H.B. Fuller Company — Q3 2018 Form 10-Q
Business context and period: Adhesives and sealants manufacturer; quarter ended September 1, 2018, compared with the quarter ended September 2, 2017. Results are unaudited. Royal Adhesives and Adecol acquisitions materially increased reported revenue; Royal’s operations were allocated across five reportable segments beginning in fiscal 2018.
Financial performance
Amounts below are in millions of dollars, except per-share data. The quarter and nine-month periods are compared with the corresponding 2017 periods.
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $770.1 | $562.9 | $2,272.6 | $1,627.8 |
| Gross profit | $217.2 | $150.4 | $627.3 | $435.4 |
| Gross margin | 28.2% | 26.7% | 27.6% | 26.7% |
| Operating income | $71.1 | $40.2 | $185.0 | $109.5 |
| Net income attributable to H.B. Fuller | $37.7 | $25.1 | $129.9 | $65.8 |
| Diluted EPS | $0.72 | $0.49 | $2.50 | $1.28 |
| Net interest expense | $24.9 | $7.3 | $74.7 | $22.5 |
- Q3 revenue rose 36.8%; management attributed growth to volume (including 34.2 percentage points from acquisitions), pricing and mix, partly offset by a 2.2% unfavorable currency effect. Nine-month revenue rose 39.6%, with acquisitions contributing 34.0 percentage points and currency contributing 1.9% positively.
- Operating income increased 77% in Q3 and 69% year to date. Gross margin expanded 150 basis points in Q3 and 90 basis points year to date, primarily from pricing and the Royal acquisition, partly offset in Q3 by higher restructuring costs.
- Q3 diluted EPS increased to $0.72. Year-to-date net income included a provisional $35.6 million tax benefit related to U.S. Tax Reform; the filing reports a nine-month income tax benefit of $9.8 million overall.
- Cash from operations was $106.8 million for nine months, versus $70.8 million. Capital expenditures were $46.5 million and dividends paid were $23.3 million, leaving reported free cash flow after dividends of $37.0 million, versus $13.2 million.
- Cash was $150.1 million at September 1, 2018, down from $194.4 million at December 2, 2017. Total debt was $2,364.2 million, down from $2,451.9 million; debt to total capital was 67.6%, compared with 60.3% at fiscal year-end and 43.6% a year earlier. Current assets were $1,167.9 million and current liabilities $518.5 million.
- Working-capital indicators improved year over year: receivables DSO was 54 days versus 62, and inventory days on hand were 69 versus 73. However, working-capital changes used $71.5 million of cash in the first nine months.
Material changes and management commentary
- The Royal Adhesives acquisition, completed in October 2017, and Adecol, acquired in November 2017, were the principal drivers of reported growth. The acquisitions accounted for $195.2 million of Q3 revenue and $544.6 million for the first nine months of 2018.
- Growth was broad but uneven: Q3 segment revenue rose 105.1% in Construction Adhesives and 63.4% in Engineering Adhesives; Asia Pacific grew 4.6%. EIMEA operating income declined 2.2% in Q3 despite higher revenue, while Construction Adhesives moved from an operating loss to income.
- Management expects approximately $20 million of costs under the Royal integration restructuring plan, with completion expected by the end of fiscal 2020. The 2017 restructuring plan had incurred $19.9 million through September 1, 2018 and was expected to finish by fiscal year-end 2018. Combined expected restructuring costs are approximately $40 million.
- No specific revenue or earnings guidance is provided. Management says operating cash flows should meet ongoing liquidity and capital expenditure needs and that it believes it can access additional debt if needed. The company was in compliance with its credit covenants; its leverage covenant ratio was 4.8 against a maximum of 5.9.
Risks, contingencies and unusual items
- Leverage and interest costs increased substantially following acquisition financing. A one-percentage-point change in rates on variable-rate debt was estimated to change net income by approximately $5.0 million, or $0.10 per diluted share.
- Foreign-exchange exposure is significant: approximately 54% of Q3 revenue was generated outside the United States. Management estimated a hypothetical 10% U.S. dollar change would affect net income by about $10 million; a 1% change in raw-material costs would affect net income by about $9.4 million.
- The company is investigating possible resale of products to Iran and potential sanctions-related issues involving sales by subsidiaries in Turkey and India. It voluntarily notified OFAC and estimated potential penalties, based on the investigation to date, could range from zero to $10 million; outcome remains uncertain.
- Environmental remediation liabilities were $11.4 million, including $4.8 million associated with a CERCLA-designated site in Simpsonville, South Carolina. The company also faces asbestos claims; it reported seven settlements totaling $0.3 million in the nine-month period, with $0.3 million in insurance payments received or expected. Management does not currently expect these matters to have a material adverse effect, but notes adverse developments could affect future periods.
- The September-quarter comprehensive result attributable to H.B. Fuller was a loss of $95,000, primarily reflecting a $36.8 million foreign-currency translation loss, despite positive net income.
Important facts for investors to verify
- How much of future revenue and earnings growth reflects acquired businesses versus organic volume, pricing and mix, and whether acquisition synergies and integration benefits are being realized.
- Whether gross-margin improvement can persist amid raw-material cost volatility, and whether segment-level pressure—particularly Q3 EIMEA margin compression—continues.
- Debt repayment capacity, refinancing and covenant headroom, variable-rate exposure, and the effect of higher interest expense on earnings and cash generation.
- Cash conversion and working-capital requirements, especially inventory investment during acquisition integration and the sustainability of free cash flow after dividends.
- Developments in the OFAC investigation, environmental remediation and asbestos claims, including any changes in expected penalties, liabilities or insurance recoveries.