H.B. Fuller Company (FUL) 2005 Q4 法說會逐字稿

Good morning and welcome to the H.B. Fuller fourth quarter 2005 earnings release. At the request of the Company, this 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 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, Senior Vice President and CFO; also is Mr. Steven Brazones, Director of Investor Relations. At this time, I would like to turn the meeting over to Mr. Steven Brazones. Sir, you may begin.

Thank you, Tina, and welcome, everyone.

Today's conference call will be available for replay approximately one hour after we are finished with the question-and-answer portion of our call. Before beginning, I would like to inform everyone that 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. In addition, during today's conference call, we will be discussing certain non-GAAP financial measures, specifically free cash flow and pro forma diluted earnings per share. Management believes that the discussions of these measures is useful to investors because they provide both insight into the ability of the Company to fund such things as debt reduction and acquisitions, and assist in understanding the comparability of results in light of specific items identified in our earnings release, and the forthcoming change in accounting policy regarding option expense. For more information, please refer to our recent press release, quarterly reports on Form 10-Q and annual report on Form 10-K filed with the Securities and Exchange Commission. All of which are available on our web site at www.hbfuller.com under the investor relations section.

Now, John Feenan.

Thank you, Steve, and good morning to everyone.

2005 was a year of constant change, and unprecedented raw material cost pressure. Rising petroleum and natural gas prices, together with supply constraints, led to profound raw material cost inflation. Nevertheless, our strategy enabled to us enhance the profitability of the business. This was done through focusing on continual process improvements, remaining disciplined in our pricing approach, and emphasizing productivity improvements through the utilization of Lean Six Sigma. This validates the strength of our strategy, and gives us confidence as we begin 2006. We are proud of our performance in 2005, and the efforts of our team members to meet the challenge.

For the fourth quarter, net revenue was $413.2 million, 9.2% higher than the $378.5 million of net revenue in the fourth quarter of 2004. This year's fourth quarter includes an extra week, and excludes the results of our Japanese operations. Adjusting for these two factors, net revenue growth was 4.4%. The components of the 9.2% increase in net revenue were as follows -- pricing increased 8.9%, volume increased 3.2%, currency effects accounted for a 0.1% increase, and the deconsolidation of the Company's Japanese operations accounted for a 3% decrease. The extra week contributed 7.8 percentage points of the increase in net revenue for the fourth quarter, and it was primarily volume related. Without the extra week, volume would have declined 4.6%. Gross margin for the fourth quarter was 26.9%, compared to last year's fourth quarter gross margin of 24.6%. The 230 basis point increase in gross margin was driven by operational efficiencies at the plant level and was helped by our disciplined pricing methodology. Included in this year's fourth quarter cost of sales was both a gain on insurance settlements of $1.3 million, and additional environmental remediation expense of $3.1 million. Although we are very encouraged by the progress made throughout 2005, we are still well short of achieving our long-term goal 30%. In order to recover the decline in gross profit margin that began several years ago, we must remain vigilant and not waiver from our focus on profitable growth.

SG&A expense was $79.4 million, up $7.2 million versus last year's fourth quarter of $72.2 million. As a percentage of net revenue, SG&A was 19.2%, roughly flat versus last year's fourth quarter of 19.1%. For the year we are pleased with the progress made towards our long-term goal of reducing SG&A expense to 18%. Through the utilization of Lean Six Sigma and thorough cost controls, SG&A expense in 2005 declined 100 basis points from 21.6% in 2004, to 20.6% in 2005. Operating income, which is defined as gross profit less SG&A expense, for the fourth quarter was $31.8 million, up sharply from last year's fourth quarter operating income of $20.7 million. This represents an improvement of over 50% year-over-year, bringing our operating margin from 5.5% in the fourth quarter of last year, to 7.7%, a 220 basis point improvement.

On a segment basis, Global Adhesives continued its noteworthy improvement by increasing operating income from $9.5 million in the fourth quarter of 2004 to $18.9 million in this year's fourth quarter. This represents an increase of 300 basis points and segment operating profit margin year-over-year. Full-Valu/Specialty also posted improvement during the fourth quarter. Operating income was $12.8 million, up $1.6 million from last year's fourth quarter operating income of $11.2 million, an increase of almost 15% year-over-year.

Interest expense of $3.2 million was 3.9% lower than the $3.3 million for the fourth quarter of 2004, primarily due to the repayment of private placement debt earlier in the year. Net gains on sales of assets were $74,000 in the fourth quarter of 2005, as compared to zero in last year's fourth quarter. Other income expense net in the fourth quarter was $1.1 million of income, compared to $1.4 million of expense in the fourth quarter of 2004. Included in this year's fourth quarter other income expense is a gain on insurance settlement of $1.2 million. Excluding this gain, the improvement was driven primarily by lower currency exchange losses, and higher interest income.

Pretax earnings of $29.8 million for the fourth quarter of 2005 was almost double that of last year's fourth quarter pretax earnings of $16.1 million. The effective tax rate for the fourth quarter was 26.8%, compared to 35.6% in last year's fourth quarter. This year's fourth quarter improved tax rate was primarily due to the geographic mix of earnings. Accordingly, for the fourth quarter of 2005, net income increased from $10.9 million in the prior year, to $23.3 million. Our net margin increased 270 basis points from 2.9% in the fourth quarter of 2005, to 5.6%. Diluted earnings per share were $0.79, compared to $0.38 for last year's fourth quarter. Last year's fourth quarter included a $2 million or $0.07 impact related to the misappropriations uncovered during the investigation of our Chilean operations. This year's net income includes, on a pretax basis, gains on insurance settlements of $2.5 million, and additional environmental remediation expense of $3.1 million. The impact to diluted earnings per share was $0.06 and $0.07, respectively, almost offsetting one another. In addition, this year's fourth quarter benefited from an extra week and an improved effective tax rate. The impact to diluted earnings per share was $0.07 and $0.05, respectively. Adjusting for these items, pro forma diluted earnings per share equalled $0.68. A detailed reconciliation from reported to pro forma diluted earnings per share is included in our fourth quarter earnings release.

For the year, net income was $61.6 million, up $26 million over last year's net income of $35.6 million. The diluted earnings per share was $2.11 in fiscal year 2005, versus $1.23 in fiscal year 2004. As identified in our previous 2005 quarterly earnings releases and including the fourth quarter items mentioned previously, this year's net income includes, on a pretax basis, $4 million in severance-related expense, $1 million in investigation expense related to our Chilean operations, $3.1 million in additional environmental remediation expense, $6.5 million in gains on sales of assets related to two significant transactions, and $3.5 million in insurance gains. In addition, the fiscal year also benefited from an extra week and an improved effective tax rate. The net impact of all of these items to diluted earnings per share was $0.16. Adjusting for these items, pro forma diluted earnings per share for fiscal year 2005 was $1.95. Fiscal year 2004 included a $2 million or $0.07 impact related to the misappropriations uncovered during the investigation of our Chilean operations. In addition to the reconciliation for the fourth quarter, a detailed reconciliation from reported to pro forma diluted earnings per share for the fiscal year is included in our fourth quarter earnings release.

Beginning in 2006, we will be expensing stock options in accordance with Financial Accounting Standard 123R. This will have a negative impact on reported earnings relative to prior periods. Assuming we had adopted FAS 123R at fiscal year 2005, pro forma diluted earnings per share would have been reduced by $0.09 from $1.95 to $1.86. The [technical difficulties] expense adjusted pro forma diluted earnings per share of $1.86 formed the basis for which we derived our 2006 earnings expectations, and in our view, ensures an apples-to-apples comparison.

Before discussing the balance sheet, I would like to remind everyone the following figures are subject to minor changes prior to following our 10-K. Cash at then of the quarter totaled $157.6 million, up $90.6 million versus the fourth quarter of last year. The increase in cash is the result of the significant free cash flow generation of the business. Regarding the use of this cash, our plans have been and continue to be to use this cash to fund our mergers and acquisitions strategy. Networking capital, which is defined as net trade accounts receivable plus inventory minus trade accounts payable, amounted to $246.2 million. As a percentage of annualized net revenue, networking capital, adjusted for the extra week, was 16% for the fourth quarter. This represents a decline of 100 basis points from the previous year's fourth quarter. Improvements were made in both accounts receivable and inventory. We are pleased that we continue to progress towards our long-term goal of reducing networking capital to between 14 and 15%. Capital expenditures for the fourth quarter were $7.6 million, down $4.1 million versus last year's fourth quarter spend of $11.7 million. For 2006, we expect capital expenditures to be in the range of 30 to $40 million. Depreciation and amortization expense in the fourth quarter was $14.1 million, essentially flat with the prior year level of $14.4 million. For 2006, we expect depreciation and amortization expense to be in the range of 45 to $50 million. The decline in 2006 is primarily due to certain IT assets reaching a fully depreciated status in fiscal year 2005. Total debt at the end of the fourth quarter was $146.8 million compared to $174.4 million at the end of the fourth quarter of 2004. This represents a decrease of $27.6 million year-over-year. In 2006, we will make a $25 million payment on our private placement debt, in accordance with the scheduled amortization.

Additionally, in December, we announced a new five-year, $125 million senior unsecured multi-currency revolving credit facility. This new facility contains an accordion feature that would allow us to increase the aggregate facility size to up to $250 million and it provides us additional flexibility. The Company's capitalization ratio was 20% at the end of the quarter compared to 24% at the end of the fourth quarter of last year. Free cash flow for the quarter, defined as cash flow provided by operations less dividends paid in capital expenditures, was a positive $49.8 million, compared to a positive $33.1 million in the fourth quarter of 2004. The components for the fourth quarter of 2005 were as follows. Cash flow provided by operating activities was a positive $61.3 million, dividends paid were $3.9 million, and capital expenditures were $7.6 million.

In summary, we are very pleased with our fourth quarter performance and our continual incremental improvement throughout 2005. Faced with a dynamic and escalating raw material cost environment, we remain focused and executed on our strategy. Our entire team should be proud of what we have accomplished. However, as we begin 2006, we must remain focused and diligent on our journey of continuous improvement.

I will now turn the call over to Al.

Thank you, John, and good morning to everyone who is joining us today for this conference call.

John has given you a lot of the detail in his part of the presentation. I would like to give you a little bit more background, why we were able to perform at a higher level than the conditions and the marketplace might have suggested. When we talked to you last, we were still trying to get a handle on the impact that the hurricane season would have on our business, because of the uncertainties surrounding the prices and availability of many of our key raw materials. In the course of the year, we, like many other companies, were facing some difficult choices and we had to make tough decisions regarding the strategic direction we needed to pursue. We came to the conclusion that over the past two years, we had been seeing some fundamental changes. And they were more than just another raw materials cycle. Rather, we concluded that we might be seeing a fundamental shift from a deflationary environment to an inflationary period, driven by global demand and availability patterns. We chose to focus on pricing, and in particular, on cycle time reduction of the pass-through of basic raw material increases. At any given time, such a shift carries some inherent risk with it. Customers, used to years of cost reductions, are initially not at all receptive to such fundamental directional change. Very often, there are quite a few competitors that are willing to use such an opportunity to break into an account. As a result, our volume suffers in such a period and we saw this happening in the course of this year.

In particular, around the middle of this year, some people in the industry believed that the raw material run-up had run its course and we had quite a bit of competitive pressure. When it became evident in July and August that the raw material pressures were likely to persist and the hurricane activity of August and September exacerbated the situation, it was obvious to most in the industry that absorbing these costs was really not an option. The resulting increases still were slow in coming, with some long lead times between announcement and effective date. During this time, we were more assertive in our pricing discussions with our customers across the board of Adhesives and Full-Valu/Specialty than the market in general, and the negative volume impact, in my view, is reflective of the situation I just described. I have to add that the high percentage of the volume we lost to competitors was not lost because we were not aware of the competitive offering, but because we felt that at the price levels of the discussion, it would not be economical to pursue the business, in light of the existing and anticipated raw material availability and prices. Despite our pricing actions so far, we are still about 1 percentage point higher in raw material costs as a percent of sales, versus a dismal 2004, and more than 3 percentage points higher than the level in place before we went into the last recession. In this inflationary environment, we will continue to make our decisions judiciously and in the process, we are also gradually repositioning our portfolio to the higher value added existing product lines, newer and innovative products and the customer base that puts greater value on our expertise and services.

Concurrent with our actions in the marketplace, we have been working over the last couple of years to enhance our basic fundamentals and to reduce our cost base and improve profitability and productivity, of course. In fact, the significant profitability improvement we achieved has, to a large degree, to do with the productivity improvement within our Company. The implementation of Lean Six Sigma across our Company has been very successful and has helped us in dealing with the many challenges that we faced, and created a culture of data-based decision making. This has been extremely helpful in this environment of rapidly changing conditions and led to benefits of close to $30 million in the course of this year. These benefits have occurred across all regions, across functions, cost centers, distribution, sales and marketing activities.

With that as a general background, let me talk a little bit about the trends in the regions last quarter. In our North American Adhesives business, price and mix improvements considerably surpassed the volume losses that we incurred as we were raising prices throughout the quarter. Many competitors have announced substantial increases as of January 1st. We expect that this belated reaction will lead to a more balanced volume development in the coming quarters. Our Full-Valu/Specialty businesses with price improvements of well over 5% had volume developments that differed significantly from business to business. Strong growth in our construction-related business stood in stark contrast to our powder coatings business that suffered from paint industry specific dynamics, where volume and utilization considerations seemed to prevail, regardless of the raw material evolution.

In Europe, similar to the U.S., our Adhesives business had a price and mix development that outpaced the negative volume impact. Those of you that follow the chemical industry have heard the lament about European companies being extremely slow in adjusting prices to the raw material run-up from numerous other chemical companies, so I don't have to go into detail here. Suffice it to say that in our view, the same dynamics and supply-demand apply to Europe, and we feel very comfortable with the direction we have taken. On top of our market-oriented activities, Europe, as I already indicated in last quarter's call, has done an outstanding job in productivity improvements, and contributed significantly to the profitability improvement of the Company this year.

Latin America very often serves as the swing market for raw materials. In times of shortages, prices tend to rise much more rapidly than elsewhere. In that environment, our associates in Latin America did an admirable job in adjusting their market prices to these new conditions. Improvements in market segmentation and coordination of our activities across the region led to economies that had a very positive impact from the bottom line of Adhesives. Our paint business, similar to what I said about the powder coatings business, struggles with competitive activity that is more geared towards volume and market position than basic economics. We see, though, that we are making progress with the steps we have implemented.

Asia Pacific, with its strong growth momentum, particularly in China, is notoriously difficult with regard to price increases. Yet also here we are making solid pricing progress, and at the same time, enjoying continuing volume growth. The joint ventures with Sekisui are off to a good start, and we are confident that the benefits we expected from these ventures with regard to synergies, market positioning and penetration will start to materialize in the coming year. All regions had a solid year of improvements and progress towards becoming an even more effective and successful company.

The repositioning that I talked about earlier is also being helped by our focus on new product introductions. For the quarter, we saw a solid trend with new products now accounting for 19.4% of our sales at average gross margins that are generally 7 to 8 percentage points above our corporate average. It is natural that the new product ratio will drop off from time to time, as successful new introductions reach the time limit and will become part of our core offering. They will, nevertheless, remain contributory to our margin and business expansion. Overall, we are pleased with our performance in the past quarter, and I am very grateful to our associates who have made it possible. It is their determination and can-do spirit that have led to the recognition of being included in the Forbes list of best managed big companies in the U.S., finishing in the top 10 list of the chemical industry segment.

Now, let's look at this year. Raw material costs for the first quarter are going up at an even more rapid pace than in the fourth quarter because some of the increases that happened last quarter will only now have a full quarter effect. Keeping in mind what I said earlier regarding a general inflationary trend, I have no reason to believe that we will see any significant change in the course of the year. At best, we may see raw material cost increases at lower levels than we may have experienced in the past two years, but increases nevertheless. We have been raising our prices frequently and intend to continue in this fashion in order to make up for the cost development in our raw material base. With some of the competitive action as of January 1st that I referred to earlier, we expect the negative volume impact to diminish. Our focus in the coming year will be on improving our profitability and we expect that on a comparable basis, despite an increase of approximately $6 million in pension expense, we should be able to achieve a double digit improvement of our earnings. As the term "comparable basis" has a lot of implications, please refer to our fourth quarter earnings release for a detailed reconciliation and calculation of our pro forma diluted earnings per share results. For 2006, we expect to increase earnings $0.20 to $0.25 per share, reaching between $2.06 to $2.11 per share.

I believe this might be an appropriate time to end our prepared comments and open it up for your questions.

[OPERATOR INSTRUCTIONS]. Mr. Ray Kramer.

Hi, this is Allan Cohen here with Ray. A couple of broader questions. In terms of raw material sourcing strategy, as less capacity goes in in the U.S. and more and more capacity on a go-forward basis goes up the Middle East, how are you looking at your global availability of raw materials? Is that -- you did comment that there may have been some issues in the most recent quarter in terms of the availability, and how -- how are you looking at your long-term sourcing strategy?

Allan, we started about five years ago or even more, six years ago with a strategic sourcing effort throughout the Company. Because we recognized that since raw materials are such a significant part of our cost structure, that we had to have a level of expertise in this area that equaled the level of expertise that we have in our product lines. And we have been applying methodologies over the last couple of years that involved participation from all functions in the Company -- whether it's marketing or legal department or labs or manufacturing or sales -- to make decisions with regard to raw materials. And that is the only way we could really eventually broaden our scope of available suppliers, because we had to change formulations, we had to change, in some cases, the willingness of our customers to accept products with different raw materials, and so it's been a fairly long and lengthy process. But it has really stood us in good stead over the last year and a half, because it has given us the flexibility that we needed and it has made sourcing from other regions and other locations and other suppliers a much easier effort for us as an organization, and it has given us, even in these difficult raw material environments as far as availability is concerned, the capability to basically make sure that we could cover all our customers without delays and without interruption.

Okay. And then one other question, with your -- if you will, moving upscale with -- with respect to customers and higher value-added products, powder coatings, which when you entered it, was probably two decades ago was a novel, high growth, high value-added sector for the paint company that the traditional paint companies had -- didn't really across the board and go after it. It was a nice specialty opportunity for you, at least in [North] America and I believe worldwide. That's no longer the case. It's just another paint product. In fact, I think one of the producers in the U.S. recently closed a plant. How do you -- how do you look -- if you don't want to comment explicitly on powder, how do you look at, if you will, as part of moving upscale, walking away from both -- you've talked about walking [technical difficulties] customers, how do you look at walking away from products?

Allan, I'm not shy at all, so I'll talk about powder business. I've talked about it in the past. It's not really a core business for us. We held on to the business because it still has decent contributions, even today, with its weakening position, it still has a good contribution. But we clearly are willing to look at alternatives for this business. On the other hand, I have to say, as well, that we are still enjoying, perhaps, from the bulk powder business that you may be referring to, which goes into appliances and the automotive industry, considerably higher prices and margins. But that, of course, also makes us a target, especially in times when overall demand is down and these people that are generally focused on the commodity area, come in and grab a customer here or there, and improve their situation a little bit. I think longer term, though, the more significant issue for us, is that our customer base in the powder area that allows us a better segmentation and higher prices is moving offshore and is moving to China and to other regions of the world. And I think that is certainly an issue that puts a new light on this business.

Okay. I -- thank you [technical difficulties] forthrightness and certainly wanted to comment that the Forbes listing was certainly well-earned.

Thank you very much.

Mr. David Begleiter.

Thank you. Good morning, Al and John.

Hi.

Al, do you expect to recapture any of the lost volume going forward as the competitors raise their own selling prices?

I think, David, you asked a similar question at the last meeting, and the point is, yes. I cannot really give you, however, a time line or a date. I recall one instance, for instance, in the course of this year, where we had lost a very large customer in July it was, I believe, and then two months later, the customer came back because they were not able to get the same quality, the same service, or the same performance of the products or even the price that had induced them to go over to the new supplier. I would say, especially when you move through a phase of these rapidly escalating raw material costs and if you have a time delay in competitive activity to adjust to those prices, it really depends a lot on how quickly they are going to move before you see a willingness on the part of the customer to possibly come back again. But I believe what is much more important to us is that in the process, when we make our decisions with regards to should we retain the business or not, or can we match what is available, we really look the longer term profit viability of this account. If that account has to be helped over a rough spot, or a difficult period of time, but has always been willing to value the services and the technology aspects of our business, then, of course, we have a greater attachment to that customer than the customer who basically on a monthly basis, changes suppliers depending on who is the low guy on the totem pole.

Al, was Q4 the peak of the volume loss?

I -- I would say since it was a fairly active pricing environment, I would not be surprised if it also signified the peak of the volume impact.

And, Al, just on your own selling price increases, how much could be retained if we were to see a decline in some of your raw materials?

Well, again -- and I think it goes a little bit back to the point that I addressed with Allan earlier with regard to raw materials. Also here in our marketing and our pricing activities we have some fairly complex processes that we put in place. We make sure that we have a much better understanding of what actually is happening in the marketplace at the front of the customer, so that we do not have knee-jerk reactions and say because raw materials is going down, we have to go down with prices in anticipation of competitive action. I think we feel today, at least reflected in the efficacy and in the cycle time of our price increase, that we have a much more fundamental and better understanding of the pricing dynamics and I'm sure that's going to help us significantly also, should the situation in raw materials change.

Al, last question. Thank you for your time. Just on the M&A outlook for '06 and further consolidation in the adhesives industry.

Well, we eternally optimistic and I think that we have done a lot of leg work. We've had a few disappointments, but they were disappointments, again, muted by our understanding that they did not meet the criteria with regard to strategic fit and profitability that we had to them and so we said that's the cutoff point for us. And I think we will most probably see some successes in the first half of this year.

Thank you very much.

Jeffrey Zekauskas.

Hi, good morning.

Good morning, Jeff.

Your inventories really moved down from 159 to 142. And this was a quarter where in many areas in the chemical industry, there were production outages. How did you get your inventories down so far in the light of your sales growth, and were there any LIFO or FIFO benefits in the quarter?

I think as far as the overall situation is concerned with regard to why we were able to work our inventories down, we have mentioned in the past couple of calls that we have been involved in implementing Lean Six Sigma processes, which are fairly heavy data-driven processes which allows us to use the models to much better understand what the needed inventory levels are going to be to aid our customers and supply our customers on time. That combined with the short supply of materials despite the prevailing shortages in the marketplace that we could secure to our strategic sourcing team efforts, we basically did not have to buildup inventory for the rainy day. We basically knew what was coming in and we knew what was -- how it was going out, and that really allows to us really shrink the pipeline significantly. John can comment on the impact with regard to LIFO.

Two additional comments, Jeff. As Al alluded to, our focus on the working capital has really been around accounts receivable and inventory. And what you're seeing is the impact of that effort on a global scale, number one. Number two, to answer your question around the impact of LIFO, it was only circa about $1 million.

$1 million benefit?

Correct.

Okay. Secondly, in terms of the extra environmental charge and the insurance gain, how does that affect the individual segment income? That is, how do those two events affect Adhesives and Full-Valu?

Well, generally the insurance recovery is generally for something where we already have an outlay of money before. So it flows back to the business unit, where it occurs. Some of the insurance things are corporate issues. On the insurance, I cannot really give you a firm handle. But on the inventory side -- on the environmental side, that was for our Brazilian operation. The main part of that charge was for our Brazilian operation, where we're cleaning up the soil.

Yes, the majority of that was on the global adhesives side. There was a small amount in the environmental and the Full-Valu/Specialty.

Small amount --

And the insurance, as Al said, is mainly at corporate.

Right. And if I could just do a couple of housekeeping questions. The SFAS charge pro forma was $0.09 for fiscal '05. Is it -- is it the case that it's likely to be the same for [inaudible] '06?

Correct. Exactly. It's going to be about $0.09.

And in terms of the decrease in depreciation charges that you expect for next year --

Yes.

So if your -- call it 56 million this year, and you go to 45 million next year, is that a $0.26 a share benefit? Or if you go to 50, it's $0.13? Is that the rough calculation we should make?

Well, John can -- can go specific on the depreciation and amortization numbers. But overall, the way I look at it, we are dropping off of a depreciation schedule, but we're also, as I mentioned in my comments, picking up about $6 million of additional pension expenses in the course of the coming years. So it's almost offsetting.

That will offset?

Yes, exactly.

Okay. And lastly, the -- the -- I mean, the margin improvement you've achieved is substantial. Is it the case in your opinion that going into your -- to your first fiscal quarter of '06, your margins are widening out, in that they -- or are they sort of narrowing down? That is, the timing of some of the issues is a little bit difficult for us to see from our perspective.

Well, that is heavily dependent, of course, what's happening in raw materials because raw materials still account for about three-quarters of our cost of sales.

Yes.

And as I indicated in my comments, we saw a run-up in raw materials in the fourth quarter, which was not insignificant.

Right.

I believe at the last conference call, I've been asked what we anticipated, I said about 3% and it ended up to be about 2.5, or 2.7, or so sequentially quarter-over-quarter. We expect that rate to be in the first quarter higher, quarter-over-quarter. We expect it to be around 4 or so percent.

Yes.

Because what happened is a lot of these increases only flow through sequentially in the course of the quarter and are only hitting in full in the first quarter of this year. We think that we were fast enough with our pricing actions to maintain the margin, but we'll have to see how it actually shakes out, because some of that raw material pricing activity is still ongoing.

And just as a last question, do you expect your volumes to grow in fiscal '06?

In certain business areas, certainly. I mean, I've already mentioned to you the significant growth that we're seeing in new products and new product introductions. And it is certainly my estimate at this point in time that based on the pricing action that we have now also seen by our competitors as of January 1st, that we certainly are going to see a mitigating impact. And if you look at the total year, our volume had an impact of, I think, actual [products shipped] was 1.9% below the volume of last year so it's not been a huge decrease and I think we have to look at this over the longer time periods than just quarter-to-quarter to get a base understanding of what the dynamics -- underlying dynamics are.

So your goal is to grow 2 or 3% for the Company as a whole?

I would hope that we at least will be able to grow with the market place, and that's generally in that range.

Thank you very much.

Rosemarie Morbelli.

Good morning, all.

Good morning.

Continuing on the new product, Al, you mentioned that the gross margin of those products is 7 to 8% above that of the corporate average. How does that translate at the operating level? Are you losing a lot on introduction costs, marketing and so on? And then it -- those basis points disappear by the time you get at the operating level?

I think that varies a bit, Rosemarie. If you are going into new products for more consumer-oriented applications or closer to the consumer, you generally have market introduction costs that are significant because very often, you use additional third parties to be the channel to the marketplace and they, of course, would like to be compensated for their additional efforts. If I look at our adhesives-related businesses, generally, that's a more deliberate and slower process and is not accompanied by a lot of marketing activity, because it really requires convincing individual technical counterparts or customers that this product really brings a benefit. So the dynamics are different. But to compensate for that, we, of course, demand in our Full-Valu/Specialty product lines also a higher minimum gross margin for new products to be able to compensate for that.

So the bottom line is that with all of the steps you are taking, you are ending up with at least a 5% benefit at the operating level?

Absolutely.

Would that be a fair way of looking at it, you only lose about 2 to 3%?

Absolutely. It still is significantly contributory over and above what we have in the rest of our business.

Okay. And when you -- when you talk about the earnings per share projection for 2006, have you already included the option costs or do we have to add it?

No, that's already included, Rosemarie.

It is. And could you remind me what those numbers were?

Yes, the option expense was $0.09 a share.

And you gave us an estimate of $2.06 to $2.11? Is that --

$2.06 to $2.11.

Okay. And then lastly, it looks as though you are collecting a lot of -- or making sure that you have a lot of money available, and you -- all you mentioned that you would have most likely acquisitions announcement in the first half of this year. It sounds as though we are either going to have a lot of little ones or one reasonably sizeable one. Is that a good perception?

Well, we are looking at quite a variety of projects at this point in time and there are a few big ones in there and there are a few small ones. So we don't know which ones are the first that will come to fruition, but you know from my past discussions, Rosemarie, that our tendancy is in the adhesives side to look more to the larger transactions because the basic driver is economies of scale and synergies; whereas in the Full-Valu/Specialty business area, very often it is more related to entering new market segments and channels into the marketplace and also very often the available range of companies in the Full-Valu/Specialty segment tend to be privately held companies which to a large extent tend to be also smaller in nature.

All right. And you are looking in both areas?

Absolutely.

Okay. And then lastly, is there still a lag between your raw material cost increases and price increases, or with the price increases you have announced it will be closed by, let's say, the end of the second quarter?

No, I think, as you heard from my comments, that we're still for the year 1 percentage point behind 2004, which was not a terrific year and about 3 percentage points still below where we were before we moved into the recession. You see that we still haven't made up for the time lag. I think we have become much better at it and so what's being thrown at us right now with regards to additional increases, we have a better process in place, but we certainly have not yet made up for what we may have lost in periods before we had those instruments in place.

Okay. Actually, I do have one last question. I apologize. Are you seeing in any of your markets a slowdown in demand?

Would you repeat that question, please?

Yes. Are you seeing in any of your markets whether it be North America, Europe, Latin America, a slowdown in the level of demand, showing that the consumer is actually getting a little tired of all of this spending?

No, I would say overall the demand is still strong. And the reason I'm saying that is because if we're losing, as I'd indicate some volume because of pricing actions, of course, very difficult to say what the entire market is doing. But I've been listening and reading some reports from people that are active in these areas that I commented, and some of the people that have been announcing price warnings or did not achieve their results certainly had some volume growth that was significant. So I assume that while we are observing is still a solid market the demand it's just at this point in time going to the companies that perhaps are in their pricing area not as active as we are.

Okay. Thank you.

Godfrey Birckhead.

Yes, good morning, Al and John. Could you give us the equity, please, as of December 3rd, or the net worth, whatever you want to call it?

Yes, the stockholders equity, Godfrey, 588.2.

Okay. 588.2. Second question is that your -- oh, gosh, here. I got lost here. Oh, dear. Al, I had a question of you about where we are in terms of the life span of the adhesives business. It seems to me that it's fair to say that you're in a -- in a mature business, and generally when that happens a couple of things go on. Number one is competitors get lost in the path because they can't keep up, and number two, a lot of consolidation goes on. I mean, that's been the history of most of the industries that -- that we've watched over a long period of time. Could you address that? And say where you think we are now, and whether the two points that I made are correct or not?

Yes, Godfrey, I think quite a bit of that has already been happening and so today you have perhaps five or six global companies that combined have a perhaps, 30 to 35% market share overall in adhesives and in the United States, for instance, I may have mentioned these numbers before. There are 400 manufacturers of adhesives, in Europe, 500, in China alone there are 1800. So you can fairly well imagine that the average size of the competitors becomes small, very quickly. And so the question then is going to be how do you consolidate? Do you eventually consolidate by letting people go out of the business without assuming their product lines, without assuming their customers? Because that, of course, has an inherent problem attached to it because even a small adhesive manufacturer generally has about 400 or 500 different products. They generally have one or two manufacturing facilities. This they have a whole slew of other issues and the question then becomes fairly rapidly for the larger company, does it really make sense to go after these small companies to do a rolloff? I don't think it makes a lot of sense.

We have focused, therefore, our sights on the more substantive companies, the larger companies, and they generally also have a lot more of financial capability than the smaller ones. So they most probably are able to survive this temporary up and down what we have in raw materials. I'm afraid I cannot give you a more substantive answer than that. But it at least gives you some general atmospheric approach to this marketplace.

What's small and what's large?

Well, I'd say large -- I would consider it to be about 100 million and over in this market. There are -- I would call that substantive. It's not large. I would call that substantive.

Yes, right. And small would be what?

Well, small is below $10 million.

10 million. Okay. 10 to 100 million. Okay. I finally found my place here for my question. I apologize about that gap. Income from equity investments was 1.4 million versus 0.5 million last year in the quarter. What's going on there? What are the drivers and what's the outlook for '06, please?

Well, you understand that we did enter in two joint ventures with Sekisui, which led to a deconsolidation of the Japanese business from our sales and, of course, it is now reflected in the income lines that you're referring to. John may be able to give you some more details.

Okay. Thank you.

Godfrey, the improvement was essentially twofold and Al hit on it. It was the improvement in our JV with EMS-Chemie in the European Asia Pacific business, and then also in the income from equity investments we now have the Japan JV performance reflected in there. So that -- those two drivers are the 900 delta year-to-year.

Okay. And what is the income for the year as a whole is 3.3 million and your fourth quarter is 1.5 million. Should we multiply by 4 if we're making an earnings model for that particular item?

Yes, because that will include the run rate now of our Japanese operations going forward in '06.

So $6 million would be a good guess as to what that business will contribute in '06?

That's correct.

Okay. Thank you very much, guys.

You're welcome.

Chitra Sundaram.

Yes, thank you. You have talked about the fact that your competitors have been behind the curve in increasing prices. When we now come into the new year, how do you think the competitors stack up? Because you all have been fairly aggressive in raising prices. Do you have a sense that it is now even and it is a level playing field or are they still playing catchup?

Well, I, of course, do not have insight as to how they are doing overall in the marketplace. I can also only look at it from our perspective and what we saw is that, particularly when we had such rapid raw material increases in the second half of the year, there were quite a few delays. And I would assume that what has been announced with regard to January 1st is not going to be the only step that we're going to see in the next couple of months because I think that by itself would not necessarily recover entirely what was happening in the marketplace. And as I mentioned to you before on this call, the impact of raw material is going to be more severe in the first quarter than it is going to be in the fourth quarter, because of the time delay of some of the increases. So I would expect there still is going to be some -- have some activity going forward.

All right, I see where you are going with that. And then -- I guess I just missed one particular number, which was the global adhesive operating profit, if you could just give that to me. I just missed that number.

Yes, I have that, Chitra. The global adhesive operating profit was 18.9.

Oh, yes. Thank you. And lastly, I guess just on -- again, going back to the volume, I guess what I'm trying to understand, and I think most people on the call are probably trying to is get a sense -- versus, the third quarter, the fourth quarter, in global adhesives the volume decline seemed to increase. And [Full-Valu] seemed to get better and I'm just taking the volume growth for the total quarter and then adjusting that for the data you gave for the extra week and I'm --

When you make that comparison, you have to take into account that there is a seasonality difference as well. In the Full-Valu/Specialty business, because we have our paint business in central America, and our do-it-yourself business in Latin America, as well as in Australia, generally, those tend to be the high seasons for those businesses and that throws the number off a little bit.

Ladies and gentlemen, we have reached the end of our allotted time for questions and answers. Gentlemen, do you have any closing remarks?

We do not. We'd just like to thank everybody for taking the time to participate in today's call. Have a good day.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may all disconnect.