Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended May 28, 2022
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission file number: 001-09225
H.B. FULLER COMPANY
(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code: (651) 236-5900
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to section 12(b) of the Act:
Title of each class
Trading Symbol
Name of each exchange on which registered
Common Stock, par value $1.00 per share
FUL
New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12(b) of the Exchange Act. Yes ☐ No ☒
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PROCEEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ☐ No ☐
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of shares outstanding of the Registrant’s Common Stock, par value $1.00 per share, was 53,162,785 as of June 17, 2022.
H.B. Fuller Company
Quarterly Report on Form 10-Q
Page
PART 1. FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS (Unaudited)
4
Consolidated Statements of Income for the three and six months ended May 28, 2022 and May 29, 2021
Consolidated Statements of Comprehensive Income for the three and six months ended May 28, 2022 and May 29, 2021
5
Consolidated Balance Sheets as of May 28, 2022 and November 27, 2021
6
Consolidated Statements of Total Equity for the three and six months ended May 28, 2022 and May 29, 2021
7
Consolidated Statements of Cash Flows for the six months ended May 28, 2022 and May 29, 2021
8
Notes to Consolidated Financial Statements
9
ITEM 2.
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
23
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
34
ITEM 4.
CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
LEGAL PROCEEDINGS
ITEM 1A.
RISK FACTORS
35
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
36
ITEM 6.
EXHIBITS
37
SIGNATURES
38
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
H.B. FULLER COMPANY AND SUBSIDIARIES
Consolidated Statements of Income
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended
Six Months Ended
May 28,
May 29,
2022
2021
Net revenue
Cost of sales
Gross profit
Selling, general and administrative expenses
Other income, net
Interest expense
Interest income
Income before income taxes and income from equity method investments
Income taxes
Income from equity method investments
Net income including non-controlling interest
Net income attributable to non-controlling interest
Net income attributable to H.B. Fuller
Earnings per share attributable to H.B. Fuller common stockholders:
Basic
Diluted
Weighted-average common shares outstanding:
Dividends declared per common share
See accompanying Notes to Unaudited Consolidated Financial Statements.
Consolidated Statements of Comprehensive Income
(In thousands)
Other comprehensive (loss) income
Foreign currency translation
Defined benefit pension plans adjustment, net of tax
Interest rate swaps, net of tax
Cross-currency swaps, net of tax
Comprehensive (loss) income
Less: Comprehensive income attributable to non-controlling interest
Comprehensive (loss) income attributable to H.B. Fuller
Consolidated Balance Sheets
(In thousands, except share and per share amounts)
November 27,
Assets
Current assets:
Cash and cash equivalents
Trade receivables (net of allowances of $12,701 and $9,935, as of May 28, 2022 and November 27, 2021, respectively)
Inventories
Other current assets
Total current assets
Property, plant and equipment
Accumulated depreciation
Property, plant and equipment, net
Goodwill
Other intangibles, net
Other assets
Total assets
Liabilities, non-controlling interest and total equity
Current liabilities:
Notes payable
Trade payables
Accrued compensation
Income taxes payable
Other accrued expenses
Total current liabilities
Long-term debt
Accrued pension liabilities
Other liabilities
Total liabilities
Commitments and contingencies (Note 12)
Equity:
H.B. Fuller stockholders' equity:
Preferred stock (no shares outstanding) shares authorized – 10,045,900
Common stock, par value $1.00 per share, shares authorized – 160,000,000, shares outstanding – 53,153,056 and 52,777,753 as of May 28, 2022 and November 27, 2021, respectively
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss
Total H.B. Fuller stockholders' equity
Non-controlling interest
Total equity
Total liabilities, non-controlling interest and total equity
Consolidated Statements of Total Equity
H.B. Fuller Company Shareholders
Accumulated
Additional
Other
Common
Paid-in
Retained
Comprehensive
Non-Controlling
Stock
Capital
Earnings
Income (Loss)
Interest
Total
Balance at November 27, 2021
Comprehensive income
Dividends
Stock option exercises
Share-based compensation plans and other, net
Repurchases of common stock
Balance at February 26, 2022
Comprehensive income (loss)
Share-based compensation plans other, net
Balance at May 28, 2022
Balance at November 28, 2020
Balance at February 27, 2021
Balance at May 29, 2021
Consolidated Statements of Cash Flows
May 28, 2022
May 29, 2021
Cash flows from operating activities:
Adjustments to reconcile net income including non-controlling interest to net cash (used in) provided by operating activities:
Depreciation
Amortization
Deferred income taxes
Income from equity method investments, net of dividends received
Loss on sale or disposal of assets
Share-based compensation
Pension and other post-retirement benefit plan activity
Change in assets and liabilities, net of effects of acquisitions:
Trade receivables, net
Net cash (used in) provided by operating activities
Cash flows from investing activities:
Purchased property, plant and equipment
Purchased businesses, net of cash acquired
Proceeds from sale of property, plant and equipment
Cash received from government grant
Cash payments related to government grant
Net cash used in investing activities
Cash flows from financing activities:
Proceeds from debt
Repayment of long-term debt
Payment of debt issuance costs
Net proceeds of notes payable
Dividends paid
Contingent consideration payment
Proceeds from stock options exercised
Net cash provided by (used in) financing activities
Effect of exchange rate changes on cash and cash equivalents
Net change in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
(Amounts in thousands, except per share amounts)
Note 1: Basis of Presentation
Overview
The accompanying unaudited interim Consolidated Financial Statements of H.B. Fuller Company and Subsidiaries have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information necessary for a fair presentation of results of operations, comprehensive income, financial position and cash flows in conformity with U.S. generally accepted accounting principles. In our opinion, the unaudited interim Consolidated Financial Statements reflect all adjustments of a normal recurring nature considered necessary for the fair presentation of the results for the periods presented. Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole.
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ from these estimates. These unaudited interim Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K for the year ended November 27, 2021 as filed with the Securities and Exchange Commission.
New Accounting Pronouncements
In November 2021, the FASB issued ASU No. 2021-10, Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance. This ASU requires business entities to make annual disclosures about transactions with a government they account for by analogizing to a grant or contribution accounting model under ASC 958-605. Our effective date for adoption of this ASU is our fiscal year beginning December 4, 2022 with early adoption permitted. We have evaluated the effect that this guidance will have on our Consolidated Financial Statements and determined it will not have a material impact.
Note 2: Acquisitions
Apollo
On January 26, 2022, we acquired Apollo Chemicals Limited, Apollo Roofing Solutions Limited and Apollo Construction Solutions Limited (collectively, "Apollo") for a base purchase price of GBP 151,214, or approximately $203,573, which was funded through borrowings on our credit facility. The agreement requires us to pay an additional GBP 1,500, or approximately $2,019, following the completion of certain environmental studies. Apollo, headquartered in Tamworth, UK, is a manufacturer of liquid adhesives, coatings and primers for the roofing, industrial and construction markets. Apollo is expected to enhance our position in key high-value, high-margin markets in the UK and throughout Europe. The acquisition fair value measurement was preliminary as of May 28, 2022. The acquisition will be included in our Construction Adhesives operating segment.
The following table summarizes the preliminary fair value measurement of the assets acquired and liabilities assumed as of the date of acquisition:
February 26, 2022
Adjustments
Cash
Current assets
Other intangibles
Customer relationships
Trademarks/trade names
Technology
Current liabilities
The expected useful lives of the acquired intangible assets are 12 years for customer relationships and technology and 10 years for trademarks/trade names.
Based on the fair value measurement of the assets acquired and liabilities assumed, we allocated $118,244 to goodwill for the expected synergies from combining Apollo with our existing business. Such goodwill is not deductible for tax purposes. The goodwill was assigned to our Construction Adhesives operating segment. The Apollo acquisition does not represent a material business combination, and therefore pro forma financial information is not provided.
Fourny NV
On January 11, 2022, we acquired Fourny NV ("Fourny") for a base purchase price of EUR 12,867, or approximately $14,627, which was funded through existing cash. The agreement requires us to pay an additional EUR 3,100, or approximately $3,524, 18 months following the date of acquisition. Fourny, headquartered in Willebroek, Belgium, is a manufacturer of construction and automotive adhesives. Fourny is expected to enhance our position in key high-value, high-margin markets in Europe. The acquisition fair value measurement was preliminary as of May 28, 2022 and includes intangible assets of $10,117, goodwill of $6,593, cash of $75 and other net assets of $1,366. Goodwill is not deductible for tax purposes. Fourny is recorded in our Construction Adhesives operating segment. The Fourny acquisition does not represent a material business combination, and therefore pro forma financial information is not provided.
Tissue Seal, LLC
On November 30, 2021, we acquired certain assets of Tissue Seal, LLC ("TissueSeal") for a base purchase price of $22,167, which was funded through existing cash. The agreement requires us to pay an additional $2,475 on the first anniversary of the acquisition and contingent consideration of up to $500 on November 30, 2024 based on certain agreement provisions. TissueSeal, headquartered in Ann Arbor, Michigan, is a distributor of topical tissue adhesives and sutures. With this acquisition, we add TissueSeal's regulatory clearances, customer and distribution relationships, regulatory approvals and trademarks into our portfolio of products. The acquisition fair value measurement was preliminary as of May 28, 2022 and includes intangible assets of $11,160, goodwill of $13,765 and other net assets of $217. Goodwill is deductible for tax purposes. See Note 11 for further discussion of the fair value of the contingent consideration liability. TissueSeal is recorded in our Hygiene, Health and Consumable Adhesives operating segment. The TissueSeal acquisition does not represent a material business combination, and therefore pro forma financial information is not provided.
STR Holdings, Inc.
On January 13, 2021, we acquired certain assets of STR Holding, Inc. ("STR") for a base purchase price of $5,445 which was funded through existing cash. The agreement required us to pay an additional $800 on the first anniversary of the acquisition and contingent consideration of up to $1,700 based on certain agreement provisions. STR, headquartered in Enfield, Connecticut, is a manufacturer of encapsulant products used in the solar industry. The acquisition fair value measurement, which includes intangible assets of $6,700 and other net assets of $1,245, was final as of November 27, 2021. The agreement provisions for the contingent consideration were met, and as a result, $1,700 was paid as of November 27, 2021. No goodwill was recorded for this acquisition. STR is reported in our Engineering Adhesives operating segment. The STR acquisition does not represent a material business combination, and therefore pro forma financial information is not provided.
D.H.M. Adhesives, Inc.
On February 3, 2020, we acquired certain assets of D.H.M. Adhesives, Inc. (“D.H.M.”) for approximately $9,500 which was funded through existing cash. In addition, the agreement required us to pay contingent consideration of up to approximately $8,100 based upon a formula related to revenue during the fiscal years ended November 27, 2021 and December 3, 2022. D.H.M., headquartered in Calhoun, Georgia, is a provider of hotmelt adhesives. The acquisition fair value measurement was final as of May 30, 2020 and includes goodwill of $1,063 and customer relationship intangible of $11,900. The fair value of the contingent consideration as of the date of acquisition was $5,000 resulting in a final purchase price of $14,500. As of November 27, 2021, the agreement provisions for the contingent consideration were met, and as a result, $8,100 was paid during the period ended February 26, 2022. Goodwill is deductible for tax purposes. D.H.M. and the related goodwill are reported in our Hygiene, Health and Consumable Adhesives operating segment. The D.H.M acquisition does not represent a material business combination, and therefore pro forma financial information is not provided.
Note 3: Restructuring Actions
The Company has approved restructuring plans consisting of consolidation plans, organizational changes and other actions related to the reorganization of our business into three segments, the integration of the operations of Royal Adhesives with the operations of the Company and other actions to optimize operations. The following table summarizes the pre-tax charges under these restructuring plans by income statement classification:
Selling, general and administrative
The restructuring charges are all recorded in Corporate Unallocated for segment reporting.
A summary of the restructuring liability is presented below:
Employee-Related
Expenses incurred
Non-cash charges
Cash payments
Non-cash charges include accelerated depreciation resulting from the cessation of use of certain long-lived assets. Restructuring liabilities have been classified as a component of other accrued expenses in the Consolidated Balance Sheets.
Note 4: Inventories
The composition of inventories is as follows:
Raw materials
Finished goods
Total inventories
Note 5: Goodwill and Other Intangible Assets
The goodwill activity by reportable segment for the six months ended May 28, 2022 is presented below:
Hygiene, Health
and Consumable
Engineering
Construction
Adhesives
TissueSeal acquisition
Fourny acquisition
Apollo acquisition
Foreign currency translation effect
Balances of amortizable identifiable intangible assets, excluding goodwill and other non-amortizable intangible assets, are as follows:
Purchased
Customer
Amortizable Intangible Assets
and Patents
Relationships
Trade Names
Original cost
Accumulated amortization
Net identifiable intangibles
November 27, 2021
Amortization expense with respect to amortizable intangible assets was $18,620 and $17,753 for the three months ended May 28, 2022 and May 29, 2021, respectively, and $36,412 and $35,649 for the six months ended May 28, 2022 and May 29, 2021, respectively.
Estimated aggregate amortization expense based on the current carrying value of amortizable intangible assets for the next five fiscal years is as follows:
Remainder
Fiscal Year
2023
2024
2025
2026
Thereafter
Amortization expense
Non-amortizable intangible assets as of May 28, 2022 and November 27, 2021 are $468 and $493, respectively, and are related to trademarks and trade names. The change in non-amortizable assets as of May 28, 2022 compared to November 27, 2021 was due to changes in foreign currency exchange rates.
Note 6: Components of Net Periodic Benefit related to Pension and Other Postretirement Benefit Plans
Three Months Ended May 28, 2022 and May 29, 2021
Pension Benefits
Postretirement
U.S. Plans
Non-U.S. Plans
Benefits
Net periodic cost (benefit):
Service cost
Interest cost
Expected return on assets
Amortization:
Prior service cost (benefit)
Actuarial loss
Settlement charge
Net periodic benefit
Six Months Ended May 28, 2022 and May 29, 2021
Service cost is included with employee compensation cost in cost of sales and selling, general and administrative expenses in the Consolidated Statements of Income. The components of our net periodic defined benefit pension and postretirement benefit costs other than service cost are presented in other income, net in the Consolidated Statements of Income.
In the second quarter of 2022, we recognized a non-cash settlement charge of $3,329 related to the termination of our Canadian defined benefit pension plan. The settlement charge is included in other income, net in the Consolidated Statements of Income.
Note 7: Accumulated Other Comprehensive Income (Loss)
The following table provides details of total comprehensive income (loss):
Three Months Ended May 28, 2022
Three Months Ended May 29, 2021
Non-
controlling
H.B. Fuller Stockholders
Pre-tax
Tax
Net
Net income attributable to H.B. Fuller and non-controlling interest
Foreign currency translation adjustment¹
Defined benefit pension plans adjustment²
Interest rate swap³
Cross currency swaps³
Other comprehensive income (loss)
Six Months Ended May 28, 2022
Six Months Ended May 29, 2021
Pretax
¹ Income taxes are not provided for foreign currency translation relating to permanent investments in international subsidiaries.
² Loss reclassified from accumulated other comprehensive income ("AOCI") into earnings as part of net periodic cost related to pension and other postretirement benefit plans is reported in cost of sales and SG&A expense.
³ Income (loss) reclassified from AOCI into earnings is reported in other income, net.
The components of accumulated other comprehensive loss are as follows:
H.B. Fuller
Stockholders
Foreign currency translation adjustment
Interest rate swap, net of taxes of $112
Cash flow hedges, net of taxes of ($3)
Defined benefit pension plans adjustment, net of taxes of $42,292
Reclassification of AOCI tax effects
Interest rate swap, net of taxes of $3,224
Cash flow hedges, net of taxes of ($53)
Defined benefit pension plans adjustment, net of taxes of $63,925
Note 8: Income Taxes
Income tax expense for the three and six months ended May 28, 2022 includes $4,149 and $1,248 of discrete tax expense, respectively, relating to the revaluation of cross-currency swap agreements due to depreciation of the Euro versus the U.S. Dollar, as well as various foreign tax matters offset by the tax effect of legal entity mergers. Excluding the discrete tax expense, the overall effective tax rate was 27.9 percent for both the three and six months ended May 28, 2022.
Income tax expense for the three and six months ended May 29, 2021 includes $600 and $558 of discrete tax benefit, respectively. Excluding the discrete tax benefit, the overall effective tax rate was 27.1 percent and 27.2 percent for the three and six months ended May 29, 2021 respectively.
As of May 28, 2022, we had a liability of $15,414 recorded for gross unrecognized tax benefits (excluding interest) compared to $13,281 as of November 27, 2021. As of May 28, 2022 and November 27, 2021, we had accrued $3,215 and $2,448 of gross interest relating to unrecognized tax benefits, respectively.
Note 9: Earnings Per Share
A reconciliation of the common share components for the basic and diluted earnings per share calculations is as follows:
(Shares in thousands)
Weighted-average common shares - basic
Equivalent shares from share-based compensations plans
Weighted-average common and common equivalent shares diluted
Basic earnings per share is calculated by dividing net income attributable to H.B. Fuller by the weighted-average number of common shares outstanding during the applicable period. Diluted earnings per share is based upon the weighted-average number of common and common equivalent shares outstanding during the applicable period. The difference between basic and diluted earnings per share is attributable to share-based compensation awards. We use the treasury stock method to calculate the effect of outstanding shares, which computes total employee proceeds as the sum of (a) the amount the employee must pay upon exercise of the award and (b) the amount of unearned share-based compensation costs attributed to future services. Share-based compensation awards for which total employee proceeds exceed the average market price over the applicable period have an antidilutive effect on earnings per share, and accordingly, are excluded from the calculation of diluted earnings per share.
Share-based compensation awards of 658,511 and 208,888 shares for the three months ended May 28, 2022 and May 29, 2021, respectively, and 744,479 and 2,107,062 shares for the six months ended May 28, 2022 and May 29, 2021, respectively, were excluded from diluted earnings per share calculations because they were antidilutive.
Note 10: Financial Instruments
As a result of being a global enterprise, our earnings, cash flows and financial position are exposed to foreign currency risk from foreign currency denominated receivables and payables.
We use foreign currency forward contracts, cross-currency swaps and interest rate swaps to manage risks associated with foreign currency exchange rates and interest rates. We do not hold derivative financial instruments of a speculative nature or for trading purposes. We record derivatives as assets and liabilities on the balance sheet at fair value. Changes in fair value are recognized immediately in earnings unless the derivative qualifies and is designated as a hedge. Cash flows from derivatives are classified in the Consolidated Statement of Cash Flows in the same category as the cash flows from the items subject to designated hedge or undesignated (economic) hedge relationships. We evaluate hedge effectiveness at inception and on an ongoing basis. If a derivative is no longer expected to be effective, hedge accounting is discontinued. Hedge ineffectiveness, if any, is recorded in earnings.
We are exposed to credit risk in the event of nonperformance of counterparties for foreign currency forward exchange contracts and interest rate swap agreements. We select investment-grade multinational banks and financial institutions as counterparties for derivative transactions and monitor the credit quality of each of these banks on a periodic basis as warranted. We do not anticipate nonperformance by any of these counterparties, and valuation allowances, if any, are de minimis.
Cash Flow Hedges
As of May 28, 2022, we had cash flow hedges of four cross-currency swap agreements effective October 20, 2017 to convert a notional amount of $267,860 of foreign currency denominated intercompany loans into U.S. dollars, which mature in 2022. As of May 28, 2022, the combined fair value of the swaps was an asset of $24,932 and was included in other current assets in the Consolidated Balance Sheets. The swaps were designated as cash flow hedges for accounting treatment. The lesser amount between the cumulative change in the fair value of the actual swaps and the cumulative change in the fair value of hypothetical swaps is recorded in accumulated other comprehensive income (loss) in the Consolidated Balance Sheets and in other net cash provided by operating activities in the Consolidated Statement of Cash Flows. The differences between the cumulative change in the fair value of the actual swaps and the cumulative change in the fair value of hypothetical swaps are recorded as other income, net in the Consolidated Statements of Income. In a perfectly effective hedge relationship, the two fair value calculations would exactly offset each other. Any difference in the calculation represents hedge ineffectiveness. The amount in accumulated other comprehensive income (loss) related to cross-currency swaps was a gain of$190 as of May 28, 2022. The estimated net amount of the existing gain that is reported in accumulated other comprehensive income (loss) as of May 28, 2022 that is expected to be reclassified into earnings within the next twelve months is $190. As of May 28, 2022, we do not believe any gains or losses will be reclassified into earnings as a result of the discontinuance of these cash flow hedges because the original forecasted transaction will not occur.
The following table summarizes the cross-currency swaps outstanding as of May 28, 2022:
Fiscal Year of
Notional
Expiration
Interest Rate
Value
Fair Value
Pay EUR
Receive USD
On February 27, 2018, we entered into an interest rate swap agreement to convert $200,000 of our $2,150,000 Term Loan B to a fixed interest rate of 4.589 percent. During the second quarter of 2021, we settled a portion of this interest rate swap as the debt underlying this swap was less than the swap value due to debt paydown. We settled the ineffective portion of the interest rate swap by making a cash payment of $378 and recorded that payment to interest expense in our Consolidated Statements of Income during the second quarter of 2021. On October 20, 2017, we entered into interest rate swap agreements to convert $1,050,000, which was amortized down to $800,000 on October 20, 2021, of our $2,150,000 Term Loan B to a fixed interest rate of 4.0275 percent. The combined fair value of the interest rate swaps was a liability of $460 at May 28, 2022 and was included in other liabilities in the Consolidated Balance Sheets. The swaps were designated for hedge accounting treatment as cash flow hedges. We are applying the hypothetical derivative method to assess hedge effectiveness for these interest rate swaps. Changes in the fair value of a hypothetically perfect swap with terms that match the critical terms of our $1,125,000 variable rate Term Loan B are compared with the change in the fair value of the swaps.
On April 23, 2018, we amended our Term Loan B Credit Agreement to reduce the interest rate from LIBOR plus 2.25 percent to LIBOR plus 2.00 percent. Fixed interest rates related to swap agreements disclosed have been updated to reflect the amendment.
The amounts of pretax gains (losses) recognized in Comprehensive Income related to derivative instruments designated as cash flow hedges are as follows:
Cross-currency swap contracts
Interest rate swap contracts
Fair Value Hedges
On February 12, 2021, we entered into interest rate swap agreements to convert our $300,000 Public Notes that were issued on October 20, 2020 to a variable interest rate of 1-month LIBOR plus 3.28 percent. The combined fair value of the interest rate swaps was a liability of $33,901 at May 28, 2022, and was included in other liabilities in the Consolidated Balance Sheets. The swaps were designated for hedge accounting treatment as fair value hedges. We apply the short cut method and assume hedge effectiveness. Changes in the fair value of a hypothetically perfect swap with terms that match the critical terms of our $300,000 fixed rate Public Notes are compared with the change in the fair value of the swaps.
Derivatives Not Designated As Hedging Instruments
We use foreign currency forward contracts to offset our exposure to the change in value of certain foreign currency denominated assets and liabilities held at foreign subsidiaries that are remeasured at the end of each period. Although the contracts are effective economic hedges, they are not designated as accounting hedges. Foreign currency forward contracts are recorded as assets and liabilities on the balance sheet at fair value. Changes in the value of these derivatives are recognized immediately in earnings, thereby offsetting the current earnings effect of the related foreign currency denominated assets and liabilities. See Note 11 for fair value amounts of these derivative instruments.
As of May 28, 2022, we had forward foreign currency contracts maturing between May 31, 2022 and December 13, 2022. The mark-to-market effect associated with these contracts was largely offset by the underlying transaction gains and losses resulting from the foreign currency exposures for which these contracts relate.
The amounts of pretax gains recognized in other income, net related to derivative instruments not designated as hedging instruments for the six months ended May 28, 2022 and May 29, 2021 were $5,089 and $404, respectively.
Concentrations of credit risk with respect to trade accounts receivable are limited due to the large number of entities in the customer base and their dispersion across many different industries and countries. As of May 28, 2022, there were no significant concentrations of credit risk.
Note 11: Fair Value Measurements
Estimates of fair value for financial assets and liabilities are based on the framework established in the accounting guidance for fair value measurements. The framework defines fair value, provides guidance for measuring fair value and requires certain disclosures. The framework discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow) and the cost approach (cost to replace the service capacity of an asset or replacement cost). The framework utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:
●
Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.
Level 3: Unobservable inputs that reflect management’s assumptions, and include situations where there is little, if any, market activity for the asset or liability.
Balances Measured at Fair Value on a Recurring Basis
The following table presents information about our financial assets and liabilities that are measured at fair value on a recurring basis as of May 28, 2022 and November 27, 2021, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.
Fair Value Measurements Using:
Description
Level 1
Level 2
Level 3
Assets:
Marketable securities
Foreign exchange contract assets
Cross-currency cash flow hedge assets
Liabilities:
Foreign exchange contract liabilities
Interest rate swaps, cash flow hedge liabilities
Interest rate swaps, fair value hedge liabilities
Contingent consideration liability
Adjustments to the fair value of contingent consideration are recorded to selling, general and administrative expenses in the Statement of Income.
The valuation of our contingent consideration liability related to the acquisition of TissueSeal resulted in a fair value of $500 as of May 28, 2022. As of November 27, 2021, the agreement provisions for the D.H.M contingent consideration were met, and as a result, $8,100 was paid during the period ended February 26, 2022. See Note 2 for further discussion regarding our acquisitions. The following table provides details of the contingent consideration liabilities:
Amounts
Acquisition
Payment of contingent consideration
Mark to market adjustment
Balances Measured at Fair Value on a Nonrecurring Basis
We measure certain assets and liabilities at fair value on a nonrecurring basis. These assets include intangible assets acquired in an acquisition. The identified intangible assets of customer relationships, technology and tradenames acquired in connection with our acquisitions were measured using unobservable (Level 3) inputs. The fair value of the intangible assets was calculated using either the income or cost approach. Significant inputs include estimated revenue growth rates, gross margins, operating expenses, attrition rate, royalty rate and discount rate.
See Note 2 for further discussion regarding our acquisitions.
Balances Disclosed at Fair Value
Long-term debt had an estimated fair value of $1,819,598 and $1,618,291 as of May 28, 2022 and November 27, 2021, respectively. The fair value of long-term debt is based on quoted market prices for the same or similar issues or on the current rates offered for debt of similar maturities. The estimated fair value of these long-term obligations is not necessarily indicative of the amount that would be realized in a current market exchange.
Note 12: Commitments and Contingencies
Environmental Matters
From time to time, we become aware of compliance matters relating to, or receive notices from, federal, state or local entities regarding possible or alleged violations of environmental, health or safety laws and regulations. We review the circumstances of each individual site, considering the number of parties involved, the level of potential liability or our contribution relative to the other parties, the nature and magnitude of the hazardous substances involved, the method and extent of remediation, the estimated legal and consulting expense with respect to each site and the time period over which any costs would likely be incurred. Also, from time to time, we are identified as a potentially responsible party (“PRP”) under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) and/or similar state laws that impose liability for costs relating to the clean up of contamination resulting from past spills, disposal or other release of hazardous substances. We are also subject to similar laws in some of the countries where current and former facilities are located. Our environmental, health and safety department monitors compliance with applicable laws on a global basis. To the extent we can reasonably estimate the amount of our probable liabilities for environmental matters, we establish an undiscounted financial provision. We recorded liabilities of $6,378 and $6,603 as of May 28, 2022 and November 27, 2021, respectively, for probable and reasonably estimable environmental remediation costs. Of the amount reserved, $3,078 and $3,333 as of May 28, 2022 and November 27, 2021, respectively, is attributable to a facility we own in Simpsonville, South Carolina as a result of our Royal Adhesives acquisition that is a designated site under CERCLA.
Currently, we are involved in various environmental investigations, clean up activities and administrative proceedings and lawsuits. In particular, we are currently deemed a PRP in conjunction with numerous other parties, in a number of government enforcement actions associated with landfills and/or hazardous waste sites. As a PRP, we may be required to pay a share of the costs of investigation and clean up of these sites. In addition, we are engaged in environmental remediation and monitoring efforts at a number of current and former operating facilities. While uncertainties exist with respect to the amounts and timing of the ultimate environmental liabilities, based on currently available information, we have concluded that these matters, individually or in the aggregate, will not have a material adverse effect on our results of operations, financial condition or cash flow.
Other Legal Proceedings
From time to time and in the ordinary course of business, we are a party to, or a target of, lawsuits, claims, investigations and proceedings, including product liability, personal injury, contract, patent and intellectual property, environmental, health and safety, tax and employment matters. While we are unable to predict the outcome of these matters, we have concluded, based upon currently available information, that the ultimate resolution of any pending matter, individually or in the aggregate, including the asbestos litigation described in the following paragraphs, will not have a material adverse effect on our results of operations, financial condition or cash flow.
We have been named as a defendant in lawsuits in which plaintiffs have alleged injury due to products containing asbestos manufactured more than 35 years ago. The plaintiffs generally bring these lawsuits against multiple defendants and seek damages (both actual and punitive) in very large amounts. In many cases, plaintiffs are unable to demonstrate that they have suffered any compensable injuries or that the injuries suffered were the result of exposure to products manufactured by us. We are typically dismissed as a defendant in such cases without payment. If the plaintiff presents evidence indicating that compensable injury occurred as a result of exposure to our products, the case is generally settled for an amount that reflects the seriousness of the injury, the length, intensity and character of exposure to products containing asbestos, the number and solvency of other defendants in the case, and the jurisdiction in which the case has been brought.
A significant portion of the defense costs and settlements in asbestos-related litigation is paid by third parties, including indemnification pursuant to the provisions of a 1976 agreement under which we acquired a business from a third party. Currently, this third party is defending and paying settlement amounts, under a reservation of rights, in most of the asbestos cases tendered to the third party.
In addition to the indemnification arrangements with third parties, we have insurance policies that generally provide coverage for asbestos liabilities, including defense costs. Historically, insurers have paid a significant portion of our defense costs and settlements in asbestos-related litigation. However, certain of our insurers are insolvent. We have entered into cost-sharing agreements with our insurers that provide for the allocation of defense costs and settlements and judgments in asbestos-related lawsuits. These agreements require, among other things, that we fund a share of defense costs, settlements and judgments allocable to years in which the responsible insurer is insolvent.
A summary of the number of and settlement amounts for asbestos-related lawsuits and claims is as follows:
3 Years Ended
Lawsuits and claims settled
Settlement amounts
Insurance payments received or expected to be received
We do not believe that it would be meaningful to disclose the aggregate number of asbestos-related lawsuits filed against us because relatively few of these lawsuits are known to involve exposure to asbestos-containing products that we manufactured. Rather, we believe it is more meaningful to disclose the number of lawsuits that are settled and result in a payment to the plaintiff. To the extent we can reasonably estimate the amount of our probable liabilities for pending asbestos-related claims, we establish a financial provision and a corresponding receivable for insurance recoveries.
Based on currently available information, we have concluded that the resolution of any pending matter, including asbestos-related litigation, individually or in the aggregate, will not have a material adverse effect on our results of operations, financial condition or cash flow.
Note 13: Segments
We are required to report segment information in the same way that we internally organize our business for assessing performance and making decisions regarding allocation of resources. Revenue and operating income of each of our segments are regularly reviewed by our chief operating decision maker to make decisions about resources to be allocated to the segments and assess their performance. Segment operating income is identified as gross profit less SG&A expenses. Corporate expenses, other than those included in Corporate Unallocated, are allocated to each operating segment. Consistent with our internal management reporting, Corporate Unallocated amounts include business acquisition and integration costs, organizational restructuring charges and project costs associated with our implementation of Project ONE. Corporate assets are not allocated to the operating segments. Inter-segment revenues are recorded at cost plus a markup for administrative costs.
We have three reportable segments: Hygiene, Health and Consumable Adhesives, Engineering Adhesives and Construction Adhesives. The business components within each operating segment are managed to maximize the results of the overall operating segment rather than the results of any individual business component of the operating segment. Results of individual components of each operating segment are subject to numerous allocations of segment-wide costs that may or may not have been focused on that particular component for a particular reporting period. The costs for these allocated resources are not tracked on a "where-used" basis as financial performance is assessed at the total operating segment level.
The table below provides certain information regarding net revenue and operating income (loss) for each of our operating segments.
Operating
Revenue
Hygiene, Health and Consumable Adhesives
Engineering Adhesives
Construction Adhesives
Total segment
Corporate Unallocated1
Corporate Unallocated
1 Consistent with our internal management reporting, Corporate Unallocated amounts in the tables above include charges that are not allocated to the Company’s reportable segments.
The table below provides a reconciliation of operating income to income before income taxes and income from equity method investments:
Operating income
We view the following disaggregation of net revenue by geographic region as useful to understanding the composition of revenue recognized during the respective reporting periods:
Americas
EIMEA
Asia Pacific
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the MD&A included in our Annual Report on Form 10-K for the year ended November 27, 2021 for important background information related to our business.
Net revenue in the second quarter of 2022 increased 20.0 percent from the second quarter of 2021. Net revenue increased 18.5 percent due to price, 3.4 percent due to sales volume and 2.0 percent due to the acquisition of Fourny and Apollo. Negative currency effects of 3.9 percent compared to the second quarter of 2021 were primarily driven by a weaker Euro, Turkish lira and Argentinian peso, partially offset by a stronger Brazilian real and Chinese renminbi compared to the U.S. dollar. Gross profit margin decreased 80 basis points primarily due to higher raw material costs and higher net revenue.
Net revenue in the first six months of 2022 increased 19.1 percent from the first six months of 2021. Net revenue increased 16.8 percent due to price, 4.6 percent due to sales volume and 1.5 percent due to the acquisition of Fourny and Apollo. Negative currency effects of 3.8 percent compared to the first six months of 2021 were primarily driven by a weaker Euro, Turkish lira and Argentinian peso, partially offset by a stronger Chinese renminbi and Brazilian real compared to the U.S. dollar. Gross profit margin decreased 120 basis points primarily due to higher raw material costs and higher net revenue.
Net income attributable to H.B. Fuller in the second quarter of 2022 was $47.2 million compared to $49.1 million in the second quarter of 2021. On a diluted earnings per share basis, the second quarter of 2022 was $0.86 per share compared to $0.90 per share for the second quarter of 2021.
Net income attributable to H.B. Fuller in the first six months of 2022 was $85.5 million compared to $78.9 million in the first six months of 2021. On a diluted earnings per share basis, the first six months of 2022 was $1.55 per share compared to $1.47 per share for the first six months of 2021.
Market Conditions
On March 11, 2020, the World Health Organization declared the outbreak of the novel coronavirus ("COVID-19") a pandemic. Throughout fiscal year 2021, the COVID-19 pandemic had a significant disruptive impact on global economies, supply chains and industrial production. Although government restrictions have been relaxed, it is currently not possible to estimate additional impacts this outbreak may have on our business. We continue to effectively manage our global operations focusing on the health and safety of our employees and ensuring business continuity across our supplier, manufacturing and distribution networks.
See "Risk Factors" in Item 1A in our Annual Report on Form 10-K for the year ended November 27, 2021 as filed with the Securities and Exchange Commission for further information of the effects of the COVID-19 pandemic on our business including raw material cost and availability.
Restructuring Plan
During the fourth quarter of 2019, we approved a restructuring plan related to organizational changes and other actions to optimize operations in connection with the realignment of the Company into three global business units (“2020 Restructuring Plan”). We have incurred costs of $19.7 million under this plan as of May 28, 2022. We expect to incur total costs of approximately $20.0 million ($15.8 million after-tax), which includes cash expenditures for severance and related employee costs globally, costs related to streamlining of processes, and other restructuring-related costs. The 2020 Restructuring Plan was implemented in the fourth quarter of 2019 and is currently expected to be completed in fiscal 2022.
Results of Operations
Net revenue:
2022 vs
($ in millions)
We review variances in net revenue in terms of changes related to sales volume, product pricing, business acquisitions and divestitures (“M&A”) and changes in foreign currency exchange rates. The following table shows the net revenue variance analysis for the second quarter and first six months of 2022 compared to the same periods in 2021:
May 28, 2022 vs. May 29, 2021
Organic growth
M&A
Currency
(3.8
19.1
Organic growth was 21.9 percent in the second quarter of 2022 compared to the second quarter of 2021 driven by a 24.5 percent increase in Hygiene, Health and Consumable Adhesives, a 21.8 percent increase in Engineering Adhesives and a 14.3 percent increase in Construction Adhesives . The increase is predominately driven by an increase in product pricing and sales volume. The 2.0 percent increase from M&A is due to the acquisition of Fourny and Apollo. The negative 3.9 percent currency impact was primarily driven by a weaker Euro, Turkish lira and Argentinian peso, partially offset by a stronger Brazilian real and Chinese renminbi compared to the U.S. dollar.
Organic growth was 21.4 percent in the first six months of 2022 compared to the first six months of 2021 driven by a 23.8 percent increase in Construction Adhesives, a 22.7 percent increase in Hygiene, Health and Consumable Adhesives and a 19.3 percent increase in Engineering Adhesives. The increase is predominately driven by an increase in product pricing and sales volume. The 1.5 percent increase from M&A is due to the acquisition of Fourny and Apollo. The negative 3.8 percent currency impact was primarily driven by a weaker Euro, Turkish lira and Argentinian peso, partially offset by a stronger Chinese renminbi and Brazilian real compared to the U.S. dollar.
Cost of sales:
Other manufacturing costs
Percent of net revenue
Cost of sales in the second quarter of 2022 compared to the second quarter of 2021 increased 80 basis points as a percentage of net revenue. Raw material cost as a percentage of net revenue increased 300 basis points in the second quarter of 2022 compared to the second quarter of 2021 due to higher raw material costs. Other manufacturing costs as a percentage of revenue decreased 220 basis points in the second quarter of 2022 compared to the second quarter of 2021 due to higher net revenue.
Cost of sales in the first six months of 2022 compared to the first six months of 2021 increased 120 basis points as a percentage of net revenue. Raw material cost as a percentage of net revenue increased 360 basis points in the first six months of 2022 compared to the first six months of 2021 due to higher raw material costs. Other manufacturing costs as a percentage of revenue decreased 240 basis points in the first six months of 2022 compared to the first six months of 2021 due to higher net revenue.
Gross profit:
Gross profit in the second quarter of 2022 increased 16.5 percent and gross profit margin decreased 80 basis points compared to the second quarter of 2021. The decrease in gross profit margin was primarily due to higher raw material costs and higher net revenue.
Gross profit in the first six months of 2022 increased 13.8 percent and gross profit margin decreased 120 basis points compared to the first six months of 2021. The decrease in gross profit margin was primarily due to higher raw material costs and higher net revenue.
Selling, general and administrative (SG&A) expenses:
SG&A
SG&A expenses for the second quarter of 2022 increased $17.6 million, or 11.9 percent, compared to the second quarter of 2021. The increase is primarily due to higher compensation and acquisition project costs and the impact of the Fourny and Apollo acquisitions.
SG&A expenses for the first six months of 2022 increased $29.5 million, or 10.1 percent, compared to the first six months of 2021. The increase is primarily due to higher compensation and acquisition project costs and the impact of the Fourny and Apollo acquisitions.
Other income, net:
Other income, net in the second quarter of 2022 included $4.1 million of net defined benefit pension benefits and $1.4 million of other income, offset by $5.5 million of currency transaction losses. The $4.1 million of net defined benefit pension benefits included a $3.3 million settlement loss related to the termination of our Canadian defined benefit pension plan. Other income, net in the second quarter of 2021 included $8.0 million of net defined benefit pension benefits and $5.2 million of other income, offset by $1.3 million of currency transaction losses. Other income in the second quarter of 2021 includes gains related to a legal entity merger and a transactional tax legal settlement in Brazil.
Other income, net in the first six months of 2022 included $11.5 million of net defined benefit pension benefits and $1.6 million of other income, partially offset by $7.0 million of currency transaction losses. The $11.5 million of net defined benefit pension benefits included a $3.3 million settlement loss related to the termination of our Canadian defined benefit pension plan. Other income, net in the first six months of 2021 included $15.9 million of net defined benefit pension benefits and $6.9 million of other income, offset by $3.1 million of currency transaction losses.
Interest expense:
Interest expense in the second quarter of 2022 was $19.8 million compared to $19.9 million in the second quarter of 2021. Interest expense in the second quarter of 2022 compared to the second quarter of 2021 was lower due to lower interest rates partially offset by higher debt balances.
Interest expense in the first six months of 2022 was $38.0 million compared to $40.3 million in the first six months of 2021. Interest expense in the first six months of 2022 compared to the first six months of 2021 was lower due to lower interest rates partially offset by higher debt balances.
Interest income:
Interest income in the second quarter of 2022 and 2021 was $2.1 million and $2.5 million, respectively, consisting primarily of interest on cross-currency swap activity and other miscellaneous interest income.
Interest income in the first six months of 2022 and 2021 was $4.0 million and $5.2 million, respectively, consisting primarily of interest on cross-currency swap activity and other miscellaneous interest income.
Income taxes:
Effective tax rate
Income tax expense of $23.6 million in the second quarter of 2022 includes $4.1 million of discrete tax expense. Excluding the discrete tax expense, the overall effective tax rate was 27.9 percent. The discrete tax expense relates to impacts of the revaluation of cross-currency swap agreements due to depreciation of the Euro versus the U.S. Dollar and other various foreign tax matters. Income tax expense of $16.7 million in the second quarter of 2021 includes $0.6 million of discrete tax benefit. Excluding the discrete tax benefit, the overall effective tax rate was 27.1 percent. The discrete tax benefit relates to various U.S. and foreign tax matters.
Income tax expense of $33.8 million in the first six months of 2022 includes $1.2 million of discrete tax expense. Excluding the discrete tax expense, the overall effective tax rate was 27.9 percent. The discrete tax expense relates to the revaluation of cross-currency swap agreements due to depreciation of the Euro versus the U.S. Dollar, as well as various foreign tax matters offset by the tax effect of legal entity mergers. Income tax expense of $27.3 million in the first six months of 2021 includes $0.6 million of discrete tax benefit. Excluding the discrete tax benefit, the overall effective tax rate was 27.2 percent. The discrete tax benefit relates to various U.S. and foreign tax matters.
Income from equity method investments:
The income from equity method investments relates to our 50 percent ownership of the Sekisui-Fuller joint venture in Japan. The lower income for the second quarter and first six months of 2022 compared to the same period of 2021 relates to lower net income in our joint venture.
Net income attributable to H.B. Fuller:
The net income attributable to H.B. Fuller for the second quarter of 2022 was $47.2 million compared to $49.1 million for the second quarter of 2021. The diluted earnings per share for the second quarter of 2022 was $0.86 per share as compared to $0.90 per share for the second quarter of 2021.
The net income attributable to H.B. Fuller for the first six months of 2022 was $85.5 million compared to $78.9 million for the first six months of 2021. The diluted earnings per share for the first six months of 2022 was $1.55 per share as compared to $1.47 per share for the first six months of 2021.
Operating Segment Results
We have three reportable segments: Hygiene, Health and Consumable Adhesives, Engineering Adhesives and Construction Adhesives. Operating results of each of these segments are regularly reviewed by our chief operating decision maker to make decisions about resources to be allocated to the segments and assess their performance.
The tables below provide certain information regarding the net revenue and operating income of each of our operating segments.
Corporate Unallocated amounts include business acquisition and integration costs, organizational restructuring charges and project costs associated with our implementation of SAP ONE.
Net Revenue by Segment:
% of
Segment total
Segment Operating Income (Loss):
Segment
Income
(Loss)
Segment operating income
Segment operating margin
The following table provides details of the Hygiene, Health and Consumable Adhesives net revenue variances:
Net revenue increased 20.0 percent in the second quarter of 2022 compared to the second quarter of 2021. The increase in organic growth was attributable to an increase in product pricing and sales volume. The negative currency effect was due to a weaker Euro, Turkish lira and Argentinian peso, partially offset by a stronger Brazilian real and Chinese renminbi compared to the U.S. dollar. As a percentage of net revenue, raw material costs increased 420 basis points due to higher raw material costs partially offset by higher net revenue. Other manufacturing costs as a percentage of net revenue decreased 230 basis points primarily due to higher net revenue. SG&A expenses as a percentage of net revenue decreased 110 basis points due to higher net revenue. Segment operating income increased 11.3 percent and segment operating margin as a percentage of net revenue decreased 80 basis points compared to the second quarter of 2021.
Net revenue increased 18.1 percent in the first six months of 2022 compared to the first six months of 2021. The increase in organic growth was attributable to an increase in product pricing and sales volume. The negative currency effect was due to a weaker Euro, Turkish lira, Argentinian peso and Colombian peso, partially offset by a stronger Chinese renminbi and Brazilian real compared to the U.S. dollar. As a percentage of net revenue, raw material costs increased 460 basis points due to higher raw material costs partially offset by higher net revenue. Other manufacturing costs as a percentage of net revenue decreased 240 basis points primarily due to higher net revenue. SG&A expenses as a percentage of net revenue decreased 150 basis points due to higher net revenue. Segment operating income increased 9.6 percent and segment operating margin as a percentage of net revenue decreased 70 basis points compared to the first six months of 2021.
The following tables provide details of the Engineering Adhesives net revenue variances:
Net revenue increased 17.4 percent in the second quarter of 2022 compared to the second quarter of 2021. The increase in organic growth was attributable primarily due to an increase in product pricing and sales volume. The negative currency effect was due to a weaker Euro and Turkish lira, partially offset by a stronger Chinese renminbi compared to the U.S. dollar. Raw material costs as a percentage of net revenue increased 240 basis points due to higher raw material costs partially offset by higher net revenue. Other manufacturing costs as a percentage of net revenue decreased 210 basis points due to higher net revenue. SG&A expenses as a percentage of net revenue decreased 160 basis points due to higher net revenue. Segment operating income increased 33.6 percent and segment operating margin increased 130 basis points compared to the second quarter of 2021.
Net revenue increased 15.4 percent in the first six months of 2022 compared to the first six months of 2021. The increase in organic growth was attributable primarily due to an increase in product pricing and sales volume. The negative currency effect was due to a weaker Euro and Turkish lira, partially offset by a stronger Chinese renminbi compared to the U.S. dollar. Raw material costs as a percentage of net revenue increased 330 basis points due to higher raw material costs partially offset by higher net revenue. Other manufacturing costs as a percentage of net revenue decreased 220 basis points due to higher net revenue. SG&A expenses as a percentage of net revenue decreased 150 basis points due to higher net revenue. Segment operating income increased 20.8 percent and segment operating margin increased 40 basis points compared to the first six months of 2021.
The following tables provide details of the Construction Adhesives net revenue variances:
Net revenue increased 27.5 percent in the second quarter of 2022 compared to the second quarter of 2021. The increase in organic growth was attributable primarily to an increase in product pricing partially offset by a decrease in sales volume. The increase in net revenue from M&A was due to the acquisition of Fourny and Apollo during the first quarter of 2022. The negative currency effect was due to a weaker Euro and Australian dollar compared to the U.S. dollar. Raw material costs as a percentage of net revenue increased 70 basis points due to higher raw material costs partially offset by higher net revenue. Other manufacturing costs as a percentage of net revenue decreased 170 basis points due to higher net revenue and the impact of acquisitions. SG&A expenses as a percentage of net revenue decreased 110 basis points due to higher net revenue. Segment operating income increased 79.4 percent and segment operating margin increased 210 basis points compared to the second quarter of 2021.
Net revenue increased 34.7 percent in the first six months of 2022 compared to the first six months of 2021. The increase in organic growth was attributable primarily to an increase in product pricing and sales volume. The increase in net revenue from M&A was due to the acquisition of Fourny and Apollo during the first quarter of 2022. The negative currency effect was due to a weaker Euro and Australian dollar compared to the U.S. dollar. Raw material costs as a percentage of net revenue increased 150 basis points due to higher raw material costs partially offset by higher net revenue. Other manufacturing costs as a percentage of net revenue decreased 290 basis points due to higher net revenue and the impact of acquisitions. SG&A expenses as a percentage of net revenue decreased 370 basis points due to higher net revenue. Segment operating income increased 875.0 percent and segment operating margin increased 510 basis points compared to the first six months of 2021.
Segment operating loss
NMP = Non-meaningful percentage
Corporate Unallocated includes acquisition and integration-related charges, restructuring-related charges, and costs related to the implementation of Project ONE.
Segment operating loss in the second quarter and first six months of 2022 increased 22.0 percent and 42.6 percent compared to the second quarter and first six months of 2021, respectively, reflecting increased acquisition project costs.
Financial Condition, Liquidity and Capital Resources
Total cash and cash equivalents as of May 28, 2022 were $68.1 million compared to $61.8 million as of November 27, 2021 and $69.6 million as of May 29, 2021. The majority of the $68.1 million in cash and cash equivalents as of May 28, 2022 was held outside the United States. Total long and short-term debt was $1,935.8 million as of May 28, 2022, $1,616.5 million as of November 27, 2021 and $1,712.4 million as of May 29, 2021. The total debt to total capital ratio as measured by Total Debt divided by (Total Debt plus Total Stockholders’ Equity) was 54.5 percent as of May 28, 2022 as compared to 50.2 percent as of November 27, 2021 and 52.2 percent as of May 29, 2021.
We believe that cash flows from operating activities will be adequate to meet our ongoing liquidity and capital expenditure needs. In addition, we believe we have the ability to obtain both short-term and long-term debt to meet our financing needs for the foreseeable future. Cash available in the United States has historically been sufficient and we expect it will continue to be sufficient to fund U.S. operations, U.S. capital spending and U.S. pension and other postretirement benefit contributions in addition to funding U.S. acquisitions, dividend payments, debt service and share repurchases as needed. For those international earnings considered to be reinvested indefinitely, we currently have no intention to, and plans do not indicate a need to, repatriate these funds for U.S. operations.
Our credit agreements include restrictive covenants that, if not met, could lead to a renegotiation of our credit lines and a significant increase in our cost of financing. At May 28, 2022, we were in compliance with all covenants of our contractual obligations as shown in the following table:
Covenant
Debt Instrument
Measurement
Result as of May 28, 2022
Secured Indebtedness / TTM EBITDA
Term Loan B Credit Agreement
Not greater than 5.9
Revolving Credit Agreement
TTM EBITDA / Consolidated Interest Expense
Not less than 2.0
TTM = Trailing 12 months
We believe we have the ability to meet all of our contractual obligations and commitments in fiscal 2022.
Selected Metrics of Liquidity
Key metrics we monitor are net working capital as a percent of annualized net revenue, trade receivable days sales outstanding (“DSO”), inventory days on hand, free cash flow after dividends and debt capitalization ratio.
Net working capital as a percentage of annualized net revenue1
Accounts receivable DSO (in days)2
Inventory days on hand (in days)3
Free cash flow after dividends4
Total debt to total capital ratio5
1 Current quarter net working capital (trade receivables, net of allowance for doubtful accounts plus inventory minus trade payables) divided by annualized net revenue (current quarter multiplied by four).
2 Trade receivables net of the allowance for doubtful accounts at the balance sheet date multiplied by 91 (13 weeks) and divided by the net revenue for the quarter.
3 Total inventory multiplied by 91 and divided by cost of sales (excluding delivery costs) for the quarter.
4 Year-to-date net cash provided by operating activities, less purchased property, plant and equipment and dividends paid. See reconciliation of net cash provided by operating activities to free cash flow after dividends below.
5 Total debt divided by (total debt plus total stockholders’ equity).
Free cash flow after dividends, a non-GAAP financial measure, is defined as net cash provided by operations less purchased property, plant and equipment and dividends paid. Free cash flow after dividends is an integral financial measure used by the Company to assess its ability to generate cash in excess of its operating needs, therefore, the Company believes this financial measure provides useful information to investors. The following table reflects the manner in which free cash flow after dividends is determined and provides a reconciliation of free cash flow after dividends to net cash provided by operating activities, the most directly comparable financial measure calculated and reported in accordance with U.S. GAAP.
Reconciliation of "Net cash provided by operating activities" to Free cash flow after dividends
Less: Purchased property, plant and equipment
Less: Dividends paid
Free cash flow after dividends
Summary of Cash Flows
Cash Flows from Operating Activities:
Net income including non-controlling interest was $85.5 million in the first six months of 2022 compared to $78.9 million in the first six months of 2021. Depreciation and amortization expense totaled $72.7 million in the first six months of 2022 compared to $71.6 million in the first six months of 2021. Deferred income taxes was a use of cash of $5.0 million in 2022 compared to $1.2 million in the first six months of 2021. Accrued compensation was a use of cash of $40.4 million in 2022 compared to $8.8 million last year. Other assets was a use of cash of $21.9 million in the first six months of 2022 compared to $21.7 million in the first six months of 2021. Other liabilities was a use of cash of $23.6 million in the first six months of 2022 compared to $29.0 million in the first six months of 2021.
Changes in net working capital (trade receivables, inventory and trade payables) accounted for a use of cash of $103.7 million compared to a use of cash of $28.1 million last year. The table below provides the cash flow impact due to changes in the components of net working capital:
Inventory
Total cash flow impact
Trade receivables, net – Trade receivables, net was a use of cash of $35.5 million and $43.2 million in the first six months of 2022 and 2021, respectively. The lower use of cash in 2022 compared to 2021 was due to more cash collected on trade receivables in the current year compared to the prior year. The DSO were 59 days at May 28, 2022 and 61 days at May 29, 2021.
Inventory – Inventory was a use of cash of $95.4 million and $100.4 million in the first six months of 2022 and 2021, respectively. The lower use of cash in 2022 is due to lower inventory purchases in 2022 compared to 2021. Inventory days on hand were 70 days as of May 28, 2022 and 67 days as of May 29, 2021.
Trade payables – Trade payables was a source of cash of $27.2 million and $115.5 million in the first six months of 2022 and 2021, respectively. The lower source of cash in 2022 compared to 2021 reflects higher payments on trade payables in the current year compared to the prior year.
Cash Flows from Investing Activities:
Purchases of property, plant and equipment were $69.1 million during the first six months of 2022 compared to $50.7 million for the same period of 2021. This difference reflects the timing of capital projects and expenditures related to growth initiatives.
During the first six months of 2022, we paid cash to acquire TissueSeal for $22.2 million, Fourny for $14.5 million, net of cash acquired, and Apollo for $192.6 million, net of cash acquired.
Cash Flows from Financing Activities:
Borrowings on our revolving credit facility were $335.0 million in the first six months of 2022 to finance acquisitions and for general working capital purposes. We did not make any payments of long-term debt in the first six months of 2022 and payments of long-term debt in the first six months of 2021 were $68.0 million. Net proceeds of notes payable were $3.6 million in the first six months of 2022 and $9.3 million in the same period of 2021. Cash dividends paid were $19.0 million in the first six months of 2022 compared to $17.2 million in the same period of 2021. Repurchases of common stock were $3.6 million in the first six months of 2022 compared to $2.6 million in the same period of 2021.
Forward-Looking Statements and Risk Factors
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may be identified by the use of words like "plan," "expect," "aim," "believe," "project," "anticipate," "intend," "estimate," "will," "should," "could" (including the negative or variations thereof) and other expressions that indicate future events and trends. These plans and expectations are based upon certain underlying assumptions, including those mentioned with the specific statements. Such assumptions are in turn based upon internal estimates and analyses of current market conditions and trends, our plans and strategies, economic conditions and other factors. These plans and expectations and the assumptions underlying them are necessarily subject to risks and uncertainties inherent in projecting future conditions and results. Actual results could differ materially from expectations expressed in the forward-looking statements if one or more of the underlying assumptions and expectations proves to be inaccurate or is unrealized. In addition to the factors described in this report, Item 1A. Risk Factors identifies some of the important factors that could cause our actual results to differ materially from those in any such forward-looking statements. In order to comply with the terms of the safe harbor, we have identified these important factors which could affect our financial performance and could cause our actual results for future periods to differ materially from the anticipated results or other expectations expressed in the forward-looking statements. These factors should be considered, together with any similar risk factors or other cautionary language that may be made elsewhere in this Quarterly Report on Form 10-Q.
The list of important factors in Item 1A. Risk Factors does not necessarily present the risk factors in order of importance. This disclosure, including that under Forward-Looking Statements and Risk Factors, and other forward-looking statements and related disclosures made by us in this report and elsewhere from time to time, represents our best judgment as of the date the information is given. We do not undertake responsibility for updating any of such information, whether as a result of new information, future events, or otherwise, except as required by law. Investors are advised, however, to consult any further public company disclosures (such as in filings with the SEC or in our press releases) on related subjects.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to various market risks, including changes in interest rates, foreign currency rates and prices of raw materials. Market risk is the potential loss arising from adverse changes in market rates and prices, such as interest rates and foreign currency exchange rates. See Part II, Item 7A in our Annual Report on Form 10-K for the year ended November 27, 2021 for further discussion of these market risks. There have been no material changes in the reported market risk of the Company since November 27, 2021.
Item 4. Controls and Procedures
Controls and Procedures
We conducted an evaluation, under the supervision and with the participation of our president and chief executive officer and executive vice president, chief financial officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (Exchange Act)) as of May 28, 2022. Based on this evaluation, our president and chief executive officer and executive vice president, chief financial officer concluded that, as of May 28, 2022, our disclosure controls and procedures were effective.
For purposes of Rule 13a-15(e), the term disclosure controls and procedures means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act (15 U.S.C. 78a et seq.) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its president and chief executive officer and executive vice president, chief financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during our most recently completed fiscal quarter that have materially affected or are reasonably likely to materially affect our internal control over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act.
Item 1. Legal Proceedings
From time to time, we become aware of compliance matters relating to, or receive notices from, federal, state or local entities regarding possible or alleged violations of environmental, health or safety laws and regulations. Also, from time to time, we are identified as a potentially responsible party (“PRP”) under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) and/or similar state laws that impose liability for costs relating to the clean up of contamination resulting from past spills, disposal or other release of hazardous substances. We are also subject to similar laws in some of the countries where current and former facilities are located. Our environmental, health and safety department monitors compliance with applicable laws on a global basis.
Currently, we are involved in various environmental investigations, clean up activities and administrative proceedings and lawsuits. In particular, we are currently deemed a PRP in conjunction with numerous other parties, in a number of government enforcement actions associated with landfills and/or hazardous waste sites. As a PRP, we may be required to pay a share of the costs of investigation and clean up of these sites.
We are also engaged in environmental remediation and monitoring efforts at a number of current and former operating facilities. To the extent we can reasonably estimate the amount of our probable liabilities for environmental matters, we establish a financial provision. It is reasonably possible that we may have additional liabilities related to these known environmental matters. However, the full extent of our future liability for environmental matters is difficult to predict because of uncertainty as to the cost of investigation and clean up of the sites, our responsibility for such hazardous substances and the number of and financial condition of other potentially responsible parties.
While uncertainties exist with respect to the amounts and timing of the ultimate environmental liabilities, based on currently available information, we have concluded that these matters, individually or in the aggregate, will not have a material adverse effect on our results of operations, financial condition or cash flow. However, adverse developments and/or periodic settlements could negatively impact the results of operations or cash flows in one or more future periods.
From time to time and in the ordinary course of business, we are a party to, or a target of, lawsuits, claims, investigations and proceedings, including product liability, personal injury, contract, patent and intellectual property, environmental, health and safety, tax and employment matters. While we are unable to predict the outcome of these matters, we have concluded, based upon currently available information, that the ultimate resolution of any pending matter, individually or in the aggregate, including asbestos-related litigation, will not have a material adverse effect on our results of operations, financial condition or cash flow. However, adverse developments and/or periodic settlements could negatively impact the results of operations or cash flows in one or more future periods.
For additional information regarding environmental matters and other legal proceedings, see Note 12 to our Consolidated Financial Statements.
Item 1A. Risk Factors
This Form 10-Q contains forward-looking statements concerning our future programs, products, expenses, revenue, liquidity and cash needs as well as our plans and strategies. These forward-looking statements are based on current expectations and we assume no obligation to update this information. Numerous factors could cause actual results to differ significantly from the results described in these forward-looking statements, including the risk factors identified under Part I, Item 1A. Risk Factors contained in our Annual Report on Form 10-K for the fiscal year ended November 27, 2021. There have been no material changes in the risk factors disclosed by us under Part I, Item 1A. Risk Factors contained in the Annual Report on Form 10-K for the fiscal year ended November 27, 2021, except for the addition of the following risk factor:
The military conflict between Russia and Ukraine, and the global response to it, could adversely impact our revenues, gross margins and financial results.
The U.S. government and other nations have imposed significant restrictions on most companies’ ability to do business in Russia as a result of the military conflict between Russia and Ukraine. It is not possible to predict the broader or longer-term consequences of this conflict, which could include further sanctions, embargoes, regional instability, geopolitical shifts and adverse effects on macroeconomic conditions, security conditions, currency exchange rates and financial markets. Such geo-political instability and uncertainty could have a negative impact on our ability to sell to, ship products to, collect payments from, and support customers in certain regions based on trade restrictions, embargoes and export control law restrictions, and logistics restrictions including closures of air space, and could increase the costs, risks and adverse impacts from these new challenges. We may also be the subject of increased cyber-attacks. While Russia does not constitute a material portion of our business, a significant escalation or expansion of economic disruption or the conflict's current scope could have a material adverse effect on our results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
Information on our purchases of equity securities during the second quarter ended May 28, 2022 is as follows:
(d)
Maximum
Approximate Dollar
(a)
Value of Shares that
(b)
may yet be
Number of
Average
Purchased Under the
Shares
Price Paid
Plan or Program
Period
Purchased1
per Share
(millions)
February 27, 2022 - April 2, 2022
April 3, 2022 - April 30, 2022
May 1, 2022 - May 28, 2022
1 The total number of shares purchased are shares withheld to satisfy the employees’ withholding taxes upon vesting of restricted stock.
Repurchases of common stock are made to support our stock-based employee compensation plans and for other corporate purposes. Upon vesting of restricted stock awarded to employees, shares are withheld to cover the employees’ minimum withholding taxes.
On April 7, 2022, the Board of Directors authorized a new share repurchase program of up to $300.0 million of our outstanding common shares. Under the program, we are authorized to repurchase shares for cash on the open market, from time to time, in privately negotiated transactions or block transactions, or through an accelerated repurchase agreement. The timing of such repurchases is dependent on price, market conditions and applicable regulatory requirements. Upon repurchase of the shares, we reduce our common stock for the par value of the shares with the excess being applied against additional paid-in capital. This authorization replaces the April 6, 2017 authorization to repurchase shares.
Item 6. Exhibits
31.1
Form of 302 Certification – James J. Owens
31.2
Form of 302 Certification – John J. Corkrean
32.1
Form of 906 Certification – James J. Owens
32.2
Form of 906 Certification – John J. Corkrean
101
The following materials from the H.B. Fuller Company Quarterly Report on Form 10-Q for the quarter ended May 28, 2022 formatted in Inline Extensible Business Reporting Language (Inline XBRL): (i) the Consolidated Statements of Income, (ii) the Consolidated Statements of Comprehensive Income, (iii) the Consolidated Balance Sheets, (iv) the Consolidated Statements of Total Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Notes to Consolidated Financial Statements.
104
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated: June 23, 2022
/s/ John J. Corkrean
John J. Corkrean
Executive Vice President,
Chief Financial Officer
Exhibit Index
Exhibits