H.B. Fuller Company — Q1 2015 Form 10-Q
Reporting period: 13 weeks ended February 28, 2015; comparisons are to the 13 weeks ended March 1, 2014 unless otherwise noted. Amounts are in U.S. dollars; financial statement amounts below are in millions except per-share data.
Business context and results
H.B. Fuller makes adhesives and construction products and reports four segments: Americas Adhesives, EIMEA, Asia Pacific and Construction Products. The quarter included acquisitions of Tonsan Adhesive in China and Continental Products in Kenya.
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net revenue | $470.7 | $486.0 | Down 3.2% |
| Gross profit / margin | $116.2 / 24.7% | $133.0 / 27.4% | Profit down 12.7%; margin down 2.7 percentage points |
| Operating income by segment, total | $21.4 | $36.2 | Down 41.0% |
| Special charges | $2.4 | $11.7 | Down 79.9% |
| Income before taxes and equity-method income | $13.3 | $19.3 | Down 31.4% |
| Net income attributable to H.B. Fuller | $9.7 | $14.6 | Down 33.4% |
| Diluted EPS | $0.19 | $0.28 | Down $0.09 |
| Operating cash flow | $66.2 | $(17.1) | Improved |
| Capital expenditures | $28.4 | $50.9 | Down |
Performance drivers and material changes
- Revenue declined despite 1.0% higher volume and 0.4% higher pricing; currency reduced revenue 4.6%, primarily reflecting weaker currencies against the U.S. dollar. Constant-currency growth was 1.4%.
- Gross margin fell 270 basis points, driven by less profitable sales mix, Business Integration Project production inefficiencies and acquisition-related inventory step-up costs. Raw-material costs were lower, but other manufacturing costs increased.
- Segment revenue and operating income were mixed: Americas Adhesives revenue was $203.9 million and operating income $20.8 million; EIMEA revenue was $147.6 million and operating loss $0.7 million; Asia Pacific revenue was $70.0 million and operating loss $0.5 million; Construction Products revenue was $49.2 million and operating income $1.8 million.
- Construction Products revenue rose 23.8%, supported by market-share gains and the ProSpec acquisition. Asia Pacific revenue rose 7.6%, including Tonsan, while EIMEA revenue fell 14.0%, including a 10.8% adverse currency effect and operating disruption from integration-related production inefficiencies.
- Interest expense increased 47.9% to $6.1 million, primarily due to higher average debt and lower capitalized interest. The effective tax rate was 35.9%, versus 33.8%.
- Foreign-currency translation generated a $33.3 million other comprehensive loss; comprehensive loss attributable to H.B. Fuller was $22.1 million.
Cash, debt and liquidity
- Cash was $71.6 million at February 28, 2015, down from $77.6 million at November 29, 2014; $64.7 million was held outside the United States.
- Total short- and long-term debt was $763.6 million, versus $574.9 million at fiscal year-end and $533.7 million a year earlier. Debt to total capital was 46.8%, versus 39.2% and 36.4%, respectively.
- Cash flow from operations was $66.2 million; investing activities used $244.7 million, including $217.6 million for business acquisitions. Financing activities provided $176.1 million, including $317.0 million of long-term debt proceeds and $130.0 million of repayments.
- Management reported free cash flow of $31.8 million, using its definition of operating cash flow less capital expenditures and dividends. Net working capital was 22.1% of annualized revenue; receivable days were 58 and inventory days were 67.
- The company reported compliance with debt covenants: trailing-twelve-month EBITDA/interest was 9.5x against a 2.5x minimum, and indebtedness/EBITDA was 3.4x against a temporarily increased 3.75x maximum. The maximum is scheduled to return to 3.50x in Q1 2016.
- The board’s dividend declared per common share was $0.12, up from $0.10 in the prior-year quarter.
Acquisitions, outlook and risks
- H.B. Fuller acquired 95% of Tonsan Adhesive for approximately $215.9 million, funded with a term loan, and acquired Continental Products for approximately $1.7 million. Purchase accounting was preliminary. Tonsan includes a future obligation to acquire the remaining 5% for approximately $11.8 million and contingent consideration of up to approximately $68.1 million; related fair-value liabilities were recorded.
- The Business Integration Project targets $90 million of annual cash savings and other pre-tax profit improvements. Expected total project costs increased from approximately $125 million to $164 million. The company now expects to reach its 15% EBITDA-margin target in 2016 rather than 2015; Q1 EBITDA margin was 8.3%, versus 10.5% a year earlier. Management cited delays and higher implementation costs.
- No company-wide revenue or earnings guidance is provided in the supplied filing text. Management said operating cash flows should meet ongoing liquidity and capital needs and stated it expects to meet fiscal 2015 contractual obligations.
- Risks include integration delays and costs, foreign-exchange movements, raw-material price and supply changes, interest-rate exposure, weak end-market demand, and environmental and asbestos-related proceedings. Management did not expect the disclosed legal and environmental matters to have a material adverse effect based on information then available, while noting future developments could affect results or cash flows.
- Management stated disclosure controls were effective. Its internal-control assessment excluded the recently acquired businesses, which represented approximately 11% of total assets.
Investor verification points
- Track whether integration efficiencies improve production, margins and EBITDA, and whether the revised 2016 target and estimated project costs are achieved.
- Assess post-acquisition performance, purchase-accounting adjustments, goodwill and the Tonsan contingent and redemption obligations.
- Monitor debt reduction, covenant headroom and the scheduled step-down in the maximum leverage covenant in Q1 2016.
- Separate underlying volume and pricing trends from foreign-exchange effects, particularly in EIMEA and Asia Pacific.
- Review the company’s exposure to environmental and asbestos claims, including insurance recoveries and the unresolved appeal affecting insurer cost allocation.