H.B. Fuller Company — Q3 2014 Form 10-Q
Business context and period: Global adhesives and construction-products company. The quarter was the 13 weeks ended August 30, 2014; year-to-date figures cover 39 weeks. Comparisons are with the corresponding 2013 periods. Dollar amounts below are in millions unless noted.
Financial performance
| Metric | Q3 2014 | Q3 2013 | 39 weeks 2014 | 39 weeks 2013 |
|---|---|---|---|---|
| Net revenue | $526.8 | $514.6 | $1,556.8 | $1,513.4 |
| Gross profit | $125.2 | $144.5 | $400.9 | $424.5 |
| Gross margin | 23.8% | 28.1% | 25.7% | 28.0% |
| Net income attributable to H.B. Fuller | $4.0 | $28.3 | $39.1 | $74.9 |
| Diluted EPS | $0.08 | $0.55 | $0.76 | $1.47 |
- Revenue rose 2.4% in Q3 and 2.9% year to date. Q3 volume increased 2.0%, pricing fell 0.7%, and currency added 1.1%; year-to-date volume rose 3.2%, pricing fell 0.6%, and currency added 0.3%.
- Q3 operating income before tax and equity-method income was $10.5 million versus $35.5 million; year-to-date it was $57.6 million versus $96.2 million. Q3 income taxes were $8.0 million, with a 76.9% effective rate; the year-to-date rate was 40.7%.
- Special charges were $12.3 million in Q3 and $37.6 million year to date, primarily for the Business Integration Project. Year-to-date special charges were higher than 2013’s $29.0 million.
- Q3 segment operating income (excluding special charges) fell to $28.4 million from $53.9 million. Americas Adhesives earned $21.9 million (down 37%); EIMEA $3.1 million (down 78%); Asia Pacific $0.9 million (down 43%); Construction Products $2.5 million (down 24%).
Cash flow, debt and liquidity
- For the first 39 weeks, operating cash flow from continuing operations was negative $12.6 million, versus positive $89.2 million in 2013. Capital expenditures were $116.2 million versus $82.5 million. Reported free cash flow, defined by the company as operating cash flow less capital expenditures and dividends, was negative $145.8 million versus negative $7.7 million.
- Cash was $75.5 million at August 30, 2014, down from $155.1 million at November 30, 2013; $67.8 million was held outside the U.S. Net working capital was 19.6% of annualized revenue versus 18.0% a year earlier; receivables days were 59 versus 55, and inventory days were 66 versus 56.
- Total short- and long-term debt was $562.9 million, compared with $492.9 million at November 30, 2013. Debt to total capital was 37.2%, versus 36.4% at fiscal year-end. The company reported compliance with debt covenants; trailing EBITDA/interest was 10.4x against a minimum 2.5x, and debt/EBITDA was 2.9x against a maximum 3.5x.
Material changes, outlook and risks
- Management attributed lower gross margin to less favorable pricing and mix and production inefficiencies tied to the Business Integration Project, ERP rollout, and startup of supply-chain activity for new business. It also cited soft core European markets and longer EIMEA lead times.
- Management’s integration objective is $90 million of annual cash savings and other pretax cash-profit improvements. The target of a 15% EBITDA margin, previously expected by 2015, was delayed to 2016 or shortly thereafter. Q3 EBITDA margin was 8.6%, versus 13.3% a year earlier. Project costs were estimated at $125 million; management expected the final total to exceed that estimate by approximately 25%, with $142.7 million incurred through August 30.
- No specific revenue or earnings guidance was provided. Management said operating cash flows and available borrowing capacity should meet ongoing liquidity and capital needs. It noted that covenant breaches could require renegotiation of credit lines and increase financing costs.
- ERP implementation and integration delays, execution costs, production inefficiencies, raw-material availability and prices, currency movements, and weaker economic conditions are key business risks. A 1 percentage-point interest-rate change on variable-rate debt was estimated to affect annual interest expense by about $1.4 million; a hypothetical 10% U.S. dollar change was estimated to affect net income by about $3.3 million.
- Environmental proceedings and asbestos-related litigation were not expected by management to have a material adverse effect, although adverse developments could affect future periods. Some asbestos insurers are insolvent; allocation of future costs under an insurer settlement depends on an appeal. The filing reports four asbestos settlements totaling $190,000 year to date, with $155,000 of insurance payments received or expected.
- During Q3, the company recorded out-of-period inventory and tax adjustments between Q2 and Q3, including a $1.646 million cost-of-sales adjustment and tax adjustments. Management concluded neither quarter was materially misstated. On September 3, 2014, the company acquired ProSpec Construction Products for approximately $26 million.
Important facts for investors to verify
- Whether gross-margin and segment-profit declines reverse as ERP and integration-related inefficiencies ease, particularly in EIMEA and Americas Adhesives.
- Progress toward the revised 15% EBITDA-margin target, expected $90 million benefits, and the higher-than-planned project cost and timing.
- Whether working-capital investment, negative operating cash flow, and elevated capital spending improve, and how the company funds dividends, debt service, and acquisitions.
- The impact of tax-rate changes and out-of-period adjustments on reported earnings, and the final costs or obligations arising from litigation, environmental matters, and the asbestos-insurance appeal.