PPG Industries, Inc. — Q2 2017 Form 10-Q Summary
Business context and reporting period
PPG Industries is a global coatings manufacturer operating through two reportable segments: Performance Coatings and Industrial Coatings. This unaudited Form 10-Q covers the three and six months ended June 30, 2017, compared with the corresponding 2016 periods. Historical results were recast to classify the former Glass segment as discontinued operations.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $3,806 million | $3,782 million | $7,292 million | $7,193 million |
| Income from continuing operations | $509 million | $345 million | $842 million | $680 million |
| Net income attributable to PPG | $501 million | $370 million | $835 million | $717 million |
| Diluted EPS from continuing operations | $1.95 | $1.25 | $3.21 | $2.47 |
| Diluted EPS attributable to PPG | $1.94 | $1.37 | $3.22 | $2.66 |
| Cash flow from operating activities | Not separately provided | Not separately provided | $446 million total; $434 million continuing operations | $(1) million total; $(79) million continuing operations |
- Q2 sales increased 0.6%, while six-month sales increased 1.4%.
- Q2 income from continuing operations attributable to PPG was $504 million, versus $339 million in 2016. Adjusted Q2 EPS from continuing operations was $1.83, versus $1.73.
- Q2 cost of sales rose 4.7% to $2,082 million, and cost of sales as a percentage of sales increased to 54.7% from 52.6%. SG&A declined 7.0% to $865 million, or 22.7% of sales versus 24.6%.
- The reported Q2 effective tax rate was 24.1%, versus 45.2% in 2016; the adjusted rate was 24.6%, compared with 24.8%.
- Performance Coatings sales declined 1.6% to $2,301 million and segment income declined 3.5% to $413 million. Industrial Coatings sales increased 4.2% to $1,505 million, while segment income declined 9.6% to $264 million.
- Cash and short-term investments totaled approximately $1.6 billion at June 30, 2017, compared with $1.9 billion at December 31, 2016. Total debt was approximately $4.6 billion, including current debt and capital leases; the debt-to-total-capital ratio was 45%.
- Capital expenditures were $135 million, business acquisitions used $62 million, the TCI investment used $100 million, dividends paid were $205 million, and share repurchases were $163 million during the first six months.
Material changes versus the prior comparable period
- Profitability improved materially, primarily because of the absence of the 2016 asbestos trust funding tax charge, lower SG&A, lower interest expense, restructuring savings and higher other income.
- Underlying operating performance was pressured by higher raw-material costs, wage and other cost inflation, lower selling prices in portions of Industrial Coatings, unfavorable currency translation and weakness in marine and certain architectural coatings markets.
- Foreign currency translation reduced Q2 sales by approximately $65 million and six-month sales by approximately $125 million; six-month pre-tax income was reduced by approximately $29 million by currency translation.
- Working capital consumption increased: operating working capital was $2,467 million, or 16.2% of annualized sales, versus 14.6% at December 31, 2016. Receivables and inventories increased substantially from year-end.
- PPG acquired Romanian coatings maker DEUTEK and certain assets of Futian Xinshi, acquired a 40% interest in Taiwan Chlorine Industries for $100 million, and sold the Plaka business, recording a $25 million pre-tax gain.
- PPG announced the planned sale of its remaining North American fiber glass business, expected to close in the second half of 2017 for approximately $545 million of pre-tax proceeds. The Glass businesses were reported as discontinued operations.
- Discontinued operations contributed $6 million after tax in Q2 2017 versus $31 million in Q2 2016, and $11 million for the first six months versus $50 million.
Guidance, outlook, risks and unusual items
- Management expected seasonally lower sequential sales in Q3 2017, continued growth in automotive refinish, aerospace and industrial coatings, and seasonally lower U.S. and Canadian architectural coatings sales.
- Management expected higher selling prices to address raw-material inflation, $20 million to $25 million of net acquisition-related Performance Coatings sales in Q3, and only a minor currency impact based on then-current exchange rates.
- Full-year 2017 capital spending was expected to be 2.5% to 3.0% of sales. PPG expected $15 million to $25 million of mandatory non-U.S. pension contributions during the second half of 2017 and at least $3.5 billion of acquisition and share-repurchase cash deployment for 2017 and 2018 combined.
- The restructuring program targets approximately 1,700 position reductions, with approximately $125 million of annual savings when fully implemented. PPG expected $40 million to $50 million of savings in 2017 and substantial realization of the remaining savings by year-end 2018.
- Unusual Q2 items included the $25 million Plaka gain, an $18 million legal settlement benefit and $5 million of transaction-related costs. The first half also included a $22 million pension settlement charge.
- PPG had approximately 650 open and active asbestos-related claims and approximately $180 million of reserves for non-channelled asbestos liabilities. Environmental reserves totaled $270 million, including $151 million for New Jersey Chrome; reasonably possible unreserved environmental losses were estimated at $100 million to $200 million.
- Other potential exposures included $177 million of letters of credit and surety bonds and $12 million of guarantees. Management stated that litigation, environmental matters and guarantees were not expected to have a material effect on consolidated financial position or liquidity, although individual-period earnings impacts remain possible.
- Key risks include raw-material availability and pricing, foreign exchange, global economic conditions, competition, acquisition integration, restructuring execution, environmental regulation and litigation outcomes.
Investor verification checklist
- Verify the extent to which EPS growth reflects the lower tax rate, prior-year asbestos-related tax effects, share repurchases and other unusual items rather than recurring operating improvement.
- Monitor raw-material inflation, pricing actions and segment margins, particularly the divergence between sales growth and declining segment income.
- Assess working-capital normalization and the conversion of reported earnings into operating cash flow.
- Confirm completion, proceeds and accounting treatment of the North American fiber glass divestiture and the expected use of proceeds.
- Track restructuring savings, employee reductions and related cash costs through early 2018.
- Review developments in asbestos litigation, environmental remediation, foreign-currency exposures and the pending adoption of revenue-recognition and lease accounting standards.