increases in the past several years.
Many of our strategic actions over the past several years were to diversify our business and geographic sales mix. These actions had more complexity versus remaining or expanding predominantly in the United States and not exploring new end markets. But we were successful in executing and we are realizing the dividends today as indicated by the financial performance we posted this quarter. This includes our recent SigmaKalon acquisition which is currently tracking ahead of our 2008 financial targets.
Also, earlier this month we signed an agreement to sell approximately 60% of our Automotive Glass and Services businesses and we expect the deal to close in the third quarter. Since the third quarter of 2007, this business had been classified in our financial statements as a discontinued operation because of our intent to sell the entire business. Because we are retaining 40% interest in the business, generally accepted accounting principles require us to report this business as part of our continuing operations for both the second quarter and in our historical financial results.
Therefore, included in today’s presentation is second quarter and June year to date financial information which identifies the operating results of the Automotive Glass and Services businesses and one time charges, including those related to the pending sale of the business. We believe this provides investors with all the pertinent details relating to our financial results both with and without the Automotive Glass and Services businesses.
Now if you turn to the next slide, let me quickly recap our strong operating performance in the quarter. First regarding sales, our reported sales were nearly $4.5 billion, up over 40% from last year and easily establishing a new PPG record for any quarter in the company’s history, demonstrating the consistency of our growth, this is the 21st consecutive quarter, or over five years in a row now where we have delivered a year over year quarterly sales record.
All eight of our coatings business units, both Optical and Specialty Materials business units, our commodity chemicals business and our Performance Glazing glass business unit posted second quarter sales records. Many of these business units also delivered second quarter earnings records as well.
We delivered overall organic growth of 5% in the quarter, with both volume and price contributing. Also, currency added an additional 5% to sales. We experienced extremely weak US end market demand in automotive OEM and residential construction, with our volumes in businesses directly serving these markets down over 10%.
However, we more than offset those volume declines with solid organic volume growth in Asia, Latin American and Europe, along with solid volume gains in several businesses including Commodity Chemicals, Aerospace, Optical, and Specialty Materials. Higher year over year selling prices added just about $90 million to our sales, again one of our largest increases in the past several years.
Our acquisition of SigmaKalon added about 30% to PPG’s total sales, and increased the sales in our combined coatings segments by 50%. All SigmaKalon sales for 2008 will be reported as acquisition gains for PPG since we closed on the purchase January 2, 2008. However, on a year over year basis, overall SigmaKalon sales were up double digit percentages aided by favorable currency and low to mid single digit organic growth.
Our segment earnings grew by double digit percentages, which is a direct result of the global breadth of our businesses portfolio and the solid performance of our commodity chemical business. Once again, we are proud of our business growth and overall solid performance given today’s economic conditions.
Now let me compare our total company results. The next slide provides a recap of our adjusted financial results for both this year and last, excluding the Automotive Glass & Services business results and unusual and one time charges. A detailed reconciliation from our reported results to this recap for both years is available in the appendix of today’s presentation.
The results provide a clear illustration of our growth this quarter with our adjusted earnings per share for the quarter of $1.62, which is $0.17 or 12% higher than our prior year results. I will remind you this performance is despite a variety of headwinds including softer economic conditions and higher inflation.
Also, although it is not reflected on this slide, let me also comment that our cash generation results are impressive. On a year to date basis we have generated over $350 million of cash from operations which is about 60% higher than last year.
As I mentioned earlier, we are very proud of our financial results for the second quarter given the prevailing environment as they reflect the strength of our business portfolio and also demonstrate in a clear and measurable fashion the success of our past strategic actions. Now let’s review some of the details.
Looking quickly at our sales results by region, our sales in the United States and Canada grew by 5%, with 4% price gains and 1% due to Canadian currency. We experienced flat volumes in the quarter in the United States and Canada. As I mentioned previously, the US automotive OEM and US architectural paint end markets in this region were very weak and our businesses, while outperforming the end markets, experienced low double digit percentage declines.
Meanwhile high volume growth in other businesses, including excellent results in commodity chemicals and optical and specialty materials, provided for a complete offset. Looking ahead into the third quarter, we expect current market conditions to remain and we are not anticipating much volume growth in this region. However, we have a variety of selling price actions either announced or already implemented, and expect higher pricing gains in the third quarter.
Moving to the next slide, our European sales grew by just under $1 billion dollars, up 140% primarily due to our SigmaKalon acquisition and currency. We also recorded higher selling prices of about 2%.
Once again all SigmaKalon sales, including organic growth versus their 2007 performance, are classified as increases due to acquisition. Again, I will discuss SigmaKalon in detail in a few minutes, but SigmaKalon grew organically low to mid single digit percentages.
In the region, our 2% percent selling price increase was supplemented by volumes in the quarter which rose by 1%. Of note and illustrated in the trend graph, our second quarter comparables from both 2007 and 2006 were exceedingly difficult. Obviously we are pleased in maintaining our cumulative gains from these prior years.
We are anticipating some moderation of overall economic growth in Europe in the third quarter, which is historically a seasonally slower quarter in Europe. However, we expect our year over year performance to remain fairly similar to the second quarter. Similar to the United States, we also have current pricing initiatives in this region which will provide benefits during the third quarter.
Our Asian results are detailed on the next slide and our overall sales are up about 80% this year. Our quarterly sales in this region were right at $500 million, up over 325% from just two years ago providing a quantification of the rapid and material growth we are driving in this region. Also, this region remains one of the best in terms of operating margins. Acquisitions were a sizable component of this growth, but our sustained growth in volumes in this region continued, advancing 14%. Prices added an additional 1% to our organic results.
Each of our coatings businesses in the region is contributing towards our solid volume performance, and despite transportation changes in certain areas in China ahead of the 2008 Summer Olympics, we expect commensurate performance next quarter due to the continuation of strong demand in the broad end markets that we serve.
Now before I discuss each of our business segments, let me discuss a few macro topics. As detailed on the next slide, the rising cost of energy and raw materials remains a dominant topic globally. In the quarter, our primary energy cost, natural gas, inflated to about $10.50 per unit, compared with just under $7.75 in the second quarter of last year, and $8.50 in the first quarter of this year.
For those of you less familiar with PPG, we use 60 to 70 trillion BTUs of natural gas a year that 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 $1.00 per million BTU, our pre tax costs change by about $60 to $70 million on an annual basis.
Looking ahead we have about one third of our third quarter gas needs hedged at about $8.50 per million BTU, and current unit market price for the remainder is about $12.00. As a reference point, our third quarter 2007 natural gas costs were about $6.75. We have also experienced inflation in our coatings raw material costs, which include petroleum, based materials, and is by far the largest component of production costs for coatings.
Our expectation at the onset of the second quarter was for inflation in the range of 2% to 4% and our actual inflation was slightly over 3%. We communicated a few weeks back that feedstock pressures have elevated further and we expected our third quarter 2008 raw material inflation to be in the range of 4% to 6% and this remains our expectation.
It is very important to note that this is a blended rate for all of PPG coatings businesses and geographies. The range differs greatly by geography, with a higher range in the United States, and generally lower ranges outside the United States. As detailed on the pie chart, only about 30% of our coatings sales are in the United States and Canada.
In addition to raw materials and direct energy costs, we also experienced continued inflationary pressures in transportation costs and surcharges associated with rising gasoline costs. Our total transportation costs in the quarter increased by an additional $20 million versus last year, an increase of about 20%. Regarding inflation overall, we are not anticipating any easing from the current environment.
We have increased our efforts to identify and qualify new and more cost effective sources of raw materials. Also, as I mentioned earlier, our pricing was up 3% this past quarter and our businesses are working to secure further pricing to offset these rising 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 first 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 a third amended plan of reorganization to address issues the court raised in its ruling. While we believe we are closer to a potential resolution this quarter versus last quarter, 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. Second quarter sales grew by almost $300 million or 30%. Acquisitions added about 24% growth, currency added 6%, volumes slipped by 2% and price added 2%. Also I will add that regionally, we delivered 20% organic growth in Asia, with each business unit contributing nicely.
Our segment earnings were $171 million, up 8% versus the prior year. The acquisition of SigmaKalon’s Protective & Marine Coatings business was nicely accretive to earnings. Also, strong organic volume gains in our legacy Protective & Marine coatings business and Aerospace, along with favorable currency impacts, offset the earnings impact of significantly lower volumes in our United States architectural coatings business. Inflation was mitigated by cost reduction actions and pricing gains.
Let me review a few key items in our business units; our Architectural Coatings Americas and Asia business unit grew sales by 9%. This growth was principally due to non-US acquisitions and currency. Our volumes in the United States and Canada were down slightly more than 10%, with declines in all channels. This performance is reflective of the significant residential housing recession and slower home remodeling market.
Looking ahead we are not expecting any improvement for, at a minimum, the remainder of 2008 in this end market. Due to cost actions, we minimized the overall earnings impact of the lower volumes, and will continue to manage costs aggressively in the business. In addition, we have already secured and are seeking further selling price increases.
In Aerospace, our sales grew 11%, supported by volume and pricing gains, and currency. This remains a solid growth driver and we continue to expect similar performance looking ahead. Our Automotive Refinish sales grew 17% with price, volumes, currency and acquisitions all contributing. As evidenced this quarter, this business is a very reliable contributor, and we anticipate similar consistency in the future.
Protective & Marine Coatings was added as a separate business unit in this reportable segment this year, as the SigmaKalon acquisition more than doubled our sales into this end market. In addition to acquisition growth, we also achieved solid organic growth from our base business with both pricing and volume gains. As we mentioned last quarter, sizable growth opportunities remain in the future as the global shipping market and large scale civil infrastructure construction projects served by this business remain robust.
To summarize the quarter for this segment, despite lower activity levels in our Architectural Coatings business, we still delivered organic sales growth and posted 8% earnings growth. This performance was due in large part to consistent organic growth in the Aerospace and Protective and Marine businesses, strong Asian growth and nicely accretive acquisition results from the Protective and Marine portion of SigmaKalon which is ahead of our expectations.
Moving to the next slide detailing our Industrial Coatings segment, our sales rose by about $200 million or 22%. Similar to last quarter, about half of the gain was due to the acquisition of SigmaKalon’s industrial coatings business with the remainder due to favorable currency, positive volume growth and a slight pricing improvement.
By region, we continued to experience headwinds in the United States and Canada with volumes declining about 10%, but that region now only accounts for slightly more than 25% of this segment’s total. We more than offset these negative impacts with organic growth of just under 10% in every one of our other regions, Europe, Asia and Latin America, which combined now account for about 75% of the segment.
Our segment earnings were flat reflecting the impact of the rising inflation and a notably weaker US automotive OEM end market. We offset these headwinds with strong results outside the United States and positive SigmaKalon acquisition related earnings. Also of importance is we continued to fund our growth initiatives in key end markets and regions.
Let me quickly comment on each of the businesses comprising the Industrial Coatings segment; our Automotive OEM Coatings business grew by 11% and not only set a new second quarter sales record but a new record for any quarter. Currency added 8% and pricing was flat. Volumes were up 3% despite severely negative results in the US and Canadian market, a region which represents about 30% of the business unit sales. Our non-US regions averaged double digit percentage growth in recognition of our strong customer base and overall global growth in the industry.
We continue to communicate to the equity markets the growth performance and overall strength of the global auto OEM industry, and our results this quarter provide yet another measurable milepost of this. However, we remain convinced that the global growth potential is vastly misunderstood and incorrectly valued by the equity markets.
Industrial Coatings business unit sales improved by 44% with the SigmaKalon acquisition the main contributor of the growth. Overall volumes were flat, as softer US volumes, which approached double digit percentage declines, were offset by solid growth in all other regions. Packaging Coatings sales grew by 15% with currency the main factor, although volumes and price also contributed.
Overall our Industrial Coatings segment results truly reflect the geographic diversity of the segment as we were able to offset appreciably lower US market results. Looking ahead we expect generally similar results in all regions in the third quarter.
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 $667 million. Excluding positive currency impacts, sales grew by low to mid single digit percentages versus pre-acquisition SigmaKalon results last year, reflecting continued organic growth in several regions.
Earnings for the segment were $71 million. These earnings include the majority of the $20 million quarterly, non-cash amortization of intangibles stemming from the acquisition. In addition, this segment incurs about $20 million of non-cash depreciation per quarter as well. This business remains very healthy and is well ahead of their strong 2007 financial performance.
While construction activities in a few countries in Europe, such as Spain, Ireland, Italy and the UK, are slowing, we generally and historically have very minimal participation in most of these regions. The UK is a market in which we do participate and our year to date sales into that market are flat. Based on our geographic footprint, including strong positions in several Eastern European countries, we anticipate the overall business will continue to post good results in the third quarter.
Now let me take this opportunity to provide you with a mid year 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 Performance Coatings segments. 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 are on schedule and we remain on our target to achieve roughly $50 million of cost synergies this year. On top of that we have through the first two quarters of the year achieved an additional $20 to $40 million of raw material cost mitigation due to our enhanced purchasing power.
Looking at combined operating financial results from all businesses, I am happy to report that we are exceeding our original 2008 financial targets at mid year due to strong performance in all three business segments, and this does not include the $20 to 40 million in raw material cost mitigation I just mentioned. So obviously, we are very pleased with the performance of this acquired business. It is a core element of our successful financial performance this year and also of our growth moving forward.
Shifting to our Optical and Specialty Materials segment on the next slide, our next generation
Transitions VI lens product which we introduced in the United States at the onset of this year continues to drive strong sales growth. In addition, our Specialty Materials businesses posted solid sales gains as well. Segment earnings improved 7% driven by volume growth in Optical and higher segment pricing which offset inflation in our Specialty Materials businesses due to higher raw material costs along with higher advertising spending at Transitions Optical. Segment operating margins were 25%.
Looking ahead, we are accelerating to the fourth quarter of this year the roll out of our new generation Transition Optical VI lens product in certain European countries. We will likely incur slightly higher year over year ad spending in the third quarter, but also anticipate strong year over year sales gains during the quarter.
Shifting to the next slide detailing our Commodity Chemicals segment, sales increased by about 30% to a new quarterly record. Volumes and price contributed equally to the sales gain. Segment earnings improved by about 20% with favorable manufacturing and overhead cost performance contributing to the volume gains.
Meanwhile, natural gas, ethylene and freight costs experienced significant year over year inflation, which equally offset higher pricing. Toward quarter end we declared force majeure due to a weather related incident which reduced production capacity at our largest chlor-alkali facility and strained our inventory levels.
We were able to continue to manage our order book. However we are carrying a significant backlog. We expect our low inventory position to continue into the third quarter, compounded by river transportation issues due to the flooding in the Midwest. Also, price increases have been announced for select products for the third quarter.
Our next business segment slide details our Glass segment. During the quarter, our reported sales, including Automotive Glass and Services, were flat. Positive currency equally offset negative volumes.
Earnings in the segment declined by about $20 million due to lower volumes and higher inflation, partially offset by lower manufacturing costs.
Looking at results by business unit; Performance Glazing sales improved 9% due to positive volumes, price and currency. Volumes are up over 5% as similar to last quarter, continued weaker sales to the residential market were more than offset by higher commercial construction market sales. Fiber Glass sales advanced slightly as favorable currency and price offset weaker volumes.
Automotive Glass and Services sales were down due to lower volumes. This segment continues to face challenging end market conditions and higher input costs. We will continue to aggressively manage costs in this business. Also, as noted earlier, we signed a sales agreement for the controlling interest in our Automotive Glass and Services business and expect that transaction to close in the third quarter.
Now let’s move to our cash results. The next slide details our prioritized cash uses, which most of you have heard us discuss for some time. For the quarter we generated over $300 million in cash from operations. On a year to date basis our cash from operations exceeds $350 million and is more than $125 million or about 60% ahead of last year’s pace.
Our uses of cash through the first six months are as follows; year to date we have spent approximately $150 million on organic capital spending, excluding acquisitions necessary to keep the businesses healthy and competitive. Our dividend payments year to date totaled about $170 million, up 4% over last year.
Regarding debt, we increased our debt by about $1.5 billion in the first quarter to partially finance the SigmaKalon acquisition. Since the beginning of the year, we repaid about $250 million of debt from cash from operations. Separately regarding the pensions, it is likely we will make pre-tax contributions of about $100 million this year.
Next are acquisitions, and outside of SigmaKalon we have not completed any sizable acquisition this year. We use share repurchases for any excess cash, and through the second quarter our focus remained to offset dilution from option exercises.
I will conclude our cash discussion by commenting that we are delivering, once again, strong performance in cash generation. We have been and will remain focused on balancing our uses of cash with overriding goals to strengthen and grow our businesses and provide for sustainable earnings growth opportunities for the benefit of our shareholders.
Now let me conclude my commentary on our second quarter results by highlighting a few key takeaways from the quarter. As I mentioned at the onset to today’s call, our financial results remain solid with double digit percentage growth in sales, segment earnings and adjusted earnings per share and these results continue to validate the success of our past strategic actions.
This success is amplified when considering today’s economic backdrop. Our SigmaKalon acquisition is tracking ahead of our mid year financial performance targets. We continue to advance our transformation strategy, and signed a sales agreement for controlling interest in our Automotive Glass and Services businesses and our cash generation, a PPG hallmark, remains well ahead of a solid prior year figure.
In conclusion, as we look ahead we are even more confident in the direction of our company and expect our performance to compare favorably versus our industry groups.
This concludes the second quarter 2008 financial commentary, featuring comments by William Hernandez, Senior Vice President and Chief Financial Officer.