H.B. Fuller Company (NYSE:FUL) Q1 2023 Earnings Call Transcript

H.B. Fuller Company (NYSE:FUL) Q1 2023 Earnings Call Transcript March 30, 2023

Operator: Good morning. My name is Colby and I will be your conference operator today. At this time, I would like to welcome everyone to the H.B. Fuller Q1 2023 Earnings Conference Call. Thank you. I will now turn the call over to Steven Brazones. You may begin.

Steven Brazones: Thank you, operator. Welcome to H.B. Fuller’s first quarter 2023 investor conference call. Presenting today are Celeste Mastin, President and Chief Executive Officer and John Corkrean, Executive Vice President and Chief Financial Officer. After our prepared remarks, we will have a question-and-answer session. Before we begin, let me remind everyone that our comments today will include references to certain non-GAAP financial measures. These measures are supplemental to the results determined in accordance with GAAP. We believe that these measures are useful to investors in understanding our operating performance and to compare our performance with other companies. Reconciliation of non-GAAP measures to the nearest GAAP measures are included in our earnings release.

Unless otherwise noted, comments about revenue refer to organic revenue and comments about EPS, EBITDA and profit margins refer to adjusted non-GAAP measures. We will also 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 covered in our earnings release, comments made during this call and the risk factors detailed in our filings with the Securities and Exchange Commission, all of which are available on our website at investors.hbfuller.com. I will now turn the call over to Celeste Mastin. Celeste?

Celeste Mastin: Thank you, Steven, and welcome, everyone. In the first quarter of fiscal year 2023, the team executed exceptionally well to deliver solid first quarter results that were in line with our expectations despite challenging demand conditions, particularly in Construction Adhesives. The diversification of our portfolio enabled us to deliver stable organic sales. Even with these challenges, and diligent management of price and raw material dynamics drove significant gross margin improvement both year-on-year and sequentially. Overall, this resulted in a solid adjusted EBITDA performance and led to higher adjusted EBITDA margin year-over-year. Looking at our consolidated results in the first quarter, organic revenue was significantly impacted by continued demand weakness affecting Construction Adhesives.

CA experienced significant customer destocking impacts which began in the fourth quarter of last year and continued in the first quarter of this year. It is uncertain when and how significant a restocking event will be. However, the benefits of the company’s geographic and end market diversification offset a significant portion of CA’s declines and led to stable, consolidated, organic sales year-on-year. This was driven by Hygiene, Health and Consumable Adhesives and Engineering Adhesives, which, on a combined basis, continued to generate positive organic growth in the first quarter and significant margin expansion. These GBUs continue to outperform the market by leveraging innovation-based market share gains to expand existing customer relationships and generate new business wins.

From a profitability perspective, we performed at the high-end of our guidance, and we continue to be very encouraged by the team’s disciplined approach to optimizing price and raw material cost developments to expand margins. On a year-over-year basis, adjusted EBITDA was stable in the first quarter, and adjusted EBITDA margin increased 40 basis points to 13.6%. On a constant currency basis, adjusted EBITDA was up approximately 6% year-on-year. Given the strength of the comparable Construction Adhesives’ quarter in fiscal 2022, this demonstrates the power in our portfolio to overcome down cycles in any of the 30 market segments we served. Overall, global economic conditions are slow, but aside from what we have seen in CA largely in line with our projections.

We expect a mild global recession in 2023, which will adversely impact economic activity. While we are well positioned to grow EBITDA in such a scenario, we are proactively initiating a restructuring plan focused on reducing costs across the enterprise and particularly in Construction Adhesives. This restructuring will better align our cost structure with the current economic outlook. These actions are enabled by process efficiencies that were highlighted during our last Investor Day and are also consistent with our longer-term strategic objectives of improving our gross profit and EBITDA margins and increasing our ROIC. The restructuring is focused on both reducing manufacturing costs and SG&A. When completed, we expect these actions to deliver annualized cost savings of between $30 million and $35 million, including approximately $10 million this year.

From a raw material perspective, while costs are still higher year-over-year, the rate of inflation continued to slow during the first quarter, consistent with our expectations. We are on track to deliver between $130 million to $160 million in net benefit from price and raw material cost management as evidenced by the strong expansion in gross margin we achieved in the first quarter. Offsetting this benefit somewhat will be approximately $80 million of headwinds from lower volume and wage and other inflationary pressures. We continue to appropriately manage pricing in this dynamic raw material cost environment. As we indicated previously, we purchased approximately 4,000 different raw materials and the cost movements of these are not synchronous.

Most are stable sequentially, some are decreasing, yet a meaningful portion are still increasing. This requires continued comprehensive pricing execution, which we continue to demonstrate. Now let me move on to review the performance in each of our segments in the first quarter. In HHC, organic revenue was up 4.5% year-on-year. This was a particularly strong result given the current economic backdrop and a difficult year-on-year comparison where organic sales increased 21% in the first quarter of last year. Strength in hygiene, packaging, tissue and towel, graphic arts and health and beauty markets continued in the first quarter of the year. HHC’s responsible management of pricing dynamics offset lower volume and drove organic revenue growth in the quarter.

Adjusted EBITDA for HHC increased 28% year-on-year, and adjusted EBITDA margin increased 360 basis points to 15.6%, driven by favorable price and raw material cost management. In Engineering Adhesives, organic revenue declined slightly in the first quarter impacted by continued weakness in China as well as some destocking and somewhat slower demand in durable goods and products used in the construction trades as expected. This more than offset strong growth in automotive and aerospace markets. Adjusted EBITDA was flat in EA, and adjusted EBITDA margin increased 90 basis points year-on-year to 15%. Here too, favorable price and raw material cost management drove the increase in adjusted EBITDA margin year-on-year. In Construction Adhesives, organic sales significantly declined year-on-year.

As expected, the substantial customer destocking actions that began in the fourth quarter of last year continued in the first quarter of this year and considerably impacted organic sales. CA also had a very challenging year-on-year comparison due to the prior year’s first quarter benefiting greatly from the post-COVID demand surge in construction markets. The roofing market segment continues to be hardest hit by customer destocking actions and drove most of the decline in organic revenue for CA. Adjusted EBITDA for Construction Adhesives was severely impacted by lower volume and negative operating leverage in the first quarter. The restructuring actions that I referenced earlier are heavily weighted to CA and will lower the cost structure of the business and allow for significant margin expansion as volume trends return to more normal levels.

Geographically, Americas organic growth was down 4% year-on-year, significantly impacted by the decline in Construction Adhesives. Organic growth, excluding CA, was up low single digits in the Americas in the first quarter led by HHC. In EMEA, organic revenue increased 5% versus the first quarter of last year. Both HHC and EA generated very solid organic growth, given the economic backdrop, up mid-single digits on a combined basis. In Asia-Pacific, organic revenues decreased 8% year-on-year. Although China ended their stringent COVID-related restrictions in January, spiking infection rates during the first quarter delayed a rebound in economic activity and adversely impacted demand. This was consistent with our expectations. Now let me turn the call over to John Corkrean to review our first quarter results in more detail and our outlook for 2023.

John Corkrean: Thanks, Celeste. I’ll begin on Slide 8 with some additional financial details on the first quarter. For the first quarter, revenue was down 5.5% versus the same period last year. Currency had a negative impact of 4.9%, and acquisitions increased revenue growth by 1.9%. Adjusting for these items, organic revenue was down 2.5% with pricing having a favorable impact of 8.3% year-on-year in the quarter and volume down 10.8% reflecting a continuation in significant customer destocking in Construction Adhesives and a general slowdown in end market demand. Adjusted gross profit margin was 26.9%, up 190 basis points versus last year, as the net effect of pricing and raw material cost developments more than offset the impact of lower volume.

Adjusted earnings per €“ adjusted selling, general and administrative expense was up approximately 3% year-on-year, as higher wage inflation was offset by good cost management and the favorable impact of exchange. Adjusted EBITDA for the quarter of $110 million was at the top end of our expected range, but down slightly year-on-year, reflecting the favorable impact of pricing and raw material development being more than offset by lower volume, higher wage inflation and unfavorable foreign currency translation. On a constant currency basis, adjusted EBITDA for the quarter was up approximately 6% year-on-year. Adjusted earnings per share of $0.55, was down versus the first quarter of 2022 as expected, driven by lower volume, unfavorable foreign currency and significantly higher interest rates.

Higher interest expense and unfavorable foreign exchange negatively impacted adjusted EPS in the first quarter by approximately $0.17 and $0.11, respectively. Adjusting for the impact of currency and higher interest expense, adjusted EPS in the quarter was up about 6% year-on-year. Operating cash flow in the quarter improved year-on-year, as improving margins and slightly lower working capital requirements more than offset lower volume, higher interest expense and unfavorable foreign currency translation. With that, let me now turn to our guidance for the 2023 fiscal year. Our guidance for the year is largely unchanged. We now expect full year net revenue to be down 1% to 4% versus 2022 and for organic revenue to be in the range of down 1% to up 1%.

This reflects lower-than-expected volume for Construction Adhesives in the first quarter as well as slightly weaker economic demand for the full year. Foreign currency translation is now expected to negatively impact revenue by 1% to 2% versus 2022. We continue to expect adjusted EBITDA to be between $580 million and $610 million, representing a 9% to 15% year-on-year increase, up 11% to 17% adjusting for the extra week in 2022. This reflects the slightly lower organic revenue expectations, offset by savings associated with our restructuring initiatives and a slightly improved foreign currency outlook. Combined, these assumptions result in full year adjusted earnings per share in the range of $4.10 to $4.50. We continue to expect full year operating cash flow to be between $300 million and $350 million weighted toward the second half of the year.

Finally, based on the seasonality of our business and the timing of pricing and raw material development over the course of the year, we would expect to realize about 42% to 43% of full year EBITDA in the first half of the year. Now let me turn the call back over to Celeste to wrap this up.

Celeste Mastin: Thank you, John. I am extremely proud of the performance and execution of our team in the current challenging environment. It is a reflection of our strong entrepreneurial culture, which is a strategic differentiator for H.B. Fuller that not only drives financial performance, but also inspires and aligns us around a greater purpose. I would like to highlight a few external accolades that our team has recently received. First, at the end of 2022, Investor’s Business Daily named H.B. Fuller to their list of 100 Best ESG Companies for 2022. IBD evaluated over 6,000 companies globally to select those that remain committed to sustainable and ethical business practices while still exceeding profitability and return on investment goals.

H.B. Fuller was ranked number 57 on IBD’s Top 100 List. We are committed to maintaining a safe and respectful work environment for our team members, improving the communities where we live and work, supporting our customers and achieving their sustainability goals through innovation and reducing our own environmental footprint. We are very proud to have been recognized by IBD for our accomplishments and exceptionally proud of our team members for their commitment to our culture and pursuit of winning the right way. Second, at the beginning of this year, Forbes named H.B. Fuller to their list of 500 Best Midsized Employers for 2023. The ranking is based on a survey of 45,000 American workers at companies and institutions with 1,000 to 5,000 U.S. based employees.

Participants surveyed were asked how strongly they would recommend their current employer to friends and family and to cite any other employer they would also recommend. H.B. Fuller was ranked number 61 on Forbes Top 500 List. I am quite proud of our team members’ collective accomplishments as they embody our winning culture, and I want to thank them for their commitment to making H.B. Fuller a great company and a great place to work. Now as I conclude my prepared remarks, I would like to provide an overall perspective. 2023 started largely as we had expected, and we are performing very well in line with our guidance. Our anticipation of slowing macroeconomic conditions, including weakness in China and challenging end market demand in construction, drove us to prepare for the challenges we are encountering.

Consequently, we remain confident we will achieve our full year financial objectives. We are realizing gross margin expansion according to our expectations, driven by our commitment to balance raw material movement and pricing actions. We expect this benefit to accelerate as we progress throughout the year, which, coupled with the restructuring actions we are taking, will further expand adjusted EBITDA margin and ROIC in the quarters ahead. That concludes our prepared remarks for today. Operator, please open the line for questions.

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Q&A Session

Operator: Your first question comes from the line of Ghansham Panjabi from Baird. Your line is open.

Ghansham Panjabi: Thank you. Good morning, everybody.

John Corkrean: Hi, Ghansham.

Celeste Mastin: Good morning, Ghansham.

Ghansham Panjabi: Good morning, Celeste and John. I guess, first off on the CA segment. I know you mentioned that roofing was particularly weak and volumes were pressured by continued destocking. But how would you assess actual end market demand across your various verticals if you adjust for destocking? Maybe you could just kind of zoom out on that segment, just give us a sense as to how much is commercial versus residential, new versus maintenance? And then also, could you give us a sense as to what you saw in March and also your order book for April?

Celeste Mastin: Sure, Ghansham. So when you look at our construction business, let’s just start there. A very small portion of our construction business is residential in nature. Mostly we participate in the commercial construction part of the business. And certainly, our construction business continues to feel the effects of destocking. However, really, we’re not seeing anything that’s catalyzing market demand either. And so as we look at that business, we decided to take action to implement this restructuring plan because we really want to be prepared €“ we wanted to prepare our cost structure for lower volume demand throughout the year, and that is reflected in our guidance.

Ghansham Panjabi: And what you’re seeing in March for the segment?

Celeste Mastin: Yes. We’re still seeing some destocking underway, but the sentiment is improving, and we’re seeing a few more indications that we’re going to have some kind of construction season €“ market this season. We’re still trying to determine to what level.

Ghansham Panjabi: Okay. Got it. And then for my second question, obviously, margin expansion is a big variable that’s underpinning the EBITDA improvement. And I know you laid out a pretty significant price/cost number for 2023. Are you also saying that raw material is a dynamic, the end markets are a little bit weaker. So I guess what gives you confidence in achieving the price/cost number? Because it just €“ unless you disagree, I mean, it seems logical that as end markets get weaker, pushing pricing through incrementally is going to get a little bit more challenging.