RPM International Inc. — Q1 FY2017 Form 10-Q
Business context and period. Unaudited results cover the three months ended August 31, 2016, compared with the three months ended August 31, 2015. RPM sells specialty paints, protective coatings and roofing systems, sealants, adhesives, and related products through Industrial, Specialty, and Consumer segments. The company notes that weather affects its business and that quarterly results are seasonal.
Financial results
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $1,252.1 million | $1,242.5 million | +0.8% |
| Gross profit / margin | $552.0 million / 44.1% | $533.0 million / 42.9% | Margin +1.2 percentage points |
| SG&A | $384.1 million | $372.9 million | +3.0%; 30.7% of sales vs. 30.0% |
| Income before taxes | $148.5 million | $142.2 million | +4.4% |
| Net income attributable to RPM shareholders | $112.8 million | $99.8 million | +13.0% |
| Diluted EPS | $0.83 | $0.74 | +12.2% |
| Cash provided by operating activities | $6.5 million | $6.6 million | Nearly unchanged |
Margins and earnings. Gross margin improvement reflected price increases, particularly in some international markets, and more favorable manufacturing costs. Higher compensation and benefits, bad debt, freight and professional-services costs, and pension expense contributed to higher SG&A. Net income included a $10.4 million discrete tax benefit from early adoption of share-based-payment accounting guidance; the effective tax rate was 23.6%, versus 29.4% a year earlier. Without that benefit, reported tax-rate and earnings comparisons would differ.
Segment performance. Industrial sales were $675.8 million, down 0.2%; pretax income was $89.3 million, up from $84.5 million. Specialty sales were $176.3 million, up 3.8%; pretax income was $30.5 million, versus $26.5 million. Consumer sales were $399.9 million, up 1.1%; pretax income was $70.1 million, versus $66.1 million. Segment comparisons are recast for a change in reporting composition.
Cash flow and liquidity. Operating cash flow was $6.5 million, as seasonal working-capital outflows largely offset higher net income. Inventory used $42.8 million of cash and accounts payable used $70.6 million. Capital expenditures were $17.0 million; acquisitions used $17.3 million. Cash and cash equivalents fell to $194.5 million from $265.2 million at May 31, 2016. RPM reported total available liquidity of $976.0 million, including $581.6 million available under its revolving credit facility. Cash held at foreign subsidiaries was approximately $174.4 million.
Debt and balance sheet. Long-term debt, including current maturities, was $1.657 billion at August 31, 2016, compared with $1.640 billion at May 31. The debt-to-capital ratio was 53.6%, versus 54.4%. RPM was in compliance with facility covenants; its reported leverage ratio was 52.4% against a 65% limit, and interest coverage was 9.6-to-1 against a 3.50-to-1 minimum. The company also has scheduled future contributions to a bankruptcy-related trust: $102.5 million by December 23, 2016, followed by $120 million in 2017 and $125 million in 2018. The filing reports $3.232 billion of total contractual obligations across the periods shown, including debt, leases, interest, trust payments, and estimated pension contributions.
Changes, outlook, and risks
- Consolidated sales growth comprised 1.6% organic growth and 1.3% acquisition contribution, partly offset by a 2.1% unfavorable foreign-exchange impact. Industrial results were affected by currency and continued weakness in energy-related businesses; North American commercial construction showed growth. Specialty benefited from acquisition and organic growth and flood-related demand for restoration equipment. Consumer growth was limited by below-prior-year nail-enamel results and operational challenges that management says it addressed with capital investments.
- Management described U.S. consumer market conditions as favorable, noted continued commercial-construction growth and improving Brazilian sales, and said it was expanding DAP production capacity and increasing investment in internal growth, particularly overseas. It expected added shifts, acquisition capacity, and planned capital spending to support demand through FY2017 and FY2018 and beyond. The filing provides no specific numerical revenue or EPS guidance.
- On September 9, 2016, the SEC filed an enforcement action against RPM and its General Counsel concerning the timing of fiscal 2013 disclosures and loss-reserve accruals related to Tremco Roofing’s GSA contracts. RPM disputes the allegations and intends to contest them. The company accrued the low end of an estimated loss range; it says no amount within the range would materially affect consolidated financial condition, results, or cash flows, but the action could result in sanctions, costs, and distraction. Earlier quarterly results for fiscal 2013 were restated; the filing says those restatements did not affect audited fiscal 2013 or 2014 statements.
- Other matters include a Dubai coating-system claim for which insurance coverage discussions continue, a proposed $9.3 million Rust-Oleum deck-coating settlement subject to final court approval, and environmental notices involving estimated penalties and fees. Management did not expect environmental proceedings to materially affect consolidated financial results or condition.
- Market, currency, interest-rate, raw-material, demand, acquisition, legal, environmental, warranty, and reserve-estimation risks remain relevant. The filing identifies potential goodwill impairment at the Kirker nail-enamel reporting unit if projected opportunities or demand improvements do not materialize; no impairment trigger was identified in the quarter.
Most important facts for investors to verify
- Whether earnings growth persists after separating the $10.4 million discrete tax benefit from underlying performance.
- Whether low operating cash flow and seasonal working-capital movements improve, and how inventory and payables develop.
- Progress on scheduled trust payments, debt levels, covenant headroom, and access to committed credit facilities.
- Developments in the SEC enforcement action, related accrued exposure, and the status of the Rust-Oleum settlement and other claims.
- Whether Kirker performance, foreign-exchange headwinds, energy-sector weakness, and planned capacity investments affect future sales, margins, or impairment risk.