Fuller H B Co Q1 FY2021 Earnings Call

Good day, and thank you for being here. Welcome to the H.B. Fuller Q1 2021 Earnings Conference Call. I would now like to turn the conference over to Barbara Doyle, Vice President of Investor Relations. Please proceed.

Thank you, operator, and welcome to H.B. Fuller's first quarter 2021 earnings call for the fiscal quarter ended February 27, 2021. 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 organic revenue, which excludes the impact of foreign currency translation on our revenues. We will also refer to adjusted non-GAAP financial measures during this call. These measures are in addition to the GAAP results reported in our earnings release and on our Forms 10-Q and 10-K. We believe that discussion of these measures is useful to investors to assist their understanding of our operating performance and how our results compare with other companies. Reconciliation of non-GAAP measures to the nearest GAAP measure is included in our earnings release. Unless otherwise specified, discussion of sales and revenue refers to organic revenues; and discussion of EPS, margins or EBITDA refers to adjusted non-GAAP measures. We will also be making forward-looking statements during this call. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Many of these risks and uncertainties are, and will be, exacerbated by COVID-19 and resulting deterioration of the global business and economic environment. 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 Forms 10-K and 10-Q filed with the SEC and available on our website at investors.hbfuller.com. Now I will turn the call over to Jim Owens.

Thanks, Barbara, and welcome to everyone on the call. Last evening, we reported first quarter results, which built upon the momentum we saw in Q4 of last year. Organic revenues this quarter were up 10.5%, adjusted EBITDA was up 30% and adjusted EPS of $0.66 was nearly double last year's first quarter. The H.B. Fuller team gained share and reduced operating expense in each of our businesses in 2020, which created the momentum that is delivering exceptional financial performance to begin fiscal 2021. Market innovation and exceptional service led to the share gains as H.B. Fuller solved customer problems faster than competition, and growth accelerated as demand continued to strengthen in the first quarter. As we reported last March, COVID-19 impacted our fiscal Q1 of 2020, only in China, and by about $15 million in revenue, $4.5 million in EBITDA and $0.06 of EPS. Excluding this impact, our revenues were up 8% organically, EBITDA was up 23% and EPS was up 65%, exceptional results. H.B. Fuller works with our customers to solve their toughest adhesive problems. In today's remote work environment, this means collaborating in new ways and delivering market-driven innovation faster than ever. For example, we proactively developed and qualified new engineering adhesives for mobile devices, automotive electronics, electronic vehicle batteries and solar panels to name just a few. These innovations helped drive one of our strongest quarters for Engineering Adhesives' sales growth. We created technology and branding opportunities with a new line of GorillaPro MRO adhesives, and there will be more H.B. Fuller marketing innovation in the year ahead. We work with hygiene, health and consumable customers to develop innovative applications and to assure supply to meet high demand for their products. As a result, we substantially grew our sales across the majority of our HHC end markets in the first quarter. H.B. Fuller's revenue growth was also broad-based geographically in the quarter, with organic growth in all three of our geographic regions. Importantly, our growth came with positive incremental margins driven by product mix, reduced expenses and structural efficiencies resulting from our business realignment last year. EBITDA margin increased 190 basis points year-on-year. Raw material costs increased from where we exited 2020, but we're still relatively neutral on a year-over-year basis in the first quarter and in line with our expectations. Raw material costs going forward will increase at a faster rate than originally anticipated due to increased demand, reduced inventories and supply constraints. Winter Storm Uri in the Gulf Coast in February has created additional tightening in the United States and is impacting global supply. Supply has become tight for commodity materials, which make up a smaller portion of our portfolio. As the year progresses, this will also have an impact on the supply and pricing of the specialty materials, which make up the majority of our purchases. Most suppliers have made good progress in recovering from Uri. However, the rate of recovery going forward will mostly depend on the output rates of the impacted assets and the time it takes for supply chains and inventory levels to fully recover. We have done a very good job of serving customers, thus far, by working closely to manage inventories and available materials. Our contracted positions with our suppliers, backward integration of key polymers and global breadth had helped us manage the supply crisis thus far. The breadth of our adhesive chemistry and the diversity of our raw materials has meant that no single material has had a large impact on us and has enabled us to help customers find alternatives when short supply exists. The near-term disruptions we are navigating in the U.S. are considerable, but they are temporary, and supply is expected to normalize to a more balanced level in the coming months. Our planning assumptions anticipate that the risk of supply disruption will lessen as we exit the second quarter, and we do not anticipate that it will have a material impact on our ability to meet demand. However, we now expect year-on-year raw material inflation to be in the range of 5% to 8%. H.B. Fuller has done a remarkable job in supporting customers through supply shortages, and we also have implemented over $100 million in annualized price adjustments that are effective in Q2 and will enable us to continue to seamlessly serve our customers. Some of these were effective on February 15, with most effective March 15 and April 1. We are preparing for further price adjustments, if needed, in Q3. These price adjustments will fully offset the impact of raw material increases. Now let me move on to discuss performance in each of our segments in the first quarter on Slide 4. Hygiene, Health and Consumables Adhesives' first quarter organic sales increased 7.6% year-over-year, continuing the strong performance trend in this business unit in 2020. Sales increased versus last year across the majority of our HHC markets with strong growth in packaging, tissue and towel and tape and label and good growth in Hygiene, in particular. HHC segment EBITDA margin was strong at 13.3%, up 180 basis points. Margin improved versus last year, reflecting volume leverage, restructuring benefits and good expense management. Construction Adhesives' organic revenue was down 10% versus last year as Winter Storm Uri, extreme weather and material supply issues across much of the United States impacted construction activity as we started the year. Construction Adhesives' EBITDA margin declined versus last year, reflecting these issues. Underlying operational improvements from the GBU restructuring were offset by lower volume and the impact of severe weather. Uri temporarily disrupted operations at our Construction Adhesives' facilities in Texas in February. Both plants have now been fully up and running since early March. Aside from these near-term impacts, demand for Construction Adhesives continues to be strong for residential builds and remodeling. Demand has also begun to improve on the commercial and roofing side. We are planning for both top line performance and margins to improve significantly over the rest of the year. Engineering Adhesives' results were extremely strong with organic revenue up 21% versus last year, reflecting share gains and improving end market demand. Sales increased versus last year across the majority of our EA markets with the strongest growth in electronics and new energy. We expect continued strength and double-digit full year growth in this segment. Engineering Adhesives' EBITDA margins were strong at 15.4%, up 300 basis points compared with Q1 last year, reflecting strong volume leverage and good expense management. Looking ahead at our full year results, our planning assumptions are that COVID-related shutdown impacts will remain but continue to decrease as vaccines are rolled out around the world. We anticipate that many raw materials will be tight through the summer, supply chains normalize and demand continues to be strong. We anticipate continued improvement in underlying demand in each of our business units, driving volume growth in 2021 versus 2020. Growth in some end markets such as commercial construction and aerospace will improve at a slower pace and may not return to 2019 levels of activity this year. While Engineering Adhesives demand is expected to moderate from the first quarter levels, which reflect some pent-up demand, we expect end-market demand will likely be strong for the entire year. Overall, when considering our strategic pricing actions, coupled with the solid volume growth in HHC, improved performance in Construction Adhesives and strong demand in Engineering Adhesives, we now expect full year revenue growth of high single digits to low double digits versus 2020. Now let me turn the call over to John Corkrean to review our first quarter results and our updated outlook for the full year based on these planning assumptions.

Thanks, Jim. I'll begin on Slide 5 with some additional financial details on the first quarter. Net revenue was up 12.3% versus the same period last year. Currency had a positive impact of 1.8%. Adjusting for currency, organic revenue was up 10.5%, with volume accounting for all of the growth. Pricing had a neutral impact year-on-year in the quarter. Year-on-year adjusted gross profit margin was 26.7%, up 20 basis points versus last year driven by the higher volume. Adjusted selling, general and administrative expense was up 2.9% versus last year. SG&A was down 170 basis points as a percentage of revenue, reflecting savings associated with our business reorganization, lower travel expense, general cost controls, offset by higher variable comp than last year. Net other income increased by $3 million versus last year, driven primarily by increased income on pension assets. Net interest expense declined by $2 million, reflecting lower debt balances. The adjusted effective income tax rate in the quarter was 27.5%, up 180 basis points versus the adjusted tax rate in the first quarter last year, driven primarily by mix of income and tax related to the global cash strategies. Adjusted EBITDA for the quarter of $101 million was 30% higher than the same period last year, driven by strong top line growth particularly in Engineering Adhesives, restructuring savings and good cost management, partially offset by higher variable compensation. Adjusted earnings per share were $0.66, up 94% versus the first quarter of last year, reflecting strong operating income growth and lower interest expense associated with our debt reduction. Cash flow from operations in the quarter of $36 million was up from last year, reflecting strong income growth, partly offset by higher working capital requirements to support the strong top line performance. We continue to reduce debt, paying down $16 million in the quarter compared to $6 million during the same period last year. Regarding our outlook, based on what we know today and the planning assumptions that Jim laid out earlier, we anticipate revenue to be up high single digits to low double digits versus 2020 and EBITDA to be between $455 million and $475 million as continued strong volume growth and pricing actions offset higher raw material costs. We expect cash flow to be strong for the rest of the year, allowing us to maintain our target to pay down approximately $200 million of debt during 2021.

Thank you, John. We were very pleased with our strong start in the first quarter, which follows a strong fourth quarter, both of which greatly outperformed predominantly non-COVID quarters from the prior year. We are growing through our strategy of delivering sustainable innovation and high-value solutions, and we are in a great position to continue to grow our business as global economies continue to open up in 2021. This year, we will focus on three critical priorities to profitably grow our business in a dynamic environment. Our top priority is to drive continued volume growth as we support our customers' success in the current high demand and supply-constrained environment. This means continued growth from innovation, leverage of remote servicing tools as a new standard and finding creative ways to address any raw material shortages we see in the coming months. Our second imperative is to strategically manage pricing, align to the value we deliver in this inflationary environment. Our company has built pricing tools and in-depth training in anticipation of the day when material inflation returned. And we are already executing with speed and precision to maintain and grow our business while pricing to value. Our third priority to help fuel our growth will be to release productive capacity through our operational excellence programs. Our 2020 operations investment was centered on creating the operational discipline and metrics that enable more productivity per employee work hour. In a low capital-intensive business like ours, this helps to reduce costs and increase capacity. We will also deliver an additional $200 million of debt reduction in 2021, moving the company closer to our net debt target of 2 to 3 times EBITDA. On our conference call a year ago in March of 2020, I told you that because of our extraordinary collaboration with customers, our robust global operations and supply chain and our unmatched expertise in adhesive innovation, I was confident that H.B. Fuller would strengthen its position in this industry, setting ourselves apart from competition and enabling us to grow as global economies recover. I was confident that we would emerge as an even stronger company than prior to the pandemic. Our stronger performance throughout 2020 and our exceptional results in the first quarter are proof that my confidence was well founded. This company is built on an agile business model where people collaborate remotely with each other, with customers and with suppliers around the globe. In a changing world, these attributes of agility, collaboration and flexibility have enabled H.B. Fuller to excel. As working conditions changed, supply and demand fluctuated and as supply constraints emerged, the H.B. Fuller team has been first and fastest among adhesive companies at addressing challenges. Growing the business this year in a period of economic recovery presents exciting opportunities and unique challenges. In 2021, our business priorities are squarely focused on capturing share and managing inflation risks as we continue to build on our rising leadership position in the global adhesive industry. Our culture of collaboration and innovation and our improving operational execution give me confidence that we are strongly positioned to continue to deliver sustained value for our shareholders in 2021 and in the years ahead. This concludes our prepared remarks today. Operator, please open up the call so we can take some questions.

Your first question comes from Mike Harrison from Seaport Global Securities.

Congrats on a nice start to the year. I was wondering if you can first maybe give a little bit more color on the strength in the Engineering Adhesives' business. Maybe talk in some more detail about what markets or applications are driving that strength? And trying to get a sense of how sustainable that strength could be in particular, as we see a lot of your customers probably doing some inventory restocking that's not going to last forever. So maybe comment on what you're seeing in terms of customer inventory levels as well?

Yes. As you know, Mike, our Engineering Adhesives' business had been delivering double-digit organic growth over the last few years. And we see a return to that kind of level here. Certainly, 21% is exceptional, but double-digit organic growth is something we're seeing underlying. There's some significant share gains. We've made some strategic investments to grow in the new energy segment, specifically solar panels. That's really helped us around the world. Our electronics business continues to grow significantly and now off of the bigger base. So we're winning. We won a number of new and different applications during 2020. And I can't emphasize enough how much of the work we did in 2020 to really get at opportunities and continue to do that remotely differentiate us on a number of applications and opportunities. And then another area that we focused on strategically is automotive electronics, and there's a lot of new wins in that space, not just electric vehicles, but all the electronics that are going into an automobile, and those new wins are kicking in. And then the other thing, I think if you dig into the details, Mike, some of this is offensive synergy related to the Royal deal and the Tonsan-Cyberbond combination. So in a space like this, combining these businesses takes a couple of years to get all of the specifications and the wins in the pipeline. So a lot of this is the globalization of opportunities that were happening in China and needed to happen around the world or in Germany, taking it around the world. So the short answer is, a lot of wins, a lot of fundamental organic growth just by getting specced in on new applications. We think there was a little bit of pent-up demand. I don't see any real supply chain building right now. I mean, people are just trying to get the materials they need to do their job. So I don't see a lot of inventory build in these numbers, but some of our customers are picking up some demand. So that might be 21% versus a comparable quarter, might be a little high, but certainly in the double-digit range.

All right. Great. Appreciate that. And then my second question is about your new raw material assumptions and really trying to get a sense of what the cadence of earnings could look like or how we should think about margin headwinds. You talked about the pricing efforts, some of those coming in mid-February, but maybe more of them coming in kind of the March, April timeframe. So should we expect to see maybe some margin headwind in the second quarter and then some catch-up in the third and fourth quarters as that pricing fully kicks in?

Yes. I'll let John try and get specific on some of the timing here. But overall, Mike, as you know, a smaller part of our purchases are commodity materials, which have spiked up quickly. And we're feeling those right away in terms of the raw material input costs. Some of the specialty materials take a little longer, but they're definitely things that we're factoring into our planning. But I think very importantly was the speed in which our teams got out there with price increases. And an excellent job by the team to get those in place here, March 15 and April 1. So the net-net is while there's a little risk that we won't get 100% of what we need this quarter, I feel pretty good based on the numbers that we're seeing and the timing that we'll fully offset Q2 raw material increases with the price increases we've put forth. But John, maybe you can give some deeper color on that.

Yes, I agree with you, Jim. I don’t expect to see significant pressure on margins in the second quarter. There is a lag in how raw materials affect the cost of sales, so I anticipate that we will feel more of the impact in the third quarter. The supply disruption may actually be a larger issue to address in the second quarter regarding potential top line effects.

Your next question comes from the line of Jeff Zekauskas from JPMorgan.

Why is it so easy to pass through price? What is it about the market that gives that kind of ease?

Yes, it's a great question, Jeff. We began the year aware that we would implement price increases. What's happening across many materials, not just in the chemical sector, is that customers are experiencing shortages, whether it's the plastic film they purchase or materials for other construction. The momentum we have with adhesives allows us to raise prices more easily. While the team on the ground might not find it straightforward, given the current circumstances and the importance of adhesives, which I emphasize regularly, these products are critically important to our customers. So, I would say this year has gone exceptionally well.

Okay. With the auto-related revenue likely being affected for a couple of quarters, will that indicate that the engineering business overall will see decreased revenues in the second and third quarters due to the situation in the auto sector?

Yes. I wouldn't say that our auto business is a higher-margin business, Jeff. It's similar to other businesses. And in terms of our Engineering Adhesives' business, it's probably less than 10% of that business, right? 10-ish. So it's not the big driver. But certainly, auto is robust right now.

You spent $35 million in CapEx in the first quarter, which is high for a first quarter number. What happened there? And how much do you plan to spend on CapEx for the year?

Yes. It's actually, Jeff, the second year in a row, we've had a high number in the first quarter. But you're right. Traditionally, we have a lower number in Q1. We've put some really good planning processes in place. And those have enabled us to get a better cadence of spending. So there's a combination of some things we freed up at the end of last year. If you remember when COVID hit, we really pulled back on capital spending. So we freed some things up in Q3 that ended up getting spent in Q1, but we still see the $95 million for the full year being a deliverable number. John, anything you want to add on that?

I think your point's the right one. I think last year, we spent $32 million in the first quarter and $87 million for the full year. So it's probably a similar pacing as last year.

Okay. And then lastly, your payables went up a lot. Are you going to run with a higher payables level? And does that mean that your working capital penalty this year might be a little less than you originally thought? I see that you're forecasting growth in operating cash flow, even though you're going to have a working capital build.

Yes.

I believe the rise in payables aligns with our efforts over the past few years to strategically extend our payment terms with suppliers. Looking back over the last three years, specifically from 2018 to 2020, we've managed to reduce working capital as a percentage of revenue by more than 300 basis points. This reduction has impacted all areas. I anticipate that working capital will likely be a modest cash outflow this year, despite a robust year in revenue, as we remain focused on improving this aspect. We aim for an additional improvement of 100 basis points in working capital relative to revenue, and I expect to see some of that reflected in payables. However, there may be a more noticeable improvement in inventory management, which is part of our operational efficiency project aimed at enhancing inventory control.

Your next question comes from the line of Ghansham Panjabi coming from Baird.

I guess, Jim, going back to your prepared comments. I mean, in 2020, during the peak of COVID, you were able to gain market share given some of the production disruptions across the industry. You sort of flexed your footprint and just effectively executed better. Do you see the same sort of backdrop at this point post-Winter Storm Uri? I mean I'm asking because there are media reports that say adhesive shortages in the U.S. are impacting the paper industry. Just give us a real-time view of what you see on the capacity side specific to the U.S.

Yes, the short answer is yes. I've mentioned that our team benefitted from COVID as it allowed us to be more flexible and agile, leveraging our global presence last year. The supply shortage puts us in a similar position. There are adhesive shortages, especially with water-based adhesives, which are primarily driven by VAM and the delays for Celanese, Dow, and LyondellBasell to ramp up their VAM production. One of the things that differentiates us is our backward integration in some of those polymers. We had inventory and products available, and our team has excelled in keeping our customers supplied. We have had to manage allocations and closely work with customers on their inventory levels. There are definitely challenges we're addressing, but overall feedback from our customers indicates that we are managing these issues better than most. Importantly, we are now seeing the end of these challenges. As operations in Texas have been restored, our suppliers have efficiently brought their assets back online. It’s just a matter of getting materials through the supply chain in the coming weeks.

Got it. And then on the raw material guidance, I mean 5% to 8% for the year. I think, previously, you were sort of implying kind of low single digits. First quarter was flat. How are you expecting the evolution of the curve to kind of progress as the year unfolds? Are you expecting some level of moderation as the year unfolds? And the reason I'm asking is because every chemical producer seems to be pushing price aggressively, and you see all these shortages with containerships and logistics more broadly, et cetera. So I guess the question is, of that 5% to 8%, are you just marking to market what you see now and you're assuming it stays static? Or assuming incremental more inflation or deflation? How should we think about that?

Yes. So we have a pretty in-depth process where we take all of our roughly 2,000 key raw materials, and we project out each quarter what we see the price happening going forward. So there's a forward projection, and all of it is built in. And it varies by material, Ghansham. So as you know, the commodity material have been short supply, went up quickly. Some of the specialty materials we're anticipating as there's a roll-on effect to affect us in Q3 and Q4. But I think the most important thing for us is to remain flexible. And I was very clear in my commentary, and we're very clear internally that it's likely that we're going to have a Q3 increase. And right now, we're just trying to size up the scope of that. So I think ongoing raw material pricing pressure is something we're anticipating. And some of that's built in. But if it's more than we anticipate, we're certainly prepared to respond quickly as we enter Q3.

The next question comes from the line of Vincent Anderson from Stifel.

I wanted to follow up on Mike's question because you got into a little bit, Jim. But when we think about the strategy that you applied for integrating Royal and how that's been going for Engineering Adhesives, could you give us any update on how the legacy durable assembly business has been contributing, maybe any metrics in terms of increased cross-border sales? If I recall, those were traditionally more regional businesses.

Yes. I don’t have specific data, but I can share that nearly all of the 14 segments within our Engineering Adhesives business, including the former durable assemblies, showed positive organic growth in the quarter, with some demonstrating very significant increases. As noted, some of these represent synergy points. A prime example of this is our insulating glass business, which transitioned from durable assemblies. It benefits from synergies stemming from technology developed in Germany. The global team we established is effectively promoting this worldwide, resulting in substantial growth everywhere. This patented technology offers genuine value to customers and is a major driver of growth. A key element of our realignment strategy was to integrate durable assemblies within the Engineering Adhesives model, which emphasizes getting specified early on. That strategy is proving effective. Overall, while Engineering Adhesives is experiencing slightly more growth compared to the legacy durable assembly business, the success of the latter is a significant part of our overall success formula.

Great. And how is it with COVID? It's obviously maybe tough to answer, but how are those legacy business units trending in terms of getting that margin profile, maybe not quite at legacy Engineering Adhesives but moving in that direction?

Yes. I think the cost structure savings benefited a lot. As you know, we had five segments in three regional aspects. So you see that in our underlying performance. Especially as we get the volume growth, it's just driving to a really nice incremental margin. So that's the biggest impact. I think we're getting some value pricing pieces, but the biggest impact is just driving the operational effectiveness of five segments down to three.

Great. I might be stepping into uncertain territory here. The balance sheet is improving. With some assistance on the denominator side, have you started to rebuild your bolt-on pipeline? Or is it still too early to consider this, but in terms of preparing for when you feel ready to approach it again?

Yes. Yes, strategically, all throughout the last few years, Ted and I and the leadership team have spent time talking about what it would be like when we got back active. So I think that is a 2022 issue. I think at the current guidance, we'll be around 3.1 at the end of this year, right? This is 3.1 to 3.2. So clearly in 2022, we'll be below 3, which has been our target and commitment. So I think we have a good strategic vision. Royal did a great job of acquiring businesses. We had done a really good job of acquiring businesses. So the learning of both companies is being combined into a strategic view that we're talking about and then we'll be able to execute as we go into 2022.

Your next question comes from the line of David Begleiter from Deutsche Bank.

This is Katherine Griffin on for David. First, can you provide any additional color on the breakdown of volume versus price for organic growth in the quarter and then in terms of the full year guidance? And then also just on that growth target for the full year, can you speak to what you expect for growth in each segment, either above or below that total company target?

Yes. Katherine, why don't I let John give you some of the specifics there, and I could add color if needed. John?

Certainly. For the first quarter, the organic growth was 10.5%, driven entirely by volume, with pricing being neutral at the enterprise level. Within the different business units, HHC showed slightly positive pricing, EA was neutral, and CA experienced a minor decline in pricing, but none of these units had a pricing impact exceeding 1%. Thus, it was primarily a volume-driven quarter. For the full year, we are guiding towards high single digits to low double digits for top-line growth. We anticipate that pricing will contribute an impact of about 2.5% to 3% for the year, gradually increasing as we progress. Additionally, foreign exchange effects are expected to be around 1.5% to 2%, with the remaining growth stemming from volume. From a business unit perspective, HHC has had a strong start but faces tougher comparisons in the second and third quarters, likely resulting in mid-single-digit growth. In EA, we expect double-digit growth, while CA will grow at a slower pace compared to the overall average. I hope this provides clarity.

Yes. The only thing I'd add, Katherine, is HHC had a particularly strong Q2 last year. So a little lower single digits second quarter and mid to high single digits the rest of the year.

Right. Okay. Great. And then just kind of an extension of the questions that have already been asked about raw materials. I mean, I'm just curious like what gives you confidence that you can continue to raise prices in Q3 with customers, just given the severity of raw material shortages and perhaps longer-lasting effects on the global supply chain than what you're seeing currently. I'm just curious like what those negotiations look like. And yes, what gives you confidence you can continue to raise prices?

Yes. I think Q3 could be a little more challenging than Q2, but I would say Q2 is exceptional in terms of the environment. But I think at the end of the day, Katherine, adhesives are a critical component for our customers. I think people are feeling that as we've had these really hard work to make certain we kept everybody supplied. And I think when people feel pressure on other materials, the adhesive price increase makes sense. And it's not materially driving their P&L. So yes, I think in an inflationary world, we see that we definitely will and need to get the increases.

Next question comes from the line of Paretosh Misra from Berenberg.

Just going back to the mix within the Engineering Adhesives' business, given that you supply to many different end markets. As you look ahead, you think the mix within that segment is going to remain relatively stable? Or it could be a change, so could impact your margins as we look ahead?

Yes. I think generally, our higher-margin piece, Paretosh, are growing faster than the lower margin pieces. So we do have a nice mix phenomenon there. Certainly, electronics, new energy and then auto electronics are three of the areas where we see more fundamental growth that is both organically gaining share as well as underlying markets. So there's a positive mix dynamic long term.

Got it. And how much of that business is currently China?

I can't specify that exactly, but I would estimate that it's roughly one-third. We have established a strong presence in China over the past 10 to 12 years, and it accounts for probably a little less than one-third, around 25% to 30%.

Got it. That's very useful. And then the last one, if you could just remind me where we are on the cost-cutting and restructuring? How much has been accomplished? And how much more is needed in terms of how it affects your P&L?

Yes. So I would say the SG&A piece of this is fully through. So I think this quarter, we had an incremental benefit versus Q1 of last year. But all those cost savings around what we introduced in early 2019 are through the system. The manufacturing piece, we have quite a bit to go. So it's about $20 million to $30 million, of which we expect to get more than half of that this year. And that would come in the upcoming quarters. John, do you want to give any more color on that? Or did I cover it?

No, I think that was good. Last year, we realized about $30 million in savings from our restructuring actions. We expect the annualized savings to be $35 million. We had about $3 million in incremental savings in Q1. So we're essentially annualizing against all the actions that have already been executed.

Your next question comes from the line of Eric Petrie from Citi.

So it looks like over the next three years, hybrid electric and battery electric autos are going to be growing 40% to 50% CAGR. How's H.B. Fuller positioned? And do you have the capacity runway as well as the technology to capture that full opportunity set? And then is the glue content in those applications higher than the ICE or dollar value, if you could quantify?

Yes. Yes, generally, it's higher. I think one of the things that happens with, particularly electric but electric hybrid as well is noise dampening becomes a more important issue. And there are a number of applications where that's an important part of what we provide. So that's one area. The second area I've talked a lot about is electronics. And the convergence of our electronics and our automotive business are really an important driver of growth, and that's creating more value per vehicle. And then the really interesting opportunity is in the batteries themselves. So we've got materials that help insulate those batteries to prevent any kind of combustion problems from overheating, but also disperse the energy. And that's a really exciting piece of that business that could have a big impact as we go forward. So those are the three main pieces for us, Eric. And generally, all positive, I think, in terms of what it does to our auto business.

Okay. And for my follow-up, is the Construction Adhesives business core? Or would you be willing to sell and deploy capital to higher-growth, higher-return engineering, organic or inorganic growth investments?

Yes, it is definitely a core business, and we expect it to return to levels similar to Engineering Adhesives. We focus on high-value, highly specified products in that business, which will result in significant volume leverage. As the year goes on, we anticipate margins improving nicely. COVID has negatively affected the construction sector, particularly commercial construction, and the industry is currently facing material supply shortages and some labor shortages in the U.S. However, the fundamental dynamics of this business are very positive, and we see it as a crucial component of our growth strategy moving forward.

Your next question comes from the line of Rosemarie Morbelli coming from G. Research.

Congratulations on a strong quarter. Jim, regarding Construction Adhesives, this business experienced a decline of about 10% year-over-year. Do you believe that as weather conditions improve and supply normalizes, it is possible to recover what was lost? Or do you think that the losses from the first quarter are essentially unrecoverable until next year?

Yes. The short answer is, yes, I think we'll make it up and then some. Yes, as you point out, Rosemarie, that business is the only one where I have plants in Texas that were impacted by the weather. So they were closed in the last couple of weeks of February. And we lost about $5 million or $6 million in revenue and $2 million to $3 million in EBITDA. So if you had taken that out, it would have been relatively flat, which compared to the market is pretty good. But yes, we see good momentum as we head into Q2. We're against very easy comps in Q2 and Q3 in particular. So we see very strong double-digit growth in that business as we look into Q2 and Q3, unless there's some big disruptions in the construction business.

And talking about disruption, the fact that there is a ship stuck in the middle of the Suez Canal and then another 100 kind of waiting to go through, is that something that is going to affect the supply chain that you are dealing with?

Yes, I believe that will impact the chemical supply chain to some extent. Currently, there are 150 ships waiting, and it will take a few more days for the situation to resolve. This adds to the ongoing stress in the supply chain. While it won't negatively transform everything, it is a matter we are monitoring closely. We are tracking the materials our suppliers have that may be on those ships. Since we've been operating in a global context, we meet daily to discuss the details of issues related to thousands of materials. We have a task force that includes our sourcing, supply chain, and commercial teams to ensure we continue to meet customer needs. They are fully prepared to manage these issues, and a ship stuck in the Suez is precisely what they are equipped to handle. They will manage it effectively.

All right. That is great. And then I was wondering if you could touch on the size and the potential, if not the size, of the solar business? And are you also playing in the wind area?

Yes. So on the second question, we have a very small wind business. It is an opportunity for us. So we'll see as that goes forward. So we have a whole new energy team, but the biggest piece of that new energy is around solar. And again, we don't talk specifics about each of our businesses. But Rosemarie, as you know, we have about 30 different segments. So they average about $100 million. This one is close to the average. So is it a little smaller? A little bigger? We don't go into the details, but it's a good-sized business for us that's growing.

In terms of the margin, is it at the average level, above or below?

It varies because of challenges with raw materials and the dynamics of that market, which go up and down year-to-year. But generally speaking, it's a good business for us, Rosemarie. We're a technology leader in that space. We help our customers with their next-level innovations, and we have a broad mix of products. So some products are higher margins, some are lower. But overall, it's a very nice growing, sizable, solid, middle-of-the-road margin for EA, right? So maybe above our averages, but middle of the road for EA.

We have a follow-up question from Mike Harrison from Seaport Global Securities.

Just one more question on the HHC business. You mentioned the challenging comp as you get into the second quarter. But I wanted to ask about the lower number of births that is expected in 2021 as a result of the pandemic. It seems like they're talking about that across a number of developed countries. So can you maybe help to frame up how much of the HHC business is specifically related to diapers? And maybe if you can break out how much of that is developed versus emerging, maybe just in talking about how that lower birth rate could impact the Hygiene business potentially over the next couple of years.

Yes. So I would say, first off, there's a different dynamic in emerging countries compared to mature countries. A significant portion of our business is in emerging countries because that's where most of the babies are worldwide. One of the strengths of H.B. Fuller is the diversity of our business. While the Hygiene sector is one of our largest, it only accounts for about 10% to 12% of our overall business. Therefore, if birth rates fluctuate by 1% to 2%, the overall impact on the company is minimal. The Hygiene team is managing this situation. Additionally, baby diapers represent just one segment of our business; we also have growing adult care and feminine product sectors that are performing well globally as economies develop. In summary, the impact of lower birth rates on H.B. Fuller is relatively small, at about 1% or 2% of 10% to 12% of our business.

Thank you. At this time, this concludes our question-and-answer session. I would now like to turn back the call over to Mr. Jim Owens for any closing remarks.

Thanks, everybody, for the thoughtful questions and for all of your support for H.B. Fuller. We'll talk to you soon. Bye now.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.