RPM International Inc (RPM) 2012 Q2 法說會逐字稿

Welcome to the RPM International conference call for the fiscal 2012 second quarter. Today's call is being recorded. This call is also being webcast and can be accessed live or replayed on the RPM website at www.rpminc.com. 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 risks and uncertainties, please review RPM's reports filed with the SEC. During this conference call, references may be made to non-GAAP financial measures. To assist you in understanding these non-GAAP terms, RPM has posted reconciliations for the most directly comparable GAAP financial measures on the RPM website.

Following today's presentation, there will be a question and answer session. (Operator Instructions) Please note that only financial analysts will be permitted to ask questions. At this time, I would like to turn the call over to RPM's chairman and CEO, Mr. Frank Sullivan, for opening remarks. Please go ahead, sir.

Thank you, Jennifer. Happy New Year, and welcome to the RPM International Inc. quarterly conference call for the second quarter ended November 30, 2011. As you saw from the earnings release this morning and related to our comments about our second quarter during our October conference call, there are a lot of moving parts in relationship to one-time gains in last year's second quarter and a number of offsetting one-time gains and one-time expenses in this year's second quarter, principally related to investment in acquisition activity. When you strip away the non-operating expense from last year and the various non-operating gains and expenses in this year's second quarter, we believe the right way to look at our results from an ongoing operating basis is the second quarter, where sales grew 10% and net income and earnings per share grew about 9% year over year. From a segment perspective, the non-operating income and expense items principally impacted our corporate expense categories and our industrial segment.

If you strip these non-operating items out, our industrial segment generated a year-over-year second-quarter performance of 10% sales growth and 10% earnings growth, while our consumer segment generated a year-over-year performance of 12% sales growth and a decline in EBIT of 2%. Continuing raw material challenges and the balance of higher cost versus pricing actions resulted in less than desired leverage to the bottom line in our industrial businesses and a decline in profit margins in our consumer businesses.

Our goal in coming out of the recession was a focus on growth in global expansion and we have been aggressively and successfully executing on this strategy. We are picking up market share in the vast majority of both our consumer and industrial businesses, in excess of underlying market growth. In recent months, we are also seeing the first signs of some lessening in significant raw material categories with the sole exception of TiO2, which only really impacts our consumer segment and more specifically, Rust-Oleum. It is important to note that the combination of the non-operating income and non-operating expense items in this year's second quarter almost all relate to our ongoing acquisition activity.

We've increased our investment in Kemrock in India to a level of 23%, allowing us to account for this investment for the first time on an equity basis. With the closing of the FEMA EIFS and coatings business in Germany on January 3, 2012, we have completed more than $160 million of annualized sales from acquisitions during this fiscal year. While these acquisitions have resulted in the expense of significant deal transactions, including on a number of the smaller transaction's broker fees, as well as one-time hits to the cost of goods sold and the relationship to inventory write-ups, all of which are in our industrial segment results, all of these acquisitions will be nicely additive to sales and earnings towards the end of our 2012 fiscal year and for our full 2013 fiscal year.

I would now like to turn the call over to Bob Matejka, RPM's senior vice president and chief financial officer to provide you details on the quarter, after which we'll answer your questions. Bob?

Thanks, Frank, and good morning, everyone. We thank you for joining us today. First, I'll review the results of operations and cash flow activities for our fiscal 2012 second quarter, comment briefly on some year-to-date results of operations items, I'll touch upon a few November 30, 2011 balance sheet measures and then I'll turn it back to Frank for closing comments before we take your questions. Our fiscal 2012 second-quarter results resulted in a consolidated net sales increase of 10.9% over the prior year to $916.1 million, principally due to volume improvement of 5.1%, price increases of 2.9%, and acquisition growth of 3%. These all were partially offset by unfavorable forex of about 0.1%, almost nonexistent on the forex side. The industrial segment net sales of $641.5 million, which accounted for 70% of net sales, increased 10.1% over last year with acquisition growth of 4.2%, volume increases of 3.2%, price increases of 2.9%; all which were partially offset by unfavorable foreign exchange of about 0.2%.

At the consumer segment, net sales of $274.6 million increased by 12.6% over the same quarter last year, with 9.5% attributable to unit volume growth, 3.0% from positive price, and 0.1% attributable to acquisitions. Forex had no impact on the consumer segment during this quarter.

Our consolidated gross profit increased to $369 million from $339 million last year, principally due to the higher sales volume, price increases, and some favorable mix. As a percent of net sales, gross profit declined by 80 basis points to 40.3%, due to the persistently high cost of raw materials.

Consolidated SG&A increased roughly 12.5% to $281.9 million from $250.6 million last year, due to the increase in the variable costs that are associated with higher sales volumes, such as compensation and benefits, distribution costs, advertising and promotional issues, as well as acquisition costs associated with our increased M&A activity. As a percent of net sales, SG&A increased to 30.8% of sales from 30.3% a year ago.

Earnings before interest and taxes, or EBIT, increased to $93 million this year from $89.4 million last year, due principally to the higher sales volumes. Realized price increases were not able to offset the higher raw material costs, resulting in an EBIT margin percent that declined from 10.8% to 10.2%.

At the industrial segment, EBIT increased 14% to $78.3 million from $68.7 million a year ago, driven by overall 10.1% increases in sales, including price increase, and a favorable sales mix. These improvements were more than offset by higher raw material, resulting in an EBIT margin increase to 12.2% of net sales this year compared to 11.8% last year.

Our consumer segment EBIT declined 2.0% to $26.7 million from $27.3 million a year ago. The sales increase to 12.6%, including price increases of 3%, were not able to offset higher raw material costs and an increase in variable selling expenses that are associated with higher sales volumes.

Corporate and other expenses increased by $5.4 million, primarily due to the higher acquisition costs of $3 million and insurance reimbursements in last year's second quarter of approximately $2.9 million that did not repeat this year.

Interest expense increased from $16.4 million a year ago to $17.9 million and this is primarily due to the issuance of an additional $150 million in debt in May of 2011, a higher average interest rate year over year and increased borrowings associated with this year's increased acquisition activity.

Investment income decreased $3.3 million year over year, primarily as a result of gains on sales of marketable securities last year of approximately $3.2 million that did not recur this year.

The income tax rate of 29.2% for the quarter compared to last year's rate of 30.8%, principally due to the change in the jurisdictional mix of actual and forecasted earnings, the impact of certain foreign operations on our U.S. taxes, and adjustments to certain tax valuation allowances.

The bottom line net income attributable to RPM shareholders increased 2.3% to $49.9 million compared to last year's $48.8 million and EPS was flat to last year at $0.38 per share.

As you've seen in our earnings release and Frank's comments at the beginning of this discussion, we previously reported that last year's second quarter included roughly $7.5 million of nonrecurring items representing an after-tax benefit of approximately $0.04 per diluted share. This year's second-quarter result of $0.38 per share include the benefit of the company's equity ownership in Kemrock Industries and Exports Ltd., totaling about $0.04 a share, which was offset by $0.03 per share of costs related to higher acquisition-related expenses. Excluding one-time items in both years, EPS for the second quarter of this fiscal year of $0.37 per share exceeded EPS for the same quarter last year of $0.34 a share, or an increase of 8.8%.

Now, a few comments on our year-to-date results -- consolidated net sales increased 10.5% to $1.9 billion from $1.72 billion last year, principally due to a volume improvement of 3.6%, price increases of 2.9%, acquisition growth of 1.9%, and favorable forex, or foreign exchange, of 2.1%. EBIT increased 8.6% to $229.5 million this year from $211.4 million last year, due principally to higher sales volumes. Realized price increases were not able to offset higher raw material costs, resulting in an EBIT margin that declined from 12.3% to 12.1% of sales. The net income attributable to RPM shareholders on a year-to-date basis increased 7.6% to $126.7 million compared to last year's $117.8 million. EPS increased 6.6% to $0.97 per share this year compared to $0.91 a share last year.

Looking at the balance sheet and cash flows, we find our six-month capex of [$18.4 million] (corrected by company after the call) compares to $15.3 million for fiscal 2011. The depreciation and amortization expense increased slightly to $36.9 million from last year's $36.7 million.

Cash from operating activities for the year to date of $110 million compares with $183 million a year ago. Increases in inventory of $24.7 million attributable to higher material costs, and a reduction of $46.3 million in accounts payable due to timing differences of payments, and a negative swing in other accrued liabilities were the main factors that contributed to the decrease. Our receivable days sales outstanding was 61.6 days compared to 58.7 a year ago and days of inventory of 84 this year compared to 80.2 days last year.

Finally, a few comments on our capital structure and overall liquidity -- as of November 30, 2011, total debt was $1.1 billion compared to $925.1 million last November. On May 24, 2011, we sold $150 million aggregate principal amount of 6.125% notes, which were a follow-on issuance of our $300 million aggregate principal amount of notes due in 2019, which we initially issued on October 9, 2009. The follow-on offering was priced at a premium with an effective yield to maturity of 4.934%. The proceeds will continue to be used for general corporate purposes. Our net-debt-to-cap ratio of 38.7 at November 30, 2011 compared to 34.5 a year ago. The increase is primarily attributable to the additional $150 million of new debt issued in May of 2011. The total long-term liquidity at November 30, 2011 was $803.9 million, with $301 million in cash and $502.9 million available through our bank revolver in accounts receivable securitization facilities.

With that, I'll turn the call back to Frank.

Thanks, Bob. For the second half of our fiscal year, we expect continued high single-digit growth in our consumer businesses and continuing low double-digit growth in our industrial businesses, as a result of underlying unit volume growth, continuing price increases, market share gains, and the impact of completed acquisitions. As mentioned earlier, we are seeing relief in most of our major raw materials, with the exception of TiO2. We are counting on this as an important aspect of our ability to continue to deliver the full-year result targeted at $1.60 to $1.65 per share, which we discussed at the beginning of this fiscal year.

I'd like to remind you that RPM's third quarter, covering the months of December, January and February, are historically a seasonal low. This year is obviously no exception and we will be somewhat negatively impacted by the acquisition costs and inventory write-up of the FEMA transaction in our third quarter. In providing the details on that quarter, we'll call out the one-time impact of this acquisition to provide you a better understanding of the expected growth in sales and earnings of the core RPM businesses in our third quarter.

With hints of improving economic conditions in North America, both as it relates to consumer takeaway and in some of the construction markets we serve, expectations of some raw material relief in relationship to the huge challenges we have faced over the last couple of years, and the full and positive impact of the acquisitions we have completed this year, we expect a strong finish to our 2012 fiscal year and a good start to our 2013 fiscal year.

That concludes our prepared remarks. We'd now be pleased to answer your questions.

(Operator Instructions) Ivan Marcuse, KeyBanc Capital Markets.

On the consumer side, the volume is very strong. Was there any benefit from weather, or was there pre-buying activity ahead of announced price increases by your customers, or could you give a little detail? How much of that percentage increase was due to new products? What new products are you seeing a lot of momentum in?

The unit volume growth there has been very good, about 9% in the quarter, and we're continuing to get raw material price increases or product price increases. I'm not aware of any pre-buying, but I do know we have some additional price increases going into effect at the beginning of this calendar year. A lot of it is market share gains, both at our core retail customers, as well as pickups in some new accounts and also some new channels. We're continuing to gain share, for instance, in the automotive sector. Some of the gross margin issues are a mix issue, as we're picking up share in lower margin categories relative to, for instance, Rust-Oleum's historic margins. Some of it relates, in particular, to TiO2 -- just significant ongoing raw material cost increases that are impacting the whole industry. But the strategy that we had coming out of the recession, we're executing. And it was really to focus on aggressive growth in all of our businesses, and we are executing on that.

One other comment I would make in relationship to some of the new product introductions at our Rust-Oleum businesses and our DAP businesses, a good example would be DAP. We just announced a whole new window, door, and sealant line into the construction markets, particularly in relationship to seeing those markets bottom out. And in the process, we have incurred a significant amount of SG&A expense in terms of packaging, product introductions, and the expense associated with a new product line whose potential over time is tens of millions of dollars of new sales, but whose P&L today looks a lot like expense and not a lot of sales because it was just introduced.

We are focused on growth. We are focused on market share gains. And we believe, over time, that a combination of price increases and relief in raw materials will get our margins back in line.

Great. Looking into the third quarter, are the acquisitions that you've made in the first half of the year -- I know historically the quarters were breakeven, plus or minus $0.05 here or there. Would you expect, due to the acquisitions contribution, to be in the black for the quarter? Or is it still, think about it breakeven, plus or minus a couple of cents?

No, we still have a little bit of inventory write-off relative to the Legend Brands, or write-up relative to Legend Brands business that we closed in September, and the FEMA transaction which we closed just this month, January 3. We'll also have some negative impact on our third quarter as it relates to inventory write-up. It'll be a hit to cost of goods sold, and also the acquisition-related costs in that transaction. But we will call out those separate results.

Historically, you've never really called out acquisition costs. Is that a change going forward that you're going to start calling that out? Or was this quarter just particularly high due to all the activity that you've had in the first half, and you just want to make people aware of that?

I think the answer is yes to both. For a number of reasons, our acquisition activity kind of in the mid to late 2000s had slowed down, and we were doing mostly relatively small product lines. I think the last sizable acquisition we did was illbruck in 2005, and that was in relationship to private equity valuation expectations, which are down dramatically, which is a good thing. We are buying businesses at our historic valuations, not the inflated valuations of 2006 to 2008. And in relation to that, changes in accounting, where five to seven years ago, all of your acquisition costs, be they legal costs, due diligence costs, or on some privately negotiated deals, broker fees, were all capitalized. In today's world, all those costs are period expenses.

Great. In the consumer segment going forward, even with the market share gains and the mix issues, you'd still expect to benefit from an improving price/cost spread. I know there's a volume issue in the third quarter, but going forward you'd expect the price/cost spread to sort of improve going forward, even with the lower mix?

That's correct. You will begin to see price/cost mix improvement really in the spring, as our third quarter is so seasonally low. It's hard to really guess at what that will be, but we have been experiencing some significant benefits in certain raw material categories with a FIFO accounting that will start to show up here in the coming months.

Great. Thanks a lot for taking my questions.

John McNulty, Credit Suisse.

With regard to the negative mix that you're talking about in the consumer business, can you flush out what product lines might be dragging that mix down? Also, if they're some of the newer ones, is it an issue of you have to discount to get the initial shelf space, and then over time we can see them go back, or is this something that could be a permanent drag on the margins going forward?

In some cases, for instance, in automotive channels, a number of the product areas are lower margin, so that'll be permanently lower margin. In other cases, it has been one-time lifts associated with getting into new accounts or getting new space, which won't be repeated. Then the other issue is just a continuing game of catch-up on what has been an extraordinary increase in raw materials, particularly TiO2 that has hit our industry broadly. The good news about TiO2 is it really does not impact RPM's industrial businesses. The only place that it really has an impact on us today is in our Rust-Oleum Group, a little bit in small project paints, and principally in primers. Our primer business is a multi-$100 million business, and it is white. That white comes from TiO2, and that's been the raw material that has been most frustratingly high for our Rust-Oleum Group, as well as for our industry.

Okay, great. One last question, you reiterated your full-year guidance that you gave back in July. And since then, you've made three acquisitions that you say are going to be at least modestly accretive. I'm wondering what incrementally is getting worse than maybe what you were expecting, if anything, or is it just you're taking maybe just a conservative approach?

I don't think we're taking a conservative approach. I think what's happening is two things -- number one, our sales are better a little bit than we anticipated, particularly in consumer, but our raw material costs are worse, up until this point, than we anticipated. And then, the acquisitions will most definitely help us in the fourth quarter. But on the full year, they're kind of a wash because, as you look at $1.60 to $1.65 target in EPS, it seems like we're behind the curve. Part of that is the expensing of acquisition expenses, $3 million, $3.5 million of which hit this quarter, as well as the one-time negative hit to cost of goods sold from inventory write-ups. Those acquisitions have actually hurt us now. You will see a nice benefit in the fourth quarter, which will make the fourth quarter look good. But relative to our full-year targets, we'll essentially offset the negative impacts of the transaction costs in the period in which the deals were done.

Okay, great. Thanks for the color.

Saul Ludwig, Northcoast Research.

In the past, you used to give us gross profit margin by the segments, if you would have that information available for both the quarter and for the six months?

We do not have that, and it was brought to our attention mostly from a number of outside sources, including our businesses, that it's not required by the SEC, and none of our peers provide segment gross profit information. We are advocates of providing segment gross profit information, and we would encourage you and all the investors here to encourage our peer companies and all companies; you can even write a letter to the SEC and suggest that companies provide gross margin information by segment. We think it would provide better information to investors. We may get back to that unilaterally on our own accord, but you can only get hit over the head by so many places as to why we're the only one providing it relative to our industrial peers, and so that's what's behind that. We are advocates of it. As you point out, we've done it in the past, but it has, in certain instances, competitively served to hurt us in our businesses, because our peer companies do not provide it, nor does the SEC require it to be provided.

Maybe just qualitatively, if your total gross profits were down 80 basis points, was it mostly in one segment or the other?

It was entirely in our consumer segment. Our industrial segment gross margins are relatively flat, and the deterioration in the quarter was entirely in consumer.

Great. That is helpful. Kemrock -- how much do you have invested in Kemrock? Where does it show up on the balance sheet? This run rate of $600,000 of equity income, ex the one-time catch-up, is that what we should be looking for?

Yes. The investment in Kemrock's currently about $36 million. We would hope that that would go up over time. It's an extraordinary company that we have partnered with in India. Seven years ago, it was a $14 million business. This year, it will do about $250 million in sales. Our ownership interest over that period has gone from 5% to what is now 23%. I think that's correct, the ongoing benefit from an equity accounting is about $600,000 a quarter. We would hope, over time, that that would grow with Kemrock, both in relationship to their growth and our growing investment.

What do you think -- two balance sheet items, cash flow from operations, last year you had $238 million, and you're running way behind in the first half of the year. What would you expect the full-year cash from operations to be? What do you think your full-year cap spending will be?

I think the full-year cap spending will be around $70 million, and I think free cash flow will be around $100 million. We're in generally good shape on cash from operations in our industrial business. The shortfall is a combination of higher inventory and lower margin delivery in the consumer segment, and that's being addressed. A lot of that is at our Rust-Oleum Group, that's, over time, one of our better businesses. I would expect us to catch that up by the end of the fiscal year. We've targeted about $100 million of free cash flow for the year, and I think we'll get there.

$100 million is after dividends or before dividends?

That's after capital spending and after dividends, but before acquisitions.

Got you. Cap spending, $70 million, dividends about $110 million, so that's $190 million. Sounds like you would look for about $280 million, $290 million cash from operations?

Correct, somewhere in that range.

Okay, good. Finally, you have this non-controlling interest that was $4 million. What are the sales that you've consolidated that reflect that non-controlling interest? What was 100% of the earnings of those businesses that you took $4 million off the bottom?

I'm not sure I understand the question.

You have $4 million of earnings that were attributed to non-controlling interest. That's the portion of --

Yes, those are a combination of joint ventures and other items. We haven't disclosed that. It would be business by business. Some of that is joint ventures or licensees associated with our Carboline business or other joint venture activity, not any one of which is material.

No, what I mean is, Frank, when you take off $4 million off the bottom for non-controlling interest, that's the percentage of those businesses that you don't own, that are owned by somebody else. But you've consolidated 100% of their revenue and 100% of their earnings up above. So my question --.

No, that's an accounting issue that we had explained earlier. It's in relationship to SPHC, and the accounting for that situation is such that there are businesses that, for instance, as I've highlighted in the past, Day-Glo is part of SPHC, but the Day-Glo subsidiaries or operations outside of the United States are not. And so it is a percentage of minority ownership of SPHC companies, principally Day-Glo and Dryvit, affiliated with those two entities' foreign operations or foreign subsidiaries that are not part of the SPHC/Bondex filing.

Got you. Okay. Thank you very much.

Kevin McCarthy, Bank of America.

This is Aleksey Yefremov for Kevin. Frank, could you size the expected price increases in consumer pricing, maybe on a blended rate, how much it would help sales in the back half of the year?

Yes, year to date we're about 3%, and I don't know that we would guesstimate what it would be in the back half, but it'll at least be 3%. It could be more, and I, at this point, don't have a good sense of what that is. We've had, in general, about 3% price increases across both of our segments on average. Of course, that is a widely varying mix of some product categories where we have not gotten price increases, and other unique product categories where we've had price increases in double-digit ranges. But on average, it's been 3%, and on average holds about the same for each segment. There are new price increases continuing, some of which were announced in January.

Okay, thank you. Can you size, at this point, the expected cost hit from the FEMA acquisition in the third quarter?

No, we can provide that -- we will call that out in the third quarter. We'll have some transaction expenses, as well as an inventory write-up that'll one-time negatively impact cost of goods sold. When we report the third quarter, we will specifically call out those numbers.

Okay. Finally, if I may, multi-family residential construction seems to be doing better than single family. Where do you have exposure to this multi-family market within your portfolio? Is it in consumer or industrial? Do you see better performance in those product lines?

There are two areas where that will, in the future, impact us. The one area where we're currently starting to benefit is in our Building Solutions Group. Our Tremco sealants, in particular, is showing modest single-digit growth in sales and earnings. That's continuing, and it's principally in relationship to our broad distribution, which gets at multi-family housing, and gets at some of the small construction activity that's picking up. We are benefiting from that there in our Building Solutions Group in particular, and in particular, our sealant product lines.

The other area that we would expect to benefit from that in the future is this new WDS category that we have been investing forward in, in our DAP business. It is a new product line that was just launched that is specifically targeted at the residential and light commercial markets. I think the timing is such that we feel that the worm has turned a little bit on those markets. There's not going to be any huge rebound, but we believe we've found a base at which you're starting to see modest growth. Multi-family housing in particular, in relationship to rent versus own, is an area that's starting to grow pretty nicely.

Okay. Thank you.

Jeff Zekauskas, JPMorgan.

This is Silke Kueck for Jeff. Can you clarify how much of the 80 basis point in gross margin squeeze is due to higher raw material costs, and how much may be due to the acquisition-related inventory write-ups?

The 80 basis points in the quarter was all in our consumer segment. About two-thirds of that was cost/price, maybe 70%-plus was cost/price difference, and the balance is negative mix, which is deliberate. The step-up in inventory is entirely in our industrial segment. All the acquisitions that we have done this year, about $160 million on annualized sales, is in our industrial segment, and I think it's about $2.5 million in the quarter.

From a raw material cost standpoint, it seems that going into November, raw material costs shouldn't have really increased. So, does your comment on TiO2 have to do with there also being some share gains in specialty primers? How come your raw material costs still seem to be lifting rather than moving lower?

There's a couple issues -- number one is gains in our Zinsser primer areas. Number two is market share mix into some different channel areas, and number three is FIFO accounting. We're on a first in/first out inventory accounting basis, where the majority of our peers are on LIFO. We would pick up the benefits of improving raw materials 60, 75 days later than what you might see in somebody -- then if we had been on, for instance, LIFO accounting.

What you really hope for is a very strong fourth quarter?

We are already seeing, in major raw material areas, improvements in costs. That is in the marketplace today, and that will show up in our results in the coming months. We are also getting additional price increases across a number of our consumer industrial businesses. Unless there is a resurgence in raw material price increases, which we don't see, but in certain categories like TiO2, the market dynamics are such that it's a little bit unconnected to supply and demand, it's hard to predict.

Lastly, the December retail sales number seemed reasonably strong, and supported by heavy discounting. Is that stuff representative of what's happening in the consumer product side as well? Can you just talk about trends?

We had a 9% unit volume growth in our consumer businesses in the quarter, and there was some negative impacts to some lifts, some cost of lifting competitive product in some new areas, both in terms of existing customers and some new customers. But the principal -- again, as I said, about 70%, two-thirds to 70% of that gross margin deterioration was associated with just the lag in cost/price. The balance was an issue of mix or lift cost, things like that.

But I guess my question was -- how sales trends look in December, both on the consumer side, maybe the industrial side?

Sales trends look good. We anticipate, for the balance of the year, that consumer sales will be up in the high single-digits, and a combination of continuing unit growth, market share gains, price increases, and the benefit of these acquisitions will allow our industrial segment to finish the year with low- to mid-teen sales growth.

Okay, thanks.

Edward Yang, Oppenheimer.

On the consumer side, what do you think is a good margin long term for that business? You lost some margin this quarter, but when I look at the full year margins you'll probably have for this year, which is probably going to be in the 13% range, it's not all that out of whack with the 12% to 14% range you've experienced in the last five to 10 years or so.

Sure. We have a couple hundred basis points of operating margin to pick up in that business. We have lost gross margin in a number of our product categories significantly over the last two or three years. We have made that up through a sharper focus in SG&A, the benefits of continuing to focus on sales growth, which has been a very deliberate strategy that's working, and then obviously some loss in operating margin. There is absolutely a couple hundred basis points of operating margin that we would expect to pick up relative to where we will be this year.

How long do you think that will take?

It really depends on the trajectory of raw material costs. If raw material costs have peaked, and most analysis of the cyclical nature of raw materials would suggest that in a lot of cases that they're there and passed, I think sooner rather than later. As I indicated earlier, there's some market dynamics that are unconnected to supply and demand, which are challenging. The one that's the biggest challenge there is TiO2. Fortunately, that's not a huge raw material for RPM on a consolidated basis, but it's a meaningful raw material to our Rust-Oleum Group.

Do you expect to see any competitive response? You've spoken a couple of times about gaining share in consumer.

We are continuing to execute growth plans across all of our businesses, and we face competitive responses every day. And I don't mean that cavalierly. Different people in our industry have approached this raw material situation and some of the economic turmoil, depending on their regional focus, in different manners. Certain industry competitors have announced multi-$100 million restructurings and divestitures. We are very focused on growth. We think, in the long run, that's the right strategy relative to delivering bottom-line results and utilizing the asset base that we have.

Okay. In this quarter, you called out the acquisition costs. The increase was $0.03. But these costs are fairly recurring. How should we think about these costs going forward? Do you expect them to decline, stay about where they are, or increase from where they are? I would think that you would continue to pursue acquisition opportunities.

Yes, normally we wouldn't go through the exercise of adding pluses and minuses that changed our $0.38 to $0.37. However, as we talked about last year in the second quarter, and we talked about in relationship to the upcoming second quarter in our last conference call in October, it was important that we got the financial community focused on the base of last year, which was more like $0.34. You can't go through that exercise of identifying for people your one-time non-operating gains or expenses, and not do it equally in both quarters. I think that's a fair statement. We don't try and call out every little expense item, but if you're going to do it in relationship to a prior period, I think you need to make your adjustments on a consistent basis, and that's what we did.

Got it. With the acquisition of FEMA and Grupo, could you give us an update on your exposure to Europe, and maybe some qualitative or quantitative comments in terms of what you're seeing in terms of demand there?

Sure. Interestingly enough, our European sales and earnings are relatively flat to last year, and we haven't lost any margin. It's a combination of the fact that our exposure in Europe is principally industrial. Our Performance Coatings Group, which is our most global group and also has a big presence in Europe, is serving what is an expanding industrial capital spending and industrial maintenance spending market pretty much across all of our product categories and channels, whether it's in energy, oil and gas, infrastructure, a lot of areas like aerospace or food service. We have a very broad presence in multiple channels, and that is the area both in North America and globally where we're seeing continued strength.

When you look at that industrial segment growth of about 10%, and you realize that half of that is in building materials, mostly North America that are growing 3% or 4%, it gives you a sense of the strong growth in the high performance coatings that serve the industrial capital spending and maintenance markets in what they're doing. Secondly, our largest concentration of business in Europe is in Germany, and that's just been in part strategic, but also lucky, because that's the largest market in Europe and the one that continues to show some positive momentum.

Okay, but even on the industrial side, there have been some press reports about refineries having issues in Europe. But you haven't seen any impact on industrial demand you're seeing in Europe?

None.

Okay.

It's slower than in North America. It's slower than what little business we do in South America or Asia, but it's still positive. Our results in Europe are not in any way in relationship to the headlines that you see every day.

Okay.

I think the impact is more in the consumer markets, which we don't serve, except for the UK.

Okay. Just final question from me on the guidance, $1.60 to $1.65, what's the level of confidence there? Year to date, you've had $0.95 in earnings. The third quarter for you is usually a wash. The fourth quarter, just by subtraction, would mean $0.65 to $0.70 in earnings. That would be up 20% to 30% year over year. What's your updated level of confidence in hitting that number this year?

Without getting into the expectations from one quarter to the next, as I commented earlier, I think we're still comfortable that we can get into that range. It will be a combination of the raw material environment that we see today continuing. I think we're confident that the raw material environment and the cost/price situation that we see today is such that we ought to have some improvement. Having been through what we've been through the last two years, it does not anticipate another significant rise in major raw materials this spring. That's one factor.

The other factor is, we have done a pretty good chunk of nice, strategic acquisitions, and year to date they have hurt our gross margin in industrial because of inventory step-ups, and they have hurt our corporate/other expense to the tune of $3.5 million or $4 million. In the fourth quarter, the one-time expenses will be gone. The inventory write-ups will have happened, and you're going to be looking at businesses with sales and earnings that will begin to contribute nicely to the bottom line.

Okay. Thank you for the clarification.

Rosemarie Morbelli, Gabelli & Company.

Frank, when you are rather confident that raw material costs are going to stay more or less level with where they are currently. But with the outlook for oil going up, and oil being already up versus the second quarter, how confident are you that actually you are not going to have any cost increases announcements?

Highly confident, Rosemarie, is an overstatement. We're hopeful, and we're more hopeful than we've been for a while. There have been some significant reductions in certain resin prices and certain packaging and certain solvent areas, and oil prices aren't particularly out of whack relative to where they were a few years ago. Again, the raw material environment we see today makes us hopeful that we'll have a better second half as it relates to the cost/price impact on our gross margins. Having experienced what we've experienced the last couple of years, I'm hopeful that we're not going to jump into another environment where our raw material suppliers are increasing prices 15% or 20%. They're not signaling that, and we don't see it, but it doesn't mean it couldn't happen.

Could you give us a feel for how much you spent in order to introduce the new DAP product line, and when do you think that amount is going to go away?

Without being real specific, we've spent many single millions of dollars to build up an independent division of DAP, and have just introduced the product. Obviously, construction, particularly -- it's a North American, basically U.S.-focused effort at this point, and the construction markets, obviously, are seasonal. I would think the first impacts of that would be this spring and this summer, and depending on our distribution and penetration level, it's a very exciting product line for us. It has potential to add tens of millions of dollars to DAP and RPM, but obviously we've got to have the right product and get broad distribution to get going. So far, it's been an expense base as we build up this organization, develop the packaging, and introduced the product. Revenues from that effort should show up late spring and in the summer.

Are they introduced to the Lowe's of the world, or are they going into industrial applications?

This is going into more building materials, independent distributors, and really focused on residential and light commercial construction as opposed to the consumer DIY channels and presence, which is predominantly what DAP serves today.

Okay. Talking about the DIY, what are you hearing in terms of your kind of product lines going forward? Are they seeing more maintenance, more renovations, or is it flattish from where we are today?

Our unit volume growth in the quarter was 9%. As we've commented, some of that was new product and market share gains, but we are seeing consumer takeaway pick up across a number of our product categories, and I think that makes sense given the relatively low price point and either small project redecorating and/or home maintenance and repair nature of our products. We would expect that modest pickup in consumer takeaway to continue for the balance of the year.

Okay. You talked about Europe and the fact that you haven't seen any decline at this particular point. But if you talk about anecdotes, whatever you hear in the field as well, once you may not have seen it yet in the third quarter, what do you hear going forward from your customers, for example?

Yes, again, I don't want to overstate Europe. We are generally, in sales, earnings, and margins, flat to last year. We have some areas of strength, but we're not experiencing the significant deterioration that the daily headlines would suggest. Given the nature of the products that we are manufacturing and selling in Europe, we don't anticipate any big deterioration there. The biggest challenge at this stage from Europe is what happens to the euro versus the dollar, and the impact on revenues and through our P&L of changes in relative foreign currencies, basically the dollar to the euro.

Okay. Lastly, if I may, could you update us on the performance of Legend Brands versus what you were anticipating?

Legend Brands is brand new, and so I don't have a good sense of where they're going. Unfortunately, they add to the seasonality of RPM, and so their winter months are also seasonally low. We're not getting the big boom from them relative to the seasonality of their business, but they are on target in the early months of their ownership by RPM, and we're real excited about that business and its growth prospects long term.

Okay. Thank you very much.

(Operator Instructions) Saul Ludwig.

I have a couple quickie follow-ups. The $1.60 to $1.65, that's all-in with all the goodies and the baddies, right?

That is every bit of good, bad, and help that we can get, Saul.

Okay, and then as we look to the fourth quarter, we'll recall that last year you had a $5.5 million bad debt charge, which was $0.06 a share, that we hope doesn't repeat, which would give you $0.06 goodie in the fourth quarter just for showing up, right?

Yes, we also had, I think, many millions of dollars of one-time gains from a change in insurance, as well as marketable securities. I think last year's fourth quarter is essentially between the goods and the bads where it is. The Lancaster was the bankruptcy, and we highlighted that as it related to the results of our consumer segment, because it hit in the last month of our fourth quarter. But on a consolidated basis, that was essentially offset by marketable securities gains from our captive insurance companies and other insurance items. I don't recall what those were, but on a consolidated basis, the fourth quarter is what it was.

Got it. One final thing, your corporate expense last year, third quarter, fourth quarter was $16 million and then $4 million; $16 million expense in the third quarter, and only $4 million expense in the fourth quarter. Why such a divergence in numbers, and how should we think about corporate expense in the back end of the year?

I'll let Bob talk about the quarterly corporate expense. But, again, without looking at the numbers, Saul, just to the comment you and I made, my guess is that the one-time gains in relationship to marketable securities or a pickup in insurance recovery that I mentioned in relationship to the Lancaster write-off, would have occurred in the corporate/other category as the offsets. Because, again, on a year-over-year basis, our fourth quarter essentially was what it was, with the hit on Lancaster being offset by corporate non-Other in the quarter.

Now, as it relates to how to think about corporate expense in the third or fourth quarter, the balance of the year, maybe Bob can add to that.

Saul, that fourth quarter a year ago was impacted, as Frank said, a lot of insurance adjustments and prior-year stuff. You should probably look at each quarter at somewhere between $11 million to $12 million. It would be a normal run rate on the corporate and other side of our P&L structure.

Okay. Thanks very much.

And that's assuming that everything is -- no unique items, one-timers happening in those quarters.

You're not assuming any securities gains or losses in the back end of the year, in your outlook comments?

No.

That is correct.

Very good. Thank you.

Rosemarie Morbelli.

Just quickly, on the pension expense, could you give us a feel for how much you spent in 2011? And given the level of the rates and the performance in the market, what do you expect for 2012?

Our pension expense for 2012 should be flat to what we spent in 2011. We had a pickup in pension expense last year in relationship to a drop in securities, as well as an adjustment in the discount rate, relative to interest rates. But I think year over year, we will be flat in pension expense on 2012 to what we spent in 2011.

Can you remind me how much that was?

I don't have that number handy, Rosemarie. I think it's disclosed in our 10-K, but we can get back to you on that.

Okay. I'll check the 10-K. Thanks. Okay. That was it for me. Thank you.

And there are no further questions at this time. I will now turn the call back over to Mr. Frank Sullivan, Chairman and CEO. Please proceed.

Thank you for your participation on our investor call this morning. We look forward to providing you the details of our third quarter in April of this year, and also to giving you our expectations for the 2012 finish, and our outlook for our 2013 fiscal year. In the meantime, please accept our best wishes for a happy, healthy, and successful new year. Thank you for your investment in RPM.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.