H.B. Fuller Company (FUL) 2007 Q3 法說會逐字稿

Good morning, and welcome to the H.B. Fuller third quarter 2007 investor conference call. At the request of the company, this conference is being recorded for instant replay purposes. This event 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. Michele Volpi, President and Chief Executive Officer, Mr. Jim McCreary, Interim Chief Financial Officer and Corporate Controller and 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, Lynn, and welcome, everyone. Today's conference call is being webcast and will therefore be archived on our website for future listening. In addition, this 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 operating income. Free cash flow is defined as cash provided by operations, less dividends paid, less capital expenditures. Operating income is defined as income before taxes, minority interest and income from equity investments, plus interest expense, less other income expense, less gains and losses on sales of assets. These measures should not be construed as an alternative to the reported results determined in accordance with GAAP.

Management believes that a discussion of these measures is useful to investors because it assists in understanding the operating performance of the company and its operating segments as well as provides insight into the ability of the company to fund such things as debt reduction and acquisitions. Non-GAAP information discussed today may not be consistent with the methodologies used by other companies. All non-GAAP information is reconciled with reported GAAP results on the last page of this presentation. Lastly, I want to remind everyone that the results discussed today for all periods are from continuing operations and do not include the divested powder coatings business. For more information, please refer to our recent press release, quarterly reports on Form 10-Q and end report on form 10-K filed with the Securities and Exchange Commission, all of which are available on our website at www.hbfuller.com under the Investor Relations section.

I will now turn it over to Michele.

Thank you, Stephen. Good morning, everyone, and thank you for joining us this morning. I'm pleased to report that the acceleration in financial performance continues, and we delivered another impressive quarter. Gross margin continued to climb, increasing 100 basis points year-over-year as a result of a better mix coupled with raw material management and productivity gain. This improvement was achieved despite a non-conducive pricing environment. SG&A expense continued to improve, down 80 basis points versus last year's third quarter. Disciplined cost controls and productivity enhancements primarily generated by the regional realignment led to this improvement. When you combine all these positive developments, operating income was a record high 10.7% of net revenue. Diluted earnings per share from continuing operations grew 21% on a year-over-year basis. This resulted in a record return on sales of 7.7% in the third quarter. Net working capital again improved year-over-year, resulting in not only less cash being tied up on the balance sheet but also reduced exposure to write-offs for obsolete inventory and bad debts, with a resulting positive implications on the credit ability and level of health of the income statement. Finally, we executed on the recently announced share repurchase program and have already completed 25% of the progress.

Volumes declined--[easily]--declined [east]--slightly in the third quarter, but we feel it's too early to define it as a trend reversal. Still, based on the evolution of our new business pipeline and progress around the key internal leading indicators we remain cautiously optimistic that we will be able to return to positive organic growth sometime in 2008. We have room to grow due to the novelty of our (inaudible) and concerted effort on geographic expansion. Our transformation into a more differentiated and solution-selling organization will help us in this difficult economic environment. From a regional perspective, Europe's organic growth was relatively flat, both on a year-over-year basis and sequentially, while the other regions each reported diminishing declines year-over-year. Average selling prices increased again despite the previously mentioned nonconducive pricing environment. [Mix] management continued pricing discipline and a higher proportion of sales from new product, led to a 2.2% increase on a year-over-year basis. From an external growth perspective acquisitions did not benefit the top-line development to the same extent as in prior quarters, as they largely became part of the basis. Foreign currency's inflation continued to benefit the top line as the dollar weakened versus most major foreign currencies during the quarter.

Raw material costs in the third quarter were up slightly both sequentially and year-over-year in aggregate, mainly due to certain industry supply disruptions relating to (inaudible) and continued upward pressure in hydrocarbon resins. With that said, we continued to experience a benefit from our sourcing and reformulation efforts, resulting in the decline of raw material costs as a percentage of net revenue. In the fourth quarter, we expect upward pressures to persist, particularly with respect to (inaudible) and hydrocarbon (inaudible) until the supply disruptions subside. We are continuously monitoring the situation and utilizing nimble procurement tactics in each region to maintain raw material cost abilities. These tactics, coupled with our ability to leverage a global supply network, are enabling us to procure enough raw materials to fulfill all of our customer demand. Although (inaudible) supplies continue to experience problems, we are comfortable with our supply position heading into 2008. Furthermore, we have proven pricing tools and processes that enable us to be thorough and proactive to rising raw material costs. These processes, implemented globally, enable us to continuously adapt our pricing to any changes we encounter in raw material.

Regarding external growth, we remain committed to take advantage of M&A opportunities that fall within the parameters of what we consider good business judgment. Clearly, we do not plan to join the recent trend of paying excessive multiples to gain market share. We are committed to delivering shareholder value and will only engage in transactions that will be strategically meaningful and accretive over time to both earnings per share and more importantly to return on investment. We continue to look for opportunities that are both strategic and synergistic. We expect the current macroeconomic turmoil and corresponding credit crunch will provide additional opportunities, and we believe that multiples will count down to make the likelihood of consummation realistic. Together, with employee and customer satisfaction, maximizing returns to shareholders over the long term is paramount for our organization. To that end, a few months ago we implemented the first share repurchase program for the company in nearly 10 years. Our strong balance sheet position, strong free cash flow generation and ongoing commitment to long-term shareholder value creation led us to initiate the $100 million repurchase program. With this program in place, we now have a more balanced approach to returning capital to shareholders. We still preserve a significant amount of flexibility with which to invest in key growth initiatives and to adequately pursue strategic merging and acquisition targets. During the quarter, we repurchased $25 million of stock at a very attractive average price of $27.15. This equates to slightly more than 920,000 shares and completes 25% of the announced program. This is a clear signal of our commitment to shareholder value and of our expectations for continued strong performance of the business.

Now, let me briefly provide you a regional review of the business. In North America, as we expected, both the slowdown in construction-related end market and sluggish automotive sector conditions persisted through the third quarter. These conditions will most likely continue well into 2008. Fundamentals continue to be weak and are having an impact in several related industries as well as in consumer confidence. Inventories [of unsold homes are at a] 15-year high, and homebuilder confidence continues to erode as they take significant write-downs on unsold properties. Price concessions and builder incentives have not been enough to stem the tide, and with the tightening availability of credit, it is quite conceivable that the worst is yet to come. This situation continues to have spill-over effects for the consumer market, as the big box home improvement retailers continue to struggle. Retail same-store sales are still in negative territory, and based on some of the latest comments, they do not expect any relief heading into 2008. Despite this challenging environment, the performance of our North American segment continued to improve. Operating income increased 5.5% and operating margin expanded by 150 basis points year-over-year. Focus on high grade value segments of the market and Lean Six Sigma productivity [programs] led to the improved results. Specialty packaging was especially strong with near double-digit organic growth and impressive increase in operating income.

The European economy showed signs of a slowdown in the third quarter. However, it remained relatively strong. Unemployment has dropped to its lowest level since 1999, and it appears as though Europe's growth will outpace both the United States and Japan in 2007. For the first three quarters, this is true for our business as well. However, lately, the ripple effect of the North American financial market turmoil and corresponding credit crunch has muted the (inaudible) region. At this point in time we believe it is still premature to make a definitive call for 2008. But we believe the western and southern part of the continent will grow at a slower pace than today, offset somewhat by a very buoyant economy in the eastern part of the region. Economic concerns aside, we are very pleased with the performance of our European segment. It continued to deliver very strong financial results in the third quarter. Organic sales were roughly flat in the period. However, strong operating profit improvements continued with operating margin expanding nearly 400 basis points year-over-year. Tight expense controls and productivity enhancements primarily led to the improvement.

In Latin America, political uncertainty continues to dampen business investment activity in the region. Several elections and policy reforms will be decided in the coming months, and a number of regional central banks have begun shifting towards tighter monetary policies. As a result, the tenuous business outlook continues. Like the other regions, despite [the ability] prevalent throughout the region, the Latin American segment continued to enhance its profitability profile. Operating income increased nicely year-over-year, and operating margin increased 110 basis points as the benefits of last quarter's Lean Six Sigma initiatives started to favorably impact the business.

Lastly, the Asia Pacific economic landscape remains robust. China's GDP continues to grow at double-digit rates, and the rest of the region in the single-digit range. Lately, inflation in China has crept up, running in the mid single-digits according to recent estimates. The Chinese government has responded with a series of interest rate increases, indicating that perhaps the rates of growth in this region as well may start to trend down modestly in the future. Our Asia Pacific segment began to benefit from the new regional structure and heightened management oversight. Profitable new business had a favorable impact on the top line, resulting in not only positive organic growth for the first time since 2004 but near double-digit organic growth. Likewise, we are seeing the benefits flowing through the income statement as operating income for the region grew despite an increased level of investment in SG&A. During the quarter, we decided to exercise our option to increase our equity stake in the Japanese business joint venture with our partner, Sekisui Chemical, to 50% from 40%. For the joint venture agreement we will pay $12 million to Sekisui Chemical once the transaction is completed. Although our stake will be at 50% due to the structure of the joint venture, we will continue to utilize the equity method to account for the joint venture.

With that overview, I will now turn it over to Jim for a more detailed review of the consolidated financials.

Thank you, Michele, and good morning everyone. For the third quarter, consolidated net revenue was $367.9 million, down 1.1% from last year's third quarter. The impact of acquisitions and foreign currency translation favorably contributed 1 and 2.2 percentage points respectively to net revenue growth. Higher average selling prices contributed 2.2 percentage points, and volume declines reduced growth by 6.5 percentage points year-over-year. Gross profit was $108.6 million for the quarter, compared to $105.8 million in the third quarter of 2006. Gross margin for the third quarter was 29.5%, up 100 basis points on a year-over-year basis. The improvement was primarily driven by a favorable shift in mix, greater proportion of new product sales, a more rigorous implementation of profitable pricing techniques in the former Full-Valu/Specialty businesses and continued Lean Six Sigma improvements in productivity. SG&A expense was $69.2 million versus last year's third quarter of $73 million. As a percentage of net revenue, SG&A expense was down 80 basis points from 19.6% in last year's third quarter to 18.8% this year. Solid cost controls and process improvement projects continue to reduce SG&A expenses.

Operating income for the third quarter was $39.4 million versus $32.8 million in last year's third quarter. As a result, operating margin improved by nearly 200 basis points from 8.8% in last year's third quarter to 10.7% in this year's third quarter. The effective tax rate for the quarter was 28.4% compared to 24.2% in last year's third quarter and 29% in the second quarter of 2007. This year's third quarter effective tax rate includes a discrete tax benefit of approximately $200,000. Last year's third quarter effective tax rate benefit is from both an improvement in the geographic mix of earnings and a favorable tax settlement. We continue to anticipate an effective tax rate of 29% for the year. For the third quarter 2007, net income from continuing operations was $28.4 million, up from $23.1 million in the prior year. This resulted in diluted earnings from continuing operations of $0.46 per share compared to last year's third quarter of $0.38 per share, an increase of 21%. The share repurchase program had a [diminimite] impact to earnings per share in the third quarter, given the timing of repurchases throughout the quarter.

Prior to discussing the balance sheet, I would like to remind everyone that the following figures are subject to minor changes prior to filing the 10-Q. Cash at the end of the quarter totaled $219.2 million, up $95.6 million year-over-year and $18.2 million versus last quarter. The increase in cash sequentially was driven by the continued strong free cash flow generation, partially offset by the repurchase of shares during the quarter. The after-tax proceeds from the powder coatings divestiture in December 2006 contributed to the year-over-year improvement in addition to strong free cash flow generation throughout the period. Total debt at the end of the third quarter was $171.9 million compared to $287.9 million at the end of the third quarter of 2006 and was essentially flat on a sequential basis. Net working capital, defined as the net amount of trade accounts receivable, inventory and trade accounts payable, amounted to $196.7 million. As a percentage of annualized net revenue, net working capital was 13.4% for the third quarter. This represents a decline of 60 basis points from last year's third quarter. The regional realignment is enabling a more rigorous management of working capital across all businesses in each region. Capital expenditures for the third quarter were $4.7 million, up $300,000 versus last year's third quarter spend of $4.4 million. For fiscal year 2007, we now expect capital expenditures to be in the range of $20 million to $25 million. Depreciation expense in the third quarter was $9.7 million, down $100,000 from the prior year's level. Amortization expense was $3 million in this year's third quarter, flat with last year. For 2007, we continue to expect depreciation expense to be between $35 million and $40 million, and amortization expense to be between $14 million and $15 million. Finally, free cash flow for the quarter was $39.3 million. Components for the third quarter were as follows. Cash provided by operating activities was $48 million. Dividends paid were $3.9 million, and capital expenditures were $4.7 million.

I will now turn it back to Michele for some brief closing comments.

Thank you, Jim. Before I close, allow me to recap some of the accomplishments of the quarter. We improved gross profit margin, reduced SG&A expense, both in dollars and as a percentage of sales, [grew] diluted earnings per share from continuing operations by 21%, continued to enhance our networking capital position and we announced and executed on the authorization to buy back our common stock. We are energized and cautiously optimistic about our future. We are committed to profitability improvements and consistent and steady results. We are today a much more solid and reliable business with a low risk profile and attractive returns. Despite a deteriorating macroeconomic environment, we are confident to raise our earnings expectation for the year to between $1.75 and $1.78. Previously, we expected to come in at the higher end of the provided range of between $1.65 and $1.75. In addition, we look forward to unveiling the next phase of our long-term strategy and corresponding financial metrics during our institutional investor day one week from today on October 3. We celebrate and congratulate our associates for the 11th quarter in a row of strong performance and for delivering a notable 23% growth in net income from continuing operations in a challenging economic environment.

In summary, we believe we have an attractive [impact]. In an environment where certain industry participants are reducing guidance and lowering expectations, we have continued to deliver impressive performance. We remain committed to consistent and predictable results and maintaining our relatively low risk profile. Thank you for your continued support. I will now open up the call for your questions.

(OPERATOR INSTRUCTIONS) The company would like to provide everyone the opportunity to ask a question, so if you could please limit yourself to two questions at a time, it would be greatly appreciated. You may requeue as often as you would like, time permitting. We'll pause for just a moment to compile the Q-and-A roster. Your first question comes from Jeff Zekauskas with J.P. Morgan.

Hi, good morning.

Good morning, Jeff.

Good morning, Jeff.

2007 has been a year in which Fuller has been able to sharply reduce its SG&A expense. Is that something you believe can continue into '08? And can you talk about some of the earnings dynamics you might face in 2008 given that you think that the economic environment is deteriorating a little bit, both in the United States and Europe?

Thank you, Jeff. Let me address first the SG&A, and cost of goods portion of your question. As for us, SG&A, we have solid cost controls in place, and continuous improvement [projects] that review our spend but also our structure and the processes that generate those (inaudible). We have been introducing those beginning of '05. So what you see today is the continuation of something that is meant to stay. We have ownership and accountability in key managers that has introduced a culture of investment and returns and risk assessment on those versus a culture of spending that we may have had several years ago. While injections of resources has already started to take place, and we'll accelerate farther in the growth part of the organization, I would say that the productivity improvements in both P&L and balance sheet continue relentlessly. One of the things I am more happy of is that we have created the ability to [variablize] much more of our cost structure. And that applies not only to SG&A, but also to raw material management, which is not just the way we source but also how we [deformulate], how we manage the risks preemptively, how we he manage global sourcing. It's also the continuous productivity improvement projects around factory labor and manufacturing overhead in the plant. So everything is scrutinized. Every day we come out with new projects, and that is meant to continue. It is an improvement process. It's not a cost cutting process.

Clearly, going back to the second part of your question, which is how we see the outlook of earnings to composition for next year. It's clear that while our mix efforts and reposition efforts meant to improve the gross margin percentage, and the cost initiatives that we discussed before will continue. And we'll address, as we said, not only P&L but also the balance sheet on the net working capital side. It's clear that we are committed to positive organic growth sometime during 2008. And when we look at our rate of new business closure, we see the momentum that we are generating in spite of a deteriorating economy. It makes us cautiously optimistic. So it's going to be a combination of all the components of the profit and loss and balance sheet that is what makes us confident.

And secondly, previously had you said that you thought your organic volume growth would resume in the fourth quarter of '07 and so you've changed that to sometime in '08, or am I mistaken about that?

Well, one thing is we always stated 2008 as being positive organic growth.

Yes.

What we spoke about the fourth quarter of 2008 was the beginning of a trend reversal in fourth quarter of '07--sorry--fourth quarter of '07. Clearly, the rate of improvement is not expected to be linear. When we speak of trend reversals, we have to be cautious. And we need more than one (inaudible) point. Clearly, we are happy to see volume declines easing in the third quarter. We believe it's a bit too early to call that a trend. I [feel] that between the third quarter--the fourth quarter of 2007 plus the fourth quarter of 2008--we will see a pattern that will bring us to the ultimate goal. And I think we have quarterly reviews for each one of our shareholders to monitor the progress. But we want to be very, very careful in jumping to conclusions on third quarter volume declines easing and making that a trend.

Okay, thank you very much.

Thank you, Jeff.

Your next question comes from the line of Douglas Chudy with KeyBanc.

Good morning. A couple of quick questions. I think it was mentioned during the call that during the quarter, the quarter benefited from pricing techniques that have been employed in the former Full-Valu/Specialty segment. Can you comment a little bit further on these and kind of where you're seeing the successes?

Well, first of all, we have to say, Doug, that the current environment, specifically North America, is not very conducive to pricing environments when you have people that are really struggling and reducing inventories, in reengineer the products, shutting down plants, is not that easy. We continue with our efforts. We continue not only Full-Valu/Specialty, which clearly is at the beginning of the cycle in terms of pricing improvement processes, but also in Global Adhesives. We are becoming more and more refined to make sure that we do not frustrate our customers. But still we continue the processes that we put in place at the end of 2004, and we are committed to them because it's part of our business model.

Thank you. And one final question. Can you just give a quick update on kind of what you've been seeing in the European insulated glass business? I think in the second quarter you were being undercut a bit on pricing. Have you seen any improvement that in market?

Well, I have to say that the insulating glass business in Europe is meeting expectations. Clearly, the construction market in Europe has not been as buoyant lately as it was before. Clearly, we're not speaking of a huge downturn, but a bit softening. So it's clear that we have to offset that with much more effort around our controllables, which is pushing more the new products, pushing the geographic expansion, basically working on our controllables.

All right. Thank you very much.

Thanks, Doug.

Your next question comes from David Begleiter with Deutsche Bank.

Thank you. Good morning, Michele.

Good morning, David.

Michele, how does the Henkel National Starch combination impact you and the industry going forward?

Well, it's a clear threat if it goes through, but we are positioned and equipped to deal well with it. Clearly, if this transaction is approved it will reduce the number of (inaudible) global competitors from four to three. Now, clearly, we do not compete on price but on value--the value that we bring to our customers. And we will make sure that this doesn't affect the way we deal with them. And actually, we will try to show our differential value, services and innovation in this environment. But clearly from a structured standpoint is a major change, and that's why we are working on it, in case that this is approved.

Fair enough. And as we look into '08 and beyond on volume, what is your organic volume growth potential, do you believe, Michele?

Well, Dave, next week you're going to be here. You're going to see which financial metrics we commit to and in what time frame, which we never had before. What new metrics we are going to add, some others to replace, and we will be very clear as for us what are our growth commitments, but also giving a good sense of confidence of how we're going to get there, and (inaudible) really a plan to get there. It is clear that we are here to accelerate our transformation and not just to manage a business.

Thank you.

Thank you, Dave.

Your next question comes from Rosemarie Morbelli with Ingalls & Snyder.

Good morning all.

Morning.

Morning.

Congratulations on a very good quarter.

Thank you, Rosemarie.

Michele, are you totally done with voluntary business elimination, meaning accounts, product lines, customers who are not profitable? And if so, if you would be left with the most profitable customers. And if the economy continues to slow down in 2008, which you are expecting to, and so do I, would that--you would then at that point start losing some business from your now new most profitable business partners. And would that affect your margins, or are you doing enough in house to be able to offset it?

Thank you, Rosemarie. Well, first of all, let me break down your question in different portions. The first one is, better positioning, our increasing gross margin percentages. Well, that's an evolution. If you look at it from this perspective, what was once a long-term target of 30% gross margin is by other companies very successful. Let me make an example. Like 3M is considered like a commodity. So clearly, our effort is over time by introducing new products, doing a better job with our customers, delivering more value is clearly making more money and is not at the expense of our customers but is together with our customers. That's why we have pushed a lot of the focus of Lean Six Sigma towards commercial practices, both on sales force effectiveness, on new product introductions, on marketing products, (inaudible). Another component, now I'm going to the second part, which is the risk part of your question of us losing market share, the more profitable business that is today part of our portfolio, I have to tell you that we have only 5% market share. Clearly, it's nowhere near to the one of Henkel and National. I think there is a lot of fragmentation in this market, so the opportunity is to grow in a profitable manner, if we do a good job are there. And that is what makes us cautiously optimistic. And we are not accepting any excuses coming from the situation of the economy. We are committed to growth, and it's going to be growth together with profitability.

So what you are saying is that if--let's assume that all of the customers or product lines you didn't want are are gone, and you are now sitting on a book of business which--with a higher level of profitability obviously. Even if the economy slows down substantially in 2008, there is still so much more room to grow profitably that even if those current customers order less because the demand is slower, you will not see an impact on your profitability.

I think, Rosemarie, that we will continue to move our portfolio to more differentiated and value-added position. We are committed to it. We already seen the actions of that. We have lots of things that we can do. On top of that going back to how much of the, call it it, quote unquote, low-margin business we have shed away, I have to tell you that that's a process that continues every day, and also that we are trying to look at not just from a gross margin percentage ratio, but also, I would say, looking at the profit returns on gross investment. Not just fixed assets but also working capital (inaudible) in the business. So we are introducing also other (inaudible) to make sure that our shareholders are happy with the current portfolio of products, customers and geographies we have, and they return the right amount of dollars on the capital [investment]. Now, moving forward, clearly we have visibility to our pipeline. The pipeline is developing nicely. Some of these things clearly take time. A lot is project related work. It's not price/volume equation short-term. And we look at that every day. We're engaged with customers. We see some good results. And that's what makes me cautiously optimistic and raising the guidance for this year and come in front of you and your other colleagues and the rest of our investors too and build a plan for a the future. And if I may ask one quick question of Jim, and thank you for that answer, by the way, why was the interest expense substantially lower in Q3 than it was in Q2 of this year. Sequentially, I mean? And what do we expect for the fourth quarter?

Yes. The biggest impact would have been the $25 million buyback with the shares.

Yes, but that--then that should have translated in higher interest expense, not lower, because--

We also had the payment of the private placement of $25 million in June--June 2--that impacted the interest expense.

Okay. So this is a good level for the fourth quarter? Or because you bought back stock, it will go back up?

Yes. The debt will be relatively flat third to fourth quarter. We still have the repurchase program that's in place, though.

Right. Okay. Thank you.

You're welcome.

Thank you, Rosemarie.

(OPERATOR INSTRUCTIONS) Your next question comes from Christopher Butler with Sidoti & Company.

Hi. Good morning, gentlemen.

Good morning to you.

Morning.

Question on the--with the growth that we saw out of your Asian segment. You had mentioned it was due to a new structure and management oversight. I was hoping you might be able to go into a little bit more detail there, and then give us an idea. Is this something that you think might be able to be rolled out into some of the other segments, or has that already taken place?

In (inaudible) and commitment, is yes. Let me tell you, the way we are doing it is not only putting the right leadership in place. Is also making sure that we invest in the region, that we put resources enough, and we have the right focus. That, I have to tell you, yes, there are some first positive signs that it is working. But there is another scene that you don't see, the results are [so important] and that is motivating me highly, that some of the new business projects, key milestones of value-added differentiated projects that we put in place 18 or 24 months ago have come to fruition. And that proves again that we can grow fast in a profitable manner in also very competitive regions like Asia Pacific. And that's why the answer that I gave you before is yes, of course we are working very hard to make sure that that model is becoming even better and is accelerating even better. It's solid, it's [table], it's sustainable and it's translating the rest of the regions. I can tell you that with the leadership team that we have put in place at the beginning of this year, we have followed the same logic everywhere else.

And shifting gears a little bit, it sounds as if you're taking a more cautious stance on mergers and acquisitions so as to not overpay for them. Looking at your cash position and free cash flow outside of the share repurchase program, if we're not looking at an acquisition here immediately, is there another direction that you have for cash at this point?

Well, that would be also part [crease] of the investment conference we will have next week where we will unveil how we're going to grow the business and what role will be played by M&A. We'll explain which are our criteria, and it will not just be me. It will be also Fabrizio Corradini, our new Chief Strategy Officer, which is going to align not only what he's going to be of the strategy, but what is the process, how are we going to measure ourself to give you confidence that we have a good plan, a good activity that is meant to bring only successful mergers, acquisitions and divestitures.

Thank you very much. I look forward to it.

Thank you, Chris.

Your next question comes from [Steve Schwartz] with [First Analysis].

Good morning.

Good morning.

Drilling down, in North America, in your auto segment, was op income positive this quarter?

Well, we have said all along that the automotive part of the business was not necessarily one of the most attractive parts of the portfolio, not just from a perspective of belonging to the core or not belonging to the core, but also from a results perspective, results both in gross margin percentage, in operating income percentage, and also growth profiles. And also I would have to add from a return on the gross investment into the business. So clearly, that situation has not improved given the deterioration in North America. It was slightly down this quarter year-over-year, the operating income. And I have to say in a tough environment while our partners of (inaudible) which are managing the joint venture in Europe and Asia Pacific all along have been able in a different economic environment to somehow manage the business. You have decent margins in most other segments in North America.

Is there--is there something you can do in automotive to improve that? What--how do you see improving that?

Well, we are working very closely with our customers. But you know very well how competitive that business is, and really what is the cost of doing business there. Clearly it's, I would say, a question mark in our portfolio. And we are continuously reviewing it, and we should be able to be more specific next week at the investor conference, as far as what we expect to do with the different parts of the performance of the company.

Okay. And then, last one, on Europe with the operating margins, it looks like they've stabilized around 10%. Do you think that they could ultimately reach that level where--a little higher, closer to maybe 15%, or at least where North America is at?

Our intention is to continue to improve returns over time. We will be more specific again next week. I think Europe has a terrific potential regardless of what the economy does. We have a great team in place. And if you look at what that region has done for H.B. Fuller in the last three years, in nearly triplicating the operating income as a percentage of sales, becoming a much more solid balance sheet component as well, it's something that we are very very proud of.

Great. Okay, thanks, gentlemen. Nice improvement this quarter.

Thank you very much.

You have a follow-up question from Jeff Zekauskas with J.P. Morgan.

Thanks very much. Can you just detail why other income was up $0.5 million in the quarter, or what was the difference from year-to-year?

Yes. Just one second, Jeff. I will ask Jim to answer that question in detail, please.

Yes, Jeff. When you look at it year-to-year, the biggest thing is the interest income. And that's driven by the cash generation. That's the largest factor in the other income in terms of the driver year-over-year.

Okay, so the interest income is in other, and interest expense is, in fact, just simply interest expense.

Yes, the interest expense is really the debt-driven piece.

Okay. And then lastly, over time, would you expect your capital expenditure budget to rise because you might need to build capacity in Asia, or, do you think that there are ways that you can grow with Sekisui so that there are no undue increases in your capital expenditures?

Jeff, let me take this one. Clearly, Sekisui-Fuller is a strategic joint venture. It's working well. We like our partners. We have been able to find a way to collaborate and grow the business together. So it is, yes, our intention to leverage that business. Now, there are some things that we are already doing in Japan. We are trying to accelerate much more the leverage of their contacts with Japanese transplants in China, for instance. But it is also clear, going back to your CapEx question, that--and not only in China, but also in other parts of the region, could be Eastern Europe, could be North Africa, could be India--we need to increase our presence to grow faster in those faster growing markets. We will discuss about that in detail next week at the investor conference. What is clear is that we will look at all the options, both CapEx, both alliances, joint ventures and acquisitions. And it's maybe different, as you will see next week, according to the regions, and the share we are in and the market segments we are targeting. So allow me to be a bit more specific next week, but it's clear that CapEx over the long term needs to follow the investment plans that we have.

Okay. Thank you very much.

Thank you, Jeff.

You have a follow-up question from Rosemarie Morbelli with Ingalls & Snyder.

Just quickly. Could you give us a better feel as to why the equity in the European joint venture is down by almost $1 million sequentially?

Yes, most of those--when you look at the sequential, it's really ties into seasonal-type items, Rosemarie. There isn't anything specifically relative to the activities in the automotive sections in Europe and Asia that would be fundamentally causing any type of an issue. So it's just seasonal swings between second and third quarter.

Do you--do you think that your partner in the automotive joint venture would be interested in acquiring your share?

I think, Rosemarie, that all options are always on the table. What we always said concerning the automotive business is that first, we were going to manage it, to make sure that our shareholders were not hurt by any kind of indecision, and that also we would have looked at all opportunities of acquisitions and divestitures that were providing shareholder value. So if this was considered a divestiture candidate, like other parts of the portfolio, maybe, and we will discuss about that next week. We would make sure that we get the right price for it.

Okay. Thank you.

Thank you, Rosemarie.

(OPERATOR INSTRUCTIONS) Your next question comes from [Steve Schwartz] of [First Analysis].

Hi. Back with a follow-up here. Can you go through basically how the share buyback's going to work out? Since we sequentially did not see a drop in the share count. And then, if you could, explain what prompted you to do the buyback or initiate it right now in this quarter.

Well, the buy back was the result of addressing our capital structure. I think we haven't been doing a lot on that in the last 10 years. We have focused everything on M&A. While I think that is one of the levers we have to look at. We have listened to our investors, and we believe that we have come out with a balanced approach to return on capital. We have committed to doing $100 million buy back, and as you have seen, typical of our culture, we like to execute on what we promise to shareholders. So we executed $25 million of that. And we have a plan in place and I may ask Jim to give more details about that. And we are making sure that we acquire and we do that in the best interest for our shareholders. Jim, would you like to answer?

Yes. In terms of the impact, for example, in the third quarter, we had a very little impact on the buyback relative to EPS, probably less than $0.001, given the timing and the weighted average nature of the way the shares would be calculated. So that's why you don't see a significant drop in the number of shares. And then looking at the impact so far of the buy back, into the fourth quarter, you're probably looking at something in the 1/3 of $0.01 per share type of a range.

Okay, was it--was it the share price that prompted you to start off with this 25% of the program now? Because if I remember when you announced the program, you were pretty much open-ended with when it might technically occur.

Clearly, we were open-ended, but we have our plan in place and our (inaudible) strategy of what to do and when to do it. And we believe that we are an attractive investment, and that's why we have in the third quarter executed on 25% of it.

Okay. So it doesn't sound like it was the fact that the share price was low, and you were able to get it at 27 and change. There were other factors there, in other words.

We have a plan in place. We are executing to that. And I can tell you that we are doing--trying to do our best to make sure that we execute on our promises and that we have very good compliance but also technical execution. So there are several levers, and as everything in this company, we try to manage all of the controllables.

Great. That helps a lot. Thank you.

Thank you very much.

At this time, there are no further questions. Gentlemen, are there any closing remarks?

We'd just like to thank everybody for joining us today. And please have a good day, and we look forward to seeing you next week.

Thank you. That does conclude today's conference call. Thank you for your participation. You may now disconnect.