H.B. Fuller Company (FUL) Q4 2019 Earnings Report, Transcript and Summary

Good morning, and welcome to H.B. Fuller 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 five operating segments into three global businesses, which are enabling better organic growth and a more simplified business structure which will operate with approximately $30 million in lower cost. 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 in 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 and hygiene, packaging, new energy and general industries. But we're 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-up costs at three 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 the 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 commitments 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’ll 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 cost 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 whole Europe. Year-over-year volume trends improved in Q4 compared to Q3. The EIMEA segment EBITDA margin of 11% improved year-over-year driven by favorable raw material cost and good expense controls. Asia-Pacific organic sales increased by 2% year-over-year, a 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 costs, and solid expense controls. Construction Adhesives' space continued external headwinds in the fourth quarter. Lower private construction spending in the U.S. impacted in 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 Adhesives portfolio for 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 improve 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 solution, regional growth opportunities and customers that will drive above market growth rates. 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, membrane, 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 improved inefficiencies 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 remains very robust at a 21% margin driven by volume growth mixed 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 three 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 customer's 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 strategy faster, while eliminating the cost and complexities and inefficiencies associated with our regional structure. By shifting the majority of our resources into the three 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 three GBUs are similar in that they are focused on identifying market trends Designing advanced Adhesives 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 and 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 in 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 costs synergy. Our hygiene health and Consumables adhesives 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 converging trends and new applications and in hygiene, sustainable packaging, beauty and medical care. This business is expected to deliver long-term growth at above market rates for low to mid-single digits with an EBITDA margin in the mid-teen. The Construction Adhesives 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 over 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 two-thirds 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 three 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 in 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 thickners 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 giveback 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 costs 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 pay down. 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 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 surfactant and technology 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 two years, we have repaid over $470 million of debt exceeding the pay down target that we laid out at the end of 2017 by 34 percent. 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 a 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 AJC and Construction Adhesives. We expect consolidated gross profit margins to be up by 10 basis points 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 2024 tax rate to be between 26% and 28% compared to our 29% for 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 expected to vote approximately $200 million of our cash flow after CapEx investments and dividends to the 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 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. Let me turn the call back over to Jim to wrap up us.

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 several ways, by gaining share in our target markets, better aligning our business with our strategic growth markets, accelerating our debt pay down 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 lower. The current external outlook is that 2020 will look pretty similar to 2019. Brexit, the U.S. election cycle and 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 Adhesive business are behind us and the positive impacts from our investment in this business are ahead of us. Our plan delivers organic growth and a continued challenging global manufacturing environment and the cost reductions resulting from our GBU restructuring support additional earnings growth, which we target a 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 focus capital management programs we remain on track to significantly exceed our committed $600 million in debt pay down 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 today. Operator, please open up the call so we can take some questions.

[Operator Instructions] First question comes from Mike Harrison, Seaport Global Securities. Please go ahead.

Jim, in the fourth quarter of 2017 you were issuing guidance for fiscal 2018 and expected to hit the $465 million level. We are now two years later still kind of guiding to a number that’s below that $465 million level. So the question is aside from FX in 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 this $600 million of EBITDA?

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 two 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 it's very global. You have to take that current if you’re going to try and look over a long horizon, you have to take that currency piece into perspective. That I'd say as 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 achieve?

Well - I think we said about six quarters ago that our goal is to deliver a 10% EBITDA growth and I think.

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's we targeted that we delivered in 2018, 2019 and the environment we were and we didn't, but certainly that's 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 environments. And I think that's the metric you should measure us again.

And then in terms of the facility cost and inventory cost that impacted your margins this quarter. I 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 three facilities?

Yes, I think one of the Royal integration issues that we've been managing is moving their business model, which is very different plant to plant to a sort of best practice model. So that's putting in best practices in sales and operations planning, in cycle counts, in standardize 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 change over costs and we injected extra labor to make certain that we serve customers and work to reduce backlog. But the bigger aspect was 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 when 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 do. It wasn’t three 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 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 an engineering adhesives. So those plants serve all three of those businesses.

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 constrains? Thank you.

Yes, again it's tied to that same issue I talked about. So one of the plants we talked about serve 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 of backlog. So yeah - like you I expected us to work through that this quarter. I'm happy to report that the backlog is dramatically reduced here in Q1, so the work we were doing in Q4 has paid off, but it didn't pay off by the end of the year. But - 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 and we’re looking in 2020.

Our next question comes from Ghansham Panjabi, Baird. Please go ahead.

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 you know in terms of the guidance for fiscal year 2020 with pricing down 0% to 1% and just your base assumption of a tepid macroeconomic backdrop. I'm just curious what sort of visibility do you have on your volumes as we head into fiscal year 2020?

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 GBUs has between three 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 business as 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 you know we see really - you know you can see in the PMI numbers right across the manufacturing sector that there is 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.

It’s volume visibility.

Oh volume visibility, yes. So I'd say you know especially here at the end of the year we have better visibility because we - report a month later. So we see in the P1 results, I think that the - 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. And I know certainly I'm concerned and 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. Now 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 - that 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 one month.

Okay. And then just kind of going back to 4Q, you know you mentioned an improving trend line from a volume standpoint, was that skew 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, third in pocket the manufacturer including auto OEM and the region, if you sense that - that played out for you as well?

Well. A reminder for us, our Q4 ends November 30th. So that's far enough from Chinese New year 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 of the side - I don’t think it’s going to have a big impact. But John do you want to comment more on month-to-month?

No. I think you know 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. We kind of kept up through Q1.

And then, just one final one on Americas Adhesive, was there anything unusual that weighed on segment EBITDA margins year-over-year you know it was done about 180 basis points?

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

Thank you so much.

Yes. Year-on-year - we didn’t have - Dalton divestiture which was a high margin business has a little bit of impact in Q4.

The next question comes from David Begleiter from Deutsche Bank. Please go ahead.

If you look at your 2020 EBITDA guidance Jim, I think the point of about $20 million per year which is basically all the pull from the GBU realignment and if you include world synergies 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. You know 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 and in other costs and - and solid performance on a price raw material standpoint. And that gets you the 10% EPS with a - with limited growth right. And if we can deliver more Growth, and if we can deliver more growth, we’ll 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 our expectations we want lay off there to the street. But John do you want comment more?

Yes. So I mean I think if you think about - 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. You know the impact of our variable compensation rebuild and merit is the biggest offset and so you're right the savings represent the biggest positive. We'll get some benefit related to organic growth and some loss, but that's really kind of offset of the bonus rebuilding in there.

And John how much is that - is that $10 million or $5 million …

It’s in that $50 million range.

And especially your cash flow for up to 2020 - expectations on working capital and other items 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 $3 million with debt which would put us well ahead of our three year target. Most of that will come from the EBITDA growth that we've just talked about as well as we plan to see additional working capital improvement and on the order of 1% to 2% of revenue.

So hopefully it be pretty broad based. We've got activities going on around receivables and around the inventory and around increasing payable terms that we’re seeing - so as we exit the benefit as exit of this year and we expect that to continue in next year.

Well, you'll see in the details, Davis, 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. Please go ahead.

I just want to follow-on that a helpful discussion - on the fiscal 2020 guidance. I guess what I'm missing in all of that is after backing out the GBU saving and then you know kind of a lower organic growth environment why aren't we seeing maybe a bit more margin expansion up of the mix shift that you expect that continue to grow your higher margin in the EBITDA business relative to the rest of the portfolio.

Yes. I mean I think - I think we are seeing some of that 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 you know there's - there isn't a significant difference in the growth businesses [indiscernible].

And then just you had a competitor [indiscernible] market share this quarter in North America assuming at least some of that had to from H.B. Fuller maybe that how much would you chalk that up to your strength during the year in delivering those product versus you know maybe trying to deemphasize selling or just [indiscernible] sales in general.

Yes. I saw that. I think you're talking about [indiscernible]. 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 but that was - and the roofing business had a positive year overall. So if you take a look at our construction [indiscernible] 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 million. So, if we look at our numbers we would have a couple million more in sales here in Q4 heading to the year with the backlog. But no, we didn't lose share to the RBS.

And then you mentioned if I could pick one more, and you mentioned share gains and hygiene and packaging. Maybe I missed that, but you were pretty happy with how your progress with [indiscernible] electronic business earlier this year, how is that going 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 it.

Electronics is still our star performing business. We had an outstanding year this year. Again we don't put the numbers on specific sub segments 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 off share gains, 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, 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, yeah we see our electronics business as a very important growth driver of engineering.

Next question comes from Eric Petrie from Citi. Please go ahead.

Eric you might be a mute. We don't hear you. Okay, Operator.

Yes. Let's go to the next question.

Let’s go to the next caller and we’ll put Eric back in the queue.

Next question is from Jeff Zekauskas JPMorgan. Please go ahead.

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.

Was price - sorry - were prices down in all geographies?

They weren’t they were up in Construction Adhesives down modestly on the other business. I think the answer on your question about - will they go back to - we really did all of our pricing work in the first half of last year which is just - this has significantly drove margins in the second half of last year and all of this year. We've analyzed against that when you look at kind of Q3 to Q4 it was very similar from a pricing standpoint.

Yes, so Q3 to Q4 were very similar Jeff and I would say that - Royals are coming down so there's some slight kickbacks whether those are contractual or 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 - 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 - from a volume standpoint. You know 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. If you're talking about core Europe, it's a - 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 you know either because of the Chinese New Year or extent shutdowns? And then what you expect is for a reacceleration later in the year? Is that your general plan and how do you see business conditions in China?

Yes. So, yes, 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 one month of Q1 we're seeing further improvement on our organic basis. I'm not sure that's an indication what our markets are doing now Jeff. So I think that was your question. So you know so I can’t give you a really solid read as to whether the world's getting better here in Q1. As I mentioned there are works that have shutdowns in a lot of factories in Germany versus - or in Europe overall but Germany in particular. And we do have some - some word with some factories in China are going to have extended shutdowns here in. So we're hearing a little of that. For us, overall though you know I think our share gains are overcoming what we see at least early on in the quarter.

Larry, I’ll just say you know the question around the shape of the year. Yeah, I think given Jim’s point on some of the impacts of the extended shutdowns for Christmas and Chinese New Year, and just the fact we’ve got easier comparisons I would say in the second half of the year we would expect you know the trends to ramp up though on 2020.

So you know 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 you know if you look at for example the industrial gas products moved over from an end market segmentation to 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 you know a more global revenue mix because the end markets, 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 that's - it's going to be a lot better, Jeff. So first off strategically we got to manage our business by the 28 segments 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 two thirds of the business regionally. So what happens is the execution model is not fully aligned with the strategic model, plus five segments has a lot more cost involved with it than three segments. So our ability to see the visibility of the market and then drive the results where we need to is much better in this model then the old operating model. In terms of your question of visibility, we’ll have better visibility here you know and again only to share with you so you see up - but for us down the organization we're going to get good visible - regional visibility for each one of those businesses. 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 as we ran two globals and three regionals. So it was a - 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 and he's right on HHC. He's got a leaders looking out at the Americas as well as now in those global businesses. GUA, he is running electronics and durable assembly and insulating glass all separately but he's got a leader in Asia who's looking in detail at that. So I think we've got a very well covered. John do you want to add there anything…

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

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

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

Next question comes from Eric Petrie from Citi. Please go ahead.

On your gross margin guidance of 10 basis points to 30 basis points, I wanted to get a little more color as to why you think there would be pricing give back as well as you know 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 can get into the math of it you know I think the - first off some of our customers may be 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 address some of what happens with pricing. And I think the other thing that happens is in certain markets you'll find that competitive pressures especially in roles are coming down, put you in a position where you lower price to sell. So it's not a big impact on 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 their manufacturing costs to go down in 2020. So that's definitely what we have in our plans. So John will comment further.

So as a - if you look at kind of what's driving the gross margin improvement, it really is how attribution margin aligns. So with 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.

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 paint so just looking for any differences between baskets?

Yes, I think in our Investor Day there is a really good shot Eric that shows the diversity of our raw material. 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 phenyl acetate or ethylene. We buy materials that are further down the chain. The number one 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 G Research. Please go ahead.

Jim when - 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 million of net debt. And if I use your EBITDA guidance at the midpoint of $450 million now we have a net leverage of 3.7 times. I was wondering if you could 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’ve 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 when we did Royal we were 5.9 so it 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 – from a recessionary standpoint. Yeah I think of it, the two years have proved – proving anything to our investors is the resiliency of our cash flows. So we had negative organic growth and exceeded our debt pay down target. So this is a very cash flow generative business low capital intensity we got a lot of leverage to pull on cash flow. So we feel really good about our position to withstand any kind of a difficult environment, but the short answer to question 2 to 3 you want to add John.

No I think that’s the target – I think I am going to say – yeah I think 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 that when the top line slows – we have less working capital usage and raw materials come down and those are cash flow generative

Right.

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

Yes.

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

Correct, correct. Yeah so if I wasn't clear yet but – in somewhere in 2021 is where we see ourselves getting below three.

Okay, I may have missed that, thanks. And then you have some you know 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 say 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, you know 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 numbers 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 based 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 is the growth of that business and then our ability to grow right. Our aerospace business – the aerospace business you've heard from Boeing and 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.

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

We’re not building that into our plan, Rosemarie. I think there is an opportunity for that to happen you know we were in the second year of a decrease in auto builds. It’s rare that the auto industry has three years in a row of decline. So, but we haven’t built any of that into our expectation. So if auto has improved our numbers will be better than the ones we outlined.

And since we are – on the auto subject – 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 need to have thermal conductive materials that are EV like materials and encasing. So we'll see over time, but most of the data indicates that EVs will use more adhesives than non-EVs.

Our next question comes from Paretosh Misra from Berenberg. Please go ahead.

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 toward that 10%. So I think – the way I think about it is 2020 should be at mid single-digit business for the combined business, but as I said Q1 being flattish and then when you look at the 2021 and 2022 moving towards that double-digit. And we have – and why is because we're leveraging that engineering adhesives business model of where to focus and how to focus to win market share.

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 we don’t say you know both of them are slower but both of them are positive in China about some of us.

[Operator Instructions] Our next question comes from Christopher Perrella, Bloomberg Intelligence. Please go ahead.

Quick question on the cash costs I'm assuming these are cash costs of 6% to 10% for the business realignment and 12% to 15% of ERP. Would you be finished with those given those lag in 2021?

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

But that amount in the release is going to be incurred this year.

Correct.

That’s our expectations.

That’s correct.

Yes, that's all this year.

Yes.

Yes.

All right that's it for me. Thank you very much.

Thank you very much, Christopher. Hey thanks sorry, we went a little over. Thanks to everyone for your interest and your focus on H.B. Fuller. And I wish everyone a great 2020. Thanks.

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