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Securities
Registered Pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on
which registered
Common Stock – Par Value $1.66 2/3
New York Stock Exchange
0.000% Notes due 2019
New
York Stock Exchange
0.875% Notes due 2022
New York Stock Exchange
0.875% Notes due 2025
New York Stock Exchange
1.400% Notes due 2027
New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the
Registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. YES x NO ¨
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ¨ NO x
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such
filing requirements for the past 90 days. YES x NO ¨
Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES x NO ¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K/A or any amendment to this Form 10-K/A. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large
accelerated filer x
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company ¨
(Do not check if a smaller reporting company)
Emerging growth company ¨
If
an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Act). YES o NO x
The aggregate market value of common stock held by non-affiliates as of June 30, 2017, was $28,173
million.
As of January 31, 2018, 249,880,613 shares of the Registrant’s common stock, with a par value of $1.66 2/3 per share, were outstanding. As of that date, the aggregate market value of common stock held by non-affiliates was $29,638 million.
As used in this report, the terms “PPG,”“Company,”“Registrant,”“we,”“us” and “our” refer to PPG Industries, Inc., and
its subsidiaries, taken as a whole, unless the context indicates otherwise.
EXPLANATORY NOTE
PPG is filing this Amendment No. 1 (this “Form 10-K/A”) to amend our Annual Report on Form 10-K for the year ended December 31, 2017 filed with the Securities and Exchange Commission (the “SEC”) on February 15, 2018 (the “Original Filing”) to restate our audited consolidated financial statements for the years ended December 31, 2017 and 2016 and to amend related disclosures, including those regarding our disclosure controls and procedures. We have also restated certain unaudited quarterly
results related to the quarters ended December 31, 2016, March 31, 2017, June 30, 2017, September 30, 2017 and December 31, 2017. This Form 10-K/A also amends certain other items in the Original Filing, as listed in “Items Amended in this Filing” below.
Background of the Restatement
On April 16, 2018, we received a report through our internal reporting system alleging violations of our accounting policies and procedures regarding the failure to accrue certain specified expenses in the first quarter of 2018. Based on our initial review at that time, we identified approximately $1.4
million of expenses (including legal fees, property taxes and performance-based compensation) that should have been accrued in the first quarter of 2018 and that were then reflected in our earnings for the quarter ended March 31, 2018, released on April 19, 2018. In addition, the report alleged that there may have been other unspecified expenses, potentially up to $5 million in the aggregate, that were improperly not accrued in the first quarter.
The Audit Committee of the Board of Directors (the “Audit Committee”) oversaw an investigation of the matters set forth in the internal report with the assistance of outside counsel and forensic accountants. The investigation identified the following items with respect to the quarter ended March 31, 2018, in addition to the approximately
$1.4 million of expenses described above: (1) failure to record amortization expense in the amount of $1.4 million to correct for amortization of an intangible asset that was inadvertently not recorded over a three-year period and discovered in March 2018; (2) understatement of a health insurance accrued liability in the amount of $0.5 million; and (3) failure to record an adjustment increasing the value of inventory in our Europe, Middle East and Africa region in the amount of $2.2 million due to inflation of raw materials costs which, when corrected, had a positive effect on income in the first quarter of 2018. These three items resulted in a net increase to income from continuing operations before income taxes of approximately $0.3 million.
The investigation also identified certain inadvertent errors with respect to the quarter ended March 31, 2018. Correction of such inadvertent
errors, together with the matters discussed in the immediately preceding paragraph, resulted in a net decrease in income from continuing operations before income taxes of $5.7 million for the quarter ended March 31, 2018. The correction of these inadvertent errors also resulted in a net decrease in income from continuing operations before income taxes of $2.3 million for the year ended December 31, 2017.
The investigation identified the following items with respect to the year ended December 31, 2017: (1) improper reclassifications of gains from income from discontinued operations to income from continuing operations in total pre-tax amounts of $2.5 million in the quarter ended June 30, 2017 and $4.7 million in the quarter ended
December 31, 2017; (2) improper shifting of pre-tax expenses between quarterly periods in 2017, including a total of $3.5 million in compensation expense recorded in the third and fourth quarters of 2017 that should have been recorded in the quarter ended June 30, 2017; an additional expense accrual for health care claims in the amount of $3.5 million recorded in the third quarter of 2017 that should have been recorded in the quarter ended June 30, 2017; additional expense for paid vacation in the amount of $2.2 million recorded in the quarter ended December 31, 2017 that should have been recorded in the second and third quarters of 2017; and additional pension expense in the amount of $1.0 million recorded in the fourth quarter of 2017 that should have been recorded in
the quarter ended September 30, 2017.
On May 10, 2018, management, in consultation with the Audit Committee and our independent registered public accounting firm, PricewaterhouseCoopers LLP (“PwC”), concluded that our consolidated financial statements for the year ended December 31, 2017 included in the Original Filing and the related report of PwC, and for the quarterly and year-to-date periods in 2017, should no longer be relied upon because of certain misstatements contained in those financial statements.
The investigation identified the following items with respect to the year ended December
31, 2016: (1) improper classification in the consolidated statement of income of the release of a reserve related to the Company’s 2015 business restructuring program in the amount of $3.4 million and (2) an improper reduction in the payout assumption for certain performance-based restricted stock units that had the impact of recognizing a $6.8 million reduction in stock based compensation expense in the fourth quarter of 2016. In the first quarter of 2017, the payout assumption for these same performance-based restricted
2 2017 PPG ANNUAL REPORT AND 10-K/A
stock units was increased, resulting in $6.8 million of stock-based compensation expense in the first
quarter of 2017 that would not have been recorded if the payout assumption had not been reduced in the fourth quarter of 2016.
On June 27, 2018, management, in consultation with the Audit Committee and PwC, concluded that our consolidated financial statements for the year ended December 31, 2016 included in the Original Filing and the related report of PwC, and for the final quarterly and year-to-date period in 2016, should no longer be relied upon because of certain misstatements contained in those financial statements.
On June 27, 2018, the Audit Committee determined that its investigation was complete, and authorized the filing of our restated audited consolidated financial statements for the years ended December
31, 2017 and 2016 and certain quarterly periods within those fiscal years in order to correct our previously issued financial statements.
Impact of the Restatement
Annual
As a result of the restatement, reported net income from continuing operations was decreased by $2 million, or $0.01 per diluted share, and income from discontinued operations, net of tax, was increased by $5 million, or $0.02 per diluted share, for the year ended December 31, 2017. Reported net income from continuing operations decreased by $4 million, or $0.01 per diluted share, and there was no impact to income from discontinued operations, net of tax, for the year ended December 31, 2016.
Quarterly
As a result of the restatement, reported net income from continuing operations and earnings per diluted share from continuing operations and income from discontinued operations, net of tax, and earnings per diluted share from discontinued operations were adjusted for the appropriate quarterly periods within 2016 and 2017 as follows:
•
For the quarter ended December 31, 2016, net income from continuing operations decreased $4 million, or $0.01 per diluted share, and there was no impact to income from discontinued operations, net of tax.
•
For
the quarter ended March 31, 2017, net income from continuing operations increased $3 million, or $0.01 per diluted share, and there was no impact to income from discontinued operations, net of tax.
•
For the quarter ended June 30, 2017, net income from continuing operations decreased $7 million, or $0.03 per diluted share, and income from discontinued operations, net of tax, increased by $2 million, or $0.01 per diluted share; and for the six months ended June 30, 2017, net income from continuing operations decreased $4 million, or $0.02 per diluted share and income from discontinued operations,
net of tax, increased by $2 million, or $0.01 per diluted share.
•
For the quarter ended September 30, 2017, net income from continuing operations increased $1 million, or zero cents per diluted share, and there was no impact to income from discontinued operations, net of tax; and for the nine months ended September 30, 2017, net income from continuing operations decreased $3 million, or $0.01 per diluted share, and income from discontinued operations, net of tax, increased by $2 million, or $0.01 per diluted share.
•
For
the quarter ended December 31, 2017, net income from continuing operations increased $1 million, or zero cents per diluted share, and income from discontinued operations, net of tax, increased by $3 million, or $0.01 per diluted share.
Internal Control Over Financial Reporting and Disclosure Controls and Procedures
Management has concluded that a material weakness existed in the Company’s internal control over financial reporting as of December 31, 2017 because the Company did not maintain effective controls within its financial close process. Specifically, the
Company’s former Vice President and Controller directed his subordinates to improperly override the Company’s internal controls during the Company’s financial close process, which directions were followed and not disclosed to others in senior management, the Audit Committee or the Company’s independent registered public accounting firm and not otherwise detected by the Company’s internal controls. These actions often occurred after the end of a quarter and close to the end of the financial close process for the quarter and had the effect of positively impacting income from continuing operations reported for such quarter. This material weakness
resulted in misstatements in the Company’s annual financial statements that were not prevented or detected on a timely basis and led to the restatement described above. Based on this evaluation, management has concluded that, as of December 31, 2017, the Company’s internal control over financial reporting was ineffective. Accordingly, management has restated its report on internal control over financial reporting. For more information, refer to Item 8. “Financial Statements and Supplementary Data—Management Report.”
In connection with the restatement described above, the Company’s principal executive officer and principal
financial officer re-evaluated the effectiveness of our disclosure controls and procedures and have concluded that PPG’s disclosure controls
2017 PPG ANNUAL REPORT AND FORM 10-K/A 3
and procedures were not effective. For more information, refer to Item 9A. “Controls and Procedures—Evaluation of disclosure controls and procedures” and “Prior period disclosure controls and procedures and internal control over financial reporting” of this Form 10-K/A. In connection with the investigation described in this Explanatory Note, the Company has identified and implemented, and continues to identify and implement, actions to improve the effectiveness of its
internal control over financial reporting and disclosure controls and procedures, including plans to enhance the Company’s resources and training with respect to financial reporting and disclosure responsibilities. For more information, refer to Item 9A. “Controls and Procedures—Remediation of material weakness” of this Form 10-K/A.
Additionally, in connection with the restatement described above, the Company’s principal executive and principal financial officers have reassessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016 and, due to the existence of the material weakness
in internal control over financial reporting discussed under Item 8. “Financial Statements and Supplementary Data—Management Report” have determined that the Company’s internal control over financial reporting was not effective as of such date. For more information, refer to Item 9A. “Controls and Procedures.” Prior period disclosure controls and procedures and internal control over financial reporting” of this Form 10-K/A. Also, in connection with the restatement described above, the Company’s principal executive officer and principal financial officer reevaluated the effectiveness of our disclosure controls and procedures and have concluded that PPG’s disclosure controls and procedures were not effective as of December 31, 2016. For more information,
refer to Item 9A. “Controls and Procedures—Prior period disclosure controls and procedures and internal control over financial reporting” of this Form 10-K/A.
More Information
Note 2 titled “Restatement of Previously Reported Consolidated Annual Financial Statements” to the Company’s consolidated financial statements discloses the nature of the restatement matters and adjustments and shows the effect of the restatement matters on the Company’s consolidated financial statements for 2017 and 2016. Note 19 titled “Summary Quarterly Information (Unaudited)” to the Company’s consolidated
financial statements discloses the nature of the restatement matters and adjustments and shows the effect of the restatement matters on the Company’s restated condensed consolidated financial statements and notes (unaudited) for the interim periods ended December 31, 2016, March 31, 2017, June 30, 2017, September 30, 2017 and December 31, 2017.
Items Amended in this Filing
For the convenience of the reader, this Form 10-K/A sets forth the Original Filing, in its entirety, as amended to reflect the restatement. No attempt has been made in this Form 10-K/A
to update other disclosures presented in the Original Filing, except as required to reflect the effects of the restatement. The following items have been amended as a result of the restatement:
Financial Highlights
Part I, Item 1 - Business
Part I, Item 1 - Forward-Looking Statements
Part I, Item 1A - Risk Factors
Part I, Item 3 - Legal Proceedings
Part II, Item 6 - Selected Financial Data
Part II, Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations
Part II, Item 8 - Financial Statements and Supplementary Data
Part II, Item 9A -
Controls and Procedures
Part IV, Item 15 - Exhibits, Financial Statement Schedules
The Company’s Principal Executive Officer and Principal Financial Officer are providing currently dated certifications in connection with this Form 10-K/A. These certifications are filed as Exhibits 31.1, 31.2, 32.1 and 32.2.
As
used in this report, the terms “PPG,”“Company,”“Registrant,”“we,”“us” and “our” refer to PPG Industries, Inc., and its subsidiaries, taken as a whole, unless the context indicates otherwise.
Throughout this report, various information and data are incorporated by reference from the
Company’s 2017 Annual Report (hereinafter referred to as “the Annual Report”). Any reference in this report to disclosures in the Annual Report shall constitute incorporation by reference only of that specific information and data into this Form 10-K/A.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 5
FINANCIAL HIGHLIGHTS (As Restated)
Below are our key financial results from
continuing operations for the fiscal year ended December 31, 2017:
•
Net sales were $14.7 billion, up 3% from the prior year, driven primarily by higher sales volumes and acquisition-related sales.
•
Cost of sales, exclusive of depreciation and amortization increased 7% to $8.2 billion, driven primarily by raw material cost inflation, higher sales volumes and higher cost of sales from acquired businesses.
•
Selling,
general and administrative expenses of $3.6 billion were slightly lower compared to the prior year.
•
Income before income taxes was $2,005 million, up $1.2 billion year-over-year, due to the absence of pension settlement charges related to the purchase of group annuity contracts and a business restructuring charge.
•
Net income from continuing
operations was $1,369 million and earnings per diluted share was $5.31.
•
Adjusted net income from continuing operations was $1,511 million and adjusted earnings per diluted share was $5.86.
•
Cash and short-term investments were approximately $1.5 billion at year-end.
•
Cash
from operating activities - continuing operations was $1,551 million.
•
Capital expenditures for modernization, productivity and regulatory improvements was $360 million.
•
Cash used for business acquisitions (net of cash acquired), was $325 million.
•
The
Company raised the per-share dividend by 13%, paid approximately $434 million in dividends and also repurchased $813 million of its outstanding common stock.
•
The Company expects to deploy at least $3.5 billion for acquisitions and share repurchases during 2017 and 2018 combined, with $1.1 billion deployed in 2017.
•
The 2017 effective tax rate
was 30.7%, which includes a $134 million net charge related to the enactment of the U.S. Tax Cuts and Jobs Act. This net charge is $37 million higher than the net charge included in PPG’s fourth quarter earnings release and Form 8-K furnished on January 18, 2018, primarily due to new IRS regulations issued and refinements of the Company’s estimates. While the Company has made a preliminary assessment of the new legislation’s impact on PPG, U.S. regulatory agencies will be issuing further regulations and clarifying interpretations over 2018 which could alter the Company’s conclusions regarding the impact of the new law. Further,
PPG may continue to refine its estimates to incorporate new or better information as it comes available. The Company’s adjusted effective tax rate was 24.3%.
For further information and a full discussion and analysis of business performance for the years ended December 31, 2017, 2016, and 2015 and a reconciliation of non-GAAP financial measures, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K/A.
Part
I
Item 1. Business
PPG Industries, Inc., manufactures and distributes a broad range of paints, coatings and specialty materials. PPG was incorporated in Pennsylvania in 1883. PPG’s vision is to be the world’s leading coatings company by consistently delivering high-quality, innovative and sustainable solutions that customers trust to protect and beautify their products and surroundings. PPG’s business is comprised of two reportable business segments: Performance Coatings and Industrial Coatings.
In September 2017, PPG completed the sale of its North American fiber glass business, which represents the culmination of a multi-year strategic shift in the Company's business portfolio,
resulting in the exit of all glass operations. Accordingly, all historical information has been recast to present the Glass segment as discontinued operations and assets held for sale. Refer to Note 3, “Acquisitions and Divestitures” under Item 8 of this Form 10-K/A for further information relating to this transaction.
Performance Coatings and Industrial Coatings
PPG is a major global supplier of coatings. The Performance Coatings and Industrial Coatings reportable business segments supply coatings and specialty materials to customers in a wide array of end-use markets, including industrial equipment and components, packaging material; aircraft and marine equipment; automotive original equipment (“automotive OEM”); automotive refinish; as well as for other industrial and consumer products. PPG also serves commercial and residential new build and maintenance markets
by supplying coatings to painting and maintenance contractors and directly to consumers for decoration and maintenance. The coatings industry is highly competitive and consists of several large firms with global presence and many smaller firms serving local or regional markets. PPG competes in its primary markets with the world’s largest coatings companies, most of which have global operations, and many smaller regional coatings companies.
6 2017 PPG ANNUAL REPORT AND 10-K/A
PERFORMANCE COATINGS
Strategic Business Unit
Products
Primary
End-use Markets
Main Distribution Methods
Brands
Refinish Coatings
Coatings, solvents, adhesives, sundries, software
Automotive and commercial transport/fleet repair and refurbishing, light industrial coatings and specialty coatings for signs.
Independent distributors and direct to customers
PPG®
Aerospace Coatings
Coatings, sealants, transparencies, transparent armor, packaging
and chemical management services for the aerospace industry
Commercial, military, regional jet and general aviation aircraft
Direct to customers and company-owned distribution network
PPG®
Protective and Marine Coatings
Coatings and finishes for the protection of metals and structures
Metal fabricators, heavy duty maintenance contractors and manufacturers of ships, bridges and rail cars
Company-owned architectural coatings stores, independent distributors, concessionaires and direct to customers
PPG®
Architectural
Coatings Americas and Asia Pacific
Coatings and purchased sundries
Painting and maintenance contractors and consumers for decoration and maintenance of residential and commercial building structures
Company-owned stores, home centers and other regional or national consumer retail outlets, paint dealers, concessionaires, independent distributors and direct to customers
PPG®, GLIDDEN®, COMEX®, OLYMPIC®, DULUX® (in Canada), SIKKENS®, PPG PITTSBURGH PAINTS®, MULCO®, FLOOD®, LIQUID NAILS®, SICO®, CIL®, RENNER®, TAUBMANS®, WHITE KNIGHT®, BRISTOL®, HOMAX® among others.
Architectural Coatings Europe, Middle East and Africa
(EMEA)
SIGMA®, HISTOR®, SEIGNEURIE®, GUITTET®, PEINTURES GAUTHIER®, RIPOLIN®, JOHNSTONE’S®, LEYLAND®, PRIMALEX®, DEKORAL®, TRILAK®, PROMINENT PAINTS®, GORI®, BONDEX®, and DANKE!® among others.
Major Competitive Factors
Product performance, technology, quality, technical and customer service, price, customer productivity, distribution, and brand recognition
Global Competitors
Akzo Nobel N.V., Axalta Coating Systems Ltd., BASF Corporation, Benjamin Moore, Hempel
A/S, the Jotun Group, Masco Corporation, Materis Paints, Nippon Paint; RPM International Inc, the Sherwin-Williams Company and Tikkurila Oyj
Average Number of Employees in 2017
28,200
Principal Manufacturing and Distribution Facilities
Amsterdam, Netherlands; Birstall, United Kingdom; Budapest, Hungary; Clayton, Australia; Delaware, Ohio; Dover, Del.; Gonfreville, France; Huntsville, Ala.; Huron, Ohio; Kunshan, China; Little Rock, Ark.; Mexico City, Mexico; Milan, Italy; Mojave, Calif.; Moreuil, France; Shildon, United Kingdom; Sylmar, Calif.; Soborg, Denmark; Stowmarket, United Kingdom; Tepexpan, Mexico and Wroclaw, Poland.
2017
PPG ANNUAL REPORT AND FORM 10-K/A 7
INDUSTRIAL COATINGS
Strategic Business Unit
Products
Primary End-use Markets
Main Distribution Methods
Brands
Automotive OEM Coatings
Specifically formulated
coatings, adhesives and sealants and metal pretreaments
Automotive original equipment manufacturer (OEM)
Direct to manufacturing companies and various coatings applicators
PPG®
Industrial Coatings
Appliances, agricultural and construction equipment, consumer electronics, automotive parts and accessories, building products (including residential and commercial construction), transportation vehicles and numerous other finished products.
PPG®
Packaging Coatings
Specifically
formulated coatings
Widely used for the protection, performance and decoration of metal cans, closures, plastic tubes, industrial packaging, and promotional and specialty packaging.
SILICA - Tire, battery separator and other end-use markets;
TESLIN - used in applications such as radio frequency identification (RFID) tags and labels, e-passports, drivers’ licenses and identification cards;
OLED
- for use in displays and lighting; Lens materials - for optical lenses and color-change products.
PPG®
Coatings Services(a)
Services and coatings application
On-site coatings services within several customer manufacturing locations as well as at regional service centers. Customers ship parts to service centers where they are treated to enhance paint adhesion and painted with electrocoat, powder or liquid coatings. Coated parts are then shipped to the customer’s next stage of assembly.
On site at customer locations or at our
company-owned service centers
PPG®
(a) Effective January 1, 2018, the coating services business unit has been merged into the industrial coatings business unit to achieve operational efficiencies and to realign management teams and operations to better deliver our total value proposition and provide optimal solutions to our customers.
Technology / Alliances
PPG’s automotive OEM coatings business was the first to introduce breakthrough automotive coating technologies such as cathodic electrocoat, powder
clearcoat, compact paint systems and factory-applied spray-in bedliners, and the Company has a continued focus on innovation leadership. PPG has established alliances with Kansai Paints to serve Japanese-based automotive OEM customers in North America and Europe and Asian Paints Ltd. to serve certain aftermarket customers and automotive OEM customers in India.
Major Competitive Factors
Product performance, technology, quality, technical and customer service, price, customer productivity and distribution.
Global Competitors
Akzo Nobel N.V., Axalta Coating Systems Ltd., BASF Corporation, Kansai Paints, Nippon Paint
and the Sherwin-Williams Company
2017 Strategic Acquisitions
The Crown Group (Crown) - Refer to Note 3, “Acquisitions and Divestitures” under Item 8 of this Form 10-K/A for more information.
Average Number of Employees in 2017
14,800
Principal Manufacturing and Distribution Facilities
Barberton, Ohio; Busan, South Korea; Cieszyn, Poland; Cleveland, Ohio; Lake Charles, La.; Oak Creek, Wis.; Quattordio, Italy; San Juan del Rio, Mexico; Sumaré, Brazil; Tianjin, China, and Zhangjiagang, China
8
2017 PPG ANNUAL REPORT AND 10-K/A
Research and Development
($ in millions)
2017
2016
2015
Research
and development costs, including depreciation of research facilities
$474
$479
$484
% of annual net sales
3.2
%
3.4
%
3.4
%
Technology
innovation has been a hallmark of PPG’s success throughout its history. The Company seeks to optimize its investment in research and development to create new products to drive profitable growth. We align our product development with the macro trends in the end-use markets we serve and leverage core technology platforms to develop products for unmet market needs. Our history of successful technology introductions is based on a commitment to an efficient and effective innovation process and disciplined portfolio management. We have obtained government funding for a small portion of the Company’s research efforts, and we will continue to pursue government funding where appropriate.
PPG owns and operates several facilities to conduct research and development for new
and improved products and processes. In addition to the Company’s centralized principal research and development centers (See Item 2. “Properties” of this Form 10-K/A), operating segments manage their development through centers of excellence. As part of our ongoing efforts to manage our formulations and raw material costs effectively, we operate a global competitive sourcing laboratory in China. Because of the Company’s broad array of products and customers, PPG is not materially dependent upon any single technology platform.
Raw Materials and Energy
The effective management of raw materials and energy is important to PPG’s continued success.
The Company’s most significant raw materials are epoxy and other resins, titanium dioxide and other pigments, and solvents in the coatings businesses and sand and soda ash for the specialty coatings and materials business. Coatings raw materials, which include both organic, primarily petroleum based, materials and inorganic materials, including titanium dioxide, comprise between 70% and 80% of the Company’s cost of sales, excluding depreciation and amortization, in most coatings formulations and represent PPG’s single largest production cost component.
Most of the raw materials and energy used in production are purchased from outside sources, and the Company has made, and plans
to continue to make, supply arrangements to meet the planned operating requirements for the future. Supply of critical raw materials and energy is managed by establishing contracts, multiple sources, and identifying alternative materials or technology whenever possible. Our products use both petroleum-derived and bio-based materials as part of a product renewal strategy. While prices for these raw materials typically fluctuate with energy prices, such fluctuations are impacted by the fact that the manufacture of our raw materials is several steps downstream from crude oil and natural gas.
The Company is continuing its aggressive sourcing initiatives to broaden our supply of high quality raw materials. These initiatives include qualifying multiple and local
sources of supply, including suppliers from Asia and other lower cost regions of the world, adding on-site resin production at certain manufacturing locations and a reduction in the amount of titanium dioxide used in our product formulations.
Our global efforts to reduce titanium dioxide consumption have been successful to date and are expected to continue. Titanium dioxide is a raw material widely used in the paint and coatings industry as a pigment to provide hiding, durability and whiteness characteristics. PPG purchases both sulfate-grade and chloride-grade titanium dioxide from suppliers for use in coatings formulations. The Company has undertaken a strategic initiative to secure and enhance PPG’s supply of titanium dioxide, as well as to minimize PPG’s use of this raw material. PPG possesses intellectual property and expertise in the production
and finishing of titanium dioxide pigment. PPG intends to continue to leverage this technology and intends to develop innovative supply solutions through technical collaborations, joint ventures and licensing arrangements with other interested parties.
We are subject to existing and evolving standards relating to the registration of chemicals which could potentially impact the availability and viability of some of the raw materials we use in our production processes. Our ongoing global product stewardship efforts are directed at maintaining our compliance with these standards.
Changes to chemical registration regulations have been proposed or implemented in the EU and many other countries, including China, Canada, the United States (U.S.), and Korea. Because implementation of many of these programs has not been finalized, the financial impact cannot be estimated at this time. We
anticipate that the number of chemical registration regulations will continue to increase globally, and we have implemented programs to track and comply with these regulations.
Given the recent volatility in certain energy-based input costs and foreign currencies, the Company is not able to predict with certainty the 2018 full year impact of related changes in raw material pricing; however, PPG currently expects overall coatings raw material costs to increase a mid-single-digit percentage in the first half of 2018, with impacts varied by region and commodity. Further, given the distribution nature of many of our businesses, logistics and distribution costs are sizable, as are wages and benefits but to a lesser degree. PPG typically experiences fluctuating prices for energy and raw materials
2017
PPG ANNUAL REPORT AND FORM 10-K/A 9
driven by various factors, including changes in supplier feedstock costs and inventories, global industry activity levels, foreign currency exchange rates, government regulation, and global supply and demand factors. In aggregate, average raw material cost inflation rose by a mid-single-digit percentage in 2017 versus 2016, driven mostly by supply related factors including an unusually high number of supplier force majeure events in Europe, Chinese environmental regulation enforcement and severe hurricanes in the U.S. In addition, oil prices moved much higher in the second half of 2017 also contributing to raw material inflation.
Patents
($
in millions)
2017
2016
2015
Revenue earned from royalties and the sale of technical know-how
$11
$12
$15
PPG considers patent protection to be important; however, the
Company’s operating segments are not materially dependent upon any single patent or group of related patents.
Backlog
In general, PPG does not manufacture its products against a backlog of orders. Production and inventory levels are geared primarily to projections of future demand and the level of incoming orders.
Global Operations
PPG has a significant investment in non-U.S. operations. This broad geographic footprint serves to lessen the significance of economic impacts occurring in any one region on PPG’s total net sales and income from continuing operations. As a result of our expansion outside the U.S., we are subject to certain inherent
risks, including economic and political conditions in international markets and fluctuations in foreign currency exchange rates. During 2017, favorable foreign currency translation increased net sales by approximately $55 million and decreased income from continuing operations by $7 million.
Our net sales in the developed and emerging regions of the world for the years ended December 31st are summarized below:
($ in millions)
2017
2016
2015
Net
Sales
As Restated
United States, Canada, Western Europe
$9,911
$9,773
$9,692
Latin
America, Central and Eastern Europe, Middle East, Africa, Asia Pacific
4,837
4,497
4,549
Total
$14,748
$14,270
$14,241
Refer
to Note 20, “Reportable Business Segment Information” under Item 8 of this Form 10-K/A for geographic information related to PPG’s property, plant and equipment, and for additional geographic information pertaining to sales.
Seasonality
PPG’s income from continuing operations has typically been greater in the second and third quarters and cash from operating activities has been greatest in the fourth quarter due to end-use market seasonality, primarily in PPG’s architectural coatings businesses. Demand for PPG’s architectural coatings products is typically the strongest in the second and third quarters due to higher home improvement, maintenance and construction activity during the spring and summer months in the U.S., Canada and Europe. The Latin America paint season is the strongest in the fourth
quarter. These cyclical activity levels result in the collection of outstanding receivables and lower inventory on hand in the fourth quarter generating higher cash from operating activities.
Employee Relations
The average number of people employed worldwide by PPG during 2017 was about 47,200. The Company has numerous collective bargaining agreements throughout the world. We observe local customs, laws and practices in labor relations when negotiating collective bargaining agreements. There were no significant work stoppages in 2017. While we have experienced occasional work stoppages as a result of the collective bargaining process and may experience some work stoppages in the future, we believe that we will be able to negotiate
all labor agreements on satisfactory terms. To date, these work stoppages have not had a significant impact on PPG’s results of operations. Overall, the Company believes it has good relationships with its employees.
Environmental Matters
PPG is committed to operating in a sustainable manner and to helping our customers meet their sustainability goals. Our sustainability efforts are led by the Technology and Environment Committee of our Board of Directors and our Sustainability Committee, which is comprised of members of PPG’s senior management team. The Sustainability Committee establishes
10 2017 PPG ANNUAL REPORT
AND 10-K/A
policies, programs, procedures and goals to address sustainability in our business practices, including resource management, climate change, innovation, communications, purchasing, manufacturing and employee wellness.
Our dedication to innovation is intertwined with sustainability. Once again in 2017, we increased the percent of our sales from sustainable products. We are marketing an ever-growing variety of products and services that provide environmental, safety and other benefits to our customers. Our products contribute to lighter, more fuel-efficient vehicles, airplanes and ships, and they help our customers reduce their energy consumption, conserve water and reduce waste. These products include a compact automotive paint process that saves energy and reduces water usage; sustainable, waterborne coatings formulations; lightweight
sealants and coatings for aircraft; coatings that cool surfaces; and solutions for autonomous and battery-powered vehicles.
Public and governmental concerns related to climate change continue to grow, leading to efforts to limit the greenhouse gas (“GHG”) emissions believed to be responsible. While PPG has operations in many countries, a substantial portion of PPG’s GHG emissions are generated by locations in the U.S. where considerable legislative and regulatory activity has been taking place. PPG has, and will continue to, annually report our global GHG emissions to the voluntary Carbon Disclosure project.
PPG participates in both the U.S. Department of Energy, BETTER BUILDINGS®, BETTER PLANTS® program, formerly the SAVE ENERGY NOW® Leadership program, and the Environmental Protection Agency ENERGY STAR® Industrial Partnership program, both reinforcing the
company’s voluntary efforts to significantly reduce its industrial energy intensity. These programs include developing and implementing energy management processes and setting energy savings targets while providing a suite of educational, training, and technical resources to help meet those targets. Recognizing the continuing importance of this matter, PPG has a senior management group with a mandate to guide the Company’s progress in this area.
Our commitment to sustainability continues to yield tangible results. In 2017, we again made significant progress reducing our energy intensity, greenhouse gas emissions intensity, water usage intensity and waste intensity. More information about PPG’s sustainability values, efforts, goals and data and our community and employee engagement programs can be found in our Sustainability Report and on
our sustainability website at http://sustainability.ppg.com and on the Carbon Disclosure Project’s website at www.cdp.net.
PPG is subject to existing and evolving standards relating to protection of the environment. In management’s opinion, the Company operates in an environmentally sound manner and is well positioned, relative to environmental matters, within the industries in which
it operates. PPG is negotiating with various government agencies concerning 126 current and former manufacturing sites and offsite waste disposal locations, including 24 sites on the National Priority List. While PPG is not generally a major contributor of wastes to these offsite waste disposal locations, each potentially responsible party may face governmental agency assertions of joint and several liability. Generally, however, a final allocation of costs is made based on relative contributions of wastes to the site. There is a wide range of cost estimates for cleanup of these sites, due largely to uncertainties as to the nature and extent of their condition and the methods that may have to be employed for their remediation. The Company has established reserves for onsite and offsite remediation of those sites where it is probable that a liability has been incurred and the amount of
loss can be reasonably estimated.
The Company’s experience to date regarding environmental matters leads it to believe that it will have continuing expenditures for compliance with provisions regulating the protection of the environment and for present and future remediation efforts at waste and plant sites. Management anticipates that such expenditures will occur over an extended period of time.
In addition to the $258 million currently reserved for environmental remediation efforts, we may be subject to loss contingencies related to environmental matters estimated to be approximately $100 million to $200 million. These reasonably possible unreserved losses relate to environmental matters at a number of sites, none of which are individually significant. The loss contingencies related to these sites
include significant unresolved issues such as the nature and extent of contamination at these sites and the methods that may have to be employed to remediate them.
($ in millions)
2017
2016
2015
Capital expenditures for environmental control projects
$7
$18
$15
It
is expected that expenditures for such projects in 2018 will be in the range of $10 million to $20 million. Although future capital expenditures are difficult to estimate accurately because of constantly changing regulatory standards and policies, it can be anticipated that environmental control standards will become increasingly stringent and the cost of compliance will increase.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 11
Management believes that the outcome of these environmental contingencies will not have a material adverse effect on PPG’s financial position or liquidity; however, any such outcome may be material to the results of operations of any particular period in which costs, if any, are recognized.
See Note 14, “Commitments and Contingent Liabilities,” under Item 8 of this Form 10-K/A for additional information related to environmental matters and our accrued liability for estimated environmental remediation costs.
Available Information
The Company’s website address is www.ppg.com. The Company posts, and shareholders may access without charge, the
Company’s recent filings and any amendments thereto of its annual reports on Form 10-K/A, quarterly reports on Form 10-Q and its proxy statements as soon as reasonably practicable after such reports are filed with the Securities and Exchange Commission (“SEC”). The Company also posts all financial press releases, including earnings releases, to its website. All other reports filed or furnished to the SEC, including reports on Form 8-K, are available via direct link on PPG’s website to the SEC’s website,
www.sec.gov. Reference to the Company’s and the SEC’s websites herein does not incorporate by reference any information contained on those websites and such information should not be considered part of this Form 10-K/A.
Item 1A. Risk Factors
As a global manufacturer of paints, coatings and specialty materials, we operate in a business environment that includes risks. These risks are not unlike the risks
we have faced in the recent past nor are they unlike risks faced by our competitors. Each of the risks described in this section could adversely affect our results of operations, financial position and liquidity. While the factors listed here are considered to be the more significant factors, no such list should be considered to be a complete statement of all potential risks and uncertainties. Unlisted factors may present significant additional obstacles which may adversely affect our businesses and our results of operations.
Increases in prices and declines in the availability of raw materials could negatively impact our financial results.
Our financial results are significantly affected by the cost of raw materials. Coatings raw materials, which include both organic, primarily petroleum based, materials and inorganic materials, including titanium dioxide, comprise between 70% and
80% of the Company’s cost of sales, exclusive of depreciation and amortization, sold in most coatings formulations and represent PPG’s single largest production cost component.
While not our customary practice, we also import raw materials and intermediates, particularly for use at our manufacturing facilities in the emerging regions of the world. In most cases, those imports are priced in the currency of the supplier and, therefore, if that currency strengthens against the currency of our manufacturing facility, our margins may be lower.
Most of our raw materials are purchased from outside sources, and the Company has made, and plans to continue to make, supply arrangements to meet the planned operating requirements
for the future. Adequate supply of critical raw materials is managed by establishing contracts, procuring from multiple sources, and identifying alternative materials or technology whenever possible. The Company is continuing its aggressive sourcing initiatives to effectively broaden our supply of high quality raw materials. These initiatives include qualifying multiple and local sources of supply, including suppliers from Asia and other lower cost regions of the world, adding on-site resin production at certain manufacturing locations, and a reduction in the amount of titanium dioxide and other raw materials used in our product formulations. Our products use both petroleum-derived and bio-based materials as part of a product renewal strategy.
An inability
to obtain critical raw materials would adversely impact our ability to produce products. Increases in the cost of raw materials may have an adverse effect on our income from continuing operations or cash from operating activities in the event we are unable to offset these higher costs in a timely manner.
Refer to Item 1. “Raw Materials and Energy” of this Form 10-K/A for a discussion of the current year trends and outlook in raw material and energy costs.
The pace of economic growth and level of uncertainty could have a negative impact on our results of operations and cash flows.
During 2017, economic conditions improved in all of our major geographical regions while remaining mixed by end-use market. PPG provides products and services to a variety of end-use markets in many geographies. This broad end-use market exposure and expanded
geographic presence lessens the significance of any individual decrease in activity levels; nonetheless, lower demand levels may result in lower sales, which would result in reduced income from continuing operations and cash from operating activities.
Refer to Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K/A for discussion of the economic conditions in 2017 and our outlook on certain economic conditions in 2018.
12 2017 PPG ANNUAL REPORT AND 10-K/A
We are subject to existing and evolving standards relating to the protection of the environment.
Environmental laws and regulations control, among other things, the discharge of pollutants into the
air and water, the handling, use, treatment, storage and clean-up of hazardous and non-hazardous waste, the investigation and remediation of soil and groundwater affected by hazardous substances, and regulate various health and safety matters. The environmental laws and regulations we are subject to impose liability for the costs of, and damages resulting from, cleaning up current sites, past spills, disposals and other releases of hazardous substances. Violations of these laws and regulations can also result in fines and penalties. Future environmental laws and regulations may require substantial capital expenditures or may require or cause us to modify or curtail our operations, which may have a material adverse impact on our business, financial condition and results of operations.
As described in Note 14, “Commitments and Contingent Liabilities,” under Item 8 of this Form 10-K/A, we are currently undertaking environmental
remediation activities at a number of our current and former facilities and properties, the cost of which is substantial. In addition to the amounts currently reserved, we may be subject to loss contingencies related to environmental matters estimated to be as much as $100 million to $200 million. Such unreserved losses are reasonably possible but are not currently considered to be probable of occurrence.
We are involved in a number of lawsuits and claims, and we may be involved in future lawsuits and claims, in which substantial monetary damages are sought.
PPG is involved in a number of lawsuits and claims, both actual and potential, in which substantial monetary damages are sought. Those lawsuits and claims relate to contract, patent, environmental, product liability, asbestos exposure, antitrust,
employment, securities and other matters arising out of the conduct of PPG’s current and past business activities. Any such claims, whether with or without merit, could be time consuming, expensive to defend and could divert management’s attention and resources. We maintain insurance against some, but not all, of these potential claims, and the levels of insurance we do maintain may not be adequate to fully cover any and all losses. We believe that, in the aggregate, the outcome of all current lawsuits and claims involving PPG, including those described in Note 14, “Commitments and Contingent Liabilities” under Item 8 of this Form 10-K/A, will not have a material effect on PPG’s consolidated financial position or liquidity; however, such outcome may be material to the results of operations of any particular period in which costs, if any, are recognized. Nonetheless, the results of any future litigation or claims are inherently unpredictable, and such outcomes
could have a material adverse effect on our results of operations, cash from operating activities or financial condition.
Fluctuations in foreign currency exchange rates could affect our financial results.
We earn revenues, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar. Because our consolidated financial statements are presented in U.S. dollars, we must translate revenues and expenses into U.S. dollars at the average exchange rate during each reporting period, as well as assets and liabilities into U.S. dollars at exchange rates in effect at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against other currencies will affect our net sales, net income and the value of balance sheet items denominated in foreign currencies. We may use derivative financial instruments to reduce
our net exposure to currency exchange rate fluctuations related to foreign currency transactions. However, fluctuations in foreign currency exchange rates, particularly the strengthening or weakening of the U.S. dollar against major currencies, could adversely or positively affect our financial condition and results of operations expressed in U.S. dollars. In 2017, changes in the U.S. dollar versus our mix of currencies had a favorable impact on full year net sales and an unfavorable impact on income before income taxes from the translation of foreign earnings into U.S. dollars of approximately $55 million and $7 million, respectively.
We are subject to a variety of complex U.S. and non-U.S. laws and regulations which could increase our compliance costs.
We are subject to a wide variety of complex U.S. and non-U.S. laws and regulations, and legal compliance risks, including securities
laws, tax laws, environmental laws, employment and pension-related laws, competition laws, U.S. and foreign export and trading laws, and laws governing improper business practices, including bribery. We are affected by new laws and regulations and changes to existing laws and regulations, as well as interpretations by courts and regulators. These laws and regulations effectively expand our compliance obligations and potential enforcement actions by governmental authorities or litigation related to them.
New laws and regulations or changes in existing laws or regulations or their interpretation could increase our compliance costs. For example, regulations concerning the composition, use and transport of chemical products continue to evolve. Developments concerning these regulations could potentially impact the availability or viability of some of the raw materials we use in our product formulations and/or our ability to supply
certain products to some customers or markets. Import/export regulations also continue to evolve and could result in increased compliance costs, slower product movements or additional complexity in our supply chains.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 13
Our international operations expose us to additional risks and uncertainties that could affect our financial results.
PPG has a significant investment in global operations. This broad geographic footprint serves to lessen the significance of economic impacts occurring in any one region. Notwithstanding the benefits of geographic diversification, our ability to achieve and maintain profitable growth in international markets is subject to risks related to the differing legal, political, social and regulatory
requirements and economic conditions of many countries. As a result of our operations outside the U.S., we are subject to certain inherent risks, including political and economic uncertainty, inflation rates, exchange rates, trade protection measures, local labor conditions and laws, restrictions on foreign investments and repatriation of earnings, and weak intellectual property protection. Our percentage of sales generated in 2017 by products sold outside the U.S. was approximately 62%.
Changes in the tax regimes and related government policies and regulations in the countries in which we operate could adversely affect our results and our effective tax rate.
As a multinational corporation, we are subject to various taxes in both the U.S. and non-U.S. jurisdictions. Due to economic and political conditions, tax rates in these various
jurisdictions may be subject to significant change. Our future effective income tax rate could be affected by changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets or changes in tax laws or their interpretation. In December 2017, the U.S. enacted the U.S. Tax Cuts and Job Act. While the Company has made a preliminary assessment of the new legislation’s impact on PPG, U.S. regulatory agencies will be issuing further regulations and clarifying interpretations over the next year which could alter the Company’s conclusions regarding the impact of the new law. Further, PPG may continue to refine its estimates to incorporate new or better information as it comes available. Recent developments, including the European Commission’s investigations
on illegal state aid as well as the Organisation for Economic Co-operation and Development project on Base Erosion and Profit Shifting may result in changes to long-standing tax principles, which could adversely affect our effective tax rate or result in higher cash tax liabilities. If our effective income tax rate was to increase, our cash from operating activities, financial condition and results of operations would be adversely affected.
Although we believe that our tax filing positions are appropriate, the final determination of tax audits or tax disputes may be different from what is reflected in our historical income tax provisions and accruals. If future audits find that additional taxes are due, we may be subject to incremental tax liabilities, possibly including interest and penalties, which could have a material adverse effect on our cash from operating activities, financial condition and results of operations.
Business
disruptions could have a negative impact on our results of operations and financial condition.
Unexpected events, including supply disruptions, temporary plant and/or power outages, work stoppages, natural disasters and severe weather events, computer system disruptions, fires, war or terrorist activities, could increase the cost of doing business or otherwise harm the operations of PPG, our customers and our suppliers. It is not possible for us to predict the occurrence or consequence of any such events. However, such events could reduce our ability to supply products, reduce demand for our products or make it difficult or impossible for us to receive raw materials from suppliers or to deliver products to customers.
Integrating acquired businesses into our existing operations.
Part of the
Company’s strategy is growth through acquisitions. Over the last decade, we have successfully completed more than 50 acquisitions and we will likely acquire additional businesses and enter into additional joint ventures in the future. Growth through acquisitions and the formation of joint ventures involve risks, including:
•
difficulties in assimilating acquired companies and products into our existing business;
•
delays in realizing the benefits from the acquired companies or products;
•
diversion
of our management’s time and attention from other business concerns;
•
difficulties due to lack of or limited prior experience in any new markets we may enter;
•
unforeseen claims and liabilities, including unexpected environmental exposures or product liability;
•
unexpected losses of customers
or suppliers of the acquired or existing business;
•
difficulty in conforming the acquired business’ standards, processes, procedures and controls to those of our operations; and
•
difficulties in retaining key employees of the acquired businesses.
These risks or other problems encountered in connection with our past or future acquisitions and joint ventures could cause delays in realizing the anticipated benefits of such acquisitions or joint ventures and
could adversely affect our results of operations, cash from operating activities or financial condition.
14 2017 PPG ANNUAL REPORT AND 10-K/A
Our ability to understand our customers’ specific preferences and requirements, and to innovate, develop, produce and market products that meet customer demand is critical to our business results.
Our business relies on continued global demand for our brands and products. To achieve business goals, we must develop and sell products that appeal to customers. This is dependent on a number of factors, including our ability to produce products that meet the quality, performance and price expectations of our customers and our ability to develop effective sales, advertising and marketing programs.
We
believe the automotive industry will experience significant and continued change in the coming years. Vehicle manufacturers continue to develop new safety features such as collision avoidance technology and self-driving vehicles that may reduce vehicle collisions in the future, potentially lowering demand for our refinish coatings. In addition, through the introduction of new technologies, new business models or new methods of travel, such as ridesharing, the number of automotive OEM new-builds may decline, potentially reducing demand for our automotive OEM coatings.
Our future growth will depend on our ability to continue to innovate our existing products and to develop and introduce new products. If we fail to keep pace with product innovation on a competitive basis or to predict market demands for our products, our businesses, financial condition and results of operations could be adversely affected.
The
industries in which we operate are highly competitive.
With each of our businesses, an increase in competition may cause us to lose market share, lose a large regional or global customer, or compel us to reduce prices to remain competitive, which could result in reduced margins for our products. Competitive pressures may not only reduce our margins but may also impact our revenues and our growth which could adversely affect our results of operations.
The security of our information technology systems could be compromised, which could adversely affect our ability to operate.
Increased global information technology security requirements, threats and sophisticated and targeted computer crime pose a risk to the security of our systems, networks and the confidentiality, availability and integrity of our data. Despite
our efforts to protect sensitive information and confidential and personal data, our facilities and systems may be vulnerable to security breaches. This could lead to negative publicity, theft, modification or destruction of proprietary information or key information, manufacture of defective products, production downtimes and operational disruptions, which could adversely affect our reputation, competitiveness and results of operations.
We have concluded that certain of our previously issued financial statements should not be relied upon and have restated certain of our previously issued financial statements, which may lead to, among other things, shareholder litigation, loss of investor confidence, negative impact on our stock price and certain other risks.
As discussed in the Explanatory Note, Note 2, “Restatement of Previously Reported Consolidated Annual
Financial Statements” and in Note 19, “Quarterly Financial Information (unaudited)” under Item 8 of this Form 10-K/A, we have concluded that our previously issued financial statements as of December 31, 2017 and 2016, and for each of the quarterly and year-to-date periods in 2017, and the final quarterly and year-to-date period in 2016, should no longer be relied upon. The determination that the applicable financial statements should no longer be relied upon and that certain financial statements would be restated was made following the identification of misstatements. As a result of these misstatements, we have become subject to a number of additional risks and uncertainties, including unanticipated costs for accounting and legal fees in connection with or related to the restatement, shareholder litigation and government investigations. Any
such proceeding could result in substantial defense costs regardless of the outcome of the litigation or investigation. If we do not prevail in any such litigation, we could be required to pay substantial damages or settlement costs.
We are remediating certain internal controls and procedures, which, if not successful, could result in additional misstatements in our financial statements negatively affecting our results of operations.
We are in the process of implementing certain remediation actions. See Item 9A. “Controls and Procedures” of this Form 10-K/A for a description of these remediation measures. To the extent these steps are not successful, not sufficient to correct our material weakness in internal control over financial reporting or are not completed in a timely manner, future financial statements may contain material misstatements and we could be required to restate
our financial results. Any of these matters could adversely affect our business, reputation, revenues, results of operations, financial condition and stock price and limit our ability to access the capital markets through equity or debt issuances.
We are involved in governmental investigations, which are costly to conduct and may result in substantial financial and other penalties, as well as adverse effects on our business and financial condition.
Prior to filing the Current Report on Form 8-K disclosing our receipt of the internal report on April 19, 2018, we self-reported these issues to the SEC. We are cooperating with the SEC in its investigation of this matter. The SEC investigation is
2017 PPG ANNUAL REPORT AND FORM 10-K/A 15
continuing,
and we are currently unable to predict its duration, scope or results or whether the SEC will commence any legal action. If we are found to have violated securities laws or other federal statutes, we may be subject to criminal and civil penalties and other remedial measures, including, but not limited to, injunctive relief, disgorgement, civil and criminal fines and penalties, modifications of compliance programs and the retention of a monitor to oversee compliance. The imposition of any of these sanctions or remedial measures could have a material adverse impact on our business, reputation, revenues, results of operations and financial condition.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Properties
The Company’s corporate headquarters is located in Pittsburgh, Pa. The Company’s manufacturing facilities, sales offices, research and development centers and distribution centers are located throughout the world. As of February 15, 2018, the Company operated 133 manufacturing facilities in 39 countries. See Item 1. “Business” of this Form 10-K/A for the principal manufacturing and distribution facilities by reportable segment.
The Company has manufacturing facilities
in the following geographic areas:
United States and Canada:
39 facilities.
EMEA:
54 facilities in 23 countries.
Latin America:
14 facilities in 5 countries.
Asia Pacific:
26
facilities in 9 countries.
The Company’s principal research and development centers are located in Allison Park, Pa.; Monroeville, Pa.; Burbank, Calif.; Tianjin, China; Amsterdam, Netherlands and Tepexpan, Mexico.
The Company’s headquarters, certain distribution centers and substantially all company-owned paint stores are located in facilities that are leased while the Company’s other facilities are generally owned. Our facilities are considered to be suitable and adequate for the purposes for which they are intended and overall have sufficient capacity to conduct business in the upcoming year.
16
2017 PPG ANNUAL REPORT AND 10-K/A
Item 3. Legal Proceedings
PPG is involved in a number of lawsuits and claims, both actual and potential, including some that it has asserted against others, in which substantial monetary damages are sought. These lawsuits and claims may relate to contract, patent, environmental, product liability, asbestos exposure, antitrust, employment, securities and other matters arising out of the conduct of PPG’s current and past business activities. To the extent that these lawsuits and claims involve personal injury and property damage, PPG believes it has adequate insurance; however, certain of PPG’s insurers are contesting coverage with respect to some of
these claims, and other insurers may contest coverage. PPG’s lawsuits and claims against others include claims against insurers and other third parties with respect to actual and contingent losses related to environmental, asbestos and other matters.
The Company has self-reported to the SEC information concerning the internal investigation of accounting matters described in the Explanatory Note and in Note 2, “Restatement of Previously Reported Consolidated Annual Financial Statements” under Item 8 of this Form 10-K/A. The Company’s cooperation with the SEC’s investigation is continuing.
On May 20, 2018, a putative securities
class action lawsuit was filed in the U.S. District Court for the District for the Central District of California against the Company and certain of its current or former officers. This action, captioned Trevor Mild v. PPG Industries, Inc., Michael H. McGarry, Vincent J. Morales, and Mark C. Kelly, asserts securities fraud claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 on behalf of putative classes of persons who purchased or otherwise acquired stock of the Company during various time periods between April 24, 2017
and May 10, 2018. The allegations relate to, among other things, allegedly false and misleading statements and/or failures to disclose information about the Company’s business, operations and prospects. This action remains pending. The Company believes this action is without merit and intends to defend itself vigorously.
For many years, PPG has been a defendant in lawsuits involving claims alleging personal injury from exposure to asbestos. For a description of asbestos litigation affecting the Company, see Note 14, “Commitments and Contingent Liabilities” under Item 8 of this Form 10-K/A.
In
the past, the Company and others have been named as defendants in several cases in various jurisdictions claiming damages related to exposure to lead and remediation of lead-based coatings applications. PPG has been dismissed as a defendant from most of these lawsuits and has never been found liable in any of these cases.
In March 2016, the Natural Resource Trustees for the Calcasieu River Estuary (the United States Department of the Interior, acting through the United States Fish and Wildlife Service, the National Oceanic and Atmospheric Administration of the United States Department of Commerce, the Louisiana Department of Environmental Quality and the Louisiana Department of Wildlife and Fisheries) reached an agreement in principle with PPG and two other potentially responsible parties to resolve the Trustees’ claims for natural resource damages
alleged to have been caused by the release of hazardous substances into the Estuary. In the fourth quarter of 2017, PPG signed a consent decree prepared by the US Department of Justice for settlement of potential natural resource damage claims at the Calcasieu River Estuary. PPG’s share of this settlement is $3.6 million. Payment of PPG’s share of the settlement is required to be made into an escrow account within 30 days of filing the agreement with the court and is expected to occur in the first quarter of 2018.
Senior Vice President and Chief Financial Officer since March 2017
(a)
Mr.
McGarry served as President and Chief Executive Officer from September 2015 through August 2016, President and Chief Operating Officer from March 2015 through August 2015; Chief Operating Officer from August 2014 through February 2015; Executive Vice President from September 2012 through July 2014; and Senior Vice President, Commodity Chemicals from July 2008 through August 2012.
(b)
Mr. Bost served as Vice President and Associate General Counsel from July 2006 through June 2010.
(c)
Mr. Greindl served as Vice President,
Automotive Coatings, EMEA and President, PPG EMEA from February 2013 through February 2016, Vice President, Automotive Coatings, EMEA from January 2011 through January 2013 and Vice President, Automotive Coatings, Europe from October 2010 through December 2010.
(d)
Mr. Knavish served as Senior Vice President, Automotive Coatings from March 2016 through September 2017, Vice President, Protective and Marine Coatings from August 2012 through February 2016 and Vice President, Automotive Coatings, Americas from March 2010 through July 2012.
(e)
Mr.
Vadlamannati served as Vice President, Architectural Coatings, EMEA and Asia/Pacific from August 2014 through February 2016, Vice President, Architectural Coatings, EMEA from February 2012 through July 2014, Vice President, Architectural Coatings, EMEA for Region Western Europe from March 2011 through January 2012 and Vice President, Automotive Refinish, EMEA from September 2010 through February 2011.
(f)
Mr. Morales served as Vice President, Finance from June 2016 through February 2017. From June 2015 through June 2016, he served as Vice President Investor Relations and Treasurer and from October 2007 through May 2015 he served as Vice President, Investor Relations.
Item 4.
Mine Safety Disclosures
Not Applicable.
18 2017 PPG ANNUAL REPORT AND 10-K/A
Part II
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The information required by Item 5 regarding market information, including stock exchange listings and quarterly stock market prices, dividends and holders of common stock is included in Exhibit
13.1 filed with this Form 10-K/A and is incorporated herein by reference. This information is also included in the PPG Shareholder Information on page 4 of the Annual Report to shareholders.
Directors who are not also officers of the Company may receive common stock equivalents pursuant to the PPG Industries, Inc. Deferred Compensation Plan for Directors (“PPG Deferred Compensation Plan for Directors”). Common stock equivalents are hypothetical shares of common stock having a value on any given date equal to the value of a share of common stock. Common stock equivalents earn dividend equivalents that are converted into additional common stock equivalents but carry no voting rights or other rights afforded to a holder of common stock. The common stock equivalents credited to directors
under this plan are exempt from registration under Section 4(a)(2) of the Securities Act of 1933 as private offerings made only to directors of the Company in accordance with the provisions of the plan.
Under the PPG Deferred Compensation Plan for Directors, each director may elect to defer the receipt of all or any portion of the compensation paid to such director for serving as a PPG director. All deferred payments are held in the form of common stock equivalents. Payments out of the deferred accounts are made in the form of common stock of the Company (and cash as to any fractional common stock equivalent). The directors, as a group, were credited with 14,007; 17,807; and 15,445 common stock equivalents in 2017,
2016 and 2015, respectively, under this plan. The values of the common stock equivalents, when credited, ranged from $95.25 to $115.89 in 2017; $95.63 to $116.07 in 2016, and $90.13 to $98.73 in 2015.
Issuer Purchases of Equity Securities - Fourth Quarter, 2017
Month
Total
Number of Shares Purchased
Avg. Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Programs
Max. Number of Shares That May Yet Be Purchased Under the Programs(1)
In December 2017, PPG's board of directors approved a $2.5 billion share repurchase
program. This program is in addition to the company’s existing share repurchase authorization, which was approved in October 2016. The remaining shares yet to be purchased under the programs have been calculated using PPG’s closing stock price on the last business day of the respective month. These repurchase programs have no expiration date.
No shares were withheld in satisfaction of the exercise price and/or tax withholding obligation by holders of employee stock options who exercised options granted under the Company’s equity compensation plans in the fourth quarter of 2017.
Management and the Audit Committee have concluded that our financial statements as of December 31, 2017 and 2016, and for each of the quarterly and year-to-date periods in 2017 and the final quarterly and year-to-date period in 2016 should not be relied upon. In this Form 10-K/A, we have restated our audited consolidated
financial statements as of December 31, 2017 and 2016, and certain unaudited consolidated financial information for each of the quarterly and year-to-date periods in 2017 and the final quarterly and year-to-date period in 2016. The selected statement of operations data presented in Exhibit 13.2 and incorporated by reference herein for each of the three years in the period ended December 31, 2017 and the balance sheet data as of December 31, 2017 and 2016 have been derived from the audited consolidated financial statements included in this Form 10-K/A. The selected statement of operations data for
the years ended December 31, 2014 and 2013 and the balance sheet data as of December 31, 2015, 2014 and 2013 have been derived from consolidated financial information not included in this Form 10-K/A.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 19
For more information on this restatement, see the Explanatory Note immediately preceding the Table of Contents, Note 2, “Restatement of Previously Reported Consolidated Annual Financial Statements” and Note 19, “Quarterly
Financial Information (unaudited)” under Item 8 of this Form 10-K/A. The selected financial data reflect the restatement described in the Explanatory Note.
20 2017 PPG ANNUAL REPORT AND 10-K/A
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (As Restated)
As described in Note 2, “Restatement of Previously Reported Consolidated Annual Financial Statements” under Item 8 of this Form 10-K/A, we restated our audited financial statements as of December 31, 2017 and 2016 and for the years ended
December 31, 2017 and 2016. The impact of the restatement is reflected in Management’s Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations below. We have also restated certain unaudited quarterly results related to the three months ended December 31, 2016, March 31, 2017, June 30, 2017 (and six months ended), September 30, 2017 (and nine months ended) and December 31, 2017. The impact of the restatement to the quarterly 2017 financial statements does not result in material changes to the MD&A included in the previously filed Forms
10-Q. As such, these disclosures have not been included in this Form 10-K/A.
Performance Overview
Net Sales
% Change
($ in millions, except percentages)
2017
2016
2015
2017
vs. 2016
2016 vs. 2015
As Restated
United States and Canada
$6,307
$6,254
$6,232
0.8%
0.4%
Europe,
Middle East and Africa (EMEA)
4,389
4,164
4,103
5.4%
1.5%
Asia Pacific
2,523
2,431
2,433
3.8%
(0.1)%
Latin
America
1,529
1,421
1,473
7.6%
(3.5)%
Total
$14,748
$14,270
$14,241
3.3%
0.2%
2017
vs. 2016
Net sales increased $478 million due to the following:
● Acquisition-related sales (+1%)
● Higher sales volumes (+1%)
● Slightly favorable foreign currency translation
● Slightly higher selling prices
Net sales from acquired businesses, net of divestitures, added over $200 million of sales in 2017, primarily MetoKote, DEUTEK, Univer and The Crown Group.
U.S. and Canada sales volumes declined slightly year-over-year, with mixed demand
by business and end-use market segment. Sales volumes in architectural coatings U.S. company-owned stores grew by a mid-single-digit percentage, but were more than offset by sales volumes declines in the independent dealer networks and national retail (DIY) customer accounts in aggregate. Automotive OEM coatings sales volumes declined year-over-year and lagged industry demand levels due to a customer-driven market-share shift away from PPG that was offset in other regions of the world. These decreases in sales volumes were partially offset by higher sales volumes in specialty coatings and materials, automotive refinish coatings, general industrial coatings, aerospace coatings and packaging coatings.
EMEA sales volumes increased a low-single-digit percentage versus the prior year. Sales volumes in our automotive OEM coatings and aerospace coatings businesses each grew by a mid-single-digit percentage.
Specialty coatings and materials sales volumes grew by a double-digit percentage, driven by strong silica demand. Protective coatings volumes also grew year-over-year. These increases in sales volumes were partially offset by lower demand in architectural coatings.
Asia Pacific sales volumes expanded by a mid-single-digit percentage year-over-year led by growth in each business within the Industrial Coatings segment along with sales volume growth in the architectural coatings business. These increases in sales volumes were partially offset by lower demand in marine coatings year-over-year. From a country and sub-region perspective, sales volumes grew in India, China, and Southeast Asia versus the prior year. Korea sales volumes continued to decline year-over-year primarily due to continued weakness in new shipbuilding.
Latin
America sales volumes expanded by a mid-single-digit percentage versus the prior year primarily due to above market growth in our automotive OEM coatings and general industrial coatings businesses. The automotive OEM coatings growth was driven by industry production expansion with the opening of new assembly facilities in Mexico. Regional sales volumes were lower in architectural coatings versus the prior year primarily due to lower sales volumes in Brazil and in Mexico due to the impact of the natural disasters during the third quarter.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 21
2016 vs. 2015
Net
sales increased $29 million due to the following:
● Acquisition-related sales (+2%)
● Higher sales volumes (+1%)
Partially offset by:
● Unfavorable foreign currency translation (-3%)
Acquired businesses added approximately $310 million of sales in 2016, primarily due to the partial year sales from businesses acquired in 2015, including Revocoat, IVC Industrial Coatings, Le Joint Francais and Cuming Microwave, as well as the 2016 acquisitions of MetoKote and Univer.
Sales volume growth, excluding acquisition related sales,
grew 1% led by growth in Asia Pacific and EMEA, while U.S. and Canada sales volumes as a percentage of sales, declined modestly.
U.S. and Canada sales volumes declined a low-single-digit percentage year-over-year, with mixed demand by business and end-use market segment. Sales volumes in architectural coatings company-owned stores grew by a mid-single-digit percentage, but were more than offset by sales volumes declines in the independent dealer networks and several national retail (DIY) customer accounts. Automotive OEM coatings sales volumes declined year-over-year, in large-part due to lower industry production. These decreases in sales volumes were partially offset by higher sales volumes in automotive refinish coatings and packaging coatings.
EMEA sales volumes increased a low-single-digit percentage versus the prior year.
Sales volumes in our automotive OEM coatings and general industrial coatings businesses each grew by a mid-single-digit percentage, above market. Specialty coatings and materials sales volumes grew by a mid-single-digit percentage, driven by silica demand. These increases in sales volumes were partially offset by modestly lower demand in architectural coatings.
Asia Pacific sales volumes expanded by a mid-single-digit percentage year-over-year led by growth in each business within the Industrial Coatings segment. These increases in sales volumes were partially offset by lower demand in marine coatings year-over-year. From a country and sub-region perspective, sales volumes grew in India, China, and Southeast Asia versus the prior year. Korea sales volumes declined year-over-year primarily due to continued weakness in new shipbuilding.
Latin
America sales volumes expanded by a low-to-mid-single-digit percentage versus the prior year primarily due to above market growth in our architectural coatings, automotive OEM coatings and general industrial coatings businesses.
Unfavorable foreign currency translation reduced net sales by approximately $385 million as the U.S. dollar strengthened against most foreign currencies year-over-year, notably the British pound, the Mexican peso, and the Chinese yuan.
Cost of sales, exclusive of depreciation and amortization
%
Change
($ in millions, except percentages)
2017
2016
2015
2017 vs. 2016
2016 vs. 2015
As Restated
Cost
of sales, exclusive of depreciation and amortization
$8,207
$7,693
$7,786
6.7%
(1.2)%
Cost of sales as a % of net sales
55.6
%
53.9
%
54.7
%
1.7%
(0.8)%
2017
vs. 2016
Cost of sales, exclusive of depreciation and amortization, increased $514 million (+7%) due to the following:
● Raw material cost inflation
● Higher sales volumes
● Cost of sales attributable to acquired businesses
● Foreign currency translation
Partially offset by:
● Lower manufacturing costs
2016
vs. 2015
Cost of sales, exclusive of depreciation and amortization, decreased $93 million (-1%) due to the following:
● Foreign currency translation
● Lower manufacturing costs
Partially offset by:
● Cost of sales from acquired businesses
● Higher sales volumes
22 2017 PPG ANNUAL REPORT AND 10-K/A
Selling, general
and administrative expenses
% Change
($ in millions, except percentages)
2017
2016
2015
2017
vs. 2016
2016 vs. 2015
As Restated
As Restated
Selling, general and administrative expenses
$3,564
$3,588
$3,584
(0.7)%
0.1%
Selling,
general and administrative expenses as a % of net sales
24.2
%
25.1
%
25.2
%
(0.9)%
(0.1)%
2017 vs. 2016
Selling, general and administrative expenses decreased
$24 million (-1%) primarily due to:
● Lower net periodic pension and other postretirement benefit costs
● Lower selling and advertising costs
● Restructuring cost savings
Partially offset by:
● Wage and other cost inflation
● Selling, general and administrative expenses from acquired businesses
● Foreign currency translation
2016
vs. 2015
Selling, general and administrative expenses increased $4 million (0%) due to the following:
● Foreign currency translation
● Restructuring cost savings
Partially offset by:
● Selling, general and administrative expenses from acquired businesses
● Overhead cost inflation
Other charges and other income
%
Change
($ in millions, except percentages)
2017
2016
2015
2017 vs. 2016
2016 vs. 2015
As Restated
As
Restated
Interest expense, net of Interest income
$85
$99
$86
(14.1)%
15.1%
Business
restructuring (As Restated)
$—
$191
$136
(100.0)%
40.4%
Pension settlements
$60
$968
$—
(93.8)%
N/A
Other
charges
$64
$175
$90
(63.4)%
94.4%
Other income
($150
)
($127
)
($110
)
18.1%
15.5%
Interest
expense, net of Interest income
Interest expense, net of interest income decreased $14 million in 2017 versus 2016 primarily due to lower interest rate debt outstanding during 2017. Interest expense, net of Interest income increased $13 million in 2016 versus 2015 as interest income decreased year-over-year due to lower interest rates and lower average cash deposits on hand.
Business restructuring
In 2016, PPG recorded a pre-tax business restructuring charge of $191 million (as restated). During 2017, PPG realized approximately $50 million of cost savings related to restructuring actions. Once fully implemented, the total annual savings run rate is expected to be approximately $125 million. Refer to Note 8, "Business Restructuring" in Item 8 of this Form 10-K/A for additional information.
In
2015, PPG recorded a pre-tax restructuring charge of $136 million, of which about 85% represented employee severance and other cash charges. As of December 31, 2016, substantially all actions have been completed.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 23
Pension settlements
During 2017, PPG made lump-sum payments to certain retirees who had participated in PPG's U.S. qualified and non-qualified pension plans totaling approximately $127 million. As the lump-sum payments were in excess of the expected 2017 service and interest costs for the affected plans, PPG remeasured the periodic benefit obligation of these plans in the period payments were made and recorded settlement charges totaling $60 million ($38 million after-tax)
during 2017.
During 2016, PPG permanently transferred approximately $1.8 billion of its U.S. and Canadian pension obligations and assets to several highly rated insurance companies. These actions triggered remeasurement and partial settlement of certain of the Company’s defined benefit pension plans. PPG recognized a $968 million pre-tax settlement charge in connection with these transactions. Refer to Note 13, "Employee Benefit Plans" in Item 8 of this Form 10-K/A for additional information.
Other charges
Other charges in 2017 were lower than 2016 due to the absence of environmental charges and certain asset write-downs. In 2016, Other charges were higher than in 2015 due to environmental charges of $82 million. These charges were principally for
environmental remediation at a former chromium manufacturing plant and associated sites in New Jersey.
Other income
Other income was higher in 2017 than in 2016 primarily due to the gain from the sale of the Mexican Plaka business of $25 million. Other income in 2016 was higher than in 2015 due to gains totaling $46 million resulting from the sale of a PPG legacy U.S. automotive glass and services business and a U.S. business affiliate, higher equity earnings from a 2017 acquisition of a 40% interest in a joint venture and was partially offset by the absence of certain business transaction-related gains.
Effective tax rate and earnings per diluted share, continuing operations
%
Change
($ in millions, except percentages)
2017
2016
2015
2017 vs. 2016
2016 vs. 2015
As Restated
As
Restated
Income tax expense
$615
$214
$413
187.4%
(48.2)%
Effective
tax rate
30.7
%
27.5
%
23.7
%
3.2%
3.8%
Adjusted effective tax rate*
24.3
%
24.5
%
23.9
%
(0.2)%
0.6%
Earnings
per diluted share
$5.31
$2.04
$4.79
160.3%
(57.4)%
Adjusted earnings per diluted share*
$5.86
$5.64
$5.33
3.9%
5.8%
*See
the Regulation G reconciliations - results of operations
The effective tax rate for the year-ended December 31, 2017 was 30.7% and increased 3.2% from the prior year primarily due to recording the net charge triggered by the enactment of the U.S. Tax Cuts and Jobs Act. This charge is approximately $37 million higher than the net charge included in PPG’s fourth quarter earnings release and Form 8-K furnished on January 18, 2018, primarily due to new IRS regulations issued and refinements of management estimates.
As reported, earnings per diluted share from continuing operations for the year ended December 31,
2017 increased year-over-year, primarily due to the absence of the pension settlement charge of $616 million after-tax recorded in 2016. Refer to the Regulation G Reconciliations - Results of Operations for additional information. The Company’s earnings per diluted share and adjusted earnings per diluted share both benefited from the 7.4 million, 10.7 million and 7.0 million shares of stock repurchased in 2017, 2016 and 2015, respectively.
Regulation G Reconciliations - Results of Operations
PPG Industries believes investors’ understanding of the
company’s operating performance is enhanced by the disclosure of net income, earnings per diluted share and the effective tax rate adjusted for certain charges. PPG’s management considers this information useful in providing insight into the company’s ongoing operating performance because it excludes the impact of items that cannot reasonably be expected to recur on a quarterly basis or that are not attributable to our primary operations. Net income and earnings per diluted share adjusted for these items are not recognized financial measures determined in accordance with U.S. generally accepted accounting principles (GAAP) and should not be considered a substitute for net income or earnings per diluted share or other financial measures as computed in accordance with U.S. GAAP. In addition, adjusted net income, earnings per diluted share and the effective tax rate may not be comparable
to similarly titled measures as reported by other companies.
24 2017 PPG ANNUAL REPORT AND 10-K/A
Income before income taxes from continuing operations is reconciled to adjusted income before income taxes, the effective tax rate from continuing operations is reconciled to the adjusted effective tax rate from continuing operations and net income (attributable to PPG) and earnings per share – assuming dilution (attributable to PPG) are reconciled to adjusted net income (attributable to PPG) and adjusted earnings per share – assuming dilution below:
($ in millions, except percentages and per share amounts)
Income Before Income Taxes
Tax Expense
Effective
Tax Rate
Net income from continuing operations (attributable to PPG)
Earnings per diluted share
As reported, continuing operations
$1,745
$413
23.7
%
$1,311
$4.79
Includes:
Charges
related to transaction-related costs(1)
44
14
33.3
%
30
0.10
Charge
related to business restructuring
136
31
22.8
%
105
0.39
Charge
related to pension settlement
7
2
28.6
%
5
0.02
Charge
related to equity affiliate debt refinancing
11
4
37.6
%
7
0.03
Adjusted,
continuing operations, excluding certain charges
$1,943
$464
23.9
%
$1,458
$5.33
(1)
Transaction-related
costs include advisory, legal, accounting, valuation, and other professional or consulting fees incurred to effect significant acquisitions, as well as similar fees and other costs to effect divestitures not classified as discontinued operations. These costs also include the flow-through cost of sales impact for the step up to fair value of inventory acquired in acquisitions. These costs also include certain nonrecurring severance costs and charges associated with the Company’s business portfolio transformation.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 25
Regulation G Reconciliations - Quarterly Results of Operations (unaudited) (As Restated)
($ in millions, except percentages and per share amounts)
Income
Before Income Taxes
Tax Expense
Effective Tax Rate
Net income from continuing operations (attributable to PPG)
Earnings per diluted share
As
reported, continuing operations
$
377
$
224
59.4
%
$
148
$
0.58
Adjusted
for:
Net tax charge for Tax Cuts and Jobs Act
—
(134
)
N/A
134
0.52
Pension
settlement charge
38
14
37.9
%
24
0.09
Gain
on sale of a non-operating asset
(13
)
(5
)
37.9
%
(8
)
(0.03
)
Asset
write-downs
(7
)
—
—
%
7
0.03
Adjusted,
continuing operations, excluding certain charges
$
395
$
99
25.1
%
$
305
$
1.19
(1)
Transaction-related
costs include advisory, legal, accounting, valuation, and other professional or consulting fees incurred to effect significant acquisitions, as well as similar fees and other costs to effect divestitures not classified as discontinued operations. These costs also include the flow-through cost of sales impact for the step up to fair value of inventory acquired in acquisitions. These costs also include certain nonrecurring severance costs and charges associated with the Company’s business portfolio transformation.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 27
Performance
of Reportable Business Segments
Performance Coatings
$ Change
%
Change
($ in millions, except percentages)
2017
2016
2015
2017 vs. 2016
2016 vs. 2015
2017 vs. 2016
2016
vs. 2015
As Restated
Net sales
$8,730
$8,580
$8,765
$150
$(185)
1.7%
(2.1)%
Segment
income
$1,321
$1,314
$1,302
$7
$12
0.5%
0.9%
2017
vs. 2016
Performance Coatings net sales increased (2%) due to the following:
● Higher selling prices (+1%)
● Net sales from acquisitions (+1%)
● Modest foreign currency translation
Partially offset by:
● Slightly lower sales volumes
Selling prices increased year-over-year primarily due to selling price initiatives across all businesses to combat accelerating raw material cost inflation.
Architectural
coatings - Americas and Asia Pacific sales volumes declined a low-single-digit-percentage versus the prior year. Sales volumes increased by a mid-single-digit percentage in company-owned stores in the U.S. and Canada, including the unfavorable impact from natural disasters in the third quarter 2017. This increase was more than offset by sales volume declines in the U.S. and Canada independent dealer networks and national retail (DIY) customer accounts, as both distribution channels continued to experience soft demand. Organic sales improved in both the Latin America and Asia Pacific regions.
Architectural coatings - EMEA net sales increased by a high-single-digit percentage year-over-year, primarily due to acquisition-related sales, principally DEUTEK and Univer, which contributed approximately $85 million to net sales. Sales volumes were down year-over-year primarily driven by continued weak demand
in France and eastern Europe, as well as our turning away certain business due to low profitability or lack of customer acceptance of selling price increases. Demand growth continued in Northern Europe, where we continued to outperform the market.
Automotive refinish coatings organic sales grew by a low-single-digit percentage year-over-year, led by above-market performance in U.S. and Canada as customers continued to adopt PPG’s industry leading technologies. Organic sales also increased in the Latin American region versus the prior year, reflecting high end-use market demand. In Asia Pacific, net sales increased, largely due to the recent Futian Xinshi acquisition in China.
Aerospace coatings sales volumes grew by a low-single-digit percentage versus the prior year, led by above market performance in Europe and consistent
with the overall industry demand.
Protective and marine coatings sales volumes declined by a mid-single-digit percentage year-over-year. Protective coatings sales volumes expanded in most regions, led by Europe, but were more than offset by significant weakness in new shipbuilding activity, primarily in the Asia Pacific region.
Segment income increased $9 million (1%) year-over-year primarily due to selling price increases, lower overhead and manufacturing costs, including the initial benefits from business restructuring actions, partially offset by increasing raw material costs, wage and other cost inflation, and lower sales volumes.
28 2017 PPG ANNUAL REPORT AND 10-K/A
2016
vs. 2015
Performance Coatings net sales decreased (2%) due to the following:
● Unfavorable foreign currency translation of approximately $260 million (3%), most notably the Mexican peso, the British pound, the Chinese yuan and the euro.
Partially offset by:
● Net sales from acquisitions (+1%)
Architectural coatings - Americas and Asia Pacific organic sales were flat versus the prior year. In the U.S. and Canada, sales volumes advanced in the company-owned store channel versus the prior year, mainly due to recent
growth-related investments and initiatives. The increase in the company-owned stores channel was more than offset by sales volume declines in national retail (DIY) accounts and U.S. independent dealer channel year-over-year, despite DIY channel strengthening in the second half of 2016. Latin America organic sales were up year-over-year, led by Mexico which grew at more than double the Mexican GDP growth rate.
Architectural coatings - EMEA sales volumes were flat year-over-year. Growth in western Europe was offset by reduced demand levels in central Europe and in Africa, where economies are closely linked to depressed commodity prices. Acquisition-related sales from Univer in Italy added about $10 million in the fourth quarter 2016.
Automotive
refinish coatings organic sales grew at a low-single-digit percentage rate year-over-year, outperforming end-use market demand levels in the U.S. and Canada and Asia Pacific, as customers continued to adopt PPG’s industry leading technologies.
Aerospace coatings sales volumes increased modestly year-over-year, in line with industry growth rates. Sales growth occurred in all major regions.
Protective and marine coatings net sales volumes declined a low-to-mid-single-digit-percentage year-over-year as growth in protective coatings was offset by declines in marine coatings, primarily due to lower shipbuilding activity in the Asia Pacific region and the ongoing impact of decreased capital investment and maintenance in the oil and gas sector. Protective coatings sales volumes grew versus the prior year, led by the U.S. and Canada
and Latin America regions, including benefits from expanded distribution through the PPG-Comex concessionaire network.
Segment income increased $12 million (+1%) primarily due to the benefits from prior year business restructuring initiatives, modestly higher selling prices, lower manufacturing costs, acquisition-related income (Cumings Microwave, Le Joint Francais, Univer), partially offset by unfavorable foreign currency translation and higher growth-related spending in the U.S. architectural coatings business. Segment income margins expanded, increasing 40 basis points year-over-year.
Looking Ahead
In the first quarter 2018, we expect sales volumes in the architectural coatings - Americas and Asia Pacific
business to be seasonally lower than the fourth quarter 2017. In addition, overall volume trends by customer channel are anticipated to be consistent with the fourth quarter 2017. The PPG TIMELESS® product, launched in certain HOME DEPOT® stores in 2017, is projected to continue to meet our sales targets and is being expanded to more locations during 2018. We also anticipate additional growth-related spending of up to $5 million in the first quarter to support the continued momentum in the region. The volume growth trend for architectural coatings - EMEA is expected to improve modestly in the first quarter 2018, with results remaining uneven by country. We expect continued, high end-use demand in our automotive refinish coatings business as customers continue to adopt PPG’s industry leading technologies. In aerospace coatings, we anticipate continued improvement in industry demand growth. The protective and marine coatings business is expected to perform in-line with
the market in the first quarter 2018.
We expect raw material costs to remain elevated in the first-quarter 2018 at similar levels experienced in the fourth quarter. Further selling price increases in 2018 will be needed to offset more recent raw material inflation. There will be no material benefit from acquisition-related sales in the segment, and, based on mid-January exchange rates, foreign currency translation is expected to have a similar sequential favorable impact on segment sales and income in the first quarter 2018.
Due to the timing of the Easter holiday, there is one fewer ship day in the first-quarter 2018 compared to first-quarter 2017, which is expected to unfavorably impact global architectural coatings sales volumes by about $20 million to $25 million in net sales. This unfavorable impact will reverse in the second quarter.
2017
PPG ANNUAL REPORT AND FORM 10-K/A 29
Industrial Coatings
$ Change
%
Change
($ in millions, except percentages)
2017
2016
2015
2017 vs. 2016
2016 vs. 2015
2017 vs. 2016
2016
vs. 2015
Net sales
$6,018
$5,690
$5,476
$328
$214
5.8%
3.9%
Segment
income
$972
$1,042
$985
$(70)
$57
(6.7)%
5.8%
2017
vs. 2016
Industrial Coatings segment net sales increased (6%) due to the following:
● Higher sales volumes (+4%)
● Acquisition-related sales (+3%)
Partially offset by:
● Lower selling prices (1%)
PPG’s automotive OEM coatings sales volumes increased by a low-single-digit percentage versus the prior year, consistent with the global automotive industry production growth rate, led by China, Mexico, Europe and Brazil. Sales volumes declined in the U.S. and Canada, partially reflecting fewer automotive new builds.
General
industrial coatings and specialty coatings and materials sales volumes, in aggregate, grew by a mid-single-digit percentage year-over-year. Sales volumes grew year-over-year in every major region with mixed demand by end-use market and geography. This growth was led by Asia Pacific and the U.S., which outpaced regional industrial production demand growth. Sales volumes grew across most sub-segments, including year-over-year increases in electronics materials, heavy duty equipment and organic light emitting diode (OLED) materials. Acquisition-related sales, primarily MetoKote, added approximately $155 million.
Packaging coatings sales volumes grew by a mid-single-digit percentage year-over-year, primarily driven by ongoing industry conversions to PPG’s new can coatings technologies, led by the U.S.
Segment income decreased $70
million (-7%) year-over-year primarily due to increasing raw material costs, lower selling prices and wage and other cost inflation. These cost increases were partially offset by income from higher sales volumes, lower manufacturing and overhead costs, including the initial benefits from business restructuring actions, and acquisition-related income.
2016 vs. 2015
Industrial Coatings segment net sales increased (4%) due to the following:
● Net sales from acquired businesses (+4%)
● Higher sales volumes (+3%)
Partially
offset by:
● Unfavorable foreign currency translation of approximately $125 million (2%), most notably the Mexican peso, the British pound, the Chinese yuan and the euro.
● Lower selling prices (1%)
PPG’s automotive OEM coatings business sales volumes increased a low-single-digit-percentage over the prior year, consistent with global automotive industry production growth. PPG's sales volumes differed by region, led by year-over-year growth in Europe and Asia Pacific, while U.S. and Canada sales volumes lagged industry demand levels due to a customer-driven market-share shift away from PPG that was offset in other regions of the world.
General industrial coatings and
specialty coatings and materials sales volumes, in aggregate, increased a mid-single-digit percentage year-over-year. Sales volume growth was led by Asia Pacific and EMEA, and was driven by strong end-market demand for automotive components, electronic materials, and coil and extrusion products. Latin America sales volumes advanced moderately, while volumes in the U.S. and Canada declined modestly.
Packaging coatings sales volumes were up a mid-to-high single-digit percentage year-over-year, primarily driven by continued strong sales growth momentum related to the adoption of PPG's new can coatings technologies. This above market sales volume growth was led by U.S. and Canada and Asia Pacific regions.
Segment income increased $57 million (+6%) primarily due to lower manufacturing costs, higher sales volumes, acquisition-related
income (MetoKote, IVC Industrial Coatings, Revocoat) and the benefits from prior year restructuring initiatives, partially offset by unfavorable foreign currency translation and modestly lower selling prices. PPG experienced higher transportation and logistics costs required to meet increasing customer demand in Asia. Segment income margins continued to improve, increasing 30 basis points year-over-year.
30 2017 PPG ANNUAL REPORT AND 10-K/A
Looking ahead
In the first quarter of 2018, we expect global automotive industry production growth to be about 1% led by Europe and Mexico. In China, automotive production is expected to modestly decrease in the first
quarter of 2018, reflecting the expiration of a small engine subsidy that had been in effect the past several years. We anticipate solid general industrial demand growth trends to continue in aggregate, but remain mixed by geography and end-use market. PPG’s market outperformance is expected to continue. In our packaging coatings business, we anticipate volume growth will continue due to the ongoing industry conversion to BPA non-intent interior can coatings, with PPG’s year-over-year growth rates continuing at an above market level in 2018. We expect acquisition-related sales to add approximately $30 million to first quarter 2018 segment sales and, based on mid-January exchange rates, foreign currency translation is expected to have a similar sequential favorable impact on segment sales and income in the first quarter 2018.
Segment margin recovery continues to be a priority for 2018. Based on recent raw material inflation,
segment margin recovery is expected to continue through the first half of 2018. All businesses in the segment have made progress with selling price initiatives and additional price increases have been announced for early 2018. Also, efforts to reduce costs remain a key focus in 2018.
Review and Outlook
During 2017, economic conditions improved in all of our major geographical regions while remaining mixed by end-use market. PPG’s aggregate organic sales grew 1.5% versus the prior year and were higher in the second half of 2017 compared to the first half of 2017. Acquisition-related sales from two acquisitions completed in 2016 and the four completed in 2017 contributed over 1% to net sales growth year-over-year. Foreign currency translation was modestly favorable to net sales year-over-year. Favorable foreign
currency translation experienced in the second half of 2017 slightly offset unfavorable impacts during the first half of the year. Raw material inflation rose by a mid-single-digit percentage driven mostly by supply related factors, including an unusual high number of supplier force majeure events in Europe, government mandated production curtailments in China to help improve pollution, and severe hurricanes in the U.S. In addition, oil prices moved sharply higher in the second half of the year also contributing to raw material inflation.
U.S. and Canada
During 2017, the pace of economic activity improved in the U.S. and Canada region versus the prior year, with higher industrial production despite lower automotive industry builds. Demand in the residential and commercial construction markets were modestly higher in 2017 compared to 2016. New home starts advanced about 2% in 2017
versus approximately 6% in 2016. Residential remodeling declined 1% in 2017 versus 2016, while commercial construction was flat compared to 7% growth in 2016. Market demand for architectural paint shifted more to trade paint as U.S. unemployment continued to decline. Demand in the overall U.S. DIY paint market remained soft throughout the year. PPG’s architectural coatings performance in the U.S. followed market trends with solid improvement in company-owned same store sales throughout the year. The automotive refinish coatings business benefited from higher miles driven and more congestion on the roads due to lower unemployment. PPG’s packaging coatings business continued to expand well ahead of the industry end-use market growth driven by continued strong sales growth momentum related to customer adoption of PPG’s new interior can coatings technologies. Similar to 2016, PPG’s automotive OEM coatings business lagged industry demand levels due to a customer-driven market-share
shift away from PPG that was offset in other regions of the world. The U.S. and Canada region remained PPG’s largest, representing approximately 43% of 2017 sales, although a smaller percentage of total sales than in the prior year.
Europe, Middle East and Africa
European economic activity improved in 2017 despite continued regional uncertainty over the United Kingdom’s exit from the European Union. Overall GDP and industrial production improved in the region. Regional demand continued to be mixed by country and end-use market. Demand for PPG’s products in several end-use markets drove the regional growth rate, including above market performance in automotive OEM coatings, aerospace coatings and specialty coatings and materials. PPG’s architectural coatings - EMEA business sales volumes decreased year-over-year, driven by soft market demand in France and more competitive pressures
in Northern and Eastern Europe.
EMEA represented approximately 30% of PPG’s 2017 sales, similar to prior year levels. Regional coatings volumes remain approximately 13% below their pre-recession levels in 2008. The modest volume recovery reflects the slow pace of economic growth in the region. PPG expects continued volume growth over time at attractive incremental margins due to significant cost structure improvements and available capacity to satisfy additional demand. In the second half of the year, the euro appreciated approximately 5% against the U.S. dollar. The British pound recovered some of its 2016 declines versus the U.S. dollar gaining about 10% from the start of 2017.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 31
Asia Pacific and Latin America
The
emerging regional markets of Asia Pacific and Latin America represented 27% of PPG’s 2017 sales in aggregate, 200 basis points higher than the prior year.
Asia remained the largest emerging region, with sales of approximately $2.5 billion, led by China, which continued as PPG’s second largest country by revenue. Sales volume growth in Asia was led by the Industrial Coatings segment, in part due to strong sales volume growth in general industrial and automotive OEM. These increases were partially offset by the continued demand decline in the marine shipbuilding industry.
Overall, demand in Latin America improved year-over-year, with continued above market growth in Mexico and Central America. Economic conditions modestly improved in South America, primarily led by Brazil. In Mexico, the PPG-Comex business added over 200 new concessionaire locations, and strong growth continued in
the automotive industry due to the opening of new automotive assembly plants within the country in the past 18 months. Foreign currency translation turned favorable in the second half of the year, principally the Mexican peso and Chinese yuan. In Central America, the Company continued to grow organically following a 2015 acquisition to expand its presence in the architectural end-use market.
Regional Outlook
Looking ahead to 2018, we expect to continue to operate in a more balanced global growth environment. We anticipate the positive economic trends in 2017 to mostly continue. We expect economic growth rates to remain consistent with 2017 for the U.S. and Canada, Europe, and Asia Pacific regions, and we expect the Latin America region will increase its economic growth year-over-year, when compared
to 2017.
We anticipate PPG’s U.S. and Canada regional growth will be led by general industrial coatings and packaging coatings, with flat automotive industry builds. We expect growth in the housing and commercial construction markets to be better than 2017.
We expect growth rates in Europe to stay at similar levels as 2017 but will remain mixed by sub-region and country. Favorable end-use market trends are expected to continue, particularly in automotive OEM coatings as industry build growth rates are anticipated to remain positive. Market demand is expected to improve in the architectural coatings business. There is greater risk to the economic environment in the U.K. as their exit from the European Union progresses.
In Asia Pacific, we expect continued industrial production growth in China as well as gains in Southeast Asia and India.
In China, we see continued above global average growth with heightened risk as the Chinese economy continues to shift and rely more on domestic consumption. The regional declines in marine coatings sales volumes were less severe in the second half of 2017, and we expect a moderate recovery in sales volumes starting in the second half of 2018. Automotive build growth is expected to remain modestly positive.
In Latin America, we anticipate economic expansion will be led by Brazil and that Mexico’s economic conditions will modestly improve.
Significant other factors
During 2017, PPG finalized the divestiture of its North American fiber glass business. This is a transformational milestone for the Company as it completed the culmination of a multi-year strategic
shift in the company’s business portfolio. The pre-tax cash proceeds from the sale were approximately $540 million.
In December 2016, PPG initiated a $195 million global restructuring program, with anticipated annual savings of approximately $125 million once fully implemented. The expected cost savings are broadly spread across all regions and all business units. The company achieved approximately $50 million of savings in 2017 and expects to achieve the full annualized target of $125 million by 2019. PPG will continue to aggressively manage the company’s cost structure to ensure alignment with the overall demand environment and make adjustments as required to remain competitive
in the marketplace.
Raw materials are a significant input cost to the process of manufacturing coatings. PPG experiences fluctuating energy and raw material costs driven by various factors, including changes in supplier feedstock costs and inventories, global industry activity levels, foreign currency exchange rates, and global supply and demand factors. In aggregate, average raw material costs were higher in 2017 versus 2016, due to supplier force majeure, natural disasters and environmental regulation enforcement. PPG currently expects overall coatings raw material prices to increase a mid-single-digit percentage in the first half of 2018, with impacts varied by region and commodity.
In 2017, aggregate selling prices were modestly higher year-over-year, reflecting the company’s efforts to offset higher
raw material costs. We expect to see further benefits from selling price actions taken in 2017 and other actions planned in 2018 to recover profit contribution margins. The Company will carefully monitor raw material costs during 2018 and assess the need for additional increases to selling prices to compensate for increases in raw material costs.
32 2017 PPG ANNUAL REPORT AND 10-K/A
Pension and postretirement benefit costs, excluding settlements, curtailments and special termination benefits, totaled approximately $50 million in 2017, down approximately $70 million from 2016. In 2018, we expect pension and other postretirement benefit costs to decrease by approximately $15 million to $20 million due to strong 2017 asset
performance improving the expected return on assets component of net periodic benefit cost as well as certain U.S. plan changes made in 2017.
PPG contributed $54 million to its U.S. defined benefit pension plans in 2017 and an additional $25 million in January 2018. In 2017, the Company made contributions aggregating $33 million to its non-U.S. defined benefit pension plans. In 2018, mandatory contributions to PPG’s non-U.S. defined benefit pension plans are expected to be between $20 million and $30 million.
In 2017, unfavorable foreign currency translation experienced in the first half was completely offset by favorable foreign currency translation experienced in the second half of the year. Based on mid-January 2018 exchange rates, the
Company expects year-over-year favorable foreign currency translation to increase 2018 sales by $250 million to $300 million and 2018 income before income taxes by $25 million to $30 million. We expect the foreign currency translation impact to be more prevalent during the first half of 2018, due to prior year foreign exchange rate trends. The foreign currency environment continues to be volatile and the impact on 2018 net sales and income before income taxes could differ from the guidance provided above. The Company generally purchases raw materials, incurs manufacturing costs and sells finished goods in the same currency, so we typically incur only modest foreign currency transaction costs.
With the enactment of the U.S. Tax Cuts and Jobs Act, the Company’s
2018 effective tax rate from continuing operations is expected to be in the range of 23.0% and 24.0%. This range represents the Company’s best estimate, including the new legislation, however, our estimate is subject to revision as the Company completes its assessment of the new law and as additional regulations and interpretations are issued. Other factors may affect the expected 2018 effective tax rate positively or negatively throughout the year, including changes to various statutory tax rates and regulations around the world.
Over the past four years, the Company used $3.4 billion of cash to repurchase about 33 million shares of PPG stock, including over $800 million in 2017.
The Company ended the year with approximately $3.6 billion remaining under its current share repurchase authorizations. During 2017, the Company deployed approximately $325 million for acquisitions and $434 million for dividends. PPG increased its per-share dividend in July 2017, marking the 46th annual increase and the 118th consecutive year of dividend payments. The Company is committed to deploying a minimum of $2.4 billion of cash during 2018 on acquisitions and share repurchases as part of our previously communicated commitment to deploy $3.5 billion in 2017 and 2018 combined. In 2017, PPG deployed $1.1 million for acquisitions and share repurchases.
PPG ended 2017 with approximately
$1.5 billion in cash and short-term investments. The Company expects continued strong cash generation in 2018.
Accounting Standards Adopted in 2017
Note 1, “Summary of Significant Accounting Policies,” under Item 8 of this Form 10-K/A describes the Company’s recently adopted accounting pronouncements.
Accounting Standards to be Adopted in Future Years
Note 1, “Summary of Significant Accounting Policies,” under Item 8 of this Form 10-K/A describes accounting pronouncements that have been promulgated
prior to December 31, 2017 but are not effective until a future date.
Commitments and Contingent Liabilities, including Environmental Matters
PPG is involved in a number of lawsuits and claims, both actual and potential, including some that it has asserted against others, in which substantial monetary damages are sought. See Item 3. “Legal Proceedings” and Note 14, “Commitments and Contingent Liabilities,” under Item 8 of this Form 10-K/A for a description of certain of these lawsuits.
As discussed in Item 3 and Note 14, although the result of any future litigation of such lawsuits and claims is inherently unpredictable, management believes that, in the aggregate,
the outcome of all lawsuits and claims involving PPG, including asbestos-related claims, will not have a material effect on PPG’s consolidated financial position or liquidity; however, any such outcome may be material to the results of operations of any particular period in which costs, if any, are recognized.
It is PPG’s policy to accrue expenses for contingencies when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. Reserves for environmental contingencies are exclusive of claims against third parties and are generally not discounted. In management’s opinion, the Company operates in an environmentally sound manner and the outcome of the Company’s environmental contingencies will not have a material effect on
PPG’s financial position or liquidity; however, any such outcome may be material to the results of operations of any particular period in which costs, if any, are recognized. Management anticipates that the resolution of the Company’s environmental contingencies will occur over an extended period of time.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 33
The Company continues to analyze, assess and remediate the environmental issues associated with PPG’s former chromium manufacturing plant in Jersey City, N.J. and associated sites (“New Jersey Chrome”). Information will continue to be generated from the ongoing groundwater remedial investigation
activities related to New Jersey Chrome and will be incorporated into a final draft remedial action work plan for groundwater expected to be submitted to the New Jersey Department of Environmental Protection in 2021.
There are multiple, future events yet to occur, including further remedy selection and design, remedy implementation and execution and applicable governmental agency or community organization approvals. Considerable uncertainty exists regarding the timing of these future events for the New Jersey Chrome sites. Final resolution of these events is expected to occur over the next several years. As these events occur and to the extent that the cost estimates of the environmental remediation remedies change, the existing reserve for this environmental remediation matter will be adjusted.
Liquidity
and Capital Resources (As Restated)
During the past three years, PPG has had sufficient financial resources to meet its operating requirements, to fund our capital spending, including acquisitions, share repurchases and pension plans and to pay increasing dividends to shareholders.
Cash and cash equivalents and short-term investments
($ in millions)
2017
2016
Cash
and cash equivalents
$1,436
$1,820
Short-term investments
55
43
Total
$1,491
$1,863
Cash
from operating activities - continuing operations
($ in millions, except percentages)
% Change
2017
2016
2015
2017 vs. 2016
2016 vs. 2015
As
Restated
Cash from operating activities
$1,551
$1,218
$1,759
27.3%
(30.8)%
2017 vs. 2016
The $333 million increase in cash from operating activities - continuing operations, was primarily due to the absence of the
prior year funding of the Pittsburgh Corning asbestos trust (the “Trust”), lower defined benefit pension contributions, lower restructuring payments and lower interest payments, partially offset by higher cash taxes paid in 2017 and higher working capital.
2016 vs. 2015
The $541 million decrease in cash from operating activities - continuing operations, was primarily due to the after-tax funding of the Trust, partially offset by lower working capital and lower defined benefit pension contributions.
Operating working capital
Operating Working Capital is a subset of total working capital and represents (1) receivables from customers, net of allowance for doubtful accounts, (2) inventories, and (3) trade liabilities. See Note 4, “Working Capital Detail” under Item 8 of this Form
10-K/A for further information related to the components of the Company’s Operating Working Capital. We believe Operating Working Capital represents the key components of working capital under the operating control of our businesses.
34 2017 PPG ANNUAL REPORT AND 10-K/A
A key metric we use to measure our working capital management is Operating Working Capital as a percentage of sales (fourth quarter sales annualized).
($
in millions, except percentages)
2017
2016
Trade Receivables, net
$2,559
$2,288
Inventories,
FIFO
1,833
1,620
Trade Creditor’s Liabilities
2,321
1,907
Operating Working Capital
$2,071
$2,001
Operating
Working Capital as a % of fourth quarter sales, annualized
14.1
%
14.6
%
Trade Receivables, net as a % of fourth quarter sales, annualized
17.4
%
16.7
%
Days
sales outstanding
57
54
Inventories, FIFO as a % of fourth quarter sales, annualized
12.4
%
11.9
%
Inventory turnover
4.8
4.6
Environmental
expenditures
($ in millions)
2017
2016
2015
Cash outlays related to environmental remediation activities
$44
$47
$109
We expect cash outlays for environmental remediation activities in 2018 to be between
$25 million and $75 million.
Defined benefit pension plan contributions
($ in millions)
2017
2016
2015
U.S. defined benefit pension plans
$54
$134
$224
Non-U.S. defined benefit
pension plans
$33
$54
$39
PPG contributed $54 million and $25 million to its U.S. defined benefit pension plans during 2017 and in January 2018, respectively. Some contributions to PPG’s non-U.S. defined benefit pension plans in 2017 were required by local funding requirements. PPG expects to make mandatory contributions to its non-U.S. defined benefit pension plans in the range of $20 million to $30 million in 2018. PPG may make voluntary contributions to its defined benefit pension plans in 2018 and beyond.
Asbestos settlement trust funding
In June 2016, PPG fully funded its portion of the trust that was established by
the U.S. Bankruptcy Court for the Western District of Pennsylvania in May 2016. PPG’s total cash obligations to fund the Trust totaled $813 million (pre-tax). All payments were applied against a previously established PPG reserve for the total asbestos trust obligation. The company utilized cash on hand for the payments, and this funding had no impact on PPG’s previously stated cash-deployment targets. Refer to Note 14, “Commitments and Contingent Liabilities” under Item 8 of this Form 10-K/A for additional information.
Cash used for investing activities - continuing operations
($
in millions, except percentages)
% Change
2017
2016
2015
2017 vs. 2016
2016 vs. 2015
Cash (used for)from investing activities
($63)
$472
($349)
(113.3)%
235.2%
2017
vs. 2016
The $535 million decrease in cash used for investing activities - continuing operations, was primarily due to the absence of the prior year proceeds from the sale of the flat glass business, European fiber glass business and two Asian joint ventures, as well as lower capital expenditures, including business acquisitions, partially offset by the current year proceeds from the sale of the North American fiber glass business.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 35
2016 vs. 2015
The $821 million increase in cash from investing activities - continuing operations, was primarily due to the proceeds received from the divestiture of the flat glass business, European fiber glass business and two Asian joint ventures,
partially offset by lower cash received from the maturity of short-term investments.
Capital expenditures, including business acquisitions
($ in millions, except percentages)
% Change
2017
2016
2015
2017
vs. 2016
2016 vs. 2015
Capital expenditures (1)
$360
$380
$430
(5.3)%
(11.6)%
Business
acquisitions, net of cash acquired (2)
$325
$349
$320
(6.9)%
9.1%
Total capital expenditures, including acquisitions
$685
$729
$750
(6.0)%
(2.8)%
Capital
expenditures, excluding acquisitions as a % of sales
2.4
%
2.7
%
3.0
%
(11.1)%
(10.0)%
(1) Includes modernization and productivity improvements, expansion of existing businesses and environmental control projects.
(2) Excluding cash acquired, business acquisitions totaled $332 million, $362 million, and $440 million in
2017, 2016 and 2015, respectively.
Capital expenditures related to modernization and productivity improvements, expansion of existing businesses and environmental control projects is expected to be in the range of 2.5% to 3.0% of sales during 2018.
A primary focus for the Company in 2018 will continue to be cash deployment focused on profitable income growth, including pursuing opportunities for additional strategic acquisitions.
Cash proceeds from divestitures
In September 2017, PPG completed the sale of its North American fiber glass business to Nippon Electric Glass Co. and
received approximately $540 million in pre-tax cash proceeds.
During 2016, PPG finalized the sale of its flat glass business and several other businesses and business affiliates. The Company received total pre-tax cash proceeds of approximately $1.1 billion from these business divestitures. Refer to Note 3, “Acquisitions and Divestitures” under Item 8 of this Form 10-K/A for additional information.
Cash used for financing activities - continuing operations
%
Change
($ in millions, except percentages)
2017
2016
2015
2017 vs. 2016
2016 vs. 2015
Cash used for financing activities
($1,954)
($1,210)
($812)
61.5%
49.0%
2017
vs. 2016
The $744 million increase in cash used for financing activities - continuing operations, was primarily due to repayment of long term debt and higher dividends in 2017, partially offset by issuance of long term debt in 2016 and lower net purchases of treasury stock year-over-year.
2016 vs. 2015
The $398 million increase in cash used for financing activities - continuing operations, was primarily due to higher dividends in 2016, higher net purchases of treasury stock year-over-year, lower net issuance of long term debt in 2016, partially offset by lower taxes withheld for share-based payments.
Share repurchase activity
($
in millions, except number of shares)
2017
2016
2015
Number of shares repurchased (millions)
7.4
10.7
7.0
Cost
of shares repurchased
$813
$1,050
$751
We anticipate completing additional share repurchases during 2018. The Company has approximately $3.6 billion remaining under the current authorizations from the Board of Directors,
the latest of which was approved in December 2017. The current authorized repurchase programs have no expiration date.
36 2017 PPG ANNUAL REPORT AND 10-K/A
Dividends paid to shareholders
($ in millions)
2017
2016
2015
Dividends paid to shareholders
$434
$414
$383
PPG
has paid uninterrupted annual dividends since 1899, and 2017 marked the 46th consecutive year of increased annual per-share dividend payments to shareholders. The Company raised its per-share dividend by 13% to $0.45 per share in July 2017.
Debt issued and repaid
Debt Issued
Year
$ in millions
€300
million 0.000% Notes due 2019 and €600 million 0.875% Notes due 2025
2016
$987
€600 million 0.875% Notes due 2022 and €600 million 1.400% Notes due 2027
2015
1,240
Debt
Repaid
Year
$ in millions
3-year variable rate bank loan due 2017
2017
$587
$125 million 6.65% notes due 2018
2016
133
Two
$250 million Term Loan Credit Agreements
2016
500
$250 million 1.9% notes
2016
250
€300 million 3.875% notes
2015
336
The ratio of total debt,
including capital leases, to total debt and equity was 43% at December 31, 2017 down from 47% in 2016.
Credit agreements and lines of credit
In December 2015, PPG entered into a five-year credit agreement (the “Credit Agreement”) with several banks and financial institutions as further discussed in Note 9, “Borrowings and Lines of Credit” under Item 8 of this Form 10-K/A. The Credit Agreement provides for a $1.8 billion unsecured revolving credit facility. The Credit Agreement will terminate on December 18, 2020. During the years ended December 31, 2017 and 2016, there were no borrowings outstanding under the existing or the prior Credit Agreement.
In
addition to the amounts available under the lines of credit, the Company has an automatic shelf registration statement on file with the SEC pursuant to which it may issue, offer and sell from time to time on a continuous or delayed basis any combination of securities in one or more offerings.
See Note 9, “Borrowings and Lines of Credit,” under Item 8 of this Form 10-K/A for information regarding notes entered into and repaid as well as details regarding the use and availability of committed and uncommitted lines of credit, letters of credit, guarantees and debt covenants.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 37
Contractual obligations
We
continue to believe that our cash on hand and short term investments, cash from operations and the Company’s access to capital markets will continue to be sufficient to fund our operating activities, capital spending, acquisitions, dividend payments, debt service, share repurchases, contributions to pension plans, and PPG’s significant contractual obligations. These significant contractual obligations are presented in the following table.
($
in millions)
Obligations Due In:
Total
2018
2019-2020
2021-2022
Thereafter
Contractual
Obligations
Long-term debt
$4,123
$—
$1,151
$849
$2,123
Short-term
debt
8
8
—
—
—
Capital
lease obligations
15
4
5
2
4
Operating
leases
840
212
305
149
174
Interest
payments(1)
1,004
94
179
115
616
Pension
contributions(2)
55
55
—
—
—
Unconditional
purchase commitments(3)
124
55
39
11
19
Other
commitments
136
6
56
13
61
Total
$6,305
$434
$1,735
$1,139
$2,997
(1)
Includes
interest on all outstanding debt.
(2)
Includes the high end of the range of the expected mandatory pension contributions for 2018 only and U.S. contributions made in January 2018, as PPG is unable to estimate the pension contributions beyond 2018.
(3)
The unconditional purchase commitments are principally take-or-pay obligations related to the purchase of certain materials, including industrial gases and electricity, consistent with customary industry practice.
Other
liquidity matters
On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act (the “Act”) which, among other things lowered the U.S. corporate statutory income tax rate from 35% to 21%, eliminated certain deductible items and added other deductible items for corporations, imposed a tax on unrepatriated foreign earnings and eliminated U.S. taxes on most future foreign earnings. In December 2017, the Company recorded a net tax charge of $134 million related to the Act. The net charge consists of the tax on unrepatriated foreign earnings of approximately $250 million and a charge of approximately $125 million related to the remeasurement of PPG’s U.S. deferred tax assets and liabilities at the new enacted statutory rate. These charges were partially offset by a benefit from the reversal
of an existing deferred tax liability on repatriated foreign earnings of approximately $150 million and a benefit resulting from PPG’s decision to accelerate recognition of certain U.S. tax attributes during the fourth quarter.
This net charge is $37 million higher than the net charge included in PPG’s fourth quarter earnings release and Form 8-K furnished on January 18, 2018, primarily due to new IRS regulations issued and refinements of management estimates. The net charge recorded as a provisional amount as of December 31, 2017 represents the Company’s best estimate using information available as of February 1, 2018. The
Company anticipates U.S. regulatory agencies will issue further regulations during 2018, which may alter this estimate. The Company is still evaluating among other things, its position with respect to permanent reinvestment of foreign earnings overseas and other related outside basis difference considerations and the amount of tax owed on unrepatriated earnings by subsidiaries. The Company believes its remeasurement of the U.S deferred tax assets and liabilities is complete, except for changes in estimates that can result from finalizing the filing of our 2017 U.S. income tax return, which are not anticipated to be material, and changes that may be a direct impact of other provisional amounts recorded due to the
enactment of the Act. The Company will refine its estimates to incorporate new or better information as it comes available through the filing date of its 2017 U.S. income tax returns in the fourth quarter of 2018.
The tax owed by PPG on its unrepatriated foreign earnings is payable over eight years and is subject to a prescriptive calculation to determine the portion payable in 2018 and beyond. PPG’s current estimate, using this prescriptive method, indicates its tax payable will be increased by approximately $1 million to $3 million per year through 2025. As such, the portion of the tax on unrepatriated foreign earnings not payable within the next 12 months is presented within “Other liabilities” on the consolidated balance sheet.
The
Company currently expects its 2018 on-going effective tax rate from continuing operations to be in the range of 23% to 24%.
38 2017 PPG ANNUAL REPORT AND 10-K/A
At December 31, 2017, the total amount of unrecognized tax benefits for uncertain tax positions, including an accrual of related interest and penalties along with positions only impacting the timing of tax benefits, was $163 million. The timing of payments will depend on the progress of examinations with tax authorities. PPG does not expect a significant tax payment related to these obligations within the next year. The Company is unable to make a reasonably reliable estimate as to when any significant cash settlements
with taxing authorities may occur.
Off-Balance Sheet Arrangements
The Company’s off-balance sheet arrangements include the operating leases and unconditional purchase commitments disclosed in the “Liquidity and Capital Resources” section in the contractual obligations table as well as letters of credit and guarantees as discussed in Note 9, “Borrowings and Lines of Credit,” under Item 8 of this Form 10-K/A.
Critical Accounting Estimates
Management has evaluated the accounting policies used in the preparation of the financial statements and related notes
presented under Item 8 of this Form 10-K/A and believes those policies to be reasonable and appropriate. We believe that the most critical accounting estimates made in the preparation of our financial statements are those related to accounting for contingencies, under which we accrue a loss when it is probable that a liability has been incurred and the amount can be reasonably estimated, and to accounting for pensions, other postretirement benefits, business combinations, goodwill and other identifiable intangible assets with indefinite lives because of the importance of management judgment in making the estimates necessary to apply these policies.
Contingencies
Contingencies, by their nature, relate to uncertainties that require management to exercise judgment both in assessing the likelihood that a liability has been incurred as well as in estimating the amount of potential loss.
The most important contingencies impacting our financial statements are those related to the collectability of accounts receivable, to environmental remediation, to pending, impending or overtly threatened litigation against the Company and to the resolution of matters related to open tax years. For more information on these matters, see Note 4, “Working Capital Detail,” Note 13, “Income Taxes” and Note 14, “Commitments and Contingent Liabilities” under Item 8 of this Form 10-K/A.
Defined Benefit Pension and Other Postretirement Benefit Plans
Accounting for pensions and other postretirement benefits involves estimating the cost of benefits to be provided well into the future and attributing that cost over the time period each employee works. To accomplish this, we make extensive
use of assumptions about inflation, investment returns, mortality, turnover, medical costs and discount rates. The Company has established a process by which management reviews and selects these assumptions annually. See Note 13, “Employee Benefit Plans,” under Item 8 of this Form 10-K/A for information on these plans and the assumptions used.
Business Combinations
In accordance with the accounting guidance for business combinations, the Company uses the acquisition method of accounting to allocate costs of acquired businesses to the assets acquired and liabilities assumed based on their estimated fair values at the dates of acquisition. The excess costs of acquired businesses over the fair values of the assets
acquired and liabilities assumed were recognized as goodwill. The valuations of the acquired assets and liabilities will impact the determination of future operating results. In addition to using management estimates and negotiated amounts, the Company uses a variety of information sources to determine the estimated fair values of acquired assets and liabilities including: third-party appraisals for the estimated value and lives of identifiable intangible assets and property, plant and equipment; third-party actuaries for the estimated obligations of defined benefit pension plans and similar benefit obligations; and legal counsel or other experts to assess the obligations associated with legal, environmental and other contingent liabilities.
The business and technical judgment of management was used in determining which
intangible assets have indefinite lives and in determining the useful lives of finite-lived intangible assets in accordance with the accounting guidance for goodwill and other intangible assets.
Goodwill and Intangible Assets
The Company tests indefinite-lived intangible assets and goodwill for impairment annually by either performing a qualitative evaluation or a quantitative test. The qualitative evaluation is an assessment of factors to determine whether it is more likely than not that the fair values of a reporting unit or asset is less than its carrying amount. Fair values under the quantitative test are estimated using discounted cash flow methodologies that are based on projections of the amounts and timing of future revenues and cash flows. For more information on these matters, see Note 1,
“Summary of Significant Accounting Policies,” under Item 8 of this Form 10-K/A.
We believe that the amounts recorded in the financial statements under Item 8 of this Form 10-K/A related to these contingencies, pensions, other postretirement benefits, business combinations, goodwill and other identifiable intangible
2017 PPG ANNUAL REPORT AND FORM 10-K/A 39
assets with indefinite lives are based on the best estimates and judgments of the appropriate PPG management, although actual outcomes could differ from our estimates.
Currency
Comparing exchange rates from December
31, 2016 to December 31, 2017, the U.S. dollar weakened against the currencies in most countries in which PPG operates, most notably the Mexican peso, British pound, Chinese yuan and euro. As a result, consolidated net assets at December 31, 2017 increased by approximately $231 million from December 31, 2016.
Comparing exchange rates from December 31, 2015 to December 31, 2016, the U.S. dollar strengthened against the currencies in most countries in which PPG operates, most notably the Mexican peso, British pound, Chinese yuan and euro. As a result, consolidated net assets at December 31, 2016 decreased by approximately $465
million from December 31, 2015.
Comparing exchange rates during 2017 to those of 2016, in the countries in which PPG operates, the U.S. dollar was stronger overall, which had an unfavorable impact of approximately $7 million on full year 2017 income before income taxes from the translation of this foreign income into U.S. dollars.
Comparing exchange rates during 2016 to those of 2015, in the countries in which PPG operates, the U.S. dollar was stronger overall, which had an unfavorable impact of approximately $70 million on full year 2016 income before income taxes from the translation of this foreign income into U.S. dollars.
Forward-Looking Statements
The Private Securities
Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by or on behalf of the Company. Management’s Discussion and Analysis and other sections of this Annual Report contain forward-looking statements that reflect the Company’s current views with respect to future events and financial performance.
You can identify forward-looking statements by the fact that they do not relate strictly to current or historic facts. Forward-looking statements are identified by the use of the words “aim,”“believe,”“expect,”“anticipate,”“intend,”“estimate,”“project,”“outlook,”“forecast” and other expressions that indicate future events and trends. Any forward-looking statement speaks
only as of the date on which such statement is made, and the Company undertakes no obligation to update any forward looking statement, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our reports to the Securities and Exchange Commission. Also, note the following cautionary statements.
Many factors could cause actual results to differ materially from the Company’s forward-looking statements. Such factors include the impacts of the natural disasters in Mexico, Puerto Rico and the U.S., and their length and severity, any currently unanticipated future impacts from the natural disasters, global economic conditions, increasing price and product competition
by foreign and domestic competitors, fluctuations in cost and availability of raw materials, the ability to increase selling price, the ability to recover margins, our ability to maintain favorable supplier relationships and arrangements, the timing of and the realization of anticipated cost savings from restructuring initiatives, difficulties in integrating acquired businesses and achieving expected synergies therefrom, economic and political conditions in the markets we serve, the ability to penetrate existing, developing and emerging foreign and domestic markets, foreign exchange rates and fluctuations in such rates, fluctuations in tax rates, the impact of future legislation, the impact of environmental regulations, unexpected business disruptions, our ability to successfully remediate the material weakness in our internal control over financial reporting disclosed in this report within the time periods and in the manner currently anticipated, the effectiveness of
our internal control over financial reporting, including the identification of additional control deficiencies, further expenditures related to our restatement, the results of governmental actions relating to pending investigations, the results of shareholder actions relating to the restatement of our financial statements and the unpredictability of existing and possible future litigation. However, it is not possible to predict or identify all such factors.
Consequently, while the list of factors presented here and under Item 1A is considered representative, no such list should be considered to be a complete statement of all potential risks and uncertainties. Unlisted factors may present significant additional obstacles to the realization of forward-looking statements.
Consequences of material differences in the results compared with those anticipated in the forward-looking statements
could include, among other things, lower sales or income, business disruption, operational problems, financial loss, legal liability to third parties, other factors set forth in Item 1A of this Form 10-K/A and similar risks, any of which could have a material adverse effect on the Company’s consolidated financial condition, results of operations or liquidity.
40 2017 PPG ANNUAL REPORT AND 10-K/A
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
PPG is exposed to market risks related to changes in foreign currency exchange rates, interest rates, and was exposed to changes in PPG’s stock
price. The Company may enter into derivative financial instrument transactions in order to manage or reduce these market risks. A detailed description of these exposures and the Company’s risk management policies are provided in Note 10, “Financial Instruments, Hedging Activities and Fair Value Measurements,” under Item 8 of this Form 10-K/A.
The following disclosures summarize PPG’s exposure to market risks and information regarding the use of and fair value of derivatives employed to manage its exposure to such risks. Quantitative sensitivity analyses have been provided to reflect how reasonably possible, unfavorable changes in market rates can impact PPG’s consolidated results of operations, cash flows and financial position.
Foreign
Currency Risk
We conduct operations in many countries around the world. Our results of operations are subject to both currency transaction and currency translation risk. Foreign currency forward contracts outstanding during 2017 and 2016 were generally designated as a hedge of PPG’s exposure to foreign currency transaction risk. As of December 31, 2017 and 2016, the fair value of these contracts was a net liability of $19 million and a net asset of $16 million, respectively.
The potential reduction in PPG’s income from continuing operations resulting from the impact of adverse changes in exchange rates on the fair value of its outstanding foreign currency hedge contracts of 10% for European and Canadian currencies and 20% for Asian and Latin American currencies for the years ended December 31, 2017 and 2016 would have been $255 million and $105 million, respectively.
As of December 31, 2017 and 2016, PPG had U.S. dollar to Euro cross
currency swap contracts with a total notional amount of $560 million outstanding. As of December 31, 2017 and 2016, the fair value of these contracts was a net asset of $2 million and $65 million, respectively. A 10% increase in the value of the Euro to the U.S. dollar would have had an unfavorable effect on the fair value of these swap contracts by reducing the value of these instruments by $58 million and by $54 million at December 31, 2017 and 2016,
respectively.
As of December 31, 2017 and 2016, PPG had non-U.S. dollar denominated debt outstanding of $2.8 billion and $3.1 billion, respectively. A weakening of the U.S. dollar by 10% against European currencies and by 20% against Asian and South American currencies would have resulted in unrealized translation losses of $314 million and $344 million as of December 31, 2017 and 2016, respectively.
Interest Rate Risk
The
Company manages its interest rate risk by balancing its exposure to fixed and variable rates while attempting to minimize its interest costs. A 10% increase in interest rates in the U.S., Canada, Mexico and Europe and a 20% increase in interest rates in Asia and South America would have an insignificant effect on PPG’s variable rate debt obligations and interest expense for the years ended December 31, 2017 and 2016, respectively. Further, a 10% reduction in interest rates would have increased the present value of the Company’s fixed rate debt by approximately $61 million and $65 million as of December 31, 2017
and 2016, respectively; however, such changes would not have had an effect on PPG’s annual income from continuing operations or cash flows.
Equity Price Risk
In prior years, PPG entered into equity forward arrangements to hedge the Company’s exposure to changes in the fair value of its future obligation to contribute PPG stock to the Trust (see Note 10, “Financial Instruments, Hedging Activities and Fair Value Measurements” and Note 14, “Commitments and Contingent Liabilities,” under Item 8 of this Form 10-K/A). In June 2016, PPG satisfied its funding obligation to the Trust and the equity forward arrangements were settled. At settlement, the aggregated fair value of the equity forward arrangements
was an asset of $258 million.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 41
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of PPG Industries, Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of PPG Industries, Inc. and its subsidiaries
as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2017, including the related notes and schedule of valuation and qualifying accounts for each of the three years in the period ended December 31, 2017 appearing under item 15(a)(2) (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated
Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company did not maintain, in all material respects, effective internal
control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO because a material weakness in internal control over financial reporting related to ineffective controls within the Company’s financial close process existed as of that date.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weakness referred to above is described in the accompanying Management Report on Responsibility for Preparation of the Financial
Statements and Establishing and Maintaining Adequate Internal Control Over Financial Reporting. We considered this material weakness in determining the nature, timing, and extent of audit tests applied in our audit of the December 31, 2017 consolidated financial statements, and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements.
Restatement of Previously Issued Financial Statements and Management’s Conclusion Regarding Internal Control over Financial Reporting
As discussed in Note 2 to the consolidated financial statements, the
Company has restated its 2017 and 2016 financial statements to correct misstatements.
Management and we previously concluded that the Company maintained effective internal control over financial reporting as of December 31, 2017. However, management has subsequently determined that a material weakness in internal control over financial reporting related to ineffective controls within the Company’s financial close process existed as of that date. Accordingly, management’s report has been restated and our present opinion on internal control over financial reporting, as presented herein, is different from that expressed in our previous report.
Basis
for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in management's report referred to above. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the
Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts
and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial
42 2017 PPG ANNUAL REPORT AND 10-K/A
reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition
and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the
company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
February 15, 2018, except for the effects of the restatement discussed in Note 2 to the consolidated financial statements and the matter described in the fourth paragraph of Management Report on Responsibility for Preparation of the Financial Statements and Establishing and Maintaining Adequate Internal Control Over Financial Reporting, as to which the date is June 28, 2018.
We have served as the Company’s auditor since 2013.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 43
Management Report
Responsibility for Preparation of the Financial Statements and Establishing and Maintaining Adequate Internal Control Over Financial Reporting (As Restated)
We are responsible for the preparation of the consolidated financial statements included in this Annual Report. The consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America and include amounts that are based on the best estimates and judgments
of management.
We are also responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Internal control over financial reporting, no matter how well designed, has inherent limitations. Therefore, internal control over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements on a timely basis. In addition, because of changing conditions, there is risk in projecting any evaluation of internal controls to future periods.
We conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017.
In making this evaluation, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework (2013).
At the time that the Original Filing was made, we concluded that the Company’s internal control over financial reporting was effective as of December 31, 2017. As a result of the investigation described in the Explanatory Note immediately preceding the Table of Contents, we have subsequently concluded that the material weakness described below existed as of December 31, 2017. Therefore, we have concluded that, as of December 31,
2017, the Company’s internal control over financial reporting was ineffective. Accordingly, we have restated our report on internal control over financial reporting.
Material Weakness
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.
We did not maintain effective controls within our financial close process. Specifically, the Company’s former Vice
President and Controller directed his subordinates to improperly override the Company’s internal controls during the Company’s financial close process, which directions were followed and not disclosed to others in senior management, the Audit Committee or the Company’s independent registered public accounting firm and not otherwise detected by the Company’s internal controls. These actions often occurred after the end of a quarter and close to the end of the financial close process for the quarter and had the effect of positively impacting income from continuing operations reported for such quarter. This material weakness resulted in misstatements
in the Company’s interim and annual financial statements that were not prevented or detected on a timely basis and led to the restatement of the Company’s financial statements for the years ended 2016 and 2017 and each of the quarters in the periods ended December 31, 2016, March 31, 2017, June 30, 2017, September 30, 2017, and December 31, 2017.
Until such time as it is remediated, this material weakness could result in material misstatements of the
Company’s financial statements that would not be prevented or detected.
PricewaterhouseCoopers LLP, an independent registered public accounting firm, has issued their report, included on page 42-43 of this Form 10-K/A, regarding the Company’s internal control over financial reporting.
Cash used for investing activities -
discontinued operations
(4
)
(36
)
(46
)
Cash (used for)/from investing activities
($67
)
$436
($395
)
Financing
activities
Net change in borrowings with maturities of three months or less
($7
)
($15
)
($32
)
Net
payments on commercial paper and short-term debt
(93
)
(361
)
(528
)
Net proceeds from the issuance of long-term debt (net of discount and issuance costs)
—
988
1,242
Repayment
of long-term debt
(588
)
(379
)
(340
)
Payments related to tax withholding on stock-based compensation awards
(28
)
(26
)
(58
)
Purchase
of treasury stock
(813
)
(1,050
)
(751
)
Issuance of treasury stock
52
31
53
Dividends
paid on PPG common stock
(434
)
(414
)
(383
)
Other
(43
)
16
(15
)
Cash
used for financing activities
($1,954
)
($1,210
)
($812
)
Effect of currency exchange rate changes on cash and cash equivalents
69
(68
)
(63
)
Net
(decrease) increase in cash and cash equivalents
($384
)
$509
$625
Cash and cash equivalents, beginning of year
$1,820
$1,311
$686
Cash
and cash equivalents, end of year
$1,436
$1,820
$1,311
Supplemental
disclosures of cash flow information:
Interest paid, net of amount capitalized
$100
$118
$115
Taxes
paid, net of refunds
$648
$349
$383
The accompanying notes to the consolidated financial statements are an integral part of this consolidated statement.
48
2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of PPG Industries, Inc. (“PPG” or the “Company”) and all subsidiaries, both U.S. and non-U.S., that it controls. PPG owns more than 50% of the voting stock of most of the subsidiaries
that it controls. For those consolidated subsidiaries in which the Company’s ownership is less than 100%, the outside shareholders’ interests are shown as noncontrolling interests. Investments in companies in which PPG owns 20% to 50% of the voting stock and has the ability to exercise significant influence over operating and financial policies of the investee are accounted for using the equity method of accounting. As a result, PPG’s share of income or losses from such equity affiliates is included in the accompanying consolidated statement of income and PPG’s share of these companies’ shareholders’ equity is included in “Investments” in the accompanying
consolidated balance sheet. Transactions between PPG and its subsidiaries are eliminated in consolidation.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of income and expenses during the reporting period. Such estimates also include the fair value of assets acquired and liabilities assumed resulting from the allocation of the purchase price related to business combinations consummated. Actual outcomes could differ from those estimates.
Revenue
Recognition
The Company recognizes revenue when the earnings process is complete. Revenue is recognized by all operating segments when goods are shipped and title to inventory and risk of loss passes to the customer or when services have been rendered.
Shipping and Handling Costs
Amounts billed to customers for shipping and handling are reported in “Net sales” in the accompanying consolidated statement of income. Shipping and handling costs incurred by the Company for the delivery of goods to customers are included in “Cost of sales, exclusive of depreciation and amortization” in the accompanying consolidated statement of income.
Selling,
General and Administrative Costs
Amounts presented as “Selling, general and administrative” in the accompanying consolidated statement of income are comprised of selling, customer service, distribution and advertising costs, as well as the costs of providing corporate-wide functional support in such areas as finance, law, human resources and planning. Distribution costs pertain to the movement and storage of finished goods inventory at company-owned and leased warehouses and other distribution facilities.
Advertising Costs
Advertising costs are expensed as incurred and totaled $313 million, $322 million and $324 million in 2017, 2016
and 2015, respectively.
Research and Development
Research and development costs, which consist primarily of employee related costs, are charged to expense as incurred.
($ in millions)
2017
2016
2015
Research
and development – total
$474
$479
$484
Less depreciation on research facilities
21
20
18
Research
and development, net
$453
$459
$466
Legal Costs
Legal costs, primarily include costs associated with acquisition and divestiture
transactions, general litigation, environmental regulation compliance, patent and trademark protection and other general corporate purposes, are charged to expense as incurred.
Foreign Currency Translation
The functional currency of most significant non-U.S. operations is their local currency. Assets and liabilities of those operations are translated into U.S. dollars using year-end exchange rates; income and expenses are translated using the average exchange rates for the reporting period. Unrealized foreign currency translation gains and losses are deferred in accumulated other comprehensive loss, a separate component of shareholders’ equity.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 49
Notes to the Consolidated Financial
Statements
Cash Equivalents
Cash equivalents are highly liquid investments (valued at cost, which approximates fair value) acquired with an original maturity of three months or less.
Short-term Investments
Short-term investments are highly liquid, high credit quality investments (valued at cost plus accrued interest) that have stated maturities of greater than three months to one year. The purchases and sales of these investments are classified as investing activities in the consolidated statement of cash flows.
Marketable Equity Securities
The Company’s investment in marketable equity securities is recorded
at fair market value and reported in “Other current assets” and “Investments” in the accompanying consolidated balance sheet with changes in fair market value recorded in income for those securities designated as trading securities and in other comprehensive income, net of tax, for those securities designated as available for sale.
Inventories
Inventories are stated at the lower of cost or net realizable value. Most U.S. inventories are stated at cost, using the last-in, first-out (“LIFO”) method of accounting, which does not exceed net realizable value. All other inventories are stated at cost, using the first-in, first-out (“FIFO”) method of accounting, which does not exceed net realizable value. PPG determines cost using either average or standard factory costs, which approximate actual costs, excluding certain fixed costs such as depreciation and property
taxes. See Note 4, “Working Capital Detail” for further information concerning the Company’s inventory.
Derivative Financial Instruments
The Company recognizes all derivative financial instruments (a “derivative”) as either assets or liabilities at fair value on the consolidated balance sheet. The accounting for changes in the fair value of a derivative depends on the use of the instrument.
For a derivative that is considered “effective” as a hedge of an exposure to variability in expected future cash flows (cash flow hedge), the effective portion of the gain or loss on the derivative is recorded in other comprehensive income (“OCI”) and the ineffective
portion, if any, is reported in income from continuing operations. Amounts accumulated in OCI are reclassified into income from continuing operations in the same period or periods during which the hedged transactions are recorded in income from continuing operations.
For a derivative that is considered “effective” as a hedge of an exposure to changes in the fair value (fair value hedge) of an asset, a liability or a firm commitment, the change in the derivative’s fair value is reported in income from continuing operations, offsetting the gain or loss recognized for the change in fair value of the asset, liability, or firm commitment that is being hedged.
For a derivative, debt or other financial instrument that is considered “effective” as a hedge of a net investment in a foreign operation, the gain or loss associated with the financial instrument is reported as a translation
gain or loss in accumulated other comprehensive income (“AOCI”). Gains and losses in AOCI related to hedges of the Company’s net investments in foreign operations are reclassified out of AOCI and recognized in income from continuing operations upon a substantial liquidation, sale or partial sale of such investments or upon impairment of all or a portion of such investments. The cash flow impact of these instruments have been and will be classified as investing activities in the consolidated statement of cash flows.
Changes in the fair value of derivative instruments not designated as hedges for hedge accounting purposes are recognized in income from continuing operations in the period of change.
Property, Plant and Equipment
Property, plant and equipment
is recorded at cost. Depreciation is computed on a straight-line method based on the estimated useful lives of related assets. Additional depreciation expense is recorded when facilities or equipment are subject to abnormal economic conditions or obsolescence.
The cost of significant improvements that add to productive capacity or extend the lives of properties are capitalized. Costs for repairs and maintenance are charged to expense as incurred. When a capitalized asset is retired or otherwise disposed of, the original cost and related accumulated depreciation balance are removed from the accounts and any related gain or loss is recorded in income from continuing operations. The amortization cost of capitalized leased assets is recorded in depreciation expense. Property and other long-lived assets are reviewed for impairment whenever events or circumstances indicate that their carrying amounts may not be recoverable. See Note
5, “Property, Plant and Equipment” for further details.
50 2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
Goodwill and Identifiable Intangible Assets
Goodwill represents the excess of the cost over the fair value of acquired identifiable tangible and intangible assets less liabilities assumed from acquired businesses. Identifiable intangible assets acquired in business combinations are recorded based upon their fair value at the date of acquisition.
The Company tests goodwill of each reporting unit for impairment at least annually in connection
with PPG’s strategic planning process. The Company tests goodwill for impairment by either performing a qualitative evaluation or a quantitative test. The qualitative evaluation is an assessment of factors, including reporting unit specific operating results as well as industry, market and general economic conditions, to determine whether it is more likely than not that the fair values of a reporting unit is less than its carrying amount, including goodwill. The Company may elect to bypass this qualitative assessment for some or all of its reporting units and perform a quantitative test. The quantitative goodwill impairment test is performed during the fourth quarter by comparing the estimated fair value of the associated reporting unit as of September 30 to its carrying value. The
Company’s reporting units are its operating segments. (See Note 20, “Reportable Business Segment Information,” for further information concerning the Company’s operating segments.) Fair value is estimated using discounted cash flow methodologies.
The Company has determined that certain acquired trademarks have indefinite useful lives. The Company tests the carrying value of these trademarks for impairment at least annually, or as needed whenever events and circumstances indicate that their carrying amount may not be recoverable. The annual assessment takes place in the fourth quarter of each year either by completing a qualitative assessment or quantitatively by comparing
the estimated fair value of each trademark as of September 30 to its carrying value. Fair value is estimated by using the relief from royalty method (a discounted cash flow methodology). The qualitative assessment includes consideration of factors, including revenue relative to the asset being assessed, the operating results of the related business as well as industry, market and general economic conditions, to determine whether it is more likely than not that the fair value of the asset is less than its carrying amount.
Identifiable intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives (1 to 30 years) and are reviewed for impairment whenever events or circumstances indicate that their carrying amount may not be recoverable.
Receivables
and Allowances
All trade receivables are reported on the balance sheet at the outstanding principal adjusted for any allowance for credit losses and any charge offs. The Company provides an allowance for doubtful accounts to reduce receivables to their estimated net realizable value when it is probable that a loss will be incurred. Those estimates are based on historical collection experience, current economic and market conditions, a review of the aging of accounts receivable and the assessments of current creditworthiness of customers.
Product Warranties
The Company accrues for product warranties at the time the associated products are sold based
on historical claims experience. The reserve, pre-tax charges against income and cash outlays for product warranties were not significant to the consolidated financial statements of the Company for any year presented.
Asset Retirement Obligations
An asset retirement obligation represents a legal obligation associated with the retirement of a tangible long-lived asset that is incurred upon the acquisition, construction, development or normal operation of that long-lived asset. PPG recognizes asset retirement obligations in the period in which they are incurred, if a reasonable estimate of fair value can be made. The asset retirement obligation is subsequently adjusted for changes in fair value. The associated estimated asset retirement costs are capitalized as part of the carrying amount of the long-lived
asset and depreciated over its useful life. PPG’s asset retirement obligations are primarily associated with the retirement or closure of certain assets used in PPG’s manufacturing process. The accrued asset retirement obligation recorded on PPG’s balance sheet was $19 million and $18 million as of December 31, 2017 and 2016, respectively.
PPG’s only conditional asset retirement obligation relates to the possible future abatement of asbestos contained in certain PPG production facilities. The asbestos in PPG’s production facilities arises from the application of normal and customary building practices in the past when the facilities were constructed.
This asbestos is encapsulated in place and, as a result, there is no current legal requirement to abate it. Inasmuch as there is no requirement to abate, the Company does not have any current plans or an intention to abate and therefore the timing, method and cost of future abatement, if any, are not known. The Company has not recorded an asset retirement obligation associated with asbestos abatement, given the uncertainty concerning the timing of future abatement, if any.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 51
Notes to the Consolidated Financial Statements
Reclassifications
Certain
reclassifications of prior years’ data have been made to conform to the current year presentation. These reclassifications had no impact on our previously reported net income, cash flows or shareholders’ equity.
Accounting Standards Adopted in 2017
PPG’s adoption of the following accounting standard updates (“ASU”) in 2017 did not have a material impact on PPG's consolidated financial position, results of operations or cash flows:
Accounting Standard Update
2017-04
Simplifying
the Test for Goodwill Impairment
2016-18
Restricted Cash
2016-09
Improvements to Employee Share-Based Payment Accounting
Accounting Standards to be Adopted in Future Years
In February 2018, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2018-2, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” This ASU allows a reclassification from Accumulated other comprehensive income to Retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The amendments in this ASU are effective for fiscal years
beginning after December 15, 2018 and for interim periods therein. Early adoption of this ASU is permitted. PPG does not believe this ASU will have a material impact on its consolidated financial position, results of operations or cash flows.
In August 2017, the FASB issued ASU No. 2017-12, "Derivatives and Hedging - Targeted Improvements to Accounting for Hedging Activities." This ASU modifies the presentation and disclosure of hedging results. Further, it provides partial relief on the timing of certain aspects of hedge documentation and eliminates the requirement to recognize hedge ineffectiveness separately in income. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018 and for interim periods therein. Early adoption of this ASU is permitted. PPG does not believe this ASU will
have a material impact on its consolidated financial position, results of operations or cash flows.
In May 2017, the FASB issued ASU No. 2017-09, "Stock Compensation - Scope of Modification Accounting." This ASU requires all equity award modifications to be accounted for as a modification unless the fair value, vesting conditions and classification of the award as equity or liability are the same as the classification of the original award immediately before the original award is modified. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017 and for interim periods therein. PPG does not believe this ASU will have a material impact on its consolidated financial position, results of operations or cash flows.
In March 2017, the FASB issued ASU No. 2017-07, "Improving the Presentation
of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost." This ASU requires the service cost component of net benefit costs to be disaggregated from all other components and be reported in the same line item or items as other compensation costs. The other components of net benefit cost are required to be presented in the income statement separately from the service cost. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017 and for interim periods therein. PPG does not believe this ASU will have a material impact on its consolidated financial position, results of operation or cash flows. Beginning January 1, 2018, in connection with the adoption of this new ASU, PPG will change the method by which pension costs are allocated to its strategic business units. Namely, only service costs will be attributed to the
strategic business units and all other components will remain in unallocated corporate overhead. PPG will recast its statement of operations and segment income for this change in allocation.
In August 2016, the FASB issued ASU No. 2016-15, "Classification of Certain Cash Receipts and Cash Payments." This ASU addresses eight specific cash flow issues with the objective of eliminating the existing diversity in practice. The amendments in this ASU are effective for public business entities for fiscal years beginning after December 15, 2017 and for interim periods therein. PPG does not believe this ASU will have a material impact on its consolidated financial position, results of operations or cash flows.
In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses.” This ASU requires an organization
to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. The amendments in this ASU are effective for fiscal years beginning after December 15, 2019 and for interim periods therein. Entities may chose to adopt the new ASU as of its fiscal year beginning after December 15, 2018. PPG does not believe this ASU will have a material impact on its consolidated financial position, results of operations or cash flows.
52 2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the
Consolidated Financial Statements
In February 2016, the FASB issued ASU No. 2016-02, “Leases.” This ASU requires all lessees to recognize on the balance sheet right to use assets and lease liabilities for the rights and obligations created by lease arrangements with terms greater than 12 months. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018 and for interim periods therein. PPG is in the process of assessing the impact the adoption of this ASU will have on its consolidated financial position, results of operations and cash flows. At a minimum, total assets and total liabilities will increase in the period the ASU is adopted. Early adoption of this ASU is permitted. At December 31, 2017, PPG’s undiscounted future minimum payments outstanding for lease obligations
were approximately $840 million.
In January 2016, the FASB issued ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Liabilities.” This ASU simplifies the accounting and disclosures related to equity investments. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017 and for interim periods therein. Adoption of this ASU will not have a material impact on PPG’s consolidated financial position, results of operations or cash flows.
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers: Topic 606.” This ASU replaces nearly all existing U.S. GAAP guidance on revenue recognition. The standard prescribes
a five-step model for recognizing revenue, the application of which will require significant judgment. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017, and for interim periods therein. The provisions of this ASU may be applied retroactively or on a modified retrospective (cumulative effect) basis. PPG will adopt the standard using the modified retrospective approach in January 2018. PPG believes the preponderance of the Company’s contracts with customers are standard ship and bill arrangements where revenue is recognized at the time of shipment. Under the provisions of this ASU, PPG believes certain costs currently reported in Selling, general and administrative costs will be reclassified to Cost of sales,
exclusive of depreciation and amortization on the Consolidated Statement of Income, as they represent costs incurred in satisfaction of performance obligations. In addition, PPG expects the cost of certain customer incentives to be recorded as a reduction of Net sales rather than Cost of sales, exclusive of depreciation and amortization or Selling, general and administrative costs. Adoption of this ASU will not have a significant impact on PPG’s consolidated financial position, results of operations and cash flows.
2. Restatement of Previously Reported Consolidated Annual Financial Statements
Background
On April 16, 2018, PPG received a report through the
Company’s internal reporting system alleging violations of the Company’s accounting policies and procedures regarding the failure to accrue certain specified expenses in the first quarter of 2018. Based on the Company’s initial review at that time, the Company identified approximately $1.4 million of expenses (including legal fees, property taxes and performance-based compensation) that should have been accrued in the first quarter of 2018 and that were then reflected in PPG’s earnings for the quarter ended March 31, 2018, released on April 19, 2018. In addition, the report
alleged that there may have been other unspecified expenses, potentially up to $5 million in the aggregate, that were improperly not accrued in the first quarter.
The Audit Committee oversaw an investigation of the matters set forth in the internal report, with the assistance of outside counsel and forensic accountants. The investigation identified the following items with respect to the quarter ended March 31, 2018, in addition to the approximately $1.4 million of expenses described above: (1) failure to record amortization expense in the amount of $1.4 million to correct for amortization of an intangible asset that was inadvertently not recorded over a three-year period and discovered in March 2018; (2) understatement of a health insurance
accrued liability in the amount of $0.5 million; and (3) failure to record an adjustment increasing the value of inventory in PPG’s Europe, Middle East and Africa region in the amount of $2.2 million due to inflation of raw materials costs which, when corrected, had a positive effect on income in the first quarter of 2018. These three items resulted in a net increase to income from continuing operations before income taxes of approximately $0.3 million.
The investigation also identified certain inadvertent errors with respect to the quarter ended March 31, 2018. Correction of such inadvertent errors, together with the matters discussed in the immediately preceding paragraph, resulted in a net decrease in income from continuing operations
before income taxes of $5.7 million for the quarter ended March 31, 2018. The correction of these inadvertent errors also resulted in a net decrease in income from continuing operations before income taxes of $2.3 million for the year ended December 31, 2017.
The investigation identified the following items with respect to the year ended December 31, 2017: (1) improper reclassifications of gains from income from discontinued operations to income from continuing operations, in total pre-tax amounts of $2.5 million in the quarter ended June 30, 2017 and $4.7 million
in the quarter ended December 31, 2017; (2) improper shifting of pre-tax expenses between quarterly periods in 2017, including a total of $3.5 million in compensation expense recorded in the third and fourth quarters of 2017 that should have been recorded in the quarter ended June 30, 2017; an additional expense accrual for health care claims in the amount of $3.5 million recorded in the third quarter of 2017 that should have been recorded in the quarter ended June 30, 2017; additional expense for paid vacation in the amount of $2.2 million recorded in the quarter ended December 31, 2017 that should have been recorded in the second and
third
2017 PPG ANNUAL REPORT AND FORM 10-K/A 53
Notes to the Consolidated Financial Statements
quarters of 2017; and additional pension expense in the amount of $1.0 million recorded in the fourth quarter of 2017 that should have been recorded in the quarter ended September 30. 2017.
On May 10, 2018, management, in consultation with the Audit Committee and the Company’s independent registered public accounting firm, PwC, concluded that the Company’s
consolidated financial statements for the year ended December 31, 2017 included in the Original Filing and the related report of PwC, and for the quarterly and year-to-date periods in 2017, should no longer be relied upon because of certain misstatements contained in those financial statements.
The investigation identified the following items with respect to the year ended December 31, 2016: (1) improper classification in the consolidated statement of income of the release of a reserve related to the Company’s 2015 business restructuring program in the amount of $3.4 million and (2) an improper reduction in the payout assumption for certain performance-based restricted stock units that had the impact
of recognizing a $6.8 million reduction in stock-based compensation expense in the fourth quarter of 2016. In the first quarter of 2017, the payout assumption for these same performance-based restricted stock units was increased, resulting in $6.8 million of stock-based compensation expense in the first quarter of 2017 that would not have been recorded if the payout assumption had not been reduced in the fourth quarter of 2016.
On June 27, 2018, management, in consultation with the Audit Committee and PwC, concluded that the Company’s consolidated financial statements for the year ended December 31, 2016 included in the Original Filing and the related report
of PwC, and for the final quarterly and year-to-date period in 2016, should no longer be relied upon because of certain misstatements contained in those financial statements.
On June 27, 2018, the Audit Committee determined that its investigation was complete, and authorized the filing of our restated audited consolidated financial statements for the years ended December 31, 2017 and 2016 and certain quarterly periods within those fiscal years in order to correct our previously issued financial statements.
Impact of the Restatement
Annual
As a result of the restatement, reported net income from continuing operations was decreased by $2
million, or $0.01 per diluted share, and income from discontinued operations, net of tax, was increased by $5 million, or $0.02 per diluted share, for the year ended December 31, 2017. Reported net income from continuing operations decreased by $4 million, or $0.01 per diluted share, and there was no impact to income from discontinued operations, net of tax, for the year ended December 31, 2016.
The categories of misstatements and their impact on previously reported consolidated financial statements for the 2017 and 2016 annual periods are described below:
(a)
Customer
Rebates
The Company did not properly recognize expense associated with certain customer rebates, resulting in a misstatement of Net sales in 2017. The misstatement overstated previously reported Income before taxes by $1.8 million for the year ended December 31, 2017.
(b)
Classification of Continuing Operations and Discontinued Operations
Certain items of income related to PPG’s former Glass segment were inappropriately recorded in continuing operations rather
than in discontinued operations. The misstatements overstated previously reported Income before income taxes from continuing operations by $7.2 million for the year ended December 31, 2017. The misstatement understated previously recorded Income from discontinued operations, net of tax, by $4.5 million for the year ended December 31, 2017.
(c)
Stock-Based Compensation
In the fourth quarter of 2016, the Company improperly reduced
the payout assumption for the 2015 grant of performance-based restricted stock units from 150% to 100%, which had the effect of reducing stock-based compensation expense in that period by $6.8 million. In the first quarter of 2017, the Company increased the payout assumption for these same restricted stock units from 100% back to 150%. These improper changes to the payout assumption for these restricted stock units resulted in a misstatement of stock-based compensation expense in both 2016 and 2017. (See Note 18, “Stock-Based Compensation (As Restated),” for further information concerning the
Company’s accounting for Restricted Stock Units.) The misstatements overstated previously reported Income before income taxes by $6.8 million for the year ended December 31, 2016 and understated previously reported Income before income taxes by $6.8 million for the year ended December 31, 2017.
54 2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
(d)
Environmental
Reserve
In 2017, the Company failed to appropriately update the discount rate used to calculate a long-term environmental remediation reserve, which had the effect of understating Other expense by $0.5 million. The misstatement overstated previously reported Income before taxes by $0.5 million for the year ended December 31, 2017.
(e)
Classification of Business Restructuring Expense
The
Company misclassified the release of the unused portion of the reserve related to the 2015 business restructuring program in 2016 of $3.4 million. The income associated with the release of the reserve was classified as Other income rather than as a reduction to Business restructuring in the Consolidated Statement of Income. The misclassification had no impact on Income before taxes.
(f)
Income Taxes
Adjustments related to the income tax effects of other restatement adjustments noted above.
The financial statements included in this Form 10-K/A have been restated to reflect the adjustments described above. The
tables below summarize the effects of the restatement on PPG’s Consolidated Statements of Income for the years ended December 31, 2017 and 2016, Consolidated Statements of Comprehensive Income for the years ended December 31, 2017 and 2016, and Consolidated Balance Sheets at December 31, 2017 and 2016.
In addition to the restatement of the financial statements, certain information within the following notes to the financial statements and financial statement schedule has been restated to reflect the corrections of misstatements discussed above as well as to add disclosure language as appropriate:
Note
3. Acquisitions and Divestitures
Note 4. Working Capital Detail
Note 8. Business Restructuring
Note 11. Earnings Per Common Share
Note 12. Income Taxes
Note 17. Other Income
Note 18. Stock-Based Compensation
Note 20. Reportable Business Segment Information
Additionally, see Note 19 “Quarterly Financial Information (unaudited) (As Restated)” for the Condensed Consolidated financial statements and notes to the condensed consolidated financial statements (unaudited) as well as tables that summarize the effects of the restatement on the Condensed Consolidated Statements of Income, Condensed Consolidated Statements of
Comprehensive Income and Condensed Consolidated Balance Sheets for the appropriate quarterly periods within 2017 and 2016.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 55
Notes to the Consolidated Financial Statements
Summary of Restatement - Consolidated Statement of Income
Summary
of Restatement - Consolidated Statement of Cash Flows
There was no net impact of the 2017 and 2016 restatement adjustments on net cash provided by operating activities, net cash provided by investing activities or net cash used in financing activities in the Consolidated Statement of Cash Flows. The adjustments only had an impact on certain captions within cash from operating activities.
58 2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
3. Acquisitions and Divestitures (As Restated)
Acquisitions
The Crown
Group
On October 2, 2017, PPG acquired The Crown Group (“Crown”), a U.S.-based coatings application services business, which is reported as part of PPG's Industrial Coatings reportable segment. Crown is one of the leading component and product finishers in North America. Crown applies coatings to customers’ manufactured parts and assembled products at 11 U.S. sites. Most of Crown’s facilities, which also provide assembly, warehousing and sequencing services, are located at customer facilities or positioned near customer manufacturing sites. The company serves manufacturers in the automotive, agriculture, construction, heavy truck and alternative energy industries. Crown has annual sales of approximately $125 million.
Taiwan
Chlorine Industries
Taiwan Chlorine Industries (“TCI”) was established in 1986 as a joint venture between PPG and China Petrochemical Development Corporation (“CPDC”) to produce chlorine-based products in Taiwan, at which time PPG owned 60 percent of the venture. In conjunction with the 2013 separation of its commodity chemicals business, PPG conveyed to Axiall Corporation ("Axiall") its 60% ownership interest in TCI. Under PPG’s agreement with CPDC, if certain post-closing conditions were not met following the three year anniversary of the separation, CPDC had the option to sell its 40% ownership interest in TCI to Axiall for $100 million. In turn, Axiall had a right to designate PPG as its designee to purchase the 40% ownership interest of CPDC. In April 2016, Axiall announced that CPDC had decided to sell its
ownership interest in TCI to Axiall. In June 2016, Axiall formally designated PPG to purchase the 40% ownership interest in TCI. In August 2016, Westlake Chemical Corporation acquired Axiall, which became a wholly-owned subsidiary of Westlake. On April 11, 2017, PPG finalized its purchase of CPDC’s 40% ownership interest in TCI. The difference between the acquisition date fair value and the purchase price of PPG’s 40% ownership interest in TCI has been recorded as a loss in discontinued operations during the year-ended December 31, 2017.
MetoKote Corporation
In July 2016, PPG completed the acquisition of MetoKote Corporation ("MetoKote"), a U.S.-based coatings application services business. MetoKote applies coatings to customers'
manufactured parts and assembled products. It operates on-site coatings services within several customer manufacturing locations, as well as at regional service centers, located throughout the U.S., Canada, Mexico, the United Kingdom, Germany, Hungary and the Czech Republic. Customers ship parts to MetoKote service centers where they are treated to enhance paint adhesion and painted with electrocoat, powder or liquid coatings technologies. Coated parts are then shipped to the customer’s next stage of assembly. MetoKote coats an average of more than 1.5 million parts per day.
The following table summarizes the estimated fair value of assets acquired and liabilities assumed as reflected in the final purchase price allocation for MetoKote.
($
in millions)
Current assets
$38
Property, plant, and equipment
73
Identifiable intangible assets with finite lives
86
Goodwill
166
Deferred
income taxes (a)
(12
)
Total assets
$351
Current liabilities
(23
)
Other long-term liabilities
(22
)
Total
liabilities
($45
)
Total purchase price, net of cash acquired
$306
(a)
The net deferred income tax liability is included in assets due to the Company's tax jurisdictional netting.
The
pro-forma impact on PPG's sales and results of operations, including the pro forma effect of events that are directly attributable to the acquisition, was not significant. While calculating this impact, no cost savings or operating synergies that may result from the acquisition were included. Since the acquisition, the results of this acquired business comprise the coatings services operating segment, included within the Industrial Coatings reportable segment.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 59
Notes to the Consolidated Financial Statements
Other Acquisitions
In 2017, 2016, and 2015,
the Company completed several smaller business acquisitions. The total consideration paid for these acquisitions, net of cash acquired, debt assumed and other post closing adjustments, was $74 million, $43 million and $371 million, respectively.
In January 2018, PPG acquired ProCoatings, a leading architectural paint and coatings wholesaler located in The Netherlands. ProCoatings, established in 2001, distributes a large portfolio of well-known professional paint brands through its network of 23 multi-brand stores. The company employs nearly 100
people.
Divestitures
Glass Segment (As Restated)
In 2017, PPG completed a multi-year strategic shift in the Company's business portfolio, resulting in the exit of all glass operations which consisted of the global fiber glass business, PPG's ownership interest in two Asian fiber glass joint ventures and the flat glass business. Accordingly, the results of operations, including the gains on the divestitures, and cash flows have been recast as discontinued operations for all periods presented. PPG now has two reportable business segments.
The net sales and income from discontinued operations related to the former Glass segment for the three years ended December
31, 2017, 2016, and 2015 were as follows:
($ in millions)
2017
2016
2015
As
Restated
Net sales
$217
$908
$1,089
Income
from operations
$30
$111
$137
Net gains on the divestitures of businesses
343
421
—
Income
tax expense
140
202
42
Income from discontinued operations, net of tax
$233
$330
$95
North
American Fiber Glass Business
On September 1, 2017, PPG completed the sale of its North American fiber glass business to Nippon Electric Glass Co. Ltd. (“NEG”). Cash proceeds from the sale were $541 million, resulting in a pre-tax gain of $343 million, net of certain accruals and contingencies established in conjunction with the divestiture.
PPG’s fiber glass operations included manufacturing facilities in Chester, South Carolina, and Lexington and Shelby, North Carolina; and administrative and research-and-development operations in Shelby and in Harmar, Pennsylvania, near Pittsburgh. The business, which employed more than 1,000 people and had net sales of approximately $350
million in 2016, supplies the transportation, energy, infrastructure and consumer markets.
The Company's December 31, 2016 consolidated balance sheet has been recast to present the assets and liabilities of the North American fiber glass business as held for sale. The major classes of assets and liabilities of the Glass segment included in the PPG consolidated balance sheet at December 31, 2016 were as follows:
The net deferred income tax liability is included in assets held for sale due to the Company's tax jurisdictional netting.
60
2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
Flat Glass Business
In October 2016, PPG completed the sale of its flat glass manufacturing and glass coatings operations to Vitro S.A.B. de C.V. PPG received approximately $740 million in cash proceeds and recorded a pre-tax gain of $421 million on the sale. Under the terms of the agreement, PPG divested its entire flat glass manufacturing and glass coatings operations, including production sites located in Fresno, California; Salem, Oregon; Carlisle, Pennsylvania; and Wichita Falls, Texas; four distribution/fabrication facilities located across Canada; and a research-and-development center located in Harmar, Pennsylvania.
PPG’s flat glass business included approximately 1,200 employees. The business manufactures glass that is fabricated into products used primarily in commercial and residential construction.
European Fiber Glass Business
In October 2016, PPG completed the sale of its European fiber glass business to glass manufacturer NEG. PPG recorded a pre-tax loss of $42 million, consisting predominately of a $46 million pension settlement charge. The European fiber glass business manufactures reinforcement materials for thermoset and thermoplastic composite applications for the transportation, energy, infrastructure and consumer markets. Manufacturing facilities in Hoogezand, Netherlands, and Wigan, England, and a research and development facility in Hoogezand
were included in the transaction.
PFG Fiber Glass Joint Ventures
In November 2016, PPG sold its 50% ownership interests in its two PFG fiber glass joint ventures to its joint venture partner Nan Ya Plastics Corporation (“Nan Ya”). Nan Ya is affiliated with Taiwan-based Formosa Plastics Group. The PFG fiber glass joint ventures supply electronic yarn fibers used in integrated electronic circuit boards and fiber glass reinforcement products for automotive applications. PPG recorded a net pre-tax gain of $36 million on the sale.
Other Divestitures
Plaka Business
In June 2017, PPG completed the sale of the assets
of its Mexico-based Plaka plasterboard and cement-board business to Knauf International GmbH and recorded a $25 million pre-tax gain on the sale. The Company's consolidated balance sheet presents the assets and liabilities of the Plaka business as held for sale as of December 31, 2016.
Pittsburgh Glass Works
In April 2016, PPG sold its minority ownership interest in Pittsburgh Glass Works LLC ("PGW") to LKQ Corporation concurrent with the majority partner’s sale of its ownership interest. PPG recorded a pre-tax gain on the sale of $20 million. PPG accounted for its interest in PGW under the equity method of accounting. PPG’s share of net earnings from
PGW are reported in “Other income” in the Consolidated Statement of Income for all periods presented and have not been reclassified as discontinued operations, as the divestiture of PGW does not represent a strategic shift in PPG’s operations and PGW did not have a major impact on PPG's ongoing results of operations.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 61
Notes to the Consolidated Financial Statements
4. Working Capital Detail (As Restated)
($
in millions)
2017
2016
As Restated
Receivables
Trade
- net(1)
$2,559
$2,288
Equity affiliates
5
2
Other
- net
339
364
Total
$2,903
$2,654
Inventories(2)
Finished
products
$1,083
$947
Work in process
177
165
Raw
materials
437
370
Supplies
33
32
Total
$1,730
$1,514
Accounts
payable and accrued liabilities
Trade
$2,321
$1,907
Accrued
payroll
441
443
Customer rebates
261
235
Other postretirement and pension benefits
78
124
Income
taxes
100
94
Other
580
657
Total
$3,781
$3,460
(1)
Allowance
for Doubtful Accounts was $25 million and $36 million as of December 31, 2017 and 2016, respectively.
(2)
Inventories valued using the LIFO method of inventory valuation comprised 34% and 38% of total gross inventory values as of December 31, 2017 and 2016,
respectively. If the FIFO method of inventory valuation had been used, inventories would have been $103 million and $106 million higher as of December 31, 2017 and 2016, respectively. During the years ended December 31, 2017 and 2016, certain inventories accounted for on the LIFO method of accounting were reduced, which resulted in the liquidation of certain quantities carried at costs prevailing in prior years. The effect on income from continuing operations was zero
and income of $2 million for the years ended December 31, 2017 and 2016, respectively.
5. Property, Plant and Equipment
($ in millions)
Useful
Lives (years)
2017
2016
Land and land improvements
1-30
$487
$451
Buildings
20-40
1,488
1,324
Machinery
and equipment
5-25
3,432
3,076
Other
3-20
958
774
Construction
in progress
229
380
Total(1)
$6,594
$6,005
Less:
accumulated depreciation
3,770
3,397
Net
$2,824
$2,608
(1)
Interest
capitalized in 2017, 2016 and 2015 was $7 million, $8 million and $9 million, respectively.
6. Investments
($ in millions)
2017
2016
Investments
in equity affiliates
$135
$46
Marketable equity securities - Trading (See Note 9)
79
78
Other
54
55
Total
$268
$179
The
Company’s investments in equity affiliates are comprised principally of 50% ownership interests in a number of joint ventures that manufacture and sell coatings. In 2017, PPG purchased a 40% ownership interest in TCI. Refer to Note 3, “Acquisitions and Divestitures” for additional information.
62 2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
PPG’s share of undistributed net earnings of equity affiliates was $12 million and $7 million as of December 31,
2017 and December 31, 2016, respectively. Dividends received from equity affiliates were $8 million, $7 million and $77 million in 2017, 2016 and 2015, respectively.
7. Goodwill and Other Identifiable Intangible Assets
The
Company’s identifiable intangible assets with definite lives are being amortized over their estimated useful lives. Aggregate amortization expense was $129 million, $121 million and $132 million in 2017, 2016 and 2015, respectively.
($ in millions)
2018
2019
2020
2021
2022
Estimated
future amortization expense
$125
$115
$105
$100
$100
8. Business Restructuring (As Restated)
The Company records restructuring liabilities that represent charges incurred in connection with consolidations of certain operations, including operations from acquisitions, as well as headcount reduction programs. These charges consist primarily of severance costs and asset write-downs.
In
December 2016, PPG’s Board of Directors approved a business restructuring program which includes actions necessary to reduce its global cost structure. The program is focused on certain regions and end-use markets where business conditions are the weakest, as well as reductions in production capacity and various global functional and administrative costs.
A pre-tax restructuring charge of $191 million (as restated) was recorded in December 2016, representing $195 million of restructuring actions, net of the reversal of the remaining reserve of $4 million related to the 2015 restructuring program that was completed in 2016. Related to the $195 million of new restructuring actions approved in December 2016, approximately $136
million represents employee severance and other cash costs and $59 million is related to the write-down of certain assets held for sale and other non-cash costs. The restructuring actions will result in the net reduction of approximately 1,700 positions, with substantially all actions to be completed in the first half of 2018.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 63
Notes to the Consolidated Financial Statements
2016
Restructuring and Associated Reserve Activity
PPG
entered into several interest rate swaps which had the effect of converting fixed rate notes to variable rates, based on the three-month London Interbank Offered Rate (LIBOR). There were no interest rate swaps outstanding related to these instruments as of December 31, 2017 and 2016. The impact of the derivatives on debt represents the fair value adjustment of the debt while the interest rate swaps were outstanding, which is being amortized as a reduction to interest expense over the remaining term of the debt. The weighted average effective interest rate for these borrowings, including the effects of the swaps, was 8.4% and 8.4% for the years ended December 31,
2017 and 2016, respectively. Refer to Note 10, “Financial Instruments, Hedging Activities, and Fair Value Measurements” for additional information.
(2)
Weighted average interest rate of 3.7% and 3.8% as of December 31, 2017 and 2016, respectively.
2017 Activities
In
November 2017, PPG’s €500 million 3-year variable rate bank loan matured and the Company repaid this obligation using $587 million cash on hand.
2016 Activities
In December 2016, PPG’s $125 million 6.65% notes, due 2018, were redeemed using $133 million cash on hand. Also, the Company prepaid its $250 million Term Loan Credit Agreements, one with the Bank of Tokyo-Mitsubishi UFJ, Ltd. and the other with BNP Paribas, which PPG entered into during
May 2016. The Bank of Tokyo-Mitsubishi UFJ, Ltd. Term Loan would have originally terminated and all amounts outstanding would have been payable in March 2017. The BNP Paribas Term Loan would have originally terminated and all amounts outstanding would have been payable in May 2017.
In November 2016, PPG completed a public offering of €300 million 0.000% Notes due 2019 and €600 million 0.875% Notes due 2025. These notes were issued pursuant to PPG’s existing shelf registration statement and pursuant to an indenture between the Company and The Bank of New York Mellon Trust Company,
N.A., as trustee, as supplemented. The Indenture governing these notes contains covenants that limit the Company’s ability to, among other things, incur certain liens securing
64 2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
indebtedness, engage in certain sale-leaseback transactions, and enter into certain consolidations, mergers, conveyances, transfers or leases of all or substantially all the Company’s assets. The terms of these notes also require the
Company to make an offer to repurchase Notes upon a Change of Control Triggering Event (as defined in the Indenture) at a price equal to 101% of their principal amount plus accrued and unpaid interest. The Company may issue additional debt from time to time pursuant to the Indenture.
The aggregate cash proceeds from the notes, net of discounts and fees, was $987 million. The notes are denominated in euro and have been designated as hedges of net investments in the Company’s European operations.
For more information, refer to Note 10 “Financial Instruments, Hedging Activities and Fair Value Measurements.”
In January 2016, PPG’s $250 million 1.9% notes matured, and the Company repaid these obligations using cash on hand.
2015 Activities
In December 2015, PPG entered into a five-year credit agreement (the “Credit Agreement”) with several banks and financial institutions. The Credit Agreement replaced the Company's Five Year Credit Agreement dated as of September 12, 2012.
The Credit Agreement provides for a $1.8 billion unsecured revolving credit facility. The Company has the ability to increase the size of the Credit Agreement by up to an additional $500 million, subject to the receipt of lender commitments and other conditions. The Credit Agreement will terminate on December 18, 2020. The Company has the right, subject to certain conditions set forth in the Credit Agreement, to designate certain subsidiaries of the Company as borrowers under the Credit Agreement.
In connection with any such designation, the Company is required to guarantee the obligations of any such subsidiaries under the Credit Agreement. There were no amounts outstanding under the Credit Agreement during the years ended December 31, 2017 and 2016. The available borrowing rate on a one month, U.S. dollar denominated borrowing was 2.56% at December 31, 2017.
Borrowings under the Credit Agreement may be made in U.S. dollars or in euros. The Credit Agreement provides
that loans will bear interest at rates based, at the Company’s option, on one of two specified base rates plus a margin based on certain formulas defined in the Credit Agreement. Additionally, the Credit Agreement contains a Commitment Fee, as defined in the Credit Agreement, on the amount of unused commitments under the Credit Agreement ranging from 0.080% to 0.225% per annum. The average Commitment Fee in 2017 was 0.09%, and PPG is committed to pay 0.09% in 2018.
The Credit Agreement also supports the
Company’s commercial paper borrowings. There were no commercial paper borrowings outstanding as of December 31, 2017 and 2016.
The Credit Agreement contains usual and customary restrictive covenants for facilities of its type, which include, with specified exceptions, limitations on the Company’s ability to create liens or other encumbrances, to enter into sale and leaseback transactions and to enter into consolidations, mergers or transfers of all or substantially all of its assets. The Credit Agreement maintains the same restrictive covenant as the prior credit agreement whereby the Company must maintain a ratio of Total Indebtedness to Total Capitalization,
as defined in the Credit Agreement, of 60% or less. As of December 31, 2017, total indebtedness was 41% of the Company’s total capitalization.
The Credit Agreement also contains customary events of default, including the failure to make timely payments when due under the Credit Agreement or other material indebtedness, the failure to satisfy covenants contained in the Credit Agreement, a change in control of the Company and specified events of bankruptcy and insolvency that would permit the lenders to accelerate the repayment of any loans.
In
June 2015, PPG’s €300 million 3.875% notes matured and the Company repaid these obligations using $336 million of cash on hand.
In March 2015, PPG completed a public offering of €600 million 0.875% notes due 2022 and €600 million 1.400% Notes due 2027, or €1.2 billion ($1.26 billion) in aggregate principal amount. These notes were issued pursuant to PPG’s existing shelf registration statement and pursuant to an indenture
between the Company and The Bank of New York Mellon Trust Company, N.A., as trustee, as supplemented. The Indenture governing these notes contains covenants that limit the Company’s ability to, among other things, incur certain liens securing indebtedness, engage in certain sale-leaseback transactions, and enter into certain consolidations, mergers, conveyances, transfers or leases of all or substantially all the Company’s assets. The terms of these notes also require the Company to make an offer to repurchase notes upon a Change of Control Triggering Event
(as defined in the Indenture) at a price equal to 101% of their principal amount plus accrued and unpaid interest. The Company may issue additional debt from time to time pursuant to the Indenture.
The aggregate cash proceeds from the notes, net of discounts and fees, was $1.24 billion. The notes are denominated in euro and have been designated as hedges of net investments in the Company’s European operations. For more information, refer to Note 10 “Financial Instruments, Hedging Activities and
Fair Value Measurements.”
2017 PPG ANNUAL REPORT AND FORM 10-K/A 65
Notes to the Consolidated Financial Statements
Restrictive Covenants and Cross-Default Provisions
As of December 31, 2017, PPG was in full compliance with the restrictive covenants under its various credit agreements, loan agreements and indentures.
Additionally, the Company’s Credit Agreement contains customary cross-default
provisions. These provisions provide that a default on a debt service payment of $50 million or more for longer than the grace period provided under another agreement may result in an event of default under this agreement. The Company’s 9% non-callable debentures also contain a customary cross default provision triggered by the Company’s default on a debt service payment of $10 million or more. None of the Company’s primary debt obligations are secured or guaranteed by the Company’s affiliates.
Long-term
Debt Maturities
($ in millions)
Maturity per year
2018
$4
2019
659
2020
497
2021
133
2022
718
Thereafter
$2,127
Short-term
Debt Obligations
($ in millions)
2017
2016
Various, weighted average 1.9% and 5.8% as of December 31, 2017 and 2016, respectively.
$8
$99
Lease
Obligations
Rental expense for operating leases was $288 million, $273 million and $260 million in 2017, 2016 and 2015, respectively. The primary leased assets include paint stores, transportation equipment, warehouses and other distribution facilities, and office space, including the Company’s corporate headquarters located in Pittsburgh, Pa.
Minimum lease commitments for operating leases that have initial or remaining lease terms in excess of one year are as follows:
Lines of Credit, Letters of Credit, Surety Bonds and Guarantees
PPG’s non-U.S. operations have uncommitted lines of credit totaling $589 million of which $2 million was used as of December 31, 2017. These uncommitted lines of credit are subject to cancellation at any time and are generally not subject to any commitment fees.
The Company
had outstanding letters of credit and surety bonds of $163 million and $160 million as of December 31, 2017 and 2016, respectively. The letters of credit secure the Company’s performance to third parties under certain self-insurance programs and other commitments made in the ordinary course of business.
As of December 31, 2017 and 2016, guarantees outstanding were $14
million and $12 million, respectively. The guarantees relate primarily to debt of certain entities in which PPG has an ownership interest and selected customers of certain PPG businesses. A portion of such debt is secured by the assets of the related entities. The carrying value of these guarantees were $1 million at December 31, 2017 and 2016 and the fair values of these guarantees were $1 million at December 31, 2017 and 2016. The
fair value of each guarantee was estimated by comparing the net present value of two hypothetical cash flow streams, one based on PPG’s incremental borrowing rate and the other based on the borrower’s incremental borrowing rate, as of the effective date of the guarantee. Both streams were discounted at a risk free rate of return. The Company does not believe any loss related to these letters of credit, surety bonds or guarantees is likely.
66 2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
10. Financial Instruments, Hedging Activities and Fair Value Measurements
Financial
instruments include cash and cash equivalents, short-term investments, cash held in escrow, marketable equity securities, accounts receivable, company-owned life insurance, accounts payable, short-term and long-term debt instruments, and derivatives. The fair values of these financial instruments approximated their carrying values at December 31, 2017 and 2016, in the aggregate, except for long-term debt instruments.
Hedging Activities
The Company has exposure to market risk from changes in foreign currency exchange rates and interest rates and had exposure to PPG’s stock price changes. As a result, financial
instruments, including derivatives, have been used to hedge these underlying economic exposures. Certain of these instruments qualify as cash flow, fair value and net investment hedges upon meeting the requisite criteria, including effectiveness of offsetting hedged or underlying exposures. Changes in the fair value of derivatives that do not qualify for hedge accounting are recognized in income from continuing operations in the period incurred.
PPG’s policies do not permit speculative use of derivative financial instruments. PPG enters into derivative financial instruments with high credit quality counterparties and diversifies its positions among such counterparties in order to reduce its exposure to credit losses. The Company did not realize a credit loss on derivatives during the three-year period ended December 31,
2017.
All of PPG’s outstanding derivative instruments are subject to accelerated settlement in the event of PPG’s failure to meet its debt or payment obligations under the terms of the instruments’ contractual provisions. In addition, should the Company be acquired and its payment obligations under the derivative instruments’ contractual arrangements not be assumed by the acquirer, or should PPG enter into bankruptcy, receivership or reorganization proceedings, the instruments would also be subject to accelerated settlement.
In 2017 and 2016, there were no derivative instruments de-designated or discontinued as a hedging instrument. There were no gains or losses deferred in AOCI that
were reclassified to income from continuing operations during the three-year period ended December 31, 2017 related to hedges of anticipated transactions that were no longer expected to occur.
Fair Value Hedges
In prior years, PPG designated certain foreign currency forward contracts as hedges against the Company’s exposure to future changes in fair value of certain firm sales commitments denominated in foreign currencies.
Prior to June 2016, PPG entered into renewable equity forward arrangements to hedge the impact to PPG's income from continuing operations for changes in
the fair value of 2,777,778 shares of PPG stock that were contributed to the asbestos settlement trust as discussed in Note 14, “Commitments and Contingent Liabilities.” These financial instruments were recorded at fair value as assets or liabilities and changes in the fair value of these financial instruments are reflected in the “Asbestos settlement – net” caption of the accompanying consolidated statement of income. The total principal amount paid for these shares was approximately $60 million. During the terms of these equity forward arrangements, PPG paid to the counterparty interest based on the principal amount and the counterparty paid to PPG an amount equal to the dividends paid on these shares which reduced the transaction price by approximately $10 million, net. The difference between the principal amount and
any amounts related to unpaid interest or dividends and the market price for these shares, adjusted for credit risk, represented the fair value of these financial instruments as well as the amount that PPG received when the counterparty chose to settle these financial instruments. In conjunction with the funding of the asbestos settlement trust, the equity forward arrangements were settled. At settlement, in June 2016, the fair value of the equity forward arrangement was an asset of $258 million.
The Company has used interest rate swaps from time to time to manage it’s exposure to changing interest rates. When outstanding, the interest rate swaps were designated as fair value hedges of certain outstanding debt obligations of the
Company and were recorded at fair value. There were no interest rate swaps outstanding as of December 31, 2017 and 2016. However, in prior years, PPG settled interest rate swaps and received cash. The fair value adjustment of the debt at the time the interest rate swaps were settled is still being amortized as a reduction to interest expense over the remaining term of the related debt, the impact of which is insignificant.
Cash Flow Hedges
PPG designates certain foreign currency forward contracts as cash flow hedges of the
Company’s exposure to variability in exchange rates on intercompany and third party transactions denominated in foreign currencies. As of December 31, 2017 and 2016, the fair value of all foreign currency forward contracts designated as cash flow hedges was a net asset of $3 million and $13 million, respectively.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 67
Notes to the Consolidated Financial Statements
Net
Investment Hedges
PPG uses cross currency swaps, foreign currency forward contracts and euro-denominated debt to hedge a significant portion of its net investment in its European operations, as follows:
As of December 31, 2017 and 2016, U.S. dollar to euro cross currency swap contracts with a total notional amount of $560 million were outstanding and are scheduled to expire in March 2018. On settlement of the remaining outstanding contracts,
PPG will receive $560 million U.S. dollars and pay euros to the counterparties. During the term of these contracts, PPG receives semiannual payments in March and September of each year based on a U.S. dollar, long-term interest rate fixed as of the contract inception date, and PPG makes annual payments in March of each year to the counterparties based on a euro, long-term interest rate fixed as of the contract inception date. As of December 31, 2017 and 2016, the fair
value of these contracts was an asset of $2 million and $65 million, respectively.
At December 31, 2017 and 2016, PPG had designated €2.3 billion and €2.8 billion, respectively, of euro-denominated borrowings as hedges of a portion of its net investment in the Company’s European operations. The carrying value of these instruments at December 31,
2017 and 2016 was $2.7 billion and $2.9 billion, respectively.
During 2017, 2016 and 2015, PPG used foreign currency forward contracts to hedge a portion of its net investment in its European operations. Changes in the fair value of these derivative instruments were recorded in AOCI as gains or losses. As of December 31, 2017, 2016 and 2015, none of
these contracts remained outstanding. The Company paid $3 million to settle a foreign currency forward contract in 2017. In 2016, no cash proceeds were received from the settlement of these contracts and, in 2015, PPG received cash proceeds of $19 million from the settlement of these contracts.
Other Financial Instruments
PPG
uses foreign currency forward contracts to manage net transaction exposures that do not qualify for hedge accounting; therefore, the change in the fair value of these instruments is recorded in “Other charges” in the accompanying consolidated statement of income in the period of change. As of December 31, 2017 and 2016, the fair value of these contracts were a liability of $20 million and an asset of $2 million, respectively.
Gains/Losses Deferred in AOCI
As of December 31,
2017 and 2016, the Company had accumulated pre-tax unrealized translation gains in AOCI related to the euro-denominated borrowings, foreign currency forward contracts, and the cross currency swaps of $16 million and $482 million, respectively.
The following tables summarize the location and amount of gains (losses) related to derivative and debt financial instruments for the years ended December 31, 2017, 2016
and 2015. All dollar amounts are shown on a pre-tax basis.
The ineffective portion related to this item was $7 million, $9 million and $7 million of expense for the years ended December 31, 2017, 2016 and 2015, respectively.
68
2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
Fair Value Measurements
The Company follows a fair value measurement hierarchy to measure its assets and liabilities. As of December 31, 2017 and 2016, respectively, the assets and liabilities measured at fair value on a recurring basis were cash equivalents, equity securities and derivatives. In addition, the Company measures its pension plan assets at fair
value (see Note 13, “Employee Benefit Plans” for further details). The Company’s financial assets and liabilities are measured using inputs from the following three levels:
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets and liabilities that the Company has the ability to access at the measurement date. Level 1 inputs are considered to be the most reliable evidence of fair value as they are based on unadjusted quoted market prices from various financial information service providers and securities exchanges.
Level 2 inputs are directly or indirectly observable prices that are not quoted on active exchanges, which include quoted prices for similar assets and liabilities in
active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and inputs that are derived principally from or corroborated by observable market data by correlation or other means. The fair values of the derivative instruments reflect the instruments’ contractual terms, including the period to maturity, and uses observable market-based inputs, including forward curves.
Level 3 inputs are unobservable inputs employed for measuring the fair value of assets or liabilities. The Company does not have any recurring financial assets or liabilities that are recorded in its consolidated balance sheets as of December 31, 2017 and 2016
that are classified as Level 3 inputs.
Assets and liabilities reported at fair value on a recurring basis
Excluding capital lease obligations of $15 million and short term borrowings of $8 million as of December 31, 2017.
(b)
Excluding
capital lease obligations of $18 million and short term borrowings of $99 million as of December 31, 2016.
The fair values of the debt instruments were based on discounted cash flows and interest rates then currently available to the Company for instruments of the same remaining maturities and were measured using level 2 inputs.
Assets and liabilities reported at fair value on a nonrecurring basis
There were no significant adjustments to the fair value of nonmonetary assets or liabilities during the year ended December 31,
2017. In conjunction with the 2016 restructuring actions, certain nonmonetary assets were written down to their fair value. Refer to Note 8, “Business Restructuring” for further details associated with these actions.”
2017 PPG ANNUAL REPORT AND FORM 10-K/A 69
Notes to the Consolidated Financial Statements
Call and put option on noncontrolling interest
PPG owns a majority interest in a coatings business whose financial results are included in PPG’s consolidated financial statements. PPG has recorded the noncontrolling interest in this consolidated affiliate as a liability instead of equity in its consolidated balance sheets due to call and put option provisions associated
with the noncontrolling interest, which have similar terms. This liability was $44 million and $38 million at December 31, 2017 and 2016, respectively.
11. Earnings Per Common Share (As Restated)
($
in millions, except per share amounts)
2017
2016
2015
As Restated
As
Restated
Earnings per common share (attributable to PPG)
Income from continuing operations, net of tax
$1,369
$543
$1,311
Income
from discontinued operations, net of tax
225
330
95
Net income (attributable to PPG)
$1,594
$873
$1,406
Weighted
average common shares outstanding
256.1
265.6
271.4
Effect of dilutive securities:
Stock
options
0.9
0.8
1.0
Other stock compensation plans
0.8
1.0
1.2
Potentially
dilutive common shares
1.7
1.8
2.2
Adjusted weighted average common shares outstanding
257.8
267.4
273.6
Earnings
per common share (attributable to PPG):
Income from continuing operations, net of tax
$5.34
$2.05
$4.83
Income
from discontinued operations, net of tax
0.88
1.24
0.35
Net income (attributable to PPG)
$6.22
$3.29
$5.18
Earnings
per common share - assuming dilution (attributable to PPG)
Income from continuing operations, net of tax
$5.31
$2.04
$4.79
Income
from discontinued operations, net of tax
0.87
1.23
0.35
Net income (attributable to PPG)
$6.18
$3.27
$5.14
There
were 0.6 million outstanding stock options excluded in 2017, 2016 and 2015 from the computation of earnings per diluted common share due to their anti-dilutive effect.
12. Income Taxes (As Restated)
The provision for income taxes by taxing jurisdiction and by significant components consisted of the following:
($
in millions)
2017
2016
2015
As Restated
As Restated
Current
U.S.
federal
$179
($251
)
$132
U.S. state and local
49
(12
)
20
Foreign
349
306
261
Total
current income tax expense
$577
$43
$413
Deferred
U.S.
federal
$107
$173
$31
U.S. state and local
(16
)
(10
)
6
Foreign
(53
)
8
(37
)
Total
deferred income tax expense
$38
$171
$—
Total income tax expense
$615
$214
$413
70
2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
A reconciliation of the statutory U.S. corporate federal income tax rate to the Company’s effective tax rate follows:
2017
2016
2015
As
Restated
As Restated
U.S. federal income tax rate
35.0
%
35.0
%
35.0
%
Changes
in rate due to:
U.S. tax cost - Tax Cuts & Jobs Act
11.0
—
—
U.S./foreign
tax differential
(9.3
)
(17.7
)
(8.2
)
U.S. current tax benefit on foreign exchange realization
(4.9
)
(3.0
)
—
U.S.
tax incentives
(2.3
)
(3.7
)
(1.9
)
U.S. tax (benefit) cost on foreign dividends
(1.9
)
0.4
(1.0
)
U.S.
state and local taxes
1.1
(1.8
)
1.0
U.S. deferred tax benefit on foreign income
(0.6
)
(3.1
)
(4.1
)
Asbestos
charge
—
19.1
—
Other
2.6
2.3
2.9
Effective
income tax rate
30.7
%
27.5
%
23.7
%
On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act (the “Act”) which, among other things lowered the U.S. corporate statutory income tax rate from 35% to 21%, eliminated certain deductible items
and added other deductible items for corporations, imposed a tax on unrepatriated foreign earnings and eliminated U.S. taxes on most future foreign earnings. In December 2017, the Company recorded a net tax charge of $134 million related to the Act. The net charge consists of the tax on unrepatriated foreign earnings of approximately $250 million and a charge of approximately $125 million related to the remeasurement of PPG’s U.S. deferred tax assets and liabilities at the new enacted statutory rate. These charges were partially offset by a benefit from the reversal of an existing deferred tax liability on repatriated foreign earnings of approximately $150 million and a benefit resulting from PPG’s decision
to accelerate recognition of certain U.S. tax attributes during the fourth quarter.
The net charge recorded as a provisional amount as of December 31, 2017 represents the Company’s best estimate using information available as of February 1, 2018. The Company anticipates U.S. regulatory agencies will issue further regulations during 2018, which may alter this estimate. The Company is still evaluating among other things, its position with respect to permanent reinvestment of foreign earnings overseas and other related outside basis difference considerations and the amount of tax owed
on unrepatriated earnings by subsidiaries. The Company believes its remeasurement of the U.S deferred tax assets and liabilities is complete, except for changes in estimates that can result from finalizing the filing of our 2017 U.S. income tax return, which are not anticipated to be material, and changes that may be a direct impact of other provisional amounts recorded due to the enactment of the Act. The Company will refine its estimates to incorporate new or better information as it comes available through the filing date of its 2017 U.S. income tax returns in the fourth quarter of 2018.
The tax owed by PPG on its unrepatriated foreign earnings is payable over eight years
and is subject to a prescriptive calculation to determine the portion payable in 2018 and beyond. PPG’s current estimate, using this prescriptive method, indicates its tax payable will be increased by approximately $1 million to $3 million per year through 2025. As such, the portion of the tax on unrepatriated foreign earnings not payable within the next 12 months is presented within “Other liabilities” on the consolidated balance sheet.
The total tax expense for 2017 also includes a deferred tax benefit of $22 million related to the $60 million of pre-tax pension settlement charges discussed in Note 13, “Employee Benefit Plans.” During 2016, the Company
recorded a $151 million net tax charge associated with the funding of the Pittsburgh Corning (“PC”) asbestos settlement trust (the “Trust”) described in Note 14, "Commitments and Contingent Liabilities." Further, in conjunction with the funding of the Trust, PPG provided taxes on the earnings of certain foreign subsidiaries and recorded one-time book tax benefits for its contribution of the Company's ownership interest in PC's European subsidiary to the Trust and for a change in the measurement of certain deferred tax liabilities.
In 2017 and 2016, U.S. deferred tax on foreign earnings includes the
remeasurement of a U.S. deferred tax liability to repatriate foreign earnings on which PPG has not asserted permanent reinvestment in the foreign jurisdiction.
Income (Loss) before income taxes of the Company’s U.S. operations for 2017, 2016 and 2015 was $713 million, $(210) million and $693 million, respectively. Income before income taxes of the Company’s foreign operations for 2017, 2016 and 2015
was $1,292 million, $889 million and $1,052 million, respectively.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 71
Notes to the Consolidated Financial Statements
Deferred income taxes
Deferred income taxes are provided for the effect of temporary differences that arise because there are certain items treated differently for financial accounting than for income tax reporting purposes. The deferred tax assets and liabilities are determined by applying the enacted tax rate in the year in which the temporary difference is expected to reverse.
($
in millions)
2017
2016
As Restated
Deferred income tax assets related to
Employee
benefits
$399
$606
Contingent and accrued liabilities
164
263
Operating
loss and other carry-forwards
221
197
Inventories
6
14
Property
51
49
Other
135
100
Valuation
allowance
(173
)
(119
)
Total
$803
$1,110
Deferred
income tax liabilities related to
Property
$314
$349
Intangibles
578
647
Employee
benefits
11
4
Derivatives
1
6
Undistributed foreign earnings
24
189
Other
20
146
Total
$948
$1,341
Deferred
income tax (liabilities) assets – net
($145
)
($231
)
Net operating loss and credit carryforwards
($
in millions)
2017
2016
Expiration
Available net operating loss carryforwards:
Indefinite
expiration
$447
$376
NA
Definite expiration
247
118
2018
- 2030
Total
$694
$494
NA
Net operating loss carryforwards, tax effected
$210
$140
NA
Income
tax credit carryforwards
$9
$57
2018 - 2027
A valuation allowance of $170 million and $119 million has been established for carry-forwards at December 31, 2017 and 2016,
when the ability to utilize them is not likely.
Undistributed foreign earnings
The Company had $3.4 billion and $5.3 billion of undistributed earnings of non-U.S. subsidiaries as of December 31, 2017 and 2016, respectively. These amounts relate to approximately 250 subsidiaries in approximately 75 taxable jurisdictions. The
Company estimates repatriation of undistributed earnings of non-U.S. subsidiaries as of December 31, 2017 and 2016 would have resulted in a U.S. tax cost of approximately $30 million (assuming tax reform) and $350 million, respectively.
Over the past several years, PPG has established deferred tax liabilities on certain undistributed earnings, namely in connection with divestitures and the funding of the Pittsburgh Corning Asbestos Trust (refer to Note 14, “Commitments and Contingent Liabilities”). At December 31, 2016, the expected future tax cost to repatriate these foreign earnings which
were not permanently reinvested totaled $189 million. At December 31, 2016, no significant deferred U.S. income taxes had been provided on the remaining $3.5 billion of PPG’s undistributed earnings as they were considered to be reinvested for an indefinite period of time or will be repatriated when it is tax effective to do so.
In 2017, in conjunction with the enactment of the Act, PPG owes U.S. tax on substantially all unrepatriated earnings. As of December 31, 2017, the Company has provisionally not changed its intention to reinvest foreign earnings indefinitely or repatriate when it is tax effective to do so, and as such has not established a liability
for foreign withholding taxes or other costs that would be incurred if the earnings were repatriated.
72 2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
Unrecognized tax benefits
The Company files federal, state and local income tax returns in numerous domestic and foreign jurisdictions. In most tax jurisdictions, returns are subject to examination by the relevant tax authorities for a number of years after the returns have been filed. The Company is no longer subject to examinations by tax authorities in
any major tax jurisdiction for years before 2006. Additionally, the Internal Revenue Service has completed its examination of the Company’s U.S. federal income tax returns filed for years through 2011. The examinations of the Company’s U.S. federal income tax returns for 2012 through 2013 are currently underway.
A reconciliation of the total amounts of unrecognized tax benefits (excluding interest and penalties) as of December 31 follows:
($
in millions)
2017
2016
2015
January 1
$94
$82
$71
Current
year tax positions - additions
37
25
14
Prior year tax positions - additions
26
8
5
Pre-acquisition
unrecognized tax benefits
—
—
4
Prior year tax positions - reductions
—
(11
)
(3
)
Statute
of limitations expirations
(8
)
(8
)
(1
)
Settlements
(10
)
—
(3
)
Foreign
currency translation
9
(2
)
(5
)
December 31
$148
$94
$82
The
Company expects that any reasonably possible change in the amount of unrecognized tax benefits in the next 12 months would not be significant.
The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $140 million as of December 31, 2017.
Interest and penalties
($ in millions)
2017
2016
2015
Accrued
interest and penalties related to unrecognized tax benefits
$15
$9
$8
Loss recognized in income tax expense related to interest and penalties
$4
$1
$2
The
Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense.
13. Employee Benefit Plans
Defined Benefit Plans
PPG has defined benefit pension plans that cover certain employees worldwide. The principal defined benefit pension plans are those in the U.S., Canada, the Netherlands and the U.K. These plans in the aggregate represent approximately 93% of the projected benefit obligation at December 31, 2017, of which the U.S. defined benefit pension plans represent the largest component.
U.S. defined benefit plans
As
of January 1, 2006, the Company closed the salaried defined benefit plans to new entrants. The defined benefit plan of certain hourly employees was closed to new entrants in 2006 or thereafter. Eligible employees participate in a defined contribution retirement plan. In 2011, the Company approved amendments related to certain U.S. defined benefit plans so that depending upon the affected employee’s combined age and years of service to PPG, certain employees stopped or will stop accruing benefits either during 2011 or in 2020. The affected employees will participate in the Company’s defined contribution retirement plans from the date their benefits under their respective defined
benefit plans are frozen. The Company has amended other defined benefit plans in other countries in a similar way and plans to continue reviewing and potentially changing other PPG defined benefit plans in the future.
In June 2016, the Company entered into a Definitive Purchase Agreement by and among the Company, Massachusetts Mutual Life Insurance Company (“MassMutual”) and State Street Bank & Trust Company (“State Street”), as independent fiduciary to the
Company’s United States defined benefit pension plans (the “Plans”), and a Definitive Purchase Agreement by and among the Company, Metropolitan Life Insurance Company (“MetLife”) and State Street.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 73
Notes to the Consolidated Financial Statements
In August 2016, pursuant to the two Definitive Purchase Agreements, the Plans purchased group annuity contracts that irrevocably transferred to the two insurance companies certain pension
benefit obligations for approximately 13,200 of the Company’s retirees in the United States who started receiving their monthly retirement benefit payments on or before April 1, 2016. The value of the benefit obligation of each affected former salaried employee’s retirement benefit obligation is irrevocably guaranteed by, and split equally between, MassMutual and MetLife. Pursuant to these Definitive Purchase Agreements, MassMutual serves as the lead administrator. The value of each affected former hourly employee’s retirement benefit obligation is irrevocably guaranteed by MetLife, and MetLife will serve as the administrator. The amount of each affected retiree’s annuity payment is equal to the amount of such individual’s pension benefit. The purchase of group annuity contracts
was funded directly by the assets of the Plans. By irrevocably transferring the obligations and assets to MassMutual and MetLife, the Company reduced its overall pension projected benefit obligation by approximately $1.6 billion and recognized a non-cash pension settlement charge of approximately $535 million after-tax ($857 million pre-tax).
Following the transfer of the aforementioned U.S. retiree obligations and assets to third party insurers, PPG contributed $29 million and $146 million to its U.S. plans in 2017 and 2016, respectively. These contributions were funded using cash on hand.
During
2016, as a result of the purchase of group annuity contracts, PPG merged two of its qualified defined benefit pension plans that contained retired plan participants into one surviving plan. In conjunction with the merger and purchase of group annuity contracts, PPG remeasured its qualified pension plan benefit obligations using prevailing discount rates as of July 31, 2016 which averaged 3.6% as compared to a 4.5% discount rate as of December 31, 2015. The remeasurement increased the Company's cumulative pension benefit
obligation of its remaining plans by $306 million and increased the Company's full year 2016 qualified defined benefit pension expense by approximately $10 million.
In 2016, the Company purchased group annuity contracts that transferred pension benefit obligations for certain of the Company’s retirees and terminated vested participants
in Canada who started receiving their monthly retirement benefit payments on or before April 1, 2016 to Sun Life Assurance Company of Canada (“Sun Life”) and The Canada Life Assurance Company (“Canada Life”). The amount of each affected retiree’s annuity payment is equal to the amount of such individual’s pension benefit. The purchase of group annuity contracts was funded directly by the assets of the Canadian plans. By transferring the obligations and assets to Sun Life and Canada Life, the Company reduced its overall pension projected benefit obligation by approximately $200 million and recognized a non-cash pension settlement charge of $47 million
after-tax ($64 million pre-tax). The Company made voluntary contributions aggregating $7 million to the Canadian plans in 2016 related to the pension annuity contracts. These contributions were funded using cash on hand.
Sale of the flat glass business
In 2016, PPG completed the sale of its flat glass business as discussed in Note 3, “Acquisitions and Divestitures.” PPG transferred to Vitro certain defined benefit pension liabilities resulting in a settlement charge of $11 million which is included in the net gain on the sale of the flat glass business. This transaction
lowered the projected benefit obligation of PPG’s defined benefit pension plan by approximately $100 million. PPG transferred pension assets of $55 million in 2016 in connection with the sale and expects to transfer an additional $5 million to $10 million of pension assets in 2018.
Sale of the European fiber glass business
In 2016, PPG completed the sale of its European fiber glass business as discussed in Note 3, “Acquisitions and Divestitures.” PPG transferred to NEG certain defined benefit pension liabilities resulting in a net settlement charge of $46 million. This amount is included in Income from discontinued operations, net of tax in 2016.This
transaction lowered the projected benefit obligation of PPG’s defined benefit pension plans by approximately $340 million. PPG transferred pension assets of approximately $250 million in connection with the sale.
Postretirement medical
PPG sponsors welfare benefit plans that provide postretirement medical and life insurance benefits for certain U.S. and Canadian employees and their dependents of which the U.S. welfare benefit plans represent approximately 85% of the projected benefit obligation at December 31, 2017. Salaried and certain hourly employees in the U.S. hired on or after October 1, 2004, or rehired on or after October
1, 2012 are not eligible for postretirement medical benefits.
The U.S. welfare benefit plans include an Employee Group Waiver Plan (“EGWP”) for certain Medicare-eligible retirees and their dependents which includes a fully-insured Medicare Part D prescription drug plan. As such, PPG is not eligible to receive the federal subsidy provided under the Medicare Act of 2003 for these retirees and their dependents.
These plans in the U.S. and Canada require retiree contributions based on retiree-selected coverage levels for certain retirees and their dependents and provide for sharing of future benefit cost increases between PPG and participants based on management discretion. The Company has the right to modify, amend or terminate certain of these benefit plans in the future.
74
2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
In 2016, the Company communicated plan design changes to certain Medicare-eligible retiree plan participants. Effective January 1, 2017, the Company-sponsored Medicare-eligible plans were replaced by a Medicare private exchange. By offering retiree health coverage through a private Medicare exchange, PPG is able to provide Medicare-eligible participants with more choice of plans and plan designs, greater flexibility, and different price points for coverage. Beginning January 1, 2017, PPG’s contribution
for health care coverage related to Medicare-eligible retirees is in the form of a tax-free account known as a Health Reimbursement Arrangement (HRA). The HRA can be used to pay for health care and prescription drug plan premiums and certain out-of-pocket medical costs; unused funds can be carried over to future years.
The announcement of these plan design changes triggered a remeasurement of PPG’s retiree medical benefit obligation using prevailing interest rates. The plan design change resulted in a $306 million reduction in the Company's postretirement benefit obligation. PPG accounted for the plan design change prospectively, and the plan design change will be amortized to periodic postretirement benefit cost over a 5.6 year period.
The
following table sets forth the changes in projected benefit obligations (“PBO”) (as calculated as of December 31), plan assets, the funded status and the amounts recognized in the accompanying consolidated balance sheet for the Company’s defined benefit pension and other postretirement benefit plans:
Pensions
Other
Postretirement Benefits
($ in millions)
2017
2016
2017
2016
Projected benefit obligation, January 1
$3,252
$5,349
$792
$1,084
Service
cost
33
48
10
15
Interest cost
98
142
24
31
Plan
amendments
—
—
—
(306
)
Actuarial losses (gains) - net
185
538
(27
)
13
Benefits
paid
(167
)
(233
)
(48
)
(53
)
Foreign currency translation adjustments
165
(141
)
8
2
Settlements
and curtailments
(85
)
(2,354
)
—
—
Former glass business changes, net
(1
)
(96
)
(8
)
6
Other
(18
)
(1
)
2
—
Projected
benefit obligation, December 31
$3,462
$3,252
$753
$792
Market value of plan assets, January 1
$2,561
$4,627
Actual
return on plan assets
289
470
Company contributions
87
204
Participant
contributions
1
1
Benefits paid
(109
)
(205
)
Plan
transfers
—
(3
)
Plan settlements
(95
)
(2,338
)
Plan
expenses and other-net
—
—
Foreign currency translation adjustments
149
(134
)
Former
glass business changes, net
—
(61
)
Market value of plan assets, December 31
$2,883
$2,561
Funded
Status
($579
)
($691
)
($753
)
($792
)
Amounts recognized in the Consolidated Balance Sheet:
Other
assets (long-term)
173
110
—
—
Accounts payable and accrued liabilities
(23
)
(61
)
(54
)
(61
)
Accrued
pensions
(729
)
(740
)
—
—
Other postretirement benefits
—
—
(699
)
(724
)
Liabilities
held for sale
—
—
—
(7
)
Net liability recognized
($579
)
($691
)
($753
)
($792
)
The
PBO is the actuarial present value of benefits attributable to employee service rendered to date, including the effects of estimated future pay increases. The accumulated benefit obligation (“ABO”) is the actuarial present value of benefits attributable to employee service rendered to date, but does not include the effects of estimated future pay increases. The ABO for all defined benefit pension plans as of December 31, 2017 and 2016 was $3,382 million and $3,171 million, respectively.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 75
Notes
to the Consolidated Financial Statements
The following table details the pension plans where the benefit liability exceeds the fair value of the plan assets:
Pensions
($ in millions)
2017
2016
Plans
with PBO in Excess of Plan Assets:
Projected benefit obligation
$2,544
$2,406
Fair value of plan assets
$1,792
$1,609
Plans
with ABO in Excess of Plan Assets:
Accumulated benefit obligation
$2,434
$2,302
Fair value of plan assets
$1,749
$1,575
Net
actuarial losses and prior service cost/(credit) deferred in accumulated other comprehensive loss
($ in millions)
Pensions
Other Postretirement Benefits
2017
2016
2017
2016
Accumulated
net actuarial losses
$835
$918
$180
$226
Accumulated
prior service cost (credit)
—
1
(239
)
(298
)
Total
$835
$919
($59
)
($72
)
The
accumulated net actuarial losses for pensions and other postretirement benefits relate primarily to historical declines in the discount rate as well as updated mortality assumptions. The accumulated net actuarial losses exceed 10% of the higher of the market value of plan assets or the PBO at the beginning of the year, therefore, amortization of such excess has been included in net periodic benefit costs for pension and other postretirement benefits in each of the last three years. The amortization period is the average remaining service period of active employees expected to receive benefits unless a plan is mostly inactive in which case the amortization period is the average remaining life expectancy of the plan participants. Accumulated prior service cost (credit) is amortized over the future service periods of those employees who are active at the dates of the plan amendments and who are expected to receive benefits.
The
net decrease in accumulated other comprehensive loss (pre-tax) in 2017 relating to defined benefit pension and other postretirement benefits is primarily attributable to pension settlement charges and other postretirement plan design changes,
as follows:
($ in millions)
Pensions
Other Postretirement
Benefits
Net actuarial loss (gain) arising during the year
$38
($35
)
New prior service cost (credit)
(2
)
1
Amortization
of actuarial loss
(75
)
(12
)
Amortization of prior service (cost) credit
(1
)
59
Foreign currency translation adjustments
19
—
Impact
of settlements and curtailments
(63
)
—
Net change
($84
)
$13
The
2017 net actuarial loss related to the Company’s pension and other postretirement benefit plans of $3 million was primarily due to a decrease in the weighted average discount rate used to determine the benefit obligation at December 31, 2017, partially offset by asset performance gains in excess of the expected return on plan assets for the year.
The estimated amount of accumulated net actuarial loss for the defined benefit pension plans that will be amortized from accumulated other comprehensive income into net periodic benefit cost in 2018 is $68 million. The estimated amounts of accumulated net actuarial loss and prior service (credit) for the other postretirement
benefit plans that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost in 2018 are $17 million and $(60) million, respectively.
76 2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
Net periodic benefit cost
Pensions
Other
Postretirement Benefits
($ in millions)
2017
2016
2015
2017
2016
2015
Service
cost
$33
$48
$57
$10
$15
$16
Interest
cost
98
142
196
24
31
45
Expected
return on plan assets
(141
)
(213
)
(287
)
—
—
—
Amortization
of prior service credit
—
(1
)
(2
)
(59
)
(31
)
(9
)
Amortization
of actuarial losses
75
110
119
12
19
32
Settlements,
curtailments, and special termination benefits
60
1,015
8
—
—
—
Net
periodic benefit cost/(income)
$125
$1,101
$91
($13
)
$34
$84
Net
periodic benefit cost/(income) is included in Cost of sales, exclusive of depreciation and amortization, Selling, general and administrative, Research and development, and Income from discontinued operations, net of tax in the accompanying consolidated statements of income.
Key assumptions
The following weighted average assumptions were used to determine the benefit obligation for the Company’s defined benefit pension and other postretirement plans as of December 31, 2017 and 2016:
2017
2016
Discount
rate(1)
3.2
%
3.7
%
Rate of compensation increase
1.3
%
1.6
%
(1)
The
discount rate for U.S. defined benefit pension and other postretirement plans was 3.7% and 4.3% as of December 31, 2017 and 2016, respectively.
The following weighted average assumptions were used to determine the net periodic benefit cost for the Company’s defined benefit pension and other postretirement benefit plans for the three years in the period ended December 31, 2017:
2017
2016
2015
Discount
rate
3.6
%
3.6
%
3.8
%
Expected return on assets
5.4
%
6.1
%
6.1
%
Rate
of compensation increase
1.3
%
1.6
%
2.0
%
These assumptions for each plan are reviewed on an annual basis. In determining the expected return on plan asset assumption, the Company evaluates the mix of investments that comprise each plan’s assets and external forecasts of future long-term investment returns. The
Company compares the expected return on plan assets assumption to actual historic returns to ensure reasonability. For 2017, the return on plan assets assumption for PPG’s U.S. defined benefit pension plans was 7.5%. A change in the rate of return of 1 percentage point, with other assumptions held constant, would impact 2017 net periodic pension expense by $11 million. The global expected return on plan assets assumption to be used in determining 2018 net periodic pension expense will be 5.30% (7.40% for the U.S. plans only).
The discount rate used in accounting for pensions and other postretirement benefits is determined by reference to a current yield curve and by considering the timing and amount of projected future benefit payments. In
2016, the Company changed the method it uses to estimate the service and interest cost components of net periodic benefit cost for pension and other postretirement benefit costs for substantially all of its U.S. and foreign plans. Historically, the service and interest cost components were estimated using a single weighted-average discount rate derived from the yield curve used to measure the projected benefit obligation at the beginning of the period. The Company has elected to use a full yield curve approach (“Split-rate” method) in the estimation of these components of benefit cost by applying specific spot rates along the yield curve used in the determination of the benefit obligation to the relevant projected cash flows. The
Company made this change to improve the correlation between projected benefit cash flows and the corresponding yield curve spot rates and to provide a more precise measurement of service and interest costs. This change does not affect the measurement of the Company’s total benefit obligations. The Company accounted for this change as a change in estimate and, accordingly, began recognizing its effect in fiscal year 2016. A change in the discount rate of 1 percentage point, with all other assumptions held constant, would impact 2018 net periodic benefit expense for our defined benefit pension and other postretirement benefit plans by $22 million and $26 million, respectively.
In
2017, the Company updated mortality tables used to calculate its U.S. defined benefit pension and other postretirement benefit liabilities. The Company considered the available mortality tables released by the Society of Actuaries’ Retirement
2017 PPG ANNUAL REPORT AND FORM 10-K/A 77
Notes to the Consolidated Financial Statements
Plans Experience Committee and performed a review of its own mortality history, as well the industry in which the Company operates to assess future improvements in mortality
rates based on its U.S. population. The Company chose to value its U.S. defined benefit pension and other postretirement benefit liabilities using a slightly modified assumption of future mortality which better approximates our plan participant population.
The weighted-average healthcare cost trend rate (inflation) used for 2017 was 6.1% declining to a projected 4.5% in the year 2024. For 2018, the assumed weighted-average healthcare cost trend rate used will be 5.8% declining to a projected 4.5% between 2019 and 2039 for medical
and prescription drug costs, respectively. These assumptions are reviewed on an annual basis. In selecting rates for current and long-term health care cost assumptions, the Company takes into consideration a number of factors, including the Company’s actual health care cost increases, the design of the Company’s benefit programs, the demographics of the Company’s active and retiree populations and external expectations of future medical cost inflation rates. If these 2018 health care cost trend rates were increased or decreased by one percentage point per year, such increase or decrease would have
the following effects:
One-Percentage Point
($ in millions)
Increase
Decrease
Increase
(decrease) in the aggregate of service and interest cost components of annual expense
$1
($1
)
Increase (decrease) in the benefit obligation
$25
($15
)
Contributions
to defined benefit pension plans
($ in millions)
2017
2016
2015
U.S. defined benefit pension plans(a)
$54
$134
$224
Non-U.S.
defined benefit pension plans(b)
$33
$54
$39
(a)
During 2016 and 2015, U.S. contributions
totaling $12 million and $26 million associated with the former glass segment were recast as cash flows from operations - discontinued operations and are excluded from the table above.
(b)
During 2016 non-U.S. contributions totaling $4 million associated with the former European fiberglass business were recast as cash flows from operations - discontinued operations and are excluded from the table above.
Substantially all contributions made to PPG’s non-U.S. defined benefit pension plans in 2017 and 2016 were required by local funding requirements.
PPG expects to make mandatory contributions to its non-U.S. plans in the range of $20 million to $30 million in 2018. PPG contributed $25 million to its U.S. defined benefit pension plans in January 2018. PPG may make voluntary contributions to its defined benefit pension plans in 2018 and beyond.
Benefit payments
The estimated benefits expected to be paid under the Company’s defined benefit pension and other postretirement benefit plans are:
($
in millions)
Pensions
Other Postretirement Benefits
2018
$147
$54
2019
$147
$54
2020
$156
$53
2021
$161
$53
2022
$166
$52
2023
to 2027
$901
$231
U.S. Qualified Pension
Beginning in 2012, the Company initiated a lump sum payout program that gave certain terminated vested participants in certain U.S. defined benefit pension plans the option to take a one-time lump sum cash payment in lieu of receiving a future
monthly annuity. During 2017, PPG paid $87 million in lump sum benefits to terminated vested participants who elected to participate in the program. As the lump-sum payments were in excess of the expected 2017 service and interest costs for the qualified pension plans, PPG remeasured the periodic benefit obligation of the qualified plans and recorded a settlement charge totaling $35 million ($22 million after-tax).
U.S. Non-qualified Pension
In the first quarter 2017, PPG made lump-sum payments to certain retirees who had participated in PPG's U.S. non-qualified pension plan (the "Nonqualified Plan") totaling approximately $40 million. As the lump-sum payments were
in excess of the
78 2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
expected 2017 service and interest costs for the Nonqualified Plan, PPG remeasured the periodic benefit obligation of the Nonqualified Plan as of March 1, 2017 and recorded a settlement charge totaling $22 million ($14 million after-tax).
Plan assets
Each PPG sponsored defined benefit pension plan is managed in accordance with the requirements of local laws and regulations governing defined benefit pension plans for the
exclusive purpose of providing pension benefits to participants and their beneficiaries. Investment committees comprised of PPG managers have fiduciary responsibility to oversee the management of pension plan assets by third party asset managers. Pension plan assets are held in trust by financial institutions and managed on a day-to-day basis by the asset managers. The asset managers receive a mandate from each investment committee that is aligned with the asset allocation targets established by each investment committee to achieve the plan’s investment strategies. The performance of the asset managers is monitored and evaluated by the investment committees throughout the year.
Pension plan assets are invested to generate investment earnings over an extended time horizon to help fund the cost of benefits promised under the plans while mitigating investment risk. The asset allocation targets established
for each pension plan are intended to diversify the investments among a variety of asset categories and among a variety of individual securities within each asset category to mitigate investment risk and provide each plan with sufficient liquidity to fund the payment of pension benefits to retirees.
The following summarizes the weighted average target pension plan asset allocation as of December 31, 2017 and 2016 for all PPG defined benefit plans:
These
levels refer to the accounting guidance on fair value measurement described in Note 10, “Financial Instruments, Hedging Activities and Fair Value Measurements.”
(2)
These amounts represent holdings in investment grade debt or equity securities of issuers in both developed markets and emerging economies.
(3)
This category represents investment grade debt securities from a diverse set of industry issuers.
(4)
These
investments are primarily long duration fixed income securities.
(5)
This category represents commingled funds invested in diverse portfolios of debt securities.
(6)
This category includes mortgage-backed and asset backed debt securities, municipal bonds and other debt securities including derivatives.
(7)
Certain
investments that are measured at net asset value per share (or its equivalent) are not required to be classified in the fair value hierarchy.
The change in the fair value of the Company’s Level 3 pension assets for the years ended December 31, 2017 and 2016 was as follows:
Real
estate properties are externally appraised at least annually by reputable, independent appraisal firms. Property valuations are also reviewed on a regular basis and are adjusted if there has been a significant change in circumstances related to the property since the last valuation.
80 2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
Other debt securities consist of insurance contracts, which are externally valued by insurance companies based on the present value of the expected future cash flows.
Hedge funds consist of a wide range of investments which target a relatively stable investment
return. The underlying funds are valued at different frequencies, some monthly and some quarterly, based on the value of the underlying investments. Other assets consist primarily of small investments in private equity funds and senior secured debt obligations of non-investment grade borrowers.
Retained liabilities and legacy settlement charges
PPG has retained certain liabilities for defined benefit pension and postretirement benefits earned for service up to the date of sale of its former automotive glass and service business for employees who were active as of the divestiture date and for individuals who were retirees of the business as of the divestiture date, totaling $369 million and $342 million at December 31, 2017
and 2016, respectively, for employees who were active as of the divestiture date and for individuals who were retirees of the business as of the divestiture date. PPG recognized expense of $2 million, $20 million and $17 million related to these obligations in 2017, 2016, and 2015, respectively.
There have been multiple PPG facility closures in Canada related to the former automotive glass and services business as well as other PPG businesses. These various plant closures have resulted in partial and full windups, and related settlement charges, of pension plans
for various hourly and salary employees employed by these locations. The charges are recorded for the individual plans when a particular windup is approved by the Canadian pension authorities. The Company has made all contributions to the individual plan and has discharged the liability through either lump sum payments to participants or purchasing annuities.
During 2016, PPG completed the wind-up of two legacy Canadian plans and recorded after-tax wind-up charges totaling $34 million ($47 million pre-tax). Cash contributions made in conjunction with these windups were approximately $1 million. The
Company recorded a settlement charge of $7 million in 2015 related to legacy plant closures. We expect limited additional settlement charges related to these legacy plant closures; although the Company retains the right to continue to review and potentially change other PPG defined benefit plans in the future.
Other Plans
Defined contribution plans
The Company has defined contribution plans for certain employees in the U.S., China, United Kingdom, Australia, Italy, and other countries. For the years ended December 31, 2017, 2016,
and 2015, the Company recognized expense for its defined contribution retirement plans of $57 million, $70 million and $60 million, respectively. The Company’s annual cash contributions to its defined contribution retirement plans approximated the expense recognized in each year. As of December 31, 2017 and 2016, the Company’s obligation for contributions
to be made to its defined contribution retirement plans was $15 million and $11 million, respectively.
Employee savings plan
PPG’s Employee Savings Plan (“Savings Plan”) covers substantially all employees in the U.S., Puerto Rico and Canada. The Company makes matching contributions to the Savings Plan, at management’s discretion, based upon participants’ savings, subject to certain limitations. For most participants not covered by a collective bargaining agreement, Company-matching contributions are established each year at the discretion of the Company and are applied to participant savings up to a maximum of 6%
of eligible participant compensation. For those participants whose employment is covered by a collective bargaining agreement, the level of Company-matching contribution, if any, is determined by the relevant collective bargaining agreement. The Company-matching contribution remained at 100% for 2017.
In 2016, the Company terminated its U.S. defined contribution plan and subsequently merged the plan into the Savings Plan. Under the combined plan, eligible employees will continue to receive a contribution equal to between 2% and 5% of annual compensation, based on age and years of
service.
Compensation expense and cash contributions related to the Company match of participant contributions to the Savings Plan for 2017, 2016, and 2015 totaled $46 million, $48 million and $44 million, respectively. A portion of the Savings Plan qualifies under the Internal Revenue Code as an Employee Stock Ownership Plan. Accordingly, dividends received on PPG shares held in that portion of the Savings Plan totaling $14 million, $14 million and $13 million
for 2017, 2016, and 2015, respectively, are deductible for U.S. Federal tax purposes.
Deferred compensation plan
The Company has a deferred compensation plan for certain key managers which allows them to defer a portion of their compensation in a phantom PPG stock account or other phantom investment accounts. The amount deferred earns a return based on the investment options selected by the participant. The amount owed to participants is an unfunded and unsecured
2017 PPG ANNUAL REPORT AND FORM 10-K/A 81
Notes
to the Consolidated Financial Statements
general obligation of the Company. Upon retirement, death, disability, termination of employment, scheduled payment or unforeseen emergency, the compensation deferred and related accumulated earnings are distributed in accordance with the participant’s election in cash or in PPG stock, based on the accounts selected by the participant.
The plan provides participants with investment alternatives and the ability to transfer amounts between the phantom non-PPG stock investment accounts. To mitigate the impact on compensation expense of changes in the market value of the liability, the Company has purchased a portfolio of marketable securities that mirror the phantom
non-PPG stock investment accounts selected by the participants, except the money market accounts. These investments are carried by PPG at fair market value, and the changes in market value of these securities are also included in income from continuing operations. Trading occurs in this portfolio to align the securities held with the participant’s phantom non-PPG stock investment accounts, except the money market accounts.
The cost of the deferred compensation plan, comprised of dividend equivalents accrued on the phantom PPG stock account, investment income and the change in market value of the liability, was $19 million, $7 million and $5 million in 2017, 2016 and 2015,
respectively. These amounts are included in “Selling, general and administrative” in the accompanying consolidated statements of income. The change in market value of the investment portfolio was income of $18 million, $5 million, and $3 million in 2017, 2016 and 2015, respectively, and is also included in “Selling, general and administrative.”
The Company’s obligations under this plan, which are included in “Accounts payable and accrued liabilities” and “Other liabilities” in the accompanying consolidated balance sheet, totaled $121
million and $124 million as of December 31, 2017 and 2016, respectively, and the investments in marketable securities, which are included in “Investments” and “Other current assets” in the accompanying consolidated balance sheet, were $83 million and $82 million as of December 31, 2017 and 2016, respectively.
14.
Commitments and Contingent Liabilities
PPG is involved in a number of lawsuits and claims, both actual and potential, including some that it has asserted against others, in which substantial monetary damages are sought. These lawsuits and claims may relate to contract, patent, environmental, product liability, antitrust, employment and other matters arising out of the conduct of PPG’s current and past business activities. To the extent that these lawsuits and claims involve personal injury and property damage, PPG believes it has adequate insurance; however, certain of PPG’s insurers are contesting coverage with respect to some of these claims, and other insurers, as they had prior to the asbestos settlement described below, may contest coverage with respect to some of the asbestos claims if the settlement is not implemented. PPG’s lawsuits
and claims against others include claims against insurers and other third parties with respect to actual and contingent losses related to environmental, asbestos and other matters.
The results of any current or future litigation and claims are inherently unpredictable. However, management believes that, in the aggregate, the outcome of all lawsuits and claims involving PPG will not have a material effect on PPG’s consolidated financial position or liquidity; however, such outcome may be material to the results of operations of any particular period in which costs, if any, are recognized.
Asbestos matters
Prior to 2000, the Company had been named as a defendant in numerous claims
alleging bodily injury from (i) exposure to asbestos-containing products allegedly manufactured, sold or distributed by the Company, its subsidiaries, or for which they are otherwise alleged to be liable; (ii) exposure to asbestos allegedly present at a facility owned or leased by the Company; or (iii) exposure to asbestos-containing products of Pittsburgh Corning Corporation (“PC”) for which the Company was alleged to be liable under a variety of legal theories (the Company and Corning Incorporated were each 50% shareholders in PC).
In 2000, PC filed for Chapter 11 in the U.S. Bankruptcy Court for the Western District of Pennsylvania in an effort to permanently and comprehensively resolve all of its pending and future asbestos-related liability claims. At the time of the bankruptcy filing, the Company had been named as one of many defendants in approximately 114,000 open claims. The Bankruptcy Court subsequently entered a series of orders preliminarily enjoining the prosecution of asbestos litigation against PPG until after the effective date of a confirmed PC plan of reorganization. During the pendency of this preliminary injunction staying asbestos litigation against PPG, PPG and certain of its historical liability insurers negotiated a settlement
with representatives of present and future asbestos claimants. That settlement was incorporated into a PC plan of reorganization that was confirmed by the Bankruptcy Court on May 24, 2013 and ultimately became effective on April 27, 2016. With the effectiveness of the plan, the preliminary injunction staying the prosecution of asbestos litigation against PPG expired by its own terms on May 27, 2016. In accordance with the settlement, the Bankruptcy Court issued a permanent channeling injunction under Section 524(g) of the Bankruptcy Code that prohibits present and future claimants from asserting claims against PPG that arise, in whole or in part, out of exposure to asbestos or asbestos-containing products manufactured, sold and/or distributed
by PC or asbestos on or emanating from any PC premises. The channeling injunction, by its terms, also prohibits codefendants in cases that
82 2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
are subject to the channeling injunction from asserting claims against PPG for contribution, indemnification or other recovery. The channeling injunction also precludes the prosecution of claims against PPG arising from alleged exposure to asbestos or asbestos-containing products to the extent that a claimant is alleging or seeking to impose liability, directly or indirectly, for the conduct of, claims against, or demands on PC by reason of PPG’s: (i) ownership of a financial interest in PC; (ii) involvement in the management
of PC, or service as an officer, director or employee of PC or a related party; (iii) provision of insurance to PC or a related party; or (iv) involvement in a financial transaction affecting the financial condition of PC or a related party. The foregoing PC related claims are referred to as “PC Relationship Claims.”
The channeling injunction channels the Company’s liability for PC Relationship Claims to a trust funded in part by PPG and its participating insurers for the benefit of current and future PC asbestos claimants (the “Trust”). The Trust is the sole recourse for holders of PC Relationship Claims. PPG and its affiliates have no further liability or responsibility for, and will be permanently protected from, pending and future PC Relationship Claims. The channeling injunction does not extend to present and future claims
against PPG that arise out of alleged exposure to asbestos or asbestos-containing products historically manufactured, sold and/or distributed by PPG or its subsidiaries or for which they are alleged to be liable that are not PC Relationship Claims, and does not extend to claims against PPG alleging personal injury allegedly caused by asbestos on premises presently or formerly owned, leased or occupied by PPG. These claims are referred to as non-PC Relationship Claims.
In accordance with the PC plan of reorganization, PPG's equity interest in PC was canceled. PPG satisfied its funding obligations to the Trust on June 9, 2016, when it conveyed to the Trust the stock it owned in Pittsburgh Corning Europe
and 2,777,778 shares of PPG’s common stock and made a cash payment to the Trust in the amount of $764 million. PPG’s historical insurance carriers participating in the PC plan of reorganization are required to make cash payments to the Trust of approximately $1.7 billion, subject to a right of prepayment at a 5.5% discount rate.
On October 13, 2016, the Bankruptcy Court issued an order entering a final decree and closing the Chapter 11 case. That order provided that the Bankruptcy Court retained jurisdiction to enforce any order issued in the case and any agreements approved by the court, enforce the terms and
conditions or the modified third amended Plan, and consider any requests to reopen the case.
The following table outlines the impact on PPG's financial statements for the year-ended December 31, 2016, including the change in fair value of the PPG stock contributed to the Trust, the equity forward instrument and the increase in the net present value of the payments made to the trust.
Cash outflows related to the asbestos settlement funding totaled $813 million in 2016.
Non-PC relationship asbestos claims
At the time PC filed for bankruptcy, PPG had been named as one of many defendants in one or more of the categories of asbestos-related claims identified above. Over the course of the 16 years during which the PC bankruptcy proceedings, and corresponding preliminary injunction staying the prosecution of asbestos-related claims against PPG, were pending, certain plaintiffs alleging premises claims filed motions seeking to lift the stay with respect to more than 1,000 individually-identified premises. The Bankruptcy Court granted motions to lift the stay in respect to certain of these premises claims and directed PPG to engage in a process
to address any additional premises claims that were the subject of pending or anticipated lift-stay motions. As a result of the overall process as directed by the Bankruptcy Court involving more than 1,000 premises claims between 2006 and May 27, 2016, hundreds of these claims were withdrawn or dismissed without payment and approximately 650 premises claims were dismissed upon agreements by PPG and its insurers to resolve such claims in exchange for monetary payments.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 83
Notes to the Consolidated Financial Statements
With respect to the remaining claims not identified above and still reportable within the inventory of 114,000 asbestos-related claims at the
time PC filed for bankruptcy, the Company considers such claims to fall within one or more of the following categories: (1) claims that have been closed or dismissed as a result of processes undertaken during the bankruptcy; (2) claims that may have been previously filed on the dockets of state and federal courts in various jurisdictions, but are inactive as to the Company; and (3) claims that are subject, in whole or in part, to the channeling injunction and thus will be resolved, in whole or in part, in accordance with the Trust procedures established under the PC bankruptcy reorganization plan. As a result of the foregoing, the Company does not consider these three categories
of claims to be open or active litigation against it, although the Company cannot now determine whether, or the extent to which, any of these claims may in the future be reinstituted, reinstated, or revived such that they may become open and active asbestos-related claims against it.
Current open and active claims post-Pittsburgh Corning bankruptcy
The Company is aware of approximately 625 open and active asbestos-related claims pending against the Company and certain of its subsidiaries. These claims
consist primarily of non-PC Relationship Claims and claims against a subsidiary of PPG. The Company is defending the remaining open and active claims vigorously.
Since April 1, 2013, a subsidiary of PPG has been implicated in claims alleging death or injury caused by asbestos-containing products manufactured, distributed or sold by a North American architectural coatings business or its predecessors which was acquired by PPG. All such claims have been either served upon or tendered to the seller for defense and indemnity pursuant to obligations undertaken by the seller in connection with the Company’s purchase of the North American architectural coatings business. The seller has accepted the defense of these claims
subject to the terms of various agreements between the Company and the seller. The seller’s defense and indemnity obligations in connection with newly filed claims will cease with respect to claims filed after April 1, 2018.
PPG has established reserves totaling approximately $180 million for asbestos-related claims that would not be channeled to the Trust which, based on presently available information, we believe will be sufficient to encompass all of PPG’s current and potential future asbestos liabilities. These reserves include a $162 million reserve established in 2009 in connection with an amendment to the PC plan
of reorganization. These reserves, which are included within "Other liabilities" on the accompanying consolidated balance sheets, represent PPG’s best estimate of its liability for these claims. PPG does not have sufficient current claim information or settlement history on which to base a better estimate of this liability in light of the fact that the Bankruptcy Court’s injunction staying most asbestos claims against the Company was in effect from April 2000 through May 2016. PPG will monitor the activity associated with its remaining asbestos claims and evaluate, on a periodic basis, its estimated liability for such claims, its insurance assets then available, and all underlying assumptions to determine whether any adjustment to the reserves for these claims is required.
The amount reserved for asbestos-related claims by its nature
is subject to many uncertainties that may change over time, including (i) the ultimate number of claims filed; (ii) the amounts required to resolve both currently known and future unknown claims; (iii) the amount of insurance, if any, available to cover such claims; (iv) the unpredictable aspects of the litigation process, including a changing trial docket and the jurisdictions in which trials are scheduled; (v) the outcome of any trials, including potential judgments or jury verdicts; (vi) the lack of specific information in many cases concerning exposure for which PPG is allegedly responsible, and the claimants’ alleged diseases resulting from such exposure; and (vii) potential changes in applicable federal and/or state tort liability law. All of these factors may have a material effect upon future asbestos-related liability estimates. As a potential offset to any future asbestos financial exposure, under the PC plan
of reorganization PPG retained, for its own account, the right to pursue insurance coverage from certain of its historical insurers that did not participate in the PC plan of reorganization. While the ultimate outcome of PPG’s asbestos litigation cannot be predicted with certainty, PPG believes that any financial exposure resulting from its asbestos-related claims will not have a material adverse effect on PPG’s consolidated financial position, liquidity or results of operations.
Environmental matters
It is PPG’s policy to accrue expenses for environmental contingencies when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. Reserves for environmental contingencies
are exclusive of claims against third parties and are generally not discounted. In management’s opinion, the Company operates in an environmentally sound manner and the outcome of the Company’s environmental contingencies will not have a material effect on PPG’s financial position or liquidity; however, any such outcome may be material to the results of operations of any particular period in which costs, if any, are recognized. Management anticipates that the resolution of the Company’s environmental contingencies will occur over an extended period of time.
As of December 31, 2017 and
2016, PPG had reserves for environmental contingencies associated with PPG’s former chromium manufacturing plant in Jersey City, N.J. (“New Jersey Chrome”) and for other environmental contingencies, including National Priority List sites and legacy glass and chemical manufacturing sites. These reserves are reported as “Accounts payable and accrued liabilities” and “Other liabilities” in the accompanying consolidated balance sheet.
84 2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
Environmental
Reserves
($ in millions)
2017
2016
New Jersey Chrome
$136
$163
Legacy
glass and chemical
71
70
Other
51
52
Total
$258
$285
Current
Portion
$73
$76
Pre-tax charges against income for environmental remediation costs are included in “Other charges” in the accompanying consolidated statement of income. The pre-tax charges and cash outlays related to such environmental remediation in 2017,
2016 and 2015,
were as follows:
($ in millions)
2017
2016
2015
New
Jersey Chrome
$4
$60
$—
Other
6
34
9
Total
$10
$94
$9
Cash
outlays for environmental spending
$44
$47
$109
The Company continues to analyze, assess
and remediate the environmental issues associated with New Jersey Chrome as further discussed below. During the past three years, charges for estimated environmental remediation costs were significantly higher than PPG’s historical range. Excluding the charges related to New Jersey Chrome, pre-tax charges against income for environmental remediation have ranged between approximately $5 million and $35 million per year for the past 10 years.
Management expects cash outlays for environmental remediation costs to range from $25 million to $75 million annually from 2018 through 2022.
It is possible that technological, regulatory and enforcement developments,
the results of environmental studies and other factors could alter the Company’s expectations with respect to future charges against income and future cash outlays. Specifically, the level of expected future remediation costs and cash outlays is highly dependent upon activity related to New Jersey Chrome as discussed below.
Remediation: New Jersey Chrome
In June 2009, PPG entered into a settlement agreement with the New Jersey Department of Environmental Protection (“NJDEP”) and Jersey City, New Jersey (which had asserted claims against PPG for lost tax revenue) which was in the form of a Judicial Consent Order (the "JCO"). Under the JCO, PPG accepted sole responsibility for the remediation activities at its former chromium manufacturing location in Jersey City and 19
additional sites. The principal contaminant of concern is hexavalent chromium. The JCO also provided for the appointment of a court-approved Site Administrator who is responsible for establishing a master schedule for the remediation of the 20 PPG sites which existed at that time. One site was subsequently removed from the JCO process during 2014 and will be remediated separately at a future date. A total of 19 sites remain subject to the JCO process.
The most significant assumptions underlying the estimate of remediation costs for all New Jersey Chrome sites are those related to the extent and concentration of chromium impacts in the soil, as these determine the quantity of soil that must be treated in place, the quantity that will have to be excavated and transported for offsite disposal,
and the nature of disposal required. During 2016, PPG completed updated assessments of costs incurred to date versus current progress and the potential cost impacts of the most recent information, including the extent of impacted soils, percentage of hazardous versus non-hazardous soils, daily soil excavation rates, and engineering, administrative and other associated costs. Based on these assessments, a reserve adjustment of $60 million was recorded during 2016. Principal factors affecting costs included refinements in the estimate of the mix of hazardous to non-hazardous soils to be excavated, an overall increase in soil volumes to be excavated, enhanced water management requirements, decreased daily soil excavation rates due to site conditions, initial estimates for remedial actions related to groundwater, and increased oversight and management costs. The reserve adjustments for the estimated costs to remediate all New
Jersey Chrome sites are exclusive of any third party indemnification, as the recovery of any such amounts is uncertain. In 2017, the cost of remediation activities reduced the reserve by $27 million.
Groundwater remediation at the former Garfield Avenue chromium-manufacturing site and five adjacent sites is expected to occur over several years after NJDEP’s approval of the work plan. Ongoing groundwater monitoring will be utilized to develop a final groundwater remedial action work plan which is currently expected to be submitted to NJDEP in 2021.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 85
Notes to the Consolidated Financial Statements
PPG’s
financial reserve for remediation of all New Jersey Chrome sites is $136 million at December 31, 2017. The major cost components of this liability continue to be related to excavation, transportation and disposal of impacted soil, as well as construction services. These components each account for approximately 29%, 27% and 23% of the accrued amount, respectively.
There are multiple, future events yet to occur, including further remedy selection and design, remedy implementation and execution and applicable governmental agency or community organization approvals. Considerable uncertainty exists regarding the timing of these future events for the New
Jersey Chrome sites. Final resolution of these events is expected to occur over the next several years. As these events occur and to the extent that the cost estimates of the environmental remediation remedies change, the existing reserve for this environmental remediation matter will be adjusted.
Remediation: other sites
Among other sites at which PPG is managing environmental liabilities, remedial actions are occurring at a legacy chemical manufacturing site in Barberton, Ohio, where PPG has completed a Facility Investigation and Corrective Measure Study under USEPA’s Resource Conservation and Recovery Act (“RCRA”) Corrective Action Program. PPG has also been addressing the impacts from a legacy plate glass manufacturing site in Kokomo, Indiana under the Voluntary Remediation Program of the Indiana Department of Environmental Management. PPG is currently performing additional
investigation activities at this location.
With respect to certain other waste sites, the financial condition of other potentially responsible parties also contributes to the uncertainty of estimating PPG’s final costs. Although contributors of waste to sites involving other potentially responsible parties may face governmental agency assertions of joint and several liability, in general, final allocations of costs are made based on the relative contributions of wastes to such sites. PPG is generally not a major contributor to such sites.
Separation and merger of the commodity chemicals business
As a result of the commodity chemicals business separation transaction in 2013, PPG has retained responsibility for potential environmental liabilities that may result from future Natural Resource Damage claims and any potential tort claims at
the Calcasieu River Estuary associated with activities and historical operations of the Lake Charles, La. facility. In the fourth quarter of 2017, PPG signed a consent decree prepared by the US Department of Justice for settlement of potential natural resource damage claims at the Calcasieu River Estuary. Payment of PPG’s previously accrued for share of costs into an escrow account will be required within 30 days of lodging of the agreement with the court. Lodging is expected to occur in the first quarter of 2018.
PPG retained additional responsibility for all liabilities relating to, arising out of or resulting from sediment contamination in the Ohio River resulting from historical activities and operations at the Natrium, W.Va. facility, exclusive of remedial activities, if any, that would have been required to have been performed on-site at the Natrium facility. PPG’s obligations with respect to the Ohio River sediment contamination
terminated because PPG received no notice of any requirements to further assess or to remediate sediment contamination in the Ohio River, caused by PPG’s operation of the Natrium facility prior to the separation of the commodity chemicals business, during an indemnification period established in the agreement transferring the business to Axiall that ended on December 30, 2017.
Remediation: reasonably possible matters
In addition to the amounts currently reserved for environmental remediation, the Company may be subject to loss contingencies related to environmental matters estimated to be as much as $100 million to $200 million. Such unreserved losses are reasonably
possible but are not currently considered to be probable of occurrence. These reasonably possible unreserved losses relate to environmental matters at a number of sites, none of which are individually significant. The loss contingencies related to these sites include significant unresolved issues such as the nature and extent of contamination at these sites and the methods that may have to be employed to remediate them.
The impact of evolving programs, such as natural resource damage claims, industrial site re-use initiatives and domestic and international remediation programs, also adds to the present uncertainties with regard to the ultimate resolution of this unreserved exposure to future loss. The Company’s assessment of the potential impact of these environmental contingencies is subject to considerable uncertainty due to the complex, ongoing
and evolving process of investigation and remediation, if necessary, of such environmental contingencies, and the potential for technological and regulatory developments.
15. Shareholders’ Equity
A class of 10 million shares of preferred stock, without par value, is authorized but unissued. Common stock has a par value of $1.66 2/3 per share; 1.2 billion shares are authorized.
Unrealized foreign currency translation adjustments related to translation of foreign denominated balance sheets are not presented net of tax given that no deferred U.S. income taxes have been provided on undistributed earnings of non-U.S. subsidiaries because they are deemed to be reinvested for an indefinite period of time.
(b)
The tax benefit (cost) related to unrealized foreign currency translation adjustments on tax inter-branch transactions and net investment hedges for the years ended December 31, 2017,
2016 and 2015 was $141 million, $(34) million and $(84) million, respectively. In 2015, the balance includes a remeasurement of the tax cost on the foreign proceeds from the sale of the Company’s interest in Transitions Optical which have not been permanently reinvested. Refer to Note 3, “Acquisitions and Divestitures” for additional information.
(c)
The tax cost related to the adjustment for pension and other postretirement benefits
for the years ended December 31, 2017, 2016 and 2015 was $(33) million, $(403) million and $(51) million, respectively. Reclassifications from AOCI are included in the computation of net periodic benefit costs (See Note 13, “Employee Benefit Plans”). The cumulative tax benefit related to the adjustment for pension and other postretirement benefits at December 31, 2017 and 2016 was $243 million and $276
million, respectively.
(d)
The tax cost (benefit) related to the change in the unrealized gain on derivatives for the years ended December 31, 2017, 2016 and 2015 was $5 million, $2 million and $(2) million, respectively. Reclassifications from AOCI are included in the gain or loss recognized on cash flow hedges (See Note 10 “Financial Instruments, Hedging Activities and Fair Value Measurements”).
2017
PPG ANNUAL REPORT AND FORM 10-K/A 87
Notes to the Consolidated Financial Statements
17. Other Income (As Restated)
($ in millions)
2017
2016
2015
As
Restated
As Restated
Gain on disposals of ownership interests in business affiliates
$25
$46
$—
Royalty
income
11
12
15
Share of net earnings of equity affiliates (See Note 6)
12
8
4
Gain
on sale of assets
28
6
4
Income from a legal settlement
18
—
—
Other
56
55
87
Total
$150
$127
$110
18.
Stock-Based Compensation (As Restated)
The Company’s stock-based compensation includes stock options, restricted stock units (“RSUs”) and grants of contingent shares that are earned based on achieving targeted levels of total shareholder return. All current grants of stock options, RSUs and contingent shares are made under the PPG Industries, Inc. Amended and Restated Omnibus Incentive Plan (“PPG Amended Omnibus Plan”), which was amended and restated effective April 21, 2016. Shares available for future grants under the PPG Amended Omnibus Plan were 8.0 million as of December 31, 2017.
($
in millions)
2017
2016
2015
As Restated
As Restated
Total
stock-based compensation
$35
$45
$54
Income tax benefit recognized
$12
$17
$18
Stock
Options
PPG has outstanding stock option awards that have been granted under the PPG Amended Omnibus Plan. Under the PPG Amended Omnibus Plan, certain employees of the Company have been granted options to purchase shares of common stock at prices equal to the fair market value of the shares on the date the options were granted. The options are generally exercisable 36 months after being granted and have a maximum term of 10 years. Upon exercise of a stock option, shares of Company stock are issued from treasury stock.
The fair value of stock options issued to employees is measured on the date of grant and is recognized as expense over the requisite service period. PPG estimates the fair value of stock options
using the Black-Scholes option pricing model. The risk-free interest rate is determined by using the U.S. Treasury yield curve at the date of the grant and using a maturity equal to the expected life of the option. The expected life of options is calculated using the average of the vesting term and the maximum term, as prescribed by accounting guidance on the use of the simplified method for determining the expected term of an employee share option. The expected dividend yield and volatility are based on historical stock prices and dividend amounts over past time periods equal in length to the expected life of the options.
The following weighted average assumptions were used to calculate the fair values of stock option grants in each year:
2017
2016
2015
Weighted
average exercise price
$101.53
$95.29
$118.02
Risk free interest rate
2.4
%
1.6
%
1.9
%
Expected
life of option in years
6.5
6.5
6.5
Expected dividend yield
1.8
%
2.1
%
2.7
%
Expected
volatility
22.0
%
22.8
%
29.2
%
The weighted average fair value of options granted was $21.15 per share, $17.94 per share and $26.94 per share for the years ended December 31,
2017, 2016, and 2015, respectively.
88 2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
Stock Options Outstanding and Exercisable
Number of
Shares
Weighted Average Exercise Price
Weighted Average Remaining Contractual Life (in years)
At December 31,
2017, unrecognized compensation cost related to outstanding stock options that have not yet vested totaled $7 million. This cost is expected to be recognized as expense over a weighted average period of 1.5 years.
The following table presents stock option activity for the years ended December 31, 2017, 2016 and 2015:
($
in millions)
2017
2016
2015
Total intrinsic value of stock options exercised
$40
$34
$92
Cash
received from stock option exercises
$52
$32
$53
Income tax benefit from the exercise of stock options
$15
$12
$31
Total
fair value of stock options vested
$13
$16
$13
Restricted Stock Units (“RSUs”)
Long-term incentive
value is delivered to selected key management employees by granting RSUs, which have either time or performance-based vesting features. The fair value of an RSU is equal to the market value of a share of PPG stock on the date of grant. Time-based RSUs vest over the three-year period following the date of grant, unless forfeited, and will be paid out in the form of stock, cash or a combination of both at the Company’s discretion at the end of the three year vesting period. Performance-based RSUs vest based on achieving specific annual performance targets for earnings per share growth and cash flow return on capital over the three calendar year-end periods following the date of grant. Unless forfeited, the performance-based RSUs will be paid out in the
form of stock, cash or a combination of both at the Company’s discretion at the end of the three-year performance period if PPG meets the performance targets. The amount paid for performance-based awards may range from 0% to 180% of the original grant, based upon the frequency with which the annual earnings per share growth and cash flow return on capital performance targets are met over the three calendar year periods comprising the vesting period. For the purposes of expense recognition, PPG has assumed that performance-based RSUs granted in 2015 will vest at the 150% level and those granted in 2016 and 2017 will vest at the 100%
level. As of December 31, 2017, four of the six possible performance targets had been met for the 2015 grant, two of the four possible performance targets had been met for the 2016 grant, and one of two possible performance targets had been met for the 2017 grant.
There
was $14 million of total unrecognized compensation cost related to unvested RSUs outstanding as of December 31, 2017. This cost is expected to be recognized as expense over a weighted average period of 1.7 years.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 89
Notes to the Consolidated Financial Statements
Contingent Share Grants
The Company also provides grants of contingent shares to selected key executives that may be earned based on PPG
total shareholder return (“TSR”) over the three-year period following the date of grant. Contingent share grants (referred to as “TSR awards”) are made annually and are paid out at the end of each three-year period based on the Company’s performance. Performance is measured by determining the percentile rank of the total shareholder return of PPG common stock in relation to the total shareholder return of the S&P 500 for the three-year period following the date of grant. This comparison group represents the entire S&P 500 Index as it existed at the beginning of the performance period, excluding any companies that have been removed from the index because they ceased to be publicly traded. The payment of awards following the three-year
award period will be based on performance achieved in accordance with the scale set forth in the plan agreement and may range from 0% to 220% of the initial grant. A payout of 100% is earned if the target performance is achieved. Contingent share awards for the 2015-2017, 2016-2018, and 2017-2019 periods earn dividend equivalents for the award period, which will be paid to participants or credited to the participants’ deferred compensation plan accounts with the award payout at the end of the period based on the actual number of contingent shares that are earned. Any payments made at the end of the award period may be in the form of stock, cash or a combination of both. The TSR awards qualify as liability awards, and compensation expense is recognized over the three-year award period based
on the fair value of the awards (giving consideration to the Company’s percentile rank of total shareholder return) remeasured in each reporting period until settlement of the awards.
As of December 31, 2017, there was $3 million of total unrecognized compensation cost related to outstanding TSR awards based on the current estimate of fair value. This cost is expected to be recognized as expense over a weighted average period of 1.7 years.
19. Quarterly Financial Information (unaudited) (As Restated)
As
further described in the Explanatory Note, in lieu of filing amended quarterly reports on Form 10-Q for 2017 and 2016, quarterly financial data for 2017 and 2016 (As Restated) is included in this Annual Report in the tables that follow.
In addition to the restatement of the financial statements, certain information within the following
notes to the financial statements and financial statement schedule has been restated to reflect the corrections of misstatements discussed previously:
Acquisitions and Divestitures
Stock-based Compensation
Shareholders’ Equity
Reportable Business Segment Information
Impact of the Restatement
As a result of the restatement, reported net income from continuing operations and earnings per diluted share from continuing operations was adjusted for the appropriate quarterly periods within 2016 and 2017 as follows:
•
For
the quarter ended December 31, 2016, net income from continuing operations decreased $4 million, or $0.01 per diluted share, and there was no impact to income from discontinued operations, net of tax.
•
For the quarter ended March 31, 2017, net income from continuing operations increased $3 million, or $0.01 per diluted share, and there was no impact to income from discontinued operations, net of tax.
•
For
the quarter ended June 30, 2017, net income from continuing operations decreased $7 million, or $0.03 per diluted share, and income from discontinued operations, net of tax, increased by $2 million, or $0.01 per diluted share; and for the six months ended June 30, 2017, net income from continuing operations decreased $4 million, or $0.02 per diluted share, and income from discontinued operations, net of tax, increased by $2 million, or $0.01 per diluted share.
•
For
the quarter ended September 30, 2017, net income from continuing operations increased $1 million, or zero cents per diluted share, and there was no impact to income from discontinued operations, net of tax; and for the nine months ended September 30, 2017, net income from continuing operations decreased $3 million, or $0.01 per diluted share, and income from discontinued operations, net of tax, increased by $2 million, or $0.01 per diluted share.
90 2017 PPG ANNUAL REPORT AND 10-K/A
Notes
to the Consolidated Financial Statements
•
For the quarter ended December 31, 2017, net income from continuing operations increased $1 million or zero cents per diluted share, and income from discontinued operations, net of tax, increased by $3 million, or $0.01 per diluted share.
The categories of misstatements and their impact on previously reported consolidated financial statements for the 2017 and 2016 quarterly periods are described below:
(a)
Customer
Rebates
The Company did not properly recognize expense associated with certain customer rebates, resulting in a misstatement of Net sales in the first and second quarters of 2017. The misstatements overstated previously reported Income before income taxes by $0.4 million and $1.4 million for the quarters ended March 31, 2017 and June 30, 2017, respectively.
(b)
Classification of Continuing Operations and Discontinued Operations
Certain
items of income related to PPG’s former Glass segment were inappropriately recorded in continuing operations rather than in discontinued operations. The misstatements overstated previously reported Income before income taxes by $2.5 million and $4.7 million for the quarters ended June 30, 2017 and December 31, 2017, respectively. The misstatements understated previously recorded Income from discontinued operations, net of tax, by $1.5 million and $2.9 million for the quarters ended June 30, 2017 and December 31, 2017, respectively.
(c)
Stock-Based
Compensation
In the fourth quarter of 2016, the Company improperly reduced the payout assumption for the 2015 grant of performance-based restricted stock units from 150% to 100%, which had the effect of reducing stock-based compensation expense in that period by $6.8 million. In the first quarter of 2017, the Company increased the payout assumption for these same restricted stock units from 100% back to 150%. These improper changes to the payout assumption for these restricted stock units resulted in a misstatement of
stock-based compensation expense in both the fourth quarter of 2016 and the first quarter of 2017. (See Note 18, “Stock-Based Compensation (As Restated),” for further information concerning the Company’s accounting for Restricted Stock Units.) The misstatements overstated previously reported Income before income taxes by $6.8 million for the quarter ended December 31, 2016 and understated previously reported Income before income taxes by $6.8 million for the quarter ended March 31, 2017.
(d)
Classification
of Business Restructuring Expense
The Company misclassified the release of the unused portion of the reserve related to the 2015 business restructuring program in the fourth quarter of 2016 of $3.4 million. The income associated with the release of the reserve was classified as Other income rather than as a reduction to Business restructuring in the Consolidated Statement of Income. The misclassification had no impact on Income before taxes.
(e)
Employee Vacation Pay
The
Company did not properly recognize expense associated with a change in the Company’s vacation policy in the second and third quarters of 2017. Rather, the entire amount of expense associated with this change was recognized in the fourth quarter of 2017, resulting in a misstatement of expense in the second, third and fourth quarters of 2017. The misstatements overstated previously reported Income before income taxes by $0.9 million and $1.3 million for the quarters ended June 30, 2017 and September 30, 2017, respectively, and understated previously reported Income before taxes by $2.2 million for the quarter ended December, 31, 2017. The misstatements
had no impact on Income before taxes for the year ended December 31, 2017.
(f)
Compensation Expense
The Company did not properly record compensation expense related to a payment made to an employee upon his separation from the Company in the second quarter of 2017. Rather, the expense associated with this payment was recognized in the second, third and fourth quarters of 2017 resulting in a misstatement of expense in each of these periods. The misstatements overstated previously reported
Income before income taxes by $3.5 million for the quarter ended June 30, 2017 and understated previously reported Income before taxes by $1.4 million and $2.1 million, respectively, for the quarters ended September 30, 2017 and December 31, 2017. The misstatements had no impact on Income before taxes for the year ended December 31, 2017.
(g)
Health Care Claims
The
Company did not properly recognize expense associated with the Company’s liability for employee health care claims in the second quarter of 2017. Rather, this expense was recognized in the third quarter of 2017, resulting in
2017 PPG ANNUAL REPORT AND FORM 10-K/A 91
Notes to the Consolidated Financial Statements
a misstatement of expense in the second and third quarters of 2017. The misstatements overstated previously reported Income before income taxes by $3.5 million for the quarter ended June 30, 2017 and understated previously reported Income before taxes by
$3.5 million for the quarter ended September 30, 2017. The misstatements had no impact on Income before taxes for the year ended December 31, 2017.
(h)
Environmental Reserve
In the first quarter of 2017, the Company failed to appropriately update the discount rate used to calculate a long-term environmental remediation reserve, which had the effect of understating Other expense by $0.5 million in the quarter. The misstatement
overstated previously reported Income before taxes by $0.5 million for the quarter ended March 31, 2017.
(i)
Pension Expense
The Company did not properly recognize pension expense in the third and fourth quarters of 2017. The misstatements overstated previously reported Income before income taxes by $1.0 million for the quarter ended September 30, 2017 and understated previously reported Income before taxes by $1.0
million for the quarter ended December 31, 2017. The misstatements had no impact on Income before taxes for the year ended December 31, 2017.
(j)
Income Taxes
Adjustments related to the income tax effects of other restatement adjustments noted above.
Quarterly Basis of Presentation (unaudited) (As Restated)
We have prepared the accompanying unaudited financial statements included in Note 19 in accordance with the
requirements of the Securities and Exchange Commission and accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Under these rules, certain footnotes and other financial information that are normally required for annual financial statements can be condensed or omitted. These statements include all adjustments, consisting only of normal, recurring adjustments, necessary for a fair presentation of the financial position of PPG Industries, Inc. and its subsidiaries (the "Company" or "PPG") and the results of their operations and their cash flows. All intercompany balances and transactions have been eliminated.These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements
and notes included in this Form 10-K/A for the year ended December 31, 2017.
92 2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
Quarterly Financial Information (unaudited) (As Restated)
2017
Quarter Ended
Full Year 2017(1)
($ in millions, except per share amounts)
March 31
June 30
September 30
December 31
Net sales
$3,486
$3,804
$3,776
$3,682
$14,748
Cost
of sales(2)
1,905
2,082
2,101
2,119
8,207
Net income (loss) attributable to PPG
Continuing
operations
$331
$497
$393
$148
$1,369
Discontinued
operations
6
(1
)
217
3
225
Net income
$337
$496
$610
$151
$1,594
Earnings
per common share
Continuing operations
$1.29
$1.93
$1.53
$0.59
$5.34
Discontinued
operations
0.02
—
0.85
0.01
0.88
Earnings per common share
$1.31
$1.93
$2.38
$0.60
$6.22
Earnings
per common share - assuming dilution
Continuing operations
$1.28
$1.92
$1.52
$0.58
$5.31
Discontinued
operations
0.02
—
0.84
0.01
0.87
Earnings per common share – assuming dilution
$1.30
$1.92
$2.36
$0.59
$6.18
2016
Quarter Ended
Full Year 2016(1)
($ in millions except per share amounts)
March 31
June 30
September 30
December 31
Net sales
$3,411
$3,782
$3,660
$3,417
$14,270
Cost
of sales(2)
1,817
1,988
1,978
1,910
7,693
Net income (loss) attributable to PPG
Continuing
operations
$328
$339
($211
)
$87
$543
Discontinued
operations
19
31
27
253
330
Net income (loss)
$347
$370
($184
)
$340
$873
Earnings
(loss) per common share
Continuing operations
$1.23
$1.26
($0.79
)
$0.34
$2.05
Discontinued
operations
0.07
0.12
0.10
0.96
1.24
Earnings (loss) per common share
$1.30
$1.38
($0.69
)
$1.30
$3.29
Earnings
(loss) per common share - assuming dilution
Continuing operations
$1.22
$1.25
($0.79
)
$0.33
$2.04
Discontinued
operations
0.07
0.12
0.10
0.96
1.23
Earnings (loss) per common share – assuming dilution
$1.29
$1.37
($0.69
)
$1.29
$3.27
(1)
Full
year earnings-per-share was calculated using the full year weighted average shares outstanding. As such, the sum of the quarters may not equal the total earnings-per-share for the year.
(2)
Exclusive of depreciation and amortization.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 93
Notes to the Consolidated Financial Statements
Quarterly Condensed Consolidated Statement of Income (unaudited) (As Restated)
2017
March
31
June 30
September 30
December 31
As Restated
As Restated
As Restated
As
Restated
Net sales
$3,486
$3,804
$3,776
$3,682
Cost
of sales, exclusive of depreciation and amortization
1,905
2,082
2,101
2,119
Selling, general and administrative
882
872
902
908
Depreciation
79
81
85
86
Amortization
31
32
32
34
Research
and development, net
110
113
114
116
Interest expense
25
26
27
27
Interest
income
(4
)
(4
)
(5
)
(7
)
Pension settlement charge
22
—
—
38
Other
charges
14
12
13
25
Other income
(24
)
(69
)
(16
)
(41
)
Income
from continuing operations before income taxes
$446
$659
$523
$377
Income
tax expense
110
157
124
224
Income from continuing operations
$336
$502
$399
$153
Income
from discontinued operations, net of tax
6
(1
)
217
3
Net income attributable to the controlling and noncontrolling interests
$342
$501
$616
$156
Less:
Net income attributable to noncontrolling interests
(5
)
(5
)
(6
)
(5
)
Net income (attributable to PPG)
$337
$496
$610
$151
Amounts
attributable to PPG:
Income from continuing operations, net of tax
$331
$497
$393
$148
Income
(loss) from discontinued operations, net of tax
6
(1
)
217
3
Net income (attributable to PPG)
$337
$496
$610
$151
Earnings
per common share:
Income from continuing operations, net of tax
$1.29
$1.93
$1.53
$0.59
Income
(loss) from discontinued operations, net of tax
0.02
—
0.85
0.01
Net income (attributable to PPG)
$1.31
$1.93
$2.38
$0.60
Earnings
per common share – assuming dilution:
Income from continuing operations, net of tax
$1.28
$1.92
$1.52
$0.58
Income
(loss) from discontinued operations, net of tax
0.02
—
0.84
0.01
Net income (attributable to PPG)
$1.30
$1.92
$2.36
$0.59
Dividends
per common share
$0.40
$0.40
$0.45
$0.45
94
2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
Condensed Consolidated Statement of Income (unaudited) (As Restated)
Income
from continuing operations before income taxes
$138
($7
)
$131
Income
tax expense
43
(3
)
(j)
40
Income from continuing operations
$95
($4
)
$91
Income
from discontinued operations, net of tax
253
—
253
Net income attributable to the controlling and noncontrolling interests
$348
($4
)
$344
Less:
Net income attributable to noncontrolling interests
(4
)
—
(4
)
Net income (attributable to PPG)
$344
($4
)
$340
Amounts
attributable to PPG:
Income from continuing operations, net of tax
$91
($4
)
$87
Income
from discontinued operations, net of tax
253
—
253
Net income (attributable to PPG)
$344
($4
)
$340
Earnings
per common share:
Income from continuing operations, net of tax
$0.35
($0.01
)
$0.34
Income
from discontinued operations, net of tax
0.96
—
0.96
Net income (attributable to PPG)
$1.31
($0.01
)
$1.30
Earnings
per common share – assuming dilution:
Income from continuing operations, net of tax
$0.34
($0.01
)
$0.33
Income
from discontinued operations, net of tax
0.96
—
0.96
Net income (attributable to PPG)
$1.30
($0.01
)
$1.29
Dividends
per common share
$0.40
$—
$0.40
106
2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
Quarterly Condensed Consolidated Statement of Comprehensive Income (unaudited) - Summary of Restatement
In the Statement of Comprehensive Income for the interim periods ended March 31, 2017, June 30, 2017 and September 30, 2017, Net income attributable to the controlling and noncontrolling interests reflects the impact of the restatement adjustments. The restatement adjustments had no impact to the previously disclosed components of Other comprehensive income, net of tax.
Quarterly
Condensed Consolidated Balance Sheet (unaudited) - Summary of Restatement
As of March 31, 2017, there are no changes to the previously reported quarterly condensed consolidated balance sheet.
Quarterly Condensed Consolidated Statement of Cash Flows (unaudited) - Summary of Restatement
There was no net impact of the quarterly 2017 and 2016 restatement adjustments on net cash provided by operating activities, net cash provided by investing activities or net cash used in financing activities in the Consolidated Statement of Cash Flows. The adjustments only had an impact on certain captions within cash from operating activities.
Acquisitions and Divestitures (As Restated)
The
net sales and income from discontinued operations related to the former Glass reportable business segment for the three and six months ended June 30, 2017 and 2016 were as follows:
Three Months Ended June 30
Six
Months Ended June 30
($ in millions)
2017
2016
2017
2016
As Restated
As
Restated
Net sales
$84
$282
$167
$543
Income
from operations
$12
$43
$21
$71
Income
tax expense
4
12
8
21
Income from discontinued operations, net of tax
$8
$31
$13
$50
The
net sales and income from discontinued operations related to the former Glass reportable business segment for the three and nine months ended September 30, 2017 and 2016 were as follows:
Three Months Ended September 30
Nine
Months Ended September 30
($ in millions)
2017
2016
2017
2016
As
Restated
Net sales
$50
$285
$217
$828
Income
from operations
$5
$38
$26
$109
Net
gain on divestiture of North American fiber glass business
343
—
343
—
Income tax expense
131
11
139
32
Income
from discontinued operations, net of tax
$217
$27
$230
$77
Stock-Based
Compensation (As Restated)
Stock-based compensation and the income tax benefit recognized during the three months ended March 31, 2017 were as follows:
Three Months Ended March 31
($ in millions)
2017
2016
As
Restated
Stock-based compensation
$9
$10
Income tax benefit recognized
$3
$4
Stock-based
compensation and the income tax benefit recognized during the three and six months ended June 30, 2017 and 2016 were as follows:
Three Months Ended June 30
Six Months
Ended June 30
($ in millions)
2017
2016
2017
2016
As
Restated
Stock-based compensation
$8
$16
$17
$26
Income
tax benefit recognized
$2
$5
$5
$9
Stock-based
compensation and the income tax benefit recognized during the three and nine months ended September 30, 2017 and 2016 were as follows:
2017 PPG ANNUAL REPORT AND FORM 10-K/A 108
Notes to the Consolidated Financial Statements
Three
Months Ended September 30
Nine Months Ended September 30
($ in millions)
2017
2016
2017
2016
As
Restated
Stock-based compensation
$9
$11
$26
$37
Income
tax benefit recognized
$4
$3
$9
$12
Shareholders’
Equity (As Restated)
Changes to shareholders’ equity for the three months ended March 31, 2017 were as follows:
Quarterly Reportable Business Segment Information (As Restated)
Three Months Ended March 31
($ in millions)
2017
2016
As
Restated
Net sales:
Performance Coatings
$2,017
$2,039
Industrial
Coatings
1,469
1,372
Total
$3,486
$3,411
Segment
income:
Performance Coatings
$284
$279
Industrial Coatings
273
265
Total
$557
$544
Corporate
(56
)
(63
)
Interest
expense, net of interest income
(21
)
(24
)
Legacy items (a)
(8
)
(11
)
Pension settlement charge
(22
)
—
Transaction-related
costs (b)
(4
)
(2
)
Income from continuing operations before income taxes
$446
$444
Three
Months Ended June 30
Six Months Ended June 30
($ in millions)
2017
2016
2017
2016
As Restated
As
Restated
Net sales:
Performance Coatings
$2,299
$2,338
$4,316
$4,377
Industrial
Coatings
1,505
1,444
2,974
2,816
Total
$3,804
$3,782
$7,290
$7,193
Segment
income:
Performance Coatings
$409
$428
$693
$707
Industrial
Coatings
264
292
537
557
Total
$673
$720
$1,230
$1,264
Corporate
(32
)
(60
)
(88
)
(123
)
Interest
expense, net of interest income
(22
)
(24
)
(43
)
(48
)
Legacy items (a)
2
(10
)
(6
)
(21
)
Asset
write-down
—
(10
)
—
(10
)
Gain from the sale of an equity affiliate
—
20
—
20
Pension
settlement charge
—
—
(22
)
—
Gain from sale of a business
25
—
25
—
Income
from a legal settlement
18
—
18
—
Transaction-related costs (b)
(5
)
(6
)
(9
)
(8
)
Income
from continuing operations before income taxes
$659
$630
$1,105
$1,074
110
2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
Three Months Ended September 30
Nine
Months Ended September 30
($ in millions)
2017
2016
2017
2016
As Restated
As
Restated
Net sales:
Performance Coatings
$2,290
$2,223
$
6,606
$6,600
Industrial
Coatings
1,486
1,437
4,460
4,253
Total
$3,776
$3,660
$11,066
$10,853
Segment
income:
Performance Coatings
$366
$368
$1,059
$1,075
Industrial
Coatings
223
249
760
806
Total
$589
$617
$1,819
$1,881
Corporate
(45
)
(43
)
(133
)
(166
)
Interest
expense, net of interest income
(22
)
(28
)
(65
)
(76
)
Legacy items (a)
1
(4
)
(5
)
(25
)
Asset
write-down
—
—
—
(10
)
Gain from the sale of an equity affiliate
—
—
—
20
Pension
settlement charge
—
(968
)
(22
)
(968
)
Gain from sale of a business
—
—
25
—
Income
from a legal settlement
—
—
18
—
Transaction-related costs (b)
—
—
(9
)
(8
)
Income
(loss) from continuing operations before income taxes
$523
($426
)
$1,628
$648
(a)
Legacy
items include current costs related to former operations of the Company, including pension and other postretirement benefit costs, certain charges for legal matters and environmental remediation costs, and certain other charges which are not associated with PPG's current business portfolio.
(b)
Transaction-related costs include advisory, legal, accounting, valuation and other professional or consulting fees incurred to effect significant acquisitions, as well as similar fees and other costs to effect disposals not classified as discontinued operations. These costs may also include the flow-through cost of sales for the step up to fair value of inventories acquired
in acquisitions. These costs also include certain severance costs and charges associated with the Company's recent business portfolio transformation.
20. Reportable Business Segment Information (As Restated)
Segment Organization and Products
PPG is a multinational manufacturer with 10 operating segments (which the Company refers to as “strategic business units”) that are organized based on the Company’s major products lines. These operating segments
are also the Company’s reporting units for purposes of testing goodwill for impairment (see Note 1, “Summary of Significant Accounting Policies”).
The Company’s reportable business segments include the following two segments: Performance Coatings and Industrial Coatings. The operating segments have been aggregated based on economic similarities, the nature of their products, production processes, end-use markets and methods of distribution.
The Performance Coatings reportable segment is comprised of the refinish, aerospace, architectural coatings – Americas and Asia-Pacific, architectural coatings - EMEA, and protective and marine coatings operating segments. This
reportable segment primarily supplies a variety of protective and decorative coatings, sealants and finishes along with paint strippers, stains and related chemicals, as well as transparencies and transparent armor.
The Industrial Coatings reportable segment is comprised of the automotive original equipment manufacturer (“OEM”) coatings, industrial coatings, packaging coatings, coatings services and the specialty coatings and materials operating segments. This reportable segment primarily supplies a variety of protective and decorative coatings and finishes along with adhesives, sealants, metal pretreatment products, optical monomers and coatings, precipitated silicas and other specialty materials.
Effective January 1, 2018, the coating services operating segment has been merged into the industrial coatings operating segment
and the Company will have 9 operating segments. Management teams and operations will be realigned to better deliver our total value proposition and provide optimal solutions to our customers, as well as to achieve operational efficiencies.
Production facilities and markets for Performance Coatings and Industrial Coatings are global. PPG’s reportable segments continue to pursue opportunities to further develop their global markets, including efforts in Asia, Eastern Europe and Latin America. Each of the reportable segments in which PPG is engaged is highly competitive. The diversification of our product lines and the worldwide markets served tend to minimize the impact on PPG’s total sales and income from continuing operations of changes in demand in a particular market or in a particular geographic
area.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 111
Notes to the Consolidated Financial Statements
The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies (See Note 1, “Summary of Significant Accounting Policies”). The Company allocates resources to operating segments and evaluates the performance of operating segments based upon segment income, which is income before interest expense – net, income taxes, and noncontrolling interests and excludes certain charges which are considered to be unusual or non-recurring. The
Company also evaluates performance of operating segments based on working capital reduction, margin growth, and sales volume growth. Legacy items include current costs related to former operations of the Company, including certain environmental remediation, pension and other postretirement benefit costs, and certain charges for legal and other matters which are considered to be unusual or non-recurring. These legacy costs are excluded from the segment income that is used to evaluate the performance of the operating segments.
Corporate unallocated costs include the costs of corporate staff functions not directly associated with the operating segments, the cost of corporate legal cases, net of related insurance recoveries and the cost of certain insurance and stock-based compensation programs. Net periodic pension expense is allocated to the
operating segments and the portion of net periodic pension expense related to the corporate staff functions is included in the Corporate unallocated costs.
Product movement between Performance Coatings and Industrial Coatings is limited, is accounted for as an inventory transfer, and is recorded at cost plus a mark-up, the impact of which is not significant to the segment income of the reportable segments.
As
Restated
($ in millions)
Reportable Business Segments
Performance Coatings
Industrial
Coatings
Corporate / Eliminations / Non-Segment Items(1)
Consolidated Totals
2017
Net
sales to external customers
$8,730
$6,018
$
—
$14,748
Intersegment
net sales
—
—
—
—
Total net sales
$8,730
$6,018
$
—
$14,748
Segment
income
$1,321
$972
$
—
$2,293
Legacy
items(2)
(2
)
Pension settlement charge
(60
)
Transaction-related
costs(5)
(9
)
Asset write-downs
(7
)
Gain
from sale of the Plaka business
25
Gain from a legal settlement
18
Gain
from sale of a non-operating asset
13
Interest expense, net of interest income
(85
)
Corporate
unallocated(1)
(181
)
Income before income taxes
$2,005
Depreciation
and amortization
$272
$164
$24
$460
Share
of net earnings (loss) of equity affiliates
$2
$—
$10
$12
Segment
assets(3)
$9,763
$4,563
$2,212
$16,538
Investment
in equity affiliates
$32
$13
$89
$134
Expenditures
for property (including business acquisitions)
$224
$328
$133
$685
112
2017 PPG ANNUAL REPORT AND 10-K/A
Notes to the Consolidated Financial Statements
As Restated
($
in millions)
Reportable Business Segments
Performance Coatings
Industrial Coatings
Corporate / Eliminations / Non-Segment Items(1)
Consolidated Totals
2016
Net
sales to external customers
$8,580
$5,690
$—
$14,270
Intersegment
net sales
—
1
(1
)
—
Total net sales
$8,580
$5,691
($1
)
$14,270
Segment
income
$1,314
$1,042
$—
$2,356
Legacy
items(2)
(114
)
Business restructuring charge
(191
)
Transaction-related
costs(5)
(8
)
Pension settlement charges
(968
)
Asset
write-downs
(23
)
Gains on disposals of ownership interests in business affiliates
46
Interest
expense, net of interest income
(99
)
Corporate unallocated(1)
(220
)
Income
before income taxes
$779
Depreciation and amortization
$272
$143
$25
$440
Share
of net earnings/(loss) of equity affiliates
$5
$1
$2
$8
Segment
assets(3)
$9,168
$3,972
$2,631
$15,771
Investment
in equity affiliates
$30
$13
$3
$46
Expenditures
for property (including business acquisitions)
$187
$510
$32
$729
($
in millions)
Reportable Business Segments
Performance Coatings
Industrial Coatings
Corporate / Eliminations /
Non-Segment Items(1)
Consolidated
Totals
2015
Net
sales to external customers
$8,765
$5,476
$—
$14,241
Intersegment
net sales
—
1
(1
)
—
Total net sales
$8,765
$5,477
($1
)
$14,241
Segment
income
$1,302
$985
$—
$2,287
Legacy
items(2)
(51
)
Business restructuring charge
(136
)
Transaction-related
costs(5)
(44
)
Interest expense, net of interest income
(86
)
Corporate
unallocated(1)
(225
)
Income before income taxes
$1,745
Depreciation
and amortization
$296
$124
$26
$446
Share
of net earnings of equity affiliates
$7
$—
($3
)
$4
Segment
assets(3)
$9,917
$3,643
$3,516
$17,076
Investment
in equity affiliates
$45
$13
$36
$94
Expenditures
for property (including business acquisitions)
$298
$414
$38
$750
2017
PPG ANNUAL REPORT AND FORM 10-K/A 113
Notes to the Consolidated Financial Statements
($ in millions)
Geographic
Information
2017
2016
2015
Net sales(4)
As Restated
United
States and Canada
$6,307
$6,254
$6,232
Europe, Middle East and Africa (“EMEA”)
4,389
4,164
4,103
Asia
Pacific
2,523
2,431
2,433
Latin America
1,529
1,421
1,473
Total
$14,748
$14,270
$14,241
Segment
income
United States and Canada
$1,129
$1,152
$1,176
EMEA
569
590
539
Asia
Pacific
361
382
359
Latin America
234
232
213
Total
$2,293
$2,356
$2,287
Property—net
United
States and Canada
$1,224
$1,184
$1,101
EMEA
826
726
805
Asia
Pacific
493
447
431
Latin America
281
251
271
Total
$2,824
$2,608
$2,608
(1)
Corporate
intersegment net sales represent intersegment net sales eliminations. Corporate unallocated costs include the costs of corporate staff functions not directly associated with the operating segments, certain legal and insurance costs and stock-based compensation expense.
(2)
Legacy items include current costs related to former operations of the Company, including certain environmental remediation, pension and other postretirement benefit costs, legal costs and certain charges which are considered to be non-recurring. Until April 2016, legacy items also include equity earnings from PPG’s minority investment in Pittsburgh Glass Works, LLC. The Legacy items for 2016
include an environmental remediation pre-tax charge of $82 million. These charges relate to continued environmental remediation activities at legacy chemicals sites, primarily at PPG’s former Jersey City, N.J. chromium manufacturing plant and associated sites (Refer to Note 14, “Commitments and Contingent Liabilities”).
(3)
Segment assets are the total assets used in the operation of each segment. Corporate assets are principally cash and cash equivalents, cash held in escrow, short term investments, deferred tax assets and, until April 2016, PPG’s equity investment in it’s former automotive glass and services business. Non-segment items also includes the assets of businesses which have been
reclassified as discontinued operations in the Consolidated Statement of Income. (Refer to Note 3, “Acquisitions and Divestitures”).
(4)
Net sales to external customers are attributed to geographic regions based upon the location of the operating unit shipping the product.
(5)
Transaction-related costs include advisory, legal, accounting, valuation, and other professional or consulting fees incurred to effect significant acquisitions, as well as similar fees and other costs to effect divestitures not classified
as discontinued operations. These costs also include the flow-through cost of sales for the step up to fair value of inventory acquired in acquisitions.
114 2017 PPG ANNUAL REPORT AND 10-K/A
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
(a)
Evaluation
of disclosure controls and procedures.
The Company’s management is responsible for establishing and maintaining adequate disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Disclosure controls and procedures means controls and other procedures of the Company that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act, is recorded, processed, summarized, and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed
to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
At the time that the Original Filing was made, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2017.
The Company’s principal executive and principal financial officers re-evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2017, and have concluded that because of the material weakness in the Company’s internal control over financial reporting as discussed under Item 8. “Financial Statements and Supplementary Data-Management Report,”the Company’s disclosure controls and procedures were not effective. In light of the material weakness, the
Company performed additional analysis and other post closing procedures to ensure the Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. Accordingly, the Company’s management, including our principal executive and principal financial officers, have concluded that the consolidated financial statements included in this Form 10-K/A present fairly, in all material respects, the Company’s financial position, results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States.
(b) Changes in internal control over financial
reporting.
There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s quarter ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
(c) Management report on internal control over financial reporting.
See Management Report on page 44 for management’s annual report on internal control over financial reporting. See Report of Independent Registered Public Accounting Firm on pages 42-43 for
PricewaterhouseCoopers LLP’s audit report on the Company’s internal control over financial reporting.
(d) Prior interim period disclosure controls and procedures and internal control over financial reporting
Additionally, in connection with the restatement, the Company’s principal executive and principal financial officers have reassessed the effectiveness of the Company’s internal control
over financial reporting as of December 2016 and, due to the existence of the material weakness in internal control over financial reporting discussed under Item 8. “Financial Statements and Supplementary Data - Management Report,” have determined that the Company’s internal control over financial reporting was not effective as of such date.
(e) Remediation of Material Weakness.
In connection with the investigation described in the Explanatory Note, the Company has identified and implemented, and continues to identify and implement, actions to improve the effectiveness of its internal control over financial reporting and disclosure controls and procedures, including plans to enhance the
Company’s resources and training with respect to financial reporting and disclosure responsibilities. Management has reviewed and will continue to review such actions with the Audit Committee. To date, the following steps have been taken towards the remediation of the Company’s material weakness:
•
The Company has terminated the employment of the former Vice President and Controller. Two employees who acted under his direction have been re-assigned to different positions within the Company where they do not have
a role in the Company’s internal control over financial reporting or its disclosure controls and procedures.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 115
•
The Company has appointed its former Director of Corporate Audit Services and former Assistant Controller, Financial Reporting as Acting Controller and has initiated a search to fill this role on a permanent basis.
•
The
Company’s Chairman and Chief Executive Officer has emphasized to all employees, and to the Company’s finance employees specifically, the importance of acting ethically and adhering to the Company’s Global Code of Ethics.
The Company is committed to maintaining a strong internal control environment and to ensuring that a proper, consistent tone is communicated throughout the organization, including the expectation that previously existing deficiencies will be remediated through the implementation of processes and controls to ensure strict compliance with generally accepted accounting principles. In addition to the steps set forth above, the
Company plans to take other remedial measures as described below:
•
The Company will re-emphasize (1) its commitment to ethical standards, (2) the requirements of the Company’s Code of Ethics, (3) reporting obligations and (4) non-retaliation policy for complaints;
•
The Company will enhance
its corporate finance department by adding personnel with responsibility for areas identified in the investigation and enhance segregation of duties in the finance department;
•
The Company will enhance policies and procedures relating to the preparation, approval and entry of journal entries;
•
The Company will enhance its process to evaluate and adjust
certain significant expense accruals;
•
The Company will enhance its policies and procedures relating to inventory standard cost revaluations;
•
The Company will enhance its policies and procedures concerning accounting entries related to discontinued operations;
•
The
Company will require additional annual/onboarding education for finance staff;
•
The Company will conduct additional periodic risk assessments and targeted internal audit reviews; and
•
The Company will separate the financial forecasting process from financial accounting.
As
the Company continues to evaluate and work to improve internal control over financial reporting, the Company may determine to take additional measures to strengthen its internal control environment or modify the remediation efforts described above. Until the remediation efforts discussed above, including any additional remediation efforts that the Company identifies as necessary, are implemented, tested and deemed to be operating effectively, the material weakness described above will continue to exist.
Item 9B. Other Information
None.
Part
III
Item 10. Directors, Executive Officers and Corporate Governance
The information about the Company’s directors required by Item 10 and not otherwise set forth below is contained under the caption “Proposal 1: Election of Directors” in PPG’s definitive Proxy Statement for the 2018 Annual Meeting of Shareholders (the “Proxy Statement”) which the Company anticipates filing with the Securities and Exchange Commission, pursuant to Regulation 14A, not later than 120 days after the end of the Company’s fiscal year, and is incorporated
herein by reference.
The executive officers of the Company are elected by the Board of Directors. The information required by this item concerning the Company’s executive officers is incorporated by reference herein from Part I of this report under the caption “Executive Officers of the Company.”
Information regarding the Company’s Audit Committee is included in the Proxy Statement under the caption “Corporate Governance – Audit Committee” and is incorporated
herein by reference.
Information regarding the Company’s codes of ethics is included in the Proxy Statement under the caption “Corporate Governance – Codes of Ethics” and is incorporated herein by reference.
Information about compliance with Section 16(a) of the Exchange Act is included in the Proxy Statement under the caption “Beneficial Ownership – Section 16(a) Beneficial Ownership Reporting Compliance” and is incorporated herein by reference.
Item 11. Executive Compensation
116
2017 PPG ANNUAL REPORT AND 10-K/A
The information required by Item 11 is contained in the Proxy Statement under the captions “Compensation of Directors,”“Compensation Discussion and Analysis,”“Compensation of Executive Officers,”“Potential Payments upon Termination or Change in Control,”“Corporate Governance – Compensation Committee Interlocks and Insider Participation,” and “Corporate Governance – Officers-Directors Compensation Committee Report to Shareholders” and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by
Item 12 is contained in the Proxy Statement under the captions “Beneficial Ownership” and “Equity Compensation Plan Information” and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Item 13 is contained in the Proxy Statement under the captions “Corporate Governance – Director Independence,”“Corporate Governance – Review and Approval or Ratification of Transactions with Related Persons” and “Corporate Governance – Certain Relationships and Related Transactions” and is incorporated herein by reference.
Item 14.
Principal Accounting Fees and Services
The information required by Item 14 is contained in the Proxy Statement under the caption “Independent Registered Public Accounting Firm” and is incorporated herein by reference.
Part IV
Item 15. Exhibits, Financial Statement Schedules
(a)(1) Consolidated Financial Statements and Reports of Independent Registered Public Accounting Firm (see Part II, Item 8 of this Form 10-K/A).
The following information is filed as part of this Form 10-K/A:
(a)(2) Consolidated Financial Statement Schedule for the years ended December 31, 2017, 2016 and 2015.
The following
Consolidated Financial Statement Schedule should be read in conjunction with the previously referenced financial statements:
Schedule II – Valuation and Qualifying Accounts
Allowance for Doubtful Accounts for the Years Ended December 31, 2017, 2016, and 2015
($
in millions)
Balance at Beginning of Year
Charged to Costs and Expenses
Deductions(1)
Balance at End of Year
2017
$36
$15
($26
)
$25
2016
$43
$22
($29
)
$36
2015
$80
$10
($47
)
$43
(1)
Notes
and accounts receivable written off as uncollectible, net of recoveries, amounts attributable to divestitures and changes attributable to foreign currency translation.
All other schedules are omitted because they are not applicable.
2017 PPG ANNUAL REPORT AND FORM 10-K/A 117
(a)(3) Exhibits. The following exhibits are filed as a part of, or incorporated by reference into, this Form 10-K/A.
Management
contracts, compensatory plans or arrangements required to be filed as an exhibit hereto pursuant to Item 601 of Regulation S-K.
**
Attached as Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language) as of and for the year ended December 31, 2017: (i) the Consolidated Statement of Income, (ii) the Consolidated Balance Sheet, (iii) the Consolidated Statement of Shareholders’ Equity, (iv) the
Consolidated Statement of Comprehensive Income (Loss), (v) the Consolidated Statement of Cash Flows, (vi) Notes to Consolidated Financial Statements and (vii) Financial Schedule of Valuation and Qualifying Accounts.
Item 16. Form 10-K Summary
None.
120 2017 PPG ANNUAL REPORT AND 10-K/A
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized on June 28, 2018.
Assistant Controller and Acting Controller (Principal Accounting Officer and Duly Authorized Officer)
Pursuant to the requirements of the Securities Exchange Act
of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities indicated on June 28, 2018.