H.B. Fuller Company — Q1 2019 Form 10-Q
Reporting period: Three months ended March 2, 2019; comparative period ended March 3, 2018. Amounts below are U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Business context and results
H.B. Fuller sells adhesives, sealants and specialty chemical products through five reportable segments: Americas Adhesives, EIMEA, Asia Pacific, Construction Adhesives and Engineering Adhesives. Reported revenue fell 5.6% year over year, reflecting a 4.6% adverse currency impact and 1.0% negative organic growth. Management attributed the organic decline mainly to lower sales volume; favorable pricing partly offset it.
Key financial metrics
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Net revenue | $672.9 | $713.1 |
| Gross profit / gross margin | $179.9 / 26.7% | $185.5 / 26.0% |
| SG&A expense / % of revenue | $145.7 / 21.7% | $152.7 / 21.4% |
| Income before tax and equity-method income | $13.8 | $13.2 |
| Net income attributable to H.B. Fuller | $12.2 | $47.7 |
| Diluted earnings per share | $0.24 | $0.92 |
| Cash from operating activities | $0.5 | $(32.1) |
| Capital expenditures | $13.9 | $18.6 |
| Free cash flow after dividends | $(21.3) | $(58.3) |
Gross margin increased 70 basis points, mainly from favorable pricing, partly offset by lower volume. SG&A decreased 4.6%, primarily due to lower integration costs and favorable foreign exchange effects on spending outside the U.S. Reported net income was sharply lower largely because Q1 2018 included a $35.6 million tax benefit related to U.S. Tax Reform. Q1 2019 tax expense was $3.1 million and included a $0.8 million discrete tax benefit; excluding that benefit, the effective tax rate was 28.2%, versus 24.1% in Q1 2018 excluding discrete benefits.
By segment, revenue and operating income were mixed: Construction Adhesives revenue declined 16.1% and recorded a $3.3 million operating loss; EIMEA revenue declined 7.4% and operating income fell 42.4%. Engineering Adhesives operating income rose 52.1% on 0.3% revenue growth; Asia Pacific operating income rose 65.2% despite a 4.8% revenue decline; Americas Adhesives operating income increased 8.3% while revenue declined 3.6%.
Balance sheet, liquidity and debt
- Cash and cash equivalents were $113.5 million at March 2, 2019, down from $150.8 million at December 1, 2018. The company said most cash was held outside the U.S.
- Total debt, including current maturities and notes payable, was approximately $2.235 billion, compared with $2.248 billion at December 1, 2018. Total debt to total capital was 65.6%, versus 66.1% at fiscal year-end and 68.5% a year earlier.
- Current assets were $1.093 billion and current liabilities were $520.9 million. Inventories increased to $386.7 million from $348.5 million at fiscal year-end. DSO was 57 days versus 54 days a year earlier; inventory days on hand were 68 in both periods.
- Operating cash flow was slightly positive, but investing and financing outflows drove cash down $37.3 million during the quarter. The company repaid $20.0 million of long-term debt and paid $7.9 million in dividends.
- The company reported compliance with its debt covenants; its total indebtedness / trailing-12-month EBITDA ratio was 4.3 against a maximum of 5.9. Management said operating cash flows and access to borrowing should be adequate for foreseeable needs and contractual obligations in fiscal 2019.
Material changes, outlook and risks
- Management provided no specific full-year earnings or revenue guidance in the supplied filing text. It said SG&A plans are generally maintained for the fiscal year absent significant changes in conditions or outlook.
- The Royal Adhesives restructuring and integration plan is expected to cost approximately $20 million in total, including about $14 million of cash costs, and is expected to be completed by the end of fiscal 2020. Q1 2019 charges under the plan were approximately $1.2 million; total restructuring charges for the quarter were $1.45 million.
- Raw-material prices, foreign exchange, interest rates, economic conditions and sales volumes are key exposures. The filing estimates that a one-percentage-point increase in rates on variable-rate debt would reduce net income by about $4.9 million annually; hypothetical currency and raw-material sensitivities are also disclosed in the filing.
- The company is cooperating with the U.S. Treasury’s OFAC concerning a review of possible customer resale of hygiene products into Iran. Those sales ceased in fiscal 2018; the company reported no current Iran business and estimated potential penalties of zero to $10 million. OFAC had not responded to its submission at the filing date.
- Environmental remediation reserves were $10.5 million, including $4.6 million related to a South Carolina site. The company also faces asbestos-related claims; it reported one settlement in the quarter for approximately $12,000, with about $8,000 received or expected from insurance. Management did not expect pending legal and environmental matters to have a material adverse effect based on information then available, while noting future adverse developments could affect results or cash flow.
- Accounting changes adopted in the quarter included revenue recognition under ASC 606 and new pension-cost presentation; management said the current-quarter revenue-recognition line-item effects were not material. The filing also notes a $1.776 million opening retained-earnings increase associated with ASC 606 adoption.
Important facts for investors to verify
- Whether Construction Adhesives’ steep organic decline and operating loss improve, and whether pricing continues to offset volume and raw-material pressures.
- How much of the year-over-year earnings decline reflects the prior-year tax benefit versus underlying operating performance; compare tax-adjusted results consistently.
- Cash conversion, inventory growth, debt repayment capacity and compliance with the 5.9 covenant ceiling, especially given negative free cash flow after dividends.
- Progress, remaining cash costs and expected savings from the Royal Adhesives restructuring through its planned fiscal 2020 completion.
- The outcome and any financial impact of the OFAC matter, environmental remediation and asbestos claims, including third-party indemnification and insurance recoveries.
- Share repurchase disclosures: the cash flow statement reports $2.7 million of repurchases, while management says no shares were repurchased under the program; the filing indicates share withholding for employee tax obligations. Confirm the nature of the reported amount.