RPM International Inc (RPM) 2003 Q2 法說會逐字稿

Good day, everyone. Welcome to RMP International’s conference call. Today's call is being recorded. It is being webcast live and can be accessed through the RPM website at www.RpmInc.com. A taped telephone replay will be available from two hours after this call concludes until 8 p.m. eastern standard time, Tuesday, January 14th, and can be accessed by dialing 719-457-0820. And entering confirmation number 392850. Again, 392850. A webcast replay and written transcript will be available through our website. The webcast replay will be available two hours after this call ends and the written transcript will be available two to three business days after the call concludes. Comments made on this call may include forward-looking statements based on current expectations that is involve risks and uncertainties that could cause the results of RPM to differ materially from management's current expectations. For more information regarding these risks and uncertainties, please review RPM’s quarterly earnings releases and periodic reports filed with the Securities and Exchange Commission. The information in this conference call is related to projections or other forward-looking statements may be relied upon subject to the previous Safe Harbor Statement and may continue to be used while this call remains on the active portion of the RPM website. At this time, I would like to turn the call over to RPM’s President and Chief Executive Officer, Mr. Frank Sullivan. Please go ahead, sir.

Thank you. Good morning to everyone. Thank you for joining our conference call. We are pleased to report a strong quarter results with revenues up 6% from the prior year quarter, net earnings up 21% and earnings per share up 8%. Before I turn it over to Glenn Hasman to give you the details on the quarter, I would like to give you some color on our business over the last three months. First of all, while revenue growth accelerated in the quarter, from our first quarter and, certainly, from last year, I think it's important to realize that this is as much a reflection of the comparison to last fall rather than an indication of any improving industrial or manufacturing economy. Quite candidly, we're just not seeing that yet, in general. RPM industrial companies are posting year-over-year positive growth, and that's continuing, which we believe is coming from market share gains. A couple of exceptions worth noting--on the negative side, our Dryvit subsidiary, which is a high margin business for us, has had a difficult period this year, particularly in the fall as much of their business is related to commercial new construction, which is down pretty dramatically. While they're holding their own, their revenues are down. Given their profitability, that hurts. On the positive side, our Tremco’s WTI service business is booming. This is a service business related to roofing maintenance and some contracting work, mostly at institutions or in a lot of cases with government entities.

A year ago we did $25 or $30m in revenues. This year we will do $70m or more, and it's really growing. That is a substantially lower gross margin business for us, although the operating income level is getting slowly to where we want it. From a capital perspective, it's a great business because there’s not much capital investment, it is all people expense. The combination of those two impacted our margins, and Glenn will provide you the details on that. We also did have some extraordinary corporate expense that is we will detail for you, and, excluding those, I think you'll see that we had an excellent quarter in terms of operating leverage in both our industrial and our consumer businesses. All in all, this is a good first quarter and first half for us, and with that, I would like to turn it over to Glenn Hasman who will take you through the details of the quarter.

Thank you very much, Frank. Good morning, everyone. As Frank indicated, we had sales this second quarter of $518m. That's up 6.2% over the prior year by $30.1m. By segment, the industrial sales reached $286.3m in the second quarter. That represents 55% of the total sales for the company this quarter, and that's ahead 5.8% quarter-over-quarter, 5% of that is, in fact, organic growth, as Frank had indicated. Consumer sales were $231.7 million. That's the other 45% of our total. That's ahead 6.7% quarter-over-quarter, and most of which, again, is organic. We had solid demand throughout the quarter on the consumer side of our business as well. Gross profit itself in dollars improved by 5.5% to $234.1m from last year's $222m. That benefit really comes from the leverage from the higher sales volume and, also, some favorable year-over-year raw material costs. Gross margin on the other hand, did decline slightly to 45.2% this quarter from 45.5% during last year's second quarter. By segment, industrial margins were slightly lower at 45.5% from 46.4%.

Again, as Frank had mentioned, a lot of this is mixed with the services sales business, but there was, to the good side of that as well, there was some product pull through from those services at our more normal margins. There also were a number of favorable raw material costs in the industrial segment. Consumer gross margins quarter-over-quarter were ahead 50 basis points to 44.9% this year from 44.4% last year. Again, representing the positive volume effects and they also had a number of favorable raw material costs in the consumer segment as well. SG&A expenses. These expenses were improved this year to 35% of sales from 35.7% a year ago. By segment, industrial SG&A came in at 33.4%, compared to 36.2% last year for a significant 2.8% sales improvement. The mix issue Frank mentioned contributed to about a third of this improvement.

Beyond that, there were significant cost reduction initiatives that were initiated throughout fiscal 2002 and businesses that is were particularly impacted by the slower economy, and we're seeing those benefits come through this year. There have been continued cost containment efforts in this segment throughout this year so far as well. Those are continuing. Consumer SG&A was 32.4% of sales this year, improved from 33.1% last year. Again, the positive leverage effect of higher sales volume is what you’re seeing here, as well as continued cost containment efforts throughout the consumer segment as well. There had been some reduced freight costs at several of our businesses year-over-year. Corporate other costs, as Frank mentioned, were $10.8m. This second quarter that compares against $4.4m a year ago. As we mentioned in the conference call for the first quarter, we've had a ship this year by virtue of a tax law change that affects the incentives in place for export sales for the sales corporation. That represents a shift of what was previously income to the corporate other category and expense at the operating segments. That is now eliminated. What you're seeing is a $1.2m effect to corporate other costs, this year's second quarter compared to last year by virtue of that.

On the other hand, the corresponding change, corresponding income issue is now on the operating segment. On a consolidated basis, this is zero. We also had the reincorporation costs into the state of Delaware from the state of Ohio that took place during this quarter. That cost over $1m dollars during the quarter. We had increased product liability costs of $1.7m in the second quarter. We also had rising health care and other employee benefit costs as well as higher general corporate expenses to make up the difference. Earnings before interest and taxes were improved to $52.6m this year, compared to $47.9m last year. That's ahead nearly 10%. Obviously, margin improvement took place there.

By segment, industrial EBIT reached $34.5m. That's ahead 24.6% on their almost 6% sales growth. That's 12.1% of sales compared to last year's 10.2% of sales with EBIT of $27.7m. Consumer EBIT was $28.9m this year. That's ahead 17.7% on their 6.7% sales growth, that margin is 12.5% of sales and compares with last year's margin of 11.3% of sales and an EBIT of $24.5m. Corporate other has already been discussed. To repeat the costs were $10.8m this year, $4.4m last year. This improvement generally in EBIT is a result of the combination of the higher sales volume, lower raw material costs and the continued cost containment efforts throughout the segments. Interest expense net was improved or lower by $4.4m quarter-over-quarter. That's the result of lower interest rates based on our 70% variable debt structure. That savings amount is $1.4m. Of note, the average rates overall this year have been 4.1% during this second quarter. That compares with 4.9% last year. We also had much lower debt levels, averaging about $235m lower throughout this second quarter compared to a year ago, and that amounts to $3m of interest savings.

The tax rate this second quarter was 35.1% compared with 33% a year ago. If everyone recalls, we made a slight downward adjustment last year during the second quarter to bring our six month year-to-date to our then expected full year rate of last year to 34%. That's the reason for the 33 a year ago. The effective rate going forward for us will tend to increase as our earnings grow and the one-time benefit from our June 1, 2001 adoption of FAS142 is becoming less and less significant. Net earnings were ahead $5.2m. That's up 21% to $29.6m. That margin on our sales is ahead 70 basis points to 5.7% from a year ago 5%. Diluted earnings per share of 26 cents are ahead 2 cents or 8.3%. The 11.5 million shares sold this past March had about a 2-cent per share effect on this number. Moving now to the six-month results.

This year's sales of a billion 60,000,000.4 are improved over last year's sales by 3.8%, $39.2m. By segment, industrial sales are $578.6m through six months. That's, again, 55% of our total, and that's ahead 3.3% year-over-year. Again, most of which is organic. We did have the mix issue that Frank referred to and so forth and the other factors impacting industrial segments so far this six months. Consumer sales of $481.8m through six months are ahead 4.5%, most of which is organic. We have good strength throughout the main product lines of our consumer segments so far this year. Gross profit margin through six months has improved to 46.5% comparing to 46.3% a year ago. That's the benefit of the higher sales volume and the cost leverage that comes with that as well as favorable raw material costs. By segment it looks like the second quarter, industrial margins year-over-year were slightly lower at 47% compare to 47.4%. That's the mix issue effect coming through and somewhat of an offset to that was a number of favorable raw material costs. Consumer gross margins year-over-year improved 110 basis points to 46% from last year's 44.9%. Significant volume effects there and a number of favorable raw material costs in this segment as well.

SG&A expenses improved to 34.5% of sales this year from 34.8%. The mix did have an effect year. I will get into that. By segment, industrial was at 33.2%, SG&A this year, much improved from last year's 34.9% and about a third of that improvement coming from the mix with service sales issues that Frank referred to. Beyond that, we've had continued cost reduction initiatives that took place throughout this past year. In particular, as I mentioned, units that were impacted by the slow economy. We are seeing those benefits this year. Other cost containment efforts being continued through this year. We did have slightly other sales volume increases beyond the services sales at normal margins. The consumer segment SG&A was at 31.8% so far this year, comparing to 32.2% a year ago. That's the benefit of their higher sales volume and cost containment efforts along with some reduced freight cost. Corporate other through six months, $20.3m, comparing with last year's $11.5m. The tax law changed. I referred to earlier for the second quarter. That shift between segments is at $2.2m effect on corporate other costs through six months.

The reincorporation into the Delaware issue was there the second quarter and also for the six months, $1.1m, the increased product liability cost year-to-date so far are $3m, higher year-over-year and, again, we've had the other rising health care and benefit costs and other higher general corporate expenses. On the EBIT line, we're much improved to $127.7m compared to last year's $116.9m. That's ahead 9% on a sales increase, somewhat lower than that, giving us margin improvement. By segment, industrial EBIT of $79.6m is ahead 13.9%, up 3.3% sales growth. That margin is 13.8% of sales. That compares with $69.9m of EBIT a year ago, or 12.5% of sales. Consumer EBIT, $68.4m this year. That's ahead 17% on 4.5% sales growth. That margin is 14.2% of sales comparing with last year's EBIT of $58.5 million or a margin of 12.7% of sales. Corporate other has already been discussed. Again, those numbers were $20.3m this year and $11.5m last year.

EBIT improvement is the same as it was for the second quarter so far this year the benefits of the higher volume, lower raw material costs, cost reduction and cost containment efforts being initiated throughout the segments. Interest expense net was down $10.2m year-over-year. The benefit of the lower interest rates, that portion was $3.9m, average interest rate so far in six months were 4% this year, comparing to 5.1% a year ago. Lower debt level so far this year have averaged $240m lower, and that amounts to a $6.3m interest savings. Tax rates, six months to six months were 35% this year comparing to 34% last year. Again, those are squared up to about where we expect to be for the fiscal 2003 year by virtue mostly of the FAS142 issue I mentioned earlier. Net earnings were ahead $12.8m or 21% to $78.3m. That margin is ahead 100 basis points to 7% of sales from last year's 6% of sales. Diluted earnings per share reached 64 cents. That's ahead 4 cents from a year ago, or 6.7%. I would like now to move to some helpful detail on the balance sheet. These numbers will be in comparison to this past year end at May 31. Net accounts receivable were $364.8m. That is down $33.4m from this past year end. That's despite a major customer change in terms that we discussed in the first quarter, which had an effect particularly on our debt business this year. That dollar amount of impact is $8m roughly, so far this year. Inventory was $250.3m at November 30, 2002. That's down $1.2m from this past year end. Accounts payable $133.7m. That's down $27.1m. Obviously, some favorable timing differences taking place, for the most part, there. Total debt stands at $691.6m at quarter end.

That includes short-term debt of about $4.4m. That's down $22.2m so far this year, and that brings our debt to capital ratio down to 43% from 58% a year ago and 45% at this past year end. Perhaps more meaningfully, given our seasonality in our business, I would like to give you some comparative balance sheet numbers compared to last November. Accounts receivable are up, $11.5m from a year ago. That represents the difference with the Home Depot effect, the major customer account effect of $8m, but, other than that, our day sales outstanding are clearly improved year-over-year by over two days despite this change, and were we to factor out that change, we would be ahead days outstanding wise over three days year-over-year.

That's a significant improvement. Inventories are down $15.3m. Our days outstanding as well are down in this case by more than ten days, and that shows significant improvement in both of our operating segments year-over-year. Accounts payable are up $8.9m, both segments are contributing to that as well. Total debt, including last year's short-term debt of $111.3m, is down $236.9m during these past 12 months. That's represented by $156m from our public share offering this past March, and the difference comes from our free cash flow of about $81m, and that's net of $12.5m that we've invested in acquisitions during the past 12 months.

Moving to the cash flow statement, our cash flow from operations through six months is $90.5m. That compares with $94.2m this past year. If everyone recalls, that was a record-setting performance base a year ago. So we're nearly on pace with that. For the second quarter, which is meaningful, if you were to extract that out, our cash flow from operations was actually $68.5m, compared to $41.1m this past year. That's represented by the improvement in earnings and improvement in working capitals, which I just mentioned. Were it not for the major customer terms changed, the six months would actually be ahead on a cash flow from operations basis year-over-year. Receivables and inventories are remained well controlled. We are anticipating cash flow from operations this fiscal year in the range of 160 to $175m. Cap ex so far this year of $13.7m is nearly even with last year. We should be able to hold, as we've been mentioning to all of you, at about the 40 to $50m cap ex level for the foreseeable next few years, given that many of our larger spending needs are now behind us. We feel our capacity levels are adequate to meet the normal growth rates for the next several years. We've had several minor bolt on product lines. And they also parted the remaining interest in a joint venture. During these past six months, the total investment there has been $9.4m. I will now turn the call back over to Frank Sullivan.

Thanks, Glenn. As we look out to the third quarter, I'd like to give you a little bit of color as to what we're seeing. Number one, it's important to note that our third quarter is a seasonal low period for RPM. So that minor swings in revenues or earnings have big percentage impacts up or down because of the relative low period for us. We are still not seeing any momentum or pick-up in the industrial markets we serve. Despite that, we think the RPM industrial companies will continue to show marginal positive improvement until the economy perks up. Consumer may be temporarily slow in the third quarter. In part, due to some disruptions at Home Depot which, we believe, are temporary. Cash flow continues to be a strong focus for us. I think it's the result of continuing operational improvements. As Glenn highlighted, we're continuing to see a reduction in a number of our working capital accounts. The key one is inventory. Year-over-year we have improved that by ten days in terms of days outstanding. That only comes through real operational improvements. My hat is office to Paul Hoogenboom and Ron Rice and the folks in operations that are making that happen. In addition to the $20m debt reduced that Glenn mentioned since quarter end, we have reduced debt by another $17m.

Acquisition activity continues to be very good. We are working on a number of medium size transactions, valuations are substantially lower than they were at the end of the '90s and early 2000, 2001. Those should be coming on stream in the next 6 to 12 months, not in any manner that would impact our capitalization in any material amount, and we're pretty excited about being able to add that back to our growth profile and, certainly, expect to do those on a accretive basis. With those comments, I would like to introduce Bob Matejka, who is RPM’s Vice President and Chief Financial Officer to help me answer any of your questions.

Thank you. Our question-and-answer session is conducted electronically. If you would like to ask a question, signal by pressing the star key followed by the digit 1. Again, star one to ask a question. If you are using a speakerphone, please make sure you are not muted. It will block your signal. We will pause a moment. First question, gentlemen, comes from Karen Gilsenan from Merrill Lynch.

Good morning.

I have a couple questions on, first of all, if you could talk about the trend of business within the quarter, the three months, and, in particular, what you've seen since then, in December where we've heard a lot of companies complain about weakness and then if things have bounced back in January. Then one other kind of related question. You did mention the Home Depot softness, which I was going to ask you about. If you could give us more color on that, please.

As it relates to the trends, we had, generally, a very strong second quarter, although if you look sequentially, it was kind of a continuation of what we were seeing in our first quarter. As I indicated, Karen, I think a lot of the pick-up in revenues in our industrial business in particular were more reflective of the disruptions of 2001. December, oddly enough, continued to be a pretty good month for our industrial business. I think January is looking pretty punk. I don't see much strength at all in industrial manufacturing markets in the early months of this year. Consumer has slowed down for the first time, and we believe that's temporary, and a lot of it has come across the entire vendor base with some initiatives and programs and disruptions that are happening at Home Depot.

So how long do you think that will last, the -- when you say temporary, is that a one quarter effect, one month effect, two quarter effect?

Hopefully, it will rebound quickly. I think our business -- again, it may impact our third quarter. All indications are that for our businesses and our product lines, we're going to have a very good spring with our DIWIDE businesses. The timing of some of these issues for seasonal businesses like ours can be, percentage wise, pretty funny because there are low periods anyway

Would you expect your revenues to be down in consumer or just more flattish as opposed to the kind of growth we're seeing?

I think more flattish. Consumer has been a pretty strong area for us for the last 10 or 12 months. This is the first time we're seeing more flatness there. It has more to do with industry stuff and more specifically even with some things going on at Home Depot than the broad market in general.

And for the company overall for Q3, earnings should be flat to up? You're not looking for the business to turn break-even or unprofitable, are you, in the quarter?

We are going to stick with the guidance we have talked about since October and also talked about more recently with our board, which is to try to get away from providing quarterly guidance. You know, I can tell you that the dollar for dollar five consensus out there for the year is something we continue to be very comfortable with. I might add that we started that back in October, you know, before the Coca Cola’s and everybody else became more prominent. I think it is a good policy

And just lastly, Glenn, do you have any more specifics on the breakdown of that 6% revenue growth between currency impact, acquisition impact, price volume?

I do have some for you, Karen.

Quarter-over-quarter, November quarter over November quarter.

Foreign exchanges was minimal overall, even though within that it's probably -- the dollar has weakened against the Euro but strengthened against Latin America currencies. Basically, all of that is washing out. And acquisition added -- additional sales from acquisitions have has been minimal as well.

Slightly under 1%.

Right. The combination of the two is under 1%.

Thanks.

Next question from Timothy Gerdeman from Lehman Brothers.

Hi. It's actually Amy Hutchins for Tim. He's traveling today. I appreciate you don't want to give specific first call guidance. In an effort to reduce stock price volatility, the range is 4 cents to 10 cents. If I understand you correctly, can we, from what you're saying, you're probably at least directionally looking at more the lower end of the range, versus the 10-cent, which seems to be a bit optimistic at this point.

Again, Amy, I don't want to get into quarterly guidance, per se. If you look at where we are and look at the fact that we're comfortable with the dollar four or dollar five consensus out there for the year and then start looking at past years' quarters, maybe that can help you out a little bit

Sure. Fair enough.

But to be more specific in that is something we're trying to get away from. I think the meaning of that is, and, again, we start this in October and communicated it in a chemical conference and have done so broadly, as it dawned on us as it's dawning on other companies, no other big project falls in the last week of the quarter and jumps into the next week of the quarter. Is it meaningful on the year or our long-term goals. If it's the type of thing that drives the penny one way or another, we want to get away from that internally. We are on target for our goals this year, and barring any major changes, including geological issues that would affect everybody, I think we're pretty comfortable with where we'll end the year

Sure. Aside from what's been happening at Home Depot, have you seen any other major wins or losses in the last couple of months in other mass merchandisers and home centers?

We're continuing to pick up market share. We picked up market share at Menard’s. We have a great relationship with the folks at Lowe's, the people at Home Depot. Since the quarter end, we have completed a small acquisition of a DIWIDE wood finishes product line, a product line called Parts. That's a product line that's sold very prominently at Home Depot. We have some exciting opportunities and ambitions of growing that business to get into a new area offloor finishing. In general, I think we feel very good about that aspect and segment of our business. Unfortunately, some disruptions in the third quarter for us have slowed things down in what the seasonal slow period for us anyways.

Thank you very much.

We'll now go to Saul Ludwig. He's with McDonald Investments.

Good morning. Great quarter, guys.

Thank you.

If we look at some of the things we do know if, if we look at your interest expense, I assume third quarter will be no higher than the $7m, the second quarter may be even a little less?

I think that's a fair statement, unless we can get something acquisition wise really big. That's not likely. I think that's a fair statement.

We're halfway through the quarter already.

That's correct.

On the corporate expense number, the 10.8, you won't have the reincorporation expense again. What happens to corporate expense in the third quarter, which is really unrelated to revenues? It's more of a known budget able item?

I think that's correct. The Delaware reincorporation costs were one time. We are seeing, as all corporations are seeing and we absorb at RMP International continuing increases in health care costs and some increases in retirement plans. So that is going to continue to flow through our P&L at the corporate other line. As we indicated at the beginning of the year, we have been and will continue to increase our liability reserves, which is appropriate, principally related to asbestos.

So should this number be more, like, $9m number?

I think that's a fair guess. Again, without knowing what hiccups might come. Whatever the number is, it will not include the million one of transaction costs associated with our reincorporation, which hit our second quarter

And you have nothing else planned of a one-time nature?

No, although we will continue to monitor both a benefit cost as well as liability accruals in the coming quarters

Can you give us a run down on the asbestos, the number of cases outstanding at the end of the quarter and what your asbestos cost of settlements were in the quarter and then, finally, the trend seems to be accelerating at a fairly hefty pace on a year-over-year basis.

Actually, in the quarter, our case load was 1,490 cases. That's down from 2,154 cases we had at the end of the first quarter. So the trend in our caseload is positive and going the right way, and that's continuing in the last month. However, it's very uncertain, as you've indicated. I think cases across-the-board are hitting all kinds of companies. I'll come back to that in a minute. Our costs were down in the quarter. Our cost net of insurance were about $1.3m, which translates to a gross cost in the quarter of about $13m. As we've disclosed we have a cost sharing arrangement with our insurers where they pick up 90% of the costs and we pick up 10% of the costs. That's pretty much the news on asbestos. Again, the trend is positive as our caseload is down. The cost is slightly down. We are running today at what we estimate, excluding a few exceptions, at a $30m plus expense rate on a gross basis. As we've indicated from an insurance perspective, our insurance assets are dwindling and are likely to expire sometime in our 2004 fiscal year. That's hard to tell. Current trends are very positive

After that, would you like up a hundred percent of the costs?

Yes. After that, we pick up a hundred percent of the costs.

That sounds like a pretty big number that is going to hit you somewhere toward the end of next year?

At some point, barring legislative relief, there's going to be some pretty big numbers that hit us and a lot of companies. You know, in the near term, this is not going to be a problem issue for us. In the long term, this very well could be a problem issue for us, and so I've made it my business to understand it better. What I have come to understand about this issue is pretty shocking. According to Morgan Stanley, there are 1400 public companies who have disclosed asbestos exposure. And it's gotten very high priority in Congress this year. There are hearings temporarily scheduled for February. The expectation is, if there's legislation this year, it's likely to come by the end of the summer. If that happens, it's going to be very good news for RPM. It's not going to be driven by RPM. There are hundreds of companies that have substantially greater problems and more near term pressing concerns than us that are really driving the train here. I think for the people on the phone and the people in the broad investment community, I think they need to understand how this has evolved. 20 years ago, this was an issue of one bad actor John Manvil, who was a principal minor of this and knew of problems that hit him. There were -- basically, it evolved from Manvil to their industry, all of which is in bankruptcy. Today it's evolved into a situation which is really an attack on the public equity markets. If there are 1400 companies that now disclose asbestos exposure, there are at least, in my estimation, hundreds more. I know of a handful who have asbestos exposure in excess of ours who have not yet chosen to disclose it. If there is legislative relief of any type that will help RPM. If there is not legislative relief, I think the financial community is going to be surprised at the number of potential new disclosures. What you will get from RPM is what you've always gotten.

Just to make it clear, this insurance will run out when, Frank?

We don't know, Saul. We, like other defendants, have not disclosed our exact insurance or reserve situation. But RPM has generally been ahead of the curve in terms of disclosing our issue. We get our first cases in '85 and disclosed them then. We update, as you know, our caseload and our costs every quarter, and we've been pretty candid about this topic with our investors and we intend to continue that candor. It really depends. Current trends are very positive for us. These current trends could reverse and go negative. Depending on these trends, our insurance could last shorter or longer, but the likelihood that it expires sometime in the next fiscal year are probably pretty good.

Well, you know, what should we be doing when we talk about estimating your earnings over the next couple years where we typically have been banking, say, $3m of insurance expense -- not $3m. Maybe you've already got $3m in the first half of the year. Maybe $6m a year in insurance and asbestos costs now. Is that going to jump to $30m and is that something we should get in our heads is likely to hit?

I am not going to get into the specifics of our insurance or reserves, and some of that will play out over the next year. What I can tell you is economically, if the $30 million plus of gross costs, which is our estimate of current annual expense, excluding insurance continues or grows, economically, that cash impact will flow through RPM's cash flow statement and impact our balance sheet.

You said $30m. Didn't you have $30m in the first half of the year because you had $3m in your share? I'm confused between the 30 --

That's correct. Again, if you look at our gross -- if you look at our net costs and our gross costs, which is a function of what's covered by insurance and what's not, there were a couple exceptional events that happened in the first quarter that we don't expect to be repeated. The trends for us right now are good. Quite honestly, we don't expect the trends to continue to decline, particularly if there's not legislative action. So I think that that's an estimate of where we sit today of what might a realistic annual expense be, but, in all likelihood, over time it will continue to trend higher, and we will continue to report caseload costs and our expense on a quarter by quarter basis as it evolves.

Thank you. I encourage you -- since this is going to become a more meaningful item, the board disclosure you can make and get people teed up to have the right level of expectations would be helpful to everybody.

Terrific.

We'll go with Noah Eckless (sp). He's with Clovas (sp) Capital.

Sounds like you guys are doing a terrific job on the cost side. I have two housekeeping items. One, in the next quarter or quarter you're in now, is consumer a larger portion of your business mix than it is on an annual basis? That's question one. Then on the asbestos cases that are in the queue right now, sounds like you've had a big sequential drop in those cases. I was wondering, you had a big increase about, what, three, four quarters ago now. I was wondering, was it that group of cases that got thrown out and that was the reason for the drop? Thanks.

As it relates to the quarter, our consumer is not larger than an industrial in the quarter. They're both seasonal low. The split is about comparable to what we have throughout the year. As it relates to asbestos, we had a number of case that were dismissed. Our dismissal rate continues to be in excess of 50%. We had a number of cases -- I mentioned in an earlier cases, a number of cases at the beginning of the fiscal year that were, in our opinion, somewhat extraordinary, that were settled. With those behind us, you have seen both the lower caseload and we have received fewer cases. So we're seeing our new cases decelerate. You know, one or two quarters in this mess doesn't make a trend. We are monitoring this very closely, and we're also monitoring activity in Washington, legislative activity that hearings are set for some time in February. It will be interesting, more than interesting for us, but interesting for a lot of companies who have a huge stake in this to see what comes out of those hearings, if anything. With a Republican Congress and a Republican in the white house, if it's going to happen, it's going to happen in 2003. In my opinion, if it doesn't happen in calendar 2003, it probably won’t happen until Congress sits back and watches a number of other big companies go bankrupt over this issue.

Our next question comes from Elliot Schlang. He's at LJR Great Lakes Review.

Hi. It is Elliott Schlang.

Good morning.

Many of the questions have been answered. Let me ask, given the precarious state of many retailers, are you expanding your reserves on receivables at all?

No. I think we're in pretty good shape receivables wise. Some of the issues are with some of the bigger customers that are absolutely rock solid. So we don't have an issue there at all. We're in pretty good shape in terms of our reserves for receivables across-the-board.

And, second, can you give us any idea of what your legal expenses will look like for the current year or next, for that matter, does the caseload coming down affect in a meaningful way that legal expense, or will the legal expense continue to be high?

I can't answer that, Elliott. I can get become to you on that. I think our defense costs are somewhat in line with our caseload. So that's -- that will drop or increase as our caseload drops or increases. Right now, that's moving in the right direction. As I mentioned earlier, we had a higher defense cost related to some of the settlements that occurred at the first of the year. Now that's trailed off in a positive fashion for us.

And, last, there's been a lot of exposure recently on the increasing importance of China, both as a customer market and a manufacturing source. Could you just bring us up to date on what is occurring there with you and how meaningful that might be over the next several years? I realize it is a longer term issue.

The Asian market, obviously, is a critical market and key market, particularly for basic manufacturing and metal bending. For our consumer DIWide businesses, it has no impact on the domestic market or North American market. Our products are relatively low in terms of labor costs. We don't face, in our categories, the types of competition that some people face in hard goods. In terms of our industrial business, again, it's very much the same story, except that in many cases our industrial businesses are seeing some of their customer base, their manufacturing customer base, for instance in furniture, move offshore to China. So we are moving with them. From a longer term perspective, I think we've communicated our goal of growing more aggressively in the European marketplace where we currently have about $180m base of business. We just completed setting up a small corporate staff in Europe, and we're looking at a number of acquisitions over there. Regionally you're going to see a bigger chunk of growth for us in the European marketplace. When we get that together and get that right, which I'm very confident we will, the next step for us will be the Asian market. I think we've learned over time to do it right, we've got to have corporate presence in the market because we just can't manage it very well from here. So for the time being, our Asian exposure, about $40m, will be a result of either export business from the U.S. and our industrial businesses, or the types of distribution arrangements or joint venture arrangements that our companies will set up themselves to access those markets

Thank you. Nice quarter.

Thank you, Elliott.

Once again, if you would like to signal to ask a question, it is star 1 on your touch tone phone. If you are using a speakerphone, please make sure you are not muted. We go to Jeff Zekauskas.. He's with J.P. Morgan.

Good morning.

Good morning.

I have two questions. How have your raw material costs changed year-over-year and sequentially. Then, secondly, when we look at the sales growth on the industrial side versus the weaker comparison a year ago and assuming there are no real signs of strength, is all of the growth market share gains?

Yes. I think a couple things. The first part of your question was related to raw materials. Our raw material costs have been flat to slightly weak. There's been some rumblings in the year about raw material price increases. There's just not enough strength in the markets to see that. So we have not had much in the way -- in fact, our raw materials are flat or slightly down, depending on the segment. We don't see that changing, at least in the near term. As it relates to our industrial business, as you're aware, we entered into a two-year restructuring in August of '99. It was completed in May of 2001. I think our timing was pretty lucky. We came out of the restructuring with the operational benefits we sought. I think those were showing up in our margins, excluding the costs in this quarter, the operating leverage on our EBIT line from the revenue growth is good and reflects that. The other benefit is that we came out, even though the economy has been kind of rocky, with a feel focus. After spending two years with our operating people on this restructuring and plant consolidations, we didn't have an outside consultant assist us. It was refreshing to come back and focus on our markets and customers. For instance, just to give you some examples, Day-Glo or TCIpowdered Coatings, both of which are cyclical businesses for RPM, both of which despite lousy economic turbulence and in the case of TCI, seeing some of their customer base migrate offshore to China are experiencing double digit growth year-to-date. We are picking up market share in many of our industrial business segments. We expect that to continue..

Thank you.

We go Greg Halter. He's with LJR Great Lakes Review.

Good morning, gentlemen.

Good morning, Greg.

You talked about the asbestos. Do you have the number of cases that were paid or dismissed in the quarter and also the number of new cases in the quarter?

You know, I don't have those handy. We will file our Q on Tuesday

Okay.

And we will have all that detail in there

Okay. Can you give us an update on the EIFF litigation or settlement?

the EIFF situation is continuing to evolve positively. As we disclosed earlier, we had a fairness hearing in front of a judge for a national class action settlement, and we expected that to be resolved in the fall. It was put off because the Court asked a number of parties to clarify a few issues. That has been done. We expect a final approval of the judge, literally, any day now. It should happen in the next week or so. Once the Court gives it final approval, there is a mandatory 45-day waiting period for any further appeals, but we don't anticipate any, given the actions of the Court, after which it becomes final and official, and that continues to evolve positively for us. A national class action settlement will bring closure to this. The settlement itself is a pay as you go over a three to five-year period. It is substantially covered by insurance, and the cost to RPM will be minimal and, certainly not material

Okay. Great. That's a good offset there. Regarding your debt to cap 43% now, what kind of goal or sweet spot would you like that to be, given your strong cash flow and the amount that it's been reduced already?

Traditionally, we've been able to maintain a middle investment grade rating, which is our goal with a debt cap ratio in the range of 40% to 60%. It hit a high a couple years ago of 62%. I think going forward you will see us manage that debt cap ratio more between 40% and 50 or the low 50s as a percent of our capital structure. Going forward, you're going to see that. We will certainly use our balance sheet for acquisitions. You'll see the top end of that range be somewhat less than it has been in the past.

Okay. Would that include possibly buying any shares, or is it more reserved for acquisition type activity?

No. I don't anticipate we would be buying any shares going forward. We've done that once and, I think, very effectively. Going forward, I think you'll see our free cash flow used to either reduce debt or to fund an acquisition program, which is shaping up nicely after being quiet for a couple years.

One last housekeeping. Glenn, do you have the goodwill and other intangible number at the end of the quarter?

Yeah, I do, Greg. Goodwill is $596.5m, slightly up from year end of the acquisitions. Intangibles, $260.8m, reflecting the amortization.

Great. Thank you.

We go to Mark Shoemaker at Howland Capital Management.

Thanks for taking my call. With interest rates where they are right now, do you have any plans to transition your 70% variable debt into a higher mix of fixed debt?

No. We, at this point, our floating rate costs all in are ranging between 2.5 and 3%, depending on the security in question or our bank debt, which is a long-term revolver that’s due in 2005. Given the spreads in the long-term bond market, we would be looking at a fixed rate of somewhere in the neighborhood of 6.5 to 7%. We just don't see anything in the economy, in the near immediate future, over the next, let's say, two or three years at least that's going to drive short rates up the 300 or 400 basis points it would take to justify a fixed rate. We may be able to tap the capital markets to extend of some of our maturities. If we did it on a fix the rate basis, you would likely see us swap half of that back into floating because of our view on interest rates. Lastly, historically, we have generally maintained a debt structure that's about one-third fixed and about two-thirds floating. That's where we are today. Depending on our acquisition activity and cash flow, the debt that we have the flexibility of repaying is our floating rate debt. If we end up paying off more debt, it will, by its nature, bring that ratio down a little bit

Okay. Thank you.

Next question is a follow up from Saul Ludwig.

Two things. There's been articles in the press lately concerning safety of wood preservative materials. Are you at all in the line of fire there?

No. We, in fact, our top coat industrial business is one of the premiere producers of wood preservative products at the lumber and mill level. We’ve got a number of patented products. Our MP1 product is very environmentally benign or safe compared to some of the old [inaudible] or metals based products. So we are not -- we don't have exposure in those areas. In fact, there's been some instances -- we lost a big window customer manufacturer to PPG, who is providing the primer and the top coat, which was a business that we weren't in. And their wood preservative failed and after a big lawsuit a year ago, we got all that business back. It is a very high margin business for us. We continue to be a real leader there, both in terms of product performance, as well as having environmentally leading products, versus some of the traditional old formulations that have been around a while and are now in question, whether it's in decks or things like that which we're not involved in.

The other question is, in the comments you made about Tremco and the service business and doing, you know, three times this year what you did last year. What sort of drove Tremco into that? Whose [inaudible] so to speak as you guys picked up that business? Is it a business that could be $150m in the year after or just talk about the gestation of that service business and what it really means to you

Saul, it is a real exciting business for us. You know, we have been working on it in small and large ways since we bought Tremco. They had a relatively small contracting business, and it evolved into basically a maintenance and service business for a lot of the big institutions, whether hospitals or universities, and, also, very meaningful we've been working on getting approval to provide this service to government installations. That approval came through a year ago. That's a meaningful part of this as well. I think that it's not that -- the ox that we might be goring would be small contractors or maintenance shops, many of which in a difficult economy have been eliminated. A lot of these institutions are outsourcing this type of stuff because they begin to realize if they don't maintain or have somebody check on things as basic as roofs, they're going to turn a $500,000 maintenance expense into a $25m re-roofing expense. And it's really an exciting market that we've tapped into. We are addressing pricing issues. We are addressing all kinds of issues with a business that's growing that fast. One of the fundamental questions we've asked the Tremco people is, have you priced this right given the fact that it’s growing at 100 or 200 percent a year. We're really getting our arms around it. It is very exciting for us. If we do it right, and I say that because managing that type of growth is a challenge and we're trying to do it right, if we do it right, this could easily be a couple hundred million dollars business. If we could expand it into areas we're not in now, although that's not currently our plan sfwlo that's great. Thank you very much.

Mr. Sullivan, we have no questions remaining. I will turn it back to you for closing comments.

Good. Thank you very much. We're pleased to report another strong quarter and despite the continuing economic challenges, we are on track to meet our goals for the year. As you can tell from the questions and certainly our candor in the area of asbestos, calendar 2003 will be an important year for companies involved in this asbestos issue. There are, according to Morgan Stanley, 1400 public companies that have disclosed asbestos exposure, and there are probably hundreds more who haven't. Hopefully, this will be a good one. I would encourage all of you, because at the end of the day, this is an attack on the equity markets in this country, to have your folks weighing in on this as Congress considers it in February. We strongly support President Bush's proposal for eliminating taxes on difference tends. It would be good for RPM and the equity markets in promoting more long-term holdings of equities given equities like RPM. With that, I would like to thank everybody for their participation on the call and, certainly, our shareholders and the RPM employees who together did a great job in producing a terrific quarter and good half of the year. Thank you.

That does conclude the call. We appreciate your participation. At this time, you may disconnect. Thank you.