H. B. Fuller Company

Good day and welcome to the HB Fuller third quarter investor call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Barbara Doyle, Vice President of Investor Relations. Please go ahead.

Good morning and welcome to HB Fuller's third quarter 2020 earnings call for the fiscal quarter ended August 29, 2020. Our speakers are Jim Owens, HB Fuller President and Chief Executive Officer, and John Corcoran, 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 and references to organic revenue, which excludes the impact of foreign currency fluctuation and the impact of acquisitions and divestitures. On this call, unless otherwise specified, discussion of sales and revenue referred to organic revenues and discussion of EPS, margins, or EBITDA refer to adjusted non-GAAP measures. These measures are in addition to the GAAP results in our earnings release and in our forms 10-Q and 10-K. We believe that discussion of these measures is useful to investors to assist the understanding of our operating performance and the comparability of 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. Many of these risks and uncertainties are and will be exacerbated by COVID-19 and any worsening of the global business and economic environment as a result. 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 forms 10-K and 10-Q filed with the SEC and available on our website at investors.hbfuller.com. Now, I'll turn the call over to Jim Owens.

Thank you, Barbara, and welcome to everyone on the call. In June, we reported second quarter results that were ahead of expectations and ahead of our competitors' performance. Last evening, we reported strong third quarter results. with $691 million in sales, 76 cents of adjusted EPS, and $106 million of adjusted EBTA. Our third quarter results were also ahead of our expectations and ahead of the prior quarter. In the fourth quarter, we expect to deliver EBTA results in line with the fourth quarter of 2019. The performance over the last two quarters and our expected performance are a direct result of the actions we took to reorganize our business and invest in growth segments and opportunities. This performance is also a result of the strength of HB Fuller's leadership team and our position as a leader in the adhesive industry. Our operational performance in the third quarter resulted in a solid sequential improvement in sales, EPS, and EBITDA. In the quarter, we leveraged new business wins and market share gains into revenue performance that exceeded our expectations. We also continued to capture raw material savings and realize operational cost deficiencies from our business restructuring, supporting EBITDA results that were better than we had forecasted. Cash flow performance continued to be strong, and year-to-date cash flow from operations increased 20% versus the same period last year. and enabled us to exceed our pay down target for the quarter and keep us on track for full year debt pay down of $200 million. Throughout 2020, and especially in the last six months, we have leveraged our 72 factories and globally connected operations and supply chain teams to ensure consistent delivery of adhesives for essential goods around the globe during this crisis. We have not let our customers down. We have also leveraged our broad adhesive technology portfolio and the applications expertise of our people to support customers who needed to solve supply problems or develop new products. While other companies may have taken similar actions, HB Fuller's dedicated focus on adhesive technologies and our global capabilities have positioned us to move first and fastest to deliver results for customers. We have leveraged our investment in digital tools to improve our service to customers, deliver innovation faster, collaborate internally more effectively, and increase the speed of decision making. Our global operations are agile and have been crucial differentiators for HB Fuller as our customers face significant upward shifts in demand of some products and downward shifts in other products. Our ability to meet increased demand and ensure customer supply and our capabilities to remotely qualify new applications and troubleshoot complex problems have proven to be competitive advantages. As a result, we have been able to shorten sales cycles, increase share with existing customers, and win business with new customers. These results were evident in the second quarter as we outperformed the market and competition. Our sequential top-line improvement this quarter directly reflects the proactive, collaborative approach including our ability to deliver new applications and provide world-class remote customer support. Our performance in the third quarter also reinforces the value of HB Fuller's strong product, customer, and end market mix. Hygiene, health, and consumable results remain positive in the quarter, but moderated from the very strong performance in the second quarter as surge buying dissipated and economic slowdowns in India and Brazil impacted results. At the same time, engineering and construction adhesives' performance improved meaningfully on a sequential basis, particularly in engineering adhesives. We were well positioned to meet increasing demands as markets opened up, new customers were gained, and China began moving toward more normal demand patterns. Our reorganization into three global business units at the beginning of this year is helping us win with customers and execute more effectively in each of our market segments. The organizational realignment is also enabling us to generate $35 million of annualized savings, of which $30 million will be realized in 2020, including $7 million of SG&A savings realized in the third quarter. As discussed on our last earnings call, earlier this year we initiated a review of the company's manufacturing operations and supply chain utilizing the support of an external consultant. As an outcome of this review, we identified opportunities in three areas. One, lower cost operations at individual sites by leveraging best practices into a number of our higher cost facilities. Two, a roadmap toward manufacturing footprint consolidation. And three, acceleration of our inventory reduction plan to improve supply chain processes. Based on specific projects identified, we have validated $20 to $30 million in manufacturing cost savings from these initiatives, with approximately half of these savings to be realized in 2021. We are also targeting an inventory reduction of approximately $25 million in 2021 through these initiatives. Now I will move on to our segment results in the third quarter on slide three. Hygiene, health, and consumable adhesives, third quarter organic sales increased 1% year on year. Across the second and third quarters, we have seen strong growth throughout this segment, including packaging, tissue and towel, hygiene, and health and beauty. Third quarter global growth in hygiene, health, and consumables was muted by significant volume declines in Brazil and India. HHC segment EBTA margins were strong at 13.6%. Margin was down slightly versus last year, primarily reflecting mix and the timing of some expenses offset by lower raw material costs and savings from the restructuring of the business. Construction adhesives revenue was down 12% versus prior year, but improved from the second quarter with higher sequential revenues in both flooring and roofing. This positive progress was delivered despite continued COVID-19 related disruptions in commercial construction which is a significant part of our construction adhesive business. Retail channels remained strong for do-it-yourself activity, while contractor flooring work and commercial roofing activity improved at a slower pace. Construction adhesives EBITDA margin was solid at 15%, reflecting new product introductions and improved product mix related to last year's portfolio repositioning, as well as operational improvements from the GBU restructuring. These operational improvements position this business for strong margins when commercial construction activity increases. Engineering Adhesives results improved significantly in the third quarter. Double-digit growth in electronics, recreational vehicles, and technical textiles, and solid results in insulating glass and woodworking offset slower but improving results in transportation-related markets. Total organic engineering adhesive revenues declined less than 3 percent versus last year. Engineering adhesives EBITDA margin remained strong at 17 percent. And while margins were down versus last year, we saw very good sequential margin improvement of 210 basis points versus the second quarter due to better volume and mix, lower raw material costs, and restructuring savings. Our planning assumptions for the fourth quarter have been developed in an environment that continues to evolve and will be impacted by COVID-related restrictions and the corresponding recessionary impacts. We have taken a granular approach by segment and geography in analyzing our future results. Our core planning assumption is that COVID-related shutdowns will not worsen, but recessionary forces will result in a year-on-year economic contraction for the rest of this year and into next year. As discussed last quarter, we believe that the second quarter had the most acute impacts with sequential improvement in the third and the fourth quarters. Elevated demand for hygiene and health products, packaging, paper tissues, and towels will likely continue through the year as consumers continue to spend more time in their homes. HHC volume should improve from Q3 to Q4 as manufacturers work down inventory levels and start restocking. Construction adhesives performance in Q4 is expected to improve versus Q3, with commercial markets improving but at a slower rate than residential activity. Engineering adhesive demand picked up throughout the third quarter, and we expect those trends to continue into the fourth quarter. We anticipate that demand for the transportation and durable goods markets will continue to improve in the fourth quarter, supporting sequential improvement in engineering adhesives volumes as we exit the year. Raw material costs have started to flatten, and we expect raw material costs in the fourth quarter to be similar to costs in the third quarter, but still down year on year. Improving volume trends, our ability to capture raw material savings, and reduced working capital requirements will enable us to continue to drive strong cash flow. This will enable us to meet our commitment to pay down debt by $200 million in 2020, exceeding our three-year targets. While the economic backdrop is not great, our performance in the first nine months of 2020 demonstrates that our business is diverse and resilient, our operations are nimble, and we are executing our strategy well. HB Fuller has multiple levers to deliver strong results in this fast-changing environment. Now let me turn the call over to John Corcoran to review our third quarter results and our outlook for the fourth quarter based on these planning assumptions.

Thanks, Jim. I'll begin on slide four with some additional financial details on the third quarter. Net revenue was down 4.7% versus the same period last year. Currency and the divestiture of the surfactants and thickeners business had a combined negative impact of 2.2%. Adjusting for currency and the divestiture, organic revenue was down 2.5% with volume down 2.1% and pricing having a negative 0.4% impact year on year in the quarter. Year-on-year adjusted gross profit margin was 27.3%, down versus last year on lower volume and unfavorable mix, offset by raw material savings. Adjusted selling, general, and administrative expense was down 6.4% versus last year, reflecting actions related to the business reorganization announced last year, lower travel expense, and general cost controls. Adjusted EBITDA for the quarter of $106 million, was above the high end of our planning assumptions, reflecting strong improvement in top-line performance, particularly in engineering adhesives. Adjusted earnings per share were 76 cents, as strong volume improvements, raw material savings, and lower interest expense associated with our debt reduction actions drove higher earnings per share than last quarter. Year-to-date cash flow from operations of $193 million It's up by more than 20% versus the same period last year, reflecting continued improvement in working capital performance. This allowed us to continue to reduce debt, paying off $59 million in the quarter, keeping us on track for our full-year debt paydown plan. Regarding our outlook, based on what we know today and the planning assumptions that Jim laid out earlier, we anticipate revenue to be up 4% to 7% sequentially from Q3, which is flat to down 3% year-on-year. and EBITDA to be between $110 and $115 million in the fourth quarter as improving volumes and lower SG&A related to restructuring savings offset continued disruption in recessionary forces. We expect cash flow to continue to be strong in the fourth quarter, allowing us to maintain our target to pay down approximately $200 million of debt during 2020, keeping us well ahead of our original deleveraging plan laid out in late 2017. Additionally, We continue to have more than adequate liquidity to meet foreseeable needs. This includes a $400 million revolving credit facility with a built-in accordion feature that allows us to upsize the facility by $300 million if needed. We also have ample room under our debt covenants using even the most conservative scenarios. With that, I'll turn the call back to Jim Owens for some closing comments.

Thanks, John. Last quarter, we told you that we were in a stronger position than we were six months ago. Today, I can confidently say we are even stronger after another quarter of great execution. This performance is a direct result of consistent execution of our strategy and the way in which we have managed the business. We continue to benefit from our leadership position as the largest dedicated manufacturer of adhesives in the world, and we are focused on creating value for our shareholders through all business cycles. A decade ago, we began building a strong portfolio focused on high growth markets requiring highly specified adhesive solutions. When we acquired Royal in 2017, we diversified our customer base and expanded our technical capabilities. Our 2019 organizational realignment accelerated our ability to respond to end market trends while generating $30 million of cost savings this year. And we have begun the next phase of our operational cost improvement plan by driving efficiencies across our manufacturing footprint and reducing costs by $20 to $30 million by the end of 2022. Our leadership team is strong and experienced, including the additions over the last year in HHC, construction, and in the Chief Operating Officer role. At multiple levels across the leadership team, we have the right expertise to continue to proactively address our business opportunities and to drive results. In the near term, we are well positioned to win during the reopening of economies around the world and as end markets continue to improve. We are also well positioned for the future as new opportunities to differentiate HP Fuller evolve in electronics, sustainable packaging, medical, new energy applications, and as we help our customers reduce costs and deliver new products that improve the lives of consumers. While COVID-related uncertainties persist, our end markets continue to show signs of improvement and we are well positioned to grow as global economic forces continue to evolve. We will build on our successes from this year and leverage those wins into the fourth quarter and 2021 as we maintain the same level of focus and flexibility that helped us deliver strong results this quarter. That concludes our prepared remarks today. Operator, please open up the call so we can take some questions.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our loss. Our first question comes from Gancham Punjabi with RW Baird. Please go ahead.

Hey, guys. Good morning. Hope everybody's doing well.

Good morning, Gancham. Thanks. Hope you're doing well as well.

Thanks, Jim. Going back to the third quarter, the engineering adhesive segment seems to be the outlier on the plus side versus the initial expectations. Just wondering, Jim, can you sort of talk through the end markets that surprised you in the upside, maybe the geographies, and then also give us more color on what you're seeing in transportation as auto production has started to normalize globally.

Yeah, as you know, Gansham, engineering adhesives is our growth engine in the company, and it was at double-digit growth over the last number of years. So I think the biggest driver there is some good share wins that we've seen. So our electronics business did really well as some of the projects that we've been working on came to fruition. Wins in China Auto came through really nicely in the quarter, and combined with the fact that China Auto is moving forward. So some of the work we did to position ourselves well in the China Auto market is really improving. And also, I talk a little bit about the cultural approach we've taken to embracing this pandemic as a new way to qualify adhesives. And in the U.S. assembly market, the team's done a great job of gaining share there, as well as some of the innovations in IG. So as the IG market, the insulated glass market, came back Our innovations are growing faster than the overall market, so some of that technology investment. In terms of the markets themselves, as I mentioned, technical textiles is strong right now. RVs is very strong right now. China auto is strong. So if you think about the market forces, RVs, technical textiles, and China auto. But I think the biggest thing you see that differentiates our business there is just winning in the market with customers.

Got it. And then in terms of construction adhesives, you know, a lot of your peers that sell into the construction end markets have talked about, you know, an improvement relative to what they saw in 2Q. I'm just curious as to, you know, I know there's some nuances in terms of commercial construction exposure, but is it just a delay that you haven't benefited from, or is there something more secular going on just given the challenges in certain pockets of commercial construction?

Yeah, I think that the construction business is very differentiated. So first, let me say, we are improved, right? We were down 15.5% last quarter, and we're down 12% this quarter, which is a good improvement. We see a difference between commercial and residential. So we're much more exposed to commercial, you know, closer to 70%. And our retail business, which is only 10% of our business, so, you know, the the Menards, Lowe's, and Home Depots of the world, they're up very nicely. But for us, it's only 10% of our business. So others might have a bigger exposure in those channels. So I think the way to think of it, it's very differentiated, is if you're exposed to the retail piece, very strong. If it's residential wholesale, that's definitely improved. And then commercial is a little delayed. But I will say, Ganshan, that as we look into Q4, we see that pulling back as well. So or pulling forward in a positive way as well. So commercial construction was a little later to get into the delays related to the pandemic and a little later to come out. So, yeah, I think construction did well. It's improving, and looking forward, we're pretty positive about where it's headed. More retail exposure, though, you definitely are going to see a bigger bump.

Got it. That makes a lot of sense. Thanks so much, Jim. Okay.

Thank you, Gancho.

Our next question comes from Vincent Anderson with Stiefel. Please go ahead.

Good morning, and nice job again this quarter. Thanks, Vincent. I did want to go back to construction briefly. I was hoping for a little bit more detail on specifically why margins weren't able to expand versus the second quarter. It sounded like you had favorable operating leverage, favorable raw material tailwinds. I guess maybe utilities business was carrying something with a fairly positive mix impact maybe. I'm just trying to understand how the margins progressed through the quarter.

Yeah, construction's a business with a lot of mix impacts. So you're spot on, Vincent. Your assumption's right. In our utility and infrastructure business, we had a very nice positive mix in Q2. I'd also comment that our commercial roofing business is a nice positive mix business for us at and that was a little weaker this quarter. So I think it's just quarter-to-quarter mix. Although overall, we're really pleased with where we brought the margins. So the portfolio realignment we did last year has put us in a position where this business is down 12%, and we're getting above 15% margins. So you don't have to imagine. You can do the math. It'd be very nice margins as we pull out of this. So I think the portfolio repositioning is... enable us to expand margins more. John, is there anything you want to add to that?

No, I don't think so. I mean, I think we did reduce inventories in the quarter. And although that was a good help from a cash flow standpoint, that does create a little bit of underabsorption in that weight on margins in all three businesses.

Gotcha. Thank you. That's very helpful. And kind of staying on that topic, maybe a little bit focused on construction given the portfolio mix shift last year, but company-wide, as you look into next year and compared to what we saw this year, at any level that you could estimate the trade-off between negative operating leverage and then what you got back on raw materials in terms of whether you're going into next year with a very strong upside from operating leverage or if you got most of that back in raws?

Yeah, right now we see a lot of positive operating leverage, right? We've got the SG&A savings that we still have a little more to get on the GBU realignment. We're going to start seeing the benefits of this supply chain and operations project, so that'll help drive things. And, of course, volumes are going to be better next year given what we've dealt with this year on COVID. So we see a lot of positives. As far as raw materials, they're flattening out, but we definitely for next year see positive leverage on raws. Unless economies really took off, we don't see a drag at all on raw materials.

okay fair enough um if i could sneak one more in are you comfortable with your customer inventory levels and engineering adhesives and just kind of more generally on the fourth quarter order book is there anything that's kind of bucking seasonal typical seasonal trends uh yeah we're four weeks into the quarter we see good positive seasonal trends as we normally would so i don't think there's anything um out of the ordinary

happening in terms of the seasonality of the business. I think our electronics business is stronger the end of the year. That's turned out positive as we exited the quarter and into next year. Certainly, auto was the slowest business. Auto outside of China was the slowest business to ramp up and get to an improved order pattern. So in Europe and North America, we see auto finally coming around. So A lot of positive trends as we enter Q4 that we feel good about. All right, thank you. Yeah, thank you.

Our next question comes from Mike Harrison with Seaport Global Securities. Please go ahead.

Hi, good morning. Good morning, Mike. Jim, within the HHC business, you had expected that some of that surge buying was going to subside, and you did see it looks like about a 7% sequential decline. But it sounds like also that there are kind of a lot of moving pieces within that segment. Can you provide a little bit more color on what you're seeing there in terms of that surge buying coming to an end? maybe the weakness you referred to in India and Brazil, any trading down that's going on related to products that use less adhesive or lower-end adhesive, and also what you're seeing in terms of share gains and new customer wins.

Okay, that's a big, broad question. So, yeah, so we had organic growth of 7% in Q2. That was after positive organic growth in Q1. So in this quarter, our organic growth is 1%. There's two factors that bring us off that 7% from Q2. India and Brazil, the economies, and especially around these kinds of materials, have really slacked off, if you think about what they're dealing with down there, and not being in developed economies. These products aren't so much necessities in a lot of that economy. So think of that as taking about 2% to 3% off of the organic growth rate overall for HHC. So HHC this quarter would have been 3% to 4% versus 7%, and that delta is mostly a destocking phenomena. So I think we're targeting mid-single-digit as kind of growth, maybe a little less than 5% overall as we go forward. but certainly not at 1% or 2%, 3%, 4%, 5% is what we see as the underlying growth. In terms of market share gains, I think there's two things that are happening for us in that area. Our supply chain team has done an outstanding job. By keeping all of our factories open, by keeping our employees safe, by avoiding the spread of COVID, we've been able to take advantage of opportunities where competitors, maybe that export product around the world, haven't been able to meet a need, our team was able to step in. The second thing we've done, and this is across all of HB Fuller, we've taken a very aggressive approach toward living in the new reality by finding ways to qualify products remotely. Our lab personnel have been in our 30 technical facilities around the world throughout the crisis, and their connection with customers and our technical teams in the field is enhanced. So we're building a skill set that's helping us not just against large competitors, but especially against small competitors to stay connected in this environment. So that's how we're getting the market share gain. So the HHC business is doing a great job. And if you look at the entirety of their year with the strong start, the outstanding Q2, and Q1 still being up despite India and Brazil, it's really a good news story. So did I cover all your questions in there, Mike?

Yeah, I think you covered everything. Maybe the one thing you didn't touch on is the seasonality. I think that hygiene business sometimes has some weakness during the summer months.

Did you see that again? Yes, it does. Yeah, especially in China, interestingly enough. So, you know, China has less consumption of hygiene products in the summer months. And that normal seasonality pattern happened, and it's a fascinating business that does that. But, yeah, it'll – it'll pick back up here in Q4. And then there's a few other consumer-oriented markets that pick up in the fourth quarter that drive sequential growth Q3 to Q4 every year.

Right, right, okay. And then a question for John. You guys seem to have done a pretty nice job managing cash flow over the past couple of years and particularly in this challenging environment. Can you provide some early thoughts on how we should think about cash flow and debt paid down next year? Maybe some of the key deltas in fiscal 21 as it might relate to working capital, CapEx, any cash restructuring costs next year versus this year?

Right. So I would say, yeah, I mean, working capital's been the main driver of the positive cash flow. As we get into next year, you know, we will expect to be delivering kind of similar kind of, let's say, cash flow conversion metrics, but it'll probably be a little bit different set of levers. This year, although revenue's been down, working capital has been a source of cash, and that's partly due to lower revenue, but partly due to the actions we're taking in terms of working on increasing payables, reducing inventory. So those will continue next year. I would say working capital will probably be more neutral to a slight source of cash as revenue increases. And, you know, we have this project that we've kicked off in terms of operations improvement that should help us drive an improvement in inventory. So I think you're going to see the same type of cash flow conversion metrics, but it's probably going to be a little bit different set of levers.

All right. And CapEx up a little bit next year or pretty similar to this year?

I would say it would be probably up a little bit next year. We pulled back on a few projects, more so they kind of pulled themselves back, given the environment, as opposed to us pulling them back. And those will probably get back on track. So I would expect it to be up a little bit next year.

Got it. All right. Thanks very much, everyone. Thank you, Mike.

Our next question comes from Jeff with JPMorgan. Please go ahead.

Thanks very much. Your HHC business is the largest business you have, but it has the lowest EBITDA margins. Why is that? What are the businesses in there that are pulling your returns down?

Yeah, I would say, Jeff, as you know, we've worked to – transform our business to be more highly specified adhesives. So this is the segment of our business where we have more localized competition. With that said, I think we do see a real opportunity to drive continued margin improvement, which we have. You know, I think when I joined the company, this was probably a single-digit margin business. You know, we think we can push it above 15%. You know, it's all the nuances details, Jeff. It's running our plants more efficiently, which we're doing. There's a couple plant consolidation opportunities. I mentioned those in my comments. I think there's some things we can do to help improve those. We continue to work on our pricing strategies in this business. And then the really important thing that Andy's trying to drive today is making certain that the growth opportunities grow faster. So I look at some of the sustainable packaging strategies we have in place. The healthcare initiatives that we put in place, part of setting up HHC was to enable us to focus on health and beauty. It's turning quickly into our fastest growing segment as we target new growth opportunities in health and beauty. So really getting the kind of growth dynamics in that business that we have in terms of more highly specified adhesives in EA is the strategy that will drive those margins higher.

It's funny because year over year, the sales are sort of flat and the margins are sort of flat. It doesn't look like your cost reduction program has really touched HHC. Is the cost reduction program more focused on the engineering business and the construction business?

Well, I would say year to date, and again, we talked about this quarter, I think year to date, margins are up to 50 basis points in that business. And that's definitely a result of some of the GBU realignment that we've done, Jeff. So if we had a little more growth, we would have more improvement. But 50 basis points year-to-date is, I think, a good improvement in this environment.

Did you say your construction business would be stronger in your fiscal fourth quarter than it was in your third quarter?

I said sequentially the growth rate would be improved. So we're down 12 and we'll be, I would say, in the single digits down next quarter, Jeff.

And then for John, I think you said that you expected to lower your inventories by $25 million. what's the base? Is it your average inventory level in 2000? Yeah.

So there is some seasonality in our businesses, you know, Jeff, so it's, it's not going to be a, it's going to, I would say be a reduction, um, kind of year on year. So you will see inventories rise during part of next year. Um, and you will see them go down as we move into the parts of the year where volume is slower. But overall, we expect by the end of the year to be at a run rate that will have our inventory 25 million lower year on year. Okay.

And then lastly, in engineering, can that business be up year over year in the fourth quarter? I would imagine, you know, auto was really tough and it's really roaring back and your other businesses are growing. Are you going to have positive year over year volumes in engineering?

At this point, Jeff, we're not projecting it, but the momentum is very strong. But right now, when we model out fourth quarter, it's still slightly down. But I would say the momentum is very positive. As you say, auto is going to come back. China continues to drive forward as it has. I'm bullish on the business, but today, from a modeling standpoint, we have it down slightly.

Okay, great. Thank you so much.

Thank you, Jeff.

Our next question comes from David Begleder with Deutsche Bank. Please go ahead.

Thank you. Good morning. Jimmy mentioned a few times in the release and comments about lower raw materials. Can you quantify the impact in Q3 and what you're looking at and expecting in Q4 from raws?

Yeah. Well, let me have John give you some specifics on where our raws are. But, you know, I think obviously down year over year, And then, as we mentioned, flat sequential Q3 to Q4. John?

Yeah. So I think, David, I would say it's probably down 2% to 3% year-on-year. So that's, you know, roughly $8 million to $10 million. And it will be flat sequentially to Q4.

Very good. And, Jim, do you have an early read, and, John, on perhaps incremental margins in 2021? given the impact from the various cost actions and probably a continuation of low RAS in next year versus this year?

Yeah, well, as you know, David, the big driver is what's going to happen to economies and volumes and revenues. So that's going to be a big factor. We're committed to grow EBITDA significantly in all kinds of different environments. And we've set an internal benchmark that we'll have EBITDA above 2019 and 2021. How far above depends on a lot of different factors, but we've built scenarios. I think we're getting very good visibility a quarter out, but to kind of predict exactly what happens in 2021 today would be a little premature.

And just last, I know you're not really in the M&A market right now, but how do you see the pipeline developing over the next couple of years as you pay down debt and get to a level where you could look at some other opportunities on the M&A front?

Yeah, so as you know, we're targeting to get our debt-to-EVTA ratio down below three before we get active in the M&A market. But we have, between Ted and I, Ted who ran Royal and myself and the leadership team, identified a strategy and a number of targets. So we think there's a good pipeline out there. It's a very fragmented market, and I think we understand strategically where we'd invest. So I think as we look to lower our debt to EBITDA ratio, there will be a pipeline of opportunities. We only have 5% share, and we're still number two in the market overall globally. So I think there's a lot of opportunity there as we move from paying down debt to investing in M&A opportunities a couple years down the road.

Thank you very much.

Okay. Thank you, David.

Our next question comes from Eric Petri with Citi. Please go ahead.

Hi. Good morning, Jim and John. Good morning, Eric. You know, there's been a recent push towards a green energy economy and renewables to reduce carbon emissions. Can you just discuss how, you know, Fuller's position to take advantage of those trends?

Yeah, so we're the world leader today in adhesives for solar panels. It's a strong position. Most of those are made in China, and we're very strongly positioned, but globally with other manufacturers around the world. So we see ourselves as very well positioned from a solar energy standpoint. We also have some applications in wind. The bigger trend that we see is electric vehicles. So we have a strategic focus towards towards targeting our electrical vehicle opportunities. I mentioned earlier also that in HHC, we see a real focus on growth opportunities. And for us in the packaging space, that's about sustainable solutions. So we have a disproportionate number of our projects focused on sustainable R&D opportunities, whether that's new types of packaging, less packaging, paper straws, those types of things. And then in construction, you know, we target those applications that are making buildings more energy efficient. So think about our roofing business. Most of the energy in a building goes out the building, interestingly enough. And focusing on new systems that make buildings more energy efficient is a big driver in construction. Then a final one in our durable assembly business is the insulating glass business, which is, again, a big driver of, sustainability and lower energy. And our focus in innovation there has been around there. So we see it as an integral driver of our innovation strategy. And it's paying off, frankly.

Well, thank you for those comments. And then I believe Royal used to supply adhesive and sealants in the aerospace. Can you just talk about how much of a drag that's been on either top line or bottom line?

Fortunately for us, the aerospace business has been a share gain opportunity. Royal had developed some technology that enabled airplanes to be built faster and lighter weight. It was a significant development project that was coming to fruition as we bought Royal. Those share gains are still coming through. While we're still negative this year, we're negative a lot less than the aerospace build numbers that you'll see out there. And that's because the team's doing a great job of gaining share. The other thing that the Royal Aerospace team has been able to do is leverage some HB Fuller technology. So while that's not showing up in the numbers, there's a number of pieces of technology that Fuller had that was qualified in aerospace that we're now getting traction that we see as a growth opportunity. So So while aerospace is a drag, it's not a big drag on us, and we see it as a big growth opportunity. Thank you, Dan. Thanks, Eric.

Our next question comes from Rosemarie Morbelli with G-Research LLC. Please go ahead.

Thank you. Good morning, everyone, and congratulations on the quarter. Jim, I was wondering if you could touch on Europe as they are going through a second wave of COVID, which is going to happen here most likely. Have you seen it? Are you hearing anything from your customers? Can you talk about the trends there during the quarter, if you look at the different months, and what you are seeing so far in September?

Yeah, so regionally, our strongest region was definitely Asia in Q3. Both Europe and North America were down less than Q2. Europe was down a little more than North America, but both were down. In terms of recent trends, we don't see, I know there's a lot of news about this, but from a manufacturing demand standpoint, we don't see an impact of of the most recent news that's coming out of Europe. We're certainly keeping an eye on it. And John and I stay close with the team there in Europe. We do, you know, we have, in this COVID environment, gotten very granular by business on a biweekly basis on our forward projections. So I can tell you that, as of our latest projection, there's not a downtick seen in Europe, and we haven't seen it so far this month. See you. I'm sorry. Go ahead. John, anything you want to add to that? No, thank you. That covers it.

I was wondering how much visibility you have with your customers and whether in the past they have actually seen their business as it occurred or whether they were wrong in their assumptions.

Yeah, I would say what we've done is because we have such a diverse array of customers, we've been able to, I'd say, triangulate, because I think you're right, Rosemary, some people are more optimistic than some aren't. And I think if you look at what we projected in Q2, which, you know, at the end of Q1 was, you know, pretty difficult. I think we had a good view of what was going to happen in Q2. We did the same in Q3. It was a little better than we expected, but it was, I think when I look segment by segment, geography, geography, we did a good job. So I think we do have a good view. picture. It's not always what our customer says is going to happen, but when we triangulate all those customers along with our own know-how and experience, we have a pretty good view.

Okay, thanks. And then looking at your discretionary expense, could you give us the size and how much of those will be coming back as people start moving around again?

Yeah, so John, maybe you can get a sense of what the T&E savings are and how much of that we think might come back next

We saw a little bit of that coming back in Q3. I think we probably saw a reduction on the magnitude of a million dollars a month in terms of T&E spend, sort of the middle of Q2 to the middle of Q3, and we saw that start to come back. It's not a significant number in the big picture, but we would expect SG&A to be up a little bit sequentially from Q3 to Q4.

All right. Thank you very much.

Thank you, Rosemary.

Our next question comes from Paritosh Mishra with Berenberg Capital Markets. Please go ahead.

Thank you. Good morning. In the electronics business, I just wanted to understand how much of the growth in that business is driven by more electronics getting produced as opposed to just more use of adhesives and in new cell phones and tablets and uh along those lines i guess as we think ahead we look ahead and the telecom industry goes to 5g and electronic devices carry more hardware is that a meaningful tailwind for you guys yeah so i i would say paratash the biggest driver for us are share gains in the electronic space you know we still

While it's now turning into a sizable business, we still have a relatively low share, and we're gaining new applications each year as these products are redeveloped and redesigned. So that's a bigger driver of our growth than the market itself. Yeah, we see change as the best opportunity for us. So as 5G comes and new devices are developed or new applications occur or more hardware has to be put into devices, we see that as opportunity for us. Leveraging our electronics business strength into automotive and other areas. So we have a group we call automotive electronics, right? So we're building that convergence strategy across those two is also a driver for us. So yeah, I think 5G is a meaningful opportunity because it's when change happens that we get the opportunity. That's when we get our opportunity to solve a problem and get specced into a new product that will stay in place for quite a while. So we see the 5G evolution is very good for our business.

Thanks for the detailed color. And then just a quick follow-up on your earlier comments about the automotive sector. I guess It sounds like you are expecting strong momentum in Q4 in the automotive sector. That's across the globe, right? Or is there specific end markets like China that are only those that are growing?

No, I think China is already growing. So China is in a good positive spot. We have the market in a positive place and we've got share gains there. So China for us is very positive in auto. I think the comment I was trying to make is that auto ramp-up was slower than some other markets. So we finally saw here in August some ramp-up, and we think that's going to continue. I don't know that I'm predicting some auto boom in these numbers, just that the revenue for us in Europe and North America will be better than Q3 because we'll have a whole quarter of this new ramp up. So it'll definitely be more positive in Q4 than it was in Q3.

Understood. And if I could just create one last one, I guess for John, are you anticipating any special charges in Q4 like I'm thinking a good will impairment test or any restructuring costs that might flow through in Q4?

No, I mean, I think what you're seeing in those special charges are mostly the restructuring that we put in place at the end of last year. We are in the middle of this, you know, operations project, so depending on what comes out of that, you know, we could have something to do for it, but we don't have anything planned at this point.

Great. Thanks, everyone.

Thank you, Paranash. And thanks to...

Operator, are there any more questions? I'm currently showing no further questions in queue.

Thanks, everyone, for your time. Thanks for your support and interest in HB Fuller. I hope everyone has a great day. Thank you.

Operator, we'll close out the call now.

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