H.B. Fuller Company — Q3 2019 Form 10-Q
Reporting period: Quarter ended August 31, 2019; year-to-date results cover the nine months ended August 31, 2019. Comparative periods ended September 1, 2018. Amounts below are in U.S. dollars; financial statement amounts are converted to millions unless noted.
Business context and results
H.B. Fuller makes adhesives, sealants and other specialty chemical products. Its five reportable segments are Americas Adhesives, EIMEA, Asia Pacific, Construction Adhesives and Engineering Adhesives.
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net revenue | $725.4 million | $770.1 million | $2,157.9 million | $2,272.6 million |
| Gross profit | $207.3 million | $215.0 million | $605.7 million | $620.7 million |
| Gross margin | 28.6% | 27.9% | 28.1% | 27.3% |
| Income attributable to H.B. Fuller | $49.7 million | $37.7 million | $98.6 million | $129.9 million |
| Diluted EPS | $0.97 | $0.72 | $1.90 | $2.50 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $160.2 million | $106.8 million |
Financial position, cash flow and liquidity
- Cash and cash equivalents were $119.8 million at August 31, 2019, down from $150.8 million at December 1, 2018. Most cash was held outside the United States.
- Total short- and long-term debt was $2,097.1 million, versus $2,247.5 million at December 1, 2018. The total debt-to-total-capital ratio was 64.1%, down from 66.1% at December 1, 2018 and 67.6% a year earlier.
- Nine-month investing cash flow was positive $18.6 million, including $70.3 million of proceeds from the sale of the surfactants and thickeners business. Capital expenditures were $47.0 million.
- Nine-month financing cash use was $199.1 million, including $173.5 million in long-term debt repayments and $24.2 million in dividends paid. Cash declined by $31.0 million over the period.
- Free cash flow after dividends, a non-GAAP measure defined as operating cash flow less capital expenditures and dividends, was $89.0 million, compared with $37.0 million in the prior-year period.
- Management said operating cash flows should be adequate for ongoing liquidity and capital spending needs and that the company expects to be able to obtain debt financing as needed. The company reported compliance with its credit covenants; its secured-debt-to-TTM-EBITDA covenant result was 3.9 against a maximum of 5.9.
Material changes versus comparable periods
- Q3 revenue declined 5.8% year over year: organic growth was negative 3.3%, divestiture impact was negative 0.6%, and currency impact was negative 1.9%. Management attributed the organic decline mainly to lower sales volume. Nine-month revenue fell 5.1%, including negative 1.2% organic growth and negative 3.7% currency impact; favorable pricing partly offset volume weakness.
- Gross margin increased 70 basis points in Q3 and 80 basis points year to date, primarily from lower raw-material costs and, year to date, favorable pricing. Lower volume partly offset these benefits.
- Q3 net income rose 31.8%, while nine-month net income fell 24.1%. Q3 other income included a $20.3 million gain on asset sales, principally associated with the divestiture. The year-ago nine-month period included a $35.6 million tax benefit related to U.S. Tax Reform; 2019 nine-month income tax expense was $38.9 million.
- Segment performance diverged. Q3 revenue fell 13.0% in Construction Adhesives and 10.0% in EIMEA; Engineering Adhesives operating income rose 32.1% and Asia Pacific operating income rose 64.9%. For the nine months, Construction Adhesives operating income fell 54.5%, while Engineering Adhesives operating income rose 35.5%.
- Other comprehensive loss was $38.0 million in Q3 2019 and $75.0 million for the first nine months, mainly reflecting foreign-currency translation and changes in interest-rate swaps.
Outlook, commentary, risks and unusual items
- The filing provides no specific full-year revenue or earnings guidance. Management said cash flows should cover ongoing needs and expects the Royal Adhesives restructuring plan to be completed by the end of fiscal 2020. The plan is expected to cost approximately $20 million in total, including approximately $14 million of cash costs.
- The July 1, 2019 sale of Dalton Holdings, which primarily made surfactants and thickeners, generated a pretax gain of $16.6 million in the acquisition note; MD&A reports a $20.3 million gain on sale of assets in Q3, reflecting its broader presentation. Sale proceeds were $70.3 million.
- Revenue and earnings remain exposed to sales volume, raw-material costs, foreign exchange and interest-rate movements. Management noted weaker currencies across several markets; it reported no material change in market risk since December 1, 2018.
- Environmental remediation liabilities were $8.7 million. The company also disclosed asbestos-related claims, with third-party indemnity and insurance covering a significant portion of costs, though some insurers are insolvent. Management said currently known matters were not expected to have a material adverse effect, while noting adverse developments could affect future results or cash flows.
- An internal investigation concerns possible resale of hygiene products into Iran by customers in Turkey and India. The sales ceased in fiscal 2018, and the company said it does not currently do business in Iran. OFAC had not responded to the company’s submission; potential penalties were estimated at zero to $10 million.
- The company expects to record the financial impact of Swiss tax reform in Q4 2019. It adopted several accounting standards during the period, including revenue recognition; management said the quantitative effects of the revenue standard on current-period line items were not material.
Important facts for investors to verify
- Whether volume trends, particularly in Construction Adhesives and EIMEA, stabilize and whether Engineering Adhesives growth continues.
- How much of Q3 earnings improvement came from the asset-sale gain versus recurring operations, and how margins respond to sales volume and raw-material costs.
- Debt repayment progress, covenant headroom, cash availability by geography and the sustainability of free cash flow after dividends.
- The remaining restructuring costs and timing, and the final purchase accounting for the Ramapo acquisition, which was preliminary at quarter-end.
- Developments in the OFAC matter, environmental and asbestos contingencies, and the Q4 Swiss tax-reform impact.