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.

I'll begin on slide nine with some additional financial details on the second quarter. For the quarter, revenue was down 9.6% versus the same period last year. Currency had a negative impact of 3.4%, and acquisitions positively impacted net revenue by 2.1%. Adjusting for those items, organic revenue was down 8.3%, with pricing having a favorable impact of 5.9% year-on-year in the quarter and volume down 14.2%, reflecting a continuation in customer destocking across all GBUs and a general slowdown in industrial demand. Adjusted gross profit margin was 29%, up 330 basis points versus last year, as a net effect of pricing and raw material cost actions more than offset the impact of lower volume. Adjusted selling, general, and administrative expense was essentially flat year on year. Good cost management, initial restructuring benefits, lower variable compensation, and favorable foreign currency impacts offset inflation in wages and other costs. Adjusted EBITDA for the quarter of $143 million was at the midpoint of our guidance range and up 3% year-on-year. This reflects actions on pricing and raw material costs, as well as restructuring and cost savings, which more than offset lower volume, unfavorable foreign exchange, and wage and other inflation during the quarter. On a constant currency basis, adjusted EBITDA was up approximately 7% year-on-year. Adjusted earnings per share of 93 cents was down versus the second quarter of 2022, as expected, driven by significantly higher interest expense and unfavorable foreign currency. Higher interest expense and unfavorable foreign exchange negatively impacted adjusted EPS in the second quarter by approximately 19 cents and 7 cents, respectively. Operating cash flow in the quarter improved significantly year on year, as improving margins and lower net working capital requirements more than offset the impacts of lower volume, higher interest expense, and unfavorable foreign currency translation. Second quarter and year-to-date cash flow from operations increased year-on-year by $94 million and $118 million, respectively. With that, let me now turn to our guidance for the 2023 fiscal year. We now expect full-year net revenue and organic revenue to be down 3% to 5% versus 2022. This reflects lower than expected volume in the second quarter a decreasing level of destocking activity in the second half of the year, as well as slightly weaker industrial demand expectations for the full year. The combined impact of FX, acquisitions, and the extra week in fiscal 2022 are expected to be effectively neutral versus fiscal 2023. Additionally, we continue to expect adjusted EBITDA to be between $580 to $610 million, representing a 9 to 15% year-on-year increase. This reflects lower organic revenue expectations offset by contributions from additional cost reductions as well as the value-creating acquisitions discussed earlier. Net interest expense is now expected to be in the range of $125 million to $135 million, and depreciation and amortization expense is expected to be approximately $160 million, reflecting recent acquisition activity and higher interest rates. Combined, these assumptions result in full-year adjusted earnings per share in the range of $3.80 to $4.20. We now expect full-year operating cash flow to be between $325 and $375 million, up between 26 and 46 percent year-on-year, reflecting our expectations of more robust reductions in net working capital through the end of the year. Finally, based on the seasonality of our business and the timing of pricing and raw material actions over the course of the year, we expect to realize between $155 and $165 million of EBITDA in the third quarter of the year. Now let me turn the call back over to Celeste to wrap us up.

Thank you, John. I am extremely proud of the performance and execution our team has demonstrated in the current environment. We continue to provide our customers with exceptional service and greatly value our partnership with them to bring new innovations to the marketplace. These innovations are centered on the goal of helping our customers do more with less, to use drops, not trucks, and to improve the value and sustainability of their products. Our innovative partnership approach is a key competitive differentiator for HB Fuller. We continually collaborate with our customers to address their innovation challenges and to assist them in capturing the opportunities associated with current megatrends such as sustainability, e-commerce, and labor availability. I would like to highlight for you just a couple of examples of our recent innovations that are changing the world and capturing significant attention. First, HB Fuller's EA team was the proud winner of the 2023 Adhesive and Sealant Council Innovation Award for our new product, EVProtect, a lightweight encapsulant for lithium ion batteries used in the production of electric vehicles. EVProtect is a game-changing innovation that, when exposed to a thermal event, significantly reduces or delays thermal propagation. The semi-structural properties of EVProtect also provide noise, vibration, and harshness mitigation benefits to the battery system by unitizing the battery module and absorbing external environmental impacts. This new patent-protected innovation greatly improves the safety of EV battery systems and will enable us to capture more market share and continue to significantly grow our EV business. HHC is leading the industry in innovating and enabling sustainability in the global hygiene market. Recently, one of our customers, Nine, a leading manufacturer of feminine care products in India, unveiled an incredible innovation in feminine hygiene, creating one of the industry's first biodegradable sanitary napkins. HHC's new bio-based adhesive technology, the Full Care 900 series, which generates 90% lower carbon emissions compared to standard petrochemical-based adhesives, was critical to their new product design. Through collaborative partnering with our customers, HB Fuller is leading the way in creating game-changing, sustainable solutions across industries to reduce waste and improve the environment. Now, as I conclude my prepared remarks, I would like to provide an overall perspective. We are well positioned in the marketplace and continue to expect strong growth in adjusted EBITDA and operating cash flow in fiscal 2023. Our diverse portfolio and robust innovation pipeline engender continual product line upgrades, enabling strong profit growth in almost any economic environment. Our confidence remains high in a stronger second half performance as we expect customer destocking activities to fade, EBITDA margins to continue to expand due to price and raw material cost actions, demand in China to improve, foreign currency comparisons to be favorable year-on-year, and restructuring benefits ramp through the end of the year, delivering another strong year of EBITDA growth and setting us up to continue that trend in 2024. That concludes our prepared remarks for today.

At this time, I'd like to remind everyone, in order to ask a question, press star, then the number 1 on your telephone keypad. We'll pause for just a moment to compile. the Q&A roster. We'll take our first question from Mike Harrison with Seaport Research Partners. Your line's open.

Hi, good morning. Hey, Mike. Celeste, a lot of companies are saying that this ongoing destocking is making it difficult to know what underlying demand looks like and saying that visibility is very poor right now. You seem to be indicating that underlying demand is pretty solid. Is that based on what you're seeing in order patterns or on customer conversations or what? Can you help us understand what's giving you confidence while other companies are pointing to more limited visibility?

Sure. Thanks, Mike. So when you look at our underlying demand, we have a lot of anecdotal information, and we also have a view into our P7, which is this month. And what we really see is in the CA business, you know, we saw really strong destocking month over month during the quarter. We're seeing that lighten up significantly by about half, in fact, in P7. In the EA business, we've just seen this progression month over month of improving volumes. And now we're at the point where it looks like the EA business is down sort of low, single digits as it relates to volume, which I think is really indicative of the underlying demand, kind of low single digit comparison. And then HHC, you know, HHC was the last one, the last business we have that has become involved in this destocking phenomena. And, you know, they're going to be the last one to pull out of it. So what we're seeing in that business, which, as you know, is dominated by a lot of large consumer products, businesses, and companies, is that we're seeing ongoing low demand in that particular area. And it's very hard to say exactly what the underlying demand is because it's still so mired in destocking. But my intuition would say that overall, we're going to see demand settle out around 3% or 4% lower than than a typical year.

Well, and that makes sense because that tends to be a more defensive category. Question on M&A strategy. If we looked at your pipeline of deals, and I'm looking at slide seven here where you have this matrix or kind of four different buckets of categories for acquisitions. How would that pipeline kind of split roughly among those four buckets? And how do you think about the risks and value creation opportunities as you think about new technologies and new geographies versus something that's more of a low-risk consolidation play?

Yeah, I think what you see for this year is going to be a very typical dispersion of those acquisitions within the pipeline. By the very nature of the strategies that we have in our 30 different market segments, you know, there tends to be more of a drive to the need for adding new technologies in existing regions or to expand the technology we have into new regions. That's where we see, you know, really our best opportunities for growth. However, you know, there are certainly... opportunities that we've found and the tissue seal deal or the adhesion deal are examples of this where it makes sense to step out into an adjacent space and to build a capability like we're building in the medical adhesives business. So to your point on risk, right? I mean, finding the right platform in those areas on that left-hand side of the matrix is what's so critical. So when you look at the adhesion deal, you know, the reason we just loved that acquisition was because they have great technology. You can see how many products they have certified, all the FDA clearance they have, you know, really robust technology. In fact, it's an extension of our cyanoacrylates. It's an octal-based version, which is a lot more applicable in a broader part of that space. But what they didn't have was a good channel to market, which is why they weren't generating a lot of EBITDA. And in a very challenging situation, we have that channel to market. So while it's on the left-hand side of the matrix and it looks like there's a little more risk, There's always reasons we're looking at things that are in that part of the four box. And it's typically because we bring a lot of capability that de-risks the opportunity.

Excellent. Thank you very much. And then the last question I had is on the really nice margin improvement you saw in construction adhesives. It sounds like a lot of that was related to cost action, but can you maybe... Walk through the pieces. How much was volume leverage? How much was price-cost improvement? And I guess as we look at this sort of mid-teens EBITDA margin level, is that sustainable as we look into the second half and maybe into fiscal 24?

Yes. So remember, the construction adhesives business is a highly specified business. And, you know, that is a business that sustainably over time will be in that, mid-teens to high-teens EBITDA margin level. As we grow the business, that's what we're targeting. And what you're seeing in that CA turnaround is we made a decision back in January that we knew we had to lower the break-even point of that business. We recognize the building product space is more volatile than the other businesses that we're in. And in order to be able to buffer that extreme movement in demand, we decided we wanted to put in place a lower cost structure. So the team's been working on it over the course of the year. I know it looks like a quick turnaround, but they've done a tremendous amount of work, and you really have made a difference. And then the other thing I would point out before, and I'll turn it over to John to talk about how that breaks out by savings type, But the other thing I would point out is for this portfolio overall and the sustainability of our margins, this is a very recession-resistant business. We are in a position that we help our customers lower their cost. We can help them at a time like this use lower-cost substrates or we can bring a lower-cost adhesive. But all of these actions that we can take at this point in time really reinforces our pricing value Well, at the same time, because of general low global demand, we have a lot of volume that we can use as leverage with suppliers. So that ability to expand EBITDA margins at a time like this really fits nicely with our portfolio, and the team has done a nice job adding cost reductions on top of that to be able to buffer this extremely low demand that we're experiencing.

Mike, and I'll just add a couple comments on the progression of the margins in CA. So obviously this is the most kind of seasonal of our businesses, and Q1 is always the lowest because of the fact that the weather results in less activity in the first quarter. So you always do see a step up from Q1 to Q2. Last year it was probably up a couple hundred basis points from Q1 to Q2. That's about normal. This year, if you look at the volume progression, The volume progression from Q1 to Q2 this year was actually a little more than last year, which is a sign also of not only the seasonality but the recovering markets. So some of it's certainly driven by seasonality. You know, maybe we're talking 300 to 400 basis points, but I'd say the majority of it is around the restructuring of the business and taking costs out.

Great. Thank you very much for all the cover there.

Next, we'll go to Gansham Panjambi with Baird. Your line is now open.

Hey, Gansham. Hey, guys. Hey, Celeste. Good morning, everybody. I guess going back to the, you know, kind of the destocking question, you know, it looks like you and others are experiencing some level of phased destocking, right, depending on the category and so on and so forth. Celeste, as you kind of think back, you know, which category started to get destocked first? You know, how are the volumes trending in those categories? Are there any sort of green shoots that are starting to appear as it relates to specific quantification related to destocking versus the anecdotes that you cited?

Yeah, so we started seeing this destocking first in CA. And really, too, as you can see, you know, a very extreme degree. So the construction adhesive business, both our roofing and flooring businesses in particular, have taken the brunt of that. But also... the construction-related businesses that we have in our EA division. You know, woodworking, for example, lowered quickly. And then, you know, insulated glass has now sort of followed along. So it wasn't first within the construction trades, but later in the construction trades to feel that pinch. And, you know, we have a very innovative product in in a 4SG that we've introduced in the insulated glass industry. So I think that, you know, that kind of, that innovation was taking share and buffering some of the destocking we saw. But even now, we are seeing that in that space. So we're seeing that progression occur. CA was first. Then I would say we started really feeling it more so in EA just this quarter. Now, in EA, we're starting to see the green shoots because China or China business is starting to pull out of that low-volume funk that they were in in Q1. In fact, Gansham, if you look at China, we were down, you know, volume was down. It was almost flat, frankly. Volume was almost flat in China, and EA benefits a lot from that. So we're going to see a pullout of destocking in the EA market. as well as CA, I believe, very fast. And again, we're seeing some green shoots. HHC is a different story, right? They were the last ones to fall into this destocking mode. And I think we're going to see on into Q3 impacts of that at a pretty significant level. They also have done a nice job of being able to buffer volume with their pricing performance. They're bringing a lot of value to their customers through innovation. which is helping, and that'll help sort of mitigate some of the impact of this.

Perfect, Celeste. Thanks so much. And as it relates to the volume trend line, I know each month gets choppy. There's base impact issues, et cetera. But what's your sense as to how June is tracking from a volume standpoint on a year-over-year basis relative to the 14% decline that you saw in the second quarter?

Yeah, so when we look at our volumes over the last four months, we were kind of P4 down 17%, P5 down 14%, P6 down 10%. So that's for the business in total. And what we're seeing in P7 is high single digits decline in volume. So it does continue to get steadily better.

Okay, perfect. And then just last one from me. You know, as it relates to the consolidated volume trend line that's baked into your guidance for the back half of the year, maybe a question for John. You know, what are you baking in as your base case for volumes in the back half of the year? And then also, could you bridge the EPS differential between your original guidance and your revision as it relates to all the moving parts?

Sure, Gancham. So on the first question, you know, we're projecting the volume will still be down in the second half of the year. and that's organic volume. Remember last year we had the extra week, so when we talk about organic volume, we exclude the impact of the extra week last year, which is additional drag. So even absent that, we expect volume to be down in the second half of the year, down about 6% to 7% for the full year is what we're now projecting, and probably down a similar number in Q3. So Q4 we expect to get to sort of flattish to modest volume growth, and that's what our full year kind of down 3% to 5% guidance range is based on. On the question on bridging the EPS, so two things. One is interest expense is expected to be kind of at the midpoint of our guidance, about $10 million higher than it was coming into Q2. The majority of that is driven by the acquisitions that Celeste talked about. That's probably driving $7 or $8 million of that increase. And the rest is the fact that interest rates can kind of continue to tick up. And then the other driver of the change in EPS guidance is depreciation and amortization, which is about $10 million higher than we had expected at the beginning of the year. And, again, that's all acquisition-driven.

Thank you so much. You're welcome.

Okay, next we'll go to Vince Anderson with Stiefel. Your line is now open.

Hi, Vincent. Hey. So, you know, Mike brought up adhesion, but I want to kind of dig into it just a little bit more, you know, and really just skin bonding adhesives more generally because at first glance to a layman, you know, cyber bond, tissue seal, now adhesion, have fairly similar chemistry sets. What to you does a proper medical adhesive business look like when you talk about creating a growth platform and market leadership? Is it just about having the best products available to scale through, or are we missing something else?

Thanks, Vincent. So we're looking at this $8 billion medical adhesive space to include four different components. One is, as you mentioned, the wound closure market, which is often deploys the cyanoacrylate, and we're tackling that through adhesion, cyber bond, and tissue seal, as you referenced. There are two other very large spaces in the medical adhesives industry. One is the medical device adhesive space. And when you think about it, that's a lot like what we do in engineered adhesives. So we feel we have a right to succeed in a product line to succeed in the medical device space as well. And then, you know, the third, the bigger category in the space is stick to skin. And, you know, clearly we have the technology to pursue stick to skin bonding and we are doing more of that with some of our existing customers. So we look at that as a platform sum total that we're pursuing, again, an $8 billion market with a high growth rate and a very high EBITDA margin, you know, 20% to 30% plus EBITDA margins. And as I look at this opportunity, I really feel like this is one way we can transform this portfolio. We made a big shift in the portfolio when we added the engineered adhesives business, and we've grown that successfully. I see growing in the medical adhesive space quite similarly. And again, that will be a big aid in helping us drive the overall portfolio to those high teens EBITDA margins.

Okay, that's helpful. I guess then if I think about that, more broadly given you already play at least in a lot of these chemistry sets, but it's never quite coalesced to a major business unit for you up until now. What has been preventing the broader adhesive industry from creating a market leader then? Is there something very distinctly different in the commercialization strategy that you were lacking?

So it's a good question. My belief is that as the biggest pure play adhesive company in the world, we are one of the few that would have the scale and the capital to pursue this market. And because adhesive is what we do and only what we do, we also have the focus to pursue this. I guess it's a question for others, not me, because I feel like there are certainly opportunities for us to expand here. It is largely going to be a market where we're going to have to acquire because having the certifications and the qualifications due to the regulations is very rate limiting. Growing it is would take a very long time. I think acquiring companies like Adhesion to enter the space are going to be the most expedient way for us to do this.

Okay, that's helpful. I appreciate it. And actually, if we could stay on the topic of M&A. I just wanted to get kind of your philosophy on setting at least the public post-synergy expectations. I mean, I assume some of these portfolios have fat to trim on the product line, so not sure how you balance that against commercial synergies, if you include any at all. And then, you know, maybe specifically on a consolidation acquisition, how much restructuring benefit is included in your synergy expectations relative to just kind of your normal SG&A and procurement type cost outs?

And so for the... So for the consolidation synergies, sorry, can you repeat your question just real quickly, Vincent?

Make sure I got it. Yeah, if you think about what you set for fiscal 25 and what you're comfortable bucketing in that from kind of day one and giving the market as a target, does that include things like commercial synergies? Does that include things like larger asset restructurings? Or, you know, is that initial target really based more on, you know, the low-hanging fruit and procurement and back office, and then really it's three through five?

So the target, as we define it, is what we can, the synergies we can drive in a three-year period. So for the 2023 collection, for example, I'll just give you some examples, the, you know, our... When you look at the 2023 collection and exclude adhesion, because this is a very different kind of a deal, but let's just look at the other four acquisitions. We are acquiring those for a pre-synergy multiple of around nine times and the post-synergy multiple of around three. So in getting from nine to three, there are raw material synergies, there are Facilities synergies, again, we have facilities all over the world. Oftentimes, especially with larger acquisitions, there will be facility consolidation or capacity rationalization. As far as the back office goes, yes, you're right. In fact, we don't have a back office in every country of the world. We have shared services centers, which make it very easy for us to move back office work from companies we acquire into our existing workload. And of course, you know, the raw material synergies definitely dominate this. When you look at, you know, these consolidation acquisitions, if you look at just like XCAM and Bardo, the SKU overlap that we had between those companies was on the order of about 50% of the SKUs they bought. And When you take it a step further, what you find is that we look at our price paid on those SKUs compared to theirs, and in every case where we brought more volume, we had a lower price, which we then get the opportunity to leverage to the acquired company's spend. And there were two or three cases where the acquired company bought more of something and And, again, it works the other way around. We're able to leverage their cost to our SKU base. So really the synergies come most heavily from raw material spend and then I would say facilities we can take out within three years as well as, of course, back office. John, you want to elaborate?

Yeah, so to kind of parse that apart, if you think about that, getting to the $50 million by 2025, most of that comes from the synergies, some of it's organic growth. But of the synergies that we're projecting, Vincent, about 80% of them are cost synergies, so exactly what Celeste explained, and maybe 20% are commercial synergies.

Yeah, in fact, if you look at the 2023 collection, the commercial synergies were largely just associated with adhesion. It was de minimis other than that. So we are trying not to bake in revenue synergies unless we really, really know it's a true synergy. We don't include the growth rate. We're just a synergy. And adhesion was a great example, right, because we were able to bring the channel to market, which is what enabled the company to grow, will enable the business to grow quickly.

Okay, excellent. I appreciate all the details on that. I'll let you go.

Thanks, Vincent. Next, we'll go to Jeffrey Zakakis with JP Morgan. Your line is now open.

Thanks very much. In the quarter, sequentially, prices go up meaningfully in any area or did prices go down meaningfully in any area?

So if you look at Q2 versus Q1, Jeff, we saw more carryover price as a percent of the total pricing value in this quarter versus last quarter. They haven't gone meaningfully down in any area, but Certainly, there is more price competition in the market now as volumes are declining. But again, our customers aren't going to save a lot of money by getting price reductions on glue. They save more money when they use us to enable them to use lower cost substrates or to change their line speeds or something that has much more impact.

Where is there a little bit of price competition? In what subsector?

So you see the price competition in, for example, the solar market in China. In fact, we've seen more in China, more price competition than in other parts. And I would say in the end-of-line packaging part of the business, there's business we've walked away from because of that. And in fact, if you look at sort of this overall, if you look at our 14% decline, you sort of try to parse it out between market share, destocking, and underlying demand. As it relates to market share, we have a very sophisticated model that helps us use predictive analytics on customers' orders to determine what kind of business we've lost or how many customers we've lost and which ones. And our estimate is that we've probably walked away from about 1% market share that had pricing that we were not willing to meet.

Okay, good. In terms of your non-recurring charges, I think last year maybe your non-recurring charges were about $40 million after tax. And I think this year maybe they're running $20 million for the first half. Order of magnitude, are the non-recurring charges going to be about level with last year?

I think the answer is yes, Jeff. The restructuring charges have been largely recorded, at least the ones we know so far in Q2. I'm trying to think of other non-cash one-off items that hit last year in the second half. I don't think there were much. I think that's a pretty good estimate that they'll be pretty level because there will be some continuing restructuring charges in the second half.

And then in terms of your cash flow, do you expect your accounts payable by the end of the year to be flat with what they were last year, roughly? And can you talk about what's going on in deferred taxes and why there's a use of cash of, I think, about $16 million for the first half in deferred tax.

Yeah. So I'd say on accounts payable, yes, I would think that it would be flat up slightly. We are working on a project to look at vendor terms, and we would expect that to bear some fruit in the second half of the year. So the cash flow for this quarter was obviously driven by improvements in working capital, and we would expect those to continue and actually be a little bit bigger. in the second half of the year on um... on taxes you know the that overall that i'd say taxes are a kind of a drag on cash flow in a relatively modest way just uh... primarily related to settling old tax audits so i think if you look at the tax payable line in the deferred tax plan at the negative the negative ten million dollars roughly and that's more or less in line with old tax audits that we've settled in the last six months.

Okay, great. Thank you very much.

Thanks, Jeff. Next, we'll go to David Begletter with Deutsche Bank. Your line is now open.

Hey, this is David Huang here for Dave. I guess first on the $130,000 to $160,000 price cost tailwind and then the $80,000 headwind, how much of those have been realized or occurred in the first half? And how should we think about the split between Q3 and Q4 on those two numbers?

Yeah, so at a high level, I think if you look at the impact of pricing in the first two quarters, it was roughly $130 million, right? So just pricing alone is at the bottom end of that range. But on a year-on-year basis, raw material costs were up year-on-year, more so in Q1 than Q2. So I couldn't give you an exact number, but we haven't realized 130, but we've realized probably closer to 80 to 100. And in the second half of the year, that raw material benefit will accelerate. but pricing will become less of a benefit. So, you know, I would say we're definitely kind of realizing half of it, maybe a little bit more, and that's kind of what I would think given the way this year is going to play out, given that the pricing carryover will be much more of a benefit in the first half, much less in the second half, and then vice versa for raw materials.

Okay, and then I guess back to the guidance. Is it fair to say that it's more realistic that you would achieve the lower half of the range. If not, I guess what could still drive the higher end of that guidance range for the year?

Yes, if you look at the higher end of the range, it's certainly bolstered by the acquisitions we've done. Also, a more dramatic upturn in volume would push us more so toward the higher end of the range. The lower end of the range we preserved with cost restructuring. We're going to continue to drive restructuring actions throughout the business.

Maybe lastly, I think you noted some improvement in China. Can you talk about that? Where are you seeing that improvement? I can see your guidance. What type of volume growth are you embedding in your guidance on the lower half of China?

So I'll talk a little bit about China, and then, John, maybe you can speak to the guidance there. So I actually just returned from China. I was there in May. And while I was there in May, in front page of the China Daily, the government essentially was announcing that they are going to be incentivizing more domestic spending. Okay. I believe we're benefiting from that, particularly because our volumes have lifted to near neutral. So that's one source of improvement that we're seeing there. The other area is in the electronics business, interestingly enough. So actually some of the larger electronics producers in China are anticipating their volumes to be down 50% versus 2021. And some of the multinationals would cite numbers more like down 20%. But we are doing well, and it is because we have been able to innovate and take share in that electronic space. And there's some favorable trends happening in electronics for adhesives versus, for example, tapes. A tape is not something that can be applied as quickly as an adhesive in, say, a touch panel screen. That's where liquid adhesives are really much more beneficial. And even as you see phones and other electronic devices get thinner, it's more difficult to use the traditional taping method to construct those. And adhesive is just a much better application much better material to create a bond in a situation like that. So I think we're doing well in electronics, to your question, in China, just through innovative sharetake more so than actual underlying volume in that space.

And just on the progression in terms of volume development, so the first quarter, China's volume was down nearly 10%. It was down a couple percent in Q2. I think Celeste referenced these earlier. We think that volume will be up in the second half of the year, but not up dramatically. I think we will have easier comparisons when you think about the timing of the lockdowns in China last year. So we're optimistic that we'll see growth, but not robust. If there is significant investment in China in terms of government investment to stimulate the economy, that could be an upside.

Okay, thank you.

Okay, next we'll go to Rosemary Morbelli with Gabelli Funds. Your line's open.

Hi, Rosemary. Good morning, everyone. You have given us a lot of information, Celeste, and I really appreciate it. I was wondering if you could talk about the competition, the existing competition in the medical adhesive space. I presume that you are not the only one. We have all used those, well, bandages, you know. sticky bandages. So who else is in that space and how are you going to compete as a small entrant?

Let's start with the wound closure market. J&J is really the biggest participant in that part of the space with their Dermabond product. But other than that, it's, you know, adhesion was really, I think, second or third largest in that industry. So they already had a strong position, and that's, you know, not a very large market in particular in medical adhesives, but we do feel the technology is applicable to other places. The... In the medical device space, again, you see a lot of fragmentation. A lot of really actually mid-sized companies are participating in that space. And then stick to skin, of course, you know, there are a number of large players that can compete in that market. But we have tremendous technology as it relates to PSAs that is relevant to skin bonding, and we'll have the ability to have a strong position there. We already toll for some companies in that space today.

So, Celeste, if you look at that $8 billion space, and you talked about the three major categories, can you split that $3 billion between those three categories?

Yeah, so the biggest part of the $8 billion is, let's call it seven of the $8 billion, is split between medical devices and stick-to-skin. And then the remainder is wound closure. However, the wound closure market, while it's smaller, is really growing fast. I think there's been some recognition that there is a technological advantage to bonding wounds closed rather than using sutures, for example. And there's a lot of reasons from an infection prevention perspective to use adhesive rather than sutures as well. So wound closure is smaller, but it is really growing rapidly. I'll call it about a billion-dollar market as well. Thanks.

That is very helpful. Then you mentioned in your prepared remark product substitution. So usually in this kind of an environment, companies will substitute to something cheaper. And I was wondering if you could give us a better feel for what you are substituting or your customers are substituting and their impact on your operations.

Yeah, when we talk about product substitution, what we really should be saying is lower cost formulations of the same product. It's really substituting our raw materials one for another. So when we formulate our adhesives, there's multiple inputs that go into a finished adhesive. And oftentimes, especially once we get to know our customers better and we understand their line speeds and depth and just you know, they change substrates, you know, see what kind of substrates they're working with, oftentimes we'll be able to offer either a lower cost adhesive, a lower cost to the customer, but margin preserving for us, or we'll be able to switch out a raw material within an adhesive that makes the overall formulation less expensive and, you know, both the customer gets a cost savings and we preserve our margin. And that's That's one of the things we do. And again, you know, however, in a time like this where we add even greater value for our customers is by being able to help them switch out their substrates. That usually requires a different type of an adhesive, an adhesive that's formulated specifically to those substrates and their line conditions. And again, by being able to change a substrate or run a line faster, a customer will save a lot more money than just saving pennies on qualifying a new adhesive formulation that we can provide.

And we've reached our allotted time. At this time, I'll turn the call back over to Celeste Mastin for any additional or closing remarks.

Thanks, everyone, for your participation today. We're proud of our second quarter results. You know, I think what you saw was great execution coupled with an effective business model allowing us to drive a 3% EBITDA improvement despite 14% volume decline, and we're going to deliver more of that. So thanks very much.

And this concludes today's conference call. You may now disconnect.