RPM International Inc (RPM) 2005 Q1 法說會逐字稿

Good day and welcome to the RPM International conference call for fiscal 2005 first quarter. Today's call is being recorded. This call is also being webcast live and can be accessed through the RPM website at www.rpminc.com. A taped telephone replay will be available 2 hours after the call concludes until 8 pm eastern time on Wednesday, October 13th and can be accessed (888)286-8010. The confirmation code is 50958063. A webcast replay and written transcript will also be made available through the RPM website. The webcast replay will be available approximately 2 hours after this call ends. The written transcript will be available within 24 hours after the call concludes. Comments made on the call may include forward-looking statements based on current expectations that involve risks and uncertainties which could causes the results of RPM to differ materially from management's current expectations. For more information on the risks and uncertainties please review RPM's quarterly earnings releases and periodic reports filed with the Securities and Exchange Commission. Your information on the conference call related to projections or other forward-looking statements may be replied upon subject to the previous Safe Harbor statements and may continue to be used while this call remains on the active portion of the RPM website. During the conference call RPM's spokespersons may reference non-GAAP financial measures. To assist you in understanding such non-GAAP terms as well as to comply with SEC requirements RPM has posted reconciliations to the most directly comparable GAAP financial measures including disclosure on the reasons for the use of non-GAAP measures on the company website in the Investor Relations section under webcast presentations. Following today's presentation there will be a question and answer session at which time if you wish to ask a question you'll need to press star then 1 on your touchtone phone. At this time I will turn the call over to RPM's President and Chief Executive Officer Mr. Frank Sullivan for opening remarks. Please go ahead, sir.

Thank you, Jean, and good morning and welcome to RPM's conference call for the first quarter of our 2005 fiscal year. The quarter ended August 31, 2004. We had a very strong quarter in terms of sales and earnings growth as well as excellent cash generation. In the quarter we benefited from the strengthening industrial markets as well as market share gains in a number of our industrial companies associated with investments over the last 2 or 3 years made during the manufacturing recession that are paying off now. We also enjoyed strong consumer takeaway during the summer months which benefited our consumer segment. Our businesses have demonstrated good cost control resulting in continuing operating margin improvement which we expect for this year and the coming years. This is especially notable in light of the very challenging raw material cost environment which we and many companies have been experiencing, certainly for us in the last quarter, and expect that to continue. I'd like to turn the call over to Glenn Hasman, RPM's Vice President of Finance and Communications, to provide the details of the quarter, after which I will provide some comments on our outlook and address your questions. Glenn.

Thank you very much, Frank. Good morning, everyone. We first want to remind everyone that our reported comparative results this first quarter do reflect the new classification of co-op advertising expenses. They are now reflected as a reduction to net sales as opposed to the previous classification as a selling, general and administrative expense, or SG&A, and this new classification puts us more in conformity with industry practice in this area. We do want to remind you also that there is no earnings effect on this change in classification, be it earnings before interest and taxes, or EBIT, net income or earnings per share. And separately our fiscal 2005 results reflect our early adoption of FAS 123, which is Accounting for Stock Based Compensation I'll first talk through the income statement, give you some highlights there, then we will talk to the balance sheet and the cash flow statement.

For the income statement, this year's first quarter net sales grew 13.9% to a record first quarter sales level of $661.5 million. The organic sales growth amounted to $66 million or 11.3% of that. We had 5 acquisitions during their first year, net of a small divestiture that took place this first quarter, which added $8 million or 1.4% to this net sales growth, and we had continued net favorable foreign exchange which contributed the remaining 1.2% of sales, mainly against the Euro and the Canadian dollar. By segment, the industrial segment had sales -- net sales of $365.5 million which grew 16% over last year's first quarter. The organic industrial segment growth was 12%, plus another 2% from net favorable foreign exchange. Our roofing services led the way again this quarter and the following product lines also experienced double-digit internal growth: Powder coatings, our exterior insulating finishing systems, or EIFS, here in the US, as well as China and Poland and North American construction sealants, chemicals and admixtures, and part of this growth is due to the increased U.S. commercial construction activity. The balance of our industrial growth came from 4 acquisitions during their first year with RPM, including 2 stand-alone businesses in Europe, which added $8 million or 3% to net sales growth, and which were offset by $2 million or 1% due to the recent divestiture of a small subsidiary.

Our consumer segment sales grew 12% or $31 million over last year's first quarter and the organic consumer segment growth was 10%, or $28 million, plus 1% or $2 million from net favorable foreign exchange here as well. The following consumer product lines all registered double-digit year-over-year internal growth during this first quarter, excluding foreign exchange; wood finishes and wood care products; Testors hobby and craft products, Rust-Oleum, including their new wood stain program being marketed under the Varathane brand name introduced during this past year, and EPOXYShield garage floor coatings; DAP caulks and sealants also had double-digit growth as did Zinsser primer-sealers. The balance of consumer growth came from a bolt-on product line acquisition that was made last fall, which added 1% to net sales growth.

On a gross profit, our gross profit margin this year's first quarter of 44.6% was off from 46% a year ago. This margin reduction is principally the result of continued higher material costs which impacted this margin by 110 basis points this quarter, plus the higher roofing services sales which carry lower gross margin. This combination more than overcame the benefits that were derived from the leverage of the higher product sales volume and some initial price increases. We did expect higher petroleum-based material costs, such as epoxy resins, acetones, plastics, asphalts, certain polymers and solvents, and steel pails, would continue to impact our results this quarter, and these higher costs are continuing. Our businesses have been negotiating and implementing their own price increases for several months now. These will continue to phase in to help compensate or recover these higher costs in order to preserve margins.

Our industrial segment gross margin declined quarter-over-quarter to 45.9% from 47.3%. This was principally because of the sales mix, namely the continued growth of the lower margin roofing services business, and higher raw material costs.

The consumer segment gross margin quarter-over-quarter also declined to 43% from 44.4%. Higher raw material and packaging costs mainly impacted this segment, by 220 basis points this quarter, but there was partial favorable offset mainly from the positive leverage of their continued strong organic sales growth.

SG&A expenses. These improved 160 basis points on sales to 30.6% this year from 32.2% last year during the first quarter.This overall improvement mainly reflects the leverage benefits from the double-digit internal sales growth, plus the other side of the higher roofing services sales where related support costs are much lower as well as general cost controls. These benefit and measures more than compensated for higher distribution costs we saw this quarter, due to the higher cost of fuel and certain promotional and growth-related investments.

Industrial segment SG&A was 30.5% of sales this year, much lower than 32.4% last year. This principally reflects the leverage of the solid growth in this segment in organic sales volume, including the growth in lower SG&A roofing services sales during the quarter, plus ongoing cost containment and savings programs. The consumer segment SG&A was 27.3% of sales this year, also much lower than their 28.5% of sales last year. This segment also benefited in the SG&A category from the strong growth in organic sales volume and ongoing cost controls.

Corporate/other expenses increased to $9.9 million this year from $9 million last year. You are seeing here compensation increases, the last year establishment of our European development office, FAS 123 expenses are in this category from our early adoption, effective June 1 of this year, and these expense increases were partly offset by a reduction in insurance cost this year.

Moving to EBIT, or earnings before interest and taxes, our 15.3% growth here represents the positive leverage result of our 13.9% higher sales volume, which more than overcame the 110 basis points of margin impact we saw from higher material costs, which resulted in EBIT margin improvements of 14% of sales from 13.8% a year ago. The industrial segment EBIT was $56.1 million up $9.1 million year-over-year or 19.3%, a margin of 15.4% of sales compared to last year's 14.9%. Consumer segment EBIT of $46.3 million was ahead $4.2 million or 9.9%, a margin of 15.6% compared to last year's 15.9%. Combined, our operating EBIT growth totaled $13.3 million or ahead 14.9%.

Interest expense, net was up $1.7 million quarter over quarter. This increase reflects additional financing costs for our acquisitions during the past year and $2.2 million of higher interest rate cost year over year, the result of our strategic floating-to-fixed rate refinancings, including the $200 million 6.25% notes sold last December. Our average interest rates of 4.7% the first quarter of this year compared with 3.5% during the same period a year ago. This expense increase was partially reduced through additional investment income this year, as well as savings from debt paydowns during the past 12 months.

Tax rates both years were at 35.5% and our net income reached a record $54.5 million, ahead $6.8 million or 14% over a year ago. The margin on sales held steady at 8.2% both years despite the 110 basis point pretax impact from higher material costs during this year's first quarter. Diluted earnings per share reached a record 47 cents, ahead 15% from last year's 41 cents.

Moving now to the balance sheet, and again given our seasonality, I'll provide some meaningful comparisons back to last August. Net accounts receivable were up $39 million. Acquisitions, net of the divestiture, account for $4 million of that difference. Foreign exchange translation account for another $9 million, and then sales increases in both segments accounts for the balance of that increase of $26 million or about 6%. When you compare that with our 11% organic sales growth this first quarter, our days sales outstanding are further improved and we are in fact down 2.5 days overall year over year.

Inventory was up $40 million. Acquisitions were $2 million of that, foreign exchange another $5 million, and the remaining increase of about $33 million was attributable to organic growth in both segments. That's a 13% increase and compares with the year-over-year organic cost of sales increase of about 14%. So, you are seeing some additional days outstanding in inventory improvement here, as well.

Accounts payable were up $55 million. Acquisitions were $1 million of that, foreign exchange $3 million, and the balance comes from the combination of business growth in both segments and some timing of payments.

Our total debt at August 31 stands at $724 million and that does include the short term balance of $234 million. That combination is down $6 million year-over-year. We added $33 million of additional debt for our acquisitions during the past year, less about $39 million of debt repayments during that same time. Total debt to capital ratio has improved to 42% at August 31, '04, down from 45% a year ago. Our composition of debt now stands at about 77% fixed rate versus 23% variable. That's nearly the inverse of what that composition was about 15 months ago. Our available liquidity including our cash balance now stands at $659 million at August 31.

Moving to the cash flow statement, our strong performance and more efficient asset utilization this first quarter translated also into strong cash flow from operations, but was partly offset by $7 million higher after-tax asbestos-related payments. If you set those payments aside for the moment, our pro forma cash flows from operations this year and last would have been $52.9 million and $35.7 million, respectively, putting this year ahead $17.2 million, with some of this improvement due to timing, but a much better indication of the strength of our operating cash flows so far this year. Our capital expenditures of $7.4 million this quarter compared with depreciation of $12.3 million. Our capital expenditures are still expected to continue to approximate depreciation levels for the next several years as our capacity levels will mostly be adequate at normal growth rates. Our free cash flow generation during this first quarter, and again we define free cash flow as cash from operations less capital expenditures and less dividends, amounted to $17.4 million, that compares with $9.1 million a year ago. That's strong growth and again reflects the higher after-tax asbestos related payments this year; otherwise our free cash flow this year and last would have been $29.3 million against $13.9 million respectively, putting this year ahead $15.4 million. You're welcome to visit our website for further information on how we derive our free cash flows. I'll now turn the call back over to Frank.

Thank you, Glenn. Subsequent to quarter end, RPM issued $200 million of 5 year notes. They were at a fixed rate of 4.45%. We swapped that back to floating at rates just less than 3% to continue to maintain about a 75% fixed, 25% floating balance on our debt. This bond is in place to provide funding for a bond which matures in June of 2005. Once we complete that repayment of that maturing bond our next debt obligation will mature in 2008. The impact of this capital market decision, or capital structure decision over the last 12 months will result in about a 3 to 4 cent additional interest cost, that's 3 to 4 cents per share, for the balance of this year versus the prior year. Nonetheless, we feel that these capital markets transactions position us for continuing long-term growth, particularly given the very attractive mix of rates that kept our average interest rate about 4.5%. It will also protect our income statement from further interest rate increases. Also Glenn mentioned FAS 123. In combination with our existing option program and assuming that shareholders approve the long-term omnibus equity plan which we would expect to happen this Friday at our annual meeting, the full year impact of the FAS 123 expense in 2005 will be in the neighborhood of 4 to 5 cents a share for the year. We believe that adopting FAS 123 is the right thing to do and that in any event it will ultimately become mandatory. This also highlights the very reasonable nature of our equity incentive plans versus some of our peers and especially versus the excesses in the broader market that people have seen over the last couple of years. From an outlook perspective, as we indicated in our press release, we do not expect to be able to maintain the mid teen revenue growth rates that we've experienced over the last couple of quarters in part because we see a little bit of a slowing down in some of the markets but mostly because in future quarters we will be experiencing tougher comparisons to our results last year as our business began to improve.

We are comfortable with our original forecast of finishing the year with revenue growth in the high single-digit range. Raw material costs will continue to be an issue for this year. We are experiencing price increases that are starting to be phased in at the end of the summer and in the early fall months in both our industrial and our consumer segments. If you adjust our raw materials -- I'm sorry, if you adjust our cost of goods sold for the WTI roofing services business, in the first quarter year over year gross margins were roughly flat in our industrial segment, indicating that the area that we are getting hit the hardest as it relates to the combination of rising raw material costs and pricing issues is in our consumer segment. Including the extra interest expense associated with these capital structure transactions and FAS 123, we are still comfortable with our original forecast of year-over-year earnings growth in the 10 to 12% range. I think when you take into account these extra expenses which we did not incur last year you can appreciate the underlying earnings strength of RPM particularly given the revenue increases that we've experienced and that we expect to experience for the balance of the year. With that I'd be happy to answer any questions you have.

(Caller instructions) We will take a question from Mark Altherr , please go ahead. Good morning,

Hi, thank you. I just wonder if you could give some color in terms of what you are seeing on the asbestos front both in terms of claims, settlements and -- and, I guess, state developments?

As it relates to asbestos costs in the quarter, and this was included in our prerelease of earnings a few weeks ago and the details will be included in our 10(Q) which will be filed on Monday, but roughly gross costs for the quarter were $19 million versus gross costs last year, that's excluding any insurance proceeds we had last year in the first quarter, of about $17 million. Cases stand at 600 -- I'm sorry, 6,820. That's up 907 cases from year-end and up from 2,131 cases at the end of last year's first quarter. As it relates to what's driving these cases, 75% of the increase from year-end and 85% of the increase from last year are nonmalignant, unimpaired cases. We have an 85% plus dismissal rate without cost and I think that's reflected in our first quarter cost. When you break out the -- the difference between settlement costs and legal costs, actually our legal cost in this first quarter doubled and our settlement costs year-over-year were flat. We expect to see as we go into the next year or so our settlement costs remain flat or trend down but you will also see some of our defense costs trending up. As it relates to state impact, the state law changes that we've been talking about are starting to have an impact. The 4 principal key states driving our claims and costs in the past, Ohio, Texas, Mississippi and Illinois, all have claims trending down year-over-year. We particularly expect that in Texas, after the 2005 fiscal year, as you recall from our year-end conference call Texas drove about $35 million to $40 million of our total settlement and defense costs in 2004. That's on a total cost in 2004, a gross cost of $63 million. And as we get through the remaining old law cases we would expect our cases to drop -- our costs to drop pretty dramatically in the state of Texas. The only state in which we are seeing increased trends right now is in Florida. Those are cases that we've talked about over the last 4 or 5 months and in every instance they are filings of unimpaired or nonmalignant claimants and at the same time we are getting those dismissed by the dozens. And so that is a trend that is driving our case increases but not a trend that is likely to drive our cost increase.

Great. So do you see as you go out to 2006, do you see the debt, this being sort of a peak year or do you have any sense of a -- kind of a leveling off in terms of cost on an annual basis going forward?

You know, I will give you a longer term perspective on that which is I think for a number of reasons including the attention that the abuses in our tort system have seen associated with asbestos and a number of the state law changes particularly in key states for us, that we are at a level this year where we would expect to see our costs be about the same as last year or less, particularly given our expectations for starting to see some of these benefits in the second half of the year. The real question is how quickly will this cost trend down and will we be at the level that we are at now for a number of years, will it get truncated very quickly by some Federal legislation and, if not, are we looking at a tail that lasts 5 years and you start to see a cost drop pretty noticeably over, let's say, a 3 to 5 year period, or are we looking at something that's got a longer tale of 10 or 15 years? I can't answer that question today other than we think we are kind of at the peak and the real question for us is how quickly will this tail trend down versus how long will we remain at the current level.

Thanks very much.

Thank you.

We will take our next question from Saul Ludwig of KeyBanc Capital Markets. Please go ahead.

Morning, Saul.

Hey, good morning, guys. Frank, what was the acquisition that you made for about $10 million in the first quarter and what was it that you divested for which you got about $4.5 million?

The divestiture was of American Emulsions and American Emulsions was in carpet cleaning, chemicals and carpet chemicals, textile chemicals. It was a relatively small business. We actually took a -- about a $500,000 hit in the divestiture of that business so it wasn't a -- it didn't add but we generated cash in the sale of that business and it really was not core to us, it was not a leading brand. And that business and those employees have a new home with a company that's maintaining the manufacturing and the employee base and really focused on that market which is not an area we were focused on. The acquisition was of a business called Radiant Color, which is into our Day-Glo business, and we would -- we are in the process of integrating manufacturing this year into our Day-Glo plants here in Cleveland and would expect that to be a nicely accretive transaction although it was relatively small to the whole.

When exactly did that close and what would be their annual sales?

It closed in July and we haven't disclosed the purchase price or any of the details on it. You know, the revenue increase -- I'm sorry, the revenue on an annualized basis there is about $8 to $10 million.

Okay. And the next question unrelated to that is, you know, in fiscal '04 versus fiscal '03 your expenses for product liability rose about $8 million on an annual -- for the year. And, of course, you had good earnings last year even with incurring $8 million of higher product warranty expenses. In your -- in your first quarter were your accruals for product warranty expenses equal to, greater than or less than last year and is that going to be an area that will at least offset some of the higher costs that you're going to incur for stock options and interest expense?

The 2 things, Saul, that drove our higher warranty or liability costs that you're referring to over the last year were some higher D&O insurance costs which increased pretty dramatically thanks to our friends at Enron and Tyco and a few other places. We've actually seen those costs not only flatten out but we think the trend in those will be down. And Dryvit, as you will recall, we increased going into last year our reserves at Dryvit on a year-over-year basis by about $4 to $5 million of an accrual in excess of what they were normally accruing. That's done. We are now at a new accrual level for warranty reserves there that we are comfortable with and we don't see those costs increasing. As Glenn mentioned in the quarter year-over-year insurance costs including product liability insurance we are actually down slightly. And in terms of the FAS 123 and the higher interest costs, the higher interest costs should not be new to anybody that followed RPM. The only difference there is we will have a negative arbitrage that will probably impact us by a penny or a penny and a half associated with a bond deal we just completed and holding that cash in investments until such time as we use it to retire these maturing bonds in June of 2005.

And -- and just finally, is there anything different this year versus last year with 52 weeks, 53 weeks, or is it the same number of weeks in both fiscal years so that we get apples and apples comparison?

I'm -- I can't answer that question off the top of my head but I'm -- I'm pretty sure that I've never sat on one of these conference calls and explained underperformance by missing a week of the year. So I'm not aware that there are and it's not something that we focus on. You know, the exception to that would be, you know, odd holidays and, you know, where the holidays fall in December or February but it's not an issue for us.

Great, thank you very much.

We'll take your next question from Jeff Zekauskas of JP Morgan.

Good morning.

Mr. Zekauskas, you are the question.

Good morning, this is Silke Kueck sitting in for Jeff Zekauskas, how are you.

Good morning, Silke.

I have a couple of questions. The first is can you talk about the raw material requirements and how they are different in the various segments in consumer and industrial?

Our raw material requirements aren't all that different in our -- in our different businesses. A couple of things broadly. First of all the diversity of RPM's businesses are such that we typically use a lot more variety of raw materials than many of our peers or public company peers and so we don't have the same exposure to huge single raw materials. Now we do have exposure at the individual company level. For instance, shellac is a big exposure at our Zinsser business. Asphalt prices are certainly a big cost at our Tremco roofing business. The other factor is really just the ability to pass on price increases. In our industrial businesses we've been able to pass on price increases more in response to market changes and raw material price changes. As you know that is a project business and also I think that our customer base in the broad market are very aware of what's happening in the oil price area and its downstream impact on chemical raw materials as well as the impact of steel and all types of packaging in many industries, steel components directly. In our consumer business it's a little bit tougher to pass on price increases for a couple of reasons. Number one, you usually only get 1 or 2 bites at the apple a year. You just can't willy-nilly pass on price increases. You have to sit down and work with your retail partners. We have done that. And to the extent that you can convince a major customer that you have a real raw material issue, it's not a temporary spike, that you've done everything you can do to mitigate the costs internally, and that you can help maintain a retailer's margin in the marketplace, then that's a scenario in which you can get some price increases. And we are getting some price increases that are just now going into effect at some of our major retail customers. So I would expect us to pick up some but not all of the margin loss in our consumer business. As I mentioned earlier, if you exclude the mix issue associated with the Tremco roofing services business, year-over-year so far our industrial segment gross profit margins are holding about flat.

In fact, 2 more questions. In -- in terms of like the adjustments that have to be made for FASB 123, what would be the -- the number of shares outstanding at the end of the year? Is it climbing like above 120 million shares outstanding?

About 117 million shares, I think, 117 and change.

And this is where the number will remain for the -- for the -- until year-end?

I think -- I mean, I'm not sure that's even what we have now. It -- it will phase from 116 to 117 and change in part because of stock option exercises. And so that, you know, that's what's driving a -- driving a change from, again, what's about 116 million and change now to it will be 117 million and change by year-end.

Okay. And lastly, you know, I took a look at your balance sheet and saw the reserves for asbestos are roughly like 47.5 million per year and it looks at, you know, like a lot so this is the reserve for this year. And for fiscal '06 it looks at the, you know, the remain -- the reminder from your reserve is 24 million. So -- so at what point do you think you will have to take another charge?

As it relates to our existing reserve our current best guess is that this year asbestos costs on a gross basis will be in the $45 to $50 million range which will be obviously less than last year. We expect to start seeing some real benefit of these state law changes in the second half of the year. I mentioned the situation that we have in Texas. We would expect by the end of this year that we will have worked through most of the old law cases which will likely result in tens of millions of dollars of less cost associated with asbestos cases unless those cases find another home and so far they are not as far as we can tell. As it relates to years past 2006 I think we've been pretty clear in our conference calls as well as our disclosures in our Qs and Ks that we will be looking at taking an additional charge sometime between now and the end of 2006 to cover those periods that extend beyond our 2006 fiscal year. And so, you know, at the appropriate time we will adjust our reserves and look out farther. I can't tell you at this point in time what that would be. We are in the process of assessing that, how many years it would be, obviously, we will provide the details at the time that we adjust those reserves.

Okay. Thanks, I'll get back in queue.

Thank you.

We will take our next question from Greg Halter of LJR Great Lakes Review. Please go ahead.

Morning, Greg.

Morning, guys. Congratulations on some very good results. Thank you. Wondered if you were going to provide the data on the reclass on a go forward basis for the second, third and fourth quarter, just so we have accurate comparisons?

I don't have that data in front of me. But, Glenn, I don't know if you have some comments on that.

Greg, we plan to introduce that as we phase through the year. To give you an idea, though, it's in the neighborhood of $35 to $40 million total for the year. Again, we will be re-classifying the prior years presented as we introduce each quarter through this year.

Okay. And looking at the Florida specifically and some of the other states up the East Coast with the -- with the hurricane, can you camp -- comment on any particular positives or negatives you are seeing out of those events?

I think that certainly the month of September will be a funny month for us. I think our results look okay. And quite honestly it's a little bit surprising because we had some pretty negative impact by those hurricanes. Obviously it's been devastating to people in Florida in particular. But, for example, our Kop-Coat Marine business, which is a very profitable product line for us, their -- their business is sold throughout the country in the spring and summer months. But it becomes predominantly a southeast and quite honestly predominantly a Florida business in the fall. We didn't ship any business from that RPM business unit in September. We also had a negative impact from some of our Tremco Group businesses as it relates to their impact in the southeast. And so that will have some impact on our September results. I think going forward and certainly not for good reasons, but we will pick that business up and then some. Whether it's our Zinsser business in water restoration with the contractor base they have or the DAP or Tremco sealants, Tremco roofing and certainly a pick backup of the Kop-Coat business. We will pick that back up and probably then some. So I think net/net on the year it won't have any negative impact on us although it's -- you know, it will make September a funny month.

Okay. And Frank the comment that you made about the earnings growth of 10 to 12%, can you just clarify that? I think I missed exactly what you said, if that would be before or after the events on FAS 125 and so forth?

I think that, you know, it's looking like, particular things slow down a little bit, like we will probably be at the lower end of that range but I still am comfortable that we will be in the 10% range of earnings growth year-over-year after the additional impact of these higher interest costs and after the additional impact of FAS 123. And so my point was if you take what is anywhere from 8 to 9 cents per share of additional expense this year that we didn't have last year associated with higher interest costs which was a very deliberate, strategic capital structure decision, and the FAS 123, which we think is the right thing to do and is, in any event, likely to come down the path for everybody, it really shows the underlying strength of our businesses in terms of profitability. Does that clarify that for you, Greg?

Yes, that's very good.

Thank you.

And the last question I have is regarding the contingent convertibles, any thought there on what would happen if those are put into the share count?

No. You know, at this point that's a great product for us and it's a nice piece of financing and we don't have any plans to change. There's been no FAS change regarding that. There's certainly been some discussions. At the point in time, or if at some point in time, that becomes a real issue then we will look at whether or not we want to adjust the indenture on that and communicate it appropriately.

Okay. And Elliot has a question or 2 for you.

Sure.

Hi, Frank. In the release you commented on new products and services to be introduced to supplement the underlying growth. Would you comment on those a little more specifically, anything meaningful in the works that we should be aware of?

Well, it's -- it's a continuation of a lot of the things that we've been talking about for the last year, Elliot. Our Epoxi-Tech garage floor coatings through Rust-Oleum is moving very well. After 3 years of really re-formulating and working with our industrial wood finishes group, this year Rust-Oleum introduced a Varathane stains and finishes product line which has been picked up at retail. That's moving nicely. Our Tremco services business continues to grow at significant double-digit rates and so that's a business that was a $10 million, $20 million business 4 or 5 years ago and this year will be in excess of $100 million. So those are the types of things that we are talking about. Our annual meeting will be at the Strongsville, Ohio, Holiday Inn on Friday. We'll have an artist there that will be using the Chalk-It, which is Day-Glo's first consumer product and that's finding its way on retail shelves. We have really focused over the last 3 years, certainly on a lot of things, but one -- one thing in particular is how we can be driving our internal growth better. And so I think it's that focus that has allowed us to pick up some market share because we were investing in some of our industrial businesses while a number of our competitors were still cutting back during the recession. And -- and we have tried to be more deliberate about investing in new products.

Thank you.

We will take our next question from Frank DuPlack(ph) of Prudential Financial. Please go ahead.

Morning.

Morning. Just had a question -- I have 2 questions this morning, one was on the 2005 bond maturities. I thought I heard you say you are just going to hold that cash on the balance sheet until then and are not contemplating kind of buying those back early. Is that correct?

We will consider it. It all depends on the economics. And the market is pretty efficient. So, if there's an opportunity to buy those back early in a manner that's favorable to us we will certainly look at it. But, you know, that's certainly transactional and opportunistic and big picture my guess is that the majority of that cash will be invested until such time as we retire those bonds in June of 2005.

Okay. And the second one, did you mention before and there was an earlier question about the asbestos number of claims, did you talk about the number of resolutions or new cases in the -- in the period?

I did not and that detail will be in the 10Q next Monday. I don't think there's anything surprising in there.

So the average settlement cost per claim if we look at recent history that would be -- that would be pretty consistent with the prior period or 2?

That's correct. I think it's flat to slightly down.

Okay. Thank you.

We'll take your next question from Robert Kosowsky of Sidoti & Co. Please go ahead. Good morning.

Good morning, guys. Good quarter. Thank you. I was wondering if you could quantify the gross margin hit per segment because of raw materials being up?

The gross margin hit per segment is, as I mentioned earlier, Robert, when you exclude the -- exclude the impact, the mix impact in our industrial segment of this WTI, which is the Tremco services waterproofing and roofing services business, quarter-over-quarter, year-over-year, our gross margin was about flat. Whereas in the consumer segment we lost about a point and a half of gross margin. At the raw material level we lost about 30 basis points in the industrial segment, which obviously we were able to make up, and about 220 basis points at the prime margin level in our consumer segment, some of which we were able to make up through the higher volume and some productivity but obviously not all of which.

Okay. And just kind of a status on the price increases. Have the majority of the price increases gone through on the industrial side and compare that to the consumer side? And also just another kind of like broad question is when you go to these big box retailers, does it make more sense to try to do the negotiating as a whole given your broad portfolio of products or do you guys try to go business by business.

Let me answer the first part of your question. Raw material pricing is a dynamic thing and so, you know, I would anticipate that we will have to adjust whether it's formulations, price increases, productivity gains, all the different ways that we can mitigate the impact to our margins throughout the year. And, you know, I think long-term we would expect that we are at a new level of oil prices, hopefully not $50 plus a barrel, but certainly, you know, the days of $30 or lower oil prices are over. At least that's the way we are looking at our businesses and our markets. As it relates to the consumer segment, I mentioned earlier that we -- you know, you really need to partner, work with these retailers and convince them that you've got a long-term issue, not a spike that will be eliminated when things settle down. You've got to convince them that we are doing everything we can to mitigate or minimize the costs here. And then also work to figure out how to maintain the margins at the retail level. And our companies have done that pretty well. The diversity of our businesses are such that the raw material issues, the packaging issues and costs issues for DAP are-- are significantly different than the raw material or cost issues associated with Zinsser, significantly different at Bondo, significantly different at Rust-Oleum. So I think we are in a better position than many of our peers to be very candid by product line or by business unit as it relates to, you know, where we need some price relief and where we don't. And so we've had differing levels of price increases depending on where the needs are and what we've been able to do internally.

Okay. Thank you. That clears it up pretty nicely. And just one other question on the asbestos front. Are you starting to see the pace of -- I guess, given the fact that the Big Four have already passed some tort reforms, are you starting to see the pace of cases jumped from one state to another slowed down or are there any other, you know, states we should keep our eye on or any other states, you know, that, you know, are thinking about changing the tort reforms or thinking about implementing tort reforms that will be beneficial to you down the road?

I think there will be additional tort reform discussions at various state levels and at the Federal level and those will be ongoing. The outcomes of those, who can tell. But certainly there's now a trend and discussion on addressing tort issues broadly from a business perspective because it is a significant burden on the manufacturing base of this country. As it relates to our trends, as I mentioned, you know, an important trend for us is in each of the key states that have driven our case load and, most importantly, our cost, we are seeing year-over-year positive trends, downward trends in terms of cases, in terms of filings, and that's a good sign. The one exception to that is Florida where we have seen, you know, 2 to 3,000 new filings in the last 6 or 8 months. Everyone of which is an unimpaired claim.

All right, thank you.

We will take a follow-up question from Jeff, the line of Jeff Zekauskas from JP Morgan. . Hi, good morning. Good morning, Jeff.

First question is can you talk about the volume growth in the consumer business from the big boxes versus the non-big box customer base?

We don't break out the volume growth between the hardware chains or paint stores versus our big box, in particular, or anything that we've disclosed. Clearly our big box growth has outpaced the growth relative to other distribution at DIY because they continue to add new stores. And whether it's our existing products or new product introductions, we benefit not only from the core growth of the big box customers but when they open up new stores. We think that's a trend that's going to continue for another five years, after which you're, in certain areas, you are certainly going to bump into some saturation.

Can you talk about sort of the order of magnitude difference in the growth rates.

Again, not off the top of my head and it's not anything that we have disclosed as relates to specifics on any of our customers or customer segments within consumer.

Well, I guess, if I could try to put it another way, I mean, your SG&A expenses improved dramatically in the quarter.

Yep.

So is that a reflection that in your business with the big boxes there really wasn't much margin deterioration because your SG&A expenses there are intrinsically low?

No, I don't think that's the right way to look at it. I think that a lot of it had to do, the SG&A, had to do with the higher volume and good cost control. We approached this year knowing that we were going to have some raw material challenges and we wanted to keep a tight rein on expenses and I think our companies are doing an excellent job of just that. We do not have a lower SG&A at big box retailers versus other distribution. In fact by the time you load in, you know, co-op advertising, freight and a number of other items in many instances the SG&A is the same or in some cases depending on the product line, higher. So that's not a mix difference that will drive our SG&A. Our SG&A is really being driven by the efforts of our companies.

What kind of pricing benefit did you get either on a consolid -- consolidated basis or in your industrial business in the quarter?

I would expect for the full year that you will see about 2%, maybe 2.5% of our revenues generated by price increases. On an annualized basis it's a little higher than that because a lot of our price increases will not have been initiated until September or October, particularly in the consumer segment.

Just sort of a last question, in terms of your general outlook for the coatings industry in general for calendar 2005 as opposed to fiscal '05, you know, what we've seen in '04 for RPM, for Sherwin Williams, for Valspar, many, many companies have had something like double-digit volume growth and the long-term trend in the coatings area, as you know, is just a few percentage points of volume growth. Is there any -- and so obviously inventories were built this year and demand has been good. So, is there any chance in '05 in your opinion that volume growth in consumer businesses could be flattish or flat to up or flat to down, or do you expect sort of a solid year of, you know, call it 4 or 5% volume growth against a strong comparison?

Let me answer that, Jeff, by segment. First of all in RPM's industrial segment and if you look in this quarter we had strong revenue growth in the neighborhood of 16% or so driving EBIT growth of about 19%. And I think a lot of that is a combination of picking up share. We've got good businesses that are really focused on driving cash flow and profitability. And they are benefiting from the resurgence in industrial spending and industrial capital spending and there's a lot more to come. And I don't know if it's going to come down based on geo-political events but I can tell you a number of our industrial businesses, particularly those like Carboline or Stonhard that serve truly an industrial customer base, the level of capital spending or maintenance renovation spending in the oil and gas industry, in the offshore oil platform area, in the power industry, is still a fraction of what it was 5 or 7 years ago. So we are benefiting by recovering industrial markets and picking up market share and, barring anything that really slows down the economy dramatically, I think to your question in 2005 that, in calendar 2005 that should continue.

Can you speak to the consumer side as well?

In the consumer side we are pretty excited about what we see and it goes back to investors and analysts that would ask us in the mid to late 90s, how come our consumer business, which at that point was growing about 3 or 4%, wasn't growing faster because of this massive housing boom? And the answer is that our products, Rust-Oleum products, Zinsser products and to a lesser extent DAP, although DAP is used in some new construction, typically were not used in new home building but were used for maintenance, renovation, things like that. The simplest way to view it is is that our products sit on garage shelves. We are excited about the continued opportunity to see that business grow at some rate higher than the industry average because now there is this massive inventory of homes that will be using our products. So I think the outlook for us in 2005 is still above industry trend. The comment I made, though, in my prepared comments for the quarter is that we do not anticipate in our consumer or our industrial businesses to continue to see the middle teen growth that we've experienced in last year's fourth quarter or this year's first quarter. I don't think, to your comment, that 14% or 15% growth or core growth of 12% is sustainable for RPM for the balance of this year or in 2005. It will be robust, better than the industry average but, you know, I hope I'm wrong but I don't think so.

Just as a last note, if you had to change your accounting for contingent convertibles, what would your shares outstanding be?

We will have to get back to you on that. I don't know the answer off the top of my head.

Actually, Jeff, the share increase would be something just north of 8 million additional shares. Obviously at that point you would also have to reduce the interest expense. So there would be a net dilution impact, but, again, to Frank's earlier response to a question, our intention would be to examine our options and possibly amend the bonds indenture if that came along, and -that would be our plan.

Okay, thanks. That's consistent with our estimate. Thank you.

We will take our next question from Saul Ludwig of KeyBanc Capital Markets.

A couple things to just close out. During your fiscal '04, going back to the beginning of '04, you talked about plans to significantly increase your advertising and we saw a lot of your ads on TV. And also in the industrial sector to add salespeople at a time when that didn't appear to be real popular but seeing the coming improvement in the industrial economy you wanted to beef up your -- your forces there. And it looks as though both of those strategies have paid handsome dividends, while it added to your expense base it also pushed the revenues. Now that you see maybe revenue growth moderating what are your plans with regard to discretionary spending for both advertising as well as staffing levels?

I think, you know, we will continue to focus on generating internal growth. It's something that we've been getting better at for each of the last 3 or 4 years and we certainly will continue to make those investments. Having said that, as you can see from our results in the first quarter, if we are able to continue to generate decent revenue growth, and it doesn't have to be 12 or 15% it could be, you know, 7, 8, 9%, that we will continue to keep a pretty good cost control going. Because we have, as you've commented, Saul, ratcheted up our spending levels in some areas in consumer and ratcheted up our investment in selling and marketing expenses in our industrial segments. So I don't know that we will have to ratchet it up another level. We do not intend to ratchet it down until such time as we see revenues really starting to slow down meaningfully. And, you know, I still think if we can generate high single-digit revenue growth for the balance of the year that's pretty good growth for our industry.

And just finally in your consumer sales that go to big boxes, they of course have grown as both the Home Depot and Wal-Mart and Lowe's have added stores. You, I'm sure, get data on a, you know, fairly regular basis, what has happened to your sales to those clients, those customers on a comp store basis? Are you gaining any business with the individual stores or is the growth coming by virtue of their adding new stores?

In almost every instance with our major product lines our comparable store sales with our big box customers are in excess of their consolidated comp store results which they release publicly.

Very good. Thank you.

Thank you.

We will take our next question from Rosemarie Morbelli of Ingalls Snyder. Please go ahead.

Morning, Rosemarie.

Good morning, all. I had pressed the wrong button. On the reclassification, if we look at that 9 million off both the sales and the SG&A for the next 3 quarters that would give you about 36 million for the year. Is that a good place to be in order to have a feel for what to look at in terms of comparisons?

I think that's a -- that's a good -- a good estimate.

Okay. And then looking at SG&A, on an apples-to-apples basis in the first quarter, your improvement was about 160 basis points. Is that also a good number to look at on a quarter-to-quarter comparison versus the prior year?

I think that's going to be really dependent on our seasonality, Rosemarie. In this first quarter and certainly in a strong quarter like our fourth quarter you should expect to see those types of improvements to the extent that we've got good revenue growth and -- and a good control of our expenses. When you look at a little bit of a slower second quarter and, as you know, a very seasonally low third quarter, it's hard to guess because the percentages, you know, $1 million of extra expense or $1 million of less expense, while on a consolidated basis for the year doesn't mean a lot, in a third quarter it could mean a ton. So that's hard to really say other than the general trend is -- is that I think we've got a good handle on our SG&A expenses and we will continue to see margin improve, particularly at the revenue rates that we expect.

All right. And on the interest expense, once we account for that additional debt until June of next year, which is for the full balance of this -- your fiscal year, adding about $1.7 million to your interest expense net, is that an adequate number?

I think that's about right. I mean, you know, presumably you took into account our change to fixed last year. And really what we've got is a negative arbitrage. We issued $200 million in bonds and, you know, we will invest that but there is a -- a difference between our interest costs and our reinvestment income which will impact the balance of the year.

Okay. So that one -- .

About a penny and a half. And to an earlier question, you know, that's a penny and a half that was not planned for. And so, you know, if we can make it up we will make it up but it's not something that I'm as comfortable with stating that, or cavalierly stating that we can overcome unlike the FAS 123 or the other higher interest costs which are things that I think we either plan for or certainly can overcome this year and maintain our expectations for a 10 to 12% earnings growth.

Okay. And then as an answer to a prior question you said that the number of shares which was about -- which was on the average share 116.2 million for the first quarter would end up being about 1 million more due to options by the end of the year. Is that 1 million also an adequate increase in the fully diluted number excluding that convert -- that convertible you have out there?

I think it is.

Okay. And now a question of the -- on the big pictures. You mentioned that you were beginning to see some slow down in some of your markets. Could you give us a better feel as to which areas the magnitude of the slow down and does it seem to be consistent month after month after month or week after week depending on how you see it, or is it up a little one -- one week, down a little the following? Can you give us a better feel for the areas and the magnitude?

It's really hard to guesstimate that based on what we are seeing other than my belief that, you know, we had very strong consumer takeaway in the summer and to an earlier question, I don't know that 12% core growth is -- is realistic on a consistent long-term basis, certainly in our consumer businesses but also in industrial. The other factor that's -- that's kind of an oddball for us is, you know, we've started off the second quarter not too badly but September is going to be a real funny month because of the situation in Florida. It really complicates, you know, a high margin business like a Kop-Coat Marine, it's not a huge business for us but a nicely profitable business. They didn't have a month of September for all practical purposes on the revenue side. I mean they had revenues but their single largest area of sales in the fall is the State of Florida, and we also had a negative impact in our Tremco business. So, it will really be hard to tell. I think that our second quarter -- you know, to make these comments at the end of our second quarter will be more telling as to what we see for the balance of the year?

I guess what I was wondering is excluding Florida, where we all know there were quite a few hurricanes one after the other, I am looking at the markets nationwide. So eliminate Florida, are you seeing slowdowns in some of your businesses and in which areas in particular, or when you mention slowdowns in some markets, were you only thinking about Florida.

Right now we are only thinking about the southeast but the best way I can answer your question is that in both our consumer and industrial segments for the balance of the year we expect to see kind of upper single-digit revenue growth which is lower than what we experienced in either the fourth quarter of last year or this first quarter which we just reported.

Okay. Thanks.

I am showing no questions at this time. Mr. Sullivan, I would like to turn the call back over to you for closing remarks.

Great, Jean, thank you. I would like to close by thanking the more than 8,000 RPM employees worldwide for delivering continuing record results and on behalf of our shareholders we say thank you and keep up the great work. Our annual meeting of the shareholders will be held at the Strongsville, Ohio, Holiday Inn this Friday afternoon at 2 pm. This is always a good event for RPM where we host about 1,000 shareholders, review the first quarter, discuss any dividend news approved by our board and answer questions and we would encourage any and all of you to attend. Thank you very much for joining us on our first quarter conference call today and for your continuing interest in RPM. Have a great day.

Ladies and gentlemen, thank you for joining us on the call. You may now disconnect your phone lines.