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Executives

Michele Volpi, President and Chief Executive Officer

James R. Giertz, Chief Financial Officer

Steven Brazones, Director of Investor Relations

Analysts

Jeffrey Zekauskas – J.P. Morgan

Mike Sison – Keybanc

David Begleiter – Deutsche Bank

Dmitry Silversteyn – Longbow Research

Chris Butler – Sidoti and Company

Chitra Sundaram – Cardinal Capital

Rosemarie Morbelli – Ingalls & Snyder

Mike Harrison – First Analysis

H.B. Fuller Company (FUL) F2Q08 Earnings Call June 25, 2008 10:30 AM ET

Operator

Good morning, and welcome to the H.B. Fuller Second Quarter 2008 Investor Conference Call. (Operator Instructions). Management in attendance on today’s call include Michele Volpi, President and Chief Executive Officer, Mr. Jim Giertz, Senior VP and Chief Financial Officer, and Steven Brazones, Director of Investor Relations. At this time, I’d like to turn the meeting over to Mr. Steven Brazones. Sir, you may begin.

Steven Brazones

Thank you, Kimberly, and welcome everyone. Today’s conference call is being webcast live and will also 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 operating income, earnings before interest expense, taxes, depreciation expense and amortization expense, or EBIDTA, and return on gross investments, or ROGI. Operating income is defined as gross profit less SG&A expense. EBIDTA is defined as gross profit less SG&A expense plus depreciation and amortization expense, and ROGI is defined as trailing 12-month gross cash flow divided by gross investments.

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 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 this presentation.

For more information, please refer to our recent press release, quarterly report on Form 10-Q, and annual report on Form 10-K filed with the Securities and Exchange Commission, all of which are available on our website at www.hbfuller.com under the investor relations section.

Now, I would like to turn the call over to Michele.

Michele Volpi

Good morning everyone, and thank you for joining us. During the second quarter, we were able to maintain the share profitability level through continued focus on expense and capital management despite a continuation of the macroeconomic challenges we faced during the first quarter. Let me share some of the highlights and challenges of the quarter with you.

First earnings from continued operations per diluted share increased 2% year over year. Second, the organic sales trend improved sequentially, and net revenue was up 1% year over year. Third, continued focus on expense management and our significant curtailment of discretionary spending led to a $6 million decline in SG&A year over year. This was accomplished in conjunction with increased investments for growth.

Next, the turnaround of Roanoke business has begun. At the end of the first quarter, we landed a major new program with a significant customer, and that customer began ordering on a normalized basis in the second quarter. Based on our rollout performance and level of service, we have already been awarded additional business with this key strategic account.

Lastly, during the quarter, we completed our $200 million share repurchase plan. This plan is a clear signal of the confidence we have in our strategic 5-year plan as well as our commitment to returning value to our shareholders.

In terms of challenges, raw material costs continue to escalate and increased even more than we had anticipated last quarter. Additionally as we outline during our first quarter conference call, we began to ramp up our pricing actions in the second quarter. However, due to the lag effect between announcement and realization, very little benefit from these price increases was procured during the second quarter. Finally, the construction-related end-markets in the United States continue to languish, and as previously anticipated, it is very unlikely that we will see a return to normal growth this year.

Now, let me provide a brief update on our long-term strategic goals and where we stand at the end of the second quarter on a 5-year period. As I mentioned in my opening comments, the top line trends improved modestly in the second quarter. The organic sales trend improved sequentially from negative 7.6% in the first quarter to negative 4.5%. The improvement was consistent throughout the quarter. In addition, net revenue growth which includes foreign currency translation turned positive up 1% year over year. While improvement from one quarter to the next does not necessarily establish a new trend, we are still encouraged by what we are seeing on the top line, and we are optimistic that incremental improvements will continue in the second half despite the economy.

Regarding EBIDTA margin, we realized a decline of 140 basis points year over year. The savings from the significant reductions in SG&A achieved during the quarter helped to offset the markedly higher raw material cost and corresponding margin erosion from the lagging prices. It is important to note though that the reductions in SG&A were net of a significant increase in investments for growth.

Similarly to the trend in organic sales, the trend in profitability also showed incremental improvement each month during the quarter. ROGI declined slightly on a sequential basis. The decline was primarily due to the declining EBITDA for the aforementioned reasons. Gross investment was relatively stable between the first and second quarters. Although gross investment was flat, we began to make progress in reducing net working capital. As a percentage of annualized net revenue, net working capital declined from 17.5% at the end of the first quarter to 16.1% at the end of this quarter. Inventory was reduced by about 4% and days receivables declined by three days. We expect these favorable trends to continue in the second half of the year.

Lastly, EPS growth from continuing operations remains positive. This was driven by the significant amount of repurchase activity in first half of 2008. Let me reiterate that we are committed to returning value to our shareholders. In the last year, we announced and executed upon two repurchase programs totaling $300 million. Our aggressiveness to buy back shares stems from both our confidence in our 5-year strategic plan and our view of the value of the shares. These re-purchases are significantly accretive to earnings and are expected to generate and implied return on investment that is significantly above our cost to capital.

Now, let me comment on the pricing and raw material costs. As we anticipated in the first quarter, prices continue to lag raw material cost increases in the second quarter. Revitalization of our pricing vigor and discipline was initiated in the second quarter and resulted in significant pricing actions being taken. These initiatives largely went into effect at the end of the quarter resulting in minimal impact to the second quarter financial results.

It is important to note that the environment we are facing today is much different than in the past few years. Today, we are not only experiencing raw material cost inflation but also weak end-market demand which has led to delicate pricing environment. While we have seen some of the larger competitors announce price increases, which is encouraging, customers are only now slowly starting to become accustomed to price increases. We expect our customer intimacy model to aid us in our pricing endeavors. At the same time, we expect the environment to remain difficult for some time to come.

Regarding raw materials, inflation accelerated during the quarter. In aggregate, our raw material costs were up 3% sequentially and 10% year over year. At this time we expect raw material costs to increase between 13% and 15% for the full year, significantly up from our prior expectation of 3% to 5%. Overall, we have experienced various challenges in 2008.

We have continued to maintain balance between short-term operating performance and position the company to achieve our 5-year financial goals. We have shifted the focus to the front office. We have utilized cost control initiatives to not only offset weakness resulting from the pricing and raw material situation, but to also invest further in the business to drive top line growth. These investments have been made mainly in the fastest growing regions of the world and to date have been focused mostly on sales and marketing talent and training. Despite our increased level of investment, we were still able to reduce overall SG&A spending by $6 million year over year or more than 9% and by $2 million sequentially or more than 3% versus the first quarter. This was achieved through both staffing reductions of roughly 75 positions versus last year’s second quarter as well as significant reductions in discretionary spending.

Also, note that foreign currency translation from Europe only added approximately $1.8 million to SG&A in the second quarter. In this case, currency is working against us.

Now let me provide you with a brief regional review of the business. In North America, the marked economic slowdown persisted, particularly with respect to residential construction-related end markets. Our construction-related businesses, specialty construction and insulting glass, were both off approximately 15% on an organic basis. Adhesives top line was also negatively impacted by the spillover effects of the construction markets but to a lesser extent, while packaging solutions was relatively strong with organic growth of 5% year over year.

Profitability for the region deteriorated during the quarter with EBDA margin down 220 basis points year over year. The pricing and raw material dynamic negatively impacted profitability. However, a larger contraction was avoided due to the strong cost controls implemented in the region during the quarter. There were two one-time charges that occurred during the second quarter in North America which significantly reduced the profitability of the segment. These changes totaling $2.7 million on a pretax basis were associated with realignment of an adhesive facility in Paducah, Kentucky, as well as channel resetting costs associated with the acquisition of new retail business within the company’s specialty construction business. Taken together, these one-time charges reduced EBDA margin by approximately 150 basis points in North America in the second quarter. On consolidated basis, these charges reduced EBDA margin by roughly 70 basis points in the second quarter and reduced diluted earnings per share by $0.03.

We are very pleased with the new business landed at specialty construction within the retail sector. Turning the Roanoke disappointment around was one of the cornerstones of our 5-year strategic promise. The change in sales trend clearly shows the resolve, determination, and ability to execute on growth from our construction teams in spite of a difficult macroeconomic environment.

In Europe, the organic growth trend worsened versus the first quarter. Heightened competition on price, particularly in the more commodity-laden product lines such as polymer resulted in higher than expected volume erosion as we held firm on pricing. This volume erosion was mostly made up of lower margin product lines.

On the new business front, we are optimistic. We expect the current and future investments in the growing parts of Europe to possibly contribute to the top line development in the quarters ahead. We are encouraged by some of the most recent news coming from our innovation team in Europe. I’m proud to say that we have been able to land new business with Adidas with whom we have partnered to develop the official soccer ball used at this year’s European Championship. This is an example of how we plan to further grow in the future through game changing innovation and superior performance. Great momentum has been created during the second quarter with an increased rate of new product introductions. We expect positive results to hit the ledger as we continue down this path.

From a profitability perspective, the pricing and raw material dynamic negatively impacted results in Europe as well. Nevertheless, significant cost control measures coupled with strict limits on discretionary spending helped mitigate a large portion of this squeeze. Together with favorable foreign currency translation, EBDA dollars held steady year over year.

In Latin America, the top line situation is marginally improving. The investments made late last year to improve the customer’s buying experience contributed greatly to that region’s organic growth rate in the second quarter. Likewise, incremental sales and marketing additions have helped drive new sales and have led to an acceleration in organic sales. In aggregate, we are pleased that the growth in Latin America is running higher than our long-terms goal of 3-5%. This suggests to us that our initial steps towards geographic expansion are working well and hold promise for the future.

On the bottomline, Latin America also performed well and held steady. This was primarily due to the success the region had in increasing prices during the quarter by more than 3%. In addition, on the cost side of the equation, here too strict cost control measures and limits on discretionary spend were implemented. Combined, these actions resulted in holding EBDA dollars flat year over year with only a slight decrease in EBDA margins.

Asia Pacific was the strongest performing region in the second quarter. The investments we have made in talent are beginning to directly benefit the top line evolution. We are particularly excited with the pipeline of new business being developed and closed. Combined with a new regional technology center, the region is well positioned for continued profitable organic growth. From a profitability standpoint, the Asia Pacific region more than doubled its operating income and grew it’s EBDA margin by more than 200 basis points year over year. Significant growth in new business and a less severe raw material inflationary environment versus the rest of the world led to the strong operating performance during the second quarter.

The performance of this region is encouraging and reinforces our belief that our geographic expansion strategy in Asia comprises of investments, resources, talent, and focus is the right one. We are proving here as well that we can execute on profitable organic growth.

Before concluding today’s presentation, I would like to provide you with a quick update of our expectations for the full year. As we discussed earlier, we are confident in our ability to execute on the controllable items and effectively deal with inflationary raw material environment. This confidence leads us to reaffirm our guidance for the year to earn between $1.76 and $1.86 per diluted share. In addition, provided the timing of approved projects, it is likely that the actual CapEx this year will be slightly lower than we previously expected. We now anticipate total spend between $20 and $25 million. Furthermore, we still anticipate an effective tax rate for the year of approximately 29% excluding any future significant discreet item. Regarding depreciation expense and amortization expense, there are no changes to our outlook for the year.

In conclusion, as we begin the second half of 2008, one thing is steadfast, and that is our commitment to deliver in both the short- and the long term. The challenges we faced during the first half of the year will continue, but we are prepared to effective deal with them. The headwinds from raw material price increases and volume deterioration in some key North American markets had a significant negative impact on our results in the second quarter. These mostly over shadowed the positive developments that we believe point to better results in the future.

Let me share with you some indicators that may be helpful to monitor our progress in the quarters ahead. First, we are revitalizing our pricing discipline. This would reduce the pricing lag and ultimately lead to EBDA margin recovery and growth in EBDA dollars. This quarter, we began to lay the groundwork, but obviously more work needs to be done. All necessary resources have been deployed to remedy the current situation, and we are confident that we can regain and maintain the rigor necessary to effectively deal with the current and future raw material environment. The fact that we have reaffirmed our guidance reinforces that margins can and will improve in the second half of the year relative to the first half.

Second, we will continue to make investments to accelerate geographic expansion. This quarter, both Latin America and Asia Pacific achieved organic growth that exceeded our consolidated long-term of 3-5%. This was driven principally by the investments we have already made in these regions.

Third, we will continue to manage our cost structure to help mitigate the interim margin pressure brought about by the existing environment. During the second quarter, we reduced SG&A by $6 million year over year and $2 million sequentially while continuing to fund new investments in sales and marketing.

Fourth, we will focus on net working capital. This quarter, we began taking steps to address the significant increase in the first quarter, and we started moving in the right direction. Last, although we still have more work to do, we are confident we are on the right path with the Roanoke acquisition. As we discussed earlier, we landed significant new business at the end of the first quarter. This is just the beginning of the turnaround. Now this is not an exhaustive list by any measure, but rather just a few of the indicators you can use to monitor our progress.

Before we end, let me remind you that 2008 is the first year of a 5-year transformation, a year of transition from a turnaround phase to a growth phase as we stated repeatedly last October during our investor conference. Even though the first year coincides with a very difficult macroeconomic environment, we believe we are making progress by balancing short-terms pressures with long-terms investments for growth. We are confident in our leverage potential and our ability to execute, and we are committed to all of our stakeholders, employees, customers, and shareholders. Based on this confidence, we have reaffirmed our guidance.

Thank you for your time, and we would now like to open the call up for your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Jeffrey Zekauskas with J.P. Morgan.

Jeffrey Zekauskas – J.P. Morgan

How many employees did you have at the end of the quarter, if you know?

Michele Volpi

Well, I can tell you that the employee total at the company at the close of second quarter was 3162. That is the total H.B. Fuller census at the end of the second quarter.

Jeffrey Zekauskas – J.P. Morgan

Second question is you talked about this new pieces of business that grow now. Can you size the magnitude of this business you’ve picked up?

Michele Volpi

As you know, there are expectations in retail. It depends on how the construction market is doing, but it is significant enough for us to talk about it, and is significant, strategic, and solid enough for us to take some special charges in the quarter. We are very happy this has been going on. Of course, we didn’t speak about it for confidentiality reasons in the quarters before, but that was behind my commitment to turn around the business, and they’ve done a terrific business. It’s long-term business that we had targeted, that we have landed, and it goes in the direction of our strategy. Allow me not to be specific as far as numbers are related, but we are speaking clearly of several millions of dollars.

Jeffrey Zekauskas – J.P. Morgan

In terms of the price increases, what is the order of magnitude of new price increases that you’ve issued, and what do you hope to achieve over the next couple of quarters?

Michele Volpi

It is clear that we were able to remedy some situations in the second quarter, but the vast majority, it is fair to say, it was a time of preparation in the second quarter. Very tough time of preparation because things kept moving and keep moving, and you’ve seen all the announcements in the market place. At a certain point in time, we made a calculation and we said we’ll go with this, but it is clear that we are speaking for the full year of double-digit price increases, and they are necessary to cope with the ever-escalating raw material prices. You’ve seen our expectations; it is between 13-15% over the year. Of course, our sourcing teams and technology teams are working as much as possible on reformulation, but it is important that our teams and our customers understand this situation.

Jeffrey Zekauskas – J.P. Morgan

This quarter your prices were up a percentage point roughly, so next quarter, are you hoping for some number like plus 6?

Michele Volpi

Certainly, it’s going to be significantly higher than the second quarter. What I cannot tell you right now is that if we are going to have further surprises on the raw material side with additional announcements coming over, but I tried to make clear the picture, and it is more difficult than it was in ’05 and ’06 because it’s also a combination with very weak demand, and we have to be very careful. At the same time, we are trying to build long-term relationships, and we have to keep an eye also on the 5-year plan, so we are very judicious in the moves that we are taking.

Operator

Your next question comes from the line of Mike Sison with Keybanc.

Mike Sison – Keybanc

In terms of the raw materials, I am trying to understand your forecast a little bit. We saw Dow raise prices again for July. Are you expecting more increases from your suppliers heading into the second half of the year, or is sort of that incorporating what we just saw recently from a lot of the commodity guys and maybe no more increases as of at the end of July?

Michele Volpi

We have done our trend analysis, and clearly it’s not just based on what has already been implemented or announced, but it’s also in our expectations for the rest of the year. That is a gross number, and I hope that our sourcing and technology teams can do better, but also we have to continuously update you and investors on a quarterly basis on also what are the surprises on the raw materials side. I think the environment is very volatile, and what I am confident with now more than in the first quarter is that we’re getting momentum and we’re getting back to the discipline we had in the past. I think we have learned over three years or so to be a bit more judicious and work better on the front end in terms of in terms of customer intimacy and relationships.

Mike Sison – Keybanc

When you take a look at the volume and the clients that you have in North America and Europe, was that mostly indicative of demand or are you walking away from some areas that you don’t want to be in through that old product rationalization efforts that you were doing the last couple of quarters?

Michele Volpi

I think that in North America actually the situation is slightly getting better. Even if you are speaking of negative volume growth, you are speaking more of less worse than before, but I’m very encouraged by the pipeline and the momentum that we’re getting, with the things already committed. We hear very good feedback from the customers, so I think that we are improving from a share standpoint, and our expectations of continuing this improvement in the second half of the year are based on our own forces and not on the economy. As far as Europe, we had a more fierce environment. I think that areas like Eastern Europe, Middle East, and North Africa are faring better than Western Europe, but also there as I said in my script, innovation is starting to ramp up, and it is in line with our long-term strategy. Again, it doesn’t happen in one day, but I think we’re going to have positive results out of that.

Mike Sison – Keybanc

Just a quick followup. When you think about the second half of the year, the volume growth should be less negative for the full year, but you’ll have much stronger pricing, so organic sales growth in total should be positive?

Michele Volpi

Let’s say that we are walking in that direction. There are several components that are a bit less controllable, and we have to see really what the customers do on the other side. Very weak demand is not only in North America. Inflation is pain to all. People are shutting down plants, and we want to get share, but not with undermining our profitability, so clearly the work and the trend is there. Where it’s going to end up, we want to be cautious. So we are on one side optimistic. We see what we’re doing. We are encouraged by it, but we want to be cautious because there are lots of balls up in the air.

Operator

Your next question comes from the line of David Begleiter with Deutsche Bank.

David Begleiter – Deutsche Bank

What was the gap between pricing and raw materials in Q2?

Michele Volpi

Basically raw materials went up I would say sequentially by 3%, and our pricing sequentially went up nearly 1%, so there is a gap there. Clearly, dollars is a bit less, but if you remember, Dave, when we made the first quarter conference call, we said that we were still going to struggle because we knew it was going to take time, and in these situations you don’t want to panic, you don’t want to over-react. Specifically, if you have your customers in mind and you want to build something with them over 5 years. I think we’ve done very good preparation in the second quarter, and I think that that gap is going to be reduced in the third quarter and the fourth quarter.

David Begleiter – Deutsche Bank

Will it still be negative in those two quarters?

Michele Volpi

I can’t tell you right now, because you do a price increase and the day after you receive another letter from a raw material supplier they’ve increased their price, a lot is not about number you go for, but it’s also the timing, so it’s a very volatile environment. I think that we haven’t kind of inflation for years, and I think everybody is trying to get used to it. I think we have good processes for that. We’re gaining momentum on that, but that is also why we’re very strong on cost controls because we knew it was coming.

David Begleiter – Deutsche Bank

Just on the volume front, would you expect positive volume growth in 2009?

Michele Volpi

If everything that we do is working well and we still have easy camparables, I would say that’s a reasonable expectation. Now, there are lots of ifs there. I think we can be confident and cautiously be optimistic on our controllables, but on the demand side, I think that lots of people are realizing now that what we were saying one year ago is really out there, and the value of being realistic about that is that you just can get prepared.

David Begleiter – Deutsche Bank

Lastly, given the share buybacks, what share accounts should we be using for Q3 and Q4?

James R. Giertz

I think that number is 49 million.

David Begleiter – Deutsche Bank

In that diluted or basic?

James R. Giertz

49 million diluted shares both in the third quarter and the fourth quarter.

Operator

Your next question comes from the line of Dmitry Silversteyn with Longbow Research.

Dmitry Silversteyn – Longbow Research

I’d just like to follow up a little bit on the pricing issue, Michele. You talked about teaching your customers a discipline of price increases. I think Sherwin Williams yesterday talked about implementing prices and the fact that it takes them about 12 to 18 months to fully offset the raw material increases. You guys have similar gross margins and raw materials as a percentage of gross margin, and their customers have been all trained to accept price increases, so I’m just understand your confidence in getting traction in the next quarter having just announced price increases over the last couple of quarters. Is your market at all so you can get them through quicker, versus 12 to 18 months that Sherwin Williams thinks that they’ll be able to get their pricing in?

Michele Volpi

I am pretty happy with our concept and the speed of our team. I have to say that we are having a better understanding from customers as far as what is happening in the environment. Our teams are working very closely with them. I cannot say that we will not lose any volume at all, but we are trying to make sure that we do all the right things in terms of early notification to customers, that we are explaining the reasons, that we are working them, that there are several components of cost to serve; it’s not just raw materials, and trying to find solutions that are win-win. So from that perspective, I think that our teams have gone a long way, and that gives me a lot of confidence. Will we have some volume loss? Maybe, but am I more confident than three years ago on how the teams are doing things strategically? Yes, and I think that we are also supported by new product introductions and projects that we are doing with our accounts.

Dmitry Silversteyn – Longbow Research

Can you comment on your industry overall? You’ve done a lot of things to improve the company in terms of value-added margin over the past three years and being a little bit more aggressive with your customers and pricing and not being afraid to lose volume. Do significant competitors of yours follow this strategy? In other words, has this market place become more disciplined and a little bit more amenable to price increases versus two years ago?

Michele Volpi

I think that clearly our number one and number two competitors have just got together. I think we all know that there are more that you get in situations like those, a fact that is accentuated by the turbulent macroeconomic environment, but I believe that over the long term, consolidation will make things more rational, more professional, but clearly it’s all about timing, and you want to make sure that you stay the course, and at the end specifically key global players will behave rationally.

Dmitry Silversteyn – Longbow Research

You’ve done an excellent job executing your $200 million share repurchase program, and that really gave you almost a 16% lift in earnings per share this quarter versus last. The stock is still valued very attractively. You still have a pretty strong balance sheet when you look at the net debt and the cash you’re building on in the balance sheet. Are there any thoughts of another reauthorization of similar magnitude, or are you going be deploying your cash elsewhere for the balance of the year?

James R. Giertz

I think the best answer to that is that we don’t have any current plans for additional share repurchase, but it’s something that’s always under consideration. I think our balance sheet is capacity, or it has the capacity to do more share repurchase, but we don’t have any specific plans to do that right now.

Michele Volpi

Also, I want to Dmitry that in line with our 5-year plan, we are going to make sure that we maintain resources to invest whether there are acquisitions or organic investments because we are committed to that, specifically if you remember the geographic expansion section plus financing this offers growth that we believe in over 5 years.

Operator

Your next question comes from the line of Chris Butler with Sidoti and Company.

Chris Butler – Sidoti and Company

Just following up on the last thing that you said about acquisitions. Could you give us some ideas of what the prices look like, what’s going on with valuations as the economy here in the US and Europe slows? Are the opportunities becoming better for you now?

Michele Volpi

First, macro-response, I think that over time, it will get better. I think more reasonable multiples will come. I don’t think the time is there yet. There have been multiples in our industry that have clearly created expectations for everybody, but I believe that there will be more room for strategic players in the industry. I think that the current turbulent will clearly make a split between those that perform and those that do not perform. I think we’re going to be on the set of those that perform, so I think we will be active in the market place. I am speaking in terms of results. In terms of activity, there is a lot of activity where the team is engaged in several regions of the world, and I am confident that we will do what is right and what we said in October. We talked about geographic expansion, and we said that in some cases, there were going to be acquisitions, and in some cases, we are going to be entry points into the market place to then further develop from there, and in other cases, we said we were going to organically if the right acquisitions that we felt comfortable with were not available. We are working on that, and as soon as we have news, we will inform you Chris.

Chris Butler – Sidoti and Company

Also, with use of cash, you had mentioned that your expectation for CapEx is a little bit lower for the full year. Is this case of timing or is it keeping power dry as the things slow down here?

Michele Volpi

A lot of that is timing. We are very judicious as far as capital expenditures or other real investments, so we have good project discipline, and in some cases we don’t pull the trigger if we are not ready. In some cases, some of those capital expenditures are linked to other conditions, but overall, remember that when we had spoken about investments, we had spoken not only about CapEx but also about investments in resources and in talent, and sometimes you want first to have the people, the process, and have the process ready before you really put whatever is still on the ground or you make an acquisitions. So in some cases, we may have been late, but we are really doing what we said that we were doing in October, and if you stay tuned, you will see.

Chris Butler – Sidoti and Company

The strength that you saw out of your Asian segment, I was hoping for a little bit more color on that. Also, are you going to run up against any capacity constraints, and you could also touch on maybe investments that you’re putting in place there?

Michele Volpi

The good thing is that on average, and this is valid company-wide, we have a lot of leverage. We are not speaking only financial, but we’re also speaking from a capacity perspective, so that’s good and I think it’s making this a positive for us. As far as Asia Pacific, I think we are hitting all cylinders. We did what we needed to do. We started already one year ago deploying talent at different levels of the organization. We made sure we put the focus. We got support from the entire global resources. We had added resources in sales and in marketing, and we are starting to see the results. I think that for those that didn’t attend the October investor conference where we were saying that we were going to reverse our sales trend [_______] that we have two regions out of four that [inaudible] to move in that direction. Obviously, the other regions are bigger masses to move, but they will come as well. So Asia Pacific is going in the right direction. We have obviously challenges there, but as you see both top line and bottom line we are working on out there, and we expect to use the same approach with everything else. Even in Europe and North America, you have pockets of business where we have trend reversals, and in other cases like specialty packaging in North America or Easter Europe are going pretty well already.

Operator

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

Rosemarie Morbelli – Ingalls & Snyder

Going back to the strong performance in Asia Pacific, your income line doubled or just about, but you also said something to the effect that the raw material cost increases were not as steep there as they were in the rest of the world. Do you see signs that actually they are about to catch up on the raw material cost increase there and there it could affect your margin in the second half of the year?

Michele Volpi

Clearly, Asia Pacific has a time lag advantage. From the perspective of the raw materials, it’s a more competitive environment, so while it is a thorn on the selling price side, it’s somehow an advantage on the reverse side, on the raw materials side. Clearly, we all have seen the decisions of the Chinese government as far as gas prices. We can expect some inflation there as well, but I think that our Asia Pacific teams are really learning and getting ready from what is happening to the other regions. At the same time, I see them already in the last year starting to push for more value-added applications, business does take longer cycle, but it is more specification related and that’s our past now. You don’t do that in one day because it’s long cycle. It takes lots of changes in the organization. I think that Asia Pacific is getting results not just because of tactical operational management but really strategic choices.

Rosemarie Morbelli – Ingalls & Snyder

So even if inflation grows, let’s call it, 10% for the balance of the year there the same way you’re expecting for the full year company-wide, do you think that you can raise prices there without a lag then? Did I understand that correctly?

Michele Volpi

I think that the struggle depends on how big is the raw material increase, how sudden it is, but as I said I am cautiously optimistic that like we did in the past we can raise prices and we can do this in collaboration with our customers.

Rosemarie Morbelli – Ingalls & Snyder

Still on Asia Pacific, how much of the business you are doing there with your customers is for customers exporting back into the US and how much is for local customers?

Michele Volpi

Our vast majority Rosemarie is really local business in China, and that is actually our strategy. That’s the reason why we decided to localize our technology center there, and we are planning to increase the level of investment because it’s a market that’s over time going to be not just an external market, but it’s going to have internal consumer demand growing.

Rosemarie Morbelli – Ingalls & Snyder

Okay, so that is good news, because it seems that those Chinese companies and other Asian companies that are mostly working on exports back into the US or Western Europe are beginning to slow down, so you are saying that it is not really going to affect you.

Michele Volpi

Well, at the same time, Rosemarie, let’s be fair that we have a pretty small share in the Asia Pacific market, so more than what is the market doing is what are we doing and how are we managing our share and what parts of the market are we targeting. I think that is having more of an impact, and that’s why I’m cautiously optimistic.

Rosemarie Morbelli – Ingalls & Snyder

On price increases, raw material costs have been going up for the past 2-3 years, and this year they have accelerated further. What changes are you making in the way you are approaching customers that you haven’t already done, and what kind of elasticity do we have in this environment and particularly since your number one and number two competitors have joined forces, and they may have some synergies which allow them not to push pricing as much as you are or as much as you need to?

Michele Volpi

I cannot comment on the synergy realization of Henkel and National, and I’ll let them do their work, but as far as working better with customers, I think it’s a continuous improvement process. It’s part of our late six sigma methodology, and it is something that I see the teams working better on closer engagements with their accounts, explaining better what is going on, and working with them on trade-offs. The cost to serve economics is at multiple levels. It’s not just raw materials. It’s container, packaging, transportation, size of the order, length of the order, and it is just doing a better job. At the end, we have in many cases very big professional customers that are already doing this process on their own internally, so we are really speaking the same language. So from that perspective, I think we are getting better in an even more difficult environment. So I’m not saying that we are exempt, but I think that together with cost controls and investments, we are making progress.

Rosemarie Morbelli – Ingalls & Snyder

On the acquisition side, it sounds as though the valuation has not come down enough to be really interesting to you at this particular point. Is that right?

Michele Volpi

As I said, things are moving. I think that the teams are doing a good job in terms of making sure that we scan proactively the market for opportunities that are strategic in nature, in doing a good job of understanding what is really the detail behind the synergy, that it is not a pie in the sky, and then conversations may take longer but I think we are well positioned. When there is a bit more realism, we may be able to close on some things.

Operator

Your next question comes from the line of Steve Schwartz with First Analysis.

Mike Harrison – First Analysis

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It’s actually Mike Harrison sitting in for Steve. I was hoping, Michele, that I could get some clarification on the magnitude of the pricing actions you expect to take or that you’ve been taking here at the end of Q2. It sounded to me like you said that you expect for the full year for pricing to be up double digits. Looking at the first half, pricing was up between a half percent and a full percent. That would suggest to me that the magnitude for the second half would be something like 20%. Do I understand that correctly, or can you just give me a little bit color on the magnitude there?

Michele Volpi

Thank you for giving me the opportunity to clarify. I am speaking of double digits in terms of communicated and in terms of implemented. I am not speaking necessarily of things hid in the ledger because then it would have a radical impact on our P&L that would be above and beyond the guidance that we are reaffirming today. Clearly, there is a time lag, but based on what I was telling Rosemarie, I think we are doing what is right in terms of managing the relationships and being very realistic and pragmatic as far as what is needed to deliver on the management of our P&L.

Mike Harrison – First Analysis

In terms of what you’ve communicated to your customers then, the magnitude is more like 20% than like 10%, when you’re talking in terms of double digit. Is that correct?

Michele Volpi

It varies in different regions of the world because there are different dynamics in terms of raw material supply. It varies in terms of raw materials, we have thousands of those, so I would say that is still a situation in evolution, and I’m sure we will get a better picture when we speak at the third quarter conference call.

Mike Harrison – First Analysis

I was also hoping you can give us a sense for how the $2.7 million in special charges breaks down between the adhesives business and the specialty construction business as well as between cost of goods sold and SG&A.

James R. Giertz

The entire amount is in cost of sales, and then to the first part of your question, I think we’ll just decline to answer that one. We don’t wish to be more specific about that.

Mike Harrison – First Analysis

Is roughly 50:50 a good number to use?

James R. Giertz

No, I can’t be any more specific.

Mike Harrison – First Analysis

The last question I had is the $3.9 million in interest expense for this quarter, is that a good run rate to use for the remainder of the year?

James R. Giertz

Yes, it is.

Operator

Your next question comes from the line of Chitra Sundaram with Cardinal Capital.

Chitra Sundaram – Cardinal Capital

CapEx, did you all mention what it was for Q2, and on the cash flow from operations, do you have anything there you can give us?

James R. Giertz

Yes, just one second. Let me grab my notes.

Chitra Sundaram – Cardinal Capital

Then as I wait for that, on the price increase, I know lots of questions are coming out. I am just trying to understand. Clearly in Q2 towards the end, you all have communicated price increases. As we are now approaching the end of June, is there any color on how that is being absorbed in the system given the weak demand environment?

Michele Volpi

I think that customers understand, but clearly I cannot tell you what the reaction will be since it’s not going to be our last price increase this year, and the situation keeps moving, so we are staying very close to our accounts to keep them informed. I would say that for what we have communicated up till now, we have got very good collaboration and partnership. I have ironed out several things, but really the situation is very volatile, and we are continuously speaking to accounts because it’s not over.

James R. Giertz

I have the notes now. CapEx in the second quarter was $4.6 million. With respect to free cash flow, free cash flow was positive approximately $20 million for the quarter, so that’s a substantial increase sequentially from first quarter this year.

Operator

There are no further questions in queue.

James R. Giertz

Thank you for joining us today. Have a good day!

Operator

This concludes today’s conference. You may now disconnect.

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