PPG Industries, Inc. — Fiscal 2017 Form 10-K Summary
Business context and reporting period
PPG Industries manufactures and distributes paints, coatings and specialty materials through two reportable segments: Performance Coatings and Industrial Coatings. The filing covers the fiscal year ended December 31, 2017, with quarterly information including the quarter ended December 31, 2017. Historical results were recast to present the former Glass segment as discontinued operations following the completion of the North American fiber glass divestiture.
Key financial metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Net sales | $14.750 billion | $14.270 billion | Up 3.4% |
| Income before income taxes | $2.008 billion | $786 million | Up $1.222 billion |
| Net income attributable to PPG | $1.591 billion | $877 million | Up $714 million |
| Continuing operations income attributable to PPG | $1.371 billion | $547 million | Up $824 million |
| Diluted EPS from continuing operations | $5.32 | $2.05 | Up 159.5% |
| Adjusted diluted EPS | $5.87 | $5.67 | Up 3.5% |
| Effective tax rate | 30.7% | 27.6% | Up 3.1 percentage points |
| Cash from operating activities—continuing operations | $1.556 billion | $1.218 billion | Up 27.8% |
| Capital expenditures | $360 million | $380 million | Down 5.3% |
| Cash acquisitions, net of cash acquired | $325 million | $349 million | Down 6.9% |
Cost of sales excluding depreciation and amortization increased 6.6% to $8.204 billion, causing the ratio to sales to rise to 55.6% from 53.9%. Selling, general and administrative expense declined slightly to $3.570 billion, or 24.2% of sales versus 25.1% in 2016. Adjusted income from continuing operations was $1.513 billion, compared with $1.506 billion in 2016, and adjusted effective tax rate was 24.4%.
Performance Coatings generated $8.732 billion of sales and $1.323 billion of segment income. Industrial Coatings generated $6.018 billion of sales and $972 million of segment income. Industrial Coatings sales increased 5.8%, but segment income declined 6.7% due primarily to raw material inflation, lower selling prices and wage inflation. Performance Coatings sales increased 1.8% and segment income increased 0.7%.
At December 31, 2017, cash and short-term investments totaled $1.491 billion. Total debt, including capital leases, represented 43% of total debt and equity, compared with 47% in 2016. Long-term debt was $4.134 billion, and PPG had no borrowings outstanding under its $1.8 billion revolving credit facility.
For the fourth quarter, net sales were $3.682 billion and diluted EPS from continuing operations was $0.58. Fourth-quarter continuing operations income attributable to PPG was $147 million.
Material changes versus the prior comparable period
- Sales growth reflected approximately 1% acquisition-related growth, 1% volume growth, slightly favorable currency translation and modestly higher selling prices.
- Raw material cost inflation increased materially, driven by supplier force majeure events in Europe, Chinese environmental restrictions, hurricanes in the United States and higher oil prices.
- Reported earnings benefited from the absence of the $968 million pre-tax pension settlement charge and $195 million restructuring charge recorded in 2016. PPG recorded a $60 million pension settlement charge in 2017.
- The U.S. Tax Cuts and Jobs Act produced a provisional $134 million net tax charge, contributing to the higher reported effective tax rate.
- PPG completed the sale of its North American fiber glass business for approximately $541 million of cash proceeds and recognized a $343 million pre-tax gain in discontinued operations. The transaction completed the strategic exit from glass operations.
- PPG repurchased 7.4 million shares for $813 million, paid $434 million in dividends and increased the per-share dividend 13% to $0.45 in July 2017.
- Cash from operations increased primarily because 2016 included $813 million of funding for the Pittsburgh Corning asbestos trust, while 2017 benefited from lower pension contributions, restructuring payments and interest payments.
Guidance, outlook, risks and unusual items
Management expects 2018 coatings raw material costs to increase at a mid-single-digit percentage rate in the first half of the year. Further selling-price increases and cost reductions are expected to support margin recovery, particularly in Industrial Coatings. PPG expects 2018 foreign currency translation to increase sales by approximately $250 million to $300 million and income before taxes by approximately $25 million to $30 million, based on mid-January 2018 exchange rates.
PPG expects a 2018 continuing-operations effective tax rate of approximately 23.0% to 24.0%, although the estimate may change as regulations and interpretations of the Tax Cuts and Jobs Act develop. The company expects capital expenditures for modernization, productivity and environmental projects to equal approximately 2.5% to 3.0% of sales and expects to deploy at least $2.4 billion on acquisitions and share repurchases in 2018.
Key risks include raw material price increases or supply shortages, inability to recover costs through pricing, economic and end-market weakness, intense competition, foreign currency volatility, international political and regulatory risks, acquisition integration, business disruptions, cybersecurity, environmental obligations and litigation. Coatings raw materials comprise approximately 70% to 80% of cost of sales in most formulations.
Environmental reserves totaled $258 million at year-end, including $136 million for New Jersey Chrome. Additional reasonably possible but unreserved environmental losses were estimated at approximately $100 million to $200 million. PPG expects environmental remediation cash outlays of $25 million to $75 million annually from 2018 through 2022. The company also maintained approximately $180 million of reserves for non-channelled asbestos claims and was aware of approximately 625 open and active asbestos-related claims.
The 2017 results include unusual items such as the Tax Cuts and Jobs Act charge, pension settlement charges, transaction costs, asset write-downs, gains from business and asset sales, and a legal settlement. Management states that environmental and litigation contingencies are not expected to materially affect consolidated financial position or liquidity, although costs recognized in an individual period could be material.
Important facts for investors to verify
- Reconcile reported EPS of $5.32 with adjusted EPS of $5.87 and assess the recurring nature of the excluded items.
- Evaluate whether pricing actions can offset expected mid-single-digit raw material inflation and restore Industrial Coatings margins.
- Verify the provisional $134 million tax reform charge and the 2018 effective tax-rate outlook as tax guidance develops.
- Assess the planned $2.4 billion of 2018 acquisitions and share repurchases against cash generation, debt maturities and liquidity.
- Review environmental remediation estimates, particularly the New Jersey Chrome reserve and the $100 million to $200 million unreserved exposure.
- Monitor asbestos claims, insurance coverage and the expiration of seller defense and indemnity obligations for certain claims after April 1, 2018.
- Consider the effect of discontinued Glass operations and divestiture gains when comparing ongoing operating performance.
- Confirm the impact of the 2018 accounting changes for revenue recognition, leases and pension-cost allocation on comparability.