RPM International Inc: Form 10-Q for the period ended Aug 31, 2024

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our financial statements include all of our majority-owned and controlled subsidiaries. Investments in less-than-majority-owned joint ventures over which we have the ability to exercise significant influence 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; reserves for excess and obsolete inventories; allowances for recoverable sales and/or value-added 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, 2024.

BUSINESS SEGMENT INFORMATION

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.

(In thousands)

(a) The presentation includes a reconciliation of Income (Loss) Before Income Taxes, a measure defined by GAAP, to EBIT.

(b) Interest Income (Expense), Net includes the combination of Interest Income (Expense) and Investment Income (Expense), Net.

(c) 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 Income (Expense), Net is essentially related to corporate functions, 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.

RESULTS OF OPERATIONS

Three Months Ended August 31, 2024

Net Sales

(in millions, except percentages)

Our CPG segment generated organic sales growth during the first quarter of fiscal 2025, led by turnkey roofing systems and wall systems serving high-performance building construction and remodeling, partially offset by unfavorable foreign exchange translation. This growth is in addition to a strong prior year period when segment sales grew 10.8%.

Our PCG segment generated organic sales growth during the first quarter of fiscal 2025 when compared to the same prior year period. Organic sales growth was driven by the flooring business, which benefited from its focus on maintenance and restoration and specified solutions for high-performance new construction projects. This increase was also facilitated by improved demand in emerging markets. The divestiture of USL's Bridgecare services division in the first quarter of fiscal 2024 and unfavorable foreign exchange translation offset this growth.

Our Consumer segment experienced sales declines in the first quarter of fiscal 2025 driven by reduced DIY takeaway at retail, customer destocking, the rationalization of certain lower-margin products and unfavorable foreign exchange translation. This was partially offset by volume growth in certain international markets.

Our SPG segment experienced organic sales declines during the first quarter of fiscal 2025, which were driven by soft demand in specialty OEM markets and a decline in the disaster restoration business as high customer inventories muted the impact of storm activity in the current period.

Gross Profit Margin Our consolidated gross profit margin of 42.5% of net sales for the first quarter of fiscal 2025 compares to a consolidated gross profit margin of 41.2% for the comparable period a year ago. The current quarter gross profit margin increase of approximately 1.3%, or 130 basis points, resulted primarily from our MAP 2025 initiatives, which generated incremental savings in procurement, manufacturing and commercial excellence that favorably impacted our gross margin, in conjunction with benefits generated from the commodity cycle.

We expect year-over-year gross margins to continue improving in the second quarter of fiscal 2025 due to MAP 2025 initiatives.

SG&A Our consolidated SG&A expense during the period was $4.9 million lower versus the same period last year but increased to 26.7% of net sales from 26.4% of net sales for the prior year quarter. Reduced bad debt expense, stock compensation and insurance costs were primary drivers, along with MAP savings. In addition, the prior period includes the $4.5 million loss on the sale of USL's Bridgecare services division as described above in Note 3, "Restructuring," to the Consolidated Financial Statements. These reductions were partially offset by increased commission expense and bonuses, along with merit increases. Further, the prior period includes the $10.3 million gain on business interruption insurance proceeds as described above in Note 13, "Contingencies and Other Accrued Losses," to the Consolidated Financial Statements, which did not recur.

Our CPG segment SG&A decreased approximately $3.1 million during the first quarter of fiscal 2025 versus the comparable prior year period and decreased slightly as a percentage of net sales. The decrease in expense was mainly due MAP savings and a decrease in warranty expense, partially offset by variable costs associated with improved results such as commissions, along with merit increases.

Our PCG segment SG&A was approximately $12.0 million lower for the first quarter of fiscal 2025 versus the comparable prior year period and decreased as a percentage of net sales. The decrease in expense was mainly due to a reduction in bad debt expense, along with the $4.5 million loss on the sale of USL's Bridgecare services division recorded during the prior year quarter.

Our Consumer segment SG&A increased by approximately $12.1 million during the first quarter of fiscal 2025 versus the same period last year and increased as a percentage of net sales. The quarter-over-quarter increase in SG&A was primarily attributable to the $10.3 million gain on business interruption insurance proceeds received in the prior period that did not recur in the current period and merit increases, partially offset by MAP savings, along with decreased advertising costs and a reduction in variable distribution costs.

Our SPG segment SG&A increased approximately $0.7 million during the first quarter of fiscal 2025 versus the comparable prior year period and increased as a percentage of net sales. The increase in SG&A expense is attributable to investments in growth initiatives, partially offset by MAP savings.

SG&A expenses in our corporate/other category during the first quarter of fiscal 2025 decreased approximately $2.6 million versus last year’s first quarter. This was mainly due to decreased insurance costs, reduced professional fees related to our MAP 2025 operational improvement initiatives and reduced stock compensation, partially offset by increased employee related expenses.

The following table summarizes the retirement-related benefit plans’ impact on income before income taxes for the three months ended August 31, 2024 and 2023, as the service cost component has a significant impact on our SG&A expense:

(in millions)

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, both of which are difficult to predict, but which may have a material impact on our consolidated financial results in the future.

Restructuring Charges

The following table summarizes restructuring charges recorded during the three months ended August 31, 2024 and August 31, 2023, related to our MAP 2025 initiative, which is a multi-year restructuring plan designed to improve margins by streamlining business processes, reducing working capital, implementing commercial initiatives to drive improved mix, pricing discipline and salesforce effectiveness and improving operating efficiency:

(in millions)

Most activities under MAP 2025 are anticipated to be completed by the end of fiscal 2025; however, we expect some costs to extend beyond this date. We currently expect to incur approximately $21.8 million of future additional charges related to the implementation of MAP 2025.

For further information and details about MAP 2025, see Note 3, “Restructuring,” to the Consolidated Financial Statements.

Interest Expense

(in millions, except percentages)

(a) The interest rate decrease was a result of lower market rates on the variable cost borrowings.

(in millions)

Investment (Income), Net

See Note 5, “Investment (Income), Net,” to the Consolidated Financial Statements for details.

Other (Income) Expense, Net

See Note 6, “Other (Income) Expense, Net,” to the Consolidated Financial Statements for details.

Income (Loss) Before Income Taxes (“IBT”)

(in millions, except percentages)

On a consolidated basis, our results reflect MAP 2025 benefits, including benefits generated from the commodity cycle. Our CPG segment results reflect improved fixed-cost utilization from volume growth and MAP 2025 benefits. Our PCG segment results reflect improved fixed-cost leverage from positive volumes, which were enhanced by MAP 2025 initiatives. In addition, our prior PCG segment results reflect the $4.5 million loss on the sale of USL's Bridgecare services division, the impairment of an indefinite lived-intangible asset, and higher bad debt expense. Our Consumer segment results reflect negative volumes and the impact on fixed-cost absorption while our prior period results include the $10.3 million gain on business interruption insurance proceeds. The current period earnings decline was mitigated by improved operating efficiencies related to MAP 2025 and rationalization of lower margin products. Our SPG segment results reflect sales declines and reduced fixed cost leverage at plants, partially offset by MAP 2025 benefits. Our Non-Op segment results reflect reduced interest expense, pension non-service costs, insurance costs and stock compensation, partially offset by increased employee related costs.

Income Tax Rate The effective income tax rate of 21.3% for the three months ended August 31, 2024 compares to the effective income tax rate of 25.2% for the three months ended August 31, 2023. The effective income tax rates for both periods reflect variances from the 21% statutory rate due to the unfavorable impact of state and local income taxes, non-deductible business expenses, 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. Additionally, the effective income tax rate for the three-month period ended August 31, 2024, reflects a favorable adjustment for incremental U.S. foreign tax credits associated with the distribution of historic foreign earnings that were previously not considered to be permanently reinvested. The distribution of such earnings was done in conjunction with global cash redeployment and debt optimization projects executed during the quarter. The effective income tax rate for the three-month period ended August 31, 2023, reflected incremental tax expense related to increases in the estimated net deferred income tax liability for unremitted foreign earnings and our liability for uncertain tax positions.

Net Income

(in millions, except percentages and per share amounts)

LIQUIDITY AND CAPITAL RESOURCES

Fiscal 2025 Compared with Fiscal 2024

Operating Activities

Approximately $248.1 million of cash was provided by operating activities during the first three months of fiscal 2025, compared with $359.2 million of cash provided 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 $27.2 million during the first three months of fiscal 2025 versus the same period during fiscal 2024.

During the first three months of fiscal 2025, the change in accounts receivable provided approximately $9.7 million less cash than the first three months of fiscal 2024. Average days sales outstanding (“DSO”) at August 31, 2024, decreased to 60.2 days from 64.3 days at August 31, 2023.

During the first three months of fiscal 2025, the change in inventory used approximately $66.3 million more cash compared to spending during the same period a year ago. This is due to increased inventory purchases compared to the prior year period when our operating segments were using safety stock built up in response to supply chain outages and raw material inflation. Average days of inventory outstanding (“DIO”) at August 31, 2024 decreased to 76.7 days from 85.1 days at August 31, 2023.

The change in accounts payable during the first three months of fiscal 2025 used approximately $33.3 million less cash than during the first three months of fiscal 2024. This is associated with working capital efficiencies enabled by MAP 2025 initiatives. Average days payables outstanding (“DPO”) increased to 87.3 days at August 31, 2024 from 79.7 days at August 31, 2023.

The change in accrued compensation and benefits during the first three months of fiscal 2025 used approximately $28.3 million more cash than during the first three months of fiscal 2024. This was primarily associated with increased bonus payments in the first quarter of fiscal 2025 compared to the same period in fiscal 2024.

Investing Activities

For the first three months of fiscal 2025, cash used for investing activities increased slightly by $2.6 million to $64.1 million as compared to $61.5 million in the prior year period. This year-over-year increase in cash used for investing activities was driven by a $2.2 million increase in cash used for business acquisitions.

We paid for capital expenditures of $50.7 million and $52.2 million during the first three months of fiscal 2025 and fiscal 2024, respectively. Our capital expenditures facilitate our continued growth, allow us 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. We continue to invest capital spending in growth initiatives and to improve operational efficiencies in fiscal 2025.

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, 2024 and May 31, 2024, the fair value of our investments in available-for-sale debt securities and marketable equity securities, which includes captive insurance-related assets, totaled $169.7 million and $154.3 million, respectively.

As of August 31, 2024, approximately $208.6 million of our consolidated cash and cash equivalents were held at various foreign subsidiaries, compared with $215.2 million at May 31, 2024. 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 7, “Income Taxes,” to the Consolidated Financial Statements for additional information regarding unremitted foreign earnings.

Financing Activities

For the first three months of fiscal 2025, financing activities used $186.0 million of cash, which compares to cash used for financing activities of $274.3 million during the first three months of fiscal 2024. The overall decrease in cash used for financing activities was driven principally by debt-related activities. During the first three months of fiscal 2025, we repaid the $130.0 million outstanding on our accounts receivable securitization program ("AR Program"), compared to payments of $175.0 million in the prior year period. In addition, we borrowed $37.8 million on our revolving credit facility during the first three months of fiscal 2025, compared to payments of $15.8 million in the prior year period. See below for further details on the significant components of our debt.

Our available liquidity, including our cash and cash equivalents and amounts available under our committed credit facilities, stood at $1.44 billion and $1.36 billion as of August 31, 2024 and May 31, 2024, respectively.

Revolving Credit Agreement

During the quarter ended August 31, 2022, we amended our $1.3 billion unsecured syndicated revolving credit facility (the "Revolving Credit Facility"), which was set to expire on October 31, 2023. The amendment extended the expiration date to August 1, 2027 and increased the borrowing capacity to $1.35 billion. The Revolving Credit Facility bears interest at either the base rate or benchmark interest rate (i.e. the adjusted Secured Overnight Financing Rate (SOFR) for USD denominated debt), as defined, at our option, plus a spread determined by our debt rating. 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 Revolving Credit Facility is available to refinance existing indebtedness, to finance working capital and capital expenditures, and for general corporate purposes.

The Revolving Credit Facility requires us to comply with various customary affirmative and negative covenants, including a leverage covenant (i.e. Net Leverage Ratio) and interest coverage ratio, which are calculated in accordance with the terms as defined by the Revolving Credit Facility. 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 1.00. During certain periods and per the terms of the Revolving Credit Facility, this ratio may be increased to 4.25 to 1.00 upon delivery of a notice to our lender requesting an increase to our maximum leverage or in connection with certain “material acquisitions.” The minimum required consolidated interest coverage ratio for EBITDA to interest expense is 3.50 to 1.00. The interest coverage ratio is calculated at the end of each fiscal quarter for the four fiscal quarters then ended using EBITDA as defined in the Revolving Credit Facility.

As of August 31, 2024, we were in compliance with all financial covenants contained in our Revolving Credit Facility, including the Net Leverage Ratio and Interest Coverage Ratio covenants. At that date, our Net Leverage Ratio was 1.54 to 1.00, while our Interest

Coverage Ratio was 10.95 to 1.00. As of August 31, 2024, we had $956.6 million of borrowing availability on our Revolving Credit Facility.

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

As of August 31, 2024, we did not have an outstanding balance under our AR Program, compared to the maximum availability of $250.0 million. The maximum availability under the AR Program is $250.0 million, but 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 $250.0 million of funding available under the AR Program.

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. See “Revolving Credit Agreement” above for details on our compliance with all significant financial covenants at August 31, 2024.

Stock Repurchase Program

See Note 9, “Stock Repurchase Program,” to the Consolidated Financial Statements, for further detail surrounding our stock repurchase program.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet financings. 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.”

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 and regional markets and general economic conditions, including uncertainties surrounding the volatility in financial markets, the availability of capital and the viability of banks and other financial institutions; (b) the prices, supply and availability of raw materials, including assorted pigments, resins, solvents, and other natural gas- and oil-based materials; packaging, including plastic and metal containers; and transportation services, including fuel surcharges; (c) continued growth in demand for our products; (d) legal, environmental and litigation risks inherent in our 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, the ability to identify additional cost savings opportunities, and the risks of failing to meet any other objectives of our improvement plans; (j) risks related to the adequacy of our contingent liability reserves; (k) risks relating to a public health crisis similar to the Covid pandemic; (l) risks related to acts of war similar to the Russian invasion of Ukraine; (m) risks related to the transition or physical impacts of climate change and other natural disasters or meeting sustainability-related voluntary goals or regulatory requirements; (n) risks related to our or our third parties' use of technology including artificial intelligence, data breaches and data privacy violations; (o) the shift to remote work and online purchasing and the impact that has on residential and commercial real estate construction; and (p) other risks detailed in our filings with the Securities and Exchange Commission, including the risk factors set forth in our Form 10-K for the year ended May 31, 2024, 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.

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, 2024.

(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, 2024 (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, 2024 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In addition to the other information set forth in this report, you should carefully consider the other risk factors disclosed in Item 1A of our Annual Report on Form 10-K for the fiscal year ended May 31, 2024.