UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 31, 2019,
or
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission File No. 1-14187
RPM International Inc.
(Exact name of Registrant as specified in its charter)
Delaware
02-0642224
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification No.)
P.O. BOX 777;
2628 PEARL ROAD;
MEDINA, Ohio
(Address of principal executive offices)
44258
(Zip Code)
(330) 273-5090
(Registrant’s telephone number including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading
Symbol(s)
Name of each exchange on which registered
Common Stock, par value $0.01
RPM
New York Stock Exchange
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒.
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ☐ No ☒.
As of October 1, 2019, the registrant had 129,680,345 shares of common stock, $0.01 par value per share, outstanding.
RPM INTERNATIONAL INC. AND SUBSIDIARIES*
INDEX
Page No.
PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements:
Consolidated Balance Sheets
3
Consolidated Statements of Income
4
Consolidated Statements of Comprehensive Income
5
Consolidated Statements of Cash Flows
6
Consolidated Statements of Stockholders’ Equity
7
Notes to Consolidated Financial Statements
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
27
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
35
Item 4.
Controls and Procedures
PART II. OTHER INFORMATION
Legal Proceedings
36
Item 1A.
Risk Factors
Unregistered Sale of Equity Securities and Use of Proceeds
37
Item 6.
Exhibits
38
Signatures
39
*
As used herein, the terms “RPM” and the “Company” refer to RPM International Inc. and its subsidiaries, unless the context indicates otherwise.
2
PART I. – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
RPM INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except per share amounts)
August 31, 2019
May 31, 2019
Assets
Current Assets
Cash and cash equivalents
$
212,091
223,168
Trade accounts receivable (less allowances of $57,185 and $54,748, respectively)
1,109,259
1,232,350
Inventories
860,518
841,873
Prepaid expenses and other current assets
234,401
220,701
Total current assets
2,416,269
2,518,092
Property, Plant and Equipment, at Cost
1,674,713
1,662,859
Allowance for depreciation
(861,697
)
(843,648
Property, plant and equipment, net
813,016
819,211
Other Assets
Goodwill
1,249,818
1,245,762
Other intangible assets, net of amortization
601,747
601,082
Operating lease right-of-use assets
257,628
-
Deferred income taxes
36,335
34,908
Other
221,612
222,300
Total other assets
2,367,140
2,104,052
Total Assets
5,596,425
5,441,355
Liabilities and Stockholders' Equity
Current Liabilities
Accounts payable
477,050
556,696
Current portion of long-term debt
582,611
552,446
Accrued compensation and benefits
119,349
193,345
Accrued losses
20,142
19,899
Other accrued liabilities
297,420
217,019
Total current liabilities
1,496,572
1,539,405
Long-Term Liabilities
Long-term debt, less current maturities
2,018,185
1,973,462
Operating lease liabilities
215,131
Other long-term liabilities
407,285
405,040
113,227
114,843
Total long-term liabilities
2,753,828
2,493,345
Commitments and contingencies (Note 16)
Stockholders' Equity
Preferred stock, par value $0.01; authorized 50,000 shares; none issued
Common stock, par value $0.01; authorized 300,000 shares; issued 142,865 and
outstanding 129,670 as of August 31, 2019; issued 142,439 and outstanding 130,995
as of May 31, 2019
1,297
1,310
Paid-in capital
1,001,081
994,508
Treasury stock, at cost
(543,650
(437,290
Accumulated other comprehensive (loss)
(601,253
(577,628
Retained earnings
1,485,917
1,425,052
Total RPM International Inc. stockholders' equity
1,343,392
1,405,952
Noncontrolling Interest
2,633
2,653
Total equity
1,346,025
1,408,605
Total Liabilities and Stockholders' Equity
The accompanying notes to consolidated financial statements are an integral part of these statements.
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
August 31,
2019
2018
Net Sales
1,472,764
1,459,989
Cost of Sales
898,010
910,636
Gross Profit
574,754
549,353
Selling, General and Administrative Expenses
400,566
415,053
Restructuring Charges
6,622
20,076
Interest Expense
28,317
24,406
Investment (Income), Net
(5,385
(2,433
Other Expense, Net
1,785
313
Income Before Income Taxes
142,849
91,938
Provision for Income Taxes
36,353
21,752
Net Income
106,496
70,186
Less: Net Income Attributable to Noncontrolling Interests
308
422
Net Income Attributable to RPM International Inc. Stockholders
106,188
69,764
Average Number of Shares of Common Stock Outstanding:
Basic
128,882
131,861
Diluted
129,504
136,430
Earnings per Share of Common Stock Attributable to RPM International Inc.
Stockholders:
0.82
0.52
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments
(28,434
(40,689
Pension and other postretirement benefit liability adjustments
(net of tax of $1,104 and $982, respectively)
3,623
3,056
Unrealized gain on securities and other (net of tax of $1 and $668, respectively)
371
2,476
Unrealized gain on derivatives (net of tax of $579 and $15, respectively)
784
921
Total other comprehensive (loss)
(23,656
(34,236
Total Comprehensive Income
82,840
35,950
Less: Comprehensive Income Attributable to Noncontrolling Interests
277
164
Comprehensive Income Attributable to RPM International Inc. Stockholders
82,563
35,786
CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows From Operating Activities:
Net income
Adjustments to reconcile net income to net cash provided by (used for) operating activities:
Depreciation and amortization
35,839
35,540
Restructuring charges, net of payments
611
7,084
(4,580
(561
Stock-based compensation expense
6,560
6,668
Other non-cash interest expense
775
Realized/unrealized (gains) losses on marketable securities
(2,854
250
992
Changes in assets and liabilities, net of effect from purchases and sales of businesses:
Decrease in receivables
116,349
32,389
(Increase) in inventory
(22,640
(27,207
(Increase) in prepaid expenses and other current and long-term assets
(5,801
(18,282
(Decrease) in accounts payable
(63,831
(88,271
(Decrease) in accrued compensation and benefits
(73,180
(56,747
Increase in accrued losses
404
8,415
Increase in other accrued liabilities
50,588
20,857
928
1,027
Cash Provided By (Used For) Operating Activities
145,139
(7,129
Cash Flows From Investing Activities:
Capital expenditures
(36,602
(28,295
Acquisition of businesses, net of cash acquired
(30,598
(26,366
Purchase of marketable securities
(9,996
(12,695
Proceeds from sales of marketable securities
2,837
9,758
(97
(2,881
Cash (Used For) Investing Activities
(74,456
(60,479
Cash Flows From Financing Activities:
Additions to long-term and short-term debt
75,718
120,702
Reductions of long-term and short-term debt
(874
(21,952
Cash dividends
(45,323
(42,715
Shares repurchased
(100,000
(6,994
Shares returned for taxes
(6,127
(13,587
Payments of acquisition-related contingent consideration
(131
(3,456
(295
(319
Cash (Used For) Provided By Financing Activities
(77,032
31,679
Effect of Exchange Rate Changes on Cash and Cash Equivalents
(4,728
(6,310
Net Change in Cash and Cash Equivalents
(11,077
(42,239
Cash and Cash Equivalents at Beginning of Period
244,422
Cash and Cash Equivalents at End of Period
202,183
Supplemental Disclosures of Cash Flows Information:
Cash paid during the period for:
Interest
18,485
19,747
Income Taxes, net of refunds
11,295
13,525
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Common Stock
Accumulated
Number
Total RPM
of
Par/Stated
Paid-In
Treasury
Comprehensive
Retained
International
Noncontrolling
Total
Shares
Value
Capital
Stock
Income (Loss)
Earnings
Inc. Equity
Interests
Equity
Balance at June 1, 2019
130,995
Other comprehensive (loss)
(23,625
(31
Dividends paid ($0.35 per
share)
Other noncontrolling
interest activity
(297
Share repurchases under
repurchase program
(1,656
(16
16
Stock compensation
expense and other
deferred compensation,
shares granted less
shares returned for taxes
330
6,557
(6,360
200
Balance at August 31, 2019
129,669
Balance at June 1, 2018
133,647
1,336
982,067
(236,318
(459,048
1,342,736
1,630,773
2,765
1,633,538
Cumulative-effect
adjustment upon
adoption of ASU
2014-09
(2,833
(33,978
(258
Dividends paid ($0.32 per
(103
(1
1
(136
10,018
(3,570
Balance at August 31, 2018
133,408
1,334
992,086
(256,899
(493,026
1,366,952
1,610,447
2,932
1,613,379
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 — CONSOLIDATION, NONCONTROLLING INTERESTS AND BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles in the U.S. (“GAAP”) for interim financial information and the instructions to Form 10-Q. In our opinion, all adjustments (consisting of normal, recurring accruals) considered necessary for a fair presentation have been included for the three month periods ended August 31, 2019 and 2018. For further information, refer to the consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended May 31, 2019.
Our financial statements include all of our majority-owned subsidiaries. We account for our investments in less-than-majority-owned joint ventures, for which we have the ability to exercise significant influence, under the equity method. Effects of transactions between related companies are eliminated in consolidation.
Noncontrolling interests are presented in our consolidated financial statements as if parent company investors (controlling interests) and other minority investors (noncontrolling interests) in partially-owned subsidiaries have similar economic interests in a single entity. As a result, investments in noncontrolling interests are reported as equity in our consolidated financial statements. Additionally, our consolidated financial statements include 100% of a controlled subsidiary’s earnings, rather than only our share. Transactions between the parent company and noncontrolling interests are reported in equity as transactions between stockholders, provided that these transactions do not create a change in control.
Our business is dependent on external weather factors. Historically, we have experienced strong sales and net income in our first, second and fourth fiscal quarters comprising the three month periods ending August 31, November 30 and May 31, respectively, with weaker performance in our third fiscal quarter (December through February).
NOTE 2 — NEW ACCOUNTING PRONOUNCEMENTS
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” which increases lease transparency and comparability among organizations. Under the new standard, lessees are required to recognize a right-of-use (“ROU”) asset representing our right to use an underlying asset and a lease liability representing our obligation to make lease payments over the lease term, with the exception of leases with a term of 12 months or less, which permits a lessee to make an accounting policy election by class of underlying asset not to recognize lease assets and liabilities. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, and early adoption is permitted. In March 2018, the FASB approved an alternative transition method to the modified retrospective approach, which eliminates the requirement to restate prior period financial statements and requires the cumulative effect of the retrospective allocation to be recorded as an adjustment to the opening balance of retained earnings at the date of adoption.
We have adopted the new leasing standard on the required effective date of June 1, 2019 using the alternative transition method as described above. Results for reporting periods beginning on June 1, 2019 are presented under Topic 842, while prior period amounts continue to be reported and disclosed in accordance with our historical accounting treatment under Accounting Standards Codification (“ASC”) 840, “Leases (ASC 840).” We elected to apply the package of practical expedients permitted under the ASC 842 transition guidance. Accordingly, we did not reassess whether any expired or expiring contracts contain leases, lease classification between finance and operating leases, and the recognition of initial direct costs of leases commencing before the effective date. We also applied the practical expedient to not separate lease and non-lease components to existing leases, as well as new leases through transition. However, we did not elect the hindsight practical expedient to determine the lease term for existing leases. Adoption of the new lease standard resulted in additional operating lease right-of-use assets and operating lease liabilities of approximately $257.6 million and $265.8 million, respectively, as of August 31, 2019. The effects of our transition to ASC 842 resulted in no cumulative adjustment to retained earnings in the period of adoption. As a result of our adoption procedures, we have determined that the new guidance had a material impact on our Consolidated Balance Sheets and did not have a material effect on our Consolidated Statements of Income, Consolidated Statements of Cash Flows or our debt covenants. Refer to Note 14, “Leases,” for additional information.
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses,” which requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Additionally, the standard amends the current available-for-sale security other-than-temporary impairment model for debt securities. The guidance is effective for fiscal years beginning after December 15, 2019 and for interim periods therein. Early adoption is permitted beginning after December 15, 2018. We are currently reviewing the provisions of this new pronouncement, but do not expect our adoption of this guidance to have a material impact on our Consolidated Financial Statements.
In August 2018, the SEC issued Final Rule Release No. 33-10532, “Disclosure Update and Simplification,” which makes a number of changes meant to simplify interim disclosures. The new rule requires a presentation of changes in stockholders’ equity and noncontrolling interest in the form of a reconciliation, either as a separate financial statement or in the notes to the financial statements, for the current and comparative year-to-date interim periods. In July 2019, the FASB issued ASU 2019-07, “Codification Updates to SEC Sections – Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company Reporting Modernization and Miscellaneous Updates (SEC Update).” ASU 2019-07 codifies Final Rule Release No. 33-10532. The additional elements of this release did not have a material impact on our overall Consolidated Financial Statements. We adopted the new disclosure requirements in our Form 10-Q for the period ended February 28, 2019.
In January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment,” to eliminate step two from the goodwill impairment test in order to simplify the subsequent measurement of goodwill. The guidance is effective for fiscal years beginning after December 15, 2019. Early application is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. Adoption of this guidance is not expected to have a material impact on our Consolidated Financial Statements.
In February 2018, the FASB issued ASU 2018-02, “Income Statement (Topic 220), Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income” which allows for an entity to reclassify the tax effects of the U.S. Tax Cuts and Jobs Act of 2017 (“Tax Act”) that were previously recorded in accumulated comprehensive income to retained earnings. The adoption of this new guidance, effective June 1, 2019, did not have a material effect on our consolidated financial statements as we did not elect the option to reclassify to retained earnings the tax effects resulting from the Tax Act that were previously recorded in accumulated other comprehensive income.
In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820), – Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement,” which makes a number of changes meant to add, modify or remove certain disclosure requirements associated with the movement amongst or hierarchy associated with Level 1, Level 2 and Level 3 fair value measurements. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted upon issuance of the update. We do not expect our adoption of this guidance to have a material impact on our Consolidated Financial Statements.
In August 2018, the FASB issued ASU 2018-14, “Compensation—Retirement Benefits—Defined Benefit Plans—General (Subtopic 715-20), Disclosure Framework – Changes to the Disclosure Requirements for Defined Benefit Plans,” which makes a number of changes meant to add, modify or remove certain disclosure requirements associated with employers that sponsor defined benefit or other postretirement plans. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption is permitted for all entities and the amendments in this update are required to be applied on a retrospective basis to all periods presented. We are currently reviewing the provisions of this new pronouncement, but do not expect our adoption of this guidance to have a material impact on our Consolidated Financial Statements.
NOTE 3 — CHANGE IN ACCOUNTING PRINCIPLE
During the first quarter of fiscal 2020, we changed our method of accounting for shipping and handling costs, which we have identified as costs paid to third-party shippers for transporting products to customers. Under the new method of accounting, we include shipping costs in cost of sales, whereas previously, they were included in SG&A expense.
We believe that including these expenses in cost of sales is preferable, as it better aligns these costs with the related revenue in the gross profit calculation and is consistent with the practices of other industry peers. This change in accounting principle has been applied retrospectively, and the consolidated statements of income reflect the effect of this accounting principle change for all periods presented. This reclassification had no impact on income before income taxes, net income attributable to RPM International Inc. Stockholders, net income or earnings per share. The consolidated balance sheets, statements of comprehensive income, statements of stockholders’ equity, and statements of cash flows were not impacted by this accounting principle change.
The consolidated statements of income for the three months ended August 31, 2018 have been adjusted to reflect this change in accounting principle. The impact of the adjustment for the three months ended August 31, 2018 was an increase of $44.7 million to cost of sales and a corresponding decrease to SG&A expense.
9
NOTE 4 — RESTRUCTURING
We record restructuring charges associated with management-approved restructuring plans to either reorganize one or more of our business segments, or to remove duplicative headcount and infrastructure associated with our businesses. Restructuring charges can include severance costs to eliminate a specified number of employees, infrastructure charges to vacate facilities and consolidate operations, contract cancellation costs and other costs. Restructuring charges are recorded based upon planned employee termination dates and site closure and consolidation plans. The timing of associated cash payments is dependent upon the type of restructuring charge and can extend over a multi-year period. We record the short-term portion of our restructuring liability in Other Accrued Liabilities and the long-term portion, if any, in Other Long-Term Liabilities in our Consolidated Balance Sheets.
2020 MAP to Growth
Between May and August 2018, we approved and implemented the initial phases of a multi-year restructuring plan, the 2020 Margin Acceleration Plan (“2020 MAP to Growth”). The initial phases of our 2020 MAP to Growth affected all of our reportable segments, as well as our corporate/nonoperating segment, and focused on margin improvement by simplifying business processes; reducing inventory categories and rationalizing SKUs; eliminating underperforming businesses; reducing headcount and working capital; and improving operating efficiency. The majority of the activities included in the initial phases of the restructuring activities have been completed.
During the second quarter ended November 30, 2018, we formally announced the final phases of our 2020 MAP to Growth. This multi-year restructuring is expected to increase operational efficiency while maintaining our entrepreneurial growth culture and will include three additional phases between September 2018 and December 2020. Our execution of the 2020 MAP to Growth will continue to drive the de-layering and simplification of management and businesses associated with group realignment. We will implement four center-led functional areas including manufacturing and operations; procurement and supply chain; information technology; and accounting and finance.
Our 2020 MAP to Growth will optimize our manufacturing facilities and will ultimately provide more efficient plant and distribution facilities. In the first phase of the restructuring we are implementing the planned closure of twelve plants and seven warehouses. We also expect to incur additional severance and benefit costs as part of our planned closure of these facilities.
Throughout the additional phases of our 2020 MAP to Growth initiative, we will continue to assess and find areas of improvement and cost savings. As such, the final implementation of the aforementioned phases and total expected costs are subject to change. In addition to the announced plan, we have continued to broaden the scope of our 2020 MAP to Growth initiative, specifically in consolidation of the general and administrative areas, potential outsourcing, as well as additional future plant closures and consolidations; the estimated costs of which have not yet been finalized. The current total expected costs associated with this plan are outlined in the table below and increased by approximately $17.5 million compared to our previous estimate, primarily attributable to increases in expected severance and benefit charges of $13.0 million and facility closure and other related costs of $4.3 million. Most activities under our 2020 MAP to Growth are anticipated to be completed by the end of calendar year 2020.
10
Following is a summary of the charges recorded in connection with restructuring by reportable segment:
Three Months
Ended
Cumulative
Costs
Total Expected
(in thousands)
August 31, 2018
to Date
Construction Products Segment:
Severance and benefit costs (a)
160
2,419
11,389
20,182
Facility closure and other related costs
688
13
3,657
4,404
Other asset write-offs
365
1,590
1,929
Total Charges
848
2,797
16,636
26,515
Performance Coatings Segment:
Severance and benefit costs (b)
2,500
4,405
8,913
14,617
109
423
3,583
6,689
213
351
1,207
2,609
5,041
12,847
22,513
Consumer Products Segment:
Severance and benefit costs (c)
767
1,019
8,145
11,663
516
7,208
9,308
25
1,283
15,378
20,996
Specialty Products Segment:
Severance and benefit costs (d)
366
2,220
5,702
8,979
1,459
2,703
6,330
64
1,067
1,425
1,889
9,472
16,734
Corporate/Other Segment:
Severance and benefit costs (e)
(7
8,999
12,113
Consolidated:
Severance and benefit costs
3,786
19,062
46,262
67,554
2,772
436
17,151
26,731
578
3,033
4,586
66,446
98,871
(a)
Severance and benefit costs are associated with the elimination of 21 positions and 31 positions during the three months ended August 31, 2019 and 2018, respectively. Additionally, $0.2 million included in the charges incurred during the three months ended August 31, 2018 are associated with the prior elimination of one position within the legal function during fiscal 2018.
(b)
Severance and benefit costs are associated with the elimination of 51 positions and 85 positions during the three months ended August 31, 2019 and 2018, respectively.
(c)
Severance and benefit costs are associated with the elimination of 2 positions and 9 positions during the three months ended August 31, 2019 and 2018, respectively.
(d)
Severance and benefit costs are associated with the elimination of 10 positions and 25 positions during the three months ended August 31, 2019 and 2018, respectively.
(e)
Charges for the three months ended August 31, 2018 reflect the severance of two corporate executives, as well as accelerated vesting of equity awards for two corporate executives, four specialty segment executives and two construction segment executives in connection with the aforementioned restructuring activities.
11
A summary of the activity in the restructuring reserves related to our 2020 MAP to Growth is as follows:
Severance and
Benefits Costs
Facility
Closure and
Other Related
Other Asset
Write-Offs
9,957
6,184
1,373
17,514
Additions charged to expense
Cash payments charged against reserve
(12,575
(418
(12,993
Non-cash charges included above (e)
(5,484
(838
(1,951
(8,273
10,960
5,364
16,324
4,837
7,857
12,694
(5,677
(334
(6,011
(865
(64
(929
2,946
9,430
12,376
Non-cash charges primarily include accelerated vesting of equity awards and asset-write offs.
In connection with our 2020 MAP to Growth, during the first quarter of fiscal 2020, we incurred approximately $2.0 million, $0.9 million and $0.3 million of inventory-related charges at our performance coatings, consumer and construction segments, respectively. During the first quarter of fiscal 2019, we incurred approximately $4.3 million and $0.2 million of inventory-related charges at our performance coatings and construction products segments, respectively. The fiscal 2019 inventory-related charges were partially offset by a favorable adjustment of approximately $0.2 million to the fiscal 2018 inventory write-off at our consumer segment. All of the aforementioned inventory-related charges are recorded in cost of sales in our Consolidated Statements of Income. These inventory charges were the result of product line and SKU rationalization initiatives in connection with our overall plan of restructuring.
NOTE 5 — MARKETABLE SECURITIES
The following tables summarize available-for-sale marketable securities held at August 31, 2019 and May 31, 2019 by asset type:
Available-For-Sale Securities
Amortized
Cost
Gross
Unrealized
Gains
Losses
Fair Value
(Net Carrying
Amount)
Fixed maturity:
U.S. treasury and other government
24,832
546
(124
25,254
Corporate bonds
57
479
Total available-for-sale securities
603
25,733
24,483
372
(308
24,547
43
(3
462
24,905
415
(311
25,009
12
Marketable securities, included in other current and long-term assets totaling $9.3 million and $16.4 million at August 31, 2019, respectively, and included in other current and long-term assets totaling $8.6 million and $16.4 million at May 31, 2019, respectively, are composed of available-for-sale securities and are reported at fair value. We carry a portion of our marketable securities portfolio in long-term assets since they are generally held for the settlement of our general and product liability insurance claims processed through our wholly owned captive insurance subsidiaries.
Marketable securities include available-for-sale debt securities and are reported at fair value. Realized gains and losses on sales of investments are recognized in net income on the specific identification basis. Changes in the fair values of securities that are considered temporary are recorded as unrealized gains and losses, net of applicable taxes, in accumulated other comprehensive (loss) within stockholders’ equity. Other-than-temporary declines in market value from original cost are reflected in investment income, net in the period in which the unrealized losses are deemed other than temporary. In order to determine whether other-than-temporary declines in market value have occurred, the duration of the decline in value and our ability to hold the investment are considered in conjunction with an evaluation of the strength of the underlying collateral and the extent to which the investment’s amortized cost or cost, as appropriate, exceeds its related market value.
As of August 31, 2019, we held approximately $97.9 million in equity securities. Additionally, as of August 31, 2019 and May 31, 2019, we held approximately $12.8 million and $12.3 million, respectively, in trading securities in relation to our deferred compensation plan.
Summarized below are the available-for-sale securities we held at August 31, 2019 and May 31, 2019 that were in an unrealized loss position and that were included in accumulated other comprehensive (loss), aggregated by the length of time the investments had been in that position:
Total investments with unrealized losses
6,802
11,508
Unrealized losses with a loss position for less than 12 months
283
806
(2
Unrealized losses with a loss position for more than 12 months
6,519
10,702
(309
We have reviewed all of the securities included in the table above and have concluded that we have the ability and intent to hold these investments until their cost can be recovered, based upon the severity and duration of the decline. Therefore, we did not recognize any other-than-temporary impairment losses on these investments. The unrealized losses generally relate to investments whose fair values at August 31, 2019 were less than 15% below their original cost. From time to time, we may experience significant volatility in general economic and market conditions. If we were to experience unrealized losses that were to continue for longer periods of time, or arise to more significant levels of unrealized losses within our portfolio of investments in marketable securities in the future, we may recognize additional other-than-temporary impairment losses. As such, we continue to closely evaluate the status of our investments and our ability and intent to hold these investments.
The net carrying values of debt securities at August 31, 2019, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.
Amortized Cost
Due:
Less than one year
9,370
9,338
One year through five years
10,161
10,242
Six years through ten years
4,548
4,816
After ten years
1,175
1,337
NOTE 6 — FAIR VALUE MEASUREMENTS
Financial instruments recorded in the balance sheet include cash and cash equivalents, trade accounts receivable, marketable securities, notes and accounts payable, and debt.
An allowance for anticipated uncollectible trade receivable amounts is established using a combination of specifically identified accounts to be reserved, and a reserve covering trends in collectibility. These estimates are based on an analysis of trends in collectibility and past experience, but are primarily made up of individual account balances identified as doubtful based on specific facts and conditions. Receivable losses are charged against the allowance when we confirm uncollectibility.
All derivative instruments are recognized in our Consolidated Balance Sheets and measured at fair value. Changes in the fair values of derivative instruments that do not qualify as hedges and/or any ineffective portion of hedges are recognized as a gain or (loss) in our Consolidated Statements of Income in the current period. Changes in the fair value of derivative instruments used effectively as cash flow hedges are recognized in other comprehensive income (loss), along with the change in the value of the hedged item. We do not hold or issue derivative instruments for speculative purposes.
The valuation techniques utilized for establishing the fair values of assets and liabilities are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect management’s market assumptions. The fair value hierarchy has three levels based on the reliability of the inputs used to determine fair value, as follows:
Level 1 Inputs — Quoted prices for identical instruments in active markets.
Level 2 Inputs — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3 Inputs — Instruments with primarily unobservable value drivers.
The following tables present our assets and liabilities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy.
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Significant
Observable
Inputs (Level 2)
Unobservable
Inputs (Level 3)
Fair Value at
Available-for-sale debt securities:
U.S. Treasury and other government
Total available-for-sale debt securities
Trading and other equity securities:
Mutual funds - foreign
33,595
Mutual funds - domestic
77,053
Total trading and other equity securities
110,648
Contingent consideration
(15,668
136,381
120,713
14
May 31,
32,082
67,739
99,821
(21,551
124,830
103,279
Our investments in available-for-sale debt securities and trading and other equity securities are valued using a market approach. The availability of inputs observable in the market varies from instrument to instrument and depends on a variety of factors, including the type of instrument, whether the instrument is actively traded and other characteristics particular to the transaction. For most of our financial instruments, pricing inputs are readily observable in the market, the valuation methodology used is widely accepted by market participants, and the valuation does not require significant management discretion. For other financial instruments, pricing inputs are less observable in the market and may require management judgment.
The contingent consideration represents the estimated fair value of the additional variable cash consideration payable in connection with recent acquisitions that is contingent upon the achievement of certain performance milestones. We estimated the fair value using expected future cash flows over the period in which the obligation is expected to be settled, and applied a discount rate that appropriately captures a market participant's view of the risk associated with the obligation, which are considered to be Level 3 inputs. During the first three months of fiscal 2020, we paid approximately $5.9 million for settlements of contingent consideration obligations relating to certain performance milestones that were established in prior periods and achieved during the current period. During the first three months of fiscal 2019, we paid approximately $4.6 million for settlements of contingent consideration obligations relating to certain performance milestones that were established in prior periods and achieved during last year’s first three months. In the Consolidated Statements of Cash Flows, payments of acquisition-related contingent consideration for the amount recognized at fair value as of the acquisition date are reported in cash flows from financing activities, while payments of contingent consideration in excess of fair value are reported in cash flows from operating activities.
The carrying value of our current financial instruments, which include cash and cash equivalents, marketable securities, trade accounts receivable, accounts payable and short-term debt approximates fair value because of the short-term maturity of these financial instruments. At August 31, 2019 and May 31, 2019, the fair value of our long-term debt was estimated using active market quotes, based on our current incremental borrowing rates for similar types of borrowing arrangements, which are Level 2 inputs. Based on the analysis performed, the fair value and the carrying value of our financial instruments and long-term debt as of August 31, 2019 and May 31, 2019 are as follows:
At August 31, 2019
Carrying Value
Marketable equity securities
97,895
Marketable debt securities
Long-term debt, including current portion
2,600,796
2,709,219
At May 31, 2019
87,525
2,525,908
2,526,817
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NOTE 7 — DERIVATIVES AND HEDGING
Derivative Instruments and Hedging Activities
We are exposed to market risks, such as changes in foreign currency exchange rates and interest rates. To manage the volatility related to these exposures, from time to time, we enter into various derivative transactions. We use various types of derivative instruments including forward contracts and swaps. We formally assess, designate and document, as a hedge of an underlying exposure, each qualifying derivative instrument that will be accounted for as an accounting hedge at inception. Additionally, we assess, both at inception and at least quarterly thereafter, whether the financial instruments used in the hedging transaction are effective at offsetting changes in either the fair values or cash flows of the underlying exposures.
Net Investment Hedge
In October 2017, as a means of mitigating the impact of currency fluctuations on our Euro investments in foreign entities, we executed a fair value hedge and two cross currency swaps, in which we will pay variable rate interest in Euros and receive fixed rate interest in U.S. Dollars with a combined notional amount of approximately €85.25 million ($100 million U.S. Dollar equivalent), and which have a maturity date of November 2022. This effectively converts a portion of our U.S. Dollar denominated fixed-rate debt to Euro denominated variable rate debt. The fair value hedge is recognized at fair value in our Consolidated Balance Sheets, while changes in the fair value of the hedge are recognized in interest expense in our Consolidated Statements of Income. We designated the swaps as net investment hedges of our net investment in our European operations under ASU 2017-12 and applied the spot method to these hedges. The changes in fair value of the derivative instruments that are designated and qualify as hedges of net investments in foreign operations are recognized in accumulated other comprehensive income (“AOCI”) to offset the changes in the values of the net investments being hedged. Amounts released from AOCI and reclassified into interest expense did not have a material impact on our Consolidated Financial Statements for any period presented.
Derivatives Not Designated as Hedges
At August 31, 2019, and May 31, 2019, we held one foreign currency forward contract designed to reduce our exposure to changes in the cash flows of intercompany foreign-currency-denominated loans related to changes in foreign currency exchange rates by fixing the functional currency cash flows. The contract has not been designated as a hedge; therefore, the changes in fair value of the derivative are recognized in earnings as a component of selling, general and administrative expenses (“SG&A”). Amounts recognized in earnings did not have a material impact on our Consolidated Financial Statements for any period presented. As of August 31, 2019 and May 31, 2019, the notional amounts of the forward contract held to purchase foreign currencies was $77.7 million and $38.7 million, respectively.
Disclosure about Derivative Instruments
All of our derivative assets and liabilities measured at fair value are classified as Level 2 within the fair value hierarchy. We determine the fair value of our derivatives based on valuation methods, which project future cash flows and discount the future amounts to present value using market based observable inputs, including interest rate curves, foreign currency rates, as well as future and basis point spreads, as applicable.
The fair values of qualifying and non-qualifying instruments used in hedging transactions as of August 31, 2019 and May 31, 2019 are as follows:
Derivatives Designated as Hedging Instruments
Balance Sheet Location
Assets:
Interest Rate Swap (Fair Value)
Other Current Assets
77
513
Cross Currency Swap (Net Investment)
1,737
2,482
Other Assets (Long-Term)
5,103
6,163
1,733
Liabilities:
Other Accrued Liabilities
230
Other Long-Term Liabilities
1,108
4,276
Derivatives Not Designated as Hedging Instruments
Foreign Currency Exchange
51
318
NOTE 8 — INVESTMENT EXPENSE (INCOME), NET
Investment (income), net, consists of the following components:
Interest (income)
(1,348
(904
Net (gain) on marketable securities
(3,540
(386
Dividend (income)
(497
(1,143
Investment (income), net
Net (Gain) on Marketable Securities
During the first quarter of fiscal 2020, we recognized unrealized gains on trading securities of $0.6 million and unrealized gains of $2.9 million on marketable equity securities.
During the first quarter of fiscal 2019, we recognized gross realized gains and losses on sales of marketable securities of $0.6 million and $0.1 million, respectively, as well as other-than-temporary impairments of $0.1 million.
NOTE 9 — OTHER EXPENSE, NET
Other expense, net, consists of the following components:
Royalty expense, net
266
Loss (income) related to unconsolidated equity affiliates
91
(118
Pension non-service costs
1,428
428
Other expense, net
NOTE 10 — INCOME TAXES
The effective income tax rate of 25.5% for the three months ended August 31, 2019 compares to the effective income tax rate of 23.7% for the three months ended August 31, 2018. The effective income tax rates for the three months ended August 31, 2019 and 2018 reflect variances from the 21% statutory rate due primarily to the unfavorable impact of state and local income taxes and the net tax on foreign subsidiary income resulting from the global intangible low-taxed income provisions, partially offset by tax benefits related to equity compensation. The quarter over quarter increase in the effective income tax rate is primarily attributable to a decrease in the equity compensation income tax benefit.
Our deferred tax liability for unremitted foreign earnings was $18.8 million as of August 31, 2019, which represents our estimate of the foreign tax cost associated with the remittance of $413.9 million of foreign earnings that are not considered to be permanently reinvested. We have not provided for foreign withholding or income taxes on the remaining foreign subsidiaries’ undistributed earnings because such earnings have been retained and reinvested by the subsidiaries as of August 31, 2019. Accordingly, no provision has been made for foreign withholding or income taxes, which may become payable if the remaining undistributed earnings of foreign subsidiaries were remitted to us as dividends.
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NOTE 11 — INVENTORIES
Inventories, net of reserves, were composed of the following major classes:
Raw material and supplies
302,410
296,493
Finished goods
558,108
545,380
Total Inventory, Net of Reserves
NOTE 12 — STOCK REPURCHASE PROGRAM
On January 8, 2008, we announced our authorization of a stock repurchase program under which we may repurchase shares of RPM International Inc. common stock at management’s discretion for general corporate purposes. As announced on November 28, 2018, our goal is to return $1.0 billion in capital to stockholders by May 31, 2021 through share repurchases. On April 16, 2019, after taking into account share repurchases under our existing stock repurchase program to date, our Board of Directors authorized the repurchase of the remaining $600.0 million in value of RPM International Inc. common stock by May 31, 2021. As a result, we may repurchase shares from time to time in the open market or in private transactions at various times and in amounts and for prices that our management deems appropriate, subject to insider trading rules and other securities law restrictions. The timing of our purchases will depend upon prevailing market conditions, alternative uses of capital and other factors. We may limit or terminate the repurchase program at any time. During the three months ended August 31, 2019, we repurchased 1,655,616 shares of our common stock at a cost of approximately $100.0 million, or an average cost of $60.40 per share, under this program. During the three months ended August 31, 2018, we repurchased 103,446 shares of our common stock at a cost of approximately $7.0 million, or an average cost of $67.61 per share, under this program.
NOTE 13 — EARNINGS PER SHARE
The following table sets forth the reconciliation of the numerator and denominator of basic and diluted earnings per share, as calculated using the two class method, for the three-month periods ended August 31, 2019 and 2018.
Numerator for earnings per share:
Net income attributable to RPM International Inc. stockholders
Less: Allocation of earnings and dividends to participating securities
(623
(611
Net income available to common shareholders - basic
105,565
69,153
Add: Undistributed earnings reallocated to unvested shareholders
Add: Allocation of earnings and dividends to participating securities
Add: Income effect of contingently issuable shares
1,480
Net income available to common shareholders - diluted
105,567
70,634
Denominator for basic and diluted earnings per share:
Basic weighted average common shares
Average diluted options and awards
622
636
Additional shares issuable assuming conversion of convertible securities (1)
3,933
Total shares for diluted earnings per share (2)
Earnings Per Share of Common Stock Attributable to
RPM International Inc. Stockholders:
Basic Earnings Per Share of Common Stock
Diluted Earnings Per Share of Common Stock
(1)
Represents the number of shares that would have been issued if our contingently convertible notes had been converted. We included these shares in the calculation of diluted EPS as the conversion of the notes were eligible to be settled, at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock. On November 27, 2018, we redeemed all of our 2.25% convertible senior notes due 2020, primarily for cash, but also issued 598,601 shares of our common stock in the transaction.
(2)
Restricted shares totaling 178,000 and 126,750 for the three months ended August 31, 2019 and 2018, respectively, were excluded from the calculation of diluted earnings per share as their effect would have been anti-dilutive. In addition, stock appreciation rights (SARs) totaling 790,000 for the three months ended August 31, 2019 and 890,000 for the three months ended August 31, 2018, were excluded from the calculation of diluted earnings per share as their effect would have been anti-dilutive.
18
NOTE 14—LEASES
We have leases for manufacturing facilities, warehouses, office facilities, equipment, and vehicles, which are primarily classified and accounted for as operating leases. We have a small portfolio of finance leases, which are not material to our consolidated financial statements. Some leases include one or more options to renew, generally at our sole discretion, with renewal terms that can extend the lease term from one to five years or more. In addition, certain leases contain termination options, where the rights to terminate are held by either us, the lessor, or both parties. These options to extend or terminate a lease are included in the lease terms when it is reasonably certain that we will exercise that option. We have made an accounting policy election not to recognize ROU assets and lease liabilities for leases with a term of twelve months or less, with no purchase option that we are reasonably certain to exercise. ROU assets and lease liabilities are recognized based on the present value of the fixed and in-substance fixed lease payments over the lease term at the commencement date. The ROU assets also include any initial direct costs incurred and lease payments made at or before the commencement date and are reduced by lease incentives. We use our incremental borrowing rate as the discount rate to determine the present value of the lease payments for leases, as our leases do not have readily determinable implicit discount rates. Our incremental borrowing rate is the rate of interest that we would have to borrow on a collateralized basis over a similar term and amount in a similar economic environment. We determine the incremental borrowing rates for our leases by adjusting the local risk-free interest rate with a credit risk premium corresponding to our credit rating.
Operating lease cost is recognized on a straight-line basis over the lease term. Finance lease cost is recognized as a combination of the amortization expense for the ROU assets and interest expense for the outstanding lease liabilities using the discount rate discussed above. The depreciable life of assets and leasehold improvements are limited by the expected lease term, unless there is a transfer of title or purchase option reasonably certain of exercise. Certain vendors have the right to declare that we are in default of our agreements if any such vendor, including the lessors under its vehicle leases, determines that a change in our financial condition poses a substantially increased credit risk. Our lease agreements do not contain any significant residual value guarantees or material restrictive covenants. Income from subleases was not significant for any period presented.
During the three months ended August 31, 2019, we incurred lease cost of $20.7 million, which is primarily comprised of operating lease cost of $18.1 million and other costs of $2.6 million which include costs for our finance leases, short-term leases, and variable lease payments.
For the three months ended August 31, 2019, we paid approximately $16.9 million for operating lease obligations. These payments are included in operating cash flows. In addition, we recognized ROU assets for $3.1 million in exchange for new operating lease obligations. At August 31, 2019, the weighted-average remaining lease term under our operating leases was 8.4 years, while the weighted-average discount rate for our operating leases was approximately 3.8%.
The following represents our future undiscounted cash flows for each of the next five years and thereafter and reconciliation to the lease liabilities, as of August 31, 2019:
Year ending May 31,
Operating Leases
2020 (excluding the three months ended August 31)
46,387
2021
51,794
2022
40,792
2023
31,889
2024
26,759
Thereafter
121,011
Total lease payments
318,632
Less imputed interest
52,787
Total present value of lease liabilities
265,845
As of August 31, 2019, our current lease liability balance was $50.7 million and recorded within Other Accrued Liabilities on our Consolidated Balance Sheet.
19
Following is a summary of our future minimum lease commitments, as determined under ASC 840, for all non-cancelable lease agreements, for each of the next five years and in the aggregate, as of May 31, 2019:
2020
59,163
49,731
40,339
32,798
27,716
119,607
329,354
Related party leases and subleases were not significant during any period presented, and therefore are not disclosed. Further, we do not have leases that have not yet commenced, which would create significant rights and obligations for us, including any involvement with the construction or design of the underlying asset.
NOTE 15 — PENSION PLANS
We offer defined benefit pension plans, defined contribution pension plans, and various postretirement benefit plans. The following tables provide the retirement-related benefit plans’ impact on income before income taxes for the three months ended August 31, 2019 and 2018:
U.S. Plans
Non-U.S. Plans
Pension Benefits
Service cost
9,856
9,382
1,391
1,219
Interest cost
5,104
5,497
1,193
1,399
Expected return on plan assets
(8,573
(8,467
(1,834
(2,051
Amortization of:
Prior service cost (credit)
29
(9
(8
Net actuarial losses recognized
4,629
3,272
523
319
Net Periodic Benefit Cost
11,018
9,713
1,264
878
Postretirement Benefits
429
392
48
282
291
Prior service (credit)
(55
Net actuarial (gains) losses recognized
(6
158
115
Net Periodic Benefit (Credit) Cost
(34
(13
869
798
Due to slightly lower discount rates, net periodic pension and postretirement cost for fiscal 2020 is higher than our fiscal 2019 expense. We expect that pension expense will fluctuate on a year-to-year basis, depending upon the investment performance of plan assets and potential changes in interest rates, but such changes are not expected to be material to our consolidated financial results. We previously disclosed in our financial statements for the fiscal year ended May 31, 2019 that we expected to contribute approximately $0.9 million to our retirement plans in the U.S. and approximately $6.4 million to plans outside the U.S. during the current fiscal year, and as of August 31, 2019, those amounts remain unchanged.
NOTE 16 — CONTINGENCIES AND OTHER ACCRUED LOSSES
20
We provide, through our wholly owned insurance subsidiaries, certain insurance coverage, primarily product liability coverage, to our other subsidiaries. Excess coverage is provided by third-party insurers. Our product liability accruals provide for these potential losses as well as other uninsured claims. Product liability accruals are established based upon actuarial calculations of potential liability using industry experience, actual historical experience and actuarial assumptions developed for similar types of product liability claims, including development factors and lag times. To the extent there is a reasonable possibility that potential losses could exceed the amounts already accrued, we believe that the amount of any such additional loss would be immaterial to our results of operations, liquidity and consolidated financial position.
We also offer warranties on many of our products, as well as long-term warranty programs at certain of our businesses, and have established product warranty liabilities. We review these liabilities for adequacy on a quarterly basis and adjust them as necessary. The primary factors that could affect these liabilities may include changes in performance rates as well as costs of replacement. Provision for estimated warranty costs is recorded at the time of sale and periodically adjusted, as required, to reflect actual experience. It is probable that we will incur future losses related to warranty claims we have received but that have not been fully investigated and related to claims not yet received. While our warranty liabilities represent our best estimates at August 31, 2019, we can provide no assurances that we will not experience material claims in the future or that we will not incur significant costs to resolve such claims beyond the amounts accrued or beyond what we may recover from our suppliers. Based upon the nature of the expense, product warranty expense is recorded as a reduction of sales, as a component of cost of sales, or within SG&A.
Also, due to the nature of our businesses, the amount of claims paid can fluctuate from one period to the next. While our warranty liabilities represent our best estimates of our expected losses at any given time, from time-to-time we may revise our estimates based on our experience relating to factors such as weather conditions, specific circumstances surrounding product installations and other factors.
The following table includes the changes in our accrued warranty balances:
Beginning Balance
10,414
11,721
Deductions (1)
(5,513
(6,614
Provision charged to expense
5,168
5,478
Ending Balance
10,069
10,585
Primarily claims paid during the year.
In addition, like other companies participating in similar lines of business, some of our subsidiaries are involved in several proceedings relating to environmental matters. It is our policy to accrue remediation costs when it is probable that such efforts will be required and the related costs can be reasonably estimated. In general, our environmental accruals are undiscounted liabilities, which are exclusive of claims against third parties, and are not material to our financial statements during any of the periods presented.
We were notified by the SEC on June 24, 2014, that we are the subject of a formal investigation pertaining to the timing of our disclosure and accrual of loss reserves in fiscal 2013 with respect to the previously disclosed U.S. Department Of Justice (the “DOJ”) and the U.S. General Services Administration (the “GSA”) Office of Inspector General investigation into compliance issues relating to Tremco Roofing Division’s GSA contracts. As previously disclosed, our Audit Committee completed an investigation into the facts and circumstances surrounding the timing of our disclosure and accrual of loss reserves with respect to the GSA and DOJ investigation, and determined that it was appropriate to restate our financial results for the first, second and third quarters of fiscal 2013. These restatements had no impact on our audited financial statements for the fiscal years ended May 31, 2013 or 2014. The Audit Committee’s investigation concluded that there was no intentional misconduct on the part of any of our officers.
21
In connection with the foregoing, on September 9, 2016, the SEC filed an enforcement action against us and our General Counsel. We have cooperated with the SEC’s investigation and believe the allegations in the complaint mischaracterize both our and our General Counsel’s actions in connection with the matters related to our quarterly results in fiscal 2013 and are without merit. Both we and our General Counsel filed motions to dismiss the complaint on February 24, 2017. Those motions to dismiss the complaint were denied by the Court on September 29, 2017. We and our General Counsel filed answers to the complaint on October 16, 2017. Formal discovery commenced in January 2018 and closed as of June 3, 2019, other than one remaining discovery dispute. The parties engaged in written discovery, and several fact witnesses were deposed. The dispositive motion briefing schedule was vacated by the Court on July 2, 2019, due to the remaining discovery dispute, and will be reset once this dispute is fully resolved. We intend to continue to contest the allegations in the complaint vigorously.
Also in connection with the foregoing, a stockholder derivative action was filed in the United States District Court, Northern District of Ohio, Eastern Division, against certain of our directors and officers. The court has stayed this stockholder derivative action pending the completion of the SEC enforcement action.
The action by the SEC could result in sanctions against us and/or our General Counsel and could impose substantial additional costs and distractions, regardless of its outcome. We have determined that it is probable that we will incur a loss relating to this matter and have estimated a range of potential loss. We have accrued at the low end of the range of loss, as no amount within the range is more likely to occur, and no amount within the estimated range of loss would have a material impact on our consolidated financial condition, results of operations or cash flows.
NOTE 17 – REVENUE
We operate a portfolio of businesses and product lines that manufacture and sell a variety of specialty paints, protective coatings and roofing systems, sealants and adhesives. We disaggregate revenues from the sales of our products and services based upon geographical location by each of our reportable segments, which are aligned by similar economic factors, trends and customers, which best depict the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. See Note 18, “Segment Information,” for further details regarding our disaggregated revenues as well as a description of each of the unique revenue streams related to each of our four reportable segments.
Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. The majority of our revenue is recognized at a point in time. However, we also record revenues generated under construction contracts, mainly in connection with the installation of specialized roofing and flooring systems and related services. For certain polymer flooring installation projects, we account for our revenue using the output method, as we consider square footage of completed flooring to be the best measure of progress toward the complete satisfaction of the performance obligation. In contrast, for certain of our roofing installation projects, we account for our revenue using the input method, as that method was the best measure of performance as it considers costs incurred in relation to total expected project costs, which essentially represents the transfer of control for roofing systems to the customer. In general, for our construction contracts, we record contract revenues and related costs as our contracts progress on an over-time model.
We have elected to apply the practical expedient to recognize revenue net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities. Payment terms and conditions vary by contract type, although our customers’ payment terms generally include a requirement to pay within 30 to 60 days of fulfilling our performance obligations. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined that our contracts generally do not include a significant financing component. We have elected to apply the practical expedient to treat all shipping and handling costs as fulfillment costs as a significant portion of these costs are incurred prior to control transfer.
Significant Judgments
Our contracts with customers may include promises to transfer multiple products and/or services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. For example, judgment is required to determine whether products sold in connection with the sale of installation services are considered distinct and accounted for separately, or not distinct and accounted for together with installation services and recognized over time.
22
We provide customer rebate programs and incentive offerings, including special pricing and co-operative advertising arrangements, promotions and other volume-based incentives. These customer programs and incentives are considered variable consideration. We include in revenue variable consideration only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the variable consideration is resolved. In general, this determination is made based upon known customer program and incentive offerings at the time of sale, and expected sales volume forecasts as it relates to our volume-based incentives. This determination is updated each reporting period. Certain of our contracts include contingent consideration that is receivable only upon the final inspection and acceptance of a project. We include estimates of such variable consideration in our transaction price. Based on historical experience, we consider the probability-based expected value method appropriate to estimate the amount of such variable consideration.
Our products are generally sold with a right of return and we may provide other credits or incentives, which are accounted for as variable consideration when estimating the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period as additional information becomes available. We record a right of return liability to accrue for expected customer returns. Historical actual returns are used to estimate future returns as a percentage of current sales. Obligations for returns and refunds were not material individually or in the aggregate.
We offer assurance type warranties on our products as well as separately sold warranty contracts. Revenue related to warranty contracts that are sold separately is recognized over the life of the warranty term. Warranty liabilities for our assurance type warranties are discussed further in Note 16.
Contract Balances
Timing of revenue recognition may differ from the timing of invoicing customers. Our contract assets are recorded for products and services that have been provided to our customer but have not yet been billed, and are included in prepaid expenses and other current assets in our consolidated balance sheets. Our short-term contract liabilities consist of advance payments, or deferred revenue, and are included in other accrued liabilities in our consolidated balance sheets.
Accounts receivable, net of allowances, and net contract assets (liabilities) consisted of the following:
(In thousands, except percents)
$ Change
% Change
Accounts receivable, less allowance
(123,091
-10.0
%
Contract assets
26,464
21,628
4,836
22.4
Contract liabilities - short-term
(27,402
(25,896
(1,506
5.8
Net Contract Liabilities
(938
(4,268
3,330
-78.0
The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence. The $3.3 million change in our net contract liabilities from May 31, 2019 to August 31, 2019 resulted primarily from the timing of construction jobs in progress. During the first quarter of fiscal 2020, we performed a substantial amount of work on construction projects, and as such, our unbilled revenue is higher as of August 31, 2019 than it was at May 31, 2019. We also record long-term deferred revenue, which amounted to $65.6 million and $66.5 million as of August 31, 2019 and May 31, 2019, respectively. The long-term portion of deferred revenue is related to assurance type warranty contracts and is included in other long-term liabilities in our consolidated balance sheets.
We have elected to adopt the practical expedient to not disclose the aggregate amount of transaction price allocated to performance obligations that are unsatisfied as of the end of the reporting period for performance obligations that are part of a contract with an original expected duration of one year or less.
We recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. As our contract terms are primarily one year or less in duration, we have elected to apply a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. These costs include our internal sales force compensation program and certain incentive programs as we have determined annual compensation is commensurate with annual sales activities.
NOTE 18 — SEGMENT INFORMATION
Effective June 1, 2019, we realigned certain businesses and management structure to recognize how we allocate resources and analyze the operating performance of our businesses. Among other things, the realignment of certain businesses occurred as a result of the
23
2020 MAP to Growth plan that was approved and initiated between May and August 2018. As we began to execute on our operating improvement initiatives, we identified ways to realign certain businesses, and concluded that moving to an expanded reporting structure could help us to better manage our assets and improve synergies across the enterprise.
This realignment changed our reportable segments beginning with our first quarter of fiscal 2020. As such, we will begin reporting under four reportable segments instead of our three previous reportable segments. Our four reporting segments will now be: the Construction Products Group (“CPG”), Performance Coatings Group (“PCG”), Consumer Group (“Consumer”) and Specialty Products Group (“Specialty”). In connection with the realignment, we shifted our Kirker business out of Consumer into Specialty, and also shifted our Dryvit and Nudura businesses out of Specialty into CPG. The newly formed CPG will also include our Tremco, Tremco illbruck, Euclid Chemical, Viapol, Vandex and Flowcrete businesses. PCG will include Stonhard, Carboline, USL and Fibergrate businesses, while Consumer will comprise the Rust-Oleum and DAP businesses.
We operate a portfolio of businesses and product lines that manufacture and sell a variety of specialty paints, protective coatings and roofing systems, sealants and adhesives. We manage our portfolio by organizing our businesses and product lines into four reportable segments as outlined above, which also represent our operating segments. Within each operating segment, we manage product lines and businesses which generally address common markets, share similar economic characteristics, utilize similar technologies and can share manufacturing or distribution capabilities. Our four operating segments represent components of our business for which separate financial information is available that is utilized on a regular basis by our chief operating decision maker in determining how to allocate the assets of the company and evaluate performance. These four operating segments are each managed by an operating segment manager, who is responsible for the day-to-day operating decisions and performance evaluation of the operating segment’s underlying businesses. We evaluate the profit performance of our segments primarily based on income before income taxes, but also look to earnings (loss) before interest and taxes (“EBIT”), and/or adjusted EBIT, as a performance evaluation measure because interest expense is essentially related to acquisitions, as opposed to segment operations.
Our CPG reportable segment products are sold throughout North America and also account for the majority of our international sales. Our construction product lines are sold directly to contractors, distributors and end-users, such as industrial manufacturing facilities, public institutions and other commercial customers. Products and services within this reportable segment include construction sealants and adhesives, coatings and chemicals, roofing systems, concrete admixture and repair products, building envelope solutions, insulated cladding, flooring systems, and weatherproofing solutions.
Our PCG reportable segment products are sold throughout North America, as well as internationally, and are sold directly to contractors, distributors and end-users, such as industrial manufacturing facilities, public institutions and other commercial customers. Products and services within this reportable segment include high-performance flooring solutions, corrosion control and fireproofing coatings, infrastructure repair systems, fiberglass reinforced plastic gratings and drainage systems.
Our Consumer reportable segment manufactures and markets professional use and do-it-yourself (“DIY”) products for a variety of mainly consumer applications, including home improvement and personal leisure activities. Our consumer segment’s major manufacturing and distribution operations are located primarily in North America, along with a few locations in Europe and other parts of the world. Our consumer reportable segment products are primarily sold directly to mass merchandisers, home improvement centers, hardware stores, paint stores, craft shops and through distributors. The Consumer reportable segment offers products that include specialty, hobby and professional paints; caulks; adhesives; silicone sealants and wood stains.
Our Specialty reportable segment products are sold throughout North America and a few international locations, primarily in Europe. Our specialty product lines are sold directly to contractors, distributors and end-users, such as industrial manufacturing facilities, public institutions and other commercial customers. The Specialty reportable segment offers products that include industrial cleaners, restoration services equipment, colorants, nail enamels, exterior finishes, edible coatings and specialty glazes for pharmaceutical and food industries, and other specialty original equipment manufacturer (“OEM”) coatings.
In addition to our four reportable segments, there is a category of certain business activities and expenses, referred to as corporate/other, that does not constitute an operating segment. This category includes our corporate headquarters and related administrative expenses, results of our captive insurance companies, gains or losses on the sales of certain assets and other expenses not directly associated with any reportable segment. Assets related to the corporate/other category consist primarily of investments, prepaid expenses and headquarters’ property and equipment. These corporate and other assets and expenses reconcile reportable segment data to total consolidated income before income taxes and identifiable assets.
We reflect income from our joint ventures on the equity method, and receive royalties from our licensees.
24
The following tables present a disaggregation of revenues by geography, and reflect the results of our reportable segments consistent with our management philosophy, by representing the information we utilize, in conjunction with various strategic, operational and other financial performance criteria, in evaluating the performance of our portfolio of businesses. Information for all periods presented has been recast to reflect the current quarter change in reportable segments.
Three Months Ended August 31, 2019
CPG Segment
PCG Segment
Consumer
Segment
Specialty
Consolidated
Net Sales (based on shipping location)
United States
307,659
181,906
381,229
131,731
1,002,525
Foreign
Canada
50,443
20,973
32,505
2,228
106,149
Europe
114,302
64,459
51,009
20,839
250,609
Latin America
42,847
8,441
6,315
432
58,035
Asia Pacific
20,396
7,424
6,181
4,858
38,859
Other Foreign
458
14,038
2,091
16,587
Total Foreign
228,446
115,335
98,101
28,357
470,239
536,105
297,241
479,330
160,088
Three Months Ended August 31, 2018
289,799
177,457
375,536
137,881
980,673
43,338
22,188
29,005
2,246
96,777
125,287
60,614
57,876
22,800
266,577
37,985
9,642
6,122
307
54,056
20,290
10,212
6,912
5,481
42,895
793
16,306
1,912
19,011
227,693
118,962
101,827
30,834
479,316
517,492
296,419
477,363
168,715
Income (Loss) Before Income Taxes
82,680
65,044
28,057
8,325
Consumer Segment
59,158
50,969
Specialty Segment
23,327
23,816
Corporate/Other
(50,373
(56,216
Identifiable Assets
1,594,453
1,573,329
992,995
951,644
1,987,280
1,953,279
711,348
689,133
310,349
273,970
NOTE 19 — GOODWILL
We account for goodwill and other intangible assets in accordance with the provisions of ASC 350 and account for business combinations using the acquisition method of accounting and, accordingly, the assets and liabilities of the entities acquired are recorded at their estimated fair values at the acquisition date. Goodwill represents the excess of the purchase price paid over the fair value of net assets acquired, including the amount assigned to identifiable intangible assets.
We assess goodwill for impairment annually during the fourth quarter, or more frequently, if events and circumstances indicate impairment may have occurred. We test goodwill for impairment at the reporting unit level. Goodwill is assigned to reporting units that are expected to benefit from the synergies of the business combination as of the acquisition date. Once goodwill has been allocated to the reporting units, it no longer retains its identification with a particular acquisition and becomes identified with the reporting unit in its entirety. Accordingly, the fair value of the reporting unit as a whole is available to support the recoverability of its goodwill. We evaluate our reporting units when changes in our operating structure occur, and if necessary, reassign goodwill using a relative fair value allocation approach.
Subsequent to our prior annual impairment test as of the first day of our fourth fiscal quarter, the composition of our reportable segments was revised, as further discussed in Note 18, “Segment Information.” Prior to implementing the revised segment reporting structure during our current quarter of fiscal 2020, our previously disclosed Industrial Segment comprised two operating segments, the CPG operating segment and the PCG operating segment. Each of these operating segments comprised several reporting units, all of which were tested during our last annual goodwill impairment test during the fourth quarter of fiscal 2019.
Also, in connection with our 2020 Map to Growth initiative, we realigned certain businesses and management structure within our Specialty segment. As such, our former Wood Finishes Group reporting unit was split into two separate reporting units: Guardian and Wood Finishes Group. Additionally, our former Kop-Coat Group reporting unit was split into two reporting units: Kop-Coat Industrial Protection Products and Kop-Coat Group. We performed a goodwill impairment test for each of the new reporting units upon the change in reportable segments, business realignment and management structure using a quantitative assessment. We concluded that the estimated fair values exceeded the carrying values for these new reporting units, and accordingly, no indications of impairment were identified as a result of these changes during the first quarter of fiscal 2020.
The following table summarizes the changes in the carrying amount of goodwill, by reportable segment, for the periods presented:
CPG
PCG
Industrial
Balance as of May 31, 2019
526,419
499,387
219,956
Allocation to new segments
407,429
185,259
(526,419
(66,269
Acquisitions
14,689
Translation adjustments
(3,578
(2,577
(3,568
(910
(10,633
Balance as of August 31, 2019
418,540
182,682
495,819
152,777
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ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our financial statements include all of our majority-owned subsidiaries. Investments in less-than-majority-owned joint ventures for which we have the ability to exercise significant influence over are accounted for under the equity method. Preparation of our financial statements requires the use of estimates and assumptions that affect the reported amounts of our assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We continually evaluate these estimates, including those related to our allowances for doubtful accounts; inventories; allowances for recoverable taxes; uncertain tax positions; useful lives of property, plant and equipment; goodwill and other intangible assets; environmental, warranties and other contingent liabilities; income tax valuation allowances; pension plans; and the fair value of financial instruments. We base our estimates on historical experience, our most recent facts, and other assumptions that we believe to be reasonable under the circumstances. These estimates form the basis for making judgments about the carrying values of our assets and liabilities. Actual results, which are shaped by actual market conditions, may differ materially from our estimates.
A comprehensive discussion of the accounting policies and estimates that are the most critical to our financial statements are set forth in our Annual Report on Form 10-K for the year ended May 31, 2019.
BUSINESS SEGMENT INFORMATION
Effective June 1, 2019, we realigned certain businesses and management structure to recognize how we allocate resources and analyze the operating performance of our businesses. Among other things, the realignment of certain businesses occurred as a result of the 2020 MAP to Growth plan that was approved and initiated between May and August 2018. As we began to execute on our operating improvement initiatives, we identified ways to realign certain businesses, and concluded that moving to an expanded reporting structure could help us to better manage our assets and improve synergies across the enterprise.
This realignment changed our reportable segments beginning with our first quarter of fiscal 2020. As such, we will begin reporting under four reportable segments instead of our three previous reportable segments. See Note 18, “Segment Information,” to the consolidated financial statements for further detail.
The following tables reflect the results of our reportable segments consistent with our management philosophy, and represent the information we utilize, in conjunction with various strategic, operational and other financial performance criteria, in evaluating the performance of our portfolio of businesses. Information for all periods presented has been recast to reflect the current quarter change in reportable segments.
Income Before Income Taxes (a)
Interest (Expense), Net (b)
(2,027
(2,290
EBIT (c)
84,707
67,334
(129
28,186
8,443
(105
(174
59,263
51,143
Interest Income, Net (b)
93
23,301
23,723
(Expense) Before Income Taxes (a)
(20,697
(19,484
(29,676
(36,732
Add: (Provision) for Income Taxes
(36,353
(21,752
Interest (Expense)
(28,317
(24,406
Investment Income, Net
5,385
2,433
165,781
113,911
The presentation includes a reconciliation of Income (Loss) Before Income Taxes, a measure defined by generally accepted accounting principles ("GAAP") in the U.S., to EBIT.
Interest (expense), net includes the combination of interest (expense) and investment income/(expense), net.
EBIT is a non-GAAP measure, and is defined as earnings (loss) before interest and taxes. We evaluate the profit performance of our segments based on income before income taxes, but also look to EBIT as a performance evaluation measure because interest expense is essentially related to acquisitions, as opposed to segment operations. We believe EBIT is useful to investors for this purpose as well, using EBIT as a metric in their investment decisions. EBIT should not be considered an alternative to, or more meaningful than, income before income taxes as determined in accordance with GAAP, since EBIT omits the impact of interest in determining operating performance, which represent items necessary to our continued operations, given our level of indebtedness. Nonetheless, EBIT is a key measure expected by and useful to our fixed income investors, rating agencies and the banking community all of whom believe, and we concur, that this measure is critical to the capital markets' analysis of our segments' core operating performance. We also evaluate EBIT because it is clear that movements in EBIT impact our ability to attract financing. Our underwriters and bankers consistently require inclusion of this measure in offering memoranda in conjunction with any debt underwriting or bank financing. EBIT may not be indicative of our historical operating results, nor is it meant to be predictive of potential future results.
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RESULTS OF OPERATIONS
Net Sales Consolidated net sales of $1,472.8 million for the first quarter of fiscal 2020 grew by approximately 0.9% from net sales of $1,460.0 million for last year’s first quarter. Acquisitions added 2.3%, while organic sales, which include the impact of price and volume, reduced consolidated net sales by 0.1%. Consolidated net sales for the quarter also reflect an unfavorable foreign exchange impact of 1.3%.
CPG segment net sales for the current quarter grew by 3.6% to $536.1 million, from net sales of $517.5 million during the same period a year ago. The improvement resulted from recent acquisitions, which contributed 4.4% to net sales during the current quarter, and organic growth, which contributed 0.7% during the quarter, driven mainly by increases in selling prices. Unfavorable foreign exchange impacted construction segment net sales by 1.5% during the current quarter. Sales growth was highest in our basement waterproofing business and our Brazilian operation, but was offset by unfavorable weather, in the first month of the quarter, and labor shortages.
PCG segment net sales for the current quarter grew by 0.3% to $297.2 million, from net sales of $296.4 million during the same period a year ago. The improvement resulted from recent acquisitions, which contributed 1.8% to net sales during the current quarter, and organic growth, which contributed 0.4% during the quarter, driven mainly by the increases of selling prices over the comparable period last year. Unfavorable foreign exchange impacted performance coatings segment net sales by 1.9% during the current quarter. Sales growth was dampened by strategic decisions to exit low-margin businesses.
Consumer segment net sales for the quarter grew by 0.4% to $479.3 million, from $477.4 million during last year’s first quarter. Recent acquisitions provided 1.3% of the growth in net sales, while organic growth provided 0.1%, during the current quarter, driven primarily by price increases. Unfavorable foreign currency impacted net sales in the consumer segment by 1.0% during the current quarter versus the same period a year ago. Sales growth was dampened due to soft economy in the U.K. related to Brexit, unfavorable weather in the first month of the quarter, deferred promotional activity by big box retailers, and a difficult comparison to the prior year, when there were load-ins for new business.
Specialty segment net sales for the quarter decreased by 5.1% to $160.1 million, from $168.7 million during last year’s first quarter. Organic declines of 4.3%, during the current quarter, resulted from decreases in fluorescent pigments, specialty coatings and OEM businesses. Additionally, foreign currency had an unfavorable impact on specialty segment net sales for the quarter of 0.8%.
Gross Profit Margin Our consolidated gross profit margin of 39.0% of net sales for the first quarter of fiscal 2020 compares to a consolidated gross profit margin of 37.6% for the comparable period a year ago, after giving effect to the change in classification of shipping and handling costs. Last year’s reported gross profit margin of 40.7% has been recast to 37.6% in order to reflect the current year change in accounting principle related to shipping and handling costs, which were previously recognized in SG&A expenses and are now recognized in cost of sales. The current quarter gross profit increase of approximately 1.4% of net sales reflects an improvement of approximately 380 basis points (“bps”) resulting from a combination of increases in selling prices and 2020 MAP to Growth savings, partially offset by the impact of lower volume and unfavorable mix of product sold versus last year for approximately 160 bps, in addition to higher raw material costs for approximately 30 bps and supply chain challenges throughout the period for approximately 50 bps. Recent changes in international trade duties and policies could materially impact the cost of our raw materials. Specifically, recently imposed tariffs, including tariffs on steel imports into the U.S., will likely have an unfavorable impact on the cost of our cans and packaging.
SG&A Our consolidated SG&A expense during the current period was $14.5 million lower versus the same period last year, and decreased to 27.2% of net sales from 28.4% of net sales for the prior year quarter. Last year’s reported SG&A percentage of net sales of 31.5% has been recast to 28.4% in order to reflect the current year change in accounting principle related to shipping and handling costs, which were previously recognized in SG&A expenses and are now recognized in cost of sales. During the first quarter of fiscal 2020, we continued our 2020 MAP to Growth and have generated $6.3 million of incremental savings. In connection with this plan, we incurred ERP implementation and consolidation expenses and professional fees in connection with implementing our 2020 MAP to Growth initiative totaling approximately $11.7 million. Additionally, in the prior year comparable period, there was approximately $10 million in unfavorable legal settlements and associated legal fees and unfavorable transactional foreign exchange of approximately $5.7 million, both of which did not reoccur in the current year. Additional SG&A expense incurred from companies acquired during the previous 12 months approximated $5.4 million during the first quarter of fiscal 2020.
Our CPG segment SG&A was approximately $1.5 million lower for the first quarter of fiscal 2020 versus the comparable prior year period and decreased as a percentage of net sales, mainly due to 2020 MAP to Growth savings in the current quarter and unfavorable transactional foreign exchange that occurred in the prior comparable quarter. Partially offsetting these decreases in SG&A was approximately $3.7 million of additional SG&A expense generated from companies acquired during the past 12 months.
Our PCG segment SG&A was approximately $8.3 million lower for the first quarter of fiscal 2020 versus the comparable prior year period and decreased as a percentage of net sales, mainly due to 2020 MAP to Growth savings in the current quarter, decreased allowance for doubtful accounts associated with accounts deemed uncollectible as a result of changes in our market and leadership strategy and unfavorable transactional foreign exchange that occurred in the prior comparable quarter. These decreases were slightly offset by approximately $0.4 million of additional SG&A expense generated from companies acquired during the past 12 months.
Our Consumer segment SG&A decreased by approximately $5.8 million during the first quarter of fiscal 2020 versus the same period last year and decreased as a percentage of net sales. This was primarily attributable to 2020 MAP to Growth savings as well as unfavorable legal settlements and associated legal fees, which occurred during the prior comparable quarter. This was slightly offset by approximately $1.2 million of additional SG&A expense generated from companies acquired during the past 12 months.
Our Specialty segment SG&A was approximately $0.1 million lower during the first quarter of fiscal 2020 versus the comparable prior year period, but increased as a percentage of net sales. The decrease in SG&A expense is mainly attributable to cost control measures, which were offset by additional costs associated with the ERP consolidation plan associated with our 2020 MAP to Growth.
SG&A expenses in our corporate/other category of $28.5 million during the first quarter of fiscal 2020 increased by $1.1 million from $27.4 million recorded during last year’s first quarter, resulting primarily from professional fees in connection with our 2020 MAP to Growth initiative, which approximated $8.0 million, compared to $4.3 million in the prior comparable quarter.
We recorded total net periodic pension and postretirement benefit costs of $13.1 million and $11.4 million for the first quarter of fiscal 2020 and 2019, respectively. The $1.7 million increase in pension expense resulted from the combination of higher net actuarial losses recognized during the current quarter versus last year’s first quarter for approximately $1.6 million and a higher service costs of approximately $0.7 million during the current quarter versus the same period a year ago. These increases were partially offset by a decrease of approximately $0.6 million in interest costs during the current quarter, when compared to the same period a year ago. We expect that pension expense will fluctuate on a year-to-year basis, depending upon the investment performance of plan assets and potential changes in interest rates, but such changes are not expected to be material to our consolidated financial results.
Restructuring Charges We recorded restructuring charges of $6.6 million during the first quarter of fiscal 2020, which compares with $20.1 million during the first quarter of fiscal 2019. These charges were the result of our continued implementation of our 2020 MAP to Growth, which focuses upon strategic shifts in operations across our entire business. On a consolidated basis, we incurred $3.8 million of severance and benefit costs during the first quarter of fiscal 2020 compared with $19.1 million during the same period a year ago. Facility closure and other related costs totaled $2.8 million during the first quarter of fiscal 2020 versus $0.4 million during the first quarter of fiscal 2019. Finally, $0.1 million of other asset write-offs during the period compared with $0.6 million during the same period a year ago. These charges were associated with closures of certain facilities as well as the elimination of duplicative headcount and infrastructure associated with certain of our businesses.
We expect to incur approximately $32.4 million of future additional charges in relation to this initiative. These additional charges include approximately $21.3 million of severance and benefit costs, $9.6 million of facility closure and other related charges, as well as $1.5 million of other asset write-offs. We expect these charges to be incurred by the end of calendar year 2020, upon which we expect to achieve an annualized pretax savings of approximately $290 million per year. Additionally, upon the completion of this initiative, we have targeted $230.0 million of improvement of working capital, and believe that, assuming 3% organic growth and approximately $150 million to $200 million annually in acquisitions of businesses, our fiscal year 2021 cash flow from operations will improve to approximately $872.0 million. In addition, we have continued to assess and find areas of improvement and cost savings as part of our 2020 MAP to Growth. As such, the final implementation and expected costs of our plan are subject to change. Most notably, we have broadened the scope of our announced plan to include the consolidation of the general and administrative areas, potential outsourcing, as well as additional future plant closures and consolidations; the estimated future costs of which have not yet been established. See Note 4, “Restructuring,” to the consolidated financial statements, for further detail surrounding our 2020 MAP to Growth.
Interest Expense Interest expense was $28.3 million for the first quarter of fiscal 2020 versus $24.4 million for the same period a year ago. Excluding acquisition-related borrowings, higher average borrowings quarter over quarter increased interest expense by approximately $1.7 million during the first quarter of fiscal 2020 when compared to the prior year quarter. Higher average borrowings, related to recent acquisitions, increased interest expense during this year’s first quarter by approximately $1.3 million versus the same period a year ago. Higher interest rates, which averaged 4.13% overall for the first quarter of fiscal 2020 compared with 4.06% for the same period of fiscal 2019, increased interest expense by approximately $0.9 million during the current quarter versus the same period last year.
Investment (Income), Net Net investment income of approximately $5.4 million for the first quarter of fiscal 2020 compares to net investment income of $2.4 million during the same period last year. Dividend and interest income totaled $1.8 million and $2.0 million for the first quarter of fiscal 2020 and 2019, respectively. Net gains on marketable securities totaled $3.5 million during the first quarter of fiscal 2020, while there were net realized gains of $0.4 million during the same period a year ago.
30
Income Before Income Taxes (“IBT”) Our consolidated pretax income for the first quarter of fiscal 2020 of $142.8 million compares with pretax income of $91.9 million for the same period a year ago. Our CPG segment had IBT of $82.7 million, or 15.4% of net sales, for the quarter ended August 31, 2019, versus IBT of $65.0 million, or 12.6% of net sales, for the same period a year ago. Our CPG segment results reflect 2020 MAP to Growth savings, prior year selling price increases and increased earnings from recent acquisitions. Our PCG segment had IBT of $28.1 million, or 9.4% of net sales, for the quarter ended August 31, 2019, versus IBT of $8.3 million, or 2.8% of net sales, for the same period a year ago. Our PCG segment results reflect 2020 MAP to Growth savings and non-recurring one-time items that occurred in the prior comparable quarter. Our Consumer segment IBT approximated $59.2 million, or 12.3% of net sales, for the first quarter of fiscal 2020, versus the prior year first quarter pretax income of $51.0 million, or 10.7% of net sales. The prior quarter results reflect the unfavorable legal settlements and related legal fees of approximately $10.0 million. Our Specialty segment had pretax income of $23.3 million, or 14.6% of net sales for the quarter ended August 31, 2019, versus pretax income of $23.8 million, or 14.1% of net sales, for the same period a year ago, reflecting declines in sales volume in our fluorescent pigment, specialty coatings and OEM businesses.
Income Tax Rate The effective income tax rate of 25.5% for the three-months ended August 31, 2019 compares to an effective income tax rate of 23.7% for the three-months ended August 31, 2018. The effective income tax rates for the three-month periods ended August 31, 2019 and 2018 reflect variances from the 21% federal statutory rate due primarily to the unfavorable impact of state and local income taxes and the net tax on foreign subsidiary income resulting from the global intangible low-taxed income provisions, partially offset by tax benefits related to equity compensation. The quarter over quarter increase in the effective income tax rate is primarily attributable to a decrease in the equity compensation income tax benefit.
Net Income Net income of $106.5 million for the quarter ended August 31, 2019 compares to net income of $70.2 million for the comparable prior year period. Net income attributable to RPM International Inc. stockholders for the first quarter of fiscal 2020 was $106.2 million, or 7.2% of consolidated net sales, which compared to net income of $69.8 million, or 4.8% of consolidated net sales for the comparable prior year period.
Diluted earnings per share of common stock for the quarter ended August 31, 2019 of $0.82 compares with diluted earnings per share of common stock of $0.52 for the quarter ended August 31, 2018.
LIQUIDITY AND CAPITAL RESOURCES
Operating Activities
Fiscal 2020 Compared with Fiscal 2019
Approximately $145.1 million of cash was provided by operating activities during the first three months of fiscal 2020, compared with $7.1 million of cash used by operating activities during the same period last year. The net change in cash from operations includes the change in net income, which increased by $36.3 million during the first three months of fiscal 2020 versus the same period during fiscal 2019. During the first three months of fiscal 2020, we recorded $6.6 million in restructuring charges and made cash payments of $6.0 million related to our 2020 MAP to Growth, as further described in Note 4, “Restructuring.” Changes in working capital accounts and all other accruals provided approximately $130.6 million more cash flow during the first three months of fiscal 2020 versus the same period last year.
The change in accounts receivable during the first three months of fiscal 2020 provided approximately $84.0 million more cash than during the same period a year ago. This resulted from improved earnings and initiatives that shifted approximately $100.0 million in receipts from the fourth quarter of fiscal 2019 to the first quarter of fiscal 2020. Days sales outstanding (“DSO”) at August 31, 2019 increased to 63.7 days from 62.3 days at August 31, 2018. While many of our businesses achieved decreases in DSO during the current quarter versus last year, those improvements were more than offset by increased DSO at our consumer segment resulting from a reduction of the volume of cash collections subject to early payment discounts.
During the first three months of fiscal 2020, we spent approximately $4.6 million less cash for inventory compared to our spending during the same period a year ago, which resulted primarily from the timing of purchases by retail customers. Days of inventory outstanding (“DIO”) at August 31, 2019 increased to 86.2 days from 84.4 days at August 31, 2018. While many of our businesses improved their DIO by several days during the current quarter versus last year, those improvements were more than offset by inventory increases at certain of our other businesses in order to accommodate and maintain customer service levels.
The change in accounts payable during the first three months of fiscal 2020 used approximately $24.4 million less cash than during the first three months of fiscal 2019, resulting principally from the timing of certain payments as we continue to move toward a center-led procurement process that includes negotiating modified payment terms. Cash provided from operations, along with the use of available credit lines, as required, remain our primary sources of liquidity.
31
Investing Activities
Capital expenditures, other than for ordinary repairs and replacements, are made to accommodate our continued growth to achieve production and distribution efficiencies, expand capacity, introduce new technology, improve environmental health and safety capabilities, improve information systems, and enhance our administration capabilities. During the first three months of fiscal 2020, we paid $30.6 million for acquisitions, net of cash acquired, versus $26.4 million during the comparable prior year period. Capital expenditures of $36.6 million during the first three months of fiscal 2020 compare with depreciation of $23.6 million. In the comparable prior year period, capital expenditures were $28.3 million, which compared with depreciation of $24.1 million. We have been increasing, and will continue to increase, our capital spending in fiscal 2020, in an effort to consolidate ERP systems and our plant footprint, as part of 2020 MAP to Growth. We anticipate that additional shifts at our production facilities, coupled with the capacity added through acquisition activity and our planned increase in future capital spending levels, will enable us to meet increased demand throughout fiscal 2020 and beyond.
Our captive insurance companies invest their excess cash in marketable securities in the ordinary course of conducting their operations, and this activity will continue. Differences in the amounts related to these activities on a year-over-year basis are primarily attributable to differences in the timing and performance of their investments balanced against amounts required to satisfy claims. At August 31, 2019 and May 31, 2019, the fair value of our investments in marketable securities totaled $123.6 million and $112.5 million, respectively. The fair value of our portfolio of marketable securities is based on quoted market prices for identical, or similar, instruments in active or non-active markets or model-derived-valuations with observable inputs. We have no marketable securities whose fair value is subject to unobservable inputs.
As of August 31, 2019, approximately $197.1 million of our consolidated cash and cash equivalents were held at various foreign subsidiaries, compared with $205.8 million at May 31, 2019. Undistributed earnings held at our foreign subsidiaries that are considered permanently reinvested will be used, for instance, to expand operations organically or for acquisitions in foreign jurisdictions. Further, our operations in the U.S. generate sufficient cash flow to satisfy U.S. operating requirements. Refer to Note 10, “Income Taxes,” to the Consolidated Financial Statements for additional information regarding unremitted foreign earnings.
Financing Activities
Our available liquidity, including our cash and cash equivalents and amounts available under our committed credit facilities, stood at $1.20 billion at August 31, 2019, compared with $1.28 billion at May 31, 2019.
4.550% Notes due 2029
On February 27, 2019, we closed an offering for $350.0 million aggregate principal amount of 4.550% Notes due 2029 (the “2029 Notes”). The proceeds from the 2029 Notes were used to repay a portion of the outstanding borrowings under our revolving credit facility and for general corporate purposes. Interest on the 2029 Notes accrues from February 27, 2019 and is payable semiannually in arrears on March 1st and September 1st of each year, beginning September 1, 2019, at a rate of 4.550% per year. The 2029 Notes mature on March 1, 2029. The indenture governing this indebtedness includes cross-acceleration provisions. Under certain circumstances, where an event of default under our other instruments results in acceleration of the indebtedness under such instruments, holders of the indebtedness under the indenture are entitled to declare amounts outstanding immediately due and payable.
4.250% Notes due 2048
On December 20, 2017, we closed an offering for $300.0 million aggregate principal amount of 4.250% Notes due 2048 (the “2048 Notes”). The proceeds from the 2048 Notes were used to repay $250.0 million in principal amount of unsecured 6.50% senior notes due February 15, 2018, and for general corporate purposes. Interest on the 2048 Notes accrues from December 20, 2017 and is payable semiannually in arrears on January 15th and July 15th of each year, beginning July 15, 2018, at a rate of 4.250% per year. The 2048 Notes mature on January 15, 2048. The indenture governing this indebtedness includes cross-acceleration provisions. Under certain circumstances, where an event of default under our other instruments results in acceleration of the indebtedness under such instruments, holders of the indebtedness under the indenture are entitled to declare amounts outstanding immediately due and payable.
5.250% Notes due 2045 and 3.750% Notes due 2027
On March 2, 2017, we issued $50.0 million aggregate principal amount of 5.250% Notes due 2045 (the “2045 Notes”) and $400.0 million aggregate principal amount of 3.750% Notes due 2027 (the “2027 Notes”). The 2045 Notes are a further issuance of the $250 million aggregate principal amount of 5.250% Notes due 2045 initially issued by us on May 29, 2015. Interest on the 2045 Notes is payable semiannually in arrears on June 1st and December 1st of each year at a rate of 5.250% per year. The 2045 Notes mature on June 1, 2045. Interest on the 2027 Notes is payable semiannually in arrears on March 15th and September 15th of each year, at a rate of 3.750% per year. The 2027 Notes mature on March 15, 2027. The indenture governing this indebtedness includes cross-acceleration provisions. Under certain circumstances, where an event of default under our other instruments results in acceleration of the indebtedness under such instruments, holders of the indebtedness under the indenture are entitled to declare amounts outstanding immediately due and payable.
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Revolving Credit Agreement
During the quarter ended November 30, 2018, we replaced our previous $800.0 million revolving credit agreement, which was set to expire on December 5, 2019, with a $1.3 billion unsecured syndicated revolving credit facility (the “Revolving Credit Facility”), which expires on October 31, 2023. The Revolving Credit Facility includes sublimits for the issuance of swingline loans, which are comparatively short-term loans used for working capital purposes and letters of credit. The aggregate maximum principal amount of the commitments under the Revolving Credit Facility may be expanded upon our request, subject to certain conditions, up to $1.5 billion. The Revolving Credit Facility is available to refinance existing indebtedness, to finance working capital and capital expenditures, and for general corporate purposes. Accordingly, during October 2019, it is likely we will utilize available funds from our Revolving Credit Facility to repay our unsecured 6.125% senior notes, which mature on October 15, 2019. At May 31, 2019, the outstanding balance on our 6.125% senior notes approximated $450.5 million, which is included in the current portion of long-term debt on our consolidated balance sheets.
The Revolving Credit Facility requires us to comply with various customary affirmative and negative covenants, including a leverage covenant and interest coverage ratio, which are calculated in accordance with the terms as defined by the credit agreement. Under the terms of the leverage covenant, we may not permit our leverage ratio for total indebtedness to consolidated EBITDA for the four most recent fiscal quarters to exceed 3.75 to 1.0. During certain periods and per the terms of the Revolving Credit Facility, this ratio may be increased to 4.25 to 1.0 in the event of an acquisition for which the aggregate consideration is $100.0 million or greater. The minimum required consolidated interest coverage ratio for EBITDA to interest expense is 3.50 to 1. The interest coverage ratio is calculated at the end of each fiscal quarter for the four fiscal quarters then ended. For purposes of these computations, EBITDA is defined in the Revolving Credit Facility.
As of August 31, 2019, we were in compliance with all financial covenants contained in our Revolving Credit Facility, including the leverage and interest coverage ratio covenants. At that date, our leverage ratio was 3.12 to 1, while our interest coverage ratio was 7.47 to 1. Our available liquidity under our Revolving Credit Facility stood at $916.7 million at August 31, 2019.
Our access to funds under our Revolving Credit Facility is dependent on the ability of the financial institutions that are parties to the Revolving Credit Facility to meet their funding commitments. Those financial institutions may not be able to meet their funding commitments if they experience shortages of capital and liquidity or if they experience excessive volumes of borrowing requests within a short period of time. Moreover, the obligations of the financial institutions under our Revolving Credit Facility are several and not joint and, as a result, a funding default by one or more institutions does not need to be made up by the others.
Accounts Receivable Securitization Program
On May 9, 2014, we entered into a $200.0 million accounts receivable securitization facility (the “AR Program”). The AR Program, which expires on May 8, 2020, was entered into pursuant to (1) a second amended and restated receivables sales agreement, dated as of May 9, 2014, and subsequently amended on August 29, 2014; November 3, 2015; December 31, 2016; and March 31, 2017 (the “Sale Agreement”), among certain of our subsidiaries (the “Originators”), and RPM Funding Corporation, a special purpose entity (the “SPE”) whose voting interests are wholly owned by us, and (2) an amended and restated receivables purchase agreement, dated as of May 9, 2014 and subsequently amended on February 25, 2015 and May 2, 2017 (the “Purchase Agreement”), among the SPE, certain purchasers from time to time party thereto (the “Purchasers”), and PNC Bank, National Association as administrative agent.
Under the Sale Agreement, the Originators may, during the term thereof, sell specified accounts receivable to the SPE, which may in turn, pursuant to the Purchase Agreement, transfer an undivided interest in such accounts receivable to the Purchasers. Once transferred to the SPE, such receivables are owned in their entirety by the SPE and are not available to satisfy claims of our creditors or creditors of the originating subsidiaries until the obligations owing to the participating banks have been paid in full. We indirectly hold a 100% economic interest in the SPE and will, along with our subsidiaries, receive the economic benefit of the AR Program. The transactions contemplated by the AR Program do not constitute a form of off-balance sheet financing, and will be fully reflected in our financial statements.
The maximum availability under the AR Program is $200.0 million. Availability is further subject to changes in the credit ratings of our customers, customer concentration levels or certain characteristics of the accounts receivable being transferred and, therefore, at certain times, we may not be able to fully access the $200.0 million of funding available under the AR Program. As of August 31, 2019, the outstanding balance under the AR Program was $130.0 million, which compares with the maximum availability on that date of $200.0 million.
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The interest rate under the Purchase Agreement is based on the Alternate Base Rate, LIBOR Market Index Rate, one-month LIBOR or LIBOR for a specified tranche period, as selected by us, plus in each case a margin of 0.80%. In addition, as set forth in an Amended and Restated Fee Letter, dated May 2, 2017 (the “Fee Letter”), the SPE is obligated to pay a monthly unused commitment fee to the Purchasers based on the daily amount of unused commitments under the Agreement, which ranges from 0.30% to 0.50% based on usage. The AR Program contains various customary affirmative and negative covenants, as well as customary default and termination provisions.
Our failure to comply with the covenants described above and other covenants contained in the Revolving Credit Facility could result in an event of default under that agreement, entitling the lenders to, among other things, declare the entire amount outstanding under the Revolving Credit Facility to be due and payable immediately. The instruments governing our other outstanding indebtedness generally include cross-default provisions that provide that, under certain circumstances, an event of default that results in acceleration of our indebtedness under the Revolving Credit Facility will entitle the holders of such other indebtedness to declare amounts outstanding immediately due and payable.
2.25% Convertible Senior Notes due 2020
On December 9, 2013, we issued $205 million of 2.25% Convertible Senior Notes due 2020 (the “Convertible Notes”). We paid interest on the Convertible Notes semi-annually on June 15th and December 15th of each year.
We completed the redemption of all $205.0 million aggregate principal amount of our outstanding Convertible Notes on November 27, 2018.
Stock Repurchase Program
On January 9, 2008, we announced our authorization of a stock repurchase program under which we may repurchase shares of RPM International Inc. common stock at management’s discretion. As announced on November 28, 2018, our goal is to return $1.0 billion in capital to stockholders by May 31, 2021 through share repurchases. On April 16, 2019, after taking into account share repurchases under our existing stock repurchase program to date, our Board of Directors authorized the repurchase of the remaining $600.0 million in value of RPM International Inc. common stock by May 31, 2021. As a result, we may repurchase shares from time to time in the open market or in private transactions at various times and in amounts and for prices that our management deems appropriate, subject to insider trading rules and other securities law restrictions. The timing of our purchases will depend upon prevailing market conditions, alternative uses of capital and other factors. We may limit or terminate the repurchase program at any time. During the quarter ended August 31, 2019, we repurchased 1,655,616 shares of our common stock at a cost of approximately $100.0 million, or an average cost of $60.40 per share, under this program. During the quarter ended August 31, 2018, we repurchased 103,446 shares of our common stock at a cost of approximately $7.0 million, or an average cost of $67.61 per share, under this program.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet financings for the year ended May 31, 2019, other than the minimum operating lease commitments as previously disclosed in our Form 10-K for the year ended May 31, 2019. As of June 1, 2019, upon adoption of ASC 842, the minimum operating lease commitments are no longer off-balance sheet. We have no subsidiaries that are not included in our financial statements, nor do we have any interests in, or relationships with, any special purpose entities that are not reflected in our financial statements.
OTHER MATTERS
Environmental Matters
Environmental obligations continue to be appropriately addressed and, based upon the latest available information, it is not anticipated that the outcome of such matters will materially affect our results of operations or financial condition. Our critical accounting policies and estimates set forth above describe our method of establishing and adjusting environmental-related accruals and should be read in conjunction with this disclosure. For additional information, refer to “Part II, Item 1. Legal Proceedings.”
34
FORWARD-LOOKING STATEMENTS
The foregoing discussion includes forward-looking statements relating to our business. These forward-looking statements, or other statements made by us, are made based on our expectations and beliefs concerning future events impacting us and are subject to uncertainties and factors (including those specified below), which are difficult to predict and, in many instances, are beyond our control. As a result, our actual results could differ materially from those expressed in or implied by any such forward-looking statements. These uncertainties and factors include (a) global markets and general economic conditions, including uncertainties surrounding the volatility in financial markets, the availability of capital and the effect of changes in interest rates, and the viability of banks and other financial institutions; (b) the prices, supply and capacity of raw materials, including assorted pigments, resins, solvents, and other natural gas- and oil-based materials; packaging, including plastic containers; and transportation services, including fuel surcharges; (c) continued growth in demand for our products; (d) legal, environmental and litigation risks inherent in our construction and chemicals businesses and risks related to the adequacy of our insurance coverage for such matters; (e) the effect of changes in interest rates; (f) the effect of fluctuations in currency exchange rates upon our foreign operations; (g) the effect of non-currency risks of investing in and conducting operations in foreign countries, including those relating to domestic and international political, social, economic and regulatory factors; (h) risks and uncertainties associated with our ongoing acquisition and divestiture activities; (i) the timing of and the realization of anticipated cost savings from restructuring initiatives and the ability to identify additional cost savings opportunities; (j) risks related to the adequacy of our contingent liability reserves; and (k) other risks detailed in our filings with the Securities and Exchange Commission, including the risk factors set forth in our Annual Report on Form 10-K for the year ended May 31, 2019, as the same may be updated from time to time. We do not undertake any obligation to publicly update or revise any forward-looking statements to reflect future events, information or circumstances that arise after the filing date of this document.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk from changes in raw materials costs, interest rates and foreign exchange rates since we fund our operations through long- and short-term borrowings and conduct our business in a variety of foreign currencies. There were no material potential changes in our exposure to these market risks since May 31, 2019.
ITEM 4.
CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of August 31, 2019 (the “Evaluation Date”), have concluded that as of the Evaluation Date, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports we file or submit under the Exchange Act (1) is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms, and (2) is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow for timely decisions regarding required disclosure.
(b) CHANGES IN INTERNAL CONTROL.
There were no changes in our internal control over financial reporting that occurred during the fiscal quarter ended August 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II — OTHER INFORMATION
ITEM 1.
LEGAL PROCEEDINGS
SEC Investigation and Enforcement Action
As previously disclosed, we were notified by the SEC on June 24, 2014, that we are the subject of a formal investigation pertaining to the timing of our disclosure and accrual of loss reserves in fiscal 2013 with respect to the previously disclosed DOJ and GSA Office of Inspector General investigation into compliance issues relating to Tremco Roofing Division’s GSA contracts. As previously disclosed, our audit committee completed an investigation into the facts and circumstances surrounding the timing of our disclosure and accrual of loss reserves with respect to the GSA and DOJ investigations, and determined that it was appropriate to restate our financial results for the first, second and third quarters of fiscal 2013. These restatements had no impact on our audited financial statements for the fiscal years ended May 31, 2013 or 2014. The audit committee’s investigation concluded that there was no intentional misconduct on the part of any of our officers.
In connection with the foregoing, on September 9, 2016, the SEC filed an enforcement action in the U.S. District Court for the District of Columbia against us and our General Counsel. We have cooperated with the SEC’s investigation and believe the allegations in the complaint mischaracterize both our and our General Counsel’s actions in connection with the matters related to our quarterly results in fiscal 2013 and are without merit. The complaint seeks disgorgement of gains that may have resulted from the conduct alleged in the complaint, and payment of unspecified monetary penalties from us and our General Counsel pursuant to Section 20(d) of the Securities Act and Section 21(d)(3) of the Exchange Act. Further, the complaint seeks to permanently enjoin us from violations of Sections 17(a)(2) and (a)(3) of the Securities Act, Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act, and Exchange Act Rules 12b-20, 13a-1, 13a-11 and 13a-13, and to permanently enjoin our General Counsel from violations of Sections 17(a)(2) and (a)(3) of the Securities Act and Exchange Act Rules 13b2-1 and 13b2-2(a). Both we and our General Counsel filed motions to dismiss the complaint on February 24, 2017. Those motions to dismiss the complaint were denied by the Court on September 29, 2017. We and our General Counsel filed answers to the complaint on October 16, 2017. Formal discovery commenced in January 2018 and closed as of June 3, 2019, other than one remaining discovery dispute. The parties engaged in written discovery, and several fact witnesses were deposed. The dispositive motion briefing schedule was vacated by the Court on July 2, 2019, due to the remaining discovery dispute, and will be rest once this dispute is fully resolved. We intend to continue to contest the allegations in the complaint vigorously.
Environmental Proceedings
As previously reported, several of our subsidiaries are, from time to time, identified as a “potentially responsible party” under the federal Comprehensive Environmental Response, Compensation and Liability Act and similar local environmental statutes. In some cases, our subsidiaries are participating in the cost of certain clean-up efforts or other remedial actions. Our share of such costs to date, however, has not been material and management believes that these environmental proceedings will not have a material adverse effect on our consolidated financial condition or results of operations. See “Item 1 — Business — Environmental Matters,” in this Annual Report on Form 10-K.
On June 7, 2019, Rust-Oleum received a show cause letter from the United States Environmental Protection Agency (“U.S. EPA”) formally notifying it of an alleged violation of 2017 TRI Form R reporting requirements for its Hagerstown, MD plant. Rust-Oleum is negotiating a settlement agreement with U.S. EPA associated therewith that includes a proposed penalty of approximately $134,000.
On August 13, 2019, Kirker Enterprises Inc. received an Administrative Order and Civil Administrative Penalty Assessment letter from the State of New Jersey Department of Environmental Protection Division of Air Enforcement formally notifying it of alleged failures to fulfill all conditions of an air permit applicable to its Patterson, New Jersey facility. The letter includes a proposed penalty of approximately $192,000.
ITEM 1A.
RISK FACTORS
In addition to the other information set forth in this report, you should carefully consider the risk factors disclosed in Item 1A of our Annual Report on Form 10-K for the fiscal year ended May 31, 2019.
UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS
(c) The following table presents information about repurchases of common stock we made during the first quarter of fiscal 2020:
Maximum
Total Number
Dollar Amount
of Shares
that
Purchased as
May Yet be
Part of Publicly
Purchased
Average
Announced
Under the
Price Paid
Plans or
Period
Purchased(1)
Per Share
Programs
Programs(2)
June 1, 2019 through June 30, 2019
966,327
59.56
956,000
July 1, 2019 through July 31, 2019
762,235
61.98
699,616
August 1, 2019 through August 31, 2019
19,229
69.14
Total - First Quarter
1,747,791
60.72
1,655,616
Includes 92,175 shares of common stock that were disposed of back to us in satisfaction of tax obligations related to the vesting of restricted stock which was granted under RPM International Inc.'s Amended and Restated 2014 Omnibus Equity and Incentive Plan and 2007 Restricted Stock Plan.
The maximum dollar amount that may yet be repurchased under our program was approximately $494.7 million at August 31, 2019. Refer to Note 12 to the consolidated financial statements for further information regarding our stock repurchase program.
ITEM 6.
EXHIBITS
Exhibit
Description
10.1
Amended and Restated Employment Agreement, effective December 31, 2008, by and between the Company and Keith R. Smiley, Vice President – Finance and Controller. (x)
18.1
Preferability letter of Deloitte & Touche LLP, independent registered public accounting firm. (x)
31.1
Rule 13a-14(a) Certification of the Company’s Chief Executive Officer.(x)
31.2
Rule 13a-14(a) Certification of the Company’s Chief Financial Officer.(x)
32.1
Section 1350 Certification of the Company’s Chief Executive Officer.(x)
32.2
Section 1350 Certification of the Company’s Chief Financial Officer.(x)
101.INS
Inline XBRL Instance Document- the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH
Inline XBRL Taxonomy Extension Schema Document.
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document.
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document.
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document.
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document.
104
The cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended August 31, 2019, has been formatted in Inline XBRL
(x)
Filed herewith.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
By:
/s/ Frank C. Sullivan
Frank C. Sullivan
Chairman and Chief Executive Officer
/s/ Russell L. Gordon
Russell L. Gordon
Vice President and
Chief Financial Officer
Dated: October 3, 2019