Good morning, and welcome to H.B. Fuller's Fiscal 2020 Second Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Barbara Doyle. Please go ahead..

Good morning, and welcome to H.B. Fuller's fiscal 2020 second quarter earnings call for the fiscal quarter ended May 20, 2020. Our speakers 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 questions.

Please let me cover a few items before I turn the call over to Jim. First, a reminder that our comments today will include references to non-GAAP financial measures and references to organic revenue, which excludes the impact of foreign currency fluctuation and the impact of acquisitions and divestitures.

On this call, unless otherwise specified, discussions of sales and revenue refer to organic revenues, and discussions of EPS, margins or EBITDA refer to adjusted non-GAAP measures. These measures are in addition to the GAAP results in our earnings release and in our Forms 10-Q and 10-K.

We believe that discussion of these measures is useful to investors to assist 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. Many of these risks and uncertainties are, and will be exacerbated by the COVID-19 and any worsening of the global business and economic environment as a result.

Actual results could differ materially from these expectations due to factors discussed in our earnings release, comments made during this call or risk factors in our Form 10-K filed with the SEC and available on our Web site at investors.hbfuller.com. Now, I will turn the call over to Jim Owens..

Thank you, Barbara, and welcome to everyone on the call. Last evening, we reported strong results for our second quarter. Solid revenue performance, lower raw material costs, restructuring savings and operational efficiencies across our business drove EBITDA of $101 million in the quarter, which exceeded our expectations.

Cash flow also continued to be strong in the quarter, with year-to-date cash flow from operations up 40% versus last year. Our robust cash flow performance keeps us on track for our full-year debt paydown plan of $200 million. Our results reflect H.B.

Fuller's leadership in the adhesive industry, the vital nature of adhesives in essential products, and the culture of collaboration we've created with employees, suppliers, and customers around the globe. The H.B.

Fuller team proactively addressed challenges presented by the COVID-19 pandemic, and gained market share while reducing costs and keeping employees safe as we successfully applied what we learned from the outbreak in China to our operations in the rest of the world. Throughout the quarter, all of H.B. Fuller factories were open and operational.

By rapidly implementing health and safety protocols and business continuity plans around the world, we were able to successfully protect employees, maintain efficient operations, and deliver products to customers.

We also found new ways to collaborate, internally and externally, and accelerate customer wins and internal productivity during this period. Over the past several years, we have invested in electronic and virtual collaboration tools that have proven invaluable during this period.

We leveraged these investments to facilitate fast decision-making, maintain high levels of customer service, and develop new customer relationships. In several cases, we shortened the sales cycle through virtual product trials. Sales trends during the second quarter were in line with the expectations we provided in our Q1 call.

Sales levels varied around the globe and by market segment, but overall were down in March, and weakened into April and then May, and have shown improving performance in the end of May and June.

We successfully met increased demand for certain markets in hygiene, health, and consumable adhesives, which were up 7% organically in the quarter, including double-digit growth in a number of end markets.

HHC Adhesives sales surged in March, were strong in April, and moved back to more typical levels in May, as customers moved towards more normalized inventory levels.

End markets in Engineering Adhesives experienced the biggest impacts related to the pandemic, reflecting the significant downturn in global production as countries locked down during the quarter. The biggest impacts were in transportation end markets and for construction-related goods such as insulation glass, panels, and woodworking.

With positive volume growth in new energy in technical textiles, we expect improving sales performance in Engineering Adhesives in the third quarter as global production begins to ramp up.

Construction Adhesives had a good start to the quarter in March, and activities slowed in April and May as contractors and distribution channels minimized inventory, given the reduced ability to access building interiors and overall uncertainty in the construction industry.

As building permits have started to pick up in May, we are seeing increased project activity and order volume in June, especially in roofing. Results varied by geography, as China saw strengthening performance and an overall organic growth of 1% as performance strengthened in all segments throughout the quarter.

Latin America and the Middle East felt the COVID impact later than other regions, and are not seeing a recovery in June. We expect these regions to see improved year-over-year trends later in Q3.

Despite significant negative impacts from the pandemic on several end markets, our total organic sales declined by 7%, which we believe is better than the overall performance of our end markets.

This performance reflects the broad diversity in our customer base and products, and our capabilities to meet technical adhesive needs of manufacturers around the world.

Meeting the supply assurance and operational needs of our customers more effectively than competitors enabled us to increase share in several markets over the quarter, which will improve revenue performance going forward.

In addition, benefits from raw materials, restructuring efficiencies, and rigorous cross management supported strong EBITDA and cash flow. Raw material costs continued to move lower in the quarter supporting Q2 margins and strong cash flow. We expect further declines in raw material purchase prices through the rest of the year.

From a P&L perspective, this will deliver a more favorable benefit in the second-half of the year. We reorganized into three global business units at the beginning of the year which is helping us win with customers and execute more effectively.

The organizational realignment is expected to generate $35 million of total annualized savings, of which $25 million to $30 million will be realized in 2020. We delivered $7 million of SG&A savings in the second quarter from these projects.

We continue to proactively asses our business for additional efficiencies, and in the second quarter we initiated a review of the company's manufacturing operations and supply chain, utilizing the support of an external consultant.

The goal of this phase was to identify opportunities to streamline and improve efficiencies in our large facilities, to establish a roadmap towards site consolidation, and to accelerate our inventory reduction strategy to improve supply chain planning.

Based on the specific projects identified, we are initially targeting $20 million to $30 million in manufacturing cost savings from these initiatives. We expect these savings to have a small impact in Q4 of this year, ramp up in 2021, and reach full-year run rate levels in 2022.

We are also targeting an inventory reduction of approximately $25 million through these initiatives. We're in the process of finalizing these projects, and will provide a more detailed view of savings, timing, and the cost required to achieve them during our third quarter earnings call, in September of 2020.

As a result of the proactive steps we have taken to serve customers during the pandemic to address new business opportunities, and to drive savings and efficiencies in our cost structure, we will be a stronger company, better positioned to grow as the global economy recovers.

Now, I'll move on to our segment results in the second quarter, on side four. Organic revenues in Engineering Adhesives declined by 20%, driven by the impact of COVID-19 among end market demand. Automotive and transportation related markets were the hardest hit, while new energy and technical textiles showed good volume growth in the quarter.

Adjusted EBITDA margin of 14.9% was lower than last year driven by volumes, but up 250 basis points versus the first quarter on lower raw material costs and restructuring savings. We continue to see strong profitability improvements in Construction Adhesives despite construction activity being impacted by COVID-19.

Organic Construction Adhesives revenue were down 15% in the quarter, with declines in both the roofing and flooring businesses. Retail channels remained strong for do-it-yourself activity, but contractor work decreased dramatically. Utilities and infrastructure business grew by mid single digits.

Construction Adhesives' EBITDA margin of 17.7%, was up 140 basis points year-on-year, reflecting new product solutions and improved product mix related to last year's portfolio repositioning, as well as operational improvements from the restructuring.

The underlying operational improvements in this business position us for strong margins in this segment as construction activity resumes. Organic sales in Hygiene, Health, and Consumable Adhesives were up 7% year-on-year in the quarter, with double-digit growth in hygiene, packaging, tape and label, and health and beauty.

Some of the favorability early in the quarter was related to temporary inventory build, however increases from changes in consumer behavior associated with more eat-in-the-home and work-in-the-home trends are expected to be longer lasting.

We'd also note that some of the growth in Q2 is related to market share gains associated with being in a superior position to meet customer needs during the crisis, and that affect will also be longer lasting.

HHC segment EBITDA margin of 14% improved 70 basis points year-over-year, driven by strong volume, favorable mix, lower raw material costs, and savings from the restructuring of the business. Our planning assumptions for the third quarter have been developed in an environment that continues to evolve and is difficult to predict.

COVID cases are escalating in Latin America and India, and there is uncertainty of new case trends as other countries open up, and the recessionary impact of COVID is still unclear.

Our core planning assumption is the COVID related shutdown impacts will continue to abate, but recessionary forces will result in economic contraction in the third quarter, which will likely extend into the fourth quarter this year.

We expect the second quarter will have the most acute impacts from COVID-19, with sequential improvements in the third and fourth quarters. Elevated demand for hygiene and health products, packaging, paper tissues, and towels will likely continue through the year as consumers continue to spend more time in their homes.

HHC growth will moderate in the second half of the year from second quarter levels as surge buying dissipates and manufacturers work down inventory levels. Strong revenue performance in construction adhesives during the first quarter continued into the early part of Q2, but slowed dramatically in April and the first part of May.

Our forward orders for construction adhesives improved over the last month resulting in increased demand in June, and we expect this level to continue through the third quarter. In total, we forecast construction adhesive revenues in the third quarter will be down versus prior year, but down less than in Q2.

Likewise, engineering adhesive demand has picked up throughout the last month. While we expect continued soft demand versus 2019, we are seeing improved top line and profit performance relative to Q2. Transportation-related industries will be weaker than other segments such as electronics, new energy, filtration, and textiles.

We anticipate the demand for the transportation, durable goods, and construction-related markets will start to improve in the third quarter supporting sequential improvement in engineering adhesive volumes as we exit the year.

Raw materials benefited margins in the second quarter, and we continue to plan for lower raw material cost over the rest of the year. This will be driven by supply demand dynamics. Improving volume trends, lower raw material costs, and reduced working capital requirements will enable us to drive strong cash flow.

This supports our plan to pay down debt $200 million this year and to pay dividend of approximately $34 million which H.B. Fuller raised in April for the 51st consecutive year. While the economic backdrop continues to evolve, our new organization has enhanced our line of sight into our three businesses.

This improves our visibility and fosters our bias for action. As we demonstrated in our first half results, we are executing our strategy well, our operations are nimble, and we have multiple levers to deliver strong results in a fast-changing environment.

Now, let me turn the call over to John Corkrean to review our second quarter results and our outlook for the fiscal 2020 based on these planning assumptions..

Thanks, Jim. I will begin on Slide 5 with some additional financial details on the second quarter. Net revenue was down 11% versus the same period last year. Currency and the divestiture of the surfactants and thickeners business had a combined negative impact of 4%.

Adjusting for currency and the divestiture, organic revenue was down 7% with almost all of the decline related to volume. We started strong volume growth in HHC with organic sales up 7% year-on-year offset by the impact of COVID-19 on engineering and construction adhesives.

Year-on-year adjusted gross profit margin was 27.7%, down versus last year on lower volume associated with COVID-19, but up 120 basis points versus Q1 on raw material savings and efficiency gains.

Adjusted selling, general, and administrative expense was down 10% versus last year, reflecting actions related to the business reorganization announced last year, lower travel expense, lower variable compensation as well as general cost controls.

Adjusted EBITDA for the quarter of $101 million was above the high end of our planning assumptions reflecting slightly lower than expected raw material cost and higher expense reductions including savings from our restructuring actions.

Adjusted earnings per share were $0.68, also slightly higher than expectations reflecting lower than expected raw material cost, high expense reductions, and lower interest expense associated with our debt reduction actions and lower interest rates.

Year-to-date cash flow from operations of $108 million increased by 40% compared with the first half of last year based on continued improvement in working capital performance. This allowed us to continue to reduce debt, paying off $45 million of debt in the quarter; slightly more than last year keeping us on track for full-year debt pay down plan.

Regarding our outlook based on what we know today and the planning assumptions that Jim laid out earlier, we anticipate revenue to be down 5 to 10% year-on-year and EBITDA to be between $95 million and $105 million in the third quarter as disruption and recessionary forces are offset by a continued decline in raw material cost, low SG&A, and restructuring related savings.

We expect cash flow to continue to be strong for the remainder of the year, given the lower expected working capital requirements associated with reduced demand as well as higher anticipated raw material cost savings.

This is allowing us to maintain our target to pay down approximately $200 million of debt during 2020, keeping us well ahead of our original deleveraging plan laid out in late 2017 with $40 million to $50 million of debt pay down expected in Q3. Additionally, we continue to have more than adequate liquidity to meet any foreseeable needs.

This includes a $400 million revolving credit facility with a built-in accordion feature that allows us to upsize the facility by $300 million if needed. We also have ample room under our debt covenant, even using the most conservative scenarios. With that, I'll turn the call back over to Jim Owens for some closing comments..

Thanks, John, our strong performance through the first half of this year is a testament to the importance and diversity of adhesives in our world, the agility of our team and the resilience of our margins and cash flows in recessionary environments. Our nimbleness and robust global operations have been crucial differentiators for H.B.

Fuller during this crisis, and they will continue to be sources of competitive advantage going forward. We anticipated challenges and we responded to events quickly, activating alternate work arrangements, implementing health and safety protocols to ensure the protection of our employees and communities and reinforcing our supply chains.

By doing so, we have been able to assure customer service and product deliveries, including considerable demand in the HHC segment. Customers know that H.B. Fuller delivers when they need us most, and we're a stronger company today than we were six months ago with a better focus, global coordination and lower cost to serve customers.

Our new organizational alignment has improved our ability to respond rapidly to end market conditions, and efficiencies from the new structure will deliver $35 million in SG&A expense savings.

We're driving additional productivity gains from the next phase of project; this time to streamline operations and better leverage our global factory and distribution network and supply chain. We estimated an additional $20 million to $30 million in cost savings from these projects along with approximately $25 million of inventory reduction.

This crisis has required us to work smarter and more creatively than ever before.

We have leveraged our technology investment to deliver extraordinary levels of collaboration with customers during this period, and we continue to invest in our future, including innovative, sustainable adhesive solutions in each of our segments that help reduce packaging and waste, reduced energy requirements, and our customers end applications and improve daily life to highly engineered products.

Significant social health and economic challenges remain ahead of us. H.B. Fuller is up to the task. We have proven our ability in these extraordinary times to serve our customers, outperform our competitors and deliver strong business results.

We remain committed to ensuring delivery of adhesive for goods that are central in our world to taking actions that protect the health of our employees and to extending support to build our communities as we solve the world's effusion challenges. This period of change provides continued opportunities to differentiate H.B.

Fuller as the world's largest dedicated provider of adhesives. We are well-positioned to continue creating significant value for our customers, our shareholders and other stakeholders by solving the world's adhesion challenges better and faster than our competitors. That concludes our prepared remarks today.

Operator, please open up the call so we can take some questions..

We will now begin the question-and-answer session. [Operator Instructions].

Okay. The first question is -- I'm sorry.

Can you go with the first question, Operator?.

Yes. Our first question will come from Ghansham Panjabi with Baird. Please go ahead..

Thank you. Good morning, everybody. I hope that each of you is doing well..

Good morning, Ghansham..

Hey, Ghansham..

I hope you're doing well too. Thanks..

Thank you, thank you.

So I guess first off, maybe you could just quantify for us organic sales as the quarter unfolded in 2Q, and just give us a sense of what the run rate is thus far in June on a year-over-year basis? Would you be able to do that?.

Yes, I don't think we're giving that level of detail by month, but I would be very clear with you, Ghansham, that we started off because the shutdown happened in May, that things weakened -- I'm sorry, it started in March, outside of China of course. That generally speaking, things weakened in March.

April got worse, May was the weakest quarter, but we saw -- and we've set up a set of weekly metrics, so we're studying this on a week-by-week basis in each one of our businesses, and certainly as we ended May and went into June we saw a turn in demand overall for the company.

As I pointed out in the prepared comments, this is a cycle that's happening around the world. Certainly China is two months ahead of what we see in the U.S. And as I pointed out, China's strengthened all through the quarter.

So the comments I was just making were really predominantly related to North America and Europe, and then places like Latin America and the Middle East, they saw a little different curve and they were definitely a month to a month-and-a-half behind what we saw in the rest of the world, but we gave that range of 5% to 10% for next quarter, and that's very much based on a lot of visibility into this month, which we're four weeks into today.

So I think you can imagine where we might be as a result of that, but we don't typically give out weekly or monthly sales. So hopefully that gives you enough color though, Ghansham..

Yes, that's very helpful, thanks so much, and then just based -- just on that, I guess I'm curious as to why wouldn't EBITDA for 3Q be better than in 2Q on an absolute basis? I mean I know HHC is moderating a little bit, but there should be some net mixed benefit just given the recovery in EA, restructuring savings, you talked about raw material costs being lower.

I know there's a little bit of seasonality 3Q versus 2Q, but are there any other negative offsets we should consider?.

Yes, I think the biggest issue is the seasonality, as you pointed out. So we're trying to look more year-over-year, and certainly the year-over-year results are getting better every single week, and we see that happening through this quarter.

The mix is going to be definitely more positive for us, but we are having a little bit of the HHC moderation that I mentioned, right. So HHC wasn't as strong ending the quarter. I think there was a little bit of inventory build, so it's -- HHC probably won't be up 7% as we look at Q3.

So I think it's that mix that plays out in that range, and but -- John, maybe you want to add a little something on the EBITDA?.

Yes, I think you hit all the key items, other than SG&A was probably a little bit lower than it will be in Q2 than it will be in Q3, just travel is down dramatically. So we do have some variable comp true-up that happens in Q2. So I think SG&A will be slightly higher in Q3 than Q2..

So, John, just to clarify, would decremental margin 3Q year-over-year be better or worse than what you delivered in 2Q?.

Margins should be better in Q3 than in Q2. Gross profit margins and EBITDA margins should be similar..

Thanks so much. I'll turn it over..

Okay, thanks, Ghansham..

Our next question will come from Vincent Anderson with Stifel. Please go ahead..

Yes, good morning, and nice job on the quarter..

Thanks, Vincent..

Yes. I was hoping you could -- I know you said you're going to discuss this in more detail next quarter, but just a quick clarification on your comments about site optimization and your increased cost saving target.

Is this more about shifting production locations to optimize logistics or is there a potential for existing some assets and maybe even potentially some lower margin product lines?.

Yes, there's really three elements to the plan. The first is productivity improvements, especially in some key plans. So I think there's some learning and fundamentals around OEE downtime and productivity enhancements that's not only going to save us money but improve capacity, which helps us from a capital standpoint.

The second piece is on asset consolidation. So some of that might be plant closures, and some of it might be consolidating production -- or product lines to certain facilities. So that's a second part of it, and then the third is our SNLP planning.

Certainly the move toward more of our facilities on SAP, and just some of the tools around the SNLP are things that we think we can leverage that are going to create a level of savings, but also help unleash some of that working capital that we see as an opportunity for us.

So it's all three bucket, and obviously the first one will come sooner than the second one in terms of timing, but we're definitely looking at all three..

That's helpful, thank you. And then just if we could maybe get a little bit more detail on the improvement in construction margins.

Just if you're willing parse out some of the more sustainable savings from cost-outs and the new product mix after the lines that you exited in 2019 versus the raw material benefits and maybe some of the natural SG&A declines related to the lockdown, just in terms of what you think is very easily sustainable in a recovery versus what was a bit more countercyclical?.

Yes, so maybe I'll try and give a high level, and John can put some numbers to it. Yes, I think the biggest fundamental change, and we talked about it a lot last year as we were doing it, is a shift in our portfolio.

So what we saw in our construction business was a business that had a real opportunity to focus on where the big innovation was and where the growth opportunities were, and do that through a series of strategic moves last year that affected our top line a bit, but really made us a stronger, healthier business. You saw that in the results in Q1.

Organic growth was up as were the margins in Q1, and we're seeing it again this quarter even though we're not getting the organic growth. And it's fundamentally -- we're a company that has really great innovations that helps contractors and people in the construction industry do better highly specified jobs faster.

So that was the big enabler, and it really mostly was around how we focused on the real growth opportunities, and I think that's changed our growth profile too. What Boz and the team are doing is finding those areas where we can create value in the marking and making those happen.

So I think while it was negative organic growth, we did some really nice things in that business to do the numbers we did, and that's because of these innovations that we're putting. So it's mostly around that. There was some SG&A savings related to both the restructuring and just, as John said, a teeny activity, but it was more a mix in portfolio.

As far as raw materials, that business has less of a petrochemical impact, so it definitely had some raw material impact, but no more than the other businesses, and maybe even a little less than the other two businesses in terms of raw material impact.

John, you want to add anything to that?.

No, I think the points you made are exactly right. I do think there's a little bit of a probably a more pronounced mix -- favorable mix impact in Q2. I think flooring, which is a little bit lower margin business, was not as strong as roofing, and then some of this SG&A timing that I talked about generally.

So I think the margins that we're seeing are the ones that we think we can hit long-term, maybe not every quarter, but I think long-term that's -- this is the range and above that we would think about for this business..

And that's very helpful. Thanks again..

Our next question will come from Jeff Zekauskas with J.P. Morgan. Please --.

Zekauskas..

Yes, please go ahead..

Thanks very much..

Good morning, Jeff..

Hi, good morning.

Do you think your revenues will grow sequentially on an organic basis?.

Sequentially on an organic basis, yes I think so. Yes, so I think we said the range is 5 to 10 this quarter, and there is some currency negativity in there, Jeff, so yes..

Yes, I'd just -- I would say there there'd be -- I think the range we gave would be pretty similar, but we will have a little less, but I think given currency it will probably be slightly better from an organic standpoint..

Right. You talked about knocking out $25 in inventory costs, but I was wondering from what base in that your inventories were 388, which were up year-over-year even though your organic sales were down 7.

So like on a more normal basis here your inventories have been, I don't know, 355, and so your goal is to get to 320,000?.

Yes, I'd say it's off than more normalized basis. It's the way the set the targets, Jeff, was we built an understanding of what we thought the year was going to progress, and then how we were going to improve off of what would have been an improved in normalized level of performance.

So I think you're right, our inventories this quarter weren't at our normalized levels as we slowed down plants, and especially in EA tried to pull back to normalize levels, but yes, it's off normalized level, not off of a Q2 level. That would be the way to think of it..

Okay.

Do you think that it will be hard to grow in the hygiene business in the next fiscal year because of, you know, I guess, the unusual purchasing patterns this year, or do you think next year you can grow your hygiene business of whatever level you pretend to fiscal 2020?.

Yes, I think we'll have a continued strong performance. The underlying performance of that business has always been good. I think it gets more exposure in the HHC world, because it was buried in three regions, but we have a very strong team in hygiene, Jeff, and a lot of the growth in that business continues to be in emerging and developing markets.

It's a real opportunity that that we've positioned ourselves well.

I think right now, there is decreased demand in places like Latin America, India, Middle East, there's real demand destruction, right? So, in countries like this, there're some increases, but in other places, there's -- people aren't able to afford some of these basic necessities, but fundamentally our team is very strong, we've got a winning value proposition, and I think you'll see in that business in particular, I think you'll see -- not double-digit performance, but I think you'll see good organic growth based on the team we have..

Which raw materials have moved down for you that have been important?.

Yes, so it's pretty broad base, Jeff, I think as you know, 87% of our materials are specialty materials. So, 13% are commodity materials; think of that as solvents, MBI, vinyl acetate monomer, and these things move, they're pretty volatile, right? So, those moved as oil prices moved down.

The other 87% is really demand-driven, supply/demand-driven, and in this kind of environment, there's a lot of pressure on those materials through alternate materials. So it's pretty broad-based across the whole field of petrochemicals with some of the commodity materials going down faster and bouncing up to a more normalized level.

John, do you want to add any color to that?.

I think you've covered, and I think it is very broad-based..

Yes.

And then lastly, what are your largest capital projects this year?.

So we had, we're building capabilities in China around certain specialty materials, both in electronics and other materials. So, some of them we had told in the past, some of them we see as big growth areas.

So we've got an expansion of our Yantai facility, and then the second large is in the Middle East, our demand, a lot of it comes out of our facility in Egypt, which we had bought back in 2009, I think so, it's an aging facility. So we're relocating and expanding our footprint in Egypt.

So those are the two largest, but as you know, our business, Jeff, there's it's a lot of small projects that add-up to our spend. So it's a million here. It's 200,000 here, it's 500, but those would be the two largest investments..

Okay, great. Thanks so much, Jim for all those answers..

Thanks, Jeff. Thanks for the interest..

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

Hi, good morning..

Good morning, Mike..

Jim, can you talk a little bit about what you're seeing in terms of pricing typically in a deflationary environment, you would be passing some of these lower raw material costs back to customers, but I think you've also seen some expansion in areas where you're serving more specified applications, have more specified or specialized adhesives, and I'm guessing that the pricing there can be a little bit stickier.

So what are you seeing in this current environment?.

No, I think you understand our business pretty well, Mike.

So we have about 15% to 20% of our business that's on some sort of an index, and that moves up and down as raw materials move up and down and then the other 80% is negotiated pricing and especially in those highly specified areas, we don't see a lot of price movement in those areas, and I would say generally, in this environment, supply assurance is what customers are looking for and we're providing a lot of that in the market.

I mentioned in the comments, our team has done an outstanding job of making certain that every need, whether it was a surge need or specialty need or a new opportunity, in some markets, products that used to be made in China got in-sourced for things like gowns or surgical masks and our team was able to respond quickly to those.

So I think around the business that supply assurance is really what people are looking for, but yes, generally not a lot of price pressure at this point..

All right. And then within the HHC business, I think I was a little bit surprised that given the strength of volume, that margin wasn't up a little bit more there given that volume strength, given some raw material tailwind as well as the restructuring savings.

So was mix a drag in there or what other factors should we keep in mind when we look at the margin performance in HHC?.

Yes, so it was pretty good margin performance, Jeff -- I'm sorry Mike, but I agree with you more would have been better, and I'll share your comments with the team there, but maybe John can give you some specifics, because we do have a couple specifics on there as to what's behind it..

Yes, it's primarily mix, Mike just within the quarter, the mix of sales was towards slightly lower margin products, and some timing on costs too. So I think you're going to see that margin improve over the rest of the year..

Right, and then last question for me is you mentioned that mix in general for the company dragged a little bit on gross margin, was this primarily the engineering adhesives weakness and more of a segment level mix impact? You mentioned obviously, what's going on in HHC but what are some of the other mix factors that we need to keep in mind that played out in the quarter?.

Yes, certainly the biggest one was engineering adhesives versus HHC. So I think we also have some pretty high margin businesses in construction that were off as well. So I think we did have, when you look at our margin, it was very strong for the quarter. That's with that negative mix playing into the factors and I think that's the biggest piece of it.

John, anything you want to add on that?.

That's exactly right. I mean there's a little bit of intra segment mix impact, but the biggest one is lower revenue in CA and EA as a percentage of total..

All right, thanks very much..

Thank you, Mike..

Our next question will come from Eric Petrie with Citi. Please go ahead..

Hey, good morning, Jim and John..

Good morning.

How are you there, Eric?.

Good, good. So you have six manufacturing sites in China.

I was just curious, can you talk a little bit about the split between consumption domestically and product that's for exports and how those two categories are faring?.

Yes, absolutely there's a difference right. So, as you know, our business is made around the world in country for country and most of our China business is produced and consumed in China.

So that part of the business that was domestically driven, whether it's hygiene, packaging, products that are used in the durable or engineering area by Chinese consumers was strong. We saw a bounce back in some of those areas and real solid demand, the business environment in many ways the life environment in China is back to a new normal.

That's very robust, and where we did see weakness was in some areas that are export related.

So a great example where we saw strong performance especially the second half of the quarter was Chinese Autos for China, where we're relatively strong, hygiene business relatively strong, but if we had a customer who made products in China that they shipped around the world, those were a little slower. So that would be just a high level.

The other thing I'd say again, across the company, the performance that we're seeing, I think was really exceptional. So I'm not sure China's manufacturing environment if you took the last quarter was performed as well as we did, but our team has done a great job of being first and fastest.

I think this whole strategy we employed to keep employees safe, educate them on what needed to happen, give them a sense of comfort, but also focus on customers and how we were going to do things differently played out in China as well, and that team's doing an outstanding job of finding opportunities and seizing them in this environment and that entrepreneurial spirit, I think helped the numbers as well..

Okay, and just as a follow-up, do you think the mix is like 70:30 or more less than that, just trying to get a peg for how that correlates 1% growth rate?.

Yes, I mean I'd be guessing, but I'd say it's more than 70% China for China, so whether it's 80% or 90% or higher but it's not 100%, it's not 70%. So pick 85% or 90%, I guess if you wanted to model it..

Okay, helpful.

And then within construction adhesives, how much is tied to the retail channel, Lowe's Menards and were those volumes up?.

Yes, so most of it is a contractor business for us. So we don't specifically say how much we do with each of those customers, but I think you want to think of our business as predominantly a contractor business with let me try and put a ballpark number on it. I'd say less than 10% going to of the overall business going through those retail channels.

John, does that sound right to you?.

Yes, I think that sounds exactly right..

Okay.

And then lastly a question maybe for John, how much were raw materials down on a percentage basis in 2Q and what are you expecting for a second half?.

Eric, if they're down in sort of the 3% range kind of year-on-year, and I would say that we would expect that to be slightly higher in this back-half of the year; maybe 4%..

Helpful, thank you..

Thanks, Eric..

Our next question will come from David Begleiter with Deutsche Bank. Please go ahead..

Thank you. Good morning.

You mentioned some share gains in the quarter, could you talk about where they were maybe quantify the size and what drove those share gains?.

Yes, so I'd say they were. Thanks for the question, David. Yes, they're very broad-based. I think it's fundamentally driven by the energy and the culture of collaboration. I think in a crisis environment, a team that works collaboratively like ours and has to work in different ways. Lowe was able to get after opportunities in impressive ways.

Some of them came because our supply chain was very reliable. We did not let one customer down anywhere around the world, and when some people did have hiccups out there, we were able to step-up. So that was some of the gains and some of those are going to stick with us.

We had five sales conferences a few weeks ago outlining various stories of how people were winning business in around the world using remote tools, and it was really impressive to see how our team is finding new opportunities and tackling those, so this is the normal winning and losing of business, and it's pretty clear that our abilities to connect with corporate accounts that connect with decision makers to run remote trials enabled us to get a series of wins that were very impressive in terms of when I look at our win loss ratio this quarter versus others.

So the second category was just new wins of new technology. We had a couple of competitors that are regional that sell products around the world, and those competitors struggled to source their products around the world either getting it out there or customers were a little concerned about getting product from halfway around the world.

Fourth opportunity was in just new to the world opportunities, I mentioned briefly earlier, couple of examples would be surgical gowns being produced in the U.S. that our team was able to jump on, that's going to be an ongoing need. These are products that used to be made overseas. We have an interesting product.

It's a disinfectant that's been used in the past in our infrastructure business, when somebody had water damage. Well, it's a CDC EPA approved product that we used as a primer for adhesives.

That's now turned into a product because it kills coronavirus that our team was able to leverage and exploit, and again we see ongoing demand there, and then finally, this first and fastest approach, I mentioned in China, but we see it everywhere else. So those are sort of the five categories.

I could give you a list of 100 wins, but it's not like there's one -- but when I looked across our 28 segments, I was able to find wins in just about all of them except automotive, which basically shut down, and even now I'm sure if I talked to the team, they'd find something, but it's pretty broad-based..

Very impressive. Hi, Jim, just on the cost side, everything about this latest cost action. I feel if you take a step back and look at the Royal cost synergies that the business realignments savings and now these are global operations savings.

Is this the last piece of the puzzle for Fuller, and if it is how should think about incremental margins as things normalize given the costs you've removed from the entire portfolio..

Yes. I'll let John try and quantify that number, but -- of course there is never a last piece. There is always more to go after and more opportunities.

I think this operations piece is long-term probably bigger than this $20 million to $30 million, but I think we've defined it to a half a dozen projects that we're going to get after and deliver here in the next 2021 essentially.

It will start in Q4, but there is always more opportunities, but I think the point is that you make at the end in your question is, I think we are really positioning ourselves such that our incremental margins are increasing.

So, as growth happens, anybody can predict whether it's going to happen this year or next year or the year after, we are in a really good position to leverage that down to the bottom line because of all the work we've done and we're doing on the cost side.

So those incremental margins on a business that we've now created between the Royal acquisition that restructuring of what we did in or the repositioning of what we did in construction, and an HHC business that's now changing its focus, right? We have the healthcare business in there is really giving us very nice incremental margins when growth happens.

So are you going to share - do you have a number for that. You want to share with David, John, or I think….

Well, I think I would just David you remember when we announced the Royal deal and we talked about synergies, we didn't have a very big number associated with manufacturing, right.

I think our focus was delivering procurement synergies, SG&A synergies, and then making sure we integrated the business and kept it running well, and I think that served us very well particularly in this period, but I think we always knew that there was an opportunity to come back and find more manufacturing savings, and so I don't know if it's the last, but I think this is sort of the next logical step in terms of the process with the Royal integration..

That's very helpful, John.

And just lastly, John, just on working capital can you remind us of your targets this year for working capital, I guess source of cash?.

Yes. So, well, I think the way we've looked at it is, we've looked at it sort of as a percentage of revenue, so we had a target to reduce working capital by a hundred basis points as a percentage of revenue for the full-year.

So that'll be a little -- it should be a little bit bigger number in terms of a source of cash given the fact that revenue will be lower, but that's the way we've always thought about it, so that we're not targeted on a dollar, we're adjusting that based on the revenue of the company..

Thank you very much..

Thank you, David..

[Operator Instructions] Our next question will come from Rosemarie Morbelli with G Research. Please go ahead..

Thank you. Good morning, everyone..

Good morning, Rosemarie..

Good morning, Rosemarie..

I was wondering if you could give us a little more details as to how you are benefiting from all of your technology investments, which give you new ways quoting you -- new ways to cooperate with customers.

Can you share some more details on that?.

Yes. They fall into a number of different buckets Rosemarie. We set up a while ago remote customer service center so that people could work remotely and serve our customers in case of any kinds of emergencies. Of course this was a huge dynamic that happened.

So having that competency immediately allowed us from a supply chain standpoint to get the work done. With respect to customers, we invested in a technology called Google Glass that enabled us to visually have our technology experts see what the customer is seeing on their lines.

So, a lot of times in our business the nuance of where the adhesive is right at that point of contact is really important. So we let's fly somebody halfway around the world to see that. So we invested in this technology, so that we'd be able to get the eyes of the expert's right on the line. We certainly leveraged that technology during this.

I think one of the things that was really helpful for us, Rosemarie, is our ability to use WebEx and other video conferencing tools. This has been a normal part of life at Fuller because we're such a global coordinated business. So that technology is one that we didn't just use. We had perfected how to use it and how to collaborate on it.

So it was very natural for our team to not only do it, but also then start sharing it with customers. We train numbers of customers on ways to collaborate with us during this process that drove different levels, and then finally, I think the collaboration information sharing tools that we have are ones that we embedded in our systems and leverage.

So those are the four categories. There is more specifics in there, but video is very powerful. Google Glass is very powerful for customers, and then importantly, this culture that we have of collaboration enabled I think those tools..

Okay, thanks. And then I was wondering, so you have been gaining share, right, because you are able to supply your customers better than some of your smaller competitors.

So when the economy returns to normal, whatever the new normal is going to be, do you think that you could lose those new customers as the small competitors decides to lower price in order to gain it back?.

Yes, Rosemarie. I think this is a fundamental shift in how people are working and we are really well positioned to take advantage of it, and we're proud of the results of this quarter, but what I'm most proud of is how we've positioned ourselves from a growth and leveraging these wins into the future.

So this new way of working is changing at our customers, it's changing in the market and we are very focused not just on delivering great results in Q3 or during this pandemic, but how do we transform, how we are better out there in the market using remote technical service, using remote tools combined with face-to-face tool.

So the short answer is, no Rosemarie, I don't really feel this is a threat. I think this is just the beginning of leveraging what we've done and what we've learned. I'm really excited about that how we're managing through this, but also how it's changed in our company to be more capable and more aggressive..

All right, that is very helpful. Thanks. And then one last question if I may. You had given 2020 targets for HHC margin of 18%, construction 20, and engineering and adhesives 22%. So I realize that this has been pushed out.

Do you think that you can achieve those by year-end 2021, or do you need a next to a year in order to get to those targets or maybe more?.

Yes. I think we have laid those out as long-term targets Rosemarie without a specific date on them, but I think when it comes to 2021, we are doing the planning right now for 2021. We've laid out four scenarios in terms of what could happen out there in all of those scenarios.

We see ourselves being stronger than we were in 2019, and we have a lot of leverage to get there if the world picks up, we've got some good growth opportunities and if for whatever reason things are in a negative kind of world next year as well. I think we have to leverage the pull to help us deliver the results we are.

So we're mapping out multiple scenarios. We're monitoring the world just as we did this quarter. We're now looking out at 2021 and making certain that we deliver what our shareholders expect, which is growth on the bottom line..

All right, thanks very much..

Thanks, Rosemarie..

Operator, any other questions?.

Operator:.

, :.

Thank you and good morning, Jim and John..

I'm sorry, Rosemarie. I think your phone might still be on.

Can you mute please?.

Go ahead, Paretosh..

Thank you..

Okay. Sorry guys, I actually joined a little bit late, but just curious, what are you seeing in your electronics and textiles business. I think electronics were up double-digit in Q1.

So how did they do in Q2 and what are your expectations for the second half?.

Yes, as you know most of our wins in electronics are driven by share gains that we've got a great team that's innovating in part of new businesses. So we're optimistic about what we're going to see in the second half.

I think the business is picking up as we exit the quarter here and going to the second-half, but more importantly some of our wins in new products will kick-in. So, we are pretty optimistic about that.

Technical textiles; part of that is the gowns and other things that are happening underlying it, but part of it is just new trends in textiles that instead of single laminations materials, there is multi lamination. So, those two factors are driving our growth there, but we see good performance in both of those businesses as we go forward..

Okay. And then, on the automotive business within engineering adhesives, so auto sales in China have been pretty good last couple of months. So, just wondering how you are thinking about it for the second half. Do you think it's sustainable? We are hearing about some promotional deals announced by companies to increase sales.

So, second half in China should be pretty good, but just wondering if you are hearing and seeing that too?.

Yes, we see our customers up. In fact, I think I mentioned briefly our revenue in auto in China was actually up in Q2. So, that shows the pipeline filling that's going on there as people are producing vehicles as well as some of our share gains there, and that's dramatically different than what we see with the automakers in Europe and North America..

Got it.

And then, the last quick one, did you quantify the sequential impact from raw materials, like how much benefits you are expecting in Q3 versus Q2?.

John?.

Yes….

I don't think we specifically -- go, John, yes..

Yes. I think what we had said, Paretosh, to an early question, I think raw material is probably down about 3% in Q2 year-on-year, and we expect to be down more like 4% on the back-half of the year..

Got it, that's helpful. Thanks, guys. That's all I had..

Yes..

Thanks, Paretosh..

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

Hi. Just a quick follow up. The new energy business if I look at Slide 10 and your expected near-term impact, you would expect that business to be down significantly, and I believe that you said that it was actually up and sounds like it improved pretty dramatically versus your expectation.

So, what happened in Q2 to drive that, and what is your expectation for that business in Q3?.

Yes. So, a combination of two things; one, again the supply assurance issue, our team did a great job of meeting demand in that market as they came back quicker than people expected. I think as there is a rebuild of economic activity in China one of the areas where there is some focus is in the solar space.

So, solar came back certainly differently than we expected, and fortunately, we were able to respond. So, we got more benefit probably than the market as a result. Going forward, we see certainly stabilizing, being positive but not as dramatically positive as it was in Q2..

All right, thanks very much..

Thank you..

Our last question today will come from Vincent Anderson with Stifel. Please go ahead..

Hi. Yes, thanks for humoring me.

Just one more kind of broader question, how should we think about the timing of any recovery that we observed out there flowing through your sales compared to maybe more normal pass cycles just with regards to how your customers are managing inventories right now?.

Yes. So, it varies by segment, Vincent, is what I would say, but, it's not a huge impact. People don't drive their inventories off of how much adhesive they hold.

So, we are probably muted versus any other industry impact, but fundamentally I think the best indicator is what happens with manufacturing activity overall and then segment by segment what we see, and auto is a great example, right? So, auto sales are ramping up. In China, our sales are ramping up as you start seeing auto in the U.S.

ramp up almost immediately. It's not like there is a not lot of inventory these cars around. You'll see the impact on our business. So, not a huge lag.

What happened in HHC this quarter was an exception because of the surge in demand and just real need for people to get on top of this, but we usually don't see a big inventory sway based on activity in the market..

Okay, excellent. Thank you..

Thank you..

So, no more questions.

Operator, that's it, right?.

Yes. This will conclude our question-and-answer session. I would like to turn the conference back over to Jim Owens for any closing remarks..

Thanks everyone for your time and attention today. We appreciate your support. Certainly very proud of the results of our team, but most importantly, what we are building for the future. Please keep yourselves and your family safe as we are doing as the top priorities are our employees, and again, thanks for your interest in H.B. Fuller..

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