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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended May 31, 2003
-------------------------------------------------
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)
Minnesota 41-0268370
- ---------------------------------------------------------------- ----------------------------------------
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
1200 Willow Lake Boulevard, Vadnais Heights, Minnesota 55110-5101
- ----------------------------------------------------------- ---------------------------------
(Address of principal executive offices) (Zip Code)
(651) 236-5900
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
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 [X] No [_]
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Act). [X]
The number of shares outstanding of the Registrant's Common Stock, par value
$1.00 per share, was 28,387,773 as of June 30, 2003.
This document contains 29 pages.
The exhibit index is set forth on page 24.
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
H.B. FULLER COMPANY AND SUBSIDIARIES
Statement of Consolidated Income
(In thousands, except per share amounts)
(Unaudited)
13 Weeks Ended 26 Weeks Ended
-------------------------- --------------------------
May 31, June 1, May 31, June 1,
2003 2002 2003 2002
-------------------------- --------------------------
Net revenue $ 324,481 $ 319,402 $ 619,069 $ 612,642
Cost of sales (234,909) (231,965) (447,349) (450,027)
-------------------------- --------------------------
Gross profit 89,572 87,437 171,720 162,615
Selling, general and administrative expenses (73,129) (71,382) (144,073) (140,214)
Interest expense (3,602) (4,420) (7,367) (9,136)
Other expense, net (614) (334) (3,294) (1,464)
-------------------------- --------------------------
Income before income taxes, minority interests,
and income from equity investments 12,227 11,301 16,986 11,801
Income taxes (2,664) (3,573) (4,298) (3,511)
Minority interests in consolidated income (292) (328) (550) (607)
Income from equity investments 495 535 874 918
-------------------------- --------------------------
Net income $ 9,766 $ 7,935 $ 13,012 $ 8,601
========================== ==========================
Basic income per common share $ 0.35 $ 0.28 $ 0.46 $ 0.31
========================== ==========================
Diluted income per common share $ 0.34 $ 0.28 $ 0.45 $ 0.30
========================== ==========================
Weighted-average common shares outstanding:
Basic 28,223 28,071 28,212 28,038
Diluted 28,648 28,643 28,654 28,540
Dividends per share $ 0.1125 $ 0.1100 $ 0.2225 $ 0.2175
See accompanying notes to consolidated financial statements.
2
H.B. FULLER COMPANY AND SUBSIDIARIES
Consolidated Balance Sheet
(In thousands, except share and per share amounts)
(Unaudited)
May 31, November 30,
2003 2002
---------------------------
Assets
Current assets:
Cash and cash equivalents $ 5,872 $ 3,666
Trade receivables 230,757 220,430
Allowance for doubtful accounts (7,875) (8,088)
Inventories 155,949 143,012
Other current assets 64,957 49,854
---------------------------
Total current assets 449,660 408,874
Property, plant and equipment, net 354,625 354,964
Other assets 103,103 106,456
Goodwill 77,282 71,020
Other intangibles, net 20,171 20,125
---------------------------
Total assets $1,004,841 $961,439
===========================
Liabilities and Stockholders' Equity
Current liabilities:
Notes payable $ 22,789 $ 20,020
Current installments of long-term debt 1,245 1,362
Trade payables 112,374 113,297
Accrued payroll / employee benefits 24,741 37,109
Other accrued expenses 36,396 25,070
Restructuring liability 5,555 8,508
Income taxes payable 10,062 9,480
---------------------------
Total current liabilities 213,162 214,846
Long-term debt, excluding current installments 167,322 161,763
Accrued pensions 96,954 87,393
Other liabilities 37,753 34,532
Minority interests in consolidated subsidiaries 15,126 14,575
---------------------------
Total liabilities 530,317 513,109
---------------------------
Commitments and contingencies
Stockholders' equity:
Common stock, par value $1.00 per share 28,387 28,362
Shares outstanding were 28,387,418 and 28,362,316, respectively
Additional paid-in capital 40,184 39,665
Retained earnings 418,514 411,818
Accumulated other comprehensive loss (11,212) (29,679)
Unearned compensation - restricted stock (1,349) (1,836)
---------------------------
Total stockholders' equity 474,524 448,330
---------------------------
Total liabilities and stockholders' equity $1,004,841 $961,439
===========================
See accompanying notes to consolidated financial statements.
3
H.B. FULLER COMPANY AND SUBSIDIARIES
Consolidated Statement of Cash Flows
(In thousands)
(Unaudited)
26 Weeks Ended
----------------------
May 31, June 1,
2003 2002
----------------------
Cash flows from operating activities:
Net income $ 13,012 $ 8,601
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 25,486 29,631
Change in assets and liabilities:
Accounts receivables, net (1,874) (5,133)
Inventories (7,191) (6,177)
Other assets (730) (5,622)
Accounts payables (5,065) (2,949)
Accrued payroll / employee benefits and other accrued expenses (5,028) 1,764
Short-term restructuring liability (3,445) 5,457
Income taxes payable 262 3,518
Accrued pensions 1,498 (3,150)
Other liabilities 5,182 2,231
Other (2,555) 3,437
----------------------
Net cash provided by operating activities 19,552 31,608
Cash flows from investing activities:
Purchased property, plant and equipment (15,775) (12,448)
Purchased investment (2,742) -
Proceeds from sale of property, plant and equipment 327 975
----------------------
Net cash used in investing activities (18,190) (11,473)
Cash flows from financing activities:
Proceeds from long-term debt 11,200 21,635
Repayment of long-term debt (6,018) (50,748)
Net proceeds from notes payable 2,372 5,114
Dividends paid (6,316) (6,169)
Other 300 592
----------------------
Net cash provided by (used in) financing activities 1,538 (29,576)
Effect of exchange rate changes (694) 171
----------------------
Net change in cash and cash equivalents 2,206 (9,270)
Cash and cash equivalents at beginning of period 3,666 11,454
----------------------
Cash and cash equivalents at end of period $ 5,872 $ 2,184
======================
See accompanying notes to consolidated financial statements.
4
H.B. FULLER COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Amounts in thousands)
1. Accounting Policies: The accompanying unaudited consolidated financial
statements have been prepared in accordance with accounting principles
generally accepted in the United States of America 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, financial position, and cash
flows in conformity with accounting principles generally accepted in the
United States of America. In the opinion of management, the interim
consolidated financial statements reflect all adjustments of a normal
recurring nature considered necessary for a 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
accounting principles generally accepted in the United States of America
requires management 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 the
company's Annual Report on Form 10-K for the year ended November 30, 2002 as
filed with the Securities and Exchange Commission.
2. Net Income per Common Share: A reconciliation of the net income and common
share components for the basic and diluted net income per common share
calculations follows:
13 Weeks Ended 26 Weeks Ended
------------------------------------
May 31, June 1, May 31, June 1,
2003 2002 2003 2002
------------------------------------
Net income $ 9,766 $ 7,935 $13,012 $ 8,601
Dividends on preferred shares - (3) - (7)
------------------------------------
Income attributable to common shares $ 9,766 $ 7,932 $13,012 $ 8,594
====================================
Weighted-average common shares - basic 28,223 28,071 28,212 28,038
Equivalent shares - stock-based
compensation plans 425 572 442 502
------------------------------------
Weighted-average common shares - diluted 28,648 28,643 28,654 28,540
====================================
The computations of diluted income per common share do not include stock
options with exercise prices greater than the average market price of the
common shares of 38 and 2 for the three-month periods ended May 31, 2003 and
June 1, 2002 and 28 and 3 for the six-month periods ended May 31, 2003 and
June 1, 2002, respectively, as the results would have been anti-dilutive.
3. Comprehensive Income: The components of total comprehensive income follows:
13 Weeks Ended 26 Weeks Ended
------------------------------------
May 31, June 1, May 31, June 1,
2003 2002 2003 2002
------------------------------------
Net income $ 9,766 $ 7,935 $13,012 $ 8,601
Other comprehensive income
Foreign currency translation, net 8,857 4,604 18,467 3,742
------------------------------------
Total comprehensive income $18,623 $12,539 $31,479 $12,343
====================================
5
Components of accumulated other comprehensive income follows:
Accumulated Other Comprehensive Income
--------------------------------------
------------------------
May 31, November 30,
2003 2002
------------------------
Foreign currency translation adjustment $ 13,980 $ (4,487)
Minimum pension liability (25,192) (25,192)
------------------------
Total accumulated other comprehensive income $(11,212) $(29,679)
========================
4. Inventories: The composition of inventories follows:
May 31, November 30,
2003 2002
------------------------
Raw materials $ 59,290 $ 57,041
Finished goods 107,026 96,192
LIFO reserve (10,367) (10,221)
------------------------
$155,949 $143,012
========================
5. Restructuring and Other Related Costs: During the second quarter of 2003, the
company recorded pretax charges of $3,190 ($2,507 after tax) in connection
with its restructuring plan that was announced on January 15, 2002. For the
first six months of 2003 pretax charges recorded were $7,652 ($5,560 after
tax). The plan, which was contemplated in 2001, approved and implemented
throughout 2002, will be completed in 2003. Completion of the plan will
result in the elimination of approximately 20 percent of the company's 2001
global manufacturing capacity. In 2002, the company closed 12 manufacturing
facilities in the Global Adhesives operating segment - eight in North
America, three in Latin America and one in Europe. In the Full-Valu/Specialty
operating segment, two manufacturing facilities were closed - one in the
United States and one in Latin America and one production line was shut down
in another facility in the United States. In connection with the
restructuring plan, the company also upgraded and realigned the Global
Adhesives operating segment sales force. The plan will result in the
elimination of approximately 530 positions, of which approximately 490 have
occurred through the end of the second quarter of 2003. Of the total
reductions of 490, 115 occurred in the first six months of 2003 - 75 in the
Global Adhesives operating segment and 40 in the Full-Valu/Specialty
operating segment. Charges have been accrued for the elimination of the
remaining 40 positions in the second half of 2003. Offsetting the reduction
of 530 positions will be approximately 110 newly hired employees (of which
105 were hired as of May 31, 2003), primarily in manufacturing facilities
that assumed additional volume previously produced by facilities that were
closed as part of the restructuring plan, and sales-related positions as part
of the upgrading and realignment of the sales force.
Upon completion of the restructuring plan in 2003, the company expects to
have recorded total cumulative net pretax charges of approximately $35,000,
net of gains associated with asset sales subject to the restructuring plan.
Since inception of the plan and through the first six months of 2003, total
pretax charges recorded to date have been $40,997. These charges were offset
by $2,044 of gains on sales of assets in 2002. The charges include employee
separation costs, accelerated depreciation on assets held and used until
disposal, lease/contract termination costs and other costs directly related
to the restructuring plan. Cash costs of the plan, net of proceeds from sales
of assets subject to the plan are expected to be approximately $15,000 -
$20,000. As of May 31, 2003 cash costs incurred were $22,435 offset by $4,171
of proceeds from sales of assets subject to the plan. The following table
summarizes the restructuring charges and the related restructuring
liabilities:
6
Employee
Severance Accelerated
and Benefits Depreciation Other Total
-----------------------------------------------------
Balance at December 2, 2001 $ 349 $ 176 $ 525
2002 Charges:
First quarter 4,784 $ 1,637 1,254 7,675
Second quarter 2,831 2,830 961 6,622
Third quarter 1,572 1,501 3,253 6,326
Fourth quarter 5,561 1,282 4,315 11,158
-----------------------------------------------------
Total charges 14,748 7,250 9,783 31,781
Non-cash (1,638) (7,250) - (8,888)
Currency change effect (170) (170)
Cash payments (7,648) (4,986) (12,634)
-----------------------------------------------------
Total liabilities at November 30, 2002 5,811 4,803 10,614
Long-term portion of liabilities (2,106) (2,106)
-----------------------------------------------------
Current liabilities at November 30, 2002 5,811 2,697 8,508
=====================================================
Balance at November 30, 2002 5,811 4,803 10,614
2003 Charges:
First quarter 2,388 190 1,884 4,462
Second quarter 1,107 184 1,899 3,190
-----------------------------------------------------
Total charges 3,495 374 3,783 7,652
Non-cash (374) (674) (1,048)
Currency change effect 674 674
Cash payments (5,807) (3,993) (9,800)
-----------------------------------------------------
Total liabilities at May 31, 2003 3,499 4,593 8,092
Long-term portion of liabilities (2,537) (2,537)
-----------------------------------------------------
Current liabilities at May 31, 2003 $ 3,499 $ 2,056 $ 5,555
=====================================================
The pretax charges of $3,190 in the second quarter of 2003 were included in
the income statement as: $1,609 in cost of sales and $1,581 in SG&A expenses.
The $1,609 in cost of sales consisted of $1,047 associated with the closure
of manufacturing facilities such as; equipment tear down and shutdown
expenses, facility maintenance and clean-up costs and equipment and inventory
relocation expenditures. Of the remaining costs $475 was the result of
employee severance and benefits, $87 related to accelerated depreciation,
adverse lease termination costs and asset impairments. The $1,581 in SG&A
expenses consisted of $678 of employee severance and benefits and $903 of
other costs directly attributed to the restructuring plan, primarily
relocation and recruiting costs.
Through the first six months of 2003, the pretax charges of $7,652 were
recorded in the income statement as: $3,436 in cost of sales and $4,216 in
SG&A expense. The $3,436 in cost of sales included $2,574 of costs associated
with the closure of manufacturing facilities such as; equipment tear down and
shutdown expenses, facility maintenance and clean-up costs and equipment and
inventory relocation expenditures. The remaining $862 consisted of $582 of
employee severance and benefits, $125 of accelerated depreciation, $107 of
adverse lease termination costs and $48 of asset impairments. The $4,216 in
SG&A expenses consisted of $2,957 of employee severance and benefits and
$1,259 of other costs directly attributed to the restructuring plan,
primarily relocation and recruiting costs. Of the total pretax charges of
$7,652 incurred in the first six months of 2003, $6,639 was attributed to the
Global Adhesives operating segment, $999 to the Full-Valu/Specialty operating
segment and corporate office cost centers recorded $14.
Non-cash charges attributed to employee severance and benefits are related to
the granting of accelerated vesting on restricted stock held by certain
employees during 2002 subject to the restructuring
7
and to charges resulting from curtailment and other special termination
benefits associated with the U.S pension and other postretirement benefit
plans. The long-term portion of the restructuring liability relates to
adverse lease commitments that extend out to 2012.
The beginning balance of $525 at December 2, 2001 in the restructuring
liability relates to a prior restructuring plan.
6. Derivatives: Derivatives consist primarily of forward currency contracts used
to manage foreign currency denominated assets and liabilities. The company
currently has outstanding forward foreign currency contracts, primarily for
buying and selling euros in exchange for British pound sterling, Canadian
dollars and U.S. dollars. Because the derivative instruments outstanding were
not designated as hedges, the gains and losses are recognized in the income
statement as mark-to-market adjustments during the periods the derivative
instrument is outstanding.
As of May 31, 2003, the company had forward foreign currency contracts
maturing between June 12, 2003 and November 20, 2003. Included in Other
expense, net, the mark-to-market impact associated with these contracts were
net losses of $451 for the three-month and net gains of $423 for the
six-month periods ended May 31, 2003.
7. Operating Segments: Segment data follows:
13 Weeks Ended
--------------------------------------------------------------------
May 31, 2003 June 1, 2002
-------------------------------- ---------------------------------
Inter- Inter-
Trade Segment Operating Trade Segment Operating
Revenue Revenue Income Revenue Revenue Income
-------------------------------- ---------------------------------
Global Adhesives $227,199 $ 1,311 $14,133 $219,807 $ 757 $14,574
Full-Valu/Specialty 97,282 271 5,500 99,595 284 8,103
Corporate and Unallocated - (1,582) - - (1,041) -
-------------------------------- ---------------------------------
Total $324,481 $ - $19,633 $319,402 $ - $22,677
================================ =================================
26 Weeks Ended
--------------------------------------------------------------------
May 31, 2003 June 1, 2002
-------------------------------- ---------------------------------
Inter- Inter-
Trade Segment Operating Trade Segment Operating
Revenue Revenue Income Revenue Revenue Income
-------------------------------- ---------------------------------
Global Adhesives $429,404 $ 2,447 $25,066 $420,622 $ 2,255 $ 23,897
Full-Valu/Specialty 189,665 375 10,233 192,020 472 12,801
Corporate and Unallocated - (2,822) - - (2,727) -
-------------------------------- ---------------------------------
Total $619,069 $ - $35,299 $612,642 $ - $ 36,698
================================ =================================
Consistent with the company's internal management reporting, net charges
related to the restructuring plan are excluded from the segment operating
income results. In addition, other expense, net is excluded from the segment
operating income because it consists primarily of items that are not subject
to the control of management within the operating segments.
8
Reconciliation of Operating Income to Income before Income Taxes:
13 Weeks Ended 26 Weeks Ended
-------------------------------------------
May 31, June 1, May 31, June 1,
2003 2002 2003 2002
-------------------------------------------
Operating income $19,633 $22,677 $35,299 $36,698
Restructuring and other related costs (3,190) (6,622) (7,652) (14,297)
Interest expense (3,602) (4,420) (7,367) (9,136)
Other expense, net (614) (334) (3,294) (1,464)
-------------------------------------------
Income before income taxes $12,227 $11,301 $16,986 $11,801
===========================================
8. Accounting for Stock-Based Compensation: The intrinsic value method is used
to account for stock-based compensation plans. If compensation expense had
been determined based on the fair value method, net income and income per
share would have been adjusted to the pro forma amounts indicated below:
13 Weeks Ended 26 Weeks Ended
-------------------------------------------
May 31, June 1, May 31, June 1,
2003 2002 2003 2002
-------------------------------------------
Net income, as reported $9,766 $7,935 $13,012 $8,601
Add back: Stock-based employee compensation
expense recorded 182 324 305 743
-------------------------------------------
Net income excluding stock-based compensation 9,948 8,259 13,317 9,344
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects (663) (723) (1,263) (1,589)
-------------------------------------------
Pro forma net income $9,285 $7,536 $12,054 $7,755
===========================================
Basic income per share:
As reported $ 0.35 $ 0.28 $ 0.46 $ 0.31
Pro forma $ 0.33 $ 0.27 $ 0.43 $ 0.28
Diluted income per share:
As reported $ 0.34 $ 0.28 $ 0.45 $ 0.30
Pro forma $ 0.32 $ 0.26 $ 0.42 $ 0.27
Compensation expense for pro forma purposes is reflected over the vesting
period.
9. Commitments and Contingencies
Environmental: The company is party to various lawsuits and governmental
proceedings. In particular, the company is currently deemed a potentially
responsible party (PRP) or defendant, generally in conjunction with numerous
other parties, in a number of government enforcement and private actions
associated with hazardous waste sites. As a PRP or defendant, the company
may be required to pay a share of the costs of investigation and cleanup of
these sites. The company has recorded its best probable estimate of
liabilities for estimated costs of environmental remediation. These
estimates are based primarily upon internal or third-party environmental
studies, and estimates as to the company's responsibility. Recorded
liabilities are adjusted as circumstances change.
Product Liability Claims: As a participant in the chemical and construction
products industries, the company faces an inherent risk of exposure to
claims in the event that the failure, use or misuse of its products results
in, or is alleged to result in property damage and/or bodily injury. Product
liability claims relate primarily to exterior insulated finish systems
(EIFS) sold by a subsidiary to the residential construction market in the
southeastern United States. The number and amount of all potential claims
related to this product line are limited. The company continually
reevaluates these amounts. At May 31, 2003, the company's reserve for
liability and costs for pending and future claims was $3.9 million
reflecting an increase of $1.2 million. Associated with these claims is $1.6
million for estimated
9
insurance recoveries. The company cannot always definitively determine
liabilities. While the company believes that a material adverse impact on
its consolidated financial position, results of operations, or cash flows
from any such future charges for EIFS related claims is unlikely, given the
inherent uncertainty of litigation, a possibility exists that a future
adverse ruling or unfavorable development could result in future charges
that could have a material adverse impact on the company.
In addition to claims discussed above, the company and its subsidiaries are
involved in claims or legal proceedings which it believes are not out of the
ordinary in a business of the type and size in which it is engaged.
Guarantees: In July 2000, the Board of Directors adopted the Executive Stock
Purchase Loan Program, designed to facilitate immediate and significant
stock ownership by executives, especially new management employees. The
loans are guaranteed by the company only in the event of the executive's
default. Effective September 2001, the company discontinued issuing new
loans under the program.
10. Recently Adopted Accounting Standards: In June 2001, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards (`SFAS') No. 143, "Accounting for Asset Retirement Obligations",
("FAS 143"), which must be adopted no later than December 1, 2002. This
statement establishes accounting standards for recognition and measurement
of a liability for an asset retirement obligation and the associated asset
retirement cost. The company does not have any asset retirement obligations
as of May 31, 2003.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which addresses financial accounting and
reporting for costs associated with exit or disposal activities. This
standard supersedes EITF No. 94-3 and will be adopted for exit and disposal
activities initiated after December 31, 2002. The principal difference
between SFAS No. 146 and EITF No. 94-3 relates to when an entity can
recognize a liability related to exit or disposal activities. SFAS No. 146
requires that a liability be recognized for a cost associated with an exit
or disposal activity at the time the liability is incurred. EITF No. 94-3
allowed a liability to be recognized at the date an entity committed to an
exit plan. The restructuring charge described in Note 5 for the three and
six month periods ended May 31, 2003 have been accounted for in accordance
with SFAS No. 146.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation --Transition and Disclosure (An amendment of FASB Statement No.
123)". The company intends to continue its current practice and accounting
of applying the recognition and measurement principles of APB No. 25,
"Accounting for Stock Issued to Employees", however, additional quarterly
disclosure requirements of FAS No. 148 are included in Note 8 to the
Consolidated Financial Statements.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 provides guidance
on disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has
issued. The interpretation also clarifies (for guarantees issued after
December 31, 2002) that a guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the obligations
undertaken in issuing the guarantee. The company does not have any
guarantees as of May 31, 2003, other than those disclosed in Note 9.
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities" ("FIN 46"). FIN 46 provides accounting
requirements for business enterprises to consolidate related entities in
which they are determined to be the primary beneficiary as a result of their
variable economic interests. The interpretation provides guidance in judging
multiple economic interests in an entity and in determining the primary
beneficiary. The interpretation outlines disclosure requirements for
variable interest entities ("VIEs") in existence prior to January 31, 2003,
and provides consolidation requirements for VIEs created after January 31,
2003. The company's accounting and disclosures attributed to its VIEs has
been appropriate.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other
10
contracts and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." The company is reviewing the
requirements of this standard.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of
the first interim period after June 15, 2003. The company does not have any
financial instruments subject to SFAS No. 150 as of May 31, 2003.
11. Supplemental Financial Statement Information
The following provides additional details of income statement amounts for
the three-month and six-month periods ending,
Other expense, net 13 Weeks Ended 26 Weeks Ended
-----------------------------------------
May 31, June 1, May 31, June 1,
2003 2002 2003 2002
-----------------------------------------
Foreign currency transaction gains/(losses), net $ 288 $ 406 $(2,147) $ (585)
Gains on trading securities 16 23 80 41
Amortization of affordable housing investments (520) (505) (1,039) (1,009)
Interest income 148 125 361 267
Other, net (546) (383) (549) (178)
-----------------------------------------
Total other expense, net $ (614) $(334) $(3,294) $(1,464)
=========================================
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
Net Revenue: Net revenue in the second quarter of 2003 of $324.5 million was 1.6
percent higher than the net revenue of $319.4 million in the second quarter of
2002. The 1.6 percent increase was attributable to favorable currency
translation which increased net revenues by 4.5 percent. The favorable currency
effects resulted primarily from the euro, which was approximately 20 percent
stronger versus the U.S. dollar in the second quarter of 2003 as compared to the
second quarter of 2002. The strengthening of the Japanese yen and Australian
dollar also contributed to the second quarter sales increase as compared to last
year. The favorable currency effects were partially offset by a 1.9 percent
decrease in sales volume and a 1.0 percent reduction in average selling prices
as compared to the second quarter of 2002. The lower sales volume was a
reflection of the slow economic activity - especially in Europe and North
America. Operating segment results reflected an increase in net revenue in the
Global Adhesives segment of 3.4 percent as compared to the second quarter of
2002 and in the Full-Valu/Specialty segment net revenue decreased 2.1 percent as
compared to last year's second quarter.
Through six months of 2003, net revenue was $619.1 million as compared to $612.6
million in the first six months of 2002 - an increase of 1.0 percent. Similar to
the second quarter results, favorable currency effects of 3.9 percent were
partially offset by lower sales volume of 2.0 percent and lower average selling
prices of 0.9 percent. Net revenue increased 2.1 percent in the Global Adhesives
segment and decreased 1.2 percent in the Full-Valu/Specialty segment as compared
to the first six months of 2002.
Gross Profit Margin: The consolidated gross profit margin of 27.6 percent in the
second quarter of 2003 reflected an increase of 0.2 percentage points from the
second quarter of 2002. Included in the cost of goods sold in the second quarter
of 2003 were expenses of $1.6 million associated with the company's
restructuring initiatives. The cost of goods sold in the second quarter of 2002
included expenses related to the restructuring of $3.8 million. The second
quarter of 2003 cost of goods sold also included approximately $3.0 million of
savings related to the restructuring activities implemented in 2002. These
savings resulted from lower payroll, depreciation and other facility operating
costs due to the closure of 14 manufacturing facilities during 2002. Raw
material and container costs as a percentage of net revenue
11
increased by 1.3 percentage points in the second quarter of 2003 as compared to
the second quarter of 2002. The raw material cost increase as a percentage of
net revenue was mainly due to increases in ethylene-based materials such as
vinyl acetate monomer (VAM) and vinyl acetate emulsion (VAE). These materials
are used primarily in the Global Adhesives operating segment in the production
of water-based adhesives. The prices of the ethylene-based materials, which are
sensitive to the fluctuations in energy prices, increased between the periods
due to the instability related to Iraq and other political uncertainties. Also
contributing to the higher raw material costs as a percentage of net revenue was
lower average selling price levels as compared to the second quarter of 2002.
For the first six months of 2003, the consolidated gross profit margin of 27.7
percent was 1.2 percentage points higher than the 26.5 percent margin posted in
the first six months of 2002. The cost of goods sold in the first six months of
2003 included $3.4 million of expenses resulting from the restructuring
initiative as compared to $10.1 million in the first six months of 2002. The
cost of goods sold in the first half of 2003 also included approximately $6.0
million of savings resulting from the 2002 restructuring activities. Raw
material and container costs as a percentage of net revenue increased 1.1
percentage points as compared to the first six months of 2002.
Selling, General and Administrative (SG&A) Expenses: SG&A expenses in the second
quarter of 2003 of $73.1 million were $1.7 million or 2.4 percent higher than
the SG&A expenses of $71.4 million recorded in the second quarter of 2002. As a
percentage of net revenue the SG&A expenses were 22.5 percent in the second
quarter of 2003 and 22.3 percent in second quarter of 2002. The 2003 SG&A
expenses included $1.6 million of restructuring-related costs as compared to
$2.8 million of restructuring-related costs in the second quarter of 2002.
Expenses attributed to the U.S. pension and other postretirement benefit plans
in the second quarter of 2003 were $2.5 million more than in the second quarter
of 2002. These pension and benefit plan expense increases were due primarily to
the amortization of actuarial losses attributed to the diminished asset
portfolio performance in recent years and the reduction in the discount rate
used to calculate the projected benefit obligations from 7.0 percent for 2002 to
6.5 percent for 2003. The reduction in the expected return on assets assumption
from 10.5 percent in 2002 to 9.75 percent in 2003 also increased pension and
benefit plan expense. Another SG&A expense increase in the second quarter of
2003 as compared to the second quarter of 2002 resulted from an increase of $1.2
million in reserves for claims associated with an exterior insulation finishing
system sold by a subsidiary of the company prior to 1999. Stronger foreign
currencies also contributed to the higher SG&A expenses in 2003 as compared to
2002. This strengthening of primarily the euro, yen and Australian dollar
resulted in $2.8 million of additional SG&A expenses in 2003 as compared to last
year.
Headcount reductions, resulting primarily from the restructuring initiative,
helped to mitigate the SG&A expense increases mentioned in the previous
paragraph. Total employee census at May 31, 2003 was 4,473 as compared to 4,746
at June 1, 2002. The decrease of 273 employees consisted of 85 related to SG&A
expenses and188 related to cost of sales activities. Another area of SG&A
expense reductions in the second quarter of 2003 as compared to the second
quarter of 2002 related to management incentive compensation. These expenses are
accrued according to the company's financial performance as compared to
management's expectations for the fiscal year. The company's relative
performance in 2003 has not been as strong as the performance in 2002 resulting
in a $2.2 million reduction in management incentive compensation expense in the
second quarter of 2003 as compared to the second quarter of 2002.
Through six months of 2003, SG&A expenses of $144.1 million were $3.9 million or
2.8 percent more than the SG&A expenses in the first six months of 2002. As a
percentage of net revenue, the SG&A expenses were 23.3 percent in the first six
months of 2003 as compared to 22.9 percent in the first six months of 2002.
Restructuring-related expenses were $4.2 million in the first six months of both
2003 and 2002. Expenses related to the U.S. pension and other postretirement
benefit plans increased $5.0 million in the first six months of 2003 as compared
to the same period last year. The six-month impact on SG&A expenses from
stronger foreign currencies was an increase of $4.9 million in 2003 as compared
to the first six months of 2002. The management incentive compensation expense
in the first half of 2003 was $2.6 million less than the first half of 2002.
Interest Expense: Interest expense was $3.6 million in the second quarter of
2003 as compared to $4.4 million in the second quarter of 2002. For the first
six months of 2003 interest expense was $7.4 million
12
as compared to $9.1 million for the same period in 2002. Lower average debt
levels in 2003 versus 2002 was the primary reason for the reduced interest
expense.
Other Expense, net: Other expense, net was $0.6 million in the second quarter of
2003 and $0.3 million in the second quarter of 2002. Included in the other
expense, net were foreign currency transaction gains of $0.3 million in the
second quarter of 2003 as compared to gains of $0.4 million in the second
quarter of 2002. Through six months of 2003 other expense, net was $3.3 million
as compared to $1.5 million in the first six months of 2002. The first six
months of 2003 included foreign currency transaction losses of $2.1 million as
compared to $0.6 million of losses in the first six months of 2002. The losses
incurred in 2003 resulted from exposures to the rate of exchange between the
pound sterling and the euro combined with a significant weakening of the pound
sterling against the euro during the first quarter. Hedging contracts were
executed late in the first quarter of 2003 in an effort to neutralize future
currency impacts. The currency losses incurred in the first half of 2002 were
primarily due to the devaluation of the Argentine peso.
Income Taxes: The effective income tax rate in the second quarter of 2003 was
21.8 percent. Included in the income taxes was a one-time tax benefit of $1.5
million related to the liquidation of an inactive European legal entity as we
continue to rationalize our European legal structure. This tax benefit reduced
the effective rate for the quarter by 12.2 percentage points. Pretax charges in
the second quarter of $3.2 million related to the restructuring initiative
resulted in tax benefits of $0.7 million, or 21.4 percent of the
restructuring-related losses. The effective tax rate in the second quarter of
2002 was 31.6 percent. Included in the 2002 income taxes were $2.4 million of
tax benefits related to $6.6 million of pretax charges associated with the
restructuring initiative.
The effective income tax rate for the first six months of 2003 was 25.3 percent
as compared to 29.8 percent in the first six months of 2002. Included in the
2003 results was $2.1 million of tax benefit on $7.7 million of pretax
restructuring charges as well as the one-time tax benefit of $1.5 million
related to the liquidation of an inactive European legal entity. The 2002 income
taxes included $5.0 million of tax benefit attributable to the $14.3 million of
pretax restructuring-related charges.
Net Income: Net income was $9.8 million in the second quarter of 2003 as
compared to $7.9 million in the second quarter of 2002. The diluted earnings per
share were $0.34 in the second quarter of 2003 and $0.28 in the second quarter
of 2002. Included in the net income figures were charges, net of tax, of $2.5
million ($0.09 per diluted share) in the second quarter of 2003 and $4.1 million
($0.14 per diluted share) in the second quarter of 2002 related to the
restructuring initiative.
Through the first six months, net income was $13.0 million and $8.6 million in
2003 and 2002, respectively. The diluted earnings per share were $0.45 in 2003
and $0.30 in 2002. The after-tax restructuring charges were $5.6 million ($0.19
per diluted share) in 2003 and $9.0 million ($0.32 per diluted share) in 2002.
Operating Segment Results
Note: Management evaluates the performance of its operating segments based on
operating income which is defined as gross profit less SG&A expenses and
excluding other expense, net. Charges attributed to the restructuring
initiative, net of gains on the sales of assets in connection with the
restructuring are excluded from the operating segment results, consistent with
internal management reporting. Corporate expenses are fully allocated to the
operating segments.
Global Adhesives: Net revenue of $227.2 million in the second quarter of 2003
was $7.4 million or 3.4 percent more than the net revenue recorded in the second
quarter of 2002. Favorable currency effects of 5.9 percent were the primary
reason for the increase. These currency effects were partially offset by sales
volume reductions of 1.3 percent and average price reductions of 1.2 percent.
The slow economy, especially in Europe and North America, was the primary reason
for the sales volume declines. The Asia Pacific and Latin American geographic
regions experienced solid growth in the second quarter of 2003. Two key markets
that experienced economic slowdowns in the second quarter of 2003 as compared to
2002 were automotive and converting (corrugated, tape and label, tissue and
towel, etc.) As evidence of the automotive slowdown, vehicle production rates of
the North American auto manufacturers decreased approximately 4 to 5 percent in
the second quarter of 2003 as compared to the same period in 2002.
13
Markets that experienced volume growth during the second quarter were graphic
arts and footwear. The gross profit margin in the second quarter of 2003 in
global adhesives decreased 0.5 percentage points from the second quarter of
2002. Savings from the restructuring initiative only partially offset the
increases in raw material prices. SG&A expenses increased $1.2 million primarily
as a result of the increase in U.S. pension and other postretirement benefit
expenses as well as the increases attributed to the stronger foreign currencies.
The resulting operating income of $14.1 million in the second quarter of 2003
was $0.4 million less than the operating income in the second quarter of 2002.
As a percent of net revenue, operating income was 6.2 percent in the second
quarter of 2003 and 6.6 percent in the second quarter of 2002.
For the first six months of 2003 net revenue of $429.4 million was 2.1 percent
higher than the net revenue of $420.6 million in the first six months of 2002.
The positive currency effects were 5.2 percent with volume and pricing decreases
of 1.8 percent and 1.3 percent, respectively. The causes of the variances were
similar to the second quarter results with slow economic activity in North
America and Europe driving the volume reductions. Operating income for the first
six months of 2003 was $25.1 million as compared to $23.9 million for the same
period of 2002. As a percentage of net revenue, the operating income was 5.8
percent in the first half of 2003 as compared to 5.7 percent in the first half
of 2002.
Full-Valu/Specialty: Net revenue in the second quarter of 2003 of $97.3 million
was 2.3 percent below the $99.6 million of net revenue recorded in the second
quarter of 2002. Sales volume decreased 3.0 percent, average selling prices
decreased 0.6 percent and currency had a positive impact of 1.3 percent. The
volume decrease was due primarily to reduced volume in the powder coatings
market which continues to be impacted by the slow economies in North America and
Europe. Increased pricing competition has also impacted the powder coatings
market. Volume growth was realized in the second quarter in the consumer product
line, especially in Australia, as well as in the company's window products.
Sales of the window products trend closely with U.S. housing starts, which
continue to experience strong growth due to low interest rates. The gross profit
margin in the second quarter of 2003 was 0.1 percentage point less than the
gross profit margin in the second quarter of 2002. Gross profit margin increases
in the Adalis and Specialty Construction Brands product lines helped offset the
margin decrease in the powder coatings market. SG&A expenses in the second
quarter of 2003 were $1.8 million or 6.9 percent higher than the SG&A expenses
in the second quarter of 2002. Increased expenses associated with the U.S.
pension and other postretirement benefit plans were one reason for the expense
increase. Another reason was the increased accrual of $1.2 million related to
claims for the exterior insulation finish system. Operating income of $5.5
million in the second quarter of 2003 was $2.6 million or 32.1 percent less than
the operating income recorded in the second quarter of 2002.
Through six months of 2003, the net revenue in the Full-Valu/Specialty operating
segment of $189.7 million was $2.4 million or 1.2 percent less than the net
revenue of $192.0 in the second quarter of 2002. Sales volume decreased 2.3
percent, average selling prices decreased 0.2 percent and currency fluctuations
had a positive impact of 1.3 percent. Similar to the 2003 second quarter
results, significant volume decreases realized in the powder coatings products
were partially offset by volume increases in the consumer and window products.
Operating income of $10.2 million in the first half of 2003 was $2.6 million or
20.1 percent less than the operating income in the first half of 2002. As a
percent of net revenue, operating income in the first six months of 2003 was 5.4
percent as compared to 6.7 percent in the first six months of 2002.
Restructuring and other Related Costs
During the second quarter of 2003 pretax charges of $3.2 million ($2.5 million
after tax) were recorded in connection with the company's restructuring plan
that was announced on January 15, 2002. In the first six months of 2003 the
company recorded pretax charges of $7.7 million ($5.6 after tax). The plan,
which was contemplated in 2001, approved and implemented throughout 2002, will
be completed in 2003. The second quarter of 2003 was the final quarter in which
charges related to this restructuring plan are expected to be incurred. As part
of the plan the company has eliminated approximately 20 percent of the company's
2001 global manufacturing capacity. In 2002, the company closed 12 manufacturing
facilities in the Global Adhesives operating segment - eight in North America,
three in Latin America and one in Europe. In the Full-Valu/Specialty operating
segment, two manufacturing facilities were closed - one in the United States and
one in Latin America and one production line was shut down in another facility
in the United States. In connection with the restructuring plan, the company
also upgraded and realigned the
14
Global Adhesives operating segment sales force. By reducing capacity and
eliminating other cost structures management currently estimates that upon
completion of all restructuring related activities, operating costs will be
reduced at least $12 million annually. These savings, consisting primarily of
reduced employee-related costs and reduced depreciation expenses, were
approximately $3.0 million in both the first and second quarters of 2003. The
plan will result in the elimination of approximately 530 positions, of which
approximately 490 have occurred through the end of the second quarter of 2003.
Charges have been accrued for the elimination of the remaining 40 positions in
the second half of 2003. Of the total reductions of 490, 115 occurred in the
first six months of 2003 - 75 in the Global Adhesives operating segment and 40
in the Full-Valu/Specialty operating segment. Offsetting the reduction of 530
positions will be approximately 110 newly hired employees (of which 105 were
hired as of May 31, 2003), primarily in manufacturing facilities that assumed
additional volume previously produced by facilities that were closed as part of
the restructuring plan, and sales-related positions as part of the upgrading and
realignment of the sales force.
Since inception of the plan, the company has recorded total pretax charges of
$41 million. These charges were offset by $2.0 million of gains on sales of
assets impacted by the restructuring plan. Additional sales of assets subject to
the plan are expected to yield gains that will bring the total net pretax
charges down to approximately $35 million. The charges related to the plan
included employee separation costs, accelerated depreciation on assets held and
used until disposal, lease/contract termination costs and other costs directly
related to the restructuring plan. Cash costs of the plan, net of proceeds from
sales of assets subject to the plan are expected to be approximately $15-$20
million. As of May 31, 2003 cash costs incurred were $22.4 million offset by
$4.2 million of proceeds from sales of assets subject to the plan. The remaining
restructuring liability as of May 31, 2003 was $8.1 million. The following table
summarizes the restructuring charges and the related restructuring liabilities:
15
Employee
Severance Accelerated
and Benefits Depreciation Other Total
---------------------------------------------------
Balance at December 2, 2001 $ 349 $ 176 $ 525
2002 Charges:
First quarter 4,784 $ 1,637 1,254 7,675
Second quarter 2,831 2,830 961 6,622
Third quarter 1,572 1,501 3,253 6,326
Fourth quarter 5,561 1,282 4,315 11,158
---------------------------------------------------
Total charges 14,748 7,250 9,783 31,781
Non-cash (1,638) (7,250) - (8,888)
Currency change effect - (170) (170)
Cash payments (7,648) (4,986) (12,634)
---------------------------------------------------
Total liabilities at November 30, 2002 5,811 4,803 10,614
Long-term portion of liabilities (2,106) (2,106)
---------------------------------------------------
Current liabilities at November 30, 2002 5,811 2,697 8,508
===================================================
Balance at November 30, 2002 5,811 4,803 10,614
2003 Charges:
First quarter 2,388 190 1,884 4,462
Second quarter 1,107 184 1,899 3,190
---------------------------------------------------
Total Charges 3,495 374 3,783 7,652
Non-cash (374) (674) (1,048)
Currency change effect 674 674
Cash payments (5,807) (3,993) (9,800)
---------------------------------------------------
Total liabilities at May 31, 2003 3,499 4,593 8,092
Long-term portion of liabilities (2,537) (2,537)
---------------------------------------------------
Current liabilities at May 31, 2003 $ 3,499 $ 2,056 $ 5,555
===================================================
The pretax charges of $3.2 million in the second quarter of 2003 were included
in the income statement as: $1.6 million in cost of sales and $1.6 million in
SG&A expense. The $1.6 million in cost of sales included $1.1 million of costs
associated with the closure of manufacturing facilities such as; equipment tear
down and shutdown expenses, facility maintenance and clean-up costs and
equipment and inventory relocation expenditures. The remaining $0.5 million
consisted primarily of employee severance and benefits, with insignificant
amounts related to accelerated depreciation and adverse lease termination costs.
The $1.6 million in SG&A expenses consisted of $0.7 million of employee
severance and benefits and $0.9 million of other costs directly attributed to
the restructuring plan, primarily relocation and recruiting costs. Of the total
pretax charges of $3.2 million incurred in the second quarter of 2003, $2.5
million was attributed to the Global Adhesives operating segment, $0.6 million
to the Full-Valu/Specialty operating segment and corporate office cost centers
recorded $0.1 million.
The pretax charges of $7.7 million in the first six months of 2003 were included
in the income statement as: $3.5 million in cost of sales and $4.2 million in
SG&A expense. The $3.5 million in cost of sales included $2.6 million of costs
associated with the closure of manufacturing facilities such as; equipment tear
down and shutdown expenses, facility maintenance and clean-up costs and
equipment and inventory relocation expenditures. The remaining $0.9 million
consisted of $0.6 million of employee severance and benefits, $0.1 million
related to accelerated depreciation and $0.2 million for adverse lease
termination and other related costs. The $4.2 million in SG&A expenses
consisted of $2.9 million of employee severance and benefits and $1.3 million of
other costs directly attributed to the restructuring plan, primarily relocation
and recruiting costs. Of the total pretax charges of $7.7 million incurred in
the first six months of 2003, $6.7 million was attributed to the Global
Adhesives operating segment and $1.0 million to the Full-Valu/Specialty
operating segment.
16
Non-cash charges attributed to employee severance and benefits are related to
the granting of accelerated vesting on restricted stock held by certain
employees during 2002 subject to the restructuring and to charges resulting from
curtailment and other special termination benefits associated with the U.S
pension and other postretirement benefit plans. The long-term portion of the
restructuring liability relates to adverse lease commitments that are expected
to be paid beyond one year.
The beginning balance of $0.5 million at December 2, 2001 in the restructuring
liability relates to a prior restructuring plan.
Liquidity and Capital Resources
Net cash provided from operating activities in the first six months of 2003 was
$19.6 million as compared to $31.6 million in the first six months of 2002.
Working capital changes were the primary cause of the decreased operating cash
flows in 2003 as compared to 2002. One key factor related to the short-term
restructuring liability which reflected a decrease of $3.4 million in the first
six months of 2003 as compared to an increase of $5.5 million for 2002.
Incentive compensation payouts were approximately $5.0 million higher in the
first half of 2003 as compared to the first half of 2002. Reductions in trade
accounts payable resulted in operating cash outflows of $5.1 million in the
first six months of 2003 as compared to outflows of $2.9 million in the first
six months of 2002. Accounts receivable days sales outstanding (DSO) were 62
days at the end of the second quarter in both 2003 and 2002. Inventory days on
hand of 62 days at May 31, 2003 were one day higher than the 61 days at June 1,
2002.
Cash used in investing activities was $18.2 million in the first half of 2003 as
compared to $11.5 million in the first half of 2002. Capital expenditures
(primarily for information technology projects and manufacturing improvements)
were $15.8 million in the first six months of 2003 as compared to $12.4 million
in the first six months of 2002. In the second quarter of 2003 the company
purchased certain assets of an adhesive company in the U.S. for $1.7 million.
During the second quarter of 2003 the company also invested $1.0 million for a
minimal ownership percentage of a technology company. During the second quarter
the company reclassified $6.1 million of property, plant and equipment to assets
available for sale. This relates to properties that are expected to be sold in
less than one year. On the consolidated balance sheet they are included in other
current assets.
Total debt increased in the first half of 2003 by $8.2 million as compared to a
decrease of $23.9 million in the first half of 2002. The company's
capitalization ratio, defined as total debt divided by total debt plus
stockholders' equity, was 28.7 percent at May 31, 2003, 29.0 percent at November
30, 2002 and 32.3 percent at June 1, 2002.
Forward-Looking Statements and Risk Factors
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. In this Quarterly Report on Form 10-Q, the company
discusses expectations regarding future performance of the company which include
anticipated financial performance, savings from restructuring initiatives,
global economic conditions, liquidity requirements, the effect of new accounting
pronouncements and one-time accounting charges and credits, and similar matters.
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. Forward-looking statements are based on
certain assumptions and expectations of future events that are subject to risks
and uncertainties. Actual future results and trends may differ materially from
historical results or those projected in any such forward-looking statements
depending on a variety of factors. In order to comply with the terms of the safe
harbor, the company identifies in this Quarterly Report on Form 10-Q important
factors which could affect the company's financial performance and could cause
the company's actual results for future periods to differ materially from the
anticipated results or other expectations expressed in the forward-looking
statements. Additionally, the variety of products sold by the company and the
regions where the company does business makes it difficult to determine with
certainty the increases or decreases in sales resulting from changes in the
volume of products sold, currency impact, changes in product mix and selling
prices. However, management's best estimates of these changes as well as changes
in other factors have been included. 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.
17
Competition: The company sells a wide variety of products in numerous markets,
each of which is highly competitive. Many of the company's competitors are part
of large multi-national companies and may have more resources than the company.
Any increase in competition may result in lost market share or reduced prices,
which could result in reduced gross margins. This may impair the company's
ability to grow or even to maintain current levels of revenues and earnings.
Acquisitions: As part of the company's growth strategy, the company intends to
pursue acquisitions of complementary businesses or products and joint ventures.
The ability to grow through acquisitions or joint ventures depends upon the
company's ability to identify, negotiate and complete suitable acquisitions or
joint venture arrangements.
International: Operations outside the United States accounted for approximately
47 percent of the company's net revenues in the first half of 2003.
International operations could be adversely affected by changes in political and
economic conditions, conflicts, sanctions, trade protection measures,
restrictions on repatriation of earnings, differing intellectual property rights
and changes in regulatory requirements that restrict the sales of products or
increase costs. Also, fluctuations in exchange rates between the U.S. dollar and
other currencies could result in increases or decreases in the company's
earnings and may adversely affect the value of the company's assets outside the
United States.
Raw Materials: The company obtains the raw materials needed to manufacture its
products from a number of suppliers. Many of these raw materials are
petroleum-based derivatives, minerals and metals. Under normal market
conditions, these materials are generally available on the open market and from
a variety of producers. From time to time, however, the prices and availability
of these raw materials fluctuate, which could impair the company's ability to
procure necessary materials, or increase the cost of manufacturing its products.
The company generally attempts to increase its selling prices to address certain
increases in its raw materials. However, the company's revenues may be
negatively impacted by its customers reaction to these increases, or the company
may be unable to successfully pass the increases in raw materials on to its
customers which could result in reduced profit margins.
Environmental and Litigation: The company is subject to numerous environmental
laws and regulations that impose various environmental controls on the company
or otherwise relate to environmental protection, the sale and export of certain
chemicals or hazardous materials, and various health and safety matters. To
date, the company's expenditures related to environmental matters have not had a
material adverse effect on the company's business, financial condition, results
of operations or cash flows. However, the company cannot predict that it will
not be required to make additional expenditures to remain in or to achieve
compliance with environmental laws in the future or that any such additional
expenditures will not have a material adverse effect on the company's business,
financial condition, results of operations or cash flows.
As a participant in the chemical and construction products industries, the
company faces an inherent risk of exposure to claims in the event that the
failure, use or misuse of its products results in, or is alleged to result in
property damage and/or bodily injury. Claims could result in significant legal
expenditures and/or substantial damages. Please refer to Part II Item 1. Legal
Proceedings in this Quarterly Report on Form 10-Q. Given the unpredictability of
litigation and the complexity of the issues presented the company carefully
monitors and evaluates its ongoing litigation and claims.
Other: Additional factors which could affect future results include: (i)
economic matters over which the company has no control, including changes in
inflation, tax rates, and interest rates; (ii) changes in fiscal, governmental
and other regulatory policies; (iii) the loss or insolvency of a major customer
or distributor, (iv) natural or manmade disasters (including material acts of
terrorism or hostilities which impact the company's markets); (v) loss of, or
changes in, executive management; and (vi) changes in accounting standards which
are adverse to the company. In addition, the company notes that its stock price
can be affected by fluctuations in quarterly earnings.
The company may refer to this section of the Form 10-Q to identify risk factors
related to other forward looking statements made in oral presentations,
including telephone conferences and/or webcasts open to the public.
18
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market Risk: The company is 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.
Interest Rate Risk: There is exposure to changes in interest rates primarily as
a result of borrowing activities used to fund operations. Committed floating
rate credit facilities are used to fund a portion of operations.
Management believes that probable near-term changes in interest rates would not
materially affect its consolidated financial position, results of operations or
cash flows. The impact on the results of operations of a one-percentage point
interest rate change on the outstanding balance of its variable rate debt as of
June 1, 2003 would not be material.
Foreign Exchange Risk: As a result of being a global enterprise, there is
exposure to market risks from changes in foreign currency exchange rates, which
may adversely affect operating results and financial position. Approximately 47
percent of net revenue is generated outside of the United States. Principal
foreign currency exposures relate to the euro, British pound sterling, Japanese
yen, Australian dollar, Canadian dollar, Argentine peso and Brazilian real.
Management's objective is to balance, where possible, the local currency
denominated assets to the local currency denominated liabilities to have a
natural hedge and minimize foreign exchange impacts. The company enters into
cross border transactions through importing and exporting goods to and from
different countries and locations. These transactions generate foreign exchange
risk as they create assets, liabilities and cash flows in currencies other than
the local currency. This also applies to services provided and other cross
border agreements among subsidiaries.
Management minimizes risks from foreign currency exchange rate fluctuations
through normal operating and financing activities and, when deemed appropriate,
through the use of derivative instruments. Management does not enter into any
speculative positions with regard to derivative instruments. From a sensitivity
analysis viewpoint, based on 2002 financial results a hypothetical overall 10
percent change in the U.S. dollar would have resulted in a change of
approximately $0.05 per diluted share.
Raw Materials: The principal raw materials used to manufacture products include
resins, polymers, vinyl acetate monomer, starch, dextrines and natural latex.
The company generally avoids sole source supplier arrangements for raw
materials. While alternate sources for most key raw materials are available, if
worldwide supplies were disrupted due to unforeseen events, or if unusual demand
causes products to be subject to allocation, shortages could occur.
The company's single largest expenditure was the purchase of raw materials.
Management acknowledges that in the long-term, prices of most raw materials will
probably increase. Management's objective is to purchase raw materials that meet
both its quality standards and production needs at the lowest total cost. Most
raw materials are purchased on the open market or under contracts which limit
the frequency but not the magnitude of price increases. In some cases, however,
the risk of raw material price changes is managed by strategic sourcing
agreements which limit price increases to increases in supplier feedstock costs,
while requiring decreases as feedstock costs decline. The company also uses the
leverage of having substitute raw materials approved for use wherever possible
to minimize the impact of possible price increases.
Item 4. Controls and Procedures
With the participation of management, the company's chief executive officer and
chief financial officer evaluated the company's disclosure controls and
procedures within 90 days of the filing date of this quarterly report. Based
upon this evaluation, the chief executive officer and chief financial officer
concluded that the company's disclosure controls and procedures are effective in
ensuring that material information required to be disclosed is included in the
reports that it files with the Securities and Exchange Commission.
19
There were no significant changes in the company's internal controls or, to the
knowledge of the management of the company, in other factors that could
significantly affect these controls subsequent to the evaluation date.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
As a participant in the chemical and construction products industries, the
company faces an inherent risk of exposure to claims in the event that the
failure, use or misuse of its products results in, or is alleged to result in
property damage and/or bodily injury.
As previously reported, a subsidiary of the company is a defendant in a number
of lawsuits related to exterior insulated finish systems ("EIFS"). The EIFS
product was used primarily in the residential construction market in the
southeastern United States. Claims and lawsuits seek monetary relief for damage
to property from moisture intrusion. None of the claims have alleged any
personal injury. Typically, the company's subsidiary, along with the builder,
applicator and other parties pay to repair the damaged homes. The claims
experienced by the company's subsidiary relate primarily to systems applied
prior to 1999. The company's subsidiary has not had any material claims related
to EIFS sold after the redesign of the system in 1998-1999.
It is difficult to estimate the cost of resolving all pending and future EIFS
related claims. A key assumption guiding the amount accrued by the company for
future claims was that the number of claims would decline by 2003. However,
plaintiff attorneys have been successful in continuing to locate and bring
claims at a consistent rate.
Because such claims have not declined in frequency, in the second quarter, the
company reassessed and adjusted its reserves. At May 31, 2003, the company's
reserve for liability and costs for pending and future claims was $3.9 million
reflecting an increase of $1.2 million. Associated with these claims is $1.6
million for estimated insurance recoveries. The company only has insurance
coverage for certain years. Projecting future events, such as the number of new
claims to be filed each year, the average cost of disposing of each such claim,
as well as the numerous uncertainties surrounding litigation in the United
States, could cause the actual costs and related insurance recoveries to be
higher or lower than those recorded.
As a result of the bankruptcy of most major asbestos producers, plaintiffs'
attorneys are increasing their focus on other defendants. From time to time, the
company or its subsidiaries are named in asbestos-related lawsuits in various
state courts involving alleged exposure to products manufactured 20 to 30 years
ago. These lawsuits frequently seek both actual and punitive damages, often in
very large amounts. In cases were, plaintiffs are unable to demonstrate that
they have suffered any compensable loss as a result of such exposure, or that
injuries incurred in fact resulted from exposure to products manufactured by the
company or its subsidiaries. The company is generally dismissed. With respect to
those cases where compensable disease, exposure and causation are established
with respect to one of the company's products, the company generally settles for
amounts that reflect the confirmed disease, the seriousness of the case, the
particular jurisdiction and the number and solvency of other parties in the
case. Substantially all of these cases have involved multiple co-defendants, and
the company is typically a de minimis party.
Insurance or indemnification from solvent third party insurers in accordance
with applicable policies or contracts have paid the indemnity and defense costs
associated with the company's asbestos litigation. As a result, these cases have
been defended, dismissed or settled without a material effect on the company's
financial condition, results of operations, or cash flows. However, given the
unpredictability of litigation and the complexity of the issues presented the
company carefully monitors and evaluates these claims.
During the second quarter the company settled two asbestos related lawsuits for
an aggregate of $475,000. In connection with these two settlements, the company
agreed to an allocation formula to
20
determine the contribution from several insurers. Based on this allocation, the
company's insurers have paid or are expected to pay at least $215,000 of the
settlement amounts. The remainder of the settlement amounts represents (i)
amounts allocable to years in which the responsible insurer is insolvent, or
(ii) amounts below the minimum retained deductibles under the applicable
policies. The company is pursuing recovery for these amounts from the
liquidators for the insolvent insurers and is asserting claims for coverage from
solvent excess insurers. The company and its insurers have also commenced
negotiations with respect to the terms of a cost sharing arrangement insurers.
21
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Registrant's annual meeting was held on April 17, 2003. There was a
total of 28,381,047 shares of Common Stock entitled to be cast at the
meeting.
(b) The following matters were submitted to a vote of security holders during
the second quarter:
Proposal 1 - Election of Directors for a term expiring at the 2006 annual
meeting of shareholders:
Common Stock
------------
Director Name Votes in Favor Share Votes Withheld
------------- -------------- --------------------
Alfredo L. Rovira 23,949,199.715 1,647,451.479
Albert P.L. Stroucken 23,878,493.323 1,718,157.871
Norbert R. Berg, Freeman A. Ford, Knut Kleedehn, John. J. Mauriel, Jr., J.
Michael Losh, Lee R. Mitau and R. William Van Sant continued to serve as
directors following the meeting. Directors Gail D. Fosler and Reatha Clark King
retired at this meeting.
Proposal 2 - Proposal to Ratify the Appointment of PricewaterhouseCoopers LLP as
the Registrant's independent auditors for the fiscal year ending November 29,
2003:
Common Share Votes
------------------
For Against Abstain
--- ------- -------
25,133,257.258 431,335.246 32,058.690
Proposal 3 - Approval of the H.B. Fuller Company Annual and Long-Term Incentive
Plan:
Common Share Votes
------------------
For Against Abstain
--- ------- -------
24,616,878.290 890,489.497 89,283.407
Item 5. Other Information
On June 11, 2003, the company announced that Stephen J. Large was appointed
Group President and General Manager of the Full-Valu/Specialty operating segment
succeeding Linda Welty who left the company to pursue other opportunities.
On July 8, 2003, the company announced Edward Snyder was appointed Chief Process
Improvement Officer as successor to Mr. Large.
On July 14, 2003, the company announced that James R. Conaty was appointed Group
President and General Manager of Global Adhesives business segment to succeed
Peter Koxholt who retired from the company due to an illness.
22
Item 6.
Exhibits and Reports on Form 8-K
Exhibits
12 Computation of Ratios
99.1 Form of 906 Certification - Albert P.L. Stroucken
99.2 Form of 906 Certification - Raymond A. Tucker
(b) Reports on Form 8-K during the quarter ended May 31, 2003.
On March 26, 2003, a Form 8-K was filed during the quarter ended May 31,
2003 to report the financial results for the quarter ended March 1, 2003.
SIGNATURES
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.
H.B. Fuller Company
Dated: July 15, 2003 /s/ Raymond A. Tucker
--------------------------------------------------
Raymond A. Tucker
Senior Vice President and Chief Financial Officer
23
Exhibit Index
Exhibits
12 Computation of Ratios
99.1 Form of 906 Certification - Albert P.L. Stroucken
99.2 Form of 906 Certification - Raymond A. Tucker
CERTIFICATIONS
I, Albert P.L. Stroucken, certify that:
1. I have reviewed this quarterly report on Form 10-Q of H.B. Fuller Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the Audit Committee
of registrant's Board of Directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: July 15, 2003
/s/ Albert P.L. Stroucken
- ------------------------------------------
Albert P.L. Stroucken
Chairman, President and Chief Executive Officer
I, Raymond A. Tucker, certify that:
1. I have reviewed this quarterly report on Form 10-Q of H.B. Fuller Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the Audit
Committee of registrant's Board of Directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: July 15, 2003
/s/ Raymond A. Tucker
- -------------------------------------------------
Raymond A. Tucker
Senior Vice President and Chief Financial Officer