H.B. Fuller: second quarter 2012 results

“Our underlying business had an outstanding quarter with sales up over 6% and profits up over 25% versus prior year,” said Jim Owens, H.B. Fuller president and chief executive officer.

H.B. Fuller Company has reported financial results for the second quarter that ended 2 June 2012.
Second-quarter 2012 highlights included:
* Organic revenue from continuing operations increased 6.1% year-over-year;
* Gross profit margin at 30.1% for the combined legacy and discontinued operations, up 150 basis points over last year;
* Regional operating income grew over 30% versus last year;
* Adjusted diluted earnings per share from continuing operations up 27% versus last year;
* Acquisition of the industrial adhesives business from Forbo Group completed and detailed integration plans communicated within first 90 days;
* Agreement signed to divest Latin America Paints business to the Pintuco division of Grupo Mundial.
The year-over-year comparison of financial results for the second quarter and year-to-date is complicated because the make-up of the business has changed significantly from the year ago period. Specifically, the Latin America Paints business segment is now recorded as a discontinued operation and the Forbo industrial adhesives business, acquired in March of 2012, is now fully incorporated into the company’s financial statements. To derive total adjusted earnings, the special charges associated with the business integration and the one-time negative impact of the fair value step-up on the inventory acquired with the Forbo business are eliminated from reported earnings. To derive the adjusted earnings from continuing operations, the earnings attributed to the Paints business is eliminated from the total adjusted earnings number.
“Our underlying business had an outstanding quarter with sales up over 6% and profits up over 25% versus prior year,” said Jim Owens, H.B. Fuller president and chief executive officer. “The acquired Forbo business performed at expected levels, and the synergies we committed to are clearly attainable. Our team delivered this business result while making key strategic moves that are enhancing our portfolio. We achieved this quarter’s strong performance while completing the largest acquisition in the company’s history and making the strategic decision to sell a long held, non-core part of our business. We also announced within 90 days of the acquisition our specific plans to integrate the combined businesses and deliver the profit performance committed to in our strategic plan.”
Net income for the second quarter of 2012 was USD 1.9 million, or USD 0.04 per diluted share, versus net income of USD 25.1 million, or USD 0.50 per diluted share, in last year’s second quarter. Adjusted total diluted earnings per share in the second quarter of 2012 was USD 0.56, up 12% from the prior year. Excluding the Latin America Paints business, adjusted diluted earnings per share from continuing operations was USD 0.62.
Excluding the Latin America Paints business, net revenue for the second quarter of 2012 was USD 527.0 million, up 43.1% versus the second quarter of 2011. Higher average selling prices and acquisitions positively impacted net revenue growth by 6.8 and 39.4 percentage points, respectively. Foreign currency translation and lower volume reduced net revenue growth by 2.4 and 0.7 percentage points, respectively. Organic revenue grew by 6.1% year-over-year.
Reported gross margin was down 210 basis points compared to the prior year. Gross profit margin on the legacy H.B. Fuller business was up approximately 140 basis points, primarily due to the cumulative effect of pricing actions over the past year. The primary cause of the gross profit margin deterioration was the addition of the Forbo adhesives business, which currently generates lower gross profit margins relative to the legacy business. In addition, gross profit margin was negatively impacted by the fair value inventory step-up related to the Forbo transaction and the elimination of the Paints business from continuing operations. Relative to the prior year, Selling, General and Administrative (SG&A) expense increased by 33% to USD 93.0 million, but was down 140 basis points as a percentage of net revenue to 17.6%. The reduction in the SG&A expenses as a percentage of net revenue is due primarily to the inclusion of the Forbo business, which currently has a lower SG&A expense level than the legacy H.B. Fuller business. In addition, the reclassification of the Latin America Paints business to discontinued operations positively impacted this ratio. The amortization expense on intangible assets increased from USD 2.5 million in the second quarter last year to USD 5.4 million this year, primarily due to the inclusion of the intangible assets from the acquired Forbo business.
At the end of the second quarter of 2012, the company had cash totalling USD 154 million and total debt of USD 617 million. This compares to first quarter levels of USD 150 million and USD 228 million, respectively. Sequentially, net debt was higher by approximately USD 385 million, which reflects the new debt drawn down to complete the purchase of the industrial adhesives business from the Forbo Group.
Net income for the first half of 2012 was USD 17.2 million, or USD 0.34 per diluted share, versus USD 39.5 million, or USD 0.79 per diluted share, in first half of last year. Adjusted total diluted earnings per share in the first half of 2012 was USD 1.00, up 27% from the prior year. Excluding the Latin America Paints business, adjusted diluted earnings per share from continuing operations was USD 1.03.
Excluding the Latin America Paints business, net revenue for the first half of 2012 was USD 872.4 million, up 28.4% versus the first half of 2011. Higher average selling prices, higher volume, and acquisitions positively impacted net revenue growth by 8.2, 0.4 and 21.4 percentage points, respectively. Negative foreign currency translation reduced net revenue growth by 1.6 percentage points. Organic sales increased by 8.6% year-over-year in the first half of 2012.
The company completed the acquisition of the Forbo industrial adhesives business on 5 March 2012, and during the second quarter announced plans to integrate the business. In addition, in July of 2011, the company announced its intentions to take a series of actions in its EIMEA business segment to improve the profitability and future growth prospects of this business. Going forward, the company’s ongoing EIMEA business transformation project has been rolled up into the global acquisition integration project, and the combined projects will be referred to as the “business integration.” The business integration represents a significant investment project designed to create an optimized, unified business. The integration strategy and execution plan is unique for each business segment.
In the North America adhesives business segment, the integration work represents a consolidation of two similar businesses. The customer-facing portion of the two businesses (sales, marketing, technical, etc.) is now being combined into a new, streamlined organization that is designed to be more efficient and more responsive to customer needs. The production capacity of the two organizations will be optimized mostly by transferring volume from the acquired Forbo business to existing facilities within the legacy North America adhesives business segment. Six existing production facilities will be closed. Since capacity exists within the receiving facilities, the capital investment required to transfer this production and the time required to affect these transfers will be minimized. All of the planned restructuring activities are scheduled to be completed by the second quarter of 2013.
In the EIMEA business segment, the business integration touches more aspects of the business and is more complex. Similar to the North America project, the customer-facing organizations will be optimized by combining the two organizations into one new, streamlined organization that is more efficient and more responsive to the individual customer groups that the company serves. In addition, the support and administrative functions of both businesses will be reorganized and, in many cases, relocated to create more efficient functions. The integration of the production assets will be more complicated in EIMEA because both the legacy business manufacturing network and the acquired manufacturing network are inefficient and in need of upgrades. Five existing plants will be closed, and new, enhanced production assets will be installed in existing sites to provide greater operating efficiencies and a solid foundation for future growth. This portion of the project will require an estimated USD 90 million of capital investment over the next three years. The EIMEA portion of the business integration project is expected to be completed by the second quarter of 2014.
In the Asia Pacific segment, the integration project is less complex because the acquired business in that region was relatively small. The focus of the integration work in this region will be to build a solid foundation for growth in the commercial and technical areas and, over time, create a more efficient manufacturing network in China.
The benefits of the business integration are expected to be substantial. The company has targeted annual pre-tax profit improvement of USD 90 million when the various integration activities are completed. The profit improvement target reflects the synergy the company expects to capture from the Forbo acquisition plus the planned profit improvement in its legacy EIMEA business segment. By 2015, the business integration activities are expected to improve the EBITDA margin of the business from just under 11% in 2011 to a target level of 15%. The costs to achieve these benefits will be significant and will occur over the next several years. Total cash costs to complete the business integration are estimated at USD 115 million to be incurred by the end of fiscal year 2013.
The capital expenditures related to the business integration project will be funded as part of the company’s annual capital spending program, which would normally total about USD 40 million per year for the legacy business and an additional USD 10 million per year for the acquired Forbo business. Going forward, the company expects its capital spending program to increase to about USD 65 million per year for the years 2012, 2013 and 2014.
The company’s new, revised continuing operations earnings guidance for the 2012 fiscal year is a range of USD 2.10 to USD 2.15 per diluted share. On a comparable basis, the mid-point of the company’s continuing operations earnings guidance has been increased to USD 2.13 per diluted share from USD 2.04 per diluted share under the original baseline guidance. This guidance replaces all previous guidance. This guidance excludes all special charges associated with the business integration project and the one-time negative impact of the fair value inventory step-up portion of the acquisition purchase accounting, which was recorded in the second quarter and totalled USD 0.05 per diluted share. The new, revised guidance reflects the foreign currency exchange rates in effect at the beginning of the company’s third fiscal quarter, including the US dollar to Euro exchange rate of 1.24. Guidance for continuing operations results exclude all income statement impacts of the Paints business. A reconciliation of the previous guidance to the current guidance follows.
Prior guidance was provided in two parts. At the beginning of the year, the company’s earnings guidance was set as a range of USD 2.05 to USD 2.15 per diluted share, with the acquired Forbo business expected to be neutral to diluted EPS. After the Forbo industrial adhesives business acquisition was completed, the company provided further guidance indicating that the acquired business was expected to generate incremental earnings in the current fiscal year of between USD 0.05 and USD 0.15 per diluted share. The two parts of guidance, taken together, indicated an expected earnings range for this year of between USD 2.10 and USD 2.30 per diluted share, representing our baseline earnings guidance. The company’s new, revised guidance, on the same basis, is a range of between USD 2.26 and USD 2.31 per diluted share.
Subsequent to issuing this guidance, the company announced its intentions to divest the Latin America Paints business and, as of the second quarter of 2012, the Paints business is accounted for as a discontinued operation. The amount of 2012 fiscal year earnings attributed to the Paints business and included in the company’s original baseline guidance is USD 0.16 per diluted share. Therefore, excluding the Paints business, the original baseline earnings guidance for the company’s continuing operations would have been a range of USD 1.94 to USD 2.14 per diluted share.