PPG Industries, Inc.

Good morning. My name is Jason and I will be your conference operator today. At this time, I would like to welcome everyone to the PPG second quarter 2021 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press star followed by the number one or your telephone keypad. If you'd like to withdraw your question, please press star then two. To allow everyone an opportunity to ask questions, the company requests that each analyst ask only one question. Thank you. I would now like to turn the conference over to John Bruno, Vice President of Investor Relations. You may begin your conference. Thank you, Jason, and good morning, everyone. Once again, this is John Bruno. We appreciate your continued interest in PPG and welcome you to our second quarter 2021 Financial Results Conference Call. Joining me on the call from PPG are Michael McGarry, Chairman and Chief Executive Officer, and Vince Morales, Senior Vice President and Chief Financial Officer. Our comments relate to the financial information released after U.S. equity markets closed on Monday, July 19, 2021. We have posted detailed commentary and accompanying presentation slides on the Investor Center of our website, ppg.com. The slides are also available on the webcast site for this call and provide additional support to the brief opening comments Michael will make shortly. Following management's perspective on the company's results for the quarter, we will move to a Q&A session. Both prepared commentary and discussion during this call may contain forward-looking statements reflecting the company's current view of future events and their potential effect on PPG's operating and financial performance. These statements involve uncertainties and risk, which may cause actual results to differ. The company is under no obligation to provide subsequent updates to these forward-looking statements. This presentation also contains certain non-GAAP financial measures. The company has provided in the appendix other presentation materials which are available on our website, reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures. For additional information, please refer to PPG's filings with the SEC. Now, let me introduce PPG Chairman and CEO, Michael McGarry.

Thank you, John, and good morning, everyone. I would like to welcome everyone to our second quarter 2021 earnings call. Most importantly, I hope you and your loved ones are remaining safe and healthy. Now let me provide some comments to supplement the detailed financial results we released last evening. For the second quarter, our net sales were a record and nearly $4.4 billion, and our adjusted earnings for diluted share from continuing operations were $1.94. Our adjusted EPS was significantly higher than the second quarter of 2020, partially due to last year's second quarter, including various pandemic-related impacts. Looking back to pre-pandemic results, our adjusted EPS was similar to the second quarter of 2019, despite sales volumes being 6% lower than that period, and we are dealing with historical high levels of raw material inflation in the current period. Our strong year-over-year sales reflect a partial recovery from the unfavorable pandemic effects of last year, but also include better-than-market performance across many of our businesses for this quarter. We achieved these higher sales levels despite significant supply and component disruptions, including ones that reduced the overall manufacturing capability of our customers. Coming into the quarter, we expected these disruptions would have an estimated impact of $70 to $90 million, However, the actual impact was much more severe and closer to $200 million. Our adjusted EPS in the second quarter, while near all-time record levels, was below our April forecast. Three main factors impacted the difference. Due to supply disruptions, we experienced unprecedented levels of raw material and transportation costs that continually elevated as the quarter progressed. This drove raw material inflation to be up a mid to high teen percentage on a year-over-year basis versus our original estimate of a high single-digit percentage increase. Our automotive OEM business was impacted most significantly from supply disruptions, as we estimate that more than 2 million less cars were built than initially expected during the quarter. This impacted our sales by about $100 million, or higher than $40 million more than we expected in April. Finally, as we expected, the supply disruptions led to shortages of certain raw materials. We anticipated an impact of $30 to $50 million, but the actual impact was closer to $100 million. We're highly confident that the sales related to these production disruptions will be deferred to later quarters, and this will elongate the global automotive OEM recovery. As I mentioned in April, coming into the year, we're expecting an inflationary environment and had prioritized selling price increases across all our businesses. This helped us achieve solid price increases year-to-date, and our pace of price realization is well ahead of the most recent raw material inflation cycle in 2017 and 2018. Clearly, this inflation cycle is much higher than anyone anticipated, and we are continuing on a business-by-business basis, working to secure further selling price increases. This includes executing additional pricing actions during the third quarter. As a reminder, the second quarter of 2021 was our 17th consecutive quarter of higher selling prices. We're also continuing our strong cost management evidenced by our SG&A as a percentage of sales being 130 basis points lower than the second quarter of 2019. This is being supported by our ongoing execution on our structural cost savings programs realizing an incremental $40 million of savings in the second quarter. We've increased our targeted full-year 2021 savings by about 10% to $135 million. In the second quarter, we finalized three acquisitions, Ticarilla, Vorvog, and Cetelon. We funded the acquisitions for a combination of cash and external financing, which came in at a very attractive borrowing rate. We had yet another strong operating cash performance during the quarter and ended the quarter with about $1.3 billion of cash and cash equivalents, giving us continued flexibility to do additional accretive cash deployment in the upcoming quarters. In regards to our other two recently completed acquisitions, our new traffic solutions business, which is comprised of the NS Flint acquisition, performed to our expectations in the quarter, despite significant challenges with raw material availability, and its order book is at historical highs entering the third quarter. Our Versaflex acquisition, while smaller, is performing well, and it's already helped us win significant protected coatings projects in Central America due to the advanced technologies that we acquired. Another notable accomplishment during the second quarter was the appointment of our company's first-ever Vice President of Global Sustainability. PPG has been a clear ESG leader in the coatings industry through our market-leading sustainable products, and we have plans to further improve our overall ESG program. We will provide updates on these initiatives in subsequent quarters. Moving to our current outlook, most important is that we continue to see very robust and broad-based demand globally, including in many industrial and OEM in-use markets, and strong architectural coatings trade activity in the U.S. Many of our customers have indicated that their order books were at high levels exiting the second quarter. We anticipate this strong global demand pattern to continue. In addition, we expect an eventual restocking of inventory to occur in many of our selling channels either later this year or in 2022. In the near term, We expect some of our customers will continue to be challenged with input or component shortages, so their production capabilities and schedules likely to remain choppy throughout the third quarter. PPG is also experiencing the continuation of spot outages of direct coatings raw materials. As a result, we expect some unfavorable sales impacts from both our direct supply chain disruptions and the production curtailments of some of our customers in the third quarter. Our current best estimate is that our sales are expected to be unfavorably impacted by about $150 million in the third quarter due to these issues. We expect these sales will be largely deferred to subsequent quarters. We also expect raw material costs to remain at elevated levels in the third quarter. Our current best estimate is that they will be inflated by as much as 20% compared to the third quarter of 2020, with businesses and our industrial coating segments experiencing the largest increases due to the raw material mix of those types of coatings. As a result, all our businesses are securing additional selling price increases. Due to the significant increases we experienced in the second quarter and anticipate in the third quarter, we now fully expect to offset raw material cost inflation in the fourth quarter on 2021 on a run rate basis. As I've said previously, these current disruptions are temporary and we strongly believe there's sufficient capacity available in our supply chain once operating conditions normalize. I'm very pleased that we've completed five recent acquisitions since December 2020. In the third quarter, these acquisitions will add about $500 million of incremental sales to our company. As we continue to integrate these acquisitions, we'll start to realize meaningful synergies that will be a strong earnings catalyst. We're also witnessing domestic flight activity picking up all over the world. This will begin to benefit our commercial aftermarket business in aerospace in the second half of 2021. In the information we posted to our website yesterday evening, we're projecting aggregate sales volumes to be up a low single-digit percentage in the third quarter compared to the prior year quarter. With differences by business and region, Including our acquisitions, we expect overall sales growth to be over 20% compared to the third quarter of 2020. In addition, full-year 2021 adjusted earnings, excluding amortization expense and other non-recurring items, is expected to be $7.40 to $7.60, which at the midpoint would be about 13% higher than the adjusted EPS we realized in 2019 despite the significant raw material inflationary pressures we are dealing with this year, and the fact that sales volumes are still not fully recovered from the pandemic when compared to 2019. Finally, I'm very pleased that our board recently approved a dividend increase of about 10%. Our September payment, coupled with the anticipated payment of a similar quarterly dividend in December, will mark 50 consecutive years of annual per share increases in a company's dividend This is another testament of our company's legacy of consistently rewarding our shareholders and the confidence that the board and I have in our ability to continue to generate and grow our operating cash flow. In closing, I could not be more proud of our now 50,000 employees around the world who serve our customers, our communities, and our many stakeholders. Their dedication and commitment to doing better today than yesterday every day helps assure that PPG continues to protect and beautify the world. Thank you for your continued confidence in PPG. This concludes our preparing remarks. And now, Jason, would you please open the line for questions?

Thank you. At this time, I would like to remind everyone, in order to ask a question, press star then the number one on your telephone keypad. And to allow everyone an opportunity to ask a question, the company requests that each analyst ask only one question. We'll pause just for a moment to compile the Q&A roster. Our first question comes from Ganshan Punjabi. From there, please go ahead.