Once again, that's www.rpminc.com. Comments made on this call may be forward-looking statements based on current expectations that involve certain risks and uncertainties, which could cause actual results to be materially different. For more information on these risks and uncertainties, please review RPM's reports filed with the SEC. During this conference call, references may be made to non-GAAP financial measures. To assist you in understanding these non-GAAP terms, RPM posted reconciliations to the most directly comparable GAAP financial measures on the RPM website. Following today's presentation, there will be a question and answer session, at which time, if you wish to ask a question, you'll need to press star then one on your telephone. Please note that only financial analysts will be permitted to ask questions. At this time, I would like to turn the call over to RPM's Chairman and CEO, Mr. Frank Sullivan, for opening remarks.
Please go ahead, sir.
Thank you, Jason. Good morning, and welcome to the RPM International Investor Call for our fiscal 2018 second quarter ended November 30, 2017. On the call with me today are Rusty Gordon, RPM's Vice President and Chief Financial Officer, and Barry Slifstein, our Vice President of Investor Relations. Today, we will discuss our second quarter results, then provide detailed guidance for the balance of fiscal 2018, and of course, answer your questions. We are pleased with our performance during the second quarter. Our strategically balanced business model is alive and well, and we continue to see the benefit of last year's product line acquisitions and cost reduction actions on improved leverage, which more than offset higher raw material costs that have negatively impacted gross margins across most all of our businesses.
Earnings per share of $0.70 improved 34.6% from last year's adjusted results of $0.52 per share, and increased 17.3%, excluding a $0.09 per share benefit based on a lower tax rate recognized in the quarter relative to last year's tax rate. Sales in our industrial segment increased 11% in the quarter, driven by strong organic growth of 5.4% and acquisition growth of 3.3%. We saw solid organic growth in our North American roofing businesses and those businesses providing polymer flooring to commercial and industrial markets. We also saw a slight rebound in our company serving the oil and gas sector with positive organic sales growth for the first time in three years. We continue to see mixed results in Europe and continued poor performance in Latin America, particularly Brazil.
EBIT results for the industrial segment reflect a combination of higher raw material costs, unfavorable foreign transactional foreign exchange, and continued disappointing results in struggling Latin America, partially offset by price increases and better SG&A leverage from fiscal 2017 expense initiatives. Sales in the consumer segment increased 11.1% in the quarter, driven by last year's acquisition of Touch 'n Foam in the U.S. and SPS in Europe, as well as a return to solid organic growth of 3%. Consumer segment EBIT declined due to higher raw material costs, unfavorable manufacturing overhead absorption, and product mix. Sales in the specialty segment increased 7.4%, driven by recent acquisitions and a solid organic growth of 2.8%, after overcoming a 3% loss of sales associated with the fiscal 2017 closure of an unprofitable European business, and further reduced by the impact of the recent patent expiration in our edible coatings business.
Sales were particularly robust in our restoration services business due to the severe hurricane season and strong growth in our powder coatings and wood finishes business. We saw strong EBIT leverage in specialty as we were able to more than offset higher raw material costs and the negative impact of the recent patent expiration with good cost control. We also recognized $11.1 million in cost savings in our corporate other segment with lower pension health care, acquisition, and other professional fee reductions. Lastly, the strong results in our second quarter could have been better in relationship to the two weeks at the beginning of the quarter that were impacted by the devastating hurricanes, particularly in strong markets like Florida, Texas, as well as in Puerto Rico. I would now like to turn the call over to Barry Slifstein to provide you with more detail on our second quarter results.
Thanks, Frank, and good morning, everyone. I will review the results of operations for our fiscal 2018 second quarter compared to last year's second quarter adjusted results, then cover some November 30th, 2017, balance sheet and cash flow items before turning the call over to Rusty, who will provide more detail on our guidance for the balance of the fiscal year. Last year's second quarter adjusted results exclude the impact from the impairment charge and Middle East business closure. Second quarter consolidated net sales of $1.32 billion increased 10.5% from last year. Organic sales increased 4.2%, acquisition growth added 4.7%, and foreign currency translation increased sales by 1.6%. Industrial segment sales increased 11% quarter-over-quarter to $702.9 million. Organic sales increased 5.4%, acquisition growth added 3.3%, and foreign currency translation increased sales by 2.3%. Consumer segment sales increased 11.1% to $415.4 million. Organic sales increased 3%.
Acquisition growth added 7.3%, and foreign currency translation increased sales by 0.8%. Specialty segment sales increased 7.4% to $197.1 million from $183.6 million last year. Organic sales increased 2.8%, acquisition growth added 3.8%, and foreign currency translation increased sales by 0.8%. Consolidated gross profit increased 5.5% to $551 million from $522.2 million last year. As a percent of net sales, gross profit declined 200 basis points due to higher raw material costs and unfavorable manufacturing absorption and product mix. Consolidated SG&A increased 2.9% to $419.6 million from $407.7 million last year. The increase was largely due to added SG&A from acquisitions. As a percent of net sales, SG&A declined 230 basis points to 31.9% from 34.2%, reflecting last year's cost reduction actions and lower expenses in the corporate other segment. Consolidated earnings before interest and taxes.
EBIT increased 15.4% to $131.8 million from $114.2 million last year on higher organic sales and last year's product line acquisitions and cost reduction actions, partly offset by lower gross profit margins, principally due to higher raw material costs. Industrial segment EBIT increased 8.9% to $70.2 million from $64.5 million last year due to higher sales and last year's cost reductions, which more than offset higher raw material costs, unfavorable transactional foreign currency exchange, and continued disappointing results in Latin America, especially Brazil. Consumer segment EBIT declined 5.3% to $45.2 million from $47.7 million last year, principally due to higher raw material costs, unfavorable manufacturing absorption, and unfavorable product mix, partially offset by better SD&A leverage.
Specialty segment increased 10.8% to $34.4 million from $31 million last year due to solid organic and acquisition-related sales growth, especially in our restoration service businesses, combined with better SG&A leverage due to cost-cutting actions. This was partially offset by higher raw material costs and the unfavorable impact from a recent patent expiration. Corporate other expense of $18 million declined from $29 million last year. The decrease is predominantly attributable to lower pension expense, healthcare costs, outside professional service fees, and acquisition related expenses. Income taxes. The effective income tax expense rate was 12.2% for the three months ended November 30th, 2017, compared to an effective income tax rate of 24% for the three months ended November 30th, 2016. The lower rate was due to favorable tax benefits recognized as a result of legal entity restructurings that were completed during the second quarter.
Net income of $95.5 million increased 35.3% from last year's $70.5 million. Current quarter EPS of $0.70 per share compares to EPS last year of $0.52 per share, representing a 34.6% increase. Now a quick look at the cash flows and capital structure. Cash provided by operating activities was $115.2 million this year, compared to $158.7 million last year. The decrease was principally attributable to an increase in accounts receivables resulting from substantially higher sales, the timing of receivable collections this year versus last year, and the timing of payments to suppliers. Total debt. As of November 30th, 2017, total debt was $2.1 billion compared to $1.6 billion last year.
The increase is largely attributable to cash used for fiscal 2017 acquisitions of $254.2 million, the payment to the 524(g) trust in December 2016 of $102.5 million, and the pre-funding of the December 2017 524(g) trust payment of $119.1 million, and the 2018 pension plan contribution of $52.8 million. Included in total debt for this year is $253.7 million of short-term debt, reflecting the upcoming maturity in February 2018 of our 6.5% $250 million bond. In December 2017, the company issued $300 million of 4.25% 30-year notes due 2048. The net proceeds of which will be used to retire the $250 million of 6.5% bonds due this February, thereby lowering RPM's overall interest rate. With that, I'll turn the call over to Rusty.
Thank you, Barry. I'd like to provide some color on our fiscal 2018 guidance, which we are raising today. I'm happy to report record results for RPM today. RPM's model, as Frank mentioned, is built on strategic balance, which is working well. To be more specific, when we talk about strategic balance, that is the balance between acquisition and organic growth, as well as the strategic balance in our business portfolio between consumer, industrial, and specialty businesses. Originally, our fiscal 2018 guidance was built upon our accomplishments last year in brisk acquisition activity and cost reduction actions. Through six months, I'm pleased to say that we have realized the benefits of these activities from last year. Operationally, we have performed in line with our expectations.
I'm especially pleased to say that our bottom line has exceeded our expectations as our tax team has realized more discrete benefits through six months than we originally anticipated. As we look ahead to the back half of the year, some themes. First of all, raw materials will continue to be a challenge for us. There's a couple of drags we've talked about a lot over the last three years that are appearing to turn the corner. First of all, our industrial segment sales to energy markets have turned a quarter in the most recent quarter reported. Secondly, we're expecting the translation impact of foreign exchange to be positive. That's the impact from translating the sales and earnings of our foreign subsidiaries into US dollar results. In general, we see more positives than negatives, which is why we are raising our guidance today.
We share optimism in the U.S. economy with the new tax law. In U.S. construction, we see an uptick being led by regions impacted by the recent hurricanes. We're also looking ahead to overall improvement in the global economy. We're optimistic in regards to the opportunities from the new tax law to further invest in our great businesses and brands, and we'll talk a bit about that more later. I'll start by talking about our industrial segment, which had the strongest organic growth of our three segments in the second quarter, led by roofing. Our construction activity has picked up in some of the hurricane-impacted regions. We expect that to continue in the second half. As I mentioned, our industrial coatings business especially has been impacted by the downturn in energy markets, and we expect that to turn the corner.
Also, our industrial segment is the most global of our three segments, with 50% of its business outside of the U.S. We expect to see the most favorable impact of a global economic improvement here, which will be compounded by the strengthening of the euro, the pound, and the Canadian dollar that we've seen lately. I say that should help us in terms of our translational foreign exchange impact. In terms of some of the challenges, we are lapping the anniversary of several of our fiscal 2017 acquisitions. Last year, you might remember the bulk of these were done by January. You'll hear this theme again as we discuss the other two segments. Another challenge for us is Brazil. The macroeconomy is challenging to us, the comps do get easier as we progress into the back half of the year.
One additional note on industrial, as we mentioned before on our October earnings call, we continue to pursue additional cost savings in the segment to improve the operating leverage. For the balance of this year, we expect the industrial segment's sales to grow in the upper single-digit range. Moving now to consumer. Frank and Barry already spoke to some of the margin challenges in this segment. Another near-term challenge will be the favorable acquisition impact that we've seen this year is going to end this month in January as we lap the anniversary of the SPS and Touch 'n Foam acquisitions. In terms of looking beyond the near-term challenges, however, we do see a positive future for home improvement spending. As a result, we plan to invest in stepped-up advertising and promotional activity during the upcoming spring.
In summary, we expect our consumer segment sales to grow in the low to mid-single-digit range. We do expect the back half earnings to be flat to last year as a result of some of these stepped-up investments in brand advertising and promotional activity. Moving to the specialty segment. We did report nice results in the second quarter with good leverage, but their performance has been even better than the numbers indicate. For example, their organic growth of 2.8% in the quarter was the lowest of our three segments, but it actually would have been the highest if sales are factored out of the prior year from a European business that we closed last winter. Another note on specialty is that they're generating this good performance in spite of the drag on sales from a U.S. patent that expired prior to the second quarter.
As we mentioned, this impacts our edible coatings business. As we already discussed, the negative impacts on sales have been offset so far this year by great sales in our restoration service business, as well as a couple of businesses selling into OEM markets. In summary, we expect our specialty segment sales to grow in the low single-digit range as the acquisition impact from FY 2017 is reduced as we move forward in the back half of this year. I'll conclude with some overall comments. As we mentioned, our operations are performing in line with the expectations when we issued our original guidance in July. Sales are a bit better. Raw materials are a bit more challenging, but overall, we're in line with expectations, and we expect this to continue in the back half. One area we mentioned we are better than we anticipated is taxes.
Our year-to-date effective tax rate of 19.6% is better than we expected. Barry already mentioned the discrete benefits, which we recognize. Even if there was no tax reform in the U.S., our fiscal 2018 effective tax rate would turn out to be better than we originally expected. As we move forward with the new tax law enacted in December, we're going to see a reduction in our federal statutory rate from 35%-21%, which is effective for the last five months of RPM's fiscal year, and that blends to a rate of 29.2% for RPM in fiscal 2018. We expect this to give us a $0.10 per share benefit to EPS and allows us to increase our full-year EPS guidance now to a range of $3-$3.10 per share. Let me make an important note here.
This excludes a one-time adjustment that we expect to record in the third quarter that will result from the new tax law that has been enacted. This one-time adjustment stems from a couple of factors. First of all, based on the new tax law, we're going to remeasure our deferred tax assets and liabilities. That's one impact. The second impact is that there will be a transition tax on our deferred foreign earnings. We still have to refine our estimates for these two different impacts. We don't have a number, but we will be recording a one-time adjustment in the third quarter, and that is not built into this guidance range of $3-$3.10 per share. With that, we look forward to answering your questions.
Thank you. If you have a question, please press star then one on your touch tone phone. If you wish to remove yourself from the queue, please press the pound sign or the hash key. If you are using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you would like to ask a question, please press star then one on your touch tone phone. Our first question comes from Frank Mitsch from Wells Fargo Securities.
Morning, Frank.
Good morning, gentlemen. How are you doing?
Good.
Hey, I think your tax team did a great job excluding the tax reform. Maybe that tax team should help out the Browns. Just a thought. Look, Frank, you talked a lot about better growth, organic growth, sequentially improvement over the fiscal first quarter, looking at upper single digits in industrial. Actually, I think Rusty was talking about if you exclude some of the shutdown, Specialty would have been better as well. I'm trying to get a handle on how much of this is hurricane related in terms of getting a better fiscal second half growth relative to other initiatives that you have underway.
Sure. In general, I think our industrial businesses have demonstrated some good growth after three tough years, particularly in the heavy industry area. As Rusty said, we're seeing the first positive, very modest, but first positive organic growth in product categories that serve oil and gas, for instance.
We're seeing the first year after three years of not having FX hurt us. Quite candidly, industrial activity is picking up pretty broadly. Geographically, this will give you a good sense of it, since most of our consumer is in North America. There is a slug of it in Europe, but across the region, or across the world, we were up 10% in the U.S., up 12% in Europe. On a small base, up 11% in Asia, up 18% in Canada. The only places where we were down were in the Middle East with a lot of turmoil. While we were modestly positive in Latin America, it was all currency related.
If anything, our consumer businesses and our industrial businesses could have been better in the second quarter. We got, like everybody, hit pretty hard at the start of the quarter with the impact of the hurricanes, particularly in consumer, where you had almost two weeks of 1,000-plus retail outlets shut down in major markets like Texas and Florida, and to a lesser extent, Puerto Rico. That hurt us. We expect the positive trends that we're showing in industrial to continue in the second half. I think Specialty managing through the challenges that we've talked about very well. Consumer, I think, will continue to be challenged in the second half, just like they have in the first. I would remind folks, and we've talked about this in prior quarters, we're continuing to hold or gain share in the first half of the calendar year.
A number of our direct competitors were down organically in the 10%-11% range. In the most recent quarter, where we were up 3%, as far as we can tell, competitors are down anywhere from 1%-3%. We are going to end up with a year, quite candidly, that's disappointing in consumer. To address that for our 2019 fiscal year, we are planning to kick in some aggressive promotion and advertising programs in the spring, and that's part of the revised guidance that we provided.
All right. That's very helpful. One of the factors you mentioned was the manufacturing absorption issue in consumer. What exactly is that? How sustainable is that? What should we be thinking there?
Well, we've been through a seven-year run in consumer that's been in our core consumer businesses. All the Rust-Oleum product lines and DAP product lines have really done great. We've added capacity, and as we have demonstrated throughout the year, we've had a slowdown with flat to moderately negative organic growth. We've had some absorption issues there, along with some significant major customer inventory cutbacks. At a couple of our major customers, you're looking at inventory levels that are down anywhere from low to mid-teens, while our sales are only either flat or down modestly. Even there, the takeaway has been better than what our sales have been in because of inventory adjustments.
The last comment I would make, which is a little bit off this, for our entire industry, and it certainly impacted us, the raw material situation has been broader, bigger, and more persistent than anybody anticipated in the middle of the year.
To that end, now that you brought it up, how's your pricing relative to that? I know there was an expectation three months ago that obviously you'd face some margin pressures due to higher raws for the fiscal second quarter, but then that would abate in the second half. Are you suggesting that those raw pressures are going to continue to persist into the fiscal second half of your year?
Yes. We are seeing, as I said, pretty broad and persistent raw material price increases in some categories, in some regions like silicones in Europe, MMA resins, different odds and ends. We have seen some shortages in allocation. I think, again, it's been a bigger challenge for our whole industry than anybody anticipated in the spring or early summer, and we are managing our way through that as aggressively as we can.
Thank you, Frank.
Thank you.
Thank you. Next, we have Rosemarie Morbelli from Gabelli & Company.
Good morning.
Good morning, congratulations on a good quarter.
Thank you.
Frank, I was wondering if when we look at your change in guidance, it is $0.15 above previous guidance, $0.10 of which is going to come from the benefits from the new tax law, if I understood properly, and then $0.05 from operations. When we look at that $0.05, assuming I am correct, is that mostly from the hurricane benefits that you are going to see offsetting the hit in the second quarter?
Most of our change in guidance is tax related. If you go back to the beginning of the year, we are comfortable on a consolidated basis with being in the original guidance that we provided. The tax benefits that we did not anticipate but realized in the second quarter are one reason that we increased our guidance, and then the second reason is in anticipation with a May 31 fiscal year end of five months of benefit of the new Tax Reform that we would add an additional $0.10 for fiscal 2018. That's what gets you to the $3.00-$3.10. I think to add just a little bit to the comments I made earlier, I think we're comfortable with our guidance, and we'll certainly do well this year despite the raw material issues.
It's likely that we will outperform our expectations in industrial and underperform our expectations at the beginning of the year in consumer.
When you look at the second quarter and look at it versus a full year, are you looking at EPS of $0.61, which excludes the tax benefit in the second quarter, which is how we are going to look at it mostly?
Yes.
Are you looking at the $0.70?
No, I think the right way on an apples-to-apples basis for the quarter is to look at revenue growth that was up 10% with a solid almost 5% organic growth, EBIT growth that was up 15%. Despite big raw material issues, we were able to leverage that growth to our bottom line, the EBIT line. Then an adjusted EPS, which is equalized for last year's tax rate, of plus 17% or $0.61. I think you want to eliminate the impact, plus or minus, of the tax issue, compare our year this year to the same tax rate last year's quarter, and you come up with a $0.61 quarter, which is plus 17%. That's how we think about it in terms of the operating performance.
Okay, thanks for clarifying. Looking at shellac, how large is that particular business? The fact that the patent expires, does it mean just more competition on pricing, or are there other issues?
No. Our MBZ business, we didn't release the size of the product line, but they were the inventors of Nature Seal, which was the product that allowed apples to be coated with Nature Seal and a water wash and not brown. That went off patent this summer. The management team there was able to negotiate with all of their major customers, new contracts, we did not lose any market share. They were very aggressive in recognizing the patent expiration, wanting to continue to keep that customer base, we slashed our prices pretty aggressively. You've got significantly lower volume and a lower gross profit margin on what is still a very healthy business in a kind of a unique specialty products company that's involved in specialty food coatings and additives.
Okay, then going back to my question on the hurricane benefit, what do you think it is going to be in the second half of this year?
It's hard to say. I think it depends when the winter breaks, for starters. We haven't had a very harsh winter for the last couple of years, and this year's winter season seems to be getting off to a pretty robust chill. That's likely to impact business. I think in our Tremco roofing business, construction businesses on the consumer side, probably more DAP caulk and sealants and patch repair. We would expect to have some benefits in the spring and early summer as people do more patch repair and/or renovation continues.
Thank you very much.
Thank you.
Thank you. Next, we have Vincent Andrews from Morgan Stanley.
Good morning.
Good morning. Sorry about that. I just want to clarify the previous question on the EPS guidance and the $0.61 versus the $0.70. When you talk about now doing your new guidance, does that assume that you did $0.61 in the second quarter or $0.70?
70.
$0.70. Okay. Thank you.
I assume 70 in the quarter, but in terms of doing apples to apples, I think 61 is the right number to look at.
Understood. Okay. Thank you. I just wanted to ask about the investment spending in Consumer, and maybe for a little more detail, because it sounds like you are gaining share, but you're just not delighted with the overall volume performance. Is this spend designed to try to grow the category? Is it designed to try to grow share or both? I guess my follow-up to that would just be, you talked about EBIT and Consumer being flat in the back half of the year as a result of this. Is that because there's going to be higher raw material inflation, or are you just not expecting to get an immediate return on this spend?
Well, we won't get an immediate return on the spend, but it's been a challenging year for Consumer across the board, not just us, but a lot of our peers. We have gotten new placements in a number of major customers in wood stains and finishes. We continue to be the lead provider of small project paints. We continue to grow in the concrete and garage floor coatings category, both in terms of share and increase in the market. I think that with a very disappointing year, this spring, we intend to increase our promotional spending and our advertising spending in light of what's going to continue to be in the second half, I think, challenging results. Modest growth and challenges with raw materials, and that's also in our guidance.
Really, it's a goal to move some of our new product categories and pick up the whole market. It's interesting when you look at some of our major customers. You can slice and dice their categories in different ways. One interesting way is, at a major home center, items that are $35 or higher are up in the high teens, and items that are lower than that are in the single digits. There's been seemingly a spend on bigger renovation and different odds and ends, and less on the decorating and small project paint, for instance. To ensure that we have a return to strong sales and earnings growth in fiscal 2019, we're going to spend the dollars that we think are appropriate in the right places this spring.
Okay. Thank you very much.
Thank you.
Thank you. Next, we have Ghansham Panjabi from Robert W. Baird.
Good morning, Ghansham.
Hey, guys. Good morning. Morning, Frank. Happy New Year to you.
Happy New Year.
Thank you. First off, can you give us a better sense as to what drove the strength for polymer flooring? Any particular end markets that are growing faster that you can call out?
I think that whether it's in polymer flooring or roofing, and those are two interesting categories, this also applies to our Dryvit business. We've got good opportunities and good growth, interestingly, one of the challenges that's inhibiting better growth is the availability of contractors. That's been for a number of reasons, immigration issues and a pickup in construction activity, with not a concurring pickup or return to that market of real qualified contractors. That's one area where in roofing and polymer flooring, particularly in our Stonhard business where we actually do the application, and our Tremco roofing business where we do the application, and then to a lesser extent in Dryvit because of some shortages and some of the contracting there, that's been an impediment to us. Broadly speaking, we're doing well in North America and in Europe.
The developing world is so modest it's almost not worth talking about in those categories.
Okay. Thank you for that. On the specialty segment, how much was restoration up year-over-year during the second quarter? Would margins in that segment have been down year-over-year, especially were it not for the strength in restoration given the patent expiration impact you called out?
Yeah. I don't know that we've ever disclosed the particular product categories in restoration within our specialty segment. I can tell you that the revenues and earnings in that area are both up double digits. Were they flat, you might very well see more modest to flat results in our specialty segment as a result of the patent expiration in the MBZ business. I think that the leaders of those businesses are managing those businesses really well. They particularly manage the patent expiration well. I think those businesses, given their specialty nature, are managing the raw material gross margin situation better than most, and to a certain extent, we'll take luck when we get it. In this case, the strong restoration activity has showed up when it was needed in relationship to offsetting some of the declines in earnings in the edible coatings area.
Okay, just one final one. I know there's some nuances on the tax line specific to 2018, at least your fiscal year. Can you give us a better sense as to what the tax rate would look like for RPM post the U.S. tax law changes, FY 2019 and beyond? Thanks so much.
Yeah. I'll give you just a rough cut of it, and then we'll have a better sense, like everybody, as the year unfolds and everybody starts to better understand the nuances of what's somewhat complicated bill. I think Barry referenced that we'll have five months of the new tax law. If you just look at statutory rates, the statutory rate for our U.S. business was 35%, and with the 21% statutory rate, on a blended basis, we'd be at 29.2%. These are just statutory rates. Obviously in our next fiscal year, we'd be at 21%. There are some gives and takes. There were manufacturing credits in the old tax law that are gone. There's some different odds and ends.
We estimate that for fiscal 2018, the five months impact of the new tax law will add $0.10 per share, roughly, give or take $0.01, for this fiscal year. My best guess is that in 2019, we would pick up another $0.10 per share, as a result of having a year in which the tax law is fully applicable.
Would that drop down to cash almost equally?
Yeah. Again, this is very rough and we'll refine this, but my guess is in the coming year, so past 2018 into 2019, the impact of the tax reform for RPM will be an increase in after-tax cash flow somewhere in the neighborhood of $30 million-$40 million.
Okay. Thanks so much.
Thank you.
Thank you. Next, we have Arun Viswanathan from RBC Capital Markets.
Great. Thanks. Good morning. Happy New Year. How you guys doing?
Good. Happy New Year.
Great. Yeah. Sorry to belabor this point. On the tax issue, it looks like you are recognizing the $0.09 benefit in FQ2, and then there's another $0.10 benefit from the impact from the lower rate for the rest of the year. That's $0.19 and your midpoint is up $0.15. Is it incorrect to think that the actual fundamental performance is down $0.04? Or is that what you're trying to interpret as well, with the guidance?
No. I guess what I'll comment on is just a repeat of what we've said. Here are the factors. Number one, we are on target on a consolidated basis despite what's been a broader, persistent, and bigger raw material issue hitting us and our whole industry. Factor number one. As we look into the future, our industrial businesses are performing well despite those challenges, and we continue to see that happen. If anything, they'll outperform our original expectations for the year. Our specialty businesses are managing well and on plan given the challenges that we've communicated. Our consumer business is underperforming. We expect that to persist. In light of looking to the strength of our businesses, their market share, their products, we plan on some increases above what we originally anticipated in promotional and advertising spending this spring.
Those are all the factors that weigh in on the operating side, along with the tax issues that you've highlighted for our revised outlook, up to $3-$3.10.
When you think about the EBIT or even top-line performance for each segment, do you feel more encouraged by that post this quarter or about the same?
I think we feel good about where industrial is and where it's going. I think we're really pleased with how well the leaders of our specialty segment businesses have managed this year, given the challenges we knew we'd face. I think we're disappointed in our consumer performance year-to-date. We see that persisting, and we intend to take actions to make sure that 2019 is a return to really solid performance and growth in the top and the bottom line in our consumer segment.
Okay. That's helpful. Just on corporate, excuse me, that was also a little bit below us. Is that due to some of your focused efforts on lowering SG&A, or how do you think about corporate for expense for the rest of the year?
I think it'll be consistent with where we've been. We last year, as Barry and Rusty had alluded to, took a number of actions in our corporate expense area and also across our operations, including probably a 240 person RIF in the fourth quarter, shut down some small operations, and addressed some corporate area expense. All of that is helping us leverage sales to the bottom line. That should continue for the balance of the year.
just lastly, on M&A, could you just update us on what you're expecting to complete the rest of the year or if there's any particular areas that you're finding more opportunity and if there's any improvement on that post this tax reform? Thanks.
Sure. Our M&A activities remain what they have been. We're continuing to focus on kind of small to medium sized product lines that we can integrate, and/or family businesses that will join RPM as a freestanding entrepreneurial business. Really don't have much more to add to that, other than announcing deals when they happen. The M&A environment remains the same. I think the only impact in that area of the tax reform is some limitation on the deductibility of interest expense. That will not be an issue we do not anticipate for RPM. Perhaps it'll be an issue for some of the highly levered private equity or LBO activity, which has been a competitor to RPM in kind of the mid-range. We can only hope. That's kind of the state of play in the M&A market right now.
Got it. Thanks, Frank.
Thank you.
Thank you. Next we have Kevin McCarthy from Vertical Research Partners.
Morning, Kevin.
Good morning and happy New Year. Frank, in the consumer segment, you referenced organic sales growth of 3% in the quarter. How would you disaggregate that between volume contribution and price contribution?
Yeah, it's mostly all volume, and it's mostly in caulk sealant patch and repair product categories. We're continuing to have relatively flat results in the small project paint area. Again, I'd point out that through the year, from what we can see of our major U.S. competitors, we're continuing to outperform relative to what's been a very punky market in that space for most of calendar 2017.
As a follow-up, was price positive at all? Given your comments on raw materials, how would you characterize the prospects for an acceleration in price realization over the next several quarters?
Given 40 different business units and hundreds of different product lines, the impact of price across RPM businesses varies widely. I would say that price is probably 25% or 30% of our organic growth on a consolidated basis. I would expect that to continue for the balance of the year. It's very different in different business units, product lines, and segments of RPM, and that's about all the detail we provide on that.
I guess a broad question, last question on SG&A and cost reductions. You've done a nice job there. Sounds like you're going to be ramping some spend in consumer. Can you give us a sense for what inning of the game we're in? Perhaps it's a never-ending game in some respects, but how much prospective cost reduction opportunity is there still?
On the one hand, it's a never-ending game in relationship to what our cost structure looks like relative to revenue and particularly revenue growth. I don't know that we have any significant expense reduction initiatives planned now per se, other than how we manage our spending base at each business unit. We continue to look at opportunities to realign RPM businesses, particularly as we think about how we're best positioned to get to be a $10 billion business. There'll be some opportunities there that, when it's appropriate, we'll talk about.
Okay. Thank you very much.
Thank you.
Thank you. And next we have Jason Rogers from Great Lakes Review.
Just to follow up on the raw material cost increases. Could you quantify the magnitude of those increases you saw on a year-over-year basis in the quarter, as well as the success that you're having implementing price increases to offset that?
A little bit. In certain categories, we're seeing raw material prices that went up 8%-10% in the late spring or early summer, and some of those are going up again. In certain categories that I had commented on, silicones, and particularly in Europe, are one. You're seeing not only significant price increases, but some availability issues. It really is across the board. We're seeing raws that are petroleum based go up modestly, resins going up more aggressively, and then certain categories, like the ones I mentioned, that have been going up with two or three price increases. We have attempted, in a number of our businesses, to institute price increases at the beginning of the year. We have new price increases, some of which have gone in place in January. It's really a mixed bag between product line price increases.
In some cases, it might be as much as 8%-10%, and other product categories where we have really not gotten much in the way of price yet.
I wonder if you could provide an update on Kirker and how the changes you've made there are progressing to improve results.
Kirker, as those that have followed us know, is a smaller business than it was a few years ago and relatively modest in size. It had virtually no impact on RPM. I'm happy to say that in the quarter, their sales and earnings were better than they were last year.
Finally, I wondered if you'd care to mention any developments or milestones you're seeing in some of your major new products like ToughStrand, AlphaGuard, or NuBrick. Thanks.
Certainly. The ToughStrand continues to move nicely. A little bit seasonal in North America in terms of concrete pours that don't happen so much in cold weather like we're seeing now. We are looking at and continuing to execute on capacity expansion now more outside of the U.S. NuBrick, which is a Dryvit product, is just getting going. The early signs on that are pretty exciting. We're looking at ramping up production in the East Coast and possibly, and the new tax bill might help us in terms of immediate expensing, adding some West Coast manufacturing that would come later in calendar 2018. Our RockSolid product line at Rust-Oleum is doing extraordinarily well. It's a high performing product that outperforms all of our peers and some of Rust-Oleum's older, lower priced versions of concrete coatings and garage floor coatings.
As our numbers show, we're continuing to maintain, and in some cases, pick up share versus peers that have had the same or more challenges in the small project paint area. I guess the last comment I would make is that we picked up a significant wood stain and finishes placement. We should start to see the benefits of that in the spring. Our AlphaGuard product line, which is a proprietary resinous-based coating for roofs, continues to grow at double digits with Tremco, and we're looking to add capacity there in the spring.
Thank you.
Thank you.
Thank you. Next, we have Mike Harrison from Seaport Global Securities.
Morning.
Hi, good morning. Frank, I was wondering if you could address the manufacturing absorption issues that you noted in the consumer business. It just seems a little bit odd that the volume would be up year-over-year, but we're having some of these absorption issues.
The volume in our spray paint, small project paint areas for the year is not up. After an extraordinary seven-year run both there and in caulks and sealants, patch and repair products in the last year and a half, we added some significant capacity. We'll look to continue to add capacity where it's appropriate and also optimize some of our manufacturing. It's really the first year after a great run of seven years of good, strong organic growth, where in the first half of the year, we actually experienced negative growth, -1% or so, and relatively flat in some of these areas. It's a very seasonal business, so when times were booming, we would be manufacturing product anywhere and everywhere we could. It's where our inventory build is the biggest because of the seasonality of the business.
We have more capacity than we need in the late fall and in the winter months, we tend to have less capacity than we need in the peak season, we have to build inventory into that. I think we're correcting that, both in terms of capacity as well as manufacturing processes. In those categories, we are dealing with absorption issues. At the same time, we're dealing with raw material issues, and that's been one of the negative impacts in our consumer segment results.
Okay. That makes sense now. Looking at the caulk and sealants uptick that you've seen, are we starting to see any benefit from hurricane-related rebuild? Should I think of that as being related more to kind of an easier comp? If I recall correctly, you were capacity constrained in the prior year.
That's correct. I think that we're hopeful that we'll see some benefit from that in the construction products areas, and again, on the consumer side, more in the DAP caulk and sealants patch and repair products in the spring. Some of the devastation there was such that the real rebuild and construction activity isn't going to happen until the spring or the summer. I think the easier comps will be in industrial and consumer next year in the second quarter because we lost probably 10 days of the negative impact in some major markets like Florida and Texas.
Got it. Can you just comment at all on what you've experienced in the line review processes you've gone through here around year-end? Any potential gains in shelf space in some of these small project paints and wood stains and other areas, particularly as there's been some consolidation in the industry? Thank you.
Sure. We've continued to maintain our market share across our consumer businesses. The area where we picked up some share at some of our major accounts is with our Varathane wood stains and finishes line. The other areas that have been driving what growth we've been getting is in kind of new or unique product categories like the RockSolid concrete and garage floor coating businesses. Share or market presence isn't the issue. It's just been modest or punky consumer takeaway exacerbated by big inventory issues at some of our major customers. Once those are mostly behind us as we get into fiscal 2019, we should certainly be seeing easier comps in relationship to our activities and interest in being more aggressive in promoting and advertising and not annualizing the inventory issues that we faced at a couple major customers this year.
Got it. Thank you very much.
Thank you.
Thank you. Next we have Mike Sison from KeyBanc Capital Markets.
Morning, Mike.
Hey, guys. Happy New Year.
Happy New Year.
Your industrial segment is doing pretty well. If they have extra time, I don't think the Jets have made the playoffs in a decade. In terms of the growth outlook for sales, do you think EBIT growth in the second half will be in line with that upper single-digit growth? A little bit better? A little bit worse because of raw materials?
I would expect with one caveat, which is look out the window almost anywhere in America and you can see snow. I would expect for the third and fourth quarter that we'll generate high single-digit revenue growth, certainly in the third quarter. The fourth quarter should be maybe a little moderate because we'll have annualized most of the acquisition activity from last year. That growth, despite raw material issues on a consolidated basis, should generate mid- to upper-teen income growth.
Great. Just as a quick follow-up on raw material, what's the actual squeeze this year? If you get some pricing, could that be maybe a positive for you in 2019 as you catch up with the raw materials?
I think we and our whole industry are working to catch up. Typically, we're maybe a three or four-month lag in our industrial and specialty businesses and as much as a year lag in our consumer businesses. The challenges that we've been facing is multiple price increases in certain categories that have hit three or four months after the last one. We're playing catch up. Our whole industry is playing catch up, I would expect that to settle down sometime this spring. I think our whole industry, no matter who you talk to last spring, kind of expected things to settle down at the end of the summer, that has not happened yet.
Great. Thank you.
Thank you.
Thank you. Next we have Steve Byrne from Bank of America.
Morning.
Hi, good morning. This is Ben Gottesdiener on for Steve. Just a quick follow-up on some of your prior raw material commentary. Do you have a line of sight as to when some of these raw material shortages will be alleviated?
I don't have a good answer to that question as we sit here. I don't know that there's shortages in any of the petrochemical type products. I think the area that's been the biggest challenge is in silicones in terms of a broader category, and then some unique raw materials that go into some of our M&A areas where RPM companies, both in terms of waterproofing products and flooring products, are global leaders. So we've seen some easing in those shortages. It's hard to know in the silicone area how much of it is capacity and how much of it, were organized, but in any event, that's the best I can tell you at this point sitting here, but we'll look into that.
Understood. That's helpful. Thank you very much.
Thank you. Next we have Silke Kueck from J.P. Morgan.
Morning, Silke.
Good morning. With retailers lowering inventories in the mid-teens range, that's presumably something that affected last calendar year volumes. Can you tell how ordering patterns look like currently as the retail channels get ready to stock up for the spring season?
The answer to that is yes, we can. The inventory issues hit us late spring and throughout the summer. They're issues that we had to manage through, and in some cases, they were good inventory management practices to a new level at major customers. In other areas, you could go into major customers and literally for weeks be out of stock in basic colors like black and white. Most of that's behind us. We do have insight into consumer takeaway on a pretty regular basis and what we think that will do for us. That's really not going to be a factor for us until the spring. Again, this is a seasonal business, particularly in the small project paint area and the outdoor painting area and roofing and other things. Inventory builds typically don't start until the February timeframe.
Okay. Secondly, do you have any insights as to how the big box retailers are reacting to the consolidation among the U.S. paint companies?
We're really not in the architectural paint business, I do think it's interesting to see how that shakes out. Beyond that, I really don't have much of a comment. We continue to be the leader in almost all the small project paint categories, regardless of whether it's for metal or for elements of wood, for concrete, patch repair, and caulk and sealants. We're getting more into the adhesives area. One of the product categories I failed to mention for Rust-Oleum was a partnership with Tremco and their first entree in a major way with a major big box customer into the building materials aisles with five-gallon pails of roof coatings. That's a new and exciting area for us. We've been working on that for probably a couple of years, and you'll see that take off this spring as well.
That's a whole new product category and a whole new aisle and area of home centers that we hope to better penetrate in the future.
Thank you.
Thank you. Our final question comes from Rosemarie Morbelli. Your line is open.
Thank you. Frank, I was just wondering, or Rusty, if you could give us an update on what you are doing with this, where you are on the 524(g). You have been prepaying. Where do we stand? How much more is there to go, when do you have a choice between putting either cash or stock into that fund?
Our final payment on that is due in December of 2018, so 11 months from now. There is a possibility relative to our understanding of the new tax legislation that that could be accelerated to being paid before May 31. We'll have a better feel for that when we talk to investors on our April conference call.
Okay, thanks.
Thank you.
Thank you. We have no further questions at this time.
Thank you to all for your participation in our investor call today. We're pleased with our second quarter results, particularly in light of a lot of the major challenges that we knew we were facing at the beginning of the year, exacerbated by the ongoing raw material issues. We remain excited about our ability to deliver solid sales and leverage that to mid-teens or better earnings growth for the balance of the year, and for positioning RPM for another year of strong growth in our fiscal 2019. We look forward to communicating to all of you throughout the year, and again on our investor call for the third quarter in April. Thank you to all, Happy New Year.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating, and you may now disconnect.