H.B. Fuller Company — Q3 2016 Form 10-Q
Reporting period: Quarter ended August 27, 2016; year-to-date figures cover the nine months ended that date. Comparisons are with the corresponding 2015 periods. Amounts are in millions of dollars unless otherwise stated.
Business context
H.B. Fuller manufactures adhesives and reports five segments: Americas Adhesives, EIMEA, Asia Pacific, Construction Products and Engineering Adhesives. During 2016 it acquired Advanced Adhesives in Australia and New Zealand for $10.4 million and Cyberbond in the United States for $42.5 million. Cyberbond’s purchase-price allocation was preliminary at quarter-end. Segment reporting was reorganized in 2016, with prior-period segment results recast.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $512.9 | $524.1 | $1,519.7 | $1,535.6 |
| Gross profit | $146.1 | $146.8 | $442.0 | $412.0 |
| Gross margin | 28.5% | 28.0% | 29.1% | 26.8% |
| Net income attributable to H.B. Fuller | $32.7 | $26.8 | $85.0 | $61.7 |
| Diluted EPS | $0.64 | $0.52 | $1.66 | $1.20 |
| Operating cash flow | Not separately reported | Not separately reported | $145.9 | $153.0 |
| Capital expenditures | Not separately reported | Not separately reported | $49.6 | $48.6 |
Q3 revenue declined 2.2%: volume rose 0.9%, pricing fell 2.1%, and currency reduced revenue 1.0%. For the first nine months, revenue declined 1.0%, as volume growth of 2.5% was outweighed by lower pricing and a 2.2% adverse currency effect. Management attributed margin improvement mainly to lower raw-material costs. Nine-month free cash flow, as defined by the company after capital expenditures and dividends, was $75.8 million, down from $85.2 million.
Segment results were mixed. In Q3, Engineering Adhesives revenue grew 7.8% and Asia Pacific grew 5.2%; Construction Products revenue fell 11.1%, and Americas Adhesives fell 3.7%. For the first nine months, EIMEA and Engineering Adhesives recorded notable operating-income improvement, while Construction Products operating income declined 49.8%.
Financial position and liquidity
At August 27, 2016, cash and cash equivalents were $133.1 million, including $120.3 million held outside the United States. Total debt was stated in MD&A as $713.6 million, versus $722.9 million at November 28, 2015. The reported debt-to-total-capital ratio was 42.6%, compared with 45.3% at fiscal year-end 2015. The balance-sheet debt line items sum to approximately $711.6 million, so the difference from the MD&A total should be checked.
Operating cash flow was $145.9 million year to date. Cash used in investing was $96.5 million, including acquisition spending of $51.3 million and capital expenditures of $49.6 million. Financing used $31.5 million, including $20.6 million of dividends and $11.9 million of share repurchases. The company said operating cash flow and access to borrowing should meet foreseeable liquidity and capital needs. It reported compliance with debt covenants; covenant ratios were 10.5 for trailing EBITDA to interest (minimum 2.5) and 2.6 for indebtedness to trailing EBITDA (maximum 3.5).
Material changes, outlook and risks
- Net income attributable to the company rose 22.2% in Q3 and 37.8% year to date, despite slightly lower revenue; lower raw-material costs supported gross-margin gains.
- Q3 results included a $2.8 million net credit in special charges, primarily reflecting a $3.6 million gain on the sale of the Wels, Austria facility. The Business Integration Project had incurred $159.3 million through the quarter; expected total project costs were approximately $164 million.
- Nine-month other expense included $9.1 million of currency translation and remeasurement losses, largely related to the Argentine peso. Interest expense rose 5.1% year to date.
- No specific earnings or revenue guidance was provided. Management expressed confidence in liquidity and financing capacity but cautioned that results can be affected by economic conditions, sales volumes and pricing, foreign exchange, interest rates, and raw-material costs.
- Environmental, asbestos and other legal matters were not expected by management to have a material adverse effect based on available information; the filing notes that adverse developments or settlements could affect future-period results or cash flows.
- Disclosure controls and procedures were deemed ineffective at quarter-end because of a previously identified material weakness involving accounting for business combinations. Remediation was in progress; the filing did not say the weakness had been remediated.
Important facts for investors to verify
- Reconcile the $713.6 million debt total in MD&A with approximately $711.6 million from the balance-sheet debt line items.
- Track remediation and any subsequent assessment of the material weakness in acquisition accounting controls.
- Review final purchase-price allocations for Cyberbond and Advanced Adhesives, including identified intangible assets and goodwill.
- Assess whether Construction Products’ revenue and margin declines, and foreign-exchange exposure, persist; compare these with continued cost and margin benefits.
- Monitor cash conversion, capital spending, project costs, and the company’s ability to meet debt covenants and obligations.
- Consider the scale and timing uncertainty of environmental and asbestos liabilities, including the extent of insurance and third-party recoveries.