H.B. Fuller Company (FUL) 2003 Q3 法說會逐字稿

Good morning, and welcome to the third quarter year 2003 earnings release. At the request of the company, this conference is being recorded for instant replay purposes. Following today's presentation, there will be a formal question-and-answer session. Instructions will be given at that time should you wish to ask a question. Management in attendance on today's call includes Mr. Al Stroucken, Chairman of the Board, President and CEO; Mr. John Feenan, CFO; and Mr. Scott Dvorak, Director of Investor Relations.

At this time, I would like to turn the meeting over to Mr. Scott Dvorak. Sir, you may begin.

Thank you. Good morning, everyone. This morning's conference call will be available for replay approximately 1 hour after we are finished with questions. Before beginning, I would like to inform everyone that the discussion today will cover certain financial information that has been adjusted to reflect our restructuring initiatives and considered to be non-GAAP under applicable SEC regulations. Our earnings press release, issued yesterday, provides a reconciliation of these non-GAAP items with our GAAP results. This press release is posted on our Web site at www.HBFuller.com, under Shareholder Relations and Press Releases.

In addition, certain matters discussed during this call will include forward-looking statements as that term is defined under the Private Securities Reform Act of 1995. Since such statements reflect our current expectations, actual results may differ. For more information, please refer to our press release, quarterly report on Form 10-Q an annual report on Form 10-K filed with the SEC.

Now, Al Stroucken.

Thank you, Scott, and good morning, and welcome to all of you. Before we begin the third-quarter results, I would first like to introduce John Feenan, our new CFO. John joined H.B. Fuller on August 26, and has already had the opportunity of talking or meeting with several of you over the phone or in person. John has extensive experience in the role of CFO as well as other key finance and operating roles, including controlling, financial analysis, mergers and acquisitions and general management.

In the past, he has served as CFO for the North American adhesives, sealants, and coatings operation for La Port, [PLC], and for [Fomax]. Most recently, John served as CFO for Jostens Inc., a consumer product firm based here in the Twin Cities. I am confident that John will make significant contributions to our organization, and we're fortunate having him join our leadership team.

I will now turn it over to John for a review of the third-quarter results.

Thanks Al, and good morning, everyone. Before I begin, let me first say that I'm excited to be here at H.B. Fuller. In my short tenure, I'm very encouraged by the strong foundation that has been built for future growth, the quality and integrity of the associates, and the number of initiatives ongoing that will generate future shareholder value.

With that said, let's discuss the financial performance.

Current and prior year results discussed will be prior to any special charges or gains incurred due to the restructuring initiatives. During the last quarterly conference call, we had indicated that the second quarter would be the last quarter impacted by restructuring expenses. Due to certain changes and estimates, we did incur expenses related to the restructuring initiative and have provided pro forma statements. In addition, per-share amounts are reported on a diluted basis.

Net earnings for the quarter decreased from $13.1 million in the prior year to $11.8 million. Earnings per share were 41 cents, 5 cents lower than last year's 46 cents. Included in last year's third-quarter results was a gain on the sale of an asset outside of a restructuring initiative that accounted for 2 cents of earnings.

As we have mentioned previously, this quarter's earnings per share included an increased expense associated with our U.S. pension and post retirement benefit plans as compared to that of last year's third-quarter of $2.5 million or approximately 6 cents per share.

For the first nine months, net earnings of $30.4 million decreased $300,000, a variation of approximately 1 percent or 2 cents per share. In comparing these results, the cumulative effect of the increased pension costs for the first nine months is $7.5 million or approximately 17 cents per share.

Net revenue for the quarter, was $322.1 million, 2.6 percent higher than Q3 2002 revenue of $313.9 million. For the first nine months, revenues increased 1.6 percent over last year to $941.2 million.

Looking at the components of the 2.6 percent sales increase for the quarter, we see the following. First, pricing was down 1 percent; second, volume decreased one-half of a percent; and third, the currency effects, primarily due to the euro and to a lesser degree the yen and Australian dollar, accounted for a 4.1 percent increase.

Gross margin of 27.1 percent was 120 basis points lower than last year's gross margin of 28.3 percent. The decline is mainly due to selling prices not keeping pace with raw material costs, offset somewhat by lower manufacturing labor and overhead costs.

Operating expenses were $67.2 million or $1.3 million higher than last year. As a percentage of sales, operating expenses were 20.9 percent, slightly favorable to last year's 21 percent. Excluding the effect of the higher pension expense, operating expenses as a percentage of sales were 20.1 percent. Operating income decreased 11.3 percent to $20.3 million compared to $22.8 million for the third quarter of last year.

Operating income in Global Adhesives in the third quarter were $12.6 million, a decrease of $2.1 million for the third quarter from the third quarter of 2002, driven by lower gross margin percentages due to price increases not keeping pace with the raw material development and the increased pension costs.

Full-Valu/Specialties operating income of $7.6 million decreased $500,000 from the previous year's third quarter. This year's third quarter includes increased pension costs in excess of $1 million. Consistent with the other financial information we have reported, operating income for the business segment excludes special charges and gains related to the restructuring initiative.

Interest expense of $3.7 million was $700,000 or 15.9 percent lower than the third quarter of 2002, driven by a lower average outstanding debt level. Miscellaneous other expense of $1 million in Q3 compares to $1.1 million of income for Q3 of 2002. Included in this year's expense were foreign currency losses of $500,000 as compared to gains of $700,000 last year. As I previously mentioned, last year's amount included a gain on the sale of a nonproductive asset of $900,000.

Pretax earnings of $15.6 million was $3.9 million lower than the previous year's third-quarter pretax earnings of $19.6 million. The effective tax rate for the quarter was 27.9 percent to adjust the overall annual effective rate to 30.4 percent, the expected effective rate for the remainder of the year. This decrease was due to a change in the mix of earnings and assessment of global exposure. This compares to an effective rate for 2002 of 33 percent.

I would now like to remind everyone that the following balance sheet may be subject to minor changes prior to filing the third-quarter 10-Q. First, cash at the end of the quarter totaled $1.8 million. Operating working capital amounted to $265 million compared to 254 million in the previous quarter, an increase of approximately $11 million. The majority of the increase was caused by lower trade payables and other current liabilities.

As a percentage of sales, operating working capital was 20.6 percent versus 19.6 percent last quarter. Capital spending for the quarter was $12.5 million compared to last year's third-quarter spend of $12.8 million.

For the first nine months, capital expenditures were $28.3 million versus $25.3 million from the light period of 2002. Depreciation and amortization were $15.4 million for the quarter; debt increased from the previous quarter end by $9.6 million to $201 million. The Company's capitalization ratio was 30 percent at the end of the third quarter compared to 29 percent at the end of 2002 and 30 percent one year ago.

Free cash flow for the quarter was a negative $16 million compared to a positive $15.3 million in the third quarter of 2002. The most significant factor contributing to the negative cash flow was our decision during the quarter to contribute $20 million to the U.S. pension plan. This $20 million contribution brought the U.S. plan up to a fully-funded status.

At this point, I would like to provide an update on the restructuring initiative. During the third quarter this year, we sold property related to the initiative for a pretax gain of $2 million. Also during the quarter, we incurred pretax charges of $1 million through changes in estimates to the reserves.

Net charges for the restructuring initiative of the last eight quarters have totaled $38 million. We still estimate the total net charges to be approximately $35 million, once all the remaining related assets have been sold.

In summary, the continuing lackluster manufacturing environment in North America and Europe and the relatively consistent high cost of crude oil and natural gas, along with a high level of competition for volume, has created a challenging operating environment. While we are making progress within certain segments of the business, we're not satisfied with our results.

We had good sales growth in Asia Pacific and Latin America, and face continuing challenges in North America and Europe. Though difficult, we are not daunted by the current business environment, and we will continue to strengthen the foundation of Fuller to provide a solid platform for future growth.

I'd now like to turn it over to Al Stroucken.

Thank you, John. As John mentioned, there is no change in the general business environment that is strong enough to provide any sense of significant upward momentum from the overall business conditions that we are encountering in our two main regions, North America and Europe. True, there are positive signs in certain sections of our business, and I will talk about them later. But on the other hand, we are continuing to see sluggish demand and fierce price competition in other markets. However, Asia Pacific and Latin America continued with solid growth.

As we had expected, raw material prices did not significantly change during this last quarter, yet some impact from the second quarter still flowed through the inventories and income statement, along with some considerable sequential increases in transportation and delivery expenses that were mainly driven by the write-off in gasoline and diesel prices.

Considering the increased pension and post-retirement benefit costs that John talked about that required us to improve our internal productivity to the tune of 49 cents per share over the full years 2002 and 2003, and 6 cents for this quarter alone, I must say that although not satisfied with our results, our Company is certainly getting better at performing in challenging times.

This quarter's results were slightly below that of the previous year. On a year-to-date basis, our earnings are approximately within 1 percent of last year. With such dramatic variations in oil, gas, transportation, energy and ultimately, raw material costs, we're focusing on the right areas, and I believe it shows. We are certain that an economic upturn for the manufacturing sector in North America, which is now predicted for the first quarter of next year, has a greater degree of the likelihood than those predictions of the past.

I also believe that like the rising tide will raise all ships, the specialty chemicals industry will benefit from such a development on a broad base. It is our task to ensure that our ship will ride higher on the water and will be better prepared, should things once again change in the future.

Now let me review the developments we saw in the third quarter, and then I'll try to put some of that in perspective with some general observations. Our total Company sales reflect the gradually strengthening increase over the last three quarters on a year-over-year US dollar comparison, with actual volume improvements continuing in the Asia Pacific and Latin American regions, as well as in certain end markets here in the United States. At a global level, we experienced year-over-year sales improvements in all of our adhesive end markets except in converting.

In North America, even though our adhesives was down by .2 percent, that still signifies an improvement over the approximately 2 percent volume decrease that we saw in the previous quarter. In converting the consolidation and shifting of production outside of North America in the corrugated bag, tobacco and envelope industries are leading to a reduction in treatments in those markets ranging from 6 to 10 percent according to industry sources.

This is leading to some unprecedented competitive activity in these areas. For instance, in the corrugated industry, generally a water-based product market, and you will recall, water-based products are the ones most severely impacted by the rising costs of vinyl acetate monomer, VAE and polyvinyl alcohol, we have seen prices in some cases drop by percentages that don't make any economical sense, at least not based on any economical principles that I am familiar with.

As this is a fairly high volume business, it will take some time to replace those businesses that have no economical viability with other more attractive volumes. But, we are making some progress in other business areas that fall within our converting classification.

Our Flexible Packaging business in North America maintains its growth rate, that's considerably exceeding the 6 percent industry growth. For the year, we expect our Flexible Packaging, albeit from a small base, to have grown by rates nearly triple that of the industry. Inevitably contributing to this growth are some of our more recently developed products using water-based technology for Web bond laminating and heat seals.

In our assembly business, we're seeing positive effects from our top-grading initiative of the sales force, as we are recording year-over-year increases globally since the beginning of the year, and now also in North America for the first time in more than eight quarters.

For our Full-Valu Specialty North American business, window and (indiscernible) keep on posting year-over-year improvement with a combined growth rate of nearly 8 percent. The powder coatings division continues to suffer from the overall industry conditions and shifting of demand and production of its customer base outside North America. Depths have been taken to reduce our cost structures to the reduced demand, and at the same time, we're pursuing growth opportunities to replace some of this lost business.

Europe's overall economy shows no sign of improvement, with Germany and France having the greatest impact due to their size and their economic dependency on exports as well as their ongoing difficulties to resolve social issues in those countries. Five countries of the euro-zone posted a negative adjustment to the second-quarter revised GDP, including Germany and Italy, joining the Netherlands in an official recession with two or more quarters of contraction.

Year-to-date, our tonnage is down by approximately 6 percent in the region. Some of that may also have been impacted by a slower than expected replacement of sales positions vacated last year through our top-grading process. We now have a full team on board, and expect a positive impact soon.

I believe it is important to note that despite this drop in volume, our operating income for Europe improved significantly over that of the previous years.

In Latin America, we realized an increase in volume of 5 percent in the quarter, seeing improvements in the nonwoven, graphic arts and converting markets, as we are benefiting from the shifting of production to Argentina and realizing the advantages of exporting based on the present lower cost base of that country.

In our Full-Valu Specialty business, our liquid paints unit also has shown improvement, posting a 4.1 percent volume increase over the previous year.

In the Asia-Pacific region, we realized strong growth with an increase in volume of our adhesives business of well over 14 percent, particularly in nonwoven, packaging and assembly. China meets the region in growth, but also Japan having spread solid upward momentum. In Australia and New Zealand, our consumer business has also shown significant increase in sales of approximately 33 percent in US dollars or 15 percent in local currency.

Our new products continue to show a remarkable year-over-year development, and have provided us the ability to benefit penetrate new and existing markets. This quarter alone, the sales of our new product offerings grew 14 percent over the second quarter of this year, and 30 percent over the third quarter of last year.

An even more encouraging sign is the sequential increase of our total sales these new products deliver, increasing two percentage points from that of the previous quarter, accounting for approximately 16 percent of our total sales. I have highlighted several of these new products in the past, so will not need to go into further description of the products.

I believe that what we are seeing here are the results of aligning our research and development within the business units, thus allowing for the development of new robust products that provide for a market solution, and will generate growth opportunities for our Company in the future.

The balancing act between raising prices and maintaining volume continued this quarter. As a company, our pricing levels stayed virtually flat with previous the quarter, and are still trailing last year by one percentage point. In our Full-Valu Specialty business, we saw a somewhat greater pricing impact this quarter, driven mainly by the competitive situation in our TEC business, paints and the powder coating markets.

As I mentioned in the previous quarterly conference call, price increases for our water-based products have been the most difficult to achieve as the competitive pressure to obtain volume growth in an overall declining market seems to be overriding the need to recover margins.

Raw material prices maintained their levels of the previous quarter as we expected. Though natural gas and crude oil prices lately have seen some relief since their earlier highs of the year, they still remain at levels well above their historical average for this time of the year.

Inventories for natural gas still remain below their five-year average, but inventory injections are occurring at record levels. As the economy and economic recovery has been slow to materialize, the low demand should help counteract the high-feed stock prices in our raw material base, and we may even be able to realize a slight relief in the upcoming quarter.

In addition to our strategic procurement efforts, we persist with our adhesives product line rationalization efforts, supporting our plant consolidation on the operational excellence model. We have realized an estimated 9 percent reduction of products again this quarter from that of the previous year, and have eliminated over 55 percent of our products since 2000.

Despite the increased pressure of our higher pension and post-retirement benefit costs that we are facing again this year, our operating expenses as a percent of sales remain comparable to those of the previous year. Eliminating the pension effect or actual operating expense dollars would be well below that of the previous year, and our expenses as a percentage sales, a full percentage point lower. The improvements we have made in our cost structure, and the continued tight control we have on our spend levels have played a key role in being able to maintain these comparable levels.

In conclusion, let me take a few moments to give you some overall perspective. Despite the fact that our growth expectations have not occurred at the rate we had originally believed, and pressures from raw material costs continue, we have been able to adjust and continue to perform reasonably well. But there can be no question that the specialty chemical industry and the adhesives industry, in particular, are going through some fundamental underlying changes.

We have tried to get our company prepared for those changes, and I believe we have ensured that we will be benefiting during this change process. An economic upturn will most likely take some of the pressure off, but mid to long-term, the issues will return and focus industry on proceeding with its consolidation process. It will have to come to grips with its commoditization and significant market segments, as clearly demonstrated by the reverse auctions; its overcapacity and lack of differentiation in water-based products; as well as the forces of globalization that will mainly affect the hundreds of small and medium-sized adhesive companies.

We're not alone in this market as you know, and we will not be able to create the market conditions of the future single-handedly, nor would we want to. But what we can do and are doing, is ensuring that we do what is right for our Company and for shareholders to benefit from the opportunities that we are thus creating. You have seen that in our performance so far this year, and I expect that to continue.

Thank you for your attention, and I will now open it up for your questions.

Our first question comes from Rosemarie Morbelli.

Good morning, all. You mentioned, Al, that one of the major problems seems to be with the corrugated volumes. Some of that industry is going overseas, and you have as a result, more excess capacity in that category, if I understood you properly, than elsewhere; and yet met raw material costs are going up; prices are coming down. Are you planning on eliminating some of that capacity, considering that the business itself is just going out of the country?

Rosemarie, let me clarify. The corrugating industry itself is not moving outside of the country, but the demand for the products is moving out, because their customer base is moving more manufacturing into overseas operations, than they buy their cartonage then, locally.

Now with regard to the capacity situation that exists -- and it's exactly in this area of the water-based products where we have focused over the last four or five years to reduce our capacity, and most of the 50 percent capacity reduction that we have implemented has been in the water-based areas -- and therefore, I think we have taken the steps already in the past that are necessary, given the spend.

But when you see the business, as the demand is continuing to move out of this country, doesn't that imply that in order to stay at the same level, you have to keep eliminating capacity?

Yes. But there are also other business areas that use water-based products that do not see that trend, and it is our effort at this point in time to move businesses to those other segments; but that does not happen from today to tomorrow because of the significant volume hits that you would take, and the one on our customer in the converting area. But certainly, over a period of a year and a half or two years, you would be able to make amends for that.

Could you give us a feel as to which markets are really actually growing, or where you can make a dent?

Well, I think if you really looked at the overall market position, we have, on a global basis, approximately a 5 percent market share in the adhesive industry. So, there is significant business still out there in the marketplace that we have not been participating in, and that we do not have. I'm sure that if I look, for instance, in the area of assembly, which is also a water-based area, there are myriad opportunities for us to use our capabilities that we have established over the last couple of years, and again, a greater share of that business.

On top of that, it also is a business that has a much greater distributed customer base, and therefore, is not as price sensitive as the area of the converting business.

And I have a question for John, if I may. John, you have only been there for about two months. Has anything jumped at you in terms of any major change that you need to institute, or everybody needs to institute?

Good morning. How are you?

Okay.

Let me answer that in a couple-fold. First of all, as I said upfront, I'm very happy to be here and I think Al has built a very strong team, that in my mind in the early days, has a very balanced skill set, which I think can only help us going forward. As I alluded to earlier, there's a tremendous foundation here for future growth. I think the two areas, Rosemarie, that I'm going to be focusing on are one, obviously trying to bring some unique insight into how to grow the top line, both organic and through other means.

I think the other area, as I alluded to when I met you one-on-one, I mean, my focus is going to be not only on trying to strengthen the P&L, but on a heavy emphasis on the balance sheet as well, where I think there's opportunities to generate cash, improve our working capital; and hence, that will just give us more (technical difficulty) as we head to the future.

Thanks. I'll get back on queue.

Our next question comes from Jeff Zekauskas.

Hi. Good morning, gentlemen. I have two questions. The first is, can you discuss strength and weakness of various end markets that you've got? And second, can you give us some indication of your consolidated tax rate for fiscal '04?

I'll have John talk about the tax rate, but let me first talk a bit about the various industries. As I had said, on a global basis, we have been growing in our adhesive business and all segments with the exception of the converting industry. Some of that growth rate of course varies, and the ranges are from approximately 2 percent to 7.5 percent growth. I

In most cases, that growth is, of course, influenced by a variety of factors; in some cases, it has regional specificity; and in other cases, there is also some benefit from the change rates. But I'd say on a broad-base, the more distributed to customer bases, the closer our businesses are to the consumer that's where we generally see some uptick. Where we are more in the base industrial manufacturing area is where we still see some lagging of the overall industry.

How large is your flexible packaging business now? Forgive me.

I don't think I would want to get into that specificity. It's part of our overall packaging business. And as I have mentioned in the past, the flexible packaging business has developed quite significantly over in Europe as well as here in the United States; and it's a trend that we in the early years of that development, which were in the late '80s and early '90s, missed, and we are trying to make up for that at this point in time. I'll have John talk to you about the tax rate now.

Jeff, what we're estimating for 2004 is a range of somewhere between 32 and 33 percent, back to the historical run rates. And again, that will depend on the mix of earnings. But, I would use that range for your estimate.

So, if I understand what you just said to me, in order for you to hit that kind of range, you'd have to have much stronger volumes in the United States and Europe; is that correct?

Yes. And would basically have to go back to the old proportionality that we have in our business.

And if it turns out that the distribution of sales and earnings for 2004 were relatively similar to the way it is in 2003, your tax rate would be at roughly 30 percent; is that correct?

No, not quite. But we had one-time tax issues in the last quarter, that would not be repeatable. And we, I think, had predicted an ongoing tax rate at that point in time of 32 percent.

Forgive me. Were there one-time tax issues in this quarter?

The situation was pretty much that the income from North America was slightly lower than what we had planned. And as you know, it has a higher effective rate. We then had higher income from our other countries, whichever different tax structure; so the net of those two was the lower effective rate. But I think looking forward, as I said, that range right around 32 percent is where you want to be.

Our next question comes from Allan Cohen.

Thank you, and good morning. Al, you've done a great job of positioning the company to the future in terms of external changes -- consolidation in the industry, improvement in the customer base and the like; and it was a real challenge given the culture you inherited in Jim Conaty and John Feenan, who I know less well, seem to be real strong adds. But if you look out there and strip away the externalities now, and just focus on the things that are really under your control, you've pointed out that you've only got 5 percent market share. Take us through your growth parameters, growth focus, what do you think you can do? And was the loss of business from weeding out products finally over, or is that still really contributing?

I think, Allan, what you are alluding to is that we in the past perhaps needed a greater marketing focus. We have tried to change that by bringing in talent and people from the outside that have extensive marketing experience in the industrial as well as in the consumer areas, so that we are able to segment our markets more effectively and efficiently to guide us in our path forward to go after those segments that give us the greatest opportunities for growth and margin stability.

We are at the same time, of course, cognizant of the fact that because of the success of the pieces in some industries, the products have become fairly staple products that can be offered by a variety of suppliers. And I think we have to realize that that segment needs a different model, and we've made changes in our organization to address that appropriately.

I believe that, overall, we will most probably see greater growth opportunities in those product lines, that are getting closer to the consumer, that will have a brand recognition item attached to it, then we would see, in the typical large volume businesses, than we have perhaps pursued in the past.

It does not mean that we can do one without the other. I think there is a mutual dependency on each, because the large volume creates the cost structures, and the more distributed customer base creates the income level. And I think we are moving the company in that direction; and I believe we've collected the talent over the last couple of years, and developed the capabilities in our organization to do that.

When do you see the results unfolding, excluding any changes in the external world?

Could you repeat that? I didn't hear that acoustically.

When do you see the results unfolding, excluding any changes in the external world?

Well, I think that what we have seen now, and what my experience has been in this industry, that certainly raw materials have a dramatic impact on the profitability of this industry, more so than I think anything that the industry by itself has been able to do and accomplish. And I believe that the combination of an economic upturn and stable raw material prices are basically what are going to drive the income levels of the companies that are active in this market segment, including H.B. Fuller.

Let me put it a little more explicitly to try and box you in. You've got 5 percent market share; you put in place a lower cost structure, a lot of marketing tools. What, excluding any change in the external world, what kind of pace do you think you can take your market share from 5 to 7 percent?

Over what period of time?

Yes.

I would say I would have to do some calculations on that. But our goal is to grow our business at approximately 4 percent in the adhesive area, which is about a 1, 1.5 percent of our overall market growth. And that will then gradually move us to a higher market share.

Thank you, very much.

Our next question comes from Regina [Pesavino].

Hi. You had talked about last quarter how you had lost some overall market share in adhesives due to competitors coming in with lower prices on some of the lower end products. I was wondering if you feel that you've regained any of that market share anywhere? And if there's been any change in pricing strategy in doing so?

Well, perhaps I can best answer that question by giving an example without being too specific. We've had several situations in the beginning of the year where we had lost some business where we had competitors in a bid situation come in with a product that had not yet been approved by the customer, but offered a significant lower price to that customer.

Since that time, the customer has found out that the products that the supplier is offering did not work in his operation, and has come back to our Company to be supplied. And that has happened several times. Unfortunately, in the situation but when the bidding occurs, however, it has a tendency to go past the overall price level that's being offered to the customer.

So it's creating a situation where we will be able to regain the businesses back; but generally, it is at a price level that certainly is lower than what was in place before, but still higher than the price level that the competitors have offered.

Our next question comes form Mary Beth Connolly.

Thank you. Good morning. Could you please talk to us in some more detail on what you are seeing in terms of the competitive landscape in the powder coatings business? And then also maybe discuss your view on the potential for future consolidation in that area?

Yes, I think what we are seeing in the powder coatings business, and especially the segment that we have been covering, which has been small manufacturing and small appliances, garden tools, garden appliance and so on. A lot of that production is moving over to Asia-Pacific and in particular, China. And as a result, and also the coating of those products is moving over into that area.

On top of that, I believe, based on statistics from the Powder Coatings Institute and the United States' demand since the year 2000 for powder coatings has dropped overall, which is a reversal of a, I think, 25-year trend for powder coatings restoring. And what we're seeing is that some of the companies that in the past were concentrating more on the commodity areas, and large volume applications, like automotive and large appliances, are now also moving into the sector where there are higher price levels and a more differentiated product approach.

I believe that, certainly, that is going to lead to cost pressures, and resulting from that also to a renewed consolidation effort in the marketplace.

Okay, thanks.

Our next question comes from Godfrey Birkhead.

Yes, good morning, Al. Al, let's talk a little bit about the four points that you made -- consolidation, as I recall; and please take exception if I've got the wrong numbers. But looking at those Goldman Sachs numbers, as I recall, there's something like 150 specialty chemical companies; and if you've got a 5 percent market share with 1 billion 2 of sales, why that makes them industry of 20 to 25 billion bucks, we're talking about total. You're exiting the commoditization markets, which everybody has extolled, and that's certainly proper.

The product differentiation -- you're bringing out new products; certainly you should be complemented on that. You've reduced capacity by 55 percent in terms of the number of products and so forth. The one thing that hasn't happened is that there have been no important consolidations. Could you address that subject overall for us, and what's going on there, and how soon that will take, and what have the problems been in not allowing you to-date to make some important acquisitions that I think you probably would like to make at some point?

Okay. I'll be happy to try to answer that. Overall, I have said before that consolidation in the adhesive industry is required and is necessary. I also believe that it would make only sense -- economic sense -- for a company of our size to consolidate at a significant scale. I don't think we can really get any significant benefit from consolidating $2 million, $3 million, $4 million companies.

We, therefore, are really trying to find companies that are willing to move in that direction with us. Now we have all seen in the past couple of years in the specialty chemical industries that very often, acquisitions have not worked out because of the valuations very often were out of whack with what really could be achieved through the consolidation effect. There have been very few exceptions to that, but there have been a few.

Could you talk about the EBITDA that's been paid in that regard, please?

Could I talk about what?

The EBITDA paid for those companies?

Okay. Well, the multiples, of course, have been changing over the last couple of years. In the past, we have seen transactions from eight times to 11 times, and sometimes even twelve times; that has certainly come down over the last couple of months. We have seen EBITDA ratios of 5.5 to 7.5. It all really is dependent on what's the underlying growth and the underlying percentages.

So they're getting more reasonable?

Yes, of course. I think also, one other thing that is impacting, at this point in time, I think people are becoming impatient with waiting for an economic upturn, which perhaps was still affecting some of the willingness of people to start engaging in discussions half a year ago.

So there's an incentive to sell now that wasn't there before?

I think people are more willing to talk, yes.

Okay.

Our next question comes from Rosemarie Morbelli.

You mentioned the now lack of growth, or rather decline, in the powder coatings business. And if my memory serves me right -- and I may be totally wrong about that -- I think that your business is about 100 million in revenues, which is kind of small in the grand scheme of things. Would you consider participating in the consolidation, but giving away your business as opposed to taking some in?

Well, we wouldn't give it away, but (multiple speakers).

Well, selling it as opposed to acquiring sorry.

No. I think, Rosemary, certainly given the consolidation and further consolidation that also has taken place in the powder coatings business, we're looking at all the options that are available at this point in time. I don't think that we are dogmatic about any particular direction at this point.

And you would consider this new EBITDA level as a reasonable level for you to let it go, or you would rather -- I mean, obviously, you would rather sell it at the past multiple. But is that something that actually makes sense and is likely to happen?

Well, I would say I'll discuss the EBITDA ratio with a person that is interested in the business. But at this point in time, I would not want to make a public statement about that.

Okay. And you mentioned also that you have lost some business. And when you get it back, your price is lower than what it would've been. Are you satisfied with that particular level of profitability when you do get it back at a lower price? Or do you do it with the understanding that, okay, for the first year, we will let it go at this particular price; but next year, we have to get our reasonable objective profits, and prices will go up and customers agree to that?

Well, I think when we make our decisions, we make our decisions based on the economics these transactions offer to the Company. And I believe it's as balanced as we're always trying to achieve between what is the maximum value that we can get for our products, and what is the maximum benefit that we can achieve for our company. And in some cases, you make judgments and say, I can still hold onto that business for a particular price and were wrong; and then you have to go back a month later or a quarter later and try to regain it.

But still, the consideration in all the decisions we make is, is this going to add contribution and benefits to the results of the company? And that is the process that we follow. And I think that what has helped us, of course, in this entire environment and situation, is that we have been able to take out considerable costs over the last couple of years to allow us to do that.

All right. You have made progress on SG&A as a percentage of sales. What do you think is a reasonable goal for your company in the, let's say two or three years out? (multiple speakers).

(multiple speakers) I've said before that I believe that for the company, with the product portfolio that we have today and the product distribution that we have today, that that percentage should be below 20 percent. And I believe I've mentioned before something like 18 percent as a rate that I would think is a reasonable expectation.

And how long do you think it would take you to get down to (multiple speakers)?

Well, you just gave me a timeline of three to four years, I believe. And I hope that we will be able to get to that point in that period of time.

Then lastly if I may, EFTEC Europe did better than I was anticipating. And this is your joint venture in the automotive business. Can you talk about what is happening in Europe and what is happening in North America, and now that Jim has responsibility for the adhesives as well, have you brought in new people on the automotive in North America, or can he handle it all?

Well, we have replaced Jim's position and the joint venture with Chad [Ricker], who used to be their CFO, and who used to run the North American adhesives business of our partner in the past before we joined together. So he is very familiar with the business, and also has general manager's experience.

With regard to the overall industry trends that we are seeing, we expect that the automotive industry strengthened a little bit in the last quarter. I think some of the inventory corrections have taken place over the summer. The overall expectation at this point in time is still about, I think, between 15.8 and 16 million units of production with about 3.2 million units in inventory. So I think what we mostly still is stabilization, also now after they have come to contract agreements.

Europe is also, in this year, slowed down from last year with overall demand. The big growth area that we see on a global basis is China, where we just see dramatic increases in overall production on sales of automotive -- of cars -- and that is, of course, helping us on a global basis.

So when we look at the contribution from the JV, China and other parts of Asia-Pacific, are in that JV, and this is why the business was stronger than what I was anticipating?

A significant effect on that, yes.

Okay. Thanks.

Our next question comes from Jeff Zekauskas.

Just a couple of questions. Can you remind me as to what the tax rate should be for the fourth quarter of fiscal '03,? And you talked somewhat about the price trends and the raw material trends for the quarter. Do you see your pricing environment over the next couple of quarters as becoming worse or better or staying the same? And likewise with raw materials, all things being equal?

I'll have John answer the tax question first, and then I'll talk about the price trends.

Jeff, the tax, for the fourth quarter, 30.4 percent.

Okay.

With regard to price trends and raw material trends, I think raw materials, as I indicated in the fourth quarter, is most likely going to be flat. We might possibly even see in one other case, some slight weakening, but not that significant. We are seeing, in our old product markets, no activity at this point in time in the marketplace that would lead me to believe that we're going to see price increases. So I think we will most probably have more of the same.

Okay. Thank you, very much.

Our next question comes from Godfrey Birkhead.

Off the wall question, I apologize, guys. I know that the North American automobile market is around 16 million and the European market is 14 to 15 million. What's the size of the Chinese market? Does anybody know that now?

No, you stumped me, but I'm sure we can get the number to you. We'll have Scott give you a call.

We're probably talking hundreds of thousands now, you think, Al?

No. I think it's picking up quite a bit. Because we've seen growth rates, I think, in the last quarter, of 80 percent -- it's fairly dramatic. But I'll have Scott give you a call.

Please do. Thank you, sir.

Maggie, I think with the time allowed that we had for the meeting, with no questions out there, we will end the conference call.

All right.

All right. Thank you, very much, for your participation in this conference call. I look forward to the next opportunity to speak with you. Thank you, very much.