H.B. Fuller Company — Q3 2017 Form 10-Q
Business context and reporting period. H.B. Fuller manufactures adhesives and related products. This unaudited report covers the three and nine months ended September 2, 2017; comparisons are with the periods ended August 27, 2016 unless noted. Amounts below are in millions of U.S. dollars, except per-share data and ratios.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $562.9 | $512.9 | $1,627.8 | $1,519.7 |
| Gross profit | $150.4 | $146.1 | $435.4 | $442.0 |
| Gross margin | 26.7% | 28.5% | 26.7% | 29.1% |
| Net income attributable to H.B. Fuller | $25.1 | $32.7 | $65.8 | $85.0 |
| Diluted EPS | $0.49 | $0.64 | $1.28 | $1.66 |
| Interest expense | $8.1 | $6.8 | $24.6 | $19.7 |
Revenue grew 9.8% in Q3 and 7.1% year to date. Constant-currency growth was 11.3% and 10.1%, respectively, partly offset by currency headwinds of 1.5% and 3.0%. Gross margin fell 180 basis points in Q3 and 240 basis points year to date, mainly from higher raw-material costs, with acquired businesses and the 2017 restructuring plan also affecting margins. SG&A rose 12.8% in Q3 and 8.2% year to date, reflecting acquisitions, transaction costs, higher variable compensation and restructuring-related costs.
For the first nine months, operating cash flow was $70.8, down from $145.9. Investing cash outflow was $159.3, including $123.3 for Wisdom Adhesives and $35.5 of capital expenditures. Financing provided $61.2, including debt issuance and repayments; cash dividends paid were $22.1 and share repurchases were $21.7. Reported free cash flow, defined by the company as operating cash flow less capital expenditures and dividends, was $13.2 versus $75.8.
Financial position and liquidity
- At September 2, 2017, cash and equivalents were $119.6, down from $142.2 at December 3, 2016. Current assets were $916.9 and current liabilities were $349.0.
- Total short- and long-term debt was $799.0, compared with $703.3 at December 3, 2016. Total debt to total capital was 43.6%, versus 42.8% at year-end 2016.
- Working capital measures weakened year over year: net working capital as a percentage of annualized revenue was 23.0% versus 21.7%; receivables DSO was 62 versus 60 days; inventory days were 73 versus 67.
- The company reported compliance with debt covenants: trailing-twelve-month EBITDA to interest was 7.8x (minimum 2.5x), and indebtedness to EBITDA was 3.1x (maximum 3.5x).
Material changes and segment performance
Growth was strongest in Engineering Adhesives, with Q3 revenue up 18.1% and segment operating income up 31.3%; year-to-date revenue rose 20.0% and operating income 93.0%. Americas Adhesives revenue increased 16.0% in Q3, but operating income fell 16.3%, as higher raw-material costs and Wisdom acquisition/integration effects pressured margins. Construction Products revenue declined 8.3% in Q3 and 6.4% year to date; the segment reported a year-to-date operating loss of $1.6, citing facility-upgrade service issues, Hurricane Harvey, restructuring actions and related inefficiencies. EIMEA revenue grew 5.2% in Q3 but only 0.5% year to date, with currency weighing on reported results. Asia Pacific revenue grew 9.5% in Q3 and 10.9% year to date.
Segment operating income totaled $40.2 in Q3 versus $48.4 and $109.5 year to date versus $140.8. The 2017 figure includes $4.8 of unallocated Royal Adhesives transaction costs. The income statement reported no special charges in 2017; restructuring costs were recorded in cost of sales and SG&A.
Outlook, transactions, risks and unusual items
- Royal Adhesives: On September 2, 2017, the company agreed to acquire Royal Adhesives and Sealants for $1.575 billion, subject to customary adjustments, with closing expected in Q4 2017. The company expected about $20 million in transaction costs, of which $4.8 million had been incurred by quarter-end. Its proposed financing included a new $1.85 billion secured term loan and $300 million of additional unsecured notes; estimated financing costs were $72.9 million, including about $32.5 million expected to be capitalized. Completion remained subject to regulatory approvals and other conditions. Certain termination circumstances could trigger a $78.8 million fee.
- Restructuring: The company expected approximately $20 million of pretax costs for its 2017 plan, expected to be completed by mid-fiscal 2018. It recorded $17.1 million through the first nine months, including $1.3 million in Q3.
- Management outlook: The filing provides no specific full-year revenue or earnings guidance. Management stated that operating cash flows and planned acquisition financing were expected to meet ongoing liquidity and capital needs for the foreseeable future.
- Notable accounting and currency items: A change in Latin American subsidiaries’ functional currencies contributed an $11.3 million cumulative translation adjustment in the first nine months. Foreign-currency translation also materially increased Q3 other comprehensive income. Interest expense rose with higher U.S. debt balances and LIBOR rates. The company reported $4.8 million of contingent consideration liability at year-end falling to $2.3 million, including a mark-to-market reduction partly offset by an agreement amendment.
- Risks and contingencies: Raw-material price and supply changes, foreign exchange, interest rates, and acquisition financing, integration, regulatory approval and leverage are significant risks. Environmental matters and asbestos-related litigation remain outstanding; management did not expect them to have a material adverse effect based on information available, while noting adverse developments could affect future results or cash flows. Seven asbestos claims were settled in the first nine months for $1.6 million, with $1.3 million of insurance payments received or expected.
Investor verification priorities
- Verify Royal Adhesives closing status, final purchase price, funding terms, transaction and integration costs, and resulting leverage.
- Track raw-material cost recovery, gross-margin trends, restructuring savings and completion costs.
- Assess cash conversion and working-capital trends, particularly inventory and the year-over-year decline in operating cash flow and free cash flow.
- Monitor Construction Products’ recovery from facility-upgrade and hurricane-related disruption, and continued performance across segments.
- Review covenant headroom after any acquisition financing and developments in environmental and asbestos claims.