Business context and reporting period
H.B. Fuller Company’s unaudited Form 10-Q covers the three months ended March 3, 2018, compared with the three months ended March 4, 2017. The adhesives manufacturer’s results include its 2017 acquisitions of Royal Adhesives and Adecol; the company also reallocated Royal across its five reportable segments for this quarter.
Financial performance
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net revenue | $713.1 million | $503.3 million |
| Gross profit / margin | $187.7 million / 26.3% | $139.0 million / 27.6% |
| SG&A expenses | $151.0 million | $112.9 million |
| Income before taxes and equity-method income | $13.2 million | $18.3 million |
| Net income attributable to H.B. Fuller | $47.7 million | $14.8 million |
| Diluted EPS | $0.92 | $0.29 |
| Cash flow from operations | $(32.1) million | $16.5 million |
| Capital expenditures | $18.6 million | $19.9 million |
| Free cash flow, company-defined | $(58.3) million | $(10.5) million |
- Revenue rose 41.7%; management attributed 35.3 percentage points to sales volume, including 34.4 points from acquisitions, 1.8 points to pricing, 0.4 points to mix, and 4.2 points to currency.
- Gross margin fell 130 basis points, primarily from higher raw-material and delivery costs and the effect of acquired businesses. SG&A increased 33.7% but declined as a share of revenue, from 22.4% to 21.2%.
- Net income benefited from a provisional $35.6 million U.S. tax-reform benefit. Excluding $35.8 million of discrete tax benefits, the effective tax rate was 24.1%. Higher interest expense—$27.5 million versus $8.4 million—also weighed on pretax income.
- Segment operating income was $36.7 million versus $26.1 million. Americas Adhesives income declined 16.7%; EIMEA, Asia Pacific, Construction Adhesives and Engineering Adhesives reported higher segment income. Growth in most segments reflected acquisitions; Asia Pacific revenue grew 6.4%.
Balance sheet, liquidity and debt
- At March 3, 2018, cash and equivalents were $132.5 million, down from $194.4 million at December 2, 2017. Current assets were $1.12 billion and current liabilities $522.8 million.
- Total short- and long-term debt was $2.44 billion, compared with $2.45 billion at December 2, 2017 and $804.8 million a year earlier. Debt to total capital was 68.5%, versus 70.1% at fiscal year-end and 45.9% a year earlier.
- The company reported a 5.2 total-indebtedness-to-TTM-EBITDA covenant ratio against a maximum of 6.5 and said it was in compliance with its covenants. Management believes operating cash flows and access to borrowing will meet liquidity and capital needs.
- Operating cash outflow included a $46.7 million inventory use of cash; working-capital changes used $35.1 million. DSO improved to 54 days from 60, and inventory days on hand to 68 from 70.
Outlook, risks and unusual items
- No specific revenue or earnings guidance is provided. Management expects cash flows to cover ongoing liquidity and capital needs.
- A Royal integration restructuring plan is expected to cost about $20 million, including approximately $14 million in cash costs, and is expected to be completed by fiscal 2020. Q1 restructuring charges were $1.8 million, compared with $10.2 million in the prior-year quarter.
- The U.S. tax-reform benefit is provisional: it includes a $76.4 million deferred-tax remeasurement benefit, offset by $40.8 million of transition-tax expense, and remains subject to adjustment during the measurement period.
- Risks include raw-material price and supply changes, foreign-exchange movements, floating-rate debt, and acquisition integration. A 1-percentage-point rate change on variable-rate debt was estimated to affect annual net income by about $7.9 million; a hypothetical 1% raw-material cost change by about $3.0 million.
- The company is investigating possible resale of its products to Iran and possible sanctions-related sales by subsidiaries in two other countries. It voluntarily contacted OFAC in January 2018 and said the investigation’s outcome cannot be predicted. Related customer sales were under 1% of revenue in each of the prior three fiscal years.
- Environmental remediation liabilities were $11.2 million. Asbestos claims and other proceedings remain pending; management said these matters are not expected to have a material adverse effect, while noting adverse developments could affect future periods. The company had not yet included Royal and Adecol in its internal-control-over-financial-reporting assessment.
Important facts for investors to verify
- How much of revenue and segment growth is sustainable without acquisition contributions, and whether pricing can offset continued input-cost inflation.
- Whether the provisional tax benefit, particularly the transition-tax estimate, changes as the measurement period progresses.
- Cash conversion, inventory levels and working-capital needs, alongside the company’s ability to service and reduce its substantially higher debt.
- Integration progress and final costs and timing of the Royal restructuring plan.
- Developments in the OFAC investigation, environmental matters and asbestos litigation, including potential liabilities and insurance recoveries.