H.B. Fuller Company — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended May 28, 2016; comparisons are to the periods ended May 30, 2015. Financial statements are unaudited. The company reorganized its reporting into five segments: Americas Adhesives, EIMEA, Asia Pacific, Construction Products and Engineering Adhesives.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Net revenue | $532.5 million | $540.8 million | $1,006.8 million | $1,011.4 million |
| Gross profit | $158.3 million | $148.9 million | $295.9 million | $265.1 million |
| Gross margin | 29.7% | 27.5% | 29.4% | 26.2% |
| Net income attributable to H.B. Fuller | $33.3 million | $25.2 million | $52.2 million | $34.9 million |
| Diluted EPS | $0.65 | $0.49 | $1.02 | $0.68 |
| Segment operating income | $54.6 million | $48.4 million | $92.4 million | $69.7 million |
Revenue declined 1.5% in Q2 and 0.5% in the first half. Volume rose 1.0% and 3.3%, respectively, but lower pricing and unfavorable currency effects offset the gains. Lower raw-material costs and improved sales mix drove gross-margin expansion. SG&A increased 3.1% in Q2 and 4.1% year to date, partly reflecting payroll, incentives and a full six months of Tonsan results.
Cash flow, debt and liquidity
- First-half operating cash flow was $82.6 million, down from $116.2 million. Capital expenditures were $35.7 million; company-reported free cash flow was $33.3 million versus $64.7 million.
- Cash and equivalents were $146.0 million at May 28, 2016, including $88.8 million held outside the U.S. Total debt was $721.8 million; the debt-to-total-capital ratio was 43.9%, compared with 45.3% at November 28, 2015.
- Current assets were $824.7 million and current liabilities $394.2 million. Net working capital as a percentage of annualized revenue was 21.3%, versus 19.9% a year earlier; receivables DSO and inventory days were each 59 and 65 days, respectively, unchanged year over year.
- The company reported compliance with debt covenants: trailing-twelve-month EBITDA/interest was 10.5 against a 2.5 minimum; indebtedness/EBITDA was 2.7 against a 3.5 maximum.
Changes, segments and unusual items
- Segment performance was mixed. Q2 EIMEA revenue rose 1.8% and operating income increased to $11.0 million from $2.3 million, with improved production efficiency and lower raw-material costs. Construction Products revenue fell 10.8% and operating income fell 60.1% to $2.5 million, reflecting lower volume and higher supply-chain and operating costs.
- Americas Adhesives revenue declined 5.2% in Q2, including weaker hygiene-market share and Latin American demand; operating income was nearly flat. Engineering Adhesives revenue rose 11.9% in Q2 and 37.4% in the first half, with the year-to-date increase partly reflecting a full six months of Tonsan. Asia Pacific Q2 revenue increased 4.5%, while currency reduced reported growth.
- The company acquired Australian and New Zealand industrial adhesives business Advanced Adhesives on April 29 for $9.1 million, funded with cash. Its purchase-price allocation was preliminary, including $4.5 million of preliminary goodwill. Acquisition-related costs were approximately $0.5 million.
- On June 6, 2016, after quarter-end, the company agreed to acquire Cyberbond for approximately $42.4 million; the business is expected to join Engineering Adhesives.
- Other expense was $6.6 million in the first half, primarily reflecting $8.2 million of currency translation and remeasurement losses, most of which related to the Argentine peso. Q2 special charges were $0.4 million, versus $0.9 million; first-half charges were $0.8 million, versus $3.3 million. The ongoing Business Integration Project had incurred $162.1 million of approximately $164.0 million expected total costs.
Outlook, risks and contingencies
- No specific revenue or earnings guidance is provided in the filing. Management said operating cash flows should cover ongoing liquidity and capital needs, and stated it expects to meet fiscal 2016 contractual obligations and has access to short- and long-term borrowing.
- Key exposures include foreign exchange, raw-material prices, interest rates and economic conditions. The filing estimates a 1% change in raw-material costs would affect net income by approximately $3.7 million; a 1% change in variable interest rates by approximately $2.7 million annually. Foreign-exchange sensitivity estimates are also disclosed, including approximately $3.3 million of net-income impact for a hypothetical 10% U.S. dollar change in relevant balance-sheet positions.
- Environmental matters and asbestos litigation remain outstanding. Management does not currently expect these matters, individually or in aggregate, to materially affect results, financial condition or cash flow, but notes adverse developments or settlements could affect future periods. Four asbestos claims were settled in the first half for $0.3 million; $0.3 million of insurance payments were received or expected.
- Internal controls: Disclosure controls and procedures were deemed ineffective as of May 28, 2016 because of a material weakness previously identified in acquisition accounting. Management is implementing remediation, including additional resources and stronger review and documentation controls.
- The company reported no material changes to the risk factors in its prior annual report. It does not intend to repatriate indefinitely reinvested foreign earnings for U.S. operations.
Important facts for investors to verify
- Progress and effectiveness of remediation for the acquisition-accounting material weakness.
- Whether Construction Products’ sales and margins recover, and whether EIMEA’s improvement is sustained.
- Cash conversion and working-capital trends, given lower operating cash flow and free cash flow year over year.
- Final Advanced Adhesives purchase accounting and the financing, integration and performance implications of the Cyberbond transaction.
- Future foreign-exchange losses, particularly exposure to the Argentine peso, and developments in environmental and asbestos matters.