H.B. Fuller Company (FUL) 2010 Q1 法說會逐字稿

Good morning and welcome to the H.B. Fuller first quarter 2010 investor conference call. 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 Giertz, Senior Vice President and Chief Financial Officer, and Mr. Steven Brazones, Assistant Treasurer.

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

Thank you, Lauren, and welcome, everyone. Today's conference call is being webcast live and will also be archived on our website for future listening.

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 those 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, operating income, earnings before interest expense, taxes, depreciation expense, and amortization expense, or EBITDA, adjusted earnings per share, and return on gross investment, or ROGI. Operating income is defined as gross profit less SG&A expense. EBITDA is defined as gross profit less SG&A expense plus depreciation and amortization expense. Adjusted earnings per share is defined per our earnings release, and varies depending on the period. And ROGI is defined as trailing 12 month gross cash flow divided by gross investment.

All of the non-GAAP measures discussed today 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 the comparability of results. And it provides insight into the ability of the Company to fund such things as debt reduction, acquisitions, and share repurchase programs. The 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 pages of our presentation.

For more information, please refer to our recent press release and annual report for the year ended November 28, 2009, on Form 10-K as amended, filed with the Securities and Exchange Commission. Both of which are available on our website at www.hbfuller.com, under the Investor Relations section.

I will now turn the call over to Michele.

Thank you, Steven. Good morning, everyone and thank you for joining us today.

Although we began the year with a fair bit of uncertainty about the global economic landscape, we started to see end market conditions improve during the first quarter. As you know, throughout the recession we have been focused on investing in our organization to position ourselves well for the global economic recovery, and to capture some opportunities arising in the marketplace. We began to capitalize on these investments in the first quarter and our strong results are evidence of our success. Last, we are committed and confident that these investments will drive further consistent growth in future years. Let me now share with you a few of the highlights from the quarter.

First, our organic growth plan reversal continues now for three quarters in a row. And we achieved double-digit sales growth. Organic sales grew more than 6% in the first quarter, driven by strong volume gains year-over-year. The improvement was broad-based in every region, except for Latin America posted positive organic growth. The investments we have made within our customer facing functions are clearly producing results. As we implement our strategic transformation towards differentiation, innovation, and value, we are unlocking and capitalizing on a number of new growth opportunities.

Second, we maintain gross margin at the strong fourth quarter levels. Although raw material cost inflation began to pick up during the first quarter, the full impact to gross margin was delayed, as lower cost inventory on the balance sheet cycled through cost of goods sold. This delay, combined with the benefits of our reformulation efforts and product mix management, enabled us to maintain our margin at historically high levels in the first quarter.

Third, we improved our EBITDA significantly year-over-year. EBITDA dollars grew more than 50% and EBITDA margin improved 340 basis points versus the first quarter of last year. Higher volume and lower raw material costs drove gross profit dollars higher by $23 million. This improvement in gross profit more than offset increased SG&A spending, and led to the strong improvement in EBITDA year-over-year.

Next, diluted earnings per share increased nearly three-fold to a historically high level in the first quarter, driven by the significant expansion in operating profit and by lower below the line items, including taxes. Overall, diluted earnings per share improved to $0.38 in the first quarter of this year, up from $0.13 in last year's first quarter.

Finally, soon after the end of our first quarter, we announced acquisition of Revertex Finewaters in Malaysia. Revertex is a strategic acquisition in southeast Asia which will expand our geographic presence in the emerging markets of Malaysia, Thailand, Indonesia, the Philippines, Vietnam, and Singapore. In 2009, Revertex reported net revenue of approximately $80 million. This acquisition will enhance our product offering in the region and improve our proximity to our customers. As a result, we expect this transaction to generate significant growth synergies in the years ahead. This transaction should close by the end of the second quarter.

With that, as a quick summary of our first quarter highlights, I would now turn the call over to Jim for a review of our financial and operational performance.

Okay, thanks, Michele, and good morning to everyone.

As we do each quarter, I'll start with a quick review of our four key financial metrics. As Michele mentioned in his opening comments, during the first quarter we returned to positive organic growth. Strong volume gains of 8.3%, offset somewhat by slightly lower pricing, resulted in organic sales growth of 6.1% year-over-year. As the chart indicates, in late 2008 we were well on our way to reestablishing an organic growth trend, and then the global recession hit. We've now weathered that storm, returned to positive territory and, we believe, positioned ourselves for consistent organic growth going forward.

For the trailing 12-month period ending this quarter, EBITDA margin was 13.2%. This represents an improvement of 70 basis points versus the previous quarter, and 270 basis points versus the first quarter of 2009. In the recent past, our EBITDA improvement has been driven by gross margin expansion. And now as we move forward, further EBITDA expansion should be driven by leveraging our fixed cost base over higher revenue.

In the first quarter of 2010, ROGI improved 70 basis points sequentially to 8.4%. The improvement was driven primarily by the increase in EBITDA and, to a lesser extent, by a slightly lower gross investment.

Our final metric is EPS growth. Our long-term goal is to achieve a five-year compound annual growth rate, in diluted earnings per share, of between 10% and 15%. At the end of the first quarter the trailing 12-month five-year compound annual growth rate was almost 22%, well above our target range.

Now we turn to the balance sheet and cash flow. We continue to maintain very strong credit ratios for our BBB credit rating, and we are in a very strong liquidity position. Cash on hand at the end of the period totaled $149 million and debt totaled $279 million, resulting in net debt of $130 million. At the end of the first quarter we received the final tranche of our private placement debt offering and formally concluded that process. We utilized the proceeds from the private offering to pay down existing revolving credit facility debt. At the end of the quarter, borrowings on the revolving credit facility were less than $5 million. As a result of these capital structure enhancements, liquidity has been significantly improved. However, interest expense will increase and start exceeding prior year levels, beginning in the second quarter.

In the first quarter, we reduced our investment in net working capital from 20.1% of annualized net revenue to 17.3%, an improvement of 280 basis points year-over-year. On a days basis, inventory days improved the most, but all components showed improvement year-over-year. Sequentially, networking capital increased 180 basis points to 15.5% -- from 15.5% to 17.3%. However, this was primarily due to the seasonality of net revenue, as total networking capital investment was essentially flat in dollar terms versus the fourth quarter.

Our operating cash flow performance was really stronger than the reported numbers suggest. On a reported basis, cash flow from operations was slightly positive and essentially flat with last year's first quarter. However, this year's first quarter number included higher benefit and incentive compensation-related payments of approximately $17 million. After adjusting for these timing factors, the year-over-year improvement in the underlying cash generation of the business is evident.

And lastly, regarding capital expenditures, we reported a noticeable increase in spend, from $4.9 million in last year's first quarter to $9.4 million this year. A large portion of the increased investment was related to growth initiatives. Specifically, the construction of our new facility in China, and the upgrade and build-out of our facility in Egypt.

With that as a summary of our financial performance, I will now provide a brief regional update. During the first quarter each region made progress in improving its revenue growth profile, and with the exception of the paints business in Latin America, all business components in each region achieved positive organic growth. Investments in sales, marketing, and technology have aided new business development efforts, and more favorable end-market conditions have led to improved demand for adhesives and related products in each region. Along with improved growth profiles, each region has significantly improved its profitability profile versus the prior year. The improvement in each region was driven primarily by lower raw material costs, higher volumes, and improved product line profitability, as a result of each region's reformulation actions.

In North America, both business components grew organically and both posted positive volume growth year-over-year. The adhesives component achieved organic growth of nearly 7% year-over-year, driven by strong volume gains across most end markets. For our specialty construction business component, this is the first time in four years that it has generated positive volume growth. Clearly, the comparisons are relatively easy, given the dramatic decline in construction-related activity in the region, but this is encouraging news nonetheless. Our specialty construction business is benefiting from management changes made in 2009, internal initiatives undertaken to enhance their channel and product offering, as well as the slowdown in the decline of the construction-related end markets.

In Europe, India, Middle East, Africa, strong volume growth of 12.7% more than offset a 4.6% decline in average selling price, resulting in organic growth of 8.1%. An improvement in general economic activity led to volume expansion within the construction and packaging market segments, and our strong presence in the Middle Eastern markets also helped to improve the overall growth profile of the region.

In Latin America, net revenue was essentially flat versus last year's first quarter. Like last quarter, there was a meaningful difference in the performance of our two business components. Adhesives expanded organic sales 4.9%, as a result of higher volumes in the hygiene and packaging marketing segments, while paints experienced a decline in organic sales of 5.1% year-over-year, as volume declined across all channels. The decline in paints volume was related to the fall-off in construction-related activity in Central America and the generally more subdued economic conditions throughout that region.

In January, we elected to realign the region with North America. As a result, our North America and Latin America operations will now operate collaboratively as one region, reporting to Jim Owens, who has been named Senior Vice President of the Americas. Since his arrival less than two years ago, Jim has moved quickly to set a course and bring our strategy to life within North America. So we are confident that the entire Americas region will benefit from his leadership as we go forward.

Lastly, our Asia Pacific region was the most improved region year-over-year, on both the sales and an EBITDA basis, continuing the profit improvement that began in the second half of last year. Organic sales for the region grew 15% year-over-year, driven by higher volumes in hygiene and strength in both consumer and industrial adhesives in Australia. The improvement in EBITDA was impressive as well, with nearly a six-fold increase in EBITDA year-over-year and a 640 basis point expansion in EBITDA margin. This strong momentum in the region will be reinforced with our acquisition in Malaysia.

So with that as a regional update, I would now like to turn the call back to Michele for a brief discussion of our expectations for the remainder of the fiscal year.

Thank you, Jim.

We are off to a great start in 2010, and we continue to be optimistic for the balance of this year and beyond. Our pipeline of new business continues to grow, as a result of the success we have had in both gaining new business and expanding our offerings with existing customers. In addition, the more stable global economic conditions are positively impacting end-market demand for the industry as a whole. We are now generating solid organic growth, and we fully expect this trend to continue throughout the rest of the year and well into the future.

For 2010, we expect net revenue to increase between 9% and 11% versus the prior year. Most of the growth will be organic and will largely be volume driven. Future acquisitions, including the impact of Revertex Finewaters, will be incremental to these estimates.

Although raw material costs were down about 5% year-over-year in the first quarter, they are set to increase approximately 8% year-over-year in the second quarter, and 6% for the full year. While we began implementing pricing actions already in the first quarter, we are now in the process of ramping up those actions to compensate for the higher inflation. As a result, gross margin in the second quarter will likely decline from the historically high level achieved in the first quarter, and then rebound somewhat in the third and fourth quarters. As we have demonstrated success in growing organic sales, we are encouraged to continue to make additional investments to further support our strategic growth initiatives. These investments will primarily be talent related. Similar to the investments we have made in the past, these new investments will also be concentrated on improving our collaboration with customers. All regions will be adding resources, but there will be special emphasis made to enhancing our capabilities in our EMEA region in 2010. By their very nature these investments are not expected to produce immediate results, but we are confident, based on the success we have enjoyed thus far, that they will further enhance the growth profile of the Company, and lead to even higher organic growth in the future.

Lastly, for 2010, we continue to expect capital expenditures of approximately $25 million and an effective tax rate, before discrete items, of approximately 34%. We are very pleased with our strong start to the year, and we are committed to finishing the year strong.

I would now like to open the call up for your questions.

Thank you, sir.

(Operator instructions) If company would like to provide everyone the opportunity to ask a question, so if you could please limit yourself to one question at a time, it would be greatly appreciated. You may requeue as often as you would like, time permitting.

And our first question comes from Jeff Zekauskas. Please go ahead.

Good morning, this is Olga Guteneva, sitting in for Jeff.

Good morning, Olga.

How are you? Good quarter.

Quick question on raw materials. So with your raw material inflation forecast, do you assume pricing sort of flat from now on, or going down through the year? What's the assumption behind the raw material inflation?

Thank you, Olga.

Clearly at the beginning -- at the end of fourth quarter, when we were outlooking for 2010, we were expecting low- to mid- single digits in terms of inflation, and instead, we are facing higher numbers and faster pace. So that's why we caution that on the second quarter, we expect sequential increase that is going to be around 5% which, year-over-year, is an 8%.

Pricing, we have started taking pricing actions in the first quarter, and more is expected in the second quarter. But we are trying to do that in a way that really doesn't compromise our growth, that we do it in a collaborative way with customers. But you can expect that there will be some price increase in our organic growth for the next three-quarters.

Okay.

If I may, just quick question on European margins. I though this question comes up every single conference call, but margins still seem like lagging North American margins. What are your goals there, and what are you trying to achieve in Europe?

Well, overall, I can tell that you longer term, we really would like to reduce the variance between the regions. And when we're speaking of margins, we are speaking really of our long-term metrics, which are EBITDA margin and ROGI margins, and clearly that goes through all the components of the P&L. Clearly it starts with growing sales, and making sure that we get to the right critical mass in each one of the critical countries in Europe. It talks about innovation, it talks about aligning the pricing with the cost to serve economics, which are a bit more complex. There is more fragmentation in Europe in than in North America. But longer term, we expect Europe, but not only Europe, also Latin America and Asia Pacific, to reduce their gap as far as North America is concerned.

Thanks for that.

And just one more housekeeping question. For the interest expense, is it something like $10 million per year we should expect on the annualized basis from now on, or smaller than that?

Yes. Hi, Olga. This is Jim.

At the fourth quarter conference call, so our last conference call, we gave a little guidance on this. So we said our interest expense would be about $4 million higher than last year. So interest expense last year was $7.7 million, and so that would indicate about $11.7 for the year. That was our guidance last quarter.

Similar, although I think our outlook has been that our interest expense will be a little bit lower than that, than we originally had forecast. So it's something on the order of $3 million per quarter for the last three-quarters of the year, would probably be a pretty good estimate for interest expense.

Okay. Thanks a lot. I'll get back in the queue.

Okay.

And our next question comes from Mike Sison with KeyBanc. Please go ahead.

Hi, guys. Nice start to the year.

Thank you.

Hi, Mike.

You guys have done a good job changing your commercial organization and sort of winning new project wins. I'm curious, when you take a look at the improvement in organic sales growth here in the first quarter, and your outlook for 2010, how much of that is sort of what you have done in terms of changing your business, and then how much of it is, to some degree, maybe restocking from customers sort of that rebound from that part of it?

Well, I think, Mike, that is a combination of all of the above. Clearly we were facing in the first quarter easier comps. Everybody knows that. Clearly last year everybody was de-stocking in a massive way, and now people are still cautious. I wouldn't say that they are restocking, but, you know, there is some replenishment going on. But there is also us clearly gaining new business and growing the current customers. So I really believe that we grew faster than the market, and that is our intention for the future. Basically, what we have put in place is something that we expect to continue, and I would encourage everyone on the call to look for consistent organic growth over the next quarters. That's what we're committed to, and that's why we're making investments that we mentioned before.

Okay.

And just a quick follow-up, Michele. When you think about 2010, it does sound like raw materials are going to be higher than you initially thought. At the same time, looks like the outlook for organic sales growth could be a little bit better than you thought. I know you stopped giving earnings guidance, but when you take a look at your plan for the year in terms of earnings, has it changed a lot, meaning that, you know, the better volumes offsetting the higher raw materials at the end of the day, you'll probably still end up where you initially thought?

Mike, let's look at it from a high level.

We are positioning ourselves for growth for the years to come. The company has not really grown for the last 12 years, so this is a pretty big change right? And when we are making so many changes, you know, that results are not necessarily [inaudible]. But one thing that you saw, why we committed intensive guidance, is that organic growth is going to continue. We are making sure that our margin management strives to maintain them at high levels, but we are doing that in a cautious way.

At the same time, we need to make sure that to put legs behind this strong organic growth, that we do those investments that we mentioned before, which is not just bringing people in, it's also training people, also developing people, it's compensating people adequately, and doing all the things that you want to do when you are transforming a business, from maybe more of a commodity model to a growth model.

Okay. I'll get back in the queue.

Our next question comes from Jason Miner with Deutsche Bank.

Thank you. Good morning.

Good morning, Jason.

Sticking with that transformation theme, Michele, I know your efforts to revision the company here have involved a lot of investment in customer facing talent, and that you've reformulated to offset higher raw materials, but back at the investor day we discussed some new product and initiatives. I wondered if you had any commentary, or even metrics, on maybe new product vitality, or what you've done in the product portfolio to be part of that repositioning and transformation.

Well, I can tell you one thing, Jason. We are working very actively on that, and I expect towards the second half of this year to be able to come up with something that is meaningful, that can be tracked.

For now, I can tell you the technology department has done an amazing work at supporting the reformulation efforts of the businesses. That has been critical. It's strategic. I think today we are much better equipped than in the past. We can deal well with customers, we can work with them, we are very, very fast. At the same time, I can tell you that the number of patents is increasing, clear evidence that there is a lot of innovation efforts going on. I think what we have to do next is exactly as you're saying, is putting some metrics that are visible for everybody, so it can be understood and can be tracked.

Okay, that's encouraging. Thanks. I look forward to hearing more about that.

On the raw materials side, I wondered if you expect any regional concentration, and I guess coupled with that, on the margin front, what I mean by that is, would raw materials pressure be stronger in any region versus another? And then, I was trying to bundle another question in, and ask if pricing is more challenged in any region versus any others.

Well, I would say that what we have seen lately has been across the board. Clearly some of the things that can change that feature and create an imbalance between the regions, are also shortages, shutdowns of plants that happen in regions, regardless of cost dynamics. We're watching on that, because recently there have been outages and plants down. And so clearly as the economy is revamping, people are trying to cope with the capacity.

Okay, I'll overstay my welcome for one last one for Jim, perhaps.

If the Euro were to stay where it was or perhaps even weaken, would you guys expect a head wind to earnings from FX through the year?

Well, Jason, I can say that, to start with, the revenue guidance that we gave you has the Euro and all the currencies reset to basically the rates that were in effect at the end of the quarter. So I guess my answer to you would be -- and we don't give earnings guidance -- so I guess my answer would be no.

Okay, fair enough, thank you.

Our next question comes from Dmitry Silversteyn with Longbow Research. Please go ahead.

Good morning, guys, and congratulations getting the year off to such a strong start.

Good morning, Dmitry.

Couple of questions, if I may.

First of all, when you talk about tax rate being 34% for the year, since it started out at a much lower rate in the first quarter, I would assume it would be higher than 34% for the balance of the three-quarters, correct?

Yes, this is Jim.

When we say the tax rate is 34%, we say that's our rate without the discrete items. So the difference between between 34% and the actual tax rate that we posted in the first quarter is accounted for by discrete items.

So what were the discrete items in the first quarter?

It's about a million dollars of discrete items. It lowered our taxes by about a million dollars, a little over a million dollars. It's variety of different things. It's expiration of -- statute of limitations expirations and the settlement of different disputes and claims. It's a miscellaneous variety of things.

But basically to your question, without discrete items, the tax rate was about 34% in the first quarter, and we anticipate it will be the same in the balance of the year.

Okay, so do you expect any discrete items -- how should we think about this guidance going forward? It's not a huge driver of earnings, but it does, you know, jerk earnings around by $0.03 to $0.05 any given quarter depending on whether you assume 34% or 30%.

The fact of the matter is that, in most quarters, we do have some discrete items. And I think the pattern would be that generally they're favorable. That's not always the case, but that's generally the pattern. We try to give the guidance the best way that we can, to give you a basic understanding of what the underlying structural tax rate.

Right.

Let me ask you a different question, Jim. Or same question, differently. For the year in 20 10, what do you expect your tax rate to be all in, including all the discrete items within individual quarters?

Hang on. I might have that one.

Well, it's basically 34% minus the $1 million of taxes, discrete items that we already generated in the first quarter.

Okay.

Hang on. I'm looking at a chart that will give me that answer, or solve for that, which is about 32.75%.

Okay. Something under 50%. That's fine.

Second question is, the profit decline that we've seen in the EMEA region, when you look at the level of revenues, which is kind of corresponding to perhaps what we saw back in the third quarter or so of 2009, and the profitability is significantly down from that level. So can you give us an idea of, you know, if you kind of compare similar revenues of $94 million this quarter versus the August 2009 quarter, and yet your operating profit is 40% lower and your operating margin is significantly lower as a result. Given the positive raw material trends that you've expressed, and flattish revenues, comparing -- comparing those two periods, why is the profitability decline so much and where can we expect that to go, going forward?

Dmitry, let me first understand your question, because the operating income for the first quarter of this year in EMEA was $4.1 million.

Right. And it was $7 million in 2009, when you had the same $94 million in revenues.

Last year we had $1.8 million, right?

I'm not talking about first quarter of last year. I'm talking -- I'm looking at comparable revenue numbers. So the last quarter -- last year in the third quarter, in the August quarter, you had $94 million for that region generated, and you've generated about $7.2 million in operating profit. In the first quarter of this year, you had the same $94 million in revenues, but you only had $4 million in operating profit.

Well, I think that while we are working on the top line, we have also been investing in terms of structurally, adapt this business for the future goals. So clearly there is higher SG&A.

Okay. So it's a question of SG&A basically offsetting the benefits of raw materials, or whatever else you may be seeing.

Yes, and that's in line with what we're trying to do, Dmitry, right? The company has not grown for 12 years, and we are in some opportunities that are available in the marketplace. We are trying to be both strategic and tactical. Capture them. You know, we're not just looking at one quarter.

I understand, Michele, I'm not arguing with the numbers, I'm just trying to understand what's behind them. That's all.

Okay. And then, finally, you've talked about raw materials moving up, perhaps a little bit faster than you expected, and trying to go after them with pricing. Have you begun your price initiatives, and if so, can you give us an idea of how successful they have been, what the customers are receptive to, and what they're less receptive to, and what the competitive environment is like currently?

Well, the pricing actions have started already in the first quarter. Clearly we'll accelerate in the second quarter. And so far, we have made sure that our customer relations were not endangered. But one thing that is conducive to what we're trying to do, is that we see pretty rational competition. Nearly everybody is going for price increases also, because everybody has seen that raw materials are going up higher and faster than expected.

Now, you did get pricing, obviously the first time around, when raw materials were up in 2007, 2008, and you didn't give up too much pricing when raw materials were down in 2009. Is there a sense among the customers that you're trying to get paid twice for the same price increase, now that raw materials are going back up, or are customers able to pass through price increases to their end markets, and therefore are more receptive to accepting price increases from you?

Well, it changes from customer to customer and market segment to market segment. I can tell you in 2008, if we go back to the past, we didn't do such a great job in terms of recovering raw material increases, and we were not really that fast. So clearly, that is something we have to take into consideration as far as comparisons are concerned. I think we are having a pretty good balance, and making sure that we have a balanced approach with the customers.

Is one market easier to get pricing than the other? In other words, adhesives versus specialty construction?

Well, I would say that it's not just the market, it's also how we go at it, what is our value proposition, and the different customer base. So far, I can tell you we're having a very similar approach across all market segments and geographies.

Okay, Michele. Thank you very much.

Thank you, Dmitry.

(Operator instructions)

Our next question comes from Steve Schwartz with First Analysis. Please go ahead.

Good morning, everyone.

Good morning.

Michele, the price decline in the fourth quarter and in this first quarter, would you tag that as being more strategic in nature, or was it contract driven, or is there something else that was driving your price down?

Well, I would say that a lot of that is related to the fact that raw materials were coming down, and clearly you have to recognize that, or part of that to your customers, to make sure that you keep growing with those customers, and it's a fair relationship. So I wouldn't see anything else, trying to read anything else behind that, because as you have seen, we have managed our profitability pretty well in the fourth quarter and in the first quarter, and we are making sure that everybody in our organization understands that we need to manage well the polarity between price and volume, and that we need to do both, of course. You have a different approach, as far as the year is concerned compared to the quarter, and we care more about the year than the quarter. But I think we have got to a pretty good level.

Okay.

Just with respect to volume, Europe versus North America. They both had similar year-over-year comps in terms of volume, but Europe grew much more than North America, depending on -- numerous economists are pointing out that Europe is recovering, perhaps in some ways, slower than North America. How is it that you guys got the stronger growth in Europe?

Well, we were also starting from a much lower base in Europe, right? Plus, clearly we have put a lot of effort there, but I would say that, you know, when you compare negative volume of nearly 16% for both, and you go to a positive volume of 7% for North America and 12% for EMEA, we're basically speaking of 28 points of trend reversal versus 23. So I would say both of them good, both of them impressive, both of them sustainable. Clearly one started from a lower base.

Okay.

And then if you could, Michele, just clarify, if I've missed this, when you talked about gross margin second quarter, and then 2H-10. The second quarter comment that you made, is that on a year-over-year basis that you expect it to the drop, or sequentially?

And then in the second half of '10, I think you got some very high comparables on gross margin. Would you expect to top those, or at least match them?

Well, you know, clearly in the second quarter, we're speaking sequentially, and also what we are speaking about is that, if you remember, first quarter of '09 to second quarter of '09, gross margin went up by 300 basis points. So clearly on a year-over-year comparison we have a much tougher comparable. So that's basically what is going on in the second quarter. There is the typical time lag of raw materials pricing dynamics, and based on what we know today, clearly that's why we said that gross margin would likely decline. That doesn't mean that we are not pushing on price, that we are not pushing on reformulations. But again, based on what we know today, that's what we expect, and we want to make sure that we manage that pricing and raw material dynamic without compromising the volume growth that we have committed to with everybody, not just for 2010.

So it declines from 31.6% in this quarter. Does it go below the 29.9% you did in the second quarter of '09? What's your feeling there?

That brings me to giving even gross margin guidance. I'm not giving EPS guidance, so allow me to just tell you directionally where we think we are headed.

Okay. Well felt compelled to ask anyway. So, thank you for taking the questions.

Fair. Thanks.

Our next question comes from Rosemarie Morbelli with Ingalls & Snyder. Please go aheaad.

Good morning.

Good morning, Rosemarie.

Congratulations on a good first quarter.

Thank you.

Following up on the gross margin, I understand the direction, I understand you are not wanting to commit to being above the 29.9% you had in the second quarter, and I understand that also you will have some improvement sequentially again in the second half, and most likely not to the 31.8% you had in the third quarter. But do you think that by year end, you could actually reach the 31.2% you had in the fourth quarter of last year, which was actually lower than the first quarter of this year?

Thanks for keeping me on the same point, Rose Marie.

Basically we are changing lots of things at the same time, right? We are moving from negative organic growth to positive organic growth, and I would say a substantial one. We are introducing lots of new people. We are putting a lot of effort on developing everybody. We are rebuilding customer relationships, and at the same time, we are managing also the price and volume relationship. So there are lots of balls moving. I think directionally we are very, very happy with where we are headed, but the change is not linear.

So at this point in time, one of the reasons why we are not providing guidance is not just because the market is still uncertain, but because there are so many balls that we are juggling in the year, and we want to make sure we are not compromising the long term for the short term. So if you allow me, and I don't want to be impolite, I'm not going to provide specific guidance on gross margin.

Okay.

And could you give us, since you have a new person, a new manager in charge now of the Americas, and I apologize, I forgot his name, have any thoughts come out from his looking at both regions regarding the paint business in Latin America and what his role is. Is it helpful to the adhesives business, or now that you have it as one region it really makes no sense at all? Could you give us a feel for that?

First of all, his name is Jim Owens.

Thank you.

And he took over basically Latin America into the new region I would say, like one month ago, so let's be fair and give him some time to understand a bit better what he's got. But, you know, it's on his plate, like everybody, one of the questions is paints. But remember that, you know, and we stick to this, we have never said that paints was core to our business, but clearly it's a business that has strong brands and leading market share in Central America, and even though revenues declined, profitability is improving, and we expect this to continue through the rest of the year.

So, I think that the move of Jim Owens taking over as well Latin America is going to be a boost for the region. I think this is going to realize a lot of synergies and get a lot of support from North America and counterparts, and will allow us to get a different, fresher views on paints, and once we have come to conclusion, we'll get back to you.

Okay.

And just following up on that, just very quickly, is the distribution setup for the paint helping the adhesives, or are they kind of independent from one another?

Well, so far I would say that it's very, very limited overlap, but that's one of the questions that we are trying to address, investigate farther are there synergies. But my first take is that it is very limited synergies. That's what I've seen since I'm at Fuller, and that's why I have always said this business is non-core. Nonetheless, we need to make sure that we manage it, and we improve the profitability of the business, especially the ROGI and the EBITDA.

Sure, the more profit, the higher price you can get.

If I could ask a question regarding the first quarter, do you think that some revenues which would normally have gone into the second quarter were actually pushed into the first, ahead from material cost increases and all of your selling price increases?

Well, Rosemarie, we are very proud of being a very ethical and compliant company, so we don't push, we don't manage earnings as they come. We accounted for --

That's not what I meant at all, Michele. I was wondering if customers, knowing knowing that their material costs were going up, and that obvious price increases were going to come, didn't buy a little more in Q1 than they would otherwise have done.

Oh, actually I can tell that you we saw, in February, you know, due also to the weather issues in the northeast of the US, actually a slowdown, compared to January and to March. So I would say that we didn't see at all people moving, anticipating things from March to February, and therefore, making our quarter bigger than expected.

Okay, thanks, I really appreciate it. And well, I guess I'll go back on queue.

Thank you, Rosemarie.

Thanks.

Our next question comes from Mike Sison with KeyBanc. Please go ahead.

Hi, guys, two quick follow-ups.

In terms of your outlook for gross margin, nothing specific, but when you think about the changes in raw materials volumes now, is your outlook about same for 2010 that you thought, let's say three months ago? Is it higher? Is it lower?

Look, Mike, first of all, I think, let me give our overall long-term perspective. Our focus is on ROGI margin and on EBITDA margin. We want to make sure that we capitalize on the benefits as well of volume leverage, and that was since the very beginning, call it since 2007 investor conference, what we stressed upon. And I just want to make a point on that, with all the questions we are getting on gross margin.

At the same time, you know, speaking of these gross margin that you're asking, anyway, clearly I think we are doing a pretty good job at managing the mix, and mix is both product management but is also innovation. I think we're doing a good job at reformulation. I think we are much smarter in terms of negotiations. But clearly the raw materials, as we said, have been going up faster than we were expecting, and we are trying to react faster than we had planned. But there is always a time lag, especially if you don't want to compromise your volume growth and making sure that customers keep giving you higher and higher share of their business, and what we're doing in new developments.

Okay.

In terms of competitive, do you think that the big player out there is looking to raise prices as well?

Well, as I said before, Mike, so far, what we have seen is, with very, very limited exceptions, rational behavior on the competitive side. I think everybody got clearly the lesson in 2008, when we are double digit raw material increases faster, that caught everybody by surprise. And also I think that lots of competitors have seen the great job we've been doing in 2009, and everybody understands that there is value in managing price in a rational way, working collaboratively with customers, but making sure that you line it with cost of service. So I think we still have a lot of work to do, but so far, again, based on what I see, there is conducive, competitive behavior.

Right.

And then, quick follow-up on specialty constructions. Glad to see that business rebound. How big is that, and when, if construction does turn around at some point, what is sort of your leverage to that -- to a rebound in construction markets?

Well, I think that clearly, for a business that is bidding 100, and 120 -- I'm asking right now as we speak, exactly the number -- and they are confirming that it's more or less that direction, 130, basically, there are two things that we have to do. One is clearly expecting that the market doesn't go down farther. Again, we're not speaking of going from half a million houses to two million houses, right? I think -- I don't know when we will see the two million number again, but, you know, based on what we are doing and some good business we already landed last year and we are building upon this year, regaining relationships with some key distributors and key customers. I think that with the market is going to be on the low single digits, we can grow better than that, and increase our volume.

I think that business, as you said, is rebounding from the past. I think we've got the right leadership in place. There is good momentum, like in everything else in the business. And that business reports to Jim Owens, and he's handling that exactly as everything else. He's put a new leader in that business, and we are doing much better than before, and it's an interesting part of our portfolio to watch.

Great. Thank you.

Thank you.

Our next question comes from Robert Felice with J. Goldman & Company.

Hi, guys, just a couple of quick questions.

First, Michele, you mentioned that price declined year-over-year. How did it fare sequentially from the fourth quarter to the first quarter?

Well, it's maybe slightly down, but less than, clearly, the year-over-year, and a lot of that is also due to mix. But clearly also we've seen the quarter there is a difference between the first half of the quarter and the second half of the first quarter, when we started really moving up on price, when we saw that raw materials were going up.

Okay.

And given where you stand today, in terms of price, and what you know in terms of cost inflation for the second quarter, maybe you can give us a sense as to how much of the cost inflation you anticipate recovering in the second quarter. And I know maybe you don't want to get into specific dollar amounts, but just on a percentage basis, would you anticipate being able to recover 50% of that gap? How should we think about that?

Well, you know, we want to be a healthy business and have profitable growth, so I would say, together with all the levers that we discussed before, you know, product mix, the reformulation, and price increases, but also new products and customer mix, you know, it's on the long term, gross margin needs to be strong. And I don't think there is continuity for a business that takes hits on the raw material and doesn't recover those.

So I mean, clearly by the back half of the year, you anticipate having fully recovered that cost inflation. Is that a fair assessment?

I would say the fair assessment is that there will be somewhat of a rebound in terms of gross margin percentage in the second half of the year, versus what most likely will happen in the second quarter.

Okay, fair enough. Thanks for taking my questions.

Thank you, Rob.

Our next question comes from Steve Schwartz with First Analysis.

Hi, thanks for taking the follow-up.

This one is for Jim. Jim, a favorite topic of yours, pensions. I ran some numbers around the comments you guys put in your K, and tell me if I'm far off in thinking that SG&A could be $10 million higher in FY '10 versus FY '09 because of changes in assumptions about discount rate and return on plan assets.

No, that number is way high.

Okay.

I don't have all that right in front of me here, but I think we said our pension expense is going to be up about -- pension-related expenses, were going to be up about $4 million in 2010 versus 2009. Those are related to a lot of different plans, not just our defined -- not just our ERISA defined benefit plans here in the United States, but all of our plans together. And I think just roughly, probably half of that is in SG&A, and half of it is in COGS.

Okay. That's why I ask these questions.

So if we're working off a base of 264, your SG&A for FY '10 might be 275 to 280, given the strategic spending you're doing?

Well, of course, we don't give that -- we're going to let you work through that and make your own estimates. Obviously we've been saying quite frequently, in this call and in other calls, that we are investing in our business, and so that's the guidance we're giving on that.

Maybe let me add one thing and give a perspective to everybody, right.

SG&A is clearly up. We always said those are investments. Taking into account that, of that number that is in the first quarter was $9 million year-over-year up, 30% of that number is currency. Overall, you know, we can say that nearly half of that $9 million is currency, acquisitions, and pension. The remainder is really headcounts in the commercial side, on the technical side, it's training, development, and compensation of talent.

Definitely helpful, that color. So thank you both for that.

Thank you.

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

Thanks for taking it.

Why did the interest expense, Jim, come down so much Q1 versus Q4, and then you expect for the balance of the year for it to go back to the fourth quarter level of last year? Why that drop in the Q1?

So it is -- that balance is -- and also interest rates, interest rates continue to go down. In the first quarter we're still benefiting from the very low priced debt that we have under our revolver, and the reason that interest expense is going to be going up in the subsequent quarters, is because now we're refinancing all that debt up to market rates, and that's primarily the increase that you're seeing in future quarters.

But didn't you have that benefit in Q4? When interest rate was $3 million?

I've lost track of the question now. So you're asking me why --

When you look at Q4, interest rate was $3 million, and you had a big chunk, you know, of debt from the revolver. Q1, you still that have same chunk, but yet interest expense is $1.9 million. Why the drop sequentially?

I can't answer the question, but what I can -- as we go forward, what I can tell you is what I told before you, which is our interest expense is going to be about $3 million a quarter in the subsequent quarters. So I think that's the most important thing to keep in mind. I can't answer your question. I don't have all that right in front of me. I don't have all the explanations. The important thing is, going forward, we can till pretty clearly what our interest expense is going to profile out in the end of the year, and it's about $3 million a quarter in the subsequent quarters.

Okay, which is a number I expected for all the quarters in Q1, which is why in -- in 10, which is why I was surprised, but that's all right.

The construction market is still weak. And you have shown a little growth. Have you seen some, in addition to taking maybe some new business, have you seen some positive signs within the construction, or is it still as gloomy as it used to be?

The positive is that it's not going down farther, so I would say that's a positive. The other positive is that, you know, we had some new business that we landed last year, that is really hitting the ledger and is generating growth. But the most interesting thing is the momentum we are getting on generating additional business and that's -- that contributes to our revenue guidance for the year.

And the new business you are generating is really at the expense of some of your competitors, as opposed to the whole construction market actually moving up a little?

Well, I would say the new business we landed last year clearly was new business and clearly it was not ours before. So you understand, it was more of, I would say new business for us. And what we are doing this year is just trying to, between price, mix, innovations, reformulations, invest our customer relationships, to make sure that we also regain some of the things we lost in the past.

Okay, and then a follow-up from a comment that you made last quarter, Michele, which had to do with, you were hearing customers talking about making some investments, going ahead with them. Have you seen any of that happening? Have the projects started, or is it still talk?

Well, so far, and this is anecdotical, what I can tell you [inaudible], is that we don't hear any more people really doing massive restructurings or laying off with the same pace that they were doing, beginning of 2009. We hear people engaging in conversations, making plans, longer-term plans, so that I would say is a positive sentiment. But maybe we can elaborate farther on that on the second quarter call.

All right.

And one last question, if I may. Has your visibility improved? Do you have a better feel for what the economy is going to do or your customers are going do in the second half, based on actual orders, or do you still have a very short window? In other words, you don't know from out more than two months, what it's going to happen?

Overall, the sentiment, and all the things that we see is better than it was last year. So that's why, you know, we are also pretty bullish on our top-line growth. It's not just ourselves. I think the market is stabilizing, and that was the expectation we already gave in the fourth quarter, and, you know, you see we are not alone feeling that way.

Okay, thank you very much.

Thank you, Rosemarie.

Thank you, ladies and gentlemen. This does conclude today's H.B. Fuller first quarter 2010 investor conference call. You may now disconnect.