FULLER H B CO annual report, FY2019

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H.B. Fuller Company — FY2019 Form 10-K

Business context and reporting period. H.B. Fuller manufactures and sells adhesives, sealants and specialty chemicals globally across five segments: Americas Adhesives, EIMEA, Asia Pacific, Construction Adhesives and Engineering Adhesives. This annual report covers the fiscal year ended November 30, 2019; the fourth quarter ended on that date. Amounts below are in U.S. dollars.

Financial performance

  • Revenue: FY2019 net revenue was $2.897 billion, down 4.7% from $3.041 billion. The change included a 3.3% negative currency impact, 2.1% lower volume, a 0.3% impact from the surfactants and thickeners divestiture, and 1.0% favorable pricing. Organic sales growth was negative 1.1%.
  • Profit and margins: Gross profit was $806.9 million, down 2.6%; gross margin improved to 27.9% from 27.2%, mainly on pricing and lower raw-material costs. Net income attributable to H.B. Fuller was $130.8 million versus $171.2 million, down 23.6%. Diluted EPS was $2.52 versus $3.29. The filing attributes the earnings decline to lower revenue and higher income tax expense, partly offset by lower operating costs and the divestiture gain.
  • Fourth quarter: Q4 revenue was $739.1 million versus $768.4 million a year earlier. Net income including non-controlling interests was $32.2 million versus $41.4 million; diluted EPS was $0.61 versus $0.80.
  • Cash flow and investment: Cash from operations was $269.2 million, up from $253.3 million. Capital expenditures were $62.0 million, and dividends paid were $32.4 million. Free cash flow after dividends, a non-GAAP measure, was $174.8 million versus $153.9 million.
  • Liquidity and debt: Cash and equivalents were $112.2 million, down from $150.8 million. Total debt, including notes payable, was approximately $1.979 billion, down from $2.248 billion. The $400 million revolving facility was undrawn, with approximately $393.1 million available after letters of credit. The company reported compliance with debt covenants; its total-indebtedness-to-TTM-EBITDA ratio was 3.8 against a maximum of 5.9.
  • Other indicators: Net working capital was 18.0% of annualized revenue versus 18.5%; receivables DSO rose to 59 days from 56, while inventory days fell to 58 from 60. Debt capitalization declined to 61.8% from 66.1%.

Material changes and notable items

  • Engineering Adhesives revenue grew 0.9% and operating income rose 26.5%; its operating margin increased to 13.7% from 10.9%. Asia Pacific operating income increased 24.9% despite lower reported revenue.
  • Construction Adhesives revenue fell 12.6% and operating income declined 60.5%, with margin decreasing to 3.0% from 6.7%. EIMEA revenue fell 8.1% and operating income declined 24.7%. Americas Adhesives revenue declined 2.7% and operating income declined 6.9%.
  • The July 2019 sale of Dalton Holdings generated a reported pre-tax gain of $18.8 million. The year’s other income also included gains on asset disposals; reported total gains on disposal of assets were $24.3 million.
  • Income tax expense was $49.4 million, compared with a $6.4 million tax benefit in 2018. FY2019 included $12.4 million of discrete tax expense; FY2018 included $49.0 million of discrete tax benefits, principally related to U.S. tax reform.
  • FY2019 restructuring charges were $14.5 million across restructuring actions. The 2020 Restructuring Plan, approved in Q4, is expected to cost approximately $9–$11 million and is expected to be completed by mid-FY2021; the company reported $10.1 million incurred under this plan in FY2019.
  • The company acquired certain Ramapo Sales and Marketing assets for $8.3 million, with up to $3.4 million in contingent consideration. After year-end, it agreed to acquire substantially all assets of D.H.M. Adhesives for approximately $9.5 million, plus contingent consideration of up to approximately $8.1 million.

Outlook, risks and contingencies

  • The filing provides no specific FY2020 revenue or earnings guidance. Management expects operating cash flow to meet ongoing liquidity and capital needs and estimates FY2020 capital expenditures of approximately $85 million.
  • Project ONE, the global ERP implementation, is continuing in North America, EIMEA and Asia Pacific. Estimated total project spending is $195–$210 million, with 50–55% expected to be capital expenditures; management cautions total cost could exceed the estimate. Approximately $79 million had been spent through FY2019.
  • Key exposures include raw-material availability and prices (about 75% of cost of sales), foreign currency, economic conditions, competition, acquisition integration and leverage. Management estimates that a 1% change in raw-material costs would change net income by about $11.5 million; a 1% currency-driven change in cost of sales would change net income by about $8.1 million.
  • Goodwill totaled $1.282 billion. No impairment was recorded, but headroom was relatively limited for Flooring (8%) and EIMEA (21%); the auditor identified impairment analysis for these reporting units as a critical audit matter.
  • Environmental remediation liabilities accrued were $8.5 million; approximately $13.8 million of environmental compliance spending is estimated over the next two years, including $1.4 million of capital expenditures. Asbestos-related claims and other legal matters remain pending; management does not expect them to have a material adverse effect based on current information.
  • An internal investigation into possible resale of products into Iran by customers in Turkey and India was reported to OFAC. The sales ceased in FY2018; the company had not received an OFAC response and estimated potential penalties at zero to $10 million.
  • LIBOR was expected to be phased out after 2021, creating potential amendment and hedging risks for debt and derivative agreements. The company also cited risks from ERP implementation and integration of the Royal Adhesives acquisition.

Important facts for investors to verify

  • Whether organic volume trends, particularly in Construction Adhesives and EIMEA, stabilize and whether Engineering Adhesives growth continues.
  • How much of FY2019 earnings depended on asset-sale gains, and whether pricing and raw-material savings can offset volume and currency pressure.
  • Progress on debt reduction, covenant headroom, floating-rate exposure and transition away from LIBOR.
  • Actual costs, timing and realized savings from restructuring and Project ONE, along with the FY2020 capital-spending plan.
  • Developments in the OFAC inquiry, environmental matters and asbestos claims, and any change in the impairment outlook for Flooring or EIMEA goodwill.

KPMG issued an unqualified audit opinion on the financial statements and concluded internal control over financial reporting was effective as of November 30, 2019.