FULLER H B CO - Quarter Report: 2019 March (Form 10-Q)

 

 

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 2, 2019

 

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes [X] No [  ]

 

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

 

Large accelerated filer [X]	Accelerated filer [  ]
Non-accelerated filer [  ]	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 50,885,501 as of March 25, 2019.

 

 

 

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 2, 2019 and March 3, 2018	3
	Condensed Consolidated Statements of Comprehensive Income for the three months ended March 2, 2019 and March 3, 2018	4
	Condensed Consolidated Balance Sheets as of March 2, 2019 and December 1, 2018	5
	Condensed Consolidated Statements of Total Equity for the three months ended March 2, 2019 and March 3, 2018	6
	Condensed Consolidated Statements of Cash Flows for the three months ended March 2, 2019 and March 3, 2018	7
	Notes to Condensed Consolidated Financial Statements	8
ITEM 2.	MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	25
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	35
ITEM 4.	CONTROLS AND PROCEDURES	36
PART II. OTHER INFORMATION		36
ITEM 1.	LEGAL PROCEEDINGS	36
ITEM 1A.	RISK FACTORS	38
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	39
ITEM 6.	EXHIBITS	40
SIGNATURES		41

 

 

 

		Three Months Ended
		March 2,				March 3,
		2019				2018
Net revenue		$	672,935			$	713,079
Cost of sales			(493,010	)			(527,566	)
Gross profit			179,925				185,513
Selling, general and administrative expenses			(145,713	)			(152,707	)
Other income (expense), net			3,365				4,912
Interest expense			(26,807	)			(27,545	)
Interest income			3,053				3,041
Income before income taxes and income from equity method investments			13,823				13,214
Income taxes			(3,140	)			32,632
Income from equity method investments			1,565				1,821
Net income including non-controlling interest			12,248				47,667
Net (loss) income attributable to non-controlling interest			(4	)			15
Net income attributable to H.B. Fuller		$	12,244			$	47,682
Earnings per share attributable to H.B. Fuller common stockholders:
Basic			0.24				0.94
Diluted			0.24				0.92
Weighted-average common shares outstanding:
Basic			50,752				50,471
Diluted			51,901				51,898
Dividends declared per common share		$	0.155			$	0.150

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		Three Months Ended
		March 2,				March 3,
		2019				2018
Net income including non-controlling interest		$	12,248			$	47,667
Other comprehensive income (loss)
Foreign currency translation			17,699				21,455
Defined benefit pension plans adjustment, net of tax			1,482				1,660
Interest rate swaps, net of tax			(11,444	)			15,952
Cash flow hedges, net of tax			4,086				(6,841	)
Other comprehensive income			11,823				32,226
Comprehensive income			24,071				79,893
Less: Comprehensive income (loss) attributable to non-controlling interest			10				(28	)
Comprehensive income attributable to H.B. Fuller		$	24,061			$	79,921

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		March 2,				December 1,
		2019				2018
Assets
Current assets:
Cash and cash equivalents		$	113,476			$	150,793
Trade receivables (net of allowances of $14,235 and $14,017, as of March 2, 2019 and December 1, 2018, respectively)			478,326				495,008
Inventories			386,725				348,461
Other current assets			114,138				95,657
Total current assets			1,092,665				1,089,919
Property, plant and equipment			1,322,466				1,303,590
Accumulated depreciation			(685,148	)			(667,041	)
Property, plant and equipment, net			637,318				636,549
Goodwill			1,314,615				1,305,171
Other intangibles, net			892,391				908,151
Other assets			229,111				236,524
Total assets		$	4,166,100			$	4,176,314
Liabilities, non-controlling interest and total equity
Current liabilities:
Notes payable		$	17,839			$	14,770
Current maturities of long-term debt			71,225				91,225
Trade payables			284,910				273,378
Accrued compensation			59,655				78,384
Income taxes payable			16,001				12,578
Other accrued expenses			71,245				75,788
Total current liabilities			520,875				546,123
Long-term debt, excluding current maturities			2,146,152				2,141,532
Accrued pension liabilities			69,488				70,680
Other liabilities			255,481				264,768
Total liabilities			2,991,996				3,023,103
Commitments and contingencies (Note 14)
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 – 50,883,771 and 50,732,796, as of March 2, 2019 and December 1, 2018, respectively			50,884				50,733
Additional paid-in capital			100,573				95,940
Retained earnings			1,290,571				1,286,289
Accumulated other comprehensive loss			(268,335	)			(280,152	)
Total H.B. Fuller stockholders' equity			1,173,693				1,152,810
Non-controlling interest			411				401
Total equity			1,174,104				1,153,211
Total liabilities, non-controlling interest and total equity		$	4,166,100			$	4,176,314

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		H.B. Fuller Company Shareholders
		Common Stock				Additional Paid-in Capital				Retained Earnings				Accumulated Other Comprehensive Income (Loss)				Non- Controlling Interest				Total
Balance at December 1, 2018, as previously reported		$	50,733			$	95,940			$	1,285,246			$	(280,152	)		$	401			$	1,152,168
Change in accounting principles			-				-				1,043				-				-				1,043
Balance at December 1, 2018, as adjusted		$	50,733			$	95,940			$	1,286,289			$	(280,152	)		$	401			$	1,153,211
Comprehensive income			-				-				12,244				11,817				10				24,071
Dividends			-				-				(7,962	)			-				-				(7,962	)
Stock option exercises			41				1,025				-				-				-				1,066
Share-based compensation plans other, net			168				6,233				-				-				-				6,401
Repurchases of common stock			(58	)			(2,625	)			-				-				-				(2,683	)
Balance at March 2, 2019		$	50,884			$	100,573			$	1,290,571			$	(268,335	)		$	411			$	1,174,104
Balance at December 2, 2017		$	50,389			$	74,662			$	1,127,028			$	(200,655	)		$	393			$	1,051,817
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			$	1,185,402			$	(186,757	)		$	365			$	1,128,185

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		Three Months Ended
		March 2, 2019				March 3, 2018
Cash flows from operating activities:
Net income including non-controlling interest		$	12,248			$	47,667
Adjustments to reconcile net income including non-controlling interest to net cash provided by operating activities:
Depreciation			16,842				17,422
Amortization			19,212				19,243
Deferred income taxes			(1,426	)			(50,613	)
Income from equity method investments, net of dividends received			(1,565	)			(1,821	)
Loss (gain) on sale of assets			30				(2,098	)
Share-based compensation			5,906				5,651
Loss on mark to market adjustment related to contingent consideration liability			-				48
Change in assets and liabilities, net of effects of acquisitions:
Trade receivables, net			5,873				16,613
Inventories			(21,630	)			(46,713	)
Other assets			(21,065	)			(38,137	)
Trade payables			7,905				(5,016	)
Accrued compensation			(19,205	)			(22,211	)
Other accrued expenses			(5,253	)			(10,465	)
Income taxes payable			(1,622	)			8,733
Accrued / prepaid pensions			(5,289	)			(2,218	)
Other liabilities			(3,009	)			29,897
Other			12,541				1,939
Net cash provided by (used in) operating activities			493				(32,079	)
Cash flows from investing activities:
Purchased property, plant and equipment			(13,865	)			(18,555	)
Proceeds from sale of property, plant and equipment			141				1,367
Net cash used in investing activities			(13,724	)			(17,188	)
Cash flows from financing activities:
Repayment of long-term debt and payment of debt issuance costs			(20,000	)			(5,375	)
Net payment of notes payable			2,645				231
Dividends paid			(7,883	)			(7,642	)
Proceeds from stock options exercised			1,065				762
Repurchases of common stock			(2,683	)			(3,268	)
Net cash used in financing activities			(26,856	)			(15,292	)
Effect of exchange rate changes on cash and cash equivalents			2,770				2,639
Net change in cash and cash equivalents			(37,317	)			(61,920	)
Cash and cash equivalents at beginning of period			150,793				194,398
Cash and cash equivalents at end of period		$	113,476			$	132,478
Supplemental disclosure of cash flow information:
Dividends paid with company stock		$	79			$	7
Cash paid for interest, net of amount capitalized of $73 and $66 for the periods ended March 2, 2019 and March 3, 2018, respectively		$	31,400			$	29,701
Cash paid for income taxes, net of refunds		$	8,699			$	9,797

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Note 1: Basis of Presentation

 

Overview

 

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 1, 2018 as filed with the Securities and Exchange Commission.

 

Change in Accounting Principle – Accounting for Inventory

 

During the year ended December 2, 2018, we elected to change our method of accounting for certain inventories in the United States within the Company’s Americas Adhesives and Construction Adhesives segments from the last-in, first-out method (“LIFO”) to weighted-average cost. We retrospectively adjusted the Consolidated Financial Statements for all periods presented to reflect this change.

 

Change in Accounting Principle – Revenue Recognition

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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. We adopted this ASU during the three months ended March 2, 2019 using the modified retrospective method of adoption. As a result of the adoption of this ASU, we recorded an increase to opening retained earnings of $1,776 as of December 2, 2018 related to accelerated recognition for arrangements where we provide shipping and handling services after control of the goods has transferred to the customer. Prior periods were not restated. We have included the disclosures required by this ASU in Note 7.

 

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 were adopted during the three months ended March 2, 2019 with ASU No. 2014-09 as discussed above.

 

Change in Accounting Principle – Income Tax Impact of Intra-Entity Transfers of Assets Other Than Inventory

 

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. We adopted this ASU during the three months ended March 2, 2019. We recorded a decrease to opening retained earnings of $733 as of December 2, 2018 as a result of the adoption of this ASU.

 

 

Change in Accounting Principle – Net Periodic Defined Benefit Pension and Postretirement Benefit Costs

 

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 non-operating expenses. The classification requirements of this ASU are applied on a retrospective basis. The ASU also stipulates that only the service cost component of net benefit cost is eligible for capitalization on a prospective basis. We adopted this ASU during the three months ended March 2, 2019. As a result of adoption, the components of our net periodic defined benefit pension and postretirement benefit costs other than service cost are now presented as non-operating expenses for all periods presented. Service cost remains in operating expenses. As a result of the retrospective adjustment for the change in accounting principle, certain amounts in our Condensed Consolidated Statement of Income for the three months ended March 3, 2018 were adjusted as follows:

 

 

New Accounting Pronouncements

 

In August 2018, the FASB issued ASU No. 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (a consensus of the FASB Emerging Issues Task Force). This ASU requires entities that are customers in cloud computing arrangements to defer implementation costs if they would be capitalized by the entity in software licensing arrangements under the internal-use software guidance. The ASU may be applied retrospectively or prospectively to implementation costs incurred after the date of adoption. Our effective date for adoption of this ASU is our fiscal year beginning November 29, 2020 with early adoption permitted. We early adopted this ASU during the three months ended March 2, 2019 on a prospective basis which did not have a material impact on our Consolidated Financial Statements and related disclosures.

 

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. This ASU modifies the disclosure requirements on fair value measurements. The ASU removes the requirement to disclose: the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level 3 fair value measurements. The ASU requires disclosure of changes in unrealized gains and losses for the period included in other comprehensive income (loss) for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. Our effective date for adoption of this ASU is our fiscal year beginning November 29, 2020 with early adoption permitted. We have evaluated the effect that this ASU will have on our Consolidated Financial Statements and related disclosures and determined it will not have a material impact.

 

In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements. This ASU allows entities to not recast comparative periods in transition to ASC 842 and instead report the comparative periods presented in the period of adoption under ASC 840. The ASU also includes a practical expedient for lessors to not separate the lease and nonlease components of a contract. The amendments in this ASU are effective in the same timeframe as ASU No. 2016-02 as discussed below. We are incorporating this ASU into our assessment and adoption of ASU No. 2016-02.

 

 

In July 2018, the FASB issued ASU No. 2018-10, Codification Improvements to Topic 842, Leases. This ASU includes certain clarifications to address potential narrow-scope implementation issues which we are incorporating into our assessment and adoption of ASU No. 2016-02. The amendments in this ASU are effective in the same timeframe as ASU No. 2016-02 as discussed below.

 

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. We adopted this ASU during the three months ended March 2, 2019. Adoption of this ASU will have a presentation impact only and will result in a retrospective reclassification of debt prepayment and extinguishment costs of $16,598 within the Consolidated Statement of Cash Flows for the year ended December 2, 2017 from operating to financing cash outflows.

 

In June 2016, the FASB issued 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. In November 2018, the FASB also issued ASU No. 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses. This ASU clarifies that receivables arising from operating leases are within the scope of Topic 842, Leases. The amendments in this ASU affect the guidance in ASU No. 2016-13 and are effective in the same timeframe as ASU No. 2016-13. Our effective date for adoption of this ASU is our fiscal year beginning November 29, 2020. We are currently evaluating the effect that this ASU will have on our Consolidated Financial Statements.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Subtopic 842). This ASU 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. In December 2018, the FASB also issued ASU No. 2018-20, Leases (Topic 842): Narrow-Scope Improvements for Lessors, which clarifies the accounting for lessors for variable payments that relate to both a lease component and a nonlease component and is effective in the same timeframe as ASU 2016-02, and ASU No. 2019-01, Leases (Topic 842): Codification Improvements, which clarifies the transition disclosure requirements. Our effective date for adoption of this ASU is our fiscal year beginning December 1, 2019 with early adoption permitted. The new ASU must be adopted using a modified retrospective transition approach, and provides for certain practical expedients. We have begun implementing lease accounting software and are currently evaluating the impact that the new ASU will have on our Consolidated Financial Statements.

 

 

Note 2: Restructuring Actions

 

The Company has approved restructuring plans 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, and other actions to optimize operations. The following table summarizes the pre-tax distribution of charges under these restructuring plans by income statement classification:

 

 

 

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

 

 

A summary of the restructuring liability is presented below:

 

 

Restructuring liabilities have been classified as a component of other accrued expenses in the Condensed Consolidated Balance Sheets.

 

 

Note 3: Inventories

The composition of inventories is as follows:

 

 

 

Note 4: Goodwill and Other Intangible Assets

 

The goodwill activity for the three months ended March 2, 2019 is presented below:

 

 

 

As discussed in Note 15, as of the beginning of the three months ended March 2, 2019, we realigned certain customers across operating segments. We allocated goodwill within our reporting units to reflect this realignment using the relative fair value approach.

 

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

 

 

 

Amortization expense with respect to amortizable intangible assets was $19,212 and $19,243 for the three months ended March 2, 2019 and March 3, 2018, respectively.

 

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

 

 

Non-amortizable intangible assets as of March 2, 2019 and December 1, 2018 are $558 and $493, respectively and are related to trademarks and trade names.

 

 

Note 5: 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 1, 2018.

 

 

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 2, 2019 and March 3, 2018 was calculated using the following weighted average assumptions:

 

 

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 was $5,906 and $5,651 for the three months ended March 2, 2019 and March 3, 2018, respectively. All share-based compensation expense was recorded as selling, general and administrative (SG&A) expense.

 

As of March 2, 2019, there was $13,819 of unrecognized compensation costs related to unvested stock option awards, which is expected to be recognized over a weighted-average period of 1.4 years. Unrecognized compensation costs related to unvested restricted stock units was $17,420, which is expected to be recognized over a weighted-average period of 1.4 years.

 

Stock Option Activity

 

The stock option activity for the three months ended March 2, 2019 is presented below:

 

 

 

The fair value of options granted during the three months ended March 2, 2019 and March 3, 2018 was $9,331 and $7,645, respectively. Total intrinsic value of options exercised during the three months ended March 2, 2019 and March 3, 2018 was $910 and $638, 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 2, 2019 and March 3, 2018 were $1,065 and $762, respectively.

 

Restricted Stock Activity

 

The nonvested restricted stock activity for the three months ended March 2, 2019 is presented below:

 

 

Total fair value of restricted stock vested during the three months ended March 2, 2019 and March 3, 2018 was $7,846 and $7,900, respectively. The total fair value of nonvested restricted stock at March 2, 2019 was $23,135.

 

We repurchased 57,917 and 63,540 restricted stock shares during the three months ended March 2, 2019 and March 3, 2018, respectively, related 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 2, 2019 is presented below:

 

 

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

 

 

 

Note 6: Components of Net Periodic Cost (Benefit) related to Pension and Other Postretirement Benefit Plans

 

 

 

Note 7: Revenue

 

Revenue Recognition

 

We sell a variety of adhesives, sealants and other specialty chemical products to a diverse customer base. The vast majority of our arrangements contain a single performance obligation to transfer manufactured goods to the customer as governed by an individual purchase order. 

 

We recognize revenue at the amount of consideration to which we expect to be entitled in exchange for transferring the promised goods to the customer. The transaction price includes an estimation of any variable amounts of consideration to which we will be entitled. The most common forms of variable consideration within our arrangements are customer rebates, which are recorded as a reduction to revenue at the time of the initial sale using the expected value method. The expected value method is the sum of probability-weighted amounts in a range of possible consideration amounts and is based on a consideration of historical, current and forecast information. Changes in estimates are updated each reporting period. There are no material instances where variable consideration is constrained and not recorded at the initial time of sale. Product returns are recorded as a reduction to revenue based on historical experience and anticipated sales returns that occur in the normal course of business. We primarily have assurance-type warranties that do not result in separate performance obligations. We have elected to present revenue net of sales taxes and other similar taxes.

 

We recognize revenue when control of goods is transferred to the customer. For the vast majority of our arrangements, control transfers at a point in time either upon shipment or upon delivery of the goods to the customer. The timing of transfer of control is determined considering the timing of the transfer of legal title, physical possession, and risks and rewards of goods to the customer. 

 

We record shipping and handling revenue in net revenues and outbound shipping and handling costs in cost of goods sold. The majority of our shipping and handling activities are performed prior to transfer of control of the goods to the customer. For those arrangements where we provide shipping and handling services after control of the goods has transferred to the customer, we have elected the practical expedient allowed under ASC 606 to account for these activities as a fulfillment cost rather than as a separate performance obligation. Election of this practical expedient resulted in an increase in the balance of retained earnings of $1,776 at the beginning of fiscal 2019. Based on an analysis of the financial statement line items affected in the quarter ended March 2, 2019 in the application of ASU No. 2014-09 as compared with previous reporting, the Company has determined that the quantitative changes to each financial statement line item are not material. As a result, for the quarter ended March 2, 2019, the Company is not disclosing the quantitative amount by which each financial statement line item is affected in the current reporting by the application of this ASU as compared with the guidance that was in effect before the change.

 

 

Practical Expedients Elected

 

We have elected the following practical expedients allowable under ASC 606:

-

Election to present revenue net of sales taxes and other similar taxes

-

Election to account for shipping and handling services performed after control has transferred to the customer as fulfillment activities

 

Disaggregated Revenue Information

 

We view the following disaggregation of revenue by product type as useful to understanding the composition of revenue recognized during the respective reporting periods:

 

 

 

 

 

 

Note 8: Accumulated Other Comprehensive Income (Loss)

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

 

 

¹ Income taxes are not provided for foreign currency translation relating to permanent investments in international subsidiaries.

² Loss reclassified from accumulated other comprehensive income ("AOCI") into earnings as part of net periodic cost related to pension and other postretirement benefit plans is reported in cost of sales and SG&A expense.

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

 

The components of accumulated other comprehensive loss is as follows:

 

 

 

 

 

Note 9: Income Taxes

 

As of March 2, 2019, we had a liability of $8,630 recorded for gross unrecognized tax benefits (excluding interest) compared to $8,420 as of December 1, 2018. As of March 2, 2019, we had accrued $955 of gross interest relating to unrecognized tax benefits. For the three months ended March 2, 2019, our recorded liability for gross unrecognized tax benefits increased by $210.

 

 

Note 10: Earnings Per Share

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

 

 

Basic earnings per share is calculated by dividing net income attributable to H.B. Fuller by the weighted-average number of common shares outstanding during the applicable period. Diluted earnings per share is based upon the weighted-average number of common and common equivalent shares outstanding during the applicable period. The difference between basic and diluted earnings per share is attributable to share-based compensation awards. We use the treasury stock method to calculate the effect of outstanding shares, which computes total employee proceeds as the sum of (a) the amount the employee must pay upon exercise of the award and (b) the amount of unearned share-based compensation costs attributed to future services. Share-based compensation awards for which total employee proceeds exceed the average market price over the applicable period have an antidilutive effect on earnings per share, and accordingly, are excluded from the calculation of diluted earnings per share.

 

Share-based compensation awards for 3,002,073 and 2,226,893 shares for the three months ended March 2, 2019 and March 3, 2018, respectively, were excluded from the diluted earnings per share calculations because they were antidilutive.

 

 

Note 11: 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

 

As of March 2, 2019, we had the following cash flow hedges: 1) six cross-currency swap agreements effective October 20, 2017 to convert a notional amount of $401,200 of foreign currency denominated intercompany loans into U.S. dollars and maturing in 2021 and 2022; 2) one cross-currency swap agreement effective February 24, 2017 to convert a notional amount of $42,600 of foreign currency denominated intercompany loans into U.S. dollars and maturing in 2020; and 3) one cross-currency swap agreement effective October 7, 2015, to convert a notional amount of $44,912 of foreign currency denominated intercompany loans into U.S. dollars and maturing in 2019. 

 

As of March 2, 2019, the combined fair value of the swaps was an asset of $3,071 and was included in other assets in the Condensed Consolidated Balance Sheets. The swaps were designated as cash flow hedges for accounting treatment. The lesser amount between the cumulative change in the fair value of the actual swaps and the cumulative change in the fair value of hypothetical swaps is recorded in accumulated other comprehensive loss in the Condensed Consolidated Balance Sheets. The differences between the cumulative change in the fair value of the actual swaps and the cumulative change in the fair value of hypothetical swaps are recorded as other income (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 loss related to cross-currency swaps was a loss of $7,971 as of March 2, 2019. The estimated net amount of the existing loss that is reported in accumulated other comprehensive loss as of March 2, 2019 that is expected to be reclassified into earnings within the next twelve months is $2,115. As of March 2, 2019, 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 2, 2019:

 

 

On March 26, 2018, we entered into interest rate swap agreements to convert $100,000 of our $2,150,000 Term Loan B issued on October 20, 2017 to a fixed interest rate of 4.312 percent. On March 9, 2018, we entered into an interest rate swap agreement to convert $100,000 of our $2,150,000 Term Loan B to a fixed interest rate of 4.490 percent. On February 27, 2018, we entered into an interest rate swap agreement to convert $200,000 of our $2,150,000 Term Loan B to a fixed interest rate of 4.589 percent. On October 20, 2017, we entered into interest rate swap agreements to convert $1,050,000 of our $2,150,000 Term Loan B to a fixed interest rate of 4.0275 percent. The combined fair value of the interest rate swaps in total was an asset of $14,282 at March 2, 2019 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 hypothetical derivative method to assess hedge effectiveness for these interest rate swaps. Changes in the fair value of a hypothetically perfect swap with terms that match the critical terms of our $1,450,000 variable rate Term Loan B are compared with the change in the fair value of the swaps.

 

On April 23, 2018, we amended our Term Loan B Credit Agreement to reduce the interest rate from LIBOR plus 2.25 percent to LIBOR plus 2.00 percent. Fixed interest rates related to swap agreements disclosed have been updated to reflect the amendment.

 

 

The amounts of pretax gains (losses) recognized in Comprehensive Income related to derivative instruments designated as cash flow hedges are as follows:

 

 

 

Fair Value Hedges

 

On February 14, 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 $5,288 at March 2, 2019 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 hypothetical derivative method to assess hedge effectiveness for these interest rate swaps. Changes in the fair value of a hypothetically perfect swap with terms that match the critical terms of our $150,000 fixed rate Public Notes are compared with the change in the fair value of the swaps.

 

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 12 for fair value amounts of these derivative instruments.

 

As of March 2, 2019, we had forward foreign currency contracts maturing between March 4, 2019 and November 19, 2019. The mark-to-market effect associated with these contracts was largely offset by the underlying transaction gains and losses resulting from the foreign currency exposures for which these contracts relate. 

 

The amounts of pretax gains (losses) recognized in other income (expense), net related to derivative instruments not designated as hedging instruments are as follows:

 

 

 

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 2, 2019, there were no significant concentrations of credit risk.

 

 

Note 12: 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 2, 2019 and December 1, 2018, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.

 

 

 

 

Long-term debt had an estimated fair value of $2,132,275 and $2,123,447 as of March 2, 2019 and December 1, 2018, respectively. The fair value of long-term debt is based on quoted market prices for the same or similar issues or on the current rates offered for debt of similar maturities. The estimated fair value of these long-term obligations is not necessarily indicative of the amount that would be realized in a current market exchange.

 

 

Note 13: 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 2, 2019 and March 3, 2018. 

 

 

Note 14: Commitments and Contingencies

 

Environmental Matters 

 

From time to time, we become aware of compliance matters relating to, or receive notices from, federal, state or local entities regarding possible or alleged violations of environmental, health or safety laws and regulations. We review the circumstances of each individual site, considering the number of parties involved, the level of potential liability or our contribution relative to the other parties, the nature and magnitude of the hazardous substances involved, the method and extent of remediation, the estimated legal and consulting expense with respect to each site and the time period over which any costs would likely be incurred. Also, from time to time, we are identified as a potentially responsible party (“PRP”) under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) and/or similar state laws that impose liability for costs relating to the clean up of contamination resulting from past spills, disposal or other release of hazardous substances. We are also subject to similar laws in some of the countries where current and former facilities are located. Our environmental, health and safety department monitors compliance with applicable laws on a global basis. To the extent we can reasonably estimate the amount of our probable liabilities for environmental matters, we establish an undiscounted financial provision. We recorded liabilities of $10,532 and $10,665 as of March 2, 2019 and December 1, 2018, respectively, for probable and reasonably estimable environmental remediation costs. Of the amount reserved, $4,634 and $4,784 as of March 2, 2019 and December 1, 2018, respectively, is attributable to a facility we own in Simpsonville, South Carolina as a result of our Royal Adhesives acquisition that is a designated site under CERCLA.

 

Currently we are involved in various environmental investigations, clean up activities and administrative proceedings and lawsuits. In particular, we are currently deemed a PRP in conjunction with numerous other parties, in a number of government enforcement actions associated with landfills and/or hazardous waste sites. As a PRP, we may be required to pay a share of the costs of investigation and clean up of these sites. In addition, we are engaged in environmental remediation and monitoring efforts at a number of current and former operating facilities. While uncertainties exist with respect to the amounts and timing of the ultimate environmental liabilities, based on currently available information, we have concluded that these matters, individually or in the aggregate, will not have a material adverse effect on our results of operations, financial condition or cash flow.

 

Other Legal Proceedings 

 

From time to time and in the ordinary course of business, we are a party to, or a target of, lawsuits, claims, investigations and proceedings, including product liability, personal injury, contract, patent and intellectual property, environmental, health and safety, tax and employment matters. While we are unable to predict the outcome of these matters, we have concluded, based upon currently available information, that the ultimate resolution of any pending matter, individually or in the aggregate, including the asbestos litigation described in the following paragraphs, will not have a material adverse effect on our results of operations, financial condition or cash flow.

 

We have been named as a defendant in lawsuits in which plaintiffs have alleged injury due to products containing asbestos manufactured more than 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:

 

 

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.

 

During 2018, we retained legal counsel to conduct an internal investigation of the possible resale of our hygiene products into Iran by certain customers of our subsidiaries in Turkey (beginning in 2011) and India (beginning in 2014), in possible violation of the economic sanctions against Iran administered by the U.S. Department of the Treasury’s Office of Foreign Assets (“OFAC”) and our compliance policy. The sales to these customers represented less than one percent of our net revenue in each of our last three fiscal years.  The sales to the customers who were reselling our products into Iran ceased during fiscal year 2018 and we do not currently conduct any business in Iran. In January 2018, we voluntarily contacted OFAC to advise it of this internal investigation and our intention to cooperate fully with OFAC and, in September 2018, we submitted the results and findings of our investigation to OFAC. We have not yet received a response from OFAC. At this time, we cannot predict the outcome or effect of the investigation, however, based on the results of our investigation to date, we believe we could incur penalties ranging from zero to $10,000.