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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 2003,
OR
- --- TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________________ TO
__________________.
COMMISSION FILE NO. 1-14187
RPM INTERNATIONAL INC.
-----------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 02-0642224
- ------------------------------- ----------
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
P.O. BOX 777; 2628 PEARL ROAD; MEDINA, OHIO 44258
- ------------------------------------------------ ---------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE (330) 273-5090
- --------------------------------------------------------------------------------
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 (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS) AND (2) HAS BEEN SUBJECT TO THE FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
YES X NO.
------ ------
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT).
YES X NO.
------ ------
AS OF JANUARY 6, 2004
115,788,334 SHARES OF RPM INTERNATIONAL INC. COMMON STOCK WERE OUTSTANDING.
RPM INTERNATIONAL INC. AND SUBSIDIARIES*
----------------------------------------
INDEX
-----
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
- ------------------------------
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED):
CONSOLIDATED BALANCE SHEETS 3
CONSOLIDATED STATEMENTS OF INCOME 4
CONSOLIDATED STATEMENTS OF CASH FLOWS 5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 24
ITEM 4. CONTROLS AND PROCEDURES 24
PART II. OTHER INFORMATION
- ---------------------------
ITEM 1. LEGAL PROCEEDINGS 25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS 28
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 30
SIGNATURES 31
* As used herein, the terms "RPM" and the "Company" refer to RPM International
Inc. and its subsidiaries, unless the context indicates otherwise.
3
PART I. -- FINANCIAL INFORMATION
--------------------------------
ITEM 1. -- FINANCIAL STATEMENTS
-------------------------------
RPM INTERNATIONAL INC. AND SUBSIDIARIES
---------------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
(UNAUDITED)
(In thousands, except per share amounts)
ASSETS
November 30, 2003 May 31, 2003
----------------- ------------
Current Assets
Cash and short-term investments $ 48,498 $ 50,725
Trade accounts receivable (less allowances of
$18,304 and $17,297, respectively) 424,045 439,623
Inventories 264,341 253,204
Deferred income taxes 54,143 51,285
Prepaid expenses and other current assets 139,446 133,257
---------- ----------
Total current assets 930,473 928,094
---------- ----------
Property, Plant and Equipment, at Cost 737,781 714,009
Allowance for depreciation and amortization (368,929) (343,220)
---------- ----------
Property, plant and equipment, net 368,852 370,789
---------- ----------
Other Assets
Goodwill 648,364 631,253
Other intangible assets, net of amortization 277,471 282,949
Other 36,074 34,126
---------- ----------
Total other assets 961,909 948,328
---------- ----------
Total Assets $2,261,234 $2,247,211
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 150,785 $ 171,956
Current portion of long-term debt 1,615 1,282
Accrued compensation and benefits 67,997 77,577
Accrued loss reserves 57,759 64,230
Asbestos-related liabilities 49,203 41,583
Other accrued liabilities 66,265 59,759
Income taxes payable (2,024) 11,263
---------- ----------
Total current liabilities 391,600 427,650
---------- ----------
Long-Term Liabilities
Long-term debt, less current maturities 721,620 724,846
Asbestos-related liabilities 69,035 103,000
Other long-term liabilities 60,480 59,951
Deferred income taxes 73,159 54,756
---------- ----------
Total long-term liabilities 924,294 942,553
---------- ----------
Stockholders' Equity
Preferred stock, par value $0.01; authorized 50,000 shares;
none issued
Common stock, par value $0.01 authorized 300,000 shares;
issued 115,731 and outstanding 115,702 as of November 2003;
issued 115,596 and outstanding 115,496 as of May 2003 1,157 1,156
Paid-in capital 509,999 508,397
Treasury stock, at cost (337) (1,167)
Accumulated other comprehensive loss (2,958) (17,169)
Retained earnings 437,479 385,791
---------- ----------
Total stockholders' equity 945,340 877,008
---------- ----------
Total Liabilities and Stockholders' Equity $2,261,234 $2,247,211
========== ==========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
4
RPM INTERNATIONAL INC. AND SUBSIDIARIES
---------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
---------------------------------
(UNAUDITED)
(In thousands, except per share amounts)
SIX MONTHS ENDED THREE MONTHS ENDED
NOVEMBER 30, NOVEMBER 30,
------------------------------ -----------------------
2003 2002 2003 2002
----------- ----------- --------- ----------
NET SALES $ 1,179,925 $ 1,060,381 $ 589,834 $ 517,968
COST OF SALES 637,946 569,499 323,966 285,197
----------- ----------- --------- ----------
GROSS PROFIT 541,979 490,882 265,868 232,771
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 400,466 363,136 204,548 180,122
INTEREST EXPENSE, NET 12,994 14,188 6,711 6,984
----------- ----------- --------- ----------
INCOME BEFORE INCOME TAXES 128,519 113,558 54,609 45,665
PROVISION FOR INCOME TAXES 45,624 39,745 19,386 16,025
----------- ----------- --------- ----------
NET INCOME $ 82,895 $ 73,813 $ 35,223 $ 29,640
=========== =========== ========= ==========
AVERAGE NUMBER OF SHARES OF COMMON STOCK OUTSTANDING:
BASIC 115,613 115,001 115,670 115,240
=========== =========== ========= ==========
DILUTED 116,335 115,981 116,443 116,201
=========== =========== ========= ==========
BASIC EARNINGS PER SHARE OF COMMON STOCK $ 0.72 $ 0.64 $ 0.30 $ 0.26
=========== =========== ========= ==========
DILUTED EARNINGS PER SHARE OF COMMON STOCK $ 0.71 $ 0.64 $ 0.30 $ 0.26
=========== =========== ========= ==========
CASH DIVIDENDS PER SHARE OF COMMON STOCK $ 0.2700 $ 0.2550 $ 0.1400 $ 0.1300
=========== =========== ========= ==========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
5
RPM INTERNATIONAL INC. AND SUBSIDIARIES
---------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
(Unaudited)
(In thousands)
Six Months Ended November 30,
----------------------------------------
2003 2002
-------- --------
Cash Flows From Operating Activities:
Net income $ 82,895 $ 73,813
Depreciation and amortization 30,925 28,081
Items not affecting cash and other (11,074) (2,872)
Changes in operating working capital (36,883) (8,489)
-------- --------
65,863 90,533
-------- --------
Cash Flows From Investing Activities:
Capital expenditures (15,457) (13,702)
Acquisition of businesses, net of cash acquired (20,000) (9,387)
-------- --------
(35,457) (23,089)
-------- --------
Cash Flows From Financing Activities:
Reductions of long-term and short-term debt (2,893) (22,900)
Cash dividends (31,208) (29,111)
Exercise of stock options 1,468 2,828
-------- --------
(32,633) (49,183)
-------- --------
(Decrease) Increase in Cash and Short-Term Investments (2,227) 18,261
Cash and Short-Term Investments at Beginning of Period 50,725 42,172
-------- --------
Cash and Short-Term Investments at End of Period $ 48,498 $ 60,433
======== ========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
6
RPM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2003
(UNAUDITED)
- --------------------------------------------------------------------------------
NOTE A - BASIS OF PRESENTATION
- ------------------------------
The accompanying unaudited consolidated financial statements have been prepared
in accordance with the instructions to Form 10-Q and do not include all of the
information and notes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments
(consisting of normal, recurring accruals) considered necessary for a fair
presentation have been included for the three and six month periods ended
November 30, 2003 and 2002. For further information, refer to the Consolidated
Financial Statements and notes included in our Annual Report on Form 10-K for
the year ended May 31, 2003.
Certain reclassifications have been made to prior year amounts to conform to the
current year presentation.
NOTE B - INVENTORIES
- --------------------
Inventories were composed of the following major classes:
NOVEMBER 30, 2003 MAY 31, 2003
----------------- ------------
(IN THOUSANDS)
Raw materials and supplies $100,280 $ 80,517
Finished goods 164,061 172,687
-------- --------
$264,341 $253,204
======== ========
NOTE C - COMPREHENSIVE INCOME
- -----------------------------
Other comprehensive income includes foreign currency translation adjustments,
minimum pension liability adjustments and unrealized gains or losses on
securities. Total comprehensive income, comprised of net income and other
comprehensive income, amounted to $59.0 million and $31.0 million during the
second quarter of fiscal years 2004 and 2003, respectively, and $97.1 million
and $75.9 million for the six-month periods ended November 30, 2003 and 2002,
respectively.
NOTE D - REINCORPORATION
- ------------------------
At the annual shareholders meeting on October 11, 2002, RPM shareholders
approved a plan to change RPM's legal place of incorporation from Ohio to
Delaware. Under the plan, a new legal entity, RPM International Inc., was
incorporated in Delaware and became the parent holding company of Ohio-based
RPM, Inc. and several other intermediate holding companies and wholly owned
subsidiaries. In addition to the creation of a newly formed Delaware legal
entity, the legal structures of various operating companies were realigned in
consistency with their
7
RPM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2003
(UNAUDITED)
- --------------------------------------------------------------------------------
respective business objectives. All of the outstanding treasury shares of RPM,
Inc. were cancelled and retired without any consideration. In addition, each
common share of RPM, Inc. issued and outstanding on October 15, 2002 was
converted into one share of the Company, with a $0.01 par value per share. This
transaction did not have any effect on the book value per share,
post-reincorporation.
NOTE E - STOCK BASED COMPENSATION
- ---------------------------------
At November 30, 2003, we had two stock-based compensation plans accounted for
under the recognition and measurement principles of Accounting Principles Board
Opinion (APBO) No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. Pro forma information regarding the impact of stock-based
compensation on net income and earnings per share is required by SFAS No. 123,
"Accounting for Stock-Based Compensation," and SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure." Such pro forma information,
determined as if we had accounted for our employee stock options under the fair
value recognition provisions of SFAS No. 123, is illustrated in the following
table:
Six Months Ended Three Months Ended
November 30, November 30,
------------------------ ---------------------
2003 2002 2003 2002
------- ------- -------- -------
(In thousands, except per share amounts)
Net Income, as reported $82,895 $73,813 $35,223 $29,640
Add: Stock-based employee compensation expense from
restricted stock plans included in reported
net income, net of related tax effects 666 585 333 341
Deduct: Total stock-based compensation expense determined
under fair value-based method for all awards, net of
related tax effects (2,018) (1,940) (1,220) (1,104)
------- ------- ------- -------
Pro Forma Net Income $81,543 $72,458 $34,336 $28,877
======= ======= ======= =======
Earnings per Share, as reported:
Basic $ 0.72 $ 0.64 $ 0.30 $ 0.26
======= ======= ======= =======
Diluted $ 0.71 $ 0.64 $ 0.30 $ 0.26
======= ======= ======= =======
Pro Forma Earnings per Share:
Basic $ 0.71 $ 0.63 $ 0.30 $ 0.25
======= ======= ======= =======
Diluted $ 0.70 $ 0.62 $ 0.29 $ 0.25
======= ======= ======= =======
8
RPM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2003
(UNAUDITED)
- --------------------------------------------------------------------------------
NOTE F - ASBESTOS-RELATED LIABILITIES
- -------------------------------------
Certain of our wholly owned subsidiaries, principally Bondex International, Inc.
(Bondex), along with many other U.S. companies, are and have been involved in a
large number of asbestos-related suits filed primarily in state courts during
the past two decades. These suits principally allege personal injury resulting
from exposure to asbestos-containing products.
The rate at which plaintiffs filed asbestos-related suits against Bondex
increased in the fourth quarter of fiscal 2002 and the first three quarters of
fiscal 2003, influenced by the bankruptcy filings of numerous other defendants
in asbestos-related litigation. Based on the significant increase in asbestos
claims activity and inequitable joint and several liability determinations
against Bondex, as previously reported, our third-party insurance was depleted
in the first quarter of this fiscal year. Our third-party insurers historically
have been responsible, under various cost-sharing arrangements, for the payment
of approximately 90% of the indemnity and defense costs associated with our
asbestos litigation. Prior to this sudden precipitous increase in loss rates,
the combination of book loss reserves and insurance coverage was expected to
adequately fund asbestos loss payments for the foreseeable future. We have
reserved our rights with respect to various of our third-party insurers' claims
of exhaustion, and in late calendar 2002 commenced reviewing our known insurance
policies to determine whether or not other insurance limits may be available to
cover our asbestos liabilities. As a result of this examination, on July 3,
2003, the Company filed a complaint in Federal Court against several insurance
carriers for declaratory judgment, breach of contract and bad faith. We are
unable at the present time to predict whether, or to what extent, any additional
insurance may cover our asbestos liabilities.
During the last seven months of fiscal 2003, new state liability laws were
enacted in three states where more than 80% of the claims against Bondex are
pending. The changes generally provide for liability to be determined on a
"proportional cause" basis, thereby limiting Bondex's responsibility to only its
share of the alleged asbestos exposure. The ultimate impact of these new laws is
difficult to predict given the limited time following enactment, because the
full influence of these law changes on legal settlement values is not expected
to have an impact on asbestos litigation affecting us until the latter part of
fiscal 2004 or early in fiscal 2005.
At the end of fiscal 2002 and through the third quarter of fiscal 2003, Bondex
had concluded it was not possible to estimate its cost of disposing of
asbestos-related claims that might be filed against Bondex in the future. During
the fourth quarter of fiscal 2003, Bondex retained a nationally recognized
consulting firm with broad experience in estimating resolution costs associated
with mass tort litigation, including asbestos, to assist it in analyzing its
loss history data, to evaluate whether it would be possible to estimate the cost
of disposing pending claims in light of both past and recent loss history, and
to assist in determining whether future asbestos-related claims reasonably
expected to be filed against Bondex were measurable, given recent changes of
law.
9
RPM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2003
(UNAUDITED)
- --------------------------------------------------------------------------------
As of May 31, 2003, the consultants concluded that it was not possible to
currently estimate the full range of the cost of resolving future
asbestos-related claims against Bondex because of various uncertainties
associated with those potential future claims. These uncertainties included the
following:
- The bankruptcies in the years 2000 through 2002 of other companies
facing large asbestos liability were a likely contributing cause of a
sharp increase in filings against many defendants, including Bondex.
- The recent state law changes in states wherein the vast majority of our
claims are pending and have been historically filed are expected to
materially affect future losses and future claim filing activity and
resolution costs.
- The currently proposed federal legislative initiative aimed at
establishment of a federal asbestos trust fund has influenced and
changed the demand behavior of plaintiffs from that of historic levels,
creating further uncertainty in the estimation process.
At this time, we cannot estimate the liability that will result from all future
claims. We established a reserve at May 31, 2003 for those pending cases that
had progressed to a stage where the cost to dispose of these cases could
reasonably be estimated. The estimation of even pending cases is difficult due
to the dynamic nature of asbestos litigation. The reserve was established by
taking an asbestos charge to fiscal 2003 operations of $140.0 million for
measurable known claims and a provision for the future claims that can presently
be estimated. We believed then and continue to believe that the asbestos reserve
would be sufficient to cover asbestos-related cash flow requirements through
fiscal 2006. The estimates for the $140.0 million asbestos charge were developed
in consultation with our outside consulting firm and defense counsel, taking
into account both historical and current settlement values. We recognize that
future facts, events and legislation, both state and/or federal, may alter our
estimates of both pending and future claims. We cannot estimate possible
liabilities in excess of those accrued because we cannot predict the number of
additional claims that may be filed in the future, the grounds for such claims,
the damages that may be demanded, the probable outcome, or the impact of recent
state and pending federal legislation on prospective asbestos claims.
In conjunction with outside advisors, we continue to study our asbestos-related
exposure and evaluate the adequacy of this reserve and the related cash flow
implications in light of actual claims experience, the impact of state law
changes and the evolving nature of federal legislative efforts to address
asbestos litigation. As of November 30, 2003, we believe the underlying facts
and assumptions supporting establishment of the $140.0 million reserve (an
amount adequate to cover approximately three years of cash flow requirements)
have undergone no significant change, other than passage of time.
Due to the uncertainty inherent in the loss reserve estimations process, we are
unable to estimate an additional range of loss in excess of our accruals. It is
at least reasonably possible that actual
10
RPM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2003
(UNAUDITED)
- --------------------------------------------------------------------------------
costs will differ from estimates, but, based upon information presently
available, such future costs are not expected to have a material adverse effect
on our competitive or financial position or ongoing results of operations.
However, such costs could be material to results of operations in a future
period.
NOTE G - SUBSEQUENT EVENT
- -------------------------
Subsequent to quarter end, on December 4, 2003, the Company issued and sold $200
million aggregate principal amount of 6.25% Senior Notes due 2013. The total net
proceeds of this offering were used to pay in full the $128 million outstanding
balance of the Company's $500 million revolving credit agreement and $69 million
of the outstanding $72 million balance of the Company's asset securitization
program.
11
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2003
- --------------------------------------------------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- ------------------------------------------------
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
- ------------------------------------------
Our consolidated financial statements include the accounts of RPM International
Inc. and its majority-owned subsidiaries. Preparation of our financial
statements requires the use of estimates and assumptions that affect the
reported amounts of our assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. We continually evaluate these estimates, including those
related to allowances for doubtful accounts, inventories, allowances for
recoverable taxes, useful lives of property, plant and equipment, goodwill,
environmental and other contingent liabilities, income tax valuation allowances,
pension plans and the fair value of financial instruments. We base our estimates
on historical experience and other assumptions, which we believe to be
reasonable under the circumstances. These estimates form the basis for making
judgments about the carrying value of our assets and liabilities. Actual results
may differ from these estimates under different assumptions and conditions.
We have identified below the accounting policies that are critical to our
financial statements.
REVENUE RECOGNITION
Revenues are recognized when title and risk of loss passes to customers. The
Securities and Exchange Commission's Staff Accounting Bulletin (SAB) No. 101,
"Revenue Recognition," provides guidance on the application of Generally
Accepted Accounting Principles (GAAP) in the U.S. to selected revenue
recognition issues. We have concluded that our revenue recognition policy is
appropriate and in accordance with GAAP and SAB No. 101.
TRANSLATION OF FOREIGN CURRENCY FINANCIAL STATEMENTS AND FOREIGN CURRENCY
TRANSACTIONS
Our reporting currency is the U.S. dollar. However, the functional currency of
all of our foreign subsidiaries is their local currency. We translate the
amounts included in our consolidated statements of income from our foreign
subsidiaries into U.S. dollars at year-to-date average exchange rates, which we
believe are fairly representative of the actual exchange rates on the dates of
the transactions. Our foreign subsidiaries' assets and liabilities are
translated into U.S. dollars from local currency at the actual exchange rates as
of the end of each reporting date, and we record the resulting foreign exchange
translation adjustments in our consolidated balance sheets as a component of
accumulated other comprehensive income (loss). If we determine that the
functional currency of any of our foreign subsidiaries should be the U.S.
dollar, our financial statements would be affected. Should this occur, we would
adjust our reporting to appropriately account for such change(s).
As appropriate, we use permanently invested intercompany loans as a source of
capital to reduce exposure to foreign currency fluctuations at our foreign
subsidiaries. These loans are treated as analogous to equity for accounting
purposes. Therefore, foreign exchange gains or losses on these
12
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2003
- --------------------------------------------------------------------------------
intercompany loans are recorded in other comprehensive income (loss). If we were
to determine that the functional currency of any of our subsidiaries should be
the U.S. dollar, we would no longer record foreign exchange gains or losses on
such intercompany loans.
GOODWILL
We adopted two new accounting standards issued by the Financial Accounting
Standards Board in June 2001. Statement of Financial Accounting Standards, or
SFAS, No. 141, "Business Combinations," eliminates the pooling method of
accounting for all business combinations initiated after June 30, 2001, and
addresses the initial recognition and measurement of goodwill and intangible
assets acquired in a business combination. Accordingly, we apply the provisions
of SFAS No. 141 to all business combinations initiated after its effective date.
We also adopted SFAS No. 142, "Goodwill and Other Intangible Assets," effective
June 1, 2001. Goodwill amortization ceased upon adoption of the standard, and
the required initial impairment tests were performed. Results of these
impairment tests have not generated any impairment loss to date.
Prospectively, goodwill will be tested on an annual basis, or more frequently as
impairment indicators arise. Impairment tests, which involve the use of
estimates related to the fair market values of the business operations with
which goodwill is associated, are performed at the end of our first quarter.
Losses, if any, resulting from impairment tests will be reflected in operating
income in our income statement.
OTHER LONG-LIVED ASSETS
We assess for impairment of identifiable non-goodwill intangibles and other
long-lived assets whenever events or changes in facts and circumstances indicate
the possibility that the carrying value may not be recoverable. Factors
considered important which might trigger an impairment evaluation, include the
following:
- significant under-performance relative to historical or projected
future operating results;
- significant changes in the manner of our use of the acquired assets or
the strategy for our overall business; and
- significant negative industry or economic trends.
When we determine that the carrying value of non-goodwill intangibles and other
long-lived assets may not be recoverable based upon the existence of one or more
of the above described indicators, any impairment would be measured based on
projected net cash flows expected from the asset(s), including eventual
disposition.
13
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2003
- --------------------------------------------------------------------------------
CONTINGENCIES
We are party to claims and lawsuits arising in the normal course of business,
including the various asbestos-related suits discussed herein and in Note H of
our Consolidated Financial Statements included in our Annual Report on Form 10-K
for the year ended May 31, 2003. Although we cannot precisely predict the amount
of any liability that may ultimately arise with respect to any of these matters,
we record provisions when we consider the liability probable and reasonably
estimable. The provisions are based on historical experience and legal advice,
are reviewed quarterly and are adjusted according to developments. Changes in
the amount of the provisions affect our consolidated statements of income. Due
to the inherent uncertainties in the loss reserve estimation process, we are
unable to estimate an additional range of loss in excess of our accruals.
Our environmental-related accruals are similarly established and/or adjusted as
information becomes available upon which costs can be reasonably estimated. Here
again, actual costs may vary from these estimates because of the inherent
uncertainties involved, including the identification of new sites and the
development of new information about contamination. Certain sites are still
being investigated and therefore we have been unable to fully evaluate the
ultimate cost for those sites. As a result, reserves have not been taken for
certain of these sites and costs may ultimately exceed existing reserves for
other sites. We have received indemnities for potential environmental issues
from purchasers of certain of our properties and businesses and from sellers of
properties or businesses we have acquired. We have also purchased insurance to
cover potential environmental liabilities at certain sites. If the indemnifying
or insuring party fails to, or becomes unable to, fulfill its obligations under
those agreements or policies, we may incur additional environmental costs in
addition to any amounts reserved, which may have a material adverse effect on
our financial condition, results of operations or cash flows.
14
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2003
- --------------------------------------------------------------------------------
REPORTABLE SEGMENT INFORMATION
- ------------------------------
RPM has two operating segments -- Industrial and Consumer -- based on the nature
of business activities, products and services, the structure of management, and
the structure of information as presented to the Board of Directors. Within each
segment, individual operating companies or groups of companies generally address
common markets, utilize similar technologies, and can share manufacturing or
distribution capabilities. We evaluate the profit performance of our operating
segments based on earnings before interest and taxes since interest expense is
essentially related to corporate acquisitions, as opposed to segment operations.
In addition to the two operating segments, there are certain business
activities, referred to as corporate/other, that do not constitute an operating
segment, including corporate headquarters and related administrative expenses,
results of our captive insurance companies, gains or losses on the sales of
certain assets and other expenses not directly associated with either operating
segment. Related assets consist primarily of investments, prepaid expenses,
deferred pension assets, and headquarters property and equipment. Comparative
six month and second quarter results on this basis are as follows:
- -------------------------------------------------------------------------------
SIX MONTHS ENDED NOVEMBER 30, QUARTER ENDED NOVEMBER 30,
------------------------------------------ -----------------------------------------
(In thousands) 2003 2002 2003 2002
--------------------- ------------------- ------------------ ---------------------
NET SALES:
Industrial Segment $ 646,498 $ 578,562 $ 330,304 $ 286,317
Consumer Segment 533,427 481,819 259,530 231,651
----------- ----------- --------- ---------
TOTAL $ 1,179,925 $ 1,060,381 $ 589,834 $ 517,968
=========== =========== ========= =========
INCOME BEFORE INCOME TAXES (a):
Earnings Before Interest and Taxes (EBIT) (b)
Industrial Segment $ 85,957 $ 79,580 $ 38,912 $ 34,543
Consumer Segment 74,165 68,439 32,030 28,890
Corporate/Other (18,609) (20,273) (9,622) (10,784)
----------- ----------- --------- ---------
Total EBIT 141,513 127,746 61,320 52,649
Consolidated Interest Expense, Net (12,994) (14,188) (6,711) (6,984)
----------- ----------- --------- ---------
TOTAL $ 128,519 $ 113,558 $ 54,609 $ 45,665
=========== =========== ========= =========
IDENTIFIABLE ASSETS: NOVEMBER 30, 2003 MAY 31, 2003
----------------- -----------------
Industrial Segment $ 1,090,589 $ 1,067,916
Consumer Segment 1,024,201 1,038,350
Corporate/Other 146,444 140,945
----------- -----------
TOTAL $ 2,261,234 $ 2,247,211
=========== ===========
(a) The presentation includes a reconciliation of EBIT to Income Before
Income Taxes, a measure defined by Generally Accepted Accounting
Principles ("GAAP") in the U.S.
(b) EBIT is defined as earnings before interest and taxes. We believe that
EBIT provides one of the best comparative measures of pure operating
performance, and it is a widely accepted financial indicator used by
certain investors and analysts to analyze and compare companies. EBIT is
not intended to represent cash flows for the period, nor is it presented
as an alternative to operating income or as an indicator of operating
performance. EBIT should not be considered in isolation, but with GAAP,
and it is not indicative of operating income or cash flow from operations
as determined by those principles. Our method of computation may or may
not be comparable to other similarly titled measures of other companies.
EBIT may not be indicative of our historical operating results, nor is it
meant to be predictive of potential future results.
15
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2003
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
- ---------------------
THREE MONTHS ENDED NOVEMBER 30, 2003
- ------------------------------------
NET SALES
Net sales on a consolidated basis for the second quarter of fiscal 2004 of
$589.8 million improved 13.9 percent, or $71.8 million, over last year's second
quarter net sales of $518.0 million. Growth in organic sales, resulting from
continued solid demand for consumer/do-it-yourself ("DIY") products, rapid
growth of roofing maintenance services and generally increased demand for
industrial products, contributed 7.1 percent of this improvement, or $36.7
million, while acquisitions of seven smaller product lines contributed 3.8
percent or $19.8 million. Lastly, favorable foreign exchange rates, relating
principally to the Canadian dollar and the euro, provided almost 3.0 percent, or
$15.3 million, of increased sales quarter over quarter.
Industrial segment net sales for the second quarter amounted to 56.0 percent of
the RPM total, and grew 15.4 percent to $330.3 million from last year's $286.3
million. This segment's net sales growth comes primarily from organic sales
growth of 9.9 percent, including 3.9 percent from net favorable foreign exchange
differences. Three smaller product line acquisitions during the past 12 months
added the remaining 5.5 percent to industrial sales. Excluding the foreign
exchange effect, organic sales growth in the industrial segment was
approximately 6.0 percent, as the sales from lower-margin roofing maintenance
services continued to grow rapidly, and demand for industrial products increased
in general as the economy improved. We continue to secure new business and grow
market share in many of our industrial segment operations.
Consumer segment net sales for the second quarter amounted to 44.0 percent of
the RPM total, and grew 12.0 percent to $259.5 million from last year's $231.7
million. This segment's net sales growth comes primarily from organic growth
among the main consumer product lines (DAP, Rust-Oleum, Zinsser), which added
10.2 percent to consumer sales, including favorable foreign exchange
differences, and from four smaller product line acquisitions during the past 12
months, which added the remaining 1.8 percent to consumer segment sales.
GROSS PROFIT MARGIN
Consolidated gross profit margin of 45.1 percent of net sales this second
quarter improved from 44.9 percent a year ago. The benefits derived from
leveraging higher organic sales volume plus improved productivity and higher
margins from acquisitions were slightly offset by a continued number of higher
raw material and packaging costs, including oil-derivative materials such as
acetones and solvents, which impacted gross margin by 70 basis points.
Additionally, we experienced continued growth in certain strategic but
lower-margin product lines and services.
16
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2003
- --------------------------------------------------------------------------------
Industrial segment gross profit margin for the second quarter improved to 45.4
percent of net sales from 45.0 percent last year, as a result of leveraging the
volume improvements plus acquisitions, which more than offset the effect of
continued, lower-margin growth from services business.
Consumer segment gross profit margin for this second quarter declined to 44.7
percent of net sales from 44.9 percent last year, despite the positive leverage
from higher organic sales volume, primarily due to certain higher raw material
and packaging costs, as well as in planned-for growth in certain lower-margin
product lines. The impact of higher raw material costs experienced this quarter
is not expected to be as significant for the remainder of this fiscal year.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (SG&A)
Consolidated SG&A expense levels improved to 34.7 percent of net sales compared
with 34.8 percent a year ago. This improvement is attributable in large part to
positive leverage from the sales growth, especially in industrial services that
require much lower SG&A support, and lower cost acquisitions. Additionally,
certain marketing and growth-related investments continued this second quarter
in both operating segments, partly offsetting these sales volume benefits on
SG&A.
Industrial segment SG&A of 33.6 percent of net sales this second quarter
compared to 32.9 percent a year ago. Higher volume benefits were more than
offset by growth-related investments made in this segment, higher product
liability accruals associated with our exterior insulating finishing systems, or
EIFS (see Item 1. Legal Proceedings, Part II - Other Information for further
discussion), and last year's $1.6 million insurance recovery during the second
quarter.
Consumer segment SG&A of 32.3 percent of net sales this second quarter compared
favorably against 32.4 percent a year ago, fully attributable to the sales
growth, partly offset by increased advertising and other growth-related
investments made in this segment as well.
Corporate/Other costs decreased during this year's second quarter to $9.6
million from $10.8 million during last year's second quarter. Product liability
costs of $2.2 million were accrued for a year ago, associated with our asbestos
exposure (see Item 1. Legal Proceedings, Part II - Other Information for further
discussion), versus none this year, since there was an asbestos charge taken as
of this past fiscal year-end, which was estimated to cover approximately 3 years
worth of related cash costs at that time. Partly offsetting this cost reduction
were higher insurance and legal costs related primarily to corporate governance
issues affecting essentially all U.S. publicly held companies.
License fee and joint venture income of $0.3 million during each of the second
quarters ended November 30, 2003 and 2002 are reflected as reductions of
consolidated SG&A expenses.
EARNINGS BEFORE INTEREST AND TAXES (EBIT)
We believe that EBIT best reflects the performance of our operating segments, as
interest expense and income taxes are not consistently allocated to operating
segments by the various constituencies utilizing
17
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2003
- --------------------------------------------------------------------------------
our financial statements. Requests for operating performance measures received
from research analysts, financial institutions and rating agencies typically
focus on EBIT, and we believe EBIT disclosure is responsive to our investors.
Consolidated EBIT for this year's second quarter grew by $8.7 million, or 16.5
percent, to $61.3 million from $52.6 million during last year's second quarter,
with margin improvement to 10.4 percent of net sales from 10.2 percent a year
ago. This growth reflects the positive impact from higher sales volume,
including accretive acquisitions, despite the 70 basis points negative impact
from higher material costs.
Industrial segment EBIT grew by $4.4 million, or 12.7 percent, to $38.9 million
from last year's $34.5 million, mainly from the higher sales volume and the
accretive results of its recent acquisitions.
Consumer segment EBIT grew by $3.1 million, or 10.9 percent, to $32.0 million
from last year's $28.9 million, mainly from the net profitability of the organic
sales growth in this segment less the impact from higher material costs.
NET INTEREST EXPENSE
Net interest expense was $0.3 million lower this second quarter than a year ago.
Interest rates averaged 3.49 percent during this second quarter, 59 basis points
lower than a year ago, accounting for $0.8 million of the interest savings.
Higher average net borrowings this year, primarily associated with recent
acquisitions, of approximately $51 million added $0.2 million of interest cost,
and investment income performance declined by $0.3 million year-over-year.
INCOME TAX RATE
The effective income tax rate this year of 35.5 percent compares with 35.1
percent a year ago. Reflected in the prior year rate is the accumulation of
several years worth of research tax credits, while in the current year rate, the
research tax credit benefit is limited to the current year. Additionally, the
slight changes in our geographic mix of earnings have increased the current year
tax rate.
NET INCOME
This year's second quarter net income of $35.2 million increased $5.6 million,
or 18.8 percent, from last year's $29.6 million. Margin on sales strengthened to
6.0 percent of sales from last year's 5.7 percent despite the 70 basis points
(pre-tax) impact from higher material costs. Earnings per common share increased
by 15.4 percent, to $0.30 from $0.26 a year ago.
SIX MONTHS ENDED NOVEMBER 30, 2003
- ----------------------------------
NET SALES
Net sales on a consolidated basis for the first six months of fiscal 2004 of
$1.180 billion improved 11.3 percent, or $119.5 million, over last year's first
half net sales of $1.060 billion. Growth in
18
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2003
- --------------------------------------------------------------------------------
organic demand contributed 5.0 percent of this improvement, or $53.0 million,
while acquisitions of nine small product lines contributed 3.6 percent or $38.2
million. Lastly, favorable foreign exchange rates relating principally to the
Canadian dollar and the euro provided almost 2.7 percent, or $28.3 million, of
increased sales over last year.
Industrial segment net sales for these first six months amounted to 54.8 percent
of RPM consolidated net sales, and grew 11.7 percent to $646.5 million from last
year's $578.6 million. This segment's net sales growth comes from five small
product line acquisitions during the past 12 months, which added $29.9 million
or 5.1 percent to industrial sales, and from organic sales growth of 6.6
percent, which includes 3.4 percent growth from net favorable foreign exchange
differences. Excluding the foreign exchange effect, organic sales growth in the
industrial segment was approximately $18.2 million or 3.1 percent better than
the prior year, as the sales from roofing maintenance services continued to grow
rapidly and the demand for industrial products increased in general as the
economy improved. Additionally, we continue to secure new business and grow
market share in many of our industrial segment operations.
Consumer segment net sales for these first six months amounted to 45.2 percent
of RPM consolidated net sales, and grew 10.7 percent to $533.4 million from last
year's $481.8 million. This segment's net sales growth comes primarily from
organic growth among the main consumer product lines, including DAP, Rust-Oleum,
and Zinsser, which added 9.0 percent to consumer sales, including 1.8 percent
from favorable foreign exchange differences. Also contributing to growth in this
segment year-over-year were four small product line acquisitions during the past
12 months, which added the remaining 1.7 percent of sales growth.
GROSS PROFIT MARGIN
Consolidated gross profit margin of 45.9 percent of net sales this first half
declined from 46.3 percent a year ago. The positive impacts of improvements in
sales volume, productivity, and accretive acquisitions over the last 12 months
could not overcome the combination of 60 basis points negative impact from
increased raw material and packaging costs, and continued growth in certain
strategic, but lower-margin, product lines and services.
By segment, the industrial gross profit margin for the first six months of
fiscal 2004 declined to 46.3 percent of net sales from 46.5 percent last year,
primarily from the continued growth of lower-margin maintenance service
businesses.
Gross profit margin for the consumer segment also declined these first six
months of fiscal 2004, to 45.5 percent of net sales from 46.0 percent last year.
While this segment has experienced positive leverage from increased sales
volume, productivity gains and benefits from ongoing cost reduction efforts,
higher material costs, planned-for growth in certain strategic, but lower-margin
product lines, and lower-margin acquisitions over the last 12 months have more
than offset these benefits. The impact of higher raw material costs experienced
these first six months is not expected to be as significant for the remainder of
this fiscal year.
19
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2003
- --------------------------------------------------------------------------------
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (SG&A)
Consolidated SG&A expense levels for the first six months of fiscal 2004
improved to 33.9 percent of net sales compared with 34.2 percent a year ago,
reflecting positive leverage from growth in net sales, especially the growth in
lower-margin services that require much lower SG&A support, and lower cost
structure acquisitions. Certain marketing and growth-related investments were
also made in both segments this first half, partly offsetting these benefits.
Industrial segment SG&A as a percent of net sales for this first half of 33.0
percent compares to 32.8 percent a year ago. The leverage benefits from improved
sales volume were more than offset by certain growth-related investments made
these first six months, higher product liability accruals associated with our
exterior insulating finishing systems, or EIFS (see Item 1. Legal Proceedings,
Part II - Other Information for further discussion), and last year's $1.6
million insurance recovery.
Consumer segment SG&A as a percent of net sales for this first half of 31.6
percent compares favorably against 31.8 percent a year ago, fully attributable
to the sales growth, partly offset by growth-related investments made in this
segment as well.
Corporate/Other costs decreased during this year's first half to $18.6 million
from $20.3 million last year. Product liability costs of $4.0 million were
accrued for a year ago, associated with our asbestos exposure (see Item 1. Legal
Proceedings, Part II - Other Information for further discussion), versus none
this year, since there was an asbestos charge taken as of this past fiscal
year-end, which was estimated to cover approximately 3 years worth of related
cash costs at that time. Partly offsetting this cost reduction were higher
insurance and legal costs related primarily to corporate governance issues
affecting essentially all U.S. publicly held companies.
License fee and joint venture income of $0.4 and $0.5 million during the first
six months ended November 30, 2003 and 2002, respectively, are reflected as
reductions of consolidated SG&A expenses.
EARNINGS BEFORE INTEREST AND TAXES (EBIT)
Consolidated EBIT for this year's first half grew by $13.8 million, or 10.8
percent, to $141.5 million from $127.7 million during last year's first half,
while margins held steady at 12.0 percent of sales. Growth in consolidated EBIT
reflects the positive impact of net sales improvements year-over-year, including
recent accretive acquisitions, despite the 60 basis point negative impact of
increased raw material and packaging costs.
20
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2003
- --------------------------------------------------------------------------------
By segment, Industrial EBIT grew by $6.4 million, or 8.0 percent, to $86.0
million from last year's $79.6 million. Consumer segment EBIT grew this first
half by $5.7 million, or 8.4 percent, to $74.2 million from last year's $68.4
million. This growth in operating EBIT reflects solid growth in net sales,
including accretive acquisitions over the last twelve months, offset partially
by increases in material costs and growth-related initiatives.
NET INTEREST EXPENSE
Net interest expense was $1.2 million lower these first six months than a year
ago. Interest rates averaged 3.52 percent during the first half of this year, 52
basis points lower than a year ago, accounting for $1.3 million of the interest
savings. Additionally, investment income improved slightly over last year's
performance, by approximately $0.1 million, combined with debt repayments over
the past year which saved an additional $0.5 million in interest cost.
Offsetting these savings were approximately $0.8 million of added interest costs
associated with recent acquisitions.
INCOME TAX RATE
The effective income tax rate this year of 35.5 percent compares with 35.0
percent a year ago. Reflected in the prior year rate is the accumulation of
several years worth of research tax credits, while in the current year rate, the
research tax credit benefit is limited to the current year. Additionally, the
slight changes in our geographic mix of earnings have increased the current year
tax rate.
NET INCOME
Net income of $82.9 million for this year's first half increased $9.1 million,
or 12.3 percent, from last year's $73.8 million. Earnings per common share
increased by 10.9 percent, to $0.71 from $0.64 a year ago. Margin on sales has
held at 7.0 percent, despite the 60 basis points (pre-tax) impact from higher
material costs.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
CASH FLOWS FROM:
OPERATING ACTIVITIES
There was $65.9 million of cash generated from operations during the first six
months of fiscal 2004 compared with $90.5 million generated during the same
period a year ago, or a net decrease of $24.6 million. Cash flow from operations
was positively impacted by $11.9 million from an increase in net income of $9.1
million and depreciation and amortization of $2.8 million versus the prior
year's results. The decrease in cash flow from "Changes in operating working
capital" and "Items not affecting cash and other" is mainly a result of
year-over-year changes in long-term and short-term asbestos related reserves,
net of taxes, of approximately $17.6 million. As disclosed in our "Critical
Accounting Policies and Estimates" and our discussion on asbestos litigation
(refer to Item 1. Legal Proceedings, Part II-Other Information), the significant
increase in asbestos claims activity and inequitable joint and several liability
determinations against our Bondex subsidiary caused our related third-party
insurance to be depleted during the first quarter of our current fiscal year.
Accordingly, we are now required to fund costs previously covered by insurance
with our cash from operations. Trade accounts receivable generated a
21
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2003
- --------------------------------------------------------------------------------
year-over-year decrease in cash flow of $13.5 million which was principally
associated with an increase in sales in this year's second quarter versus last
year. In addition, as it relates to accounts receivable during the first six
months of fiscal 2004, there was $3.9 million negative effect due to exchange
rates caused by a weakening U.S. dollar since May 31, 2003. Inventories also
required an additional $11.2 million of operating cash as a result of the
increased sales volume and the associated inventory required to support these
levels. Here on inventory similarly to accounts receivable, there was $2.8
million negative effect due to exchange rates in this year's first six months.
Management continues to focus on improving accounts receivable collection and
managing inventory levels to lower levels as a result of strengthened
information technology systems and continuous improvements in operating
techniques, such as Class "A" manufacturing. Accounts payable had a positive
year-over-year increase in cash flow of $4.2 million while all other remaining
balance sheet changes related to cash flows had a net positive impact of $1.6
million. Since quarter's end, approximately $30 million of cash from operations
was realized as the heavy second quarter sales in accounts receivable at
quarter's end were collected.
Cash provided from operations remains our primary source of financing internal
growth, with limited use of short-term debt.
INVESTING ACTIVITIES
Capital expenditures, other than for ordinary repairs and replacements, are made
to accommodate our continued growth through improved production and distribution
efficiencies and capacity, and to enhance administration. Capital expenditures
during the first six months of fiscal 2004 of $15.5 million compare with
depreciation of $23.3 million, well within the maintenance level of spending. We
are not capital intensive and capital expenditures generally do not exceed
depreciation in a given year. Capital spending is expected to hold at
approximately the maintenance level of $40 million to $50 million annually for
the next several years.
During the first six months of fiscal 2004, we invested a total of $20.0 million
for acquisitions.
FINANCING ACTIVITIES
On June 6, 2002, we entered into a $125 million accounts receivable
securitization transaction with several banks through June 4, 2005, which is
subject to continuation by an annual renewal by the banks. The securitized
accounts receivable are owned in their entirety by RPM Funding Corporation, a
wholly owned consolidated special-purpose entity ("SPE"), and are not available
to satisfy claims of our creditors until the participating banks' obligations
have been paid in full. This securitization is being
22
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2003
- --------------------------------------------------------------------------------
accomplished by having certain subsidiaries sell various of their accounts
receivable to the SPE, and by having the SPE then transfer those receivables to
a conduit administered by the banks. This securitization did not constitute a
form of off-balance sheet financing, and is fully reflected in our financial
statements. The amounts available under this program are subject to changes in
the credit ratings of our customers, customer concentration levels and certain
characteristics of the underlying accounts receivable. This transaction
increased our liquidity and reduced our financing costs by replacing up to $125
million of existing borrowing at lower interest rates. As of November 30, 2003,
$72 million was outstanding under this program.
On February 12, 2003, we announced the authorization of a share repurchase
program, allowing the repurchase of up to 10 million shares of RPM common stock
over a period of 12 months. As of November 30, 2003, we had repurchased 100,000
of our shares at an average price of $11.67 per share.
In May 2003, we issued $297 million face value at maturity unsecured 2.75%
Senior Convertible Notes ("2.75% Notes") due May 13, 2033. We generated net
proceeds of $146 million from the sale of the 2.75% Notes. The 2.75% Notes are
convertible into 8,034,355 shares of our common stock at a price of $18.68 per
share, subject to adjustments, during any fiscal quarter for which the closing
price of our common stock is greater than $22.41 per share for a defined
duration of time. The 2.75% Notes are also convertible during any period in
which our credit rating is below a specified level, or if specified corporate
transactions have occurred. The 2.75% Notes are redeemable by the holder for the
issuance price plus accrued original issue discount in May 2008, 2013, 2018,
2023, 2028 and 2033. Interest on the 2.75% Notes is payable at a rate of 2.75%
beginning November 13, 2003 until May 13, 2008, depending upon the market price
of the Notes. After that date, cash interest will only accrete and will not be
paid prior to maturity, subject to certain contingencies.
Also in May 2003, we established a $200 million non-rated commercial paper
("CP") program under which borrowings are unsecured for terms of 270 days or
less. This CP program currently allows for lower interest cost than that
available under the Company's $500 million revolving credit facility. The $500
million credit facility is available to back up our CP program to the extent it
is not drawn upon. As of November 30, 2003, there was $115.6 million outstanding
under this CP program.
Our debt-to-capital ratio was 43% at November 30, 2003, down from 45% at May 31,
2003.
23
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2003
- --------------------------------------------------------------------------------
The following table summarizes our financial obligations and their expected
maturities at November 30, 2003 and the effect such obligations are expected to
have on our liquidity and cash flow in the periods indicated.
Less than After
Total 1 year 1-3 years 3 years
----- -------- --------- -------
($ in millions)
Current portion of long-term debt $ 1.6 $ 1.6 $ - $ -
Long-term debt 721.6 - 431.4 290.2
Non-cancelable operating lease obligations(1) 72.8 16.8 23.9 32.1
------ ------ ------ ------
$796.0 $ 18.4 $455.3 $322.3
====== ====== ====== ======
(1) We calculate non-cancelable operating lease obligations on an annual basis
and consequently such information is not available at November 30, 2003. The
amounts shown above are for the fiscal year end May 31, 2003.
We maintain excellent relations with our banks and other financial institutions
to provide continual access to financing for future growth opportunities.
Subsequent to quarter end, on December 4, 2003, the Company issued and sold $200
million aggregate principal amount of 6.25% Senior Notes due 2013. The total net
proceeds of this offering were used to pay in full the $128 million outstanding
balance of the Company's $500 million revolving credit agreement and $69 million
of the outstanding $72 million balance of the Company's asset securitization
program.
STOCKHOLDERS' EQUITY
- --------------------
Effective October 15, 2002, the Company changed its legal place of incorporation
from Ohio to Delaware, following approval by its shareholders of a plan of
reincorporation at its annual meeting on October 11, 2002. Under the plan, RPM
International Inc. became the parent holding company of Ohio-based RPM, Inc. and
several other intermediate holding companies and wholly-owned subsidiaries. In
addition to the creation of a newly formed Delaware legal entity, the legal
structure of various operating companies were realigned in consistency with
their respective business objectives. In connection with the reincorporation,
shareholders approved and adopted the Company's amended and restated certificate
of incorporation, which authorizes the issuance of up to 300,000,000 shares of
Common Stock and 50,000,000 shares of Preferred Stock, both at a par value of
$0.01 per share. In conjunction with reincorporation, all of the outstanding
treasury shares of RPM, Inc. were cancelled and retired without any
consideration. In addition, each common share of RPM, Inc. issued and
outstanding on October 15, 2002 was converted into one share of the Company,
with a $0.01 par value per share. This transaction did not have any effect on
the book value per share, post-reincorporation.
OFF-BALANCE SHEET ARRANGEMENTS
- ------------------------------
We do not have any off-balance sheet financings. We have no subsidiaries that
are not included in our financial statements, nor do we have any interests in or
relationships with any special purpose entities that are not reflected in our
financial statements.
24
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2003
- --------------------------------------------------------------------------------
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
We are exposed to market risk from changes in interest rates and foreign
exchange rates since we fund our operations through long- and short-term
borrowings and denominate our business transactions in a variety of foreign
currencies. There were no material changes in our exposure to market risk since
May 31, 2003.
ITEM 4. CONTROLS AND PROCEDURES
- --------------------------------
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
The Company's Chief Executive Officer and Chief Financial Officer,
after evaluating the effectiveness of the Company's disclosure controls and
procedures (as defined in Exchange Act Rule 13a-14) as of November 30, 2003 (the
"Evaluation Date"), have concluded that as of the Evaluation Date, the Company's
disclosure controls and procedures were effective in ensuring that information
required to be disclosed by the Company in the reports it files or submits under
the Exchange Act is recorded, processed, summarized and reported, within the
time periods specified in the Commission's rules and forms.
(b) CHANGES IN INTERNAL CONTROLS.
There were no changes in the Company's internal controls over
financial reporting that occurred during the fiscal quarter ended November 30,
2003 that have materially affected, or are reasonably likely to materially
affect, the Company's internal controls over financial reporting.
25
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
ITEM 1. LEGAL PROCEEDINGS
- ---------------------------
EIFS LITIGATION
- ---------------
As previously reported, Dryvit is a defendant or co-defendant in numerous
exterior insulated finish systems ("EIFS") related lawsuits. As of November 30,
2003, Dryvit was a defendant or co-defendant in approximately 370 single-family
residential EIFS cases, the majority of which are pending in the Southeastern
region of the U.S. Dryvit is also defending EIFS lawsuits involving commercial
structures, townhouses and condominiums. The vast majority of Dryvit's EIFS
lawsuits seek monetary relief for water intrusion related property damages,
although some claims in certain lawsuits allege personal injuries from alleged
exposure to mold.
As previously reported, Dryvit settled the North Carolina class action styled
Ruff, et al. v. Parex, Inc., et al. ("Ruff"). As of November 30, 2003, a
cumulative total of 728 claims had been submitted to the Ruff claims
administrator for verification and validation since the January 17, 2000 notice
to the Ruff class. Of these 728 claims, 338 claims were rejected and 375 claims
were paid in the aggregate amount of approximately $6.1 million pursuant to
funding arrangements with Dryvit's historical insurers. The claim period for
filing claims in the Ruff class action expired on January 17, 2003. The
remaining submitted claims are at various stages of review by the Ruff claims
administrator. Based on the funding commitments in place to cover the Ruff
claims, Dryvit does not expect the costs of resolving the residual claims to be
material.
As previously reported, Dryvit is a defendant in an attempted state class action
filed on November 14, 2000 in Jefferson County, Tennessee styled Bobby R. Posey,
et al. v. Dryvit Systems, Inc. (formerly styled William J. Humphrey, et al. v.
Dryvit Systems, Inc.) (Case No. 17,715-IV) ("Posey"). As previously reported, a
preliminary approval order was entered on April 8, 2002 in the Posey case for a
proposed nationwide class action settlement covering, "All Persons who, as of
June 5, 2002, in any State other than North Carolina, in whole or in part, with
Dryvit EIFS installed after January 1, 1989, except persons who (1) prior to
June 5, 2002, have settled with Dryvit, providing a release of claims relating
to Dryvit EIFS; or (2) have not obtained a judgment against Settling Defendant
for a Dryvit EIFS claim, or had a judgment entered against them on such a claim
in Settling Defendants' favor; and (3) any employees of Dryvit." Nationwide
notice to all eligible class members began on or about June 13, 2002. Any person
who wished to be excluded from the Posey settlement was provided an opportunity
to individually "opt out" and thus not be bound by the final Posey order.
A fairness hearing was held on October 1, 2002 (which continued on December 16,
2002), for the court to determine whether the proposed settlement is fair,
reasonable and adequate. An order and judgment granting final approval of the
settlement was entered on January 14, 2003. Subsequent to the Final Order,
notices of appeal were filed by persons seeking to challenge certain provisions
of the proposed settlement. Dryvit believes the persons challenging the
settlement have no standing to complain about the settlement. Dryvit is
vigorously challenging this appeal and expects that the Final Order will be
upheld.
26
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
Dryvit's insurers have paid or are currently paying a portion of Dryvit's
defense costs in the class actions, and individual commercial and residential
EIFS lawsuits. Dryvit, the Company's wholly-owned captive insurer, First
Colonial Insurance Company, and certain of Dryvit's umbrella insurers have been
parties to cost-sharing agreements the terms of which are subject to periodic
renegotiation. Under current cost-sharing agreements and funding obtained from
one of Dryvit's historical carriers, Dryvit's indemnity and defense costs
continue to be substantially covered by insurance; however, Dryvit has recently
assumed a greater share of its EIFS litigation costs. Dryvit has secured insurer
funding commitments to cover a substantial portion of the anticipated costs of
the Posey national settlement. Since Dryvit does not presently have sufficient
claims experience under the proposed Posey settlement, it is possible that the
rate of actual claims may, at some point in the future, exceed management's
current expectations. Based on consultation with counsel, management believes
that to the extent some of the Posey settlement costs are not covered by
existing funding commitments, such amounts will not have a material adverse
effect on the Company's consolidated financial condition, results of operations
or cash flows.
ASBESTOS LITIGATION
- -------------------
As previously reported, certain of the Company's wholly-owned subsidiaries,
principally Bondex International, Inc. (collectively referred to as "the
Subsidiaries"), are defendants in various asbestos-related bodily injury
lawsuits filed in various state courts with the vast majority of which are
pending in four states - Illinois, Ohio, Mississippi and Texas. These cases
generally seek unspecified damages for asbestos-related diseases based on
alleged exposures to asbestos-containing products previously manufactured by one
of the Company's Subsidiaries.
The Company's Subsidiaries vigorously defend these asbestos-related lawsuits and
in many cases, the plaintiffs are unable to demonstrate that any injuries they
have incurred, in fact, resulted from exposure to one of our Subsidiaries'
products. In such cases, the Subsidiary is generally dismissed without payment.
With respect to those cases where compensable disease, exposure and causation
are established with respect to one of our Subsidiaries' products, the
Subsidiary generally settles for amounts that reflect the confirmed disease, the
particular jurisdiction, applicable law, the number and solvency of other
parties in the case and various other factors which may influence the settlement
value each party assigns to the case.
As of November 30, 2003, the Company had a total of 2,737 active asbestos cases
compared to a total of 1,490 cases as of November 30, 2002. For the quarter
ended November 30, 2003, the Company's dismissals and/or settlements covered 208
cases for a total of $18.6 million of gross settlement and defense costs. For
the comparable period ended November 30, 2002, the Company's dismissals and/or
settlements covered 1,086 cases for a total of $13.4 million of gross settlement
costs which included then applicable third party insurance contributions during
the quarter. In some jurisdictions, the dismissal or settlement of a case may
involve more than one individual plaintiff.
Beginning in the fourth quarter of fiscal 2002 continuing into fiscal 2003, the
Company's Subsidiaries (principally Bondex), incurred higher settlement and
defense costs resulting from higher settlement demands in certain jurisdictions
due primarily to the insolvency of other co-
27
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
defendants in the asbestos litigation which, in many cases, disproportionately
increased our Subsidiaries' share of the alleged liability. The Company expects
that it will continue to experience these higher settlement and defense costs
during the current fiscal year. The federal legislative initiative to establish
a trust fund coupled with recent state tort law changes could significantly
alter future settlement values and claim rates. Based on the significant
increase in asbestos claims and the inequitable impact of joint and several
liability laws on Bondex, as previously reported, our undisputed third-party
insurance was depleted during the first quarter of 2004. Prior to this sudden
and precipitous increase in claims and settlement values, the combination of
reserves and available insurance was expected at that time to adequately cover
our asbestos claims for the foreseeable future.
As previously disclosed, during the fourth quarter of fiscal 2003, the Company
engaged an outside advisor to assist its Subsidiaries in evaluating their
asbestos-related liabilities. Estimating the future cost of these asbestos
related contingent liabilities is subject to many uncertainties, including (i)
the ultimate number of claims filed against the Subsidiaries, (ii) the cost of
resolving both current known and future unknown claims, (iii) the amount of
insurance available to cover such claims, (iv) future earnings and cash flow of
the Company's Subsidiaries, (v) the impact of bankruptcies of other companies
whose share of liability may be imposed on the Company's Subsidiaries under
certain state liability laws, (vi) the unpredictable aspects of the litigation
process including the scheduling of trial dates and the jurisdictions in which
trials are scheduled, (vii) the lack of specific information in many cases
concerning exposure to the Subsidiaries' products and the claimants' diseases,
and (viii) potential changes in applicable federal and/or state law. Recently
adopted state tort law changes have created significant uncertainty with respect
to future defense strategies, settlement values and, over time, are expected to
positively impact claim frequency and severity. The changes generally provide
for liability to be determined on a proportional cause basis. These state law
changes are not expected to have an impact on asbestos litigation until the
latter part of fiscal 2004 or early in fiscal 2005. Therefore, at this time, the
Company has concluded that the potential liability that may result from all
known and future unknown claims is not presently estimable.
The Company has, however, established a reserve for those pending cases that
have progressed to a stage where the cost to dispose of these cases can
reasonably be estimated. For those claims for which the Company has been able to
develop estimates, it has done so in consultation with its outside advisor and
defense counsel taking into account disease, dismissal rates and applicable
settlement values experience. The reserve was established by taking an asbestos
charge in fiscal 2003 of $140 million for measurable known claims and a
provision for some future claims that are estimable. After payments made during
the first two quarters of this fiscal year, the remaining amount of the reserve
is $118 million. We believe this asbestos reserve will be sufficient to cover
our Subsidiaries' asbestos-related cash flow requirements into fiscal 2006.
28
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
The Company recognizes that future facts, events and legislation (both state
and/or federal) may alter its estimates of both its pending and future claims.
The Company cannot estimate possible liabilities in excess of those accrued
because it cannot predict the number of additional claims that may be filed
against its Subsidiaries in the future, the grounds for such claims, the damages
that may be demanded in such claims or the probable outcome of such claims. The
Company, in conjunction with outside advisors, will continue to study its
Subsidiaries' asbestos-related exposures, and regularly evaluate the adequacy of
this reserve and the related cash flow implications in light of actual claims
experience, the impact of state law changes and the evolving nature of federal
legislative efforts to address asbestos litigation.
As previously disclosed, the Company's Subsidiaries' undisputed third party
insurance coverage was depleted during the first quarter of the 2004 fiscal
year. Since the third quarter of fiscal 2003, the Company's Subsidiaries have
been in the process of reviewing their known (and searching for any additional
unknown) insurance policies to determine whether or not other insurance limits
may be available to cover its asbestos liabilities. On July 3, 2003, certain of
the Company's Subsidiaries filed a complaint for declaratory judgment, breach of
contract and bad faith in the U.S. Federal District Court (Northern District of
Ohio, Eastern Division) against several of their third party insurers who had
issued liability insurance policies that provided various types of primary and
excess coverage during various policy periods between 1968 and 1984. Under these
liability insurance policies, the insurers provided defense and/or indemnity
coverage to certain of the Company's Subsidiaries for asbestos bodily injury
claims. This coverage action was filed when these insurers ceased providing
defense and/or indemnity coverage to certain of the Company's Subsidiaries and
wrongfully claimed that aggregate limits of liability of their respective
insurance policies have been exhausted. The Company is unable at the present
time to predict the outcome of this recently filed action.
ENVIRONMENTAL PROCEEDINGS
- -------------------------
As previously reported, several of the Company's subsidiaries are, from time to
time, identified as a "potentially responsible party" under the Comprehensive
Environmental Response, Compensation and Liability Act and similar state
environmental statutes. In some cases, the Company's Subsidiaries are
participating in the cost of certain clean-up efforts or other remedial actions.
The Company's share of such costs, however, has not been material and management
believes that these environmental proceedings will not have a material adverse
effect on the Company's consolidated financial condition or results of
operations. See "Business-Environmental Matters," in the Company's Annual Report
on Form 10-K for the year ended May 31, 2003.
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -----------------------------------------------------------
The Annual Meeting of Stockholders of RPM International Inc. was held on
October 10, 2003. The following matters were voted on at the meeting.
29
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
1. Election of Bruce A. Carbonari, James A. Karman, Donald K. Miller and
Joseph P. Viviano as Directors of the Company. The nominees were
elected as Directors with the following votes:
Bruce A. Carbonari
------------------
For 93,471,705
Withheld 5,072,519
Broker non-votes -0-
James A. Karman
---------------
For 91,712,094
Withheld 6,832,130
Broker non-votes -0-
Donald K. Miller
----------------
For 92,851,013
Withheld 5,693,211
Broker non-votes -0-
Joseph P. Viviano
-----------------
For 93,662,411
Withheld 4,881,813
Broker non-votes -0-
In addition to the Directors above, the following Directors' terms of office
continued after the Annual Meeting of Stockholders: Dr. Max D. Amstutz, Edward
B. Brandon, E. Bradley Jones, William A. Papenbrock, Albert B. Ratner, Frank C.
Sullivan, Thomas C. Sullivan and Dr. Jerry Sue Thornton.
2. The proposal to approve the 2003 Restricted Stock Plan for Directors
was approved with the following votes:
For 63,416,987
Against 7,468,382
Abstain 2,524,488
Broker non-votes -0-
For information on how the votes for the above matters were tabulated, see the
Company's definitive Proxy Statement used in connection with the Annual Meeting
of Stockholders on October 10, 2003.
30
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K
- ------------------------------------------
(a) EXHIBITS
--------
EXHIBIT NUMBER EXHIBIT DESCRIPTION
------------- -------------------
*10.1 RPM International Inc. 2003 Restricted Stock Plan for
Directors. (x)
11.1 Computation of Net Income per share of Common Stock. (x)
31.1 Rule 13a-14(a) Certification of the Company's Chief
Executive Officer. (x)
31.2 Rule 13a-14(a) Certification of the Company's Chief
Financial Officer. (x)
32.1 Section 1350 Certification of the Company's Chief
Executive Officer. (x)
32.2 Section 1350 Certification of the Company's Chief
Financial Officer (x)
- -------------
(x) Filed herewith.
* Management contract or compensatory plan or arrangement.
(b) REPORTS ON FORM 8-K
-------------------
(i) We furnished to the SEC a Current Report on Form 8-K,
dated October 8, 2003, regarding the Company's financial
results for the first quarter ended August 31, 2003.
31
SIGNATURES
PURSUANT TO THE REQUIREMENTS 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.
RPM INTERNATIONAL INC.
BY /s/ Frank C. Sullivan
-------------------------------------
FRANK C. SULLIVAN
PRESIDENT AND CHIEF EXECUTIVE OFFICER
BY /s/ Robert L. Matejka
-------------------------------------
ROBERT L. MATEJKA
VICE PRESIDENT, CHIEF FINANCIAL OFFICER AND CONTROLLER
DATED: JANUARY 14, 2004