NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
As of
February 28, 2018
(Dollars In Millions, Except Share Data)
Note A – Basis of Presentation
The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X and, therefore, do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the OMNOVA Solutions Inc. (“OMNOVA Solutions” or the “Company”) Annual Report on Form 10-K for the year ended
November 30, 2017
, previously filed with the Securities and Exchange Commission (“SEC”).
The financial statements as of
February 28, 2018
have been derived from the unaudited interim consolidated financial statements at that date and do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.
These interim consolidated financial statements reflect all adjustments that are, in the opinion of Management, necessary for a fair presentation of the results for the interim period and all such adjustments are of a normal recurring nature except as disclosed herein. The results of operations for the interim period are not necessarily indicative, if annualized, of those to be expected for the full year.
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires Management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could materially differ from those estimates.
The consolidation method is followed to report investments in subsidiaries. The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Inter-company accounts and transactions are eliminated during the consolidation process of these accounts.
A detailed description of the Company’s significant accounting policies and Management judgments is located in the audited consolidated financial statements for the year ended
November 30, 2017
, included in the Company’s Form 10-K filed with the SEC.
Description of Business
– The Company is an innovator of emulsion polymers, specialty chemicals and engineered surfaces for a variety of commercial, industrial and residential end uses. The Company's products provide a variety of important functional and aesthetic benefits to hundreds of products that people use daily. The Company holds leading positions in key market categories, which have been built through innovative products, customized product solutions, strong technical expertise, well-established distribution channels, recognized brands, and long-standing customer relationships. The Company utilizes strategically-located manufacturing, technical and other facilities in North America, Europe, China, and Thailand to service a broad customer base. The Company has two business segments: Specialty Solutions, which is focused on the Company's higher growth specialty businesses, and Performance Materials, which is focused on the Company’s more mature businesses.
Specialty Solutions
– The Specialty Solutions segment develops, designs, produces, and markets a broad line of specialty polymers for use in coatings, adhesives, sealants, elastomers, laminates, films, nonwovens, and oil & gas products. These products are used in numerous applications, including architectural and industrial coatings; nonwovens used in hygiene products, filtration and construction; drilling additives for oil and gas exploration and production; elastomeric modification of plastic casings and hoses used in household and industrial products and automobiles; tapes and adhesives; sports surfaces; textile finishes; commercial building refurbishment; new construction; residential cabinets; flooring; ceiling tile; furnishings; manufactured housing; health care patient and common area furniture; and a variety of industrial films applications. The segment's products enhance our customers’ products performance, including stain, rust and aging resistance; surface modification; gloss; softness or hardness; dimensional stability; high heat and pressure tolerance; and binding and barrier (e.g. moisture, oil) properties.
The Specialty Solutions segment consists of Specialty Coatings & Ingredients, Oil & Gas, and Laminates & Films. The Specialty Coatings & Ingredients business line encompasses products that have applications for specialty coatings, nonwovens (such as disposable hygiene products, engine filters, roofing mat, and scrub pads), construction, adhesives, sealants, tape, floor care, textiles, graphic arts, and various other specialty applications. Oil & Gas applications include drilling fluid additives, which provide fluid loss control and sealing to enhance wellbore integrity, as well as cement additives for gas migration and fluid loss. The Laminates & Films product line applications include kitchen and bath cabinets, wall surfacing, manufactured
housing and recreational vehicle interiors, flooring, commercial and residential furniture, retail display fixtures, home furnishings, commercial appliances, and a variety of industrial film applications.
Performance Materials
– The Performance Materials segment serves mature markets with a broad range of emulsion polymers based primarily on styrene butadiene (SB), styrene butadiene acrylonitrile (SBA), styrene butadiene vinyl pyridine, high styrene pigments, polyvinyl acetate, acrylic, styrene acrylic, calcium stearate, glyoxal, and bio-based chemistries. Performance Materials' custom-formulated products are tailored latexes, resins, binders, antioxidants, hollow plastic pigment, coated fabrics, and rubber reinforcing which are used in tire cord, polymer stabilization, industrial rubbers, carpet binders, paper coatings, and various other applications. Its products provide a variety of functional properties to enhance the Company’s customers’ products, including greater strength, adhesion, dimensional stability, ultraviolet resistance, improved processibility, and enhanced appearance.
The Performance Materials segment encompasses performance additives, paper coatings, carpet binders, and coated fabrics. This segment encompasses products that have applications in the paper coatings, paperboard, carpet binders, polymer stabilization, industrial rubbers, and tire cord industries. Paper and paperboard coatings are used in magazines, catalogs, direct mail advertising, brochures, printed reports, food cartons, household, and other consumer and industrial packaging. Carpet binders are used to secure carpet fibers to carpet backing and meet stringent manufacturing, environmental, odor, flammability, and flexible installation requirements. Tire cord is used in automotive tires. The Coated Fabrics product line applications include upholstery used in refurbishment and new construction for the commercial office, hospitality, health care, retail, education and restaurant markets, marine and transportation seating, commercial and residential furniture, automotive soft tops, and automotive after-market applications.
Accounting Standards Adopted in 2018
In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory, which removes the prohibition against the immediate recognition of the current and deferred income tax effects of intra-entity transfers other than inventory. The guidance is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2017 with early adoption permitted as of the beginning of the annual reporting period in which the ASU was issued. ASU 2016-16 was adopted by the Company effective December 1, 2017 on a modified retrospective basis, resulting in a
$6.9 million
adjustment to retained earnings and a reduction in prepaid assets.
Accounting Standards Not Yet Adopted
In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allow a reclassification from accumulated other comprehensive income to retained earnings for standard tax effects resulting from the Tax Cuts and Jobs Act. ASU 2018-02 must be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. This guidance is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2018 with early adoption permitted in any interim period. The Company is currently evaluating the potential impact on its consolidated financial statements and related disclosures.
In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which require that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The amendments in this Update also allow only the service cost component to be eligible for capitalization when applicable. ASU 2017-07 must be applied retrospectively for the presentation of the service cost component and the other components of net periodic pension cost and net periodic postretirement benefit cost in the income statement and prospectively, on and after the effective date, for the capitalization of the service cost component of net periodic pension cost and net periodic post-retirement benefit in assets. This guidance is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2017 with early adoption permitted as of the beginning of the annual reporting period in which the ASU was issued. The Company is currently evaluating the potential impact on its consolidated financial statements and related disclosures.
In January 2017, the FASB issued ASU No. 2017-01, Clarifying the Definition of a Business, which clarified existing guidance on the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The guidance is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2017 with early adoption permitted as of the beginning of the annual reporting period in which the ASU was issued. The Company does not expect the adoption of this guidance to have a material impact on its consolidated results of operations, financial position, or cash flows.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments, which clarifies existing guidance related to accounting for cash receipts and cash payments and classification on the statement of cash flows. This guidance is effective for fiscal years, and interim periods within those years, beginning
after December 15, 2017, and early adoption is permitted. The adoption of this ASU will not have an impact on the Company's financial position, results of operations, or cash flows.
In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments, which requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected. The income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decrease of expected credit losses that have taken place during the period. This ASU changes the impairment model for most financial assets and certain other instruments, which will result in earlier recognition of allowances for losses. The guidance requires a modified-retrospective approach, through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019 including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company does not expect the adoption of this guidance to have a material impact on its consolidated results of operations, financial position or cash flows.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires a lessee to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases with a lease term of more than twelve months. Leases will continue to be classified as either financing or operating, with classification affecting the recognition, measurement and presentation of expenses and cash flows arising from a lease. The new guidance is effective for the Company’s fiscal year that begins on December 1, 2019 and requires a modified retrospective approach to the adoption for lessees related to capital and operating leases existing at, or entered into after, the earliest comparative period presented in the financial statements, with certain practical expedients available. Early adoption is permitted. The Company is currently evaluating the potential impact on its consolidated financial statements and related disclosures.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10: Recognition and Measurement of Financial Assets and Financial Liabilities), which revised entities’ accounting related to: (i) the classification and measurement of investments in equity securities; and (ii) the presentation of certain fair value changes for financial liabilities measured at fair value. The ASU also amends certain disclosure requirements associated with the fair value of financial instruments. The new guidance is effective for the Company’s fiscal year that begins on December 1, 2018 and requires a modified retrospective approach to adoption. Early adoption is only permitted for the provision related to instrument-specific credit risk. The Company is currently evaluating the potential impact on its consolidated financial statements and related disclosures.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which clarifies existing accounting literature relating to how and when a company recognizes revenue. Under ASU 2014-09, a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods and services. This guidance is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. The standard will require additional disclosures in the notes to the consolidated financial statements, including qualitative and quantitative disclosures identifying the nature, amount, timing and significant judgments impacting revenue from contracts with customers. The Company expects to adopt this standard during the first quarter of fiscal year 2019 and will utilize the modified retrospective approach and record a cumulative effect adjustment to retained earnings, to the extent necessary, for the impact of any current contracts then meeting the standards' criteria for revenue recognition as of December 1, 2018. The Company is implementing controls to support recognition and disclosure under the new standard. The Company continues to assess the potential impact of the standard through contract evaluation. Once this evaluation is complete, the Company will be able to determine the impact, if any, on its consolidated financial statements and related disclosures.
Note B – Financial Instruments and Fair Value Measurements
Financial Risk Management Objectives and Policies
The Company is exposed primarily to credit, interest rate, and foreign currency rate risks, which arise in the normal course of business.
Credit Risk
Credit risk is the potential financial loss resulting from the failure of a customer or counterparty to settle its financial and contractual obligations with the Company as and when they fall due. The primary credit risk for the Company is its accounts receivable, which are generally unsecured. The Company has established credit limits for customers and monitors their balances to mitigate its risk of loss. Concentrations of credit risk with respect to accounts receivable are generally limited due to the wide variety of customers and markets using the Company's products. There was no single customer that that represented more than
10%
of the Company’s consolidated net sales during the three month period ending February 28, 2018, and there was one Performance Materials customer, whose sales were more than 10% of consolidated net sales during the three month
period ending
February 28, 2018
. There was no single customer who represented more than
10%
of the Company’s net trade receivables at
February 28, 2018
or at November 30, 2017.
Interest Rate Risk
The Company’s exposure to the risk of changes in market interest rates relates primarily to the Company’s
$350.0 million
Term Loan B (balance of
$304.8 million
at
February 28, 2018
) and various foreign subsidiary borrowings, which bear interest at variable rates, approximating market interest rates. The Term Loan B has a LIBOR floor of
1.00%
, which eliminates the variability in interest rate changes on Eurodollar loans as long as LIBOR is under
1.00%
. As of
February 28, 2018
, LIBOR was above
1.00%
, which unfavorably impacted the Company's interest expense.
Foreign Currency Rate Risk
The Company incurs foreign currency rate risk on sales and purchases denominated in other than the functional currency. The currencies giving rise to this risk are primarily the Euro, Great Britain Pound Sterling, Renminbi, and Thai Baht.
Foreign currency exchange contracts are used by the Company to manage risks from the change in market exchange rates on cash payments by the Company's foreign subsidiaries and U.S. Dollar cash holdings in foreign locations. These forward contracts are used on a continuing basis for periods of approximately thirty days, consistent with the underlying hedged transactions. Hedging intends to offset the impact of foreign exchange rate movements on the Company’s operating results. The counterparties to these instruments are investment grade financial institutions and the Company does not anticipate any non-performance. The Company maintains control over the size of positions entered into with any one counterparty and regularly monitors the credit rating of these institutions. Such instruments are not purchased or sold for trading purposes. These contracts are not designated as hedging instruments and changes in fair value of these instruments are recognized in earnings immediately. Net gains on foreign currency contracts that were recorded in the Consolidated Statements of Operations, as a component of other income, for the
three
-month period ending
February 28, 2018
were
$0.4 million
. Net gains (losses) on foreign currency contracts for the
three
month period ending
February 28, 2017
were not material. Foreign currency transaction losses recorded in the Consolidated Statements of Operations, as a component of other income, exclusive of foreign currency contracts, were
$0.6 million
for the three-month period ending February 28, 2018 and were not material for the three-month period ending February 28, 2017.
Derivative Instruments
The Company recognizes the fair value of qualifying derivative instruments as either an asset or a liability within its statement of financial position. For derivative instruments not designated as hedges, the change in fair value of the derivative is recognized in earnings each reporting period. The Company defines fair value as the price that would be received to transfer an asset or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company uses a hierarchy of valuation inputs to measure fair value.
The hierarchy prioritizes the inputs into three broad levels:
Level 1 inputs—Quoted market prices in active markets for identical assets or liabilities.
Level 2 inputs—Observable market based inputs or unobservable inputs that are corroborated by market data.
Level 3 inputs—Unobservable inputs that are not corroborated by market data.
Fair Value Measurements
The Company uses the market approach and the income approach to value assets and liabilities as appropriate. The following financial assets and liabilities are measured and presented at fair value on a recurring basis as of
February 28, 2018
and
November 30, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notional Amount
|
|
Fair Value
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
(Dollars in Millions)
|
Fair value measurements - February 28, 2018:
|
|
|
|
|
|
|
|
|
|
Financial assets
|
|
|
|
|
|
|
|
|
|
Foreign currency exchange contracts
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Total assets
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
Financial liabilities
|
|
|
|
|
|
|
|
|
|
Contingent consideration
1
|
|
|
$
|
1.7
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1.7
|
|
Foreign currency exchange contracts
|
$
|
19.4
|
|
|
$
|
.2
|
|
|
$
|
.2
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Total liabilities
|
$
|
19.4
|
|
|
$
|
1.9
|
|
|
$
|
.2
|
|
|
$
|
—
|
|
|
$
|
1.7
|
|
|
|
|
|
|
|
|
|
|
|
Fair value measurements - November 30, 2017:
|
|
|
|
|
|
|
|
|
|
Financial assets
|
|
|
|
|
|
|
|
|
|
Foreign currency exchange contracts
|
$
|
9.8
|
|
|
$
|
.1
|
|
|
$
|
.1
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Total assets
|
$
|
9.8
|
|
|
$
|
.1
|
|
|
$
|
.1
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
Financial liabilities
|
|
|
|
|
|
|
|
|
|
Contingent consideration
1
|
$
|
—
|
|
|
$
|
1.0
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1.0
|
|
Total liabilities
|
$
|
—
|
|
|
$
|
1.0
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1.0
|
|
(1)
Contingent consideration obligations arise from business or product line acquisitions. The fair values are based on a probability weighted discounted cash flow analysis reflecting an estimated achievement of specified performance measures of the acquired product lines. Contingent consideration is classified in the consolidated balance sheets as other current liabilities or other non-current liabilities based on contractual payment dates.
The changes in Level 3 assets and liabilities measured at fair value on a recurring basis at February 28, 2018 are summarized as follows:
|
|
|
|
|
|
Contingent Consideration
|
|
(Dollars in Millions)
|
Balance at November 30, 2017
|
$
|
1.0
|
|
Additions and adjustments
|
0.7
|
|
Balance at February 28, 2018
|
$
|
1.7
|
|
Contingent consideration liabilities increased $0.7 million as a result of an increase in the estimated future sales of acquired product lines.
There were no other transfers into or out of Level 3 during the
first three months
of
2018
or
2017
.
The fair value of the Company’s Term Loan B at
February 28, 2018
approximated
$305.6 million
, which is
more
than its book value of
$304.8 million
as a result of prevailing market rates on the Company’s debt. The carrying value of amounts due banks approximates fair value due to their short-term nature. The fair value of the Term Loan is based on market price information and is measured using the last available trade of the instrument on a secondary market in each respective period and therefore is considered a Level 2 measurement. The fair value is not indicative of the amount that the Company would have to pay to redeem these instruments since they are infrequently traded and are not callable at this value. The fair value of the Company's capital lease obligation approximates its carrying amount based on estimated borrowing rates to discount the cash flows to their present value.
Note C - Restructuring and Severance
The following table is a summary of restructuring and severance charges for the
three months ended February 28, 2018 and 2017
, respectively:
|
|
|
|
|
|
|
|
|
|
Three Months Ended February 28,
|
|
2018
|
|
2017
|
|
(Dollars in Millions)
|
Severance Expense:
|
|
|
|
Specialty Solutions
|
$
|
.7
|
|
|
$
|
.2
|
|
Performance Materials
|
—
|
|
|
.3
|
|
Corporate
|
.6
|
|
|
.4
|
|
Total Severance Costs
|
$
|
1.3
|
|
|
$
|
.9
|
|
Facility Closure Costs:
|
|
|
|
Specialty Solutions
|
$
|
—
|
|
|
$
|
—
|
|
Performance Materials
|
—
|
|
|
.1
|
|
Total Facility Closure Costs
|
$
|
—
|
|
|
$
|
.1
|
|
Total Restructuring and Severance Costs
|
$
|
1.3
|
|
|
$
|
1.0
|
|
2017 Restructuring Plan
Restructuring and severance expenses of
$1.3 million
incurred in the first quarter of 2018 relate to the One OMNOVA initiative announced during the first quarter of 2017. This initiative is focused on improving functional excellence in marketing, sales, operations, supply chain and technology, as well as various corporate functions. The plan is designed to reduce complexity and drive consistency across the global enterprise through a standardized, integrated business system. The Company expects the One OMNOVA initiative to continue through 2018. Total estimated costs for this initiative are expected to be between
$5.0 million
and
$7.0 million
. For this initiative, the Company incurred no expense in the first quarter of 2017. Total expense incurred to date for this initiative is
$4.8 million
, of which
$4.1 million
has been paid as of February 28, 2018 and the remainder is expected to be paid by the end of 2018. The remaining expected costs for this initiative will be incurred by the end of 2018.
2016 Restructuring Plan
Restructuring and severance expenses of
$1.0 million
incurred during the first quarter of 2017 relate to restructuring and severance activities initiated in 2016 including continued cost reduction and efficiency improvement actions, as well as a change in the Company’s CEO. For these activities, the Company incurred total restructuring and severance costs of
$8.7 million
, of which
$5.5 million
was recognized in 2016 and
$2.1 million
was recognized in 2017. As of February 28, 2018,
$7.5 million
was paid and the remaining
$1.2 million
is expected to be paid by the end of 2018.
The following tables summarize the Company's liabilities related to restructuring and severance activities:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
November 30, 2017
|
|
2018
|
|
February 28, 2018
|
|
Provision
|
|
Payments
|
|
|
(Dollars in millions)
|
Total
|
$
|
2.2
|
|
|
$
|
1.3
|
|
|
$
|
1.2
|
|
|
$
|
2.3
|
|
The Company may incur future costs related to its restructuring activities, as processes are continually evaluated to enhance the efficiency and cost effectiveness of its operations, and to ensure competitiveness across its businesses and across geographic areas. Future costs could include costs related to closed facilities and restructuring plan implementation costs and these will be recognized as incurred.
Note D – Income Taxes
On December 22, 2017, U.S. federal tax legislation, commonly referred to as the Tax Cuts and Job Act (the “Tax Act”) was signed into law. The Securities and Exchange Commission Staff Accounting Bulletin No.118 (“SAB 118”), provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740, Income Taxes. In accordance with SAB 118 guidance, the Company estimated certain effects of the Tax Act and have recorded a provisional net tax benefit of approximately
$5.0 million
related to the reduction of the U.S. federal corporate income tax rate and repeal of the Alternative Minimum Tax (“AMT”). These provisional amounts were recorded as discrete items for the three months ended February 28, 2018. The Company has estimated an income inclusion of
$11.6 million
related to the foreign earnings on which U.S. income taxes were previously deferred. The Company intends to utilize existing net operating loss carryforwards to offset the income inclusion, and therefore will have no cash taxes related to
the transition tax. As a result of a valuation allowance in the U.S. on tax attribute carryforwards, no charge to income tax expense was recorded related to the one-time transition tax. While the Company was able to make reasonable estimates of the items above, the ultimate impact may differ from these provisional amounts due to additional analysis, changes in interpretations and assumptions, additional regulatory guidance that may be issued and actions we may take as a result of the Tax Act. Adjustments to the provisional amounts recorded by the Company that are identified within a subsequent measurement period of up to one year from the enactment date will be included as an adjustment to income tax expense in the period the amounts are determined.
For each interim reporting period, the Company makes an estimate of the effective tax rate it expects to be applicable to the full fiscal year for its operations, adjusted each quarter for discrete items. This estimated effective tax rate is used in providing for income taxes on a year-to-date basis. The Company recorded an income tax benefit of
$5.1 million
and
$1.6 million
for the three months ended February 28, 2018 and 2017, respectively. The Company’s effective tax rate for the first three months of 2018 was different than its U.S. federal statutory rate primarily due to discrete items related to the Tax Act. These items included a
$4.1 million
income tax benefit related to the re-measurement of the U.S. deferred taxes as the U.S. federal tax rate was reduced from
35%
to
21%
and a
$0.9 million
income tax benefit associated with the reversal of the valuation allowance against the existing AMT credit carryforward as it is refundable under the Tax Act. In addition, during the first quarter of 2018, the Company recognized a
$0.8 million
income tax benefit related to the impact of a French tax rate change on the Company’s deferred tax liabilities. The French tax rate was reduced to
25.0%
beginning in
2022
and the Company's deferred tax liabilities were reduced to appropriately reflect this legislation as a current period tax benefit. The Company’s effective tax rate for the first three months of 2017 was different than its U.S. federal statutory rate primarily due to discrete items including a
$1.6 million
benefit related to the reversal of French deemed distribution legislation in the first quarter of 2017 and a
$1.8 million
benefit related to the impact of a French tax rate change on the Company's deferred tax liabilities. The French tax rate will be reduced from
33.3%
to
28.0%
beginning in 2020. The discrete benefits were partially offset by losses in jurisdictions in which no tax benefit exists.
As of both February 28, 2018 and November 30, 2017, the Company had
$91.1 million
of U.S. federal net operating loss carryforwards (NOLCs),
$8.6 million
of U.S. federal capital loss carryforwards, and
$86.8 million
of state net operating loss carryforwards. As a result, cash tax payments in the U.S. are expected to be minimal for the foreseeable future. Also, the Company does not expect any cash tax payments related to the transition tax. The Company utilized approximately
$7.8 million
and
$15.6 million
of federal net operating loss carryforward for the years ended November 30, 2017 and 2016, respectively. If not utilized, the majority of the federal, state and local NOLCs will otherwise expire in tax years
2023
through
2034
and the capital loss will expire in tax year
2022
. The Company has a valuation allowance against the U.S. federal and state NOLCs and the U.S. federal capital loss carryforward. As of February 28, 2018, the Company had approximately
$46.4 million
of foreign NOLC's of which
$35.2 million
have an indefinite carryforward period. The Company has a valuation allowance against the
$35.2 million
foreign NOLC's which have an indefinite carryforward period as the Company does not anticipate utilizing these carryforwards.
The Company operates in numerous taxing jurisdictions and is subject to regular examinations by various United States federal, state and local tax authorities, as well as by authorities in non-United States jurisdictions. With limited exceptions, the Company is no longer open to audit by the Internal Revenue Service and various states and foreign taxing jurisdictions for years prior to 2012.
Note E – Income (Loss) Per Share
The Company presents both basic and diluted income per common share amounts. Basic income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the reporting period. Diluted income is calculated by dividing net income by the weighted average number of common shares and common equivalent shares outstanding during the reporting period that are calculated using the treasury stock method for share-based awards. The treasury stock method assumes that the Company uses the proceeds from the exercise of awards to repurchase common shares at the average market price during the period.
The following table sets forth the computation of earnings per common share and fully diluted earnings per common share:
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended February 28,
|
|
|
2018
|
|
2017
|
|
|
(Dollars in millions, except per share data)
|
Numerator
|
|
|
|
|
Net income (loss)
|
|
$
|
7.3
|
|
|
$
|
3.6
|
|
|
|
|
|
|
Denominator
(shares in millions)
|
|
|
|
|
Denominator for basic earnings (loss) per share - weighted average shares outstanding
|
|
44.6
|
|
|
44.3
|
|
Effect of dilutive securities
|
|
.4
|
|
|
.4
|
|
Denominator for dilutive earnings (loss) per share - adjusted weighted average shares and assumed conversions
|
|
45.0
|
|
|
44.7
|
|
|
|
|
|
|
|
|
|
|
|
Income (Loss) Per Share - Basic and Diluted
|
|
$
|
.16
|
|
|
$
|
.08
|
|
Anti-dilutive share equivalents related to share-based incentive compensation are excluded from the computation of dilutive weighted-average shares and were not material for all periods presented.
Note F – Accumulated Other Comprehensive Income (Loss)
The following tables reflect the changes in the components of accumulated other comprehensive income (loss), net of tax, for the
three
months ended
February 28, 2018
and
2017
, respectively:
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended February 28, 2018 and 2017
|
Foreign Currency Items
|
|
Defined Benefit Plans
|
|
Accumulated Other Comprehensive Income (Loss)
|
|
(Dollars in millions)
|
Balance November 30, 2017
|
$
|
(23.1
|
)
|
|
$
|
(102.2
|
)
|
|
$
|
(125.3
|
)
|
Other comprehensive income (loss) before reclassifications
|
6.3
|
|
|
—
|
|
|
6.3
|
|
Amounts reclassified to earnings
|
—
|
|
|
1.1
|
|
|
1.1
|
|
Balance February 28, 2018
|
$
|
(16.8
|
)
|
|
$
|
(101.1
|
)
|
|
$
|
(117.9
|
)
|
|
|
Foreign Currency Items
|
|
Defined Benefit Plans
|
|
Accumulated Other Comprehensive Income (Loss)
|
|
(Dollars in millions)
|
Balance - November 30, 2016
|
$
|
(29.6
|
)
|
|
$
|
(108.9
|
)
|
|
$
|
(138.5
|
)
|
Other comprehensive income (loss) before reclassifications
|
.7
|
|
|
—
|
|
|
.7
|
|
Amounts reclassified to earnings
|
—
|
|
|
.6
|
|
|
.6
|
|
Balance February 28, 2017
|
$
|
(28.9
|
)
|
|
$
|
(108.3
|
)
|
|
$
|
(137.2
|
)
|
Amounts reclassified from accumulated other comprehensive income (loss) related to defined benefit plans were included in net periodic benefit expense.
Note G – Inventories
Inventories are stated at net realizable value. Certain U.S. inventories are valued using the last-in, first-out (“LIFO”) method and represented approximately
$53.6 million
, or
50.6%
, and
$50.7 million
, or
52.1%
, of inventories at
February 28, 2018
and
November 30, 2017
, respectively. The remaining portion of inventories, which are primarily located outside of the U.S., are valued using costing methods that approximate the first-in, first-out (“FIFO”) or average cost methods. Interim LIFO calculations are based on management’s estimates of expected year-end inventory levels and costs and are subject to final year-end LIFO inventory valuations. Inventory costs include material, labor, and overhead. Inventories, net, consisted of the following:
|
|
|
|
|
|
|
|
|
|
February 28, 2018
|
|
November 30, 2017
|
|
(Dollars in Millions)
|
Raw materials and supplies
|
$
|
34.0
|
|
|
$
|
30.6
|
|
Work-in-process
|
5.2
|
|
|
4.5
|
|
Finished goods
|
66.7
|
|
|
62.1
|
|
Inventories, gross
|
105.9
|
|
|
97.2
|
|
LIFO reserve
|
(15.1
|
)
|
|
(14.3
|
)
|
Obsolescence reserve
|
(7.1
|
)
|
|
(6.4
|
)
|
Inventories, net
|
$
|
83.7
|
|
|
$
|
76.5
|
|
Note H – Debt and Credit Lines
Debt obligations due within the next twelve months consist of the following:
|
|
|
|
|
|
|
|
|
|
February 28, 2018
|
|
November 30, 2017
|
|
(Dollars in Millions)
|
$350 million Term Loan B – current portion (interest at 5.82% and 5.49%, respectively)
|
$
|
3.5
|
|
|
$
|
3.5
|
|
Capital lease obligations
|
.7
|
|
|
.7
|
|
Total
|
$
|
4.2
|
|
|
$
|
4.2
|
|
The Company maintains borrowing facilities at certain of its foreign subsidiaries, which consist of working capital credit lines and facilities for the issuance of letters of credit. Total borrowing capacity for foreign working capital credit lines and letters of credit facilities was
$7.3 million
at
February 28, 2018
, of which
$7.2 million
was available for utilization, and
$7.0 million
at
November 30, 2017
all of which was available for utilization. These letters of credit support commitments made in the ordinary course of business.
The Company’s long-term debt consists of the following:
|
|
|
|
|
|
|
|
|
|
February 28, 2018
|
|
November 30, 2017
|
|
(Dollars in millions)
|
$350 million Term Loan B (interest at 5.82% and 5.49%, respectively)
|
$
|
304.8
|
|
|
$
|
345.6
|
|
Capital lease obligations
|
16.0
|
|
|
16.2
|
|
Total debt
|
320.8
|
|
|
361.8
|
|
Less: current portion
|
(4.2
|
)
|
|
(4.2
|
)
|
Unamortized original issue discount
|
(2.4
|
)
|
|
(2.8
|
)
|
Debt issuance costs
|
(4.3
|
)
|
|
(5.0
|
)
|
Total long-term debt, net of current portion
|
$
|
309.9
|
|
|
$
|
349.8
|
|
The Company's U.S. debt facilities include a
$350 million
Term Loan B ("Term Loan B") and a Senior Revolving Credit Facility (“Facility”). The Term Loan B was issued at a discount of
$3.5 million
which is reflected as unamortized original issue discount.
The weighted-average interest rate on the Company’s debt was
5.70%
and
5.22%
during the
first
quarters of
2018
and
2017
, respectively.
Term Loan
The Company's
$350 million
Term Loan B matures on August 26, 2023 and is primarily secured by all real property, plant, and equipment of the Company's U.S. facilities and fully and unconditionally and jointly and severally guaranteed by the material U.S. subsidiaries of the Company. The Term Loan B contains affirmative and negative covenants, including limitations on additional debt, certain investments, and acquisitions outside of the Company’s line of business. The Term Loan B requires the Company to maintain a total net leverage ratio of less than
5.0
to 1.0. The Company is in compliance with this covenant.
During December 2017, the Company prepaid
$40 million
of its outstanding Term Loan B principal balance. As a result the Company's interest expense was reduced by
$0.4 million
during the first quarter of 2018.
Senior Revolving Credit Facility
The Company also maintains a Senior Revolving Credit Facility (the "Facility") which matures on
August 26, 2021
. The Facility is secured by U.S. accounts receivable, inventory and intangible assets. The Facility contains affirmative and negative covenants, similar to the Term Loan B, including limitations on additional debt, certain investments and acquisitions outside of the Company’s line of business. If the average excess availability of the Facility falls below
$25 million
during any fiscal quarter, the Company must then maintain a fixed charge coverage ratio greater than
1.1
to 1.0 as defined in the agreement. The Company was in compliance with this requirement at
February 28, 2018
. Also, there were no amounts borrowed under the Facility and the amount available for borrowing under the Facility was
$73.5 million
at
February 28, 2018
.
Capital Lease Obligations
At
February 28, 2018
, the Company had net assets under capital leases totaling
$15.7 million
, which are included in property, plant, and equipment in the accompanying Consolidated Balance Sheets.
The following is a schedule by year of future minimum lease payments under the Company's capital lease together with the present value of the net future minimum lease payments as of
February 28, 2018
:
|
|
|
|
|
Year Ending November 30:
|
(Dollars in millions)
|
2018
|
$
|
1.2
|
|
2019
|
1.5
|
|
2020
|
1.5
|
|
2021
|
1.4
|
|
2022
|
1.4
|
|
Thereafter
|
16.6
|
|
Total minimum lease payments
|
23.6
|
|
Less: Amount representing estimated executory costs
|
(.6
|
)
|
Net minimum lease payments
|
23.0
|
|
Less: Amount representing interest
|
(7.0
|
)
|
Present value of minimum lease payments
|
$
|
16.0
|
|
Debt Issuance Costs and Original Issue Discounts
Debt issuance costs and original issue discounts incurred in connection with the issuance of the Company's debt are being amortized over the respective terms of the underlying debt, including any amendments. Total amortization expense of debt issuance costs and original issue discounts is included as a component of interest expense and was
$0.3 million
for both the first quarters ended February 28, 2018 and 2017.
As a result of the December 2017
$40.0 million
prepayment, the Company determined that this constituted a partial extinguishment of debt and as such, wrote-off
$0.8 million
of debt issuance costs and original issue discounts during the first quarter ended
February 28, 2018
.
Note I – Share-Based Employee Compensation
The Company provides compensation benefits to employees under the OMNOVA Solutions 2017 Equity Incentive Plan (the “Plan”), which was approved by shareholders on March 22, 2017. The Plan permits the Company to grant to officers, key employees and non-employee directors of the Company incentives directly linked to the price of OMNOVA Solutions’ common shares. The Plan authorizes the issuance of Company common shares in the aggregate for (a) awards of options rights to purchase Company common shares, (b) performance shares and performance units, (c) restricted shares, (d) restricted share units, or (e) appreciation rights. Shares granted under the Plan may be either newly issued shares or treasury shares or both. As of
February 28, 2018
, approximately
2.2 million
Company common shares remained available for grants under the Plan. All options granted under the Plan are granted at exercise prices equal to the market value of the Company’s common shares on the
date of grant. Additionally, the Plan provides that the term of any option granted under the Plan may not exceed
10 years
. Prior to March 22, 2017, the Company granted equity compensation under the OMNOVA Solutions Third Amended and Restated 1999 Equity and Performance Incentive Plan, which had substantially similar features.
Share-based compensation is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the requisite service period (generally the vesting period). The fair value of Restricted Share Awards ("RSA's") and Restricted Share Units ("RSU's") is determined based on the closing market price of the Company’s ordinary shares at the date of grant. RSU's entitle the holder to receive one ordinary share for each RSU at vesting, generally over a three year period from the date of grant. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by employees who receive equity awards, and subsequent events are not indicative of the reasonableness of the original estimates of fair value made by the Company.
Compensation expense for all share-based payments included in general and administrative expense was
$0.5 million
for both the
first three months
of
2018
and
2017
.
As of
February 28, 2018
, there was
$2.5 million
of unrecognized compensation cost related to non-vested share-based compensation arrangements.
A summary of the RSA and RSU activity for 2018 follows:
|
|
|
|
|
|
|
|
|
Restricted Share Awards & Units
|
|
Weighted-Average Grant Date Fair Value per Share
|
Nonvested at December 1, 2017
|
567,600
|
|
|
$
|
7.08
|
|
Granted
|
108,100
|
|
|
10.61
|
|
Vested
|
(113,200
|
)
|
|
8.18
|
|
Canceled and Forfeited
|
(21,450
|
)
|
|
6.69
|
|
Nonvested at February 28, 2018
|
541,050
|
|
|
$
|
7.87
|
|
The Company also provides employees the opportunity to purchase Company common shares through payroll deductions under the OMNOVA Solutions Employee Share Purchase Plan (the "ESPP"). Under the ESPP, eligible employees receive a
15%
discount from the trading value of common shares purchased. The purchase price for common shares purchased from the Company will be
85%
of the closing price of the common shares on the New York Stock Exchange ("NYSE") on the investment date. Participants may contribute funds to the ESPP, not to exceed twenty-five thousand dollars in any calendar year. If a participant terminates his or her employment with the Company or its subsidiaries, the participant's participation will immediately terminate, uninvested funds will be remitted to the participant and the participant's account will be converted to a regular brokerage account. As of
February 28, 2018
,
18,818
shares were held by eligible participants through the ESPP.
Note J – Employee Benefit Plans
The Company maintains a number of defined benefit and defined contribution plans to provide retirement benefits for employees. These plans are maintained and contributions are made in accordance with the Employee Retirement Income Security Act of 1974 (“ERISA”), local statutory law, or as determined by the Board of Directors. The plans generally provide benefits based upon years of service and compensation. Pension Plans are funded except for a U.S. non-qualified pension plan for certain key employees and certain foreign plans. Future service benefits are frozen for all participants under the Company's U.S. defined benefit plan. All benefits earned by affected employees through the dates on which such benefits were frozen have become fully vested with the affected employees eligible to receive benefits upon retirement, as described in the Plan document.
Net periodic benefit cost (income) consisted of the following for the three month periods ending February 28, 2018 and 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension
Plans
|
|
Health Care
Plans
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
(Dollars in millions)
|
Service costs
|
$
|
.6
|
|
|
$
|
.7
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Interest costs
|
2.3
|
|
|
2.3
|
|
|
—
|
|
|
—
|
|
Expected return on plan assets
|
(3.9
|
)
|
|
(3.8
|
)
|
|
—
|
|
|
—
|
|
Amortization of net actuarial (gain) loss
|
1.3
|
|
|
1.2
|
|
|
(.2
|
)
|
|
(.2
|
)
|
Net periodic (benefit) cost
|
$
|
.3
|
|
|
$
|
.4
|
|
|
$
|
(.2
|
)
|
|
$
|
(.2
|
)
|
The Company expects to contribute
$6.4 million
to its pension plans during fiscal
2018
. There were no contributions made during the first three months of 2018.
The Company also sponsors a defined contribution 401(k) plan. Participation in this plan is voluntary and is available to substantially all U.S. salaried employees and to certain groups of U.S. hourly employees. Company contributions to this plan are based on either a percentage of employee contributions or on a specified amount per hour based on the provisions of the applicable collective bargaining agreement. Company contributions are made in cash. Expense for this plan was
$0.8 million
for the
first three months
of
2018
and
2017
.
Note K – Contingencies
From time to time, the Company is subject to various claims, proceedings, and lawsuits related to products, services, contracts, employment, environmental, safety, intellectual property, and other matters. The ultimate resolution of such claims, proceedings, and lawsuits is inherently unpredictable and, as a result, the Company’s estimates of liability, if any, are subject to change. Actual results may materially differ from the Company’s estimates and an unfavorable resolution of any matter could have a material adverse effect on the financial condition, results of operations, and/or cash flows of the Company. However, subject to the above and taking into account such amounts, if any, as are accrued from time to time on the Company’s balance sheet, the Company does not believe, based on the information currently available to it, that the ultimate resolution of these matters will have a material effect on the consolidated financial condition, results of operations or cash flows of the Company.
Note L – Business Segment Information
The Company’s
two
operating segments were determined based on products and services provided as defined under Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 280, Segment Reporting. Accounting policies of the segments are the same as the Company’s accounting policies. The Company’s operating segments are strategic business units that offer different products and services. They are managed separately based on certain differences in their operations, technology, and marketing strategies.
Segment operating profit represents net sales less applicable costs, expenses and provisions for restructuring and severance costs, asset write-offs and work stoppage costs relating to operations. However, Management excludes restructuring and severance costs, asset write-offs and work stoppage costs when evaluating the results and allocating resources to the segments.
The following table sets forth a summary of operations by segment and a reconciliation of segment sales to consolidated sales and segment operating profit to consolidated income (loss) before income taxes:
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended February 28,
|
|
|
2018
|
|
2017
|
|
(Dollars in Millions)
|
Net Sales:
|
|
|
|
|
Specialty Solutions
|
|
$
|
109.2
|
|
|
$
|
93.7
|
|
Performance Materials
|
|
69.5
|
|
|
80.9
|
|
Total Net Sales
|
|
$
|
178.7
|
|
|
$
|
174.6
|
|
Segment Operating Profit:
|
|
|
|
|
Specialty Solutions
|
|
$
|
13.6
|
|
|
$
|
9.5
|
|
Performance Materials
|
|
2.1
|
|
|
4.7
|
|
Total segment operating profit
|
|
15.7
|
|
|
14.2
|
|
Interest expense
|
|
(5.1
|
)
|
|
(5.2
|
)
|
Corporate expenses
|
|
(8.4
|
)
|
|
(7.0
|
)
|
Income (Loss) Before Income Taxes
|
|
$
|
2.2
|
|
|
$
|
2.0
|
|
Note M - Subsequent Events
On March 2, 2018, the Company amended its
$350.0 million
Term Loan B Agreement. Primarily, the Term Loan Amendment (1) reduces the margins for borrowings under the Term Loan Agreement by
100
basis points to
3.25%
for Eurodollar rate loans and
2.25%
for base rate loans and (2) permits the Company to request additional term loans or incremental equivalent debt borrowings (the “Additional Term Loans”) in a maximum aggregate amount equal to the greater of (a)
$120.0 million
(an increase from
$85.0 million
previously) and (b) an aggregate principal amount such that, on a pro forma basis (giving effect to any Additional Term Loans), the Company’s senior secured leverage ratio will not exceed
4.0
to
1.0
. Related to this amendment, the Company incurred
$0.9 million
of additional deferred financing fees which will be amortized over the remaining term of the loan.