H.B. Fuller Company — Q2 2017 Form 10-Q
Business context and reporting period
Unaudited results cover the three and six months ended June 3, 2017; comparisons are with the periods ended May 28, 2016. H.B. Fuller makes adhesives and related products and reports five segments: Americas Adhesives, EIMEA, Asia Pacific, Construction Products and Engineering Adhesives. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $561.7m | $532.5m | $1,065.0m | $1,006.8m |
| Gross profit | $146.0m | $158.3m | $285.0m | $295.9m |
| Gross margin | 26.0% | 29.7% | 26.8% | 29.4% |
| Net income attributable to H.B. Fuller | $25.9m | $33.3m | $40.7m | $52.2m |
| Diluted EPS | $0.50 | $0.65 | $0.79 | $1.02 |
| Interest expense | $8.1m | $6.6m | $16.5m | $12.9m |
Operating cash flow was $32.8m for the first six months, down from $82.6m. Capital expenditures were $27.1m, and reported free cash flow—defined by the company as operating cash flow less capital expenditures and dividends—was negative $9.1m, versus positive $33.3m a year earlier. Cash was $94.1m at June 3, 2017, compared with $142.2m at December 3, 2016. Total short- and long-term debt was $786.1m, versus $703.3m at fiscal year-end; debt to total capital was 44.2%, versus 42.8%.
Current assets were $850.4m and current liabilities $325.4m. Inventory rose to $302.3m from $247.4m at year-end. Management reported covenant compliance: trailing EBITDA to interest was 8.4x against a 2.5x minimum, and indebtedness to trailing EBITDA was 2.9x against a 3.5x maximum.
Changes versus the prior comparable period
- Quarterly revenue increased 5.5%; constant-currency growth was 9.6%, offset by a 4.1% unfavorable currency effect. For six months, revenue rose 5.8%, with 9.6% constant-currency growth and a 3.8% unfavorable currency effect.
- Profitability weakened: quarterly net income fell 22.4% and diluted EPS declined from $0.65 to $0.50. Six-month net income fell 22.2% and diluted EPS declined from $1.02 to $0.79.
- Higher raw-material costs, acquired-business effects and the 2017 restructuring plan contributed to gross-margin contraction. Quarterly cost of sales rose 11.0%, faster than revenue growth of 5.5%.
- Segment performance was mixed. Engineering Adhesives and Asia Pacific grew revenue; Construction Products revenue declined and the segment recorded an operating loss of $1.9m for the quarter. Americas Adhesives revenue grew, but segment operating income fell 26.3%.
- Operating cash flow declined substantially, including a $34.9m cash use from changes in receivables, inventory and payables, compared with a $3.3m use in the prior-year period. Inventory days increased to 70 from 65 and receivables DSO to 61 from 59.
Outlook, management commentary, risks and unusual items
- The company expects total pre-tax costs of approximately $17m–$20m under its 2017 restructuring plan, with completion expected by mid-fiscal 2018. It recorded $15.8m of charges in the first six months. The filing gives no specific revenue or EPS guidance.
- Management said operating cash flows should meet ongoing liquidity and capital-expenditure needs and that debt financing should remain available. It also said cash in the U.S. is expected to be sufficient for U.S. needs. Most reported cash was held outside the U.S.; indefinitely reinvested foreign earnings were not expected to be repatriated for U.S. operations.
- In January 2017, the company acquired Wisdom Adhesives for $123.3m, funded with revolving-credit borrowings. Purchase accounting was preliminary, including $60.6m of goodwill. Acquisition and integration effects contributed to cost pressure.
- Debt financing changed during the period: H.B. Fuller issued $300m of 4.00% notes due 2027 and entered a new $400m revolving facility and $100m term loan. The company used proceeds to repay existing borrowings; interest expense increased year over year.
- A $3.6m mark-to-market gain on contingent consideration reduced the liability during the first six months; a subsequent agreement was expected to increase that liability by approximately $1.1m using Q2 valuation assumptions.
- Risks include raw-material price and supply volatility, foreign-exchange exposure, interest-rate changes, economic and consumer-spending weakness, and restructuring execution. Management described environmental and other legal matters, including asbestos claims, as not expected to have a material adverse effect based on information then available, while noting future settlements or adverse developments could affect results or cash flows.
- For market-risk sensitivity, the filing estimates a 1 percentage-point change in variable interest rates would change net income by about $7.9m, and a hypothetical 1% change in raw-material costs by about $4.1m, based on the stated period and balances.
Important facts for investors to verify
- Whether price increases and other actions can offset raw-material inflation and restore gross margins.
- Construction Products’ recovery prospects and the impact of its product discontinuations and facility project.
- Restructuring spending, expected savings, completion timing and effects on segment results and cash flow.
- Working-capital needs, especially inventory levels, and the resulting trajectory of operating and free cash flow.
- Debt, floating-rate exposure, covenant headroom and the final Wisdom Adhesives purchase-price allocation.
- Developments in contingent consideration, foreign exchange, environmental matters and asbestos claims.