H.B. Fuller Company (FUL) 2019 Q4 法說會逐字稿

Good morning, and welcome to H.B. Fuller's Fourth Quarter 2019 Investor Call. (Operator Instructions) Please note, the event is being recorded.

I would now like to turn the conference over to Ms. Barbara Doyle, Vice President of Investor Relations. Please go ahead.

Good morning, and welcome to H.B. Fuller's 2019 Fourth Quarter Earnings Call for the Fiscal Period Ended November 30, 2019. Our speakers are Jim Owens, H.B. Fuller President and Chief Executive Officer; and John Corkrean, Executive Vice President and Chief Financial Officer. After our prepared remarks, we will take questions.

Please let me cover a few items before I turn the call over to Jim. First, a reminder that our comments today will include references to non-GAAP financial measures. These measures are in addition to the GAAP results in our earnings release and in our forms 10-K and 10-Q.

We believe that discussion of these measures is useful to investors to assist the understanding of our operating performance and the comparability of our results with other companies. Reconciliation of non-GAAP measures to the nearest GAAP measure is included in our earnings release.

Also, we will be making forward-looking statements during this call. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially from these expectations due to factors discussed in our earnings release, comments made during this call or risk factors in our Form 10-K filed with the SEC and available on our website at investors.hbfuller.com. We do not undertake any duty to update any forward-looking statements.

Now please turn to Slide 3 in the investor deck, and I will turn the call over to Jim Owens.

Thank you, Barbara, and welcome to everyone on the call.

Last evening, we announced our year-end results for 2019 and our guidance for 2020. In a challenging manufacturing environment where overall end markets were showing negative growth, in the full year of 2019, we delivered organic constant currency EPS growth of 6%, margin improvement, solid cost control, and very strong cash flow, which allowed us to reduce debt by $268 million, well ahead of our target.

We achieved these results, while at the same time, building momentum for 2020. We announced the realignment of our business from 5 operating segments into 3 global businesses, which are enabling better organic growth and a more simplified business structure which will operate with approximately $30 million in lower costs.

Our momentum and our preparedness going into 2020 is strong and will result in an approximate 10% improvement in EPS, despite our expectation of a continued weak macro environment and the manufacturing sector globally.

I'll talk more about our 2020 plans and our business realignment later in the call. But first, let's review the fourth quarter and 2019 results.

In the fourth quarter, we saw good organic growth in the Americas Adhesives, in Asia Pacific Adhesives and Engineering Adhesive segments. These were driven by higher volumes in hygiene, packaging, new energy and general industries, but were offset by weak automotive and construction volumes. Overall, organic revenues were down less than 1% compared with the fourth quarter of 2018. This was an improvement from negative 3.3% in Q3. For the full year, EBITDA and EPS, excluding the divestiture, were up at constant currency. This profit growth was achieved despite the fact that we had negative annual organic growth for the first time in 10 years.

In the fourth quarter, EBITDA was weaker than anticipated because we had some temporary increases in manufacturing and inventory write-off costs at 3 of our acquired factories, which totaled about $7 million. The higher costs are not expected to recur. Strong free cash flow conversion and working capital improvements continued in the fourth quarter and enabled us to pay down $118 million of debt in the quarter for a total of $268 million for the full year. This exceeded the $260 million commitment we made on our September investor call and far exceeds the $200 million commitment we made at the beginning of the year. These results demonstrate the strength and the resiliency of our cash flow.

And in the fourth quarter, we completed significant steps in our business realignment by finalizing our new global business unit organizations, establishing clear operational plans for 2020 and executing on cost reduction commitment in our functions.

Our realigned organization includes a focus of resources on standardizing and simplifying key business processes across the company. This will drive further savings and focus on customers as we streamline and strengthen support for our commercial teams, improve consistency and visibility across the businesses and drive down our cost to serve customers.

Our GBU realignment has also allowed us to streamline our organizational structure and drive immediate savings of approximately $20 million in 2020.

Now I will review segment performance in the fourth quarter on Slide 4. Weakness in the Industrial sector continued to impact volumes in the quarter. In the U.S., average PMI of 48 for the quarter worsened versus 51 in the third quarter and 59 in the fourth quarter of last year. Eurozone PMI also continued to trend lower, averaging 46 in the fourth quarter compared with 47 in Q3 and 52 in the fourth quarter of 2018.

With that backdrop, H.B. Fuller's organic revenues in the Americas increased by 3%, driven by volume growth in hygiene.

Adjusted EBITDA margin of 14.1% was lower than last year as volume growth and favorable raw material costs were offset by impact of the surfactants divestiture and higher manufacturing costs.

The EIMEA revenues were down 3.5% year-over-year on an organic basis, reflecting the widespread market slowdown in core Europe. The year-on-year volume trends improved in Q4 compared to Q3, however.

The EIMEA segment EBITDA margin of 11% improved year-over-year, driven by favorable raw material costs and good expense controls.

Asia Pacific organic sales increased by 2% year-over-year as strong growth in Korea and solid results in Southeast Asia and China offset slower sales in Australia and New Zealand. Asia Pacific EBITDA performance was strong, increasing 100 basis points year-over-year, driven by volume growth, favorable mix, lower raw material cost and solid expense controls.

Construction Adhesives faced continued external headwinds in the fourth quarter. Lower private construction spending in the U.S. impacted flooring and roofing sales, and weak industrial spending outside the U.S. impacted utility and infrastructure volumes.

We confronted a series of factors in Construction Adhesives this year. Lower construction spending in the U.S. and Europe overall were magnified by a repositioning of our Construction Adhesive portfolio toward business areas that provide higher margin and growth potential.

These portfolio adjustments, which we began in the fourth quarter of 2018, unfavorably impacted segment revenues by approximately 6% on a full year basis or about half of the full year decrease versus last year. Construction Adhesives organic sales, excluding the portfolio repositioning, were down about 6%. This is in line with overall private residential U.S. construction spending, which declined by 6.4% for the full year versus 2018.

Lower volume, capacity constraints on certain roofing products, and higher levels of manufacturing cost and inventory write-offs in the quarter negatively impacted EBITDA margin versus last year on a quarterly and full year basis.

While the refocus of our Construction business has negatively impacted our results in 2019. I am extremely confident that the actions we have taken will result in a significant change in the growth profile and profit performance of this business in 2020 and beyond.

Let me share some of the steps we have taken this year to position ourselves to capture construction-related growth opportunities around the world and improved performance in this segment in 2020. In 2019, as you know, we exited less profitable products and product lines and reduced our cost structure. We have also focused resources on new product solutions, regional growth opportunities and customers that will drive above-market growth rate. This includes adding resources and new leadership in Europe to accelerate our growth of differentiated products in that region; commercializing new H.B. Fuller applications in North America, such as sprayable adhesives for roofing membranes, which is an exciting innovation for this industry and is showing strong market acceptance; and investments to build awareness and promote and grow our Fast 2K technology, which is generating a lot of excitement as a concrete replacement.

We also upgraded staff, equipment, and improved operations planning processes to address capacity constraints and improve efficiencies in one of our acquired factories as we completed our integration activities.

Additionally, I'm pleased to announce that on December 2, Boz Malik joined H.B. Fuller to take on leadership of the new Construction Adhesives GBU. Boz has deep experience in construction end markets with more than 20 years of experience in global, industrial and construction roles. He joins us from Masonite International, where he led their $900 million North American residential business. We are happy to welcome Boz to H.B. Fuller, and we are confident in his ability to drive profitable growth.

As a result of all of these actions, we anticipate a return to revenue growth in Construction Adhesives in 2020. We also forecast increased EBITDA margin, driven by volume growth, mix, the efficiency actions that are underway and the cost reductions we have taken relative to the GBU alignment.

Lastly, organic revenues in Engineering Adhesives increased by low single digits compared with a very strong fourth quarter last year, when this business grew sales by 17%. Strong performance in new energy, general industries and other parts of the business were offset by weak results in automotive and other vehicles, reflecting a slowdown in global auto production. Engineering Adhesives organic volume grew by mid-single digits in the fourth quarter and the full year, driven by share gains in our end markets. Engineering Adhesives EBITDA performance remained very robust at a 21% margin, driven by volume growth, mix, lower raw material costs and good expense and pricing discipline.

Now I will provide an update on our business realignment and its impact on our business going forward. On our last quarterly call in September, we announced a strategic realignment of our business into 3 new global business units, or GBUs: Engineering Adhesives; Hygiene, Health and Consumable Adhesives; and Construction Adhesives. As of December 1, our realignment has been completed and is fully operational. This realignment is a natural and important next step in our company's evolution. This structure enables us to accelerate growth by identifying market trends and solving our customers' problems better, faster and at lower cost than our competitors. Given the importance of this business change, we engaged expert consultants to help design an organizational structure that enables us to do just that.

Our primary objective for this realignment is simple: to drive higher long-term profitable growth. As a global company, we have global market strategies in all of the market segments where we operate. By organizing into global business units rather than regional businesses, we can execute our growth strategies faster while eliminating the cost, complexities and inefficiencies associated with our regional structure.

By shifting the majority of our resources into the 3 GBUs and assigning more direct accountability to our sales, technical and manufacturing teams, we will more rapidly identify market trends, streamline decision-making and accelerate innovation.

Our 3 GBUs are similar in that they are focused on identifying market trends, designing advanced adhesive and application systems and bringing solutions to market quickly. However, each has a distinct strategic and financial profile.

Engineering Adhesives, which already operates as a global business unit, is adding our durable assembly business, which was previously operated regionally. These businesses focus on highly specified, high-performance adhesives. This combined business generated $1.2 billion of revenue in fiscal 2019, an EBITDA margin of about 18%.

In the near-term, we expect mid-single-digit growth, reflecting the inclusion of the durable assembly business. However, as we introduce the engineering adhesive business model, leverage synergies across the business and operate in a more stable business environment, we expect double-digit growth longer term. We expect an EBITDA margin range in the high-teens in the near-term, which will exceed 20% over the next several years. Given the overlap between our historical Engineering Adhesives and durable assembly businesses in terms of plants, products and technology, the combination creates significant growth and cost synergies.

Our Hygiene, Health and Consumable Adhesive business generated $1.3 billion of revenue in fiscal 2019, an EBITDA margin of about 12%. With a global rather than regional focus, we will be better able to strategically identify emerging trends and new applications in hygiene, sustainable packaging, beauty and medical care. This business is expected to deliver long-term growth at above market rates, or low- to mid-single digits, with an EBITDA margin in the mid-teens.

The Construction Adhesive business remains largely unchanged. By enabling architects, builders and construction workers to complete projects in less time at lower cost with higher levels of durability and sustainability, we expect long-term growth and above market rates in Construction Adhesives, with an EBITDA margin in the high-teens.

As I mentioned earlier, another critical outcome of this realignment is that it allows us to simplify management of our business and reduce the cost required to deliver high-quality service to our customers. As part of the realignment, we now anticipate annualized cost savings in the range of $25 million to $35 million by the end of 2021, with approximately 2/3 of those savings being realized in 2020. This narrows our previously estimated savings range of $20 million to $40 million.

We will begin reporting our financials under the 3 new segments in the first quarter of 2020. And in February, we will share with you more detailed recasted 2019 quarterly historical results under this new segment reporting.

I'd like to thank our entire team for their work in executing this realignment. It is truly a testament to the dedication and talent of our people that we were able to execute this initiative so quickly. Because of these efforts and unity across the company, we are entering 2020 poised to realize the benefits of our new operating model.

Now let me turn the call over to John Corkrean to review our fourth quarter results and our outlook for fiscal 2020.

Thanks, Jim. I'll provide some additional financial details on the fourth quarter as well as guidance for 2020. Revenue was down 3.8% in the fourth quarter versus last year's fourth quarter. Currency and the divestiture of the surfactants and thickeners business had a combined negative impact of 2.9%. Organic revenue was down 0.9%. And while volumes were still down 0.4%, volume trends improved versus Q3, with growth in the Americas, Asia Pacific and Engineering Adhesives, offset by slower results in Construction in Europe.

And pricing was down 0.5% year-on-year, reflecting some give back of lower raw material costs.

Adjusted gross profit margin was down 20 basis points year-on-year, as the impact of favorable raw material cost was more than offset by lower volumes and higher manufacturing cost and inventory write-offs. As Jim discussed, these costs were temporarily higher in the quarter, especially in Construction Adhesives and are projected to return to lower more typical rates in 2020.

Adjusted selling, general and administrative expense was roughly flat year-on-year. Interest expense and taxes were both down year-on-year. Net interest expense declined by 15%, driven by debt paydown. The adjusted effective tax rate of 18.8% in the quarter reflects a cumulative catch-up of favorable mix of income by geography. The annual average adjusted effective tax rate of 24.5% for full year 2019 was down from fiscal 2018 rate of 25.1%.

This performance resulted in adjusted diluted earnings per share for the year of $2.96, down 1.3% versus last year and up about 6% versus last year, adjusting for exchange and the divestiture of the surfactants and thickeners business.

Cash flow from operations was $109 million in the fourth quarter and $269 million for the full year, resulting in full year cash flow conversion ratio of 135% of adjusted net income.

Strong operating cash flow as well as the proceeds from the sale of the surfactants business allowed us to pay down $268 million of debt for the year, more than $60 million higher than our original target for the year and also exceeding the $260 million estimate that we set out at the end of the third quarter.

Over the last 2 years, we have repaid over $470 million of debt, exceeding the paydown target that we laid out at the end of 2017 by 34%.

With that, now let me turn to our guidance for the 2020 fiscal year. Our projected organic revenue growth of 1% to 2% in 2020 reflects improving volume growth and pricing that is flat to down 1% year-on-year. Net revenue is projected to be flat to up 1% in 2020 versus 2019, with foreign currency expected to have an unfavorable impact on revenue of about 0.5% at current rates. And the divestiture of the surfactants and thickeners business also expected to have a negative 0.5% impact on year-on-year sales.

From a segment standpoint, we expect mid-single-digit organic growth in Engineering Adhesives and low single-digit organic growth in HHC and Construction Adhesives. We expect consolidated gross profit margin to be up by 10 to 30 basis points versus 2019, as lower raw material cost and volume leverage is offset by modestly unfavorable pricing and slightly higher manufacturing costs.

Operating expense is projected to be down about 2% year-on-year, reflecting savings from the business reorganization and efficiency projects that Jim referenced earlier, offset by variable compensation rebuild and some investments in the faster-growing parts of our business.

We expect that volume growth, raw material savings, net of some pricing give back and savings from the business reorganization and efficiency projects will contribute to adjusted EBITDA of between $440 million and $460 million. We expect full year depreciation and amortization to be about $140 million. And we expect full year net interest expense of about $80 million.

Depreciation, amortization and interest expense are expected to be incurred ratably over the year. We expect our 2020 core tax rate to be between 26% and 28% compared to our 2019 core tax rate of about 25%. The higher tax rate as a result of forecasted income by region, and impacts from ongoing tax reform and tax law changes in the U.S. and foreign countries where we do business.

Capital expenditures are expected to be approximately $85 million in the 2020 fiscal year. We expect to devote approximately $200 million of our cash flow after CapEx investments and dividends to repayment of debt, allowing us to significantly exceed our original plan to pay down $600 million of debt from 2018 through 2020.

Given these factors, we are introducing an adjusted full year EPS guidance range of between $3.15 and $3.35. The midpoint of this range represents growth of 10% versus the 2019 fiscal year.

As a reminder, based on the seasonality of our business as well as the fact that we have both the Christmas Holidays and Chinese New Year in our first quarter, we would expect to achieve about 23% of our full year revenue and 17% to 18% of our full year EBITDA in the first quarter.

Now let me turn the call back over to Jim to wrap us up.

Thank you, John. Clearly, 2019 presented a more challenging macroeconomic environment than we anticipated. By remaining focused on matters under our control, we strengthened our underlying business during the year in several ways: by gaining share in our target markets, better aligning our business with our strategic growth markets, accelerating our debt paydown and driving continued improvement in EBITDA margin.

Establishing our new Hygiene, Health and Consumables; Engineering and Construction Adhesives global business units and getting them fully operational as we start 2020 positions us to quickly realize benefits of this new operating model. In addition, our focus on standardizing and simplifying core business functions across the company is designed to improve our consistency and visibility and drive our cost to serve customers longer.

The current external outlook is that 2020 will look pretty similar to 2019. Brexit, the U.S. election cycle, the continued strong U.S. dollar and other macroeconomic and geopolitical forces will likely continue to create uncertainty and potential headwinds on global manufacturing growth. We do not expect a significant change in the macro forces outside of our control. The actions we have taken within our control will drive our results.

In 2020, we are focused on executing on the growth drivers and the cost savings that are enabled by our GBU realignment and the further growth synergies provided by the Royal Adhesives acquisition. In addition, negative impacts from the portfolio adjustments in our Construction Adhesives business are behind us, and the positive impacts from our investment in this business are ahead of us.

Our plan delivers organic growth in a continued challenging global manufacturing environment. And the cost reductions resulting from our GBU restructuring support additional earnings growth, which we target at 10% at the middle of our guidance range. And as a result of improved profit margins, working capital reductions, high cash flow conversion rates and our focused capital management programs, we remain on track to significantly exceed our committed $600 million in debt paydown by the end of 2020.

The outcome in 2020 will be low single-digit organic growth, above expected industry rates, achieved through customer innovation and share gains. This will be combined with efficiency benefits from our reorganizations that will drive EPS growth of approximately 10% and strong results in EBITDA and cash flow growth. The actions we have taken have positioned us to capture growth opportunities in the global adhesive markets where we operate, and they provide sustainable cost and efficiency improvements that will enhance our profitability in 2020 and in the years ahead.

That concludes our prepared remarks today.

Operator, please open up the call, so we can take some questions.

(Operator Instructions) First question comes from Mike Harrison, Seaport Global Securities.

Jim, in the fourth quarter of 2017, you were issuing guidance for fiscal '18 and expected to hit the $465 million level. We're now 2 years later, still kind of guiding to a number that's below that $465 million level. So the question is, aside from FX and the macro headwinds that I think we can all acknowledge are there, can you help us understand what maybe has stood in the way of H.B. Fuller leveraging the Royal acquisition and delivering on the potential that you saw when you first did the acquisition? And maybe give us an update on where we stand on the longer-term plan to get to $600 million of EBITDA?

Yes. Thanks for the question, Mike. Yes, I think in fourth quarter -- I mean, the fundamental issue between now and fourth quarter of 2017 is FX, right? Since that day, the change in exchange rates has impacted our revenue by about $150 million -- $160 million and EBITDA by $40 million to $50 million. So that's the biggest driver. And of course, the environment we've operated in globally from a manufacturing standpoint is completely different. So if you were to try and pull those 2 items out, you'd see significant growth overall in the businesses. And I think the fundamentals of market share gains, cost reductions are coming through in the Royal integration in each one of the elements of our business. So when I step back and look at the horizon over the last 18 months, that's the biggest driver of the numbers. And I think, as you saw last year, and you saw the year before, on a constant currency basis, our EBITDA has grown each of those years, our EPS has grown each of those years. And I think for a company like ours that's very global, you have to take that currency into account if you're going to try and look over a long horizon. The other thing I'd say is, even despite that, our cash flow management has been outstanding. To, in that kind of environment, deliver well above the targets that we've had from a cash standpoint is pretty significant. So certainly, there are things I'd like to see better in the business. There's things that we've over-delivered, but that cash flow stands out, I think, especially in that macro environment.

And the $600 million longer-term target. Is that still achievable at this time?

Well, I think we said about 6 quarters ago, that our goal is to deliver 10% EBITDA growth, right?

at constant currency.

On a constant currency basis, right? So that's our objective. We laid that out in the middle of last year. I think the math at a constant currency basis would say that, that's what we targeted and that's we delivered in 2018. In 2019 and the environment we were in, we didn't. But certainly, our expectation going forward is those are the kind of returns that we expect out of the business on a constant currency basis in normal manufacturing environment. And I think that's the metric you should measure us against.

Okay. And then in terms of the facility cost and inventory cost that impacted your margins this quarter. Understand you quantified those at about $7 million, and it sounds like most of that was in the Construction business. But can you help us understand exactly what it is that was going on in those -- it sounds like 3 facilities?

Yes. I think one of the Royal integration issues that we've been managing is moving their business model, which is a very different plant to plant to a sort of best practice model. So that's putting in best practices in sales and operations, planning and cycle counts and standardized work processes and safety. And in 15 of the 18 plants that has gone extremely well. So I think building those kind of systems allows us to have better safety, lower cost, better service to customers. In a few of the plants, I would say, the integration didn't go as well as it should. That led us to getting behind on some orders for customers, having some changeover cost, and we injected extra labor to make certain that we serve customers and work to reduce backlog. But the bigger aspect showed up in the inventory. So when we finally did our -- when we did our physical inventory count at the end of the year, this is where inventories were off. So when I say it's one-off, it's mostly a physical inventory adjustment issue, combined with some extra labor we had to do. It was at 3 of the 18 plants. I think the really good news about that, Mike, is those plants now are running on better standard processes. So we're in a better position to manage cost, to serve customers as we go forward. So in terms of where they impacted us, they were all U.S.-based plants. About $2 million of it was in the Americas, about $3 million of it was in Construction Adhesives and about $2 million was in Engineering Adhesives. So those plants serve all 3 of those businesses.

Got it. And then last question is just on the capacity constraints that you had in, I believe, you said roofing products within Construction. Can you help us understand what's going on there? And what I would have thought was a slower seasonal period why you were having capacity constraints?

Yes. Again, it's tied to that same issue I've talked about. So one of the plants we talked about serves the roofing business. And we've been a little behind all year. I think we didn't build inventories as quickly as we needed to in the first quarter. And then we've been playing catch up all year. And I think we ended the year with about $2 million in backlog. So like you, I expected us to work through that this quarter. I'm happy to report that the backlog has dramatically reduced here in P1. So the work we were doing in Q4 has paid off, but it didn't payoff by the end of the year. But it's -- the roofing business is really well poised and a slowdown here in December allowed us to catch up, build some inventories and we're well positioned for a great year in roofing in 2020.

Our next question comes from Ghansham Panjabi from Baird.

Jim, just picking up on your prepared comments on share gains. Can you just sort of expand on that? Which segments in particular did you see the gains? What is it actually based on? And then second, in terms of the guidance for fiscal year '20, with pricing down 0% to 1% and just your base assumption up a tepid macroeconomic backdrop. I'm just curious, what sort of visibility do you have on your volumes as we head into fiscal year '20?

Okay. Yes, I'd say the -- what we've done, Ghansham is -- and this is one of the beauties of the new GBU alignment is we're executing strategically along the lines that we look at our business. So each one of our GBU has between 3 and 10 market segments where they operate. So we look at the share within those markets. And as I mentioned in the prepared comments, real good gains in new energy, solid gains in electronics continue to be a real positive for us. This quarter, we're very pleased to see Hygiene share gains, which is really important for our HHC businesses. It's an important part of that. And our Packaging business had some share gains. So we analyzed what's happening in those markets and we saw good share gains. So we look at each market and look for where the share gains are. And I would say, we see a really -- you can see in the PMI numbers, right, across the manufacturing sector that there's a slowdown in lots of areas, but we try to analyze each one of those market segments and then pull that together to identify our share. In terms of -- the second part of your question was around pricing?

Volume visibility.

Volume visibility. Yes. So I'd say, especially here at the end of the year, we have better visibility because we have -- we report a month later. So we've seen the P1 results. I think that what we see here in P1 is encouraging. I would say it's not an encouraging external market, but our ability to gain share in markets has improved. So as I mentioned, Q4 was a rougher environment than Q3, but our organic growth improved. We see -- again, it's only one period and it's December, we see more positive improvement here. I know -- certainly, I'm concerned, I'm sure investors are concerned about CA. We see CA moving back to that positive territory. HHC off to a good start. EA, I think this first quarter will be affected by both in Europe. New EA is now the combined EA and DA. So we had extended shutdowns in a lot of facilities in Europe here in Christmas, and we're seeing extended shutdowns in China. So I do see EA -- the new EA, which includes durable assembly being more flattish here in Q1 with popping back as we go through the year, but that's more seasonality than anything else. But in any case, visibility here in Q1 is pretty good. And I'd say we feel good about what's happening organically, at least after 1 month.

Okay. And then just kind of go back to 4Q. You mentioned an improving trend line from a volume standpoint. Was that skewed to any particular month? I'm just curious as to how the quarter played out? And there's been some chatter about how the timing of the Chinese New Year could have impacted certain pockets of manufacturing, including auto OEM in the region. Do you sense that played out for you as well?

Well, a reminder for us, our Q4 ends November 30. So that's far enough from Chinese New Year...

That's a Q1 impact for us.

...that we would have not seen a big difference. Certainly here in Q1, Chinese New Year affects our Q1, but it's December, January and February and it's in the middle. So I don't think that would have had a big impact. But John, do you want to comment more on month-to-month?

From a month-to-month standpoint, I would say, it played out pretty consistently through the month, maybe with a little bit of momentum as we exited, right? Kind of kept up for Q1.

Yes..

Okay. And then just one final one on Americas Adhesive. Was there anything unusual that weighed on segment EBITDA margins year-over-year. It was down about 180 basis points.

Yes. I mentioned those manufacturing costs. So $2 million of those were there. So I think if you put those $2 million back, that would get you into the low 15s, and then the rest is mix, Ghansham. So nothing exceptional there, except that $2 million of manufacturing cost at the Royal facility.

Yes, and here we've also had a delta from the divestiture, which was a high-margin business, and had a little bit of impact in Q4.

Yes. So that project cost is 30 basis points or something. Yes, part of the mix.

Your next question comes from David Begleiter from Deutsche Bank.

If you look at your 2020 EBITDA guidance, Jim. At the midpoint of about [$18] (corrected by the company after the call) million per year, which is basically all that you pull from the GBU realignment. And if you include Royal synergies, it implies that base business is down year-over-year. Why is that the case?

Yes. So I'll have John take you through some of the specifics there. I think the fundamentals of where we're at is we're building our business plan off of that $20 million in savings, with a bit of inflation in other costs and solid performance on a price raw material standpoint. And that gets you to the 10% EPS with limited growth, right? And if we can deliver a little bit more organic growth, we're going to deliver a lot more EBITDA growth. But that's how we built our plan and expectations we want to lay out there to the Street. But John, do you want to comment more?

Yes. So I mean, I think if you think about when you mentioned Royal synergies, we've really captured the vast majority of those in 2018 and 2019. So there's a little bit of a tail, but it's pretty small in 2020. The impact of our variable compensation rebuild and merit is the biggest offset. So you're right, the savings represent the biggest positive. We'll get some benefit related to organic growth and some raws, but that's really kind of offset by the bonus we build in merit.

And John, how much is that, is that $10 million or $5 million.

It's in the $15 million range.

Got it. And just lastly, your cash flow for 2020 expectations on working capital and other items that impact cash flow?

Yes. So we expect a strong cash flow performance again in 2020. We -- as we said in our prepared remarks, we believe we can pay off $200 million worth of debt, which would put us well ahead of our 3-year target. Most of that will come from the EBITDA growth that we just talked about as well as we plan to see additional working capital improvement and on the order of 1% to 2% of revenue. That's going to hopefully be pretty broad-based. We've got activities going on around receivables, around inventory and around increasing payable terms, and we're seeing -- we saw that as we exit the benefit as we exited this year, and we expect that to continue next year.

What you'll see in the details, David, is we've done a nice job on payables here in 2019. There's more of that to come with what we've put in place for 2020. And then we've got some really good programs around inventory management that are going to also help working capital in 2020.

Our next question comes from Vincent Anderson from Stifel.

I just wanted to follow-on that helpful discussion on the fiscal '20 guidance. I guess what I'm missing in all of that is after backing out the GBU savings and then kind of a lower organic growth environment, why aren't we seeing maybe a bit more margin expansion off of a mix shift? Do you expect to continue to grow your higher-margin that you're going to need this business relative to the rest of the portfolio?

Yes. I mean, I think we are seeing some of that since when we -- in terms of kind of what we expect to flow through from a sales growth standpoint. But as we talked about in terms of our targets for this year, there isn't a significant difference in the growth businesses as has been in the past. It probably generates a little bit more about the mix favorability year-on-year.

Okay. And then just you had a competitor in Roofing, Adhesives claim they took market share this quarter in North America, assuming at least some of that had to come from H.B. Fuller or maybe I didn't. How much would you talk that up to your constraints during the year in delivering those products versus maybe trying to deemphasize selling or just lost sales in general?

Yes. I saw that -- I think you're talking about RPM, and I saw the results, which were good. We don't compete with them. So that is not at our expense. I think when we look at our roofing share this year, it was positive, but it was -- and the roofing business had a positive year overall. So if you take a look at our Construction Adhesives business, it was the flooring business where we had more challenges. But that backlog, like I mentioned, was all roofing and that was a couple of million. So if we look at our numbers, we would have had a couple of million more in sales here in Q4 had we not exited the year with the backlog. But no, we didn't lose share to RPM.

That's very helpful. And then you mentioned -- if I could sneak one more in. You mentioned share gains in Hygiene and Packaging, maybe I missed it, but you were pretty happy with how your progress have gone in Electronic Adhesives earlier this year. How has that gone in the fourth quarter and through the first part of 2020? And then you talked about last quarter about the bigger win coming through in 4Q and 1H. Are those panning out, just kind of speaking outside of [Hygiene and Packaging].

Yes, Electronics is still our star performing business, had an outstanding year this year. Again, we don't quote the numbers on specific subsegments, but it's been extremely strong all year. And I just saw the P1 numbers and they're off to a great start here in P1. So -- and those are share gains. And I think what we've been able to do there is identify new applications and allocate resources to those. So I think the benefit we have is given our share in that business, we've really focused our business on where are the new trends, what are the new products that are being introduced and what are the problems out there, whether that's better waterproof, better connectivity and enabling someone to provide thinner lines of adhesives, get a bigger screen. Whatever that problem is, we work on those with our customers. And then the other thing we're doing is we're taking our technology further into the devices so we've got more penetration into microelectronics rather than just assembly. So yes, we see our Electronics business as a very important growth drivers of engineering. So -- and it still continues. So thanks for the question.

Next question comes from Eric Petrie from Citi.

Eric, you might be on mute. We don't hear you.

Next question is from Jeff Zekauskas, JPMorgan.

Was price down in all geographies? And why aren't pricing trends better? And are they deteriorating?

Yes. So we didn't hear the first part of your question, Jeff, but I think...

Were prices down in all geographies?

They were up in Construction Adhesives, down modestly in the other businesses. I think the answer on your question about [deteriorating] trend, we really did all of our pricing work in the first half of last year, which obviously significantly drove margins in the second half of last year and all of this year. We've annualized against that. If you look at kind of Q3 to Q4, it was very similar from a pricing standpoint.

Yes, Jeff, Q3 to Q4 were very similar, Jeff. And I would say that raws are coming down. So there's some slight givebacks, whether those contractual, which is a small percentage of our business or not. But I'd say that negative 0.5% of price is similar to what we had in Q3.

Do you think volumes in Europe will grow in 2020 or you can't tell?

Yes. I'd say it's probably going to be very tough, especially core Europe, I think you're going to see a really tough environment from a volume standpoint. As you know, our EIMEA business includes India, Middle East and Africa. Our India business still continues nicely. We've got some good wins in Africa. And if you're talking about core Europe, it's a tough environment from a manufacturing environment. We don't expect growth here.

Do you think your markets are decelerating in your first quarter and either because of the Chinese New Year or expense shutdowns and then what you expect just for a reacceleration later in the year. Is that your general plan? And how do you see business conditions in China?

Yes. So I think what we saw in Q4, if you look at the external data, whether it's PMI or auto builds, they were worse than Q3. It's a little early for us to project what's going to happen here in Q1. I would say our business has improved. So we improved from an organic standpoint, Q4 versus Q3. And in 1 month of Q1, we're seeing further improvement on an organic basis. I'm not sure that's an indication of what the markets are doing, though, Jeff. So I think that was your question. So I couldn't give you a really solid read as to whether the world is getting better here in Q1. As I mentioned, there are -- were extended shutdowns in a lot of factories in Germany versus -- or New York overall, but Germany, in particular. And we do have some word that some factories in China are going to have extended shutdowns here in -- so we're hearing a little of that. For us, overall, though, I think our share gains are overcoming what we see at least early on in the quarter.

Let me say to the question around the shape of the year. Yes, I think given Jim's points on some of the impacts of the extended shutdowns for Christmas and Chinese New Year and just the fact that we have easier comparisons, I would say, in the second half of the year, we would expect the revenue trends to ramp up in 2020.

So if I could -- just a final question. You're changing your segment reporting essentially from a geographic reporting structure to an end market reporting structure. And that's different than many companies that is, if you look at, for example, the industrial gas guys, their products moved over from an end market segmentation to a geographic segmentation following what the old Praxair did. And I don't think you guys export a lot from your individual regions, and there's no strong growth dynamic right now. Aren't you afraid that you might lose the granularity of data that you had in having more segments by having fewer segments. And because you're now going to have a more global revenue mix because it's end market, are you going to get the kind of granular data you need to manage the costs in your business? Or why should it be better?

So let's -- it's going to be a lot better, Jeff. So hence, first off, strategically, we got to manage our business by the 28 segments that we operate in, right? So if it's roofing, roofing has a profile that we need to manage. Electronics, Hygiene Packaging, we've been building those strategies globally, but working to execute them for 2/3 of the business regionally. So what happens is the execution model is not fully aligned with the strategic model. Plus, 5 segments has a lot more costs involved with it than 3 segments. So our ability to see the visibility in the market and then drive the results where we need to is much better in this model than the old operating model. In terms of your question of visibility, we'll have better visibility here. And again, we'll need to share with you, so you see it. But for us, down the organization, we're going to get good regional visibility for each one of those businesses. So our P&Ls are built along those 28 segments and there's a regional one for each one of those 28 segments. We've got good accountability on each of those. So our visibility will be much higher in terms of our ability to see exactly what's happening in each segment all the way down the P&L. So I don't see the issue you're talking about at all for us. We -- as you know, right, we run 2 globals and 3 regionals. So it was sort of this mix. Now it's very clear. And I would say within each one of our businesses, to your point about the world being different, Andy's run an HHC, he's got a leader, who's looking out at the Americas as well as down those global businesses. Zhiwei, he's running Electronics and durable assembly and insulating glass all separately, but he's got a leader in Asia who's looking at detail at that. So I think we've got it very well covered. John, do you want to add anything?

No. I'd just say, we had our business reviews yesterday, and I felt like we had great visibility. So I think it was sort of proof of that.

So does that mean that you'll reduce your headcount by reducing regional managers so that you only have an end market focus? Or will you keep all the different regional and end market management layers?

Yes. No, we've definitely reduced -- and we reduced it in December. So if you think about it, I had 5 finance partners for 5 segments. I now have 3. I had 5 HR partners, I had 5 sourcing partners, I had 5 manufacturing leaders. Now we do have some things we share across those businesses, but those leaders are global, 5 R&D leaders.

Next question comes from Eric Petrie from Citi.

On your gross margin guidance of about 10 to 30 basis points, I wanted to get a little more color as to why you think there would be pricing giveback as well as manufacturing costs are expected to be higher, but I believe during 2018 Investor Day you were talking about lowering manufacturing costs?

Yes. So maybe I'll take the high level and John will get into the math of it. I think the -- first off, some of our customers maybe about 15% of our business are built on a contractual basis as raw materials move up and down. So you see a little of that, that drive some of what happens with pricing. And I think the other thing that happens is, in certain markets, you'll find that competitive pressures, special enrolls are coming down, put you in a position where you'll lower prices. So it's not a big impact to our numbers, but I would say, overall, we expect slightly down rather than slightly up in this environment where raw materials are going down. We very much expect our manufacturing costs to go down in 2020. So that's definitely what we have in our plan. So John, do you want to comment further?

So as a -- if you look at kind of what's driving the gross margin improvement is that really is the contribution margin line. So it's our ability to capture raw material costs. And manufacturing costs as a percentage of sales are flat despite the fact that volume is growing. Some of those bonus rebuild that I talked about show up in manufacturing. So we're offsetting that with productivity.

Okay. Helpful. And secondly, on your raw material basket, can you talk about what raw materials are moving up versus down? It seems that your gross margins aren't improving as much as paints. So just looking for any differences between baskets?

Yes, I think in our Investor Day, there's a really good chart, Eric, that shows the diversity of our raw materials. So what's different for us versus, say, the paints guys is they have this big margin, this big monomer component, whether it's acrylic or vinyl acetate or ethylene. We buy materials that are further down the chain. The #1 raw material we buy is about 4% of our purchases, 87% of what we buy are second or third tier materials. So 13% of what we buy are monomers and solvents and other materials that are more commodity driven. The others are downstream from those. So we don't see as much volatility on the positive or negative side as you would see in a paints business from a raw material standpoint.

Next question comes from Rosemarie Morbelli from GE Research.

Jim and John, when we look at your target of reducing debt by another $200 million by the end of this year, you will end up with about $1.66 billion of net debt. And if I use your EBITDA guidance at the midpoint of $450 million, now we have a net leverage of 3.7x. I was wondering if you could give us a feel as to what is the optimum leverage for H.B. Fuller, particularly if we go into a recession? I don't know whether we are or not, but we certainly haven't had any for about 10 years. So we are due for one. So what would be the optimum leverage that you would be comfortable operating in?

Yes, I think our goal, Rosemarie, is to be between 2 and 3 debt-to-EBITDA -- net debt. And that's what we're targeting. We see that happening in 2021. As you say, we'll be in the low 3s by the end of this year. If you recall, we did Royal we were 5.9%. So we've dramatically reduced that number. It will come down again dramatically this year. And we see that as really positive progression. The other thing I'd say from a recessionary standpoint, yes, I think of the 2 years have proven anything to our investors is the resiliency of our cash flows. So we had negative organic growth and exceeded our debt paydown target. So this is a very cash flow generative business, low capital intensity. We got a lot of leverage to pull on cash. So we feel really good about our position to withstand any kind of a difficult environment. But the short answer to your question, 2 to 3, do you want to add to that?

No, I think that's the target, I think, and I'd say, I think that the fact that we're able to -- some of this has been work on reducing working capital, but also it's a little bit of a reflection of when the top line slows we have less working capital usage and raw materials come down, and those are cash flow generative rest.

Now at the end of this year, my calculation, which may be wrong is 3.7x leverage, which is still substantially above where you are comfortable?

So are we talking about that 2 to 3 by the end of 2021?

Correct, correct. Yes. So if I wasn't clear yet, but it's somewhere in 2021 is where we see ourselves getting below 3.

Okay. I may have missed that. And then you have touched on the different markets you served. But I was wondering if you could give us a little more details on your expectations for those different markets? And particularly, since you'll see that you are growing faster than they are and organic revenues of 1% to 2% is still pretty low. So you must be expecting some markets to be substantially below, I mean, in the negative area.

Yes, Rosemarie, we're leveraging off of PMI data, right? When PMI is below 50, that shows the manufacturing sector declining. And I think what we've seen both in Europe and North America, the data is a little fuzzier in China and Asia, our number is below 50 and decreasing quarter-over-quarter. So that shows in the manufacturing sector overall. And there's other data and market-specific that shows that there is an overall decline in manufacturing output around the world. So that's what we base the expectations on. And I can't go through each one of our 28 segments, but we look in detail at each one of them in terms of what we see as the growth of that business and then our ability to grow, right? Our Aerospace business, the aerospace business, you've heard from Boeing, right, it's not a huge part of our business, but they're shutting down lines and slowing down. Clearly, that's a pretty negative environment. We're gaining share there. So we have really good positive share gains in that space, but it's in a market slowdown. That would be one example of the 28.

Okay. And you don't see any change in the auto world in terms of...

We're not building that into our plan, Rosemarie. I think there's an opportunity for that to happen. We're in the second year of a decrease in auto build. It's rare that the auto industry has 3 years in a row of decline. So but we haven't built any of that into our expectations. So if autos improve, our numbers will be better than the ones we outlined.

And since we are in -- on the auto subject, is -- does an EV use more of your products than a regular engine type of car?

Yes, that's a good question. Most of the analytics out there say that it will use more. There's more sound deadening that has to happen because these cars are so quiet. And then the batteries themselves, depending on the design, and there's a few different designs, we need to have thermal conductive materials that are adhesive-like materials and in casing. So we'll see over time, but most of the data indicates that EVs will use more adhesives than non-EV.

Our next question comes from Paretosh Misra from Berenberg.

On Slide 5, in Engineering Adhesives, it looks like you're looking at mid single-digit growth in the near-term and double-digit in the long-term. Can you just elaborate on what's driving that improvement? Is that just more volumes or pricing and mix also play a role?

Yes. So yes, I think the move, as you know, Paretosh, the Engineering Adhesive business has a very strong track record of double-digit growth. We've now combined that with the durable assembly business. The durable assembly business has not been growing at that rate. So that's why this year, in particular, we see mid-single digits. The potential in that business is to do a lot of the things that Engineering Adhesives is doing. By focusing on new trends and new opportunities in that space and specific technologies, we see that combined business moving back towards that 10%. So I think the way I think about it is 2020 should be a mid-single-digit business for the combined business. But as I said, Q1 being flattish and then when you look out to 2021 and 2022, moving towards that double digit and we have -- it's -- and why is because we're leveraging that Engineering Adhesives business model of where to focus and how to focus to win market share.

Got it. And maybe if I could just go back to some comments on China. Any contrast that you're seeing between consumer demand versus industrial demand in the country?

I'd say consumer demand is probably a little better than industrial demand, but I would say you really have to look at business by business, but both of them are slower, but both of them are positive in China, if I were to summarize.

(Operator Instructions) Our next question comes from Christopher Perrella, Bloomberg Intelligence.

Quick question on the cash costs. I'm assuming these are cash costs of $6 million to $10 million for the business realignment and $12 million to $15 million of ERP. Would you be finished with those or do you any of those lag into 2021?

So the -- kind of the costs related to the business realignment are really done in 2020, we completed that. The costs related to the ERP rollout will continue. And those -- see that that's got a little bigger number. We've stepped up the pace of that. So we would expect to complete it faster. But certainly, it will be a couple of more years at least, several more years.

But that amount in the release is going to be incurred this year. That's the expectations, right?

That's right.

That's all this year.

Yes.

Yes.

Thanks, everyone, a little over. Thanks, everyone, for your interest and your focus on H.B. Fuller. And I wish everyone a great 2020. Thanks.

Conference has now concluded. Thank you for attending today's presentation. You may now disconnect.