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
Page |
||
ITEM 1. |
3 |
|
3 |
||
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 |
|
7 |
||
8 |
||
ITEM 2. |
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
29 |
ITEM 3. |
39 |
|
ITEM 4. |
40 |
|
41 |
||
ITEM 1. |
41 |
|
ITEM 1A. |
42 |
|
ITEM 2. |
43 |
|
ITEM 6. |
44 |
|
45 |
H.B. FULLER COMPANY AND SUBSIDIARIES |
(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 |
|||||
(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 |
||||||
(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 |
(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 |
||||||||
(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 |
48 | |||
Foreign currency translation adjustment |
22 | |||
Balance at March 3, 2018 |
$ | 566 |
Balances Measured at Fair Value on a Nonrecurring Basis
We measure certain assets and liabilities at fair value on a nonrecurring basis. These assets include tangible and intangible assets acquired and liabilities assumed in an acquisition, and cost basis investments that are written down to fair value when they are determined to be impaired.
Property, plant and equipment related to acquisitions – Property, plant and equipment acquired in connection with our acquisitions were measured using unobservable (Level 3) inputs, using the cost approach. The cost approach computes the cost to replace the asset, less accrued depreciation resulting from physical deterioration, functional obsolescence and external obsolescence.
Intangible assets related to acquisitions – The identified intangible assets acquired in connection with our acquisitions were measured using unobservable (Level 3) inputs. The fair value of the intangible assets was calculated using either the income approach or a discounted market-based methodology approach. Significant inputs include estimated revenue growth rates, gross margins, operating expenses, attrition rate, royalty rate and discount rate.
See Note 2 for further discussion regarding our acquisitions.
Note 15: Share Repurchase Program
On April 6, 2017, the Board of Directors authorized a share repurchase program of up to $200,000 of our outstanding common shares. Under the program, we are authorized to repurchase shares for cash on the open market, from time to time, in privately negotiated transactions or block transactions, or through an accelerated repurchase agreement. The timing of such repurchases is dependent on price, market conditions and applicable regulatory requirements. Upon repurchase of the shares, we reduce our common stock for the par value of the shares with the excess being applied against additional paid-in capital. This authorization replaces the September 30, 2010 authorization to repurchase shares.
We did not repurchase any shares during the three months ended March 3, 2018 and March 4, 2017.
Note 16: Commitments and Contingencies
Environmental Matters
From time to time, we become aware of compliance matters relating to, or receive notices from, federal, state or local entities regarding possible or alleged violations of environmental, health or safety laws and regulations. We review the circumstances of each individual site, considering the number of parties involved, the level of potential liability or our contribution relative to the other parties, the nature and magnitude of the hazardous substances involved, the method and extent of remediation, the estimated legal and consulting expense with respect to each site and the time period over which any costs would likely be incurred. Also, from time to time, we are identified as a potentially responsible party (“PRP”) under the Comprehensive Environmental Response, Compensation and Liability Act and/or similar state laws that impose liability for costs relating to the clean up of contamination resulting from past spills, disposal or other release of hazardous substances. We are also subject to similar laws in some of the countries where current and former facilities are located. Our environmental, health and safety department monitors compliance with applicable laws on a global basis. To the extent we can reasonably estimate the amount of our probable liabilities for environmental matters, we establish an undiscounted financial provision. We recorded liabilities of $11,193 and $11,380 as of March 3, 2018 and December 2, 2017, respectively, for probable and reasonably estimable environmental remediation costs. The reserve for environmental matters is primarily related to our acquisitions of Royal Adhesives and Adecol during fiscal 2017.
Currently we are involved in various environmental investigations, clean up activities and administrative proceedings and lawsuits. In particular, we are currently deemed a PRP in conjunction with numerous other parties, in a number of government enforcement actions associated with landfills and/or hazardous waste sites. As a PRP, we may be required to pay a share of the costs of investigation and clean up of these sites. In addition, we are engaged in environmental remediation and monitoring efforts at a number of current and former operating facilities. While uncertainties exist with respect to the amounts and timing of the ultimate environmental liabilities, based on currently available information, we have concluded that these matters, individually or in the aggregate, will not have a material adverse effect on our results of operations, financial condition or cash flow.
Other Legal Proceedings
From time to time and in the ordinary course of business, we are a party to, or a target of, lawsuits, claims, investigations and proceedings, including product liability, personal injury, contract, patent and intellectual property, environmental, health and safety, tax and employment matters. While we are unable to predict the outcome of these matters, we have concluded, based upon currently available information, that the ultimate resolution of any pending matter, individually or in the aggregate, including the asbestos litigation described in the following paragraphs, will not have a material adverse effect on our results of operations, financial condition or cash flow.
We have been named as a defendant in lawsuits in which plaintiffs have alleged injury due to products containing asbestos manufactured more than 30 years ago. The plaintiffs generally bring these lawsuits against multiple defendants and seek damages (both actual and punitive) in very large amounts. In many cases, plaintiffs are unable to demonstrate that they have suffered any compensable injuries or that the injuries suffered were the result of exposure to products manufactured by us. We are typically dismissed as a defendant in such cases without payment. If the plaintiff presents evidence indicating that compensable injury occurred as a result of exposure to our products, the case is generally settled for an amount that reflects the seriousness of the injury, the length, intensity and character of exposure to products containing asbestos, the number and solvency of other defendants in the case, and the jurisdiction in which the case has been brought.
A significant portion of the defense costs and settlements in asbestos-related litigation is paid by third parties, including indemnification pursuant to the provisions of a 1976 agreement under which we acquired a business from a third party. Currently, this third party is defending and paying settlement amounts, under a reservation of rights, in most of the asbestos cases tendered to the third party.
In addition to the indemnification arrangements with third parties, we have insurance policies that generally provide coverage for asbestos liabilities, including defense costs. Historically, insurers have paid a significant portion of our defense costs and settlements in asbestos-related litigation. However, certain of our insurers are insolvent. We have entered into cost-sharing agreements with our insurers that provide for the allocation of defense costs and settlements and judgments in asbestos-related lawsuits. These agreements require, among other things, that we fund a share of settlements and judgments allocable to years in which the responsible insurer is insolvent.
A summary of the number of and settlement amounts for asbestos-related lawsuits and claims is as follows:
Three Months Ended |
3 Years Ended |
|||||||||||
March 3, 2018 |
March 4, 2017 |
December 2, 2017 |
||||||||||
Lawsuits and claims settled |
2 | 3 | 9 | |||||||||
Settlement amounts |
$ | 185 | $ | 833 | $ | 1,673 | ||||||
Insurance payments received or expected to be received |
$ | 171 | $ | 685 | $ | 1,365 |
We do not believe that it would be meaningful to disclose the aggregate number of asbestos-related lawsuits filed against us because relatively few of these lawsuits are known to involve exposure to asbestos-containing products that we manufactured. Rather, we believe it is more meaningful to disclose the number of lawsuits that are settled and result in a payment to the plaintiff. To the extent we can reasonably estimate the amount of our probable liabilities for pending asbestos-related claims, we establish a financial provision and a corresponding receivable for insurance recoveries.
Based on currently available information, we have concluded that the resolution of any pending matter, including asbestos-related litigation, individually or in the aggregate, will not have a material adverse effect on our results of operations, financial condition or cash flow.
We have retained legal counsel to conduct an internal investigation of possible resale of our products by certain customers to Iran contrary to U.S. law and regulations and our compliance policy. The sales to those particular customers being investigated represented less than one percent of our net revenue in each of our last three fiscal years. The investigation also includes a review of sales by our subsidiaries in two countries outside the United States in possible violation of the sanctions regulations of the Office of Foreign Assets Control (“OFAC”) and other applicable laws and regulations. In January 2018, we voluntarily contacted OFAC to advise it of this internal investigation and our intention to cooperate fully with OFAC. At this time, we cannot predict the outcome or effect of the investigation.
Note 17: Operating Segments
We are required to report segment information in the same way that we internally organize our business for assessing performance and making decisions regarding allocation of resources. For segment evaluation by the chief operating decision maker, segment operating income is identified as gross profit less SG&A expenses. Corporate expenses are fully allocated to each operating segment. Corporate assets are not allocated to the operating segments. Inter-segment revenues are recorded at cost plus a markup for administrative costs. Operating results of each segment are regularly reviewed by our chief operating decision maker to make decisions about resources to be allocated to the segments and assess their performance.