RPM International Inc (RPM) 2005 Q2 法說會逐字稿

Good day and welcome to RPM International's conference call for the fiscal 2005 second quarter. Today's call is being recorded. This call is also being webcast live and can be accessed through the RPM's website at www.rpminc.com. A taped telephone replay will be available two hours after this call concludes until 8:00 p.m. eastern time on Thursday, January 13, and can be accessed by dialing 888-286-8010. The confirmation code is 78613313. A webcast replay in written transcription will also be available through the RPM website. The webcast replay will be available approximately two hours after this call ends. The written transcript will be available within 24 hours after the call concludes.

Comments made on this call may include forward-looking statements based on current expectations that involve risks and uncertainties which would cause the results of RPM's to differ materially from management's current expectations. For more information on these risks and uncertainties, please review RPM's quarterly earnings release and periodic reports filed in the Securities and Exchange Commission. The information in this conference call related to projections are often 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 this conference call, RPM spokespersons may reference nonGAAP financial measures.

To assist you in understanding non -- such nonGAAP terms, as well as to comply with SEC's requirements, RPM has posted reconciliations to the most directly comparable GAAP financial measures including disclosures on the reasons for the use of nonGAAP measures on the Company's website in the investor relations sections 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 followed by 1 on your touch-tone phone.

At this time, I would like to turn the call over to RPM's President and Chief Executive Officer, Mr. Frank Sullivan for opening remarks. Please, go ahead, sir.

Thank you, Candice, and good morning. I'd like to start by commenting on our weather here in Northeastern Ohio. We have had a pretty good ice storm and have lost power periodically, so we are on a land-line phone which will hold up regardless of what the power does, but the clarity of the call may be such that if you -- if we're not clear in terms of our voice, please ask any questions again. If our power goes out, you'll be able to hear us, of course we won't be able to see our notes so that should be interesting.

I'm pleased to report a good performance for our second quarter ended November 30, 2004 with sales up approximately 7%, EBIT up 12%, net income up 9%, and EPS up 10%, all before a charge associated with an increase in our asbestos liability reserves. The quarter was negatively impacted by hurricanes throughout the southeast in September, slower revenues in our consumer business, which we feel is temporary, and continuing significant raw material cost increases. Additionally, at the corporate level, higher interest costs, the impact of the adoption of FAS 123 accounting for stock options, in conjunction with our new long-term incentive equity plan, cost RPM about 2 cents per share in the quarter versus last year. Despite these higher costs and significant market issues, we're able to continue generating good growth and solid earnings performance.

Before Glenn Hasman provides the detail on our performance for the quarter, I'd like to address our asbestos charge to increase our asbestos liability reserves. First, I'd like to provide the quarterly detail on our cost and cases for the second quarter versus comparable figures of last year's second quarter. Active cases for this quarter were 7,523 versus 2,733 cases in last year's second quarter. Consistent with the last couple of quarters, the vast majority of the year-over-year increase involved unimpaired filings in the state of Florida. Our gross cost for the quarter were $15.4 million versus $18.6 million in last year's second quarter. As you will recall, given the positive changes in various state laws, we have been talking about a more aggressive defense posture to try and begin stemming the tide on the cost of our asbestos cases.

When we look at the pieces of our expense this quarter versus last year's second quarter, you'll start to see the strategy having an effect. Of the $15 million of asbestos costs in this current second quarter, approximately $10 million were associated with indemnity or settlement costs and 5 million were associated with defense costs. A year ago indemnity costs were about $16 million and defense costs were about $2 million, thus highlighting some of the issues associated with our increasing reserves, which I'll address in a minute, as well as a significant reduction in indemnity or settlement cost year-over-year.

Generally, we are seeing our dismissal rates up and our average settlement costs down. Even in Madison County, Illinois, a jurisdiction that got some attention yesterday, we are starting to see some positive court rulings, particularly in the area of venue. In October, the new judge who presides over the asbestos dockets dismissed two mesothelioma cases in which Bondex was a party concluding that they were not properly filed in Illinois based on venue law. This is the first time ever that the Madison County, Illinois Court has applied Illinois venue law to any of our asbestos cases. Our lawyers estimate that approximately 40% of our Madison County claims are filed by non-Illinois residents which could be similarly dismissed based on venue.

Finally, under Senator Specter's leadership, there's been renewed discussions in movement on some form of federal legislation with hearings beginning next week on Tuesday, over the coming months we expect to see some clarification of the context and timing of the proposed Federal Trust Fund, the FAIR Act, and having said all that, we still expect total asbestos costs for the 2005 fiscal year to be somewhere in the neighborhood of $50 million. Going forward, as we have done today, we will highlight the shift of our indemnity and defense costs, which is a positive ratio in our view. And as we have always done, we'll continue to disclose the details of our cases and costs each quarter in our 10-Q's and 10-K's as we've done for many years. For all these various reasons ascertaining the number and type of future cases, the costs of settling or dismissing any such cases is, in our view, much less certain today then it was even 18 months ago when we first established our initial reserve.

With this backdrop, we have, however, determined it is appropriate to take an additional charge to increase our asbestos liability reserves by $47 million, most of which will be allocated to cover the cost of our stepped up defense costs. This will put our total reserves at approximately $103 million, sufficient to cover cases in hand, which roughly cover about a 24-month time cycle from first being filed to being resolved. While we have seen our average settlement cost dismissal rates and state law changes going in the right direction, and we believe some form of federal legislation is once again at the forefront, the landscape is still not sufficiently clear to assess future unknown claims that may be filed down the road or their associated costs. Accordingly, we will adjust our reserve each quarter based on our experience, and it is our expectation that you will see this quarterly reserve charge, and, over time, the total level of our balance sheet reserves decline.

Though we cannot say with any certainty whether or not we will see a relatively quick solution, for instance, via some type of federal legislation or a long, slow decline of this liability., either way, we will continue to manage the issue in the long-term best interest of RPM's stockholders. At the end of the day, even with the adjustment to our asbestos liability reserves and our change in philosophy of addressing an appropriate view of our reserves and reserve adjustment each quarter, the economic impact, which we have discussed, and will continue to discuss each quarter, has not changed and, in fact, is improving.

I would now like to turn the call over to Glenn Hasman, RPM's Vice President of Finance and Communications, to provide you with the details of our performance during the quarter. Glenn?

Thank you very much, Frank. Good morning, everyone. We first want to remind everyone that Iour reported comparative results for the second quarter in the first six months, and the comments that follow reflect this year's new classification of CO-OP advertising expenses as a reduction now of net sales, as opposed to their previous classification as a component of selling general and administrative expense. Prior periods have been similarly re-classified for comparative purposes, and those numbers were $8.3 million for the second quarter last year, and $17.4 million for the six months of last year. And, we also want to remind everyone again that this change has no effect on our earnings measures such as our earnings before interest and taxes or EBIT, our net income or our earnings per share. Also, since Frank Sullivan has further reviewed the asbestos charge that we've taken this quarter and the rationale behind that charge, the comments that follow will refer to only our adjusted operating results before the charge. I'll first review our income statements, then I'll talk to some comments and highlights of the balance sheet and then on our cash flow statements.

Beginning with the income statement, our net sales, this year second quarter net sales grew 7.2% or $41.9 million year-over-year to a record second quarter sales level of $623.5 million. Organic sales growth within that amounted to $24 million or 4.1%. Four acquisitions during their first year net of a small divestiture during this years first quarter added $8.6 million or 1.5% to net sales growth, and net favorable foreign exchange contributed the remaining 1.6% or $9.3 million mainly against the Euro, and the Canadian dollar.

The industrial segment net sales reached $364.9 million, which grew $34.6 million or 10.5% over last years second quarter. Organic industrial segment growth amounted to $19.6 million or 6% plus another $7 million or 2.1% growth from net favorable foreign exchange. The balance of the industrial growth came from three acquisitions, including two stand alone businesses in Europe, which added $9.2 million or 2.8% to net sales growth, which was offset slightly by $1.2 million or 0.4% due to the recent divestiture.

Consumer segment net sales of $258.6 million grew 2.9% or $7.3 million over last year's second quarter. And, as Frank mentioned earlier, the consumer segment sales did slow during the quarter, partly due to the hurricanes which affected the southeast regions and some changes in order patterns year-over-year. The organic consumer segment growth was 1.8% or $4.4 million, plus another 0.9% or $2.3 million which came from net favorable foreign exchange. The balance of consumer growth came from a bolt-on product line acquisition made last fall.

Gross profit. The gross profit margin of 43.4% this second quarter is off from 44.3% a year ago. This 90 basis points net margin reduction is principally the result of continued higher material costs which impacted this margin by 240 basis points, and which more than overcame benefits that were derived from the leverage of the higher product sales volume and some additional price increases. It's important to note, however, that the margin this second quarter, the narrowing did improve from the decline we had in the first quarter which was off 140 basis points. We expected higher petroleum-based material costs such as in epoxy resins, plastics, asphalts, certain polymers and solvents, acetones, as well as steel pails, would again impact our results this quarter and the higher costs are continuing. Our businesses continue to negotiate and implement their own price increases and these will continue to phase in to help compensate or recover these higher costs in order to preserve margins.

The industrial segment gross margin declined quarter over quarter to 44.7% from 45.4%. This 70 basis points margin decline is principally because of higher raw material costs, partly offset by price increases. The consumer segment gross margin quarter over quarter also declined to 41.6% from 42.9%. That 130 basis points of margin decline is principally due to higher raw material and packaging costs, which impacted this segment by 320 basis points this quarter., partly offset by price increases.

Moving to SG&A expenses, this category improved 130 basis points on sales to 32.4% this year from 33.7% last year during the second quarter, and this improvement mainly reflects our leverage benefits from the organic industrial sales growth and continued controls over general spending, which more than compensated for continued higher distribution costs due to the higher costs of fuel, higher transactional costs from the weaker U.S. dollar and additional costs recognized due to our early adoption of FAS 123 last quarter.

Industrial segment SG&A of 32.1% of sales this year is much lower than 33.6% last year. Our 150 basis points of improvement principally reflects the leverage of this segments solid, organic sales growth, plus ongoing cost containment and savings programs. Consumer segment SG&A at 29.5% of sales also is lower than last year's 30.1%. This segment’s 60 basis points of improvement mainly reflects effective cost control, especially in light of their slower sales this quarter.

Corporate/Other expenses decreased to $8.5 million this year from $9.6 million last year. Primarily lower insurance costs this year, which more than offset increased expenses from FAS 123, last year's establishment of our European development office, and higher costs related to corporate governance, principally Sarbanes-Oxley compliance.

In terms of EBIT, 12% EBIT growth this quarter represents the net positive results of our 7.2% higher sales volume, additional pricing benefits and cost reductions, which more than overcame 240 basis points of margin impact from higher material costs, resulting in EBIT margin improvement to 11% of sales this year from 10.6% a year ago. Industrial segment was ahead $7 million or 18% in the EBIT category. That's a margin of 12.6% of sales compared to last year's 11.8%. The consumer segment was actually down slightly or by $0.8 million, down 2.4%. That's a margin of 12.1% of sales compared to last year's 12.7%. Combined, however, our operating EBIT growth totaled $6.2 million which is ahead 8.8%.

Moving to interest expense net, which was up $2.2 million quarter over quarter. This reflects primarily our $2.8 million of higher interest rate costs year-over-year, which is the result of our strategic floating to fixed rate refinancings during the past year, namely, the $200 million, 6.25% notes sold last December 2003, and $200 million of 4.45% notes sold this September, plus additional financing costs for acquisitions during the past year. Average rates this year were 4.8% overall compared with 3.5% during this period last year. Partially reducing interest expense this quarter was additional investment income from the temporarily excess cash from the September notes. Our tax rate was flat this year with last year at roughly 35.6%.

Net income reached a record $38.5 million, that's increased by $3.3 million or 9.3% over last year. And, the margin on sales improved to 6.2% from 6.1% last year, again, despite the much higher material costs. Our diluted earnings per share reached a record 33 cents per share up from 30 cents last year or up 10%. And keep in mind that FAS 123 and our new equity plan, as Frank mentioned earlier, combined with our higher interest rate costs from the recent refinancings, cost about 2 cents per share this quarter.

Moving to the six months results with some highlights here. Our net sales this year first six months grew 10.5% or $122.4 million to a record first six month sales level of $1.285 billion. The organic sales growth in that is $89.6 million or 7.7%. Five acquisitions during their first year, net of the small divestiture, added $16.8 million or 1.4% in net sales growth. And net favorable foreign exchange contributed the remaining 1.4% or $16 million of sales growth, again mainly against the euro and the Canadian dollar.

The industrial segment, their net sales of $730.4 million grew $83.9 million or 13% from a year ago. The organic portion of that was 8.9%, $57.2 million plus another 1.9% or $12.1 million from net favorable foreign exchange. The balance of the industrial growth came from four acquisitions including the two stand alone businesses in Europe, which added $17.5 million or 1.9%. That was offset by $2.9 million or just under .5% due to the first quarter divestiture.

Consumer segment net sales grew by 7.5% or $38.5 million over last year's first six months. The organic consumer growth amounted to 6.3% after six months, or $32.3 million, plus another .8% or $4 million from net favorable foreign exchange. The balance of the consumer growth came from a boltr-on product line acquisition made last fall, which added the remaining sales growth.

Gross profits through six months, the margin there, 44% compared to 45.1% a year ago. This 110 basis points of net margin reduction is principally the result of our continued higher material costs, which impacted this margin through six months by 160 basis points, partly offset by mainly the leverage of 7.7% higher organic sales volume and additional price increases. The industrial segment gross margin declined year-over-year to 45.3% from 46.3%. Principally, the higher material costs are the factor there. The consumer segment gross margins also declined to 42.3% from 43.7%. Again, higher raw material and packaging costs mainly impacted this segment over the industrial.

SG&A expenses through six months were improved by 150 basis points on sales to 31.5% from 33% a year ago, and this improvement mainly reflects the leverage benefits from the 7.7% organic sales growth. The industrial segment SG&A at 31.3% of sales is much lower than 33% a year ago. That reflects the leverage of their solid growth in organic sales volume. The consumer segment SG&A at 28.3% is much lower than their 29.3% a year ago. This segment also benefited here through six months, mainly from the strong growth in their organic sales volume.

Corporate/Other expenses are nearly flat through six months at $18.5 million from $18.6 million. Mainly, lower insurance costs this year were able to offset FAS 123 and the additional European development office expenses.

Our 13.8% EBIT growth this first half represents the net positive result of the higher organic sales volume, pricing benefits and cost reductions, which more than compensated for the 160 basis point margin impact from higher material costs. And, that resulted in EBIT margin improvement to 12.5% of sales from 12.1% through six months a year ago. The industrial segment was ahead $16.1 million or 18.7%. That's a margin of 14% on their sales compared to last year's 13.3%. The consumer segment EBIT was ahead $3.4 million or 4.6% through six months., a 14% margin compared to last year's 14.4%. Combined, our operating EBIT growth totaled $19.5 million or 12.2% through six months.

Interest expense net was up $3.9 million year-over-year. That reflects $4.9 million of higher interest rate costs year-over-year.,the result of our deliberate floating fixed rate refinancings during the past year, partially reduced by additional investment income. Average rates this six months of 4.7% compared with 3.5% during the same period a year ago.

Tax rates are again flat year-over-year. Net income reached a record $93 million, increasing 10.1 million or 12.2%, and the margin on sales has improved to 7.2% from 7.1% despite the much higher material costs. Diluted earnings per share reached a record 79 cents per share up from 71 cents a year ago or +11%. And,keep in mind again that FAS 123 and the new equity plan, combined with our higher interest rate costs this year, cost about 4 cents a share this first half.

Moving now to the balance sheet. Again, as always, given our seasonality, I'd like to make some meaningful comparisons back to last November. Our net accounts receivable are up $14 million. Acquisitions, net of divestiture account for $2.9 million of that. Foreign exchange translation effect accounts for $10.8 million, and sales increases in both segments account for the small balance of only $.3 million or .1%. You compare that with our 4.1% organic sales growth this second quarter and clearly our days sales outstanding have made further improvement. In fact, those were down two days overall year-over-year.

Our inventory levels are up $50 million year-over-year. Acquisitions, net of the divestiture, account for $2 million of that. Foreign exchange translations 6.7 million, and the remaining increase of $41 million is attributable to the organic growth in both segments, plus certain strategic inventory builds in light of our higher cost environment, and to address certain commodity allocations.

Accounts payable were ahead $34 million year-over-year. Acquisitions, net accounted for $1 million of that. foreign exchange translation, $3 million. The balance of $30 million is up 20% from a combination of business growth and the timing of payments in both segments. That serves as a partial offset to the $41 million inventory increase year-over-year.

Our total debt of $842 million at November 30, '04 includes the short term of $4 million. That's ahead $119 million year-over-year. We had $22 million of additional debt for net acquisitions during the past year less about $29 million of average debt repayments during the year. During this second quarter, on September 27th, we sold $200 million of 4.45% senior notes due 2009. A portion of those net proceeds were used to repay outstanding borrowings under our commercial paper program, and $15 million short-term debt that came due during the quarter. The balance of those proceeds is being held in cash, and/or short-term investments, until our $150 million 7% senior notes come due next June. So, for the time being, our total debt to capital ratio is best viewed as a net debt to capital ratio, the net being the reduction of our debt position by the cash position on our balance sheet. As of November 30, '04, our net debt to capital ratio has improved significantly to 37.3% from 41.6% a year ago and from 41.1% this past year end, May 31.

I'd like to now move to the cash flow statement. Our continued operating performance improvements and more efficient asset utilization again the second quarter translated into strong cash flow from operations. We were ahead $14.5 million this second quarter or 33%. We are also ahead $24.7 million year-to-date which is also ahead 33% year-over-year. Our six months' capital spending of $21.8 million compares with depreciation of $24.7 million this six months.

Our free cash flow generation during 2005 to date, and again we define free cash flow as our cash flow from operations less our capital expenditures and less our dividends, amounted to $44 million compared with $28.2 million a year ago, which was ahead $15.8 million or 56%. That's strong growth, especially when you consider the additional $5 million of higher after-tax asbestos-related payments this year over last. And you are welcome to visit our website for further information on how we derive our free cash flow.

I'll now turn the call back over to Frank Sullivan.

Thank you, Glenn. Before I answer your questions, I'd lake to make a few comments on the outlook for our balance of this year. Glenn commented on the temporary slowdown of sales in our consumer division in the second quarter. Given the seasonal nature of RPM, we don't expect to see much difference in the third quarter. In fact, as we mentioned a couple times, you'll need to keep in mind that the year-over-year impact of our adoption of FAS 123 in conjunction with our new long term equity incentive plan and higher interest costs will hit our third quarter by 2 cents per share. And this, as you know, given the seasonality of RPM will have a disproportionate impact on our third quarter, which is our seasonal low.

Having said that, we expect to see a return to better and more normal growth levels in our consumer business in our traditionally strong spring-selling season. Our industrial segment continues to show strong growth and good operating leverage to the bottom line. And all indications suggest that this will continue. We're particularly pleased with the discipline in costs and expenses exhibited by our companies and our people in order to continue margin gains despite the most challenging raw material environment we have seen in decades. Although the timing and amounts of price increases is varied by operating unit, we expect to see some improvement of the gross margin level going forward.

Whether or not these pricing actions are enough to stem the tide of higher raw material costs, and begin to generate margin gains back to our traditional levels, we are confident that we would be able to regain our gross profitability over the full cycle of raw material price increases and the economy. We continue to be comfortable with our original guidance for fiscal 2005 performance of high-single digit revenue growth and 10 to 12% earnings growth adjusted for the asbestos reserves, and despite the raw material challenges, higher year-over-year interest expense and the unplanned but appropriate impact of FAS 123, which we've discussed.

One other expense area that I'd like to comment on is the cost of Sarbanes-Oxley, particularly the cost of accounting for the 404 controls and procedures. The combination of accounting and legal costs of Sarbanes-Oxley, which cost us about $1.5 million last year, will cost us in excess of $3 million this year. On a going forward basis, we believe that the requirements of Sarbanes-Oxley will cost RPM between $1- and $1.5 million annually going forward as a regular part of our then expense.

Lastly, we're continuing to see good opportunities for acquisition growth and continue to support investment in new products and new services which bodes well for our ability to sustain record revenues and earnings growth in the coming years.

I'd now be pleased to answer any questions you have concerning our second quarter results.

Ladies and gentlemen, if you wish to ask a question, please press star followed by one on your Touch-Tone telephone. If your question has been answered or you wish to withdraw your question, please press star followed by 2. Please press star 1 to begin. One moment while we compile our list of questions. Our first question comes from Saul Ludwig of Keybanc. Please proceed.

Good morning, Saul.

Good morning, everybody. You mentioned that the consumer was affected by two things. One was the hurricanes, and then you alluded to something about the unusual order patterns. Wondering if you could elaborate a little more on that unusual order patterns, and if they were unusual on the downside, have you seen a reversion in those, in the months following the end of your second quarter?

We -- they were unusual on the down side. We believe a lot of it has to do with timing. There was some slower consumer take away in the fall months, and in trying to understand it, I suspect the best thing we could come to, other than the impact of the hurricanes throughout some key southeastern states, was perhaps election paralysis. At the beginning of the third quarter, we are seeing that growth pick up a little bit, but as I commented on my formal comments at the beginning of the call, as you know, our third quarter is so seasonal, that's not going to have much of an impact on the year. But, the fact that the year-over-year results are picking up, I think, bodes well for our expectations for the fourth quarter, which is a particularly strong quarter for our consumer businesses.

Great. Secondly, you commented that you expect your total asbestos costs for the year to be $50 million, which is consistent with what's been the story all along. The additional reserves that you've taken of $47 million, are we to imply that all of that additional increase will hit in fiscal '06 along with the remaining portion of the original reserve?

No. As you'll see in our press release, the $47 million increase in our asbestos liability reserves is really split in two pieces. The first piece is a $32 million piece principally associated with expected higher defense costs going forward. A year ago, we had about $5 million in annual defense costs. In this past second quarter alone, we had $5 million of defense costs, and as we look out for the cases that we had in hand, which typically take about a two-year period to be resolved, you know, we believe that a higher level of defense cost is going to be the reality, and in fact it's very much our strategy to make sure that we do benefit from a number of these state law changes, as well as the costs associated with our insurance coverage case and other related items. So that's the principal piece of it. The second piece is a $15 million piece, which really related to our assumption in the second quarter of the appropriate level of adjusting our reserves as it relates to new cases that have come in. And we will be adjusting our reserves now on a quarterly basis. And that adjustment, really, as you know accounting is circular, will be to increase our balance sheet reserves. So in some quarters, it may be related to our cash costs during the quarter. That's one proxy of trying to understand value. Another quarter it may be substantially lower, based on what we experienced out in the marketplace whether it's changes on venue in Madison County, or more visibility into the positive benefits of some of these state law changes. But you're likely to see quarterly reserves adjustments that could range anywhere from 0 to 17, 18 million bucks, and we will line item those every quarter. Then separately, we will continue to highlight the specific case data and cash cost data as we have every quarter. And we will now segregate that data between indemnity costs and defense costs.

Thank you. The point that I'm not clear on, Frank, is when you took the original reserve, that was supposed to be a reserve for three years, and then at the end of three years you would reassess the situation. Now, with the additional reserves being taken, is there any sort of time line over which they're expected to be expended, if you will? Are we now moving past the end of fiscal '06 relative to your expectations for asbestos costing?

The answer to that is, yes, in the sense that, as we've always said, there's about a 24-month tail. So the balance sheet reserves we have today, and this is isn't exact, some cases get resolved in 6 months, and other cases get resolved in 30 months. But on average there's about a 24-month time period from when a claim is filed to when a claim is resolved, and so 24 months from today gets us past our 2006 fiscal year and into 2007. So clearly, the balance sheet reserves that we have today are now getting us past the original 2006 period.

Thank you.

Our next question comes from Jeff Zekauskas of JP Morgan. Please proceed.

Good morning. This is Silke Kueck for Jeff. How are you?

Good morning, Silke.

Can you just like analyze a little bit the trends in the industrial businesses as well, and that is, I think in the first quarter was up 12% , in the fourth quarter 12%. industrial, and, in the second quarter, I think we saw 6% now. Is this like an ongoing run rate or is it more seasonal? Can you just talk about the moving pieces?

I think it's a little more seasonal. The same issues that impacted our consumer business also impacted our industrial business in the second quarter. So again, going forward, particularly as we get through our seasonal low period and into the spring, I would expect higher growth rates out of our industrial business. I don't know if they'll be back in the 12% plus range but they should be higher than the second quarter. As we go into the second quarter, particularly into the construction season, and/or the DIY season, our sales shift from the northeast and the midwest from a weather perspective more towards the southeast and the southwest. And the hurricanes that hit repeatedly in the southeast really stymied projects, stymied order shipments, both to major retail customers as well as in our industrial segment. Then the other piece of it, as I mentioned, I don't have any better analysis than to chalk it up to election paralysis, because we did see a slowdown that really didn't have a good explanation. Fortunately, and the early results in one month doesn't make a quarter, let alone a year, but the early results in our third quarter indicate a pickup to better growth levels.

I'm just going to ask a second question. In terms of your raw material costs, like your acetone solvent, and plastic packaging, where do you expect to be by year end? Do you think you'll be able to entirely close your raw material gap? Where do you stand currently, and where do you think you'll be by year end?

I do not expect that by this fiscal year end, or five months from now, that we will be able to entirely close the raw material gap. I think that we're maybe three or four months behind the curve. Maybe a little less than that in our industrial segment, and at least six months behind the curve in our consumer segment. We have been able to institute price increases across almost all of our businesses and product lines. Some of those were done at the end of the summer. Other of those were done in the fall months. It is likely in a number of our different product categories that we will have additional price increases in this calendar -- in the early part of calendar '05, because we continue to see significant pressure, not only on prices, but also in certain select areas on availability of raw materials. So we don't see that abating. The macro news about slowing down in China, and perhaps steel prices coming down, oil prices at a lower level, suggest that at some point, maybe in calendar '05, maybe in '06, that you'll see some of the raw material pricing pressure abate. And, it's over that period of time that I'm pretty confident that we will regain the margin profitability of the gross margin level that we lost. In the interim, as I mentioned, I think our companies and our people have done a tremendous job in a very challenging and very competitive environment to adjust at the SG&A level so that despite these raw material price pressures, which have been very severe in some cases, we've been able to year over year improve our EBIT margin.

Lastly, if I could ask one more time on asbestos. The gross cost for the first six months are currently like $34, $35 million. So do you think you really can keep costs at like a $50 million run rate? Are you confident that in the second half of the year, the claims we see -- the settlement cost will be significantly lower than the first half?

To say that I'm confident about anything in terms of asbestos, you know, I couldn't say that. I'm confident long term that we're going to see, as we mentioned earlier, a year ago, Texas was half of our costs. The time line in which it takes, or is taking us to resolve old law cases has slowed down because the settlement costs for us and all defendants had gone a lot higher. It's forcing a lot of jury trials. I think we mentioned earlier, you know, we've taken five cases all the way through to jury and so far we have five favorable verdicts. So we're learning now better to defend ourselves. But it slows down the whole docket, it's not just an RPM issue but across all defendants. It slows down the whole docket. So I'm confident in the trend, but in terms of a settlement cost, particularly as it results to Texas or Illinois, or some kind of cost related to a particular case, that could cause a spike in a quarter. The good news is that we're not seeing significant new filings and we're very confident that once we get through the old law cases in that state that you'll see a dramatic drop in terms of our costs in Texas. Now, whether or not some of those cases will be refiled somewhere else, we'll have to see.

Thanks very much.

Thank you.

Our next question comes from Andrew O'Connor of Wells Fargo. Please proceed.

Good morning.

Good morning, Frank, Glenn. Good quarter.

Thank you.

You guys have already talked around this, but given that we're a month into the third quarter, I was wondering if you could be more explicit. How do you see EBIT margins trending in the third quarter for both the industrial and consumer segments? Thanks so much.

As you know, we stopped giving guidance on a quarterly basis about three years ago. We're going to stick to that. But we have provided outlook comments, and, I guess, the two comments I would make about the third quarter is on the positive side we're seeing better growth in the early parts of the quarter than we experienced in the second quarter and that's good news. We are still exhibiting good cost control. Raw materials will be an issue in the third quarter just like they've been throughout the year. And that's a little bit worth keeping in mind as it relates to the size of the quarter and the seasonality of it. And we hit, if you noticed, about five times the FAS 123 cost, which on a full year basis for us would be about 4 cents. That and the FAS 123 costs were not something we planned on, although, I think we can overcome them. Certainly, we did plan on the higher interest costs. We hit on it because, you know, 2 cents a share, or the 8 cents a share, is something that I feel pretty good about in terms of overcoming on a full-year basis, but people need to keep into account the disproportionate impact of a 2 cent per share year-over-year hit on a quarter in which last year we did 5 cents a share.

Okay.

And so that's kind of where we are. I'm also hopeful that as a lot of analysis has been written about FAS 123, that people will look through those 4 cents and say on a year-over-year basis, these guys, they did the right thing a little ahead of the curve on accounting for stock options and equity-type incentives. B; if we back that out, you can really see the true strength of what we've done in what's otherwise been a challenging environment, particularly in the raw material side.

Thanks for that. Secondly, can you update us for CapEx for full year '05? Thanks again.

Sure. CapEx for the full year '05 is going to be roughly $55 million.

Okay. How would you apportion that, Frank?

Apportion it between what, Andy?

I don't know, maintenance CapEx and new initiatives?

I think probably about 30 million or so, 30 to 35 is maintenance CapEx, and about 20 million of it. So last year, it was a little bit higher. This year it's a little bit higher. We are expending on some capacity expansion in a number of areas. We've added an aerosol line at Rust-Oleum, we've added some capacity at DAP. We've added capacity at our TREMCO business, particularly as it relates to their residential water proofing business, which is something we acquired about a year and a half, two years ago. So, that's a good news story, and a different story from where we were, and more relevant to our complaints and a lot of people's complaints three or four years ago where industrial America is in terms of capital spending.

Thanks, gentlemen.

Thank you.

Our next question comes from Rosemarie Morbelli of Ingalls & Snyder. Please proceed.

Good morning, Rosemarie.

Good morning, all. I know you already touched on the selling price increases, but could you give us the better feel on the attitude of the large customers, and the chance that you would actually be able to recover at all, or when raw material costs stop stabilizing it, yes, stabilizing I guess is the right word, stabilizing or coming down, are they going to turn around and say, Okay, this is it, you can't get any more?

None of our customers, be they large or small like price increases. So it's really behooved us, and I say us collectively, our businesses and our sales people to convince our large customers, as well as our contracter customers and smaller customers that we have done a number of things. Number one, we've got to demonstrate that we've got a true raw material price problem, and we've done that on an individual basis. And I think it's become very evident in the broad press, obviously. The second issue is to convince folks that we've done everything we can internally to mitigate those costs and we've done that. The one thing that we will not do is compromise a formulation quality or product performance quality in light of a raw material problem. So that's an area where we draw the line. And so, once you go through that process, then you talk about price increases, and one other piece of that is trying to help our customer base to the extent it's relevant to different pieces of it, is to recapture that higher price themselves in the marketplace. So far we've been successful with that. As we've indicated, it's easier to do in our industrial segment, and those price increases were instituted, really over the summer months, towards the end of the summer, it's tougher to do in our consumer segment. But to the extent that you do it ,not only in the manner I mentioned, but also consistently across your entire customer base, I think that's how we've gotten it done. We've had price increases. Again, the timing has been very different and the amounts have been different by product line and by company. We've had price increases as of today across every one of our businesses and almost all of our product lines. We expect probably another round of price increases early this year, in light of what are continuing raw material price pressures, and as I mentioned, in some cases, material shortages or availability of material in certain areas at this stage is a more important issue than price. We are hopeful that, you know, if you believe what you read from a macro level in a newspaper that maybe this cycle is going to come to an end sometime in 2005. Time will tell.

By cycle, you are talking about raw material cost increases?

That's correct. Our history has been when we go through these spikes, they last anywhere from a 12 to a 24-month period. Some combination of slowing growth in certain areas or new capacity begins to mitigate and bring down some of those pricing issues, raw material cost issues.

And you do feel, if I translate what you said in two words. You do feel that you will be able to pass through all of your higher costs on the consumer side?

I believe -- no, I believe we'll be able to regain our gross margin profitability over the cycle. That will be a combination of price increases as well as internal adjustments that we have made and we will make. I give credit to our folks there, but, clearly our ability to maintain or increase margins back to our historical level are going to be a combination of pricing and a combination of continuing to be more efficient.

Okay. And on the industrial side, are you seeing -- you have been hurt actually on both sides of your businesses by the hurricanes in Florida. I am assuming that at this stage, there is a lot of fixing up, reconstruction, and so on going on. Are you seeing a pickup higher than what would be a seasonal pickup, are you actually seeing some of that activity or is that still in the future?

I think it's still in the future, as I indicated, Rosemarie. We are seeing better revenue growth in the early part of our third quarter than we saw in the second quarter, which is good news. And, beyond that, Idon't know that I have enough data, really, to answer your question. Other than, I think over time we will pick up, certainly some of the business we lost and then some, related to particularly commercial repair activity.

Okay. So you don't think that that's actually occuring quite yet.

Again, we're seeing higher revenues in the third quarter, but I don't have the data to to tell you what's driving it, other than it is a heartening sign.

On the interest expense, the 8.9 million in the second quarter, is that as high as it goes, or the impact was not for the entire quarter, and it could be somewhat higher in the third?

It's as high as it goes for the year, I think, because we've got a pretty good balance, about 75% fixed. And the one issue that we have is a negative arbitrage, because on a timely basis, you know, we issued bonds this fall at 4.45%. We have a bond maturing in June that has a coupon of 7%. For the first time in our history, we have probably $200 million of excess cash or 180 million, depending on the accounting. And so we have a negative arbitrage between the cost of that debt and our reinvestment options, which has been conservative, until such time as we use those proceeds to redeem the maturing bonds in June. Then you'll see a little bit of a decrease in our interest costs because that negative arbitrage will disappear.

Okay. And then lastly, I know you said you saw some pick up in volume, but when you look at past quarters and you adjust for seasonality and so on, you think it is just pick up versus a slower second quarter. Is that hiding the fact that maybe the overall trend is slowing down? In other words, the economy is actually beginning to slow, or is it (indiscernible) all of your numbers and you don't have a feel for it?

I'll tell you my gut feel in talking with our people. I said it earlier and I'll say it again. I think the economy suffered from some election paralysis, and post election, I think, you know, we're seeing a return to some higher levels of growth. You know, we are looking at more difficult comparisons year-over-year. Our results started picking up nicely in last year's second quarter. So that was also somewhat of the reason we had a slower second quarter. That will be true throughout the year. But, I really think hurricanes, consumer sentiment, election paralysis, whatever it was, we saw a slowdown and it was pretty consistently across all our businesses from where we'd been in the fourth quarter to the first quarter. Fortunately, we're seeing revenue growth pick up again a little bit. And so it's better than we were three years ago where we were really in a flat or down economy. In the markets we serve we'd see one good month and hope it was a pickup and it turned out not to be. I really believe the couple months in our second quarter that were slow are the aberration. And that adjusting for stronger quarters last year, we're still going to show some pretty good growth, particularly in our spring selling season.

Then my last question, if I may, when you add all of the positives, the negatives in terms of your higher costs, but then positive with pickup in volume and so on, is it too optimistic to look at a flat third quarter?

Again, I want to avoid discussions of providing guidance on a quarterly basis, other than what we've already done, which is we've seen revenue growth pick up from our second quarter, which is good news, but we continue to face raw material cost pressures, which are a challenge. I think, we came into this year a little stronger than we originally planned such that year-over-year we're comfortable of picking up the cost of FAS 123, which we didn't plan on. But the 2 cent impact of- higher interest costs, which obviously your interest costs are a flat, especially with more fixed rates now, a relatively flat charge month by month. The impact of FAS 123 in the third quarter, people need to keep in mind, for instance, 2 cents in our fourth quarter is not much, given the robustness of revenues and cash flow and earnings. That's certainly not true in the third quarter.

Okay. Thanks a lot.

Thank you.

Our next question comes from Greg Halter of Great Lakes Revenue. Please proceed.

Good morning, Greg.

Great. I wish we have a lot of revenue. Frank and Glenn, thanks for taking the call. Frank, you talked about the hurricane impact and the timing of shipment impact. Can you quantify that at all?

No. I don't have the data.

Okay.

In terms of being able to tell you, other than what you see in our revenue growth in the quarter versus what it was. I'll tell you the way to get at it quickly is look at our revenue growth in the quarter by segment versus what it was in the fourth quarter of last year and the first quarter of this year. And I think that will get you to the same answer that I'd come to.

Okay. And, in particular, if you could look at the industrial and consumer segments and point out any particular strong units or not so strong units?

Again, in the second quarter, the troubling thing and the good news is that, you know, we're perking back up, is softness was pretty much across the board. I think the most interesting thing to us is, three of our strongest performing businesses, well not largest business, would be our Dryvit business, our DayGlo business, and TCI powder coatings business. All three of those businesses are probably the three most, or three of the five most economically sensitive businesses that RPM has, and all three of those are growing year-to-date at double digit levels on an internal basis.

Okay. That's a good sign.

It is a good sign.

Can you comment on your ad spending? I know you had ramped that up some on, I think, epoxy tech?

That's correct. We increased our ad spending a year ago on epoxy tech. We continued that ad spending over the college football kickoff weekend in August, and we will continue that ad spending, perhaps even in a bigger manner, over the Memorial Day weekend. Again, further highlighting, kind of bracketing our selling season, the spring and then the fall is really when it makes most sense for us to do any significant ad spending on a national basis.

Okay. I haven't heard any comments on WTI in this particular quarter. How's that company doing?

It's continuing to do well. If it was on out-paced performance we would have commented specifically on it, continuing to show good growth. But in the most recent quarter it's not exhibiting the 50% plus growth that it was. And, I guess it'll take time to decide whether, at $130 or $140 million unit, whether, as you know, from $20 or $30 million five years ago, whether we're going to continue to experience very strong out of the ordinary growth in that service business, or whether we're at a level where the growth will slow down a little bit and be more normal with the rest of our business. That's a recent experience. To the extent it was a good quarter, but to the extent that that or any unit had an outsized impact on either our revenue's, profitability or margin, we would comment on.

And your available liquidity at November 30th was how much?

I think our available liquidity was 600 million. Net it was $468 million. We -- in the quarter, that brings up a good point. We had a five-year revolving credit facility with a group of good banking partners. In the quarter we renegotiated that for a new five-year term. So, you know, our next maturity is this June, by maturity, which we have the cash on hand and currently invested in treasuries to retire. Beyond that are, we have $400-some million of liquidity, and the five-year facility that we had with the banks has been renewed on very favorable basis and is now another five-year piece, which matures in '09.

Okay.

November of '09.

Do you have anything drawn on that or the receivable securitization?

I don't believe so. If we did, we used our cash to pay it off. No. Those are the pieces and parts of the $468 million of liquidity.

Okay. And can you comment on acquisition opportunities and what you're seeing out there these days?

We are eager to put that $468 million of liquidity to work. We are looking at, as I commented in the past, a number of acquisition opportunities in Europe, which would typically be free standing entities. We are looking at a number of product line acquisitions in the United States, which, from a size perspective, as you know, over the last couple of years have not been big, but from an impact on our individual operations and the ability to either bring in a new product line or integrate a product line into an existing business like DayGlo or like a TREMCO business, really has a nice impact both because of our ability to buy it at a decent price, and then our ability to integrate it. And credit to our sales people, so far in every instance, you know, we've acquired these businesses and integrated them and have seen an increase in sales. Which, when you are buying a business and integrating it into another company, particularly where there's a little bit of a competitive overlap, you run the risk in the early year of losing some revenues, and we have not seen that at TREMCO or DayGlo, so, we're pursuing more of those. Of course we continue to have the discussions with numerous, larger, owners of, or people associated with larger transactions that we've always done with the hopes that over a four or five-year period one of those would fall into place. So that's kind of a continuation of our normal acquisition activity.

Okay. One last question, can you comment on what's changed, or new, or different, or maybe not different with the contingent convertible bonds?

Yes. The contingent convertible bonds, we have a decision to make by the end of the third quarter as to whether or not to change the indenture related to the impact of potential dilution of those underlying shares. When we make that decision, we will communicate it, certainly at the third quarter conference call. I anticipate that we will take action on that.

To limit the dilution?

That's correct.

Okay. Thank you.

It's a third quarter event, and it's not been done yet. We'll communicate that. If it was done I'd tell you. It's not done. That's the only reason I'm hedging my bet. It is a simple change of the indenture and doesn't require a vote of bond holders, and we have to do it before the end of the third quarter.

All right. Thank you very much. Great results.

Thank you.

Our next question comes from Frank Dublack of Presidential Financial. Please proceed.

Good morning.

Good morning, guys. One quick one. Just looked like the number of asbestos claims was up about 700 million in the quarter. And if I had to rough it out, I would think there was maybe about 100 resolved claims and about 800 new claims just to try to get a feel for the mix there?

First of all, 700 million was maybe a slip of the tongue. We don't have -- I don't have in front of me the detail of the claims resolved in the quarter. We will file that with our Q, which will be filed Monday, Monday morning, and again, our settlement costs, on average, were down and our dismissal rate was up. So, I do not have that data in front of me.

Okay.

You know, the only thing to keep in mind is, and you can go back and look at the last couple quarters, the year-over-year quarter increase of 4000 and change, is almost exclusively unimpaired claims filed in the state of Florida.

Okay. One other one. The question earlier, you talk about a $50 million, kind of, expected, maybe, payment this year for asbestos, and somebody said, Okay, it's been 34 year-to-date. Am I supposed to think of that 50 million as a net number, which is then, it's been 21 through the first six months and will grow to 50 in the second, as the remainder of the year?

The only net number that we talked about was in the past related to insurance proceeds, and we had about $9.5 million of remaining insurance a year ago.

I'm sorry. Not net. After tax. Is your 50 million kind of guidance --

No, no, no, our 50 million guidance is pretax. Now, again, a spike in a quarter could make 50 million, 55 or 57, better performance could make it 45 or 47. So, my hesitancy was, I can't guarantee anybody over the coming quarters what one case or one group of settlements, particularly related to these overall cases in Texas, might do to a quarterly period. Barring any, particularly good news or bad news, I think around 50 million or 50 something million is kind of what we expect on a pretax basis.

Thanks. That clears that one up. And then, I think I'm done. Thanks a lot.

Thank you.

Our next question comes from Robert Kosowsky of Sidoti Company. Please proceed.

Good morning. I was wondering if you have any comments on the increase in shares outstanding over the year-over-year, even over the past quarter? Looks like up a little over a million shares.

It is stock options, which we view as a great sign, that's our people exercising options. And, for the most part, holding on to them.

Would you think about employing repurchase campaigns, maybe kind of keep the shares outstanding pretty constant?

We do not have a repurchase program -- we have a repurchase program but it's not active today. We would certainly consider a repurchase program for any number of reasons in the future, and when it becomes active, we would, I think we have an obligation to publicly let folks know that we have an active program. We do not have one today, but it's certainly possible in the future for that or other reasons.

Okay. And also, is there any changes from you guys on maybe doing a $100 million plus acquisition?

No. If we find the right transaction, a big transaction that makes sense for us, we'll certainly look at it and go out there and try to get it done. We've been very disciplined, as we always have in the past. The transactions we've gotten done in the last couple of years have been fairly valued and typically are product lines that we can integrate. But we have been looking at larger transactions, and if we can get them done on the right basis and it makes sense, we'll do them.

Okay. Also, I guess on the asbestos front, did you guys bake into your expectations a couple years ago some of the state law changes that, maybe, were about to happen when you did set the $140 million reserve?

You know, we baked in some of the changes in what was anticipated, but at the time that we took the reserve, the only state law change that was done was in Mississippi. We anticipated a little bit of what we thought might happen in Texas but did not fully, So, the answer is, yes , to a limited degree.. And, you know that's the real challenge to us to try and predict future costs, because whether it was Mississippi or Texas or Ohio, there was a real rush to the courthouse to get in new cases prior to the enactment date of all these new tort reform laws. Those are the cases that we are working through. You know, the good news is, the settlement cost of an old law case in Texas, or the costs in the jury trial in the old law case in Texas has no bearing on the future cost of a new case in Texas. The same is true in Ohio, and the same is true in Mississippi. Texas remains the state where, we'll be as candid on all these as we can, remains the state where we are incurring the highest average costs and I think the highest jeopardy in terms of settlement demands as we clean out these old law cases.

Have you gone through most of the old law cases in Mississippi and Ohio as well?

I don't know the answer to that exactly. We don't have the backlog of mesothelioma claims, which is the highest value claims, in those states as we have in Texas. And Mississippi, the law changes in Mississippi were earlier, so, if you take that 24 month timeline, we're further along the path of cleaning out old law cases and dealing with new cases. And we're certainly not getting as many. The other area that continues to be the biggest driver of our costs is the state of Illinois. As we mentioned earlier, in the month of October, we actually had two cases in Illinois dismissed on venue grounds. The first time that's ever happened for us. There's been one other case of another defendant that was dismissed on venue grounds. If the Madison County court continues to apply Illinois law on venue that could have significant positive implications at least as it relates to Madison County and Illinois which has been the toughest venue for us and anybody in this litigation area.

Hopefully the risk in Illinois would then, you know, somewhat come down. Are there any other states where' the risk could maybe come up, they'd be a little bit more, you know, friendly towards the out-of-state claims coming in?

I think that's exactly the right question to ask and is a question I asked our defense counsel. So far, you know, there is no good answer to that. The vast majority of states have some form of proportional liability. and many now have some type of caps on damages. I guess the answer I've got, and want to keep asking that is, there are other venues that could be problematic, but there are no other venues in the country that are anything like Texas was prior to their tort reform, or anything like the state of Illinois or Madison County continues to be today. Madison county particular. Best example that I've been given, and I can give to you is West Virginia, which continues to be a particularly challenging venue for any type of tort, but even there, a year ago West Virginia changed their law from a venue perspective such that to file a tort claim in West Virginia, you need to be a West Virginia resident and/or prove that you were harmed in the state. So, while we may face challenging cases in a particular venue, the opportunity to pile 2 or 300 meso filings in one location is -- does not seem to be the case anymore.

Okay. Thank you. That was very helpful.

We have a follow-up question from Jack Zekauskas of JP Morgan. Please proceed.

Yes, good morning. Just a small follow-up. Glenn mentioned that earlier part of the increase in inventory had to do with like a build in raw materials. Is this sort of like a strategic move because you expect prices to increase even further? Were there any product shortages that you were able to identify to protect yourself from? Are you like in arbitration with any of the larger suppliers?

We are not in arbitration with any of our larger suppliers. Some of it is related to making sure we have product availability, or perhaps some prebuys before next round of price increases go up. It's different by different companies. One example would be Zinsser, in the shellac area, because there's been, not only price increases, but periodic shortages of quality raw materials, to lack of. So it's different by company, but it is very much a result of the pricing environment that we find ourselves in from the raw material perspective. We are not in arbitration with any of our suppliers. We have had some challenging discussions with a number of suppliers, and it's just a very challenging environment in terms of trying to keep raw material prices down to the extent that's reasonable and making sure that we have the ample supply.

Thanks very much.

Ladies and gentlemen, this concludes the question and answer portion of today's call. I would now like to turn it back to Mr. Sullivan for closing remarks.

Thank you, Candice. Thank you, everybody, for your participation on our conference call today. I'd also like to thank the RPM employees worldwide for the outstanding efforts they've done to continue to generate record results in a very challenging environment. And we look forward to talking with many of you throughout the year ,as well as reporting our third quarter results in April. Thank you and have a great day. Happy new year.