RPM International Inc (RPM) 2007 Q2 法說會逐字稿

Welcome to RPM International's conference call for fiscal 2007 second quarter. [OPERATOR INSTRUCTIONS] Comments made on this call may include forward-looking statements based on current expectations that involve risks and uncertainties, which could cause actual results to be materially different. For more information on these risk and uncertainties, please review RPM reports filed with the SEC. During this call references may be made to non-GAAP financial measures. To assist you in understanding these non-GAAP terms RPM has posted reconciliations to the most directly comparable GAAP financial measures on the RPM website. [OPERATOR INSTRUCTIONS]

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

Thank you, Francis. Welcome to the RPM second quarter conference call. We're pleased to report strong results for the quarter ended November 30, 2006. On a 9.5% increase in sales, net income grew 186%, including a $15 million settlement payment from one insurance company associated with our asbestos insurance coverage case. This settlement is very good news. It was with the insurance carrier who had the smallest exposure in terms of coverage. There remain five other insurance carrier defendants with, in our opinion, substantially greater exposure in this case. And while we cannot guarantee that we will see any more recovery at all, we're encouraged by the momentum in the case and continue to pursue it vigorously. Excluding the impact of asbestos items, both this year and last, our 9.5% revenue growth generated a 46% increase in EBIT, a 54% year-over-year increase in net income and a 48% increase in earnings per share, driven by continuing strong performance in our industrial business and a return to positive revenue growth and positive earnings growth in our consumer businesses.

A couple more comments on our results before turning the call over to Glenn Hasman to provide the quarter details. Gross margins are flat year over year, and while they're down materially from a couple of years ago, this is the first time that we are seeing a combination of price increases in raw material costs catch up such that gross margins are flat as opposed to deteriorating. We anticipate some pick up in the coming years as we strive to get back to historic gross margin levels. You'll also recall that last year in the second quarter we took $10.5 million of one-time hits to income through SG&A expense. As has been our trend, SG&A as a percent of sales showed good improvement in the quarter. Even adjusting for these one-time items, SG&A last year would have been 31.8% of sales compared to 30.9% in this second quarter. Adjusted for last year's one-time items, EBIT increased 21%.

I'll now turn the call over to Glenn Hasman to provide more details in the quarter, after which we'll be pleased to do answer your questions. Glenn?

Thank you very much, Frank. Good morning, everyone. The P&L performance comments that follow will compare against our adjusted second quarter operating results before the asbestos-related items. That's the charge taken a year ago and the insurance settlement income that we secured this year. I'll begin with a review of our P&L results followed by highlights from our balance sheet and cash flow statements, and I'll begin with our second quarter.

This year's second quarter net sales grew 9.5% year over year to a record second quarter sales level of $809.4 million. Six acquisitions, net of a divesture, added 2% to this year's net sales. Organic sales growth amounted to 7.5%, with pricing equal to 2.2% of that and including net favorable foreign exchange providing 120 basis-points from the stronger Canadian dollar and euro year over year less a weaker South African rand and several Latin America and other currencies. Our industrial segment net sales reached $528.6 million, a growth of 13.5% over last year's second quarter. Four acquisitions added 2.2% to industrial net sales growth. Organic industrial segment growth was 11.3% including pricing of 2.9% and 160 basis-points from foreign exchange. Of note, the following industrial product lines all registered double-digit organic growth this second quarter: Corrosion control coatings; fiberglass reinforced plastic grating composites; most all of our international operations of the StonCor Group; specialty pleasure marine coatings; institutional roofing and related services; and exterior insulating finish systems.

Our consumer segment net sales of $280.8 million this quarter were up 2.6% from a year ago. The organic sales growth in this segment was 1% including pricing of 90 basis-points and 60 basis-points from net foreign exchange. Retail buying behavior continued to fluctuate this quarter, including continued inventory reductions by several of our major customers and the declines in existing homes turnover and, to a lesser extent, new housing starts have affected several lines of our business. The balance of the consumer segment sales increase, 1.6%, came from two acquisitions, net of a divesture a year ago.

Gross profit. The gross profit margin of 40.3% this second quarter equaled last year's second quarter margin. As Frank noted, that's an encouraging result for us, considering there were a number of still higher raw material costs this quarter, such as epoxy and polyester resins and latex polymers. And when compared with the margin short falls we've been experiencing for some time now, all attributable mainly to higher raw material costs. The industrial segment gross margin was steady at 42% both periods. Despite increased lower margin service sales at our Tremco business, which is partly a reflection of productivity gains from our 6.8% organic unit sales growth in this segment. Consumer segment gross margin of 37.1% this second quarter was off 40 basis-points from 37.5% a year ago, mainly the result of a new freight pick up arrangement with a major customer and from net higher raw material costs.

SG&A expenses. These improved to 30.9% of sales this year, as Frank mentioned, from 33.2% a year ago. This percentage decrease reflects leverage benefit from our organic sales growth and, of course, last year's second quarter one-time costs of $10.2 million, plus the new freight pick up arrangement with a major customer and spending controls. The industrial segment SG&A improved significantly as a percentage of sales to 29.8% compared with 31.1% last year, and the consumer segment SG&A improved to 27.4% from last year's 28%. Corporate other expenses declined to $15.3 million this year from $24.5 million last year. That essentially reflects the one-time cost we look last year of $10.2 million and that was partly offset by mainly higher compensation-related costs.

Earnings before interest and taxes, or EBIT. Total EBIT dollars grew 45.6%. That's a margin of 9.4% compared with 7.1% last year, reflecting the SG&A improvements in relation to sales. The industrial segment had an EBIT that increased 26.3%. That's a 12.2% margin on sales compared to last year's 10.9%. Consumer segment EBIT was up 5.1%, a 9.7% margin on sales compared to last year's 9.5%. Our interest expense net was up $1.4 million quarter over quarter. That reflects acquisition-related debt service plus Fed-driven net rate increases on our variable debt, partly offset by additional investment income year over year. Overall rates have averaged 5.5% this second quarter compared with 4.9% last year.

Our tax rate this quarter, 33.8%, compares with last year's 33.5% effective rate, again before the asbestos items. This year-over-year rate change reflects differences in the projected U.S., state and local income taxes, the effect of tax rates on our foreign earnings and valuation allowances associated with our foreign net operating losses and U.S. foreign tax credit carry forwards. Net income of $43.1 million this year represents record earnings for our second quarter, increasing 52.1% from last year's $28.3 million before the asbestos charge, with a margin in sales improvement to 5.3% compared with 3.8% a year ago. Diluted earnings per share, $0.34 this year, also represents a record for our second quarter, and that was up 47.8% compared with last year's $0.23.

I will now make some comments about the first six months. This year's first half net sales grew 11.2% year over year to a record first-half sales level of $1.65 billion. Seven acquisitions, net of the divesture, added 5.6% to this year's net sales growth. Organic sales growth also amounted to 5.6%, with pricing equal to 2.4% of that, and including net favorable foreign exchange, which provided 120 basis-points. Industrial segment net sales of $1.074 billion grew 19.8% over last year's first half. Five acquisitions added 8.8% to this year's industrial net sales. Organic industrial segment growth was 10.9% through six months. That includes pricing of 2.8% and 150 basis-points from foreign exchange.

The following industrial product lines have all registered double-digit organic growth for this first half: Corrosion control coatings; most all of international operations of our StonCor Group; fiberglass reinforced plastic grating composites; institutional roofing and related services; exterior insulating finish systems; and floor cleaning compounds. Our consumer segment net sales of $579.7 million were down 1.8% from last year's first half. The organic sales decline in this segment was 2.6%, including pricing of 1.8% and 70 basis-points from net foreign exchange. Two acquisitions, net of the divesture a year ago, have added 80 basis-points of consumer segment sales growth. I will skip over the gross profit and SG&A through six months since those changes are much the same as they were for the second quarter.

Moving to our EBIT line, total EBIT dollars grew 19.6% this six months, with a margin improvement to 11.1% compared with 10.3% last year. Interest expense net was up $6.1 million over last year's first half. Other than the additional acquisition-related debt service and Fed-driven net rate increases that affected our second quarter, we incurred up-front costs associated with our early retirement of $40 million private placement senior notes during this year's first quarter, all partly offset by additional investment income year over year. Our overall rates have averaged 5.5% this first six months compared with 4.9% last year. Tax rate through six months, again before asbestos items, 34.5% compared to last year's 35.2% effective rate. Net income, $104.4 million this year, represents record earnings for the first six months, increasing 19.1% from last year's $87.6 million, before the asbestos charge, with a higher margin on sales of 6.3% compared with 5.9% a year ago. Diluted earnings per share, $0.83 through six months, also represents a record, and that's up 18.6% compared with last year's $0.70 before the asbestos charge.

I'll now make some comments on the balance sheet and again, while compared to November 30 of '05, since we have seasonality, it's a fairer comparison. Net accounts receivable up $42.2 million, net acquisitions account for $12.5 million of that increase, foreign exchange translation effect accounts for another $14.2 million, and sales increases account for the balance of the increase of $15.5 million or 3%. That compares with our 6.3% organic sales increase this quarter, resulting in lower total day sales outstanding year over year. Our inventory is up $70.6 million year over year. Net acquisitions are $4 million of that. Foreign exchange translations, $7.8 million. The remaining increase, 16.1%, essentially is related to organic business growth, as well as certain strategic inventory builds, as well as the uneven retail buying behavior that I noted earlier.

Accounts payable were up $36.7 million year over year. Net acquisitions accounted for $5.5 million of that, foreign exchange translation differences were $5.3 million, and the balance of the increase came from a combination of business growth and the timing of payments, and partly offset the organic inventory increase year over year. Total debt at November 30 stood at $949.8 million including our short-term, and that's up $83.4 million year over year. That mainly reflects $109.7 million of additional indebtedness for our acquisitions during the past 12 months, less $26.3 million of debt repayments. The composition of our debt at November 30 was approximately 53% fixed, 47% variable. Our available liquidity, including cash, stood at $430.8 million at November 30. Our 44.3% net debt-to-capital position improved from 45.3% at May 31, 2006, and provides continued financial flexibility to pursue small to medium-sized acquisitions.

Our liabilities related to asbestos are reflected in two balance sheet areas. Our current liability, $58.5 million. Under long-term liabilities, another $332.6 million. That $391.1 million total compares with $421.3 million at May 31, '06, reflecting the $30.2 million in pretax payments during the first six months of this fiscal year compared with $29.9 million a year ago. Broken down, our defense costs were $13.2 million through six months this year. That compared with $9.7 million a year ago. Settlement costs have been $17 million this year, which are down, versus $20.2 million a year ago. Our total cash costs for asbestos this second quarter were $13.8 million. That's essentially flat compared to our total cash costs of $13.4 million in the same period last year. Of that $13.8 million this year, $6.6 million was spent on defense and $7.2 million on settlements, which compare with $5.2 million on defense and $8 million for settlements in last year's second quarter.

You will see in our 10-Q that we secured dismissals in our settlements of 324 claims versus 234 in the second-quarter period last year. Our number of active cases at the end of our fiscal 2007 second quarter stood at 11,021 compared with 9,501 at the end of last year's second quarter, and sequentially was quite flat with this year's first quarter active case load of 10,934. The average monthly number of new cases filed over the past several quarters continues to move down. As we've noted in the past, we will have some quarter-to-quarter volatility in our total cash costs, but overall, we are tracking generally in line with our key reserve assumptions, which we will review at year end relative to any needed adjustment to the reserve at that time.

Now I'll discuss the cash flows briefly. Our cash flow from operations was $91.4 million for the first six months compared with last year's $95.6 million, reflecting primarily the strategic inventory builds in certain circumstances and increased payments year over year for higher incentive and other compensation, based mainly on the strength of our fiscal 2006 operating performance.

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

Thanks, Glenn. A couple of comments before we get to your questions. Subsequent to quarter end, we refinanced our bank revolver to a $400 million five-year facility. This is up from our prior agreement of $330 million, and in the process we're able to obtain improvements, both in terms of transaction fees and costs as well as interest costs associated with this facility. During the quarter we completed three small acquisitions. Day-Glo acquired the Dane business based in the UK, approximately a $20 million business in fluorescent color. Our Carboline business acquired the Nu-Chem product line, adding to its leading market share in intumescent coatings. And our Tremco Sealant business acquired the Permaquik business in Canada, a waterproofing business serving that market. The combination of the Nu-Chem and Permaquik product lines will add about $12 million initially on an annual basis. We're pleased to be able to complete these acquisitions, despite a continuing hyper-competitive M&A market, particularly driven by private equity, and are pleased we remain able to identify and complete transactions at a fair price and with a great strategic fit with RPM businesses, without losing our focus on driving internal growth.

Speaking of private equity, Glenn Hasman will be leaving RPM after nearly 27 years to join a small private equity-backed business as their CFO. We wish Glenn well. He will be with us for the remaining part of this week and next, certainly to answer your questions, and I know many of you have had a good association with Glenn and for the fine job he's done, particularly in investor relations and with the financial community. For going forward, any questions should be sent to Kathie Rogers. Her phone number is 330-273-8813. Her e-mail is krogers -- K-R-O-G-E-R-S -- at rpminc.com, and Kathy will make that sure she gets any questions or calls to my attention, Kelly Tompkins, who's our Executive Vice President and Chief Administrative Officer, or Robert Matejka, RPM's Vice President and CFO, to promptly return your calls and answer your questions. Glenn will be here for the next couple of days for any follow-up calls following this conference call. Glenn?

Thank you, Frank. I want to thank everyone I've worked with over the years. It's been a nice ride. When I started with RPM, it was $100 million, so obviously I've seen a lot of change over the years. And it's been a pleasure certainly working with all of the RPM folks and certainly more recently, a pleasure working with the investment community over the past roughly eight to ten years, and I want to wish all of you the very best.

A few comments on our outlook. We expect positive sales and earnings growth from our consumer businesses, and while the growth was modest in the second quarter, early signs are that this growth is accelerating somewhat. Our industrial businesses are continue to go show good growth, but at a slightly slower rate than last year or so, all of which makes us comfortable in reaffirming our original earnings guidance for the year of earnings growth in the 10% to 12% range year over year. While this may seem modest in our second half of the year, keep in mind that for the next six months we will be comparing to a prior-year period, where sales grew by 20% and earnings grew by 30%. The key elements of our ability to meet or beat our current expectations remain the level of manufacturing and industrial construction activity and the direction of raw material costs in the coming quarters.

We'd now be pleased to answer your questions.

[OPERATOR INSTRUCTIONS] And your first question is from the line of Jeff Zekauskas with JPMorgan. Please proceed.

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

Good morning, Silke. Good.

On the industrial side can you break out growth in Europe versus growth in the U.S., and can you talk about whether you gained share in any area?

We generally haven't broken out growth by geography, but we have been growing at a higher rate in our international markets over the last six months or so than we have been growing in North America, and we see that continuing. In terms of market share, we're picking up market share in a number of areas. In the protective coatings and corrosion control coatings we've had very strong gains. After a couple years of challenges particularly from some Chinese import product in our Fibergrate® product line, we are picking up market share there, both domestically and internationally. And we continue to, in certain areas in our consumer segment, pick up shelf space with a number of new products.

Okay. On the consumer side it seems that volumes this quarter again were negative. When do you expect that to reverse?

As you'll recall, Silke, volumes were down probably 5% or so in the first quarter, and on a unit basis we were roughly flat year over year, with the year-over-year growth really the function of some small acquisitions and then pricing. And as I noted in my comments, we see that improving performance continuing. And so in the coming months we certainly expect to show continued improvement on a quarter-by-quarter basis, starting with a rather meager first-quarter performance and flat year over year in the second quarter, and we would expect to be up in our consumer product lines in our third and fourth quarters.

And then lastly, can you give an update where you stand with discussions with the other insurance carriers and like an estimate that, if there were favorable outlook as like how much you possibly could recover?

We really can't get into the details with the other carriers. There are five remaining carriers and in our opinion, they have substantially greater exposure than the one small carrier that settled out. I think the fact that a carrier has taken a look at this case and decided to settle now with a cash payment bodes well for the balance of the case. And as I have said on prior calls, we still have an opportunity here with this case to either have a reinstatement of insurance, which would cover a substantial portion of all our future asbestos liability, or we could end up with the goose egg depending on the outcome of summary judgment, which should come sometime this year, late winter/early spring, or the ultimate outcome of a trial, which is where we're headed at this stage with the other carriers.

Okay. Thanks very much, and best of luck to Glenn. We'll miss him.

Thank you very much, Silke.

Your next question is from the line of Saul Ludwig with KeyBanc. Please proceed.

Morning.

Morning, Saul.

Hi, Frank. You mentioned that your inventories were built intentionally, I think, in anticipation of better times ahead in consumer. Was that the reason the inventories were built or was it because you didn't sell as much as you thought you were going to sell?

It is a combination of both, Saul. We've built into the year, particularly in consumer, anticipating some levels of higher growth. And as we've commented in the past, principally associated with one or two of our major accounts, some inventory adjustments impacted buying patterns. Subsequent to quarter end, we're seeing that shift in a positive manner, and we would expect to see a better working capital performance for the balance of the year.

Could you talk about Rust-Oleum? We haven't heard much about Rust-Oleum in the last two or three conference calls. Are things starting to sort of disappoint there in any respect?

Not at all. Rust-Oleum is doing extraordinarily well. We have a number of new products that are just being introduced to our major retailers, so we're picking up some shelf space, and I qualified that in an earlier comment. It's really not picking up market share so much as it is picking up shelf space in some new products. As you'll recall, a year ago we put the responsibility for our Zinsser businesses under Rust-Oleum, so they have been very busy with our Zinsser businesses, particularly with our major accounts, and we anticipate that that will come to some very good outcomes here as we get into the first part of calendar 2007. So the Rust-Oleum® team is doing extraordinarily well. They've got some bigger responsibilities with the Zinsser product lines, and quite the contrary, so far so good. And we anticipate, as I said earlier, again these are modest growth rates, but the improvement in performance from the first quarter to the second quarter should be continuing as we get into the third quarter and into the fourth quarter.

Finally, in light of the management change at your big customer, do you anticipate any changes in the way you're going to do business with those guys?

Home Depot is, on a consolidated basis, RPM's single largest customer and certainly the largest customer of our consumer businesses, and we've had a great run with Home Depot. They've got a great group of associates who have been partners with us, and we continue to do good things there in category management. There have been a number of operational disruptions at Home Depot over the years, and we think for a number of reasons those are improving, and will improve.

Great. Thank you. Glenn, best wishes to you, too.

Thanks very much, Saul.

Your next question is from the line of Edward Yang with CIBC World Markets. Please proceed.

Thank you. Good morning, Frank. Happy new year.

Good Morning, Ed. Happy new year to you, too.

The first question on the insurance settlement, the five other insurance that haven't settled yet, do they represent 90% of the remaining liability, 80%, would just appreciate context there?

I'd be hesitant to put any numbers on that, but suffice it to say that the insurance carrier that settled was, in fact, a major, very sophisticated carrier with a very modest exposure versus the remaining carriers. And so, in relationship to their settlement dollars, we would expect substantially different things, not only from the remaining group but from individual carriers. And the fact that a very sophisticated insurer has, at this stage of the case, decided to spend real dollars to settle I think bodes well for the outcome. But I'll reiterate, the outcome on this -- and this kind of gets to your question -- could be as substantial as either settlement dollars and/or reinstatement of insurance that would cover the substantial portion of our future asbestos liability or nothing. And so we are still in that stage of very aggressively pursuing what we think is the appropriate outcome after this group of insurance carriers improperly claimed exhaustion and stopped honoring their contracts.

And Frank, I think in the past you've said philosophically that you didn't want to take a nickel-or-dime approach to settlement, and you wanted zero or something very significant?

That's correct.

And when you think about something significant, just understanding the thought process a little bit, your asbestos reserve on the balance sheet is almost $400 million.

That's significant.

You also paid out $200 million in asbestos out of pocket since the fiscal first quarter of '04. Would you -- I guess you would argue should have been covered by insurance? If you think about the best case scenario -- and I understand there's a lot of uncertainties -- if the best case scenario were to prevail, would you receive the $200 million that you paid in the past that wasn't covered by insurance and you would also be indemnified for the future $400 million that you have reserved on your balance sheet?

Essentially, Ed, there's three areas. Number one is, is that we feel strongly that the claims of exhaustion were improper, which means that these carriers should have been, and in most instances should be and should be continuing to cover the substantial portion of our asbestos liability. That really covers two pieces of this, which is what we have paid out and then what we will pay in the future. And then the third piece is we think there is evidence that certain changes in insurance industry practice are such that the insurance carriers did what they did deliberately and knowing they had an obligation to continue to cover us. So who knows what the value of that is. So those are the three areas where we feel the actions by the insurance carriers were improper and deliberately so.

Okay. And just moving away from the legal situation and on in your outlook, I was somewhat surprised that you're still looking for consumer revenue to be positive year over year. When I looked at the text in the press release, you reiterated guidance, but last quarter the consumer weakness was mostly an inventory issue, but this quarter the language seems to indicate there's a little bit more negative retail take away. I'm just trying to understand what you're looking for for industrial versus consumer, relative to what you expected last quarter?

Well, we think that certainly in the third quarter and into the fourth quarter we will see a continuation of steady improvement in our consumer business results, so -- and early signs in our third quarter, which started on December 1, are that there is a strong retail take away, and you have to separate our products, which are relatively low value -- patch and repair, decorative, consumer maintenance products -- versus some of the reports on retailers that you're seeing related to the Christmas season, and clothing, electronics, white goods, things like that, which, depending on the category, have had a fair Christmas or fair fourth quarter or lower bad fourth quarter. That's not our space, and so early indications in our space with most of our channels is that there is solid consumer take away and certainly better than the last couple of months. And given the characteristics of our businesses and the trend that we're seeing, we're not going to go from being down to being flat to being up 10%, but we are seeing and we expect to see a continued improvement, both in sales growth take away, and bottom line growth in our consumer segment.

And it seems, Frank, that on the margin how much -- what do you need to happen in housing, both existing and new construction to be able to meet your guidance? We've heard so many conflicting things out of housing.

Sure.

Do you need housing to stay where it is now or are you baking in some additional weakness going forward or are you baking in some improvement?

I think our assumptions are that economic activity stays like it is, and that includes our industrial businesses. Our industrial businesses are continuing to show great performance. We expect lesser year-over-year growth in our second half, but that has more to do with a tremendous finish to last year with high high teen internal growth, and on a consolidated basis 20% revenue growth and 30% net income growth. So we've got a big mountain to climb on a comparable basis, but we are not anticipating a pick-up in activity from where we are, which is obviously soft in certain areas. We're also not anticipating any deterioration. The other element that I mentioned in my comments is that raw material costs have seemed to stabilize to meet or beat our expectations. We don't need them to improve, but we are also not anticipating any further deterioration. So as we said in past quarters, raw material costs will also have a meaningful impact on our ability to meet or beat our expected performance for the year.

Okay. Thank you very much.

Your next question is from the line of Amy Norflus with Pilot Advisors. Please proceed.

Morning, Amy.

Hi, good morning. Great quarter. Good luck, Glenn. And Frank, you have some tough shoes to fill. Regarding the asbestos claims, I know we've kind of hashed this out, but the $15 million that you already received, can you break that out? Is there any pain and suffering in that? Is this insurance carrier going to go ahead and reinstate and how did you come up with that number?

This $15 million is, again, from one carrier. It's a cash payment, and it releases them from essentially any future claims associated with the case. Without getting into details that are subject to a confidentiality agreement, they were a minor player compared to the remaining five insurers. And so this is good news, and at least in terms of momentum and trend, good news way beyond the $15 million settlement amount.

And was it that they came to you and they said we didn't like the facts, we want to settle? Or was it you constant talking with them and how did it all take place?

You know, I don't think it's appropriate to get into the details of how we're pursuing the case, but they were a minor player. They're a very sophisticated insurance company, and the fact that, given their limited exposure, they decided they wanted to get out is good news.

Okay. And you're in talks with the other five right now or --?

I am really not, again, at liberty to give you too many details, other than we think in a few instances that the acts of some of these carriers has been so deliberate and so egregious that we expect at this point in time to pursue this case to a jury trial and full reinstatement of all future insurance and insurance that they should have paid in the past. And that's a process by which these lawsuits will properly put these insurers back in the place that they should be and should have been, or this process gets derailed in the legal process and we get nothing. Again, without going much further with the remaining carriers, we think it's appropriate that we pursue full reinstatement of our insurance and reimbursement of past costs, and if a jury sees appropriate, some amounts associated with what we think is a deliberate breach of contract.

Okay. And the earliest, March/April, is that when they open up again or --?

The wheels of justice grind fine, but they grind slow. And we are in a federal court in Cleveland, have an excellent judge, but they have a full docket. And we are continuing to proceed, but we're proceeding at the pace that the federal court system proceed at. Our discovery is essentially done, motions on summary judgment are due, and it's up to the federal court here in Cleveland to slot the time as to when they'll review those and make a ruling. Once there's a ruling on summary judgment, the case could either be thrown out or could proceed to a jury. If we get through the summary judgment phase, I think that this whole situation ratchets up to a new and better level from our perspective. And I think the fact that a very sophisticated insurer before that time looked at the facts of this case and decided to make a settlement suggests, at least in one case, that there's a very sophisticated insurance company out there that thinks we have a good case.

Okay, great. Well, thanks. Lots of luck. Good luck, Glenn, and keep up the good work.

Thank you.

Thanks, Amy.

[OPERATOR INSTRUCTIONS] Your next question is from the lane of Rosemarie Morbelli with Ingalls Snyder. Please proceed.

Good morning, all. My best wishes to Glenn.

Thank you, Rosemarie.

When your SG&A was reasonably low, was there anything special in it -- and that applies to corporate expenses, et al -- is there a question of timing of some payments, such as self insurance or other things like that, that are going to pop up in the third quarter?

No, Rosemarie. The SG&A results for this quarter are really without any exceptional items. That's why I mentioned in my comments, I think you need to back out the $10.2 million of expense last year, which gets you down to a better comparison of last year, I believe 31.8% versus the 30.9% this year. So we are continuing to show good -- for the third or fourth year in a row -- improvement in SG&A, and it's a combination of two things. It's a combination of benefiting from revenue growth, as well as very deliberate expense control on the one hand, and I think a more focused growth investment strategy for internal growth in the other, where we are targeting our SG&A dollars at proven or bigger growth opportunities, and so it's been working. And it's a process that operating people here at the corporate office and our operating people in the field have been have been pursuing deliberately. And one further comment on that, if and when we see some relief in raw materials, with the SG&A improvement we've experienced over the last four years, I don't know if we'll get back to our historic gross margin levels -- it's certainly our goal -- but if and when we do, you're going to see an EBIT level as a percent of sales that's substantially higher than its ever been at RPM.

In other words, we may not go back to the higher gross margin level, but then you will make up the difference at the SG&A level as you continue cutting costs?

We have been, and we certainly expect in the coming years to see our gross margins start to move in the right direction. We won't recover all of the gross margin deterioration in the last four or five years, because some of it has been a deliberate mix issue. As our Tremco services business has grown, as I've mentioned before, that's been at a decidedly lower gross margin than our product sales. Illbruck came with a gross margin that was below the RPM average, so that's brought down our average deliberately. But there is a good 250 basis-points of gross margin deterioration, which is entirely associated with raw material costs that we have not been able to cover through price increases.

Okay, that is very helpful. Thank you. And if you could give us a little more on the small acquisitions you recently made, what kind of growth rates they have, what kind of margins, and what kind of growth are you expecting in the future? How much of your RPM products can you trickle down those new channels?

It depends on the particular acquisition, and I'll just give you some examples of the ones that we just completed. The Dane acquisition of Day-Glo is a very deliberate part of their strategy of expanding their global presence, and so that's a business that's very strong in the UK, has a strong presence in Asia and in other parts of Europe. The Nu-Chem acquisition of Carboline really rounds out their intumescent coatings. We now have solvent-based coatings, water-based coatings, basically leading technology in intumescent coatings at all levels, from cementitious fire proofing to decorative intumescent coatings that go more into commercial applications. So it really rounds out for the Carboline sales force and the Nu-Chem sales force as complete a product line in terms of fire proofing protection and coatings as exists in the marketplace. Permaquik is a great addition to Tremco Sealants, and I would expect over time that the Permaquik sales force could see some accelerated growth by the inclusion of some other Tremco products. Those are just three examples to give you a sense of what these smaller acquisitions will do for different RPM companies, whether it's help expand our geographic presence or take a product line that can be expanded more quickly through our larger sales forces or distribution.

So realizing that they are very small entities, could they add over the next five years, for example, an additional 1% to 2% growth rate to your whole Company growth or is that a little too optimistic?

It depends on the transaction, but collectively if -- as we've indicated in the past, our goal has been to do about 5% of our revenue base in acquisitions, so if we're able to do $100 million in these acquisitions per year -- two, three, four of them -- and fit them in properly and then accelerate their growth because of either what they do for the RPM business that acquired them or what the RPM business can do for those product lines, that certainly helps accelerate internal growth in future years.

I really meant the growth once you have had them for one year.

Absolutely, and that's what I'm saying. Again, the way we count internal growth is any growth of a business once it's annualized the acquisition. So if in the second year, Rosemarie, we can take a product line and expand it into broader distribution, and that helps accelerate the growth in the second and third year, that's certainly part of the internal growt,h which would only happen because of the strategic fit of a particular product line to an existing RPM business.

Okay. And then you have talked about seeing some signs of slowing in the industrial segment. Is that both in the U.S. -- and we know it is slowing here -- but are you seeing it internationally and which particular areas are you seeing with most of the slowdown?

It's mostly in North America, and it's mostly in construction activities and to the extent that -- as we talked about in the past, to the extent there's some product lines in our Tremco Group that are actually associated with residential new construction, such as below-grade waterproofing for basements or some of the admixtures of Euclid that go into residential new construction, that's certainly been hurt, and we've talked about that for the past couple of quarters. But the exposure of our product lines to major industries -- power, petrochemical, pharmaceuticals -- that's continuing to be relatively robust, and in general commercial construction activities continuing to be okay.

I have been reading articles regarding the fact that actually commercial is beginning to slow down, as is maintenance type of areas. Have you seen it?

Not yet, but we're certainly cautious as we read the same articles, but we're not experiencing that yet. And so far, with a few exceptions that I mentioned, we're in pretty good shape.

Do you usually lag by three to six months or more than that?

It depends on the product line, Rosemarie. We certainly lag, particularly in construction activity, because as construction activity slows down, we are still servicing projects that were started now or in prior months.

And I know you have talked about the industrial segment slowing for the last couple of quarters, but have you seen an acceleration of the slowdown or is it more or less at a similar level?

It's generally at a similar level.

All right. Then lastly, if I may, could you bring us up to date as to the progress you are making on reintroducing Dryvit to the residential market?

It's going a little slower than we anticipated, but it's going very well. The acceptance is good. In fact, there was a new project in Brooklyn, very small, that is using Dryvit along with other grain materials and really focusing on either residential construction or multi-unit residential construction and the energy efficiency aspects of their buildings, and the EIFS component -- and Dryvit is by far and away the largest market share leader there -- is becoming a critical part of those more environmentally-friendly building practices. So we see it going well, although it's going somewhat slower than we anticipated, I think partly because of the slowdown in the residential market.

Okay. Thanks a lot.

Thank you.

Your next question is from the line of Greg Halter with Great Lakes Review. Please proceed.

Morning, Greg.

Morning, guys. And Glenn, congratulations on the move and hope it's a profitable one.

Thanks a lot, Greg.

We'll miss you. Wondered if you could comment on the full year's tax rate for fiscal '07 and then what you foresee for '08, if you have any kind of feeling at this point?

I think for this year the full rate is going to be somewhere around 34.5%, and I couldn't tell you -- I couldn't give you any guidance at this point about our fiscal '08, which starts June 1. Our tax rate will move like any tax rate, and, obviously, with new regulations coming out, new tax issues coming out, a new Congress, who knows where tax rates are going to go. But our tax rate doesn't move big up or down, so as you're thinking about 2008, I'd look at that 34.5% rate and give yourself a little bit of a cushion, and then as we get closer to the year, we'll have a better sense in terms of guidance.

Okay. Is 36% too much of a cushion, 150 basis-points higher?

Hey, listen, the bigger, the better. [LAUGHTER] I certainly wouldn't go any higher than that.

Okay.

And again, that's assuming that there are no dramatic changes in tax rates or things like that.

All right. And then you commented on the mergers and acquisitions outlook for the Company, but I wondered if you could provide some input on where you're looking currently and whether or not you think you're being priced out of the box at this point and what kind of valuations are you willing to pay, either in EBIT or EBITDA or whatever metrics you want to use?

I won't get into the valuations that we'll pay, other than to say that we've been consistent in the way that we value businesses for the last 30 years. And over the cycles of that 30-year period there have been periods in which we are a high payer, and over some of those cycles there are a period in which we are a below-average payer, and we are certainly in that period at the top end where we are getting priced out of the market by private equity. Private equity tends to drive billion dollars plus deals, which is not our space. But particularly in Europe we have seen $100 million, $150 million family businesses that are looking at valuations that don't match up with where we will get a deal done. And in some instances those deals are being bought up by private equity firms. In other instances they're not selling to private equity because they don't want to, but they got ten or 12 times EBITDA in their valuation sights and that's not where we go. And at some of these levels you just can't compete as a strategic buyer, because you don't have the extraordinarily leveraged capital structure that some of these private equity firms are now using.

I don't think in the long run some of these aggressive capital structures are sustainable, especially if there are any hiccups, and we will still be here doing acquisitions at good fair prices for sellers, as we've always done for 30 years, and that are good strategic fits with RPM. In the interim, the transactions that are getting done in the $20 million, $50 million, $70 million and $100 million range, we are still very competitive, deliver great value, and we see opportunities continuing in the coming years.

All right. And wonder if you could comment on the raw materials that the particular items that you see are moving favorably on a price basis? And then I think you mentioned several where they're still going up or not coming down, at least?

In general raw materials have now stabilized. We've seen some hiccups in epoxy resins this summer and early fall that we didn't anticipate, which is a combination some raw material inputs and perhaps some discipline between resin suppliers, whatever that is. And we have seen some weakness in some other raw materials. So in general they have stabilized. We're seeing some costs trending down. They are not yet anywhere near the levels below -- or at or below where they were prior to the hurricanes last year. And so we anticipate with a little slowing economy and where oil prices are that we should start to see some raw material improvements, except for the fact that in some major areas we're not. We've seen them stabilize. So that's the best I can tell you, other than to reiterate comments that we've made on prior calls. There is significant capacity coming on in the chemical space in the Middle East and China, should be coming on in calendar '08, '09 and '10. And all of that bodes well for supply and the direction of raw material costs on a longer term or more intermediate term basis.

Okay, great. And I know you've made a foray into India with Kemrock. I just wonder if you could comment on your own thoughts on how India is like China and unlike China, and I think so far you've been hesitant to really do much in China so far?

Yes, we have in China probably about a $15 million or $20 million base of business and growing. It's split between three or four different business; our Dryvit business, our Wood Finishes business, some Tremco business, more project related Stonhard business. The differences between China and India for us is that I think, because there is no rule of law and no intellectual property protection in China, it's still difficult to produce consumer products or building materials in China for the Chinese market without having your product technology or your know-how knocked off and with no recourse. And at the same time, even without that, without facing significant competition from lower-priced, substantially lower-quality products, our Dryvit business is a good example, and we're starting to see this turn. We literally sat down with the Ministry of Construction eight or nine years ago and introduced the Chinese Minister of Construction to EIFS, which is a tremendous product for the northern portions of China. We have a relatively small market share in an EIFS business that's growing like a weed. And three to five years later finally some of low-priced, low-quality product are falling off walls for what should be a product that lasts 30 or 40 years. So I think quality issues are going to start to help us there.

India, on the other hand, while it's quite bureaucratic, it has a rule of law. You can better protect intellectual property. And I think in the long- and short-run we're finding, for smaller specialty businesses like ours, India is a better place to start up and do business, where as for big infrastructure and big chemical plants and big investments, the Chinese government is more direct, gets things done, such as this multi-billion dollar BASF chemical plant that just came online. We like India. Our investment in India since we made it, albeit small in a small public company, has doubled in three months. Our business continues to grow at significant double-digit rates, and we are looking at other opportunities in India, albeit small.

All right, great. Thank you and hope Glenn doesn't give you too much competition on the private equity side. [LAUGHTER]

Thanks.

Your next question is a follow-up from Saul Ludwig with KeyBanc. Please proceed.

Just a quickie. You may have commented on this before, but I missed it. The corporate expense, which was $8 million in the first quarter and now $15 million, what was $7 million more and what should we be thinking about this number as we look at the balance of the year, because there is such a big difference in lack of continuity?

I'll have to get back to you on that, Saul. I don't have a quick answer to that. I think the $15 million number in the second quarter is a better number, a more normal number for us. I'll have to look back at the first quarter. I don't have that data in front of me to, A) confirm what it was and, then B) get a response as to why there is a difference or if there was something unique about it. Nothing comes to mind.

To Frank's point, Saul, the second quarter number is more the normal run rate, corporate expenditures.

Well, let's see. Last year in the third quarter you had $13 million, and then in the fourth quarter you had $15 million.

Right. This quarter we were about $15 million.

Okay. So it's the first quarter that was unusual, although it's been $10 million every year in the first quarter.

Yes.

And then the final question on this asbestos -- this one settlement that you took for the $15 million, was this a sort of that carrier saying we better sign up for $15 million because we can get dinged for a lot more if the summary judgment went the other way? In other words, how much was sort of left on the table on your end by agreeing to the $15 million versus what might have been had you got a favorable ruling from the court?

I guess I can answer that two ways. First of all, clearly this insurance carrier decided that it was in their best interest to settle this now as opposed to stay in this case, and beyond that their decision process I don't have any insight into.

How about from your perspective?

From our perspective, again I'll reiterate what I've said earlier. I think this is good news. This was a minor player, and their exposure was minor to the remaining five defendants, and it is a very sophisticated insurance company. And so their decision to settle now and for the amount they settled is very good. Our expectation of the remaining defendants at this stage is that they have an obligation to reimburse us for past expenses that we have paid that they should have paid. And they have an obligation based on terms and conditions to cover most of our future asbestos liability, and that is the basis on which we're proceeding.

What was the reason you took this into income as opposed to reducing your reserve, if you will?

Well, the state of the world in which we're in now -- you know, it used it be, to be very direct about it, is that when you had longer-term liability reserves, if you were under reserved, that was bad. If you were properly reserved, that was good. If you were over reserved, as long as you weren't playing games with the higher reserves, that was better. The state of accounting and Sarbanes-Oxley now is an effort to make every reserve level exactly right. And so, if you're under reserved, it's bad, but if you're over reserved, it's bad. Trying to determine exactly what the proper reserve amount is for any accrual or liability item, as if it's a specific number, is practically impossible because nobody has a crystal ball, but also practically kind of what's being driven by the current Sarbanes-Oxley and accounting environment, which we're in. And so, when we set out our reserve a year ago, we made the determination and communicated it that we would review the reserve annually at year end. And so, the possibility exists, whether it's this year end or a future year end, that we would actually take an additional charge to refresh or slightly increase our reserves for the ten-year period at the same time that we're getting income in separate periods. And that is the state of trying to be exact of accounting today.

Great. Thank you very much, Frank.

Your next question is from the line of Steve Schwartz with KeyBanc. Please proceed.

Good morning, gentlemen.

Morning.

Two questions, Frank, primarily related to Home Depot. Where you talked about the stop and start buying patterns in consumer, I assume that that's related to their transition to the centralized auto replenishment program?

I believe it's a combination of two things. I think it's -- in different product category and in different areas it's a combination of that centralizing. Basically they went from a decentralized purchasing regiment to a more centralized purchasing regiment, and perhaps got a little ahead of themselves in terms of their system's ability to give management all the information they needed centrally to drive purchasing, procurement, logistics on a centralized basis. And then the second is in competition with other retailers just from a top down looking at their level of investment in inventory, and deciding that it needed to be lower. Wal-Mart has been a good example of a retailer with pretty sophisticated and basically home-grown systems that, when they do inventory adjustments, they're always painful but they're one time and they're relatively smooth, so I think that at a Home Depot that's been some of the issues there.

Okay. In their November call they said they were at 26% of their inventory on this new system. Would you say that all of your products are in that 26% at this point?

I don't know. What I do know is that our consumer take away is continuing to improve. And I think at the end of the day that's the item that we look at, because ultimately, whether from one month to the next or one quarter to the next, our buying patterns are disrupted. If there's good consumer take away, our order flow with major accounts will catch up, and we're seeing that now.

Okay. And then the second thing, in your last conference call you made some comments about your shelf space allocation within Home Depot. Can you give us an updated on that? I thought I recall you saying that you'd actually lost some shelf space?

We had. Going into the end of this fiscal year for us, we had lost some shelf space with our Zinsser primers, and we have regained that shelf space. Given the seasonal nature of our businesses, regaining shelf space in November, December and January doesn't have the pop that it should have as we get into the spring months, but we have regained that lost shelf space. Beyond that, we continue to pick up share and/or shelf space through new products with our DAP products and with our Rust-Oleum products.

Okay, great. Thanks, gentlemen, and best wishes, Glenn.

Thank you very much.

Thank you.

There are no further questions at this time. I would like to turn it back over to Mr. Frank Sullivan for closing remarks.

Good, Francis, thank you very much. Thank you all for participating in our second quarter conference call and for your interest and investment in RPM. I would also like to thank the RPM associates worldwide for continuing to deliver for our customers and for driving record performance for our shareholders. In particular, I'd like the note the retirement of Noreen Wendt at December 31, 2006. Noreen was RPM's corporate office manager. She spent nearly 40 years with our founding Company, Republic Powdered Metals, and then RPM International, Inc. Started with RPM when we were a $3 million business working for a gentleman that reported to my grandfather, RPM's founder, and retired this year with RPM revenues in excess of $3 billion. We wish Noreen well. I mention Noreen, both to thank her for her nearly 40 years of service, and to provide some indication and thanks to the many long-term dedicated RPM employees worldwide. Thank you all, and happy new year.

Thank you for your participation in today's conference. This concludes the presentation, and you may now disconnect. Good day.