H.B. Fuller Company — Q3 2011 Form 10-Q
Reporting period: 13 weeks ended August 27, 2011; year-to-date figures cover 39 weeks. Comparatives are the corresponding 2010 periods unless noted. Amounts are in U.S. dollars; financial statement amounts below are in millions unless stated otherwise.
Business context and performance
H.B. Fuller reports six segments: North America Adhesives, Construction Products, EIMEA, Latin America Adhesives, Latin America Paints and Asia Pacific. Management changed its segment structure during the quarter and restated prior-period segment comparisons. Revenue growth was broad-based, while raw-material shortages and higher feedstock costs continued to pressure costs.
Key financial metrics
| Metric | Q3 2011 | Q3 2010 | 39 weeks 2011 | 39 weeks 2010 |
|---|---|---|---|---|
| Net revenue | $387.8 | $338.6 | $1,121.0 | $995.9 |
| Gross profit | $112.0 | $96.3 | $321.5 | $295.1 |
| Gross margin | 28.9% | 28.4% | 28.7% | 29.6% |
| Operating income | $32.4 | $22.7 | $88.7 | $74.7 |
| Net income attributable to H.B. Fuller | $23.2 | $19.0 | $62.7 | $48.9 |
| Diluted EPS | $0.47 | $0.38 | $1.26 | $0.99 |
| Income tax expense / effective rate | $9.9 / 31.8% | $4.1 / 19.3% | $26.2 / 31.9% | $17.2 / 28.3% |
Third-quarter revenue rose 14.5%; reported organic growth was 8.5%, comprising 10.5% from pricing and a 2.0% decline in sales volume. For the first nine months, revenue rose 12.6% and organic growth was 8.7% (pricing +9.1%, volume -0.4%). Currency contributed 6.0% to quarterly and 2.8% to year-to-date revenue growth; acquisitions contributed 1.1% year to date.
SG&A was $79.5 million for the quarter and $232.8 million year to date. As a share of revenue, SG&A improved to 20.5% from 21.7% in Q3 and 20.8% from 22.1% year to date. The company reported $62.1 million of operating cash flow year to date, versus $27.2 million. Capital spending was $23.6 million; cash dividends paid were $10.9 million. Company-defined free cash flow was $27.6 million, compared with negative $7.4 million.
At August 27, 2011, cash was $149.1 million, current assets $619.1 million and current liabilities $264.0 million. Total debt was approximately $238.1 million, down from $250.7 million at November 27, 2010; total debt to total capital was 24.2%, versus 28.3%. Cash included $132.0 million held outside the U.S. The company reported compliance with debt covenants. Its current ratio, calculated from the reported balances, was approximately 2.35.
Material changes and segment results
- Quarterly gross margin improved year over year as price increases partly offset raw-material inflation; year-to-date margin declined because price increases did not fully offset higher costs.
- Quarterly net income increased 22.4%; year-to-date net income increased 28.1%. The 2010 year-to-date comparison included $8.4 million after tax ($0.17 per share) of exit costs and impairment charges.
- EIMEA revenue increased 20.4% in Q3, including a 14.6% favorable currency effect; operating income rose to $6.7 million from $2.3 million. Europe’s weaker economy and discontinued low-margin product lines weighed on volume.
- Asia Pacific Q3 revenue rose 22.6%, including 12.9% from currency; year-to-date growth also included the Revertex acquisition. Q3 operating income was $2.1 million, versus $0.7 million.
- Latin America Adhesives and Latin America Paints had double-digit organic revenue growth in Q3. Year-to-date Latin America Adhesives operating income fell 5.2% as margins were pressured by raw-material costs; Latin America Paints operating income rose to $3.5 million from $1.0 million.
- North America Adhesives Q3 operating income rose 18.1% to $20.5 million. Construction Products Q3 operating income rose 52.4% to $1.7 million.
Outlook, risks and unusual items
Management said operating cash flows should be adequate for ongoing liquidity and capital-expenditure needs and that it expects access to short- and long-term borrowing for foreseeable financing needs. It expected to meet fiscal 2011 contractual obligations, including a $5.6 million term-loan payment due September 30, 2011. The filing provides no specific revenue or earnings guidance. Management cited a sluggish economic environment and continued investment in sales and technical resources.
Key operating risks include raw-material supply shortages and price increases, economic weakness affecting volumes and pricing, foreign-exchange exposure, and interest-rate changes. The company estimated that a 1 percentage-point change in rates would change annual interest expense by about $1.6 million; a hypothetical 10% change in the U.S. dollar would affect net income by about $2.8 million, or $0.06 per diluted share.
Environmental reserves were $2.3 million, including $1.0 million for remediation at the Sorocaba, Brazil site; additional costs may be required. Asbestos-related probable liabilities were $0.8 million, with $0.6 million of insurance recoveries recorded. Management did not expect these matters to materially affect long-term financial condition, but acknowledged possible effects on future-period results or cash flows.
Other notable items: the company acquired Liquamelt for $6.0 million and recorded $1.9 million of contingent consideration, with potential additional payments up to $7.0 million. It issued a 10% interest in a newly formed Turkish subsidiary for cash and customer-list consideration valued at $4.2 million; ownership may rise to 13% based on targets, and redemption options begin in 2018. A $0.3 million impairment charge related to discontinued Portugal resin products; Q3 other income included $1.4 million of asset-sale gains, primarily a $1.2 million gain on a Canadian facility. U.S. pension-plan changes froze future service and salary accruals and introduced a 3% retirement contribution to the 401(k) for affected participants.
The company stated that there were no material changes to the risk factors in its 2010 Form 10-K. It also reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether pricing can continue to offset raw-material inflation and supply constraints, especially given negative sales-volume comparisons.
- Whether elevated inventory and working-capital demands unwind: inventory rose to $172.9 million from $121.6 million at fiscal year-end, and inventory days were 58 versus 57 a year earlier.
- The sustainability of operating cash flow and company-defined free cash flow, including the effects of overseas cash balances and future capital spending.
- Future exposure from environmental remediation, asbestos claims, insurance recoveries and the solvency or coverage positions of insurers and indemnitors.
- How Liquamelt’s contingent consideration, Turkish subsidiary redemption provisions and related fair-value changes affect future earnings and liabilities.
- Segment comparability after the reporting-structure change and the extent to which revenue growth reflects pricing, currency and acquisitions rather than volume.