H.B. Fuller Company — Q3 2010 Form 10-Q
Reporting period: 13 and 39 weeks ended August 28, 2010; comparisons are with the periods ended August 29, 2009. Amounts below are in millions except per-share data. H.B. Fuller is a global adhesives and related products company reporting across North America, EIMEA, Latin America and Asia Pacific.
Financial performance
| Metric | Q3 2010 | Q3 2009 | 39 weeks 2010 | 39 weeks 2009 |
|---|---|---|---|---|
| Net revenue | $338.6 | $315.3 | $995.9 | $893.1 |
| Gross profit | $96.3 | $100.4 | $295.1 | $264.8 |
| Gross margin | 28.4% | 31.8% | 29.6% | 29.7% |
| Operating income | $22.7 | $32.1 | $74.7 | $72.4 |
| Net income attributable to H.B. Fuller | $19.0 | $35.4 | $48.9 | $59.1 |
| Diluted EPS | $0.38 | $0.72 | $0.99 | $1.21 |
| Operating cash flow | — | — | $27.2 | $117.3 |
- Q3 revenue rose 7.4%; organic growth was 8.9% (volume +6.4%, pricing +2.5%), offset partly by a 3.1% adverse currency effect. Revertex contributed $5.1 of Q3 revenue. Nine-month revenue growth was 11.5%, including 9.7% organic growth.
- Q3 cost of sales grew 12.7%, faster than revenue, as raw-material supply shortages and higher costs compressed gross margin. Management reported margin of 28.4%, down from 29.1% in Q2 2010 and 31.8% in Q3 2009.
- Q3 net income fell 46.4% year over year. Comparability is affected by the $18.8 pretax Roanoke litigation settlement gain in Q3 2009 ($11.8 after tax, or $0.24 per diluted share). Q3 2010 included $2.9 of discrete tax benefits ($0.06 per diluted share). Nine-month 2010 results included $8.4 after-tax impact from product-line exit and impairment charges.
- Cash from operations was $27.2 for the first nine months, versus $117.3 a year earlier. Working capital used $33.7 of cash, compared with a $20.6 source in 2009; inventory growth and raw-material availability purchases were significant factors. Company-defined free cash flow was negative $7.4, versus positive $92.3.
- Capital expenditures were $24.4 for the first nine months, including $5.5 of increased spending for the Nanjing, China plant. Revertex acquisition spending, net of cash acquired, was $26.8.
Liquidity, debt and balance sheet
- At August 28, 2010, cash was $140.7, total debt was $299.4 and equity was $599.5. Debt to total capital was 33.3%, compared with 26.5% at November 28, 2009 and 27.4% at August 29, 2009. Management attributed the increase primarily to $150.0 of senior notes funded in Q1 2010.
- Current assets were $551.9 and current liabilities $234.9. Cash increased $40.6 from fiscal year-end, despite operating cash generation being offset by investing outflows and foreign exchange effects.
- Inventory was $148.5, up from $116.9 at fiscal year-end; inventory days on hand rose to 57 from 49 a year earlier. Receivables DSO was 55 days versus 54.
- The company said it was compliant with all debt covenants at quarter-end and believed operating cash flow and access to borrowing would meet liquidity and capital needs. It expected to pay a $5.6 term-loan installment due September 30 from existing cash.
Material changes and segment trends
- North America Q3 revenue rose 5.2%, but operating income declined 13.9% to $18.5, primarily due to lower gross margin and higher commercial investment.
- EIMEA Q3 revenue increased 3.4% despite a 12.2% negative currency impact; operating income fell 67.7% to $2.3. Higher raw-material costs, increased SG&A and a $1.3 product-liability charge weighed on results. Nine-month results also included charges from the European polysulfide product-line exit.
- Latin America Q3 revenue rose 8.2%, while operating income fell 16.7% to $1.2, mainly due to lower adhesive margins. Nine-month operating income increased 47.5% to $6.3.
- Asia Pacific Q3 revenue increased 27.2%, including acquisition and currency contributions; organic growth was 7.6%. Operating income declined 66.4% to $0.7 as margin pressure and higher SG&A, including acquisition costs, offset growth.
- In Q2 2010, the company decided to exit its European polysulfide-based insulating glass product line. It recorded $11.4 in total pretax impairment and exit charges, including $8.8 of asset impairment.
- Revertex Finewaters, a Malaysian adhesives supplier, was acquired on June 2 for $26.8 net of acquired cash, funded with existing cash. The acquisition added $12.3 of goodwill.
Outlook, risks and contingencies
- Management forecast Q4 net revenue of $360–$365, implying full-year revenue growth of approximately 10% over 2009. It expected overall financial performance to improve versus Q3, but gave no specific EPS forecast. The expected remainder-of-2010 effective tax rate, excluding discrete items, was approximately 34%.
- Management cited raw-material shortages and price increases as key near-term pressures, limiting its ability to substitute materials or reformulate products. Other disclosed exposures include economic weakness, interest rates, foreign exchange, and raw-material supply and cost volatility.
- A September 10 fire at the Portugal manufacturing site damaged part of a building and temporarily idled production in that unit. Other European facilities were considered viable replacement sources. The company is insured, with a $2.5 per-event retention, but had not estimated total costs.
- Environmental remediation liabilities were $2.4 at quarter-end, including $1.0 for the Sorocaba, Brazil site; additional costs may be required. Probable asbestos liabilities were $2.7, with $1.4 of related insurance recoveries. The filing says these matters are not expected to materially harm long-term financial condition, but could affect future-quarter results or cash flows.
- The company reported $6.6 of gross unrecognized tax benefits and $1.6 of accrued net interest and penalties. Third-quarter audit activity reduced the recorded net uncertain-tax liability by $4.1, including a $3.8 discrete tax benefit.
Most important facts for investors to verify
- Whether raw-material availability and pricing improve, and whether selling prices can recover the Q3 margin decline.
- Whether Q4 revenue lands within management’s $360–$365 forecast and whether performance improves from Q3.
- Whether working-capital investment, particularly elevated inventory, converts into sales and stronger operating cash flow.
- The costs, insurance recovery and production impact associated with the Portugal fire.
- Debt levels, covenant headroom and financing costs, including exposure to variable rates; management estimated a one-percentage-point rate change would affect annual interest expense by about $2.2.
- Developments in environmental, asbestos and product-liability matters, including whether additional reserves or payments become necessary.