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EX-31.2 - EXHIBIT 31.2 - FULLER H B COex31-2.htm
EX-31.1 - EXHIBIT 31.1 - FULLER H B COex31-1.htm
EX-10.1 - EXHIBIT 10.1 - FULLER H B COex10-1.htm
Table of Contents

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 March 4, 2017

 

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

(I.R.S. Employer

incorporation or organization)

Identification No.)

 

 

 

 

1200 Willow Lake Boulevard, St. Paul, 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 check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer [X]

 Accelerated filer [  ]

Non-accelerated filer [  ] (Do not check if a smaller reporting company)

 Smaller reporting company [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes [  ] No [X]

 

The number of shares outstanding of the Registrant’s Common Stock, par value $1.00 per share, was 50,527,216 as of March 24, 2017.

 

 

H.B. Fuller Company

Quarterly Report on Form 10-Q

Table of Contents

  

   

Page

PART 1. FINANCIAL INFORMATION

 
     

ITEM 1.

FINANCIAL STATEMENTS (Unaudited)

3

     
 

Condensed Consolidated Statements of Income for the three months ended March 4, 2017 and February 27, 2016

3

     
 

Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 4, 2017 and February 27, 2016

4

     
 

Condensed Consolidated Balance Sheets as of March 4, 2017 and December 3, 2016

5

     
 

Condensed Consolidated Statements of Total Equity as of March 4, 2017 and December 3, 2016

6

     
 

Condensed Consolidated Statements of Cash Flows for the three months ended March 4, 2017 and February 27, 2016

7

     
 

Notes to Condensed Consolidated Financial Statements

8

     

ITEM 2.

MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

27

     

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

37

     

ITEM 4.

CONTROLS AND PROCEDURES

38

     

PART II. OTHER INFORMATION

39

     

ITEM 1.

LEGAL PROCEEDINGS

39

     

ITEM 1A.

RISK FACTORS

40

     

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

41

     

ITEM 6.

EXHIBITS

42

     

SIGNATURES

43

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

H.B. FULLER COMPANY AND SUBSIDIARIES

Condensed Consolidated Statements of Income

(In thousands, except per share amounts)

(Unaudited)

 

   

Three Months Ended

 
   

March 4,

   

February 27,

 
   

2017

   

2016

 

Net revenue

  $ 503,323     $ 474,326  

Cost of sales

    (364,327 )     (336,721 )

Gross profit

    138,996       137,605  

Selling, general and administrative expenses

    (112,915 )     (99,767 )

Special charges, net

    -       (413 )

Other income (expense), net

    621       (5,082 )

Interest expense

    (8,380 )     (6,308 )

Income from continuing operations before income taxes and income from equity method investments

    18,322       26,035  

Income taxes

    (5,765 )     (8,760 )

Income from equity method investments

    2,274       1,692  

Net income including non-controlling interests

    14,831       18,967  

Net income attributable to non-controlling interests

    (36 )     (49 )

Net income attributable to H.B. Fuller

  $ 14,795     $ 18,918  
                 

Earnings per share attributable to H.B. Fuller common stockholders:

 

Basic

    0.29       0.38  

Diluted

    0.29       0.37  
                 

Weighted-average common shares outstanding:

               

Basic

    50,243       49,958  

Diluted

    51,460       50,995  
                 

Dividends declared per common share

  $ 0.14     $ 0.13  

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

H.B. FULLER COMPANY AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income (Loss)

(In thousands)

(Unaudited)

 

   

Three Months Ended

 
   

March 4,

   

February 27,

 
   

2017

   

2016

 

Net income including non-controlling interests

  $ 14,831     $ 18,967  

Other comprehensive (loss) income

               

Foreign currency translation

    (10,519 )     (950 )

Defined benefit pension plans adjustment, net of tax

    1,590       2,665  

Interest rate swaps, net of tax

    10       10  

Cash-flow hedges, net of tax

    129       249  

Other comprehensive (loss) income

    (8,790 )     1,974  

Comprehensive income

    6,041       20,941  

Less: Comprehensive income attributable to non-controlling interests

    31       44  

Comprehensive income attributable to H.B. Fuller

  $ 6,010     $ 20,897  

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

H.B. FULLER COMPANY AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(In thousands, except share and per share amounts)

 

   

(Unaudited)

         
   

March 4,

   

December 3,

 
   

2017

   

2016

 

Assets

               

Current assets:

               

Cash and cash equivalents

  $ 116,518     $ 142,245  

Trade receivables (net of allowances of $12,427 and $12,310, as of March 4, 2017 and December 3, 2016, respectively)

    358,145       351,130  

Inventories

    286,254       247,399  

Other current assets

    71,055       70,479  

Total current assets

    831,972       811,253  
                 

Property, plant and equipment

    1,086,268       1,093,141  

Accumulated depreciation

    (576,333 )     (577,866 )

Property, plant and equipment, net

    509,935       515,275  
                 

Goodwill

    423,581       366,248  

Other intangibles, net

    243,598       205,359  

Other assets

    160,242       157,733  

Total assets

  $ 2,169,328     $ 2,055,868  
                 

Liabilities, redeemable non-controlling interest and total equity

               

Current liabilities:

               

Notes payable

  $ 47,120     $ 37,334  

Current maturities of long-term debt

    -       80,178  

Trade payables

    181,460       162,964  

Accrued compensation

    45,105       52,444  

Income taxes payable

    7,812       7,985  

Other accrued expenses

    43,569       50,939  

Total current liabilities

    325,066       391,844  
                 

Long-term debt, excluding current maturities

    757,661       585,759  

Accrued pension liabilities

    70,370       73,545  

Other liabilities

    66,466       62,174  

Total liabilities

    1,219,563       1,113,322  
                 

Commitments and contingencies (Note 16)

               

Redeemable non-controlling interest

    -       4,277  
                 

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 – 50,490,659 and 50,141,343, as of March 4, 2017 and December 3, 2016, respectively

    50,491       50,141  

Additional paid-in capital

    71,758       59,564  

Retained earnings

    1,098,645       1,090,900  

Accumulated other comprehensive loss

    (271,514 )     (262,729 )

Total H.B. Fuller stockholders' equity

    949,380       937,876  

Non-controlling interests

    385       393  

Total equity

    949,765       938,269  

Total liabilities, redeemable non-controlling interest and total equity

  $ 2,169,328     $ 2,055,868  

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

H.B. FULLER COMPANY AND SUBSIDIARIES

Condensed Consolidated Statements of Total Equity

(In thousands)

(Unaudited)

 

    H.B. Fuller Company Shareholders              
   

Common

Stock

   

Additional

Paid-in

Capital

   

Retained

Earnings

   

Accumulated

Other

Comprehensive

Income (Loss)

   

Non-

Controlling

Interests

   

Total

 

Balance at November 28, 2015

  $ 50,074     $ 55,522     $ 994,608     $ (227,284 )   $ 406     $ 873,326  

Comprehensive income (loss)

    -       -       124,128       (35,445 )     226       88,909  

Dividends

    -       -       (27,836 )     -       -       (27,836 )

Stock option exercises

    519       10,750       -       -       -       11,269  

Share-based compensation plans other, net

    116       14,485       -       -       -       14,601  

Tax benefit on share-based compensation plans

    -       1,467       -       -       -       1,467  

Repurchases of common stock

    (568 )     (22,660 )     -       -       -       (23,228 )

Redeemable non-controlling interest

    -       -       -       -       (239 )     (239 )

Balance at December 3, 2016

    50,141       59,564       1,090,900       (262,729 )     393       938,269  

Comprehensive income (loss)

    -       -       14,795       (8,785 )     31       6,041  

Dividends

    -       -       (7,050 )     -       -       (7,050 )

Stock option exercises

    261       8,288       -       -       -       8,549  

Share-based compensation plans other, net

    140       5,138       -       -       -       5,278  

Tax benefit on share-based compensation plans

    -       1,053       -       -       -       1,053  

Repurchases of common stock

    (51 )     (2,379 )     -       -       -       (2,430 )
Purchase of redeemable non-controlling interest     -       94       -       -       -       94  

Redeemable non-controlling interest

    -       -       -       -       (39 )     (39 )

Balance at March 4, 2017

  $ 50,491     $ 71,758     $ 1,098,645     $ (271,514 )   $ 385     $ 949,765  

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

H.B. FULLER COMPANY AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

   

Three Months Ended

 
   

March 4, 2017

   

February 27, 2016

 

Cash flows from operating activities:

               

Net income including non-controlling interests

  $ 14,831     $ 18,967  

Adjustments to reconcile net income including non-controlling interests to net cash provided by operating activities:

               

Depreciation

    11,945       13,258  

Amortization

    7,355       6,698  

Deferred income taxes

    (246 )     63  

Income from equity method investments, net of dividends received

    (2,274 )     (1,692 )

(Gain)/loss on sale of assets

    (95 )     -  

Share-based compensation

    5,032       4,267  

Excess tax benefit from share-based compensation

    (1,053 )     341  
Non-cash loss on mark to market adjustment related to contingent consideration liability     37       -  

Non-cash charge for the sale of inventories revalued at the date of acquisition

    193       -  
Changes in assets and liabilities, net of effects of acquisitions                

Trade receivables, net

    4,884       28,947  

Inventories

    (32,597 )     (15,861 )

Other assets

    3,960       9,298  

Trade payables

    23,989       (4,301 )

Accrued compensation

    (7,540 )     (13,235 )

Other accrued expenses

    (8,089 )     (5,258 )

Income taxes payable

    (1,109 )     5,673  

Accrued / prepaid pensions

    (1,361 )     662  

Other liabilities

    1,754       (1,445 )

Other

    (3,157     (3,821 )

Net cash provided by operating activities

    16,459       42,561  

Purchased property, plant and equipment

    (19,899 )     (23,361 )

Purchased businesses, net of cash acquired

    (123,305 )     -  

Purchased investments

    (1,250 )     -  

Proceeds from sale of property, plant and equipment

    109       863  

Net cash used in investing activities

    (144,345 )     (22,498 )

Proceeds from issuance of long-term debt

    453,000       -  

Repayment of long-term debt and payment of debt issuance costs

    (356,610 )     (5,625 )

Net proceeds from notes payable

    8,438       6,378  

Dividends paid

    (7,048 )     (6,498 )

Purchase of redeemable non-controlling interest

    (3,127 )     -  

Proceeds from stock options exercised

    8,549       32  

Excess tax benefit from share-based compensation

    1,053       (341 )

Repurchases of common stock

    (2,430 )     (6,518 )

Net cash provided by (used in) financing activities

    101,825       (12,572 )

Effect of exchange rate changes on cash and cash equivalents

    334       112  

Net change in cash and cash equivalents

    (25,727 )     7,603  

Cash and cash equivalents at beginning of period

    142,245       119,168  

Cash and cash equivalents at end of period

  $ 116,518     $ 126,771  
                 

Supplemental disclosure of cash flow information:

               

Dividends paid with company stock

  $ 2     $ 64  

Cash paid for interest, net of amount capitalized of $23 and $117 for the periods ended March 4, 2017 and February 27, 2016, respectively

  $ 6,979     $ 5,566  

Cash paid for income taxes, net of refunds

  $ 6,539     $ 4,066  

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

H.B. FULLER COMPANY AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Amounts in thousands, except share and per share amounts)

(Unaudited)

 

Note 1: Basis of Presentation

 

The accompanying unaudited interim Condensed 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 Condensed 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 Condensed 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 December 3, 2016 as filed with the Securities and Exchange Commission.

 

On December 4, 2016, for our subsidiaries in Latin America, we changed the functional currency from the U.S. dollar to the entity’s local currency based on management’s analysis of the changes of the economic facts and circumstances in which these subsidiaries operate. The change in functional currency is accounted for prospectively from December 4, 2016 and financial statements prior to and including the quarter ended February 27, 2016 and the year ended December 3, 2016 have not been restated for the change in functional currency. Monetary assets and liabilities have been remeasured to the U.S. dollar at current exchange rates. Non-monetary assets (property, plant and equipment, net; goodwill; and intangible assets, net) have been remeasured to reflect the difference between the exchange rate when the asset arose and the exchange rate on the date of the change in functional currency. As a result of this change in functional currency, we recorded an $11,317 cumulative translation adjustment included in other comprehensive loss for the quarter ended March 4, 2017.

 

 

New Accounting Pronouncements

 

In March 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2017-07, Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which requires employers to include only the service cost component of net periodic pension cost and net periodic postretirement benefit cost in operating expenses. The other components of net benefit cost, including amortization of prior service cost/credit, and settlement and curtailment effects, are to be included in nonoperating expenses. The ASU also stipulates that only the service cost component of net benefit cost is eligible for capitalization.  Our effective date for adoption of this guidance is our fiscal year beginning December 2, 2018 with early adoption permitted.  We are currently evaluating the effect that this guidance will have on our Consolidated Financial Statements.

 

In February 2017, the FASB issued ASU No. 2017-05, Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets. The ASU was issued to clarify the scope of the previous standard and to add guidance for partial sales of nonfinancial assets. Our effective date for adoption of this guidance is our fiscal year beginning December 2, 2018. We have evaluated the effect that this guidance will have on our Consolidated Financial Statements and related disclosures and determined it will not have a material impact.

 

In January 2017, the FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which removes Step 2 of the goodwill impairment test.  A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill.  Our effective date for prospective adoption of this guidance is our fiscal year beginning November 29, 2020 with early adoption permitted. We will apply this guidance to applicable impairment tests after the adoption date.

 

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business.  This ASU clarifies the definition of a business when evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses.  Our effective date for prospective adoption of this guidance is our fiscal year beginning December 2, 2018. We will apply this guidance to applicable transactions after the adoption date.

 

 

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issues Task Force). This ASU requires that the reconciliation of the beginning-of-period and end-of-period amounts shown in the statement of cash flows include cash and restricted cash equivalents. Our effective date for adoption of this guidance is our fiscal year beginning December 2, 2018. We have evaluated the effect that this guidance will have on our Consolidated Financial Statements and related disclosures and determined it will not have a material impact.

 

In October 2016, the FASB issued ASU No. 2016-17, Consolidation (Topic 810): Interests Held through Related Parties That Are under Common Control. This ASU changes how a decision maker treats indirect interests in a managed variable interest entity held through an entity under common control in its primary beneficiary (consolidation) analysis. Our effective date for adoption of this guidance is our fiscal year beginning December 3, 2017. We have evaluated the effect that this guidance will have on our Consolidated Financial Statements and related disclosures and determined it will not have a material impact.

 

In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. This ASU changes the timing of income tax recognition for an intercompany sale of assets. The ASU requires the seller’s tax effects and the buyer’s deferred taxes to be recognized immediately upon the sale instead of deferring accounting for the income tax implications until the assets are sold to a third party or recovered through use. Our effective date for adoption of this guidance is our fiscal year beginning December 2, 2018. We are currently evaluating the effect that this guidance will have on our Consolidated Financial Statements.

 

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force). This ASU requires changes in the presentation of certain items including but not limited to debt prepayment or debt extinguishment costs; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies and distributions received from equity method investees. Our effective date for adoption of this guidance is our fiscal year beginning December 2, 2018. We are currently evaluating the effect that this guidance will have on our Consolidated Financial Statements.

 

In June 2016, the FASB ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Statements. This ASU requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. Our effective date for adoption of this guidance is our fiscal year beginning November 29, 2020. We are currently evaluating the effect that this guidance will have on our Consolidated Financial Statements.

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting. This ASU provides simplification in the accounting for share-based payment transactions including the accounting for income taxes, forfeitures, statutory tax withholding requirements and classification in the statement of cash flows. Our effective date for adoption of this guidance is our fiscal year beginning December 3, 2017. We are currently evaluating the effect that this guidance will have on our Consolidated Financial Statements.

 

In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606), Principal versus Agent Considerations (Reporting Revenue Gross versus Net).  This ASU provides guidance on recording revenue on a gross basis versus a net basis based on the determination of whether an entity is a principal or an agent when another party is involved in providing goods or services to a customer.  The amendments in this ASU affect the guidance in ASU No. 2014-09 and are effective in the same timeframe as ASU No. 2014-09 as discussed below.

  

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Subtopic 842). This guidance changes accounting for leases and requires lessees to recognize the assets and liabilities arising from all leases, including those classified as operating leases under previous accounting guidance, on the balance sheet and requires disclosure of key information about leasing arrangements to increase transparency and comparability among organizations. Our effective date for adoption of this guidance is our fiscal year beginning December 1, 2019 with early adoption permitted. The new guidance must be adopted using a modified retrospective transition approach, and provides for certain practical expedients. We are currently evaluating the impact that the new guidance will have on our Consolidated Financial Statements.

 

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which requires that equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) are to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Furthermore, equity investments without readily determinable fair values are to be assessed for impairment using a quantitative approach. Our effective date for adoption of this guidance is our fiscal year beginning December 2, 2018. We have evaluated the effect that this guidance will have on our Consolidated Financial Statements and related disclosures and determined it will not have a material impact.

 

In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory, which requires a company to measure inventory within the scope of this guidance (inventory measured using first-in, first-out (FIFO) or average cost) at the lower of cost and net realizable value methods. Subsequent measurement is unchanged for inventory measured using the last-in, first-out (LIFO) or retail inventory method. Our effective date for adoption of this guidance is our fiscal year beginning December 3, 2017. We have evaluated the effect that this guidance will have on our Consolidated Financial Statements and related disclosures and determined it will not have a material impact.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This guidance will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for fiscal years and interim periods beginning after December 15, 2017 (as stated in ASU No. 2015-14 which defers the effective date and was issued in August 2015) and is now effective for our fiscal year beginning December 2, 2018. Early application as of the original effective date is permitted under ASU 2015-14. The standard permits the use of either the retrospective or cumulative effect transition method. We are currently evaluating the impact of the new guidance on the Consolidated Financial Statements. We have identified an implementation project team and related oversight processes and have commenced the assessment phase of the project. We have not concluded as to whether the new guidance will be adopted on a full or modified retrospective basis, but will not apply the early adoption provisions of the new guidance.

 

Note 2: Acquisitions

 

Wisdom Adhesives

 

On January 27, 2017, we acquired substantially all of the assets of H.E. Wisdom & Sons, Inc. and its affiliate Wisdom Adhesives Southeast, L.L.C., (“Wisdom Adhesives”) headquartered in Elgin, Illinois. Wisdom Adhesives is a provider of adhesives for the packaging, paper converting and assembly markets. The acquisition will help strengthen our position in the North America adhesives market. The purchase price of $123,305 was financed through borrowings on our revolving credit facility and was recorded in our Americas Adhesives operating segment. We incurred acquisition related costs of approximately $547, which were recorded as selling, general and administrative (“SG&A”) expenses in the Condensed Consolidated Statements of Income for the three months ended March 4, 2017.

 

The acquisition fair value measurement was preliminary as of March 4, 2017, subject to the completion of the valuation of Wisdom Adhesives and further management reviews and assessment of the preliminary fair values of the assets acquired and liabilities assumed. We expect the fair value measurement process to be completed when the final appraisals are available, but no later than twelve months from the acquisition date.

 

 

The following table summarizes the preliminary fair value measurement of the assets acquired and liabilities assumed as of the date of acquisition:

  

   

Amount

 

Current assets

  $ 13,729  

Property, plant and equipment

    10,516  

Goodwill

    60,313  

Other intangibles

       

Customer relationships

    33,300  

Trademarks/trade names

    13,600  

Current liabilities

    (8,153 )

Total purchase price

  $ 123,305  

  

The preliminary expected lives of the acquired intangible assets are 15 years for customer relationships and 10 years for trademarks/trade names.

 

Based on the preliminary fair value measurement of the assets acquired and liabilities assumed, we allocated $60,313 to goodwill for the expected synergies from combining Wisdom Adhesives with our existing business. Such goodwill is deductible for tax purposes. The goodwill was assigned to our Americas Adhesives operating segment. The Wisdom Adhesives acquisition does not represent a material business combination, therefore pro forma financial information is not provided.

 

Cyberbond

 

On June 8, 2016, we acquired Cyberbond, L.L.C., (“Cyberbond”) headquartered in Batavia, Illinois with operations in the United States and Europe. Cyberbond is a provider of industrial adhesives for the electronics, medical, audio equipment, automotive and structural markets. The acquisition will help us to broaden our global position and accelerate our growth in the high margin, high growth Engineering Adhesives segment. The purchase price of $42,182, net of cash acquired of $332, was funded through existing cash and was recorded in our Engineering Adhesives operating segment. We incurred acquisition related costs of approximately $527, which were recorded as SG&A expenses in the Condensed Consolidated Statements of Income for the year ended December 3, 2016.

 

The following table summarizes the final fair value measurement of the assets acquired and liabilities assumed as of the date of acquisition:

  

   

Amount

 

Current assets

  $ 4,425  

Property, plant and equipment

    2,038  

Goodwill

    23,654  

Other intangibles

       

Developed technology

    2,000  

Customer relationships

    14,400  

Trademarks/trade names

    700  

Other assets

    161  

Current liabilities

    (1,889 )

Long-term liabilities

    (3,307 )

Total purchase price

  $ 42,182  

  

The expected lives of the acquired intangible assets are seven years for developed technology, 15 years for customer relationships and 10 years for trademarks/trade names.

 

 

Based on the fair value measurement of the assets acquired and liabilities assumed, we allocated $23,654 to goodwill for the expected synergies from combining Cyberbond with our existing business. Such goodwill is not deductible for tax purposes. The goodwill was assigned to our Engineering Adhesives operating segment. The Cyberbond acquisition does not represent a material business combination, therefore pro forma financial information is not provided.

 

Advanced Adhesives

 

On April 29, 2016, we acquired Advanced Adhesives Pty Limited and the business assets of Advanced Adhesives (New Zealand) Limited (together referred to as “Advanced Adhesives”), providers of industrial adhesives in Australia and New Zealand. The acquisition will help us to strengthen our industrial adhesives market position and leverage a broader technology portfolio in both Australia and New Zealand. The combined purchase price of $10,365 was funded through existing cash and was recorded in our Asia Pacific operating segment. We incurred acquisition related costs of approximately $646, which were recorded as SG&A expenses in the Condensed Consolidated Statements of Income for the year ended December 3, 2016.

 

The following table summarizes the final fair value measurement of the assets acquired and liabilities assumed as of the date of acquisition:

 

   

Amount

 

Current assets

  $ 5,704  

Property, plant and equipment

    594  

Goodwill

    102  

Other intangibles

       

Customer relationships

    7,575  

Trademarks/trade names

    146  

Current liabilities

    (2,671 )

Long-term liabilities

    (1,085 )

Total purchase price

  $ 10,365  

 

The expected lives of the acquired intangible assets are 15 years for customer relationships and one year for trademarks/trade names.

 

Based on the fair value measurement of the assets acquired and liabilities assumed, we allocated $102 to goodwill for the expected synergies from combining Advanced Adhesives with our existing business. Such goodwill is not deductible for tax purposes. The goodwill was assigned to our Asia Pacific operating segment. The Advanced Adhesives acquisition does not represent a material business combination, therefore pro forma financial information is not provided.

 

Note 3: Restructuring Actions

 

Business Integration Project

 

The integration of the industrial adhesives business we acquired in March 2012 involved a significant amount of restructuring and capital investment to optimize the new combined entity. In addition, we took a series of actions in our existing EIMEA operating segment to improve the profitability and future growth prospects of this operating segment. We combined these two initiatives into a single project which we refer to as the “Business Integration Project.” During the first quarter ended February 27, 2016, we incurred costs of $413 related to transformation costs, workforce reduction costs, facility exit costs and other related costs for the Business Integration Project, which are included in special charges, net. The Business Integration Project was substantially complete at the end of 2016.

 

2017 Restructuring Plan

 

During the first quarter of 2017, we approved a restructuring plan (the “2017 Restructuring Plan”) related to organizational changes and other actions to optimize operations. The 2017 Restructuring Plan was implemented in the first quarter of 2017 and is currently expected to be completed by mid-year of fiscal 2018. The 2017 Restructuring Plan resulted in a pre-tax charge of $10,168 during the quarter ended March 4, 2017.

 

 

The following table summarizes the pre-tax distribution of restructuring charges by income statement classification:

 

   

Three Months Ended

 
   

March 4, 2017

 

Cost of sales

  $ 3,647  

Selling, general and administrative

    6,521  
    $ 10,168  

 

The following table summarizes the pre-tax impact of restructuring charges by segment:

 

   

Three Months Ended

 
   

March 4, 2017

 

Americas Adhesives

  $ 1,978  

EIMEA

    4,628  

Asia Pacific

    1,679  

Construction Products

    1,262  

Engineering Adhesives

    621  
    $ 10,168  

  

A summary of the restructuring liability during the first quarter ended March 4, 2017 is presented below:

  

   

Employee-Related

   

Asset-Related

   

Other

   

Total

 
Balance at December 3, 2016   $ -       -       -       -  

Expenses incurred

    8,759       861       548       10,168  

Non-cash charges

    -       (417 )     -       (417 )

Cash payments

    (4,479 )     (444 )     (210 )     (5,133 )

Foreign currency translation

    (49 )     -       -       (49 )

Balance at March 4, 2017

  $ 4,231     $ -     $ 338     $ 4,569  

 

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 on the Condensed Consolidated Balance Sheets.

 

Note 4: Inventories 

      

The composition of inventories is as follows:

 

   

March 4,

   

December 3,

 
   

2017

   

2016

 

Raw materials

  $ 133,615     $ 116,200  

Finished goods

    164,471       142,397  

LIFO reserve

    (11,832 )     (11,198 )

Total inventories

  $ 286,254     $ 247,399  

 

 

Note 5: Goodwill and Other Intangible Assets

 

The goodwill activity for the quarter ended March 4, 2017 is presented below:

 

   

Americas

             

Asia

   

Construction

   

Engineering

         
   

Adhesives

     

EIMEA

   

Pacific

   

Products

   

Adhesives

   

Total

 

Balance at December 3, 2016

  $ 59,821       $ 98,876     $ 17,481     $ 21,901     $ 168,169     $ 366,248  

Acquisitions

    60,313   1     -       -       -       -       60,313  

Currency impact

    (1,676 )       (533 )     (8 )     1       (764 )     (2,980 )

Balance at March 4, 2017

  $ 118,458       $ 98,343     $ 17,473     $ 21,902     $ 167,405     $ 423,581  

 

1

Preliminary goodwill balance as of March 4, 2017.

  

Balances of amortizable identifiable intangible assets, excluding goodwill and other non-amortizable intangible assets, are as follows:

 

   

March 4, 2017

 

Amortizable Intangible Assets

 

Purchased

Technology &

Patents

   

Customer

Relationships

   

All Other

   

Total

 

Original cost

  $ 69,527     $ 286,161     $ 64,164     $ 419,852  

Accumulated amortization

    (26,919 )     (118,071 )     (31,728 )     (176,718 )

Net identifiable intangibles

  $ 42,608     $ 168,090     $ 32,436     $ 243,134  

 

   

December 3, 2016

 

Amortizable Intangible Assets

 

Purchased

Technology &

Patents

   

Customer

Relationships

   

All Other

   

Total

 

Original cost

  $ 70,504     $ 251,329     $ 51,116     $ 372,949  

Accumulated amortization

    (21,448 )     (116,411 )     (30,198 )     (168,057 )

Net identifiable intangibles

  $ 49,056     $ 134,918     $ 20,918     $ 204,892  

  

Amortization expense with respect to amortizable intangible assets was $7,355 and $6,698 for the first three months of 2017 and 2016, respectively.

 

Estimated aggregate amortization expense based on the current carrying value of amortizable intangible assets for the next five fiscal years are as follows:

 

   

Remainder of

                                         

Fiscal Year

 

2017

   

2018

   

2019

   

2020

   

2021

   

Thereafter

 

Amortization Expense

  $ 24,749     $ 32,076     $ 29,910     $ 27,534     $ 26,088     $ 102,777  

 

Non-amortizable intangible assets as of March 4, 2017 are $464 and are related to trademarks and trade names.

 

Note 6: Long-Term Debt

 

On February 14, 2017, we issued $300,000 aggregate principal of 10-year long-term unsecured public notes (“4.000% Notes”) due February 15, 2027 with a fixed coupon of 4.00 percent. Proceeds from this debt issuance were used to repay $138,000 outstanding under the revolving credit facility and prepay $158,750 of our term loan. We entered into interest rate swap agreements to convert $150,000 of the $300,000 4.000% Notes to a variable interest rate of 1-month LIBOR (in advance) plus 1.86 percent. See Note 13 for further discussion of the interest rate swaps.

 

 

We adopted ASU No. 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issue Costs, during the quarter ended March 4, 2017 on a retrospective basis.  The impact of adopting ASU No. 2015-03 on our financial statements was the reclassification of deferred debt issuance costs related to our long-term debt, with the exception of our revolving credit line, from an asset to a direct deduction to the corresponding debt.  Reclassifications from an asset to a direct deduction to the corresponding debt of $4,411 and $2,386 were included in our Condensed Consolidated Balance Sheets as of March 4, 2017 and December 3, 2016, respectively. 

 

Note 7: Redeemable Non-Controlling Interest

 

We account for the non-controlling interest in H.B. Fuller Kimya Sanayi Ticaret A.S. (“HBF Kimya”) as a redeemable non-controlling interest because both the non-controlling shareholder and H.B. Fuller had an option, exercisable beginning August 1, 2018, to require the redemption of the shares owned by the non-controlling shareholder at a price determined by a formula based on 24 months trailing EBITDA. Since the option made the redemption of the non-controlling ownership shares of HBF Kimya outside of our control, these shares are classified as a redeemable non-controlling interest in temporary equity in the Condensed Consolidated Balance Sheets. The non-controlling shareholder was entitled to increase his ownership by 1 percent per year for 5 years up to a maximum of 13 percent ownership based on the achievement of profitability targets in each year. The option was subject to a minimum price of €3,500. The redemption value of the option, if it were currently redeemable, was estimated to be €3,500.

 

The results of operations for the HBF Kimya non-controlling interest is consolidated in our financial statements. Both the non-controlling interest and the accretion adjustment to redemption value are included in net income attributable to non-controlling interests in the Condensed Consolidated Statements of Income and in the carrying value of the redeemable non-controlling interest on the Condensed Consolidated Balance Sheets. HBF Kimya’s functional currency is the Turkish lira and changes in exchange rates affect the reported amount of the redeemable non-controlling interest.

 

During the first quarter of 2017, we entered into an agreement with the non-controlling shareholder to purchase the remaining shares for €4,206. The difference between the non-controlling interest balance and the purchase price was recorded in equity in the first quarter of 2017.

 

   

Redeemable

 
   

Non-Controlling

 
   

Interest

 

Balance at December 3, 2016

  $ 4,277  

Net income attributed to redeemable non-controlling interest

    39  

Purchase of redeemable non-controlling interest

    (4,468 )

Foreign currency translation adjustment

    152  

Balance at March 4, 2017

  $ -  

 

Note 8: Accounting for Share-Based Compensation

 

Overview 

 

We have various share-based compensation programs, which provide for equity awards including non-qualified stock options, restricted stock shares, restricted stock units, performance awards and deferred compensation. These equity awards fall under several plans and are described in detail in our Annual Report on Form 10-K for the year ended December 3, 2016.

 

 

Grant-Date Fair Value 

 

We use the Black-Scholes option pricing model to calculate the grant-date fair value of an award. The fair value of options granted during the quarter ended March 4, 2017 and February 27, 2016 were calculated using the following weighted average assumptions:

 

   

Three Months Ended

 
   

March 4, 2017

   

February 27, 2016

 

Expected life (in years)

      4.75           4.75    

Weighted-average expected volatility

      24.87%           29.03%    

Expected volatility

    24.84% - 24.88%       29.03% - 29.23%  

Risk-free interest rate

      1.89%           1.44%    

Expected dividend yield

      1.12%           1.56%    

Weighted-average fair value of grants

      $10.81           $7.64    

 

Expected life – We use historical employee exercise and option expiration data to estimate the expected life assumption for the Black-Scholes grant-date valuation. We believe that this historical data is currently the best estimate of the expected term of a new option. We use a weighted-average expected life for all awards.

 

Expected volatility – Volatility is calculated using our stock’s historical volatility for the same period of time as the expected life. We have no reason to believe that our future volatility will differ materially from historical volatility.

 

Risk-free interest rate – The rate is based on the U.S. Treasury yield curve in effect at the time of the grant for the same period of time as the expected life.

 

Expected dividend yield – The calculation is based on the total expected annual dividend payout divided by the average stock price.

 

Expense

 

We use the straight-line attribution method to recognize share-based compensation expense for option awards, restricted stock shares and restricted stock units with graded and cliff vesting. Incentive stock options and performance awards are based on certain performance-based metrics and the expense is adjusted quarterly, based on our projections of the achievement of those metrics. The amount of share-based compensation expense recognized during a period is based on the value of the portion of the awards that are ultimately expected to vest. The expense is recognized over the requisite service period, which for us is the period between the grant date and the earlier of the award’s stated vesting term or the date the employee is eligible for early vesting based on the terms of the plans.

 

Total share-based compensation expense of $5,032 and $4,267 was included in our Condensed Consolidated Statements of Income for the first quarter ended March 4, 2017 and February 27, 2016, respectively. All share-based compensation expense was recorded as SG&A expense. For the first quarter ended March 4, 2017, there was $1,053 of excess tax benefit recognized. For the first quarter ended February 27, 2016, there was $341 charged against the APIC pool for tax deficiencies.

 

As of March 4, 2017, there was $11,388 of unrecognized compensation costs related to unvested stock option awards, which is expected to be recognized over a weighted-average period of 1.6 years. Unrecognized compensation costs related to unvested restricted stock units was $18,035, which is expected to be recognized over a weighted-average period of 1.7 years.

 

 

Stock Option Activity

 

The stock option activity for the quarter ended March 4, 2017 is presented below:

 

           

Average

 
   

Options

   

Exercise Price

 

Outstanding at December 3, 2016

    2,986,481     $ 34.92  

Granted

    683,425       49.95  

Exercised

    (261,346 )     32.71  

Forfeited or cancelled

    (66,589 )     36.68  

Outstanding at March 4, 2017

    3,341,971     $ 38.13  

 

The total fair value of options granted during the quarter ended March 4, 2017 and February 27, 2016 were $7,384 and $6,138, respectively. Total intrinsic value of options exercised during the first quarter ended March 4, 2017 and February 27, 2016 were $4,420 and $11, respectively. Intrinsic value is the difference between our closing stock price on the respective trading day and the exercise price, multiplied by the number of options exercised. Proceeds received from option exercises during the first quarter ended March 4, 2017 and February 27, 2016 was $8,549 and $32, respectively.

 

Restricted Stock Activity

 

The nonvested restricted stock activity for the quarter ended March 4, 2017 is presented below:

 

                                   

Weighted-

 
                           

Weighted-

   

Average

 
                           

Average

   

Remaining

 
                           

Grant

   

Contractual

 
                           

Date Fair

   

Life

 
   

Units

   

Shares

   

Total

   

Value

   

(in Years)

 
Nonvested at December 3, 2016     352,744       36,953       389,697     $ 38.36       1.0  
Granted     278,043       -       278,043       49.68       1.9  
Vested     (137,891 )     (36,953)       (174,844 )     39.62       -  
Forfeited     (16,095 )     -       (16,095 )     37.15       1.6  
Nonvested at March 4, 2017     476,801       -       476,801     $ 44.54       1.7  

 

Total fair value of restricted stock vested during the first quarter ended March 4, 2017 and February 27, 2016 was $6,941 and $5,833, respectively. The total fair value of nonvested restricted stock at March 4, 2017 was $21,214.

 

We repurchased 50,687 and 66,447 restricted stock shares during the first quarter ended March 4, 2017 and February 27, 2016, respectively. The repurchases relate to statutory minimum tax withholding. 

 

 

Deferred Compensation Activity

 

We have a Directors’ Deferred Compensation plan that allows non-employee directors to defer all or a portion of their directors’ compensation in a number of investment choices, including units representing shares of our common stock. We also have a Key Employee Deferred Compensation Plan that allows key employees to defer a portion of their eligible compensation in a number of investment choices, including units, representing shares of our common stock. We provide a 10 percent match on deferred compensation invested into units, representing shares of our common stock. The deferred compensation units activity for the quarter ended March 4, 2017 is presented below:

 

   

Non-employee

                 
   

Directors

   

Employees

   

Total

 

Units outstanding December 3, 2016

    424,319       41,116       465,435  

Participant contributions

    4,462       3,964       8,426  

Company match contributions

    446       397       843  

Payouts

    (13,818 )     (6,137 )     (19,955 )

Units outstanding March 4, 2017

    415,409       39,340       454,749  

 

Deferred compensation units are fully vested at the date of contribution.

 

Note 9: Components of Net Periodic Cost (Benefit) related to Pension and Other Postretirement Benefit Plans

 

   

Three Months Ended March 4, 2017 and February 27, 2016

 
                                   

Other

 
   

Pension Benefits

   

Postretirement

 
   

U.S. Plans

   

Non-U.S. Plans

   

Benefits

 

Net periodic cost (benefit):

 

2017

   

2016

   

2017

   

2016

   

2017

   

2016

 

Service cost

  $ 28     $ 27     $ 508     $ 480     $ 52     $ 84  

Interest cost

    3,603       3,767       1,144       1,367       398       480  

Expected return on assets

    (6,364 )     (6,077 )     (2,391 )     (2,482 )     (1,447 )     (1,342 )

Amortization:

                                               

Prior service cost

    7       7       (1 )     (1 )     -       (10 )

Actuarial loss

    1,307       1,293       842       752       253       532  

Net periodic (benefit) cost

  $ (1,419 )   $ (983 )   $ 102     $ 116     $ (744 )   $ (256 )

 

 

 

Note 10: Accumulated Other Comprehensive Income (Loss)

 

The following table provides details of total comprehensive income (loss):

 

   

Three Months Ended March 4, 2017

   

Three Months Ended February 27, 2016

 
   

H.B. Fuller Stockholders

   

Non-

controlling

Interests

   

H.B. Fuller Stockholders

   

Non-

controlling

Interests

 
   

Pre-tax

   

Tax

   

Net

   

Net

   

Pre-tax

   

Tax

   

Net

   

Net

 

Net income including non-controlling interests

    -       -     $ 14,795     $ 36       -       -     $ 18,918     $ 49  

Foreign currency translation adjustment¹

  $ (10,514 )     -       (10,514 )     (5 )   $ (945 )     -       (945 )     (5 )

Reclassification to earnings:

                                                               

Defined benefit pension plans adjustment²

    2,408     $ (818 )     1,590       -       3,997     $ (1,332 )     2,665       -  

Interest rate swap³

    16       (6 )     10       -       13       (3 )     10       -  

Cash-flow hedges³

    209       (80 )     129       -       403       (154 )     249       -  

Other comprehensive income (loss)

  $ (7,881 )   $ (904 )     (8,785 )     (5 )   $ 3,468     $ (1,489 )     1,979       (5 )

Comprehensive income (loss)

                  $ 6,010     $ 31                     $ 20,897     $ 44  

  

¹ Income taxes are not provided for foreign currency translation relating to permanent investments in international subsidiaries. As discussed in Note 1, the foreign currency translation adjustment for the quarter ended March 4, 2017 includes the impact of the change in functional currency for our subsidiaries in Latin America.

 

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, SG&A expense and special charges, net.

 

³ Loss reclassified from AOCI into earnings is reported in other income (expense), net.

 

The components of accumulated other comprehensive loss is as follows:

 

   

March 4, 2017

 
   

Total

   

H.B. Fuller

Stockholders

   

Non-

controlling

Interests

 

Foreign currency translation adjustment

  $ (95,966 )   $ (95,895 )   $ (71 )

Defined benefit pension plans adjustment, net of taxes of $89,916

    (174,511 )     (174,511 )     -  

Interest rate swap, net of taxes of ($23)

    38       38       -  

Cash-flow hedges, net of taxes of $705

    (1,146 )     (1,146 )     -  

Accumulated other comprehensive loss

  $ (271,585 )   $ (271,514 )   $ (71 )

 

 

   

December 3, 2016

 
   

Total

   

H.B. Fuller

Stockholders

   

Non-

controlling

Interests

 

Foreign currency translation adjustment

  $ (85,447 )   $ (85,381 )   $ (66 )

Defined benefit pension plans adjustment, net of taxes of $90,734

    (176,101 )     (176,101 )     -  

Interest rate swap, net of taxes of ($17)

    28       28       -  

Cash-flow hedges, net of taxes of $785

    (1,275 )     (1,275 )     -  

Accumulated other comprehensive loss

  $ (262,795 )   $ (262,729 )   $ (66 )

 

Note 11: Income Taxes

 

As of March 4, 2017, we had a liability of $4,354 recorded under FASB ASC 740, Income Taxes, for gross unrecognized tax benefits (excluding interest), compared to $4,165 as of December 3, 2016. As of March 4, 2017, we had accrued $711 of gross interest relating to unrecognized tax benefits. For the quarter ended March 4, 2017, our recorded liability for gross unrecognized tax benefits increased by $189.

 

Note 12: Earnings Per Share

 

A reconciliation of the common share components for the basic and diluted earnings per share calculations is as follows:

 

   

Three Months Ended

 
   

March 4,

   

February 27,

 

(Shares in thousands)

 

2017

   

2016

 

Weighted-average common shares - basic

    50,243       49,958  

Equivalent shares from share-based compensations plans

    1,217       1,037  

Weighted-average common and common equivalent shares - diluted

    51,460       50,995  

 

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, (b) the amount of unearned share-based compensation costs attributed to future services and (c) the amount of tax benefits, if any, that would be credited to additional paid-in capital assuming exercise of the award. 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.

 

Options to purchase 632,720 and 1,495,004 shares of common stock at a weighted-average exercise price of $50.10 and $42.88 for the quarters ended March 4, 2017 and February 27, 2016, respectively, were excluded from the diluted earnings per share calculations because they were antidilutive. 

 

Note 13: Financial Instruments

 

Overview

 

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 statement of cash flows in the same category as the cash flows from the items subject to designated hedge or undesignated (economic) hedge relationship. 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 monitors the credit quality of each of these banks on 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

 

Effective February 24, 2017, we entered into a cross-currency swap agreement to convert a notional amount of $42,600 of foreign currency denominated intercompany loans into U.S. dollars. The swap matures in 2020. Effective October 7, 2015, we entered into three cross-currency swap agreements to convert a notional amount of $134,736 of foreign currency denominated intercompany loans into U.S. dollars. The first swap matures in 2017, the second swap matures in 2018 and the third swap matures in 2019.

 

As of March 4, 2017, the combined fair value of the swaps was an asset of $4,971 and was included in other assets in the Condensed 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 Condensed Consolidated Balance Sheets. The difference 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 (expense), net in the Condensed 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 ineffectiveness calculations as of March 4, 2017 resulted in additional pre-tax loss of $20 for the three months ended March 4, 2017 as the change in fair value of the cross-currency swaps was less than the change in the fair value of the hypothetical swaps. The amount in accumulated other comprehensive income (loss) related to cross-currency swaps was a loss of $1,146 as of March 4, 2017. The estimated net amount of the existing loss that is reported in accumulated other comprehensive income (loss) as of March 4, 2017 that is expected to be reclassified into earnings within the next twelve months is $986. As of March 4, 2017, 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 March 4, 2017:

  

   

Fiscal Year of

Expiration

 

Interest Rate

   

Notional

Value

   

Fair Value

 

Pay EUR

 

2017

    3.05 %   $ 44,912     $ 2,181  
Receive USD         3.9145 %                
                             

Pay EUR

 

2018

    3.45 %   $ 44,912     $ 1,750  
Receive USD         4.5374 %                
                             

Pay EUR

 

2019

    3.80 %   $ 44,912     $ 1,329  
Receive USD         5.0530 %                
                             

Pay EUR

 

2020

    1.95 %   $ 42,600     $ (289 )
Receive USD         4.30375 %                

Total

              $ 177,336     $ 4,971  

 

Except for the cross-currency swap agreements listed above, foreign currency derivative instruments outstanding are not designated as hedges for accounting purposes. The gains and losses related to mark-to-market adjustments are recognized as other income or expense in the Condensed Consolidated Statements of Income during the periods in which the derivative instruments are outstanding. See Note 14 for the fair value amounts of these derivative instruments.

 

 

As of March 4, 2017, we had forward foreign currency contracts maturing between March 21, 2017 and April 13, 2018. The mark-to-market effect associated with these contracts, on a net basis, was a gain of $3,117 as of March 4, 2017. These gains were largely offset by the underlying transaction gains and losses resulting from the foreign currency exposures for which these contracts relate.

 

Fair Value Hedges

 

We entered into interest rate swap agreements to convert $150,000 of our $300,000 4.000% Notes that were issued on February 14, 2017 to a variable interest rate of 1-month LIBOR (in advance) plus 1.86 percent. See Note 6 for further discussion on the issuance of our 4.000% Notes. The combined fair value of the interest rate swaps in total was a liability of $3,135 at March 4, 2017 and was included in other liabilities in the Condensed Consolidated Balance Sheets. The swaps were designated for hedge accounting treatment as fair value hedges. We are applying the shortcut method in accounting for these interest rate swaps as we expect that the changes in the fair value of the swap will offset the changes in the fair value of the 4.000% Notes resulting in no ineffectiveness. As a result of applying the shortcut method, the change in the fair value of the interest rate swap and an equivalent amount for the change in the fair value of the debt will be reflected in other income (expense) and no ineffectiveness will be recognized in our Condensed Consolidated Statements of Income.

 

We have interest rate swap agreements to convert $75,000 of our senior notes to variable interest rates. The change in fair value of the senior notes, attributable to the change in the risk being hedged, was a liability of $1,107 at March 4, 2017 and was included in long-term debt and current maturities of long-term debt in the Condensed Consolidated Balance Sheets. The combined fair value of the swaps in total was an asset of $1,077 at March 4, 2017 and $1,579 at December 3, 2016 and were included in other assets in the Condensed Consolidated Balance Sheets. The swaps were designated for hedge accounting treatment as fair value hedges. The changes in the fair value of the swap and the fair value of the senior notes attributable to the change in the risk being hedged are recorded as other income (expense), net in the Condensed 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. For the three months ended March 4, 2017 and February 27, 2016, a pre-tax gain of $3 and $143, respectively, was recorded as the fair value of the interest rate swaps decreased by more than the change in the fair value of the Senior Notes attributable to the change in the risk being hedged.

 

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 March 4, 2017, there were no significant concentrations of credit risk.

 

Note 14: Fair Value Measurements

 

Overview

 

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 March 4, 2017 and December 3, 2016, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.

 

   

March 4,

   

Fair Value Measurements Using:

 

Description

 

2017

   

Level 1

   

Level 2

   

Level 3

 

Assets:

                               

Marketable securities

  $ 1,245     $ 1,245     $ -     $ -  

Foreign exchange contract assets

    3,991       -       3,991       -  

Interest rate swaps

    1,077       -       1,077       -  

Cash-flow hedges

    5,260       -       5,260       -  
                                 

Liabilities:

                               

Foreign exchange contract liabilities

  $ 874     $ -     $ 874     $ -  

Interest rate swaps

    3,135       -       3,135       -  

Contingent consideration liability

    4,706       -       -       4,706  

Cash-flow hedges

    289       -       289       -  

  

   

December 3,

   

Fair Value Measurements Using:

 

Description

 

2016

   

Level 1

   

Level 2

   

Level 3

 

Assets:

                               

Marketable securities