H.B. Fuller Company — Q2 2011 Form 10-Q
Reporting period: The 13-week quarter and 26 weeks ended May 28, 2011, compared with the corresponding periods ended May 29, 2010. Financial amounts below are in U.S. dollars; income-statement and cash-flow amounts are in millions unless stated otherwise.
Business context and results
H.B. Fuller makes adhesives and related products. During Q2, the company changed its management reporting structure from four geographic segments to six reportable segments: North America Adhesives, Construction Products, EIMEA, Latin America Adhesives, Latin America Paints and Asia Pacific. Comparative segment information was restated.
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Net revenue | $393.7 | $347.9 | $733.3 | $657.4 |
| Gross profit | $112.6 | $101.1 | $209.5 | $198.8 |
| Gross margin | 28.6% | 29.1% | 28.6% | 30.2% |
| Operating income by segment measure | $35.0 | $25.8 | $56.2 | $52.0 |
| Net income attributable to H.B. Fuller | $25.1 | $11.0 | $39.5 | $30.0 |
| Diluted EPS | $0.50 | $0.22 | $0.79 | $0.60 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $33.9 | $16.3 |
| Capital expenditures | Not provided for quarter | Not provided for quarter | $14.1 | $15.4 |
Financial position and liquidity
- At May 28, 2011, cash and cash equivalents were $137.6 million, including $124.5 million held outside the U.S. Total debt, including notes payable and current maturities, was approximately $239.8 million; total debt was $250.7 million at November 27, 2010 and $292.4 million a year earlier.
- Total debt to total capital was 24.9%, compared with 28.3% at November 27, 2010 and 34.0% at May 29, 2010. The company reported compliance with its debt covenants.
- First-half net cash from operating activities was $33.9 million; investing activities used $20.0 million and financing activities used $18.7 million. Cash increased $4.3 million over the period.
- Management-defined free cash flow was $12.7 million for the first half, versus negative $5.9 million in the prior-year period. The filing defines this measure as operating cash flow less capital expenditures and dividends paid.
- Working-capital measures worsened year over year: net working capital was 16.7% of annualized revenue versus 15.6%; receivables DSO was 55 days versus 52; and inventory days on hand were 50 versus 48.
- Management said operating cash flows should cover ongoing liquidity and capital spending needs and that the company expects access to short- and long-term debt. It expected scheduled $5.6 million term-loan payments in June and September 2011 to be funded from existing cash.
Changes versus prior comparable periods
- Revenue rose 13.2% in Q2 and 11.5% in the first half. Q2 growth comprised 8.2% pricing, 0.3% volume, 3.0% currency and 1.7% acquisitions; first-half growth comprised 7.8% pricing, 0.9% volume, 1.1% currency and 1.7% acquisitions.
- Raw-material cost inflation outpaced selling-price increases, reducing gross margin by 0.5 percentage points in Q2 and 1.6 points for the first half. Management cited supply shortages and higher feedstock costs.
- SG&A rose 3.1% in Q2 and 4.4% in the first half, but declined as a share of revenue to 19.7% from 21.6% in Q2 and to 20.9% from 22.3% for the half. The company attributed higher spending mainly to sales and technical resources.
- Q2 2010 included $8.8 million of impairment charges and related exit costs; management said these items reduced prior-year Q2 net income by $8.4 million after tax, or $0.17 per share. First-half 2011 included a $0.3 million impairment charge related to discontinued resin products.
- All six segments reported positive first-half organic sales growth. EIMEA had the strongest reported first-half segment revenue increase among the listed segments at 12.0%; Asia Pacific revenue grew 32.7%, including acquisition and currency effects. First-half operating income declined at North America Adhesives and Latin America Adhesives, despite revenue growth.
Management commentary, significant items and risks
- Management described growth as broad-based, while noting a sluggish economic environment and continued investment in sales and technical capabilities. The filing provides no specific full-year revenue or earnings guidance.
- In April 2011, H.B. Fuller acquired Liquamelt Corp. assets and certain liabilities for $6.0 million in cash, with up to $7.0 million of additional contingent consideration. The acquisition added $1.9 million of recorded contingent consideration and $4.9 million of goodwill. The company also reported the prior Revertex acquisition as contributing to Asia Pacific growth.
- During Q2, the company announced changes to its U.S. pension plan: future service and salary-based benefit accruals were frozen, with a 3% increase to locked-in benefits for each additional year worked and a 3% retirement contribution to affected participants’ 401(k) accounts. The plan was remeasured, and its reported funded position improved to $39.1 million overfunded from $5.4 million at fiscal year-end, primarily due to asset performance.
- Market risks include raw-material price increases and shortages, foreign-exchange movements, interest rates and economic weakness affecting volumes, pricing and profitability. A 1-percentage-point interest-rate change was estimated to affect annual interest expense by about $1.6 million; a hypothetical 10% U.S. dollar change was estimated to affect net income by about $1.8 million, or $0.04 per diluted share.
- Environmental matters included a $2.4 million reserve, including $1.1 million for the Sorocaba, Brazil remediation. The company cautioned that additional costs may be required. Asbestos-related probable liabilities and associated insurance recoveries were $0.9 million and $0.6 million, respectively; other claims and insurance coverage remain uncertain. Management did not expect these matters to materially affect long-term financial condition, but said adverse developments could affect future-period results or cash flows.
- Foreign-currency forward contracts had a net mark-to-market loss of $0.6 million, which the company said was largely offset by underlying exposures. Interest-rate swaps covered $75 million of senior notes. The filing reported no material change in disclosed risk factors and stated that disclosure controls were effective.
Important facts for investors to verify
- Whether pricing increases can continue to offset raw-material inflation and supply constraints without further erosion in gross margin.
- Whether elevated inventory, receivables DSO and working-capital needs convert into sustained operating cash flow.
- The contribution and profitability of Liquamelt and Revertex, including Liquamelt’s performance-based contingent payments.
- How the U.S. pension-plan changes affect future pension expense, funding requirements and 401(k) costs.
- Potential cash-flow exposure from environmental remediation, asbestos claims, insurance recoveries and other litigation.
- The company’s progress against debt maturities and covenants, and its dependence on cash held outside the U.S. for liquidity.