H.B. Fuller Company (FUL) 2017 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the H.B. Fuller First Quarter 2017 Investor Conference Call. This event has been scheduled for 1 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 will turn the meeting over to our host, Director, Investor Relations and International Finance, Mr. Maximillian Marcy. Sir, you may begin.

Good morning, and welcome to our fiscal year 2017 first quarter earnings call. We have 2 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 comments may include references to 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'll report on Form 10-Q. We believe that the discussion of these 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'll turn the call over to Jim Owens.

Thanks, Max, and thank you, everyone, for joining us today. Our first quarter started off strong as we delivered profit performance better than expected and in line with our strategic plan. We delivered 10% constant currency growth, with strong growth across almost all businesses. We also completed the strategic acquisition of Wisdom Worldwide Adhesives, which added a little less than 2 percentage points to our growth rate for the quarter. I will talk in a bit more detail about Wisdom in a few minutes.

And in the face of raw material increases, we also delivered solid gross margin profit performance. The strong revenue growth and margin management contributed to adjusted earnings per share growing to $0.48 in the first quarter, a 12% improvement versus the prior year.

As we move through the remainder of the year, we aim to deliver performance consistent with our 2017 guidance and the goals in our 2020 plan as we expand margins, deliver revenue growth and meet our cash flow targets.

We have 3 areas of focus as we enter the second quarter. First will be to manage margins by delivering price increases and raw material and product substitutions. Next, we will return Construction Products to double-digit EBITDA margin on positive revenue since we have now nearly completed our facility combination in Illinois. And lastly, we will continue to drive solid double-digit volume growth in Engineering Adhesives and Asia Pacific, and will continue to drive sustainable growth in our Americas segment.

Thus far, we are delivering on our performance metrics, and we expect 2017 to be a successful year as we move toward our 2020 revenue and EBITDA margin targets.

On January 27, we purchased the industrial adhesive business of Wisdom Worldwide Adhesives, a provider of adhesives for the packaging, paper converting and assembly markets. For 140 years, Wisdom had been privately owned and operated by 5 consecutive generations of the Wisdom family. The Wisdom business generated revenue of approximately $100 million in fiscal 2016 with EBITDA margins of about 11%. The business was purchased for $123 million and is expected to generate annual run rate synergies of approximately $6 million starting in 2018, which would make the purchase price multiple equal to approximately 7x Wisdom's fiscal 2016 EBITDA on a post-synergy basis.

Wisdom's highly successful go-to-market strategy is based on a focused product line, ultrafast delivery and virtual service. This will complement H.B. Fuller's full value go-to-market solutions. This acquisition is strengthening our leading position within the Americas adhesive business. The combination of H.B. Fuller and Wisdom also provides significant cost synergy opportunities, primarily related to raw material sourcing. This acquisition will enhance and strengthen the delivery of our 2020 strategic plan commitments. So far, the integration is going very well, and we are very happy to welcome the Wisdom associates to the H.B. Fuller family.

Before I walk through the segment performance, I want to quickly mention that we will be providing some more disclosure related to our revenue performance. We have historically included the impact of product mix and small acquisitions in our volume calculation. Going forward, in order to provide more clarity and to help explain the many factors that drive our performance, we will begin splitting volume into 3 components: volume, mix and acquisitions. We will continue to separate price and FX as well. The chart currently being displayed lays out all of those components by segment.

Let me now walk through the segment performance in the first quarter. First, in the Americas segment, as we committed, the volume trends continue to improve. Organic volume grew 7% in the quarter. In addition, we completed the acquisition of Wisdom Worldwide Adhesives in the final month of the quarter. The Wisdom business added an additional 4 percentage points to growth on top of volume. Mix was negative 4%, and pricing was slightly negative versus prior year but improved versus fourth quarter. Overall, we are quite pleased with our very good constant currency revenue performance for the quarter.

Raw material costs increased in the fourth quarter, and we announced price increases, some of which impacted the quarter but most of which will come into effect later in the second quarter. The effective management of pricing and operational efficiencies helped to offset the negative impact of higher raw materials and the lower margins of the Wisdom business, driving our solid EBITDA margin performance of 15% in the quarter. We have maintained a watchful eye over discretionary expenses and expect our recent pricing initiatives and Wisdom synergy activity to bring EBITDA margin back above 17% in the second half of the year.

Our Construction Products business delivered a stronger performance than trend, with sales declining by about 5% in the first quarter versus the prior quarter -- versus the prior year, an improvement versus the fourth quarter of 2016. We expect to begin delivering positive revenue growth in the second half of the year as our facilities again operate at targeted output levels.

Pricing and contribution margins remained strong, which helped to deliver better EBITDA margin performance of 8%, an improvement of 60 basis points versus the prior year. The startup costs associated with our newly renovated facility in Aurora, Illinois, are primarily behind us, and we will return to our historic profitability profile in the second half of the 2017 fiscal year, with EBITDA margins back in double-digit range.

Moving now to our EIMEA segment. We delivered constant currency growth of over 9%, primarily driven by volume in emerging markets. Our solid operational improvements made during the prior fiscal year enabled growth, particularly in durable assembly, which was impacted most by our prior transformation and site rationalization initiatives. We anticipate moderate single-digit growth for the remainder of the year in the EIMEA.

From a profitability perspective, we improved adjusted EBITDA margin by 40 basis points versus the prior year's first quarter to 10.5%. The elements of the improvement were broad-based: volume growth, margin management and better supply chain efficiency. We expect EBITDA margin to improve slightly for the remainder of 2017 as our cost reduction efforts in operations and SG&A take effect. In addition, we are increasing prices to offset recent raw material increases.

Now turning to the Asia Pacific segment. We grew organic volume by 18% in the first quarter, offset by negative mix and pricing. The volume growth came primarily from China. The negative currency impact and a positive acquisition impact from Advanced Adhesives resulted in total revenue growth of over 16% for the quarter. We are very pleased with our revenue performance and expect to maintain this solid momentum for the remainder of the year.

Adjusted EBITDA was up 5% in this segment, but EBITDA margin was down slightly versus the prior year. This reflects the higher raw material costs, which impacted Asia in advance of other geographies, and was offset somewhat by volume leverage on fixed discretionary expenses. For the remainder of the year, we expect modest margin expansion as price increases offset raw material cost increases.

In Engineering Adhesives, we continue to show strong growth, with organic growth up 24% versus the prior year's fourth quarter. This was led by good growth in Tonsan and our electronics business. The Cyberbond acquisition contributed another 6 percentage points to revenue growth, offsetting the negative impact of foreign exchange.

Overall, we delivered revenue growth of over 25%. We expect to continue our strong volume growth trend in the 2017 fiscal year and are targeting 15% growth for the year, in line with our long-term targets.

Our Engineering Adhesives adjusted EBITDA dollars increased by 28% as margin improved slightly in the first quarter to about 10.2%. Raw material costs were slightly higher than the prior year, but the strong revenue growth helped to drive fixed cost leverage, contributing to the EBITDA margin improvement. As we move through the year, we expect continued year-over-year improvements in EBITDA.

Overall, it was a positive quarter for H.B. Fuller and in line with our strategic plan to grow in emerging markets in Engineering Adhesives while maintaining strong margin performance in our core European and Americas businesses.

With that, I'll turn the call over to John.

Thanks, Jim. Jim provided some key highlights of the first quarter results, so I'll provide some additional financial details.

Organic volume grew nearly 9% versus last year's first quarter. 4 of 5 segments delivered positive growth, led by Engineering Adhesives and Asia Pacific. A combination of acquisitions and mix added another percent to revenue growth. The impact of product pricing was less of a negative factor on our results in recent periods. For the quarter, the year-on-year impact of price was essentially flat as we've begun to increase prices in line with raw material inflation. We've also raised prices in the emerging markets, namely Turkey and Egypt, to offset currency movements in those countries. We expect pricing to become positive overall as the year progresses.

Overall constant-currency revenue increased 10% in the first quarter, with a little more than 3% of growth coming from acquisitions. Adjusted gross profit margin declined by 80 basis points versus last year, reflecting increasing raw material costs and slightly lower year-on-year pricing, while operational efficiencies offset some of the decline. Adjusted selling, general and administrative expenses increased approximately 5% in the first quarter, reflecting the impact of acquisitions and higher year-on-year variable compensation. SG&A declined as a percentage of revenue versus the prior year as we have kept a watchful eye on discretionary expenses and taken restructuring actions globally, as we announced in December, to ensure that we are able to continue to invest strategically in higher-growth market segments. Net result of this is adjusted diluted earnings per share of $0.48 for the first quarter, up 12% versus the prior year.

With that, let me now turn to our guidance for the 2017 fiscal year. Foreign currency continues to be volatile. Based on our current foreign exchange rates, we expect FX to negatively impact 2017 revenue growth by about 3%, in line with the impact in the first quarter. We expect constant currency growth of approximately 8% for the year on a comparable 52-week basis. The Wisdom acquisition accounts for approximately 4 percentage points of the constant currency growth.

As a reminder, our fourth quarter of 2016 included an extra week. This will reduce net revenue growth by about 2% for the 2017 fiscal year and reduce the fourth quarter of 2017 net revenue growth rate by 7% to 8% compared to 2016. Therefore, full year net revenue growth should be approximately 3% versus the 2016 fiscal year.

We now expect full year EBITDA of approximately $300 million, which equates to approximately 14% EBITDA margin. Cash flow from operations is expected to be about $200 million, driven by higher operating income and some improvements in working capital management, offset by restructuring-related costs. Capital expenditures are expected to be approximately $60 million for the year. The most significant capital project this year will be the implementation of SAP in our Latin America business. For the full year, we are maintaining our full year EPS guidance range at between $2.57 and $2.77. This represents about 10% growth at the midpoint versus a comparable 52-week 2016 fiscal year.

With that, I'll turn the call back to Jim Owens to wrap us up.

Thanks, John. We started off the year strong, and we made good progress in the first quarter against the 3 key initiatives we outlined for this year: delivering growth in Americas, driving exceptional volume growth in Engineering Adhesives and a return to historical operational levels in Construction Products. Our 2020 plan has us growing the top line, improving EBITDA margins to 17% and effectively investing the free cash flow generated by the business.

In this quarter, we continued to drive sizable growth in Engineering Adhesives and Asia Pacific segment as a strategic priority, and we delivered organic volume growth in most businesses. We successfully completed the synergistic acquisition of Wisdom Adhesives, and profitability remains strong, with improvements in Construction Products, EIMEA and Engineering Adhesives.

We expect to continue this strong performance through the remainder of this year to drive sales growth, offset raw material increases with strategic pricing initiatives and deliver on our cost savings initiatives. With each passing quarter, we gain confidence in our long-term targets and gather momentum as we continue to improve our operational performance.

This is the end of our prepared remarks, so now we look forward to answering your questions.

(Operator Instructions) And we'll take our first question from Eric Petrie with Citi.

I just wanted to talk about the strong growth that you showed in Engineering Adhesives and Asia. Are you seeing better trends than expected in China and emerging markets?

I would say, for the quarter, yes, probably. I mean, I think we expected strong growth in emerging markets as part of our strategic initiative, but China was positive for us. I think in Engineering Adhesives, in particular, it's a -- relatively to the size of the market, it's a smaller business. And we're doing real nice wins in engineering, in electronics, good growth, Tonsan in China, but also Tonsan products coming out of China. And we're getting some of these synergies that we expected out of Cyberbond products into China. So, yes, I would say it's a positive environment we're working in, but most of the growth, of course, is -- that sized growth is because of the wins that we're creating in the market.

Okay. And secondly, just talking about pricing in raw materials, obviously we've seen inflationary costs in first half and your pricing may be flagged at -- by quarter end, should be realized in 2Q. What is your outlook for second half?

And so -- for raw material prices? Yes, so as far as we're...

For raw materials.

Yes, yes. Yes, I got you. So yes, we -- as you point out, most of our price increases are going to come in the second quarter. Some of it starts the quarter, some of it's mid-April, some of it's May but -- so we'll see a full effect of that by Q3.

As far as raw materials the second half of the year, most of the predictions are for things to flatten out. And my experience in this business is we continue to see a little bit of inflation after these things. But our current view is that this is going to flatten out the second half of the year. We're starting to see a little of that already in Asia. Asia took a big spike early and is starting to flatten out. Certainly not go down, but we see flattening the second half of the year, is our current view, with us being prepared, if things continue to accelerate, to raise prices more, if necessary.

And next is David Begleiter with Deutsche Bank.

Jim, just looking at the cadence of quarterly earnings for the rest of the year, how would you look at Q2 progressing on a year-over-year basis with the benefit of these price increases hitting here?

I would say -- and John maybe can be more specific than I will, so I'll turn it to him. But I would say Q2 is still a little challenged from a year-over-year standpoint because our increases aren't going into effect first day of the quarter. So a lot of them are effective mid-April. Some of them are 1st of May, which is the third month of our quarter. So I would say we will have some continued challenges.

Now with that said, we did a pretty good job this quarter of managing those challenges, right? We've got the cost savings initiatives we put in place. We've got the volume growth. So I'm expecting a solid Q2 but really stronger performance the second half of the year. We also got the benefit of Construction Products really kicking in the second half of the year.

So that's the way we see the progression. Solid quarter in Q2, and a lot of this volume that we're generating, generating really stronger performance second half of the year.

John, do you want to add to that?

I would concur. I think, based on the way raws are coming on and Jim's comments, they will hit pretty hard in Q2. And we will get pricing, but the expectation is those will level and pricing will be fully implemented by the end of Q2, we'll see better growth in the second half than we will in Q2.

And John, you would still expect margins to be -- gross margins to be down quarter-over-quarter in Q2 but maybe at a lower -- less of a rate than in Q1?

Yes, I would say they're going to be down similarly probably in Q2 to what we saw in Q1.

The next question is from Rosemarie Morbelli with Gabelli & Company.

I was wondering if you could give us a little more detail on that -- on the strong volume growth that you experienced in the first quarter. And do you think that there was some inventory buildup at some of your customers in anticipation of higher prices?

Yes. So we'd have to go segment by segment. Certainly in Asia and Engineering Adhesives we don't see a big buildup related to higher prices. The prices hit pretty hard. They hit early in the quarter so -- and there?s where a lot of wins in the market. So I don't think we have any of that there. It's always a question in Europe, in North America whether you have much of that. Generally speaking, customers don't bulk up on adhesives. They really can't drive their performance by increasing their orders. So we don't typically see and we don't think we've seen here a big impact related to inventory build.

As I said, the growth in Engineering Adhesives were wins in electronics, Tonsan's solid growth and then Tonsan outside of China. So a lot of good market share gains there.

Asia Pacific, positive momentum in our hygiene business and across all of our segments as the teams invested in some good innovative approach as to how to win in our Asia business.

In Europe, it's mostly emerging markets. So it's solid performance by our team in India, our team in Egypt, our team in Turkey that's driven that.

And then the Americas, it's a broad-based approach. We don't have any wind in our face in Latin America, so we're able to grow again in Latin America. And in the U.S., the team has got good operating systems, good operating performance. All the problems that we had to deal with that were restricting our ability to grow are behind us, so they're able to go out and win in the market. Along with a positive environment. I wouldn't say it's crazy positive in the U.S., but a positive environment in the U.S. So that...

Okay. That is helpful. Thank you. And just a second question, if I may. If I look -- while you focus on the adjusted EBITDA, looking at your segment operating margin, I mean, they are all substantially -- or at least lower than last year. And if I look at all of the segments, this quarter you have a 5.2% margin versus 8.5% last year. So we have the impact from raw materials, we have the impact from mix, but I was wondering if there was anything else and if you could quantify the different pieces that hit the margin.

I think, Rosemarie, as you look at that, you're looking at numbers that include the impact of restructuring charges. So the operating margins at the segment level are not going to be nearly as helpful as looking at the adjusted EBITDA margins, which are on the same page but further down. And you can see that in EIMEA, Construction Products and Engineering Adhesives, we saw margin expansion in all 3 of those. And that's the more help -- that's the better metric to look at.

And you'd probably see similar trends in operating margins in those, right, because we don't have a big shift with D&A there. So I think the specific areas where we have year-over-year margin decline, one would be Asia. And as I mentioned, that's raw materials hitting before our price increases hit. So that's the big driver of the Asia margin. And those price increases are being implemented.

And it's a similar story, although a little different, in the Americas, where we have this year-over-year effect where prices had continued to move down last year, they're moving up now, so you have a cumulative effect of the 4 quarters there as the -- and you have a little bit of a dilution effect of Wisdom, which is lower margin than our core Americas business.

So those are the 2 that were down, both on an operating margin and EBITDA margin, and mostly driven by raws, which were recovering, and a little bit of the Wisdom dilution effect.

(Operator Instructions) We'll go next to Mike Harrison with Seaport Global Securities.

I wanted to thank you guys for starting to break out mix and acquisition contributions separately. That's very helpful. But this is the...

We're all about trying to help you, Mike. And I know John really wants to build transparency, in all seriousness, for our investors. So I appreciate that.

Makes it much easier to model. But the second -- sorry, this is the second quarter in a row now where you've called out negative mix impacting your revenue. And I was just curious, is that a function of some of the reformulations that you're working on in an inflationary raw material environment? Or are there some other drivers there? Just kind of curious how much longer we should expect mix to be a drag on revenue growth.

Yes. I would say mostly that's what it is, right? And that's a phenomenon that exists in our business, actually, Mike, in some parts of our business, where we're trying to reformulate. And I think I'd look at it as a lower revenue at the same margin phenomenon, right? So when we introduce a new product, that's a negative mix, but we do it in a way that protects our margins as we reformulate.

All right. And then turning to the Americas business, was just hoping that you could break out where the strength in the volumes is coming from. You referenced that Latin America is no longer a drag, but is this finally starting to see some regaining of lost share in the packaging space? And also curious whether there were any timing issues, I guess, on the heels of the question about inventory build potentially going on right now?

Yes. So yes, I mentioned Latin America and specifically broadly across the Americas hygiene, right? So Latin America is generally a positive hygiene story. And that was a good situation for us. Our durable assembly business was solid in the Americas quarter -- this quarter. So that business has got a very good, strong team that's winning in the market. And then I'd say, on packaging, not a huge uptick but certainly not a drag for us this quarter. So I think that's one of the things -- we've had good growth in a couple areas and packaging has been working against us. Packaging was finally positive again this quarter. So -- and that's -- that would summarize it.

Anything to add there, John?

Yes, I think that's a great summary.

All right. And then the last question I had is just on the Engineering Adhesives business. The guidance for 15% growth in volumes for the full year would be well below where you were for the first quarter. So just hoping to understand when you're expecting to see those growth rates moderate. And I guess the implication is that there's a quarter in there that's well below that 15% target. What would be driving that?

Yes. I think John and I were just talking about this, this morning, right? We're predicting, I guess, on average, it would be 12% for the rest of the year, which is closer to our strategic target of 15%. Do we want to see more than that? Certainly, right? So -- but I think it's a good, moderate target. But now there's not one quarter that's dragging that number down. I would say we're very optimistic about where that business is headed in terms of overall performance.

And the next question is from Christopher Perrella with Bloomberg Intelligence.

In terms of your leverage after the Wisdom deal, it's sitting about 2.4 adjusted EBITDA, net debt to EBITDA. Just remind me, do you have a range? And how would you characterize the pipeline of acquisitions that you're working on?

I'll talk about the range and I'll let Jim comment on the pipeline. So we tend to look at gross debt to EBITDA as the metric because it's consistent with the way the rating agencies look at it and the way that our covenants are designed in the private placements. And post acquisition we're about 2.9x. I think we ended last year at about 2.5x. And so that's above our long-term target, but we're comfortable with that because we know that that will come down over time as we use cash flow to pay down debt.

Yes. As far as the acquisition pipeline, it's positive. I think for us it's a matter of -- as you point out, we try and moderate -- we don't want to become overleveraged, so doing the right deals at the right time, both from a capital deployment but also a human resource deployment. So last year, we did Cyberbond in Engineering Adhesives; Advanced Adhesives, which was a synergistic deal. One was a growth opportunity and the other was synergy related. And we had the human capital to do those.

The team in Americas is focused on making certain Wisdom is a big success, so you wouldn't likely see another deal like that in the Americas. But if there was a synergistic opportunity in another region or a growth opportunity related to Engineering Adhesives, we'd certainly pursue those. And yes, they exist, I think, in this space. It's a highly fragmented space. We're $2 billion in a $40 billion market segment. So there are opportunities, and we pick the ones that we think are really a good fit for us and go and find a way to pursue them.

Are you seeing a lot of bids on these acquisitions? Or is it fragmented enough that it's a low competition for these deals?

Chris, our strategy is to be the buyer of choice for people who want to sell their adhesive business, right? So I think we have a good reputation in the market in terms of how we manage these situations. We have the right relationships with the right people that we target. So we want to be an acquirer of choice because of how we operate, both in terms of how we negotiate and how we integrate these deals. And I think that's worked out pretty well with us, and I think evidenced by the fact that a 140-year-old, fifth-generation, family-owned company decided they wanted to sell their business to us rather than other alternatives they might have had.

(Operator Instructions)

So thanks, everyone, for your time today. Thanks for your continued support of our company and our strategy.

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