Good morning, and welcome to H. B. Fuller 4th Quarter 2019 Investor Call. All participants will be in listen only mode. Please note the event is being recorded.
I'd now like to turn the conference over to Ms. Barbara Doyle, Vice President of Investor Relations. Please go ahead.
Good morning, and welcome to HP Fuller's 2019 4th quarter earnings call for the fiscal period ended November 30, 2019. Our speakers are Jim Owens, H. B. 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. These measures are in addition to the GAAP results in our earning release and in our forms standing of our operating performance and the comparability of our 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
discussed in our earnings release, comments made during this call or risk factors in our Form 10 K filed with the SEC, available on our website at investors. Hbfuller.com. We do not undertake any duty to update any forward looking statements. Now please turn to Slide 3 in the investor deck, and I will turn the call over to Jim Owens.
Thank you, Barbara, and welcome to everyone on the call. Last evening, we announced our year end results for 2019 and our guidance for 2020. Overall end markets were showing negative growth. In the full year of 2019, we delivered organic constant currency EPS growth of 6%. Margin improvement, solid cost control, and very strong cash flow, which allowed us to reduce debt by $268,000,000 well ahead of our target.
We achieved these results while at the same time building momentum for 2020. Approximately $30,000,000 in lower cost. Our momentum and our preparedness going into 2020 is strong, and will result in an approximate 10% improvement in EPS. Despite our expectation of a continued weak macro environment in the manufacturing sector globally. I'll talk more about our 2020 plans and our business realignment later in the call.
But first, let's review the 4th quarter and 2019 results. In the 4th quarter, we saw good organic growth in the Americas Adhesives, in Asia Pacific Adhesives And Engineering Adhesives Segments. These were driven by higher volumes in hygiene, packaging, new energy and general industries. But we're offset by weak automotive and construction volumes. Overall, organic revenues were down less than 1% compared with the fourth quarter of 2018.
This was an improvement from negative 3.3% in Q3. For the full year, This profit growth was achieved despite the fact that we had negative annual organic In the fourth quarter, EBITDA was weaker than anticipated because we had some temporary increases in manufacturing and inventory write off costs at 3 of our acquired factories which totaled about $7,000,000. The higher costs are not expected to recur. Strong free cash flow conversion and working capital improvements continued in the fourth quarter and enabled us to pay down $118,000,000 $68,000,000 for the full year. This exceeded the $260,000,000 commitment we made on our September investor call and far exceeds the $200,000,000 commitment we made at the beginning of the year.
These results demonstrate the strength and the resiliency of our cash flow And in the fourth quarter, we completed significant steps in our business realignment by finalizing our new global business unit organizations establishing clear operational plans for 2020 and executing on cost reduction commitments in our functions. Our realigned organization includes a focus of resources on standardizing and simplifying key business processes across the company. This will drive further savings improve consistency and visibility across the businesses and drive down our cost to serve customers. Our GBU realignment has also allowed us to streamline our organizational structure and drive immediate savings of approximately $20,000,000 in 20 on Slide 4. Weakness in the industrial sector continued to impact volumes in the quarter.
In the U. S, average PMI of 48 for the quarter worsened versus 51 in third quarter and 59 in fourth quarter of last year. Euro's own PMI also continued to trend lower, averaging 46 in fourth quarter compared with 47 in Q3 and 52 in the fourth quarter of 2018. With that backdrop, HB4's organic revenues in the Americas increased by 3% driven by volume growth and hygiene. Adjusted EBITDA margin of 14.1% was lower than last year's volume growth and favorable raw material costs were offset by impact of the surfactants divestiture and higher manufacturing costs.
The EIMEA revenues were down 3.5% year over year on an organic basis, reflecting the widespread market slowdown in core Europe. Year on year volume trends improved in Q44 compared to Q3. However, the EIMEA segment EBITDA margin of 11% improved year over year, driven by favorable raw material costs, and good expense controls. Asia Pacific organic sales increased by 2% year over year as strong growth in Korea, and solid results in Southeast Asia and China offset slower sales in Australia and New Zealand. Asia Pacific EBITDA performance was strong, increasing 100 basis points year over year, driven by volume growth, favorable mix, lower raw material costs, and solid expense controls.
Construction Adhesives faced continued external headwinds in the 4th quarter. Lower private construction spending in the U. S. Impacted flooring and roofing sales and weak industrial spending outside the U. S.
Impacted utility and infrastructure volumes. We confronted a series of factors in construction adhesives this year. Lower construction spending in the U. S. And Europe overall were magnified by a repositioning of our construction adhesive portfolio to our business areas that provide higher margin and growth potential.
These portfolio adjustments, which we began in the fourth quarter of 2018 unfavorably impacted segment revenues by approximately 6% on a full year basis or about half of the full year decrease versus last year. Construction Adhesives organic sales, excluding the portfolio repositioning, were down about 6%. This is in line with overall private residential U. S. Construction spending, which declined by 6.4% for the full year capacity constraints on certain roofing products and higher levels of manufacturing costs and inventory write ups in the quarter negatively impact EBITDA margin versus last year on a quarterly and full year construction business has negatively impacted our results in 2019.
I am extremely confident that the actions we have taken will result in a significant Let me share some of the steps and improved performance in this segment in 2020. In 2019, as you know, we exited less profitable products and product lines and reduced regional growth opportunities and customers that will drive above market growth rates. This includes adding resources and new leadership in Europe be fuller applications in North America, such as sprayable adhesives for roofing membranes, which is an exciting innovation for this industry, and is showing strong market acceptance and investments to build awareness and promote and grow our fast 2K technology. Which is generating a lot of excitement as a concrete replacement. We also upgraded staff equipment and improved operations planning processes to address capacity constraints and improve efficiencies in one of our acquired factories as we completed our integration activities.
Additionally, I'm pleased to announce that on December 2, Bosmollik joined HB Fuller to take on leadership of the new construction adhesives GBU. FAS has deep experience in construction end markets with more than 20 years of experience in Global Industrial And Construction roles. He joins us from Masonite International, where he led their $900,000,000 North American Residential business. Are happy to welcome Bos to H. B.
Fuller and we are confident in his ability to drive profitable growth. As a result of all of these actions, we anticipate a return to revenue growth and construction adhesives in 2020. We also forecast increased EBITDA margin driven by volume growth, mix, the efficiency actions that are underway and the cost reductions we have taken relative to the GBU alignment. Lastly, organic revenues and engineering adhesives increased by low single digits compared with a very strong fourth quarter last year when this business grew sales by 17%. Strong performance in New Energy, General Industries and other parts of the business were set by weak results in automotive and other vehicles, reflecting a slowdown in global auto production.
Engineering Adhesives Organic Volume grew by mid single digits in the 4th quarter and the full year, driven by share gains in our end markets. Engineering Adhesives EBITDA performance remained very robust at a 21% margin, driven by volume growth, mix, lower raw material costs, and good expense and pricing discipline. Now I will provide an update on our business realignment and its impact on our business going forward. On our last quarterly call in September, we announced a strategic realignment of our business into 3 new global business units, or GBUs, engineering adhesives, hygiene health and consumable adhesives and construction adhesives. As of December 1, our realignment has been completed and is fully operational.
This realignment is a natural and important next step in our company's evolution. This structure enables us to accelerate growth by identifying market trends and solving our customer's problems better, faster and at lower costs than our competitors. Given the importance of this business change, We engaged expert consultants to help design an organizational structure that enables us to do just Our primary objective for this realignment is simple to drive higher long term profitable growth. As a global company, we have global market strategies in all of the market segments where we operate. By organizing into global business units, rather than regional businesses, we can execute our growth strategies faster while eliminating the cost, complexities and inefficiencies associated with our regional structure.
By shifting the majority of our resources into direct accountability to our sales, technical and manufacturing teams, we will more rapidly identify market trends, streamline decision making and accelerate innovation. Our 3 GBUs are similar in that they are focused on identifying market trends designing advanced adhesive and application systems and bringing solutions to market quickly. However, each has a distinct strategic and financial profile. Engineering Adhesives, which already operates as a Global Business is adding our durable assembly business, which was previously operated regionally. These businesses focus on highly specified high performance adhesives.
This combined business generated 1.2000000000 of revenue in fiscal 2019 at EBITDA margin of about 18%. In the near term, we expect mid single digit growth reflecting the inclusion of the durable assembly business, However, as we introduced the engineering adhesive business model, leverage synergies across the business and operate in a more stable business environment, we expect double digit growth longer term. We expect an EBITDA margin range over the next several years. Given the overlap between our historical engineering adhesives and durable assembly businesses in terms of plants, products and technology, the combination creates significant growth and cost synergy. Our hygiene health and consumable adhesive business generated $1,300,000,000 of revenue in fiscal 2019, and EBITDA margin of about 12%.
With a global rather than regional focus, we will be better able to strategically identify emerging trends and new applications in hygiene, sustainable packaging, beauty and medical care. This business is expected to deliver long term growth at above market rates or low to mid single digits with an EBITDA margin in the mid teens. The construction adhesive business remains largely unchanged by enabling architects, builders, and construction workers to complete projects in less time at lower costs with higher levels of durability and sustainability, we expect long term growth and above market rates in construction adhesives with an EBITDA margin in the high teens. As I mentioned earlier, another critical outcome of this realignment is that it allows us to simplify management over our business and reduce the cost required to deliver high quality service to our customers. As part of the realignment, we now anticipate annualized cost savings in the range of $25,000,000 to with approximately 2 thirds of those savings being realized in 2020.
This narrows our previously estimated savings range of $20,000,000 to $40,000,000. We will begin reporting our financials under the 3 new segments we will share with you more detailed recasted 2019 quarterly historical results under this new segment reporting. I'd like to thank our entire team for their that we were able to execute this initiative so quickly. Because of these efforts in unity across the company, we are entering 2020 poised to realize the benefits of our new operating model. Now let me turn the call over to John Corcoran to review our fourth quarter results.
At our outlook for fiscal 2020.
Thanks, Jim. I'll provide some additional financial details on the fourth quarter as well as guidance for 2020. Revenue was down 3 and percent. And while volumes were still down 0.4%, volume trends improved versus Q3. With growth in the Americas, Asia Pacific And Engineering Adhesives, offset by slower results in construction in Europe.
And pricing was down 0.5% year on year, reflecting some giveback of lower raw material costs. Adjusted gross profit margin was down 20 points year on year as the impact of favorable raw material costs was more than offset by lower volumes and higher manufacturing costs and inventory write offs. As Jim discussed, these costs were temporarily higher in the quarter, especially in construction adhesives and are projected to return to lower more typical rates in 2020. Adjusted selling, general and administrative expense was roughly flat year on year. Interest expense and taxes were both down year on year.
Net interest expense declined by 15%, driven by debt pay down, The adjusted effective tax rate of 18.8 percent in the quarter reflects a cumulative catch up of favorable mix of income by geography the annual average adjusted effective tax rate of 24.5 percent for full year 2019 was down from fiscal 2018 rate 25.1 percent. This performance resulted in adjusted diluted earnings per share for the year of $2.96 down 1.3% versus last year and up about 6% versus last year adjusting for exchange and the divestiture of the surfactants and thickeners business. Cash flow from operations was $109,000,000 in the 4th quarter $269,000,000 for the full year, resulting in full year cash flow conversion ratio of 135 percent of adjusted net income. Strong operating cash flow as well as the proceeds from the sale of the Spectants business allowed us to pay down $268,000,000 of debt for the year. More than $60,000,000 higher Over the last two years, we have repaid end.
With that, now let me turn to our guidance for the 2020 fiscal year. Our projected organic revenue growth of 1% to 2% in 2020 reflects improving volume growth and pricing that is flat to down 1% year on year. Net revenue is projected to be have an unfavorable impact on half a percent impact on year on year sales. From a segment standpoint, we expect mid single digit organic growth in engineering adhesives and low single digit organic growth in HHC and construction pieces. We expect consolidated gross profit margin to be up by 10 to 30 basis by modestly unfavorable pricing and slightly higher manufacturing costs.
Operating expense is projected to be down about 2% year on year reflecting savings from the business reorganization and efficiency projects that Jim referenced earlier, offset by variable compensation rebuild some investments in the faster growing parts of our business. We expect that volume growth, raw material savings net of some pricing give back and savings from the business reorganization and efficiency projects will contribute to adjusted EBITDA of between $440,000,000 and $460,000,000. We expect full year depreciation and amortization to be and we expect full year net interest expense of about $80,000,000. Depreciation, amortization and interest expense are expected to be incurred ratably over the year. We expect our 2020 core tax rate to be between 26% 28% compared to our 29 core tax rate of about 25% The higher tax rate is a result of forecasted income by region and impacts from ongoing tax reform and tax law changes in the U S and foreign countries where we do business.
Capital expenditures are expected to be approximately $85,000,000 in the 2020 fiscal year. We expect to devote approximately $200,000,000 of our cash flow after CapEx investments and dividends to the repayment of debt. Allowing us to significantly exceed our original plan Given these factors, we are introducing an adjusted full year EPS guidance range of between $3.15 $3.35. The midpoint of this range represents growth of 10% versus the 2019 fiscal year. As a reminder, based on the seasonality we would expect to achieve about 23 percent of our full year revenue and 17% to 18% of our full year EBITDA in the first quarter.
Let me turn the call back over
by remaining focused on matters under our control, we strengthened our underlying business during the year several ways. By gaining share in our target markets, better aligning our business with our strategic growth markets, accelerating our debt pay down and driving continued improvement in EBITDA margin. Establishing our new hygiene health and consumables, engineering construction adhesive's global business units and getting them fully operational as we start point 20 positions us to quickly realize benefits of this new operating model. In addition, our focus on standardizing and simplifying core business functions across the company is designed to improve our consistency and visibility and drive our cost to serve customers lower. The current external outlook is that 2020 will look pretty similar to 2019.
Brexit, the U. S. Election cycle, the continued strong U. S. Dollar and other macroeconomic and geopolitical will likely continue to create uncertainty and potential headwinds on global manufacturing growth.
We do not expect a significant change in the macro forces outside of our control. The actions we have taken within our control will drive our results. In 2020 we are focused on executing on the growth drivers and the cost savings that are enabled by our GBU realignment and the further growth synergies provided by the Royal Adhesives acquisition. In addition, negative impacts from the portfolio adjustments in our construction adhesive business are behind us and the positive impacts our investments in this business are ahead of us. Our plan delivers organic growth in a continued challenging global manufacturing environment.
And the cost reductions resulting from our GBU restructuring support additional earnings growth, which we targeted 10% at the middle of our guidance range. And as a result of improved profit margin, working capital reductions, high cash flow conversion rates, and our focused capital management programs, we remain on track to significantly exceed our committed $600,000,000 in debt paydown by the end of 2020. The outcome in 2020 will be low single digit organic growth above expected industry rates achieved through customer innovation and share things. This will be combined with efficiency benefits from our reorganizations that will drive EPS growth of approximately 10% and strong results in EBITDA and cash flow growth. The actions we have taken have positioned us to capture growth opportunities in the global adhesive markets where we operate.
And they provide sustainable cost and efficiency improvements that will enhance our profitability in 2020 and in the years ahead. That concludes our prepared remarks today.
We'll now begin the question first question comes from Mike Harrison Seaport Global Securities. Please go ahead.
Jim, in the fourth quarter of 2017, you were issuing guidance for fiscal 2018 and expect it to hit the 4 $65,000,000 level. We're now 2 years later, still kind of guiding to a number that's below that 4 $5,000,000 level. So the question is, aside from FX and the macro headwinds that I think we can all acknowledge are there, Can you help us understand what maybe has stood in the way of H. B. Fuller leveraging the Royal acquisition and delivering on the potential that you saw when you first did the acquisition.
And maybe give us an update on where we stand on the longer term plan to get to $600,000,000 of EBITDA?
Yes, thanks for the question, Mike. Yes, I think in fourth quarter, I mean, the fundamental issue between now fourth quarter of 2017 is FX, right? Since that day, the change in exchange rates has impacted our revenue by $150,000,000 $160,000,000 and EBITDA by $40,000,000 to $50,000,000. So that's the biggest driver. Of course, the environment we've operated in globally from a manufacturing standpoint is completely different.
So if you were to try and pull those two items out, you'd see significant growth overall in the businesses. And I think the fundamentals of market share gains cost reductions are coming through in the Royal Integration, in each one of the elements of our business. So when I step back and look at the horizon over the last 18 months, that's the biggest driver of the numbers. And I think as you saw last year and you saw the year before on a constant currency basis, our EBITDA has grown each of those years. Our EPS has grown each of those years.
And, and I think, I think for a company like ours, it's very global. You have to take that current that you're going to try and look over along horizon, you have to take that currency piece into perspective. The other thing I'd say is even despite that, cash flow management has been outstanding, to, in that kind of environment, deliver well above the targets that we've had from a cash standpoint is pretty significant. So Certainly, there are things I'd like to see better in the business. There's things that we've over delivered, but that cash flow stands out.
I think especially in that macro environment.
And the $600,000,000 longer term target, is that still a
think we said about 6 quarters ago that our goal is to deliver 10% EBITDA growth, right?
I think on
a constant currency basis, right? So So that's our objective. We laid that out in the middle of last year. I think the math at a constant currency basis would say that that's what we targeted that's what we delivered in 2018, 2019 and the environment we were in, we didn't, but certainly that's our expectation forward is those are the kind of returns that we expect out of the business on a constant currency basis in normal manufacturing environments. And I think that's the metric you should measure us again.
Okay. And then in terms of the, the facility cost and and inventory costs that impacted your margins this quarter. Understand you quantified those at about $7,000,000 and it sounds like most of that was in the construction business. But can you help us understand exactly what it is that was going on in those it sounds like free facilities?
Yes. Yes. I think one of
the royal integration issues that we've been managing is moving their business model, which is very different plan to plan to a sort of best practice model. So that's putting practices in sales and operations planning, in cycle counts, in standardized work processes and safety, And in 2015 of the 2018 plants, that has gone extremely well. So, I think building those kind of systems allow us to have better safety, lower cost, better service to customers. In a few of the plants, I would say the integration didn't go as well as it should. That led us to getting behind on some orders for customers, having some changeover costs, and we injected extra labor to make certain that we serve customers.
And work to reduce backlog. But the bigger aspect was showed up in the inventory. So when we finally did our when we did our our physical inventory count at the end of the year, the physical inventories were off. So when I say it's one off, it's mostly inventory adjustment issue combined with some extra labor we had to do. It was at 3 of the 18 plants.
I think the really good news about that, Mike, is those plants now are running on better standard processes. So we're in a better position to manage costs to serve customers as we go forward. So, in terms of where they impacted us, they were all U. S. Based plants about $2,000,000 of it was in the Americas, about $3,000,000 of it was in construction adhesives and about $2,000,000 was an adhesives.
So those plants serve all 3 of those businesses.
Got it. And then last question is just on the capacity constraints that you had in, I believe you said roofing products within construction Can you help us understand what's going on there and what I would have thought was a slower seasonal period, why you were having capacity constraints? Thank you.
Yes, again, it's tied to that same issue I've talked about. So one of the plans we talked about serve the roofing business and we've been a little behind all year. I think we didn't build inventories as quickly as we needed to in the first quarter. And then we've been playing catch up all year. I think we ended the year with about $2,000,000 in backlog.
So like you, I expected us to to work through that this quarter. I'm happy to report that the backlog has dramatically reduced here in P1. So the work we were doing in Q4 has paid off but it didn't pay off by the end of the year. But, but it's, the roofing business is really well poised and, a slowdown here in December allowed us to catch up, build some inventories. And we're well positioned for a great year in roofing in 20 me.
Next question comes from Ghansham Panjabi from Baird. Please go ahead.
Good morning, Jim and John and Barbara. Hey, Jim, just picking up on your prepared comments on share gains, can you just sort of expand on that which segments in particular did you see the gains? What is it actually based on? And then second, in terms of the guidance for fiscal year 'twenty, pricing down 0% to 1%. And then just your base assumption of a tepid macroeconomic backdrop, I'm just curious what sort of visibility do you have on your volumes as we head into fiscal year 2020?
Okay. Yes, I'd say they what we've done Ghansham this is one of the beauties of the new GPU alignment is we're executing strategically along the lines that we look at our business. So So each one of our GBUs has between 3 10 market segments where they operate. So we look at the share within those markets. And as I mentioned in the prepared comments, real good gains in new energy, solid gains in electronics continue to be a real positive for us.
This quarter, we're very pleased to see high gene share gains, which is really important for our HHC business as it's an important part of that. And our packaging had some share gains. So we analyzed what's happening in those markets and we saw good share gains. So we look at each market and look for where the share gains are. And I would say, we see a really you can see in the PMI numbers, right, across the manufacturing sector, that there's a slowdown in lots of areas, but we try to analyze each one of those market segments and then pull that together to identify our share.
In terms of, of the second part of your question was around pricing, volume visibility. Ovolumvisibility. Yes. So I'd say, especially here at the end of the year, we have better visibility because we have, we report a month later. So we've seen the P1 results I think that the what we see here in P1 is encouraging.
I would say it's not an encouraging external market, but our ability to gain share in markets is improved. So as I mentioned, Q4 was a rougher environment than Q3, but our organic growth improved. We see and again, it's only 1 period in December. We see more positive improvement here. I know certainly I'm concerned, I'm sure investors are concerned CA, we see CA moving back to that positive territory.
HHC, off to a good start. EA, I think the first quarter will be affected by, both in Europe. Now EA is now the combined EA and VA. So we had extended shutdowns in a lot of facilities in Europe here in Christmas and we're seeing extended shutdowns in China. So So I do see EA, the new EA, which includes durable assembly, being more flattish here in Q1 with popping back as we go through the year, but that's more seasonality than anything else.
But in any case, visibility here in Q1 is pretty And I'd say, we feel good about what's happening organically at least after 1 month.
Then just kind of go back to 4Q, you mentioned an improving trend line from a volume standpoint. Was that skewed to any particular month. I'm just curious as to how the port played out and there's been some chatter about how the timing of the Chinese New Year could have impacted certain pockets of manufacturing, including auto OEM in the region. You sensed that that played out for you as well?
Well, a reminder for us, our Q4 ends November 30th. So that's far enough. I'm trying to see here that we would have not seen a big difference. Certainly here in Q1, Chinese New Year affects our Q1, but it's December, January, February, and it's in the middle. So I'm just going to have a big impact.
But John, you want to comment more on
I think from a month to month standpoint, I would say it played out pretty consistently through the month, maybe with a little bit of as we exited, right, to kind of kept up for Q1? Yes.
Okay. And then just one final one on Americas Adhesive. Was there anything unusual that weighed on segment EBITDA margins year over year? It was down about 180 basis points.
Yes. And I mentioned those manufacturing costs. So $2,000,000 of those were there. So I think if you put those $2,000,000 back, that would get you into the low 15s and then the rest is mix, Ghansham. So nothing exceptional there.
Except that $2,000,000 of the manufacturing cost of the broiled facility.
Yes, Gary, thank you so much. You didn't have a dollar the divestiture, which was a high margin business, has a little bit of impact in Q4.
Yes. So that probably cost us 30 basis points. Yes. That's part of the mix. Good.
Perfect. Thank you so much.
Thanks, Patrick.
Our next question comes from David Begleiter from Deutsche Bank. Please go ahead.
Thank you, Jim. Sorry for the voice. If you look at your 2020 EBITDA guidance, Jim, at the midpoint of about $20,000,000 per year, which is basically all the pull from the GBU realignment. And even if you include oral synergies implies that base business is down year over year. Why is that the case?
Yes. So I'll have John take you through some of the specifics there. I think And the fundamentals of where we're at is we're building our business plan off of that $20,000,000 in savings with a bit of inflation in other costs and solid performance on a price raw material standpoint. That gets you the 10% EPS with, with limited growth, right? And if we can deliver more growth, we'll deliver a little bit more organic growth.
We're gonna deliver a lot more EBITDA growth. But that's how we build our plan and our expectations we want to lay out there to the street. But John, you want to comment
Yes. So I mean, I think if you think about when you mentioned Royal Synergies, we've really captured the vast majority of those in 2018 2019. So there's a little bit of a tail, but pretty small in 2020. The impact of our variable compensation rebuild and merit is the biggest offset. So you're right.
The savings represent the biggest positive. We'll get some benefit related to organic growth. In some raws, but that's really kind of offset by the bonus rebuilding merit.
And Joan, how much is that? Is that $10,000,000 or $59,000,000 range. Got it. Is that your cash flow for, in 2020? Expectations on working capital and other items that impact cash flow?
Yes. So we
expect a strong cash flow performance again in 2020, we as we said in our prepared remarks, we believe we can pay off $200,000,000 worth worth of debt, which would put us well ahead of our 3 year target. Most of that will come from the EBITDA growth that we just talked about as well as we plan to see additional working cap improvement, and on the order of 1% to 2% of revenue. That's going to hopefully be pretty broad based. We've got activities going on around receivables around inventory and around increasing payable terms and we're seeing. We saw that as we exit the benefit we exited this year and we expect that to continue next year.
What you'll see in the details, David, is we've done a nice job on payables here in 2019. There's more of that to come with what we put in place for 2020. And then we've got some really good programs around inventory management that, that are going to also help working capital in 2020. Thanks, Dave.
Our next question comes from Vincent Anderson from Stifel. Please go ahead.
Yes, thank you. I just wanted to
follow on that helpful discussion on the fiscal 20 guidance. I guess what I'm missing in all of that is after backing out the GBU saving, and then kind of a slower organic growth environment. Why aren't we seeing maybe a bit more margin expansion off of a mix shift, do you expect to continue to grow your higher margin in the Houston business relative to the rest of the portfolio?
Yes, I mean, I think, I think we are seeing some of that, of kind of what we expect to flow through from a sales growth standpoint. But as we talked about in terms of our targets for this year, there's, there isn't a significant difference in the growth businesses. It's been in the past. A little bit more of next favorability year on year. Okay.
And then just you had a competitor in roofing adhesives claim they took market share this quarter in North America. Assuming at least some of that had to accomplish people or maybe then how much would you talk that up to your constraints during the year in delivering those products versus maybe be emphasized selling or just lost sales in general?
Yes, I saw that. I think you're talking about RPM and I saw the results. Which we're good. We don't compete with them. So that is not at our expense.
I think when we look at our roofing share this year, it was positive. But it was, and the roofing business had a positive year overall. If you take a look at our construction adhesive business, it was the flooring business where we had more challenges. But that backlog, like I mentioned, was all roofing and that was a couple 1,000,000. So if we look at our numbers, we would have had a couple 1,000,000 more in sales here in Q4 had we exited the year with the backlog.
But no, we didn't lose share to RPM.
That's very helpful. Thank you. You mentioned if I could speak one more in, you mentioned share gains in hygiene and packaging. Maybe I missed it, but you were pretty happy with how your progress have gone in electronics adhesives earlier this year. How has that gone in the fourth quarter and through the 1st part of 2020?
And then, you talked about last quarter about some bigger wins coming through in 4Q and 1H. Are those panning out, just kind of speaking outside of I'd be.
Yes. The electronics is still our star performing business, had an outstanding year this year. Again, we don't quote the numbers on specific sub segments, but it's been extremely strong all year. And I just saw the P1 numbers and they're off to a great start here in P1. So So, and those are share gains.
I think what we've been able to do there is identify new applications resources to those. So I think the benefit we have is given our share in that business, we've really focused our business on where are the new trends, what are the new products that are being introduced and what are the problems out there, whether that's better waterproof, better activity, enabling someone to provide thinner lines of adhesives, get a bigger screen, whatever problem as we work on those with our customers. And then the other thing we're doing is, is we're taking our technology further into the devices. So we've got more penetration into microelectronics rather than just assembly. So, yeah, we see our electronics business as is a very important growth driver of engineering.
So and it still continues. So thanks for the question. Thanks a lot.
Next question comes from Eric Petrie from Citi. Please go ahead.
Eric, you might be on mute. We don't hear you.
Yeah, let's go to the next question.
Go to the next call and we'll put Eric back in the queue.
Alright. Thank you. One moment Next question is from Jeff Zekauskas, JP Morgan. Please go ahead.
But was price down in all geographies? And why aren't pricing trends better? And are they deteriorating?
Yes. So we didn't hear the first part of your question, Jeff, but I think I
Sorry, were prices down in all geographies?
They weren't they were up in construction adhesives down modestly in the other business I think the answer on your question about losing momentum and trends, we really did all of our pricing work in the half of last year, which obviously significantly drove margins in the second half of last year and all of this year. We've annualized against that. When you look at kind of Q3 to Q4, it was very similar from a pricing standpoint.
Yes. So Q3 to Q4 were very similar, Jeff. I would say that raws are coming down. So there's some slight givebacks, whether those contractual or which is a small percentage of our business or not. It's a that negative 0.5 percent of price is similar to what we had in Q3.
Do you think volumes in Europe will grow 2020, or you can tell?
Yes, I'd say it's probably going to be very tough, especially core Europe. I think you're going to see a really tough environment from a volume standpoint. As you know, our EIMEA business includes, India, Middle East and Africa. Our India business still continues nicely. We've got some good wins in Africa.
If you're talking about core to Europe, it's a tough environment from a manufacturing environment. We don't expect growth here.
Do you think your markets are decelerating in your first quarter? And either because of the Chinese New Year or extend shut downs? And then what you expect is for a reacceleration later in the year? Is that your general plan? And how do you see business conditions in China?
Yes. So, yes, I think what we saw in Q4, if you look at the external data, whether it's PMI or auto bills, they were worse than Q3.
It's a
little early for us to project what's going to happen here in Q1. I would say our business is improving. So we improved from an organic standpoint, Q4 versus Q3. And in 1 month of Q1, we're seeing further improvement on an organic basis. I'm not sure that's an indication of what our markets are doing, though, Jeff.
So I think that was your question. So I couldn't give you a really solid read as to whether the world's getting better here in Q1. I mentioned, there are work extended shutdowns in a lot of factories in Germany versus or newer overall, but Germany in particular. And, and we do have somewhere that some factories in China are going to have extended shutdowns here in Q1. So we're hearing a little of that.
For us overall though, I think our share gains are overcoming what we see at least early on in the quarter.
To the question around the shape of the year. Yeah, I think given Jim's point on some of the impacts of the extended shutdowns for Christmas and Chinese New Year, And just the fact we've got easier comparisons, I would say, in the second half of the year, we would expect the revenue trends to ramp up in 2020.
So if I just a final question, you're changing your segment reporting essentially from a geographic the reporting structure to an end market reporting structure. And that's different than many companies. That is if you look at for example, the industrial gas, is there products moved over from an end market segmentation to a geographic segmentation following what the old Praxair did. And I don't think you guys export a lot from your individual regions. And there's no strong growth dynamic right now.
Are you afraid that you might lose the granularity of data that you had in having more segments by having fewer segments and because you're now going to have a more global revenue mix because of 10 markets, are you going to get the kind of granular the data you need to manage the costs in your business? Or why should it be better?
So let's, it's going to be a lot better, Jeff. So first off, strategically, we got to manage our business by the 28 segments that we operate in, right? So if it's roofing, roofing has a profile that we need to manage, electronics, hygiene, packaging. We've been building those strategies globally, but working to execute them for 2 thirds of the business regionally. So what happens is the execution model is not fully aligned with the strategic model.
Plus 5 segments has a lot more cost involved with it than 3 segments. So our ability to see the visibility of the market and then drive the results where we need to is much better in this model than the old operating model. In terms of your question of visibility, we'll have better visibility here. And again, we'll need to share with you. So you see for us down the organization, we're going to get good reasonable regional visibility for each one of those businesses.
So our P and Ls are built along those 28 segments. And there's a regional one for each one of those 28 segments. And we've got good accountability on each of those. So So our visibility will be much higher in terms of our ability to see exactly what's happening in each segment all the way down the P and L So I don't see the issue you're talking about at all for us. We, as you know, right, we run 2 global and 3 regionals.
So it was a it was sort of this mix. Now it's very clear. And I would say within each one of our businesses to your point about the world being different. Andy's running HHC. He's got a leader who's looking out at the Americas as well as down those global businesses.
Zhewei, he's running electronics and durable assembly and inflating glass all separately. He's got a leader in Asia who's looking at detail at that. So I think we've got it very well covered. John, do you want to ask for him?
No, I'd just say, we had our business reviews yesterday and I felt like we had great visibility. So I think it was sort of proof of, proof of that.
So does that mean that you'll reduce your headcount by reducing regional managers so that you only have a an end market focus or will you keep all the different regional and end market management layers?
Yes, no, we've definitely reduced and we reduced it in December. So if you think about it, I had 5 finance partners for five segments. Now have 3. I have 5 HR partners. I have 5 sourcing partners.
I have 5 manufacturing leaders. Now we do have some things we share across those businesses, but those leaders are global. 5 R and D. All right.
Thank you very much.
Yes. Next question comes from Eric Petrie from Citi. Please go ahead.
Hi, good morning. Thanks for taking my question.
Hi, Eric.
And your gross margin guidance of about 10% to 30 basis points. I wanted to get a little more color as to why you think there would be pricing giveback as well as manufacturing costs are expected to be higher, but I believe during 2018, Investor Day, you were talking about lowering manufacturing costs?
Yes. So maybe I'll take the high level and John get into the math of it. I think First off, some of our customers, maybe about 15% of our business, are built on a contractual basis as raw material move up and down. So you see a little of that, that drives some of what happens with pricing And I think the other thing that happens is in certain markets, you'll find that competitive pressures, special enrolls are coming down, put you in a position where you'll lower prices. So So it's not a big impact to our numbers, but I would say overall, we expect slightly down rather than slightly up in this environment where raw materials are going down.
We very much expect our manufacturing costs to go down in 20 20. So that's, that's definitely what we have in our plan. So John,
do you want to comment further? You look at kind of what's driving the gross margin improvement, it really is the contribution margin line. So it's our ability to capture raw material costs. And manufacturing costs as a percentage of sales are flat, despite the fact that volume is growing. Some of those bonus rebuild that I talked about show up in manufacturing.
So we're offsetting that with productivity.
Okay, helpful. And secondly, on your raw material basket, can you talk about what raw materials are moving up versus down? It seems that you're gross margins aren't improving as much as paint. So just looking for any differences between baskets?
Yes, I think in our Investor Day, there's a really good chart, Eric, that shows the diversity of our raw material. So what's different for us versus say the paints guys is they have this big margin this big monomer component, whether it's acrylic or finalized date or ethylene, we buy materials that are further down the chain. The number one raw material we buy is about 4% of our purchases. 87% of what we buy are our second or third tier materials. So 13% of what we buy are monomers and solvents and other materials that are more commodity driven the others are downstream from those.
So we don't see as much volatility on the positive or negative side as you would see in a paints business from a raw material standpoint.
Great. Thank you.
Thank you.
Next question comes from Rosemarie Riley. G. Research. Please go ahead.
Jim, when and John, when we look at your target of reducing debt by another $200,000,000 by the end of this year, you will end up with about 1,660,000,000 of net debt. And if I use your EBITDA guidance at the midpoint of 1,000,000. Now we have a net leverage of 3.7x. I was wondering if you could give us a feel as to what is the optimum leverage for HB Fuller particularly if if we go into a recession, I don't know whether we are or not, but we certainly haven't had any for about 10 years. So we are due for 1.
So what would be the optimum leverage, that you would be comfortable operating in?
Yes. I think our goal Rosemary is to be between 23 debt to EBITDA, net debt. And that's what we're targeting. We see that happening 2021. As you say, we'll be in the low threes by the end of this year.
If you recall, when we did Royal, we were 5.9. So dramatically reduce that number. It'll come down again dramatically this year. And, we see that as really positive progression. The other thing I'd say from, from a recessionary standpoint, yeah, I think of it, the 2 years of proof proving anything to our investors is the resiliency of our cash flows.
So we had negative organic growth and exceeded our debt pay down target. So this is a very cash flow generative business, low low capital intensity. We got a lot of leverage to pull on cash. So we feel really good about our our position to withstand any kind of a difficult environment. But the short answer to your question, 2 to 3, do you want to add that?
No, I think that's the target. I think, and I'd say, yeah, I think that the, you know, the fact that we're able to, some of this has been work on reducing working capital, but also it's a little bit of a reflection of when the top line slows, we have less working capital usage and raw materials come down and those are cash flow generative rest.
Now at the end of this year, my calculation, which may be wrong, is 3.7x leverage, which is still substantially above where you are comfortable. So are we talking about 2 to 3 by the end of 2021?
Correct, correct. Yes. So if I wasn't clear yet, but it's somewhere in 2021 is where we see ourselves getting below 3.
Okay. I may have missed that. And then you have touched on the different markets you served, but I was wondering if you could give us a little more details on your expectations for those different markets and particularly since you see that you are growing faster than they are and organic revenues of 1% to 2% is still pretty low. So you must be expecting some markets to be substantially below I mean, in the negative area?
Yes. Rosemary, we're leveraging off of PMI data, right? When PMI is below 50, that shows the manufacturing sector declining. And I think what we've seen both in Europe and North America. The data is a little fuzzier in China and Asia.
Our numbers below 50% and decreasing quarter over quarter. So that shows in the manufacturing sector overall. And there's other data in market specific that shows that there's an overall decline in manufacturing output around the world. So that's what we base the expectations on. And I mean, I can't go through each one of our 28 segments, but we look in detail at each one of them in terms of what we see as the growth of that business.
And then, our ability to grow, right? Our aerospace business, the aerospace business, you heard from Boeing, right? It's not a huge part of our business, but they're shutting down lines and slowing down. Clearly, that's a pretty negative environment. We're gaining share there.
So we have really good positive share gains in that space. But it's in a market that slowed down. That would be one example of the 28.
Okay. And you don't see any change in the auto world? In terms of
We're not building that into our plan Rosemary. I think there's an opportunity for that to happen. 1 of the 2nd year of a decrease in auto builds. It's rare that the auto industry has 3 years in a row of declines. So but we haven't any of that into our expectations.
So if autos improve, our numbers will be better than the ones we outlined.
And since we are in on the auto subject, is does an EV use more of your products than a regular engine type of car?
Yes, that's a good question. Most of the analytics out there say that it will use more. There's more sound bending that has to happen because these cars are so quiet. And then the batteries themselves, depending on the design and there's a few different designs, need to have thermal conductive materials adhesive like materials and in casing. So, so we'll see over time, but most of the data indicates that EVs will use more of these is than non EBITDA.
Thank you, Rosemary.
Our next question comes from Peritage Msrob from Berenberg. Please go ahead.
Thank you. Good morning. On Slide 5, in Engineering Adhesives, it looks like you're looking at mid single digit growth in the near term and double digit in the long term. Can you just elaborate on what's driving that improvement? Is that just more volumes or pricing and mix also play a role?
Yes. So, so yeah, I think the, the move, as you know, Pratash, the engineering adhesive business has a very strong track record of double digit growth. We've now combined that with the durable assembly the durable assembly business has not been growing at that rate. So that's why this year in particular, we see mid single digits. The potential opportunities in that space and specific technologies.
We see that combined business moving back toward that 10%. So I think the way I think about is of 2020 should be at the mid single digit business for the combined business, but as I said, Q1 being flattish And then when you look out to 2021 2022 moving towards that double digit. And we have it's and why is because we're leveraging that engineering adhesives business model of where to focus and how to focus to win market share.
Got it. Thank you. And maybe if I could just go back to some comments on China. Any contrast that you're seeing between consumer demand versus industrial demand in the
consumer demand is probably a little better than industrial demand, but I would say it's you really have to look at business by business, but you don't say both of them are slower, but both of them are possible in China if I were to summarize.
Understood. Thank you.
Okay. Thank you.
Our next question comes from Christopher Perrella, Bloomberg Intelligence. Please go ahead.
Hi guys. Thanks a quick question on the cash costs, and I'm assuming these are cash costs of 6 to 10 for the business realignment. And 12 to 15 of ERP. Would you be finished with those or do any of those lag into 2021?
So the costs related to the business realignment are really done in 2020. We'll complete that. The costs related to the ERP rollout will continue. And you'll see that that's gotten a little bit bigger number, we've stepped up the pace of that. So we would expect it to complete it faster, but certainly, it'll be a couple of more years at least several more
but that amount in the release is going to be incurred this year. That's the expectation. Correct.
That's all this year. All right.
That's it for me. Thank you very much.
Thank you very much, Christopher. And thanks. Sorry, we went a little over. Thanks, everyone, for your interest and your focus on H. B.
Fuller. And I would which I want a great point. Thanks.
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