Welcome to the H.B. Fuller Second Quarter 2017 Investor Conference. This event has been scheduled for 1 hour. Today's conference is being webcasted live and will also be archived on the company's website for future listening. And at this time, I will turn the meeting over to our host, Director of Investor Relations and International Finance, Mr. Maximillian Marcy. Please go ahead, sir.

Good morning, and welcome to our fiscal 2017 second 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 by others representing H.B. Fuller may contain forward-looking statements, which are subject to risks and uncertainties. Our SEC filings contain additional information about the factors that could cause actual results to differ from management's expectations. These filings can be found on the Investor Relations section of our corporate website at hbfuller.com. Also, please note that our comments may include references to non-GAAP measures. These results should not be confused with the GAAP numbers in yesterday's earnings release or with the GAAP numbers we report in our Form 10-Q. We believe that a 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 will turn the call over to Jim Owens.

Thanks, Max, and thank you everyone for joining us today. We are pleased with our actions in the second quarter and the trajectory of our business. However, a spike in raw material costs, combined with the timing of our price increase, negatively impacted gross margins in the second quarter. Our second quarter price increases have now been implemented. And this, along with other actions, will drive significant momentum in our margins for the rest of this year and into next year. Constant currency growth continued on its positive path, led again by very strong volume growth in Engineering Adhesives and solid growth in both Asia Pacific and EIMEA. SG&A costs were well managed across all of our businesses, and EBITDA margins improved across most of our business. As we move through the remainder of the year, the price actions we've taken will enable us to deliver higher gross margins, consistent with our 2017 guidance and the goals in our 2020 plan. We outlined 3 areas of focus as we entered the second quarter. The first was to implement price increases and raw material and product substitutions that would enable us to offset the increase in raw material prices. We were successful in this endeavor, and the actions taken will result in gross profit margin expansion over the rest of the year. Second, we committed to continuing to take the actions needed to return Construction Products to double-digit EBITDA margin by the second half of the year. We accomplished this objective earlier than expected with Construction Products recording an EBITDA margin of 10.7% in the second quarter. And we expect to see margins continuing to improve over the rest of the year and for the business to return to revenue growth in the second half. Lastly, we plan to continue to…

Thanks, Jim. Jim provided a few highlights of second quarter results, so I'll provide some additional financial details. Organic volume grew 4% versus last year's second quarter. Four of 5 segments again delivered positive volume growth led by Engineering Adhesives, Asia Pacific, and EIMEA. Acquisitions added 5.4% to growth while mix and price were basically neutral. Foreign exchange continued to have a negative impact on revenue in the emerging markets, typically Egypt, Turkey, and China as well as a weaker euro year-on-year. The negative impact of currency, overall revenue growth was reduced from nearly 10% constant currency growth down to 5.5% total growth. Adjusted gross profit margin declined versus last year at a higher rate than the previous quarter, with the primary driver of the lower year-on-year margins being higher raw material costs. As anticipated and discussed during the prior quarter's earnings call, the highest year-over-year raw material increases came in the second quarter. Previously announced pricing became effective during the quarter, which will offset the raw material costs and will result in sequential margin improvement in the back half of the year. Adjusted selling, general, and administrative expenses decreased approximately 1% in the second quarter versus last year's second quarter. Adjusting for acquisitions, SG&A expense was down about 5% year-on-year as a result of the restructuring actions we announced in December as well as thoughtful control of discretionary expenses, offset by continued investment in the faster-growing parts of our business. SG&A declined as a percentage of revenue to the lowest level in the past 6 quarters, reflecting strong cost controls and sales volume leverage. The net of this resulted in adjusted diluted earnings per share of $0.62 for the second quarter. With that, let me now turn to our guidance for the 2017 fiscal year. Foreign currency continues to…

Thanks, John. We started off the year strong, and we made good progress in the second quarter against the 3 key initiatives we outlined for this year, delivering growth in the Americas, driving exceptional volume growth in Engineering Adhesives and a return to historical operational levels in Construction Products. Gross margin expansion will occur in the coming quarters as price increases impact our results. 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 take the steps necessary to deliver that 2020 plan. We drove sizable growth in Engineering Adhesives and the Asia Pacific segment as a strategic priority. Our Construction Products business successfully returned to double-digit EBITDA margin. We took the first steps in the integration of the synergistic acquisition of Wisdom Adhesives. The Americas and the EIMEA segments delivered solid volume growth, and Asia Pacific and Engineering Adhesives both improved EBITDA margin by more than 200 basis points year-over-year. Although a spike in raw materials impacted gross margins in the quarter, the necessary pricing actions were also taken in this quarter, which will ensure margin improvement over the rest of this year. We expect to see strong performance through the remainder of this year and into next year as we drive sales growth, offset raw material increases with strategic pricing actions and deliver on our cost-savings initiatives. Our business is on track to deliver our targeted 2017 performance and our 2020 strategic objectives. This is the end of our prepared remarks. So now I look forward to your questions.

[Operator Instructions]. And we'll go first to Mike Sison at KeyBanc.

Volume growth in the second quarter was good again. Can you maybe walk us through how you see volume growth in the second half of the year, particularly in Engineering Adhesives, which, again, double-digit growth there is pretty impressive.

Yes. So yes, I'll give you a high-level view and then maybe John can give you some specific numbers. We laid out last year, as you know, Mike, a plan that said we were going to grow Engineering Adhesives as our most profitable segment by 15% a year, and we've shown that quarter after quarter. We're actually above that target the last couple quarters. It's really driven by market wins. We've put a lot of investment in the right technologists and sales teams, and we've targeted new opportunities in this whole engineering space. So our strategy is around winning in electronics, finding new trends that are happening in the automotive segments, and leveraging the Tonsan acquisition to other parts of the world. All of those things are hitting on all cylinders. Now the team's doing a great job at gaining share, solving new customer problems. So fundamentally, it's an organic growth strategy. We're also getting the benefits of the Cyberbond acquisition. They've brought some great people and some great technology that's helped us grow our Tonsan business faster than we planned but also helped us leverage Tonsan into other parts of the world. So a combination of the inorganic investments we've made and the organic investments that we put in place are creating growth. So we expect to continue to see throughout this -- the rest of this year and next year this 15% number as our number. Maybe John can put a little specific color on what we see there...

No, that's a very good description, I would say. The only other nuance is that organic volume growth should be strong in the second half of the year. We won't have the benefit of the Cyberbond acquisition from a year-on-year basis, in the second half we'll annualize against that. As it relates to the overall company, from a kind of volume growth standpoint, organic volume. We've said that 3% to 5% is our targeted organic growth range. We were on the higher end of that in the first half. We'll probably be more in the middle of that range in the second half.

Okay. Great. And then just -- I think I understand your third quarter EPS guidance pretty clearly. Can you help us, though? When you think about the walk into fourth quarter, you do need kind of a jump there to $0.80 or better to hit the low end to the midpoint of your guidance for the full year. What needs to happen to make that jump as you end the year?

Well, the big difference between third and fourth quarters are normal volume trends. So we have the summer period in Europe that you'll deal with in Q3, and certain segments of our business are just a little slower Q3 to Q4. So Q4 will have a lot more revenue than Q3 as it normally does, and then I think from a gross margin standpoint, I think you're going to see the impact of the combination of all of our pricing increases and what will happen with raws get us gross margin improvement of 100 basis points in Q3 and another 100 basis points in Q4 roughly. So you'll see gross margin move up sequentially through the next 2 quarters and the normal volume trend.

And we'll go next to Eric Petrie at Citi.

Was lowered full year EPS guidance more a function of underlying business conditions or accounting for the Tonsan call option?

It wasn't accounting for the Tonsan call option. That's not included in our adjusted.

Okay. So you excluded the $0.07?

That favorable item is not included in our [indiscernible].

That was a favorable item, that's excluded. Yes. No, I think the big difference is what happened in Q2. The price increases didn't hit as quickly as we expected in quarter 2. We expected it to happen more closer to the middle of the quarter. It really hit closest to the end, and that was really the change, right? So it's a shortfall in the timing of our price increases. Everything else in our business is hitting on just as we expected, including the size of our price increases. So we're really bullish about the second half of the year and pleased on the way things are happening. But we didn't get the increase as quickly as we expected in Q2. So that's the difference in the guidance, Eric.

Okay. And then secondly, you noted that you expected to show year-over-year -- or sorry, quarter-over-quarter EBITDA margin improvement third quarter versus second quarter and fourth quarter over third. Are we also going to see year-over-year EBITDA margins being better than second half of '16?

So yes, think -- and I'll let John answer specifically. But I would say, certainly, by fourth quarter, we should see us approaching close to 15% EBITDA margin. So you'll see strong progression, I think, in the next 2 quarters. And on a year-on-year basis, that would be upwards...

It would be similar margins in the third quarter and then higher margins.

Yes. So similar to the third [Technical Difficulty] year-over-year.

And next, we'll go to Mike Harrison at Seaport Global.

Jim, I was hoping you could talk a little bit -- you just mentioned that the price increases took a little bit longer to implement than you had hoped, but that they -- in terms of the magnitude, you're pretty pleased. I think the concern that some people have is as raw materials went up and now are showing signs, in some cases, of rolling over a little bit and coming lower, in that environment, is there any concern that maybe competitors aren't going to be pushing as hard on pricing and maybe customers are going to be pushing back on pricing that maybe you'd end up not realizing as much pricing as you might have hoped?

Yes. I would say, and you can look back at what we said last quarter, raw materials are happening just as we expected them to. We saw the spike coming and it started in Asia, so we got a good view of it. And, in fact, if you look at our Asia results, the price increases we implemented last quarter really showed up in Q2. Same exact thing started happening in North America and Europe. And we anticipated that they would spike up and then slowly come down. They're not going to come down as much as they spiked up. So I would say raw materials are happening exactly as we planned. And our price increases were implemented with that view in mind. So we didn't spike raws and then -- spike prices and then have them come down. We have them going up an appropriate amount given what's happened. I think the question might be why the delay. I think our competitors were a little slow to move on the price increases, frankly. And as they delayed some of theirs, we made some strategic decisions to delay some of the timing of our price increases. But I would say, the current trend in terms of some fading of raw materials is something that we anticipated. And we don't see that causing a problem with us getting the magnitude that we -- we've gotten frankly, so it's – there’s certainly still some more things we're doing in Q3 and we've committed with customers in Q3, but most of what's been committed is done and in place.

Okay. That's good color. Then on the Engineering Adhesives business, I know year-on-year, the margin was up, but there was a little bit of a sequential margin decline, even if sales were up a little bit. Is that some raw material impact that we're seeing? Or are there some seasonal factors that play in there? And maybe can you talk about -- you mentioned organic investment in that business. Are we still seeing some P&L impact of investments that you're making in sales force and other growth initiatives?

Yes. So you know the business well because all 3 of those are true. There's a little bit of seasonality, so there's a few different segments there. The electronics business is more weighted toward the beginning and the end of the year. So that's a little of the seasonality and that's a little higher-margin business. There was, on some of the silicone raw materials, a spike in raw materials there that hasn't fully been recovered in Q2 that's coming through in pricing in Q3. So that's in effect. But I think the fundamental issue is we're investing heavily in that business. We see it as a high -- it's a really nice high-margin business. We've got a strategic plan to grow it aggressively over the next few years. And the plan on bringing the margins out -- margins up is over the next few years. But this is a 20% EBITDA margin business that we're investing where we need to, whether it's in sales teams, supply chain, technical people, to get the critical mass that we're looking for. So it's all 3 of those, Mike, that are keeping the margin from being as high as they potentially could be. But we were happy. I mean, a 50% improvement versus the prior year, good progress in that business, and we expect margins to move up the rest of the year.

Okay. And just to quickly follow up on that. I forget exactly where you're targeting margin. I seem to have the number 20% in my head over the next 3 years. Is there going to be kind of a steady progression toward that over 3 years? Or is there going to be a point at which we kind of see you start to leverage the investments and there should be a step change at some point that would be a little bit harder to target exactly the timing?

Yes. So I would say 2020 at 20% is what we laid out as our strategic plan, and that's very achievable when you look at the fundamentals of that business. And I would say it's probably not a linear progression. But you should expect to see progression in 2018, more progression in 2019 and more in 2020 toward that goal. But that's -- our view is keep the margins of the business -- the gross margins and the material margins high, make sure we embed ourselves in the right growth programs and then leverage that as we sustain the business profile. That's our strategy.

And we'll move next to Jeff Zekauskas at JPMorgan.

In which geographic area received the most raw material pressure and in which area the least?

Yes, they're relatively similar, Jeff. I think we saw the strongest spike in Asia in Q1, and then both Europe and North America were very similar in Q2. So the timing was a little different, but Europe and North America were similar and they both hit in Q2.

Why was there margin compression in Europe given that your prices were up 4% and your volumes were up 4%? Wouldn't that be enough to offset the pressures that you were feeling?

Yes. So John can talk about some of the technicalities on that. But there's a -- part of the phenomena there has to do with the currency impact in certain countries. So we had to raise prices in emerging markets that show up at price, so -- and maybe you can give some color...

Yes. So if you look at our page in the press release that shows the price, volume mix and FX impact, you can see the large impact's in EIMEA. Probably 2/3 of that is in emerging markets, Egypt and Turkey, where the currency is devalued fairly significantly. So pricing we've got -- the majority and probably all of the pricing you're seeing there is related to offsetting those exchange rate impacts. So we have a -- we are able to get pricing in those markets. Because the currency is volatile, we're able to offset that. And so that's why you're seeing significant pricing but some margin compression.

Underlying core performance in Europe and North America was similar with price increases that were implemented in late May, June 1 and raw material impacts that happened throughout the quarter, Jeff.

How much of your -- is Engineering Adhesives Asia by another name? Or how much of Engineering Adhesives is the Asian market?

Yes, I would say about half of it is in Asia right now, Jeff.

Is that where the growth is really coming from? Or is it more wide?

It's more wide. When we bought the Tonsan business, there was a sizable piece of that business in China, some great technology, some great competencies. And a big part of our growth strategy is to leverage that around the world. So we're seeing growth in all of the world, including in China. So I don't have the number at hand, but I would say half the growth's probably in China and half of it's around the rest of the world as we leverage that. But the synergies are definitely going both ways on that deal in terms of helping us grow that business faster but also helping us grow in Europe and North America.

I guess, lastly, is your raw material inflation some mid-single-digit rate?

Yes. Low single digit, I would say.

Low single digit?

Low to mid, yes. Probably closer to mid. John said closer to mid. I should let him answer. Year-on-year.

I think we communicated in the last call that we thought, for the full year, it would in the 3% to 4% range. And we expect that again.

In your cost-reduction program, how much will you pull out this year and next year?

So when we announced that in December, we said that the full year -- that the annualized impact in terms of savings is about $18 million and we expected to get half of that this year, and we're on track for that.

[Operator Instructions]. And our next question is from Bruce Zessar at Advisory Research.

I think my questions on margin were answered. I just had a quick question, it's probably for John. Did you update guidance earlier on cash flow from operations? I may have missed the comment.

So yes. Bruce, we mentioned in our commentary that cash flow in the first half of the year was lower than last year. It's primarily due to an intentional inventory build. Some of that ahead of raw material price increases, some of it due to building inventory as part of the integration of Wisdom. So we still expect full year cash flow -- operating cash flow to be around $200 million, and we expect working capital to return to normal levels by the end of the year.

[Operator Instructions].

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