PPG Industries, Inc. — 2017 Q3 Form 10-Q Summary
Business context and reporting period
PPG is a global coatings manufacturer operating through two reportable segments: Performance Coatings and Industrial Coatings. This unaudited Form 10-Q covers the three and nine months ended September 30, 2017, compared with the corresponding 2016 periods.
PPG completed the sale of its North American fiber glass business on September 1, 2017 and exited its Glass operations. Historical Glass results were recast as discontinued operations.
Financial performance and key metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $3,776 million | $3,660 million | $11,068 million | $10,853 million |
| Income from continuing operations | $398 million | $(206) million | $1,240 million | $474 million |
| Net income attributable to PPG | $609 million | $(184) million | $1,444 million | $533 million |
| Diluted EPS from continuing operations | $1.52 | $(0.79) | $4.73 | $1.69 |
| Diluted EPS attributable to PPG | $2.36 | $(0.69) | $5.58 | $1.98 |
| Operating cash flow | Not separately provided | Not separately provided | $1,032 million total; $1,020 million continuing operations | $776 million total; $650 million continuing operations |
Q3 sales increased 3.2%, driven by favorable foreign currency translation of $67 million, higher volumes, acquisitions and modest pricing. Cost of sales rose 6.2% to $2.1 billion, reducing the cost-of-sales margin to 44.4% from 46.0%. SG&A increased 1.3% but declined to 24.0% of sales from 24.4%.
The Q3 effective tax rate was 23.6%. The prior-year quarter included a $968 million pension settlement charge and a related $352 million tax benefit, making the year-over-year profit comparison unusually favorable. Management reported adjusted diluted EPS from continuing operations of $1.52 in both periods; adjusted measures are non-GAAP.
- Performance Coatings: Q3 sales were $2,290 million, up 3.0%; segment income was $365 million, down 0.8%. Nine-month sales were $6,608 million, essentially flat, while segment income declined 1.1% to $1,063 million.
- Industrial Coatings: Q3 sales were $1,486 million, up 3.4%; segment income was $223 million, down 10.4%. Nine-month sales increased 4.9% to $4,460 million, while segment income fell 5.7% to $760 million.
- Balance sheet: Cash and cash equivalents were $2,287 million at September 30, 2017, versus $1,820 million at December 31, 2016. Total debt, based on short-term and long-term debt reported on the balance sheet, was approximately $4.7 billion, versus approximately $4.4 billion at year-end.
- Liquidity: Cash and short-term investments totaled approximately $2.3 billion. Management believed cash, operating cash flow and available borrowing capacity were sufficient for operations, capital spending, acquisitions, dividends, debt service, repurchases and pension contributions.
- Capital allocation: Nine-month capital expenditures were $207 million, acquisition spending was $69 million, the TCI investment was $100 million, dividends paid were $321 million and share repurchases were $413 million. The quarterly dividend increased 13% to $0.45 per share.
Material changes versus the prior comparable period
- Reported earnings improved substantially because the Q3 2016 pension settlement charge did not recur. A further $22 million pension settlement charge was recorded in the first nine months of 2017.
- Nine-month operating cash flow from continuing operations increased $370 million, primarily because 2016 included funding of the Pittsburgh Corning asbestos trust. The 2017 increase was partly offset by higher working capital and cash tax and interest payments.
- Raw-material, logistics, wage and other inflationary costs pressured margins, particularly in Industrial Coatings. Restructuring savings and pricing actions partly offset these pressures.
- PPG sold the North American fiber glass business for $541 million of pre-tax proceeds and recorded a $343 million pre-tax gain. Discontinued operations contributed $217 million after tax in Q3 and $220 million for the first nine months.
- PPG completed the $100 million purchase of a 40% interest in Taiwan Chlorine Industries and acquired DEUTEK, Futian assets and other businesses. Goodwill increased to $3,881 million from $3,572 million at year-end, including foreign-currency effects.
- Operating working capital increased to $2,414 million, or 16.0% of sales, from $2,001 million, or 14.6%, at December 31, 2016.
Guidance, outlook, risks and unusual items
- Management expected seasonally lower fourth-quarter sales, especially in architectural coatings in Europe, the United States and Canada.
- Hurricanes and other natural disasters reduced Q3 continuing-operations EPS by approximately $0.05; management expected continued adverse effects in Q4, including store closures in Puerto Rico and demand uncertainty in Mexico following earthquakes.
- Raw-material costs were expected to remain at current levels for the remainder of 2017. Foreign currency translation was expected to benefit Q4 results based on prevailing exchange rates.
- PPG expected the October 2017 Crown acquisition to contribute approximately $20 million to $25 million of Q4 sales, with initially dilutive margins during integration.
- Total 2017 capital spending was expected to be 2.0% to 2.5% of full-year sales. PPG targeted at least $3.5 billion of combined acquisition and share-repurchase spending for 2017 and 2018.
- The 2016 restructuring program targeted approximately $125 million of annual savings when fully implemented. PPG expected at least $45 million of savings in 2017 and substantial completion by year-end 2018.
- Asbestos reserves totaled approximately $180 million, with approximately 625 open and active asbestos-related claims at September 30, 2017. Seller indemnification for certain acquired-business claims was scheduled to cease for claims filed after April 1, 2018.
- Environmental reserves totaled $272 million, including $144 million for New Jersey Chrome. Management also identified reasonably possible but unreserved environmental losses of approximately $100 million to $200 million.
- Other contingencies included $181 million of letters of credit and surety bonds and $17 million of guarantees. Management stated that losses related to the guarantees were not likely.
- Key risks include raw-material availability and pricing, foreign-exchange movements, natural disasters, global economic conditions, acquisition integration, restructuring execution, environmental regulation and litigation outcomes. Management reported no material changes to the risk factors in the 2016 Form 10-K.
Important facts for investors to verify
- Separate recurring operating performance from the significant 2016 pension charge, 2017 Glass divestiture gain and discontinued operations.
- Assess whether pricing and restructuring savings can offset continuing raw-material, logistics and wage inflation.
- Monitor working-capital growth, cash conversion and the effect of acquisitions and share repurchases on leverage and liquidity.
- Evaluate the financial and operational impact of hurricanes, earthquakes and other natural disasters on fourth-quarter demand and margins.
- Review the asbestos reserve, remaining claims, indemnification expiration and environmental reserves for potential changes in future cash obligations.
- Compare reported and adjusted EPS carefully because adjusted results exclude selected charges and gains and are not GAAP measures.