PPG Industries, Inc.
Q3 2008 Earnings Call Transcript

Published: 16 Oct 2008

[Vince Morales:]

Good morning, this is Vince Morales, Vice President of Investor Relations for PPG Industries. Welcome to PPG's third quarter 2008 financial commentary. The financial commentary is provided by PPG's Senior Vice President and Chief Financial Officer, William Hernandez. These comments relate to the financial information released on Thursday, October 16, 2008. Visuals supporting this briefing may be accessed through the Investor Center on the PPG website at www.ppg.com. As shown on slide number two, the following presentation contains forward-looking statements reflecting the company's current views about future events and their potential effect on PPG's operating and financial performance. These statements involve risks and uncertainties that could affect the company's operations and financial results and as discussed in PPG's filings with the SEC may cause actual results to differ from such forward-looking statements. This presentation also contains certain non-GAAP financial measures. Pursuant to the requirements of Regulation G, the company has provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures presented on slide number five of the visuals supporting this briefing. Now let me introduce PPG's Senior Vice President and CFO, William Hernandez.

[William Hernandez:]

Good morning and thank you for your time and interest in PPG. Today I will review PPG's third quarter 2008 operating performance and comment on various trends that impacted our results. Before I recap the quarter, let me quickly discuss a few strategic updates. First, we completed the sale of our automotive glass and services business within our originally communicated timeline, despite challenging market conditions. I will discuss a few details on the deal later, but once again we are pleased to have followed through on our commitments. Also, we recorded a business restructuring reserve in the third quarter, which focuses on adjusting the cost structure of our ongoing operations to reflect current market conditions, and will aid in achieving the year 2009 synergy targets that we set-forth for our SigmaKalon acquisition. We anticipate the restructuring will result in a $100 million cash outlay, and expect to achieve savings at a $100 million annual run-rate by the end of 2009. Last, we repaid net debt of over $650 million, which puts us on pace to more than double our 2008 debt reduction target. Also, as you would expect from PPG, we remain financially disciplined, as we ended the quarter with cash of $500 million which exceeds our short-term commercial paper of about $175 million. We have been able to deliver these results due to our excellent cash generation, which is about $250 million or 50% ahead of a strong 2007 performance, including about $450 million of cash from operations in the third quarter. Now let me discuss our ongoing operations. As we communicated toward the end of the third quarter, several of our businesses were hampered by non-recurring items including weather related events such as the two hurricanes, Gustav and Ike, which struck the US Gulf coast, and an employee work stoppage at The Boeing Company which is a large PPG Aerospace customer. Additionally, overall economic conditions resulted in a significant drop in production levels in the automotive OEM industry and adjacent industries. Despite these challenges, we delivered double-digit percentage growth in both sales and segment earnings. Our adjusted earnings per share, which include the negative impacts from weather, the considerably slower automotive OEM end-market, and continued cost inflation, was $1.37, which is comparable with a year ago. Achieving these results despite the items I mentioned and in today's increasingly difficult economic climate, validates the strategic progress we have made in both transforming the company and making the company less prone to negative earnings shocks due to individual end-markets or regions. Collectively, the weather related events and Boeing strike, negatively impacted our results this quarter by about $17 million pre-tax, or $0.07 per share. The negative weather impact to our financial results was less severe than we originally anticipated and communicated in September, due to better end-of-month performance in our commodity chemical business, as customer demand in the Gulf Coast region returned more quickly and stronger than we expected. Meanwhile, the lower automotive OEM activity levels, which are primarily reflected in our Industrial Coatings reporting segment, combined with higher cost inflation, resulted in the majority of the substantial operating earnings decline for that segment versus last year as segment earnings fell 46%. And, although we sold the business at quarter-end, the third quarter automotive glass operating results were included in our reported earnings and also dropped versus last year. Again, despite these notable headwinds, the company still delivered comparable results as the remainder of our business portfolio performed well despite slowing in the overall economy, and our results were aided by our largest quarterly selling price increase in at least a decade. Our Commodity Chemical business, despite some negative impact from the weather related events, performed exceptionally well with year-over-year earnings up about 30%. Additionally, our Optical and Specialty Materials segment grew earnings by nearly 11% and our Performance Coatings segment despite the Boeing work stoppage in September still grew earnings by about 6%. Finally, our SigmaKalon acquisition remains ahead of our financial targets supported by the continued growth of our Architectural EMEA segment, which consists of the majority of the SigmaKalon acquisition. Third quarter year-over-year sales were up over 12% to $632 million as organic growth comprised of higher prices and stronger volumes accelerated further this quarter and were supplemented by currency gains. Segment earnings were $61 million, which includes a reduction of $30 million for depreciation and ongoing amortization stemming from acquisition accounting. Let me conclude my recap of the quarter by stating once again the strong execution, which you have come to expect from PPG, our broad geographic reach and diverse end-markets, and our prudent approach toward managing our cash has once again, produced solid financial performance despite a variety of headwinds. Also with our recently announced restructuring, we are taking further action to adjust our cost structure to the shifts in the global markets we serve. Now, if you turn to the next slide, let me review some of the details for the quarter. First, our reported sales exceeded $4.2 billion up 37% from last year, establishing a new PPG third quarter record. Despite the challenging economic backdrop, we delivered a year-over-year quarterly sales record for the 22nd consecutive quarter. Every one of our segments, except Glass, posted double-digit sales growth. Our acquisitions primarily SigmaKalon added about 30% to PPG's total sales and increased the sales in our combined coatings segments by about 50%. We also delivered our best quarterly pricing results in at least a decade, as year-over-year selling prices added about $175 million to our sales. Our volumes were down less than 1%. We experienced extremely weak US end market demand in automotive OEM, and lower demand in residential construction. We offset those volume declines with solid volume growth in several businesses including optical and aerospace, as well as continued growth in emerging regions. Currency was also slightly incremental, adding an additional 2% to sales. Our segment earnings grew by over 10%, which is a result of the earnings of acquired businesses, the double-digit growth in the Commodity Chemicals and Optical and Specialty Materials segments, and the growth we delivered in emerging regions. Many of our business units delivered third quarter earnings records as well. Once again, we are proud of our growth and overall solid performance in today's economy. Now let's review our earnings per share results. The next slide provides a reconciliation of our continuing operations reported earnings per share to our adjusted earnings per share for both this year and last, adjusting for unusual charges. Our reported earnings per share in the quarter were $0.70. We had unusual charges of $0.67 for business restructuring and $0.02 for our proposed asbestos settlement. We also had a one-time gain of $0.02 relating to our completed automotive glass divestiture. Our third quarter adjusted earnings per share excluding the one-time and unusual items is $1.37. This compares with $1.40 last year. This performance provides both validation of the strength of our portfolio as well as a milepost on the progress of the company's transformation to a coatings, optical and specialty materials company. Now let's review some of the details. Looking quickly at our sales results by region, our year-over-year sales in the United States and Canada grew by 6% in the third quarter, which is a much higher growth rate than last year despite volumes being hampered by weather related issues. Pricing improved by 8% with every business, except our Automotive OEM businesses posting fairly solid pricing gains as we continue to work to offset cost inflation. Volumes in the region were down 2% including the negative weather and Boeing strike effects. As mentioned, the US automotive OEM industry weakened even further this quarter, while residential construction remained weak. Many of our other business units did experience higher volumes in this region highlighted by optical and aerospace. We anticipate the fourth quarter to be equally challenging from an automotive OEM volume perspective, but we also expect to gain additional pricing. Moving to the next slide, our European sales grew by about $850 million dollars, up more than 130%, primarily due to our SigmaKalon acquisition and currency. All SigmaKalon sales, including organic growth versus their 2007 performance, are classified as increases due to acquisition and thus not illustrated on this chart. As I mentioned SigmaKalon's organic growth rate accelerated during the quarter. Excluding SigmaKalon, our selling prices increased by 2%, which offset slightly negative volumes, which were down 1%. As you can see on the graph, activity in the region has been fairly comparable all year. Also, with the last few quarters, our quarterly comparables from both 2007 and 2006 were exceedingly difficult, so maintaining these prior year gains is pleasing. Regarding the fourth quarter, we are currently expecting additional slowing of general industrial growth in Western Europe, which will be partially offset by solid growth in Eastern Europe. We also expect to realize higher selling prices in this region. Our Asian results are detailed on the next slide and our year-to-date sales in this region through September have already eclipsed, by about 20%, our full year sales from 2007 exemplifying our continued rapid growth in the region. During the quarter we still delivered double-digit organic growth despite lower activity levels around the 2008 Summer Olympics held in Beijing. In the region, we have established a good market presence in each of our coatings businesses and our profitability remains at a high level, when compared with both overall coatings industry margins and even PPG's other regions. We expect similar growth rates to continue in this region in the fourth quarter. Now before I discuss each of our individual business segments, let me discuss a few macro topics. As detailed on the next slide, during the quarter we continued to experience year-over-year inflationary increases in the cost of energy and raw materials. In the quarter, our primary energy cost, natural gas, inflated to just above $9.50 per unit, compared with slightly under $7 in the third quarter of last year. Our cost did move down from the second quarter of this year, when it was about $10.50 per unit. For those of you less familiar with PPG, we use 60 to 70 trillion BTUs of natural gas a year to generate power for the production of chlorine and caustic soda, and to produce glass and fiber glass. So, if natural gas unit costs change by $1 per million BTU, our pre-tax costs change by about $60 to $70 million on an annual basis. Looking ahead we have about 40% of our fourth quarter gas needs hedged at about $8.75 per million BTU. As a reference point, our fourth quarter 2007 unit costs were about $7.50. We have also experienced inflation in our coatings raw material costs, which include petroleum based materials. Raw materials are the largest major component of production costs for coatings. Our expectation at the outset of the third quarter was for year-over-year inflation in the range of 4% to 6% and our actual inflation was right at 6%. Our expectation for the fourth quarter is for year-over-year inflation in the range of 5% to 8%, but I will comment that it is a dynamic market today with both energy costs falling, but remaining very volatile, and our suppliers growing concerned about demand levels. In addition to raw materials and direct energy costs, we also experienced higher year-over-year transportation costs and surcharges associated with higher gasoline and diesel costs. Our total transportation costs in the quarter increased by about $20 million versus last year. Regarding inflation overall, we have continually increased efforts to identify and qualify new and more cost effective sources of raw materials. Also, as I mentioned earlier, our selling price was up about 6% this past quarter and our businesses are working to secure additional pricing to further offset the higher costs. Now before I review our business results in more detail, I typically provide an update on our proposed asbestos settlement. For those not familiar with the details of the proposed settlement, please refer to the disclosures beginning on page 22 of our second quarter 2008 form 10-Q. As we said in previous updates, we have filed motions asking the court to reconsider, alter or amend its ruling from December, 2006. Also, various parties, including PPG, are currently working toward an amended PPG settlement agreement to address issues the court raised in its ruling. We continue to believe we are close to a potential resolution. However, given the overall complexity of the issue we are not able to offer any time line upon, which any next step will be taken. Now let's discuss the performance in each of our business segments. The next slide illustrates the results in our Performance Coatings segment. Third quarter sales grew by over $250 million or 28%. Acquisitions added 21% growth, currency added 3%, volumes were flat and price added 4%. Our segment earnings were $148 million, up 6% versus the prior year. A few key elements driving the increased earnings were our pricing efforts, our continued growth in Aerospace despite the negative impact of the Boeing work stoppage, cost management in our US Architectural business and our Protective and Marine Coatings business results, which include a portion acquired in the SigmaKalon acquisition. Let me review a few key items in our business units

[Vince Morales:]

This concludes the third quarter 2008 financial commentary, featuring comments by William Hernandez, Senior Vice President and Chief Financial Officer.