H.B. Fuller Company (FUL) 2003 Q2 法說會逐字稿

Good morning and welcome to the H.B. Fuller Company second quarter 2003 earnings release conference call. You will be able to listen only until the question answer portion of the conference. This conference is being recorded. If you have objections you may disconnect at this time. I turn the call over to Mr. Scott Devorak (ph) Director of Investors Relation. You may begin

Thank you. Good morning everyone. This mornings conference call is being recorded and will be available for replay after we are finished with questions. With this conference call are Al Stroucken Chief Executive Officer Ray Tucker Chief Financial Officer and several other key executives. Before beginning the discussions today will cover certain financial information that has been add adjusted to reflect our restructuring initiative and non-GAAP regulations under SEC regulations. Earnings press release provided reconciliation of the non-GAAP items with our GAAP results. This press release is posted on our website on www.hbfuller.com under shareholder relations press releases.

In addition certain matters discussed in this call may have forward-looking statement as defined under the Private Securities Litigation Reform Act of 1995 Private Securities Litigation Reform Act of 1995. Since such statements reflect current expectations actual results may differ. For more information refer to press release on form 10Q and form 10k. Now Ray Tucker.

Good morning everyone. I would like to remind that you current and prior year results discussed will be prior to any special charges incurred due to the restructuring initiatives and that per share amounts are recorded on a diluted basis. We have already seen from our press release the second quarter results reflect one cent improvement in earnings per share over the previous year and year-to-date improvement of three cents or approximately 5%. Continuing along the expectations given at the beginning of the year of slightly improved earnings over that of 2002. Net earnings increased from $12 million in the prior year to $12.3 million. Earnings per share were 43 cents, one cent higher than last years 42 cents. As I mentioned in the previous conference call this quarters earnings per share include increased expense associated with pension and post retirement benefit plans as compared to that of last year's second quarter of $2.5 million or approximately six cents. For the six months net earnings of $18.6 million increased $1 million or three cents per share, includes $5 million or 12 cents per share of increased pension costs year-over-year.

Net revenue for the quarter was $325.5 million, I'm sorry $324.5 million, 1.6% higher than Q2, 2002, revenue of $319.4 million. For the first six months revenues increased 1% over last year to $619.1 million. Looking at the components for the sales change of the quarter we see the following; Pricing down 1%. Volume decreased 1.9%. Currency effects, primarily due to the Euro and to the lesser degree the yen and the Australian dollar was 4.5% increase. Gross margin of 28.1% was a half of a percentage point lower of last years gross margin of 28.6%.

Decline was due to not keeping pace of raw material cost offset by low material manufacturing labor and overhead costs. Operating expensed $71.5 million or $2.9 million higher than last year. As a percentage of sales operating expenses were 22% compared to 21.5% a year ago. The increase in percentage is attributable to higher pension expense and an increase in reserves for claims associated with our eves (ph) product was $1.2 million. Excluding these effects, operating expenses, as a percent of sale would have been 21.9%. Operating income decreased 13.4% to $19.6 million compared to $22.7 million for the second quarter of last year.

Operating income and Global Adhesives for the second quarter was a decrease of $14.1 million a decrease of $.5 million from the second quarter of 2002. Full-Value/Specialty operating income of $5.5 million decreased $2.6 million from the previous year second quarter. Shortfall and Full-Value/Specialty is attributed to the higher pension cost and increased product liability reserve. Consistent with the other financial information I have reported operating income for the business segments excludes special charges related to the restructuring initiative.

Interest expense of $3.6 million was more than $800,000 or 19% below the second quarter of 2002. Miscellaneous other expense of $600,000 compared to $300,000 of expense last year. Pretax earnings of $15.4 million compares to the previous year of second quarter earnings of $17.9 million. The effective tax rate for the quarter was 21.7%. This change in percentage was mainly due to a one time tax benefit of $1.5 million. This benefit was the result of our continuing rationalization of our European legal structure we began operating under in 2002 and resulted from the investment we have made in our tax planning initiatives starting in 2000. On a year-to-date basis, this one time tax benefit of five cents per share more than off sets the unexpected foreign currency loss of three cents per share we incurred in the first quarter.

In addition the over all annual effective rates was reduced one percentage point from the first quarter's rate of 33% to 32%. We expected the 32% rate will be the effective rate for the remainder of the year. This compares to an effective rate for 2002 of 33%. I would like to remind everyone the following balance sheet figures may be subject to minor changes prior to the filing of 10Q. Operating working capital amounted $254 million compared to $219 million last year, an increase of $35 million. The majority of the increase resulted from $10 million due to the stronger foreign currencies, primarily the Euro, yen and Australian dollar. $6 million reclassification of assets held to sale from long-term to current asset. $7 million tax related items and $4 million of other prepaid items.

As a percentage of sales, operating working capital was 19.6% versus 17.2% last year. Total debt decreased 9.1% from a year ago to $191 million. Debt decrease from the previous quarter and -- debt decreased from the previous quarter by $17 million. The Company's capitalization ratio was 29%, the same as end of 2002 and 32% a year ago. Capital spending for the quarter approximated $8 million compared to last year's second quarter spend of $5.6 million. Appreciation and amortization were $13.5 million for the quarter. Pre-cash flow for the quarter was approximately $24 million compared to $12.7 million in the second quarter of last year. Through six months our pre-cash flow is negative $3.9 million.

At this point I would like to provide an update on restructuring initiative. This is the final quarter that will be impacted by restructuring expenses. During the second quarter of this year we incurred pretax charges of $3.2 million. This consisted of $1.1 million for severance and $2.1 million of facility closing, disposal and other costs. Total net charges for restructuring over the last seven quarters equaled $39 million. We still anticipate the total net charges to be approximately $35 million once all related assets have been sold. I would like to reiterate that the annual savings from this restructuring initiative will be at least $12 million.

Before I turn it over to Al Stroucken I would like to take take moment for a more personal note. As announced last year today marks my final conference call for H.B. Fuller as I will be retiring at the end of July. I've been proud to be a part of the team. We have made significant changes at H.B. Fuller and I believe the shareholders the Company and employees are the beneficiaries of these improvements. The Company is much stronger today and well-positioned. I have enjoyed the interaction with each of you and wish you and H.B. Fuller and the employees the best in the coming years. Thank you and now Al Stroucken.

I'll like to thank Ray. The second quarter was more challenging than I had hoped for. But the speed of level of our acceptance of our price increase was going to be a significant determinant for our performance. The continued pressure from feed stocks and more competitive environment for volume created a difficult business scenario. Uncertainty concerning Iraq at the beginning of the quarter and subdued economic climate were not particularly helpful. Yet we were able to post earnings that did reflect the slight improvement over that of the previous year culminating in 5% improvement in earnings year-to-date. These results were achieved after having to offset the year-over-year pension and post retirement benefit expense and unexpected foreign exchange loss we absorbed in the quarter of this year. Sometimes the greatest sense of accomplishment comes from performance in your best and most difficult market conditions. By the end of the previous quarter I believe that there would be a need to raise prices in order to pass on the rapidly increasing raw material costs.

I was encouraged by the announcements of significant price increase from adhesives suppliers similar to our own announcement that we issued in February. I was hoping that the spike in raw materials would create a different dynamic from the more gradual cost we more typically see in raw material cycle is and that are more difficult to pass onto the market. Yet in certain of our end markets where there is a concentration of volume and large customers with demand for fairly simple water based products the desire for volume growth and the overall declining market seemed to override the need for improvement margins.

I have to draw the conclusion that we have seen a deliberate attempt to shift market share with very low prices. This is somewhat ironic, especially those products were most significantly affected by the raw material increase. As a result we lost share in last two quarters and we will need to recover lost position in the coming months. In the course of the quarter we were never able to gradually realize a increase in prices and presently are averaging 1% increase in adhesives in North America compared to price level at the end of last year and we expect to see additional increases become effective in the next couple of weeks. In year-over-year comparison we are still 1% behind be in the quarter mainly due to decrease in prices we reported in the third and fourth quarter of last year when pricing became competitive. Due to historical friends, realization of [inaudible] increases lagged behind the raw material development even though we were able to react somewhat faster than in the past.

For now it seemed to that raw materials did peak in the second quarter and have stabilized. I use that term because an immediate retreat of raw material cost does not seem likely. The reported low inventories of natural gas it appears that natural gas prices continue to hover around six-dollar until inventories are more in line with historical pattern. A lot has been written lately about the impact changing, consumption exploration and resulting price modeling of natural gas may have on cost structures may have on the U.S. chemical industry and its global competitiveness. We cannot predict it’s long term impact yet however short term it seems unlikely that we will get significantly relief from that side in our raw material cost. Crude oil availability for the remainder of the year may get a boost from the lifting of UN sanctions against Iraq and resumption of exports to Venezuela but maybe countered by a reduced odd [inaudible] level from Saudi Arabia. It would be a reasonable assumption for business to believe that crude oil prices will remain in mid-to upper 20-dollar level per barrel for the remainder of this year.

Reduced demand for feed stock derivatives has kept on cost of material from spiking further. An economic recovery in the remaining part of the year could create an increased demand for these materials and change the dynamics for continued upward pressure on raw material cost. We continue to work with customers in pricing initiative to recover the increase in cost that we have absorb as well as continuing with our strategic teams to look for help to counter the impact of raw material cost.

Our total company sales reflect over all increase on year-over-year US dollar basis with combination of economic environment and competitive pricing actions hampering our ability to gain volume growth in North America and in Europe. In Latin America and Asia/Pacific regions we were able to grow at a solid base. In North America our over all [inaudible] was down 1.8% as sluggish business spending rates and anti employment rates continued to cause a general weakness in the durable goods and automotive industry. This trend continues to depress our assembly and automotive sale. Our converting business has been significantly impacted by the downturn and highly competitive corrugated and multi-wall bag industries. Corrugated industry suffering from the shifting of productions of goods outside of North America is declining at rates of 10% to 12% and multi-wall bag industry is declining at rates of 8% to 11% based on industry publications.

Contrary to the trends just mentioned and the spike price competition our sales force continues to gain new volumes in our graphic arts, packaging and window division with value added products. For example our flexible packaging business is enjoying year-over-year improvements of more than twice that of the industry trend mainly with our [inaudible] free product offering. The Euro remains strong affecting the significant export portion that Europe is sp depending on as there own economies are contracting or flat at best. Unemployment continues to be on the rise throughout the European union as well as general social dissatisfaction in several of the countries due to the necessary changes required in their social systems. This is likely to cause increased of striking activity, delaying any hope of vigorous economic recovery until well into next year.

Our products in this region fell more than 4%. Latin America and Asia/Pacific continued to first considerable volume growth. In Latin America the restart of industrial activity in Venezuela and Brazil and Argentina most stable out look and recently strengthened currency have benefited our sales. In Asia back volume growth exceeded 20% as new business opportunities were realized mainly in China and Japan. Contrary to our exchange rate experience in the late 90's we now receive a benefit from our top line from the currency translation of operations [inaudible]. This quarter impact was favorable 4.5% as compared to second quarter of last year due to Euro, yen and Australian dollar. As I noted earlier this impact more than offset the negative top line impact of pricing and volume. Operating expenses as a percent of sales trended down from the first quarter by over one percentage point. In dollars operating expenses were higher than those previously year second quarter due to reduced income of most retirement benefit that we already alluded to end the current of translation impact of our expenses, incurred in Europe and Asia/Pacific region.

As much as the internal and external environment of weak economic conditions and raw material cost pressures remain similar to that of the previous quarters with no indications of any short term improvement, we remain focused on improving cost structures, operational excellence, regaining lost market share the development and growth of new robust products and resulting increased shareholder value. We continue to penetrate markets with our new product offerings that are growing this quarter at a rate exceeding 36% at a rate over that of last year and 15% over the first quarter of this year. Our new products now comprise approximately 14% of our total sale. Last conference call I spent sometime describing some of these new product offerings which have already been introduced to our customers and explaining the unique benefit and value they provide. This time I would like to focus on strategic initiatives that drive growth. Full value created that in several our businesses we offer our customers more than just the product. The goal was to develop offering by which the value provided to the customer and the value captured by fuller was based on the knowledge provided more than simply products. In other words a consultative or solution sale.

We have now validated this premise in our alloys (ph)business having concluded ten consulting contracts in U.S., Asia and Latin America. Under these contracts analysts provide clients with consulting services to improve performance and lower the cost of the packaging. Improving the cost of manufacturing processes or providing training. While the consulting business is still embryonic I don't know I can it provides fuller with new vehicle for growth. In early part of this year we launched an initiative of H.B. Fuller ventures. The venture capital part of the company that will be responsible for identifying ,and evaluating and selecting our investments [inaudible] the companies that can offer strategic value. The investments ranging in the half a million to $2 million range will be comprised of minority shares of start-up companies design to gain insight in to emerging and disrupting technology that has value to our organization.

Earlier this month H.B. Fuller Venture made its first investment in Nanosis, Inc. a leading Company in the growing Nano technology field. It is the size of manipulating individual atoms to create new materials. Nanosis is pursuing advanced materials opportunies in a number of areas that intersect with H.B. Fuller's market interest. Our investment in Nanosis gives us strong relationship with an early innovator and provides visibility into potentially disruptive technology that it will ultimately impact the market that we serve. H.B. Fuller Ventures continues to be evaluating more venture capital opportunities aiming to make around one to three strategic investments per year. These two initiatives I just highlighted definitely represent a change to our past growth strategy, an important step forward.

We have spent time looking for the best options for growth and have made significant structural and cultural changes in the past five years to achieve it. These changes were required to take advantage of the companies global footprint economies of scale industry knowledge and most importantly to provide and improve shareholder value. While change can often be feared once it's raised you realize that the ability to deal with change effectively offers opportunities as well. It is with that thought that I would like to address a few of the management changes occurring here at H.B. Fuller. It is never pleasant or enjoyable having to say goodbye but it is with appreciation of leadership and change process and accomplishment that we do say goodbye and wish each of them in their endeavors the best of logic luck.

As Ray indicated, he will be retiring at the end of next month and this will be the last conference call for the Company. Ray has chosen to retire as serving as Chief Financial Officer for four years. We all have come to rely on him for contributions, insight and biting wit. We will all miss him and I in particular having been exposed to him for 30 plus years. We should be able to announced the name of the replacement in the near future. As announced in the news release next week Linda Welty our group President and general manager has chosen to pursue an opportunity outside H.B. Fuller. Linda has been with us for five years was a major driver in our culture change in and embracing the importance of our full value specialty portfolio and the future growth opportunities for our company. I will miss her guidance and courage to present alternative viewpoints. Her successor will be Steve Large margin has been a member of a leadership counsel and executive committee, has a considerable international back ground worked in full value specialty for a number of years, prior to leading our North American [inaudible]. We are sure that he will be able to drive our strategy forward without using momentum and I wish him and us lots of success. I would like to thank both Ray and Linda on behalf of all of us at H.B. Fuller for hard work and dedication and for being true leaders of change. I now open up for questions.

If you would like to ask a question, please press star one. You will be announced prior to asking your question. To withdraw your question, please press star two. Our first question comes from Allen cone with First Analysis.

High this is actually Ray Kramer filling in for Allen. First I want to wish Ray the best of luck with his retirement. And I hope you don’t stay too busy. First question with the other charges related to reserve and tax benefit, I am correct that those are included in the 43 cents?

Would you repeat that question, please?

Yeah, the two charges, the three cents for the increase in reserves and the five cents charge for the tax benefit are included in the 43 cents?

Yes, they are because they are stated according to GAAP.

But I am correct those are essentially one time charges though?

Yes, they are.

Okay. Recording now, the pricing, you got, you know, the year-over-year price declines. What's happened sequentially with price?

Well I can, as I said earlier, as far as this year is concerned we have seen toward the end of the last quarter and early into this month we see about 1% increase in prices over where they were at the end of last year. What we saw sequentially last year was a development starting really already in the first quarter that prices were declining and at that point in time was following on the heel of raw material cost of decreases. However by the middle of last year raw material cost suddenly changed trends and moved up and moved up briskly towards the end of the year whereas prices were in decline at least two quarters beyond that. And that created some of the issues we saw in the first quarter with raw material price continuing to increase and we were having to recover not only the raw material increases but also what was happening in the prices of the second half of last year.

Okay and going on from that you mentioned that some competitors seem to be coming in at really low prices to try to gain share. What is your strategy in dealing with that and trying to get the share back from those guys?

First of all we have to make a determination whether the price levels that have been presented in the marketplace are price levels with which we want to do business. That is No. 1. No.2, if we find that it doesn't make any sense to compete at that level, then we have to find other opportunities of business that perhaps we have not had in the past and where we can gain additional volume at margins that are more satisfactory to the company and there is a significant effort underway in our organization to look for those opportunities and to demonstrate that we can create margins that are satisfying to our Company and to the shareholders

Okay and I know on the last call you said you thought pricing would catch up with raw materials on this quarter. Obviously that didn't happen given these unforeseen thing in the industry in raw material prices. What is your current best guess on when that is going to catch up and finally start work the other way where you are closing that gap.

You were fading out a little bit but what I said at the end of the last quarter was that because of the way our quarters fall and by the time of the announcement of the results at the last quarter that we had already seen the increases that we were going to expect in the first quarter and that has basically held through and that is also why I at this point in time can see that we most likely will see a stable pricing environment for the next couple of quarters. There is going to be some small movements, like for instance in some of the raw materials we will see the increases that occurred in vital acetate [inaudible] only a quarter later because it's the next step down in the chain of processes and those processes development in them and there is a delay about a quarter in that. I say over all if I look at discipline in time of what is on the table we see a fairly stable pricing environment for the next couple of quarters.

So the GAAP sort of between raw material costs and price increases you expect to be fairly stable?

I think just of the timing issue we are going to see a benefit because some of the price increases that would take place gradually in the course of last quarter now will be benefiting us for the full quarter and the coming quarter and then without a concurrent price movement in raw materials, that should help us improvement the situation a little bit.

Mr. David Begleiter (ph) with Deutsche Bank. You may ask your question.

Hello Lawrence Alexander for David Begleiter. Can you discuss what's been happening outside the U.S. in pricing?

Yes. There has been somewhat divergent development in raw materials outside of North America. First of all we have not seen the dramatic increases in raw material prices and some of the regions because in the United States it's largely driven and tied to the prices of natural gas which really have moved in atypical fashion in the United States from what we would normally see and that has not been reflected in the price levels in Europe as well as in Asia/Pacific. What is helping as well is a little bit the strength of the Euro which means that for the typical commodities that are greater than the tip U.S. dollars activities in you were have to extend less you're rose and that is helping them in their cost structures. But if I look at what we have been seeing as far as the pricing end is concerned, the development in the quarter in North America as well as until Europe are very close.

Okay.

In Latin America and Asia/Pacific we have seen prices trending down a bit more than we have seen in North America and Europe but that is also due to the fact that we have institute seen the raw material prices there.

Thank you can you shed some late on what recent monthly trends on how demand shaped up over the quarter and how demand looks in the markets?

It's really continuing along the line that I think I discussed last year as bump and dry along the bottom. We have one month we have decent sales, next month is down next month is up again. So it's really moving up and down. So it's difficult to determine a trend where we can say yeah right it's moving upward. For example, April was a negative surprise and that mainly had to do with the fact that Easter in two of our major regions Europe and Latin America has sales as well as in the holidays schedule interest that dropped down our sales in Easter. So I do not see a clearly recognizable trend that will be a solid improvement in the economy.

In terms of natural gas can you quantify the year-over-year impact in the second half that you are expecting or what price level you had Budgeted for natural gas. If you

If you look at natural gas prices you see prices two dollars sometimes even lower and three dollars sometimes in that range and now you have twice that level. I have not a specific number for you that ties now, the price development of BTU's of raw material cost structure for our companies. I think that may perhaps be a valuable exercise but I don't have that number at this point in time.

Mr. Andrew OConnor with Strong Capital. You may ask your question

Good morning Al, good morning Ray. Ray kind regards to you in your retirement. Al I want to do know if you could speak to stable outlook and the fact that restructuring is behind you what will allow the Company the to expand its profit margins over the coming time without a decline in raw material prices. I guess the gross margin fort Company was 27.6% in the current quarter and your EBIT margin was 3.8%.

I think our gross margin was 28.1 versus 28.6 a year ago.

Andrew OConnor Thanks for that.

So we have about a half a percent decline year-over-year. I think that the gist of your question however is okay, what is our pricing independent pants and what can we do to move forward to gain higher margins in businesses and we have found that to be focus on driving the new products, the robust products I was mentioning have seen year-over-year growth where we have been steadily moving up at fast clip and also margins that are much greater than we would see in our standard business areas.

I also believe that there is a greater level of pricing determination of pricing power on the side of our Company in relation to the value that we provide and the services that we provide for our customers generally in the hot-melt area. Where it is difficult and that is where most of the problems have occurred that I was describing earlier about aggressive pricing action is in the more standard water based product lines. However they generally have a lot of volume attached to them and that is what I think we continue to be seeing in the future.

Al, are you at liberty to say what kind of margins your consulting derive and what percent of your revenue you hope to derive from your consulting effort in fiscal 03?

I think at this point in time if I look at expenditures we have in this area with regard to procuring a sale and the formulas that we use for the pay back, the margin is very high. It basically is using what is already existing the organization and making that knowledge available. So, it did not require investing additional funds or investing additional resources. Just a relocation or a placement of resources in the right spot. I would assume that what is going to happen is similar to what I described last quarter with our new products and new product introductions that initially we will have a high margin that tends to be sometimes in excess of 50% but then as the product or service that we provide becomes more successful and does provide high margin we will see more competition and eventually lead to a trend down in margins. But at this time as I said the business is embryonic and I think it would be too speculative to Say what impact that will have on our income statement.

Can we hazard to guess in term of total revenues what percentage it would account for?

I think it's still way over the 40% level.

All right, sir. Thanks gentlemen.

What percent of sales?

Yeah.

Sorry, it's way less than 1%. As I said it's embryonic. .

Once again to ask a question, please press star one. Mr. Jeff Zekauskas (ph) with J.P. Morgan you may ask your question.

In the "Wall Street Journal" was an article about deflation in Germany in particularly the furniture industry. From your point of view due to flationary (ph) trends in Germany pressure you or does it not affect your business?

I think the nation flationary pressure that you see in the Germany industry is a significant reaction to the reduced demand. I think I may have reported in the past about this and we have seen drops in percentages of 15% to 20% in the output of the furniture industry in Germany as well as increased competition from manufacturers in the eastern countries that are now moving into the European market. And I think it's more of an issue of competitive pricing than actual real inflation and cost structure. So I think what you are seeing at this point in time is a very intense competition that leads to lower prices but I would not classify that as an inflation which is a more economic term that is used for a country in general than for a particular industry.

That is helpful. Secondly would the adhesives business having relatively tough times, are your acquisition opportunities looking more promising? Do you see properties on the market that are reasonably priced

Certainly the chatter has increased. I think that people that may have perhaps in the past five months have been waiting for better times are getting a bit impatient so I see an increased level of discussions about the potential deals or potential opportunities. But at this point in time I have not seen anything that leads me to believe that there is a real conclusion yet in the industry that a particular valuation at this point time is appropriate for the businesses. I think there still is a difference in what the buyer is considering as a value for business and what the seller is hoping for because they still have memories of what it used to be in the late 90's and I think there still is a disconnect in the realism of what really is feasible in this environment. Lastly a

Lastly a couple of questions nor Ray. What was the by my calculation I get eight cents and second were there any gains and losses from asset sales and if so how much were they?

The EPS impact from currency was two to three cents, Jeff

Was that based on normal tax rate or on your 20% tax rate.

No, normal tax rate. We didn't sell any assets during the quarter

At this time there are no further questions.

Since there are no further questions I asking the conference call we like to thank all of those that took the time to listen and participate in the call today. Thank you.