H.B. Fuller Company — Q2 2018 Form 10-Q
Business context and reporting period. The filing covers the three and six months ended June 2, 2018; comparative periods ended June 3, 2017. H.B. Fuller manufactures adhesives and related products. Results include Royal Adhesives, acquired in October 2017, and Adecol, acquired in November 2017. The company reorganized reporting into five segments, allocating Royal Adhesives across them.
Financial performance
Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Revenue | $789.4 | $561.7 | $1,502.5 | $1,065.0 |
| Gross profit | $222.4 | $146.0 | $410.1 | $285.0 |
| Gross margin | 28.2% | 26.0% | 27.3% | 26.8% |
| Operating income | $77.2 | $43.3 | $113.9 | $69.3 |
| Net income attributable to H.B. Fuller | $44.5 | $25.9 | $92.1 | $40.7 |
| Diluted EPS | $0.86 | $0.50 | $1.78 | $0.79 |
| Net cash from operating activities | Not separately provided | Not separately provided | $22.4 | $32.8 |
- Q2 revenue rose 40.5%; first-half revenue rose 41.1%. Management attributed most growth to acquisitions: acquisitions contributed 33.5 percentage points of Q2 volume growth and 33.9 points for the first half. Pricing, mix and favorable currency also contributed.
- Operating income increased, while SG&A grew 41.2% in Q2 and 37.3% in the first half, mainly due to acquired businesses and currency effects. Interest expense rose sharply to $25.2 million in Q2 and $49.7 million for the first half, primarily reflecting higher debt following acquisition financing.
- The first-half income tax line was a $19.1 million benefit, including a provisional $35.6 million benefit from U.S. tax reform. The reported first-half effective tax rate was negative 27.7%; excluding the tax-reform and other discrete benefits, management reported an effective rate of 24.8%.
Liquidity, debt and balance sheet
- At June 2, 2018, cash was $129.2 million, down from $194.4 million at December 2, 2017. Current assets were $1,155.7 million and current liabilities $515.4 million.
- Total short- and long-term debt was $2,405.0 million, versus $2,451.9 million at December 2, 2017. Debt-to-total-capital was 68.0%, compared with 60.3% at fiscal year-end and 44.2% a year earlier. Total liabilities were $3,208.7 million.
- First-half operating cash flow was $22.4 million. Capital spending was $33.2 million and dividends paid were $15.4 million, producing negative free cash flow after dividends of $26.2 million, compared with negative $8.9 million in the prior-year period. Working capital absorbed $58.4 million, principally from inventory growth.
- Management said operating cash flow and access to short- and long-term borrowing should meet foreseeable liquidity and capital needs. The company reported compliance with debt covenants; its leverage covenant ratio was 4.9 against a maximum of 6.25.
Material changes, outlook and risks
- Growth was substantially acquisition-driven. Royal Adhesives’ purchase price was approximately $1.623 billion and was funded with new debt. Its and Adecol’s combined first-half revenue contribution was $349.4 million. Purchase accounting valuations remained preliminary.
- Management expected approximately $20 million of Royal Adhesives integration restructuring costs, with the plan expected to finish by fiscal 2020. The prior restructuring plan was expected to conclude by fiscal 2018; combined expected restructuring costs were $37–$40 million. No specific revenue or earnings guidance was provided.
- Raw-material prices, foreign exchange and interest rates are material exposures. The company estimated a one-percentage-point increase in variable borrowing rates would reduce net income by about $5.3 million annually; a hypothetical 1% raw-material cost change would affect net income by about $6.2 million. Management noted potential adverse effects from economic weakness and supplier disruptions.
- Environmental remediation reserves were $11.0 million, including $4.9 million for a South Carolina site. The filing says additional environmental liabilities are possible, although management did not expect known matters to have a material adverse effect based on information available.
- An internal investigation concerns possible resale of products to Iran and possible sanctions issues involving subsidiaries in Turkey and India. The company voluntarily contacted OFAC and estimated possible penalties ranging from zero to $10 million; the outcome was uncertain.
- Three asbestos-related claims were settled in the first half for $0.2 million, with $0.2 million in insurance payments received or expected. The company noted certain insurers are insolvent and it may bear a share of related costs.
- Q2 other comprehensive income included a $40.8 million foreign-currency translation loss, contributing to comprehensive income of $9.9 million despite net income of $44.5 million. Management reported disclosure controls were effective; acquired Royal Adhesives and Adecol were excluded from the internal-control assessment.
Most important facts for investors to verify
- How much of ongoing growth and profit improvement is attributable to acquisitions versus organic volume, pricing and mix, and whether integration delivers expected synergies.
- Debt reduction, interest costs, covenant headroom and the company’s ability to restore positive free cash flow after dividends.
- Whether higher raw-material and delivery costs can be offset by pricing without impairing segment margins.
- Final acquisition purchase accounting, future amortization expense and progress and total costs of restructuring plans.
- Updates on the OFAC investigation, environmental exposures and asbestos insurance recoveries and liabilities.
- The sustainability of reported earnings given the provisional tax-reform benefit and the large first-half currency translation loss.