H.B. Fuller Company (FUL) 2004 Q4 法說會逐字稿

Good afternoon and welcome to the fourth-quarter year 2004 earnings release. At the request of the Company the conference is being recorded for instant replay purposes. This conference has been scheduled for one hour. Following today's presentation there will be a formal question-and-answer session. Instructions will be given at that time should you with to ask your questions.

Management in attendance on today's conference call include 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 call over to Mr. Scott Dvorak. Sir, you may begin.

Thank you, Sarah and welcome everyone. Today's conference will be available for replay approximately one 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 is 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 website at www.HBFuller.com under shareholder relations press releases.

In addition certain matters discussed during this call will include forward-looking statements as that term is defined under the Private Securities Litigation 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 Forms 10-Q, and annual report on Form 10-K filed with the SEC. Now, John Feenan.

Thank you, Scott. Good afternoon to everyone. Before I review the fourth-quarter and full year results I would like to comment on the investigation of our Chilean operations and our consequent need to delay filing our 10-K with the Securities and Exchange Commission. As indicated in our press release, on January 10, 2005, we determined that we were unable to reconcile certain balance sheet accounts at our Chilean operations. As a result of this development, our audit committee commenced an independent investigation into the accounting and financial reporting matters of the Company's Chilean operations. This investigation has discovered evidence indicating that certain members of the local accounting organization knowingly recorded incorrect entries to certain accounts in the Chilean financial statements.

Additionally the investigation indicates a portion of these accounting irregularities involved the misappropriation of Company assets. The impact of these actions resulted in an overstatement of net income from earlier periods resulting in our earnings per share of 38 cents. In aggregate, the investigation relating to our Chilean operations has resulted in a reduction of net income from management expectations totaling $3.8 million in 2004. This includes $2 million related to the years prior to 2004, $1.1 million related to the second and third quarters of 2004, and approximately $800,000 that has been included in our reported results for the fourth quarter of 2004.

Therefore before the impact of all charges related to the Chilean misstatements, earnings per share would've been 47 cents for the fourth quarter of 2004. I will elaborate in more detail when I review the financial results.

As a result of the discrepancies in the Chilean financial statements, and the resulting inability of the Company's independent auditor, KPMG, to complete the audit of our financial statements at this time, we were unable to file our 10-K prior to the original filing deadline with the Securities and Exchange Commission. This made it necessary to file form 12b-25 to extend our filing deadline by 15 calendar days past our original due date of February 10, 2005.

At this time, KPMG has not yet completed its audit of the Company's financial statements. Although we have no reason to believe that KPMG's audit or the additional investigative reviews or procedures described earlier will result in any material change to the results recorded yesterday and discussed today, further adjustments are possible until the audit investigative reviews and procedures are completed.

An additional consequence of the discrepancies uncovered in Chile is that we have an internal control deficiency that constitutes a material weakness as defined by the public company accounting oversight board. The material weakness identified by the Company was the insufficient supervision and oversight of certain local accounting personnel within the Latin America region. Consequently management is unable to conclude that the Company's internal controls over financial reporting are effective as of November 27, 2004.

We take this matter very seriously. Therefore we are heightening the oversight of our Latin American operations and taking the necessary actions to appropriately address and more importantly correct this material weakness.

Now I would like to turn to the financial review, but before I begin I want to remind everyone that per-share amounts are reported on a diluted basis.

Net revenue for the quarter was $378.5 million, 9.3 percent higher than Q4 2003 revenue of $346.2 million. Looking at the components of the 9.3 percent sales increase for the quarter, we see the following. Pricing increased 9.9 percent; volume increased 3.1 percent; currency effects, primarily due to the euro and to a lesser degree the yen, Australian, and Canadian dollars accounted for a 2.6 percent increase; and acquisitions had a positive impact of 2.7 percent.

The increased pricing this quarter is the first positive quarterly comparison in fiscal year 2004 and reflects a continuation in improvement in the run rate we have been experiencing since the second quarter of 2003. This improvement is reflective of the efforts that have been made to obtain price increases where it was contractually possible. As we work with our customers in mitigating the impact of the raw material cost increases, we expect to see continued to sequential improvement as it relates to selling prices.

Gross margin for the quarter was 24.6 percent, compared to last year's fourth-quarter margin of 27.0 percent. The year-over-year percentage decline in gross margin of 240 basis points was primarily due to higher raw material and container costs caused by tight market conditions and higher delivery costs due to the increase in energy prices. In addition charges from prior years related to the Chilean misstatements increased cost of goods sold by $600,000. These increases were partly offset by achieving leverage on our manufacturing costs due to our improved volumes and our success in increasing prices.

Operating expenses were $72.2 million or 19.1 percent of sales. This percentage is 180 basis points lower than last year's fourth-quarter of 20.9 percent. This improvement was primarily the result of maintaining absolute spending to prior year's fourth-quarter level on significantly higher sales volume.

Operating income for the fourth quarter decreased from $21.1 million for the fourth quarter of last year (technical difficulty) to $20.7 million. Operating income in Global Adhesives in the fourth quarter was $9.5 million compared to $10.5 million in the fourth quarter of 2003. Full value specialties operating income was $11.2 million, an increases $0.5 million or 4.3 percent over the previous year's forth quarter.

Interest expense of $3.3 million was 3.8 percent lower than the $3.4 million for the fourth quarter of 2003. Net gains and losses on asset disposals were gains of $3000 in the fourth quarter of 2004 as compared to gains of $700,000 in last year's forth quarter. Other expense in the fourth quarter was $1.7 million, compared to $1.1 million of expense in the fourth quarter of 2003. Charges from prior years related to the Chilean misstatement increased this year's fourth-quarter other expense by $1.5 million.

Pretax earnings of $16.1 million for the fourth quarter of 2004 reflect a 7 percent decrease from last year's fourth-quarter pretax earnings of $17.3 million. Charges from prior years related to the Chilean misstatements reduced pretax earnings by $2.1 million.

The effective tax rate for the quarter was 35.6 percent, compared to last year's fourth-quarter tax rate of 30.1 percent. The deviation from an expected 32 percent effective tax rate in the fourth quarter is due to the impact of the Chilean misstatements and a change in the mix of earnings. The tax benefit from the charges from prior years related to the Chilean misstatements was $100,000.

Looking forward we anticipate an effective tax rate in 2005 of 32 percent. As a result for the fourth quarter of 2004, net earnings decreased from $13.3 million in the prior year to $10.9 million. Earnings per share were 38 cents compared to 46 cents for last year's fourth quarter. Charges related to prior periods due to the Chilean misstatements reduced earnings per share by 6.7 cents.

Keep in mind as we discussed earlier Chile's results in the fourth quarter deviated from management expectations by $800,000. This resulted in impact to earnings per share of 2.6 cents.

As we turn to the balance sheet, I would like to remind everyone that the following figures may be subject to minor changes prior to filing the 10-K. Cash at the end of the quarter totaled $67 million. Net working capital amounted to $257 million. As a percentage of sales net working capital was 17 percent for the fourth quarter. This represents a decline of 240 basis points from the previous year's fourth quarter.

Capital spending for the quarter was $11.7 million compared to last year's fourth-quarter spend of $11.8 million. For the full year, capital expenditures were $31.3 million, compared to $39.3 million in fiscal year 2003. We expect to spend between 40 and $45 million in capital expenditures in 2005.

Depreciation and amortization were $14.4 million for the quarter. Total debt increased $0.5 million from $173.9 million at the end of the fourth quarter 2003 to $174.4 million at the end of the fourth quarter of 2004. In the first quarter of 2005, we made a debt repayment related to our 1994 private placement of approximately $22 million.

The Company's capitalization ratio was 24 percent at the end of the quarter, compared to 25.5 percent at the end of the fourth quarter last year. Free cash flow for the quarter defined as cash from operations less cash outlays for dividends and capital expenditures was a positive $33.1 million compared to a positive $26 million in the fourth quarter of 2003.

For fiscal year 2004, our free cash flow was a positive $78.9 million versus last year's fiscal amount of a positive $7.8 million. The increase in free cash flow is primarily driven by an improved focus on net working capital, lower-than-expected capital expenditures, and the absence of any cash contributions to the U.S. pension plan.

The fourth quarter and the full year were very challenging. Nevertheless, numerous accomplishments were made in 2004. First we completed the acquisition of Provost during the first half of the year and have heightened our M&A activity as we head into 2005.

Second, our focus on the balance sheet and net working capital led to significant improvement in free cash flow. Third, our focus on pricing culminated in positive quarterly trends in both the third and fourth quarters and we expect that to continue into 2005. This discipline on pricing should allow us to mitigate rising raw material costs and enhance our profitability.

In conclusion, we have further strengthened the foundation of Fuller for both future growth and enhanced profitability. Our central focus will be on thoroughly managing our pricing strategy, further accelerating our M&A activities and managing our cost structure.

Before I turn it over to Al, I would like to announce that Scott Dvorak has been promoted internally and will be taking on a new role within H.B. Fuller. It has been a pleasure working with Scott and we would like to thank him for his dedication and service to the shareholders of the Company over the prior four years. Taking over for Scott as Director of Investor Relations will be Steven Brizones (ph). Steven joined the company 2.5 years ago as the Manager of Corporate Finance. Steven has a strong background in finance and I'm very pleased to have him assume this key leadership role.

I will now turn it over to Al Stroucken.

Thank you, John and good afternoon. We are of course not very happy about the situation in our Chilean operation and the resulting impact on our reported results. We believe that the processes and the rigor of Sarbanes-Oxley that we have implemented in the last year helped us identify this issue and will be helpful in avoiding similar situations in the future. In addition as you heard from John, we will be taking additional steps to assure that our controls are tightened even more.

From a business perspective, this year looks to be as challenging as all the others of the recent past. The dramatic and unprecedented run-up in raw material prices and the equally demanding puzzle on how to deal with more and more of our raw materials being put on allocation or under force majeure have been keeping our employees busy. Realistically speaking, this is not going to change quickly. In this extremely difficult environment our Company team has performed admirably and I want to recognize our people's ability to adapt to and succeed in serving our customers on their rapidly changing conditions.

The ongoing raw material cost increases are driven more by strong demand than the underlying oil or gas prices. This is caused by a variety of factors. Depressed earnings of suppliers in the past have taken out a lot of surplus capacity and investments in new facilities have been minimal. Increased demand from the expanding regions like Asia have combined with economic recovery in North America and Europe and I'm sure some buildup of inventories are pushing the limits of quite a few raw materials.

We have tried to deal with the situation by increasing our own selling prices and by using the flexibility of our worldwide purchasing platform and by rigorous cost controls. As a result, we have been able to supply our existing customers and their growing demands without interruption. Our price increases have gained momentum and despite some very difficult situations, we have been working successfully with our customers to find acceptable new price levels and contract provisions in light of the cost and demand situation and conditions.

Now I will come back to the current environment and our expectations for 2005 later, but first I will comment on the fourth-quarter results. You heard from John that our reported sales for the fourth quarter continued to show significant year-over-year improvement similar to what we had experienced throughout the year reflecting an overall improvement of 9.3 percent.

Eliminating the favorable currency impact we realized a 6.7 percent improvement with the Provost acquisition accounting for 2.7 percent. A notable change to the components of the topline growth was the price (ph) development which finally turned positive with nearly 1 percentage point for the Company, a 150 basis point increase from that of the third quarter and the nearly full 200 basis point improvement from that of the first half of 2004.

Europe had been somewhat sheltered from the initial rising raw material costs in 2004 due to the strong euro as compared to the U.S. dollar combined with subdued economic activity. Consequently, competitive pricing activity in the region for most of last year was trending down rather than up. This seems to be changing now in the first quarter of this year.

In Latin America where raw materials tend to rise very rapidly when global demand picks up, we started earlier with our pricing efforts and achieved increases of around 4 percent.

In North America, we had to carry the brunt of the rapidly escalating raw materials. We were able to get higher prices for adhesives as well as for our Full-Valu Specialty product lines and I believe that in the course of the quarter, we were dealing somewhat more effectively with the typical time lag between raw material increases and our own pricing actions. That may help us avoid the gross margin compression that we saw in the last two quarters as we go into 2005.

Our gross margin percentage dropped 240 basis points sequentially from that of the third quarter as previously reported and a similar amount from that of the fourth quarter of last year.

In light of the raw material development, we have implemented a new wave of significant increases in January and February in all regions. Year-over-year volume improvements continue to bolster the topline in the fourth quarter as they had for all of 2004. Volume increased 3.1 percent impacted somewhat by mix, therefore tonnage that was shipped was up by 5.3 percent.

Leading the way in the adhesives business was the Asia-Pacific region, posting a near 6 percent volume improvement. This is somewhat below the growth rate of previous quarters and may be influenced to some extent by our pricing actions and a very competitive environment and/or the attempt of the Chinese government to slow down their overall economic growth. It is too early to tell at this time.

Latin America posted a 3.5 percent growth in volume. We saw the best improvements in Argentina and Columbia specifically in the converting and nonwoven end markets we serve. With expected 2005 GDP improvements ranging between 4 and 6 percent for most of the countries in this region and a new level of relatively political and economic stability, our expectations for growth in this region remain a key part of our overall organic growth strategy.

At the beginning of 2005, we assigned our activities in Mexico as part of the Latin American region because we feel that given the cultural affinity and market conditions, this organization can be led more effectively by our colleagues in Latin America.

In the adhesives business in North America volume improvements including mix mirrored that of the previous quarter of 2.5 percent while tonnage shipped improved by 6.6 percent, which was slightly better than that of the third quarter.

As we saw throughout 2004, our assembly and converting businesses continued to show significant year-over-year improvement. In addition, our nonwoven business also reflected solid increases over that of the previous year's fourth quarter. We cannot exclude that these comparisons even though positive may still have been negatively influenced by some market share gain by companies that were less determined to increase prices.

Our European adhesives realized a substantial improvement in the fourth quarter from the pattern that we had seen for most of 2004, posting over a 3 percent volume improvement and a 4.4 percent increase in tonnage, indicating that the economy may be improving finally.

In our Full-Valu Specialty business we have seen an impressive improvement over the previous year both in the quarter and for the entire year. In many business lines, we are starting to see the benefits of smarter market segmentation and branding orientation. Our specialty construction brands, catalysts, and window divisions posted near or double-digit growth volumes.

New products continued to be an important part of their growth and margin improvement objectives. With an overall favorable currency and pricing impact, the overall segment reported revenue growth in excess of 6 percent.

As John discussed previously, our operating expense for the quarter approximated those of last year and were significantly lower than in the previous quarter, resulting in the percent of sales of 19.1 percent. As we begin the new year, we will continue to stride towards our longer-term goal of reducing our full-year percentage to levels around 18 percent. For our adhesives business we are presently running below that rate, but given the nature of this business we will have to continue to improve that ratio even further.

Despite the challenging external environment faced throughout 2004, we continued to execute on our internal initiatives, which will enhance our capabilities and provide for a more agile and profitable Company in the future. One of the more aggressive initiatives for the year included the deployment of our Lean Six Sigma initiative and we have achieved our goal of realizing annual savings from the various projects to offset our costs incurred for training and first-year rollout. The tool sets and disciplines of the Lean Six Sigma methodology will provide much greater benefits for future years.

We ended the year with a noteworthy improvement of our free cash flow creating a source of free cash close to $79 million, the highest level in the history of H.B. Fuller. This improvement came from our continuous efforts in the areas of working capital and capital expenditure disciplines in conjunction with our reduced debt load achieving a 24 percent capitalization ratio.

We also completed our first European acquisition in more than six years with the purchase of the Provost business in Portugal. Solidifying our presence on the Iberian Peninsula and providing us with additional channels into the growth regions of the Middle East and Eastern Europe, this transaction was the first completed deal of many opportunities we continue to evaluate. The integration of Provost went very smoothly and confirms that our experience gained during the capacity reductions, consolidations, and productline rationalizations of the past can easily be utilized for the integration of acquisitions as well. This will help us considerably in this coming year when we expect the greater deal flow to lead to several transactions.

With 2004 completed, let me come back to the future, to 2005. With regards to earnings, 2005 will be a year of unremitting raw material cost pressure especially in the first half of the year. Our pricing efforts will continue to react to these increases and our price adjustments will in many cases have to fall in the double-digit category with margin restoration hopefully occurring in the second half of the year.

As a positive sign we are now experiencing a much greater level of acceptance of our increases than I have seen in the years before. Based on the start of this year when we saw our first two months coming in strongly with low double-digit growth despite some considerable price increase activity taking place during that time, I believe our volume improvements will continue unless we see significant changes in the global economic and political environment.

Once again as we experienced in 2002 and 2003, our U.S. pension and postretirement benefits will have a noticeable year-over-year impact on our 2005 earnings. With the actuarial work completed, we know that the impact of these benefits will cause a pretax increase of cost of approximately $6 million or an annual EPS impact of 14 cents spread evenly over the year. At this point we would expect our growth and internal savings initiatives to offset these additional year-over-year costs.

With the steps we have taken and the course we plan to follow in 2005, our earnings expectations at this point in time would equate to a slight improvement compared to the results of 2004 before we made the Chilean adjustment.

The first half of the year is likely to be a struggle as the timing of raw material increases and their flow through may still tend to cause margin pressure. We will of course strive to do better than that but I believe given the uncertain raw material cost and supply situation we need to be somewhat sensitive about the development until a bit later in the year.

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

(OPERATOR INSTRUCTIONS) Ray Kramer (ph).

This is Allan Cohen sitting in temporarily for Ray. First Analysis. One, congratulations in a tough environment. I really wanted to ask questions related to the SG&A, the operating expense that has been if you will a traditional issue at Fuller with a goal I think stretching back 10 years now to get SG&A as a percentage of sales down. And it was a struggle for your predecessor and it has been a challenge for you, but it seems like you are getting there. One would like to understand in the quarter what has there been of a permanent change versus a temporary kind of change? An example of a temporary change would be well we have stopped -- we have cut down on attendance at trade shows but it is something that in a better environment we would go to trade shows.

And then two, if I understand correctly the adhesives is now under 18 percent, so that if that is correct that implies the Specialty Group is in the low 20s and are there some structural issues there? In other words are those individual groups of critical mass perhaps?

I think first off, I believe that if you look at the Full-Valu Specialty businesses they typically have a different customer profile. They have many more customers, smaller customers. They generally also tend to have higher margins and a higher service requirement. Typically you would find in those businesses like for instance our paint business in Latin America where we have paint stores, you would generally have a higher service and overhead and sales expense and sales cost.

In the past when we have talked about driving our costs down we have really had to deal largely with the issues in the adhesives segment where we had as you may recall many small operations. Many small units distributed throughout the world and I think by the efforts that we have made consistently and persistently over the last couple of years to consolidate to basically bring these units together, of course we have been able to create some more critical mass and thereby reduce the ratio of expenses to that particular portion of the business.

One thing that still impacts us is of course our global reach. If I look for instance at our selling expenses or SG&A expenses for a European theater or a Asia-Pacific region with a homogeneous U.S. base where we basically have the same languages, the same laws, the same infrastructure, we of course tend to be much lower in our expenses in North America than in all these other countries.

So I believe it is going to continue to take a gradual and continuous approach from us to chop away at those costs and improve our processes and I think Lean Six Sigma is going to be an excellent tool to help us move in that direction and I expect continued improvement.

What about in the nonadhesive area, the powder coatings, the string sort of adhesive and other businesses? Are those -- how are those tracking in terms of operating expenses, SG&A?

I think also there we have seen over the last two years some reductions in those expenses. I believe that if I look at a powder coatings business which I would say aligns in its structure and its customer base much more with an adhesive business, I see great similarities in the cost there. Now if I go as I said to a paint business or if I go to a specialty construction brand where they sell (technical difficulty) materials, I see somewhat higher expenses.

Thank you, congratulations to Scott on his promotion. I think Ray has one question.

Good morning, guys. Just looking for a little more detail on some of the pricing stuff. Can you comment at all if you're seeing -- it sounds like there's still some players competitively who maybe bidding on price but can you comment if there has been any improvement there? And then sort of take us through -- you said you're getting through price increases where you didn't have contracts. About how much of your business is on contracts? How long are they and at least looking at other specialty companies, there's been a big push to reduce the duration of contract or price protection. Have you made any progress on that?

All right, it is a loaded question and let me try to give you a general flavor of what is happening. First of all, the lead times and the protection periods and virtually all contracts has been significantly reduced or has disappeared. That is very much a requirement because we from our side do no longer have protection either from our raw materials suppliers. A lot of that disappeared with the restricted and reduced availability of raw materials. You basically use your negotiation position in such an environment.

Now with regards to the overall price development, you may recall that in the last quarter's conference call I had said that in the third quarter of last year we had a 0.7 percent price increase and I'm talking now only in North American adhesives because it is very difficult to get this as a global number, but I think its indicative. And then I said at the beginning of September that we were ready -- we are running at about twice that rate. By the end of the year, we were already seeing that we were up about 2.4 percent over that midyear rate and in fact, in the first two months of this year we were averaging about 5 percent of that increase compared to the same base period.

So you see there is a continued and gradual effect and of course you understand that as you are increasing prices throughout the quarter, there is still some momentum contained in the quarter that will persist then in the future.

So I would say overall the environment has I said in my comments, been much more conducive to accepting increases. Logically our customers want to understand and to know why this is happening and what we can do to mitigate the impact, but I think clearly the general environment has helped us in this situation. There are always going to be exceptions where for the one or other reason we will find the people that walk in and walk away with some business but I think we have to look at the broad picture and the overall impact and what we're seeing at this point in time is a positive trend.

Thanks a lot, Al.

David Begleiter.

Deutsche Bank. Good afternoon. Al can you comment -- you mentioned M&A activity perhaps picking up. Could you comment on geographic preference, size, and how that might transpire across the year?

Well, David, I think I've said in the past that we are basically following two tracks. One is a consolidation acquisition play which is basically in adhesives and that would typically then be in market segments where we already have a position or where we are represented.

The other more attractive part for us is the area of Full-Valu Specialty where we do not have a global footprint and therefore anything in Europe, anything in Asia-Pacific, anything in Latin America is something that we certainly would look at and would welcome. The benefit for an acquisition in this area in the United States would of course also be aside from increasing our footprint, we might be able to get some synergistic effects which we would not get by acquisitions over in other regions.

Just looking at longer-term margin potential earnings power given the slightly improving pace and the market for pricing, what do you think Fuller has potential to earn or produce margins over two to three years?

David, I think you recall from the conversations that I had in the past that I believe we should be able in this business in the aggregate and that includes adhesives as well as Full-Valu Specialty business to operate with our present portfolio at a 5 percent after-tax rate. I have not given up on that target. We have certainly gone through some very difficult periods over the last couple of years with the economic downturn, with raw material instability, but I feel that with the positioning that we have been taking over the last couple of years and the steps that we are implementing in our pricing strategies and our marketing approach that still is a goal that should be realizable and I think that certainly is what everybody in this Company is striving towards.

Last thing on pricing if we do see a rolling over of raw materials, are these price increases being proposed to clients as a recapture or as a value recapture for your prior investments? Can you keep these price increases if you see raws rollover?

Well, I think you know from the dynamics and how this works from the past you always have a delay, so you always have a need to make up from the time delay and from the time factor and typically when I look back over of 5 or 6 year period, you see that very clearly reflected. You basically see a slow ramp up to get your prices up and then eventually you also see a slow ramp down. So I would say when the inflection point comes, we would certainly most probably see some initial benefit from the differences in raw materials and the price activities that by that time we have implemented.

I would expect though that we most probably will not see as dramatic a contraction of raw material prices as we have seen in the past, so it will be much more gradual approach and that will perhaps provide an opportunity to retain the advantages that we might create in such a situation a bit longer.

Thank you very much.

Rosemarie Morbelli.

Ingalls & Snyder. Good afternoon. Could you, back on pricing and raw material, looking at the year you got a negative price increase of 0.4 percent and a positive 0.9 percent in the fourth quarter. Could you give us a feel for what your raw materials costs did throughout the year and during the fourth quarter?

Let me give you some percentages. About 70 percent of the total raw material increase in 2004 occurred in the fourth quarter of the year. As a result, you can very well imagine that therefore the cost base is moving into 2005 is significantly higher and we therefore would expect that for the entire year 2005, our raw materials will most probably be higher by about 10 percent from the raw materials that we bought in 2004. I hope that gives you some perspective.

Yes, it does. And of that 10 percent increase in raw material, what do you think you can get on the selling price? I doubt that you're selling price will improve by 10 percent given the adhesives industry and the excess capacity in that particular area. And if you could actually comment on that, see if there is any changes coming on stream.

I think, Rosemarie, perhaps we may be witnessing a fundamental change at this point in time. I have had several discussions in our own Company trying to understand really what is happening but given the really very tight supply situation of raw materials and you know that basically we are formulators so a significant portion of our product is raw material -- that unavailability or limited availability of material is going to have an impact on the relative pricing positioning that one can take.

Now of course we want to make sure that we serve our customers well and keep our customers competitive as well but ultimately what is going to decide what is going to happen in the marketplace is the old supply/demand equation and at this point in time I think even though there may be excess capacity in the adhesives industry, if there is no excess capacity in VAN (ph) or EVA (ph) or any of the other basic raw materials, it is still going to have a drive-through effect on what is going to happen in the pricing market in adhesives. So I'm at this point in time looking at this and thinking that perhaps we might be seeing a change.

Would that translate into your being able to get about half of those raw material cost increases in selling pricing?

Rosemarie, I already mentioned the number and I do not have it for the total Company for this early part of the year yet but I already mentioned that in the first two months of this year, our average price in North American adhesives business was 5 percentage points higher than in the middle of last year. So that shows you a fairly good trend. And in fact that is a number that I haven't seen in the adhesive industry in a long time.

And you think that you're getting more than that in the Full-Valu, where there is less of a competitive environment?

Well, Full-Valu is somewhat driven by different dynamics. Some of the raw materials behave differently. If I were to look for instance in my specialty construction brands product line -- a lot of the raw materials are natural raw materials or products that do not fit into the ethylene derivative category; however, they are impacted by transportation costs because it is very heavy material.

So the dynamics are a bit different but we have seen also in those areas and virtually every business area that perhaps with one exception, we have seen price increases in the range of 3 to 4 to 5 percent as well.

And what was that exception?

I do not want to put the people on the spot.

All right, you mentioned that there may have been some inventory buildup during the fourth quarter. Do you think it is a sign of the economy slowing or was it prebuying in light of selling -- of price increases?

I think Rosemarie, we most probably have seen some prebuying because people became aware of what was going to happen and the availability of raw materials and perhaps saw a more determined supplier base coming at them with increases. And I saw a particularly strong December which is normally unusual. Typically in December people run their inventories down and generally it is a fairly lackluster month. Now of course this year we also had the strange fact that the holidays were basically on the weekend so we had some extra billing days. So it is a mixed bag but I certainly think that if people know there is going to be a significant increase and limited availability of raw materials, people are going to put some into their inventory.

Now fortunately for us, we do not have a long pipeline. Generally we go directly to the consumer of the product. Very rarely do we go to a distribution channel and so that would washout fairly quickly.

At your end, but what about at your customer's end?

Well, at the customer's end of course, it becomes very diffused because of the many different applications that we have. But there again, we are helped a bit by the broad line of applications, so one area that may be overdoing it a bit may be compensating for another area.

And you mentioned that your contracts were now shorter. Are they as short as the contract you have with your suppliers and I meant the one with your customers obviously? Are you now pricing as you are shipping? Are you pricing on a monthly basis? Can you give us a little more detail on that?

We haven't gone to an e-Bay system yet but we are certainly at this point in time out much more frequently with price adjustments. I think we have some responsibility as well as a reliable supplier to try to create visibility for ourselves what is going to happen in the raw material area so we do not always come in as a surprise. And so I think we may not yet have to go to the point where we do it on an availability basis or on and as shipped basis because I think that is something that I recall only happening sometime in the '70s when basically raw material was so tight and inflation was so high that you basically did not have a way of pricing your product appropriately. But I don't think we are at that point.

Lastly, could you give us a little bit more on the Chilean situation, was that solely in Chile? Do you think you will discover something else in Latin America or elsewhere in the world? And is there any chance for you to recoup that 3.1 million which I am guessing is kind of embezzlement in one way or another?

Rosemarie, good afternoon. This is John. We are quite confident that we have the issue isolated to Chile. There has been a lot of work both from external resources through E & Y, and the General Counsel that the audit committee hired as well as independent -- as well as internally. We have gone out and looked at every other region and site within the Latin American operations to make sure that we have a high degree of probability that it is in fact isolated. That is the first part of your question.

As far as recouping the 3.1, we do have insurance in place and we are proceeding aggressively down those paths. As you know the investigation is still ongoing. We will have more details in our 10-K but that is an avenue we are pursuing.

Okay in then lastly if I may, when you talked I am a little confused when you talk about using the '04 as a basis for 2005. I want to make sure I am looking at the same numbers you are. The first quarter was 16 cents. The second quarter you had 41 cents but then they would have normally produced only 39 cents based on the press release. Same thing for the third quarter, instead of 33 from operations they would have only 31 cents. And then I was coming up with 45 cents in the fourth quarter instead of 47 using the 2 million that you are charging from prior years. So what number are you actually looking at for 2004?

What I was looking at when I made the comment was basically to the total cost that we incurred in the year and that is a total cost of $3.8 million and I think that what we can do is we can be slightly better than 2004 if I take out that $3.8 million effect.

So essentially, Rosemarie, embedded in the fourth quarter results which we obviously hadn't published yet was about 2.5 cents a share and that gets you the bridge to the 45 to the 47.

Okay, thank you.

Godfrey Birkhead.

I had a couple of questions Al. One, in these contracts are there any escalator clauses or not?

Yes. Some of the contracts that we had did have escalator clauses but as we went through the process of these force majeure or managed availability situations, these increases were so rapid and so significant that an escalation clause if you can only apply it at the end of the quarter or after 4 or 5 months is really not very helpful. Therefore, we have been putting a lot of effort and activity into modifying existing contracts and existing relationships to allow us to be more reactive to the changing environment in the marketplace. And I of course in those cases where those contracts were in effect we have used it to the full extent. But certainly with an effort to modify them and to take into account that we ourselves also are not getting any price protection anymore.

So does that mean that you have a tacit understanding with these people that if you're costs (ph) go through the roof at any given time that you will immediately notify them of that condition?

You never have a passive pricing understanding with your customers. It's always very active and very much a point of discussion and I think as we have seen and I referred to it as in some situations we have had really very difficult discussions, it requires a lot of work and will and determination to come to a solution that is acceptable to the customer as well as to the company. (multiple speakers) We certainly have found cases where we came to the conclusion that eventually it was better to lose the contract than try to persist in continuing to supply.

Okay, I remember as you do back in the '70s when the word pricing power was used and then you referred in an earlier question to a basic change in the industry. Does that mean that you are seeing a gradual restoration of pricing power in the adhesive business?

Well, it is of course always very difficult call a trend change just at the point of change. Generally it is much easier to call it two years or three years after the fact. But based on what I am reading and based on what I have been seeing happening in the last 6 to 12 months, I think there may be a broader change in the chemical industry from a deflationary environment (multiple speakers) inflationary environment and unfortunately of course that can eventually be impacted again by what the chemical industry is going to do.

If people see vinyl acetate monomer is tight and everybody now goes and builds a vinyl acetate monomer facility, it is going to be long before too long. So it is really going to rely a little bit on whether the chemical industry is having learned from the past where they were not able to recover and to earn the cost of capital and possibly approach it a bit differently. But certainly as far as supply and demand situation is concerned, I think there is the opportunity and the indications are that there may be the change from a deflationary to an inflationary environment.

Do have a guess as to in your basic adhesive business what capacity utilization is for the industry as a whole now?

We of course have reported our own capacity utilization around 40, 45 percent in that range consistently for quite a number of years. We also have seen that based on the companies that we have looked at and the candidates that we have looked at from an acquisition perspective, that generally they are not higher. In fact generally they are lower in their capacity utilization. But again, you have to put that into perspective to okay, what is the cost of capital for this kind of business? It is not very high.

So there is always going to be a tendency to have much more installed capacity than you need and therefore, the situation in the raw material end even though we still have discussions in our industry whether we are a specialty business or whether we are a commodity business, we should clearly recognize that our commodity supply and commodity prices really drive our pricing behavior in the marketplace much more than our individual market position in the adhesives side.

That gives you some pricing power is what you say -- it comes -- or some pricing leverage?

Through the raw material situation, yes.

Do you use LIFO accounting?

We do use – we have a various (ph). I'll let John answer that.

Yes, in a portion of our business, we do use LIFO accounting.

Okay, since 70 percent of the costs came in the final quarter, it would make sense that you are starting out with if you use LIFO at a much higher cost in raw materials in your cost of goods sold -- that's the reason for the fact that the first half will be somewhat slow and the second half you're hoping to get some of that back. Am I thinking along the right lines?

That is why I was more cautious on the first half of the year than the second half of the year.

Because of the LIFO?

Yes.

Just a couple of questions (multiple speakers)

Al was talking and when he was focusing on North America; our LIFO accounting is obviously focused there as well, not so much outside the U.S.

Okay, a couple more questions. Is it possible for you to quantify what benefits you're getting from the Six Sigma programs?

We did last year have costs of the implementation of around $3.1 million and the benefits were 3.4 or something like that. We of course saw most of those benefits come in towards the last quarter, so I think anybody with a calculator can see that most probably in the coming year those benefits are going to be significantly higher. And that is one of the reasons why we feel also that we can absorb the additional cost of (multiple speakers)

Okay, so can we multiply it by 4 there and get up to close to $10 million in terms of the Six Sigma contribution in 2005?

I don't know what you are going to do with it, but --.

Good point.

I think logically you could come to that conclusion, yes.

Final question is in the discussion early on about some of your specialty businesses and the relationship between the SG&A to the total, am I correct in thinking that the offset there is a higher gross profit margin that goes there as well which is somewhat of an offset to the higher SG&A?

Absolutely. The internal discussion always is and always will be how much of that additional expense is really justified or just being taken because we have the margin?

All right. Thank you very much, gentlemen.

Robert Kosowsky.

Sidoti and Company. I was wondering if you could comment on your confidence that you are going to be able to source all the raw materials that you need in 2005?

Well, I looked our supply chain person in the eye and he nodded. I think what we are seeing that we have to resource in particular situations and that is causing us some higher transportation costs because sometimes we have to go from other regions and bring in products and also find alternate sources. So I believe that at this point in time we have a pretty good indication that we will be able to have the raw materials that are necessary to supply our existing customers with their growth. There may be limitations on how much more business or additional business we can actively go after, but we will have to see how that works.

And as maybe some of the raw materials get tight, do you think that this would maybe trend more toward some of your multipurpose products that might be ultimately better for you -- trying to get a customer to convert over to a little bit more lucrative product for you?

I think once -- adhesive is really not a very high cost product in most of these manufacturing processes. So I think ultimately if there is limited availability, customers tend to very rapidly be able to switch and move to a product and then cost is really a secondary issue. So I think and we already have seen that in some cases where a particular raw material becomes (indiscernible), the customers are now much more willing to quickly approve an alternate product very rapidly.

Okay, if raw materials do roll over, do you anticipate a surge in volume base competition again? And maybe selling prices will deteriorate pretty quickly?

I don't think I can really predict that but at this point in time I think we're still going to see quite a period of tight supply and I think perhaps in next quarter as we get perhaps a little bit closer to that point where there may be an inflection then we can possibly try to take a stab at them.

Okay and I guess getting out to the Chilean issue, it seems like it's a relatively small part of your business and it seemed like a pretty big magnitude of an impact, 2 cents a share in two consecutive quarters. Did you have any suspicion that there might be something going on there in having usually high profits?

Well, we didn't see any huge increase that was significantly different than any of the other regions in that part of the Latin American adhesive business and this really had been going on for quite some time and was quite cleverly crafted with entries into both the cost of goods sold and in the translation accounts. I think as Al alluded to earlier, not only through the initiatives of Sarbanes-Oxley and taking a further dive into the internal control focus, but also the notion of bringing in a fresh set of eyes which the audit committee initiated last year. And as you know, we changed our accounting group from PWC to KPMG. I think the combination of those two forces were instrumental in helping us identify this issue and it has obviously made us stronger going forward.

We have no further questions at this time.

Since there are no more questions we will now conclude this conference call and we'd like to thank all those who took time to participate. Thank you.