Earnings Call Transcript
RPM INTERNATIONAL INC/DE/ (RPM)
Earnings Call Transcript - RPM Q2 2023
Operator, Operator
Good morning. And welcome to the RPM International’s Fiscal 2023 Second Quarter Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions and please note that this event is being recorded. I would now like to turn the conference over to Matt Schlarb, Senior Director of Investor Relations. Please go ahead.
Matt Schlarb, Senior Director of Investor Relations
Thank you, Cole. And welcome to RPM International’s conference call for the fiscal 2023 second quarter. Today’s call is being recorded. Joining today’s call are Frank Sullivan, RPM’s Chairman and CEO; Rusty Gordon, Vice President and Chief Financial Officer; and Mike Laroche, Vice President, Controller and Chief Accounting Officer. This call is also being webcast and can be accessed live or replayed on the RPM website at www.rpminc.com. Comments made on this call may include forward-looking statements based on current expectations that involve risks and uncertainties, which could cause actual results to be materially different. For more information on these risks and uncertainties, please visit RPM’s reports filed with the SEC. During this conference call, references may be made to non-GAAP financial measures. To assist you in understanding these non-GAAP terms, RPM has posted reconciliations to the most directly comparable GAAP financial measures on the RPM website. Also, please note that our comments will be on an as-adjusted basis and all comparisons are to the second quarter of fiscal 2022 unless otherwise indicated. We have provided a supplemental slide presentation to support our comments on this call. It can be accessed in the Presentations and Webcasts section of the RPM website at www.rpminc.com. At this time, I would like to turn the call over to Frank.
Frank Sullivan, Chairman and CEO
Thanks, Matt. I will begin today’s call by sharing commentary on our consolidated performance for the second quarter, Mike will provide details on our financial results and then I will turn the call back over to Matt to provide some business updates, and then, finally, Rusty Gordon will conclude our prepared remarks with our outlook for Q3. After our prepared remarks, we will be pleased to answer your questions. In the second quarter, we continued to build on recent momentum to deliver both record second quarter sales and adjusted EBIT. This represents the 10th consecutive quarter of record revenue and four consecutive quarters of record adjusted EBIT, an impressive accomplishment in today’s uncertain economic and volatile climate. An important factor in achieving these results is our MAP 2025 Operating Improvement Program. Across RPM, associates have embraced MAP 2025 principles of collaboration and efficiency to successfully implement initiatives and help drive top and bottom-line growth and performance. MAP 2025, which officially began at the beginning of this fiscal year, is off to a strong start and we are on track to meet or exceed our first-year EBIT target improvement of $120 million from MAP initiatives. This hard work was evident in our second quarter results where we achieved strong revenue growth, as well as significant adjusted EBIT margin improvement. Importantly, we achieved these positive results despite meaningful macroeconomic headwinds, including intensifying weakness in Europe, FX headwinds and a slowdown in some of our end markets. Turning to the next slide. Revenue growth was broad-based with all four of our segments achieving record second quarter sales. This was accomplished primarily through the implementation of pricing increases in response to continued inflation. We also generated volume growth in several of our businesses that benefited from continued reshoring and infrastructure spending, as well as from improved material availability. Importantly, we not only generated strong sales growth but also expanded margins to achieve record second quarter adjusted EBIT on a consolidated basis at three of our four segments. This was driven by the successful execution of margin enhancement initiatives across the organization. The one outlier segment that did not achieve record second quarter adjusted EBIT was the Construction Products Group, which was most acutely impacted by macroeconomic headwinds, because of its relatively outsized exposure to Europe and to new residential home construction in North America. Looking at sales by geography on the next slide, Europe is clearly the laggard among the regions we serve with sales down nearly 12% for RPM and unit volume down at an even greater rate. This was driven by weak macroeconomic conditions, including persistently high inflation; additionally, FX weighed heavily on our results in Europe. FX translation also negatively impacted our sales in emerging markets, so we still achieved healthy growth in these regions. Thanks to the hard work of our associates to align our businesses and products with growing end markets, and to successfully increase prices in response to cost inflation. Demand in North America remained strong through the second quarter with growth in all of our segments, which was fueled by price increases in response to continued inflation and strengthened our businesses to serve customers who are reshoring manufacturing to the U.S. and serve infrastructure-related activities. Better material availability also contributed to organic growth in a number of our businesses in the quarter. I will now turn the call over to Mike Laroche to discuss our consolidated and segment financial results in more detail.
Mike Laroche, Vice President, Controller and Chief Accounting Officer
Thanks, Frank. Sales increased 13.4% excluding FX, which was at a 4.1% headwind. The result was a 9.3% increase in reported sales to a second quarter record of $1.79 billion, compared to $1.64 billion in the prior year period. Organic sales growth was 12.4% or $204.1 million and acquisitions contributed 1% to sales or $15.7 million. As mentioned, FX decreased sales by 4.1% or $67.6 million. Our consolidated adjusted EBIT increased 36.4% to a second quarter record of $214.7 million, compared to $157.3 million reported in the prior year period. Second quarter adjusted EBIT margins expanded 240 basis points compared to the prior year period. We achieved this expansion despite significant foreign currency translation headwinds and continued cost inflation. Adjusted diluted earnings per share were a second quarter record at $1.10, representing an increase of 39.2% compared to the $0.79 in the prior year period. Turning to the next slide. Our Construction Products Group generated second quarter record net sales of $634.1 million, an increase of 3.2% compared to the prior year period. Organic sales growth was 6.9%, with acquisitions contributing 1.5% and foreign currency translation reducing sales by 5.2%. Sales growth was driven by the restoration times for commercial roofing, facades and parking structures. Admixtures and repair products for concrete continued to gain share during the quarter. Price management in response to continued cost inflation also contributed to CPG’s revenue growth. Partially offsetting this growth, demand was weak in Europe and new residential home construction, both areas where CPG has a higher exposure than the RPM average. Demand in these two areas was particularly weak at the end of the second quarter. These headwinds, along with the negative impact from FX, unfavorable mix and reduced fixed cost leverage at plants, including the Corsicana, Texas facility that was acquired in fiscal 2022 2nd quarter, resulted in adjusted EBIT declining 12% to $80.4 million. As a reminder, unadjusted EBIT declined 40% in the quarter versus the prior year period. That was primarily due to a $41.9 million gain from the sale of real estate assets in Q2 2022 that did not recur this quarter. This gain was excluded from adjusted EBIT in Q2 2022. As you can see on the next slide, the Performance Coatings Group achieved record fiscal second quarter net sales with revenue of $335.2 million, an increase of 10.8% compared to the second quarter of fiscal 2022. Organic sales increased 15.4%, acquisitions added 0.6% and foreign currency translation was a 5.2% headwind. Flooring Systems, Protective Coatings and FRP grading all generated double-digit revenue growth. Manufacturing customers fueled the increase, including demand for those who are reshoring their production to the U.S. such as pharmaceuticals, food and beverage, EV manufacturing and electronics companies. Good demand in energy markets and price increases in response to continued inflation also contributed to the growth. Adjusted EBIT increased 16.6% to a second quarter record of $46.2 million. The growth was driven by positive volumes and price increases. Partially offsetting these positive factors, foreign exchange translation was a headwind to adjusted EBIT. Turning to the next slide, the Specialty Products Group reported record second quarter sales of $212.1 million, an increase of 9.5% compared to the prior year period. Organic sales increased 11.5%, acquisitions added 0.9% and foreign currency translation was a headwind of 2.9%. Second quarter sales were led by strength in the food coating and the additives business as a result of strategically refocusing sales management and selling efforts. In the disaster restoration business, the response to Hurricane Ian contributed to strong sales growth and its ability to quickly meet increasing demand was aided by prior operational improvement investments. Price increases in response to continued inflation also contributed to the sales growth. SPG generated record second quarter adjusted EBIT of $30 million or an increase of 43.2% compared to adjusted EBIT of $20.9 million in the prior year period. The increase was driven by strong sales growth and benefits from MAP 2025 initiatives. Moving to the following slide, the Consumer Group grew sales 15.3% to $610.4 million, which is a record for the second quarter. Organic sales increased 17.5%, acquisitions contributed 0.4% and foreign currency translation was a headwind of 2.6%. The Consumer Group sales growth was driven by price increases to catch up with continued cost inflation and strong sales growth in North America. Adjusted EBIT increased 180.3% in the fiscal 2023 second quarter to $94.2 million, which was a second quarter record. Successful implementation of MAP 2025 initiatives, many of which were enabled by improved material supply, as well as strong sales growth were key drivers to the increase in profitability. As a reminder, the Consumer Group experienced extraordinarily low profitability in Q2 2022 as a result of an explosion at an alkyd resin supplier's plant that caused severe supply disruptions and from high material cost inflation that was not offset by commensurate price increases. This contributed to the strong second quarter of 2023 year-over-year growth. Now I’d like to turn the call over to Matt to discuss capital allocation.
Matt Schlarb, Senior Director of Investor Relations
Thanks, Mike. During the second quarter of fiscal 2023, we paid cash dividends of $54.2 million or $1.68 per share on an annualized basis. On a per share basis, this represents an increase of 5% compared to fiscal 2022 and is the 49th consecutive year we have raised our dividend. Over the course of these 49 years, our strategically balanced business model has given us the ability to continually generate steadily improving cash flows and return over $3.1 billion to shareholders via dividends during this period. With regard to investments in working capital, for several quarters we have talked about increases in working capital driven by higher raw material inventories that were designed to improve supply chain resiliency. As material availability has significantly improved, we have begun normalizing our purchases of raw materials in Q2 2023 and we expect these actions to contribute to improved working capital levels in Q3 2023. On the topic of M&A, we have completed six acquisitions so far in fiscal year 2023. These have been small deals and we have remained disciplined as multiples from any potential targets have been elevated above historical levels. With the recent rise in interest rates and changes in economic forecasts, multiples appear to be normalizing and we have a strong pipeline of potential acquisition targets. We expect to continue to be active in M&A and have the financial flexibility to do so, but we will retain our disciplined approach to valuations with a sharp focus on value creation. Looking ahead, while long-term visibility remains limited, we expect economic headwinds to persist in the fiscal third quarter of 2023. Although we are not immune to economic challenges, the balanced portfolio of businesses I just referred to has historically helped us navigate economic slowdowns. Our varied businesses tend to perform differently throughout the economic cycle, which helps reduce the volatility of our results and insulate us from downturns. Additionally, several of our businesses are positioned to continue to benefit from positive reshoring and infrastructure spending trends, which we expect to continue in the future. We have also positioned our businesses to primarily focus on maintenance and restoration markets, which tend to be less economically sensitive than new construction or OEM demand. As you can see from slide 12, approximately two-thirds of our revenue is generated by demand for maintenance and restoration products and services. The reason maintenance and restoration demand tends to outperform new construction during times of economic slowdowns is demonstrated by the example on slide 13. When compared to buying or building new, our products offer a compelling value proposition during periods when budgets are in sharper focus. This is true not only for consumers but also commercial and industrial customers as well. As an example, within our Consumer segment, Rust-Oleum offers a suite of complementary and easy-to-use products that owners can utilize to renovate their bathrooms at a fraction of the cost of a typical bathroom remodel. Rust-Oleum also offers products to renovate other areas of the house, including kitchens, garages, and furniture. With that, I’d like to turn the call over to Rusty to cover our guidance and outlook.
Rusty Gordon, Vice President and Chief Financial Officer
Thanks, Matt. As Matt mentioned, we expect the headwinds that we have recently experienced to continue in the third quarter of fiscal 2023. These include slowing overall economic activity, rising interest rates, reducing construction activity and negatively impacting existing home sales, which have declined for 10 consecutive months. The bull-up effect caused some customers to temporarily moderate purchases to normalize inventory levels as material availability has improved; a strong U.S. dollar compared to the third quarter of fiscal 2022; and lastly, continued year-over-year cost inflation. Through a combination of these headwinds, results in November and December have been meaningfully below the prior months in fiscal year 2023. At this point, it is too early to determine how much of the recent slowdown is due to weakening economic conditions versus the short-term impact of inventory normalization. Customer feedback on the reduced demand has been mixed as has recent economic data. Taking all these factors into account, we anticipate third quarter fiscal 2023 consolidated sales will increase in the low single-digit to mid-single-digit percentage range compared to the prior year record results. By segment, we expect PCG to be the leader with sales up in the high single-digit to low double-digit range compared to the prior year record results. The strength is being driven by growth in businesses serving manufacturers who are reshoring their production to the U.S., including strength in energy-related markets. Additionally, PCG is expected to benefit from CS 168 initiatives, which are part of our MAP 2025 Commercial Excellence Program. Consumer sales are expected to increase in the mid-single-digit range compared to prior year record results, led by pricing increases in response to year-over-year inflation. Additionally, now that our material availability has increased, we have begun implementing new marketing and advertising initiatives, which we expect to benefit growth in the coming quarters. Partially offsetting this growth, we expect that the low levels of housing turnover will have a negative impact on Consumer volumes. SBG sales are expected to be flat to prior year record results. Here, strength in food coatings and additives, and disaster restoration equipment in response to recent winter storms is expected to be offset by volume declines at businesses serving OEM customers, which are more economically sensitive. As an example, some OEM customers have extended shutdowns of their facilities above and beyond the usual holiday timeframe for the first time in several years. We anticipate that CPG sales will decline in the low single-digit to mid-single-digit range compared to the prior year record period as it continues to be weighed down by a weak European economy and softening construction activity. With the softening macro environment, we are reducing production at some of our plants to align with expected demand. As a result, we expect to reduce inventories, which have been temporarily elevated to navigate supply chain challenges and positively impact our cash flows. We also expect that these actions will lead to lower fixed cost absorption and be a headwind to earnings. Taking all this into account, we anticipate that third quarter fiscal 2023 adjusted EBIT will be in the range of $75 million to $85 million, compared to the prior year record amount of $80.6 million. Included in this guidance are the expectations for year-over-year headwinds from FX and cost inflation. This concludes our prepared comments. We will now be pleased to answer your questions.
Operator, Operator
And our first question today will come from John McNulty with BMO Capital Markets. Please go ahead.
Frank Sullivan, Chairman and CEO
Good morning, John.
John McNulty, Analyst
Yeah. Good morning, Frank. Thanks for taking my question. So I guess the first one would just be on the raw material environment. It looks like a lot of base chemicals, coatings, and raw materials have started to slide. I guess, can you speak to what you are seeing in the raws that you are buying today and how much they may be coming off? And then, I guess, tied to that, is it fair to assume that you don’t have that in the 3Q guide just because of your FIFO accounting and it probably doesn’t impact you yet; you probably get the benefit more in the May quarter? I guess, how should we be thinking about that?
Frank Sullivan, Chairman and CEO
Yeah. I think that’s correct. So in the second quarter, year-over-year inflation was up about 17%. It was down sequentially in the quarter about 3%. We are experiencing better recovery on the spot market as you are suggesting today, but because of FIFO accounting, that’s not going to show up until the end of the fourth quarter or into the first quarter of next year. I can give you a couple of data points. Again, we are seeing sequential improvements, but there are still some significant areas of inflation year-over-year; metal packaging is up 59% in the quarter, alkyd resins were up 30% in the quarter versus the prior year. But we are in the marketplace starting to see sequential improvements.
John McNulty, Analyst
Got it. Got it. Fair enough. And then I guess on the destocking side, can you help us to think about, it sounds like there’s a little bit of confusion out there and even your customers aren’t necessarily sure how much of its destocking versus actual demand. I guess, can you give us a little bit more color as to which channels may be seeing kind of the heaviest level of destocking and the negative impact of that and where things maybe are kind of running more hand to mouth and more in line with demand? I guess, how should we be thinking about that?
Frank Sullivan, Chairman and CEO
Sure and it’s a great question. Historically, when we would talk about destocking or any of our peer competitors or companies that deal in Consumer markets, it tended to be understood as a reference to inventory adjustments by major retailers, big box consumers, discount. In this case, it’s really inventory adjustments across the whole supply chain. So with many of our customers in industrial markets, we are in a similar fashion. Supply chains were so broken, you saw people buying what they could get. While our inventory is higher than it should be, in the quarter, we have seen a meaningful improvement from higher than usual raw materials to finished goods, which is the proper step of a cash conversion cycle. And so across our customer base, you are seeing people take actions to readjust inventory levels from kind of the extraordinary actions people had to take over the last year and a half or two years in light of supply chain disruptions. Specifically, in the third quarter, Rusty referenced the Specialty Products Group and we have seen for the first time for the last couple of years some of our OEM customers did not take their usual shutdowns during the Christmas to New Year’s timeframe. In this case, they have, and some are extending it into January. Part of this is inventory level adjustments as opposed to necessarily recessionary moves. So there’s some volatility there that’s going to play out with more certainty in the next couple of months.
John McNulty, Analyst
Got it. And then maybe if I can squeeze in more questions just on MAP 2025, can you just give us an update where you are? I think you were at about a million run rate in the prior quarter. I guess, can you help us to understand where you are at? It sounds like you may have some upside to the $120 million target for this year.
Frank Sullivan, Chairman and CEO
I will hit that $120 million target this year. But one of the things that people have to adjust relative to original expectations in Q3 is most of the MAP 2025 programs are focused at the gross profit level. So it’s greater efficiencies. It’s establishing greater levels of capacity through greater efficiencies. It’s a much more deliberate data usage on managing cost price mix. And it’s having a good effect. The reason that’s relevant to Q3 is it doesn’t flow through your P&L until you sell something, and given the seasonal low of our third quarter revenues, the impact in Q3 of MAP 2025 will be less than what you saw in Q1 and Q2. Then you will see a disproportionately larger impact of MAP 2025 in Q4 because of our higher sales.
John McNulty, Analyst
Got it. Got it. Thanks very much for the color. Appreciated, Frank.
Frank Sullivan, Chairman and CEO
Sure. Yeah. Just to qualify that further. I think that’s an important thing to note that the MAP 2025 benefits will, because of where we are targeting them, be driven proportionally by a revenue basis as opposed to taking our communications about for instance $120 million and dividing it by 12 or dividing it by four. It won’t play out that way.
Operator, Operator
And our next question will come from Frank Mitsch with Fermium Research. Please go ahead.
Frank Sullivan, Chairman and CEO
Good morning, Frank.
Frank Mitsch, Analyst
Hey. Good morning, Frank, and Happy New Year to you and everybody there. The comment was made that November and December saw a significant slowdown. So I was wondering if you could kind of quantify maybe on a percentage basis or a dollar basis or what have you, the negative year-over-year impact that you have seen particularly in December. And as part of that, I’d be curious as to what’s being embedded in terms of recovery in January and February in the $75 million to $85 million operating income?
Frank Sullivan, Chairman and CEO
Sure. So, I will try and address it in two ways. Number one, the biggest negative impact in Q2 and at the end going into Q3 is regional, and it’s Europe. Europe was down 11% in revenues. If you assume price in there, you can make some assumptions that Europe was down even greater on unit volume and while we don’t disclose EBIT by region, EBIT in the European market was off by more than 50% year-over-year. And we have a disproportionate, out of a $1 billion base of business, roughly half of that is in our Construction Products Group. And so that gives you a sense of the greatest challenge that we are facing, which is regional. We also saw a slowdown in residential, which today with Nudura and a few other product lines out of a $2.7 billion Construction Products Group, we have about a $200 million exposure to residential new construction. Including some of our Consumer businesses, I’d say our total exposure to residential new construction in North America is about $300 million. The last comment I will make again, which makes the performance at the end of Q2 and the beginning of Q3 difficult is, we had a weather event not dissimilar to a year ago that impacted the entire United States, and so that slowed down results for us as we start off this third quarter.
Frank Mitsch, Analyst
Got you. That’s very helpful. And interestingly, there’s a lot of discussion regarding destock among the customer base, et cetera, your inventory levels continue to tick higher. I am wondering how we should be thinking about that?
Frank Sullivan, Chairman and CEO
As we speak, we are appropriately adjusting our inventory levels. There was a more typical cash flow in the quarter, and you should anticipate better cash generation from us in the upcoming quarters as we focus on inventory adjustments. This is occurring throughout the entire supply chain and our customer base, not just with large consumer customers. It's essentially the supply chain across nearly every business or industry we serve returning to normal inventory levels. This situation is ongoing, and we are not the only company dealing with elevated inventory levels as we adapt to the supply chain challenges of the past two years.
Frank Mitsch, Analyst
Understood. Thanks so much, Frank.
Frank Sullivan, Chairman and CEO
Yeah.
Operator, Operator
And our next question will come from Josh Spector with UBS. Please go ahead.
Frank Sullivan, Chairman and CEO
Good morning.
Josh Spector, Analyst
Good morning. I'm curious if you could provide some insights on pricing. I apologize if I missed this earlier, but can you discuss what the pricing was in the last quarter? Additionally, regarding construction, if demand is weaker since that business relies more on project-based pricing, is that affecting your ability to secure further pricing, or are you having to concede some of that due to destocking?
Frank Sullivan, Chairman and CEO
We have not provided price detail by segment. However, on a consolidated basis, the average price across RPM in the second quarter was in the 15% to 16% range. Unit volume increased in some of our businesses but decreased in the consumer packaged goods sector, especially in Europe. Overall, unit volume in the quarter was down about 3%. We have maintained our pricing in most areas, and historically, there are only a few situations where we need to reduce prices as supply chains adapt. Some of this is related to commodities, such as silicones in the Construction Products Group, where we've seen significant cost spikes over the last year and a half. Recently, there have been notable declines in silicone prices, which may lead to some price adjustments in those commodity areas. Aside from that, we generally hold our prices across RPM and plan to continue doing so through this cycle.
Josh Spector, Analyst
Okay. Thanks. And then I was just wondering if you could comment on Consumer in terms of what you are seeing. I mean, you have had strong volumes in the first quarter on some restocking and supply availability improvement. I think some of your competitors have noted some destocking in that chain. Are you now seeing more of that? Or I mean, my assumption is you are kind of assuming negative volumes in Consumer at least for next quarter. So just curious what the driver is among that?
Frank Sullivan, Chairman and CEO
Sure. I think that’s correct. There has been some destocking. I think that’s stabilized. Consumer takeaway has still been very volatile from one week to the next. It could be down in units 10% or up 2% or 3% depending on the retailer. We have lost over the last year about $40 million in market share, and I believe that market share adjustment is over, and that’s been in some categories of spray paint and wood stains and finishes in a big box account. Our Consumer Group is pretty excited about the spring, and we are going to be initiating advertising and promotional initiatives in the spring, much larger than we have over the last couple of years. It’s a combination of some new product introductions, some new market share opportunities; and finally, a supply chain such that we can deliver at the high fill rate levels that historically we have been able to deliver at. So we have done a lot of work, both through MAP 2025 and then specifically on the operations side at Rust-Oleum around some supply challenges and manufacturing efficiencies. Those have been addressed and we will be in a really strong position to be able to meet demand and also to drive demand in the spring selling season. So that’s one area of strength for us as we look into the finish of fiscal 2023.
Josh Spector, Analyst
Got it. Thank you.
Frank Sullivan, Chairman and CEO
Thank you.
Operator, Operator
And our next question will come from John Roberts with Credit Suisse. Please go ahead.
Frank Sullivan, Chairman and CEO
Hi, John.
John Roberts, Analyst
Thank you. It sounds like M&A discussions are picking up. Can you provide some color on whether it’s in the weak areas like Europe or Construction Products or is it broad based across your businesses?
Frank Sullivan, Chairman and CEO
It’s kind of broad-based across our businesses. We have done six transactions this year, all very small product lines. But there have been some nice additions to Construction Products. Through some of the big construction product mergers, we were able to pick up pieces of concrete, I am sorry, of cement additives, which was a category that Euclid Chemical was not in. We have also invested internally and through some regional acquisitions and penalization for greater energy efficiency and wall construction. So some exciting areas for us, small acquisitions that with our distribution should be able to double or triple revenues in the coming years. So that’s pretty much what we have been seeing. As Matt commented on, we have been holding our discipline and we are seeing valuations coming down, and I suspect that we will continue to see small to medium-sized acquisition activity in the coming quarters.
John Roberts, Analyst
And then how much more price do you need to get to fully get caught up on alkyd silicones and metal containers?
Frank Sullivan, Chairman and CEO
I think we have the price that we need now in the marketplace. I think the final straw of margin recovery is going to come through holding on to the price that we have got as raw materials cycle back to more normal cost levels. And when you look at our Consumer Group, the year-over-year improvement in EBIT is impressive. It has as much to do with how poorly we performed a year ago as it does today. We are still not back to record EBIT levels, but we expect to get there both through some commodity cycle recovery and the benefits of the MAP 2025 Program.
John Roberts, Analyst
Thank you.
Operator, Operator
And our next question will come from Aleksey Yefremov with KeyBanc Capital Markets. Please go ahead.
Frank Sullivan, Chairman and CEO
Good morning.
Aleksey Yefremov, Analyst
Thanks, and good morning, Frank, and everyone. I wanted to ask about the bidding activity that you see mainly in Construction Products and Performance segments, more maybe looking over the next two or three quarters, perhaps, outside the residential projects area where you highlighted the weakness?
Frank Sullivan, Chairman and CEO
Sure. As you can see from our results, the residential segment has been weak, and Europe is also facing challenges. However, we have a strong backlog in our roofing and waterproofing division as we head into spring. Currently, it appears that the upcoming spring and summer season for this part of our Construction Products Group, which is the largest and most profitable, will be robust, but we will have to wait and see. The volatility across different segments makes it difficult to determine how much of the expected underperformance in Q3 is due to customer inventory destocking and adjustments, or weather-related issues as we begin the quarter, as opposed to recessionary factors. Nevertheless, we maintain a strong backlog and take comfort in the fact that, unlike residential or conventional commercial construction, significant federal and state funding will be directed towards school and healthcare construction, both of which are strong markets for our roofing and waterproofing division.
Aleksey Yefremov, Analyst
Thank you. And then I understand it’s hard to differentiate between demand weakness and destocking, but your intentional reduction of inventory, is it possible to estimate how much that’s hurting EBIT in the third quarter?
Frank Sullivan, Chairman and CEO
Yeah. It’s a good question and it’s definitely a drag on EBIT. We have dropped shifts in certain places where we had previously been operating on a three-shift basis and that was not demand-driven. That was inventory adjustment driven. When you do that, your overhead absorption takes a hit, and so that’s temporary and you are seeing that in a number of places across RPM. There’s a deliberate effort to get inventory levels in a number of our businesses back to a normal pace, and that will hurt us in the seasonally low third quarter as these actions again negatively impact overhead absorption. I’d like to think, I don’t know how quickly we will adjust. It will be adjusted through the spring and the summer selling season, which are our strong seasons, and so those temporary negative impacts on gross margin should pick back up.
Aleksey Yefremov, Analyst
Got it. Thanks a lot, Frank.
Frank Sullivan, Chairman and CEO
Thank you.
Operator, Operator
And our next question will come from Steve Byrne with Bank of America. Please go ahead.
Steve Byrne, Analyst
Yeah. Thank you. How much of your MAP 2025 would you say is driven by targets on the manufacturing side versus initiatives on commercial improvement? And in the former, do you expect to get more active in raw material manufacturing, and in the latter view, is it more driven by cross-selling?
Frank Sullivan, Chairman and CEO
So it’s mostly, Steve, focused on areas that would affect gross profit and so it is a continuation of what we call MS 168, which is driving lean manufacturing disciplines on a consistent basis across our manufacturing base. We had in our original MAP program done so very effectively but really in our top 50 plants, and there are another 75 plants out there that are more small- to medium-sized. Our ability to get to effectively was interrupted by COVID and so that’s having an effect. There will be some modest plant consolidation, nothing to the extent of the original MAP program, but some modest plant consolidation, and so those are two big areas. Then the other area is literally being in a position today to use data much more effectively to understand cost price mix better and to be able to drive a more deliberate margin profile that we want relative to really not having that data all the way down to a salesperson level such that we can really be deliberate and effective there. And so those are the primary areas that will affect principally gross profit margin.
Steve Byrne, Analyst
I asked about the cross-selling because one of the takeaways for us from the events you had in Cleveland with Construction Products was an apparent awareness that cross-selling was an opportunity there and just would like to hear your view on that, Frank. Is this an area that you think that RPM has some significant opportunity to cross-sell between businesses, and perhaps, regionally, do you have aspirations for sales outside North America to meaningfully increase above the 20% level that it’s at now?
Frank Sullivan, Chairman and CEO
Yeah. Absolutely. So as you saw in the Investor Day presentation, over the last four years, our internal cross-selling efforts have increased from $60 million annually to $180 million, and certainly, the opportunity for that to double in the coming years exists. One example is, because of the success we have had with Arnette Polymers, which is a pre-polymer raw material resin division of Stonhard, and then the Corsicana plant which, while it’s part of our Construction Products Group, today is principally serving Consumer and Rust-Oleum. We are utilizing the leadership there to create a resin center of excellence in Europe to create the same type of stability and certainty in supply, competitive advantage in raw materials and cost selling, and that’s going to play out over the next 12 months or 18 months. So that’s one of many concrete examples of trying to continue to accelerate what’s been a pretty good story in terms of intercompany supply and/or cross-selling revenue benefits.
Steve Byrne, Analyst
Thank you.
Operator, Operator
And our next question will come from Ghansham Panjabi with Robert W. Baird. Please go ahead.
Frank Sullivan, Chairman and CEO
Good morning.
Ghansham Panjabi, Analyst
Hi, guys. Good morning and Happy New Year as well.
Frank Sullivan, Chairman and CEO
Thanks.
Ghansham Panjabi, Analyst
I guess, Frank, on the inventory adjustment dynamic, as you kind of think about it, do you see this as sort of a multi-quarter phenomenon or one that’s going to disproportionately impact one of your smaller quarters, which is 3Q, and then things sort of normalize from there? And then just related to that, just given all the complexity in the current operating environment, is there any historical parallels that you can think of that are sort of equivalent to what you are seeing at this point?
Frank Sullivan, Chairman and CEO
Thank you. The impact on Q3 will be notably negative, which is reflected in our guidance. We are reducing production in specific areas to correct inventory imbalances rather than simply responding to demand fluctuations, and I previously mentioned the effect on overhead absorption. This hit will decrease in Q4 and into Q1. It could take about six to nine months to restore inventory to our desired levels, which will be a gradual process. We have seen that our inventory levels haven’t improved significantly on a relative day basis quarter-over-quarter, but there has been a noticeable shift from carrying excess raw materials to finished goods, which is the cash conversion cycle we aim for. Now the focus is on selling this inventory to generate cash. Historically, we have mentioned destocking when large consumer clients seek to improve their inventory efficiency, and that has been the case for us too. The impact has been discussed from time to time, but in my experience, I've never encountered supply chain disruptions along with such significant inventory imbalances. For instance, last year, there was unfulfilled demand in some of our Consumer sectors due to these issues. Some customers ordered more than they needed to secure sales, and we experienced similar behavior in our Construction Products Group. These unusual situations have arisen across various businesses and industries due to supply chain disruptions. As supply chains stabilize and return to normal, we are now witnessing efforts to adjust back to standard inventory levels and focus on a stable and predictable working capital position.
Ghansham Panjabi, Analyst
I know there’s a lot going on. And for my second question, in terms of your comments related to the weakening in volumes late in the quarter, which specific businesses and end markets were the most impacted? I know you called out new construction, but just more color on that?
Frank Sullivan, Chairman and CEO
Sure. As we think about Q3 going into the spring, we saw solid performance from our Consumer Group and we would expect to see that continue. We saw really solid performance in our Performance Coatings Group and given their infrastructure function and focus and heavy industry focus and some of the onshoring and infrastructure dollars out there, we expect that to continue. The weakness was really in the Construction Products Group, particularly as we start Q3. I can’t tell you sitting here whether it’s a sustained weakness that’s continuing, that’s more recession-like or whether some of it was a result of the winter storm that impacted all of North America. We saw weakness in the OEM portion of our Specialty Products Group. Our Specialty Products Group is about $800 million; about half of that is OEM coatings, powder coatings, liquid metal, wood stains and finishes, and again, some of that could be circumstantial. Over the last couple of years, the normal between Christmas and New Year shutdowns that some of our cabinet maker customers, door customers, RV customers had traditionally, they did not have. While they did have those again this year and some of that is extending into January. How much of that is in anticipation of continuing recessionary pressure as opposed to some of these inventory adjustments we won’t know for another month or two.
Ghansham Panjabi, Analyst
Thanks so much, Frank.
Frank Sullivan, Chairman and CEO
Thank you.
Operator, Operator
And our next question will come from Jeff Zekauskas with JPMorgan. Please go ahead.
Frank Sullivan, Chairman and CEO
Good morning.
Jeff Zekauskas, Analyst
Thanks very much. Your corporate costs are annualizing at $132 million versus something like a little less than $100 million last year, and even in 2021, maybe your corporate costs were $113 million. What’s going on there? Is this a large one-time increase for this year or is it something more permanent? Why are corporate costs up so much?
Rusty Gordon, Vice President and Chief Financial Officer
Jeff, this is Rusty here. Corporate costs are up primarily from two categories; it’s pension and insurance. In terms of pension, our assets have been hit in the pension plan, and that leads to higher non-service related pension costs, as well as the fact we have had pay and wage inflation higher than our actuarial assumptions. Also, in terms of insurance, as you know, there have been several property events and insurance costs are up as well.
Frank Sullivan, Chairman and CEO
The other thing I would add to that as a result of our MAP to Growth program, as well as MAP 2025, our corporate staff has increased by about 30%. Now it starts on a relatively low basis of, let’s say, 90 people, and I’d say, we are up to about 125, 130. That’s in areas of IT, which we are driving center-led in a number of areas; it’s in a team of continuous improvement in engineering professionals that number about 12 and it’s a team of corporate staff procurement people of about eight, none of which existed in the corporate payroll three years or four years ago.
Jeff Zekauskas, Analyst
So your SG&A expense, I think, adjusted was up a little bit more than 10% this quarter versus a 9% increase in sales, and it sounds like volumes are not growing or not as strong as you expected. Is there anything you are going to do to reduce your SG&A levels and get them below your rate of sales growth?
Frank Sullivan, Chairman and CEO
We regularly review SG&A levels across all our businesses. Some of the increases in SG&A are related to wage increases, which have been influenced by a challenging employment environment. While raw material inflation is stabilizing and decreasing, wage inflation remains persistent. Additionally, we are returning to more typical levels of investment in travel and entertainment, although it's uncertain if we'll return to pre-COVID levels. During the COVID period, investments in these areas were nearly nonexistent, and now we are increasing in-person activities such as sales meetings and customer visits compared to where we were 12 to 18 months ago.
Jeff Zekauskas, Analyst
Okay. Thanks so much.
Operator, Operator
And our next question will come from Kevin McCarthy with Vertical Research Partners. Please go ahead.
Kevin McCarthy, Analyst
Yes. Good morning. Frank, just to extend the discussion on the monthly cadence and the concept of destocking, have you seen any customers following the closure of the calendar year end books that have become more liberal in their orders more willing to resume a more normal cadence of purchasing? And if so, where might you be seeing that? It didn’t sound as though that’s very prevalent from your remarks?
Frank Sullivan, Chairman and CEO
Yeah. I think that our third quarter is probably the wrong period of time, especially this quarter, to be able to answer that question. Europe is the biggest driver of the deteriorating performance. Again, if you follow my comments, the world is not ending for RPM by any way, shape or form. I talked about in Q2, regionally, Europe was down 11%, and given price increases, you can assume that unit volume was down more, and then EBIT was off 50% in Europe. That gives you a sense of the strength of RPM anywhere else. We are seeing the weakness that we talked about. And, Kevin, it’s too soon for us to be able to say how much of it was weather-related, how much of it is inventory-driven shutdowns and OEM customers versus how much of it is full-on recession. I don’t think we can answer that question today with any certainty. If you want to ask that our April call, I think we would be in a much better position to have some clarity around that question.
Kevin McCarthy, Analyst
Okay. Fair enough. And I just had maybe a couple of quick housekeeping ones. First, did you give a MAP savings number for the quarter or if not, would you comment on that? And then second, I wanted to ask about some verbiage in your press release. I think it mentioned some unfavorable mix and fixed cost leverage at Corsicana, in particular, and just wondering if you could elaborate on those dynamics.
Frank Sullivan, Chairman and CEO
Sure. The fixed cost leverage both at Corsicana, which is serving Consumer and some of our Construction Products businesses, also Carboline in terms of alkyd resins. It’s not just Corsicana; it’s knocking off some weekend activity in plants or knocking off a shift to try and make inventory adjustments. That basically slows down production so that we can get our inventory back in line, and so the overhead absorption hit as a result of that it’s going to negatively impact Q3. I don’t recall the other...
Kevin McCarthy, Analyst
Just MAP savings in the quarter...
Frank Sullivan, Chairman and CEO
We have decided not to provide MAP savings each quarter. Our goal is $120 million for fiscal 2023, and we are confident that we will achieve it. Have we disclosed what we have achieved year-to-date in the first quarter?
Rusty Gordon, Vice President and Chief Financial Officer
It was $30 million.
Frank Sullivan, Chairman and CEO
$30 million in the first quarter. You can extrapolate that across the quarter, especially regarding understanding since most of this is being driven at the gross profit level. That $120 million will flow in proportion to our revenue growth by quarter.
Kevin McCarthy, Analyst
Got it. Okay. Thank you so much, Frank.
Frank Sullivan, Chairman and CEO
Thank you.
Operator, Operator
And our next question will come from Mike Sison with Wells Fargo. Please go ahead.
Mike Sison, Analyst
Hey, guys. Happy New Year. Yeah. Just one question, Frank.
Frank Sullivan, Chairman and CEO
Hi, Mike.
Mike Sison, Analyst
If you think about the current environment and you have a lot of EBIT growth anchored with the MAP program going forward, if it started to stay this way for a while, is it challenging to grow EBIT even with the MAP program? And maybe another way to look at it is, what do you think needs to happen in the external environment to get back to the growth that you were showing prior to the third quarter?
Frank Sullivan, Chairman and CEO
We need to be effective in our sales, marketing, and promotion efforts to generate consumer interest, and we are excited about what's coming in the spring. Expect to see new product rollouts and an increase in advertising since we have returned to a high level of efficient supply. Our growth initiatives around Nudura are promising; this business has grown from $40 million to $100 million, with a significant focus on residential work. However, we must work towards getting it specified in commercial markets, particularly in schools and similar sectors. The current economic circumstances will not deter our focus. There are several exciting areas where we will continue to invest, regardless of the economic situation. Broadly, we need the Federal Reserve to stop increasing interest rates and see stability in housing and related matters. These macroeconomic factors affect not just us but the entire sector. In response to an earlier question, we manage our selling, general, and administrative expenses on a unit-by-unit basis and will continue to do so where it makes sense. However, we do not anticipate the need for any broad-based expense reduction program. Our focus remains on executing the MAP program and selectively investing in various growth initiatives.
Mike Sison, Analyst
Got it. Thank you.
Frank Sullivan, Chairman and CEO
Thank you.
Operator, Operator
And our next question will come from Vincent Andrews with Morgan Stanley. Please go ahead.
Vincent Andrews, Analyst
Thanks. Just two…
Frank Sullivan, Chairman and CEO
Good morning.
Vincent Andrews, Analyst
Good morning. I have two quick questions. Frank, I wanted to clarify the $40 million of market share in spray paint and wood stains. Did you gain that or lose it? I just didn't catch that.
Frank Sullivan, Chairman and CEO
We have experienced a loss in market share over the last 12 months, which was not unique to us but related to the challenges we faced in meeting demand due to supply disruptions. This includes a modest gain in spray paint at Home Depot and some losses in wood stains and finishes, amounting to a market share loss of about $30 million to $40 million, which I believe has now concluded.
Vincent Andrews, Analyst
Okay. Thank you. And then, Rusty, you mentioned increasing marketing ad spend, and I just wanted to clarify whether that was an actual increase versus, say, 2019 levels or whether it’s just a sort of normalization, because you took it down when you didn’t have sufficient raw materials to actually make the product. So why would you advertise? So can you just clarify what’s going on there?
Frank Sullivan, Chairman and CEO
Yeah. This is Frank. It’s a little bit of both. It will be up year-over-year just because we didn’t spend a lot in the face of the supply chain challenges. But we are working to get back to normal levels pretty quickly, and we have got some exciting new product introductions that we will talk about in the spring. We have some exciting new products; we have some new market share opportunities, and we have our operations in a position to lean in hard to support all of that. So we are going to get back to an advertising and promotion level that’s more consistent with the past and that will be necessary to support that growth.
Vincent Andrews, Analyst
Okay. Is there any quantification of that just in terms of, I assume that will fall into SG&A as well, or is that already in there?
Frank Sullivan, Chairman and CEO
It will fall in SG&A, and we will be able to provide more details on that in April.
Operator, Operator
Our next question will come from Arun Viswanathan with RBC Capital Markets. Please go ahead.
Frank Sullivan, Chairman and CEO
Good morning, Arun.
Arun Viswanathan, Analyst
Great. Good morning, Frank. Happy New Year. Thanks for taking my question. A lot of my questions have been answered, but I think maybe I will try this in a slightly different way. So, it sounded like the Construction Products sales cadence really slowed down in November, December and it sounded like, I don’t know if that was surprising. So would you say that we are still in early innings of this slowdown, and you noted that maybe it will take six months to nine months for inventories to be worked off. Is that kind of how you feel about the demand trends as well, and maybe you can just comment on if that’s the case for some of your other businesses as well? Thanks.
Frank Sullivan, Chairman and CEO
Sure. At some point, we will begin to see easier comparisons in Europe, which has been deteriorating since last spring. We are not at the beginning of this situation; we are currently experiencing a significant recession with a decline in demand. I believe that in six to nine months, we will at least start to stabilize and move in the right direction. This is influenced by geopolitical factors such as the war in Ukraine and the state of energy markets in Europe. One specific area of concern is our exposure to residential new construction, which amounts to about $300 million—$200 million from Construction Products and $100 million from Consumer. While it hasn’t come as a surprise, the data indicates a significant slowdown in that profitable sector. We will need to see stabilization in interest rates by the Fed before we can expect to see improvement in new home construction and increased housing turnover, both of which are important for our demand.
Arun Viswanathan, Analyst
…potentially sluggish demand trends and destocking that’s going on, do you expect to give back some of the price initiatives that you have achieved in a little bit more rapid fashion? How do you kind of plan to maintain the margin trajectory and recovery that you kind of had hoped for and experienced through the last couple of years? Are there other measures other than pricing, like mix or anything else that we should think about or, yeah, how do you plan to keep some of that margin recovery?
Frank Sullivan, Chairman and CEO
Sure. In the past cycles, we have been able to maintain the vast majority of the price increases that we have initiated, and we would expect to do exactly the same thing here. If you look at our performance in past commodity cycles, on the down cycle we should pick up $100 million to $200 million of margin benefit and we are working hard to do that, and we intend to do it. As I said, even Consumer with the very strong recoveries are showing there, and certainly, some of that is price driven; while the year-over-year performance is really strong, we are not yet back at record margins, and we intend to get there through a combination of maintaining price where it’s appropriate and the benefits of the MAP 2025 program.
Arun Viswanathan, Analyst
Thanks.
Operator, Operator
And this will conclude our question-and-answer session. I’d like to turn the conference back over to Frank Sullivan for any closing remarks.
Frank Sullivan, Chairman and CEO
Thank you, Cole. Thanks to all of you for your participation in our investor call today. We are pleased with our second quarter results, which reflect the resiliency of our balanced business model and the extraordinary efforts of our associates around the globe. We are carefully monitoring early signs of economic slowing but are confident in our ability to manage effectively through the entire business cycle. We look forward to providing you with details of our results in April. We will have a much better sense of where we are headed in terms of what seems to be an exciting opportunity for continuing growth in our Consumer Group and Performance Coatings Group and hopefully some improving performance out of Construction Products and Specialty Products as well. Thanks again for your time on today’s call and best wishes for a happy, healthy and successful new year.
Operator, Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines at this time.