H.B. Fuller Company — Q2 2015 Form 10-Q
Reporting period: 13 weeks ended May 30, 2015; year-to-date figures cover 26 weeks. Financial statements are unaudited; amounts below are in U.S. dollars unless noted.
Business context and reporting period
H.B. Fuller manufactures adhesives and construction products and reports four segments: Americas Adhesives, EIMEA, Asia Pacific and Construction Products. The quarter included the acquisitions of Tonsan Adhesive in China and Continental Products in Kenya. Results also reflect currency translation, ongoing Business Integration Project activity and, for discontinued operations, a settlement related to the former Central America Paints business.
Financial performance and liquidity
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Net revenue | $540.8m | $544.0m | $1,011.4m | $1,030.0m |
| Gross profit / margin | $148.9m / 27.5% | $142.7m / 26.2% | $265.1m / 26.2% | $275.7m / 26.8% |
| Net income attributable to H.B. Fuller | $25.2m | $20.5m | $34.9m | $35.1m |
| Diluted EPS | $0.49 | $0.40 | $0.68 | $0.69 |
| Operating cash flow | — | $116.2m | $(33.8)m |
Q2 revenue declined 0.6% as 6.4% constant-currency growth, including 5.5% volume and 0.9% pricing growth, was offset by a 7.0% adverse currency effect. First-half revenue fell 1.8%; constant-currency growth was 4.1%, offset by a 5.9% currency headwind. Q2 income from continuing operations was $26.6m versus $20.6m. First-half net income included a $1.3m after-tax discontinued-operations loss.
Q2 gross margin expanded 130 basis points, driven by lower raw-material and delivery costs and improved mix; first-half margin contracted 60 basis points, reflecting integration-related production inefficiencies and acquisition inventory step-up costs. Q2 SG&A rose 4.4% to $100.6m; first-half SG&A increased 1.2% to $195.4m. Special charges were $0.9m in Q2 and $3.3m in the first half, versus $13.5m and $25.3m, respectively, in 2014.
Segment trends: Q2 operating income improved in Americas Adhesives ($34.8m versus $31.9m), Asia Pacific ($5.3m versus $1.7m) and Construction Products ($6.6m versus $2.5m), but fell sharply in EIMEA ($1.7m versus $10.2m). EIMEA’s revenue decline included a 17.6% currency impact and lower volumes amid soft European markets and integration-related delivery delays. Asia Pacific and Construction Products benefited from acquisition-related and organic growth.
At May 30, 2015, cash was $79.5m, total debt was $736.9m and the debt-to-total-capital ratio was 45.3%, versus 37.2% at May 31, 2014. Cash included $63.9m held outside the U.S. First-half investing cash outflow was $255.4m, including $217.6m for businesses acquired; financing cash inflow was $145.8m. The company reported free cash flow of $64.7m, using its definition of operating cash flow less capital spending and dividends. It was in compliance with debt covenants: trailing EBITDA/interest was 9.1x against a 2.5x minimum, and debt/EBITDA was 3.3x against a 3.75x limit.
Material changes versus prior comparable periods
- Q2 earnings and diluted EPS increased year over year, helped by higher gross margin and substantially lower integration charges; first-half earnings and EPS were slightly lower.
- Currency translation materially reduced reported revenue, particularly in EIMEA. Constant-currency growth was positive for both the quarter and first half.
- First-half operating cash flow improved from an outflow to an inflow, with working-capital changes contributing $18.5m versus a $57.3m use of cash a year earlier.
- Debt increased following acquisition financing. The company borrowed $300m under a January 2015 term loan; total debt rose from $574.9m at fiscal year-end 2014 to $736.9m.
- First-half other comprehensive loss included a $37.9m foreign-currency translation loss.
Outlook, management commentary, risks and unusual items
- Management expects the Business Integration Project to deliver $90m of annual cash savings and other pretax profit improvements when complete. The targeted 15% EBITDA margin, previously expected in 2015, is now expected in 2016. Estimated total project costs increased from approximately $125m to $164m; $159.9m had been incurred through May 30, 2015. EBITDA margin was 12.4% in Q2 versus 11.5% a year earlier, and 10.5% for the first half versus 11.0%.
- No broader quantified company revenue or earnings guidance is provided in the supplied filing text. Management said operating cash flows should meet ongoing liquidity and capital expenditure needs and that debt financing should remain available; these are expectations, not guarantees.
- The company recorded a $1.3m after-tax loss after agreeing, subsequent to quarter-end, to settle matters from the 2012 Central America Paints divestiture for $8m. The payment was made June 26, 2015.
- Tonsan’s acquisition agreement includes contingent consideration of up to approximately $66.8m based on 2018 gross profit and a future purchase of the remaining 5% for approximately $13.0m beginning in 2019. The acquisition valuation remained preliminary at quarter-end.
- Key exposures include foreign exchange, raw-material prices, interest rates, economic and end-market conditions, and continued integration execution. Management estimated that a 1% change in variable-debt rates would affect annual interest expense by about $2.6m; a 1% raw-material cost change would affect net income by about $2.1m. Environmental, asbestos and other legal matters remain contingencies; management did not expect them to have a material adverse effect based on information then available, while noting future settlements could affect results or cash flows.
- The company reported effective disclosure controls. The assessment of internal control over financial reporting excluded the recent acquisitions, which represented approximately 11% of total assets.
Important facts for investors to verify
- Whether EIMEA production and delivery performance improves, and whether the revised 2016 margin target and $164m project-cost estimate remain achievable.
- Final Tonsan purchase accounting, acquisition contribution to growth and profitability, and the eventual amount and timing of contingent and remaining-equity payments.
- Debt levels, covenant headroom and financing costs as acquisition-related borrowings are integrated into operations.
- Whether constant-currency growth in Asia Pacific and Construction Products can offset currency pressure and weaker Americas and EIMEA trends.
- Cash-flow conversion, working-capital requirements and the company’s ability to sustain capital spending and dividends while carrying higher debt.
- Resolution and financial impact of the $8m Paints settlement and any material developments in environmental, asbestos or other legal contingencies.