H.B. Fuller Company (FUL) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by and welcome to the H.B. Fuller second-quarter 2015 investor conference call. This event has been scheduled for one hour. Today's conference call is being webcast live and also will be archived on Company's website for future listening.

At this time, I will turn the meeting over to our host, Senior Manager, Treasury, and Investment Relations, Mr. Maximillian Marcy. Sir, you may begin.

Thank you, Keith. Good morning and welcome to our FY15 second quarter earnings call. We have two speakers today, Jim Owens, our President and Chief Executive Officer, and Jim Giertz, our Executive Vice President and Chief Financial Officer. As always, after our prepared remarks we will have time to take our questions.

Let me also remind you that comments made by me or by others representing H.B. Fuller may contain forward-looking statements which are subject to risks and uncertainties. Our SEC filings contain additional information about factors that could cause actual results to differ from management's expectations. These filings can be found in the Investor Relations section of our corporate website at www.HBFuller.com.

Also, please note that our recorded results include non-GAAP financial measures. These results are not be confused with the GAAP numbers in yesterday's earnings release or the GAAP numbers we will report in our Form 10-Q. We believe that a discussion of these measures is useful to investors because it (inaudible) an understanding our operating performance and our operating segments as well as the comparability of results. A reconciliation of these non-GAAP measures to the nearest GAAP measure is provided an earnings release our Company issued last night. With that, I'll turn call over to our President and CEO, Jim Owens.

Thanks, Max, and thank you, everyone, for joining us today. There are many good things happening at H.B. Fuller and our performance of second quarter is strong evidence of improving execution and trends. Our adjusted EBITDA margin in the Americas and construction product segments were 18%. Our Asia-Pacific segment was at a record level near 11%, and the overall business exhibited strong cash flow generation again this quarter, bringing year-to-date cash flow from operations to $116 million.

Our EIMEA business continues to improve and will deliver the targeted performance but on delayed time table. Given the recent progress and improving margins across the business, we remain confident in our plan to deliver 15% adjusted EBITDA margin as we exit 2015 and for the full-year of 2016.

Our current performance is delivered despite entering the year with several significant operational issues carried over from last combined with some new challenges, most notably the sharp revaluation of the US dollar which negatively impacted both revenue and earnings. In the first half of this year we have been focused on improving execution in our Americas and EIMEA operating segments while at the same time taking advantage of significant opportunities to grow our business and expand our profitability profile.

Not every problem is fixed at this point and not every initiative is moving along at the pace we desire, but the list of positive developments is a long one and it's expanding. Let me provide some examples.

Our Asia-Pacific operating segment is off to a fine start this year. We completed our first full quarter with Tonsan included in the H. B. Fuller family and the Tonsan business is operating in line with the expectations that were the basis of the acquisition. The entire organization is energized and excited about the possibilities to leverage the technology and the market access available through Tonsan.

At the same time, our Legacy business in the region grew in the second quarter despite end market challenges in the region, and the operating margin in the region was improved through strong management margin, margin management in the core legacy business as well as the addition of Tonsan. Our construction product segment successfully executed a significant new product launch and expanded distribution plan with Lowe's. The segment increased revenue by over 30% in the quarter compared to last year and at nearly 18% posted the highest quarterly EBITDA margin in the history of the segment.

We've been successful managing raw materials taking advantage of lower feedstock cost in the supply chain through the appropriate substitution of alternatives and effective price management of our products in the market. The benefit is most evident and our Americas operating segment where operating margins improved significantly in the second quarter. Finally, I need to point out a positive cash flow performance in the quarter driven by strong earnings profile, reduced project expenses in Europe, and back to normal capital spending levels.

We still have work to do. Clearly, the European stabilization optimization projects are taking too long to achieve the targeted operating efficiency and margin levels. In addition, we need to get our Americas region back on track with consistent and sustained organic growth. Our plan for the second half of the year is to extend the success of the first half and convert our remaining operational challenges into opportunities, creating a strong finish to the year and a positive launching point for 2016.

We adjusted our EPS got his for the full-year down from $2.60 to $2.45. The primary driver of the change is an expected higher core tax rate and this is driven entirely by the better-than-planned performance in our US-based operating segments and at the same time lower-than-expected profitability in the European region.

However, it's important to emphasize that our outlook for a key financial metric, EBITDA dollars, has not changed materially from the [outset] of this year. Specifically, we entered the year targeting about $280 million of EBITDA in 2015 and our current outlook is for about $275 million in EBITDA for the full year, this despite significant devaluations of currencies around the globe.

We have made significant course corrections to maintain this outlook. In essence, the negative impact of adverse currency movement and the slower-than-anticipated operational improvement in Europe are being offset by the successful integration of Tonsan and the benefit of managing our raw material costs. Given that the adverse currency movements alone cost us about $125 million of reduced revenue and tens of millions in lost operating income, we think that achieving the EBITDA plan for this year will be a solid outcome.

With that overview, I'll now walk through the performance of each of the operating segments. The performance of our Americas segment continues to be a bit mixed. On the positive side, the operational problems that we experience following the implementation of SAP software in North America are behind us.

However, we have experienced some margin pressure due to foreign currency movements since in some areas we have US dollar-based cost matched against foreign currency revenue, our business in Canada being one example. Despite this negative trend, the operating margin of the segment overall is improved, now at 18.2%, well above our targeted EBITDA margin of 16%. We expect continued margin improvement for the remainder of year as we effectively manage raw material costs and continue to streamline our manufacturing cost following the SAP implementation last year.

Our constant currency revenue growth, actually a year-over-year decline of about 3%, was a disappointment. We have aggressive plans for restoring consistent revenue growth in the Americas.

There are two major factors driving under performance. First, end markets in the Americas are still not robust. The well-documented weakness in consumer spending impacts the products many of our customers produced.

Second, due to the business disruption with the SAP implementation last year, our normal pipeline of new business was temporarily diminished. We've rebuilt the growth pipeline over the past two quarters and this series of customer innovation wins will drive more positive trends as we move into the second half of the year. All of this taken together, we feel confident in our ability to drive strong results in our largest and most profitable operating segment going forward.

Our construction products segment continued it's solid performance with volume growth of nearly 30%. The recently acquired ProSpec business has made a solid contribution to our financial results.

The launch of tintable grout with Lowe's moved ahead as scheduled. The feedback we have received thus far from both Lowe's and consumers is positive. While we are focused on the volume growth in our construction product segment, the operating margins are improving as well.

The adjusted EBITDA margin and second quarter was 17.9%, over 500 basis points above the same period last year. This result was achieved because of additional volume coming on stream this year, our investments in new manufacturing processes, integration benefits of the ProSpec acquisition, and discipline around product cost and pricing, all combining to generate the strong margins in this segment.

Our Asia-Pacific segment continue to grow with constant currency growth of more than 44%, inclusive of Tonsan. Constant currency growth was positive across all subregions. Despite some of the well documented end market challenge in this region, we are still optimistic about our future potential in this segment for a couple of reasons.

First, we primarily serve domestic and consumer-oriented markets in China, most notably the hygiene segment where we anticipate strong ongoing growth. Second, we continue to build up our electronics business in China and we have strong pipeline opportunities to convert into revenue throughout the year. Finally, the Tonsan business provides us many opportunities for growth based on synergies of the aligned sales organization.

We are also seeing positive trends in operating margins in the Asia-Pacific segment. Our adjusted EBITDA margin in the second quarter of 10.7% was up more than 300 basis points compared to the prior year.

The margin improvement is based on a variety of factors, including overall better customer margin management, a richer mix of revenue, ongoing cost controls, and the addition of higher margin Tonsan business, somewhat offset by margin pressure derived from foreign exchange rate movements. Overall, our Asia business is a good story with many opportunities ahead to grow and expand our market participation and our market share.

Lastly, our European business. Mostly as expected our EIMEA had a tough first half. There are several broad forces sweeping across our European business which provide the context for a relatively weak operating performance in the second quarter.

Several key external forces continue to impact our business. End market demand in core Europe is still sluggish and end market demand in emerging markets around core Europe is not increasing at previous rates.

Looking inward, our multi-year restructuring and business transformation is now completed and we're working through a stabilization and optimization process to enhance the service level of the customers and improve the overall efficiency of the operation. We expect to see significant improvements in our yields, our logistic cost and our manufacturing cost as the year progresses.

Of the six facilities in core Europe, four are operating efficiently. At the other two facilities we see steady improvement in the internal operating metrics which indicate the health of our manufacturing network, metrics such as schedule attainment and right-first or moving in the right direction.

Excess costs are being eliminated across the network. We're also seeing everyone and customer wins they the reduction in attrition rates.

Progress is happening. Our issue is all of this is not happening fast enough relative to what we think is possible. Our ability to accelerate the ongoing improvements in Europe will be an important factor in achieving superior financial performance for the year. Our focus on this is intense.

With that summary of regional performance, I will turn the call over to Jim Giertz to share more specifics on financials and an update to the building blocks of our guidance for the remainder of the year. Jim?

Okay. Thanks Jim. Our adjusted diluted earnings per share were $0.63 in the second quarter. The increase in our expected core tax rate reduced our EPS by about $0.04 in the quarter. So, if our tax rate had been maintained at the rate we assumed in our earnings guidance at the end of the first quarter, our adjusted EPS would've been $0.67, essentially in line with our internal projections for the quarter.

The expected core tax rate increased due to strong earnings growth in our US-based operating segment where our effective tax rate is relatively high, while at the same time our projected earnings from other lower tax jurisdictions declined, most notably Europe. In 2016 and beyond we expect our core tax rate to decline toward the 30% level as the margin improvement initiatives in Europe take full effect and our business in the Asia-Pacific region continues to grow.

Our overall revenue development was soft in quarter with constant currency revenue growth of 6.4%, inclusive of Tonsan. Foreign currency translation lowered revenue by 7% in the second quarter.

Adjusted gross margin in the second quarter was up 100 basis points versus last year's second quarter and up nearly 300 basis points sequentially. The large majority of the improvement, both year-over-year and sequentially, was driven by lower raw material costs.

Adjusted SG&A spending was up 8% year-over-year. The primary driver of the sequential increase is the inclusion of the Tonsan business. Excluding the Tonsan business, adjusted SG&A was down 2% versus last year.

Adjusted SG&A spending in the second quarter was 18.1% of adjusted net revenue, in line with our long-term targets. Adjusted EBITDA margin for the second quarter was 13.5%, driven by enhancements to gross margin and tight control over discretionary expenses. Three of the four operating segments posted significant increases in EBITDA margin compared to the prior year with each of those segments operating as historically high margin levels.

Operating cash flow was strong in the quarter support a by solid net income in generation, offset somewhat by higher net working capital requirements to support seasonal increases in commercial activity. Net debt was reduced by $34 million in the quarter which equals over 6% of net revenue as capital spending has been reduced to more normal levels, freeing up cash flow for level reduction.

The reduction in debt reflects our commitment to improve our leverage metrics during the 2015 fiscal year following the Tonsan acquisition. Capital expenditures came in at $11 million in the second quarter and $39 million for the year-to-date, in line with our plan for the year.

And as a final comment about second quarter financial performance, I'll just add this historical perspective. We generated $73 million adjusted EBITDA dollars in the quarter, essentially equal to the adjusted EBITDA dollars generated in the second quarter of last year.

And this EBITDA generation represents the highest level ever achieved in a single quarter in the history of the Company. And this is with only three of our four segments operating at or their near full potential. So I think this is good evidence that we are getting back on track to achieve our longer term financial goals.

Now, let me turn to our guidance for the remainder of the year. We still expect year-over-year revenue growth will be negatively impacted by about 600 basis points in 2015 due to foreign exchange rate movements, or about $125 million. We are revising down our constant currency growth, largely due to the lower than expected revenue growth in the Americas and EIMEA operating segments in the first half of this year.

Content business is expected to add about 400 basis points of growth or about $80 million in 2015. In total, we now expect our net revenue for the full year to be about $2.1 billion, about flat from the prior year.

Our core tax rate before the impact of discrete items is expected to be higher than anticipated as already described in detail due to our current estimate of mix of earnings for the full year. We now expect the full-year core tax rate to be 34% versus our previous guidance of 31% and last year's comparable rate of 32%.

From an EBITDA perspective, we expect to deliver approximately $275 million for the fiscal year. This estimate is essentially unchanged versus our initial guidance of $280 million. We expect EBITDA margins to improve sequentially over the next two quarters and exit the year over the 15% level that we have been targeting in our multi-year plans.

Our expectations for capital expenditures for the full year remain at $70 million. The most significant capital project this year is supporting expansion and productivity enhancements for our construction product's operating segment.

We expect strong free cash generation performance or the remainder of the year as a mostly eliminate special charges related to the business integration project, reduce other one-off costs, improve profitability steadily through the year, and implement a reduced capital spending plan relative to prior years. We will continue to use of bulk of any excess cash flow this year to reduce our debt levels with a near-term target of reducing our financial covenant leverage ratio to below three times by the end of this fiscal year.

And, with that, I will turn call back to Jim Owens to wrap this up.

Thanks, Jim. Our results are moving in the direction we committed and our goals are sound. We expect to deliver double-digit growth in EBITDA despite currency challenges as we take advantage of opportunities for margin expansion.

We fully expect the growth trends in Asia-Pacific and construction products to continue and to open up future opportunities for H.B. Fuller. Our European and North American businesses will move back to growth in the second half of the year.

The plan for this year is a number of moving parts and the financial delivery is weighted to the second half of the year. We're confident in delivering our targets for the remainder of this year because the growth and profit drivers are already in place and are building momentum. These include things such as lower raw material costs and strong price management, new product shipments for Lowe's, Project ONE cost reductions in North America, efficiency improvements in Europe, improved sales pipeline in North America and Europe, new wins in electronics, and the growing Tonsan business adding to the strength of our Asia-Pacific business. We will exit 2015 with EBITDA margins of over 15% and be in a position to deliver our targeted plans for EBITDA margin and organic growth in 2016 and beyond.

This is the end of our prepared remarks so now I would like to open up the call for your questions.

(Operator Instructions)

We can take our first question from David Begleiter with Deutsche Bank.

Thank you. Good morning. Jim and Jim, just on the Americas volumes down 4%. I know there are issues behind it. I know the pipeline is filling up, but has anything happened to the market? Are you losing any share? Can you break it down by country? Any more color as to why this is an aberration and will improve?

Yes, as I said in the opening comments, there are two factors here. The one is related to this pipe line. I think when you look at our performance in the Americas last year, as we had SAP issues we were actually growing volume by over 4% in Q2. We were growing volume in Q3 by 4% as well.

But the issues we had distracted the organizations. Our sales organization wasn't focused on wins and in fact we had service issues that cost us some business. So, the way we analyze it, 1% to 2% of the impact is customers who we lost due to service issues. There is 3% or 4% that is related to the weaker pipeline and of course the economies don't help us here, so the US -- a lot of our business is consumer business, so that's impacted us.

Most of those issues -- well, those issues are behind us and the momentum is really building on the pipeline. So if you look at the internal metrics on pipeline and the wins we are having, we are back to a pipeline that looks more normal as we had going into the SAP issues. So that sort of gives you some perspective, but it's mostly related to a sales and marketing organization that was very focused on serving customers and not on growing the business the second half of last year and that led to a weak pipeline this year. Does that help?

It does. Do you expect Q3 volumes to be up year over year in the Americas?

Well, they'll certainly be better than they are this year on a year-over-year basis. Whether it will be back to positive or not is a question. It will definitely will be positive for the second half of year.

Fair enough. And lastly just on raw materials. Will the biggest benefit be in Q3 and Q4 versus Q2? Can you just describe the cadence you are seeing on raw material relief for you guys?

Yes, we will see further improvements in Q3 versus Q2 and then less improvements in Q4 would be the way I would look at it. It's a mix. There are some things that are actually moving in the wrong direction and some things are moving in the right direction. The weak euro hurts us overall because you don't get the benefits in Europe because there's been a huge devaluation in Europe. But I'd say as a cadence expect more improvement in Q3 and then less or flatter improvement in Q4.

Think you very much.

We can take our next question from Mike Harrison with Global Hunter Securities.

Hello, good morning.

Good morning, Mike.

Just continuing on the North America volume question. Are you seeing any customer inventory destocking or did you see any during the quarter or were order patterns pretty steady during the quarter?

We did not see a trend in the quarter. I can have Jim answer that, especially with respect to destocking. I would not say there was a market destocking issue, but I would say a number of our businesses are consumer goods oriented and we do see general weakness in a lot of the customers, especially larger customers, in the consumer business.

And then in the construction business you saw very strong margin there. Obviously some seasonal benefit as well as ramp up of the Lowe's business. Is that margin level kind of sustainable as we look out to next quarter or were there other unusual dynamics going on there?

I don't know if we have -- I will let Jim comment on next quarter, but generally our view based on the work we have been doing the last couple of years is that a long-term target of being in the mid to high teens in this market is what we expect to see in this business. This in the sweet spot of what we expect long term. As far as the rest of the year, Jim, are there any comments you want to make?

I think for the second half of the year we expect those margin levels to continue. I just reiterate what Jim said. I think now finally this quarter the business is operating at an EBITDA margin level that we have always expected for this business and it is finally starting to come to reality, it seems.

And then the last question for me. We are starting to hear there are reasons to be optimistic on demand patterns in Europe. What markets are you watching there? What end markets are you watching that are most in need of recovery? Are you seeing signs of improvement or still pretty cautious on the demand outlook in Europe?

Yes. For us, Mike, and in most of the issues we develop from the demand standpoint are related to some of the transformation issues we've had. So, the businesses that were affected earlier by transformation are seeing good positive signs. We have four different business segments in Europe and three of them we expect good, solid positive growth this quarter.

So some of that in the market and most of that is us improving internally. We certainly don't see Europe economically getting worse in the third quarter based on what we see.

Alright. Thanks very much.

Thank you, Mike.

Next question from Rosemarie Morbelli with Gabelli & Company.

Good morning, everyone.

Good morning, Rosemarie.

Looking back to construction, Jim, you talked about the current margin being sustainable over the longer term. That was your target. Could you talk about the growth rate when you eliminated the ProSpec, for example, and then the new sale at Lowe's? What type of normalized growth rate can we expect going forward?

Yes, so I will talk in broad terms and maybe Jim can take some numbers. ProSpec is about $6 million a quarter is what we said since we acquired the business. You could back that out roughly to get the numbers of the growth underlying. I think we have had seven or eight quarters of double-digit growth in that business.

It's a business where we went in because we are doing good work with our key distribution partners, we're choosing the right distribution partners and we're innovating. We follow the market but we certainly especially -- even if you look out in 2011, 2012, and 2013, we've outperformed what you would see as the construction market overall and that's because our team has had a good channel strategy and a good innovation strategy that has allowed us to outpace the market. Jim, do you want to comment more on the growth rates going forward?

I was just going to comment, Rosemarie, that ProSpec and Lowe's are different things. ProSpec is acquired and I understand that that's a different kind of growth, but our growth with Lowe's and our growth with Menards as examples over the last number of years are really hard won organic revenue growth and share growth.

And we have more that we can -- more share growth is available to us at the end of the year. I think we're pretty optimistic about the next couple of years and seek the opportunities at least that are ahead of us there.

So when you are talking about the next couple of years you are talking about continuation of housing and construction continuing to grow and recover in North America and I believe the US in particular. Once all of these particular part of the cycle, are we looking at less in GDP or if GDP, let's say growth for the particular sector is kind of flattish or declining? Can you still grow above that?

Again, Rosemarie, over the next couple of years I think the growth prospects are probably as much or more to do with the opportunity to gain additional market share than it is related to the underlying end market demand situation.

Thanks. That is helpful.

Okay.

Then I was looking at Asia-Pacific a similar question. What kind of legacy growth did you have, excluding Tonsan?

The legacy growth in the region is in the middle single digits in the quarter.

Okay. Thank you very much. I will get back in the queue.

We will go next to Dmitry Silversteyn of Longbow Research.

Good morning, everybody.

The morning, Dmitry.

Just to follow up on Rosemarie's questions about Tonsan. Was this a sort of $25 million quarter for you in terms of revenues you have gotten from that business?

Yes, I think that's the way we are looking at it in the quarter. It was close to that number.

You talked about it before being in line with expectations but you also, I think in your prepared remarks, talked about some slowing growth in Asia overall. Are you still between the initiatives that you have and the share that you're going to gain with or without Tonsan either through the cross-selling or just a better execution in your business. Do you still see yourself maintaining kind of a mid single-digit organic growth if you exclude contribution from Tonsan in that geography?

Yes, when we said slow in growth we mean middle single digits. We have been growing our Asian business in double digit rates the last couple of years. Yes, we think that's attainable. Or as Tonsan improves as we look into 2016, perhaps doing better than that, but I would say that would be it. Yes, definitely.

Just to follow up on the construction products opportunity and execution. You have a pretty nice pickup in volume here in the second quarter which it sounds like you expect to last into the third quarter on Lowe's channels fill and you have a margin expansion at the same time.

I'm not that familiar with sort of the categories that you are supplying to Lowe's, but I note in other large categories at Lowe's, typically the channel fill, not just at Lowe's but at big boxes in general, channel fill the first year does not generate a lot of income when you make money sort of the second year on the refill. What is different with your channel fill that you were able to not just get the volume but actually looks like get very nice incremental margin from that volume?

Dmitry, the first part of the answer is we adjusted out some of the one-time cost associated with the launch of the new business with Lowe's and that is disclosed in the back of our press release somewhere. Some of the one-time costs, I don't remember exactly what the numbers were but probably in excess of $1 million in the quarter strictly related to the launch of the new business with Lowe's, we adjust out as kind of a one-time or nonrecurring cost of acquiring the business.

Okay, okay, I've got you. That explains it.

Even without that, we have had a good history with our launches there to be positive. I can't comment on what other people who work with Lowe's, but we expect the performance in year one of our wins with Lowe's.

Very good. And then just a longer-term question on the EIMEA. You're still sort of a little bit behind on the margin profile of that business and you talked about some of the things you can do internally as far as improving costs and servicing the customers better. But at the end of the day how do you grow margins in that business when you are continuing to see volumes go in the wrong direction and your utilization rates not improving meaningfully?

We need the volumes to change, right. I think we've seen -- this third quarter last year, I think volumes were down 5%. We are down now to 2.5%. We expect that to get close to it zero and then move positive in the second half of the year. So volumes have to move in the right direction.

There are some very solid pockets of growth and, as I mentioned previously, three of our four businesses now are growing. We have one and it is the one site where we've had the longest lasting problems that is shrinking of the four businesses.

So we do expect to see volumes pick up and go forward because it needs to happen. EIMEA includes India, Middle East, and Africa. We have very strong growth in India, we have solid performance in Africa. So, the region overall has the growth potential we expect to see out of it. And there is a lot of cost that can come out of the business.

We have done a lot to serve customers and to make certain that we are meeting the needs of customers and the work we're doing today is very different. It's about optimizing our freight costs, optimizing our manufacturing costs, pulling out the cost associated with the business. So both of those will change in terms of direction in the second half of this year. Growth will come back to the business and costs are going to pull out of the business.

Got you. One final question on EIMEA, the contribution from Continental products that was about the same as it was last quarter, something like on the order of $0.5 million to $1 million?

Yes, $0.5 million in revenue and very minute in terms of profit.

Okay, thank you.

Our next question comes from Steve Schwartz with First Analysis.

Good morning, gentlemen. First question. In the footnotes of the press release you note expenses related to a new facility in China, electronics facility in Yenki. I'm just wondering, is that a facility you acquired while it's under construction or did Legacy Fuller start that up?

That was a greenfield H.B. Fuller investment related to our electronics business.

Okay, and we are hearing you talk more about electronics opportunities quarter by quarter. What kind of contribution can we expect from the facility in terms of a revenue standpoint and just because it's in the startup phase was there any impact on the region's operating margin in the quarter?

Yes. We will talk more about electronics as we go forward. It's still small in the overall scheme of things, but it's growing at very nice rates. I would expect as we get to our Investor Day which will happen certainly at the end of this order or beginning of next year we will probably talk in more depth about that market segment. But today it still relatively small in the scheme of the business. In terms of impact on the quarter?

Steve, I think some of the impacts we already started to see last year, and I don't know how much we mentioned them, but the anti-facility was brought up last year I think in the second half of the year. Some of the extra manufacturing costs, the costs associated with that facility were starting to be seen in the second quarter and now -- in the second half of last year, now second quarter this year we are kind of ramping up the volumes and that's the impact we are seeing.

Okay, okay. And then if I could ask just a follow on. Jim G., you noted that the higher tax rate is in part because of higher sales business in the US and other higher tax rate jurisdictions, yet even if we include construction products in with the Americas, it's not quite clear then why you were down 4% in volume in the Americas. Can you see what I am having trouble reconciling here?

Maybe.

I can keep going, but --

So our core tax rate, you know this, our core tax rate is set from the beginning of the year and then adjusted every quarter based on our own internal estimates of our profitability by geography for the full year. It's always -- we're always working up a full-year estimate of earnings by geography, total earnings and mix of earnings, and then we are adjusting that and making corrections every quarter so that's how we do it. That's how everybody does, I guess.

So, basically, what the change in the rate is just reflecting a change in our own estimates internally of where we are earning margin. What is reflected there is that the -- well, the US business both construction products and America [adhesives] had very strong margin quarters and those higher margin levels are expected to continue.

I think it is the higher margin that is offsetting the relatively weaker revenue growth in North America, which you referenced. Then the other part of it is the Europe business on the other side of that is performing at a lower level than we expected. So I don't know if that answered your question or not.

No, it does and it helps frame up the idea of looking at it on a single quarter basis versus your annual basis and the outlook for the year. So, no, that's very helpful.

Of course in the quarter because we made the change, you get a higher than normal impact because we have to catch up the rate for not only the second quarter but we catch up the rate for the first quarter as well. So it's a bigger impact in Q2 than we will see in Q3 and Q4. That's how you get to the $0.10.

Okay, that's helpful. Thank you very much.

Thanks, Steve.

Our next question from [Bruce Zessor] with Advisory Research.

Thanks for taking my question. I just have a question going forward. If you look into FY16, if you do get some recovery in Europe, do you think the tax rate trends back towards 30% or 31% or do you think it stays more in the 33%, 34% range?

It should definitely trend back towards the 30% rate. I don't have a forecast for you right now. I can't give you an actual estimate, but I would think that this 33%, 34% tax rate that we are talking about right now should be our high watermark because we are just not earning a lot of money in Europe right now which is where our -- and the money we are earning there is at a relatively higher tax rate now. So, this has got to be our high watermark and every improvement in Europe and also in Asia is going to drive our rate down.

And then just looking at cash flows, it looks like you had pretty strong free cash in the first six months. I think it's about $77 million. If you look at the back half of the year, do you think in the last six months of the year you will generate a similar amount of free cash?

Yes, yes, similar. I think in the first half there were a couple of items that were maybe nonrecurring but, in general, I would say the second have cash flow should be at or better than the first half.

Great, thanks. Those were my questions. I appreciate it.

We will take our next question from Christopher Butler was Sidoti & Company.

Good morning, everyone. Looking at gross margin year-over-year, could you give us a sense on how much the improvement was raw material related and how you think raw materials are going to factor as we go into the back half of this year?

Okay, I don't have a specific number on that, maybe Jim has one. Raw materials were a help. We have improvements in our North America operating performance and our manufacturing sites that had excess costs this time last year, and then we have a mix improvement, so we have a richer mix in our products. So, all three of those combined to give us the improvement we saw in the quarter.

And if I remember last, it was the second quarter of last year you first started to see some of the difficulties so as we are looking at year-over-year number, we're starting to lap some of the challenges that you began to have in the second quarter and then the second half of last year. Is that correct?

Yes, it didn't show up as much in the second quarter as it did in the third quarter, but the challenges started in second quarter and started to impact our numbers a bit in the second quarter and more in the third quarter. So you will see year-over-year significant improvement as we go forward because last year at this time we went live on SAP on April 7. So that was right in the center of our quarter.

And the European transformation issues really started to effect us toward the second half of the second quarter and really in third quarter. It will be a sizable year-over-year improvement is what I would expect, Chris, in the coming quarters.

With cash flow it really sounds like reducing debt is the priority right now after the Tonsan deal, but historically you have targeted acquisitions. Are you slowing down the pipeline in that time period or are you continuing full out and just keeping sort of a higher bar to it to jump over if something became available today?

Yes, I think when I look at the second half of this year we want to drive the performance we said we are going to deliver. You will see us really focused on performance. We do have a pipeline of opportunities. I think as we deliver the plans we want the second half of this year, some of those small deals could come to bear early in 2016. But our primary focus is bring down the debt with the cash that we are generating in the short term.

I appreciate your time.

(Operator Instructions)

We can go next with followup from Rosemarie Morebelli.

Jim, if I look at Asia-Pacific and your previous EBITDA margin target of 14% that was given to us, I believe, pre-Tonsan acquisition. Are we still looking at that 14% or do you think you can do substantially better following that acquisition?

Rosemarie, I think that's a great question. We are in the process of trying to re-evaluate what our medium- and longer-term targets are in Asia. We had originally targeted 14% in Asia. I think most recently we have kind of climbed down from that to more like the 12% based on what we saw in our legacy business.

Now we will have to re-evaluate what the Tonsan addition and some other factors mean for our longer-term targets in Asia. So that's kind of where it is right now. It's a little bit in flux.

You are talking about targets we set in 2011, Rosemarie, and I would say overall we think the Americas are going to be better than those targets. We think CP is going to be better than those targets. Then Asia and Europe will be slightly less than those targets overall, potentially. But overall the 15% target we have set is something we are very comfortable with.

The other thing I would point out with respect to Asia in particular, we've done really well in all of the emerging parts in China but if you look over the last few years, Australia and New Zealand, which was a good profit driver for us, has been a challenge each and every year. So, a lot of where we perform overall well depend on how will we can prop up and deliver the performance that we historically have in that part of Asia.

Is the issue in Australia and Asia due to their own economy or is it Fuller and you are not adjusting your structure there in line to the demands of the slower market?

Yes, I think it's a combination, right. We need to deliver the performance that we want out of [A and Jed], but if you look at the last few years in Australia and New Zealand, if your question is specifically about that, any kind of growth in that part of the world has been delivered by the mining and construction businesses and we need to make certain that's delivering the performance we expect long term. It's something we're working towards.

So is there almost as work to be done there as there is in Europe?

No, not nearly, not nearly.

Rosemarie, in Australia this year, this year especially in Australia they have margin squeeze because of the weakness of the Australian dollar is a big impact that is flowing through the business this year that we are recovering from.

Okay, and then if I may ask a question on Europe. You were planning in improving it substantially more than you did this quarter. You were disappointed so obviously nothing has happened the way you expected it. So what makes you confident in starting the second half and in 2016 you are actually going to reach those targets?

I think the things we are working on improving the business are about service and performance for customers and those steps we have seen good performance, Rosemarie. For instance, there are two sites where we have our biggest issues.

The one site, the output is 15% higher the last eight weeks than it was the prior eight weeks. On the other side, the output is 30% higher than it was in first order the last six weeks of this quarter. Our output with respect to right first time has improved three or four fold.

So when I look at the performance metrics of what we expect out of those plans and able to serve customers, those are moving in the right direction. We expected some of that to happen quicker and we also expect to deal (inaudible) with cost as we did that. Those cost saving initiatives are things that are in process right now.

So I would say the delay in the timing of our focus from performance to cost, we know where the excess costs are, we have good benchmarks from our businesses around the world and from our European business as to where we can get to. So it's very much a delay in executing on the cost part of the plan. First step was stabilize our ability to get the output we wanted and serve customers and in Q2 that's what we succeeded in achieving.

So, if I look at that 14% EBITDA margin target which obviously was given a while ago but in one of two quarters ago you mentioned that the target would be reached with one-year delay because the plants did not shut down as quickly as possible and then you had the manufacturing issues with the new facility. Are we looking at the 14% target to be reached in 2017 or is that too optimistic considering what is going on right now?

I think that would be a realistic way to look at things, Rosemarie.

Okay, thank you.

(Operator Instructions)

It appears we have no further questions at this time. I will return the program to our presenters for any additional closing remarks.

Thanks, everyone, for your time today and your continued support of our business and our strategy.

Thank you, ladies and gentlemen. This does conclude today's H.B. Fuller second quarter 2015 investor conference call. You may now disconnect. Have a good day.