Business context and reporting period
RPM International Inc. filed this unaudited Form 10-Q for the three months ended August 31, 2017, the first quarter of fiscal 2018. RPM manufactures and sells specialty paints, protective coatings, roofing systems, sealants, adhesives and related products through its Industrial, Consumer and Specialty segments. The company notes that results are seasonal and weather-dependent.
Financial results and key metrics
Unless otherwise stated, amounts are in U.S. dollars. Year-over-year comparisons are with the three months ended August 31, 2016.
| Metric | Q1 FY2018 | Prior-year quarter |
|---|---|---|
| Net sales | $1,345.4 million | $1,252.1 million |
| Gross profit / margin | $572.0 million / 42.5% | $552.0 million / 44.1% |
| SG&A / share of sales | $394.4 million / 29.3% | $384.1 million / 30.7% |
| Income before income taxes | $155.3 million | $148.5 million |
| Net income | $116.9 million | $113.4 million |
| Net income attributable to RPM stockholders | $116.4 million | $112.8 million |
| Diluted EPS | $0.86 | $0.83 |
| Operating cash flow | $(26.1) million | $6.5 million |
| Capital expenditures | $17.5 million | $17.0 million |
At August 31, 2017, cash and cash equivalents were $236.2 million, total debt (including current maturities) was $2,122.3 million, and total equity was $1,562.2 million. The company reported a 57.6% debt-to-capital ratio, compared with 59.3% at May 31, 2017. Available liquidity, including cash and committed credit facilities, was approximately $1.0 billion. Revolver availability was $568.5 million; the $200 million receivables securitization facility had no outstanding balance.
Material changes versus the prior comparable period
- Sales grew 7.5%: acquisitions contributed 5.4%, organic sales growth was 1.8%, and foreign exchange added 0.3%.
- Gross margin fell 1.6 percentage points, primarily from higher raw-material and manufacturing costs and unfavorable product mix. SG&A declined as a share of sales, reflecting cost controls, prior-year severance actions and sales growth.
- Interest expense rose to $26.8 million from $22.8 million, reflecting higher average borrowings, including acquisition-related debt, and higher interest rates.
- Operating cash flow declined by $32.6 million year over year. Working-capital movements were a significant use of cash; inventory increased and accounts payable and accrued compensation balances decreased.
- Cash dividends paid were $40.1 million, versus $36.5 million. The declared quarterly dividend was $0.30 per share, versus $0.275.
Segment sales and pretax income: Industrial sales were $729.8 million and pretax income $88.9 million (prior year $675.8 million and $89.3 million); Consumer sales were $427.1 million and pretax income $72.4 million (prior year $399.9 million and $70.1 million); Specialty sales were $188.5 million and pretax income $33.2 million (prior year $176.3 million and $30.5 million). Consumer organic sales declined 1.2%, while Industrial and Specialty organic sales grew 3.2% and 3.0%, respectively.
Outlook, commentary, risks and unusual items
- Management expects raw-material prices to continue rising, partly due to recent hurricane activity. It plans increased fiscal 2018 capital spending, particularly for overseas growth, and expects added capacity and production shifts to support demand.
- An edible-coatings patent expired in the United States in August 2017. RPM anticipates at least a $10 million impact on fiscal 2018 income before taxes.
- Current-quarter results included a net $9.0 million favorable discrete tax item related to intercompany and foreign distributions. The effective tax rate was 24.7%, versus 23.6%; favorable excess tax benefits from equity compensation were $1.5 million, versus $10.4 million.
- RPM was in compliance with its revolving-credit covenants. It reported a 56.6% leverage ratio against a 65% maximum and an 8.7-to-1 interest coverage ratio against a 3.50-to-1 minimum.
- The SEC enforcement action concerning fiscal 2013 disclosure and loss-reserve timing remained pending; the court denied motions to dismiss on September 29, 2017. RPM intends to contest the allegations. The company accrued a loss at the low end of its estimated range and stated that no amount in the range would materially affect its consolidated financial condition, results or cash flows.
- A subsidiary’s trade-secret and trademark case advanced after denial of its summary-judgment motion. RPM considers a loss reasonably possible but cannot estimate a potential amount or range. Environmental matters were not expected to materially affect consolidated results or financial condition.
- Operating lease obligations were approximately $215.7 million. RPM said adoption of the new lease standard would increase total assets and liabilities. It expected revenue recognition under the new standard to remain largely unchanged overall, though timing may change for some long-term construction contracts.
- Other stated risks include raw-material and transportation costs, economic and market conditions, interest and foreign-exchange rates, international operations, acquisitions and divestitures, litigation, environmental exposure, insurance adequacy and reserve estimates.
Important facts for investors to verify
- Whether organic growth and acquisition contributions persist, particularly given weaker Consumer organic sales and continued challenges in Brazil and oil-and-gas markets.
- Whether cost inflation and hurricane-related input costs further pressure gross margin, and whether the planned pricing, cost controls and capacity investments offset that pressure.
- Whether working-capital needs normalize and operating cash flow improves after the quarter’s cash use and inventory build.
- How the edible-coatings patent expiration affects fiscal 2018 results relative to management’s estimate of at least $10 million.
- Developments and potential costs in the SEC enforcement action and the subsidiary’s intellectual-property litigation.
- Debt maturities, covenant headroom and access to committed credit, including the remaining $125 million trust payment due on or before December 23, 2018.