Ladies and gentlemen, thank you for standing by, and welcome to the H.B. Fuller Fourth Quarter 2017 Investor Conference Call. This event has been scheduled for 1 hour. Today's conference call is being webcasted 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 of Investor Relations and International Finance, Mr. Maximillian Marcy. Sir, you may begin.

Good morning, and welcome to our fiscal year 2017 and fourth quarter earnings call. We have 2 speakers today, Jim Owens, 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 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 the GAAP numbers we will report in our Form 10-K. 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. The fourth quarter of 2017 was a successful quarter as we closed the transformational Royal transaction, while delivering record revenue, increased profits, significant cash flow performance on our corporate businesses. Royal will expand our position in highly specified and more profitable adhesive segments and have an immediate and significant impact on the margin profile and cash flow position of our company. In the fourth quarter, we began the integration process and validated our synergy targets. And later in this call, I will give you an update on the progress we have made toward delivering the commitments we outlined when we announced the Royal deal. Our underlying business finished the year with strong momentum in the fourth quarter, delivering the best quarter in the year in terms of organic growth in what has been a very good year from a top line standpoint. We also delivered adjusted EPS growth in the core business of 9% versus a comparable 13-week quarter in the prior year. We had very strong cash flow in the fourth quarter, delivering nearly $200 million in operating cash flow for the full year excluding Royal. EBITDA margins improved versus the prior quarter. However, we fell short of our margin expectation in the fourth quarter due to continued raw material increases, which were not fully offset with price increases. I will discuss this dynamic in a bit more detail in a few minutes as well. Looking back, we began the 2017 fiscal year with 3 areas of focus: increased pricing to offset raw materials; improved margins in our Construction Products business: and double-digit growth in our Engineering Adhesives business. On pricing, we successfully raised prices in the second and third quarters, which offset the inflation that began earlier in…

Thanks, Jim. Jim provided a few highlights of the fourth quarter results, so I'll provide some additional financial details on the fourth quarter as well as guidance for 2018. Organic volume grew over 6% versus last year's fourth quarter on a comparable 13-week basis. [ 4 of 5 ] segments, again, delivered strong volume growth, led by nearly 20% growth in Engineering Adhesives. Asia Pacific delivered about 10% growth with Americas Adhesive and EIMEA delivering mid-single-digit volume growth, all stronger than our long-term plans. Acquisitions contributed 3% to growth while foreign exchange and mix netted to 0. Pricing actions to offset raw materials drove positive year-on-year, price realization of approximately 2% across most markets. We expect further pricing actions to drive continued positive revenue growth for the 2018 fiscal year. Adjusted gross profit margin declined versus last year with the primary driver of the lower year-over-year margins being higher raw material costs. Adjusted selling, general and administrative expense is essentially flat versus the prior year on a comparable 13-week basis. Adjusting for acquisitions, SG&A expense was down year-on-year as a result of the restructuring actions we announced in December as well as thoughtful control of discretionary expense, offset by continued investment in the faster-growing parts of our business. The net of this resulted in adjusted diluted earnings per share of $0.75 for the fourth quarter, excluding the impact of Royal, up about 9% versus last year on a comparable 13-week basis. Cash flow from operations was very strong during the fourth quarter as anticipated. When adjusting for cash expenses related to the Royal transaction, cash flow from operations was approximately $120 million during the quarter and about $197 million for the year as working capital returned to more normal levels versus the end of the third quarter. With that, let…

Thanks, John. In the fourth quarter, we closed the Royal acquisition, we initiated the integration process, and we made strong progress against the key financial and strategic objectives outlined for our business. Our 2018 plan has us taking the next step toward realizing our 2020 plan, which will result in $600 million in EBITDA. In 2018, we will continue to deliver solid revenue growth as we innovate and provide solutions for our customers' most difficult challenges by leveraging the capabilities of both H.B. Fuller and Royal. We will also create value for our shareholders as we extract the synergies enabled through the combined power of the company's strategic purchasing decisions and targeted cost reductions, which will generate over $15 million in synergies this year. 13% annual EBITDA growth is needed to deliver the first step toward our 2020 target of $600 million in EBITDA. We will be achieving this through continued organic growth, strong pricing actions, operational efficiency and synergy delivery. We are well positioned to deliver this first step in 2018 based on the performance of our underlying business and the synergy delivery that is already being executed. I am really excited about the next several years in our business and the strong financial performance we will deliver for our stakeholders. We appreciate your continued support and interest in our company. That's the end of our prepared remarks. So now, we look forward to answering your questions.

[Operator Instructions] And we will take our first question from David Begleiter from Deutsche Bank.

Jim, just on the raw materials. First, when do you fully expect to catch up to the higher raws? And do you have enough announced price increases as of today to offset the raw materials that you were seeing?

Yes. I would say, it varies around the regions. We -- you might have seen we had some public announcements in the Americas here in early January. So yes, I think they're well positioned to exit Q1 at the targeted level of margins. Likewise, in Europe in Engineering Adhesives. I'd say, Asia's probably a little bit behind where we want to be. So -- but we'll see good progress in gross margins this quarter. We put a lot of price increases across all the businesses on January 1 and some of them needed to go back out here in March.

And just on the cost synergies of the $35 million, are you preparing to increase that? I was a little bit unclear over your commentary.

Yes, I think what I was trying to say is that the detailed plans that came out have now added up to above that number. I wouldn't say that publicly we're announcing it, right, 2020 is a ways off. But our confidence on the $600 million number has grown since we announced the deal. And we just had a very detailed review, a 4-hour review of all the work streams just yesterday in fact. And the credibility -- some of the synergies are coming in. The credibility of what's there and some of the possibilities related to some of the things that we're still working on have us very confident in the number and over time. I mean, we will report out regularly on our progress toward hitting the numbers. But I expect that we -- we feel very confident in that number and hopefully, at some point, I'll be able to announce a bigger number. But now, I'm not officially changing the number on synergies now.

And we will take our next question from Ghansham Panjabi from Baird.

So the 6% to 7% growth for fiscal year '18 that you called out for quarter sales, can you sort of break that out between volume and price and also give us a sense as to how that flows through the various operating segments?

Okay, so why don't I turn that over to John? I think he can give you a couple details behind that.

So I think, Ghansham, the way to think about it, I think I mentioned in my comments we're getting roughly 1% from FX. We'll get 1% to 2% on the annualization of acquisitions. Just the remainder, we're really kind of looking at that 3% to 5% type of growth, which is what we've targeted with a little more of that coming from pricing in 2018 than 2017. Then maybe figure 2% to 4%, 3% to 4% on pricing and the rest from volume. As it relates to the segment, I would say we're -- it's a little preliminary for us to give guidance on this segment at this point. We're -- as we've discussed, we're going to report the Royal businesses on the legacy H.B. Fuller segment. So although we have budgets for the 2 businesses, we're still in the process of putting those together on the H.B. Fuller segments.

So if I would think about it in terms of the old businesses, we definitely look at the double-digit growth to continue in Engineering Adhesives, strong single-digit growth in Asia Pacific, low single-digit in -- this is from a volume standpoint ex price in North America and Europe. And we're seeing in the underlying Royal business about 4% organic growth, which as John said, as we reported out, it's going to be spread out into our 5 segments.

Okay, Jim, that's helpful. And just a clarification question, if I could. On the $15 million in synergies that you called out in your slide deck, is that a run rate number or is that a to-be-realized number for fiscal year '18?

That's to be realized in 2015 (sic) [ 2018 ]. And as I said, a number of those have already started.

And we will take our next question from Eric Petrie of Citi.

Question on your comment regarding environmental controls in China and the impact on raw materials. Which [ chains ] are you specifically seeing pressure? And then to offset this inflation, are you announcing similar or greater than kind of that 5% to 15% price initiatives that you have in North America?

Yes. So yes. So I think the most public example is BASF and MDI facility, right, which took out a big part of the global demand. But I think if you look into the details, there's a lot of small chemical companies all throughout China where there's been this diversion that's happened from natural gas in certain parts of the economy to -- from the chemical sector to the energy sector. It's all driven by an initiative to take away coal as a heating source so -- especially during the winter, a lot of people have been put on allocation, some people had been shut down. So the big one is MDI, but it's pockets all throughout the supply chain and the chemical base where people are on reduced output levels. And then your second question was, yes, I'd say similar types of price increase announcements. These vary depending on the nature of the market segment we're in and also the nature of the raw materials that we buy, but similar levels around the world.

Okay. And then the time period that you owned Royal, it looks like EBITDA margins were 16%. Is that attributed to a normal seasonality? Or did you have a hit from higher raw materials?

Yes, I think you have to be very careful about looking at the EBITDA margins over that period because it's -- there's a holiday in there, we owned it for 6 -- plus 6.5 weeks, but we only had 5.5 weeks of revenue. So there was a slight decline in the material margin, but I would say less than ours given the nature of their businesses in that little stub period. But mostly, it's the -- as you said, a little bit of seasonality but mostly, just the time period, just too short of a period to get a real number.

And we will take our next question from Mike Harrison of Seaport Global Securities.

Was wondering if you can go into the Americas margin number in a little bit of detail. You would seem pretty confident that you could get back to the 17% EBITDA margin level. So was it just raw material impact that you saw? Or can you disaggregate how much was kind of hurricane temporary or more onetime impact versus the raw materials? And were there any other factors beyond raws and the hurricane that kept you from getting to 17% number?

Yes, so I'll let John disaggregate. I'll give you a little bit of the high-level story. I think one of the big issues in the quarter was VAM. So going into Hurricane Harvey, VAM was a big issue. We imported -- one of the things we focused on is we make certain that we have supply reliability first. So in order to make certain we had supply, we quickly imported some material from China that was at a premium and expedited freight premium that was very significant. We did put some surcharges in place to compensate that, didn't fully compensate it. And then the increases that we expected to happen in VAM actually stayed on longer. So there's a whole VAM dynamic, which flows to the numbers. But probably a bigger impact was the fact that we had built into our expectations for Q4 some price decreases that were being negotiated entering the quarter. And I would say, the net-net was price increases versus decreases. So if you think about it very high-level terms when you go into quarter expecting prices to come down a percent and they go up a percent, that's a dramatic difference on your margin. So a little bit of change makes a big difference. And then the other thing I'd say, and I don't think we talk a lot about it normally, is we have a LIFO situation. So when you have expectations built into declining raw materials in the fourth quarter, and they turn into an uptick, that actually flows through with a sort of a catch-up effect for the whole year. So that also flowed into our numbers for fourth quarter in the Americas. So anything else you want to add?

No, I think you have the key points, Jim, I think there may be a little bit of timing on other expenses, but it's mainly raws. If you look at our kind of what we call our contribution margin or material margin, it did improve between Q3 and Q4. But it was positive in the light of higher raw materials. But there -- and there are -- so there are a few other smaller items that are impacting that margin, but it's mainly raw materials.

Yes, a couple of costs in some plants, but it's more raw materials. Did that help, Mike?

Yes, that's helpful. And then in terms of the acquisition contribution in the Americas, I know you corrected the press release to about a 9% increase year-on-year, so call it $19 million in the quarter. But the Wisdom deal, that's $100 million annual revenue run rate. And then I would have thought that we would have seen at least a couple million from the Adecol acquisition as well. So why was that acquisition number relatively light? Is there anything going on there?

Yes. One thing you got to keep in mind is -- well, there's 2 things, right? There's a combination of things that are getting integrated into our business and aren't so it's sometimes a little difficult to parse out because we competed directly with Wisdom. But the bigger factor is Wisdom was a customer of ours. So there was a certain amount of revenue that we had selling them polymer that gets subtracted from that number. So the net revenue growth is not that full $100 million. There's quite a bit of polymer business that we sold them each quarter that is now a synergy. So that was one of the synergies we identified early. So that's probably the biggest factor why the number is not there. And in terms of the Adecol impact...

Adecol, we had about $4 million for 1 month, which is pretty much in line with what we expected.

But the biggest issue is the polymer sales that are no longer part of the business.

And we will take our next question from Dmitry Silversteyn from Longbow Research. [Operator Instructions] And we will take our next question from Curt Siegmeyer from KeyBanc.

So Dmitry disconnected, operator?

Yes, it looked like he disconnected right as I put him into the queue.

I know you talked a little about your EBITDA assumptions for 1Q. I was wondering if maybe we could talk about that from an EPS perspective given your guidance assumes roughly $0.75 and EPS growth at the midpoint and the seasonal weakness typical in 1Q. So was just wondering how we should think about that sort of the EPS growth ramp as we work our way through the year given it would imply just under $0.20 of EPS growth per quarter?

So yes. Let me try and get a high level just so you understand some of the changes now with Royal. We had a Construction Products business. We bought a sizable construction business. There's is in roofing. So the seasonality, December, January, February, that business is very significant. So that's one of the reasons why we always had a shift between Chinese New Year, Christmas and the fact that we had seasonality related to the Construction Products business. That's all been exacerbated with Royal. And I think what John was trying to do is give a clear picture of what EBITDA was going to happen, which is going to be lower and then things like depreciation and interest, which are constant throughout the year. But I'll let you answer the question in detail.

Yes. I think that -- I think Jim's exactly on point. So that -- of the $465 million we expect between 17%, 18% coming in, in the first quarter, you can take the interest expense and amortization numbers that I gave you, which is just ratably over the year in the 25% to 27% tax rate. So that should get you to your EPS number, but it will be our lowest quarter of the year just based on the seasonality of the business.

It will be quite low relative to the other quarters.

That's right.

We're not giving specific guidance.

Sure, sure. Great. And then if I could, just a quick follow-up on the tax rate. You mentioned 25% to 27%. 2017 finished the year at 28%. So with the addition of Royal and the higher U.S. exposure, what would your 2018 tax rate have been if the -- excluding the tax law?

Well, excluding the tax law, it would have been about 30%, probably between 33% and 34%.

We've said that when we announced the deal, we were expecting it to be close to 33% with the Royal deal. So this brings us down significantly from where we would have been.

[Operator Instructions] And we will take our next question from Jeff Zekauskas from JPMorgan.

You have the ERP charges of $7 million to $10 million for 2018. Is that a 1-year effect or will they be ongoing? And why do you exclude them from your earnings -- your adjusted earnings per share?

Okay, so I'll answer the first question. I'll let John -- yes, so this is the rollout of the ERP. As you know, we've rolled it out in North America a couple of years ago. We took that project, which was on an accelerated pace and have extended it. So we didn't mention it actually in our notes because it was such a nonevent. We did go live with our first wave of that in Latin America on the beginning of December, went extremely well. Our next wave comes in July. That's also in Latin America. And then Brazil would be about this time next year. It is a discrete project around the changing and upgrade of our systems. It is a multi-year project, so I think it's a matter of being consistent with past practices, which is why we've been calling it out.

Yes. [indiscernible], and it's a little bit lumpy, too, I would say depending on the year and what's being done. So we've excluded that expense as exceptional. All that capital that's being invested, all the depreciation associated with that flows to our adjusted results.

The capital flows through the incremental expenses, it goes up and down.

Okay. What was your adjusted EBITDA from Royal in the first quarter of last year? I guess, if your EBITDA estimate for the first quarter now is $81 million, I think, last year, your adjusted EBITDA was $61 million. And so I would assume that Royal's EBITDA was, I don't know, maybe in the neighborhood of $20 million, something like that? So basically, on a pro forma basis for the first quarter, your adjusted EBITDA is flat or down? How do the numbers actually look?

Yes, Jeff. We haven't disclosed the Royal information on a quarterly basis. I think what we would probably expect to see is modest growth year-on-year in the first quarter on a combined basis based on the timing of raw material and price increases. So I think from a full year basis, I mean, that's going to ramp as we go through the year. So we would be at about 13% growth on a full year basis.

Modest growth in Q1, I think, is the answer, Jeff.

And in Q1, does the raw material squeeze get worse versus the fourth quarter or better?

Yes. I would say the raw materials are a little up versus the fourth quarter, but the net of our pricing is more positive. So we expect margin expansion of less than 100 basis points, Q4 to Q1.

Q4 to Q1?

Yes.

Okay. Okay, great.

Did that answer your question, Jeff?

Yes, that's great.

Okay, great.

And we will take our next question from Dmitry Silversteyn from Longbow Research.

This time I pressed the right button, sorry for dropping off last time. Just wanted to follow-up on a couple of comments that you guys made. I'm just kind of looking at your guidance ex of Royal of 6% to 7% for next year. And then if you go through foreign exchange of a percentage point, acquisitions 1% to 2% and price mix of about 3%, that leaves me with about 1% volume growth number. Is that -- am I doing my calculation correct there?

Yes, I think, it's probably 1 -- it's 1% to 2%. And so as we take pricing, we are going to expect that the volume growth is going to be slightly lower next year.

Right. So then if I can then ask, you're expecting double-digit growth out of Engineering Adhesives. You were expecting high single digit growth for you I think you said out of APAC or mid-single-digit growth and low single-digit growth in volumes out of Europe and Americas. That adds up to way more than 1% to 2%. So is there going to be a negative growth -- volume growth business or division in 2018? Is that what I'm taking from this?

Yes. I think my comments were probably related to net growth, right? So those numbers were net growth. So yes. In terms of the budgeted levels, the growth levels are very low in Europe from a volume standpoint. Europe, Americas and CP, as John said, we're committed to drive these margins to where they need to be. And if that means we're going to sacrifice some volume, we'll do that. So if it affects us by 1% or 2% in volume, we'll want to do that. So we've budgeted for that, Dmitry. I wouldn't say that's our goal. We want to get the price increases and retain the volume, but I think as we've budgeted the year, we see a little bit of improvement in FX. We definitely see the pricing is going to come through. And in terms of our net plan, we're willing to risk some volume in certain areas if we have to.

Got you, got you, Jim. And I just want to clarify, when you talk about getting the Americas margins back to historical levels, are you talking about the 18% EBITDA margin that you put up in 2015 and '16? Or are you talking about sort of the 15% to 16% level that you've done in 2011 through 2024 -- 2014? What -- [ a couple ] I have to go back to.

Yes, yes. No, you've got a long history with H.B. Fuller. Yes, we've said 17% to 18% is the target for this business and we see a minimum of the underlying business, before Royal, of 17% as the target. And that's what we've laid out as our strategic plan going forward. So when I look at that business, it's got a number of years now at that 17% range and north of 17% is what we expect going forward.

Got it. And then to finish my questions on margins, you talked about getting to high teens EBITDA margin in construction division. What do you have to do to get there? And what is the timeframe that you're talking about, I mean, obviously, before 2020. But are we talking about kind of exit rate out of 2019? Or can you help us sort of bracket that recovery and margins that you expect?

Yes, I have to go through and see exactly the details on our updated strat plan. But I would say hundreds of basis points improvement this year. Incremental margins, material margins in this business are very positive. So given the investments we've put in with the Aurora plant, given the cost structure we have, that can generate a really nice margin leverage in that business. And we've got some really good things on the horizon here with that business. So I'd say few hundred basis points this year, few hundred basis points next year exiting in the low teens maybe 2019, so -- but that kind of a progression is what I would expect.

But it sounds like outside of sort of getting pricing to offset some of the raw material, the fundamental things that you need to do to get this business back, you've done. So there's nothing more that you need to do other than let sort of the price of raw materials.

Yes, operationally, we've really got that business running a lot better. So I think the issue is now to get back to driving our innovation wins in the market and regaining some of the incremental losses. And that business by the way has maintained its material margins at a very high level throughout all the dynamics we talked about. So all the pricing discussion we talked about is ex that business where they've done a really nice job of maintaining that margin.

[Operator Instructions] And we will take our next question from Mike Harrison of Seaport Global Securities.

Just following up on Dmitry's question there on the Construction Products business. Obviously, you guys were a little disappointed in the volume growth there, and it sounds like you're not really pointing to a ton of volume growth for 2018. But just kind of curious how you're seeing maybe some of the hurricane-related rebuild factor back in. And then, obviously, you have an easy comp as you get into the hurricane-impacted fourth quarter. So why wouldn't we see some pick up there?

Yes. We have budgeted mid-single digits for our existing Construction Products business. And I think you're right, there is some potential hurricane benefit there for our flooring business. It's generally about a 9-month lag from when the event start. We see even more impact potentially in the Royal business, where it's a roofing business. The roofing business is dramatically impacted. So based on historical numbers that we've got a chance to look at, we think it's going to be a really positive year for the underlying Royal business once we get through this bad cold snap that we're having across the country. As we enter Q2, we expect a really strong year on roofing construction.

All right. And then just kind of a clarification on the Royal business. You mentioned that you owned it for 6.5 weeks, but you only got 5.5 weeks of revenue. And then the holidays also negatively impacted the sales there. But you did $77 million in sales, and that suggests a run rate that's well over $700 million in revenue. So just trying to understand kind of did we see some acceleration in the underlying growth of that business? Help us understand how those numbers add up.

Yes, that's good. Yes, again, I'd caution you to not try to extrapolate the data we have there on the 6 weeks. I can tell you we've looked at the entire 3-month period from September through the end of December, and it was a net 4.5% growth. So I think when you take our stub period plus the Royal period there, we have very strong visibility. So I don't think it's a huge accelerated growth, but very positive growth there. And as I said earlier, the material margins were slightly down off of current run rates, but not a dramatic downtick. Does that help?

Got it, yes.

And we will take a follow-up from Dmitry Silversteyn of Longbow Research.

Okay. Just -- again, just as a follow-up. You mentioned that the Royal Adhesives CEO is staying on with the company. Can you talk about the role that he's assuming within the company? Not specifically about it but sort of what -- kind of what his involvement with Fuller will be going forward and with Royal or your specialty business in general?

Right. Yes, so I would say, right now, he's running the Royal business as it was, right? So we're keeping it isolated and running it independently as we begin the integration process. He's going to remain responsible for the underlying performance of those businesses. So he's going to take a caretaker role of every piece of Royal as it gets split out in the 5 businesses. And then he's also going to be responsible for leading the delivery of our synergy targets and especially the offensive synergies, right? Ted has a very strong understanding of certain core markets where we see a lot of the offensive synergies, and he's going to drive some key initiatives in that. So it's going to be sort of his key handful of roles here as we go forward over the next 24 months. And then beyond that, we'll look for other opportunities.

Got you. And in that, you actually led me into my next question, Jim. How long are you going to be continuing to report Royal as a separate, sort of, reporting entity before maybe it goes back into the business units?

Yes, our expectation is that it will be integrated from a reporting standpoint into the businesses beginning in Q1. So you'll see we'll integrate it this next quarter.

Okay. So Q1, that's not going to be a separate line item in your EBITDA and revenue. It's going to be all part of the divisions?

Right.

That's correct. John is a very busy guy these days, closing books to integrating the business and sorting out those numbers, so...

Got you, got you. And then final question, I just want to make sure I understood what you said about sort of the Royal integration. You mentioned that you found some opportunities to move volume around. Did you come to a conclusion about plant closures or not? I may have missed that in your commentary, but is there going to be an opportunity to take some plants out?

Yes, no conclusions at this point. There are 19 plants. I visit every one of them here over the last couple of months around the world. And there's lots of redundancy. You have to be very careful when you move volume out of these. But I think there's some things that are intuitive and obvious, but we got to work. We got to just [ up the working ] plant. So no decisions made, but it's clear there's some opportunities over time and it's just a matter of timing. And we will announce them once the decisions are made.

[Operator Instructions]

Okay. Thanks, everyone, for all of your time today and your continued interest in our business and our strategy.

And this concludes today's conference. Thank you for your participation, and you may now disconnect.