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Business Context and Reporting Period

Company: H.B. Fuller Company (H.B. Fuller)

Filing Type: Form 10-K (Annual Report)

Reporting Period: Fiscal year ended November 29, 2003

H.B. Fuller is a global manufacturer and marketer of adhesives and specialty chemical products with sales operations in 33 countries. The company operates two primary segments: Global Adhesives (69% of revenue) and Full-Valu/Specialty (31% of revenue). In 2003, the company completed a major restructuring initiative begun in 2002, which eliminated approximately 20% of global manufacturing capacity and 556 positions to streamline cost structures.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net revenue increased 2.5% to $1.287 billion. This growth was driven primarily by a 4.0% positive impact from foreign currency exchange rates (weaker U.S. dollar), which offset a 0.7% decrease in sales volume and a 0.8% decrease in selling prices due to competitive pressures.
• Profitability: Net income rose 37% to $38.6 million compared to $28.2 million in 2002. This improvement was aided by lower restructuring charges ($6.5 million in 2003 vs. $29.7 million in 2002) and reduced management incentive compensation expenses.
• Cost Pressures: Cost of sales increased 1.8% due to higher raw material costs (petroleum-based derivatives) and currency translation effects. Gross margin improved slightly to 27.4% from 26.9%.
• Segment Performance:
  • Global Adhesives: Revenue up 3.2%; Operating income down 18% to $47.8 million, largely due to margin compression in the North American automotive business.
  • Full-Valu/Specialty: Revenue up 1.0%; Operating income down 4% to $28.6 million.
• Cash Flow: Operating cash flow decreased 27% to $59.7 million, primarily due to a $20 million voluntary contribution to the U.S. pension plan.

Guidance, Outlook, and Risks

2004 Outlook: Management anticipates continued raw material price pressures in the early stages of 2004 due to crude oil and natural gas costs. However, signs of economic recovery in the U.S. in late 2003 suggest potential for volume growth. The company expects pension and postretirement benefit expenses to decrease by approximately $2.5 million compared to 2003. A new "Lean Six Sigma" initiative will be deployed to improve processes, though it will incur initial training costs.

Key Risks and Contingencies:

• Raw Materials: Significant exposure to petroleum-based derivative prices; inability to pass cost increases to customers could reduce margins.
• Legal Proceedings:
  • EIFS Litigation: Approximately 75 lawsuits regarding exterior insulated finish systems. Reserves of $3.2 million for liabilities and $1.2 million for insurance recoveries are recorded.
  • Asbestos Litigation: Ongoing lawsuits regarding historical products. Insurance covered 100% of defense costs in 2003; settlements totaled $0.6 million.
  • Environmental: Involved in proceedings at 26 sites. Reserves of $1.9 million are recorded, though total potential liability across all parties exceeds $1.0 billion.
• Foreign Exchange: Approximately 47% of revenue is generated outside the U.S., creating exposure to currency fluctuations (Euro, Yen, Pound Sterling).

Investor Verification Checklist

• Restructuring Completion: Verify that the $18 million+ in annual cost savings from the completed restructuring are being realized in 2004 operating results.
• Raw Material Hedging: Assess the company's ability to pass on rising energy costs to customers given the competitive market environment.
• Pension Funding: Confirm that the $20 million pension contribution in 2003 was a one-time event and that future funding requirements will not strain liquidity.
• Legal Reserves: Monitor the adequacy of reserves for EIFS and asbestos litigation, particularly regarding insurance recoveries and potential new claims.
• Volume Trends: Watch for signs of sustained volume growth in North America and Europe to offset the currency-driven revenue increases seen in 2003.