Exhibit 13.1
RPM International Inc. and Subsidiaries
MD&A
MANAGEMENT'S DISCUSSION AND ANALYSIS
of Results of Operations and Financial Condition
SEGMENT AND GEOGRAPHIC AREA INFORMATION
RPM has two operating segments - industrial and consumer - based on the
nature of our 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 segments based on earnings before interest and taxes ("EBIT")
because interest expense is essentially related to corporate acquisitions, as
opposed to segment operations.
Industrial segment products are sold throughout North America and account
for most of RPM's sales in Europe, South America, Asia, South Africa, Australia
and the Middle East. The industrial product line is sold primarily to
distributors, contractors and to end users, such as industrial manufacturing
facilities, educational and governmental institutions, and commercial
establishments. Industrial segment products reach their markets through a
combination of direct sales, sales representative organizations, distributor
sales and sales of licensees and joint ventures.
Consumer segment products are sold throughout North America to mass
merchandisers, home centers, hardware stores, paint stores, automotive supply
stores and craft shops. Major customers include Ace Hardware Stores, Canadian
Tire, Cotter & Company, Do It Best, The Home Depot, Lowe's Home Centers, W. W.
Grainger and Wal-Mart. Consumer segment products are sold to retailers through a
combination of direct sales, sales representative organizations and distributor
sales.
The eight largest consumer segment customers represented approximately 23%,
23% and 19% of consolidated net sales and approximately 50%, 49% and 41% of
consumer segment sales for 2003, 2002 and 2001, respectively. The Home Depot
represented approximately 12% and 11% of consolidated net sales and
approximately 25% and 24% of consumer segment sales for the years ended May 31,
2003 and 2002, respectively.
We reflect income from our joint ventures on the equity method, and receive
royalties from our licensees, both of which minor amounts are reflected as
offsets to selling, general and administrative expenses. Export sales were less
than 10% of net sales for each of the three years presented.
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. These
corporate and other assets and expenses reconcile operating segment data to
total consolidated net sales, earnings before interest and taxes, identifiable
assets, capital expenditures, and depreciation and amortization.
The following data reflect the adoption of Statement of Financial
Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets,"
effective June 1, 2001 (refer to Note A [10]).
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RPM International Inc. and Subsidiaries
SEGMENT AND
GEOGRAPHIC INFORMATION
(In thousands)
Year Ended May 31 2003 2002 2001
===========================================================================================================
SEGMENT INFORMATION
Net Sales
Industrial $1,117,877 $1,053,632 $1,100,682
Consumer 965,612 932,494 907,080
Corporate/Other
- -----------------------------------------------------------------------------------------------------------
TOTAL $2,083,489 $1,986,126 $2,007,762
===========================================================================================================
Income Before Income Taxes(a)
Earnings Before Interest and Taxes ("EBIT")(b)
Industrial $ 122,315 $ 107,033 $ 122,034
Consumer 131,384 118,230 62,662
Corporate/Other (179,134)(c) (30,675) (18,006)
- -----------------------------------------------------------------------------------------------------------
Total EBIT 74,565 194,588 166,690
Interest Expense, Net 26,712 40,464 65,203
- -----------------------------------------------------------------------------------------------------------
TOTAL $ 47,853 $ 154,124 $ 101,487
===========================================================================================================
Identifiable Assets
Industrial $1,067,916 $ 962,742 $1,002,209
Consumer 1,038,350 1,000,928 1,016,067
Corporate/Other 140,945 115,174 60,214
- -----------------------------------------------------------------------------------------------------------
TOTAL $2,247,211 $2,078,844 $2,078,490
===========================================================================================================
Capital Expenditures
Industrial $ 18,741 $ 17,743 $ 30,123
Consumer 22,095 20,559 23,629
Corporate/Other 978 1,629 366
- -----------------------------------------------------------------------------------------------------------
TOTAL $ 41,814 $ 39,931 $ 54,118
===========================================================================================================
Depreciation and Amortization
Industrial $ 27,537 $ 26,883 $ 38,579
Consumer 29,216 28,605 41,627
Corporate/Other 1,921 1,371 1,288
- -----------------------------------------------------------------------------------------------------------
TOTAL $ 58,674 $ 56,859 $ 81,494
===========================================================================================================
GEOGRAPHIC INFORMATION
Net Sales (based on shipping location)
United States $1,683,196 $1,615,047 $1,614,112
- -----------------------------------------------------------------------------------------------------------
Foreign
Canada 147,063 135,694 140,009
Europe 175,896 158,440 164,517
Other Foreign 77,334 76,945 89,124
- -----------------------------------------------------------------------------------------------------------
Total Foreign 400,293 371,079 393,650
- -----------------------------------------------------------------------------------------------------------
TOTAL $2,083,489 $1,986,126 $2,007,762
===========================================================================================================
Assets Employed
United States $1,830,629 $1,706,843 $1,732,238
- -----------------------------------------------------------------------------------------------------------
Foreign
Canada 151,771 147,568 128,159
Europe 197,948 160,641 144,619
Other Foreign 66,863 63,792 73,474
- -----------------------------------------------------------------------------------------------------------
Total Foreign 416,582 372,001 346,252
- -----------------------------------------------------------------------------------------------------------
TOTAL $2,247,211 $2,078,844 $2,078,490
===========================================================================================================
(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.
(c) The asbestos charge, reflected in Corporate/Other, relates to our Bondex
International, Inc. subsidiary.
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RPM International Inc. and Subsidiaries
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our Consolidated Financial Statements include accounts of RPM and all
majority-owned subsidiaries. Preparation of our financial statements requires
the use of estimates and judgments that affect the amounts of our assets,
liabilities, revenues and expenses. 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. 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 pass 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 the consolidated statements of income of 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 determined 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 the exposure to foreign currency fluctuations in our
foreign subsidiaries. These loans are treated as analogous to equity for
accounting purposes. Therefore, foreign exchange gains or losses on these
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 (refer to Note A [10]). Goodwill amortization ceased upon adoption
of the standard, and the required initial impairment tests were performed.
Results of these and subsequent 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 the first fiscal
quarter. Losses, if any, resulting from impairment tests will be reflected 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 that 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
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RPM International Inc. and Subsidiaries
the above-described indicators, any impairment will be measured based on
projected net cash flows expected from the asset(s), including eventual
disposition.
CONTINGENCIES (ALSO REFER TO NOTE H)
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. 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, and are reviewed quarterly and adjusted according
to developments. Changes in the amount of these provisions affect our
consolidated statements of income. Due to the uncertainties inherent 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. 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
some of these sites and for other sites, costs may exceed existing reserves. 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 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.
RESULTS OF OPERATIONS
FISCAL 2003 COMPARED WITH FISCAL 2002
NET SALES | Fiscal 2003 net sales grew $97.4 million, or 5%, over fiscal
2002. Organic sales growth amounted to $78.2 million, or 4% growth year over
year, from unit volume as opposed to pricing and favorable foreign exchange
differences of $19 million. These exchange differences were principally against
the euro and the Canadian dollar, net of negative differences from Latin
American currencies. Eight smaller acquisitions including Koch Waterproofing
Solutions, purchased on April 1, 2003, made up the difference, adding
approximately $19 million to sales.
Industrial segment sales amounted to 54% of the RPM total, and were ahead
year over year by 6%, 5% of which was organic growth and included favorable
foreign exchange differences. Five smaller acquisitions accounted for the
balance of the sales growth. The organic sales growth resulted primarily from
the increased demand for lower-margin maintenance and installation products and
services associated primarily with roofing and flooring throughout the year.
Aside from growth in these services, commercial construction was down and the
industrial manufacturing sectors of the economy generally remained weak
throughout the year, continuing the postponement by a number of customers of
higher-cost maintenance and replacement projects that call for many RPM
industrial products. It remains our belief that this business has not been lost
to any competitor, but becomes pent-up demand for those products and services.
Furthermore, the fact that our industrial segment has been able to grow
organically under a still-weak economic environment strongly suggests, and it is
our firm belief, that we have expanded our market share during the year.
Consumer segment sales amounted to 46% of the RPM total and were ahead 4%
year over year, 3% from organic growth, and included favorable foreign exchange
differences, primarily in the euro versus the U.S. dollar. Three smaller
acquisitions provided the balance of the sales increase. Consumer demand was
solid during the first half of the year but slowed considerably during the
second half of the year from a combination of weather factors and inventory
reduction efforts at several key accounts, which caused changes in order pattern
quantities and frequency. The consumer retail takeaway, otherwise, has remained
fairly steady and somewhat healthy throughout the year.
GROSS PROFIT MARGIN | The fiscal 2003 gross profit margin of 45.8% compares
with 45.9% during fiscal 2002, or nearly flat year over year. The benefits from
higher sales volume and some lower raw material costs were slightly more than
offset by a mix of lower-margin sales. The industrial segment gross margins
declined year over year to 46.2% from 46.9%. The benefits from improved sales
levels and a number of lower raw material costs in this segment were more than
offset by a change in sales mix created by the strong sales of lower-margin
services during 2003, related primarily to roofing and flooring.
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RPM International Inc. and Subsidiaries
The consumer segment gross margin improved year over year to 45.4% from
44.8%. This improvement is the result of positive leverage from the higher sales
volume, slightly favorable raw material costs and continued conversion
cost-saving initiatives.
Manufacturing efficiencies from expanded Class A manufacturing initiatives are
being realized in both operating segments, and these efforts will continue. Raw
material cost pressures were building during the second half of fiscal 2003, and
we believe higher costs in the material cost area may impact the first quarter
of fiscal 2004 and, possibly, beyond.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A") | Consolidated SG&A
expenses improved to 35.5% of net sales in 2003 from 36.1% during fiscal 2002,
attributable largely to significant growth in lower-margin services sales in the
industrial segment that require relatively much lower SG&A support cost, along
with ongoing cost reduction and containment efforts throughout both operating
segments.
The industrial segment SG&A was 35.2% of net sales in 2003 compared with
36.8% during fiscal 2002. The growth in sales volume, particularly service
sales, contributed about half of this improvement. Cost reduction initiatives
and cost containment efforts in both periods made up the difference.
The consumer segment SG&A improved to 31.8% of net sales from 32.1% during
fiscal 2002. This net improvement is a result of the higher sales volume
leverage and continuous cost reduction and containment efforts, partly offset by
certain increased selling and promotional spending among our primary consumer
product lines.
Corporate/other costs amounted to $39.1 million in 2003 compared with $30.7
million during fiscal 2002. This change reflects increased product liability
costs of $5.1 million and a change in export sales tax legislation that went
into effect this fiscal year. While this latter change caused $4.0 million of
the increase in corporate/ other costs during 2003, consolidated SG&A was not
affected by this tax law change because this increase in corporate/other expense
is offset by corresponding reductions of expense in the industrial and consumer
operating segments in the amounts of $2.4 million and $1.6 million,
respectively.
ASBESTOS CHARGE | Certain of our wholly owned subsidiaries, principally
Bondex International, Inc. (Bondex), along with many other U.S. companies, are
and have been involved in 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.
Asbestos-related suits against Bondex increased in the fourth quarter of
2002 and the first two quarters of 2003, influenced by the bankruptcy filings of
numerous other defendants in asbestos-related litigation. Based on the
significant increase in asbestos claims and the inequitable impact of joint and
several liability laws on Bondex, as previously reported, our third-party
insurance will be depleted during the first quarter of 2004. Prior to this
sudden precipitous increase in loss rates, the combination of reserves and
insurance coverage was expected to adequately cover our asbestos claims for the
foreseeable future. We are contesting various of our third-party insurers'
claims of exhaustion.
During the last seven months of 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. The ultimate impact of these law changes is not expected to be
significantly visible until the latter part of fiscal 2004.
During the fourth quarter of 2003, a nationally recognized consulting firm
was retained to evaluate whether it would be possible to estimate the cost of
disposing pending claims and to assist in determining whether future asbestos-
related claims were measurable. Bondex has provided the consultants with all
relevant data regarding asbestos-related claims filed against Bondex through May
31, 2003.
At this time, we cannot estimate the liability that will result from all
future claims. We have 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. The reserve was established by taking an asbestos charge to 2003
operations of $140,000,000 for measurable known claims and a provision for
future claims that can presently be estimated. We believe this asbestos reserve
will be sufficient to cover asbestos-related cash flow requirements for
approximately three years. Additionally, Bondex's share of costs (net of
then-available third-party insurance) for asbestos-related product liability
were $6,700,000, $2,800,000 and $2,300,000 for the years ended May 31, 2003,
2002 and 2001, respectively. Future facts, events and legislation, both state
and/or federal, may alter our estimates of both pending and future claims. The
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RPM International Inc. and Subsidiaries
Company 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 our outside advisors, we will continue to study our
asbestos-related exposure, 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 (also refer to Note H).
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 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 investors.
Consolidated EBIT in 2003 of $74.6 million compares with $194.6 million
during fiscal 2002, with $140.0 million of this difference representing the
asbestos liability charge. Excluding the charge, 2003 EBIT would have been
$214.6 million or ahead $20.0 million, or 10%, over fiscal 2002. That represents
margin improvement on the 5% sales increase, to 10.3% of net sales from 9.8%
during fiscal 2002, the result of the higher sales volume coupled with cost
reductions and containments.
Industrial segment EBIT grew $15.3 million, or 14%, on 6% sales growth, to
11% of net sales compared with 10% of sales during fiscal 2002. Consumer segment
EBIT grew $13.2 million, or 11%, on 4% sales growth to 14% of net sales compared
with 13% of net sales during fiscal 2002. These operating EBIT improvements
totaling $28.4 million generally are the result of the growth in sales volume,
certain lower raw material costs year over year and ongoing cost reductions and
containments across both operating segments.
NET INTEREST EXPENSE | Net interest expense declined $13.8 million during
2003 (refer to Note A [17]) as a result of much lower average debt levels and
lower interest rates. Interest rates on the variable portion of outstanding
borrowings, averaging approximately 70% of total debt (refer to Note B),
averaged a much lower 3.8% compared with 4.5% during 2002, amounting to savings
of $4.8 million in 2003. Total debt levels averaged $202 million lower
throughout 2003, accounting for $10.0 million of interest cost saved year over
year. After our issuance of 2.75% Senior Convertible Notes in May 2003 (see
Financing Activities in "Liquidity and Capital Resources"), the variable rate
portion of our total debt structure was down to 51%. During fiscal 2002, there
were marketable securities gains of approximately $1.0 million that were not
realized again during 2003.
INCOME TAX RATE | The effective income tax rate provision this year of
26.2% compares with 34.1% for fiscal 2002 (refer to Note C). This year's much
lower rate is the result of the weight of the full tax benefit (37.5%) of the
$140.0 million asbestos liability charge, and will not be a recurring rate.
Excluding the charge, our tax rate in 2003 would have been 34.6%, up 0.5% from
fiscal 2002. As a result of earnings growth, the one-time tax rate benefit from
the June 1, 2001 adoption of SFAS No. 142 becomes less and less significant, and
this trend is expected to continue.
NET INCOME | Fiscal 2003 net income of $35.3 million compares with $101.6
million during fiscal 2002 and reflects the $87.5 million after-tax cost of the
2003 asbestos liability charge. Excluding the charge, 2003 net income would have
been $122.8 million, ahead 20.9%, or $21.2 million, from fiscal 2002. The return
on sales would have been 5.9% compared with 5.1% for fiscal 2002.
During March 2002, we sold 11.5 million common shares (see Financing
Activities in "Liquidity and Capital Resources") through a follow-on public
equity offering, and this transaction had a dilutive effect of $0.01 per share
on fiscal 2003 reported diluted earnings per share. Excluding the impact of the
asbestos charge on earnings, the 11.5 million shares sold in March 2002 would
have had a $0.07 per share dilutive effect on fiscal 2003 pro forma diluted
earnings per share of $1.06.
FISCAL 2002 COMPARED WITH FISCAL 2001
NET SALES | Fiscal 2002 net sales were slightly below fiscal 2001 by $21.6
million, or 1%. The $30 million commercial Durabond unit of DAP was divested in
March 2001, with sales of $26.3 million to that point in the 2001 fiscal year.
Factoring out those sales to be comparable, plus the negative effects from
foreign exchange differences of approximately $14 million, principally against
the Canadian dollar, year-over-year sales would show a 1% increase.
Industrial segment sales amounted to 53% of the 2002 RPM total, and were
lower year over year by 3.3% when the negative foreign exchange effect of $11.2
million is
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RPM International Inc. and Subsidiaries
excluded. The industrial economy, including electronics, was generally weak
throughout 2002, which caused a number of customers to postpone higher-cost
maintenance and replacement projects, particularly flooring.
Consumer segment sales amounted to 47% of the 2002 RPM total, and were
ahead 6.2% year over year on a comparable basis, after adjusting for the
Durabond divestiture and negative foreign exchange effects. Consumer demand was
solid throughout 2002, especially for our DAP, Rust-Oleum and Zinsser products.
This growth reflected a combination of higher unit volume of approximately 5%,
with the balance from slightly higher pricing to counter increased raw material
and packaging costs during the 2001 fiscal year.
GROSS PROFIT MARGIN | The gross profit margin improved in fiscal 2002,
reaching 45.9% compared with 45.1% during fiscal 2001. The industrial gross
margin of 46.9% in 2002 was slightly behind the 47.4% realized during fiscal
2001. This was mainly a volume effect as the sales decline, particularly of
higher-margin flooring (off $44 million, or 11%), was too great to overcome
versus related overhead costs. Restructuring savings and a number of favorable
raw material costs partially offset this volume effect. Consumer gross margins,
on the other hand, reached 44.8% from 42.5% during 2001. This improvement
reflected additional restructuring savings of approximately $21 million during
fiscal 2002, plus positive cost leverage from the higher sales volume and a
number of favorable raw material costs in this segment as well.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES | SG&A expenses improved to
36.1% of sales in 2002 from 36.8% during fiscal 2001. We adopted SFAS No. 142,
"Goodwill and Other Intangible Assets" (SFAS No. 142), as of June 1, 2001, the
beginning of the 2002 fiscal year, and that change is reflected in SG&A (refer
to Note A [10]). On a pro forma basis, the fiscal 2001 SG&A percentage under
SFAS No. 142 would have been $25.1 million lower, or 35.6% of sales. The
divested Durabond unit of DAP had carried a lower SG&A percentage, having an
approximate negative effect of 0.4% of sales, bringing the fiscal 2001 SG&A
percentage, adjusted for both SFAS No. 142 and the divestiture, to approximately
36% of sales. The fiscal 2002 $2.1 million third-quarter charge related to the
devaluation of the Argentinean peso amounted to 0.1% of fiscal 2002 sales.
Without that charge, the 2002 SG&A percentage would have equaled fiscal 2001's
36%, adjusted for SFAS No. 142 and the divestiture.
By segment, industrial SG&A of 36.8% in 2002 compared with 36.3% during
fiscal 2001, or 35.2% on a pro forma SFAS No. 142-adjusted basis. This
difference was attributable to the much lower sales volume in 2002; increased
distribution costs associated with a transition to fewer warehouses; and the
Argentinean peso devaluation, all of which were partly offset by solid cost
containment efforts throughout the segment. Consumer SG&A of 32.1% in 2002
compared favorably with 35.6% during fiscal 2001, or 34.1% on a pro forma SFAS
No. 142-adjusted basis. This significant improvement was attributable to the
much higher consumer sales volume; some reduced freight costs, as there were
still restructuring-related inefficiencies during fiscal 2001; and solid cost
containment efforts throughout this segment. Corporate/other costs were $30.7
million in 2002 compared with $18 million during fiscal 2001. This change
reflected a number of increased legal and professional fees associated with
terminated acquisition and divestiture efforts; increased product liability
costs (including those described under Item 3. Legal Proceedings, Form 10-K);
rising health care and other employee benefit costs; management succession
costs; and other higher corporate costs.
EARNINGS BEFORE INTEREST AND TAXES | EBIT climbed $27.9 million in 2002,
reaching $194.6 million. Fiscal 2001 EBIT, adjusted for SFAS No. 142, would have
been $191.8 million, leaving 2002 EBIT ahead by $2.8 million, or up 1.5% on a 1%
decrease in sales. Industrial EBIT was down $15 million during fiscal 2002, or
down $26.9 million after adjusting fiscal 2001 for SFAS No. 142, with this
decline being attributable mainly to the lower flooring sales volume. Consumer
EBIT nearly doubled year over year, up $55.6 million, or still ahead $42.4
million on a SFAS No. 142-adjusted basis, with that growth almost equally
attributable to the restructuring savings and the higher comparable sales
volume.
NET INTEREST EXPENSE | Net interest expense declined $24.7 million during
2002 (refer to Note A [17]) as a result of lower interest rates and reduced debt
levels during the year. Interest rates on the variable rate portion
(approximately 75% to 80%) of outstanding borrowings (refer to Note B) were
lower in fiscal 2002. The overall effective interest rate of approximately 4.5%
in 2002 compares favorably with 6.9% during fiscal 2001, amounting to savings of
$20.3 million for 2002. Total debt levels were approximately $63 million lower
on average throughout the year, accounting for the remaining $4.4 million of
interest costs saved year over year.
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RPM International Inc. and Subsidiaries
Income Tax Rate | The effective income tax rate of 34.1% for 2002 compared
favorably with fiscal 2001's 38% rate (refer to Note C). This rate reduction was
driven by the adoption of SFAS No. 142, as goodwill is no longer being amortized
for financial purposes.
Net Income | 2002 net income of $101.6 million, or $0.97 per diluted share,
increased 61% and 56%, respectively, from fiscal 2001. On a pro forma basis
adjusted for SFAS No. 142, fiscal 2001 net earnings and diluted earnings per
share would have been $84.8 million and $0.83 (refer to Note A [10]),
respectively, putting 2002 results still ahead by 20% and 17%, respectively.
During March 2002, we sold 11.5 million common shares (see Financing
Activities in "Liquidity and Capital Resources") through a follow-on public
equity offering, and this transaction had a dilutive effect on fiscal 2002 of
$0.01 per share.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES
Operating activities generated positive cash flow of $160.6 million during
fiscal 2003 compared with $191.4 million a year ago, a decrease of $30.8
million. After adding back the $140.0 million ($87.5 million after tax) effect
of the asbestos charge, which did not affect cash flow, our adjusted net income
of $122.8 million represents a $21.2 million increase over the prior year's
$101.6 million. Depreciation and amortization were flat year over year as
capital expenditures have remained relatively flat over the past two years and
the effects of SFAS No. 142 are no longer a differentiating factor in the yearly
comparative results. The most significant movement in cash flow generated from
operating assets was in accounts receivable, where a cash usage of $37.3 million
was caused mainly by an increase in sales in the fourth quarter versus
relatively flat sales in the prior year's quarter-over-quarter sales results;
additionally, approximately $14 million of the increase in cash flow used
related to receivables is a result of translating our foreign-denominated
receivables at higher asset values as the dollar weakened against virtually all
major foreign currencies as of May 31, 2003 versus May 31, 2002. Cash flow
generated from inventories was $1.3 million as the effect of Class A
manufacturing continued to provide benefits over the last two fiscal years.
Inventories were negatively affected by approximately $8 million as a result of
the translation of foreign-denominated inventories at this year's year-end spot
rates versus those of the prior year. The Company continues a strong focus on
improving accounts receivable collections and managing inventories lower as a
result of strengthened information technology systems and continuous
improvements in operating techniques, such as Class A manufacturing, and these
efforts will continue. Prepaid and other current assets increased mostly as a
result of recording a receivable due from insurance companies of approximately
$16.6 million. Accrued loss reserves were increased by $15.4 million, mainly as
a result of recording additional loss provisions related to the insurance
receivable.
As disclosed in the Company's "Critical Accounting Policies and Estimates"
and its discussion on asbestos litigation (refer to Note H - "Contingencies and
Loss Reserves"), as a result of a significant increase in asbestos claims
activity and inequitable joint and several liability determinations against
Bondex, our third-party insurance will be depleted within the first quarter of
2004. As a result, the Company will then be required to fund costs presently
covered by insurance with its then-existing cash from operations.
Cash provided from operations remains our primary source of financing
internal growth, with limited use of short-term credit.
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 in fiscal 2003 of $41.8 million compare with depreciation and
amortization of $58.7 million. We are not capital intensive and capital
expenditures generally do not exceed depreciation and amortization in a given
year. Capital spending is expected to hold at approximately the fiscal 2003
level for the next several years as many larger spending needs have been
accomplished in recent years, such as those to accommodate the restructuring
program, plus several major information technology platform conversions. We
believe there is adequate production capacity to meet our needs for the next
several years at normal growth rates.
During fiscal 2003, there were investments totaling $66.0 million (refer to
Note A [2]) for seven product line acquisitions and one minority interest
acquisition.
Our captive insurance companies invest in marketable securities in the
ordinary course of conducting their operations, and this activity will continue
(refer to Note A [7]). Differences in these activities between years are
attributable to the timing and performance of their investments.
23
RPM International Inc. and Subsidiaries
FINANCING ACTIVITIES
During March 2002, we sold 11.5 million common shares through a follow-on
public offering at $14.25 per share, closing April 2, 2002. The entire proceeds
of the offering, $156 million, were used to permanently pay down the outstanding
balance under the $200 million term loan facility, which was then retired.
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 the Company's creditors until the participating banks'
obligations have been paid in full. This securitization is being 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 the Company's customers, customer concentration levels and certain
characteristics of the underlying accounts receivable. This transaction
increases our liquidity and reduces our financing costs by replacing up to $125
million of existing borrowing at lower interest rates. As of May 31, 2003, $91
million was securitized under this agreement, the proceeds of which were used to
reduce the outstanding balance under the $500 million revolving credit
agreement.
On February 12, 2003, the Company 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 May 31, 2003, the Company had
repurchased 100,000 of its shares at an average price of $11.67 per share.
In May 2003, the Company issued $297 million face value at maturity
unsecured 2.75% Senior Convertible Notes ("2.75% Notes") due May 13, 2033. The
Company generated net proceeds of $150 million from the sale of the 2.75% Notes.
The 2.75% Notes are convertible into 8,034,355 shares of the Company's common
stock at a price of $18.68 per share, subject to adjustments, during any fiscal
quarter for which the closing price of the Company's 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 the credit rating of the Company 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.
In May 2003, the Company 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 May 31, 2003, there was $51.7 million outstanding under
this CP program, the proceeds of which were used to reduce the outstanding
balance of the revolver mentioned above.
Our debt-to-capital ratio was 45% at May 31, 2003, unchanged from May 31,
2002.
The table below summarizes our financial obligations and their expected
maturities at May 31, 2003, and the effect such obligations are expected to have
on our liquidity and cash flow in the periods indicated.
May 31, 2003
===========================================================================================================================
(In millions) Total Less than 1 Year 1-3 Years After 3 Years
===========================================================================================================================
Current portion of long-term debt $ 1.3 $ 1.3 $ -- $ --
- ---------------------------------------------------------------------------------------------------------------------------
Long-term debt 724.8 -- 434.6 290.2
Non-cancelable operation lease obligations 72.8 16.8 23.9 32.1
- ---------------------------------------------------------------------------------------------------------------------------
$798.9 $18.1 $458.5 $322.3
===========================================================================================================================
24
RPM International Inc. and Subsidiaries
The condition of the U.S. dollar has fluctuated throughout the year, and
was moderately weaker at fiscal year end over the previous year end, causing a
favorable change in the "Accumulated Other Comprehensive Loss" (refer to Note A
[5]) component of stockholders' equity of $39.9 million this year versus $3.4
million last year. This change was offset by a decrease of $5.9 million related
to adjustments required to certain foreign subsidiaries' Minimum Pension
Liability.
We maintain excellent relations with our banks and other financial
institutions to provide continual access to financing for future growth
opportunities.
OFF-BALANCE SHEET FINANCINGS
We do not have any off-balance sheet financings, other than the minimum
leasing commitments described in Note E. 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.
QUALITATIVE AND QUANTITATIVE DISCLOSURES
ABOUT MARKET RISK
We are exposed to market risk from changes in interest rates and foreign
currency exchange rates because we fund our operations through long- and
short-term borrowings and denominate our business transactions in a variety of
foreign currencies. A summary of our primary market risk exposures follows.
INTEREST RATE RISK
Our primary interest rate risk exposure results from our floating rate
debt, including various revolving and other lines of credit (refer to Note B).
At May 31, 2003, approximately 51% of our total debt was subject to floating
interest rates. If interest rates were to increase 100 basis points (1%) from
May 31, 2003 rates, and assuming no changes in debt from the May 31, 2003
levels, the additional annual interest expense would amount to approximately
$3.7 million on a pre-tax basis. We currently do not hedge our exposure to
floating interest rate risk.
FOREIGN CURRENCY RISK
Our foreign sales and results of operations are subject to the impact of
foreign currency fluctuations (refer to Note A [4]). As most of our foreign
operations are in countries with fairly stable currencies, such as Belgium,
Canada and the United Kingdom, this effect has not generally been material. In
addition, foreign debt is denominated in the respective foreign currency,
thereby eliminating any related translation impact on earnings.
If the U.S. dollar continues to weaken, our foreign results of operations
will be positively impacted, but the effect is not expected to be material. A
10% change in foreign currency exchange rates would not have resulted in a
material impact to net income for the year ended May 31, 2003. We do not
currently hedge against the risk of exchange rate fluctuations.
FORWARD-LOOKING STATEMENTS
The foregoing discussion includes forward-looking statements relating to our
business. These forward-looking statements, or other statements made by us, are
made based on our expectations and beliefs concerning future events impacting us
and are subject to uncertainties and factors (including those specified below)
that are difficult to predict and, in many instances, are beyond our control. As
a result, our actual results could differ materially from those expressed in or
implied by any such forward-looking statements. These uncertainties and factors
include (a) general economic conditions; (b) the price and supply of raw
materials, particularly titanium dioxide, certain resins, aerosols and solvents;
(c) continued growth in demand for our products; (d) legal, environmental and
litigation risks inherent in RPM's construction and chemicals businesses and
risks related to the adequacy of our reserves and insurance coverage for such
matters; (e) the effect of changes in interest rates; (f) the effect of
fluctuations in currency exchange rates upon our foreign operations; (g) the
effect of non-currency risks of investing in and conducting operations in
foreign countries, including those relating to domestic and international
political, social, economic and regulatory factors; (h) risks and uncertain-
ties associated with our ongoing acquisition and divestiture activities; (i)
risks inherent in our contingent liability reserves, including asbestos; and
other risks detailed in our other reports and statements filed with the
Securities and Exchange Commission, including the risk factors set forth in our
prospectus and prospectus supplement included as part of our Registration
Statement on Form S-3 (File No. 333-77028), as the same may be amended from time
to time.
25
RPM International Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
May 31 2003 2002
- ---------------------------------------------------------------------------------- ----------- -----------
ASSETS
CURRENT ASSETS
Cash and short-term investments (Note A) $ 50,725 $ 42,172
Trade accounts receivable (less allowances of $17,297 in 2003
and $15,884 in 2002) 439,623 397,659
Inventories (Note A) 253,204 251,446
Deferred income taxes (Notes A and C) 51,285 42,441
Prepaid expenses and other current assets 133,257 110,037
----------- -----------
TOTAL CURRENT ASSETS 928,094 843,755
----------- -----------
PROPERTY, PLANT AND EQUIPMENT, AT COST (NOTE A)
Land 23,401 21,655
Buildings and leasehold improvements 221,954 203,428
Machinery and equipment 468,654 430,758
----------- -----------
714,009 655,841
Less allowance for depreciation and amortization 343,220 300,044
----------- -----------
PROPERTY, PLANT AND EQUIPMENT, NET 370,789 355,797
----------- -----------
OTHER ASSETS
Goodwill (Note A) 631,253 592,329
Other intangible assets, net of amortization (Note A) 282,949 264,530
Other 34,126 22,433
----------- -----------
TOTAL OTHER ASSETS 948,328 879,292
----------- -----------
TOTAL ASSETS $ 2,247,211 $ 2,078,844
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 171,956 $ 160,767
Current portion of long-term debt (Note B) 1,282 5,876
Accrued compensation and benefits 77,577 80,530
Accrued loss reserves (Note H) 64,230 48,537
Asbestos-related liabilities (Note H) 41,583 3,377
Other accrued liabilities 59,759 58,144
Income taxes payable (Notes A and C) 11,263 7,483
----------- -----------
TOTAL CURRENT LIABILITIES 427,650 364,714
----------- -----------
LONG-TERM LIABILITIES
Long-term debt, less current maturities (Note B) 724,846 707,921
Asbestos-related liabilities (Note H) 103,000
Other long-term liabilities 59,951 55,458
Deferred income taxes (Notes A and C) 54,756 92,645
----------- -----------
TOTAL LONG-TERM LIABILITIES 942,553 856,024
----------- -----------
TOTAL LIABILITIES 1,370,203 1,220,738
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.01; authorized 50,000 shares;
none issued
Common stock, par value $0.01 and without par value with a stated value of
$0.015 per share as of May 31, 2003 and 2002, respectively; authorized 300,000
and 200,000 shares, respectively; issued 115,596 and outstanding
115,496 in 2003; issued 122,653 and outstanding 114,696 in 2002 (Note D) 1,156 1,786
Paid-in capital 508,397 585,566
Treasury stock, at cost (Note D) (1,167) (88,364)
Accumulated other comprehensive loss (Note A) (17,169) (50,485)
Retained earnings 385,791 409,603
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 877,008 858,106
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,247,211 $ 2,078,844
=========== ===========
See Notes to Consolidated Financial Statements
26
RPM International Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
Year Ended May 31 2003 2002 2001
- --------------------------------------------------- ---------- ---------- ----------
NET SALES $2,083,489 $1,986,126 $2,007,762
Cost of Sales 1,128,937 1,073,910 1,101,417
---------- ---------- ----------
Gross Profit 954,552 912,216 906,345
Selling, General and Administrative Expenses 739,987 717,628 739,655
Asbestos Charge (Note H) 140,000
Interest Expense, Net 26,712 40,464 65,203
---------- ---------- ----------
Income Before Income Taxes 47,853 154,124 101,487
Provision for Income Taxes (Note C) 12,526 52,570 38,526
---------- ---------- ----------
NET INCOME $ 35,327 $ 101,554 $ 62,961
========== ========== ==========
Average Shares of Common Stock Outstanding (Note D)
Basic 115,294 104,418 102,202
Diluted 115,986 105,131 102,212
Earnings per Common Share
Basic $ 0.31 $ 0.97 $ 0.62
Diluted $ 0.30 $ 0.97 $ 0.62
Cash Dividends per Share of Common Stock $ 0.515 $ 0.500 $ 0.498
========== ========== ==========
See Notes to Consolidated Financial Statements
27
RPM International Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
Common Stock Accumulated
------------------------ Other
Number Par/ Comprehensive
of Shares Stated Paid-in Treasury Loss Retained
(Note D) Value Capital Stock (Note A) Earnings Total
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MAY 31, 2000 103,134 $ 1,616 $ 424,077 $ (88,516) $ (39,555) $ 348,102 $ 645,724
---------
Comprehensive income
Net income 62,961 62,961
Translation loss and other (13,519) (13,519)
---------
Comprehensive income 49,442
Dividends paid (50,605) (50,605)
Repurchase of stock (1,157) (11,101) (11,101)
Stock option exercises 59 1 101 309 411
Restricted stock awards 175 2 5,837 5,839
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MAY 31, 2001 102,211 1,619 430,015 (99,308) (53,074) 360,458 639,710
---------
Comprehensive income
Net income 101,554 101,554
Translation gain and other 2,589 2,589
---------
Comprehensive income 104,143
Dividends paid (52,409) (52,409)
Sale of stock 11,500 167 155,767 155,934
Stock option exercises, net 847 92 9,412 9,504
Restricted stock awards 138 (308) 1,532 1,224
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MAY 31, 2002 114,696 1,786 585,566 (88,364) (50,485) 409,603 858,106
---------
Comprehensive income
Net income 35,327 35,327
Translation gain and other 33,316 33,316
---------
Comprehensive income 68,643
Dividends paid (59,139) (59,139)
Treasury stock retired (113) (85,723) 85,836
Repurchase of stock (100) (1,167) (1,167)
Stock option exercises, net 300 2 2,015 1,269 3,286
Restricted stock awards 600 5 6,111 1,259 7,375
Par value adjustment and other (524) 428 (96)
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MAY 31, 2003 115,496 $ 1,156 $ 508,397 $ (1,167) $ (17,169) $ 385,791 $ 877,008
================================================================================================================================
See Notes to Consolidated Financial Statements
28
RPM International Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended May 31 2003 2002 2001
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 35,327 $ 101,554 $ 62,961
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 44,736 43,541 43,035
Amortization of goodwill 19,694
Other amortization 13,938 13,318 18,765
Asset impairment charge, net of gains 3,354
Asbestos charges 146,650 2,754 2,338
(Decrease) in deferred income taxes (46,733) (3,930) (6,432)
(Earnings) of unconsolidated affiliates (396) (391) (275)
Changes in assets and liabilities, net of effect
from purchases and sales of businesses:
(Increase) decrease in receivables (37,258) 14,048 (12,255)
(Increase) decrease in inventory 1,262 25,929 (37,578)
(Increase) in prepaid and other current assets (27,378) (7,464) (8,575)
Increase (decrease) in accounts payable 9,156 8,489 (2,812)
Increase (decrease) in accrued restructuring (13,540)
Increase (decrease) in accrued liabilities 9,991 (8,564) 10,035
Other including exchange rate changes 11,334 2,086 (4,220)
--------- --------- ---------
Cash from Operating Activities 160,629 191,370 74,495
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (41,814) (39,931) (54,118)
Acquisition of businesses, net of cash acquired (65,994) (3,138) (2,645)
Purchase of marketable securities (15,145) (15,693) (21,906)
Proceeds from marketable securities 11,376 19,495 28,283
Distributions from unconsolidated affiliates 974 16 647
Proceeds from sale of assets and businesses 202 1,553 31,694
--------- --------- ---------
Cash (Used for) Investing Activities (110,401) (37,698) (18,045)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Additions to long-term and short-term debt 305,200 236,681 708,850
Reductions of long-term and short-term debt (294,099) (485,662) (710,389)
Cash dividends (59,139) (52,409) (50,605)
Sale of stock 155,934
Exercise of stock options 3,286 9,504 411
Repurchase of stock (1,167) (11,101)
--------- ---------
Cash (Used for) Financing Activities (45,919) (135,952) (62,834)
--------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 4,244 526 (1,030)
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH 8,553 18,246 (7,414)
CASH AT BEGINNING OF YEAR 42,172 23,926 31,340
--------- --------- ---------
CASH AT END OF YEAR $ 50,725 $ 42,172 $ 23,926
========= ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION:
Cash paid during the year for:
Interest $ 28,678 $ 50,353 $ 60,027
Income taxes $ 55,479 $ 59,774 $ 35,216
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES:
Shares issued for restricted stock plans $ 7,375 $ 1,224 $ 1,459
Debt from business combination $ 1,230
See Notes to Consolidated Financial Statements
29
RPM International Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2003, 2002, 2001
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(1) PRINCIPLES OF CONSOLIDATION
At the Company's annual meeting on October 11, 2002, stockholders approved
a plan to change the Company'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, pursuant to a merger, the parent holding
company of Ohio-based RPM, Inc.
The Consolidated Financial Statements include the accounts of RPM
International Inc. and its majority-owned subsidiaries. The Company accounts for
its investment in less than majority-owned joint ventures under the equity
method. Intercompany accounts, transactions and unrealized profits and losses
are eliminated in consolidation.
Certain reclassifications have been made to prior-year amounts to conform
with the current-year presentation.
(2) BUSINESS COMBINATIONS
During the year ended May 31, 2003, the Company completed seven product
line acquisitions and one minority interest acquisition, all of which have been
accounted for as business combinations. The following table summarizes the
estimated fair values of the assets acquired and liabilities assumed at the
respective dates of acquisition. The Company obtained independent valuation of
certain intangible assets.
(In thousands)
- --------------
Current assets $ 8,782
Property, plant and equipment 9,213
Other intangible assets
Customer relationships 17,222
Other 12,170
Goodwill 25,334
Liabilities assumed (6,079)
--------
NET ASSETS ACQUIRED $ 66,642
========
The operating results of these businesses are reflected in the Company's
financial statements from their respective dates of acquisition.
Pro forma results of operations for the years ended May 31, 2003 and May
31, 2002 were not materially different from reported results and, consequently,
are not presented.
(3) ESTIMATES
The preparation of financial statements in conformity with Generally
Accepted Accounting Principles in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
(4) FOREIGN CURRENCY
The functional currency of foreign subsidiaries is their local currency.
Accordingly, for the periods presented, assets and liabilities have been
translated using exchange rates at year end while income and expense for the
periods have been translated using an annual average exchange rate. The
resulting translation adjustments have been recorded in accumulated other
comprehensive loss, a component of stockholders' equity, and will be included in
net earnings only upon the sale or liquidation of the underlying foreign
investment, neither of which is contemplated at this time. Transaction gains and
losses have been immaterial during the past three fiscal years.
30
RPM International Inc. and Subsidiaries
(5) ACCUMULATED OTHER COMPREHENSIVE LOSS
Accumulated other comprehensive loss (which is shown net of taxes) consists
of the following components:
Foreign Minimum Unrealized
Currency Pension Gain (Loss)
Translation Liability on
(In thousands) Adjustments Adjustments Securities Total
- -------------- ----------- ----------- ---------- -----
Balance at May 31, 2000 $(38,540) $ -0- $ (1,015) $(39,555)
Reclassification adjustments for (gains) losses
included in net income 1,015 1,015
Other comprehensive gain (loss) (14,552) (102) 120 (14,534)
-------- -------- -------- --------
Balance at May 31, 2001 (53,092) (102) 120 (53,074)
Reclassification adjustments for (gains) losses
included in net income (120) (120)
Other comprehensive gain (loss) 3,411 (151) (551) 2,709
-------- -------- -------- --------
Balance at May 31, 2002 (49,681) (253) (551) (50,485)
Reclassification adjustments for (gains) losses
included in net income (149) (149)
Other comprehensive gain (loss) 39,872 (5,938) (469) 33,465
-------- -------- -------- --------
Balance at May 31, 2003 $ (9,809) $ (6,191) $ (1,169) $(17,169)
======== ======== ======== ========
(6) CASH AND SHORT-TERM INVESTMENTS
For purposes of the statement of cash flows, the Company considers all
highly liquid debt instruments purchased with a maturity of three months or less
to be cash equivalents. The Company does not believe it is exposed to any
significant credit risk on cash and short-term investments.
(7) MARKETABLE SECURITIES
Marketable securities, all of which are classified as available for sale,
totaled $22,073,000 and $19,396,000 at May 31, 2003 and 2002, respectively. The
estimated fair values of these securities are included in other current assets
and are based on quoted market prices.
(8) FINANCIAL INSTRUMENTS
The Company's financial instruments recorded on the balance sheet include
cash and short-term investments, accounts receivable, notes and accounts
payable, and debt. The carrying amount of cash and short-term investments,
accounts receivable, and notes and accounts payable approximates fair value
because of their short-term maturity.
The carrying amount of the Company's debt instruments approximates fair
value based on quoted market prices, variable interest rates or borrowing rates
for similar types of debt arrangements.
(9) INVENTORIES
Inventories are stated at the lower of cost or market, cost being
determined substantially on a first-in, first-out (FIFO) basis and market being
determined on the basis of replacement cost or net realizable value. Inventory
costs include raw material, labor and manufacturing overhead. Inventories were
composed of the following major classes:
May 31 2003 2002
- ------ ---- ----
(In thousands)
Raw material and supplies $ 80,517 $ 75,080
Finished goods 172,687 176,366
-------- --------
TOTAL INVENTORY $253,204 $251,446
======== ========
31
RPM International Inc. and Subsidiaries
(10) GOODWILL AND OTHER INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires the use of the purchase method for all business
combinations initiated after June 30, 2001. It also provides guidance on
purchase accounting related to the recognition of intangible assets. SFAS No.
142 requires that goodwill and identifiable acquired intangible assets with
indefinite useful lives shall no longer be amortized, but tested for impairment
annually and whenever events or circumstances occur indicating that goodwill
might be impaired. SFAS No. 142 also requires the amortization of identifiable
assets with finite useful lives. Identifiable acquired intangible assets, which
are subject to amortization, are to be tested for impairment in accordance with
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
The adoption of SFAS No. 144 on June 1, 2001 did not have an impact on the
Company.
The Company elected to adopt the provisions of SFAS No. 142 as of June 1,
2001, and identified its reporting units (components) to be one level below its
industrial and consumer operating segments. The Company determined the carrying
value of each reporting unit by assigning assets and liabilities, including the
existing goodwill and intangible assets, to those reporting units as of June 1,
2001. Upon adoption of SFAS No. 142, amortization of goodwill recorded for
business combinations consummated prior to July 1, 2001 ceased, and intangible
assets acquired prior to July 1, 2001 that did not meet the criteria for
recognition apart from goodwill under SFAS No. 141 were reclassified to
goodwill. In connection with the adoption of SFAS No. 142, the Company was
required to perform a transitional goodwill impairment assessment within six
months of adoption. The Company completed its transitional goodwill impairment
assessment, with no adjustment to the carrying value of its goodwill as of June
1, 2001. Prospectively, the annual impairment test will be performed in the
first quarter of the Company's fiscal year and any losses resulting from the
test will be reflected in operating income. The annual goodwill impairment
assessment involves estimating the fair value of the reporting unit and
comparing it with its carrying amount. If the carrying amount of the reporting
unit exceeds its fair value, additional steps are followed to recognize a
potential impairment loss. Calculating the fair value of the reporting units
requires significant estimates and assumptions by management. The Company
estimates the fair value of its reporting units by applying third-party market
value indicators to the reporting unit's projected earnings before interest,
taxes, depreciation and amortization. The Company completed its annual
impairment tests with no adjustment to the carrying value of its goodwill as of
May 31, 2003 and 2002.
The changes in the carrying amount of goodwill, by reporting segment, for
the year ended May 31, 2003 are as follows:
Industrial Consumer
(In thousands) Segment Segment Total
- -------------- ------- ------- -----
Balance as of
May 31, 2002 $255,966 $336,363 $592,329
Goodwill related
to acquisitions 25,334 25,334
Translation adjustments 9,497 4,093 13,590
-------- -------- --------
Balance as of
May 31, 2003 $290,797 $340,456 $631,253
======== ======== ========
32
RPM International Inc. and Subsidiaries
Other intangible assets consist of the following major classes:
Gross Net Other
Amortization Carrying Accumulated Intangible
(In thousands) Period (in Years) Amount Amortization Assets
- -------------- ----------------- ------ ------------ ------
As of May 31, 2003
Amortized intangible assets
Formulae 10 to 33 $173,102 $ 49,849 $123,253
Customer-related intangibles 7 to 33 65,317 13,097 52,220
Trademarks/names 5 to 40 5,544 1,779 3,765
Other 3 to 20 23,583 10,419 13,164
-------- -------- -------- --------
Total Amortized Intangibles 267,546 75,144 192,402
Unamortized intangible assets
Trade names 90,547 90,547
-------- -------- --------
TOTAL OTHER INTANGIBLE ASSETS $358,093 $ 75,144 $282,949
======== ======== ========
As of May 31, 2002
Amortized intangible assets
Formulae 10 to 33 $167,721 $ 42,067 $125,654
Customer-related intangibles 10 to 33 48,094 10,960 37,134
Trademarks/names 5 to 40 4,336 1,146 3,190
Other 3 to 20 23,088 8,903 14,185
-------- -------- -------- --------
Total Amortized Intangibles 243,239 63,076 180,163
Unamortized intangible assets
Trade names 84,367 84,367
-------- -------- --------
TOTAL OTHER INTANGIBLE ASSETS $327,606 $ 63,076 $264,530
======== ======== ========
The aggregate other intangible asset amortization expense for the fiscal
years ended May 31, 2003, 2002 and 2001 was $11,904,000, $11,329,000 and
$16,602,000, respectively. For each of the next five fiscal years through May
31, 2008, the estimated annual intangible asset amortization expense will
approximate $12,000,000.
The following pro forma information reconciles net income reported for the
year ended May 31, 2001 to adjusted net income, reflecting the impact of SFAS
No. 142. All amortization amounts are reflected net of tax.
Year Ended May 31 2003 2002 2001
----------- ----------- -----------
(In thousands, except per share data)
Net Income
Reported net income $ 35,327 $ 101,554 $ 62,961
Add back: Goodwill amortization 18,468
Add back: Trade name and workforce amortization 3,336
----------- ----------- -----------
ADJUSTED NET INCOME $ 35,327 $ 101,554 $ 84,765
=========== =========== ===========
Basic Earnings per Share
Reported net income $ 0.31 $ 0.97 $ 0.62
Goodwill amortization 0.18
Trade name and workforce amortization 0.03
----------- ----------- -----------
ADJUSTED BASIC EARNINGS PER SHARE $ 0.31 $ 0.97 $ 0.83
=========== =========== ===========
Diluted Earnings per Share
Reported net income $ 0.30 $ 0.97 $ 0.62
Goodwill amortization 0.18
Trade name and workforce amortization 0.03
----------- ----------- -----------
ADJUSTED DILUTED EARNINGS PER SHARE $ 0.30 $ 0.97 $ 0.83
=========== =========== ===========
33
RPM International Inc. and Subsidiaries
(11) DEPRECIATION
Depreciation is computed primarily using the straight-line method over the
following ranges of useful lives:
Land improvements 5 to 42 years
Buildings and improvements 5 to 50 years
Machinery and equipment 3 to 20 years
(12) REVENUE RECOGNITION
The Company's subsidiaries recognize revenue when title and risk of loss
pass to customers.
(13) SHIPPING COSTS
Shipping costs paid to third-party shippers for transporting products to
customers are included in selling, general and administrative expenses. For the
years ended May 31, 2003, 2002 and 2001, shipping costs were $74,200,000,
$73,700,000 and $75,400,000, respectively.
(14) ADVERTISING COSTS
Advertising costs are charged to operations when incurred and are included
in selling, general and administrative expenses. For the years ended May 31,
2003, 2002 and 2001, advertising costs were $58,700,000, $53,400,000 and
$52,400,000, respectively.
(15) RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations when incurred and
are included in selling, general and administrative expenses. The amounts
charged for the years ended May 31, 2003, 2002 and 2001 were $23,800,000,
$20,900,000 and $21,800,000, respectively. The customer-sponsored portion of
such expenditures was not significant.
(16) STOCK-BASED COMPENSATION
At May 31, 2003, the Company 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, as more fully described in Note D. 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 the Company had accounted for its employee stock options under the fair
value recognition provisions of SFAS No. 123, is illustrated in the following
table:
Year Ended May 31 2003 2002 2001
--------- --------- ---------
(In thousands, except per
share amounts)
Net income, as reported $ 35,327 $ 101,554 $ 62,961
Add: Stock-based
employee compensa-
tion expense from
restricted stock plans
included in reported
net income, net of
related tax effects 1,339 806 905
Deduct: Total stock-based
compensation expense
determined under fair
value-based method
for all awards, net of
related tax effects (4,517) (2,949) (3,910)
--------- --------- ---------
PRO FORMA NET INCOME $ 32,149 $ 99,411 $ 59,956
========= ========= =========
EARNINGS PER SHARE:
BASIC, AS REPORTED $ 0.31 $ 0.97 $ 0.62
========= ========= =========
DILUTED, AS REPORTED $ 0.30 $ 0.97 $ 0.62
========= ========= =========
PRO FORMA BASIC
AND DILUTED $ 0.28 $ 0.95 $ 0.59
========= ========= =========
The fair value for these options was estimated as of the date of grant
using a Black-Scholes option-pricing model with the following weighted average
assumptions for all options granted:
2003 2002 2001
---- ---- ----
Risk-free interest rate 3.3% 4.4% 5.1%
Expected life of option 7yrs 7yrs 7yrs
Expected dividend yield 3.5% 3.0% 3.5%
Expected volatility rate 37.3% 34.2% 32.5%
(17) INTEREST EXPENSE, NET
Interest expense is shown net of investment income, which consists of
interest, dividends and capital gains (losses). Investment income for the years
ended May 31, 2003, 2002 and 2001 was $1,437,000, $2,094,000 and $3,682,000,
respectively.
34
RPM International Inc. and Subsidiaries
(18) INCOME TAXES
The Company and its wholly owned domestic subsidiaries file a consolidated
federal income tax return. The tax effects of transactions are recognized in the
year in which they enter into the determination of net income, regardless of
when they are recognized for tax purposes. As a result, income tax expense
differs from actual taxes payable. The Company does not intend to distribute the
accumulated earnings of consolidated foreign subsidiaries totaling approximately
$115,000,000 at May 31, 2003, and therefore no provision has been made for the
taxes that would result if such earnings were remitted to the Company.
(19) REPORTABLE SEGMENTS
Reportable segment information appears on pages 16 and 17 of this report.
(20) OTHER RECENT ACCOUNTING PRONOUNCEMENTS
In July 2002, the Financial Accounting Standards Board issued SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146
requires that a liability for costs associated with an exit or disposal activity
be recognized and measured initially at fair value only when the liability is
incurred, and is effective for exit or disposal activities that are initiated
after December 31, 2002. The Company will apply the provisions of SFAS No. 146
to any future exit or disposal activities.
NOTE B - BORROWINGS
A description of long-term debt follows:
May 31 2003 2002
-------- --------
(In thousands)
Revolving credit agreement for $500,000,000 with a syndicate of banks through
July 14, 2005. Interest, which is tied to LIBOR, averaged 2.32% at May 31, 2003. $113,000 $395,000
Unsecured $297,000,000 face value at maturity 2.75% senior convertible notes
due May 13, 2033. 150,042
Unsecured 7.00% senior notes due June 15, 2005. 150,000 150,000
Unsecured notes due March 1, 2008. Interest, which is tied to LIBOR, averaged
1.28% at May 31, 2003. 100,000 100,000
Accounts Receivable Securitization Program for $125,000,000 with two banks
through June 4, 2005, subject to annual renewal by the banks at a weighted
average interest rate at May 31, 2003 of 1.89%. These obligations, along with
other short-term borrowings, have been reclassified as long-term debt,
reflecting the Company's intent and ability, through unused credit facilities,
to refinance these obligations. 91,000
Unsecured senior notes due insurance companies: 6.12% due November 15, 2004
in the amount of $15,000,000; 6.61% due November 15, 2006 in the amount of
$10,000,000 and 7.30% due November 15, 2008 in the amount of $30,000,000. 55,000 55,000
Commercial paper with a weighted average interest rate at May 31, 2003 of 1.92%. 51,735
Revolving 364-day credit agreement for $28,000,000 with a bank through
October 13, 2003. Interest, which is tied to one of various rates, averaged 1.88%
at May 31, 2003. 11,200
Revolving multi-currency credit agreement for $15,000,000 with a bank through
December 31, 2005. Interest, which is tied to one of various rates, averaged
3.24% at May 31, 2003. 1,930 3,835
Other unsecured notes payable at various rates of interest due in installments
through 2011. 2,221 9,962
-------- --------
726,128 713,797
Less current portion 1,282 5,876
-------- --------
TOTAL LONG-TERM DEBT, LESS CURRENT MATURITIES $724,846 $707,921
======== ========
35
RPM International Inc. and Subsidiaries
At May 31, 2003, the Company had additional unused short-term lines of
credit with several banks totaling $77,700,000.
The aggregate maturities of long-term debt for the five years subsequent
to May 31, 2003 are as follows: 2004 - $1,282,000; 2005 - $15,712,000; 2006 -
$418,912,000; 2007 - $10,044,000; 2008 - $250,087,000, including $150,042,000 of
2.75% Senior Convertible Notes based on the date of the noteholders' first put
option.
In June 2002, the Company established an accounts receivable
securitization program for certain of its subsidiaries. The securitized accounts
receivable are owned in their entirety by RPM Funding Corporation, a wholly
owned consolidated subsidiary of the Company, and are not available to satisfy
claims of the Company's creditors until the participating banks' obligations
have been paid in full. This securitization transaction will remain on the
balance sheet and allows for a maximum of $125,000,000 of borrowings. The
amounts available under the program are subject to changes in the credit ratings
of the Company's customers, customer concentration levels or certain
characteristics of the underlying accounts receivable.
In May 2003, the Company issued $297,000,000 face value at maturity
unsecured 2.75% Senior Convertible Notes due May 13, 2033. The 2.75% Notes are
convertible into 8,034,355 shares of the Company's common stock at a price of
$18.68 per share, subject to adjustment, during any fiscal quarter for which the
closing price of the Company's common stock is greater than $22.41 per share for
a defined duration of time. The Notes are also convertible during any period in
which the credit rating of the Notes 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. After that date,
cash interest will not be paid prior to maturity subject to certain
contingencies.
Note C - Income Taxes
Consolidated income before taxes consists of the following:
YEAR ENDED MAY 31 2003 2002 2001
- ----------------------------------------------------- -------- --------- ---------
(In thousands)
United States $ 19,025 $ 128,883 $ 81,853
Foreign 28,828 25,241 19,634
-------- --------- ---------
CONSOLIDATED INCOME BEFORE TAXES $ 47,853 $ 154,124 $ 101,487
======== ========= =========
Provision for income taxes consists of the following:
Current
U.S. federal $ 42,500 $ 42,901 $ 31,821
State and local 3,088 4,770 3,829
Foreign 13,671 8,829 9,308
-------- --------- ---------
$ 59,259 $ 56,500 $ 44,958
-------- --------- ---------
Deferred
U.S. federal $(45,275) $ (5,370) $ (9,603)
Foreign (1,458) 1,440 3,171
-------- --------- ---------
$(46,733) $ (3,930) $ (6,432)
-------- --------- ---------
PROVISION FOR INCOME TAXES $ 12,526 $ 52,570 $ 38,526
======== ========= =========
36
RPM International Inc. and Subsidiaries
A reconciliation between the actual income tax expense provided and the
income tax expense computed by applying the statutory federal income rate of 35%
to income before tax is as follows:
YEAR ENDED MAY 31 2003 2002 2001
- ----------------------------------------------------------------- -------- -------- --------
(In thousands)
Income taxes at U.S. statutory rate $ 16,749 $ 53,943 $ 35,520
Difference in foreign taxes versus the U.S. statutory rate (2,986) (3,155) (1,563)
State and local income taxes net of federal income tax benefit 2,007 3,101 2,489
Amortization of
goodwill 4,530
Tax benefits from foreign sales corporation and extraterritorial
income exclusion (1,250) (1,362) (1,675)
Other (1,994) 43 (775)
-------- -------- --------
ACTUAL TAX EXPENSE $ 12,526 $ 52,570 $ 38,526
======== ======== ========
ACTUAL TAX RATE 26.2% 34.1% 38.0%
======== ======== ========
Deferred income taxes result from temporary differences in recognition of
revenue and expenses for book and tax purposes. Temporary differences and
carryforwards that give rise to deferred tax assets and liabilities as of May
31, 2003 and 2002 are as follows:
(In thousands) 2003 2002
- -------------------------------------------- --------- ---------
Deferred income tax assets related to:
Inventories $ 1,679 $ 2,095
Allowance for losses 18,146 13,668
Accrued compensation and benefits 9,864 11,661
Asbestos-related liabilities 54,219 1,267
Accrued other expenses 4,596 10,185
Other long-term liabilities 16,153 14,112
Tax loss/credit carryforwards 11,749 7,870
Other 1,047 2,811
--------- ---------
TOTAL $ 117,453 $ 63,669
--------- ---------
Deferred income tax (liabilities) related to:
Depreciation $ (36,806) $ (28,513)
Amortization of intangibles (84,118) (85,360)
--------- ---------
TOTAL $(120,924) $(113,873)
--------- ---------
DEFERRED INCOME TAX ASSETS
(LIABILITIES), NET $ (3,471) $ (50,204)
========= =========
Deferred tax detail above is included in the consolidated balance sheet as
follows:
2003 2002
-------- --------
Deferred income taxes - current asset $ 51,285 $ 42,441
Deferred income taxes - noncurrent (liability) (54,756) (92,645)
-------- --------
TOTAL $ (3,471) $(50,204)
======== ========
Note D - Common Stock
There are 300,000,000 shares of common stock authorized at May 31, 2003
(200,000,000 at May 31, 2002) with a par value of $0.01 per share (stated value
of $.015 per share at May 31, 2002). At May 31, 2003 and 2002, there were
115,496,000 and 114,696,000 shares outstanding, respectively, each of which is
entitled to one vote.
Basic earnings per share are computed by dividing income available to
common stockholders by the weighted average number of shares of common stock
outstanding during each year. To compute diluted earnings per share, the
weighted average number of shares of common stock outstanding during each year
was increased by common stock options with exercisable prices lower than the
average market prices of common stock during each year and reduced by the number
of shares assumed to have been purchased with proceeds from the exercised
options. The Company's convertible notes, while potentially dilutive, are not
common stock equivalents.
The Company has shares outstanding under two restricted stock plans. Under
the terms of the plans, up to 2,563,000 shares may be awarded to certain
employees, generally subject to forfeiture until the completion of five or 10
years of service. For the year ended May 31, 2003, 600,000 shares were awarded
under these plans, net of forfeitures (138,000 in 2002) and restrictions lapsed
on 508,000 shares (3,000 in 2002). At May 31, 2003, 26,000 vested shares
remained in these plans (86,000 at May 31, 2002). Unamortized deferred
compensation expense with
37
RPM International Inc. and Subsidiaries
respect to restricted stock grants was $5,231,000 at May 31, 2003 and is being
amortized over the 10-year vesting period. For the years ended May 31, 2003,
2002 and 2001, deferred compensation expense aggregated $2,143,000, $1,224,000
and $1,459,000, respectively.
In February 2003, the Company authorized the repurchase of up to
10,000,000 shares of its common stock, 100,000 of which had been repurchased at
May 31, 2003. Shares repurchased under this program will be held at cost and
included in Stockholders' Equity as treasury stock.
The Company's Stockholder Rights Plan provides existing stockholders the
right to purchase stock of the Company at a discount in certain circumstances as
defined by the Plan. The rights were not exercisable at May 31, 2003 and expire
in May 2009.
The Company has options outstanding under two stock option plans, the 1989
Stock Option Plan and the 1996 Key Employees Stock Option Plan, the latter of
which provides for the granting of options for up to 9,000,000 shares. These
options are generally exercisable cumulatively in equal annual installments
commencing one year from the grant date, and have expiration dates ranging from
July 2003 to October 2012. At May 31, 2003, 1,902,000 shares (3,093,000 at May
31, 2002) were available for future grant.
Transactions during the last two years are summarized as follows:
SHARES UNDER OPTION 2003 2002
- --------------------------------------------------------------------------- ------ ------
(In thousands, except per share amounts)
Outstanding, beginning of year
(weighted average price of $12.57 ranging from $8.69 to $16.70 per share) 6,223 7,017
Granted (price of $14.08) 1,191 496
Canceled/expired
(weighted average price of $13.98 ranging from $8.81 to $16.35 per share) (153) (390)
Exercised (weighted average price of $11.33 ranging from
$8.69 to $15.15 per share) (324) (900)
------ ------
OUTSTANDING, END OF YEAR
(WEIGHTED AVERAGE PRICE OF $12.86 RANGING FROM $8.69 TO $16.70 PER SHARE) 6,937 6,223
====== ======
EXERCISABLE, END OF YEAR
(WEIGHTED AVERAGE PRICE OF $13.19 RANGING FROM $8.69 TO $16.70 PER SHARE) 4,477 3,987
====== ======
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
AT MAY 31, 2003 AT MAY 31, 2003
--------------------------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
RANGE OF PER SHARE SHARES AVERAGE AVERAGE SHARES AVERAGE
EXERCISE PRICES (000'S) REMAINING LIFE PRICE (000'S) PRICE
- ------------------ ------- -------------- -------- ------- --------
$ 8.00 to $ 9.99 1,752 7.3 $ 9.36 989 $ 9.40
$10.00 to $14.99 3,216 6.4 $13.18 1,613 $12.85
$15.00 to $16.75 1,969 4.6 $15.46 1,875 $15.47
----- -----
6,937 6.1 $12.86 4,477 $13.19
===== =====
The Company has elected to follow APBO No. 25 and related interpretations
in accounting for its employee stock options. Under APBO No. 25, because the
exercise price of the Company's employee stock options is not less than the
market price of the shares at the date of grant, no compensation expense is
recognized in the financial statements. See Note A for pro forma information and
the alternative fair value accounting provided for under SFAS No. 123.
38
RPM International Inc. and Subsidiaries
Note E - Leases
At May 31, 2003, certain property, plant and equipment were leased by the
Company under long-term leases. Certain of these leases provide for increased
rental based upon an increase in the cost-of-living index. Future minimum lease
commitments as of May 31, 2003 for all non-cancelable leases are as follows:
MAY 31
- -----------------------------------------------------
(In thousands)
2004 $16,823
2005 13,841
2006 10,047
2007 7,682
2008 5,281
Thereafter 19,141
-------
TOTAL MINIMUM LEASE COMMITMENTS $72,815
=======
Rental expenses for all operating leases totaled $24,300,000 in 2003,
$23,100,000 in 2002 and $20,500,000 in 2001. Capitalized leases were
insignificant for the three years ended May 31, 2003.
Note F - Retirement Plans
The Company sponsors a non-contributory defined benefit pension plan (The
Retirement Plan) covering substantially all domestic non-union employees.
Pension coverage for employees of the Company's foreign subsidiaries is
provided, to the extent deemed appropriate, through separate plans, many of
which are governed by local statutory requirements. In addition, benefits for
domestic union employees are provided by separate plans.
The Retirement Plan provides benefits that are based upon years of service
and average compensation with accrued benefits vesting after five years.
Benefits for union employees are generally based upon years of service. The
Company's funding policy is to contribute annually an amount that can be
deducted for federal income tax purposes, using a different actuarial cost
method and different assumptions from those used for financial reporting.
Net periodic pension cost (income) consisted of the following for the
three years ended May 31, 2003:
U.S. PLANS NON-U.S. PLANS
- --------------------------------------------- ---------------------------------- ----------------------------------
(In thousands) 2003 2002 2001 2003 2002 2001
- --------------------------------------------- -------- -------- -------- -------- -------- --------
Service cost $ 8,904 $ 8,310 $ 7,742 $ 1,168 $ 1,073 $ 1,112
Interest cost 6,634 6,706 6,470 2,344 2,305 2,314
Expected return on plan assets (7,769) (8,589) (9,157) (2,748) (3,118) (3,396)
Amortization of:
Prior service cost 197 188 164
Net gain on adoption of SFAS No. 87 (85) (85) (87)
Net actuarial (gains) losses recognized 952 (11) (62) 324 87 (85)
Curtailment/settlement (gains) losses 11 (722)
------- ------- ------- ------- ------- -------
NET PENSION COST $ 8,844 $ 6,519 $ 4,348 $ 1,088 $ 347 $ (55)
======= ======= ======= ======= ======= =======
39
RPM International Inc. and Subsidiaries
The changes in benefit obligations and plan assets, as well as the funded
status of the Company's pension plans at May 31, 2003 and 2002, were as follows:
U.S. PLANS NON-U.S. PLANS
- ---------------------------------------------- ----------------------- ----------------------
(In thousands) 2003 2002 2003 2002
- ---------------------------------------------- --------- -------- -------- --------
Benefit obligation at beginning of year $ 96,217 $ 87,199 $ 35,244 $ 34,175
Service cost 8,904 8,310 1,168 1,073
Interest cost 6,634 6,706 2,344 2,305
Benefits paid (6,738) (14,022) (1,403) (1,465)
Participant contributions 415 385
Actuarial (gains) losses 6,001 7,508 5,471 47
Currency exchange rate changes 4,287 (1,276)
Curtailment/settlement (gains) losses (194)
Plan amendments 1,447 516
--------- -------- -------- --------
BENEFIT OBLIGATION AT END OF YEAR $ 112,271 $ 96,217 $ 47,526 $ 35,244
========= ======== ======== ========
Fair value of plan assets at beginning of year $ 85,345 $ 93,899 $ 33,477 $ 37,557
Actual return on plan assets (11,687) (4,748) (3,579) (2,101)
Employer contributions 21,749 10,216 419 360
Participant contributions 415 385
Benefits paid (6,738) (14,022) (1,485) (1,476)
Currency exchange rate changes 2,823 (1,248)
--------- -------- -------- --------
FAIR VALUE OF PLAN ASSETS AT END OF YEAR $ 88,669 $ 85,345 $ 32,070 $ 33,477
========= ======== ======== ========
Excess (deficit) of plan assets versus benefit
obligations at end of year $ (23,602) $(10,872) $(15,456) $ (1,767)
Contributions after measurement date 44 2,661 116 104
Unrecognized actuarial (gains) losses 47,881 23,571 22,065 8,439
Unrecognized prior service cost 3,135 1,896
Unrecognized net transitional asset (28) (113)
--------- -------- -------- --------
NET AMOUNT RECOGNIZED $ 27,430 $ 17,143 $ 6,725 $ 6,776
========= ======== ======== ========
Amounts recognized in the consolidated
balance sheets consist of:
Prepaid benefit cost $ 27,957 $ 17,688 $ 6,691 $ 7,739
Accrued benefit liability (1,036) (792) (8,441) (1,106)
Accumulated other comprehensive loss 473 247 8,475 143
Intangible asset 36
--------- -------- -------- --------
NET AMOUNT RECOGNIZED $ 27,430 $ 17,143 $ 6,725 $ 6,776
========= ======== ======== ========
For domestic plans with accumulated benefit obligations in excess of plan
assets, the projected benefit obligation, accumulated benefit obligation and
fair value of assets were $1,717,000, $1,670,000 and $612,000, respectively, as
of May 31, 2003 and $1,293,000, $1,293,000 and $414,000, respectively, as of May
31, 2002. For foreign plans with accumulated benefit obligations in excess of
plan assets, the projected benefit obligation, accumulated benefit obligation
and fair value of assets were $27,002,000, $22,837,000 and $14,279,000,
respectively, as of May 31, 2003 and $1,159,000, $1,106,000 and $-0-,
respectively, as of May 31, 2002.
The following weighted average assumptions were used to determine the
Company's obligations under the plans:
U.S. PLANS NON-U.S. PLANS
------------------- -------------------
2003 2002 2003 2002
------ ------ ------ ------
Discount rate 6.70% 7.25% 6.43% 6.63%
Expected return on plan assets 9.00% 9.00% 8.25% 8.13%
Rate of compensation increase 4.00% 4.00% 3.95% 4.00%
The plans' assets consist primarily of stocks, bonds and fixed income
securities.
40
RPM International Inc. and Subsidiaries
The Company also sponsors employee savings plans under Section 401(k) of
the Internal Revenue Code, which cover substantially all employees in the United
States. The plans provide for matching contributions based upon qualified
employee contributions. Matching contributions are invested in the same manner
that the participants invest their own contributions. Matching contributions
charged to income were $6,120,000, $5,206,000 and $5,222,000 for the years
ending May 31, 2003, 2002 and 2001, respectively.
Note G - Postretirement Health Care Benefits
In addition to the defined benefit pension plan, the Company provides
health care benefits to certain of its retired employees through unfunded plans.
Employees become eligible for these benefits if they meet minimum age and
service requirements. The components of this expense for the three years ended
May 31, 2003 were as follows:
(In thousands) 2003 2002 2001
- ------------------------------------------------- -------- -------- ------
Service cost -
Benefits earned during this period $ 177 $ 131 $ 81
Interest cost on the accumulated obligation 974 945 918
Amortization of unrecognized (gains) (47) (51) (124)
------- ------- -----
NET PERIODIC
POSTRETIREMENT EXPENSE $ 1,104 $ 1,025 $ 875
======= ======= =====
The changes in the benefit obligations of the plans at May 31, 2003 and
2002 were as follows:
(In thousands) 2003 2002
- ------------------------------------------------------------------ -------- --------
Accumulated postretirement benefit obligation at beginning of year $ 13,482 $ 12,615
Service cost 177 131
Interest cost 974 945
Benefit payments (933) (904)
Actuarial (gains) losses 839 804
Currency exchange rate changes 315 (109)
-------- --------
Accumulated postretirement benefit obligation at end of year 14,854 13,482
Unrecognized actuarial gains (losses) 86 973
-------- --------
ACCRUED POSTRETIREMENT HEALTH CARE BENEFITS $ 14,940 $ 14,455
======== ========
A 6.70% general discount rate was used in determining the accumulated
postretirement benefit obligation as of May 31, 2003 (7.25% for May 31, 2002). A
9.00% increase in the cost of covered health care benefits was generally assumed
for fiscal 2003 (8.00% for fiscal 2002). This trend rate in all cases is assumed
to decrease to 5.00% after several years and remain at that level thereafter,
except for various union plans, which will cap at alternate benefit levels. A
1.00% increase in the health care costs trend rate would have increased the
accumulated postretirement benefit obligation as of May 31, 2003 by $1,768,000
and the net postretirement expense by $193,000. A 1.00% decrease in the health
care costs trend rate would have decreased the accumulated postretirement
benefit obligation as of May 31, 2003 by $1,538,000 and the net postretirement
expense by $155,000.
Note H - Contingencies and Loss Reserves
Accrued loss reserves and asbestos-related liabilities consist of the
following:
MAY 31 2003 2002
- ----------------------------------------- -------- -------
(In thousands)
Accrued product liability reserves $ 51,840 $35,960
Accrued warranty reserves 6,328 5,412
Accrued environmental reserves 4,695 6,455
Accrued other 1,367 710
-------- -------
Accrued loss reserves - current 64,230 48,537
Asbestos-related liabilities - current 41,583 3,377
-------- -------
TOTAL RESERVES - CURRENT $105,813 $51,914
======== =======
Accrued warranty reserves - noncurrent $ 7,781 $ 9,655
Asbestos-related liabilities - noncurrent 103,000
-------- -------
TOTAL RESERVES - NONCURRENT $110,781 $ 9,655
======== =======
The Company, through its wholly owned insurance subsidiaries, provides certain
insurance coverage, primarily product liability, to the Company's other
subsidiaries. Excess coverage is provided by outside carriers. The reserves
reflected above provide for these potential losses as well as other uninsured
claims. Provision for estimated warranty costs is recorded at the time of sale
and periodically adjusted to reflect actual experience.
41
RPM International Inc. and Subsidiaries
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
alleged claims relate primarily to products that Bondex sold through 1977. In
many cases, plaintiffs are unable to demonstrate that they have suffered any
compensable loss as a result of such exposure, or that injuries incurred
resulted from exposure to Bondex products.
The rate at which plaintiffs filed asbestos-related suits against Bondex
increased in the fourth quarter of 2002 and the first two quarters of 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 will be
depleted within the first quarter of 2004. 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, in which we
were assisted by an archeological insurance investigation firm, 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. Our wholly owned captive insurance
companies have not provided any insurance or re-insurance coverage of any
asbestos-related claims.
During the last seven months of 2003, new state liability laws were
enacted in three states where more than 80% of the claims against Bondex are
pending. Effective dates for the last two of the law changes were April 8, 2003
and July 1, 2003. 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 impacts of these
new laws are 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 be significantly visible until the latter part of fiscal 2004.
At the end of 2002 and through the third quarter of 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 due to
a number of reasons, including its lack of sufficient comparable loss history
from which to assess either the number or value of future asbestos-related
claims. During the fourth quarter of 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.
Bondex provided the consultants with all relevant data regarding
asbestos-related claims filed against Bondex through 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, which hindered the consultant's and Bondex's ability to
project
42
RPM International Inc. and Subsidiaries
future claim volumes and resolution costs, 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, the Company cannot estimate the liability that will result
from all future claims. The Company has 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. 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 2003 operations of $140,000,000 for measurable
known claims and a provision for the future claims that can presently be
estimated. The Company believes this asbestos reserve will be sufficient to
cover asbestos-related cash flow requirements for approximately three years.
Additionally, Bondex's share of costs (net of then-available third-party
insurance) for asbestos-related product liability were $6,700,000, $2,800,000
and $2,300,000 for the years ended May 31, 2003, 2002 and 2001, respectively.
The Company developed the estimates for the $140,000,000 asbestos charge in
consultation with its outside consulting firm and defense counsel, taking into
account both historical and current settlement values. 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 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.
The Company, in conjunction with outside advisors, will continue to study
its asbestos-related exposure 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.
In addition, the Company, like others in similar businesses, is involved
in several proceedings relating to environmental matters. It is the Company's
policy to accrue remediation costs when it is probable that such efforts will be
required and the related costs can be reasonably estimated. These liabilities
are undiscounted and do not take into consideration any possible recoveries of
future insurance proceeds or claims against third parties.
Due to the uncertainty inherent in the loss reserve estimation process,
the Company is unable to estimate an additional range of loss in excess of its
accruals. It is at least reasonably possible that actual costs will differ from
estimates, but, based upon information presently available, such future costs
are not expected to have a material adverse effect on the Company's competitive
or financial position or its ongoing results of operations. However, such costs
could be material to results of operations in a future period.
43
RPM International Inc. and Subsidiaries
Note I - Quarterly Information (Unaudited)
The following is a summary of the quarterly results of operations for the
years ended May 31, 2003 and 2002:
FOR QUARTER ENDED
------------------------------------------------
(In thousands, except per share amounts) AUGUST 31 NOVEMBER 30 FEBRUARY 28 MAY 31
- ---------------------------------------- --------- ----------- ----------- ---------
2003
Net Sales $542,413 $517,968 $433,562 $ 589,546
-------- -------- -------- ---------
Gross Profit $259,204 $234,148 $186,952 $ 274,248
-------- -------- -------- ---------
Net Income (Loss) $ 44,173 $ 29,640 $ 4,883 $ (43,369)
-------- -------- -------- ---------
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE $ 0.38 $ 0.26 $ 0.04 $ (0.38)
======== ======== ======== =========
DIVIDENDS PER SHARE $ 0.125 $ 0.130 $ 0.130 $ 0.130
======== ======== ======== =========
FOR QUARTER ENDED
------------------------------------------------
(In thousands, except per share amounts) AUGUST 31 NOVEMBER 30 FEBRUARY 28 MAY 31
- ---------------------------------------- --------- ----------- ----------- ---------
2002
Net Sales $533,275 $487,880 $407,538 $ 557,433
-------- -------- -------- ---------
Gross Profit $250,674 $221,968 $178,636 $ 260,938
-------- -------- -------- ---------
Net Income $ 36,569 $ 24,490 $ 3,274 $ 37,221
-------- -------- -------- ---------
BASIC EARNINGS PER SHARE $ 0.36 $ 0.24 $ 0.03 $ 0.34
-------- -------- -------- ---------
DILUTED EARNINGS PER SHARE $ 0.36 $ 0.24 $ 0.03 $ 0.33
======== ======== ======== =========
DIVIDENDS PER SHARE $ 0.125 $ 0.125 $ 0.125 $ 0.125
======== ======== ======== =========
Quarterly earnings per share may not total to the yearly earnings per
share due to the weighted average number of shares outstanding in each quarter.
44
RPM International Inc. and Subsidiaries
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MEDINA, OHIO
We have audited the accompanying consolidated balance sheets of RPM
International Inc. and Subsidiaries as of May 31, 2003 and 2002, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the years in the three-year period ended May 31, 2003. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of RPM
International Inc. and Subsidiaries at May 31, 2003 and 2002, and the results of
their operations and their cash flows for each of the years in the three-year
period ended May 31, 2003, in conformity with accounting principles generally
accepted in the United States.
/s/ Ciulla, Smith, & Dale, LLP
Cleveland, Ohio
July 7, 2003
QUARTERLY STOCK PRICE AND DIVIDEND INFORMATION
RPM International Inc. common shares are traded on the New York Stock
Exchange under the symbol RPM. The high and low sale prices for the common
shares, and the cash dividends paid on the common shares, for each quarter of
the two most recent fiscal years are set forth in the table below.
RANGE OF MARKET PRICES
Fiscal 2003 High Low Dividends paid per share
- ---------------------- ------ ------ ------------------------
First Quarter $16.59 $11.58 $0.125
Second Quarter $16.01 $12.90 0.130
Third Quarter $15.90 $ 9.29 0.130
Fourth Quarter $12.50 $ 9.10 0.130
Fiscal 2002 High Low Dividends paid per share
- ---------------------- ------ ------ ------------------------
First Quarter $11.15 $ 8.02 $0.125
Second Quarter $15.05 $ 7.91 0.125
Third Quarter $17.08 $12.90 0.125
Fourth Quarter $17.87 $14.15 0.125
Source: The Wall Street Journal
The number of holders of record of RPM International Inc. Common Stock as of
July 14, 2003 was 38,877.
45