H.B. Fuller Company (NYSE: FUL) — Q2 2019 Form 10-Q
Business context and reporting period. Unaudited results cover the three and six months ended June 1, 2019; comparisons are with the periods ended June 2, 2018. H.B. Fuller sells adhesives, sealants and specialty chemicals through five reportable segments. Amounts below are in U.S. dollars; financial statement amounts are converted to millions where indicated.
Key financial results
| Metric | Q2 2019 | Q2 2018 | First six months 2019 | First six months 2018 |
|---|---|---|---|---|
| Net revenue | $759.6 million | $789.4 million | $1,432.5 million | $1,502.5 million |
| Gross profit | $218.5 million | $220.2 million | $398.4 million | $405.7 million |
| Gross margin | 28.8% | 27.9% | 27.8% | 27.0% |
| Net income attributable to H.B. Fuller | $36.6 million | $44.5 million | $48.9 million | $92.1 million |
| Diluted EPS | $0.70 | $0.86 | $0.94 | $1.78 |
| Operating cash flow | Not separately stated for Q2 | $77.3 million | $22.4 million |
- Q2 SG&A was $146.1 million, down 0.5%; six-month SG&A was $291.8 million, down 2.6%. Q2 interest expense was $26.9 million and six-month expense was $53.7 million, both lower year over year.
- At June 1, cash and cash equivalents were $100.2 million, compared with $150.8 million at December 1, 2018. Total debt was $2,193.8 million; total debt to total capital was reported as 65.5% in the liquidity table and 65.6% elsewhere in MD&A. The company reported compliance with its debt covenants; secured debt/TTM EBITDA was 4.2 against a maximum of 5.9.
- Six-month capital expenditures were $32.2 million and dividends paid were $16.0 million, resulting in company-defined free cash flow after dividends of $29.1 million, versus negative $26.2 million a year earlier. Cash declined $50.5 million during the six months, reflecting $86.6 million of financing outflows, partly offset by operating cash flow.
- Current assets were $1,108.8 million and current liabilities $517.6 million. The filing reports net working capital at 19.2% of annualized revenue, DSO of 59 days and inventory days on hand of 67.
Material changes and operating trends
- Revenue declined 3.8% in Q2 and 4.7% year to date. In Q2, organic growth of 0.9% was outweighed by a 4.7% adverse currency impact; for the first six months, organic growth was flat and currency reduced revenue 4.7%. Management cited weaker currencies including the euro and Chinese renminbi.
- Gross margin improved 90 basis points in Q2 and 80 basis points year to date, mainly from pricing and lower raw-material costs, partly offset by higher production costs and lower volume.
- Net income fell 17.8% in Q2 and 46.9% year to date. The year-over-year six-month comparison is materially affected by a $35.6 million U.S. tax-reform benefit recognized in the first half of 2018. The reported effective tax rate was 30.0% for the first half of 2019 versus a tax benefit rate in 2018; excluding discrete items, management gave rates of 28.6% and 24.8%, respectively.
- Segment performance was mixed. Engineering Adhesives revenue and operating income grew 5.7% and 29.8% in Q2, respectively; Asia Pacific operating income rose 16.0% despite lower reported revenue. Construction Adhesives revenue fell 9.5% and operating income 41.3% in Q2, with lower volume, product eliminations, integration costs and restructuring cited. EIMEA operating income declined 18.9% in Q2 amid lower revenue and currency effects.
- Operating cash flow rose from $22.4 million to $77.3 million year to date. Working-capital changes used $20.6 million, less than the $58.4 million use in the prior-year period.
Outlook, commentary, risks and unusual items
- The filing provides no specific revenue, earnings or margin guidance. Management said operating cash flow should be adequate for ongoing liquidity and capital expenditure needs and that the company expects to be able to meet fiscal 2019 contractual obligations.
- The Royal Adhesives restructuring plan is expected to cost approximately $20 million in total, including about $14 million of cash costs, and is expected to be completed by fiscal 2020 year-end. The company recorded $2.7 million of related charges in the first six months of 2019.
- H.B. Fuller acquired certain Ramapo Sales and Marketing assets in May for an initial $7.9 million, with up to $3.4 million contingent consideration; the estimated purchase price, including settlement of existing receivables, was $13.5 million. A definitive agreement to sell Dalton Holdings was signed in June, with completion expected in Q3 fiscal 2019; related assets and liabilities were classified as held for sale.
- Environmental remediation liabilities were $10.1 million, including $4.6 million for a South Carolina site. Management said known matters were not expected to have a material adverse effect, while noting additional liabilities are reasonably possible and outcomes and timing remain uncertain.
- An OFAC investigation concerns possible resale of products into Iran by certain customers; those sales ceased in 2018 and represented less than 1% of revenue in each of the prior three fiscal years. The company had not received an OFAC response and estimated possible penalties from zero to $10 million.
- Asbestos litigation continues; certain insurers are insolvent, and the company may bear a share of costs allocated to years with insolvent insurers. Management did not expect pending matters to have a material adverse effect, but said adverse developments could affect future results or cash flows.
- Foreign exchange, interest rates and raw-material prices remain market risks; management reported no material change in market risk since the 2018 annual report. Disclosure controls were deemed effective, with no material change in internal controls reported.
Important facts for investors to verify
- Whether organic sales trends, particularly weakness in Construction Adhesives and EIMEA, improve and how currency movements affect reported growth.
- Whether pricing and lower input costs continue to offset production costs and volume pressure, and whether segment margin gains are sustainable.
- The drivers of the sharp year-over-year decline in first-half net income, distinguishing underlying operations from the 2018 tax-reform benefit and current-period tax items.
- Debt repayment, cash levels, covenant headroom and cash conversion; note the filing’s differing 65.5% and 65.6% debt-to-capital figures.
- Final purchase accounting and contingent consideration for Ramapo, completion and proceeds of the Dalton sale, restructuring costs, and exposure from environmental, asbestos and OFAC matters.