SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 2004, OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________________ TO
___________________.
COMMISSION FILE NO. 1-14187
RPM INTERNATIONAL INC.
- --------------------------------------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 02-0642224
- ------------------------------ ----------------------------------
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
P.O. BOX 777; 2628 PEARL ROAD; MEDINA, OHIO 44258
- --------------------------------------------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE (330) 273-5090
- --------------------------------------------------------------------------------
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS) AND (2) HAS BEEN SUBJECT TO THE FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
YES [X] NO [ ].
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12b-2 OF THE EXCHANGE ACT).
YES [X] NO [ ].
AS OF DECEMBER 27, 2004
117,189,915 SHARES OF RPM INTERNATIONAL INC. COMMON STOCK WERE OUTSTANDING.
RPM INTERNATIONAL INC. AND SUBSIDIARIES*
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED):
CONSOLIDATED BALANCE SHEETS 3
CONSOLIDATED STATEMENTS OF INCOME 4
CONSOLIDATED STATEMENTS OF CASH FLOWS 5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 31
ITEM 4. CONTROLS AND PROCEDURES 31
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 32
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY 39
HOLDERS
ITEM 5. OTHER INFORMATION 40
ITEM 6. EXHIBITS 41
SIGNATURES 43
* As used herein, the terms "RPM" and the "Company" refer to RPM International
Inc. and its subsidiaries, unless the context indicates otherwise.
3
PART I. - FINANCIAL INFORMATION
ITEM 1. - FINANCIAL STATEMENTS
RPM INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOVEMBER 30, 2004 MAY 31, 2004
----------------- ------------
ASSETS
CURRENT ASSETS
CASH AND SHORT-TERM INVESTMENTS $ 211,760 $ 38,561
TRADE ACCOUNTS RECEIVABLE (LESS ALLOWANCES OF
$19,886 AND $18,147, RESPECTIVELY) 438,023 484,847
INVENTORIES 314,243 289,359
DEFERRED INCOME TAXES 53,890 51,164
PREPAID EXPENSES AND OTHER CURRENT ASSETS 139,432 130,686
----------- -----------
TOTAL CURRENT ASSETS 1,157,348 994,617
----------- -----------
PROPERTY, PLANT AND EQUIPMENT, AT COST 794,174 767,072
ALLOWANCE FOR DEPRECIATION AND AMORTIZATION (408,516) (386,017)
----------- -----------
PROPERTY, PLANT AND EQUIPMENT, NET 385,658 381,055
----------- -----------
OTHER ASSETS
GOODWILL 662,968 648,243
OTHER INTANGIBLE ASSETS, NET OF AMORTIZATION 282,310 282,372
OTHER 50,716 46,832
----------- -----------
TOTAL OTHER ASSETS 995,994 977,447
----------- -----------
TOTAL ASSETS $ 2,539,000 $ 2,353,119
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
ACCOUNTS PAYABLE $ 184,496 $ 205,092
CURRENT PORTION OF LONG-TERM DEBT 4,164 991
ACCRUED COMPENSATION AND BENEFITS 68,572 88,670
ACCRUED LOSS RESERVES 50,948 56,699
ASBESTOS-RELATED LIABILITIES 50,000 47,500
OTHER ACCRUED LIABILITIES 76,887 72,222
INCOME TAXES PAYABLE 10,499 6,319
----------- -----------
TOTAL CURRENT LIABILITIES 445,566 477,493
----------- -----------
LONG-TERM LIABILITIES
LONG-TERM DEBT, LESS CURRENT MATURITIES 837,926 718,929
ASBESTOS-RELATED LIABILITIES 53,225 43,107
OTHER LONG-TERM LIABILITIES 66,630 59,910
DEFERRED INCOME TAXES 77,452 78,388
----------- -----------
TOTAL LONG-TERM LIABILITIES 1,035,233 900,334
----------- -----------
STOCKHOLDERS' EQUITY
PREFERRED STOCK, PAR VALUE $0.01; AUTHORIZED 50,000 SHARES;
NONE ISSUED
COMMON STOCK, PAR VALUE $0.01 AUTHORIZED 300,000 SHARES; ISSUED AND
OUTSTANDING 117,146 AS OF NOVEMBER 2004;
ISSUED AND OUTSTANDING 116,122 AS OF MAY 2004 1,172 1,161
PAID-IN CAPITAL 528,885 513,986
TREASURY STOCK, AT COST
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) 34,251 (3,881)
RETAINED EARNINGS 493,893 464,026
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 1,058,201 975,292
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,539,000 $ 2,353,119
=========== ===========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
4
RPM INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
SIX MONTHS ENDED NOVEMBER 30, THREE MONTHS ENDED NOVEMBER 30,
----------------------------- ------------------------------
2004 2003 2004 2003
------------ ------------- ----------- -----------
NET SALES $1,284,982 $1,162,564 $623,469 $581,541
COST OF SALES 719,407 637,946 352,781 323,966
---------- ---------- -------- --------
GROSS PROFIT 565,575 524,618 270,688 257,575
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 404,476 383,105 202,034 196,255
ASBESTOS CHARGE 47,000 47,000
INTEREST EXPENSE, NET 16,885 12,994 8,915 6,711
---------- ---------- -------- --------
INCOME BEFORE INCOME TAXES 97,214 128,519 12,739 54,609
PROVISION FOR INCOME TAXES 33,616 45,624 3,627 19,386
---------- ---------- -------- --------
NET INCOME $ 63,598 $ 82,895 $ 9,112 $ 35,223
========== ========== ======== ========
AVERAGE NUMBER OF SHARES OF COMMON STOCK OUTSTANDING:
BASIC 116,413 115,613 116,659 115,670
========== ========== ======== ========
DILUTED 117,685 116,335 118,284 116,443
========== ========== ======== ========
BASIC EARNINGS PER SHARE OF COMMON STOCK $ 0.55 $ 0.72 $ 0.08 $ 0.30
========== ========== ======== ========
DILUTED EARNINGS PER SHARE OF COMMON STOCK $ 0.54 $ 0.71 $ 0.08 $ 0.30
========== ========== ======== ========
CASH DIVIDENDS PER SHARE OF COMMON STOCK $ 0.290 $ 0.270 $ 0.150 $ 0.140
========== ========== ======== ========
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART
OF THESE STATEMENTS.
5
RPM INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
Six Months Ended November 30,
-----------------------------
2004 2003
----------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME $ 63,598 $ 82,895
DEPRECIATION AND AMORTIZATION 32,736 30,925
ITEMS NOT AFFECTING CASH AND OTHER 23,422 8,339
CHANGES IN OPERATING WORKING CAPITAL (28,083) (30,860)
CHANGES IN ASBESTOS-RELATED LIABILITIES, NET OF TAX 7,886 (16,466)
--------- --------
99,559 74,833
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
CAPITAL EXPENDITURES (21,791) (15,457)
ACQUISITION OF BUSINESSES, NET OF CASH ACQUIRED (9,900) (20,000)
PROCEEDS FROM THE SALE OF ASSETS 4,500
OTHER 1,836 (8,970)
--------- --------
(25,355) (44,427)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
ADDITIONS TO (REDUCTIONS OF) LONG-TERM AND SHORT-TERM DEBT 125,569 (2,893)
CASH DIVIDENDS (33,730) (31,208)
EXERCISE OF STOCK OPTIONS 7,156 1,468
--------- --------
98,995 (32,633)
--------- --------
INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS 173,199 (2,227)
CASH AND SHORT-TERM INVESTMENTS AT BEGINNING OF PERIOD 38,561 50,725
--------- --------
CASH AND SHORT-TERM INVESTMENTS AT END OF PERIOD $ 211,760 $ 48,498
========= ========
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART
OF THESE STATEMENTS.
6
RPM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2004
(UNAUDITED)
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with the instructions to Form 10-Q and do not include all of the
information and notes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments
(consisting of normal, recurring accruals) considered necessary for a fair
presentation have been included for the three and six month periods ended
November 30, 2004 and 2003. For further information, refer to the Consolidated
Financial Statements and notes included in our Annual Report on Form 10-K for
the year ended May 31, 2004.
Our business is dependent on external weather factors. Historically, we have
experienced strong sales and net income in our first, second and fourth fiscal
quarters comprised of the three month periods ending August 31, November 30 and
May 31, respectively, with weaker performance in our third fiscal quarter
(December through February).
Certain reclassifications have been made to prior year amounts to conform to the
current year presentation (see Note G).
NOTE B - INVENTORIES
Inventories were composed of the following major classes:
NOVEMBER 30, 2004 MAY 31, 2004
----------------- ------------
(IN THOUSANDS)
Raw materials and supplies $ 102,042 $ 95,378
Finished goods 212,201 193,981
--------- --------
$ 314,243 $ 289,359
========= =========
NOTE C - COMPREHENSIVE INCOME
Other comprehensive income includes foreign currency translation adjustments,
minimum pension liability adjustments and unrealized gains or losses on
securities. Total comprehensive income, comprised of net income and other
comprehensive income, amounted to $44.1 million and $59.0 million during the
second quarter of fiscal years 2005 and 2004, respectively, and $101.7 million
and $97.1 million during the six month periods ended November 30, 2004 and 2003,
respectively.
NOTE D - STOCK BASED COMPENSATION
Effective June 1, 2004, we voluntarily adopted the preferable fair value
recognition provisions of Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based
7
RPM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2004
(UNAUDITED)
Compensation," for our stock-based employee compensation plans. As outlined by
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure," we chose to apply the modified prospective method in adopting this
accounting change. Under this method, stock-based employee compensation expense
recognized in fiscal 2005 is the same as that which would have been recognized
had the fair value recognition provisions of SFAS No. 123 been applied to
account for all employee awards from its original effective date. Results of
prior periods have not been restated.
The adoption of SFAS No. 123 impacted net income and earnings per share, both
basic and fully diluted, for the six months ended November 30, 2004 by
approximately $1.2 million and $0.01 per share, respectively, and for the three
months ended November 30, 2004 by approximately $0.6 million and $0.005 per
share, respectively. The following table illustrates the effect on net income
and earnings per share for the six and three month periods ended November 30,
2003, as if compensation cost for stock options granted had been determined in
accordance with the fair value method prescribed by SFAS No. 123:
SIX MONTHS ENDED THREE MONTHS ENDED
NOVEMBER 30, NOVEMBER 30,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2003 2003
---------------- ------------------
Net income, as reported $ 82,895 $ 35,223
Add: Stock-based employee compensation expense
from restricted stock plans included in reported net
income, net of related tax effects 666 333
Deduct: Total stock-based employee compensation
determined under fair value-based method for all
awards, net of related tax effects (2,018) (1,220)
------------- ------------
Pro Forma Net Income $ 81,543 $ 34,336
============= ============
Earnings per Share:
Basic, as Reported $ 0.72 $ 0.30
============= ============
Diluted, as Reported $ 0.71 $ 0.30
============= ============
Basic, Pro Forma $ 0.71 $ 0.30
============= ============
Diluted, Pro Forma $ 0.70 $ 0.29
============= ============
NOTE E - PENSION AND POSTRETIREMENT HEALTH CARE BENEFITS
We offer defined benefit pension plans, defined contribution pension plans, as
well as several unfunded health care benefit plans primarily for certain of our
retired employees. The following tables provide the retirement-related benefit
plans' impact on income before income taxes for the six and three month periods
ended November 30, 2004 and 2003:
8
RPM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2004
(UNAUDITED)
PENSION BENEFITS U.S. PLANS NON-U.S. PLANS
----------------------------- -----------------------------
(In thousands) SIX MONTHS ENDED NOVEMBER 30, SIX MONTHS ENDED NOVEMBER 30,
----------------------------- -----------------------------
2004 2003 2004 2003
-------- -------- -------- --------
Service cost $ 5,615 $ 4,940 $ 1,077 $ 848
Interest cost 3,741 3,614 2,180 1,805
Expected return on plan assets (4,880) (3,692) (2,059) (1,594)
Amortization of:
Prior service cost 147 147
Net gain on adoption of SFAS No. 87 (1) (12)
Net actuarial (gains) losses recognized 750 1,271 665 619
------- ------- ------- -------
NET PERIODIC BENEFIT COST $ 5,372 $ 6,268 $ 1,863 $ 1,678
======= ======= ======= =======
POSTRETIREMENT BENEFITS U.S. PLANS NON-U.S. PLANS
----------------------------- -----------------------------
(In thousands) SIX MONTHS ENDED NOVEMBER 30, SIX MONTHS ENDED NOVEMBER 30,
----------------------------- -----------------------------
2004 2003 2004 2003
-------- -------- -------- --------
Service cost $ 6 $ 5 $122 $ 92
Interest cost 330 318 219 179
Net actuarial (gains) losses recognized 13 13
---- ---- ---- ----
NET PERIODIC BENEFIT COST $349 $323 $354 $271
==== ==== ==== ====
PENSION BENEFITS U.S. PLANS NON-U.S. PLANS
------------------------------- -------------------------------
(In thousands) THREE MONTHS ENDED NOVEMBER 30, THREE MONTHS ENDED NOVEMBER 30,
------------------------------- -------------------------------
2004 2003 2004 2003
-------- -------- -------- --------
Service cost $ 2,808 $ 2,469 $ 539 $ 424
Interest cost 1,870 1,807 1,088 903
Expected return on plan assets (2,440) (1,846) (1,029) (797)
Amortization of:
Prior service cost 74 74
Net gain on adoption of SFAS No. 87 (1) (6)
Net actuarial (gains) losses recognized 375 636 333 309
------- ------- ------- -----
NET PERIODIC BENEFIT COST $ 2,686 $ 3,134 $ 931 $ 839
======= ======= ======= =====
POSTRETIREMENT BENEFITS U.S. PLANS NON-U.S. PLANS
------------------------------- -------------------------------
(In thousands) THREE MONTHS ENDED NOVEMBER 30, THREE MONTHS ENDED NOVEMBER 30,
------------------------------- -------------------------------
2004 2003 2004 2003
-------- -------- -------- --------
Service cost $ 3 $ 3 $ 61 $ 46
Interest cost 165 158 109 89
Net actuarial (gains) losses recognized 7 7
---- ---- ---- ----
NET PERIODIC BENEFIT COST $175 $161 $177 $135
==== ==== ==== ====
9
RPM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2004
(UNAUDITED)
The Medicare Prescription Drug, Improvement and Modernization Act (the "Act")
was enacted on December 8, 2003. The Act introduces a prescription drug benefit
under Medicare Part D, in addition to a federal subsidy to sponsors of
postretirement benefit plans that provide a prescription drug benefit that is at
least actuarially equivalent to Medicare Part D.
FASB Staff Position No. Financial Accounting Standard 106-2 ("FSP 106-2"),
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003," issued in the second quarter
of calendar 2004, provides guidance on the accounting for the effects of the
Act, including accounting for and disclosure of any federal subsidy provided by
the Act. We have determined that the enactment of the Act does not result in a
significant event under SFAS No. 106. As a result, any impact of the Act is not
reflected in the accumulated postretirement benefit obligation as of November
30, 2004 and the net periodic postretirement benefit costs for the three and six
month periods ended November 30, 2004. Pursuant to paragraph 24 of FSP 106-2, we
have deferred recognition of the Act until fiscal year end 2005.
NOTE F - ASBESTOS-RELATED LIABILITIES
Certain of our wholly owned subsidiaries, principally Bondex International, Inc.
(Bondex), along with many other U.S. companies, are and have been involved in a
large number of asbestos-related suits filed primarily in state courts during
the past two decades. These suits principally allege personal injury resulting
from exposure to asbestos-containing products. The 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 the Company's
Subsidiaries, particularly Bondex, has increased since the fourth quarter of
2002, influenced by the bankruptcy filings of numerous other defendants in
asbestos-related litigation. Based on the significant increase in asbestos
claims activity, which in many cases disproportionately increased Bondex's
exposure in joint and several liability law states, our third-party insurance
was depleted within the first fiscal quarter of 2004, as previously reported.
Our third-party insurers historically had 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 cover asbestos claims 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 other insurance
limits may be available to cover our asbestos liabilities.
As a result of this examination and as previously disclosed, certain of our
Subsidiaries filed a complaint for declaratory judgment, breach of contract and
bad faith against various third-party
10
RPM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2004
(UNAUDITED)
insurers, challenging their assertion that their policies covering
asbestos-related claims have been exhausted. Since the July 3, 2003 filing in
Ohio, this action was combined with a related case and, pursuant to a new
December 4, 2004 case management order, the parties are to complete non-expert
discovery by August 29, 2005 and expert discovery by January 30, 2006. A trial
date of March 6, 2006 is still set; however, it is possible that this and other
dates may be modified as the coverage case progresses.
We are unable at the present time to predict the timing or ultimate outcome of
this insurance coverage litigation. Consequently, we are unable to predict
whether, or to what extent, any additional insurance may be available to cover a
portion of our Subsidiaries' asbestos liabilities. We have not included any
potential benefits from this litigation either in our financial statements or in
calculating our asbestos reserve. Our wholly-owned captive insurance companies
have not provided any insurance or re-insurance coverage for any of our
Subsidiaries' asbestos-related claims.
During the last seven months of 2003, new state liability laws were enacted in
three states (Mississippi, Ohio and Texas) where at that time more than 80% of
the claims against Bondex were pending. Effective dates for the last two of the
law changes were April 8, 2003 and July 1, 2003. The changes generally provided
for liability to be determined on a "proportional cause" basis, thereby limiting
Bondex's responsibility to only its share of the alleged asbestos exposure.
During the third and fourth quarters of 2004, two of the three previously
mentioned states that adopted "proportional cause" liability in 2003 passed
additional legislation impacting medical criteria and product identification in
asbestos-related litigation. While there have been some changes in the type of
claims filed in certain of these states, the ultimate influence these law
changes may have on future claims activity and settlement values is not known at
this time. Claims in the three subject states at the quarter ended November 30,
2004, coupled with the non-malignancy filings in Florida, currently comprise
approximately 80% of the aggregate claims filed against Bondex.
At the end of 2002 and through the third quarter of 2003, Bondex had concluded
it was not possible to estimate the cost of disposing all of the
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 any future asbestos-related
claims. As previously disclosed, during the fourth quarter of 2003, Bondex
retained a consulting firm to assist 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 in various state laws
and the prospect of potential federal asbestos-related legislation.
Bondex provided the consultants with all relevant data regarding
asbestos-related claims filed against Bondex through May 31, 2003. Management,
with the consultants' input, concluded that
11
RPM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2004
(UNAUDITED)
it was not possible to currently estimate the full range of the cost of
resolving all future asbestos-related claims against Bondex. Estimating the
future cost of asbestos related contingent liabilities was and continues to be
subject to many uncertainties. These uncertainties, which hindered the
consultants' and Bondex's ability to project future claim volumes and resolution
costs included the following:
- The bankruptcies 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.
Based on the foregoing considerations, at May 31, 2003, we concluded that we
could not fully estimate the liability that would result from all future
asbestos claims. We established a reserve for those pending cases that had
progressed to a stage where the cost to dispose of these cases could, at the
time, reasonably be estimated. The estimation of even pending cases was and is
always difficult due to the dynamic nature of asbestos litigation. The estimated
range of potential loss covering measurable known asbestos claims and a
provision for future claims that were estimable at May 31, 2003 was $140.0
million to $145.0 million. Accordingly, we established a reserve equal to the
lower end of this range of potential loss by taking an asbestos charge to fiscal
2003 operations of $140.0 million. At the time of the reserve, we believed that
this asbestos reserve would be sufficient to cover asbestos-related cash flow
requirements over the estimated three-year life of the reserve. The $140.0
million charge also included $15.0 million in total projected defense costs over
the estimated three-year life of the reserve. By comparison, Bondex's share of
costs (net of then-available third-party insurance) for asbestos-related product
liability was $6.7 million and $2.8 million for the years ended May 31, 2003 and
2002, respectively.
Since May 31, 2003, we have reviewed and evaluated on a quarterly basis the
adequacy of our three-year asbestos reserve. The range of loss calculation for
the $140 million reserve was based on an extensive analysis of the most critical
factors that influence our asbestos-related costs including: (i) the gross
number of open malignancy claims (principally mesothelioma claims) as these
claims have the most significant impact on our asbestos settlement costs; (ii)
historical and current settlement costs and dismissal rates by various
categories; (iii) analysis of the jurisdiction and governing law of the states
in which these claims are pending; (iv) and outside defense counsel's opinions
and recommendations with respect to the merits of such claims. Although the
number of open malignancy claims has remained relatively constant over the first
half of the three-year period of the reserve, lower average settlement values
and higher dismissal rates have,
12
RPM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2004
(UNAUDITED)
through the quarter ending August 31, 2004, mitigated against the need for any
reserve adjustments. Since May 31, 2003 continuing through the quarter ended
November 30, 2004, our average settlement costs for malignancy claims have
declined and dismissal rates have increased. Several defense verdicts during the
second half of fiscal 2004 further contributed to lower settlement values and
higher dismissal rates. Our defense costs have also increased significantly as a
result of our more aggressive defense strategy, which includes taking selective
cases to verdict.
During the second quarter ending November 30, 2004, based on a review of our
pending known claims coupled with a review of our defense costs, we have
concluded that the $56 million balance of the $140 million reserve will not
likely be sufficient to cover our asbestos-related cash flow requirements for
the remainder of the full three-year period originally contemplated by the
reserve. Therefore, we have concluded that an increase in our existing reserve
is appropriate. An asbestos reserve adjustment of $47 million has been taken for
the quarter ended November 30, 2004, which we believe will be sufficient to
cover any incremental cash flow requirements through fiscal 2006 not covered by
the $140 million reserve, as well as the additional cash flow requirements for
the balance of our now pending known claims and anticipated higher defense
costs. Our $47 million reserve increase assumes that approximately $32 million
will be allocated to anticipated higher future defense costs, which we expect to
continue. As we review our asbestos reserve each quarter, we will make
appropriate adjustments to the reserve based on our most recent experience to
ensure that it is sufficient to cover the anticipated settlement and defense
costs associated with our then pending, known claims. Until the uncertainty of
estimating the value of any potential future unknown asbestos claims is
substantially reduced, we do not expect to establish any reserve for any such
unknown future claims.
We recognize that future facts, events and legislation, both state and/or
federal, may alter our estimates of both pending and future claims. We cannot
estimate possible liabilities in excess of those accrued because we cannot
predict the number of additional claims that may be filed in the future, the
grounds for such claims, the potential settlement values associated with any
such future claims, the ultimate resolution of such claims, the full impact of
the state law changes enumerated above or the effect of pending federal trust
fund legislation on future asbestos claims. Subject to the foregoing variables,
including the timing and impact of such variables and the increase in the
asbestos reserve, we believe that our asbestos reserves are sufficient to cover
asbestos-related cash flow requirements for the current inventory of our known
claims. It is, however, reasonably possible that our actual costs for claims
could differ from current estimates but, based upon information presently
available, such costs are not expected to have a material effect on our
competitive or financial position or our ongoing operations. As previously
disclosed, however, our existing reserve will not presently cover the costs of
future unknown claims and therefore, additional reserves will be required in
future periods for any such future claims. Any such future reserve increases,
when taken, could have a material impact on our results in such period.
13
RPM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2004
(UNAUDITED)
The Company will continue to evaluate its asbestos-related loss exposure each
quarter and review the adequacy of its reserve. In an effort to further assist
the Company in its ongoing evaluation of its asbestos costs, the Company is
using an outside consulting firm to assist in this process. In conjunction with
our outside advisors, we continue to study our asbestos-related exposure and
regularly evaluate the adequacy of our reserves 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. We will continue to explore all feasible alternatives
available to resolve our asbestos-related exposure in a manner consistent with
the best interests of our Stockholders.
The following table illustrates the movement of current and long-term
asbestos-related liabilities through November 30, 2004:
ASBESTOS LIABILITY MOVEMENT
(CURRENT AND LONG-TERM)
Additions
Charged to
Balance at Selling, General Deductions Balance at
Beginning and (Primarily End of
(In thousands) of Period Administrative Claims Paid) Period
- ---------------------------------- ---------- ---------------- ------------ ----------
Six Months Ended November 30, 2004 $ 90,607 $ 47,000 $ 34,382 $ 103,225
Year Ended May 31, 2004 144,583 53,976(a) 90,607
Year Ended May 31, 2003 3,377 146,650 5,444(b) 144,583
(a) Represents the Company's portion of total claims paid during the fiscal year
ended May 31, 2004 of $63.4 million, net of insurer contributions totaling $9.4
million. Insurance coverage was depleted in the first quarter of this fiscal
year (2004).
(b) Represents the Company's portion of total claims paid during the fiscal year
ended May 31, 2003 of $54.4 million, net of insurer contributions totaling $49.0
million.
NOTE G - ACCOUNTING RECLASSIFICATION
During the first quarter of fiscal 2005, we changed our accounting
classification for cooperative advertising by reflecting the amounts paid as a
reduction of sales, as opposed to a component of selling, general and
administrative ("SG&A") expenses and have reclassified the previous year's
information. The reclassification impacts classifications in our consumer
business segment and to a lesser degree the consolidated totals. We believe that
it is preferable to classify the amounts paid as a reduction of our sales in
light of recent developments in industry trends relating to accounting
classifications applied to such arrangements by both vendors and retailers - as
a reduction of sales and a reduction of cost of sales, respectively. The new
classification represents only a movement of expense and therefore has no impact
on our earnings or earnings per share.
14
RPM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2004
(UNAUDITED)
With respect to the impact of the accounting reclassification on consolidated
full fiscal 2004 results, annual net sales will be decreased by approximately
1.5% (3.2% for the consumer segment), gross profit margin will be decreased by
approximately 0.8% (1.8% for the consumer segment), and SG&A expense as a
percent of net sales will be decreased by approximately 1.0% (2.2% for the
consumer segment). As set forth previously, our earnings and earnings per share
are not affected by this account reclassification. With respect to the impact of
the accounting change on consolidated second quarter results for fiscal 2004,
net sales decreased by approximately 1.4% (3.2% for the consumer segment), gross
profit margin decreased by approximately 0.8% (1.8% for the consumer segment);
and SG&A expense as a percent of net sales decreased by 0.9% (2.2% for the
consumer segment). Similarly, with respect to the impact of the accounting
change on consolidated six month results for fiscal 2004, net sales decreased by
approximately 1.5% (3.3% for the consumer segment), gross profit margin
decreased by approximately 0.8% (1.8% for the consumer segment); and SG&A
expense as a percent of net sales decreased by 1.0% (2.3% for the consumer
segment). There was no impact of the change on the quarterly and annual results
for the industrial segment for fiscal 2004. The year-over-year rates of change
in gross profit and SG&A expenses under the old and new classifications are
essentially unchanged. Here again, there is no change in earnings or earnings
per share.
NOTE H - DEBT
On September 30, 2004, we issued and sold $200 million of 4.45% Senior Unsecured
Notes due 2009, which we concurrently swapped back to floating interest rate
debt. The total net proceeds of the offering of the Senior Notes will be used to
refinance existing indebtedness. More specifically, we plan to use a portion of
the net proceeds to refinance portions of our current outstanding floating rate
indebtedness. We applied a portion of the proceeds to pay off our $15.0 million
6.12% Senior Notes due 2004, which matured on November 15, 2004, $68.0 million
of commercial paper, and anticipate holding the remainder as cash or short-term
investments until such time that it can be used toward satisfying our
indebtedness under our $150.0 million 7.0% Senior Notes due 2005, which mature
on June 15, 2005.
During November 2004, we refinanced our $500 million revolving credit facility
with a $330 million 5-year credit facility (the "Facility"). This new facility
will be used for general corporate purposes, including acquisitions and to
provide back-up liquidity for the issuance of commercial paper. The facility
provides for borrowings in U.S. dollars and several foreign currencies and
provides sublimits for the issuance of letters of credit in an aggregate amount
of up to $25 million and a swing-line of up to $20 million for short-term
borrowings of less than 15 days. In addition, the size of the facility may be
expanded upon our request by up to an additional $100 million, thus potentially
expanding the facility to $430 million, subject to lender approval.
15
RPM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2004
(UNAUDITED)
NOTE I - SEGMENT INFORMATION
We operate a portfolio of businesses that manufacture and sell a variety of
specialty paints, protective coatings and roofing systems, sealants and
adhesives. We manage our portfolio by organizing our businesses into two
operating segments - industrial and consumer - based on the nature of business
activities; products and services; the structure of management; and the
structure of information as presented to the Board of Directors. Within each
segment, individual operating companies or groups of companies generally address
common markets, utilize similar technologies, and can share manufacturing or
distribution capabilities.
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 expenses reconcile operating segment data to total
consolidated net sales, income before income taxes and identifiable assets.
Comparative six month and second quarter results on this basis are illustrated
in the following table.
SIX MONTHS ENDED NOVEMBER 30, QUARTER ENDED NOVEMBER 30,
----------------------------- --------------------------
(In thousands) 2004 2003 2004 2003
----------- ----------- ----------- ---------
NET SALES
Industrial $ 730,396 $ 646,498 $ 364,888 $ 330,304
Consumer 554,586 516,066 258,581 251,237
----------- ----------- --------- ---------
CONSOLIDATED $ 1,284,982 $ 1,162,564 $ 623,469 $ 581,541
=========== =========== ========= =========
INCOME BEFORE INCOME TAXES
Industrial Segment $ 102,075 $ 85,961 $ 45,939 $ 38,941
Consumer Segment 77,666 74,205 31,311 32,059
Corporate/Other (82,527) (31,647) (64,511) (16,391)
----------- ----------- --------- ---------
CONSOLIDATED $ 97,214 $ 128,519 $ 12,739 $ 54,609
=========== =========== ========= =========
November 30, 2004 May 31, 2004
----------------- ------------
IDENTIFIABLE ASSETS
Industrial $ 1,203,502 $ 1,111,978
Consumer 1,089,319 1,087,239
Corporate/Other 246,179 153,902
------------- ------------
CONSOLIDATED $ 2,539,000 $ 2,353,119
============= ============
16
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our Consolidated Financial Statements include the accounts of RPM International
Inc. and its majority-owned subsidiaries. Preparation of our financial
statements requires the use of estimates and assumptions that affect the
reported amounts of our assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. We continually evaluate these estimates, including those
related to allowances for doubtful accounts; inventories; allowances for
recoverable taxes; useful lives of property, plant and equipment; goodwill;
environmental and other contingent liabilities; income tax valuation allowances;
pension plans; and the fair value of financial instruments. We base our
estimates on historical experience and other assumptions, which we believe to be
reasonable under the circumstances. These estimates form the basis for making
judgments about the carrying value of our assets and liabilities. Actual results
may differ from these estimates under different assumptions and conditions.
We have identified below the accounting policies that are critical to our
financial statements.
REVENUE RECOGNITION
Revenues are recognized when realized or realizable, and when earned. In
general, this is when title and risk of loss pass to the customer. Further,
revenues are realizable when we have persuasive evidence of a sales arrangement,
the product has been shipped or the services have been provided to the customer,
the sales price is fixed or determinable, and collectibility is reasonably
assured. We reduce our revenues for estimated customer returns and allowances,
certain rebates, sales incentives and promotions in the same period the related
sales are recorded.
TRANSLATION OF FOREIGN CURRENCY FINANCIAL STATEMENTS AND FOREIGN CURRENCY
TRANSACTIONS
Our reporting currency is the U.S. dollar. However, the functional currency of
all of our foreign subsidiaries is their local currency. We translate the
amounts included in our consolidated statements of income from our foreign
subsidiaries into U.S. dollars at weighted 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). Translation adjustments will be
included in net earnings in the event of a sale or liquidation of any of our
underlying foreign investments, or in the event that we distribute the
accumulated earnings of consolidated foreign subsidiaries. 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).
17
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
As appropriate, we use permanently invested intercompany loans as a source of
capital to reduce exposure to foreign currency fluctuations at our foreign
subsidiaries. These loans are treated as analogous to equity for accounting
purposes. Therefore, foreign exchange gains or losses on these intercompany
loans are recorded in accumulated 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 apply the provisions of Statement of Financial Accounting Standards ("SFAS")
No. 141, "Business Combinations," which addresses the initial recognition and
measurement of goodwill and intangible assets acquired in a business
combination. We also apply the provisions of SFAS No. 142, "Goodwill and Other
Intangible Assets," which requires that goodwill be tested on an annual basis,
or more frequently as impairment indicators arise. We have elected to perform
the required impairment tests, which involve the use of estimates related to the
fair market values of the business operations with which goodwill is associated,
at the end of our first quarter. Calculating the fair market value of the
reporting units requires significant estimates and assumptions by management. We
estimate the fair value of our reporting units by applying third-party market
value indicators to the respective reporting unit's annual projected earnings
before interest, taxes, depreciation and amortization. In applying this
methodology, we rely on a number of factors, including future business plans,
actual operating results and market data. In the event that our calculations
indicate that goodwill is impaired, a fair value estimate of each tangible and
intangible asset would be established. This process would require the
application of discounted cash flows expected to be generated by each asset in
addition to independent asset appraisals, as appropriate. Cash flow estimates
are based on our historical experience and our internal business plans, and
appropriate discount rates are applied. Losses, if any, resulting from goodwill
impairment tests would be reflected in operating income in our income statement.
OTHER LONG-LIVED ASSETS
We assess identifiable non-goodwill intangibles and other long-lived assets for
impairment whenever events or changes in facts and circumstances indicate the
possibility that the carrying value may not be recoverable. Factors considered
important, which might trigger an impairment evaluation, include the following:
- significant under-performance relative to historical or projected
future operating results;
- significant changes in the manner of our use of the acquired assets;
- significant changes in the strategy for our overall business; and
- significant negative industry or economic trends.
Measuring a potential impairment of non-goodwill intangibles and other
long-lived assets requires various estimates and assumptions, including
determining which cash flows are directly related to the asset being evaluated,
the useful life over which those cash flows will occur, their amount and the
asset's residual value, if any. If we determine that the carrying value of these
assets may not be
18
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
recoverable based upon the existence of one or more of the above-described
indicators, any impairment would be measured based on projected net cash flows
expected from the asset(s), including eventual disposition. The determination of
impairment loss would be based on the best information available, including
internal discounted cash flows, quoted market prices when available and
independent appraisals as appropriate to determine fair value. Cash flow
estimates would be based on our historical experience and our internal business
plans, with appropriate discount rates applied. We have not incurred any such
impairment loss to date.
CONTINGENCIES
We are party to claims and lawsuits arising in the normal course of business,
including the various asbestos-related suits discussed herein and in Note H to
our Consolidated Financial Statements included in our Annual Report on Form 10-K
for the year ended May 31, 2004. Although we cannot precisely predict the amount
of any liability that may ultimately arise with respect to any of these matters,
we record provisions when we consider the liability probable and reasonably
estimable. The provisions are based on historical experience and legal advice,
are reviewed quarterly and are adjusted according to developments. Estimating
probable losses requires analysis of multiple forecasted factors that often
depend on judgments about potential actions by third parties such as regulators,
courts and state and federal legislatures. Changes in the amount of the
provisions affect our consolidated statements of income. Due to the inherent
uncertainties in the loss reserve estimation process, we are unable to estimate
an additional range of loss in excess of our accruals.
Our environmental-related accruals are similarly established and/or adjusted as
information becomes available upon which costs can be reasonably estimated. Here
again, actual costs may vary from these estimates because of the inherent
uncertainties involved, including the identification of new sites and the
development of new information about contamination. Certain sites are still
being investigated and, therefore, we have been unable to fully evaluate the
ultimate cost for those sites. As a result, reserves have not been taken for
certain of these sites and costs may ultimately exceed existing reserves for
other sites. We have received indemnities for potential environmental issues
from purchasers of certain of our properties and businesses and from sellers of
properties or businesses we have acquired. We have also purchased insurance to
cover potential environmental liabilities at certain sites. If the indemnifying
or insuring party fails to, or becomes unable to, fulfill its obligations under
those agreements or policies, we may incur 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.
REPORTABLE SEGMENT INFORMATION
We operate a portfolio of businesses that manufacture and sell a variety of
specialty paints, protective coatings and roofing systems, sealants and
adhesives. We manage our portfolio by organizing our businesses into two
operating segments - industrial and consumer - based on the nature of business
activities; products and services; the structure of management; and the
structure of information as presented to the Board of Directors. Within each
segment, individual operating companies or groups of companies generally address
common markets, utilize similar technologies, and can share
19
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
manufacturing or distribution capabilities. We evaluate the profit performance
of our segments based on income before income taxes, but also look to earnings
before interest and taxes ("EBIT") as a performance evaluation measure because
interest expense is essentially related to corporate acquisitions, as opposed to
segment operations.
In addition to the two operating segments, there are certain business
activities, referred to as corporate/other, that do not constitute an operating
segment, including corporate headquarters and related administrative expenses,
results of our captive insurance companies, gains or losses on the sales of
certain assets and other expenses not directly associated with either operating
segment. Related assets consist primarily of investments, prepaid expenses,
deferred pension assets, and headquarters' property and equipment. These
corporate and other expenses reconcile operating segment data to total
consolidated net sales, income before income taxes and identifiable assets.
Comparative six month and second quarter results on this basis are illustrated
in the following table.
SIX MONTHS ENDED NOVEMBER 30, QUARTER ENDED NOVEMBER 30,
----------------------------- --------------------------
(In thousands) 2004 2003 2004 2003
----------- ----------- --------- ----------
NET SALES
Industrial $ 730,396 $ 646,498 $ 364,888 $ 330,304
Consumer 554,586 516,066 258,581 251,237
----------- ----------- --------- ---------
CONSOLIDATED $ 1,284,982 $ 1,162,564 $ 623,469 $ 581,541
=========== =========== ========= =========
INCOME BEFORE INCOME TAXES (a)
Industrial Segment
Income Before Income Taxes (a) $ 102,075 $ 85,961 $ 45,939 $ 38,941
Interest (Expense), Net 24 4 13 29
----------- ----------- --------- ---------
EBIT (b) $ 102,051 $ 85,957 $ 45,926 $ 38,912
=========== =========== ========= =========
Consumer Segment
Income Before Income Taxes (a) $ 77,666 $ 74,205 $ 31,311 $ 32,059
Interest (Expense), Net 108 40 59 29
----------- ----------- --------- ---------
EBIT (b) $ 77,558 $ 74,165 $ 31,252 $ 32,030
=========== =========== ========= =========
Corporate/Other
(Loss) Before Income Taxes (a) $ (82,527) $ (31,647) $ (64,511) $ (16,391)
Interest (Expense), Net (17,017) (13,038) (8,987) (6,769)
----------- ----------- --------- ---------
EBIT (b) $ (65,510) $ (18,609) $ (55,524) $ (9,622)
=========== =========== ========= =========
CONSOLIDATED
Income Before Income Taxes (a) $ 97,214 $ 128,519 $ 12,739 $ 54,609
Interest (Expense), Net (16,885) (12,994) (8,915) (6,711)
----------- ----------- --------- ---------
EBIT (b) $ 114,099 $ 141,513 $ 21,654 $ 61,320
=========== =========== ========= =========
(a) The presentation includes a reconciliation of Income Before Income Taxes, a
measure defined by Generally Accepted Accounting Principles ("GAAP") in the
U.S., to EBIT.
(b) EBIT is defined as earnings before interest and taxes. We evaluate the
profit performance of our segments based on income before income taxes, but also
look to EBIT as a performance evaluation measure because interest expense is
essentially related to corporate acquisitions, as opposed to segment operations.
EBIT should not be considered an alternative to, or more meaningful than,
operating income or cash flow from operations as determined in accordance with
GAAP, since EBIT omits the impact of interest and taxes in determining operating
performance, and the impact of changes in working capital and other balance
sheet items essential in determining operating cash flows. Nonetheless, we
believe disclosing EBIT is useful to our fixed income investors and the banking
community as we believe that it is helpful in analyzing our segments' core
operating performance and our ability to service debt and otherwise meet cash
needs. We also evaluate EBIT because we believe movements in EBIT impact our
ability to attract financing. EBIT may not be indicative of our historical
operating results, nor is it meant to be predictive of potential future results.
20
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
RESULTS OF OPERATIONS
THREE MONTHS ENDED NOVEMBER 30, 2004
NET SALES
Net sales on a consolidated basis for the second quarter of fiscal 2005 of
$623.5 million improved 7.2 percent, or $41.9 million, over last year's second
quarter net sales of $581.5 million. Reflected in net sales for both periods is
the reclassification of cooperative advertising expense, as discussed in Note G
to the Financial Statements. Contributing to this improvement over last year was
the continued growth in organic sales of approximately 4.1 percent, or $24.0
million, plus 4 small acquisitions, net of one small divestiture, supplying
another 1.5 percent growth in sales, or $8.6 million. Net favorable foreign
exchange rates, relating primarily to the euro and the Canadian dollar, provided
the remaining 1.6 percent, or $9.3 million, of the growth in sales over last
year's second quarter.
Industrial segment net sales for the second quarter grew 10.5 percent to $364.9
million from last year's $330.3 million, comprising 58.5 percent of the current
quarter's consolidated net sales. This segment's net sales growth comes
primarily from organic sales growth of 6.0 percent, another 2.1 percent from net
favorable foreign exchange differences, and 3 small acquisitions during the past
12 months, net of one small divestiture, which added the remaining 2.4 percent
of growth to industrial sales. There were notable organic sales improvements in
roofing products, among a number of the specialty businesses, in construction
sealants, admixtures and related products, with some of this growth related to
increased U.S. commercial construction activity, and in polymer flooring.
Consumer segment net sales for the second quarter grew 2.9 percent to $258.6
million from last year's $251.2 million, comprising 41.5 percent of the current
quarter's consolidated net sales. Growth in organic sales added 1.8 percent to
the consumer segment sales total, plus 0.9 percent from favorable foreign
exchange differences. One small bolt-on product line acquisition during the past
12 months provided the remaining 0.2 percent of sales growth in this segment
over last year. This segment's organic sales slowed during this second quarter
from the effects of the hurricanes, which struck the southeastern U.S. during
September, changes in certain order patterns year over year, and generally
slower consumer take-away at the retail level, viewed as a temporary condition
as opposed to a trend.
GROSS PROFIT MARGIN
Consolidated gross profit margin of 43.4 percent of net sales this second
quarter declined from 44.3 percent a year ago. Continued higher costs of
petroleum-based raw materials, which amounted to approximately 2.4 percent of
net sales, or 240 basis points ("bps"), more than offset the margin benefits
generated primarily from the leverage of higher product sales volume and
additional price increases being implemented by our businesses.
Industrial segment gross profit margin for the second quarter declined to 44.7
percent of net sales from 45.4 percent last year. Gross profit margin in this
segment declined principally as the result of the continued higher raw material
costs, which impacted margins by 180 bps. Price increases favorably offset these
higher costs by approximately 110 bps.
Consumer segment gross profit margin for this second quarter declined to 41.6
percent of net sales from 42.9 percent last year. Despite the price increases
that contributed approximately 200 bps to margins
21
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
this quarter, there was approximately 320 bps of negative margin impact from
higher raw material and packaging costs. This differential represented the
primary factor contributing to the overall 130 bps decline in this segment's
gross margin from last year.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A")
Consolidated SG&A expense levels improved 130 bps to 32.4 percent of net sales
compared with 33.7 percent a year ago. The reclassification of cooperative
advertising expense is reflected in both periods presented (see Note G for
additional information). The leverage of solid sales growth over last year was
the primary contributing factor to the improvement (180 bps). The higher cost of
fuel, which contributed to higher fuel-related distribution costs over last year
(30 bps), along with this year's adoption of SFAS No. 123 (refer to Note D),
combined with our new Omnibus equity incentive plan (20 bps), partially offset
this leverage.
Industrial segment SG&A improved by 150 bps, to 32.1 percent of net sales this
second quarter from 33.6 percent a year ago. In addition to the leverage of
solid sales growth, there were continued, effective cost-containment and savings
programs (200 bps, total). These improvements were partially offset by higher
distribution costs (30 bps) and compensation-related changes (20 bps).
Consumer segment SG&A improved by 60 bps, to 29.5 percent of net sales this
second quarter compared with 30.1 percent a year ago. Here again, solid growth
in organic sales over last year provided leverage benefits along with continued
cost containment and other savings programs (90 bps, total). The major item
offsetting these benefits was increased fuel-related distribution costs (30
bps).
Corporate/Other costs decreased during this year's second quarter to $8.5
million from $9.6 million during last year's second quarter. Improvements in
product liability loss experience created a benefit of approximately $1.4
million this quarter, in addition to lower other insurance costs this quarter,
approximating $1.1 million. However, higher costs related to this year's
adoption of SFAS No. 123, approximating $0.8 million, combined with additional
costs related to last year's establishment of our European development office,
approximating $0.5 million, plus additional corporate governance costs, partly
offset those gains.
License fee and joint venture income of $0.2 million and $0.3 million for the
quarters ended November 30, 2004 and 2003, respectively, are reflected as
reductions of consolidated SG&A expenses.
We recorded total net periodic pension and postretirement benefit cost of $4.0
million and $4.3 million for the quarters ended November 30, 2004 and 2003,
respectively. This decreased pension expense of $0.3 million was largely
attributable to a net improvement in the expected return on plan assets,
approximating $0.8 million, combined with decreased net actuarial losses
recognized, which positively impacted quarter-over-quarter expense by
approximately $0.2 million. Offsetting those benefits were increased pension
service and interest cost totaling approximately $0.7 million. We expect that
pension expense will fluctuate on a year-to-year basis depending upon the
performance of plan assets, but such changes are not expected to be material as
a percent of income before income taxes.
22
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
ASBESTOS CHARGE
As described in Note F to the consolidated financial statements, certain of our
wholly owned subsidiaries, principally 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. During the fiscal year ended May
31, 2003, we recorded an asbestos charge of $140.0 million for measurable known
claims, and a provision for future claims that were estimable as of May 31,
2003. We believed then that the asbestos reserve would be sufficient to cover
asbestos-related cash flow requirements over the estimated three-year life of
the reserve. The $140.0 million charge also included $15.0 million in total
projected defense costs over the estimated three-year life of the reserve.
During the second quarter ending November 30, 2004, based on a review of our
pending known claims coupled with a review of our defense costs, we have
concluded that the $56.0 million balance of the $140.0 million reserve will not
likely be sufficient to cover our asbestos-related cash flow requirements for
the remainder of the full three-year period originally contemplated by the
reserve. Therefore, we have concluded that an increase in our existing reserve
is appropriate. An asbestos reserve adjustment of $47.0 million has been taken
for the quarter ended November 30, 2004, which we believe will be sufficient to
cover any incremental cash flow requirements through fiscal 2006 not covered by
the $140.0 million reserve, as well as the additional cash flow requirements for
the balance of our pending known claims and anticipated higher defense costs.
Approximately $32.0 million of the $47.0 million reserve adjustment will be
allocated to anticipated higher future defense costs. This reserve adjustment
will put our total reserves at approximately $103.0 million. As we review our
asbestos reserve each quarter, we will make appropriate adjustments to the
reserve based on our most recent experience to ensure that it is sufficient to
cover the anticipated settlement and defense costs associated with our then
pending, known claims. While we have seen positive trends in our average
settlement costs, dismissal rates and state law changes going in the right
direction and some form of federal legislation once again being discussed, the
outlook is still not sufficiently clear to assess the future unknown claims that
may be filed against the Company's subsidiaries. Until the uncertainty of
estimating the value of any potential future unknown asbestos claims is
substantially reduced, we do not expect to establish any reserve for any such
unknown future claims.
INCOME BEFORE INCOME TAXES ("IBT")
Consolidated IBT for this year's second quarter declined by $41.9 million, or
76.7 percent, to $12.7 million from $54.6 million during last year's second
quarter, with margin deterioration to 2.0 percent of net sales from 9.4 percent
a year ago, reflecting the $47.0 million pre-tax asbestos charge taken during
this year's second quarter. The positive impact from the higher sales volume
more than offset the approximate 240 bps impact of the higher cost of raw
materials and supplies, and higher fuel-related distribution costs, which,
excluding the asbestos charge, would have resulted in a slight margin
improvement to an adjusted 9.4 percent from 9.2 percent last year.
23
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
Industrial segment IBT grew by $7.0 million, or 18.0 percent, to $45.9 million
from last year's $38.9 million, mainly from the higher organic sales volume.
Consumer segment IBT declined by $0.7 million, or 2.3 percent, to $31.3 million
from last year's $32.1 million, mainly from the organic sales growth leverage in
this segment less the impact from higher material costs. Combined operating IBT
growth totaled $6.3 million, or 8.8 percent, over last year.
NET INTEREST EXPENSE
Net interest expense was $2.2 million higher this second quarter than a year
ago. Interest rates averaged 4.8 percent during this second quarter,
approximately 130 bps higher than a year ago, accounting for $2.8 million in
increased interest expense. This increase is primarily due to our debt
refinancings (Refer to "Liquidity and Capital Resources" Section) during the
past 18 months, including the $200 million 6.25% Senior Notes issued in December
2003 and the $200 million 4.45% Senior Unsecured Notes issued in September 2004.
Higher average net borrowings this year, associated with recent acquisitions, of
approximately $29.3 million added $0.2 million of interest cost, while
investment income performance improved year-over-year, providing $1.3 million of
additional income. Additional debt outstanding during the past year cost an
additional $0.5 million during the quarter.
INCOME TAX RATE
For the quarters ended November 30, 2004 and 2003, the effective income tax rate
was 28.5 percent and 35.5 percent, respectively, reflecting the impact of the
$29.4 million after-tax asbestos charge taken during this year's second quarter.
Excluding the charge, the effective rate for this year's second quarter would
have been an adjusted 35.6 percent. Our geographic mix of earnings has remained
relatively consistent for both periods.
NET INCOME
Net income of $9.1 million for the three months ended November 30, 2004 compares
to $35.2 million for the same period last year, reflecting the impact of the
$29.4 million after-tax asbestos charge taken this year. Excluding the impact of
the asbestos charge, this year's second quarter net income would have been an
adjusted $38.5 million, representing an increase of $3.3 million, or 9.3
percent, from last year's $35.2 million. Margin on sales would have been an
adjusted 6.2 percent this year compared with 6.1 percent of sales for the three
month period ended November 30, 2003, despite the approximate 240 bps pre-tax
impact from higher material costs. Excluding the charge, earnings per common
share would have increased by 10.0 percent, to an adjusted $0.33 from $0.30 a
year ago.
24
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
SIX MONTHS ENDED NOVEMBER 30, 2004
NET SALES
Net sales on a consolidated basis for the first six months of fiscal 2005 of
$1.285 billion improved 10.5 percent, or $122.4 million, over last year's first
six months net sales of $1.163 billion. Reflected in net sales for both periods
is the reclassification of cooperative advertising expense, as discussed in Note
G to the Financial Statements. Contributing to this improvement over last year
was the continued growth in organic sales of approximately 7.7 percent, or $89.6
million, plus 5 small acquisitions, net of one small divestiture, supplying
another 1.5 percent growth in sales, or $16.8 million. Net favorable foreign
exchange rates, relating primarily to the euro and the Canadian dollar, provided
the remaining 1.3 percent, or $16.0 million, of the growth in sales over last
year's first six months.
Industrial segment net sales for the first six months grew 13.0 percent to
$730.4 million from last year's $646.5 million, comprising 56.8 percent of the
current six months' consolidated net sales. This segment's net sales growth
comes primarily from organic sales growth of 8.9 percent, another 1.9 percent
from net favorable foreign exchange differences, and 4 small acquisitions during
the past 12 months, net of one small divestiture, which added the remaining 2.2
percent of growth to industrial sales. There were notable organic sales
improvements in construction sealants, admixtures and chemicals, with some of
this growth related to increased U.S. commercial construction activity, roofing
products and services, polymer flooring and a number of the specialty
businesses.
Consumer segment net sales for the first six months grew 7.5 percent to $554.6
million from last year's $516.1 million, comprising 43.2 percent of the current
six months' consolidated net sales. Solid growth in organic sales added 6.3
percent to the consumer segment sales total, in addition to 0.8 percent from
favorable foreign exchange differences. One small bolt-on product line
acquisition during the past 12 months provided the remaining 0.4 percent of
sales growth in this segment over last year. There were notable organic sales
improvements in wood care products, hobby and craft products, primer-sealers,
and small-project paints and related products.
GROSS PROFIT MARGIN
Consolidated gross profit margin of 44.0 percent of net sales these first six
months declined from 45.1 percent a year ago. The combination of primarily
continued higher costs of petroleum-based raw materials, which amounted to
approximately 160 bps, in addition to approximately 20 bps negative margin
effect from the growth of roofing services sales, which carry lower gross
margins, more than offset the margin benefits generated primarily from the
leverage of higher organic sales volume and price increases implemented by our
businesses.
Industrial segment gross profit margin for the first six months declined to 45.3
percent of net sales from 46.3 percent last year. Gross profit margin in this
segment declined principally as the result of continued higher raw material
costs which impacted margins by approximately 120 bps, while the continued
strong growth of
25
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
the lower-margin roofing services business had a negative margin impact of
approximately 40 bps these first six months. Price increases favorably offset
these costs by approximately 50 bps.
Consumer segment gross profit margin for these first six months declined to 42.3
percent of net sales from 43.7 percent last year. Despite the margin leverage
from the higher organic sales volume and price increases implemented these first
six months, there was approximately 230 bps of negative impact from certain
higher raw material and packaging costs that principally caused the overall 140
bps decline in this segment's gross margin from last year.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A")
Consolidated SG&A expense levels improved 150 bps to 31.5 percent of net sales
compared with 33.0 percent a year ago. The reclassification of cooperative
advertising expense is reflected in both periods presented (see Note G for
additional information). The leverage of solid sales growth over last year was
the primary contributing factor to the improvement. The higher cost of fuel,
which contributed to higher distribution costs over last year (30 bps), this
year's adoption of SFAS No. 123 (refer to Note D), and certain growth-related
investments partially offset these gains.
Industrial segment SG&A improved by 170 bps, to 31.3 percent of net sales these
first six months from 33.0 percent a year ago. The main contributors to SG&A
improvement were the leverage of solid sales growth and the increase in roofing
services sales, which require lower SG&A support levels, and cost-containment
and other savings programs. These improvements were partially offset by higher
distribution costs (30 bps) and growth-related investments (30 bps).
Consumer segment SG&A improved by 100 bps, to 28.3 percent of net sales these
first six months compared with 29.3 percent a year ago. Solid organic growth in
sales over last year provided leverage benefits along with continued cost
containment and other savings programs. Partly offsetting these benefits were
increased promotional and other growth-related investments made in this segment,
in addition to increased fuel-related distribution costs (30 bps).
Corporate/Other costs decreased during this year's first six months to $18.5
million from $18.6 million during last year's first half. Generally lower
insurance costs and certain other cost reductions more than offset
higher costs related to this year's adoption of SFAS No. 123, approximating $1.4
million, increased compensation cost, approximating $1.1 million, additional
costs related to last year's establishment of our European development office,
approximating $0.7 million, and higher corporate governance costs.
License fee and joint venture income of $0.5 million and $0.4 million for the
six months ended November 30, 2004 and 2003, respectively, are reflected as
reductions of consolidated SG&A expenses.
26
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
We recorded total net periodic pension and postretirement benefit cost of $7.9
million and $8.5 million for the six months ended November 30, 2004 and 2003,
respectively. This decreased pension expense of $0.6 million was largely
attributable to a net improvement in the expected return on plan assets,
approximating $1.7 million, combined with decreased net actuarial losses
recognized, which positively impacted year-over-year expense by approximately
$0.4 million. Offsetting those benefits were increased pension service and
interest cost totaling approximately $1.5 million. We expect that pension
expense will fluctuate on a year-to-year basis depending upon the performance of
plan assets, but such changes are not expected to be material as a percent of
income before income taxes.
ASBESTOS CHARGE
As described in Note F to the consolidated financial statements, as well as in
Management's Discussion and Analysis of Financial Condition and Results of
Operations presented for the three month period ended November 30, 2004, and in
Part II, Item I - Legal Proceedings section of this filing, we recorded an
asbestos charge of $47.0 million in the second quarter of the current fiscal
year. Please refer to the sections of this filing mentioned above for further
information.
INCOME BEFORE INCOME TAXES ("IBT")
Consolidated IBT for this year's first six months of $97.2 million compares with
$128.5 million last year, with $47.0 million of this decline resulting from the
asbestos charge taken during this year's second quarter. Excluding the charge,
IBT for this year's first six months would have been an adjusted $144.2 million,
or ahead by 15.7 million, or 12.2 percent from last year's $128.5 million,
representing a slight margin improvement to 11.2 percent of net sales from 11.1
percent a year ago. This growth reflects the positive impact from the higher
sales volume overcoming the approximate 160 bps impact of higher material costs,
higher fuel-related distribution costs and the continuation of certain
growth-related investments these first six months in both operating segments.
Industrial segment IBT grew by $16.1 million, or 18.7 percent, to $102.1 million
from last year's $86.0 million, mainly from the higher organic sales volume.
Consumer segment IBT grew by $3.5 million, or 4.7 percent, to $77.7 million from
last year's $74.2 million, mainly from the organic sales growth leverage in this
segment as well, less the impact from higher material costs. Combined operating
IBT growth totaled $19.6 million, or 12.2 percent, over last year.
NET INTEREST EXPENSE
Net interest expense was $3.9 million higher these first six months than a year
ago. Interest rates averaged 4.7 percent during these first six months, compared
with 3.5 percent a year ago, accounting for $4.9 million of the interest cost
increase. This increase is primarily due to our debt
27
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
refinancings (Refer to "Liquidity and Capital Resources" Section) during the
past 18 months, including the $200 million 6.25% Senior Notes issued in December
2003 and the $200 million 4.45% Senior Unsecured Notes issued in September 2004.
Higher average net borrowings this year, associated with recent acquisitions, of
approximately $29.0 million added $0.5 million of interest cost, while
investment income performance improved year-over-year, providing $1.7 million of
additional income. Additional debt outstanding during the past year cost an
approximate $0.2 million during this first half.
INCOME TAX RATE
For the six months ended November 30, 2004 and 2003, the effective income tax
rate was 34.6 percent and 35.5 percent, respectively, reflecting the impact of
the $29.4 million after-tax asbestos charge taken during this year's second
quarter. Excluding the charge, the effective income tax rate would have also
been an adjusted 35.5 percent for the six months ended November 30, 2004. Our
geographic mix of earnings has remained relatively consistent for both periods.
NET INCOME
Net income for this year's first half of $63.6 million compares with last year's
$82.9 million, reflecting the $29.4 million after-tax cost of the asbestos
liability charge taken during this year's second quarter. Excluding the charge,
this year's first six months an adjusted net income would have been $93.0
million, ahead $10.1 million, or 12.2 percent, from last year. Margin on sales
would have improved slightly to an adjusted 7.2 percent of sales from 7.1
percent of sales during last year's first half, despite the approximate 160 bps
pre-tax impact from higher material costs. Diluted earnings per common share
would have increased to an adjusted $0.79, or by 11.3 percent, from $0.71 a year
ago.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS FROM:
OPERATING ACTIVITIES
There was $99.6 million of cash generated from operations during the first six
months of fiscal 2005 compared with $74.8 million generated during the same
period a year ago, or a net increase of $24.7 million. Excluding the $47.0
million ($29.4 million after-tax) effect of the non-cash asbestos charge taken
during the second quarter, which did not affect cash flow, our adjusted
period-over-period increase in net income and depreciation and amortization
would have been a positive $11.9 million through the first six months. "Items
not affecting cash and other" and "changes in operating working capital"
combined reflect a net positive generation of cash flow period-over-period of
$17.9 million. Changes in trade accounts receivable generated a
period-over-period increase in cash flow of $27.1 million, net of foreign
exchange differences, principally due to a 2.0 day reduction in day sales
outstanding, year-over-year. Inventories
28
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
required an additional $17.1 million of operating cash, net of foreign exchange
differences, as a result of the increased sales volume and the associated
inventory required to support those levels as well as certain strategic
inventory builds in light of the higher cost environment and to address certain
commodity allocations. Accounts payable had a positive period-over-period effect
on cash flow of $2.4 million, net of foreign exchange differences, mostly as a
result of timing of payments and receipts of materials. All other remaining
balance sheet changes related to "items not affecting cash and other" and
"changes in operating working" had a net positive impact of $5.5 million.
Management continues to focus on improving accounts receivable collection and
managing inventory levels to lower levels as a result of strengthened
information technology systems and continuous improvements in operating
techniques, such as Class "A" manufacturing.
In other areas, long-term and short-term asbestos-related reserves, net of
taxes, resulted in period over period additional usage of cash of approximately
$5.0 million excluding the second-quarter non-cash $29.4 million after-tax
increase in the Company's reserves for asbestos-related liabilities. As
disclosed in our "Critical Accounting Policies and Estimates" and our discussion
on asbestos litigation (refer to Item 1. Legal Proceedings, Part II-Other
Information), the significant increase in asbestos claims activity and the
disproportionate impact of joint and several liability laws in several states on
our Bondex subsidiary caused our third-party insurance to be depleted during the
first quarter of fiscal 2004. Accordingly, we are now required to fund costs
previously covered by third-party insurance through cash from operations. We
anticipate that cash flows from operations and other sources will be sufficient
to meet all asbestos-related obligations on a short-term and long-term basis.
Cash provided from operations remains our primary source of financing internal
growth, with limited use of short-term debt.
INVESTING ACTIVITIES
Capital expenditures, other than for ordinary repairs and replacements, are made
to accommodate our continued growth through improved production and distribution
efficiencies and capacity, and to enhance administration. Capital expenditures
during the first six months of fiscal 2005 of $21.8 million compare with
depreciation of $24.7 million, well within the maintenance level of spending. We
are not a capital intensive business and capital expenditures generally do not
exceed depreciation in a given year. Capital spending is expected to approximate
our depreciation levels for the next several years as additional capacity is
brought on-line to support our continued growth. With additional minor plant
expansions, we believe there will be adequate production capacity to meet our
needs for the next several years at normal growth rates.
During the first six months of fiscal 2005, we invested a total of $9.9 million
for one product line acquisition and received proceeds of $4.5 million from the
sale of assets.
FINANCING ACTIVITIES
In December 2003, we issued and sold $200 million of 6.25% Senior Notes due 2013
as a means of refinancing. The Notes were offered to qualified institutional
buyers under Rule 144A and to persons
29
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
outside the United States under Regulation S. The entire net proceeds of $197
million from this offering were used to repay in full the $128 million of
then-outstanding borrowings under our $500 million revolving credit facility and
$69 million of the then-outstanding $72 million balance under our asset
securitization program. On July 13, 2004, we completed an exchange offer
pursuant to which holders exchanged the initial notes for notes registered under
the Securities Act of 1933.
On September 30, 2004, we issued and sold $200 million aggregate principal
amount of 4.45% Senior Unsecured Notes due 2009 ("4.45% Senior Notes"), which we
concurrently swapped back to floating interest rate debt (refer to interest rate
risk discussion below). The Notes were offered to qualified institutional buyers
under Rule 144A. The total net proceeds of $198.0 million from this offering of
the Senior Notes will be used to refinance existing indebtedness. More
specifically, we plan to use a portion of the net proceeds to refinance portions
of our current outstanding floating rate indebtedness. We applied a portion of
the proceeds to pay off our $15.0 million 6.12% Senior Notes due 2004, which
matured on November 15, 2004, $68.0 million of commercial paper, and anticipate
holding the remainder as cash or short-term investments until such time that it
can be used toward satisfying our indebtedness under our $150.0 million 7.0%
Senior Notes due 2005, which mature on June 15, 2005. Pursuant to a Registration
Rights Agreement between the Company and the initial purchasers of the 4.45%
Senior Notes, the Company is required to register the 4.45% Senior Notes under
the Securities Act of 1933 so as to allow holders to exchange the 4.45% Senior
Notes for the same principal amount of a new issue of notes ("Exchange Notes")
with substantially identical terms, except that the Exchange Notes will be
freely transferable under the Securities Act of 1933.
During November 2004, we refinanced our $500 million revolving credit facility
with a $330 million 5-year credit facility (the "Facility"). This new facility
will be used for general corporate purposes, including acquisitions and to
provide back-up liquidity for the issuance of commercial paper. The facility
provides for borrowings in U.S. dollars and several foreign currencies and
provides sublimits for the issuance of letters of credit in an aggregate amount
of up to $25 million and a swing-line of up to $20 million for short-term
borrowings of less than 15 days. In addition, the size of the facility may be
expanded upon our request by up to an additional $100 million, thus potentially
expanding the facility to $430 million, subject to lender approval.
We are exposed to market risk associated with interest rates. We do not use
financial derivative instruments for trading purposes, nor do we engage in
foreign currency, commodity or interest rate speculation. Our hedged risks are
associated with certain fixed rate debt whereby we have a $200 million notional
amount interest rate swap contract designated as a fair value hedge to pay
floating rates of interest based on six-month LIBOR that matures during fiscal
2010. Because the critical terms of the debt and the interest rate swap match,
the hedge is considered perfectly effective against changes in the fair value of
the debt and therefore, there is no need to periodically reassess the
effectiveness during the term of the hedge.
Our debt-to-capital ratio was 43.6 percent at November 30, 2004, up from 42.5
percent at May 31, 2004. Had we been able to reduce our total outstanding debt
by all of our cash and short-term investments available as of November 30, 2004
and May 31, 2004, to satisfy some or all of our indebtedness, our adjusted net
(of cash) debt-to-capital ratio would have been 36.7 percent and 41.1 percent,
respectively.
The following table summarizes our financial obligations and their expected
maturities at November 30, 2004 and the effect such obligations are expected to
have on our liquidity and cash flow in the periods indicated.
30
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
CONTRACTUAL OBLIGATIONS
(In thousands)
Total
Contractual Payments Due In
Payment -------------------------------------------------------
Stream 2005 2006-07 2008-09 After 2009
----------- ----------- --------- --------- -----------
Long-term debt obligations $ 842,090 $ 4,164 $ 11,167 $ 626,710 $ 200,049
Operating lease obligations (1) 71,379 20,002 26,297 10,769 14,311
Other long-term liabilities (2) 144,200 11,300 16,000 27,100 89,800
----------- ----------- --------- --------- -----------
TOTAL $ 1,057,669 $ 35,466 $ 53,464 $ 664,579 $ 304,160
=========== =========== ========= ========= ===========
(1) We calculate non-cancelable operating lease obligations on an
annual basis and consequently such information is not available at November 30,
2004. The amounts shown above represent the obligations at May 31, 2004.
(2) These amounts represent our estimated cash contributions to be made in the
periods indicated for our pension and postretirement plans in the U.S. and
Canada, assuming no actuarial gains or losses, assumption change or plan changes
occur in any period. Projections for our other non-U.S. plans are not currently
determinable.
We maintain excellent relations with our banks and other financial institutions
to provide continual access to financing for future growth opportunities.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet financings. We have no subsidiaries that
are not included in our financial statements, nor do we have any interests in or
relationships with any special purpose entities that are not reflected in our
financial statements.
OTHER MATTERS
ENVIRONMENTAL MATTERS
Environmental obligations continue to be appropriately addressed and, based upon
the latest available information, it is not anticipated that the outcome of such
matters will materially affect the Company's results of operations of financial
condition. Our critical accounting policies and estimates set forth above
describe our method of establishing and adjusting environmental-related accruals
and should be read in conjunction with this disclosure. (For additional
information, refer to Note H to the Consolidated Financial Statements contained
in our Annual Report on Form 10-K for the year ended May 31, 2004.)
FORWARD-LOOKING STATEMENTS
The foregoing discussion includes forward-looking statements relating to the
business of the Company. These forward-looking statements, or other statements
made by the Company, are made based on management's expectations and beliefs
concerning future events impacting the Company and are subject to uncertainties
and factors (including those specified below), which are difficult to predict
and, in many
31
RPM INTERNATIONAL INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED NOVEMBER 30, 2004
instances, are beyond the control of the Company. As a result, actual results of
the Company 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 the Company's products; (d) legal, environmental
and litigation risks inherent in the Company's construction and chemicals
businesses and risks related to the adequacy of the Company's insurance coverage
for such matters; (e) the effect of changes in interest rates; (f) the effect of
fluctuations in currency exchange rates upon the Company's 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 uncertainties
associated with the Company's ongoing acquisition and divestiture activities;
(i) risks related to the adequacy of its contingent liability reserves,
including for asbestos-related claims; and other risks detailed in the Company's
other reports and statements filed with the Securities and Exchange Commission,
including the risk factors set forth in the Company's prospectus and prospectus
supplement included as part of the Company's Registration Statement on Form S-4
(File No. 333-114259), as the same may be amended from time to time. The Company
does not undertake any obligation to publicly update or revise any
forward-looking statements to reflect future events, information or
circumstances that arise after the filing date of this document.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk from changes in interest rates and foreign
exchange rates since we fund our operations through long- and short-term
borrowings and denominate our business transactions in a variety of foreign
currencies. There were no material changes in our exposure to market risk since
May 31, 2004.
ITEM 4. CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
The Company's Chief Executive Officer and Chief Financial Officer, after
evaluating the effectiveness of the Company's disclosure controls and procedures
(as defined in Exchange Act Rule 13a-15(e)) as of November 30, 2004 (the
"Evaluation Date"), have concluded that as of the Evaluation Date, the Company's
disclosure controls and procedures were effective in ensuring that information
required to be disclosed by the Company in the reports it files or submits under
the Exchange Act is recorded, processed, summarized and reported, within the
time periods specified in the Commission's rules and forms.
(b) CHANGES IN INTERNAL CONTROL.
There were no changes in the Company's internal control over financial
reporting that occurred during the fiscal quarter ended November 30, 2004 that
have materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
32
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
EIFS LITIGATION
As previously reported, Dryvit is a defendant or co-defendant in numerous
exterior insulated finish systems ("EIFS") related lawsuits. As of November 30,
2004, Dryvit was a defendant or co-defendant in approximately 205 single family
residential EIFS cases, the majority of which are pending in the southeastern
region of the country. Dryvit is also defending EIFS lawsuits involving
commercial structures, townhouses and condominiums. The vast majority of
Dryvit's EIFS lawsuits seek monetary relief for water intrusion related property
damages, although some claims in certain lawsuits allege personal injuries from
exposure to mold.
As previously reported, Dryvit is a defendant in an attempted state class action
filed on November 14, 2000 in Jefferson County, Tennessee styled Bobby R. Posey,
et al. v. Dryvit Systems, Inc. (formerly styled William J. Humphrey, et al. v.
Dryvit Systems, Inc.) (Case No. 17,715-IV) ("Posey"). As previously reported, a
preliminary approval order was entered on April 8, 2002 in the Posey case for a
proposed nationwide class action settlement covering, "All Persons who, as of
June 5, 2002, own a one- or two-family residential dwelling or townhouse in any
State other than North Carolina clad, in whole or in part, with Dryvit EIFS
installed after January 1, 1989, except persons who (1) prior to June 5, 2002,
have settled with Dryvit, providing a release of claims relating to Dryvit EIFS;
or (2) have not obtained a judgment against Settling Defendant for a Dryvit EIFS
claim, or had a judgment entered against them on such a claim in Settling
Defendants' favor; and (3) any employees of Dryvit." Nationwide notice to all
eligible class members began on or about June 13, 2002. Any person who wished to
be excluded from the Posey settlement was provided an opportunity to
individually "opt out" and thus not be bound by the final Posey order.
A fairness hearing was held to determine whether the proposed settlement is
fair, reasonable and adequate and an order and judgment granting final approval
of the settlement was entered on January 14, 2003. Notices of appeal were filed
by persons seeking to challenge certain provisions of the proposed settlement
including challenging the trial court's denial of certain builders and one
homeowner's right to appear at the fairness hearing and intervene in the
underlying action. On March 22, 2004, the Tennessee Court of Appeals dismissed
the homeowner's appeal but ruled that the builders should be allowed to
intervene to determine their rights and obligations, if any, under the proposed
national settlement.
During the pendency of the foregoing issues, the court allowed claims to be
processed under the proposed Posey settlement. In mid-September 2004, the court
entered a stay order which effectively suspended any further processing of
claims pending the outcome of the next court hearing. As of November 30, 2004,
7,167 total claims have been filed as of the claim filing deadline. Of these
7,167 claims, 3,384 claims have been rejected or closed for various reasons
under the terms of the settlement. An additional 1,132 claims are under review
for potential filing deficiencies. The approximately 2,651 remaining claims are
at various stages of review and processing under the terms of the proposed
settlement. As of November 30, 2004, approximately 331 claims have been paid a
total of approximately $3.23 million.
33
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Although Dryvit's claims experience under Posey is still evolving and it is
possible that future claims and payments after the stay order is lifted may vary
from management's current expectations, Dryvit believes that its reserves and
available third party excess insurance will be adequate to cover the anticipated
costs of the Posey settlement.
Certain of Dryvit's insurers have paid or are currently paying a portion of
Dryvit's defense costs in the individual commercial and residential EIFS
lawsuits and are contributing to the settlement of claims. Under current
cost-sharing agreements, the terms of which are subject to periodic
renegotiations, Dryvit's insurers cover various portions of Dryvit's indemnity
and defense costs. Dryvit has and is expected to continue to assume a greater
share of the costs depending on the type of claim and applicable date of
construction. Management believes Dryvit's current EIFS lawsuits will not have a
material adverse effect on the Company's consolidated financial condition,
results of operations or cash flows.
ASBESTOS LITIGATION
As previously reported, certain of the Company's wholly-owned subsidiaries,
principally Bondex International, Inc. (collectively referred to as "the
Subsidiaries"), are defendants in various asbestos-related bodily injury
lawsuits filed in various state courts with the vast majority of current claims
pending in five states - Illinois, Ohio, Mississippi, Texas and Florida. These
cases generally seek unspecified damages for asbestos-related diseases based on
alleged exposures to asbestos-containing products previously manufactured by the
Company's Subsidiaries.
The Company's Subsidiaries vigorously defend these asbestos-related lawsuits and
in many cases, the plaintiffs are unable to demonstrate that any injuries they
have incurred, in fact, resulted from exposure to one of our Subsidiaries'
products. In such cases, the Subsidiaries are generally dismissed without
payment. With respect to those cases where compensable disease, exposure and
causation are established with respect to one of our Subsidiaries' products, the
Subsidiaries generally settle for amounts that reflect the confirmed disease,
the particular jurisdiction, applicable law, the number and solvency of other
parties in the case and various other factors which may influence the settlement
value each party assigns to a particular case at the time.
As of November 30, 2004, the Company's Subsidiaries had a total of 7,523 active
asbestos cases compared to a total of 2,737 cases as of November 30, 2003.
Consistent with the last several quarters, the vast majority of the year to year
increase in active cases involved filings by non-malignant claimants in Florida.
The Company's Subsidiaries continue to vigorously defend these non-malignant
cases. Based upon past experience, these non-malignant claims are typically
dismissed without payment. For the quarter ended November 30, 2004, the
Company's Subsidiaries secured dismissals and/or settlements of 290 claims and
made total payments of $15.4 million, which included defense costs paid during
the current quarter of $5.2 million. For the comparable period ended November
30, 2003, dismissals and/or settlements covered 208 claims and total payments
were $18.6 million, which included defense costs paid during the
34
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
quarter of $2.3 million. Year over year, quarterly settlement costs were down;
however, defense costs were higher reflecting our more aggressive defense
strategy. This defense strategy which has contributed to lower settlement costs
and higher dismissal rates has also been one of the reasons for the reserve
adjustment discussed later. In some jurisdictions, cases may involve more than
one individual claimant. As a result, settlement or dismissal statistics on a
per case basis are not necessarily reflective of the payment amounts on a per
claimant basis and the amounts and rates can vary widely depending on a variety
of factors including the mix of malignancy and non-malignancy claims and the
amount of defense costs incurred during the period.
The rate at which plaintiffs filed asbestos-related suits against the Company's
Subsidiaries, particularly Bondex, has increased since the fourth quarter of
2002, influenced by the bankruptcy filings of numerous other defendants in
asbestos-related litigation. Based on the significant increase in asbestos
claims activity which, in many cases disproportionately increased Bondex's
exposure in joint and several liability law states, our third-party insurance
was depleted within the first fiscal quarter of 2004, as previously reported.
Our third-party insurers historically had 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 cover asbestos liabilities 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 other insurance
limits may be available to cover our asbestos liabilities.
As a result of an examination of our Subsidiaries' historical insurance and as
previously disclosed, certain of our Subsidiaries filed a complaint for
declaratory judgment, breach of contract and bad faith against various third
party insurers challenging their assertion that their policies covering
asbestos-related claims have been exhausted. Since the July 3, 2003 filing in
Ohio, this action was combined with a related case and, pursuant to a new
December 4, 2004 case management order, the parties are to complete non-expert
discovery by August 29, 2005 and expert discovery by January 30, 2006. A trial
date of March 6, 2006 is still set; however, it is possible that this and other
dates may be modified as the coverage case progresses.
We are unable at the present time to predict the timing or ultimate outcome of
this insurance coverage litigation. Consequently, we are unable to predict
whether, or to what extent, any additional insurance may be available to cover a
portion of our Subsidiaries' asbestos liabilities. We have not included any
potential benefits from this litigation either in our financial statements or in
calculating our asbestos reserve. Our wholly-owned captive insurance companies
have not provided any insurance or re-insurance coverage for any of our
Subsidiaries' asbestos-related claims.
During the last seven months of 2003, new state liability laws were enacted in
three states (Mississippi, Ohio and Texas) where at that time more than 80% of
the claims against Bondex were pending. Effective dates for the last two of the
law changes were April 8, 2003 and July 1, 2003. The changes generally provided
for liability to be determined on a "proportional cause"
35
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
basis, thereby limiting Bondex's responsibility to only its share of the alleged
asbestos exposure. During the third and fourth quarters of 2004, two of the
three previously-mentioned states that adopted "proportional cause" liability in
2003, passed additional legislation impacting medical criteria and product
identification in asbestos-related litigation. While there have been some
changes in the type of claims filed in certain of these states, the ultimate
influence these law changes may have on future claims activity and settlement
values is not known at this time. Claims in these three subject states at the
quarter ended November 30, 2004, coupled with the non-malignancy filings in
Florida, currently comprise approximately 80% of the aggregate claims filed
against Bondex.
At the end of 2002 and through the third quarter of 2003, Bondex had concluded
it was not possible to estimate the cost of disposing all of the
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 any future asbestos-related
claims. As previously disclosed, during the fourth quarter of 2003, Bondex
retained a consulting firm to assist 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 in various state laws
and the prospect of potential federal asbestos-related legislation.
Bondex provided these consultants with all relevant data regarding
asbestos-related claims filed against Bondex through May 31, 2003. Management,
with the consultants' input, concluded at the time that it was not possible to
currently estimate the full range of the cost of resolving all future
asbestos-related claims against Bondex. Estimating the future cost of asbestos
related contingent liabilities was and continues to be subject to many
uncertainties, including (i) the ultimate number of claims filed; (ii) the cost
of resolving both current known and future unknown claims; (iii) the amount of
insurance, if any, available to cover such claims, including the outcome of
coverage litigation against the Subsidiaries' third party insurers; (iv) future
earnings and cash flow of the Company's Subsidiaries; (v) the impact of
bankruptcies of other companies whose share of liability may be imposed on the
Company's Subsidiaries under certain state liability laws; (vi) the
unpredictable aspects of the litigation process including a changing trial
docket and the jurisdictions in which trials are scheduled; (vii) the outcome of
any such trials including judgments or jury verdicts, as a result of our more
aggressive defense posture which includes taking selective cases to verdict;
(viii) the lack of specific information in many cases concerning exposure to the
Subsidiaries' products and the claimants' diseases; (ix) potential changes in
applicable federal and/or state law; and (x) the potential impact of various
proposed structured settlement transactions or subsidiary bankruptcies by other
companies, some of which are the subject of federal appellate court review, the
outcome of which could materially affect any future asbestos-related liability
estimates. In addition, during calendar 2003, passage by the United States
Senate Judiciary Committee of a proposed bill to establish a trust fund to pay
future asbestos related claims and remove such cases from federal and state
courts with industry and insurers funding the trust has become a significant,
new variable that has made it increasingly difficult to predict with certainty
the full exposure of future, unknown asbestos-
36
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
related claims. The ongoing prospect of federal trust fund legislation is
expected to continue to be a significant unknown variable in assessing future
asbestos-related liabilities.
Based on the foregoing considerations, at May 31, 2003, we concluded that we
could not fully estimate the liability that would result from all future
asbestos claims. We established a reserve for those pending cases that had
progressed to a stage where the cost to dispose of these cases could, at the
time, reasonably be estimated. The estimation of even pending cases was and is
always difficult due to the dynamic nature of asbestos litigation including the
variables discussed above. As described below, the estimated range of potential
loss covering measurable known asbestos claims and a provision for future claims
that were estimable at May 31, 2003 was $140.0 million to $145.0 million.
Accordingly, we established a reserve equal to the lower end of this range of
potential loss by taking an asbestos charge to fiscal 2003 operations of $140.0
million. At the time of the reserve, we believed that this asbestos reserve
would be sufficient to cover our asbestos-related cash flow requirements over
the estimated three-year life of the reserve. The $140.0 million charge also
included $15.0 million in total projected defense costs over the estimated
three-year life of the reserve. By comparison, Bondex's share of costs (net of
then-available third-party insurance) for asbestos-related product liability
were $6.7 million and $2.8 million for the years ended May 31, 2003 and 2002,
respectively.
Since May 31, 2003, we have reviewed and evaluated on a quarterly basis the
adequacy of our three-year asbestos reserve. The range of loss calculation for
the $140 million reserve was based on an extensive analysis of the most critical
factors that influence our asbestos-related costs including: (i) the gross
number of open malignancy claims (principally mesothelioma claims) as these
claims have the most significant impact on our asbestos settlement costs; (ii)
historical and current settlement costs and dismissal rates by various
categories; (iii) analysis of the jurisdiction and governing law of the states
in which these claims are pending; (iv) and outside defense counsel's opinions
and recommendations with respect to the merits of such claims. Although the
number of open malignancy claims has remained relatively constant over the first
half of the three-year period of the reserve, lower average settlement values
and higher dismissal rates have, through the quarter ending August 31, 2004,
mitigated against the need for any reserve adjustments. Since May 31, 2003
continuing through the quarter ended November 30, 2004, our average settlement
costs for malignancy claims have declined and dismissal rates have increased.
Several defense verdicts during the second half of fiscal 2004 further
contributed to lower settlement values and higher dismissal rates. Our defense
costs have also increased significantly as a result of our more aggressive
defense strategy, which includes taking selective cases to verdict.
During the second quarter ending November 30, 2004, based on a review of our
pending known claims coupled with a review of our defense costs, we have
concluded that the $56 million balance of the $140 million reserve will not
likely be sufficient to cover our asbestos-related cash flow requirements for
the remainder of the full three-year period originally contemplated by the
reserve. Therefore, we have concluded that an increase in our existing reserve
is appropriate. An asbestos reserve adjustment of $47 million has been taken for
the quarter ended November 30, 2004, which we believe will be sufficient to
cover any incremental cash flow requirements through fiscal 2006 not covered by
the $140 million reserve, as well as the additional cash flow requirements for
the balance of our now pending known
37
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
claims and anticipated higher defense costs. Our $47 million reserve increase
assumes that approximately $32 million will be allocated to anticipated higher
future defense costs which we expect to continue. (For additional information,
refer to Note F to the Consolidated Financial Statements). As we review our
asbestos reserve each quarter, we will make appropriate adjustments to the
reserve based on our most recent experience to ensure that it is sufficient to
cover the anticipated settlement and defense costs associated with our then
pending, known claims. Until the uncertainty of estimating the value of any
potential future unknown asbestos claims is substantially reduced, we do not
expect to establish any reserve for any such unknown future claims.
We recognize that future facts, events and legislation, both state and/or
federal, may alter our estimates of both pending and future claims. We cannot
estimate possible liabilities in excess of those accrued because we cannot
predict the number of additional claims that may be filed in the future, the
grounds for such claims, the potential settlement values associated with any
such future claims, the ultimate resolution of such claims, the full impact of
the state law changes enumerated above or the effect of pending federal trust
fund legislation on future asbestos claims. Subject to the foregoing variables,
including the timing and impact of such variables and the increase in the
asbestos reserve, we believe that our asbestos reserves are sufficient to cover
the asbestos-related cash flow requirements for the current inventory of our
known claims. It is, however, reasonably possible that our actual costs for such
claims could differ from current estimates, but, based upon information
presently available, such costs are not expected to have a material effect on
our competitive or financial position or our ongoing operations. As previously
disclosed, however, our existing reserve will not presently cover the costs of
future unknown claims and therefore, additional reserves will be required in
future periods for any such future claims. Any such future reserve increases,
when taken, could have a material impact on our results in such period.
The Company will continue to evaluate its asbestos-related loss exposure each
quarter and review the adequacy of its reserve. In an effort to further assist
the Company in its ongoing evaluation of its asbestos costs, the Company is
using an outside consulting firm to assist in this process. In conjunction with
our outside advisors, we will continue to study our asbestos-related exposure
and regularly evaluate the adequacy of our reserves 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. We will continue to explore all feasible alternatives
available to resolve our asbestos-related exposure in a manner consistent with
the best interests of our stockholders.
ENVIRONMENTAL PROCEEDINGS
As previously reported, several of the Company's subsidiaries are, from time to
time, identified as a "potentially responsible party" under the Comprehensive
Environmental Response, Compensation and Liability Act and similar state
environmental statutes. In some cases, the Company's Subsidiaries are
participating in the cost of certain clean-up efforts or other remedial actions.
The Company's share of such costs, however, has not been material and management
believes that these environmental proceedings will not have a material adverse
effect on the
38
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Company's consolidated financial condition or results of operations. See
"Business-Environmental Matters," in the Company's Annual Report on Form 10-K
for the year ended May 31, 2004.
39
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of RPM International Inc. was held on October
8, 2004. The following matters were voted on at the meeting.
1. Election of Edward B. Brandon, William A. Papenbrock, Thomas C.
Sullivan and Frank C. Sullivan as Directors of the Company. The
nominees were elected as Directors with the following votes:
Edward B. Brandon
For 98,654,816
Withheld 4,312,323
Broker non-votes 0
William A. Papenbrock
For 100,518,413
Withheld 2,448,727
Broker non-votes 0
Thomas C. Sullivan
For 101,242,054
Withheld 1,725,085
Broker non-votes 0
Frank C. Sullivan
For 101,320,035
Withheld 1,647,104
Broker non-votes 0
In addition to the Directors above, the following Directors' terms of
office continued after the Annual Meeting of Stockholders: Dr. Max D.
Amstutz, Albert B. Ratner, Dr. Jerry Sue Thornton, William B. Summers,
Jr., Bruce A. Carbonari, James A. Karman, Donald K. Miller and Joseph P.
Viviano.
40
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
2. The proposal to approve and adopt the RPM International Inc. 2004
Omnibus Equity and Incentive Plan was approved with the following
votes:
For 61,223,045
Against 11,697,825
Abstain 816,864
Broker Non-Votes 29,229,405
3. The proposal to approve and adopt Amendment No. 2 to the RPM
International Inc. Incentive Compensation Plan to provide for an
increase in the aggregate bonus award pool available to participants
from 1.3% to 1.5% of the Company's pre-tax income was approved with
the following votes:
For 92,835,860
Against 9,334,286
Abstain 796,993
Broker Non-Votes 0
For information on how the votes for the above matters were tabulated, see the
Company's definitive Proxy Statement used in connection with the Annual Meeting
of Stockholders on October 8, 2004.
ITEM 5 - OTHER INFORMATION
(a) As stated above, the RPM International Inc. 2004 Omnibus Equity and
Incentive Plan (the "Omnibus Plan") was approved by stockholders of the Company
on October 8, 2004. The Omnibus Plan is intended to be the primary stock-based
award program for those employees of the Company, its subsidiaries and certain
allied enterprises, whom the Compensation Committee determines from time to time
are eligible for awards. The Omnibus Plan provides the Company with flexibility
to grant a wider variety of stock and stock-based awards, as well as
dollar-denominated performance-based awards, than are currently available under
the Company's existing equity compensation plans. Six million shares of the
Company's common stock may be subject to awards under the Omnibus Plan. A
description of the Omnibus Plan, along with a copy thereof, was included in the
Company's definitive Proxy Statement dated August 30, 2004 furnished in
connection with the Annual Meeting of Stockholders held on October 8, 2004 (the
"Proxy Statement"). A copy of the Omnibus Plan was filed as Exhibit 4.3 to the
Company's Registration Statement on Form S-8, as filed with the Securities and
Exchange Commission on October 29, 2004, and is incorporated herein by
reference.
Also as stated above, Amendment No. 2 to the RPM International Inc. Incentive
Compensation Plan to provide for an increase in the aggregate bonus award pool
available to participants from
41
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
1.3% to 1.5% of the Company's pre-tax income ("Amendment No. 2") was
approved by the stockholders of the Company on October 8, 2004. The
Incentive Plan provides for the granting of annual cash bonus awards to
those employees of the Company who in any respective fiscal year are the
Chief Executive Officer and the other four most highly compensated
officers of the Company. A description of Amendment No. 2, along with a
copy thereof, was included in the Proxy Statement. A copy of Amendment No.
2 is attached hereto as Exhibit 10.3 and is incorporated herein by
reference.
ITEM 6 - EXHIBITS
EXHIBIT
NO. EXHIBIT DESCRIPTION
--- -------------------
4.1 Indenture dated as of September 30, 2004 between the Company, as issuer,
and The Bank of New York, as trustee, which is incorporated herein by
reference to Exhibit 4.1 to the Company's Current Report on Form 8-K, as
filed with the Commission on September 30, 2004.
4.2 Registration Rights Agreement dated as of September 30, 2004 between the
Company and Goldman, Sachs & Co., which is incorporated herein by
reference to Exhibit 4.2 to the Company's Current Report on Form 8-K, as
filed with the Commission on September 30, 2004.
4.3 Form of 4.45% Senior Note Due 2009, which is incorporated herein by
reference to Exhibit 4.3 to the Company's Current Report on Form 8-K, as
filed with the Commission on September 30, 2004.
10.1 Purchase Agreement dated as of September 27, 2004 among the Company,
Goldman, Sachs & Co. and each of the Initial Purchasers named in Schedule
A to the Purchase Agreement, which is incorporated herein by reference to
Exhibit 10.1 to the Company's Current Report on Form 8-K, as filed with
the Commission on September 30, 2004.
*10.2 RPM International Inc. Omnibus Equity and Incentive Plan, which is
incorporated herein by reference to Exhibit 4.3 to the Company's
Registration Statement on Form S-8 (Registration No. 333-120067), as filed
with the Commission on October 29, 2004.
*10.3 Amendment No. 2 to the RPM International Inc. Incentive Compensation Plan.
(x)
10.4 Credit Agreement among RPM International Inc., the Borrowers party
thereto, the Lenders party thereto and National City Bank, as
Administrative Agent, dated as of November 19, 2004, which is incorporated
herein by reference to Exhibit 10.1 to the Company's Current Report on
Form 8-K, as filed with the Commission on November 24, 2004.
42
RPM INTERNATIONAL INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
11.1 Computation of Net Income per share of Common Stock. (x)
31.1 Rule 13a-14(a) Certification of the Company's Chief Executive Officer. (x)
31.2 Rule 13a-14(a) Certification of the Company's Chief Financial Officer. (x)
32.1 Section 1350 Certification of the Company's Chief Executive Officer. (x)
32.2 Section 1350 Certification of the Company's Chief Financial Officer. (x)
(x) Filed herewith.
*Management contract or compensatory plan or arrangement.
43
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.
RPM INTERNATIONAL INC.
BY /s/ Frank C. Sullivan
--------------------------------------
FRANK C. SULLIVAN
PRESIDENT AND CHIEF EXECUTIVE OFFICER
BY /s/ Robert L. Matejka
--------------------------------------
ROBERT L. MATEJKA
VICE PRESIDENT, CHIEF FINANCIAL OFFICER AND CONTROLLER
DATED: JANUARY 10, 2005