H. B. Fuller Company

Good morning. My name is David and I'll be your conference operator today. At this time, I'd like to welcome everyone to the HB Fuller Q2 2023 earnings conference call. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there'll be a question and answer session. If you'd like to ask a question during this time, simply press the star key followed by the number one on your telephone keypad. If you'd like to withdraw your question, press star one once again. Thank you, Stephen Brazones. You may begin your conference.

Thank you, Operator. Welcome to H.V. Fuller's second quarter 2023 investor conference call. Presenting today are Celeste Mastin, President and Chief Executive Officer, and John Corcoran, 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, comments about EPS, EBITDA, and profit margins, referred 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?

Thank you, Stephen, and welcome, everyone. Our second quarter profit performance was strong and in line with our expectations, despite adverse customer stocking actions and slower industrial demand. Our ability to successfully manage changing price and raw material dynamics while scaling production costs is delivering EBITDA growth and significant margin improvement, and we remain on track to deliver strong growth in adjusted EBITDA in fiscal 2023. Global industrial activity has slowed, but underlying demand across the portfolio remains much stronger than our second quarter volume performance implies due to the effect of customer destocking, which is significant but not unique to us or our industry. This destocking activity is currently tapering over a large portion of our portfolio, with Q2 representing an inflection point, and we expect our year-on-year annual sequential volume comparisons to be stronger in the second half of the year. As for our consolidated results in the second quarter, organic revenue declined 8.3% year-on-year, with all GBUs experiencing declining organic sales and challenging volume conditions. However, the decline in organic sales for CA improved significantly on a sequential basis from down 26% year-on-year in Q1 to down 14% year-on-year in Q2. The improvement in the organic sales trend for CA was better than we were expecting while the deterioration in organic sales for both HHC and EA driven principally from heavier-than-expected customer destocking activities, was more adverse than we anticipated. Organic sales for HHC and EA declined year-on-year by 5.5% and by 9% respectively in the second quarter. From a profitability perspective, we performed very well and at the midpoint of our EBITDA guidance. We are very pleased with the progression in profit improvement that the team's actions continue to drive for the business. On a year-over-year basis, adjusted EBITDA was up 3% in the second quarter, despite net revenue declining 10% and volume declining 14% versus the prior year. As a result, adjusted EBITDA margin increased 190 basis points year over year and 230 basis points sequentially from Q1 to 15.9%. The combined effort of our sales, manufacturing, and supply chain organizations helped deliver a significant portion of this margin improvement. Our sales organization, through collaboration with our customers, are continually implementing win-win product substitutions to enable our customers to receive lower costs while maintaining or improving our margins. At the same time, our manufacturing and supply chain group is appropriately leveraging our market position to not only improve the availability of supply, but to also procure raw materials and convert them at a lower cost. I'm very proud of the execution by our team and their ability to adjust to the changing market dynamics. As a result, we continue to remain very confident in our ability to achieve between $130 to $160 million in net year-on-year benefit from price and raw material cost management in fiscal 2023, consistent with our previous guidance. Also, we continue to expect approximately $80 million in year-on-year headwinds from lower volume, wage, and other inflation offset by cost savings actions and the impact from acquisitions. Although volume development will be a larger headwind for the year than we anticipated at the end of the first quarter, we believe we will be able to largely offset this impact by more aggressively managing costs and continuing to grow the business through acquisitions. Now let me move on to review the performance in each of our segments in the second quarter. In HHC, organic revenue was down 5.5% year-on-year, driven principally by unusually high and broad-based destocking activity by HHC's consumer product goods customers. Although underlying consumer demand for HHC's customers remained stable, as one would expect, destocking activity led to double-digit declines in volume for HHC in the second quarter. The packaging and beverage labeling markets experienced more pronounced destocking impacts, while the hygiene and tissue and towel market segments were less affected. Adjusted EBITDA for HHC increased 13% year-on-year to $65 million, and adjusted EBITDA margin increased 290 basis points to 16.1%. Favorable price and raw material cost management, as well as good expense control, drove the improvement year-on-year. In engineering adhesives, organic revenue declined 9% in the second quarter due to lower volume in the construction and durable goods-related markets. This more than offset continued strong growth in the automotive, bus, truck, and rail and aerospace market segments. Adjusted EBITDA in EA increased 3% year-on-year, an adjusted EBITDA margin increased 210 basis points year-on-year to 16.8%. The improvement in profitability for EA was also driven by favorable price and raw material cost actions and disciplined cost management. In construction adhesives, organic sales declined 14.2% year-on-year, CA volume continued to be negatively impacted, by customer destocking activity, particularly in the roofing market segment. However, this began to taper throughout the second quarter, improving each month and resulting in better year-on-year organic sales development compared to the first quarter. CA was our first GBU to experience significant customer destocking activity starting in the fourth quarter of last year, and it will be the first to complete the progression through this macro-level destocking phase. We believe customer destocking activity for CA has largely run its course. Adjusted EBITDA for construction adhesives in the second quarter improved considerably on a sequential basis, with adjusted EBITDA margin increasing 11 percentage points to 14.1%, significantly ahead of our expectations for this business to return to mid-teens EBITDA margins. This extraordinarily quick turnaround in profitability was driven by restructuring actions and diligent cost management by the CA team, which demonstrated great courage in expeditiously reducing costs driving significant volume leverage, and greatly improving profitability. Geographically, America's organic growth was down 9.7% year-on-year, and EIMEA was down 6.3% as the impact of customer destocking moderated in CA but accelerated in HHC and EA. In Asia Pacific, organic revenues decreased 5.5% year on year. Demand in China improved versus the first quarter as the country navigated through the challenges of reopening following their COVID lockdown restrictions. With that said, organic sales in China still declined year on year during the quarter. While sequential demand in China has improved, and we expect that trend to continue in the second half of the year, we are now expecting a longer and slower recovery as opposed to a sharp rebound. From a global economic standpoint, industrial demand continues to slow, particularly in construction and durable goods-related markets. We are planning for demand levels to remain weak for the rest of this year and into next year, but improve from current levels as destocking impacts abate. Overall, our market share position remains strong and unchanged. We believe true customer demand in our markets is down modestly and that the significant impact of customer destocking is driving the majority of the volume declines in the marketplace today. Now I'd like to talk about our M&A strategy. M&A continues to be a strategic focus for us and a valuable tool to accelerate the realization of many of our growth opportunities. We are keenly concentrated on the pursuit of strategic tuck-in acquisitions that drive meaningful synergies and carry relatively low execution and integration risk. We have a robust pipeline of proprietary deals which enable us to acquire businesses at post synergy EBITDA multiples well below our current trading multiple. These transactions are accretive to EBITDA and often deleveraging to the balance sheet as synergies are realized. We're committed to driving our net debt to EBITDA ratio below three times. Our strong cash flow profile allows us to allocate $200 to $300 million in capital annually for smaller strategic tuck-in acquisitions that are highly synergistic, while still accomplishing this capital structure objective. During the second quarter, we acquired Bairdo Adams, a UK-headquartered adhesives company with a strong presence in the packaging and labeling market segments. This is an industry consolidation acquisition with significant cost synergies expected through capacity optimization and supply chain leverage. This transaction will accelerate growth and profitability in HHC by enhancing our market position and distribution network. Also this month, we closed two strategic acquisitions, XChem and Adhesion, both of which will enable the realization of two of our most strategic growth initiatives, building a business of scale in the medical market, and globally diversifying our highly specified construction adhesives portfolio. X-Chem is an adhesives manufacturer based in the United Arab Emirates that offers a wide range of specialty adhesives and coatings for industrial and infrastructure applications in the fast-growing Middle East-North Africa regions. The acquisition expands CA's manufacturing capacity outside the United States for its flagship Foster's brand and broadens CA's portfolio of products for highly specified applications. This acquisition directly supports CA's strategy to diversify and grow the construction adhesives business geographically and improve its mix of countercyclical market exposure. Adhesion is a U.S.-based medical adhesives company with customers in more than 40 countries, more than 35 global certifications, and 105 patents. It manufactures and distributes advanced adhesives for use in wound care for a broad range of healthcare disciplines. The acquisition adds to the capabilities acquired in the company's purchase of TissueSeal in 2021 and decisively positions HB Fuller for expansion in the medical adhesives industry. This creates a solid, unique platform from which to scale and innovate in the highly profitable $8 billion healthcare adhesives space. Since the beginning of this fiscal year, we've completed five transactions. In aggregate, the 2023 collection of tuck-in acquisitions are expected to contribute approximately $100 million in sales and about $8 million in adjusted EBITDA in fiscal 2023 and $200 million in sales and $50 million in adjusted EBITDA by fiscal 2025. The combined purchase price for the 2023 collection is approximately $200 million and equates to a post synergy multiple of less than five times EBITDA and, excluding the adhesion transaction, a purchase price multiple that is less than our current net debt to EBITDA multiple. We are very pleased for these companies to become part of HB Fuller, the largest pure play adhesives company in the world, and we are excited to welcome our new team members to the HB Fuller family. Now let me turn the call over to John Corcoran to review our second quarter results in more detail and our outlook for 2023. Thank you, Celeste.