H.B. Fuller Company — Q3 2020 Form 10-Q
Reporting period: Third quarter and first nine months of fiscal 2020, ended August 29, 2020. Comparisons are with the periods ended August 31, 2019. Unless stated otherwise, financial amounts below are in U.S. dollars.
Business context and reporting period
H.B. Fuller manufactures adhesives and reports three segments: Hygiene, Health and Consumable Adhesives; Engineering Adhesives; and Construction Adhesives. The company reorganized its reporting segments at the start of fiscal 2020 and recast prior-period segment information. COVID-19 affected market conditions, although the company said its global manufacturing operations remained open and it was considered an essential business.
Financial performance
| Metric | Q3 2020 | Q3 2019 | First 9 months 2020 | First 9 months 2019 |
|---|---|---|---|---|
| Net revenue | $691.5 million | $725.4 million | $2,012.6 million | $2,157.9 million |
| Gross profit | $187.8 million | $207.3 million | $543.0 million | $605.7 million |
| Gross margin | 27.2% | 28.6% | 27.0% | 28.1% |
| Operating income | $58.7 million | $66.7 million | $144.4 million | $173.3 million |
| Net income attributable to H.B. Fuller | $41.6 million | $49.7 million | $83.1 million | $98.6 million |
| Diluted EPS | $0.79 | $0.97 | $1.59 | $1.90 |
Q3 revenue declined 4.7%; management attributed the decrease to lower volume, unfavorable pricing, the divestiture of the surfactants and thickeners business, and unfavorable currency. Gross margin fell 140 basis points, principally from lower volume and unfavorable mix, partly offset by lower raw-material costs. SG&A declined 8.2% in Q3, reflecting savings from the segment realignment and lower discretionary spending. Q3 diluted EPS also reflects a $7.2 million discrete tax benefit; excluding discrete tax items, the effective tax rate was 27.1%.
For the first nine months, revenue fell 6.7% and gross margin declined 110 basis points. Net income fell 15.7%. The prior-year comparison included a gain on sale of assets of about $20 million in other income; 2020 other income was substantially lower.
Cash flow, debt and liquidity
- Operating cash flow for the first nine months was $193.0 million, up from $160.2 million. Capital expenditures were $71.9 million, compared with $47.0 million.
- Free cash flow after dividends, a company-defined non-GAAP measure, was $96.1 million, versus $89.0 million.
- Cash and cash equivalents were $74.9 million at August 29, 2020, down from $112.2 million at November 30, 2019; the majority was held outside the United States.
- Total short- and long-term debt was $1,868.9 million, down from $1,979.1 million at November 30, 2019. The debt-to-total-capital ratio was 58.7%, compared with 61.8% at fiscal year-end 2019.
- The company repaid $128.0 million of long-term debt during the first nine months and paid $25.0 million in dividends. It reported compliance with its debt covenants; its secured-debt-to-TTM-EBITDA covenant measure was 4.1 against a maximum of 5.9.
Material changes by segment
- Hygiene, Health and Consumable Adhesives: Q3 revenue decreased 2.5%; segment operating income decreased 2.1%. For the first nine months, revenue decreased 0.9%, while operating income increased 4.7%.
- Engineering Adhesives: Q3 revenue decreased 3.7% and operating income decreased 19.0%. For the first nine months, revenue decreased 11.0% and operating income decreased 33.4%, reflecting weaker volume and pricing and lower operating leverage.
- Construction Adhesives: Q3 revenue decreased 12.2% and operating income decreased 44.2%. For the first nine months, revenue decreased 9.5% and operating income decreased 33.8%, primarily due to lower volume and unfavorable pricing.
Outlook, risks and unusual items
- The filing provides no specific financial guidance. Management said operating cash flows should be adequate for ongoing liquidity and capital needs and that it believes it can access debt financing as needed.
- Management said the pandemic’s financial impact could not yet be estimated; risks include disruption to raw-material supply, production, transport and delivery, as well as weaker demand.
- The 2020 restructuring plan is expected to be completed by mid-fiscal 2021. The company had incurred $10.9 million of costs through August 29, 2020, within its estimated total cost range of $9 million to $11 million. The Royal Adhesives restructuring plan was substantially complete.
- Environmental remediation liabilities were $7.0 million, including $3.9 million for a South Carolina site. The company stated these matters were not expected to have a material adverse effect, while noting that adverse developments could affect future results or cash flows.
- An ongoing voluntary disclosure to OFAC concerns possible resale of products into Iran by certain customers; the sales ceased in fiscal 2018. The company said potential penalties could range from zero to $10 million and that it had not received an OFAC response.
- Other notable items include a $5.0 million contingent-consideration liability related to the D.H.M. acquisition and a $15.8 million cash receipt when an interest-rate swap was terminated in May 2020.
Important facts for investors to verify
- Whether demand, volume and margins recover, especially in Engineering and Construction Adhesives, and how COVID-19 affects customers and supply chains.
- Whether operating cash flow remains sufficient alongside elevated capital expenditures, dividends and debt service.
- Progress on restructuring, including remaining costs and expected completion timing.
- Resolution and potential financial effects of the OFAC inquiry, environmental matters and asbestos-related claims.
- The effect of discrete tax benefits, prior-year asset-sale gains, foreign exchange and interest-rate hedges on earnings comparability.