H.B. Fuller Company — FY2017 Form 10-K
Business context and period. H.B. Fuller manufactures adhesives, sealants and specialty chemicals, with sales in 37 countries. The fiscal year ended December 2, 2017. This is an annual filing; fiscal 2016 included 53 weeks. Royal Adhesives became a separate reportable segment after its October 2017 acquisition.
Financial performance and liquidity
| Metric | FY2017 | FY2016 |
|---|---|---|
| Net revenue | $2,306.0 million | $2,094.6 million |
| Gross profit / margin | $603.2 million / 26.2% | $609.8 million / 29.1% |
| Net income attributable to H.B. Fuller | $58.2 million | $124.1 million |
| Diluted EPS from continuing operations | $1.13 | $2.42 |
| Operating cash flow | $140.8 million | $195.7 million |
| Cash and cash equivalents at year-end | $194.4 million | $142.2 million |
| Total debt at year-end | $2,451.9 million | $703.3 million |
Free cash flow, as defined by the company (operating cash flow less capital expenditures and dividends), was $56.2 million, down from $104.9 million. Capital expenditures were $54.9 million; the company expects approximately $90 million in FY2018. The $400 million revolving facility was undrawn, with approximately $398.3 million available. Debt capitalization was 60.3%, versus 42.9%; the debt covenant ratio was 5.2 against a maximum of 6.5. Management said operating cash flow should meet ongoing liquidity and capital needs and that it expected to meet FY2018 contractual obligations.
FY2017 Q4 revenue was $678.2 million, compared with $574.9 million in Q4 2016. Q4 income from continuing operations was a loss of $7.5 million, or $0.15 per diluted share, versus income of $39.2 million, or $0.76 per diluted share.
Material changes versus prior period
- Revenue grew 10.1%; constant-currency growth was 12.3%, driven by volume and acquisitions, partly offset by a 2.2% adverse currency impact. Acquisitions contributed $161.7 million of revenue.
- Gross margin fell 290 basis points, primarily due to higher raw-material costs, acquired-business effects and inventory step-up charges. Raw materials were 76% or more of cost of sales.
- Net income and diluted EPS declined substantially. SG&A rose 17.0% to $477.0 million, reflecting acquired businesses, acquisition transaction costs and higher variable compensation. Interest expense increased to $43.7 million.
- Operating cash flow declined by $54.9 million. The company acquired Royal Adhesives for $1.623 billion, Wisdom Adhesives for $123.5 million and Adecol for $44.7 million. Royal was funded with new debt; total business-acquisition spending was $1.745 billion.
- Construction Products revenue fell 7.0% and the segment reported a $1.1 million operating loss. Americas Adhesives and EIMEA segment operating income also declined; Engineering Adhesives revenue increased 18.0%.
Outlook, commentary, risks and unusual items
- The company recorded $18.0 million of pretax charges under its 2017 restructuring plan and expected the plan to conclude by mid-FY2018. Project ONE ERP implementation resumed in Latin America; full Latin America implementation was expected in early 2019. Total project spending was estimated at $125–$150 million, with potential to exceed that estimate.
- Royal Adhesives generated $77.0 million in FY2017 revenue and a $37.4 million segment operating loss. That loss included $32.1 million of acquisition transaction costs and $10.8 million of inventory step-up expense. Management cautioned that integration, expected synergies and growth benefits are uncertain.
- Debt rose sharply following the Royal acquisition. The Term Loan B matures in 2024 and bears floating interest, with $1.05 billion hedged to a fixed rate; $300 million of public notes mature in 2027. A one-percentage-point interest-rate change on variable-rate debt was estimated to change net income by about $9.7 million. Mandatory excess-cash-flow prepayments begin in FY2019, subject to leverage thresholds.
- A $25.5 million make-whole premium on early debt repayment contributed to FY2017 other expense. The FY2017 effective tax rate was 15.5%, including discrete benefits. U.S. tax reform enacted after year-end reduced the federal corporate rate to 21% effective January 1, 2018; the company said its financial-statement impact could be material but was still being assessed.
- Key risks include raw-material cost and supply volatility, foreign exchange, economic and end-market weakness, acquisition integration and leverage, ERP implementation, competition, litigation and environmental liabilities. Environmental reserves were $11.4 million; estimated environmental compliance spending over the next two years was approximately $13.8 million, including $1.5 million of capital spending.
- The company disclosed an internal investigation into possible resale of products to Iran contrary to U.S. sanctions and possible sanctions violations involving subsidiaries in two other countries. It voluntarily notified OFAC in January 2018 and said the outcome could not yet be predicted. Sales to the customers under investigation were less than 1% of revenue in each of the prior three fiscal years.
Most important facts for investors to verify
- Whether Royal Adhesives integration delivers the anticipated growth and synergies, and how its reported operating performance develops after one-time acquisition and inventory charges.
- Debt repayment capacity, covenant headroom, interest-rate exposure and the impact of mandatory excess-cash-flow payments.
- Whether margin pressure from raw materials and acquired businesses is reversed through pricing, productivity and cost actions.
- The final tax effects of U.S. tax reform, including deferred-tax remeasurement and deemed repatriation tax.
- Developments and any financial consequences from the OFAC-related investigation, environmental matters and other contingencies.
- Q4’s reported loss and the audited annual cash-flow figure: the filing’s MD&A contains one reference to operating cash flow of $138.2 million, while the audited cash-flow statement reports $140.8 million.