H.B. Fuller Company (NYSE:FUL) Q4 2022 Earnings Call Transcript

H.B. Fuller Company (NYSE:FUL) Q4 2022 Earnings Call Transcript January 19, 2023

Operator: Good morning. My name is Chris, and I’ll be your conference operator today. At this time, I’d like to welcome everyone to the H.B. Fuller Q4 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you. Steven Brazones, Vice President of Investor Relations, you may begin.

Steven Brazones: Thank you, operator. Welcome to H.B. Fuller’s fourth quarter 2022 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 measure 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. Before we begin to discuss our results for the fourth quarter and fiscal year, I would first like to thank the many team members I have engaged with throughout my travels over the last several months. You have been so hospitable and have smoothed my transition here into my role as CEO. Your enthusiasm and passion for our business is energizing, and I appreciate your drive and devotion in serving our valued customers each and every day. Thank you. In fiscal year 2022, we delivered exceptional financial results, driven by market share gains, responsible pricing actions and diligent execution of our strategy. We delivered strong double-digit growth in organic revenue, adjusted EBITDA and adjusted EPS.

This is particularly impressive, given the significant headwinds we endured from continued raw material cost inflation, supply chain disruptions, a strengthening US dollar and substantially higher interest rates. For the year, we grew organic revenue by 17%, with strong organic revenue growth in all three GBUs, EBITDA by 14% and adjusted EPS by 15%. We also delivered another strong cash flow performance with operating cash flow up 20% year-on-year. I am very proud of the team’s resilience and determination in executing our winning strategy to deliver these impressive results in spite of a very difficult operating backdrop. At the same time, we recognize that we did not finish the year as strong as we had expected. During the fourth quarter, we experienced an accelerated slowdown in demand in Construction Adhesives, driven by inventory destocking actions by our customers.

While we were expecting demand to decline sequentially in Construction Adhesives and had a very difficult comparison versus the fourth quarter of last year, destocking actions were more pronounced and faster than we were anticipating. In addition, more aggressive COVID-related shutdowns in China rather than an easing in such measures, negatively impacted growth in our Asia-Pacific region. This was unexpected and contrary to the strengthening demand trend we saw in the first three quarters of the year. And lastly, the US dollar, which had already strengthened quite considerably throughout the first three quarters of the year, strengthened even further during our fourth quarter. These challenges adversely impacted our revenue and EBITDA growth and our financial results fell below our expectations for the fourth quarter.

While disappointing, our underlying business remains very healthy, and we believe the conditions negatively impacting demand in Construction Adhesives will abate over time. Overall, given the diversity of our geographic and end market exposure, our pricing execution in 2022 and the expectation of lower raw material costs, we are well-positioned for continued strong profit growth and margin expansion in 2023 and beyond. Looking at our consolidated results in the fourth quarter, organic revenues increased 6% year-on-year. This was driven by strong organic growth in both Hygiene, Health and Consumable Adhesives and Engineering Adhesives. The strength of these two business units more than offset the weakness in Construction Adhesives. Responsibly strong pricing actions taken throughout the year drove the organic growth in the fourth quarter.

From a profitability perspective, despite the challenging financial results in Construction Adhesives, we again achieved sequential EBITDA margin expansion in the fourth quarter, marking the third consecutive increase in adjusted EBITDA margin this year. On a year-over-year basis, adjusted EBITDA was up 5% in the fourth quarter to $141 million and adjusted EBITDA margin remained stable year-on-year at 14.7% despite significantly higher raw material costs. Now, let me move on to review the performance in each of our segments in the fourth quarter. In HHC, organic revenue was up 12% year-on-year, with most end markets achieving strong double-digit organic growth. Beverage labeling, hygiene, packaging, tissue and towel, and health and beauty markets were particularly strong.

HHC’s pricing actions offset lower volume and drove organic revenue growth in the quarter. Adjusted EBITDA for HHC increased 5% year-on-year. Adjusted EBITDA margin decreased year-on-year due to higher raw material costs and lower volume. In Engineering Adhesives, organic revenue increased by 9%, led by exceptionally strong growth in automotive and insulated glass. Strong pricing actions and higher volume drove EA’s organic growth. Adjusted EBITDA increased 23% in EA and adjusted EBITDA margin increased 240 basis points year-on-year to nearly 18%. Pricing actions and expense management drove the improvement year-on-year and offset the impact of significantly higher raw material costs. In Construction Adhesives, organic sales declined 20% year-on-year due to customer destocking activities and more challenging economic conditions.

The prior year’s fourth quarter benefited from the post-COVID demand surge in construction markets, which has since reverted given the current economic backdrop. The decline in organic sales was driven principally by a slowdown in the roofing market. Adjusted EBITDA for Construction Adhesives declined in the fourth quarter, driven by lower volume and higher raw material costs. Geographically, Americas organic growth was up 3% year-on-year, significantly impacted by the decline in Construction Adhesives. Organic growth, absent Construction Adhesives, was up double-digits in the Americas in the fourth quarter. In EMEA, organic revenues increased 13% versus the fourth quarter of last year. Weak economic conditions in the region persisted, but did not worsen sequentially versus the third quarter.

In Asia Pacific, organic revenues increased 3% year-on-year. More severe COVID-related lockdown restrictions in China negatively impacted sales development for the region, and this was contrary to the strengthening trend we experienced during the second and third quarters of 2022. Overall, global economic conditions have slowed throughout the year, largely as we expected, but for Construction Adhesives, reflecting customer inventory reductions and slowing end market demand. Europe remains weak and an expected rebound in China has been delayed. Macro conditions in the Americas are also slowing as the impacts of higher interest rates begin to temper demand. Construction Adhesives is being disproportionately impacted in the short-term, given the economic sensitivity of this sector and heavy customer destocking activities.

Both HHC and EA are weathering the challenging economic situation well aided by their diverse geographic and end market exposures. While the economic outlook poses challenges, we are prepared and well positioned to control expenses, expand margins and grow cash flow in such an environment. We are beginning to see the rate of aggregate raw material cost inflation slow, and we expect this to continue as we progress throughout the year. Generally, it takes about a quarter for changes in raw material costs to cycle through inventory and impact the P&L. While aggregate raw material cost inflation is beginning to taper, it’s not universal. The preponderance of our raw material purchases in November were at the same or higher prices than in the month of October.

Accordingly, we continued to increase prices in the fourth quarter, and additional price increases are planned in 2023. The value we generate for our customers as a solutions provider, as reflected in our pricing performance, together with the diversity and scale of our raw material purchases will enable us to expand margins in an environment of declining raw material cost inflation. Following two years of unprecedented supply chain disruption and significantly higher raw material costs, this provides us with a meaningful opportunity to further expand EBITDA margin in the year ahead. Now let me turn the call over to John Corkrean to review our fourth quarter results in more detail and our outlook for 2023.

John Corkrean: Thank you, Celeste. I’ll begin on Slide 5 with some additional financial details on the fourth quarter. For the quarter, revenue was up 7% versus the same period last year. Currency had a negative impact of 8.7%. Acquisitions increased revenue growth by 1.6%, and the extra week compared to last year positively impacted revenue growth by 7.5%. Adjusting for those items, organic revenue was up 6.4% with pricing having a favorable impact of 11.4% year-on-year in the quarter and volume down 5%, reflecting a slowdown in end market demand, particularly in Construction Adhesives and softness in China due to COVID-related lockdowns. Adjusted gross profit margin was 26.2%, down 90 basis points versus last year, as raw material inflation and lower volumes more than offset significantly higher pricing.

Adjusted selling, general and administrative expense was down slightly year-on-year and adjusted SG&A as a percentage of revenue declined 130 basis points, reflecting strong pricing gains, lower variable compensation and overall good expense management. Adjusted EBITDA for the quarter of $141 million was up 5% versus last year, reflecting strong pricing actions, lower SG&A and the impact of the extra week, which more than offset significantly higher raw material costs and unfavorable foreign currency translation. Adjusted earnings per share of $1.04 was down slightly versus the fourth quarter of 2021 and driven by the unfavorable impact of foreign currency and significantly higher interest rates. Adjusting for unfavorable foreign exchange, which negatively impacted EPS by approximately $0.22 in the quarter, adjusted EPS was up 15% year-on-year.

Cash flow in the quarter was strong. Cash flow from operations of $208 million was up $156 million year-on-year, reflecting higher profit, reduced working capital requirements, a one-time gain on the maturity of a cross-currency swap and the impact of the extra week. Our results for the full fiscal year were also very strong. Full year organic revenues grew 17% versus fiscal 2021, reflecting outstanding pricing execution. Adjusted EBITDA increased by 14% year-on-year and adjusted EPS was up 15%. With that, let me now turn to our guidance for the 2023 fiscal year. Our geographic and end market diversification is an asset in recessionary time periods and provides us with a meaningful buffer to the volatility in demand in any one particular market.

As we assess the economic sensitivity of our portfolio with the conditions present in the marketplace today, more than half of our portfolio has little sensitivity and is well insulated from significant swings in demand. And only about 20% of our portfolio would be more highly influenced by economic conditions, but the drivers impacting recessionary sensitivity will generate different outcomes amongst the end markets. Our diversification will serve us well as we manage through what we expect to be challenging economic conditions in 2023. Based on what we know today, we anticipate full year net revenue to be flat to down 3% versus 2022 and organic revenue to be up 2% to 4%. We expect foreign currency translation to negatively impact revenue by 3% to 4% versus 2022.

Fiscal year 2023 will be a 52-week year compared to a 53-week year in 2022, which will unfavorably impact year-on-year revenue growth by approximately two percentage points. We 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 as the benefits from net changes in prices and raw material costs and strong expense management more than offset unfavorable foreign exchange. We expect our 2023 core tax rate to be between 27% and 29% compared to our 2022 core tax rate of about 27%. We expect full year interest expense to be $115 million to $125 million, reflecting higher interest rates, and we expect average diluted share count to be about 55.5 million shares.

These assumptions result in full year adjusted earnings per share in a range of $4.15 to $4.55. Finally, we expect full year operating cash flow to be between $300 million and $350 million before approximately $120 million of capital expenditures. Based on the seasonality of the business, and the timing of working capital needs, we expect operating cash flow to be weighted to the second half of the year. All of this guidance reflects the fact that H.B. Fuller will have one less reporting week in fiscal 2023 compared to 2022. We estimate that extra week will have an unfavorable impact on full year revenues of approximately 2% compared with full year 2022 and an unfavorable impact on full year EBITDA of approximately $10 million versus 2022, all occurring in the fourth quarter.

Taking into consideration low construction demand in the first half of the year and continued disruptions in China as well as the typical seasonality of the business, we expect first quarter revenue to be down low to mid-single digits and to realize approximately 17% to 18% of full year EBITDA in the first quarter. Now, let me turn the call back over to Celeste to wrap us up.

Celeste Mastin: Thank you, John. Since becoming CEO at the beginning of December, I have grown even more optimistic about our future. We have tremendous potential for continued organic growth and margin expansion, and I have confidence in our strategy and ability to achieve our long-term financial goals. As we begin 2023, we do so having successfully expanded EBITDA margin sequentially over the last three consecutive quarters, and we are entering an environment that will be more conducive to further margin enhancement. We have many competitive advantages to leverage, particularly in the current economic environment in addition to our ability to innovate with customers to serve their needs. We have pricing discipline, robust product substitution capabilities and a demonstrated ability to execute.

Each of the last three years has brought unique and extraordinary challenges, including a pandemic, a conflict between Russia and the Ukraine, unprecedented supply chain disruptions with raw material cost inflation and a significant strengthening of the US dollar. And in each of the last three years, H.B. Fuller has stepped up to those challenges and delivered for our customers, our employees and our shareholders, while consistently outperforming the competition. We expect 2023 to be no less challenging, but we are confident in our team’s abilities and resolve €“ and we believe, based on the improvements that we’ve made in our business over the last several years and our ability to bring innovation to the diverse set of end markets we serve, that we are well positioned to continue to drive growth and expand margins, while delivering outstanding cash flow.

That concludes our prepared remarks for today. Operator, please open the line for questions.

See also 12 Best Airport Stocks To Buy and 15 Most LGBTQ Friendly Companies in the US.

Q&A Session

Operator: Thank you. Our first question is from Ghansham Panjabi with Baird. Your line is open.

Ghansham Panjabi: Yes. Thanks. Hello, everybody. And, Celeste, congrats again on your new role.

Celeste Mastin: Thanks, Ghansham. How are you?

Ghansham Panjabi: Yes. Good. Thank you, thank you. So, I guess, destocking seems to be a pretty common theme so far this earnings season. You called out Construction Adhesives, which I guess, fits with intuition. But what about the other segments, HHC and even EA? And the reason I ask is, many of the CPG companies that are starting to report, they’re reporting pretty significant declines in volumes as well. So I’m just curious as to the risk associated with destocking becoming more pronounced for the other segments as well?

Celeste Mastin: Yes. That’s a great question, Ghansham. It absolutely is. Certainly, in HHC in the fourth quarter, we saw some significant destocking. And — it’s a little unusual in that CPG — in the consumer product business, but, yes, that absolutely is the case.

Ghansham Panjabi: Got it. And what about EA?

Celeste Mastin: Not so much there. Interestingly enough, now we did see our volumes impacted in EA because of this slowdown in China. Over Q2 and Q3, we saw mid-single-digit increases in growth in China. That was not the case in the fourth quarter. Fourth quarter was flat. And our EA business, certainly, that took some wind out of their sales as it relates to volume, but we did not see big destocking actions in EA.

Ghansham Panjabi: Got you. And then, maybe a question for John on the EBITDA bridge between fiscal year 2022 and 2023. I know you gave some parameters about the loss of the week and FX, but what about the other components in terms of volumes and price cost, et cetera?

John Corkrean: Yes. So I think what we had said earlier, Ghansham, is we have got — given our pricing actions in 2022, we’ve got a very nice pricing carryover into 2023. We are seeing raw materials start to ease. You have to kind of look at those two things together. And that’s really what’s driving the majority of really all of the profit growth. We estimate that the pricing carryover and raw materials easing, that’s $130 million to $160 million of profit growth for us in 2023. And that offsets the headwinds we have related to probably a little softer volume, obviously, unfavorable foreign exchange, the extra week and kind of normal inflation on wages and other things. And that’s probably about $80 million. That’s kind of how do we get to that bridge.

Ghansham Panjabi: Awesome. Thanks so much.

Celeste Mastin: Thanks, Ghansham.

Operator: The next question is from Mike Harrison with Seaport Research Partners. Your line is open.

Mike Harrison: Hi. Good morning.

Celeste Mastin: Hey, Mike. How are you?

John Corkrean: Hi, Mike.

Mike Harrison: Doing well. Thank you. Happy New Year. I wanted to maybe ask a little bit of a different question on the earnings cadence. If I do the math correctly, it looks like you’re kind of pointing to $100 million to $110 million of EBITDA for the first quarter. And I guess, I’m just trying to understand kind of what gives you confidence that you’re going to — it means that the rest of the year has to show pretty meaningful growth. Is — are you seeing the raw material declines happening as we speak? Just maybe talk about the confidence level of better earnings as we get through the rest of the year. And I guess, is that mostly driven by raw material tailwinds?

Celeste Mastin: Yes. Thanks for the question, Mike. So, let me — you’re correct, to start with, in your estimation of kind of what EBITDA looks like in the first quarter. We did guide to 17% to 18% of our full year EBITDA, which is — would be pretty flat with last year. That 17% to 18% is a little lower than what we would normally see in the first quarter. Usually, we’re around 20% of full year EBITDA. And it is this sort of, let’s call it, kind of fourth quarter hangover. We are still seeing — in our P1, which was December, we saw a December that still looked a lot like Q4. However, with the beginning of the new year, we’re starting to see things pick up a little bit. As to your question about raw materials, yes, we’re still — raw materials are really just plateauing.

We were pretty flattish Q3 versus Q4 on raws. And if you look at Q4 this year versus prior year, we’re still up. So, we’re moving towards that inflection point. We expect that will hit us during the current year. But it’s definitely not been here yet. Do you want to elaborate on that, John?

John Corkrean: Yes, that’s exactly right. I mean, yes, raw dynamics will be the big impact. The other impact I’d point out is exchange, right? Exchange — the dollar strengthened throughout 2022. I think in my prepared remarks, we indicated that it had something like a $0.20 impact unfavorable in the fourth quarter. So, we will annualize as we get through 2023. It will become less of a headwind if exchange rates stay where they are, it will actually be a little bit of a tailwind. So, those are the big dynamics, I would say, Mike, the raw material, raw material dynamic and foreign exchange.

Mike Harrison: Perfect. And then in terms of the Engineering Adhesives business, obviously, very nice performance there. Was there anything unusual or maybe more onetime in nature that drove that margin strength that we might worry about reversing at some point in 2023. I guess maybe my way of asking what you expect margins to look like in that business as we get into next year.

Celeste Mastin: Yes, we are really excited about our EA business. Aspirationally in that business, we have continued to work the portfolio. We continue to drive the portfolio in that business, particularly to those highly specified applications, which do carry higher EBITDA margins. So, to answer your question, no, there was nothing one-time. There was nothing temporary that occurred there. That was it’s by design and it’s starting to work. So, that’s the good news. I think as we proceed through the course of 2023, again, EA is a business that is influenced heavily by China. We’re forecasting — in our outlook; we’re forecasting kind of sluggish growth in China for the first half. So, we’ll see that business accelerate over the course of the year.

Mike Harrison: All right. And if I can sneak 1 more in. On pricing, it looks like if I do the math, that the two-year stack, if I look at Q3 and Q4, were both up around 25%. And so my question is, did you get any sequential pricing, or was pricing pretty flat in Q4 versus Q3?