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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 3, 2018

 

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,” “smaller reporting company” and “emerging growth 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 [  ]
  Emerging growth company [  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 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 50,553,159 as of March 29, 2018.

 

 

 

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 3, 2018 and March 4, 2017

3

     
 

Condensed Consolidated Statements of Comprehensive Income for the three months ended March 3, 2018 and March 4, 2017

4

     
 

Condensed Consolidated Balance Sheets as of March 3, 2018 and December 2, 2017

5

     
 

Condensed Consolidated Statements of Total Equity as of March 3, 2018 and December 2, 2017

6

     
 

Condensed Consolidated Statements of Cash Flows for the three months ended March 3, 2018 and March 4, 2017

7

     
 

Notes to Condensed Consolidated Financial Statements

8

     

ITEM 2.

MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

29

     

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

39

     

ITEM 4.

CONTROLS AND PROCEDURES

40

     

PART II. OTHER INFORMATION

41

     

ITEM 1.

LEGAL PROCEEDINGS

41

     

ITEM 1A.

RISK FACTORS

42

     

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

43

     

ITEM 6.

EXHIBITS

44

     

SIGNATURES

45

 

 

 

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 3,

   

March 4,

 
   

2018

   

2017

 

Net revenue

  $ 713,079     $ 503,323  

Cost of sales

    (525,374 )     (364,327 )

Gross profit

    187,705       138,996  

Selling, general and administrative expenses

    (151,020 )     (112,915 )

Other income (expense), net

    4,074       621  

Interest expense

    (27,545 )     (8,380 )

Income before income taxes and income from equity method investments

    13,214       18,322  

Income taxes

    32,632       (5,765 )

Income from equity method investments

    1,821       2,274  

Net income including non-controlling interests

    47,667       14,831  

Net income (loss) attributable to non-controlling interests

    15       (36 )

Net income attributable to H.B. Fuller

  $ 47,682     $ 14,795  
                 

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

 

Basic

    0.94       0.29  

Diluted

    0.92       0.29  
                 

Weighted-average common shares outstanding:

               

Basic

    50,471       50,243  

Diluted

    51,898       51,460  
                 

Dividends declared per common share

  $ 0.15     $ 0.14  

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

 

H.B. FULLER COMPANY AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(In thousands)

(Unaudited)

 

   

Three Months Ended

 
   

March 3,

   

March 4,

 
   

2018

   

2017

 

Net income including non-controlling interests

  $ 47,667     $ 14,831  

Other comprehensive income (loss)

               

Foreign currency translation

    21,455       (10,519 )

Defined benefit pension plans adjustment, net of tax

    1,660       1,590  

Interest rate swaps, net of tax

    15,952       10  

Cash-flow hedges, net of tax

    (6,841 )     129  

Other comprehensive income (loss)

    32,226       (8,790 )

Comprehensive income

    79,893       6,041  

Less: Comprehensive (loss) income attributable to non-controlling interests

    (28 )     31  

Comprehensive income attributable to H.B. Fuller

  $ 79,921     $ 6,010  

 

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 3,

   

December 2,

 
   

2018

   

2017

 

Assets

               

Current assets:

               

Cash and cash equivalents

  $ 132,478     $ 194,398  

Trade receivables (net of allowances of $13,101 and $11,670, as of March 3, 2018 and December 2, 2017, respectively)

    466,876       473,700  

Inventories

    410,205       359,505  

Other current assets

    107,922       117,389  

Total current assets

    1,117,481       1,144,992  
                 

Property, plant and equipment

    1,316,084       1,288,287  

Accumulated depreciation

    (640,708 )     (618,093 )

Property, plant and equipment, net

    675,376       670,194  
                 

Goodwill

    1,361,331       1,336,684  

Other intangibles, net

    982,889       1,001,792  

Other assets

    236,976       206,984  

Total assets

  $ 4,374,053     $ 4,360,646  
                 

Liabilities, non-controlling interest and total equity

               

Current liabilities:

               

Notes payable

  $ 31,167     $ 31,468  

Current maturities of long-term debt

    81,220       21,515  

Trade payables

    257,417       268,467  

Accrued compensation

    64,121       84,903  

Income taxes payable

    15,299       14,335  

Other accrued expenses

    73,603       84,225  

Total current liabilities

    522,827       504,913  
                 

Long-term debt, excluding current maturities

    2,328,819       2,398,927  

Accrued pension liabilities

    78,346       71,205  

Other liabilities

    323,673       341,581  

Total liabilities

    3,253,665       3,316,626  
                 

Commitments and contingencies (Note 16)

               
                 

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 – 50,533,050 and 50,388,839, as of March 3, 2018 and December 2, 2017, respectively

    50,533       50,389  

Additional paid-in capital

    78,642       74,662  

Retained earnings

    1,177,605       1,119,231  

Accumulated other comprehensive loss

    (186,757 )     (200,655 )

Total H.B. Fuller stockholders' equity

    1,120,023       1,043,627  

Non-controlling interest

    365       393  

Total equity

    1,120,388       1,044,020  

Total liabilities, non-controlling interest and total equity

  $ 4,374,053     $ 4,360,646  

 

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 December 3, 2016

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

Comprehensive income

    -       -       58,242       62,074       39       120,355  

Dividends

    -       -       (29,911 )     -       -       (29,911 )

Stock option exercises

    514       17,191       -       -       -       17,705  

Share-based compensation plans other, net

    165       17,203       -       -       -       17,368  

Tax benefit on share-based compensation plans

    -       2,010       -       -       -       2,010  

Repurchases of common stock

    (431 )     (21,400 )     -       -       -       (21,831 )

Purchase of redeemable non-controlling interest

    -       94       -       -       -       94  

Redeemable non-controlling interest

    -       -       -       -       (39 )     (39 )

Balance at December 2, 2017

    50,389       74,662       1,119,231       (200,655 )     393       1,044,020  

Comprehensive income (loss)

    -       -       47,682       32,239       (28 )     79,893  

Dividends

    -       -       (7,649 )     -       -       (7,649 )

Stock option exercises

    27       735       -       -       -       762  

Share-based compensation plans other, net

    180       6,450       -       -       -       6,630  

Repurchases of common stock

    (63 )     (3,205 )     -       -       -       (3,268 )

Reclassification of AOCI tax effects

    -       -       18,341       (18,341 )     -       -  

Balance at March 3, 2018

  $ 50,533     $ 78,642     $ 1,177,605     $ (186,757 )   $ 365     $ 1,120,388  

 

 

 

H.B. FULLER COMPANY AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

   

Three Months Ended

 
   

March 3, 2018

   

March 4, 2017

 

Cash flows from operating activities:

               

Net income including non-controlling interests

  $ 47,667     $ 14,831  

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

               

Depreciation

    17,422       11,945  

Amortization

    19,243       7,355  

Deferred income taxes

    (50,613 )     (246 )

Income from equity method investments, net of dividends received

    (1,821 )     (2,274 )

Gain on sale of assets

    (2,098 )     (95 )

Share-based compensation

    5,651       5,032  

Excess tax benefit from share-based compensation

    -       (1,053 )

Loss on mark to market adjustment related to contingent consideration liability

    48       37  

Non-cash charge for sale of inventories revalued at acquisition

    -       193  

Change in assets and liabilities, net of effects of acquisitions:

         

Trade receivables, net

    16,613       4,884  

Inventories

    (46,713 )     (32,597 )

Other assets

    (38,137 )     3,960  

Trade payables

    (5,016 )     23,989  

Accrued compensation

    (22,211 )     (7,540 )

Other accrued expenses

    (10,465 )     (8,089 )

Income taxes payable

    8,733       (1,109 )

Accrued / prepaid pensions

    (2,218 )     (1,361 )

Other liabilities

    29,897       1,754  

Other

    1,939       (3,157 )

Net cash (used in) provided by operating activities

    (32,079 )     16,459  
                 

Cash flows from investing activities:

               

Purchased property, plant and equipment

    (18,555 )     (19,899 )

Purchased businesses, net of cash acquired

    -       (123,305 )

Purchased investments

    -       (1,250 )

Proceeds from sale of property, plant and equipment

    1,367       109  

Net cash used in investing activities

    (17,188 )     (144,345 )
                 

Cash flows from financing activities:

               

Proceeds from issuance of long-term debt

    -       453,000  

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

    (5,375 )     (356,610 )

Net proceeds from notes payable

    231       8,438  

Dividends paid

    (7,642 )     (7,048 )

Purchase of redeemable non-controlling interest

    -       (3,127 )

Proceeds from stock options exercised

    762       8,549  

Excess tax benefit from share-based compensation

    -       1,053  

Repurchases of common stock

    (3,268 )     (2,430 )

Net cash (used in) provided by financing activities

    (15,292 )     101,825  
                 

Effect of exchange rate changes on cash and cash equivalents

    2,639       334  

Net change in cash and cash equivalents

    (61,920 )     (25,727 )
                 

Cash and cash equivalents at beginning of period

    194,398       142,245  

Cash and cash equivalents at end of period

  $ 132,478     $ 116,518  
                 

Supplemental disclosure of cash flow information:

               

Dividends paid with company stock

  $ 7     $ 2  

Cash paid for interest, net of amount capitalized of $66 and $23 for the periods ended March 3, 2018 and March 4, 2017, respectively

  $ 29,701     $ 6,979  

Cash paid for income taxes, net of refunds

  $ 9,797     $ 6,539  

 

 

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 2, 2017 as filed with the Securities and Exchange Commission.

 

New Accounting Pronouncements

 

In February 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.  The ASU addresses the stranded income tax effects in accumulated other comprehensive income resulting from the “Tax Cuts and Jobs Act”, hereafter referred to as “U.S. Tax Reform”.  In accordance with ASC Topic 740, the effect of the reduced corporate income tax rate on deferred tax assets and liabilities is included in income from continuing operations during the three months ended March 3, 2018.  Tax effects on items within accumulated other comprehensive income were left stranded at the historical tax rate.  This guidance allows entities to reclassify the stranded income tax effects from accumulated other comprehensive income to retained earnings.  Our effective date for adoption of ASU No. 2018-02 is our fiscal year beginning December 1, 2019, with early adoption permitted. We elected to early adopt the guidance during the three months ended March 3, 2018 using the security-by-security approach.  The adoption of this ASU resulted in an $18,341 reclassification from accumulated other comprehensive income (loss) to retained earnings due to the change in the federal corporate tax rate.

 

In May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting. The ASU was issued to provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. Our effective date for adoption of this guidance is our fiscal year beginning December 2, 2018 with early adoption permitted. We will apply this guidance to applicable transactions after the adoption date.

 

In March 2017, the FASB issued 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 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. 2016-16, 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.  We adopted this guidance during the three months ended March 3, 2018.  As a result of adoption, excess tax benefits/deficiencies are now recorded as income tax expense and are dependent upon market prices and the volume of stock option exercises and restricted stock vestings during the reporting period. Excess tax benefits of $636 were recorded as a reduction to income tax expense within the Condensed Consolidated Statement of Income during the three months ended March 3, 2018.  Excess tax benefits/deficiencies are now also classified as operating activities within the statement of cash flows and are excluded from the calculation of assumed proceeds available to repurchase shares under the treasury stock method.  Cash payments to tax authorities for withheld shares in net-settlement features are classified as financing activities. These changes are applied prospectively, with the exception of the classification of cash payments to tax authorities in the statement of cash flows, which were already classified as financing activities. Therefore, no prior period adjustments were made as a result of the adoption of this guidance. We are continuing our existing practice of estimating the number of awards that will be forfeited in accordance with this ASU.

 

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. We adopted this guidance during the three months ended March 3, 2018 on a prospective basis.

 

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 continuing to evaluate the effect this guidance will have on our Consolidated Financial Statements, including potential impacts on the timing of revenue recognition and additional information that may be necessary for expanded disclosures regarding revenue. We have conducted initial analyses, developed project management relative to the process of adopting this ASU, and will be completing contract reviews to determine necessary adjustments to existing accounting policies and to support an evaluation of this ASU’s impact on the Company’s consolidated results of operations and financial condition. For the majority of our revenue arrangements, no significant impacts are expected as these transactions are not accounted for under industry-specific guidance that will be superseded by the ASU and generally consist of a single performance obligation to transfer promised goods or services. We have not concluded as to whether the new guidance will be adopted on a full or modified retrospective basis, but did not apply the early adoption provisions of the new guidance.

 

 

Note 2: Acquisitions

 

Adecol

 

On November 1, 2017, we acquired Adecol Industria Quimica, Limitada (“Adecol”), headquartered in Guarulhos, Brazil. Adecol works with customers to develop innovative, high-quality hot melt, reactive and polymer-based adhesive solutions in the packaging, converting and assembly markets. The acquisition is expected to enhance our business in Brazil by partnering with customers to produce new and better consumer and durable goods products in this region. The purchase price was 145.9 million Brazilian real, or approximately $44,682, and was funded through borrowings on our revolving credit facility and existing cash. Adecol is reported in our Americas Adhesives operating segment.

 

 

The acquisition fair value measurement was preliminary as of March 3, 2018, subject to the completion of the valuation of Adecol 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:

 

 

   

December 2, 2017

   

Adjustments

   

March 3, 2018

 

Current assets

  $ 17,877     $ (1,131 )   $ 16,746  

Property, plant and equipment

    7,308       302       7,610  

Goodwill

    23,282       651       23,933  

Other intangibles

                       

Customer relationships

    17,016       (383 )     16,633  

Trademarks/trade names

    1,363       (65 )     1,298  

Other assets

    4,811       -       4,811  

Current liabilities

    (12,765 )     291       (12,474 )

Other liabilities

    (14,210 )     335       (13,875 )

Total purchase price

  $ 44,682     $ -     $ 44,682  

 

The preliminary expected lives of the acquired intangible assets are 13 years for customer relationships and five years for trademarks/trade names.

 

Based on the preliminary fair value measurement of the assets acquired and liabilities assumed, we allocated $23,933 to goodwill for the expected synergies from combining Adecol with our existing business. Such goodwill is not deductible for tax purposes. The goodwill was assigned to our Americas Adhesives operating segment. 

 

Royal Adhesives

 

On October 20, 2017, we acquired Royal Adhesives and Sealants (“Royal Adhesives”), a manufacturer of high-value specialty adhesives and sealants. Royal Adhesives is a supplier of industrial adhesives in a diverse set of end markets, including aerospace, transportation, commercial roofing, insulating glass, solar, packaging and flooring applications and operates 19 manufacturing facilities in five countries. The acquisition is expected to expand our presence in North America, Europe and China and add new technology and packaging capabilities. The purchase price of $1,622,728 was funded through new debt financing. Royal Adhesives is included in multiple operating segments for the three months ended March 3, 2018. See Note 17 for further information on the change to our operating segments for the Royal acquisition. 

 

The acquisition fair value measurement was preliminary as of March 3, 2018, subject to the completion of the valuation of Royal 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:

 

   

December 2, 2017

   

Adjustments

   

March 3, 2018

 

Accounts receivable

  $ 64,904     $ 278     $ 65,182  

Inventory

    93,680       -       93,680  

Other current assets

    58,508       528       59,036  

Property, plant and equipment

    126,192       -       126,192  

Goodwill

    866,013       6,475       872,488  

Other intangibles

                       

Developed technology

    59,800       (300 )     59,500  

Customer relationships

    645,300       (6,500 )     638,800  

Trademarks/trade names

    53,600       (300 )     53,300  

Other assets

    1,443       -       1,443  

Accounts payable

    (40,211 )     1,477       (38,734 )

Other current liabilities

    (37,261 )     (3,065 )     (40,326 )

Other liabilities

    (269,240 )     1,407       (267,833 )

Total purchase price

  $ 1,622,728     $ -     $ 1,622,728  

 

The preliminary expected lives of the acquired intangible assets are 15 years for developed technology, 18 years for customer relationships and 15 years for trademarks/trade names.

 

Based on the preliminary fair value measurement of the assets acquired and liabilities assumed, we allocated $872,488 to goodwill for the expected synergies from combining Royal Adhesives with our existing business. The goodwill was assigned to multiple operating segments. The amount of goodwill that is deductible for tax purposes is $38,275. The remaining goodwill is not deductible for tax purposes.

 

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 durable assembly markets. The acquisition is expected to strengthen our position in the North America adhesives market. The purchase price of $123,549 was financed through borrowings on our revolving credit facility and is reported 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 Statement of Income for the three months ended March 4, 2017.

 

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

 

   

December 2, 2017

 

Current assets

  $ 13,844  

Property, plant and equipment

    8,641  

Goodwill

    59,826  

Other intangibles

       

Customer relationships

    45,300  

Trademarks/trade names

    4,400  

Current liabilities

    (8,462 )

Total purchase price

  $ 123,549  

 

The expected lives of the acquired intangible assets are 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 $59,826 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.

 

 

Note 3: Restructuring Actions

 

During the three months ended March 3, 2018, we approved a restructuring plan consisting of consolidation plans, organizational changes and other actions related to the integration of the operations of Royal Adhesives with the operations of the Company. During the three months ended March 4, 2017, we approved a restructuring plan related to organizational changes and other actions to optimize operations. We recorded a pre-tax charge of $1,829 and $10,168 during the three months ended March 3, 2018 and March 4, 2017 respectively, related to these plans.

 

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

 

   

Three Months Ended

   

Three Months Ended

 
   

March 3, 2018

   

March 4, 2017

 

Cost of sales

  $ 232     $ 3,647  

Selling, general and administrative

    1,597       6,521  
    $ 1,829     $ 10,168  

 

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

 

   

Three Months Ended

   

Three Months Ended

 
   

March 3, 2018

   

March 4, 2017

 

Americas Adhesives

  $ 803     $ 1,978  

EIMEA

    (42 )     4,628  

Asia Pacific

    3       1,679  

Construction Adhesives

    809       1,262  

Engineering Adhesives

    256       621  
    $ 1,829     $ 10,168  

 

 

A summary of the restructuring liability is presented below:

 

   

Employee-

Related

   

Asset-Related

   

Other

   

Total

 
Balance at December 3, 2016   $ -     $ -     $ -     $ -  

Expenses incurred

    10,266       5,394       2,371       18,031  

Non-cash charges

    -       (4,291 )     -       (4,291 )

Cash payments

    (9,210 )     (1,103 )     (2,351 )     (12,664 )

Foreign currency translation

    430       -       -       430  

Balance at December 2, 2017

  $ 1,486     $ -     $ 20     $ 1,506  

Expenses incurred

    1,528       147       154       1,829  

Cash payments

    (598 )     (147 )     (139 )     (884 )

Foreign currency translation

    37       -       -       37  

Balance at March 3, 2018

  $ 2,453     $ -     $ 35     $ 2,488  

 

 

Non-cash charges for the year ended December 2, 2017 include accelerated depreciation resulting from the cessation of use of certain long-lived assets and the recording of a provision related to the discontinuance of certain retail and wholesale products. 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 3,

   

December 2,

 
   

2018

   

2017

 

Raw materials

  $ 198,992     $ 174,325  

Finished goods

    224,306       198,273  

LIFO reserve

    (13,093 )     (13,093 )

Total inventories

  $ 410,205     $ 359,505  

 

 

Note 5: Goodwill and Other Intangible Assets

 

The goodwill activity for the three months ended March 3, 2018 is presented below:

 

   

Americas

           

Asia

   

Construction

   

Engineering

         
   

Adhesives

   

EIMEA

   

Pacific

   

Adhesives

   

Adhesives

   

Total

 

Balance at December 2, 2017

  $ 373,328     $ 177,464     $ 21,514     $ 324,860     $ 439,518     $ 1,336,684  

Acquisitions 1

    2,382       518       25       2,258       1,943       7,126  

Currency impact

    3,045       8,588       92       (166 )     5,962       17,521  

Balance at March 3, 2018

  $ 378,755     $ 186,570     $ 21,631     $ 326,952     $ 447,423     $ 1,361,331  

 

1

Adjustments to preliminary goodwill for Royal Adhesives and Adecol as of March 3, 2018.

 

 

As discussed in Note 17, as of the beginning of the three months ended March 3, 2018, we modified our operating segment structure by allocating the Royal Adhesives segment into each of the five other segments. This resulted in a change in our reporting units. We allocated goodwill to our reporting units using the relative fair value approach.

 

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

 

   

March 3, 2018

 

Amortizable Intangible Assets

 

Purchased

Technology &

Patents

   

Customer

Relationships

   

All Other

   

Total

 

Original cost

  $ 132,528     $ 968,303     $ 110,604     $ 1,211,435  

Accumulated amortization

    (29,998 )     (158,256 )     (40,848 )     (229,102 )

Net identifiable intangibles

  $ 102,530     $ 810,047     $ 69,756     $ 982,333  

 

   

December 2, 2017

 

Amortizable Intangible Assets

 

Purchased

Technology &

Patents

   

Customer

Relationships

   

All Other

   

Total

 

Original cost

  $ 132,495     $ 968,060     $ 110,576     $ 1,211,131  

Accumulated amortization

    (27,478 )     (144,964 )     (37,417 )     (209,859 )

Net identifiable intangibles

  $ 105,017     $ 823,096     $ 73,159     $ 1,001,272  

 

 

Amortization expense with respect to amortizable intangible assets was $19,243 and $7,355 for the three months ended March 3, 2018 and March 4, 2017, 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

 

2018

   

2019

   

2020

   

2021

   

2022

   

Thereafter

 

Amortization Expense

  $ 57,416     $ 75,846     $ 73,309     $ 71,767     $ 69,193     $ 634,802  

 

Non-amortizable intangible assets as of March 3, 2018 and December 2. 2017 are $556 and $520, respectively and are related to trademarks and trade names.

 

 

 

Note 6: Long-Term Debt

 

On February 27, 2018 we entered into an interest rate swap agreement to convert $200,000 of our Term Loan B Credit Agreement (“Term Loan B”) issued on October 20, 2017 to a fixed interest rate of 4.839 percent.  See Note 13 for further discussion of the issuance of these interest rate swaps.

 

Subsequent to March, 3, 2018, we entered into interest rate swap agreements to convert $300,000 of our Term Loan B Credit Agreement to a fixed interest rate of 4.5305 percent.

 

 

Note 7: Redeemable Non-Controlling Interest

 

Prior to the end of the first quarter of 2017, we had a non-controlling interest in H.B. Fuller Kimya Sanayi Ticaret A.S. (“HBF Kimya”) which was accounted for 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 were classified as a redeemable non-controlling interest in temporary equity in the 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 results of operations for the HBF Kimya non-controlling interest were consolidated in our financial statements. Both the non-controlling interest and the accretion adjustment to redemption value were included in net income attributable to non-controlling interests in the Consolidated Statements of Income for the three months ended March 4, 2017.

 

During the three months ended March 4, 2017, we purchased the remaining shares from the non-controlling shareholder for €4,206. The difference between the non-controlling interest balance and the purchase price was recorded in additional paid-in capital for the three months ended 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 2, 2017.

 

During the three months ended March 3, 2018, we adopted ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting.  The adoption is required to be implemented prospectively.  See Note 1 for additional information regarding ASU No. 2016-09.

 

 

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 three months ended March 3, 2018 and March 4, 2017 was calculated using the following weighted average assumptions:

 

   

Three Months Ended

 
   

March 3, 2018

   

March 4, 2017

 

Expected life (in years)

      4.75           4.75    

Weighted-average expected volatility

      23.26%           24.87%    

Expected volatility

    23.18% - 23.26%       24.84% - 24.88%  

Risk-free interest rate

    2.38% - 2.53%         1.89%    

Expected dividend yield

      1.12%           1.12%    

Weighted-average fair value of grants

      $11.37           $10.81    

 

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 $5,651 and $5,032 was included in our Condensed Consolidated Statements of Income for the three months ended March 3, 2018 and March 4, 2017, respectively. All share-based compensation expense was recorded as SG&A expense. Beginning with the three months ended March 3, 2018, excess tax benefits are recorded as income tax expense in accordance with ASU No. 2016-09. For the three months ended March 4, 2017, there was $1,053 of excess tax benefit recognized in additional paid-in capital.

 

As of March 3, 2018, there was $19,196 of unrecognized compensation costs related to unvested stock option awards, which is expected to be recognized over a weighted-average period of 1.8 years. Unrecognized compensation costs related to unvested restricted stock units was $16,181, which is expected to be recognized over a weighted-average period of 1.6 years.

 

 

 

Stock Option Activity

 

The stock option activity for the three months ended March 3, 2018 is presented below:

 

           

Average

 
   

Options

   

Exercise Price

 

Outstanding at December 2, 2017

    3,860,764     $ 42.28  

Granted

    672,373       53.40  

Exercised

    (26,616 )     28.65  

Forfeited or cancelled

    (1,821 )     43.58  

Outstanding at March 3, 2018

    4,504,700     $ 41.73  

 

The fair value of options granted during the three months ended March 3, 2018 and March 4, 2017 was $7,645 and $7,384, respectively.  Total intrinsic value of options exercised during the three months ended March 3, 2018 and March 4, 2017 was $638 and $4,420, 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 three months ended March 3, 2018 and March 4, 2017 were $762 and $8,549, respectively.

 

Restricted Stock Activity

 

The nonvested restricted stock activity for the three months ended March 3, 2018 is presented below:

 

                   

Weighted-

 
           

Weighted-

   

Average

 
           

Average

   

Remaining

 
           

Grant

   

Contractual

 
           

Date Fair

   

Life

 
   

Units

   

Value

   

(in Years)

 

Nonvested at December 2, 2017

    462,241     $ 44.80       1.0  

Granted

    132,634       53.56       2.9  

Vested

    (167,419 )     42.45       -  

Forfeited

    (848 )     45.34       1.6  

Nonvested at March 3, 2018

    426,608     $ 47.63       1.6  

 

Total fair value of restricted stock vested during the three months ended March 3, 2018 and March 4, 2017 was $7,900 and $6,941, respectively. The total fair value of nonvested restricted stock at March 3, 2018 was $20,320.

 

We repurchased 63,540 and 50,687 restricted stock shares during the three months ended March 3, 2018 and March 4, 2017, 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 unit activity for the three months ended March 3, 2018 is presented below:

 

   

Non-employee

                 
   

Directors

   

Employees

   

Total

 

Units outstanding December 2, 2017

    443,570       31,606       475,176  

Participant contributions

    4,041       2,891       6,932  

Company match contributions

    404       289       693  

Payouts

    -       (3,532 )     (3,532 )

Units outstanding March 3, 2018

    448,015       31,254       479,269  

 

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 3, 2018 and March 4, 2017

 
                                   

Other

 
   

Pension Benefits

   

Postretirement

 
   

U.S. Plans

   

Non-U.S. Plans

   

Benefits

 

Net periodic cost (benefit):

 

2018

   

2017

   

2018

   

2017

   

2018

   

2017

 

Service cost

  $ 14     $ 28     $ 598     $ 508     $ 43     $ 52  

Interest cost

    3,419       3,603       1,204       1,144       371       398  

Expected return on assets

    (6,541 )     (6,364 )     (2,864 )     (2,391 )     (1,724 )     (1,447 )

Amortization:

                                               

Prior service cost

    7       7       (1 )     (1 )     -       -  

Actuarial loss

    1,475       1,307       749       842       15       253  

Net periodic (benefit) cost

  $ (1,626 )   $ (1,419 )   $ (314 )   $ 102     $ (1,295 )   $ (744 )

 

 

 

 

Note 10: Accumulated Other Comprehensive Income (Loss)

 

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

 

   

Three Months Ended March 3, 2018

   

Three Months Ended March 4, 2017

 
   

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

    -       -     $ 47,682     $ (15 )     -       -     $ 14,795     $ 36  

Foreign currency translation adjustment¹

  $ 21,468       -       21,468       (13 )   $ (10,514 )     -       (10,514 )     (5 )

Reclassification to earnings:

                                                               

Defined benefit pension plans adjustment²

    2,238     $ (578 )     1,660       -       2,408     $ (818 )     1,590       -  

Interest rate swap³

    20,727       (4,775 )     15,952       -       16       (6 )     10       -  

Cash-flow hedges³

    (4,563 )     (2,278 )     (6,841 )     -       209       (80 )     129       -  

Other comprehensive income (loss)

  $ 39,870     $ (7,631 )     32,239       (13 )   $ (7,881 )   $ (904 )     (8,785 )     (5 )

Comprehensive income (loss)

            $ 79,921     $ (28 )                   $ 6,010     $ 31  

 

¹ Income taxes are not provided for foreign currency translation relating to permanent investments in international subsidiaries. The foreign currency translation adjustment for the three months ended March 4, 2017 includes $11,317 related to 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 and SG&A expense.

 

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

 

The components of accumulated other comprehensive loss is as follows:

 

   

March 3, 2018

 
   

Total

   

H.B. Fuller

Stockholders

   

Non-

controlling

Interests

 

Foreign currency translation adjustment

  $ (34,704 )   $ (34,616 )   $ (88 )

Defined benefit pension plans adjustment, net of taxes of $73,804

    (139,511 )     (139,511 )     -  

Interest rate swap, net of taxes of ($5,958)

    17,874       17,874       -  

Cash-flow hedges, net of taxes of $998

    (12,163 )     (12,163 )     -  
Reclassification of AOCI tax effects     (18,341 )     (18,341 )        

Accumulated other comprehensive loss

  $ (186,845 )   $ (186,757 )   $ (88 )

 

 

   

December 2, 2017

 
   

Total

   

H.B. Fuller

Stockholders

   

Non-

controlling

Interests

 

Foreign currency translation adjustment

  $ (56,159 )   $ (56,084 )   $ (75 )

Defined benefit pension plans adjustment, net of taxes of $74,382

    (141,171 )     (141,171 )     -  

Interest rate swap, net of taxes of ($1,183)

    1,922       1,922       -  

Cash-flow hedges, net of taxes of $3,276

    (5,322 )     (5,322 )     -  

Accumulated other comprehensive loss

  $ (200,730 )   $ (200,655 )   $ (75 )

 

 

Note 11: Income Taxes

 

On December 22, 2017, the President of the United States signed into law U.S. Tax Reform. U.S. Tax Reform includes a number of provisions, including the lowering of the U.S. corporate tax rate from 35 percent to 21 percent, effective January 1, 2018, which results in a blended federal tax rate for fiscal year 2018. U.S. Tax Reform also includes international provisions, which generally establish a territorial-style system for taxing foreign-source income of domestic multinational corporations and imposes a one-time transition tax on deemed repatriated accumulated foreign earnings as of December 31, 2017.

 

During the three months ended March 3, 2018, we recorded a provisional $35.6 million income tax benefit related to U.S. Tax Reform. This provisional amount includes a $76.4 million benefit for the remeasurement of deferred tax assets and liabilities due to the decreased tax rate net of income tax expense for the transition tax.  The $40.8 million transition tax is based on certain foreign earnings and profits for which earnings had been previously indefinitely reinvested, as well as estimates of assets and liabilities at future dates. The provisional amounts are subject to adjustment during the measurement period of one year following the enactment of U.S. Tax Reform. Our estimates are subject to change as we review the data available and any additional guidance, and will be evaluated throughout the measurement period, as permitted by Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act.

 

As of  March 3, 2018, we had a liability of $9,116 recorded under ASC 740, Income Taxes, for gross unrecognized tax benefits (excluding interest), compared to $8,887 as of December 2, 2017. As of March 3, 2018, we had accrued $638 of gross interest relating to unrecognized tax benefits. For the three months ended March 3, 2018, our recorded liability for gross unrecognized tax benefits increased by $229.

 

 

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 3,

   

March 4,

 

(Shares in thousands)

 

2018

   

2017

 

Weighted-average common shares - basic

    50,471       50,243  

Equivalent shares from share-based compensations plans

    1,427       1,217  

Weighted-average common and common equivalent shares - diluted

    51,898       51,460  

 

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.

 

 

Share-based compensation awards for 2,226,893 and 632,720 shares for the three months ended March 3, 2018 and March 4, 2017, 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 relationships. The company evaluates hedge effectiveness at inception and on an ongoing basis. If a derivative is no longer expected to be effective, hedge accounting is discontinued. Hedge ineffectiveness, if any, is recorded in earnings.

 

We are exposed to credit risk in the event of nonperformance of counterparties for foreign currency forward exchange contracts and interest rate swap agreements. We select investment-grade multinational banks and financial institutions as counterparties for derivative transactions and monitor the credit quality of each of these banks on a periodic basis as warranted. We do not anticipate nonperformance by any of these counterparties, and valuation allowances, if any, are de minimis.

 

Cash Flow Hedges

 

Effective October 20, 2017, we entered into six cross-currency swap agreements to convert a notional amount of $401,200 of foreign currency denominated intercompany loans into U.S. dollars. The swaps mature in 2021 and 2022.

 

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 US dollars. The first swap matured in 2017, the second swap matures in 2018 and the third swap matures in 2019. 

 

As of March 3, 2018, the combined fair value of the swaps was a liability of $46,195 and was included in other liabilities in the Consolidated Balance Sheets.  The swaps were designated as cash-flow hedges for accounting treatment.  The lesser amount between the cumulative change in the fair value of the actual swaps and the cumulative change in the fair value of hypothetical swaps is recorded in accumulated other comprehensive income (loss) in the Consolidated Balance Sheets.  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 amount in accumulated other comprehensive income (loss) related to cross-currency swaps was a loss of $12,163 as of March 3, 2018. The estimated net amount of the existing loss that is reported in accumulated other comprehensive income (loss) as of March 3, 2018 that is expected to be reclassified into earnings within the next twelve months is $2,050. As of March 3, 2018, 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 3, 2018:

 

 

Fiscal Year of

Expiration

 

Interest Rate

   

Notional

Value

   

Fair Value

 

Pay EUR

2018

    3.45%     $ 44,912     $ (4,908 )
Receive USD     4.5374%                  
                           

Pay EUR

2019

    3.80%     $ 44,912     $ (5,943 )
Receive USD     5.0530%                  
                           

Pay EUR

2020

    1.95%     $ 42,600     $ (7,820 )
Receive USD     4.3038%                  
                           

Pay EUR

2018

    2.75%     $ 133,340     $ (8,930 )
Receive USD     4.9330%                  
                           

Pay EUR

2019

    3.00%     $ 267,860     $ (18,594 )
Receive USD     5.1803%                  

Total

          $ 533,624     $ (46,195 )

 

On February 27, 2018, we entered into an interest rate swap agreement to convert $200,000 of our $2,150,000 Term Loan B to a fixed interest rate of 4.839 percent.  On October 20, 2017 we entered into interest rate swap agreements to convert $1,050,000 of our $2,150,000 Term Loan B issued on October 20, 2017 to a fixed interest rate of 4.2775 percent. The combined fair value of the interest rate swaps in total was an asset of $23,997 at March 3, 2018 and was included in other assets in the Consolidated Balance Sheets. The swaps were designated for hedge accounting treatment as cash flow hedges. We are applying the shortcut method in accounting for these interest rate swaps as we expect changes in the cash flows of the interest rate swap to offset the changes in cash flows (i.e. changes in interest rate payments) attributable to fluctuations in LIBOR rates on the interest payments associated with the first $1,250,000 tranche of the variable rate Term Loan B, resulting in no ineffectiveness.

 

Subsequent to March, 3, 2018, we entered into interest rate swap agreements to convert $300,000 of our $2,150,000 Term Loan B to a fixed interest rate of 4.5305 percent.

 

The location in the Condensed Consolidated Statements of Income and Comprehensive Income and amounts of gains (losses) related to derivative instruments designated as cash flow hedges are as follows:

 

 

   

March 3, 2018

   

March 4, 2017

 

Derivatives in Cash Flow Hedging Relationships

 

Pretax Gain(Loss)

Recognized in other

Comprehensive Income

   

Pretax Gain(Loss)

Recognized in other

Comprehensive Income

 

 

 

Amount

   

Amount

 

Cross-currency swap contracts

  $ (4,563 )   $ 209  

Interest rate swap contracts

    20,727       16  

 

 

Fair Value Hedges

 

During the three months ended March 4, 2017, we entered into interest rate swap agreements to convert $150,000 of our $300,000 Public Notes that were issued on February 14, 2017 to a variable interest rate of 1-month LIBOR plus 1.86 percent. The combined fair value of the interest rate swaps in total was a liability of $8,024 at March 3, 2018 and was included in other liabilities in the 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 Public 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), net and no ineffectiveness will be recognized in our Consolidated Statements of Income.

 

Derivatives Not Designated As Hedging Instruments

 

The company uses foreign currency forward contracts to offset its exposure to the change in value of certain foreign currency denominated assets and liabilities held at foreign subsidiaries that are remeasured at the end of each period. Although the contracts are effective economic hedges, they are not designated as accounting hedges. Foreign currency forward contracts are recorded as assets and liabilities on the balance sheet at fair value. Changes in the value of these derivatives are recognized immediately in earnings, thereby offsetting the current earnings effect of the related foreign currency denominated assets and liabilities.

 

See Note 14 for fair value amounts of these derivative instruments.

 

As of March 3, 2018, we had forward foreign currency contracts maturing between March 6, 2018 and September 17, 2018. The mark-to-market effect associated with these contracts was largely offset by the underlying transaction gains and losses resulting from the foreign currency exposures for which these contracts relate. 

 

The location in the Consolidated Statements of Income and amounts of gains (losses) related to derivative instruments not designated as hedging instruments are as follows:

 

Derivatives Not Designated as Hedging Relationships

 

Pretax Gain (Loss) Recognized in Income

 
       

March 3, 2018

   

Year Ended

December 2, 2017

 

 

 

Location

 

Amount

   

Amount

 

Foreign currency forward contracts

 

Other (expense) income, net

  $ (7,421 )   $ (3,797 )

 

 

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 3, 2018, 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 3, 2018 and December 2, 2017, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.

 

   

March 3,

   

Fair Value Measurements Using:

 

Description

 

2018

   

Level 1

   

Level 2

   

Level 3

 

Assets:

                               

Marketable securities

  $ 5,973     $ 5,973     $ -     $ -  

Foreign exchange contract assets

    1,180       -       1,180       -  
Interest rate swaps, cash flow hedges     24,247               24,247          
                                 

Liabilities:

                               

Foreign exchange contract liabilities

  $ 8,600     $ -     $ 8,600     $ -  
Interest rate swaps, cash flow hedges     250               250          

Interest rate swaps, fair value hedges

    8,024       -       8,024       -  

Cross-currency cash flow hedges

    46,195       -       46,195       -  

Contingent consideration liability

    566       -       -       566  

 

 

   

December 2,

   

Fair Value Measurements Using:

 

Description

 

2017

   

Level 1

   

Level 2

   

Level 3

 

Assets:

                               

Marketable securities

  $ 7,528     $ 7,528     $ -     $ -  

Foreign exchange contract assets

    600       -       600       -  

Interest rate swaps, cash flow hedges

    3,104       -       3,104       -  
                                 

Liabilities:

                               

Foreign exchange contract liabilities

  $ 4,397     $ -     $ 4,397     $ -  

Interest rate swaps, fair value hedges

    2,121       -       2,121       -  

Cross-currency cash flow hedges

    20,136       -       20,136       -  

Contingent consideration liability

    496       -       -       496  

 

Long-term debt had an estimated fair value of $2,399,063 and $2,452,034 as of March 3, 2018 and December 2, 2017, respectively. The fair value of long-term debt is based on quoted market prices for the same or similar issues or on the current rates offered for debt of similar maturities. The estimated fair value of these long-term obligations is not necessarily indicative of the amount that would be realized in a current market exchange.

 

 

We use the income approach in calculating the fair value of our contingent consideration liability using a real option model with Level 3 inputs. The expected cash flows are affected by various significant judgments and assumptions, including revenue growth rates, profit margin percentages, volatility and discount rate, which are sensitive to change. Estimates of fair value are inherently uncertain and represent only management’s reasonable expectation regarding future developments. These estimates and the judgments and assumptions upon which the estimates are based will, in all likelihood, differ in some respects from actual future results. 

 

The contingent consideration liability activity for the three months ended March 3, 2018 is presented below:

 

   

Amount

 

Balance at December 2, 2017

  $ 496  

Mark to market adjustment