Results of Operations
Fiscal 2003 Compared with Fiscal 2002
Net Sales | Fiscal 2003 net sales grew $97.4 million, or 5%, over fiscal 2002. Organic sales growth amounted
to $78.2 million, or 4% growth year over year, from unit
volume as opposed to pricing and favorable foreign exchange differences of $19 million. These exchange
differences were principally against the euro and the Canadian dollar, net of negative differences from Latin American currencies. Eight smaller acquisitions including Koch Waterproofing Solutions, purchased on April 1, 2003, made up the difference, adding approximately $19 million to sales.
Industrial segment sales amounted to 54% of the RPM total, and were ahead year over year by 6%, 5% of which was organic growth and included favorable foreign exchange differences. Five smaller acquisitions accounted for the balance of the sales growth. The organic sales growth resulted primarily from the increased demand for lower-margin maintenance and installation products and services associated primarily with roofing and flooring throughout the year. Aside from growth in these services, commercial construction was down and the industrial manufacturing sectors of the economy generally remained weak throughout the year, continuing the postponement by a number of customers of higher-cost maintenance and replacement projects that call for many RPM industrial products. It remains our belief that this business has not been lost to any competitor, but becomes pent-up demand for those products and services. Furthermore, the fact that our industrial segment has been able to grow organically under a still-weak economic environment strongly
suggests, and it is our firm belief, that we have expanded our market share during the year.
Consumer segment sales amounted to 46% of the RPM total and were ahead 4% year over year, 3% from organic growth, and included favorable foreign exchange differences, primarily in the euro versus the U.S. dollar. Three smaller acquisitions provided the balance of the sales increase. Consumer demand was solid during the first half of the year but slowed considerably during the second half of the year from a combination of weather factors and inventory reduction efforts at several key accounts, which caused changes in order pattern quantities and frequency. The consumer retail takeaway, otherwise, has remained fairly steady and somewhat healthy throughout the year.
Gross Profit Margin | The fiscal 2003 gross profit
margin of 45.8% compares with 45.9% during fiscal 2002, or nearly flat year over year. The benefits from higher sales volume and some lower raw material costs were slightly more than offset by a mix of lower-margin sales. The
industrial segment gross margins declined year over year to 46.2% from 46.9%. The benefits from improved sales levels and a number of lower raw material costs in this segment were more than offset by a change in sales mix created
by the strong sales of lower-margin services during 2003, related primarily to roofing and flooring.
The consumer segment gross margin improved year over year to 45.4% from 44.8%. This improvement is the result of positive leverage from the higher sales volume, slightly favorable raw material costs and continued conversion cost-saving initiatives.
Manufacturing efficiencies from expanded Class A manufacturing initiatives are being realized in both operating segments, and these efforts will continue. Raw material cost pressures were building during the second half of
fiscal 2003, and we believe higher costs in the material
cost area may impact the first quarter of fiscal 2004 and, possibly, beyond.
Selling, General and Administrative Expenses ("SG&A") | Consolidated SG&A expenses improved to 35.5% of net sales in 2003 from 36.1% during fiscal 2002, attributable largely to significant growth in lower-margin services sales in the industrial segment that require relatively much lower SG&A support cost, along with ongoing cost reduction and containment efforts throughout both operating segments.
The industrial segment SG&A was 35.2% of net sales in 2003 compared with 36.8% during fiscal 2002. The growth in sales volume, particularly service sales, contributed about half of this improvement. Cost reduction initiatives and cost containment efforts in both periods made up the difference.
The consumer segment SG&A improved to 31.8%
of net sales from 32.1% during fiscal 2002. This net improvement is a result of the higher sales volume leverage and continuous cost reduction and containment efforts, partly offset by certain increased selling and promotional spending among our primary consumer product lines.
Corporate/other costs amounted to $39.1 million in 2003 compared with $30.7 million during fiscal 2002.
This change reflects increased product liability costs of
$5.1 million and a change in export sales tax legislation that went into effect this fiscal year. While this latter change caused $4.0 million of the increase in corporate/
other costs during 2003, consolidated SG&A was not affected by this tax law change because this increase
in corporate/other expense is offset by corresponding reductions of expense in the industrial and consumer
operating segments in the amounts of $2.4 million and $1.6 million, respectively.
Asbestos Charge | Certain of our wholly owned subsidiaries, principally Bondex International, Inc. (Bondex), along with many other U.S. companies, are and have been involved in asbestos-related suits filed primarily in state courts during the past two decades. These suits principally allege personal injury resulting from exposure to asbestos-containing products.
Asbestos-related suits against Bondex increased in the fourth quarter of 2002 and the first two quarters of 2003, influenced by the bankruptcy filings of numerous other defendants in asbestos-related litigation. Based on the
significant increase in asbestos claims and the inequitable impact of joint and several liability laws on Bondex, as
previously reported, our third-party insurance will be depleted during the first quarter of 2004. Prior to this
sudden precipitous increase in loss rates, the combination of reserves and insurance coverage was expected to
adequately cover our asbestos claims for the foreseeable future. We are contesting various of our third-party insurers’ claims of exhaustion.
During the last seven months of 2003, new state
liability laws were enacted in three states where more than 80% of the claims against Bondex are pending. The changes generally provide for liability to be determined on a proportional cause basis. The ultimate impact of these law changes is not expected to be significantly visible until the latter part of fiscal 2004.
During the fourth quarter of 2003, a nationally recognized consulting firm was retained to evaluate whether it would be possible to estimate the cost of disposing pending claims and to assist in determining whether future asbestos-
related claims were measurable. Bondex has provided the consultants with all relevant data regarding asbestos-related claims filed against Bondex through May 31, 2003.
At this time, we cannot estimate the liability that will result from all future claims. We have established a reserve for those pending cases that have progressed to a stage where the cost to dispose of these cases can reasonably be estimated. The reserve was established by taking an asbestos charge to 2003 operations of $140,000,000 for measurable known claims and a provision for future claims that can presently be estimated. We believe this asbestos reserve will be sufficient to cover asbestos-related cash flow requirements for approximately three years. Additionally, Bondex’s share of costs (net of then-available third-party insurance) for asbestos-related product liability were $6,700,000, $2,800,000 and $2,300,000 for the years ended May 31, 2003, 2002 and 2001, respectively. Future facts, events and legislation, both state and/or federal, may alter our estimates of both pending and future claims. The
Company cannot estimate possible liabilities in excess of those accrued because we cannot predict the number of additional claims that may be filed in the future, the grounds for such claims, the damages that may be demanded, the probable outcome, or the impact of recent state and pending federal legislation on prospective asbestos claims.
In conjunction with our outside advisors, we will continue to study our asbestos-related exposure, and regularly
evaluate the adequacy of this reserve and the related cash flow implications in light of actual claims experience, the impact of state law changes and the evolving nature of
federal legislative efforts to address asbestos litigation
(also refer to Note H).
Earnings Before Interest and Taxes ("EBIT") |
We believe that EBIT best reflects the performance of our operating segments, as interest expense and income taxes are not consistently allocated to operating segments by the various constituencies utilizing our financial statements. Requests for operating performance measures received from research analysts, financial institutions and rating agencies typically focus on EBIT, and we believe EBIT disclosure is responsive to investors.
Consolidated EBIT in 2003 of $74.6 million compares with $194.6 million during fiscal 2002, with $140.0 million of this difference representing the asbestos liability charge. Excluding the charge, 2003 EBIT would have been
$214.6 million or ahead $20.0 million, or 10%, over fiscal 2002. That represents margin improvement on the 5% sales increase, to 10.3% of net sales from 9.8% during fiscal 2002, the result of the higher sales volume coupled with cost reductions and containments.
Industrial segment EBIT grew $15.3 million, or 14%,
on 6% sales growth, to 11% of net sales compared with 10% of sales during fiscal 2002. Consumer segment EBIT grew $13.2 million, or 11%, on 4% sales growth to 14%
of net sales compared with 13% of net sales during fiscal 2002. These operating EBIT improvements totaling
$28.4 million generally are the result of the growth in sales
volume, certain lower raw material costs year over year and ongoing cost reductions and containments across
both operating segments.
Net Interest Expense | Net interest expense declined $13.8 million during 2003 (refer to Note A [17]) as a result of much lower average debt levels and lower interest rates. Interest rates on the variable portion of outstanding borrowings, averaging approximately 70% of total debt (refer to Note B), averaged a much lower 3.8% compared with 4.5% during 2002, amounting to savings of $4.8 million in 2003. Total debt levels averaged $202 million lower throughout 2003, accounting for $10.0 million of interest cost saved year over year. After our issuance of 2.75% Senior Convertible Notes in May 2003 (see Financing Activities in "Liquidity and Capital Resources"), the variable rate portion of our total debt structure was down to 51%. During fiscal 2002, there were marketable securities gains of approximately $1.0 million that were not realized again during 2003.
Income Tax Rate | The effective income tax rate
provision this year of 26.2% compares with 34.1% for fiscal 2002 (refer to Note C). This year’s much lower rate is the result of the weight of the full tax benefit (37.5%) of the $140.0 million asbestos liability charge, and will not be a recurring rate. Excluding the charge, our tax rate in 2003 would have been 34.6%, up 0.5% from fiscal 2002. As a result of earnings growth, the one-time tax rate benefit from the June 1, 2001 adoption of SFAS No. 142 becomes less and less significant, and this trend is expected
to continue.
Net Income | Fiscal 2003 net income of $35.3 million compares with $101.6 million during fiscal 2002 and reflects the $87.5 million after-tax cost of the 2003 asbestos liability charge. Excluding the charge, 2003 net income would have been $122.8 million, ahead 20.9%, or
$21.2 million, from fiscal 2002. The return on sales would have been 5.9% compared with 5.1% for fiscal 2002.
During March 2002, we sold 11.5 million common shares (see Financing Activities in "Liquidity and Capital Resources") through a follow-on public equity offering, and this transaction had a dilutive effect of $0.01 per share on fiscal 2003 reported diluted earnings per share. Excluding the impact of the asbestos charge on earnings, the 11.5 million shares sold in March 2002 would have had a $0.07
per share dilutive effect on fiscal 2003 pro forma diluted earnings per share of $1.06.
Fiscal 2002 Compared with Fiscal 2001
Net Sales | Fiscal 2002 net sales were slightly below fiscal 2001 by $21.6 million, or 1%. The $30 million commercial Durabond unit of DAP was divested in March 2001, with sales of $26.3 million to that point in the 2001 fiscal year. Factoring out those sales to be comparable, plus the negative effects from foreign exchange differences of approximately $14 million, principally against the Canadian dollar, year-over-year sales would show a 1% increase.
Industrial segment sales amounted to 53% of the 2002 RPM total, and were lower year over year by 3.3% when the negative foreign exchange effect of $11.2 million is excluded. The industrial economy, including electronics, was generally weak throughout 2002, which caused a
number of customers to postpone higher-cost maintenance and replacement projects, particularly flooring.
Consumer segment sales amounted to 47% of the 2002 RPM total, and were ahead 6.2% year over year on a comparable basis, after adjusting for the Durabond divestiture and negative foreign exchange effects. Consumer demand was solid throughout 2002, especially for our DAP, Rust-Oleum and Zinsser products. This growth reflected a combination of higher unit volume of approximately 5%, with the balance from slightly higher pricing to counter increased raw material and packaging costs during the
2001 fiscal year.
Gross Profit Margin | The gross profit margin improved in fiscal 2002, reaching 45.9% compared with 45.1% during fiscal 2001. The industrial gross margin of 46.9% in 2002 was slightly behind the 47.4% realized
during fiscal 2001. This was mainly a volume effect as the sales decline, particularly of higher-margin flooring (off
$44 million, or 11%), was too great to overcome versus related overhead costs. Restructuring savings and a number of favorable raw material costs partially offset this volume effect. Consumer gross margins, on the other hand, reached 44.8% from 42.5% during 2001. This improvement reflected additional restructuring savings of approximately $21 million during fiscal 2002, plus positive cost leverage from
the higher sales volume and a number of favorable raw material costs in this segment as well.
Selling, General and Administrative Expenses | SG&A expenses improved to 36.1% of sales in 2002 from 36.8% during fiscal 2001. We adopted SFAS No. 142, "Goodwill and Other Intangible Assets” (SFAS No. 142), as of June 1, 2001, the beginning of the 2002 fiscal year, and that change is reflected in SG&A (refer to Note A [10]). On a pro forma basis, the fiscal 2001 SG&A percentage under SFAS No. 142 would have been $25.1 million lower, or 35.6% of sales. The divested Durabond unit of DAP had carried a lower SG&A percentage, having an approximate negative effect of 0.4% of sales, bringing the fiscal 2001 SG&A percentage, adjusted for both SFAS No. 142 and the divestiture, to approximately 36% of sales. The fiscal 2002 $2.1 million third-quarter charge related to the devaluation of the Argentinean peso amounted to 0.1% of fiscal 2002 sales. Without that charge, the 2002 SG&A percentage would have equaled fiscal 2001’s 36%, adjusted for SFAS No. 142 and the divestiture.
By segment, industrial SG&A of 36.8% in 2002
compared with 36.3% during fiscal 2001, or 35.2% on a
pro forma SFAS No. 142-adjusted basis. This difference was attributable to the much lower sales volume in 2002; increased distribution costs associated with a transition to fewer warehouses; and the Argentinean peso devaluation, all of which were partly offset by solid cost containment efforts throughout the segment. Consumer SG&A of 32.1% in 2002 compared favorably with 35.6% during fiscal 2001, or 34.1% on a pro forma SFAS No. 142-adjusted basis. This
significant improvement was attributable to the much
higher consumer sales volume; some reduced freight costs, as there were still restructuring-related inefficiencies during fiscal 2001; and solid cost containment efforts throughout this segment. Corporate/other costs were $30.7 million in 2002 compared with $18 million during fiscal 2001.
This change reflected a number of increased legal and
professional fees associated with terminated acquisition
and divestiture efforts; increased product liability costs (including those described under Item 3. Legal Proceedings,
Form 10-K); rising health care and other employee benefit costs; management succession costs; and other higher
corporate costs.
Earnings Before Interest and Taxes | EBIT climbed $27.9 million in 2002, reaching $194.6 million. Fiscal
2001 EBIT, adjusted for SFAS No. 142, would have been $191.8 million, leaving 2002 EBIT ahead by $2.8 million, or up 1.5% on a 1% decrease in sales. Industrial EBIT was down $15 million during fiscal 2002, or down $26.9 million after adjusting fiscal 2001 for SFAS No. 142, with this decline being attributable mainly to the lower flooring
sales volume. Consumer EBIT nearly doubled year over year, up $55.6 million, or still ahead $42.4 million on a SFAS No. 142-adjusted basis, with that growth almost equally attributable to the restructuring savings and the higher comparable sales volume.
Net Interest Expense | Net interest expense declined $24.7 million during 2002 (refer to Note A [17]) as a result of lower interest rates and reduced debt levels during the year. Interest rates on the variable rate portion (approximately 75% to 80%) of outstanding borrowings (refer to Note B) were lower in fiscal 2002. The overall effective interest rate of approximately 4.5% in 2002 compares favorably with 6.9% during fiscal 2001, amounting to
savings of $20.3 million for 2002. Total debt levels were approximately $63 million lower on average throughout the year, accounting for the remaining $4.4 million of interest costs saved year over year.
Income Tax Rate | The effective income tax rate of 34.1% for 2002 compared favorably with fiscal 2001’s 38% rate (refer to Note C). This rate reduction was driven by the adoption of SFAS No. 142, as goodwill is no longer being amortized for financial purposes.
Net Income | 2002 net income of $101.6 million, or $0.97 per diluted share, increased 61% and 56%, respectively, from fiscal 2001. On a pro forma basis adjusted for SFAS No. 142, fiscal 2001 net earnings and diluted earnings per share would have been $84.8 million and $0.83 (refer to Note A [10]), respectively, putting 2002 results still ahead by 20% and 17%, respectively.
During March 2002, we sold 11.5 million common shares (see Financing Activities in "Liquidity and Capital Resources") through a follow-on public equity offering,
and this transaction had a dilutive effect on fiscal 2002
of $0.01 per share.
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