H.B. Fuller Company (FUL) 2016 Q4 法說會逐字稿

Welcome to the H.B. Fuller fourth-quarter 2016 investor conference call. This event has been scheduled for one hour. Today's conference call is being webcast live and will also be archived on the Company's website for future listening. At this time, I would like to turn the meeting over to our host, Director of Investor Relations and International Finance, Mr. Maximillian Marcy. Sir, you may begin.

Good morning, and welcome to our FY16 fourth-quarter and full-year earnings call. We have two speakers today, Jim Owens, our President and Chief Executive Officer; and John Corkrean, our Executive Vice President and Chief Financial Officer. As always, after our prepared remarks, we will have plenty of time to take your questions.

Let me also remind you that comments made by me or 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 hbfuller.com.

Also please note that our reported results include non-GAAP financial measures. These results should not be confused with the GAAP numbers in yesterday's earnings release or with the GAAP numbers we will report on our Form 10-K.

We believe that the discussions of this measures is useful to investors because it assists in 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 in the earnings release our Company issued last night. With that, I will turn the call over to Jim Owens.

Thanks Max. And thank you everyone for joining us today. We had a strong finish to the year and delivered our commitments. Fourth-quarter EBITDA margins were at 14% and adjusted earnings per share of $0.74 were both in line with our guidance range. Volume and revenue growth continued to be strong for the Company overall, led by our engineering adhesives and Asia-Pacific segment.

The two primary strategic objectives we outlined in our 2020 strategic plan which will deliver outsized growth in engineering adhesives and sizable margin improvement in Europe. In FY16, we met our goals in both of these areas. Volume growth was almost 15% in engineering adhesives for the fourth quarter and for the full year.

EBITDA margin was over 14% in the fourth quarter in our EIMEA segment, compared to 10.7% in the fourth quarter of 2015, continuing the positive trend we saw throughout 2016. These strategic priorities, combined with solid volume and margin performance in our Americas and Asia-Pacific segments led the way to our success in 2016.

Our construction products business was the one outlier in 2016 and we will discuss our plan to get that business operating at normal levels later in the presentation. We are very pleased with the overall 2016 results, which sets us up for further success in the years to come.

As we move into the FY17, our plan reflects continued volume growth and continued margin expansion. We expect to deliver constant currency growth of 4%. And engineering adhesives and Asia-Pacific segment should deliver double-digit growth while the other segments are expected to deliver low single-digit growth, in line with long-term targets for those segments.

EBITDA margins will continue to improve through further operational improvements across the businesses. Particularly, in construction products, where the margin profile should return to historical levels after we complete our facility combination in Illinois.

We expect the Company to deliver 14% consolidated EBITDA margin for the full year, 60 basis points above 2016. A slightly lower tax rate of 30%, driven by a favorable mix of pre-tax earnings, combined with margin enhancements, will drive EPS growth of about 10% on a comparable 52-week basis.

Before we move on to the segment discussion, I would quickly like to discuss the macroeconomic trends that are impacting our business and the steps we're taken to manage them. This will provide more context concerning next year's financial expectations.

There are two major economic factors that we are managing in order to deliver our financial performance in the FY17. Foreign currency translation rates and raw material costs versus pricing dynamics. Foreign currency translation rates have been volatile over the past 24 months with a strengthening of the US dollar versus most other global currencies.

We generate approximately 60% of our revenue outside of the United States. In most cases, we produce our products in close proximity to where we sell them. Therefore, we are fairly naturally hedged between revenue generation and costs, minimizing the impact on margin percentage. However, our operating profit outside of the United States is mainly in local currency and it is exposed to exchange-rate fluctuations.

In addition, since oil is a US-dollar based commodity, our primary petrochemical-based raw materials, although purchased in local currency, are impacted by the strength of the US dollar. Due to these factors, we face some international profit margin pressure when the US dollar shows long-term strength against local currency, as it has done in recent years.

The US dollar is currently stronger against most currencies, including our largest exposed to the Euro and the Chinese RMB. The dollar has strengthened against both currencies in the prior year by mid- to high-single digits. The other economic factor that we are managing is our raw material costs versus customers pricing.

Petrochemical prices have come down over the last 18 months and we have done a good job in driving down costs for the raw materials that we have purchased. As costs remained low in 2016, we passed along some savings to customers via price decreases and product substitution.

The petrochemical landscape is changing and some petrochemical prices are flattening and some are now increasing. We expect flat to modest inflation in the raw materials that we've purchased and modest growth margin pressure, especially the first half of the year as we ramp up our efforts to reformulate products, implement strategic price increases, and drive savings of our manufacturing costs to offset these raw material impacts.

In December, we announced a proactive restructuring to better align our teams to the 2020 strategic vision. In addition to long-term benefits, we expect these actions to offset the negative short-term impacts of these macroeconomic factors I just mentioned.

Let me now walk through the segments performance in 2016 and some expectations for 2017. First in the Americas segment, as we committed the volume, trends continue to be positive and customer wins continued. When we separate out the extra week and the impact of mix, volume grew by about 2%.

We're pleased with the positive volume progression during the FY16, which allowed us to deliver volume growth in line with our long-term goal for the segment. We expect continued volume growth in FY17. Effective management of pricing and raw material cost management drove our solid EBITDA margin performance of 17.2% in the quarter. We delivered adjusted EBITDA margin over 18% for the FY16. We will remain above our long-term EBITDA target to raw material benefits with watchful eye on discretionary expenses.

Our Construction Products business completed a disappointing year, with volume declining by about 4% in the fourth quarter versus the prior year. The primary drivers of the year-over-year decline were lower export sales in our Foster product line and lower sales at Lowes due to difficult year-over-year comparisons. These two factors drove volume down about 9% for the full year on a comparable 52-week basis.

As we begin the FY17, the difficult comparisons at Lowe's and our Foster export business are now behind us. We are already seeing better results and expect revenue growth of low- to mid-single digits for the full year.

Pricing and contribution margins remain strong in this segment, where the adjusted EBITDA margin is well below the prior year and our long-term target due to start-up costs associated with our newly renovated facility in Aurora, Illinois. We believe that the majority of the additional start-up costs will be behind us in 2017 and we will return to our historical profitability profile in the FY17, with EBITDA margins back in double-digit range during the second half of the year.

Moving now to our EIMEA segment. We delivered volume growth of 6%. When adjusting for the extra week and the negative mix impact, volume was up about 1%. The volume growth trend should improve in 2017 as the tone of our overall business and the new business pipeline is getting stronger, enabled by improved and consistent supply chain performance, and higher growth trends in emerging markets.

We expect low- to mid-single digit volume growth in the FY17, in line with our long-term targets for this segment. From a profitability perspective, we improved adjusted EBITDA margin by 330 basis points versus the prior-year fourth quarter, up to 14%.

The elements of the improvement were broad based: volume growth, raw material cost reductions, price management, better supply chain efficiency, and lower manufacturing costs. We expect to continue to drive EBITDA margin improvement in 2017 but not at the same rate of improvement that we had in 2016.

Now turning to the Asia-Pacific segment. We grew volume by 16% in the fourth quarter, or just over 8% on a comparable 13-week basis, with strong growth coming from China. Foreign exchange rates have weakened again versus the US dollar especially the Chinese Renminbi, which now sits near RMB6.9 to $1, and has had a negative impact on revenue growth.

Volume growth for the FY16 was about 9% on a comparable 52-week basis and solid in all subregions. This solid performance is directly in line with our long-term targets. We expect similar volume trends in the FY17, with revenue offset by a weaker Chinese Renminbi.

The adjusted EBITDA margin in this segment was up over 200 basis points in the fourth quarter versus the prior year, reflecting volume leverage and raw material cost savings. In engineering adhesives, we continued to show strong growth, with volume up nearly 15% versus the prior year's fourth quarter on a comparable 13-week basis, led by good growth in Tonsan and our automotive business.

For the FY16, adjusting for the annualization of Tonsan and the extra week, we delivered 14% volume growth, with strong growth across all segments. We expect to continue our strong volume growth trend in the FY17 and are targeting 15% growth, in line with our long-term targets. However, the weaker Chinese Renminbi will likely bring overall revenue growth below 10% on a comparable 52-week basis.

Our engineering adhesives adjusted EBITDA margin in the fourth quarter was 14.1%, up 70 basis points versus last year's fourth quarter. Adjusted EBITDA margin for the FY16 was 11.3%, an improvement of about 40 basis points versus 2015. Contribution margins improved with our solid revenue growth and we expect further EBITDA margin improvement in the FY17.

However, we will continue to invest in our commercial and R&D organizations in this segment to secure long-term growth prospects of this high-margin segment. Now, I will turn the call over to John.

Thanks Jim. Jim provided a few highlights of the fourth-quarter results while I'll provide some additional financial details. We grew about -- volume grew about 8% versus last year's fourth quarter. We estimate that the extra week added 7% to 8% to volume. On a comparable basis, volume was essentially flat to slightly up.

Adjusting for the extra week in 2016, the rate of volume growth in the fourth quarter was about the same as the third quarter. As we discussed earlier, our raw material costs have come down. When this happens, we work with customers, providing value-added solutions at the best possible price. In some cases, this includes substituting product SKUs to come at a lower price but at a similar cost to H.B. Fuller.

This mix has historically been recorded in our volume calculations. When we separate out our mix impact from volume, we saw volume growth in the fourth quarter in all segments except construction products. The impact of product pricing and product substitution continues to be a significant factor in our results.

For the quarter, price had a negative impact on year-on-year sales of about 2.5%. It's normal to see some price erosion during periods of prolonged raw material cost inflation. That said, we believe we are effectively handling this normal process of managing pricing with our customers.

Going forward, we expect the raw material costs environment to stabilize and actually begin to increase with pricing stabilizing as well. Constant currency revenue growth on a comparable 13-week basis fell about 2% compared to last year. Exchange also had an unfavorable impact on sales, both versus last year as well as mid-year expectation.

The Chinese Renminbi and the weaker Euro are the biggest drivers in the unfavorable exchange impact on sales on a year-on-year basis. Adjusted gross profit margin improved by 60 basis points sequentially and versus last year, reflecting effective raw material and price management offset by higher year-on-year manufacturing costs, driven by the excess costs associated with the new construction product facility start-up and incremental costs associated with the ramp-up of the new facility in Indonesia.

Adjusted selling, general and administrative expenses remained in a more normal level in the fourth quarter as a percentage of net revenue. On a comparable 13-week basis, SG&A was up about 3% versus fourth quarter of last year.

We kept a watchful eye on discretionary expenses to ensure we were able to continue investing strategically in higher growth market segments. The net of this resulted in adjusted diluted earnings per share of $0.74 for the fourth quarter, up 7% versus the fourth quarter of 2015.

With that, now let me turn to our guidance for FY17. Foreign currency continues to be volatile. Based on current foreign exchange rates, we expect FX to negatively impact 2017 revenue growth by about 300 basis points. We expect constant currency growth of approximately 4% for the year on a comparable 52-week basis.

As a reminder, our fourth quarter of 2016 included an extra week. This will reduce net revenue growth by about 2% for FY17 and reduce the fourth-quarter 2017 net revenue growth by about 7% to 8% compared to 2016. We expect full-year EBITDA margin to be about 14% in 2017, which would be up 60 basis points from full-year 2016 EBITDA margin.

This translates to EBITDA of approximately $290 million. We will achieve this by improving gross profit and reducing SG&A as percentage of net revenue at about an equal (inaudible) during the year. Cash flow from operations is expected to be incrementally better in 2017 at about $200 million, driven by higher operating income and some improvement in working capital management.

Capital expenditures are expected to be about approximately $60 million for the year, while the significant capital project next year will be the implementation of SAP in our Latin America business. All these factors considered, we are introducing an EPS guidance range of between $2.57, and $2.77. This represents about a 10% growth at the midpoint versus the comparable 52-week FY16.

Even though our fiscal year starts in December, our historical EPS delivery has been more weighted to the second half of the year, driven by US and Chinese holidays. EPS is typically about 40% lower in the first quarter versus in the fourth quarter. We expect this trend to be similar in 2017. With that, I will now turn the call back over to Jim Owens to wrap this up.

Thanks John. The end of 2016 marks a successful completion of the first year of a five-year strategic plan, which we introduced at the beginning of this year. We improved volume in four out of five segments, in line with our long-term targets and delivered an adjusted EPS in the middle of our guidance range.

We improved EBITDA margin by 60 basis points, taking a step toward our 2020 commitment of 17%. We delivered approximately $200 million in operating cash flow, another commitment we outlined in our strategic plan. And we improved our return-on-invested capital, as we improved the operating performance of the business.

We also delivered on our two most important strategic priorities: sizable margin improvement in our European segment and 15% volume growth in our engineering adhesives segment. Overall, this was a great result, especially in the face of volatile macroeconomic conditions.

We have built on our solid foundation and realigned our teams to drive further growth and profit enhancement. The 2017 plan reflects additional top- and bottom-line growth, another positive step toward our 2020 strategic objective of 17% EBITDA margin, solid organic growth, significant cash flow and double-digit EPS growth.

2017 will be another strong step forward toward our 2020 plan, as our teams around the world continue to deliver on our promise to be the best adhesive company in the world. This is the end of our prepared remarks and now we look forward to answering your questions.

(Operator Instructions)

Mike Sison, Keybanc.

Hi guys. Good Morning. Happy new year.

Morning Mike. Happy new year.

Can we walk-through -- you gave us some outlooks for volume growth in 2017. So and I think you said 4% but it's really going to be 2%, right, because you lose a week?

Those are adjusted for the extra week, Mike. So the 4% -- so we would be growing 4% on a same-week basis volume and then currency would have a negative 3% impact.

Okay. Got it. And then so if you think about some the volume growth outlooks that you've provided, let's start with the Americas, 2%. So 2% seems -- for us, it seems light, but can you walk through what your macro assumptions are and how much of that is really just your sales force finding new products and winning new business next year?

I would say the combination, Mike, in our North America and European business that falls into that 2%. There's some sizable wins in areas like packaging and hygiene some of our durable assembly business. You also have some of the older HB Fuller businesses that are shrinking. So I would say good solid market share wins along with some other segments that are just aging manufacturing segments in North America and Europe.

So there's no rebirth of manufacturing built into this. It's the steady manufacturing where we gain share with new technology in hygiene, packaging and a bit durable assembly and we have a little retrenchment in some of the, I will call them, old-school market segments.

Similar trend in Europe but in Europe, we have the benefit of emerging market. So our Africa business is built into those numbers. That's very strong. Our India business is very strong and then core Europe is more in those low single digit.

The real growth phenomena for business is the engineering adhesive business, which is global. Some of that happens in the US and Europe as well. That's where we're seeing the 15% volume growth and really nice wins in our electronics business and some of our engineering areas that are enabled by the two really strong acquisitions we made, Cyberbond has been a really great add to Tonsan to accelerate our growth and Tonsan itself has been a really success so that's a look at it. That 15% growth engine and then that low single-digit growth in the Americas.

Okay. And just as a quick follow up. When you think about your EBITDA growth for the total Company in 2017 versus 2016, $290 million versus $280 million or so, it's up 3% yet you are growing organically 4%. Is FX a 3% hit and then is raw materials another couple percent hits? So if you exclude those two, you would have better leveraged, I guess, the organic sales growth into to stronger EBITDA growth. Is that the way to think about it?

I think that's exactly the way to think about it, right? So the extra week at last year is probably about $5 million or $6 million so that brings you down to $275 million. FX is probably $8 million to $10 million. So if you're talking about a $25 million improvement underlying when you take those two elements out.

The raw material impact, we're managing but we're also doing this restructuring, which enables us to offset that, but I think underlying, there's two factors, the extra week and FX. So the business itself is performing when you take out those math factors about $25 million better than the prior year.

great. Thank you.

Rosemarie Morbelli, Gabelli & Company.

Thank you and good morning, everyone.

Good morning, Rosemarie.

Jim, could you give us -- you talked about the restructuring focusing on the construction, but as I look at the Americas Adhesives in the fourth quarter, the margin was substantially lower than last year's fourth quarter. So are you going -- are you doing anything there? Could you help us understand what is needed and then it if you could address the lower level of business with Lowes -- I kind of missed what you talked about.

So the first question is about the Americas margin. I think we've said, we expect that margin to be 17% to 18%. I think first quarter this year was 17%, fourth quarter was 17.2%. Second and third quarters were much higher, but I think that's the kind of range we're expecting for this business. We would like to see it close to 18%, 17.5% to 18% on average.

So there's a natural fluctuation, and John can talk maybe about some more details about what's going on there. But we're pleased with that business and we expect those margins to continue. It's a really strong team that adapts to whatever the conditions are. We saw a couple years, we had some volume challenges. They were able to manage their costs. As raw materials have gone up or down, they've done a really nice job of managing through those and I'm confident in that business going forward.

I'm sorry. Because I was looking at that operating income and margin, not on an adjusted basis, the operating margin. So last year's fourth quarter was 17.3%, but this year's fourth quarter, unless I made a mistake, which is always possible, I calculate 14.6%.

I think the most meaningful numbers to look at, Rosemarie, would be the adjusted EBITDA numbers which were -- would have American Adhesives at about 17.2% this year. It was much higher last year. Last year was 19.8%. It was probably one of our [higher EBITDA] margins that we've printed in that business and we were, -- as we exited last year, it was probably the peak of the raw material savings we had to give back very little in pricing.

I know there's a lag that happens between the capture of raw material savings and pricing. We knew that we would experience some of that this year and we see those EBITDA margins return to the level that we -- in fact, in that 17% and 18% range. That's what happened during the --

That's very helpful. The answer you can go back to my question. I apologize.

That's fine. That's great. I think the important point is this business will end the year, full year, at 18.1% EBITDA margin, which is actually up versus last year.

Okay. In terms of your consolidation?

I'm sorry. The second question, Rosemarie?

In terms of your restructuring, are you doing anything in America Adhesives or is it mostly on the construction side of your operations, and what is happening with those?

So the restructuring we announced in December was over 200 people across the Company. It was pretty broad-based, mostly focused on functional areas, including operations and mostly functions on Europe and the Americas, including some working construction products. I think it was an overall drive to find efficiencies in the business, a number of small projects that added up to a sizable initiative.

We did that as a proactive effect to make certain that we can continue our march towards our 17% EBITDA margins. We see the changing dynamics on raw materials. We want to make sure we get ahead of that from a cost standpoint, and we also want to do the right things proactively to get the right technical people in front of our customers, leverage technology that we've invested in.

It's a combination of a lot of small projects, Rosemarie, but it definitely does include the Americas and again, it was a proactive initiative to get ahead of what we see as things like the currency challenges. Currency, over the last couple of years, has impacted our revenue by over $200 million. We still delivered EBITDA growth and EPS growth even though we've had that phenomena of just currency going down from a dollar standpoint, the revenue (inaudible).So that is a high-level summary of what we've done. Is there anything you wanted to add to that, John?

I don't think -- that's right on. I would say as we've looked the places that we saw opportunities to restructure for savings, we've obviously focused in the areas where there are less -- not in the customer-facing areas but in the functions and supply chain more than customer-facing and then obviously, we've done very light in the areas where there's higher growth effort.

Is the decline in your business there a question of they are going away from your product so you are not able to deliver the proper product lines or is it more general with the construction business at Lowes.

It is mostly a year over year phenomena. If you look at our Construction Products business, it grew nearly 20%, I think it was over 20% in 2015; it grew nearly 20% in 2014. There's a lot sizable amount of growth and a lot of that was driven by our major customers. I think there is an inventory re-shifting. There was one product line that wasn't as successful as we wanted.

But that was more the side story than the fact that we -- we had a lot of pipeline filling and growth that happened as we [brought] new shares, that was more pipeline filling in growth that will now stabilize. So when we look at the comparables to next year, you'll see a more stable single-digit growth pattern as we go forward, until we get another one of those big wins. But at this point, we see a more stable single-digit growth pattern for 2017. 2016 was really a phenomena of we just grew a lot faster the last two years. Some of that was not -- was pipeline filling.

Okay, thank you very much.

Thank you, Rosemarie.

David Begleiter, Deutsche Bank.

Thank you. Good morning, Jim. Just to be clear on America Adhesives EBITDA margins. Are you expecting margins to be flat in 2017 or up modestly?

Yes, I would say flattish, maybe down modestly. I think we are expecting margin improvement in Europe. We are expecting significant margin improvement in Construction Products, margin improvement in Europe, and margin improvement in Asia. All those businesses will be up.

Americas at 18.1%; it will come down into the high 17%s, I would say. That's our current projection but somewhere in the range. But 17% to 18% is our target for that business, and we expect to stay in that range.

Very good. Looking at the volume expectation of 2% on a comparable 52-week basis, can you bring out some of the sectors that are performing above that or below that in 2017?

In 2017, we expect hygiene to be above that. We expect our packaging business to be above that. We expect the durable assembly business to be above that. Then some of our older, I will call them, more paper-converting type businesses, those have a natural drag on them that will be below that 2%. But hygiene packaging and durable assembly. John, were you going to add something?

Yes, David, and maybe I confused the issue, trying to respond to Mike's question but on a comparable 52-week basis, volume growth would be 4%. So not adjusting for the extra week, it will look like (inaudible) --

But -- in American Adhesives only or just the --

That's a global number.

But Americas, it's about 2% next year volume growth. And hygiene packaging, durable assembly will be more than the 2% and then our paper converting businesses will be less.

Is that 2% for American Adhesives, is that comparable for the 52-week basis?

Yes.

Thank you. Thank you very much.

Thanks David.

Eric Petrie, Citi.

Hi, good morning.

Hi, Eric.

I just wanted to focus in on your manufacturing costs. At your 2016 Investor Day, you outlined overall you could reduce by 200 basis points. Can you accelerate this effort and if you did, would that improve the FX translation impact?

I guess what I would say, Eric, is that we're probably actually getting some benefit with FX translation as it relates to manufacturing from a pure dollars standpoint but not from a margin standpoint. Because some of our costs are in euros and other currencies, renminbi, which are obviously coming down as the currencies devalue but so are the sales.

Really as we manufacture very close to our customers, there is usually a pretty good one for one match. So I would say, no, there's not an opportunity to accelerate that -- there's not an opportunity to reduce the currency impact by accelerating the rate at which we reduced manufacturing by.

Although, I would say that when you look at our plan overall, right, I think was the core of your question, the strategic plan that we have is a significant reduction in manufacturing costs and there's some of that in our 2017 plan but there's certainly more of that in their latter half of that. As we move those savings projects forward, that's a key driver of our 17% EBITDA margin is really building efficiencies into our manufacturing supply chain which we have lined out and we're investing in.

The one big one you'll see this year is a significant improvement in our Construction Products margins and that's solely driven around the efficiencies we're going to build in manufacturing and supply chain so there's definitely an opportunity to accelerate from an overall project move forward approach. So I think that hits on your question. Is that right, Eric? Or there's still more?

Yes, yes, it does. If I could shift to an engineering adhesives, you mentioned some wins in electronics. But could you discuss your pipeline opportunities in 2017 maybe in terms of project launches compared to 2016?

Yes, I think our list is even better this year. This is a business that's going from strength to strength. We invested organically a couple years before the Tonsan acquisition and got some real good momentum on some smaller projects. This year, we won some medium-sized projects. Doing very well with some international players in this space.

So we're involved in a lot of big projects. We will find out as the year goes on, which one is a hit and how they drive forward. And we have expanded from simple assembly adhesives to other electronics adhesives. So we feel really good about the momentum in that business and we get very high double-digit growth rates on higher numbers each year. So they are having a sizable impact on our business.

So but I 'd say the pipeline is very strong in the electronics business, as it is in our Tonsan and Cyberbond business, which are more on the engineering adhesives side, so there's good momentum there.

Are you cross-selling Tonsan and Cyberbond products between the regions? Then could you qualify or quantify that opportunity?

Yes, we are. Yes, we -- the Cyberbond acquisition really was about accelerating that. So I would say this year we had low single-digit millions of revenue that we generated outside of China with Tonsan products. But we've initiated a lot of projects this year that includes bringing Cyberbond products into China, which was actually the easier wins. Those have already started kicking in some of those.

And then we significantly upsized our resources to grow the Tonsan out of North America. We want to see that grow into the tens of millions of dollars over the coming year to [$2 billion], so that would be the way I would think of it. But it's still -- while we see momentum in terms of impact to the overall corporation, there's still a big upside of which we will see some next year and an even bigger impact to 2018.

Then my last question, I wanted to shift to your pricing management. You talked about rising raw materials, especially in the Americas Adhesives and you announced pricing initiatives back in October. Can you just give us just a little -- a bit of how of that has been implemented and you think that pricing will improve from a negative 300 basis points in 2016?

Yes, so we have initiated selective price increases. Certainly where anything is tied on an index basis or we move down and then move up with customers, we have introduced those and those have been implemented actually in Q4, late half of Q4. What we're seeing right now is with the weakened RMB, is some price pressure in China.

So I think that's the first price -- you'll see pricing go up because of the strength of the US dollars there. But also in Europe, this prolonged weakening of the euro has seen a little bit of pricing for international areas. I would say the first half of this year will be targeted strategic increases where it makes sense depending on the phenomena.

Now we are facing the phenomena where in 2016, we had some price decrease, but we'll be lapping some of those the first half of this year. So we had some decreases the first half of this year, really none in, I would say, the last four or five months, and an increase is kicking in at the end of this year and we will see some of those continue this year. So I would say the net net next year will not be some sizable uptick but you will -- you won't see this downtick going forward.

Okay. Thank you.

Thank you, Eric.

Mike Harrison, Seaport Global Securities.

Hi, good morning.

Good morning, Mike.

Just kind of piggybacking on this last question here around the pricing dynamics. Was wondering if you could give us a little bit better sense of how these customer discussions are going? If you are a situation here where you've seen several quarters where raw materials are deflating, the customers obviously want some return on that.

But now your outlook calls for these raw materials to maybe inflect higher. I'm just wondering how well you can hold your ground and what segments are most sensitive to movements in raw material pricing? I am guessing that you're able to dig in your heels little bit more on the more specialized things that you sell in engineering adhesives and maybe there are some more commoditized products in other segments where you have a harder time digging in. Is that the case?

Well, you're right, there is a wide array of pricing and pricing strategies across our business, as you might imagine, given the nature of the customers, the nature of the products and the degree of specification of the products. So some products are very insensitive to raw material costs. Those that are highly sensitive, we have indexed, right? As I said, about 10% of our business moves in that direction.

There's this chunk in the middle where there's a competitive market dynamic that we manage. So as walls have come down, we have found ways to introduce new raw materials, new products to customers, keeping our margins whole and giving some of that to customers and keeping some of it for ourselves.

As raw materials go up and as I say, the obvious case right now is in China, where there is a weakening of the RMB. We go to customers and we explain to them why changes are happening and we introduce the increases. Generally, customers who we have worked with over that time are understanding and accepting. Nobody wants those increases but they understand and accept that it's worked both ways.

We continue to also introduce new products, right? So what we work to do is work with raw material suppliers who want to help us win with customers. So if there's a new chemistry or a new supplier, we will bring them into the mix with a new product and that is what we will introduce as we raise prices and the customer can buy their old product at a higher price or buy a new product at a slightly lower price to help them offset the chain. That is a high-level of how we manage it.

Okay. In the construction products segment, you mentioned some of the duplicate costs and getting the new plant started up. Can you just give us an update? Looking at the EBITDA number, it was about $3 million lower quarter-on-quarter sequentially on a similar revenue number. So is all of that $3 million impact related to the duplicate costs? And when should we see those quarterly costs normalize?

So maybe I'll let John talk about the specifics on the numbers and I will cover the high-level. So the biggest piece of that is duplicate costs. There's a few pieces to that. One is running the two factories themselves. Another one is additional tolling costs that we incur because we've outsourced the production of some of those materials. Those are pretty sizable.

Then, in order to meet the demand for customers, we're making products at non-ideal locations. So there is a cost efficiency penalty and there's a freight penalty when we bring a product from Florida to the Midwest where it's supposed to be made. There's three or four different buckets to those costs.

The plant in Palatine, the double operating costs, that went down in December. So that bucket of costs will go away here in Q1. But we are running the Aurora factory, the one that is the consolidation factory at lower efficiencies than we will be ultimately. There extra costs there. There's still the extra tolling costs, and there's still the extra, I would still call it, product transfer costs.

Those are rolling off partially in Q1, fully in Q2, and that's why I say by Q3 of this year, you'll see double-digit margins back in that business. It's solely a manufacturing and supply chain cost phenomena that we're dealing with there.

I think that explains very well. Just quantifying it, or putting a context around from a numbers standpoint. I think at the last call, we said we thought those costs were adding roughly $5 million of expense. This year might be slightly higher than that. It did peak in the fourth quarter as we had some of these additional transportation costs that Jim alluded to and some other clean-up costs and then that will come down as we go into the first quarter. It won't completely be behind us but as we get into the second quarter, it should be behind. So as you're thinking about the way next year we'll plan it, I'd think about it that way.

No, that's useful. Last question I want to ask is about the special item related to the Tonsan call option. It looks like the way you adjusted your earnings here, that the value of that call option declined by about $5 million, which I think is pretty substantial given relative to the overall value. Can you give us some explanation as to why that value declined so sharply? And I was wondering if you can also comment on the current fair value of the contingent consideration for Tonsan that you had disclosed was north of $60 million and is going to be based on Tonsan's FY18 gross profit?

I will let John try and get into the technicalities. I will give you an overall view. So Tonsan is going extremely well from an overall performance. The earnout element to this contingent consideration is based on assumptions on what the future profitability of the business is going to be. Those numbers get adjusted each quarter and that is what you see flow through here.

So as the future assumptions, which have been pretty high, get adjusted up or down, it's a pretty steep curve. So a slight adjustment can make a big adjustment in the overall valuations. So that's why you see these variations. I would say things like the RMB changing can have a big impact on that number. So even though you'll generate the same number of RMB, you might have less dollars, et cetera. So I will let John probably try and give you more technicalities on the number, but it's -- content is going as planned with slight adjustments to our forward projections, is the way I would look at that contingent consideration.

That's a very good explanation. It is a -- obviously, there's -- the payout is in renminbi so the currency impact is also bringing that down. But it is a sensitive number. So small changes, it delay -- some of the delay in synergies meaning we will capture what we make and capture them a little bit later has an impact on the valuation.

So I think it went from about $21 million in -- at the end of third quarter to about [$16 million] or so. It's a fairly sensitive number and you have to factor in the impact of currency as well, just as Jim mentioned.

All right. Appreciate the detail there. Thank you.

Jeff Zekauskas, JPMorgan.

Hi, good morning.

Good morning, Jeff.

Hi. What are the cost savings that your cost savings plan is supposed to deliver? And how much will you achieve in 2017 and how much will you achieve in 2018?

I will give round numbers. It's about $18 million and about half of that will happen next year.

That's exactly right. That's how we look at it from a budgeting standpoint, about a little less than half in 2017. And then our goal is we should capture most of that $18 million by 2018.

And in which geography will that be in primarily? Or is it across the board?

It really is across the board, Jeff. I would say it lines up, to some extent, based on our footprint. But it also, as we said, we found lighter in the areas where we think we have super growth opportunities.

So a little less in electronics and engineering adhesives is probably the way to think of it and more (inaudible).

So in 2016, your SG&A costs were up about $23 million and your sales were flat. Can you analyze what's going on there? Did you have in general, some unusual events? And looking into 2017 for the year, should your SG&A be flat or down because you had such large cost inflation this year?

Let me let John take that and I can answer your comments.

I think, Jeff, one of the things we have to consider is that we did see a pricing impact this year that has a direct impact on sales so that obviously has an impact on year-on-year on sales. And then currency is the other thing we mentioned that has an outsized impact on sales, but it also has an impact on expense -- the question was about SG&A, and I was going to go back to SG&A.

Most of our costs are in US dollars, as a percentage of our costs and our revenue is [in terms of our costs]. So we do have the impact that we're overweighted towards dollar costs and the impact on gauge on sales is not the same as the impact on SG&A.

Looking forward, we would expect expenses to come down year on year, in part, due to because we had the extra week in 2016. But also because we are taking costs out through restructuring and other things. We have things that will offset that, merit increases, bonus rebuild. But if you adjust for the extra week, we will be flattish to down slightly in 2017.

The extra week is about an $8 million in each year, too, Jeff, right? So you think about $8 million outsized this year and then $8 million benefit next year.

Were there pockets of price pressure in the US? And if there are, where are they?

I wouldn't say there is really strong price pressure in the US today. I would say it is a competitive market that we manage, but I wouldn't say there's anything in particular that has a lot of price pressure. We have a couple smaller competitors in the market that we need to manage around in certain segments. But generally, not a lot of price pressure.

Because your EBIT or your EBITDA sequentially was pretty flat in the US and your revenues were, I don't know, $18 million higher, is that a mix effect, or -- when you look at the sequential comparison, why are the US (multiple speakers) --

From Q3 to Q4?

Exactly right.

There's a little bit of variability that's natural in underlying related to our mix in the business. So we went from 2017 up to almost $20 million down to $17 million throughout the year. There's a little bit of that going on. There is a phenomena though. We've had raw material prices down for a period of time until eventually those come back to customers either in the form of a new product that's at a lower price or in terms of some giveback that we'll give as we work with them to maintain their business.

So I would say it is probably a long-term phenomena effect that petrochemicals over the last couple of years have come down. There is also a lag in any of our index pricing. So anything that's indexed generally lags in terms of when we give it back to customers. So those are the couple phenomenas with respect to price. (multiple speakers) I would call them less price pressure than collaborative behavior with customers in terms of how we're working on these things and it's a lot of pressure. That help?

Yes. So I think maybe earlier in John's commentary, he said that the first quarter tends to be 40% lower on an EPS basis than the fourth quarter. Things are a little bit confusing because you've had the extra week and all that. So if you earned $0.74 in the fourth quarter of 2016, I guess you're thinking you're going to earn something around $0.45 or $0.44 or maybe even a little less in the first quarter; is that the meaning of that?

Yes, that's the math, right? And so that's -- some of that is the extra week. Obviously, a big piece of that is the extra week in the fourth quarter --

Is the extra week. Okay, good. Lastly, when you look at the global economies, do they -- do you see signs of acceleration or deceleration or businesses are more or less the same as the way you thought they would be?

It depends on what the -- I'd say the year overall, we didn't see a robust phenomena. Interestingly, Jeff, we have seen some strength in China and Asia to start the year at the end of this year and the beginning of this year is the only thing that I find a little surprising right now in terms of the feedback we're getting from customers, but stable. We don't see any real negative trends anywhere versus what was a relatively weak 2016.

Continued strength in India; continued strength in a small business in Africa, and for us, it's probably mostly share gains and just the momentum we're building but this whole electronics front-end of engineering adhesives is strong. But when you think about overall global economy, India continues to be very strong and China seems to be picking up.

Okay, great. Thank you so much.

Dmitry Silversteyn, Longbow Research.

Good morning. Thanks for taking my call. Most of my questions have been answered but I just want to go back a little bit to the -- your European business. Is the margin improvement that you've seen which -- hundreds of basis points year over year, is that a function of the lagging effect of the restructuring that you've done or is this a function of your emerging market businesses growing faster and becoming more profitable just from a scale perspective? Can you talk about the -- it was probably the most serious margin lift in terms of year-over-year metrics?

Yes, I think it's mostly a result of that restructuring effort. I think we had really targeted to have some of that done in 2015 and in 2016, we saw the benefits. A lot of investment and a lot of good work. We have a much better run business, we've Europeanized the business, we have a shared service center, we have centralized labs that are really helping us win with customers and we have manufacturing facilities that are more efficient.

There's more to do in this, right. So while it was a great year in 2016, and there's more there, I said, since I've been CEO, that the delta and margin between our North America and Europe business should be very small. They are similar businesses, similar dynamics. We're moving our European business up into the range that it should be operating, and there's still more movement to go, I think, as we look forward.

But it's running well now, Dmitry, and it's fundamentally that. As far as the emerging market piece, they are going to help us with the growth. I don't know that it's a higher margin than the core European business, so it should be similar margins so it's not an uplift in margin from that, but it should help us on the growth side.

Got it. Switching gears to this construction business. As you look towards 2017, obviously, you had a tough quarter this year margin-wise because of the start-up of the Chicago plant and I think that's going to be impacting in the first quarter as well, if I remember, or before that, that's all said and done. Besides that sort of the margin recovery once those costs go away and once the plant is up and running efficiently, what are the growth strategies for this business?

You've had a very successful penetration at Lowes, it looks like, and Menards, and you're starting to take this business globally, I think, a little bit more. But is this a question of getting more shelf space at existing customers? Is it a globalization play, or is this just getting broader distribution channel within North America beyond the first one or two channels that you serve right now?

I would tell you the priority one is get that margins back to where they should be and they will this year, as you point out, which is a big uplift to the overall Company. Just moving our CP margins up to where they were, much less beyond that which we think is possible, will have a big impact on the corporation. As far as the growth strategy is concerned, there's a couple elements.

If you remember, we bought the Prospec business so we would have a broader footprint across the country. Our share in the Southwest and the Western part of the US is disproportionately lower. Those capabilities are going to help us grow regionally with more distributors in that part of the country. The fact that our supply chain will be more efficient allows us to win with customers throughout the country.

But the big driver of our business has been innovation. We have introduced new products that help the contractors and the consumer have a higher quality, higher efficiency job. Those additive products have been the real driver of our growth. So better coverage across the US, the innovation agenda and then I think when you think of our global agenda, our existing business is not a big growth platform for us. But it does enable us maybe to make the right bolt-on investment in certain areas.

So I would say that's not a big part of the organic growth strategy but it is an opportunity for us, because we have a very strong franchise here and we can leverage some of that technology to other places.

Got it. One final question. Another company that supplies products into the packaging and hygiene market had a similar November and year-end to yours, mentioned that these markets for them weakened significantly as the November quarter ended largely and perhaps inventory control by their customers, not necessarily market weakness.

But I was wondering if you've seen anything like that in your businesses, i.e., packaging and hygiene are big end markets for you or whether you think that you may be a little bit on a delay versus other component suppliers into that market?

No, we did not see any weakness going into the start of the year. Our December was positive. We felt good about the start of the year, Dmitry. I wouldn't say we saw any phenomena that would work against us in December. It could be different materials that this -- I don't know who the customer -- who the other supplier is. But for us, hygiene and packaging were both solid in our first period which is now behind us.

Sounds good. All right, Jim. Thank you.

Christopher Perrella, Bloomberg Intelligence.

Hi, good morning. Thanks for taking my call.

Good morning, Christopher.

Good morning. The guidance, your long-term target is 17% EBITDA margin and you're going to be at 14% this year if all goes according to plan. So how do you grow margin 300 basis points from 2018 through 2020. I know restructuring will add a little bit to that. What's the driver? Is it volume? Is it price? How does the waterfall break out to get you there now?

Right. I think it's a -- it's the key question that drives the value of our Company. We targeted about 80 basis points a year. Next year, we're saying we're going to deliver at least 60 basis points. Beyond that, there's a number of things that happen. I mentioned a couple of times, the supply chain efficiency that we have in the organization is much lower than we expect long term.

So we've made some investments that are going to drive benefits. Really, a lot of what we -- right now, we're at a peak from a manufacturing cost as a percentage of sales. So we see a real opportunity there over the next three years. That will be a fundamental driver in all of our business units. Our European segment, if you look at that, you should think about being very close to our North American segment in terms of the operating performance.

So that's not just the things we've done so far and the supply chain additions but how the supply chain runs and how our SG&A cost is structured, especially as we grow a little bit in the emerging market segment of that.

Then the big driver is our engineering adhesives business. So that business today as we invest for growth is running around 12% to 13% EBITDA margin. If you see where it's going to be at the end of the plan, it's 20% margin. Fundamentally, these businesses run at that level or higher and as we look at the back end of the plan, we're going to drive that to 20% margin.

When you take those altogether, you get to that 17%-plus margin. I think it's a -- each piece when you benchmark it versus our business or competitive businesses are very attainable goals throughout the course of the plan.

Taking 60, 80, 100 basis points a year is the approach we are taking to this. We're not trying to squeeze the Company up to 17% in one chunk. But take the steps, whatever they are, whatever the economic conditions, to make certain that we march to that 17% over the next few years. I think it's 80 basis points a year and I feel pretty good that we can deliver.

So at this point, there's no real big cost chunks that are going to come out, it's run the business better and leveraging what you've already done at this point?

Yes, I would say it's definitely exactly that, right? I mean, I think we've made some good investment in 2010 to 2015 that are showing benefits. Even in the face of what is pretty sizable currency impact, we continue to improve our margins over the last couple years. So the 300 basis points is all up and down the P&L, across our European segment, our construction products segment and our engineering adhesives segment. But those are the three elements.

All right. A quick question on the construction products. The cost, the manufacturing cost overhang. That should all clear up by the third quarter?

Yes.

Okay. All right. So it will be a little bit in the second quarter then, drag from extra manufacturing costs?

That's what we're projecting now. We would like to see it all out by the end of the first quarter but I would say definitely by the end of the second quarter. Now if you just took our CP business as it was, if that margin drop had not happened this year, that would have 60 or 70 basis points in and of itself, right?

So it was a big drag on the -- it was a really good year had CP not taken that margin hit, it would have been 70 basis points higher this year. So that's a big driver of our performance in 2017.

All right. I will get that back over the year-and-a-half as it rolls through. Okay, all right. Thank you very much.

Thanks, Chris. I think that's our last question. So I thank everybody for their time and for their support of the Company.

Thank you, ladies and gentlemen. This does conclude today's HB Fuller's fourth-quarter 2016 investor conference call. You may now disconnect.