H.B. Fuller Company (NYSE:FUL) Q4 2023 Earnings Call Transcript

H.B. Fuller Company (NYSE:FUL) Q4 2023 Earnings Call Transcript January 18, 2024

H.B. Fuller Company isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by. And welcome to the H.B. Fuller Q4 2023 Earnings Conference Call. I would now like to welcome Steven Brazones, Vice President of Investor Relations to begin the call. Steven, over to you.

Steven Brazones: Thank you, Operator. Welcome to H.B. Fuller’s fourth 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 comparing 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.

Celeste Mastin: Thank you, Steven, and welcome, everyone. In the fourth quarter and throughout fiscal 2023, our team members executed exceptionally well to achieve strong profit growth despite a low volume environment, record margins and outstanding cash flow. I am very proud of the team’s response to the significant volume weakness precipitated by unprecedented customer destocking activity over the course of the year. We proactively managed rapidly changing price and raw material dynamics and supplemented those with meaningful restructuring initiatives to deliver these strong results. Overall, organic revenue improved substantially in the fourth quarter with consolidated organic revenue declining only slightly year-on-year versus the high single-digit declines we experienced in preceding quarters due to volume weakness.

Pricing was marginally lower year-on-year as expected, following lower raw material costs and also reflecting the impact of product reformulations and was primarily driven by raw material index-based supply agreements. As a highly specialized value-added adhesive sealants and functional coatings expert, with inherent price-to-value power evidenced by the fact that over half of our SKUs are specifically formulated for individual customers, we are strategically well-positioned to maintain pricing discipline. Overall, volume development improved significantly and was flat year-over-year in the fourth quarter. This is a market improvement over the previous four quarters when volume declined approximately 10% on average. From a profitability perspective, we continued to execute well and achieved both record fourth quarter and fiscal year adjusted EBITDA margins.

This is a testament to the strong leadership in each of our market segments and the power of collaboration exemplified by all our team members. Through systematic execution across all functions, our team appropriately balanced pricing and raw material movements, proactively took restructuring actions to lower our cost profile and acquired highly synergistic businesses to deliver these record margins. In the fourth quarter, we achieved a 22% increase in adjusted EBITDA year-on-year, up 32% on a comparable 13-week basis, increasing adjusted EBITDA margin 440 basis points year-on-year to 19.1%. And for the fiscal year, we achieved a double-digit increase in adjusted EBITDA, increasing adjusted EBITDA margin 240 basis points year-on-year to 16.5%.

This demonstrates how successfully executing our strategy to transform our portfolio and purposefully targeting capital allocation to the highest growth, highest margin opportunities can increase the value we provide our customers and generate higher returns for shareholders and the great news is, we are not done. The growth and margin expansion opportunities that we have in front of us are readily actionable and we are well underway in our plans to realize these improvements. Now let me move on to review the performance in each of our segments in the fourth quarter. In HHC, organic revenue was down 7.5% year-on-year, driven primarily by margin preserving index-based pricing adjustments with large volume customers and some lingering yet lessening fourth quarter customer destocking activity.

HHC has the highest concentration of index-based supply agreements given the nature of its customer base. These agreements are designed to maintain margins throughout the cycle and follow raw material cost movements over time. Adjusted EBITDA for HHC increased 42% year-on-year to $82 million and adjusted EBITDA margin increased 690 basis points to 19.9%, reflecting exceptional execution. The team overcame continued customer destocking headwinds, leveraging favorable price and raw material cost management, synergistic acquisitions and restructuring benefits to achieve record margin performance. In Engineering Adhesives, organic revenue declined 1.4% in the fourth quarter, which represents continued improvement on a sequential basis. Organic revenue declined primarily due to lower volume in solar and construction-related end markets, which offset strong organic growth in the electronics and aerospace market segments.

Adjusted EBITDA in EA increased 5% year-on-year, up 13% on a comparable 13-week basis and adjusted EBITDA margin increased 240 basis points year-on-year to 20.2%. The improvement in profitability for EA was driven by favorable price and raw material cost actions and continued strong cost management. In Construction Adhesives, the organic revenue trend reversed, increasing 5% year-on-year in the fourth quarter. Customer destocking actions began in the fourth quarter of last year and continued through the third quarter of this year. As a result, the organic growth achieved in the fourth quarter now more appropriately reflects current underlying demand for CA and our strong share position, but it is still lower than historical levels. Adjusted EBITDA for CA increased 9% year-on-year, up nearly 18% on a comparable 13-week basis and adjusted EBITDA margin increased 12.6%.

The margin improvement in CA during the fourth quarter was a positive development and followed a consistent seasonal pattern sequentially versus the third quarter, while restructuring actions in the roofing and infrastructure business units are already positively impacting the P&L, restructuring actions underway in the flooring business will contribute to profitability improvement in that market segment in 2024. Geographically, Americas organic revenue improved significantly on a sequential basis, reducing the year-on-year decline from 13% in the third quarter to a decline of 6% in the fourth quarter. Volumes were flat year-on-year in North America and improved substantially versus the third quarter. However, volumes remained weak in Latin America.

In EIMEA, organic revenue was flat year-on-year as modest organic growth in EA driven by strength in automotive and electronics was offset by modest declines in both HHC and CA. In Asia-Pacific, organic revenue decreased 2% year-on-year influenced by the relatively volatile recovery in China. While organic sales for HHC in Asia were flat year-on-year in the fourth quarter, organic sales declined slightly for EA given its greater exposure to China. The fits and starts we are seeing in the Chinese market are not unexpected and we continue to believe that the overall trend there is positive and improving. From an overall global economic standpoint conditions remain subdued. While real GDP measures have been slightly positive, sentiment, particularly within the manufacturing sector remains weak and cautious.

As a result, we continue to plan for a mild manufacturing recession in fiscal 2024 and our expectations for the year ahead reflect this scenario. We expect interest rates to remain high for the first half of the year and decline modestly in the second half, restricting industrial production and construction activity to lower than normal levels for most of the year. From a year-over-year comparison standpoint, constrained manufacturing activity will be more than offset by the absence of the destocking impact that weighed so heavily on 2023 volume. We will also benefit from the restructuring and cost saving actions that we initiated and the acquisitions that we closed in 2023, all of which will be additive to profit growth in 2024. Now let me turn the call over to John Corkrean to review our fourth quarter results in more detail and our outlook for 2024.

John Corkrean: Thank you, Celeste. I will begin with some additional financial details on the fourth quarter. For the quarter, revenue was down 5.8% versus the same period last year. On a comparable 13-week basis, revenue was up 1.2%. Currency and acquisitions collectively had a positive impact of 4.7%. Adjusting for those items, organic revenue was down 3.5%, primarily driven by pricing. Volume was flat reflecting slower but improving end market demand in HHC, offset by solid growth in Construction Adhesives. Adjusted gross profit margin was 31.3%, up 510 basis points versus last year as pricing and raw material cost actions, restructuring benefits and general cost reductions drove the margin increase year-on-year. Adjusted selling, general and administrative expense was effectively flat year-on-year, reflecting continued cost management and restructuring savings, as well as the impact of last year’s extra week offset by wage inflation and the impact of acquisitions.

Adjusted EBITDA for the quarter of $173 million was up 22% versus last year, up over 30% year-on-year adjusting for the extra week, reflecting pricing and raw material cost actions, the favorable impact of acquisitions and restructuring savings and other cost reduction actions. Adjusted earnings per share of $1.32 was up 27% versus the fourth quarter of 2022, driven by operating income growth, which more than offset higher year-on-year interest expense, depreciation and amortization expense and a higher tax rate. Cash flow was very strong for both the quarter and the full year. Full year cash flow from operations of $378 million was up $122 million year-on-year, reflecting higher operating profit and improved working capital, driving our end of the year net debt-to-EBITDA ratio down to 2.9 times.

With that, let me now turn to our guidance for the 2024 fiscal year. Based on the market assumptions outlined by Celeste earlier, we anticipate full year net revenue to be up 2% to 6% versus 2023 and organic revenue is expected to be flat to up 3%, with volume up low- to mid-single digits and pricing to be down low-single digits. We expect foreign currency translation to negatively impact revenue by about 1% versus fiscal 2023. We expect adjusted EBITDA to be between $610 million and $640 million, representing a 5% to 10% year-on-year increase as volume growth, restructuring savings and the impact of acquisitions more than offset wage and other inflation and bonus and variable compensation rebuild. We expect our 2024 core tax rate to be between 27% and 28%, compared to our 2023 core tax rate of about 27%.

We expect full year interest expense to be $115 million to $125 million, reflecting continued strong cash flow and moderating interest rates. We expect depreciation and amortization to be roughly $170 million and the average diluted share count to be about 57 million shares. These assumptions result in full year adjusted earnings per share in the range of $4.15 to $4.45, representing year-on-year growth of 7% to 15% versus fiscal 2023. Finally, we expect full-year operating cash flow to be between $300 million and $350 million before approximately $140 million of capital expenditures. Based on the seasonality of our business and the timing of working capital needs, we expect operating cash flow to be weighted to the second half of the year.

Taking into account last year’s destocking activity, as well as the typical seasonality of the business, we expect first quarter revenue to be up low-single digits and for adjusted EBITDA to be between $115 million and $125 million. Now let me turn the call back over to Celeste.

Celeste Mastin: Thank you, John. As we enter fiscal year 2024, we are confident in our outlook for positive organic growth achieving further EBITDA margin expansion and delivering strong cash flow. As the largest pure-play adhesive company in the world and the market leader in innovation, focused on providing highly tailored solutions for our customers, we have successfully transformed our portfolio over the past 15 years into one that is concentrated within the highly specified portions of our market segments. We are executing well in that portfolio as evidenced by our strong EBITDA margin expansion and we are ready to institutionalize the disciplined choices we are making. As such, we have begun to take portfolio management to the next level by being more proactive and explicit about how we are allocating capital and investing in the highest margin growth segments of the portfolio.

As I have spoken about repeatedly since becoming CEO a little more than a year ago, all of our investment decisions, both organic capital expenditures and M&A are rooted in transforming H.B. Fuller into a higher growth, higher margin and higher ROIC business. Over the course of my tenure with H.B. Fuller, I have conducted annual market segment reviews with each of our 31 market segment leaders to identify the top 25 growth and profit improvement opportunities for the company. This process has become the basis for generating and evaluating all of our growth and investment opportunities and it has evolved to the point where we have created a growth pipeline full of compelling opportunities that can unlock additional market expansion opportunity and augment our margin profile.

As a result of the success we have demonstrated in transforming our portfolio, a more robust pipeline of step change opportunities and our track record of executing with speed, we are increasing our long-term adjusted EBITDA margin target for the enterprise from the high-teens to greater than 20% within the next three years to five years. To better enable our investors to follow our progress, we have divided our market segments into two categories, growth and leverage. This replaces our previous categories of high, medium and low specification, because we have successfully migrated to a strongly specified portfolio in each of the markets we serve. About half of our market segments are in the growth category spanning all three GBUs including but not limited to medical in HHC, electronics, new energy and the newly created ePower [ph] in EA and infrastructure and roofing in CA.

Growth segments share a few key common characteristics. First, they are large and fast growing markets, which benefit from global megatrends and technological disruption, such as clean energy, sustainable packaging and labor shortage, as well as rapidly evolving product designs and the need to innovate. As a result, there is ample room for H.B. Fuller to capture share and unlock additional growth by bringing differentiated technologies to market, capitalizing on underlying market trends and supplementing with M&A. Second, in these growth markets, we have broad and relevant technology, innovation speed and the ability to create solutions for demanding applications reliably, rapidly and accurately. From a financial perspective, growth segments are expected to realize outsized revenue growth, deliver double-digit adjusted EBITDA growth and generate greater than 25% adjusted EBITDA margins.

The leverage category consists of 16 market segments, where we are focused on maximizing operating efficiency and cash flow. Leverage segments share a few key common characteristics. First, they require a highly selective go-to-market approach, one in which we are rigorous and disciplined about where we choose to play in terms of regions, product applications and customer selection, focusing on applications where we bring meaningful price to value performance for our customer. Second in leveraged segments, H.B Fuller is a disproportionate buyer of raw materials at scale, which helps create a margin uplift in these markets. Financially, leverage segments are expected to generate greater than 15% EBITDA margin through benefits of production efficiency, raw material scale and selective pursuit of applications, where we improve our customer’s productivity.

It’s important to mention that this new structure captures the intuitive decisions we have been making over the past year. With this next level approach to portfolio management, we are sharpening our focus on ensuring investment activities are directed to our highest value opportunities to profitably grow the business over the near- and long-term. As mentioned previously, we maintain an up-to-date list of the top 25 opportunities to grow our business and leverage our operating structure, either organically or through value-added M&A. While our primary focus for M&A has been and will continue to be in growth segments, this new structure does not preclude opportunistic investments in leverage segments. In fact, we recently executed several deals in leverage segments, where we are benefiting from superior buying power and efficiencies in our existing plant network as a result of market consolidation.

Acquisitions in leverage segments generally have high synergies and strong return on investment given our speed to integrate, resulting in a very meaningful difference between pre- and post-synergy acquisition multiples. I have complete confidence in our team, our strategy and our ability to execute to make this happen. As we continue to focus our high touch, highly customized portfolio on accelerating innovation and executing efficiently, we are confident in our ability to achieve our new EBITDA margin target. We look forward to keeping you updated on our progress using this new portfolio segmentation. To wrap up, I am extremely pleased with our strong performance in 2023 and very excited about the opportunities we have in 2024 to continue to drive value creation.

We are successfully executing our strategy to deploy capital to the highest returning opportunities, innovating with speed to deliver solutions for our customers, driving efficiencies throughout our manufacturing footprint and achieving meaningful synergies from our collections of acquisitions. We are performing very well and we are entering 2024 with confidence, optimism and strong momentum. That concludes our prepared remarks for today. Operator, please open the line for questions.

Operator: [Operator Instructions] Our first question comes from the line of Ghansham Panjabi with Baird. Please go ahead.

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Q&A Session

Ghansham Panjabi: Thank you, Operator. Good morning, everyone.

Celeste Mastin: Good morning, Ghansham. How are you?

Ghansham Panjabi: Good morning, Celeste. Happy New Year to you. I guess, first of all, on the base assumptions for the first quarter that gets you to your EBITDA guidance, I think, $115 million to $125 million. What are you anticipating in terms of volumes and price, you are still being impacted by destocking across any of the operating segments. And then also for fiscal year 2024, is the EBITDA guidance sort of weighted more so towards the second half versus historical seasonality?

Celeste Mastin: Yeah. So let’s start with volume. So, for 2024, we are anticipating volume growth of, call it, kind of mid-single digits. On the pricing side we are experiencing the opposite. So, as we go into 2024, there’s a few things happening. So when you look at it from a pricing perspective, we have got a number of index-based pricing arrangements with large customers that are rolling into 2024. We will see the impact of that on the topline. Also, we are reformulating our products for many of our customers so that we can offer them a product at a lower cost to them and also at a lower cost to us. So you will see that on the pricing side. On the volume side, we are projecting volume growth that’s really more consistent with what consumer buying is expected to be.

In fact, we have taken a look and analyzed our shipped volume over the past several years. And when you look at 2023, our shipped volume, our shipped tonnage was down 5% or 6% versus 2019. So we are anticipating a year that we would consider more normal in 2024.

John Corkrean: Yeah. Ghansham, I will give you a little color on kind of Q1 versus the rest of the year guidance. So if you look at the assumptions for revenue that kind of underlie this, Celeste, laid them up for the full year. For the first quarter, we would expect organic revenue to be flat to down low-single digits, offset by a positive impact of 4% to 5% from acquisitions. As it relates to EBITDA guidance, if you look at the midpoint of our EBITDA guidance for Q1 that would represent about 9% growth year-on-year and then that would — based on the midpoint of our full year guidance that would represent about 6% growth year-on-year for Q2 through Q4. Of course, there is seasonality in the business as you know, so the numbers in the second half of the year for EBITDA will be higher than the first half of the year. But I’d say, as it relates to year-on-year performance, I don’t think it’s more weighted to the second half of the year.

Ghansham Panjabi: Got you. Helpful. And then on the reformulation dynamic, can you just sort of expand on that? Is that sort of typical at this point in the raw material cycle, which segments are you seeing that at current? And then also going back to your 20% EBITDA margin threshold over the next three years to five years. Why outline that now? I mean, the world is complex, there’s a lot going on and so on and so forth, with inflation and growth, et cetera. What should we take away in terms of your confidence and outlining that as part of your yesterday’s release?

Celeste Mastin: Yeah. So let’s start with your question about the reformulation dynamic. So, yeah, that is typical at this point in the cycle. And maybe if I just kind of speak to our product portfolio and our pricing, the realities of our pricing strategy, it will help explain this. So when you look at — and I mentioned in the script, so over half of our customers or over half of our SKU base is unique to a customer. So if you look at our SKU count, over half of those SKUs are sold to a single customer. So we are working closely with these customers day-in and day-out, and we identify — we understand their needs, as you point out in this part of the cycle, cost matters to our customers. And our ability to reformulate our products not only impacts their cost, but more importantly our ability to reformulate our products enables them to often use lower cost substrates.

So that reformulation work is ever occurring. And as a consequence, there’s not only innovation that we are bringing into this customer base, but as you really — as look at it, it’s an amazing dynamic, because the amount of adhesives that is used in our end products is just so slow — small relative to the total that whatever we can do to reduce the overall system cost for the customer matters a lot more than the cost of our adhesives. So, in fact, if you look at our customer base, 97% of our customers spend less than $500,000 on adhesive. So on any given adhesive, they are spending about $25,000 per SKU or less. So one of the things that is woven into this business model is that we have a lot of pricing resilience as a consequence.

Ghansham Panjabi: Yeah. And…

Celeste Mastin: The second question — sorry.

Ghansham Panjabi: Yeah. Yeah.

Celeste Mastin: I will stop there just to make sure there is, if you had any follow-on question to the pricing piece before I talk about the margin.

Ghansham Panjabi: No. That’s perfect. Thank you.

Celeste Mastin: Yeah. Great. So, and you really see that in our gross margins recently. Moving onto your second question about EBITDA margin, why now? I mean, why not now, Ghansham? I am very confident about where we can take this portfolio. We have really dissected this and thought about it long and hard. And when you look at these two segments, what we have done is really create a structure that directs our investment. We have identified these high EBITDA margin, high growth spaces. You saw the bubble chart representing our top 20, 25, I mean, that chart was boiled down from 220 opportunities that were brought to us by our team. So there’s a lot of ways and a lot of places to grow in this $70 billion adhesive industry and we feel confident that with our organization structure, really highlighting these 31 different market segments that we are able to pinpoint those opportunities where we can really grow the business.