Good morning, and welcome to the H.B. Fuller Q3 2019 quarterly earnings conference call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Barbara Doyle, Vice President of Investor Relations for H.B. Fuller. Please go ahead.
Good morning, and welcome to H.B. Fuller's fiscal 2019 third quarter earnings call. Our speakers today are Jim Owens, H.B. Fuller President and Chief Executive Officer, and John Corkrean, Executive Vice President and Chief Financial Officer. After our prepared remarks, we will take your 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 earnings release and in our Forms 10-Q and 10-K. We believe that discussion of these measures is useful to investors to assist in the understanding of our operating performance and the comparability of results with other companies. Reconciliation of non-GAAP measures to the nearest GAAP measure is included in our earnings release. Also, we will be making forward-looking statements during this call.
These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially from these expectations due to factors discussed in our earnings release, comments made during this call, or risk factors in our Form 10-K filed with the SEC and available on our website at investors.hbfuller.com. We do not undertake any duty to update any forward-looking statements. Please turn to Slide three in the investor deck, and I will turn the call over to Jim Owens.
Thank you, Barbara. Welcome to everyone on the call. In the third quarter, we delivered solid operating performance and strong cash flow in a weakening environment for global industrial production. Adjusted EBITDA margin of 16% improved 40 basis points versus last year. Strong cash flow performance allowed us to double our debt paydown to $97 million and increase our full year debt paydown commitment to $260 million. While share gains in Asia and Engineering Adhesives blunted the impact of slower manufacturing activity around the world. We also announced the reorganization of our company into three Global Business Units instead of the combination of two global and three regional business units, which we had in the past. This will provide better strategic clarity and growth and will enable significant cost savings and efficiencies. I'll talk more about this later in the call.
In the third quarter, we continued to drive share gains in strategic markets, including Engineering Adhesives. Our Engineering Adhesives segment grew organically by mid to high single digits this quarter and double digits year to date when excluding auto-related businesses. Strong growth in electronics and new energy markets drove the share gains. Our auto business, while negative, outperformed car builds globally this quarter and year to date. We improved our margins by leveraging lower raw material costs, delivering acquisition synergies, and controlling expenses. Raw material costs were favorable in the quarter and were down about 1% from second quarter levels. This was in line with our expectations. In terms of the Royal acquisition, benefits from this business combination continued to accrue to H.B. Fuller.
We captured an additional $4 million of cost synergies in the third quarter versus our 2018 exit rate and are on track to deliver the planned $15 million of incremental cost synergies this year. We continue to proactively implement other improvements across the company to drive business efficiencies. In total, these actions are driving higher margins and improved cash flow performance. Strong free cash flow conversion of approximately 150% of adjusted net income, combined with funds from the divestiture of a non-core business, enabled us to repay $97 million of debt in the quarter, more than double our debt paydown in the third quarter last year. We are increasing our target for total debt paydown this year to $260 million, driven by improvements in our underlying operating margin, our above target debt paydown year to date, and progress on our working capital initiatives.
This is well above our original $200 million target for 2019. Although the manufacturing sector slowed in the quarter, our performance continued to be at or above target in each of the three key imperatives we identified for 2019. These are margin improvement, cash flow performance, and share gains in Engineering Adhesives. I'll review segment performance in the third quarter on Slide four. From an overall operating perspective, costs were well controlled while share gains in strategic markets were offset by weakness across numerous manufactured goods sectors. U.S. PMI continued to trend down and dropped below 50 in August. The U.S. index was in the mid-50s through March, dropped to low 50s in April through June, and to 49.1 in August. We drove solid margin performance despite weakness in the industrial sector, which is impacting the volumes many manufacturers are experiencing. H.B.
Fuller drove efficiencies and overall cost reductions in the quarter, while at the same time, we continued to make investments and portfolio adjustments that build our capabilities in more highly specified adhesives, which is fundamental to our growth strategy. In the Americas, organic revenues were about flat on a constant currency basis. Volume trends improved versus the first half of the year, and the benefits of last year's pricing actions have now been annualized. Adjusted EBITDA margin of 16% was up sequentially versus the second quarter on higher organic volumes and favorable raw material costs. We expect organic revenue and margins in the fourth quarter to remain in line with third quarter performance, reflecting economic trends. EIMEA sales were down 7% on a constant currency basis, reflecting a continued general market slowdown in core Europe.
Eurozone PMI continued to trend lower and averaged 47 in the third quarter, compared with approximately 55 in the third quarter of 2018. We improved EBITDA margins in the segment both sequentially and year-over-year as a result of favorable raw material costs, good pricing discipline, and strong expense control. We expect that fourth quarter revenue and EBITDA will be up sequentially, reflecting the typical seasonal patterns in Europe. Asia Pacific organic sales increased 1% year-over-year, led by growth in hygiene and packaging and stable performance in China, offsetting slower results in the developed markets of Australia, New Zealand, and Korea. Asia Pacific EBITDA performance was very strong, with EBITDA margin up 370 basis points year-over-year, reflecting increased volumes, improved product mix, and lower raw material costs. In the fourth quarter, we expect continued modest organic revenue growth and year-over-year margin improvement.
Construction Adhesives organic sales were down year-over-year, largely driven by the planned repositioning of the portfolio away from underperforming products and customers. Additionally, flooring and infrastructure and utility sales were softer than expected, reflecting declining trends in private construction spending in the U.S., which were down approximately 5% from last year. EBITDA margin declined by 80 basis points compared with Q2. While lower volumes impacted EBITDA performance, the repositioning of our portfolio has improved our underlying contribution margin and reduced our manufacturing and SG&A costs by more than 5% year-over-year. These actions are strengthening this business for margin growth in 2020. We are not forecasting a strong pickup from the U.S. construction business in the fourth quarter. However, revenue and margin performance for H.B.
Fuller will improve sequentially from the third quarter as we start to realize a positive impact of the portfolio repositioning actions we took last year. Lastly, revenues in Engineering Adhesives increased by 1% organically compared with last year. Strong growth in electronics and new energy and other segments of the business continued in the quarter. This strong performance was offset by slowing results in automotive, which reflects a continued slowdown in auto production. The Engineering Adhesives business, excluding automotive, showed organic growth of mid to high single digits in the third quarter and double digits on a year-to-date basis, continuing our share gains in this key segment. EBITDA dollars increased by 22% to deliver an EBITDA margin of 21%, driven by the strong growth in the higher margin parts of our business, lower raw material costs, and good pricing discipline.
Our outlook for the fourth quarter looks about the same with strong top-line performance in electronics and new energy, muted by continued sluggishness in automotive. EBITDA margin performance in the fourth quarter is expected to continue to be strong. Before I turn the call over to John, I'd like to review a realignment in our business structure we plan to implement in our fiscal 2020 year, which begins on December 1, 2019. With this realignment, we are taking proactive steps that leverage our deep expertise in adhesives across many markets in order to increase investment in areas of strong adhesives growth while reducing cost and complexity in other parts of our business.
We have spent the past several years driving improved growth and margin and building our position in markets that provide greater rates of growth and profitability, achieving nearly $3 billion in annual revenues and EBITDA margins exceeding 15%. In our earnings release yesterday, we announced the next phase of that effort, the realignment of our business from five operating segments to three Global Business Units, our GBUs, Engineering Adhesives, Hygiene, Health and Consumable Adhesives, and Construction Adhesives. This new operating model enhances our strategic alignment across end markets and positions H.B. Fuller to develop and deliver adhesive solutions around the world better and faster and in a more efficient manner. Engineering Adhesives will remain a standalone GBU, but with a broader scope.
This business will now also include what we have traditionally referred to as the company's durable assembly business, which includes critical end markets such as insulating glass, filtration, and product assembly. Combining Engineering and durable assembly will realize significant synergies through shared technology and factories for their respective end markets with similarly high specified solutions. The Engineering Adhesives business and model of identifying new opportunities in the design and development stage has generated consistent double-digit organic growth. We expect similar results in the future. Hygiene, Health and Consumable Adhesives, or HHC, is a new GBU that we created to focus on favorable trends in sustainable packaging and hygiene. It will also allow us to put a more targeted focus on the global beauty and medical care markets, where we have a modest presence today, but have great potential for growth and margin improvement.
By strategically managing the Hygiene, Health, and Consumables business globally, we will better target and resource growth opportunities while operating more efficiently at lower cost. I'm also pleased to announce that Andy Tometich has joined H.B. Fuller to lead HHC. Andy served as the senior business leader at Dow Corning prior to and during the integration into DuPont and Dow. He has broad experience marketing and selling specialty materials into diverse end markets like packaging, beauty, construction, semiconductors, and healthcare. He's a true expert in the field, has deep relationships throughout the industry, and I'm very pleased to have Andy join our team. Construction Adhesives is already reported as a segment and will remain a standalone GBU. Construction Adhesives will continue to focus on enabling architects, builders, and construction workers to complete projects in less time, at lower cost, and with greater durability.
After a period of product and customer realignment in 2019, we expect Construction Adhesives to return to growth with higher margins in 2020. The 3 GBUs will report into Ted Clark, the former CEO of Royal Adhesives, who was named H.B. Fuller's Chief Operating Officer in August, reporting to me. As COO, Ted will drive execution of our strategy and global growth initiatives across the company. This realignment is a natural and important next step in our company's evolution. All of our market segments have global strategies and require global coordination to address opportunities around the world. Organizing ourselves into Global Business Units will enable us to execute our growth strategies faster while eliminating the cost and complexity of the regional structure.
We have seen this model work effectively for Engineering Adhesives, which, as a separate global business, has delivered exceptional results, including 14% annualized organic growth and adjusted EBITDA margin now over 20%. We are applying the key learnings from Engineering Adhesives to our other businesses so they are positioned to replicate this success. The new structure is about accelerating growth. We are more quickly identifying market trends driving demand for adhesives, streamlining decision making and resource allocation, and speeding up the pace of innovation. Another important objective is to simplify the management of our business and to continue to drive down our cost to serve customers. Through this realignment, we will be increasing direct accountability for results among our sales, technical, and manufacturing teams. By sharing processes and tools globally, we will increase the efficiency and effectiveness of our functional teams.
At the same time, we recognize the need to aggressively manage our cost structure in this challenging macroeconomic environment. As we simplify the business and leverage our global support teams, we are initially targeting savings in the range of $20 million-$40 million by 2021, with approximately half to be realized in 2020. In a challenging macro environment, these savings will support our long-term target of approximately 10% year-on-year EBITDA growth. We are in the process of finalizing plans for the new structure and will provide a more detailed view of savings and the cost required to achieve them on our fourth quarter earnings call in January 2020. This change will not impact 2019 reporting. We will begin to report our financials under the three new segments with our first fiscal quarter in 2020.
We will provide recasted historical results for 2018 and 2019 into the new segments prior to reporting our fiscal Q1 2020 results. Along with the customer and financial benefits of moving to three Global Business Units, this change will also simplify the reporting of our business for you, our investors. I'm really excited about what this new organization will do for H.B. Fuller, for our customers, and for our investors. Now, let me turn the call over to John Corkrean to review our third quarter results and our outlook for the rest of the year.
Thanks, Jim. I'll begin on slide six with some additional financial details on the quarter. Net revenue was down 5.8% versus the same period last year, driven by a stronger dollar and the divestiture of the Surfactants Business, which combined, negatively impacted net revenues by 2.5% in the quarter. Adjusting for currency and the divestiture, organic revenue was down 3% as volume growth in Engineering Adhesives and Asia Pacific was offset by lower volume in Construction Adhesives, primarily due to the repositioning away from underperforming products and customers in that segment and EIMEA. Americas adhesives revenue were about flat on an organic basis. Adjusted gross profit margin increased 40 basis points year-on-year, reflecting lower raw material costs, acquisition synergies, and favorable mix. Adjusted selling, general, and administrative expense declined about 6% versus last year, reflecting the impact of foreign exchange and good control of discretionary expenses.
Adjusted EBITDA for the quarter of $116 million was down 4% versus last year. EBITDA was up year-over-year, adjusting for currency and the lost EBITDA from the divested business. EBITDA margin of 16% increased 40 basis points versus the same period in 2018. Adjusted earnings per share were $0.86, the same as last year. EPS was up, excluding impacts from currency and the divested business, as improved margins, good expense control, and lower interest expense associated with our debt reduction offset lower volume and currency headwinds versus last year. On a year-to-date basis, cash flow from operations of $160 million was up 50% compared to the nine-month period in 2018.
This strong year-to-date operating cash flow, as well as the proceeds from the sale of the surfactants business, allowed us to pay down $97 million of debt in the third quarter, more than double the amount of debt repayment for the same period last year. Let me now turn to our guidance for the 2019 fiscal year. We now expect full-year organic revenue to be down approximately 1%, reflecting continued slowing global industrial production and a tougher operating environment than anticipated mid-year. Foreign currency translation is expected to have a full-year negative impact of 3%-4%, the divestiture of the surfactants business is expected to impact sales by about 0.5%. In total, reported revenue for the full year is expected to be down approximately 5% compared with fiscal 2018.
Adjusted EBITDA is forecasted in the range of $440 million-$445 million for full year 2019, reflecting lower organic revenue growth offset by the favorable impact of raw materials and decreased expenses. Adjusted EPS is now expected to be between $2.95 and $3.05. Capital expenditures are now expected to be approximately $80 million in fiscal 2019. We are updating our full-year outlook for debt paydown to approximately $260 million from our previous estimate of approximately $250 million. This will put our two-year debt paydown in 2018 and 2019 at over $460 million, surpassing the target we set out for this period at the end of 2017 by over $90 million. We continue to deliver solid results in an increasingly challenging operating environment, with improved margins driven by acquisition synergies and focused expense management, as well as strong cash flow driven by working capital efficiencies.
We expect both to continue in the fourth quarter. With that, I'll turn the call back to Jim Owens for some closing comments.
Thank you, John. In the third quarter, we continued to execute despite a difficult macroeconomic environment. Unfortunately, these economic challenges have only intensified since June. Additional tariffs have been introduced. Increased uncertainty from the tariffs and Brexit has affected Europe and parts of Asia, and now certain end markets in the U.S. are showing signs of weakness. Our revised full year 2019 guidance reflects all of these factors. While there are signs that auto sales and U.S. construction could be improving, we are not factoring this into our guidance. It is true that our results could be better if macroeconomic trends improve in the manufacturing sector around the world. In this challenging environment, we are delivering strong cash flow performance, improving our EBITDA margins, and increasing our share in strategic market segments.
I'm proud of our entire team for remaining focused on what we can control, serving our customers, gaining share, responding quickly to market trends, and executing efficiently. The realignment of our operating structure into three global business units puts our employees in a better position to continue to win with customers and operate more cost efficiently. We're improving our ability to understand our markets and quickly anticipate and meet customers' adhesive needs. We are aggressively managing our cost structure as we deal with the new economic realities. We're confident that simplifying our business under this new operating structure will result in a more nimble organization, well-positioned for higher growth. That concludes our prepared comments for today. Operator, let's open up the call for some questions.
We will now begin the question and answer session. To ask a question, you may press star then one. To withdraw your question, please press star then two. We will pause momentarily to assemble our roster. The first question will come from Vincent Anderson with Stifel.
Good morning. Thanks for taking my question.
Good morning, Vincent.
Morning. I know it's early to discuss 2020, if you held current trends in your head, how much margin improvement would you say your mix shift that you've seen so far this year add on a full year basis?
Yeah. I think you're right. It's a little early to talk about 2020. I do think, as you point out, our mix improvement is positive across a number of our businesses. We continue in Engineering Adhesives to improve our mix. We did some significant work on our Construction Adhesives business to improve our mix. Some of the things we're doing around the realignment of our Hygiene, Health and Consumable Adhesives, as it'll be reported next year, is also driven around improving the mix. I would say it's a positive number. I'm not ready to put a number on it at this point. Go ahead, John. You want to comment?
I would say, in general, since the last couple of years, we've probably driven 20, 30 basis points of margin improvement annually related to mix from, really with the faster-growing Engineering Adhesives business at a higher margin. I would anticipate that would be in the range that we would be targeting next year, just on mix.
That's helpful. Thank you. Then just quickly, will the pace and success of the business realignment be in any way contingent on completing your ERP investment? If that's the case, can you just remind us where you are on that from both the spending and an implementation perspective?
Yep. Our ERP investment, as some of you on the call probably know, is one that we've decided to roll out over a number of years. We're taking small chunks of the business and moving it forward. I anticipate that lasting at least another 4 years, and we've divorced that from our ability to drive these savings. Yeah, we get some benefits out of our ERP, but we have overall business intelligence systems that tie our business together. No reliance on ERP. In terms of cost, maybe John can comment.
Sure. Vincent, I'd say, in general, that's.
been about $15 million-$20 million of cost, both expense and capital, on an annual basis for the last several years. I would anticipate we'll probably stay on that pace. That's always factored into our targeted capital expenditures for the year as well.
Right. About half of it's expense and half of it's capital.
Exactly.
Yeah.
Okay, thanks. If I could sneak one more in. I think you mentioned a realignment of accountability along with the realignment of the business units. It had me thinking, can you discuss the current compensation mechanisms at the sales level for those businesses? Is your sales staff variable compensation more based on revenue dollars, or do they get compensated more on gross profit or some other unit profitability metric?
Yeah. It varies a little bit by business unit. Part of what we'll do here is standardize some of those things. Some of the synergies we're going to create by bringing these businesses together is taking out some of the complexity associated with having five segments and five different approaches and simplifying them. Broadly speaking, though, we compensate our sales group, and certainly on the variable piece, on what happens with their, we call it our contribution margin, but it's either a contribution margin or a gross margin is the predominant part. There is some revenue components in some businesses, but more contribution related than revenue related.
That's great. Thank you.
Okay. Thank you, Vincent.
The next question will come from Mike Harrison with Seaport Global Securities.
Hi. Good morning.
Good morning, Mike.
Jim, can you talk a little bit about what you saw in terms of the volume trends as the quarter progressed? It sounds a little bit like the month of June was maybe a little bit stronger, and you saw some weakening as we got into July and August. Can you maybe provide a little bit of color on how those trends may be varied by region or by specific market segment?
Yeah. Well, let me make this point, Mike. I think we saw some trends early in the quarter. I think one of the points that John brought up in his script that I think is really important is that when you adjust for the divestiture and currency, our results in Q3 showed positive EBITDA growth and about 5%-7% EPS growth. Year to date, we're showing 5% in the middle of our guidance, 5% EBITDA growth and EPS growth of about 7%-8%. What we saw as we went into the quarter was a little bit of slowing, less than what we had.
The point I've tried to make here lots of times when I've talked to investors is we have a resilient business model, and when there's a little slowing in revenue, there are levers we can pull in terms of raw material costs that we can get, and also expense controls. I think this quarter was a great example of that. We definitely saw through the quarter less revenue growth than we expected, and our ability to drive bottom-line performance in that environment, I think, speaks to the resiliency of our model and the capabilities of our team. Would've been a much better quarter if we had positive revenue growth, but in this environment to deliver those kind of numbers, I think was good. I would say we saw it early in the quarter.
It probably got a little worse as the quarter went on, but I wouldn't say it was broadly like some big decline in period seven or eight. It varied by segment. Does that help?
Got it. Yeah, it does. Also I think I was surprised to see that pricing declined year-over-year after several quarters where pricing has very consistently been higher. Is that price decline really just a signal that we're starting to see raw materials come lower and that's getting passed through to customers, or is it a signal that maybe competition's intensified or something else? Just wondering, should we expect pricing to continue to be negative year-over-year as we get into Q4 and into 2020, or what are your thoughts there?
I think the biggest component is the fact that we're lapping now the big increases we saw last year. We made some significant increases in Q2, some other sizable ones in Q3, but not as big as Q2. You're right, Mike, as raws have come down this year, we give some of that back in the market. Some of it is triggered through some agreements we have with customers, and some of it is just competitive dynamics. Generally, as raws come down, we give some of it back to customers, but less than we get in raws, and that's what we saw this year. As far as the future's concerned, some of our businesses, and especially some of our specialty products in certain segments, have annualized price increases that happen at the end of the year.
That'll be some positive momentum we'll get on price more toward the end of the year. Of course, there'll be some give backs as raws come back. It'll be a combination of the two as we go forward, but we don't expect dramatic positives or negatives in the next couple quarters related to price.
All right. Thanks very much.
Okay. Thank you.
The next question will come from David Begleiter of Deutsche Bank.
Good morning. This is Katherine Griffin on for David. First, Jim, in Construction Adhesives, directionally, how much of the decline in the business has been due to repositioning the portfolio? When do you expect the repositioning to be complete? Perhaps when could we see year-over-year comparison start to get better?
Right. Yeah, most of the decline was related to the repositioning. As I mentioned during the call, we did see some slowdown in construction spending that made up the rest of the decline. That would be what I would say for Q3. Going forward, this repositioning work went forward in earnest in the middle of Q4. You'll definitely see a better organic growth rate next quarter. Still negative, but much better than what we saw this quarter, and you should expect to see positive organic growth into Q1 of next year. You'll also see next quarter improved margins, because we'll have the full effect of this thing starting to hit, year-over-year margins in Q4, and then Q1, we should definitely see positive year-over-year margins as a result of the repositioning work.
Okay, thank you. I'm wondering how businesses have been thus far in September. Have you seen any upticks, or as you mentioned, that in Europe you get seasonally better demand maybe coming out of August, or if construction-related markets have improved, if some of the decline in activity over June through August was due to weather? Where are we thus far in Q4?
Yeah, we're three weeks into our Q4. I would say, what we said in the script was our guidance is based on continuation of every trend that we see. You can find a few pieces of data that are out there. Auto sales are, even when they're negative, they're better than auto builds have been. Housing starts are picking up. There's a few pieces of data out there that are positive. I wouldn't say that we're predicting some big upturn. We don't see a lot of negative things happening here as we go into P10. I think we're projecting flat, and we don't see things that necessarily get us off of that, certainly not in a negative direction.
Great. Thank you.
Yeah.
The next question will come from Ghansham Panjabi of Baird.
Thank you. Hey, guys. Good morning.
Hi, Ghansham.
Hi, Jim and John and Barbara. I guess first off, on the Engineering Adhesives segment, clearly it's been a workhorse in terms of growth and profitability over the past several quarters. Jim, you called out autos as being particularly weak, at least specific to 3Q. Autos have been weak for a while in terms of the production schedules on a global basis. Can you just give us some more context as to where exactly you're seeing weakness, maybe from a regional standpoint, auto parts? Where are you actually seeing the weakness?
Yeah. I think you bring up a good point. I mentioned this briefly last quarter. I reread the script. Our organic revenue growth in EA last quarter was +11%, that was with a big drag on auto. Underlying, we were a lot better than 11% ex auto. We're seeing similar trends, I think, in auto in Q3 versus Q2, though worsening in some other areas. I think China's latest reported numbers are -12.2% or something, is what I saw on the last reported numbers. There's a big decline year-over-year in auto, and we've felt it, as you point out, throughout the year. Our numbers are a little better than what we see in the auto builds, and that's because of some share gains, but big negative numbers pull down your total number.
In terms of our business, think of our business as tied to things like interior trim applications, headlamp applications. Where some of our growth is, it's things related to more electronic vehicles where we've got some tie-ins. We're tying our electronics business into some of the auto wins. Think about it in terms of interior trim, headlamps, and then electronics is the growing share piece of the business. Usually Tier 1 suppliers.
Got it. No, that's helpful. Then just related to the EA segment, in terms of new project activity at the customer level, have you seen any deviation from the trends just based on what we're seeing, obviously, on the macro and just continued uncertainty more broadly?
Yeah. Well, the wins are fantastic. This team continues to go from strength to strength. We got some of the early quick wins with the Royal integration last year and early this year. There's a couple of the bigger Royal integration wins that are in the pipeline Q4 and into 2020. Yeah, a lot of momentum with that team. I think there's new applications we're winning. There's an expansion globally in that business. If you think about the acquisitions we made and the business we've had, it was China, U.S., core Europe centric. We're doing a good job of bringing that business now and growing it nicely. In India, we're getting some growth in that business, in Korea. Yeah. Bottom line is, yes, a good pipeline of wins underlying it.
Just finally, a two-part question. Just on the EBITDA margins for the Americas segment, did that come in where you thought it would? It was below our forecast and also the year-over-year margin trend over the past five quarters. Then lastly, on the segment realignment and the $20 million-$40 million in cost savings that you referenced, can you just give us some high-level buckets as to how you expect to get those savings? Thanks so much.
I think the Americas margin was broadly in line with what we expected. I think it was up sequentially versus Q2. Maybe why some people's estimates were off is they were comparing it year-on-year to Q3. I think that's a business you want to look at sequentially. We expected margins to tick up. They did in the quarter. Our long-term goals are to stay in that 16%-18% range in that business. We want to see it up in that 17%-18%, not the 16%-17%. It was a positive uptick, and as I mentioned in the script, a nice uptick in the volumes quarter-over-quarter, driven by some wins in our consumables business. The second question?
Was on the cost savings, $20-$40 for 2020, the realignment plan, the buckets associated with that.
Yeah. Maybe, again, we're doing the work right now on that. I don't want to get into too much detail about where it's coming, but fundamentally, I think you can see where it's coming from. The fact that we have three segments instead of five creates, in and itself, eliminates some redundancies. Part of the strategic positioning is to make certain we focus our resources on the real growth opportunities. Where there's areas that we have resources that aren't focused on growth, we're going to find a way to trim some of those resources. The other thing is that on a corporate level, we had a level of complexity in all of our corporate functions, managing a combination of regions and global businesses. On a corporate level, we're able to trim some costs as well.
I think there's things that naturally come out of this realignment, and whenever you go through a process like this, it's a chance to reexamine everything you spend money on, and we're going to do that as well. I think those are the buckets, but we think there's sizable numbers there, and we look forward to reporting out the details of that next quarter, and we'll give you a very clear picture piece by piece.
Thanks so much, Jim.
Thank you.
The next question will come from Dmitry Silverstein of Buckingham Research.
Good morning guys. Thanks for taking my question. A couple of questions, if I may. First of all, you completed a small acquisition of, I think, a Carolina-based company towards the end of May. Basically at the end of the second quarter in Construction. Did it have any contribution in terms of revenue or margin, positive or negative for the third quarter? Do you expect something more or less for the fourth?
Yep. You read every detail, Dmitry. Very impressive. Yeah. That actually was a distributor relationship that Royal had in North America in the insulating glass business, and we integrated that within the company. The impact in the quarter was minimal in terms of both the revenue and the EBITDA performance.
Okay, got it. It was basically a customer you were selling to that you now own.
Right. Exactly. We brought all the capabilities, resources, et cetera. Yep.
Got you. How much of tea leaf reading should I be doing here in terms of you buying a distributor? Is this something that could be a beginning of a longer-term trend for you, or is this a one-off?
No. To talk about the specifics there, short answer is no, it's not a long-term trend. We, in our insulating glass business, sold direct in the U.S. Royal, when we bought them, sold direct in Europe, but through this distributor in the U.S. We had a conflict between the Royal business and ours that we had to resolve. It was about resolving that conflict in the market.
Got you, Jim. Thank you for that. Just to follow up on an earlier question on pricing. It was down a little bit, and I understand the reasons why. Obviously, competitive environment, raw material pricing is coming down, so you have a little bit more room to keep the businesses you want to keep. Were the price declines either concentrated in any one region or any one division or business unit, or were they pretty broad-based?
Yeah, I think every business showed either less price increase or a slight price decline versus last quarter. Yeah, it wasn't concentrated in any single business.
Okay. I understand your question on Americas as an EBITDA. This was the first time in over a year that we saw a down year-over-year EBITDA margin for that business. What does that signify?
What does that signify? Yeah. I think what you saw last year was an exceptional jump, Q2 to Q3, because we put forth a really strong price increase in Q2. We were rebalancing our volume and our position with customers. I think it's reasonable to expect upticks sequentially, but year-over-year, we had a special third quarter last year, is the way I'd look at it.
Yeah. Actually looking at it now, you almost hit 18% margin in that quarter on the EBITDA line. Yeah, you were going up against a very tough comp. Okay. Final question, Jim. You maybe touched on this. Maybe you can provide a little bit more detail. In this realignment, which, by the way, great that you guys are doing it. I think simplifying, obviously, operating structure and managerial structure is key to getting your SG&A in order. Besides short-term gains of this $20 million-$40 million in cost savings you're going to generate over the next couple of years, what are some of the more sustainable mid-to-long-term benefits of this realignment, and how do you see these businesses performing in the new format and under more perhaps direct management control going forward?
Well, thanks for the feedback, Dmitry, I think you're right. It's really, really good for our company. You've followed us a long time, you understand the complexities that we had and how we had to move forward. I tried to make this point in the commentary. The biggest benefit to this are around growth. What we've done in Engineering Adhesives is we've been able to identify trends in markets then allocate resources aggressively toward the growth opportunities. We see those in our other businesses, the regional structure sometimes got in our way. That's both in terms of a new sustainability initiative that's coming down the road that we can put resources on, a new thing that's happening in the hygiene world that we see an opportunity, as I mentioned, the medical adhesive space, right?
Those are all things that I would say today we aren't aggressively putting resources behind, that we'll be able to in the future. I think the biggest change. It's also geographic. In our Engineering Adhesives business, they pick the geographies they want to go after based on where the world's moving, and our current structure in some of our businesses, because we're regionally managed, we have resources there that we can't shift as well. I think the real opportunity is around sustainable growth and ability to tackle big growth initiatives. The cost benefits are very intuitive. They come from workout exercises. They come from allowing us to simplify our businesses.
I'd say the third piece, Dmitry, is we're going to have three businesses that while they're unique in how they go to market and the markets they go after, we can have some standardization of processes which also drive cost efficiencies and simplicity so that people are focusing on the mission, which is just serving customers. Hopefully that answers your question, but there's a lot of benefits to this on the output side. Yeah.
Okay, Jim. Thanks a lot. Thanks for that response. That's all I have. Thanks.
Yeah.
The next question will come from Eric Petrie of Citi.
Hey, good morning, Jim.
Morning, Eric.
You showed nice margin improvement of 400 basis points in Engineering Adhesives. I wanted to ask, are margins different or relatively similar across regions?
Yeah, I would say, we look at those by the end segments. I think you're asking about regions within Engineering Adhesives.
Right
the shift that we're talking about is not a regional shift. It's a shift toward more higher-end market segments. Regionally, I would say, it depends on which segment we're strong in, but in any given segment, we're similar. Electronics margins are similar across the regions. Automotive margins are similar across the regions. Hopefully that answers your question.
Okay. You commented on medical being an end market growth opportunity. Should we think of the ramp in that segment similar to engineering, where you have to be specced in, or what kind of lead times to recognize revenues and profitability should we expect?
Yeah, I think you can think of it in terms of maybe not all of Engineering Adhesives, but what we saw in the electronics business. Think about what we did within Engineering Adhesives. We started with electronics. It was a business, actually, when we started, about the size of our current medical business, and then we put lots of investment behind it, and we were able to grow, sizable growth. Still very early days for me to be committing, but that's what we're looking at. I don't think you're going to see some big impact from our medical and beauty business in 2020 in the overall corporate numbers. Two or three years from now, I think it'll be something you'll hear us talking about having a sizable impact. Go, John.
I think to your question on the ramp and getting specced in, I would say it is more similar to electronics business than some of our other businesses. That's one of the reasons, and it is higher margin, and it is more sticky. That's one of the reasons we like it as well.
Okay. Lastly, do you see any risks to your revised guidance, in terms of regional? Does Europe or China keep you awake at night, or how should we look at downside risks to guidance?
I think when we look at what happened this quarter, it was certainly a lot worse than we expected going into Q2. I think when I look at Q4, I don't see a precipitous downturn from that. I see certainly even. As I mentioned, you could, if you wanted to, point to some things that are very positive that could make it a lot better than that. We don't see a lot of downside to this, I think would be the fair answer.
Okay. Helpful. Thanks, Jim.
The next question will come from Jeff Zekauskas of JPMorgan.
Thanks very much. You're moving from a regional business model to more of a global functional model. Are exports a large part of your business, like of the $3 billion revenues that you have, how much are export revenues?
Yeah. I wouldn't call it a global functional model. I think exports are a very small part of our business.
Right.
Yeah. I think the way to think about our business and why this is really important is, decisions are made in one part of the world that drive revenue in another. If you're in the electronics business, decisions made in California are driving revenues in Asia. Equipment manufacturers that sell packaging equipment around the world specify new packaging that ends up being sold all over the world. It's driving off of the strategy of where are business decisions made. Oftentimes, they're made in one part of the world, and the revenue is in another part of the world. That's why that's really important for our business.
The theory is you have regional managers and you have functional managers, and what you think is You want to blend those two strengths. Is that it? Downsize it?
Yeah, I would say the way to think about it, Jeff, is we have global strategies regionally executed, and that's the way we run our Engineering Adhesives today, right? We have a global aerospace strategy, a global electronics, a global auto strategy, and then it's executed in each one of the regions. That's what we're going to do more in Hygiene, in packaging, in health and beauty. In the past, we sort of had it backwards, right? We were building these global strategies, but the leadership was all regional. It's global leadership, global strategies, regionally executed, but regionally executed within those businesses. I'm not going to have a regional execution across the businesses. There's going to be a regional leader for Europe in each one of those businesses. Hopefully that helps.
Yeah. Lastly, the decremental margins in Construction Adhesives were really pretty large, and I had thought that had been an area where you had rationalized some of your plant functions. You had some newer plants, and you had closed some older facilities, which I thought would have lifted your, or been a positive in terms of EBITDA growth. Can you talk about why the EBITDA drop is so large relative to the revenues, and what have you done on the cost side positively in that area?
I'll let John comment further. I'm not sure if I understand your question. I think we've improved. It's a high incremental margin business, and as you point out, we've improved it incrementally. The problem is when you have negative revenue, then the impact on your EBITDA is even greater, right? When you have high margin businesses that are down, which we've got, now as they grow again next year, you'll see very positive increments. Yeah, it's a sizably positive incremental margin business, which is one of the reasons we really like it strategically. In terms of cost reduction this year, I mentioned in the script, we've got a 5% year-over-year reduction in total SG&A and manufacturing in that business. We pulled out a lot of costs. That's a combination of shift reductions at plants.
We've taken some resources that were focused on product lines and customers that weren't profitable. We took those out of the business, and we closed a facility last year. We did do a lot of cost work as we restructured.
Okay, great. Thank you.
Go, John.
If you look at the contribution margin, sort of the underlying revenue minus material cost is up versus last year related to this repositioning of the portfolio. I think if you look at the cost takeout and the underlying margin improvement, it is really getting weighed down by volume, but I think we have a much healthier business as we start to annualize that and add volume next year.
Yeah. I think your overall point that this is a high incremental margin business is true.
Yeah.
We need to get it growing so that we can see the benefits of that.
Okay, great. Thank you so much.
Thank you.
The next question will come from Rosemarie Morbelli of G. Research .
Thank you. Good morning, everyone.
Good morning, Rosemarie.
Jim, you mentioned auto being down, and based on what we read and what we hear, it sounds as though auto build might be stabilizing, but it also sounds as though heavy truck and ag equipment are beginning to show some slowdown. Are you involved in those particular applications as well, or is it mostly auto?
Our exposure to heavy truck and equipment is much smaller than our automotive. Yes, we sell into those markets, but it's very small incrementally.
Do you see a change in the recent trend in that particular area?
In that particular area. Yeah, I think, again, the external data says that there's a slowdown, especially in the U.S. and some of the ag equipment, but I don't have a good read through, Rosemarie, early, but I think the overall market data is out there on that area. In terms of your comment on builds, I don't think there's any data that shows builds are moving. There is some data that shows that sales aren't as bad as builds, so that would imply that builds are going to get better. No data yet that builds are moving that I've seen.
Okay, thanks. You mentioned that you started electronics at a very small level, and this is the same situation for medical. Can you remind us, or at least me, the size of electronics when you started and what size it is today?
Yeah. That's not something we typically share publicly on the sub-segment level, Rosemarie, but I think I've said in the past it was low tens of millions of dollars when we started, right?
Has it doubled? Tripled?
It's grown very significantly.
All right. Then lastly, if I may, on the Construction business, is that remaining a solely U.S. business, or are you planning in expanding it globally?
Yeah. Well, we want to get it running really, really well in the U.S. There are definite global opportunities with the portfolio we have. The roofing business we bought from Royal has some clear and short-term opportunities in other parts of the world. We do have a piece of that business that's in Australia. Yeah, I think in the long run, we think that the technology and the approach we have has a global presence, but that's not our short-term priority. Our short-term priority is getting back to growth and expanding the margins in 2020.
Okay. If I may, again, if I look at your 2020 targets by the different segments, if we bunch all of those up based on the new segmentations, are we looking at similar targets? Because of the current environment, there is no way you are going to get to those numbers?
Yeah, I think what we said at the end of last year, Rosemarie, when we reestablished the targets is, we think we have an opportunity in this business to grow our EBITDA by 10-ish%, which would imply a higher than that, maybe 15% EPS growth over the next few years. We're building our plans with those ideas in mind. It's a slower world, might have to get more cost out, but that's what we're looking at in terms of our future over the next few years.
All right. Thank you.
Thank you.
The next question will come from Paretosh Misra of Berenberg.
Great. Thank you. In your Engineering Adhesives business, how much is currently automotive?
Yeah. Again, we don't describe that out publicly, but I think the thing we have said is it's a little over 5% of the overall company is our auto exposure.
Got it. For the rest of the Engineering Adhesives portfolio, what would you say is the right growth rate, organic growth rate in the current environment? Like is high single digit achievable?
Yeah, certainly that or better. I think our average for the year is double digit. We're getting a lot of wins in that business. All those markets are slowing down, as you saw in Q3, but it's also a lumpy business. Some of these things come in from quarter to quarter. I would say ex auto, we're delivering double digits, and even in this environment, that's our expectation overall.
Got it. Fair enough. Moving on to Construction, and I'm sorry if I missed that, but can you quantify, maybe just ballpark, how much revenue this year you think you lost because of portfolio actions you took?
Yeah. I think we said, in this quarter, it's more than half, not even a little more. The majority of it is in the portfolio mix, and the rest of the shortfall this quarter is because we saw a sizable decline in construction spending versus what we saw last quarter.
Got it. Last one from me. For Q4, what's your raw material assumption?
Yeah, we're assuming raw materials are flat. I think there's generally a little more favorability across the batch, but there are certain materials that are going up. Overall flat.
Flat to Q3.
To Q3. Not the prior year to Q3.
Understood. Thanks guys, and good luck with everything.
Okay. Thank you, Paretosh.
The next question will come from Christopher Perrella of Bloomberg Intelligence.
Good morning. A quick question. In terms of the order book across the businesses, and maybe it varies depending on the end markets, but what's your visibility in your orders for the next couple of months? How far out does it extend?
Yeah. Customers in our business, most of them order a month in advance or less. It's a two to three week lead time business. It varies a lot by business and by market.
All right.
Now we do have a lot of visibility on our wins and our business overall, but actual orders was your question, and that's the timing on that.
Okay. With the accelerated debt pay down ahead of schedule, and I know you have the target for next year that you're looking, the leverage ratio that you're looking for. I guess, is the pace of debt pay down going to slow going forward, once you get through this year, and what does that free up in terms of cash?
Yeah, we've got a very aggressive view on what we need to do on debt pay down. I think we made a great acquisition in Royal. We levered higher than we would normally do, and our view is that's a key priority for us and for our investors. You'll see in all kinds of environments us taking the steps necessary to drive debt pay down, not just along the commitments that we've just up for this year, but also we expect aggressive pay down again in 2020.
All right. Thank you very much.
Yeah. Thank you.
This concludes our question and answer session. I would now like to turn the conference back over to Jim Owens for any closing remarks.
Okay. Well, thanks everybody for your time today. It's been what I see as a very positive result in a tough environment. We're committed to deliver for our investors, and I think our next step in our realignment of our business will also show a very positive step. Thanks for everybody's time today.
Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect. Have a great day.