10-K 1 d283603d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2011

Commission file number 0-14800

 

 

X-RITE, INCORPORATED

(Name of registrant as specified in charter)

 

 

 

Michigan   38-1737300
(State of Incorporation)   (I.R.S. Employer Identification No.)

4300 44th Street S.E., Grand Rapids, Michigan 49512

(Address of principal executive offices)

616-803-2100

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, $.10 par value   NASDAQ Global Select Market

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933.    ¨  Yes    x  No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Securities Exchange Act of 1934.    ¨  Yes    x  No

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.    x  Yes    ¨  No

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    ¨  No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act)    ¨  Yes    x  No

On March 3, 2012, the number of outstanding shares of the registrant’s common stock, par value $.10 per share, was 86,111,319.

The aggregate market value of the common stock held by non-affiliates of the registrant (i.e., excluding shares held by executive officers, directors and control persons as defined in Rule 405, 17 CFR 230.405) as of July 1, 2011, the last business day of the second quarter of the Company’s fiscal year, was $426,633,646 computed at the closing price on that date.

Portions of the Company’s Proxy Statement for the 2012 Annual Meeting of Shareholders are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

 


Table of Contents

FORM 10-K

X-Rite, Incorporated

For The Year Ended December 31, 2011

Table of Contents

 

Part

  

Topic

  

Page

 

Part I

     

Item 1

  

Business

     1   

Item 1A

  

Risk Factors

     7   

Item 1B

  

Unresolved Staff Comments

     12   

Item 2

  

Properties

     13   

Item 3

  

Legal Proceedings

     14   

Item 4

  

Mine Safety Disclosures

     14   
  

Supplementary Item—Executive Officers of the Company

     14   

Part II

     

Item 5

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     15   

Item 6

  

Selected Financial Data

     17   

Item 7

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     18   

Item 7A

  

Quantitative and Qualitative Disclosures about Market Risk

     33   

Item 8

  

Financial Statements and Supplementary Data

     34   

Item 9

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosures

     71   

Item 9A

  

Controls and Procedures

     71   

Item 9B

  

Other Information

     71   

Part III

     

Item 10

  

Directors, Executive Officers, and Corporate Governance

     72   

Item 11

  

Executive Compensation

     72   

Item 12

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     73   

Item 13

  

Certain Relationships and Related Transactions, and Director Independence

     73   

Item 14

  

Principal Accountant Fees and Services

     73   

Part IV

     

Item 15

  

Exhibits, Financial Statement Schedules

     74   
  

Signatures

     75   
  

Exhibit Index

     77   


Table of Contents

PART I

 

ITEM 1. BUSINESS

X-Rite, Incorporated (X-Rite, the Company, our, we, or us) is a global leader in color science and color technology. The Company develops, manufactures, markets and supports innovative color solutions through measurement instrumentation systems, software, color standards and services, as described below in the product overview section. X-Rite’s expertise in inspiring, selecting, measuring, formulating, communicating and matching color helps users get color right the first time and every time, which translates to better quality and reduced costs. X-Rite serves a range of markets including printing, packaging, photography, graphic design, video, automotive, paints, plastics, and textiles. We serve these markets through our core product lines of Imaging and Media, Industrial, Standards, Support Services, and Retail. A more detailed discussion of our major markets and product line offerings appears below.

Products are sold worldwide through the Company’s own sales personnel and independent sales representatives and dealers. The Company is headquartered in Grand Rapids, Michigan and has other domestic operations in New Jersey, North Carolina, and Massachusetts. In addition, the Company has locations in Switzerland, Germany, England, France, Italy, Spain, the Czech Republic, Russia, India, China, Hong Kong, and Japan. Manufacturing facilities are located in the United States, Switzerland, and Germany.

X-Rite was organized in 1958 as a Michigan corporation and completed its initial public offering of common stock in April of 1986. Historically, the Company has grown organically through investment in new products and our existing business and in more recent years our growth has been driven by investing in international expansion and strategic acquisitions.

 

   

Product Innovation

Product innovation is a key success factor to our ability to remain competitive in the color management industry. In 2011, we introduced eight new products and two major product upgrades. We also devoted resources to developing customer-specific solutions for seven of our customers. In 2011, we spent approximately ten percent of our revenues on engineering, research, and development. Our focus continues to center on color management solutions that incorporate software, hardware, standards, and services.

 

   

International Growth

With offices in twelve countries outside the U.S. and service centers across Europe, Asia, and the Americas, we continue to expand our ability to conduct business with customers around the world. The Company began to accelerate its global presence in 1993 with the establishment of sales and service subsidiaries in several locations throughout Europe and Asia. In 2006 and 2007, we expanded our global presence even further through the acquisitions of Amazys Holding AG (Amazys) and Pantone Inc. (Pantone), respectively. In 2011, 2010, and 2009 sales outside the United States represented 68.6, 66.9, and 64.7 percent of total revenue, respectively.

 

   

Amazys Holding AG Acquisition

We completed the acquisition of Amazys in 2006 for $306.7 million. With significant international operations, including its headquarters in Switzerland, Amazys developed, marketed, and supported hardware, software, and services to measure and communicate color for the imaging and media, photography, digital imaging, plastics, apparel, textiles, and automotive industries. Prior to the acquisition, Amazys was X-Rite’s largest direct competitor. Subsequent to the acquisition of Amazys, X-Rite became the leader in the color management industry, and we established our European headquarters in Regensdorf, Switzerland.

 

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Pantone, Inc. Acquisition

We completed the acquisition of Pantone in 2007 for $175.9 million. The Pantone product offerings were and continue to be a leader in color inspiration, communication and specification standards in the creative design industries. The Pantone products represent a key color standard in the graphic arts, printing, publishing and advertising industries. Pantone also provides color standards and design tools for the fashion, home furnishings, architecture, paint, industrial design, and interior design industries. With the addition of the Pantone business, X-Rite was able to expand the global reach and breadth of its product offerings into new industries and established significant international recognition by incorporating the Pantone trade name into the X-Rite corporate brand.

In connection with the completion of the aforementioned acquisitions, the Company initiated a series of operational and organizational restructuring necessary to realign the Company, realize operational synergies of the acquisitions, and continue to remain competitive across all facets of the color management industry. While the need for these initiatives was clearly identified, the timing became critical in lieu of the global economic downturn that ensued in 2008. From the onset of the restructuring activities in 2006 through the end of 2010, the Company incurred approximately $28.7 million in restructuring charges. These charges relate to the synergies realized as part of our acquisitions and integration, cost containment actions taken as a result of the global economic downturn, and other actions to align our global entity and tax structure. These restructuring activities were completed in 2010.

The debt load incurred as a result of the acquisitions coupled with the economic downturn resulted in the Company experiencing covenant defaults on its credit facilities and it was required to complete a Corporate Recapitalization Plan in 2008. Under this plan, the Company raised $155 million in capital through the issuance of additional shares of common stock. Subsequently, in the fall of 2009, the Company entered into an exchange agreement to effectively convert $41.6 million of its outstanding second lien term loan for 41,561 newly issued Series A Preferred Stock (mandatorily redeemable preferred stock or MRPS) with a stated value of $1,000 and the issuance of warrants to acquire 7.5 million shares of common stock at an exercise price of $0.01 per share. With improved results from the global economic improvement, cost reductions, and completion of the restructurings, in the fall of 2010, the Company extinguished the second lien credit agreement with cash on hand of $9.9 million and borrowings under the first lien revolving credit facility of $16.5 million. As the condition of the global economy began to improve throughout 2010, the Company started to realize the benefits of the restructuring activities discussed above. With this improved operating performance, the Company was able to complete a debt refinancing in the first quarter of 2011, whereby the Company paid off the existing MRPS and remaining first lien debt with a single new senior secured credit facility. As a result of these debt reductions, total interest expense decreased by 55.7 percent from 2010 to 2011 and by 16.5 percent from 2009 to 2010.

PRODUCT OVERVIEW

Measurement Instrumentation

 

   

Colorimeters measure light much like the human eye using red, green and blue receptors and are utilized to measure printed colors on packages, labels, textiles and other materials where a product’s appearance is critical for buyer acceptance.

 

   

Spectrophotometers offer more precision than colorimeters; they measure light at more points over the entire visible spectrum. The increased precision of spectrophotometers make them useful in predicting color formulation for many types of materials such as plastics, paints, inks, ceramics and metals. The Company offers different optical geometries of spectrophotometers as well as application types from bench-top models, to portables to non-contact versions. Each variation provides specific benefits for the wide variety of markets served, whether it is a portable multi-angle for an automotive paint or a bench-top sphere geometry for a textile application or a non-contact single angle spectrophotometer for cosmetics, the specific device and accompanying software provide solutions for management of color and appearance in almost any application where color is found.

 

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Densitometers are instruments that measure optical or photographic density, compare such measurement to a reference standard, and signal the result to the operator of the instrument. Some models are designed for use in controlling variables in the processing of x-ray film in medical and non-destructive testing applications. Other models are designed to be used to control process variables in the production of photo-transparencies, such as photographic film and microfilm, or measure the amount of light that is reflected from a surface, such as ink on paper.

 

   

Spectrodensitometers combine the function of a densitometer with the functions of a colorimeter and a spectrophotometer to provide measurements for monitoring color reproduction used for controlling the color of printed inks in graphic arts applications.

 

   

Sensitometers are used to expose various types of photographic film in a very precise manner for comparison to a reference standard. The exposed film is processed and then “read” with a densitometer to determine the extent of variation from the standard.

Software

The Company provides software and databases that interface with its color measurement instruments and other process equipment. These software packages allow the user to collect and store color measurement data, compare that data to established standards and databases, communicate color results and formulate colors from a database.

Standards Products

The Standards product line embodies products for the accurate communication and reproduction of color, digitally or in print. These products establish color standardization and are used by customers worldwide in a variety of industries including imaging and media, textiles, digital technology, plastics, paint, medical, and food.

Support Services

Support Services provides customers access to color professional specialists, training, and technical support worldwide through color seminars, classroom workshops, on-site consulting, and interactive media development. Support Services additionally provides service repair operations that specialize in repairing all X-Rite equipment.

MAJOR MARKETS AND PRODUCT LINES

As noted above, the Company operates across a broad spectrum of markets including printing, packaging, photography, graphic design, video, automotive, paints, plastics, textiles and medical. These markets are generally categorized to align with our core product line offerings as outlined below. A key to the Company’s success is our ability to integrate our products and solutions across the various industries of a product life cycle to improve the color management process from the inception of a design, through the manufacturing process and end user experience.

Imaging and Media

The Imaging and Media product line consists of Digital Imaging and Printing. The Imaging and Media product lines provide solutions for commercial and package printing applications, digital printing and photo processing, photographic, graphic design and pre-press service bureaus in the imaging industries.

The Digital Imaging product line consists of solutions for graphic designers, photo processing, photography, graphic design, pre-press service bureaus, and a myriad of calibration tools for image setters, raster image processors, and other digital applications. Our color management systems give designers control of scanned artwork, images captured with a digital camera, desktop printers, high-end proofers and commercial presses that translate color from one device to the next. These solutions work to create value at key stages of the workflow by reducing waste, increasing productivity and enhancing quality.

 

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The Printing product line supports both digital and traditional printing. X-Rite’s color-calibrated instruments, digital palettes, and output measurement devices support color communication for the entire printing and preprinting process, reducing set up time and eliminating the opportunity for costly mistakes. Our handheld products are straightforward, self-contained solutions that keep color on-target in the pre-press process, ink lab and pressroom. X-Rite’s automated scanning systems support the need for faster and more frequent color data collection.

Industrial

Our Industrial product line is concentrated in the quality and process control markets. We design, develop, and manufacture precision instrumentation, software, and systems for global manufacturers, fulfilling a need to measure color for formulation, quality, and process control for paint, plastics, and textiles. Accurate color reproduction and global supply chain management offer these manufacturers and businesses a competitive advantage, and are important factors to streamline process development when products are assembled from parts made around the world. X-Rite’s industrial product solutions are designed to reduce waste, increase production uptime, improve process management, and enable global color communication.

Standards

The Standards product line includes products for the accurate communication and reproduction of color, servicing worldwide customers in a variety of industries including imaging and media, textiles, digital technology, plastics and paint. The Pantone products represent a key color standard in the home fashion and design industries, serving the graphic arts, printing, publishing, advertising, paint, and textiles markets. The Standards product line also embodies the Munsell Color System, which is a scientifically based color order system that is used to define color based on the three attributes of color: hue, value, and chroma.

Support Services

Our Support Services market provides customers access to color professional specialists, training, and technical support worldwide through color seminars, classroom workshops, on-site consulting, and interactive media development. Our Support Services business provides both major manufacturers and end users with comprehensive solutions for their color and workflow problems. Support Services additionally operates and manages the Company’s service repair operation with facilities around the world and specializes in repairing all X-Rite equipment. The products repaired by the service department include products currently covered by our warranty program as well as those products which are out of warranty.

Retail

X-Rite’s Retail product line consists of our paint matching technology. The paint matching market is conducted under the name of MatchRite. X-Rite is a leading supplier of retail paint matching systems for home centers, mass merchants, hardware stores and paint retailers in North America, and has established a strong presence in Europe and other regions of the world. X-Rite’s Retail customers rely on its strength in color measurement instrumentation, database creation and management, custom software development, and large scale account servicing. These solution-based products reduce paint inventory for the retailer and provide a user-friendly environment for sophisticated shade matching capabilities to the consumer.

OTHER INFORMATION

Manufacturing, Sourcing, and Service

We manufacture the majority of our products at our facilities in the United States and Switzerland. We generally have multiple sources for raw materials, supplies and components but also have some materials that are single sourced. These consist primarily of electrical and molded plastic components that are generally widely

 

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available in the market. We rely on a number of strategic supply chain partners to produce key components or sub-assemblies that support our final assembly, calibration, and test process as well as our finished products. Product repair and service is provided at eleven locations throughout the world.

Competition

Our business is competitive and subject to technological change, evolving customer requirements, and changing business models. We face strong competition in many areas of our current business activities. The rapid pace of technological change creates new opportunities for both our existing competitors as well as start-ups. Moreover, the rise of new industry alliances, and mergers and acquisitions can dramatically change our competitive landscape and can result in competitors with significant resources in research and development, marketing and sales. Further, customer requirements change quickly as a result of new and more cost efficient technologies. The primary base of competition for all the Company’s products is technology and intellectual property, design, service, and price. Our competitive position may be adversely affected in the future by one or more of the factors described in this section.

The markets we serve are highly competitive and fragmented. We face direct competition from approximately eleven firms which are producing competing products in the Imaging and Media category, approximately nine manufacturers of competing products in the Retail and Industrial markets, and approximately four distributors in the Standards industry; some of whom have significant access to resources. While no single company competes with us in all of our markets and product lines, various companies compete with us in one or more of our markets and product lines. Some of these competitors may have substantially greater sales and assets than we do.

Employees

As of December 31, 2011, the Company employed 747 people on a full time basis, of which 478 were in the United States. We believe we have generally good relationships with our employees.

Patents

As of December 31, 2011, X-Rite owned 187 patents and had 67 patent applications on file. While the Company follows a policy of obtaining patent protection for its products where appropriate, it does not believe that the loss of any existing patent, or failure to obtain any new patents, would have a material adverse impact on its current operations. We expect to protect our products and technology by asserting our intellectual property rights where appropriate and prudent.

Distribution Networks

The Company’s products are sold by its own sales personnel and through independent manufacturer’s representatives. A portion of the Company’s products not sold directly to end-users are distributed through a network of independent dealers throughout Europe, Asia Pacific and the Americas.

Seasonality

The Company’s business is generally not subject to seasonal variations that significantly impact sales, production, or net income.

Significant Customers

During 2011, 2010 and 2009, the Company did not have any customers that individually accounted for greater than 10 percent of consolidated net sales.

 

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Backlog

The Company’s estimated backlog of scheduled but unshipped orders was $20.8 million as of January 30, 2012 and $20.9 million as of January 29, 2011. This backlog is expected to be utilized during the current fiscal year. Orders in backlog are subject to change or cancellation by our customers.

Research, Development and Engineering

During 2011, 2010, and 2009, the Company expensed $23.2, $23.7, and $22.6 million, respectively, on research, development, and engineering.

In addition to the research, development, and engineering costs reported as operating expenses, certain costs to develop new software products were capitalized in each of the last three years. Software development costs capitalized totaled $7.3, $6.5, and $4.4 million in 2011, 2010, and 2009, respectively. The related amortization expense was included in cost of sales as discussed in “Notes to Consolidated Financial Statements” in Item 8 of this report.

Financial Information About Segments and Geographic Areas

We operate and generate revenue as one segment in the color management industry. For further discussion of our segment reporting, see “Notes to Consolidated Financial Statements” in Item 8 of this Report.

We operate in the geographic areas described above under Item 1, “Business.” For additional information regarding our revenue and long-lived assets by geographic area, see “Notes to Consolidated Financial Statements” in Item 8 of this Report. For information regarding risks relating to our foreign operations, see Item 1A, “Risk Factors” in this Report.

Regulatory and Environmental Matters

We are subject to federal, state, local and foreign laws, rules and regulations that govern activities that may have adverse environmental effects and which impose liability for compliance and clean-up costs resulting for the discharge, handling, storage and disposal of hazardous wastes and substances. Compliance with these laws, rules and regulations has not had, and is not expected to have, a material effect on our business, results of operations or financial condition.

Availability of Information

X-Rite’s internet website is www.xrite.com. X-Rite’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Exchange Act are available free of charge through our website as soon as reasonably practicable after we electronically file with or furnish them to the Securities and Exchange Commission. The information contained on our website is not a part of, or incorporated by reference into, this Annual Report on Form 10-K.

 

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ITEM 1A RISK FACTORS

There are many risk factors that may adversely affect the Company’s operating results, including the following significant risks. See also “Notes to Consolidated Financial Statements” located herein at Item 8 for additional risks that may affect the Company.

Our future results could be harmed by economic, political, geographic, regulatory and other specific risks associated with international operations.

During 2011, we derived approximately 68.6 percent of our total revenues from sales of our products outside of the United States, compared with 66.9 and 64.7 percent during 2010 and 2009, respectively. Our foreign generated revenues were denominated in Swiss Francs, Euros, British Pound Sterling, Chinese Yuan, and Japanese Yen. The United States dollar value of our foreign generated revenues varies with currency exchange rate fluctuations. Significant increases in the value of the United States dollar relative to other currencies could have a material adverse effect on our results of operations. We address currency risk management through regular operating and financing activities. We currently have minimal hedging or similar foreign currency contracts to mitigate the risk of exchange rate fluctuations. Fluctuations in the value of foreign currencies could adversely impact the profitability of our foreign operations. We intend to continue to pursue growth opportunities in sales internationally, which could expose us to greater risks associated with international sales and operations. There can be no assurance that we will maintain or expand our international sales. If the revenues generated from international activities, especially in emerging markets, are inadequate to offset the expense of maintaining such international operations, our business, financial condition and results of operations could be materially and adversely affected. The increasingly international reach of our businesses could also subject us and our results of operations to unexpected, uncontrollable and rapidly changing economic and political conditions. Specifically, international sales and operations are subject to inherent risks, including:

 

   

lack of experience in a particular geographic market;

 

   

tariffs and other barriers, including import and export requirements, taxes on subsidiary operations and investment restrictions or requirements;

 

   

different and changing regulatory requirements in various countries and regions;

 

   

fluctuating exchange rates and currency controls;

 

   

difficulties in staffing and managing foreign sales and support operations;

 

   

longer accounts receivable payment cycles;

 

   

potentially adverse tax consequences, including repatriation of earnings;

 

   

diminished protection of intellectual property in some countries outside the U.S.;

 

   

lack of acceptance of localized products or X-Rite in foreign countries;

 

   

differing local product preferences and product requirements;

 

   

labor force instability, including possible shortages of skilled personnel required for local operations;

 

   

exposure to local economic conditions; and

 

   

political, economic, and civil instability, such as perceived or actual public health, terrorist risks, violence, civil unrest, or outbreaks of war which impact a geographic region and business operations therein.

As we expand our international operations, we may encounter new risks. For example, as we focus on building our international sales and distribution networks in new geographic regions, we must continue to develop relationships with qualified local distributors and trading companies. If we are not successful in developing these relationships, we may not be able to grow sales in these geographic regions.

 

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Our debt level and the inability to access capital markets could adversely affect our operating flexibility and put us at a competitive disadvantage.

As of December 31, 2011, the Company had outstanding borrowings of $149.8 million under its senior secured credit facility. This amount of debt will require significant interest and principal payments. Our level of debt and the limitations imposed on us by our credit facility could adversely affect our operating flexibility and put us at a competitive disadvantage. Our debt level may adversely affect our future performance, because, among other things:

 

   

We may be placed at a competitive disadvantage relative to our competitors, some of which have lower fixed payment obligations and greater financial resources than we do;

 

   

Our ability to complete future acquisitions may be limited;

 

   

We will have to use a portion of our cash flow for debt service rather than for investment in research and development and capital expenditures;

 

   

We may not be able to obtain further debt financing and/or we may have to pay more for such additional financing as we are able to obtain;

 

   

We may not be able to take advantage of business opportunities; and

 

   

We will be more vulnerable to adverse economic conditions.

The senior credit facility contains certain covenants applicable to us and our subsidiaries that may adversely affect our ability to create liens, incur indebtedness, make certain investments or acquisitions, pay dividends, repurchase shares, enter into certain transactions with affiliates, incur capital expenditures beyond prescribed limits and that require us to deliver certain reports and information, and meet certain financial ratios.

There can be no assurance that we will be able to access the capital markets to obtain future debt or equity financing on commercially reasonable terms or at all in connection with the repayment or refinancing of our indebtedness. If we are unable to service our indebtedness or satisfy our payment obligations, these obligations could be accelerated, thereby causing our business, financial condition, and results of operations to be materially adversely affected.

We may face potential tax liabilities.

We are subject to taxation in many jurisdictions in the United States, Europe, Asia and elsewhere. In the ordinary course of business, there are transactions and calculations where the ultimate tax liability cannot be determined with certainty at the time the transaction is entered into. Preparation of our income tax provision requires the use of judgments as to how these transactions will ultimately be taxed. We believe our tax accruals are accurate though the ultimate determination of these issues may be different from that which is reflected in our historical provision and accruals. Should these determinations be different from what was previously recorded and additional tax is assessed, those assessments would be recorded in the period in which they occur.

The Company’s reliance on a small number of primary manufacturing centers may affect timely production and profitability.

Manufacturing and service of much of our core color products are performed at our facility in Grand Rapids, Michigan, and in our Regensdorf, Switzerland and Carlstadt, New Jersey facilities. Should a catastrophic event occur at any of these facilities, our ability to manufacture products, complete existing orders, and provide other services could be adversely impacted for an undetermined period of time. Although we have purchased business interruption insurance to cover the costs of certain catastrophic events, there is no assurance that such insurance could be adequate to cover the losses we may incur from any such disruption or event. In addition, our inability to conduct normal business operations for a period of time could have an adverse impact on the short-term and long-term operating results.

 

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Our reliance on outsourced manufacturing presents risks to our fulfillment process.

We rely on a number of strategic supply chain partners to produce key components or sub-assemblies that support our final assembly, calibration, and test process. Some of these suppliers are single sourced small companies which may experience adverse financial conditions and therefore present risks to our fulfillment process.

We depend on new product development to compete effectively.

We have made large investments in new products and services. There are no assurances as to when future revenues from these products will be received, or that the ultimate profit margins received will be adequate to justify the investment.

Continual development of new products, technologies, and enhancements to existing products is a core component of our long-term growth plans. Our future business, financial condition and results of operations will depend to a significant extent on our ability to develop new products and services that address these market opportunities. As a result, we believe that significant expenditures for research, development and engineering will continue to be required in the future. Product development requires a time-consuming and costly research and development process. Unexpected delays in this process may significantly affect the timing of future revenues and increase costs. We must anticipate the features and functionality that customers will demand, incorporate those features and functionality into products, price our products competitively and introduce new products to the market on a timely basis. We cannot assure you that the products we expect to introduce will incorporate the features and functionality demanded by our customers, will be successfully developed, or will be introduced within the appropriate window of market demand. If there are delays in production of current or new products, our potential future business, financial condition, and results of operations could be adversely affected. In addition, the time required for competitors to develop and introduce competing products may be shorter, their manufacturing yields may be better, and their production costs may be lower than those experienced by us.

Adverse general economic and industry conditions could adversely affect our revenues and profitability.

Adverse general economic and industry conditions could lead to declines in the use of our products by our customers and a decline in sales. Many of our products are used for quality control purposes within a larger manufacturing or production process by customers who have been or may be impacted by adverse economic and market conditions. As such, our sales in some instances are linked to capital goods spending. Another economic slowdown or adverse global economic or industry conditions generally could result in a decrease in capital goods spending or sales and thereby adversely affect our revenues and profitability. In addition, accounts receivable and past due accounts could increase due to a decline in our customers’ ability to pay as a result of adverse economic and market conditions which also could adversely affect our financial performance.

If we fail to attract, hire and retain qualified personnel, we may not be able to design, develop, market or sell our products or successfully manage our business.

Our operations and the development of new products require expertise. In addition, our ability to attract new customers, retain existing customers and pursue our strategic objectives depends on the continued services of our current management, sales, product development and technical personnel and our ability to identify, attract, train and retain similar personnel. Competition for top management personnel is intense and we may not be able to recruit and retain the personnel we need if we are unable to offer competitive compensation and benefits. The loss of any one of our management personnel, or our inability to identify, attract, train, retain and integrate additional qualified management personnel, could make it difficult for us to manage our business successfully and pursue our strategic objectives. We do not carry key person life insurance on any of our employees. Similarly, competition for skilled sales, product development and technical personnel is intense and we may not be able to recruit and retain the personnel we need. The loss of the services of key sales, product development

 

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and technical personnel, or our inability to hire new personnel with the requisite skills, could restrict our ability to develop new products or enhance existing products in a timely manner, sell products to our customers or manage our business effectively.

If we are unable to protect our intellectual property rights, our business and prospects may be harmed.

We have made significant expenditures to develop and acquire technology and intellectual property rights. We actively patent and trademark these properties when deemed appropriate and will vigorously defend them against infringement. Our failure to protect our intellectual property could seriously harm our business and prospects because developing new products and technologies is critical to our success. We will incur substantial costs in obtaining patents and, if necessary, defending our intellectual propriety rights. We do not know whether we will obtain the patent protection we seek, or that the protection we do obtain will be found valid and enforceable if challenged. Our efforts to protect our intellectual property through patents, trademarks, service marks, domain names, trade secrets, copyrights, confidentiality and nondisclosure agreements and other measures may not be adequate to protect our proprietary rights. Patent filings by third parties could render our intellectual property less valuable. Disputes may arise as to ownership of our intellectual property or as to whether products designed by our competitors infringe our intellectual property rights. Employees, consultants and others who participate in developing our products may breach their agreements with us regarding our intellectual property, and we may not have adequate remedies for the breach. In addition, intellectual property rights may be unavailable or limited in some foreign countries, which could make it easier for competitors to capture market position. Competitors may also capture market share from us by designing products that mirror the capabilities of our products or technology without infringing on our intellectual property rights. In addition, as sales of our products continue to grow internationally, our exposure to intellectual property infringements in countries where intellectual property rights protections are less stringent will increase. If we do not obtain sufficient international protection for our intellectual property, our competitiveness in international markets could be impaired, which would limit our growth and future revenue.

We may be subject to intellectual property litigation and infringement claims, which could cause us to incur significant expenses or prevent us from selling our products.

A successful claim of patent or other intellectual property infringement against us could adversely affect our growth and profitability, in some cases materially. We cannot assure you that others will not claim that our proprietary or licensed products are infringing on their intellectual property rights or that we do not in fact infringe on those intellectual property rights. From time to time, we receive notices from third parties of potential infringement and receive claims of potential infringement. We may be unaware of intellectual property rights of others that may cover some of our technology. If someone claims that our products infringed on their intellectual property rights, any resulting litigation could be costly and time consuming and would divert the attention of management and key personnel from other business issues. The complexity of the technology involved and the uncertainty of intellectual property litigation increase these risks. Claims of intellectual property infringement also might require us to enter into costly royalty or license agreements or to modify our products. We also may be subject to significant damages or an injunction preventing us from manufacturing, selling or using some of our products in the event of a successful claim of patent or other intellectual property infringement. Any of these adverse consequences could have a material adverse effect on our business, financial condition and results of operations.

The markets for our products and services are competitive. If we are unable to compete effectively with existing or new competitors, our business could be negatively impacted.

The markets in which we compete are very competitive and subject to technological change, evolving standards, frequent product enhancements and introductions and changing customer requirements. A number of companies offer products and services that are similar to those offered by us and that target the same markets. In addition, any of these competitors may be able to respond more quickly to new or emerging technologies and

 

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changes in customer requirements, and to devote greater resources to the development, promotion and sale of their products than us. Our competitors may develop products and services that compete with those offered by us or may acquire companies, businesses and product lines that compete with us. It also is possible that competitors may create alliances and rapidly acquire significant market share, including in new and emerging markets. If we are not able to differentiate our products and services in the market, competitive pressures may potentially impact our sales volumes, pricing structure, gross margin, operating expenses and operating income.

Accordingly, there can be no assurance that current or potential competitors of X-Rite will not develop or acquire products or services comparable or superior to those that we develop, combine or merge to form significant competitors, or adapt more quickly than us to new technologies, evolving industry trends and changing customer requirements. Competition could cause price reductions, reduced margins or loss of market share for our products and services, any of which could materially and adversely affect our business, operating results and financial condition. There can be no assurance that we will be able to compete successfully against current and future competitors or that the competitive pressures that the company may face will not materially adversely affect our business, operating results, cash flows and financial condition.

We may be affected by environmental laws and regulations.

We are subject to a variety of laws, rules and regulations relating to discharges of substances into the air, water and land, the handling, storage and disposal of wastes and the cleanup of properties necessitated by pollutants. Any of those regulations could require us to acquire expensive equipment or to incur substantial other expenses to comply with them. If we incur substantial additional expenses, product costs could significantly increase. Also, if we fail to comply with present or future environmental laws, rules and regulations, such failure could result in fines, suspension of production or cessation of operations.

Impairment charges relating to our goodwill, indefinite lived intangibles, and long-lived assets could adversely affect our financial performance.

We regularly monitor our goodwill, indefinite lived intangibles, and long-lived assets for impairment indicators using the fair value of our reporting unit and the undiscounted cash flows expected to be generated from the long-lived assets. Changes in economic or operating conditions impacting our estimates and assumptions could result in the impairment of our goodwill, indefinite lived intangibles, or long-lived assets. In the event that we determine that our goodwill, indefinite lived intangibles, or long-lived assets are impaired, we may be required to record a significant charge to earnings that could adversely affect our financial condition and operating results.

Because a limited number of stockholders control the majority of the voting power of our common stock, our other stockholders will not be able to determine the outcome of stockholder votes.

As of December 31, 2011, affiliates of OEPX, LLC, Sagard Capital Partners, L.P. and Tinicum Lantern II, L.L.C., directly or indirectly, beneficially own and have the ability to exercise voting control over, in the aggregate, approximately 67.8 percent of our outstanding common stock. As a result, these stockholders are able to exercise significant control over all matters requiring stockholder approval, including the election of directors, any amendments to our certificate of incorporation and significant corporate transactions. These stockholders may exercise this control even if they are opposed by our other stockholders. Without the consent of these stockholders, we could be delayed or prevented from entering into transactions (including the acquisition of our company by third parties) that may be viewed as beneficial to us or our other stockholders. In addition, this significant concentration of stock ownership may adversely affect the trading price of our common stock if investors perceive disadvantages in owning stock in a company with controlling stockholders.

 

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We are involved from time to time in various legal and regulatory proceedings and claims, which could adversely affect our financial performance.

We are involved in various legal and regulatory proceedings and claims from time to time that could be significant. These are typically claims that arise in the normal course of business including, without limitation, commercial or contractual disputes, including disputes with our customers, suppliers or competitors, intellectual property matters, personal injury claims, tax matters and employment matters. No assurance can be given that such proceedings and claims will not adversely affect our financial condition, operating results and cash flows.

New laws or regulations or changes in existing laws or regulations could adversely affect our financial performance.

We are subject to a variety of federal, state, local and foreign laws, rules and regulations, including those related to health, safety and environmental matters. Governmental regulations also affect taxes and levies, capital markets, healthcare costs, energy usage, international trade, and immigration and other labor issues, all of which may have a direct or indirect effect on our businesses and our customers’ and suppliers’ businesses. We cannot predict the substance or impact of pending or future legislation or regulations, or the application thereof. Changes in these laws or regulations, the interpretation thereof or the introduction of new laws or regulations could increase the costs of doing business for us or our customers or suppliers or restrict our actions and adversely affect our financial condition, operating results and cash flows.

 

ITEM 1B UNRESOLVED STAFF COMMENTSNone

 

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ITEM 2. PROPERTIES

The Company and its subsidiaries own or lease properties throughout the world. Listed below are the principal properties owned or leased as of December 31, 2011:

 

Location

  

Principal Uses

  

Owned/Leased

Grand Rapids, MI

   Company headquarters, manufacturing,    Owned
   RD&E, sales, customer service, warehouse,   
   and administration   

Tewksbury, MA

   RD&E, sales, and administration    Leased

Greensboro, NC

   Sales and customer service    Leased

Carlstadt, NJ

   Manufacturing, RD&E, sales, customer    Leased
   service, warehouse, and administration   

Regensdorf, Switzerland

   Manufacturing, RD&E, sales, customer    Leased
   service, warehouse and administration   

Poynton, England

   Sales, customer service, and administration    Leased

Berlin, Germany

   Sales and customer service    Leased

Neu-Isenburg, Germany

   Sales and customer service    Leased

Martinsried, Germany

   Manufacturing, RD&E, sales, and customer    Leased
   service   

Luxembourg, Grand Duchy

   Administration    Leased

of Luxembourg

     

Massy, France

   Sales, customer service, and administration    Leased

Prato, Italy

   Sales and customer service    Leased

Barcelona, Spain

   Sales and customer service    Leased

Moscow, Russia

   Sales and customer service    Leased

Vyskov, Czech Republic

   Sales and customer service    Leased

Tokyo, Japan

   Sales, customer service, and administration    Leased

North Point, Hong Kong

   Sales, customer service, and administration    Leased

Beijing, China

   Sales and customer service    Leased

Guangzhou, China

   Sales and customer service    Leased

Shanghai, China

   Sales, customer service, and administration    Leased

Bangalore, India

   Sales    Leased

As of December 31, 2011, X-Rite and its subsidiaries collectively owned approximately 375,000 square feet of space and leased approximately 227,000 square feet.

Management considers all the Company’s properties and equipment to be suitable and adequate for its current and reasonably anticipated development, production, distribution, and selling requirements.

 

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ITEM 3. LEGAL PROCEEDINGS

The Company is periodically involved in legal proceedings, legal actions, and claims arising in the normal course of business, including proceedings related to product, labor, and other matters. Such matters are subject to many uncertainties, and outcomes are not predictable. The Company records amounts for losses that are deemed probable and subject to reasonable estimates. Although the results of the proceedings, actions, and claims described in this report cannot be predicted with certainty, the Company does not believe that the ultimate resolution of any of these matters will have a material adverse effect on its financial condition or results of operations.

 

ITEM 4. MINE AND SAFETY DISCLOSURES—Not Applicable

SUPPLEMENTARY ITEM—EXECUTIVE OFFICERS OF THE COMPANY

The following table lists the names, ages, and positions of all of the Company’s executive officers. Executive officers are appointed annually by our Board of Directors and serve at the pleasure of the Board of Directors.

 

Name

   Age     

Position

Thomas J. Vacchiano Jr.

     59       President, Chief Executive Officer

Rajesh K. Shah

     60       Executive Vice President, Chief Financial Officer and Secretary

Francis Lamy

     53       Executive Vice President, Chief Technology Officer

Vijender Stalam

     57       Senior Vice President, Sales & Marketing

Thomas J. Vacchiano, Jr. is the President and Chief Executive Officer of the Company and has held that position since October 1, 2006. Mr. Vacchiano also serves as a director of the Company. He joined X-Rite as its President in July 2006 as part of the Amazys acquisition. Prior to the Amazys acquisition, he served as Amazys’ President and Chief Executive Officer. Amazys was a color technology company headquartered in Switzerland and was publicly traded on the Swiss Stock Exchange.

Rajesh K. Shah is the Executive Vice President, Chief Financial Officer and Secretary of the Company and has held that position since October 2009. Prior to joining X-Rite, Mr. Shah served as Executive Vice President and Chief Financial Officer of Cadence Innovation, LLC, a global manufacturer of automotive interior systems from 2007 to March 2009. Prior to his service at Cadence Innovation, Mr. Shah was Executive Vice President and Chief Financial Officer of Remy International, Inc., a manufacturer of automotive and commercial products from 2002 to 2006.

Francis Lamy is the Executive Vice President and Chief Technology Officer of the Company and has held that position since July 2006, when he joined the Company in connection with its acquisition of Amazys. Prior to joining X-Rite, Mr. Lamy served as the Executive Vice President and Chief Technology Officer of GretagMacbeth AG, the primary subsidiary of Amazys, since 1999.

Vijender Stalam is the Senior Vice President of Sales & Marketing and joined the Company in December 2011. From 2009 to 2011, he served as Vice President, Commercial Sales (Americas Region) of Eastman Kodak Company (Kodak). From 2007 to 2009, Mr. Stalam held the position of Vice President, Global Strategic Accounts and Channels of Kodak. Prior to that, Mr. Stalam held a number of key positions over his 20 year career at Kodak including Vice President, Packaging, Commercial & Publishing Segments; Chief Marketing & Business Development Officer; Vice President Kodak Polychrome Graphics.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company’s common stock is listed on the NASDAQ—Global Select Market under the symbol “XRIT”. As of March 3, 2012, there were approximately 787 shareholders of record. Ranges of high and low sales prices reported by the NASDAQ for the past two fiscal years appear in the following table.

 

     High      Low  

Year Ended December 31, 2011:

     

Fourth Quarter

   $ 4.87       $ 3.53   

Third Quarter

     5.03         3.26   

Second Quarter

     5.08         4.28   

First Quarter

     4.99         3.83   

Year Ended January 1, 2011:

     

Fourth Quarter

   $ 4.75       $ 3.61   

Third Quarter

     3.84         3.19   

Second Quarter

     3.98         3.05   

First Quarter

     3.50         2.04   

In 2007, the Company’s Board of Directors voted to suspend payment of its dividend on common stock. This decision was made in order to accelerate the repayment of debt and to invest in future product development initiatives. Although the Board does not currently anticipate reinstating the dividend payment in the foreseeable future, it will continue to reevaluate this matter periodically. Any determination to pay cash dividends will be at the discretion of the Board and will be dependent upon the Company’s results of operations, financial condition, terms of financing arrangements, and such other factors as the Board may deem relevant.

 

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Shareholder Return Performance Graph

Set forth below is a line graph comparing the yearly percentage change in the cumulative total shareholder return on the Company’s common stock with that of the cumulative total return of the NASDAQ Stock Index (US & foreign) and NASDAQ Non-Financial Stock Index for the five-year period ended December 31, 2011 (fiscal 2011). The graph assumes an investment of $100 at the beginning of the period indicated in the Company’s common stock, the NASDAQ Stock Index (US & foreign) and the NASDAQ Non-Financial Index, with dividends reinvested.

 

LOGO

 

     2006      2007      2008      2009      2010      2011  

X-Rite, Inc.

   $ 100       $ 94       $ 12       $ 18       $ 37       $ 38   

NASDAQ US & foreign

   $ 100       $ 111       $ 53       $ 77       $ 91       $ 119   

NASDAQ Non-Financial

   $ 100       $ 113       $ 52       $ 78       $ 93       $ 113   

 

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ITEM 6. SELECTED FINANCIAL DATA

Selected financial data for the five most recently completed fiscal years is summarized below. Such data should be read in conjunction with the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and notes thereto and information included elsewhere in this Annual Report on Form 10-K.

(in thousands, except per share data)

 

     2011      2010      2009     2008     2007  

Net sales

   $ 237,552       $ 222,740       $ 191,667      $ 261,491      $ 248,710   

Operating income (loss)

     38,197         28,929         3,821        (54,864     16,643   

Net income (loss)

     49,361         3,641         (25,242     (117,824     (20,822

Net income (loss) per share:

            

Basic

     0.57         0.04         (0.33     (3.12     (0.72

Diluted

     0.56         0.04         (0.33     (3.12     (0.72

Total assets

   $ 463,128       $ 439,095       $ 472,715      $ 545,657      $ 654,824   

Long-term debt

     149,814         136,598         183,634        270,934        381,000   

Mandatorily redeemable preferred stock, net of warrant discount of $10,615 and $14,065, in 2010 and 2009 respectively

     —           36,402         29,764        —          —     

Weighted-average common shares outstanding:

            

Basic

     85,275         84,414         77,500        37,753        28,866   

Diluted

     87,357         85,799         77,500        37,753        28,866   

Assets acquired and liabilities assumed in the Pantone acquisition were recorded on the Company’s Consolidated Balance Sheets based on their estimated fair values as of the date of acquisition—October 24, 2007. The results of operations of Pantone have been included in the Company’s Consolidated Statements of Operations since the date of acquisition. The 2008 operating results include a $58.1 million impairment charge recognized in relation to acquired goodwill and indefinite-lived intangible assets.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS:

This discussion and analysis of financial condition and results of operations, as well as other sections of the Company’s Form 10-K, contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act, as amended, that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the industries it serves, the economy, and about the Company itself. Words such as “anticipates,” “believes,” “estimates,” “expects,” “likely,” “plans,” “projects,” “should,” and variations of such words and similar expressions are intended to identify such forward looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict with regard to timing, extent, likelihood, and degree of occurrence including those listed in Item 1A—Risk Factors. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. Furthermore, X-Rite undertakes no obligation to update, amend or clarify forward-looking statements, whether as a result of new information, future events, or otherwise. Forward-looking statements include, but are not limited to, statements concerning liquidity, capital resource needs, tax rates, dividends, and potential new markets.

The following management’s discussion and analysis describes the principal factors affecting the results of operations, liquidity and capital resources, as well as the critical accounting policies of X-Rite. For purposes of this discussion, amounts from the accompanying Consolidated Financial Statements and related notes have been rounded to millions of dollars, except where separately disclosed, for convenience of the reader. These rounded amounts are the basis for calculations of comparative changes and percentages used in this discussion. This discussion should be read in conjunction with the accompanying Consolidated Financial Statements and notes thereto, which include additional information about the Company’s significant accounting policies, practices and transactions that underlie its financial results.

OVERVIEW OF THE COMPANY

X-Rite is a global leader in color science and color technology. The Company develops, manufactures, markets and supports innovative color solutions through measurement instrumentation systems, software, color standards, and services. X-Rite’s expertise in inspiring, selecting, measuring, formulating, communicating and matching color helps users get color right the first time and every time, which translates to better quality and reduced costs. X-Rite serves a range of markets including printing, packaging, photography, graphic design, video, automotive, paints, plastics, textiles, dental and medical. X-Rite serves these markets through its core product lines of Imaging and Media, Industrial, Standards, Support, and Retail. A more detailed discussion of our major markets and product line offerings appears in “Business.”

Products are sold worldwide through the Company’s own sales personnel and through independent sales representatives and dealers. The Company is headquartered in Grand Rapids, Michigan and has other domestic operations in New Jersey, North Carolina, and Massachusetts. In addition, the Company has locations in Switzerland, Germany, England, France, Italy, Spain, the Czech Republic, Russia, India, China, Hong Kong, and Japan. Manufacturing facilities are located in the United States, Switzerland, and Germany.

Overview of 2011

 

   

Net sales of $237.6 million, up 6.7 percent year over year

 

   

Operating income of $38.2 million, up $9.2 million, or 32.0 percent, year over year

 

   

Net income of $49.4 million, or $0.56 per diluted share, up $45.8 million or $0.52, year over year. The results were positively impacted by a release of tax valuation allowances.

 

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RESULTS OF OPERATIONS

The following table summarizes the results of the Company’s operations for the 2011, 2010, and 2009 fiscal years (in millions):

 

                       Change  
     2011     2010     2009     2011 / 2010     2010 / 2009  

Net sales

   $ 237.6      $ 222.7      $ 191.7      $ 14.9        6.7   $ 31.0        16.2

Cost of sales

     96.9        89.6        81.1        7.3        8.0        8.5        10.6   
  

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Gross profit

     140.7        133.1        110.6        7.6        5.7        22.5        20.3   

Operating expenses

     102.5        104.1        106.8        (1.6     (1.6     (2.7     (2.5
  

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Operating income

     38.2        29.0        3.8        9.2        32.0        25.2        657.2   

Interest expense

     (12.4     (28.0     (33.5     15.6        (55.6     5.5        (16.5

Loss on redemption of preferred shares and debt refinancing costs

     (13.8     (1.1     (2.3     (12.7     1,167.5        1.2        (51.8

Other income, net

     1.6        1.5        2.1        0.1        3.1        (0.6     (24.0
  

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Income (loss) before income taxes

     13.6        1.4        (29.9     12.2        865.4        31.3        (104.7

Income tax benefit

     (35.8     (2.2     (4.7     (33.6     1,500.4        2.5        (52.3
  

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Net income (loss)

   $ 49.4      $ 3.6      $ (25.2   $ 45.8        1255.7   $ 28.8        114.4
  

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Net Sales—2011 Versus 2010

The following table summarizes net sales from continuing operations for the 2011 and 2010 fiscal years by product line (in millions):

 

     2011     2010     Change  

Imaging and Media

   $ 90.8         38.2   $ 87.3         39.2   $ 3.5        4.1

Industrial

     50.0         21.1        47.3         21.2        2.7        5.7   

Standards

     46.9         19.7        42.1         18.9        4.8        11.2   

Support Services

     29.1         12.2        25.8         11.6        3.3        12.5   

Retail

     16.1         6.8        15.4         6.9        0.7        5.1   

Other

     4.7         2.0        4.8         2.2        (0.1     (3.6
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

Total Net Sales

   $ 237.6         100.0   $ 222.7         100.0   $ 14.9        6.7
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

All of the Company’s core product lines realized year to date net sales increases with the exception of a minor decrease in Other. The Company’s sales growth was the result of recently launched product and marketing initiatives in combination with the positive effect of exchange rate changes and general economic growth particularly in the first half of 2011.

The Imaging and Media product lines provide solutions for commercial and package printing applications, digital printing and photo processing, photographic, graphic design and pre-press service bureaus in the imaging industries. The current year growth started out slow and was favorably influenced by new product releases late in the year particularly for creative, pre-press, and photo users. The new i1 Professional product family as well as i1Profiler, i1Display 3, and ColorMunki Display were notable revenue contributors. While digital printing demand continued to grow, demand for traditional sheet-fed printing solutions was fairly flat and the full year sales growth was paced by our digital imaging product portfolio.

The Industrial group product line provides color measurement solutions for the automotive quality control, process control and global supply chain markets. The Company’s products are an integral part of the manufacturing process for automotive interiors and exteriors, as well as textiles, plastics, and dyes. Net sales were up with strong sales growth early in 2011, which regressed slightly in the latter part of the year yielding a

 

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steady year over year growth. The late year slowdown was experienced across multiple geographies and product lines. This experience has historically been linked to a weakening of confidence in the economic outlook or access to financing. Our new Multi-Angle family of instruments have led our sales growth in Industrial for the majority of the year.

The Standards product line includes products for the accurate communication and reproduction of color, servicing worldwide customers in a variety of industries including imaging and media, textiles, digital technology, plastics and paint. Net sales showed significant growth in 2011 paced by strong sales of new products. Key contributors in the year include the new Pantone Matching System Plus Series, recent addition of 175 new colors in Pantone’s Fashion & Home product portfolio, and the Pantone edition of the CapsureTM product for designers.

The Support Services product line provides professional color training and support worldwide through seminar training, classroom workshops, on-site consulting, technical support and interactive media development. This group also manages the Company’s global service repair departments. Net sales for Support Services reported the strongest growth in 2011 of all the Company’s core product lines. New service programs, expanding the installed base through new sales growth in Asia Pacific, and selected price increases contributed to the continued double digit growth rate.

The Retail product line markets its paint matching products under the Match-Rite name to home improvement centers, mass merchants, paint retailers, and paint manufacturers. Strong European sales growth has offset sluggish demand in the “big box” architectural paint segment in North America in 2011. With several Retail design wins late in 2011, the Company’s new products have been well received by this market and are well positioned for the coming year.

The following table summarizes net sales from continuing operations for the 2011 and 2010 fiscal years by region (in millions):

 

     2011     2010     Change  

Americas

   $ 86.2         36.3   $ 85.5         38.4   $ 0.7         0.8

Europe

     93.9         39.5        83.2         37.4        10.7         12.9   

Asia Pacific

     57.5         24.2        54.0         24.2        3.5         6.4   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

Total Net Sales

   $ 237.6         100.0   $ 222.7         100.0   $ 14.9         6.7
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

The Company experienced net sales increases in 2011 in all the major geographic regions of the world where it conducts business.

Americas—This region experienced mix performance throughout the year and showed a marginal slowdown late in the year. This is largely attributable to year over year performance in both the Imaging & Media and Industrial product lines. Project rollouts to architectural paint companies were also unfavorable compared to prior year.

Europe—Channel sales across most product lines have been strong on a full year basis, with the exception of a slowdown in the industrial and printing product lines late in 2011. The Retail product line recorded strong sales growth for the year primarily attributable to the paint related products.

Asia Pacific—The current year increase was led by strong channel sales growth in our Imaging & Printing, Standards, and Support Service product lines. This growth offset the slowdown in the Industrial product line and the slowdown specifically to our OEM partners late in the year. Increased investments in our channel organization in Asia over the last year yielded strong improvements to date and has established the groundwork for future sales growth.

 

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In line with the Company’s international sales footprint our primary foreign exchange exposures are from the Euro and the Swiss Franc. The impact of fluctuations in these currencies was reflected mainly in the Company’s European operations. Foreign currency fluctuations, primarily the strengthening of the Euro and Swiss Franc over the U.S. dollar, had a $6.9 million favorable effect on 2011 net sales as compared to 2010. In 2011 and 2010, both domestic and international revenue increased, with international revenue accounting for 68.6 percent and 66.9 percent of net sales, respectively.

Net Sales—2010 Versus 2009

The following table summarizes net sales from continuing operations for the 2010 and 2009 fiscal years by product line (in millions):

 

     2010     2009     Change  

Imaging and Media

   $ 87.3         39.2   $ 74.1         38.7   $ 13.2        17.9

Industrial

     47.3         21.2        38.6         20.1        8.7        22.5   

Standards

     42.1         18.9        35.9         18.7        6.2        17.3   

Support Services

     25.8         11.6        23.3         12.1        2.6        11.1   

Retail

     15.4         6.9        14.3         7.5        1.0        7.3   

Other

     4.8         2.2        5.5         2.9        (0.7     (12.6
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

Total Net Sales

   $ 222.7         100.0   $ 191.7         100.0   $ 31.0        16.2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

In 2010, all of the Company’s core product lines realized year to date net sales increases with the exception of Other. The Company’s strong sales growth was the result of recently launched product and marketing initiatives in combination with the global market recovery.

The Imaging and Media product line showed a strong performance in global sales which was driven by large customers with increased demand associated with a number of new sales and marketing initiatives. This sales growth was complemented by an improving sales performance in Asia where Imaging and Media sales efforts experienced increasing success with a range of graphic arts products that serve a growing print market. As the market conditions for press manufacturers improved, demand from press manufacturers rebounded contributing favorably to our product line results.

The Industrial market had multiple products in all geographies that reported strong sales growth year over year. The economic recovery provided a strong boost to sales in this product line. New products such as our non-contact instruments and the MA9X series of products, along with a number of sales and marketing initiatives in the industrial market yielded positive results.

The Standards product line growth was lead by the new Pantone Matching System Plus Series and supported by growth in the licensing business, and ongoing sales of the cotton product line serving the Home and Fashion sectors.

The Support Services product line saw healthy demand for repair and professional services as the economy improved and instrument use increased. New service programs providing training and various support offers also gained traction.

The Retail product line results in 2010 were driven by the strong sales performance of Company’s new non-contact retail paint matching solution and new Capsure™ solution for in front of the counter use by paint contractors and decorators which were both well received in the marketplace.

 

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The following table summarizes net sales from continuing operations for the 2010 and 2009 fiscal years by region (in millions):

 

     2010     2009     Change  

Americas

   $ 85.5         38.4   $ 76.6         40.0   $ 8.9         11.7

Europe

     83.2         37.4        69.0         35.9        14.2         20.6   

Asia Pacific

     54.0         24.2        46.1         24.1        7.9         17.1   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

Total Net Sales

   $ 222.7         100.0   $ 191.7         100.0   $ 31.0         16.2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

The Company experienced net sales increases in 2010 in all the major geographic regions of the world where it conducts business.

Americas—Strong sales in the Industrial and Standards lines lead sales growth in this region, with Imaging and Media channel sales contributing. The Home Depot rollout of several hundred paint matching systems in the first half of 2009 dampened the overall sales growth results for the region.

Europe—Increasing success across multiple product lines contributed to sales performance. Improving conditions in the print market was a significant driver of improved sales, complemented by sales gains in both the Retail and Standards lines. The Industrial line was a positive contributor as well.

Asia Pacific—The increase in net sales represented strong economic growth in the overall region with the exception of Japan. The Imaging and Media line reported strong sales growth supported by a number of new sales and marketing motions. The Industrial and Support Services lines were also strong contributors to sales growth.

In 2010, the impact of translating foreign denominated net sales to U.S. dollars had an unfavorable effect on net sales of $1.6 million, as compared to the preceding year’s exchange rates. In 2010, both domestic and international revenue increased over 2009, with sales to customers outside the U.S. accounting for 66.9 percent of net sales.

Cost of Sales and Gross Profit

X-Rite’s cost of sales consists primarily of materials, labor, and overhead including amortization of tooling and capitalized software associated with manufacturing its products. Manufacturing activities are primarily conducted at facilities in the United States and Switzerland, with smaller operations located in Germany. Software development is also conducted at these facilities, as well as at a facility in Massachusetts. The Company’s gross profit historically has fluctuated within a narrow range. Principal drivers of gross profit include production volumes, product mix, labor, facilities, materials costs, and exchange rates.

The following table compares cost of sales and gross profit as a percentage of net sales (in millions):

 

     2011     2010     2009  

Cost of sales

   $ 96.9         40.8   $ 89.6         40.2   $ 81.1         42.3

Gross profit

   $ 140.7         59.2   $ 133.1         59.8   $ 110.6         57.7

Gross profit as a percentage of sales declined slightly in 2011 due to the negative impact of exchange rates which offset improvements due to favorable product and customer mix and operating efficiencies within the individual product lines.

Gross profit benefited in 2010 from increased operating efficiencies, cost control initiatives, and higher sales volume. These benefits were slightly impacted by unfavorable foreign exchange, product and sales mix, and suspension of furloughs and employee benefits implemented in 2009.

 

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Operating Expenses—2011 Versus 2010

The following table compares operating expense components as a percentage of net sales (in millions):

 

     2011     2010     Change  

Selling and marketing

   $ 58.2         24.5   $ 56.4         25.3   $ 1.8        3.2

Research, development and engineering

     23.2         9.7        23.7         10.7        (0.5     (2.1

General and administrative

     21.1         8.9        22.0         9.9        (0.9     (4.1

Restructuring and other related charges

     —           —          2.0         0.9        (2.0     (100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

Total

   $ 102.5         43.1   $ 104.1         46.8   $ (1.6     (1.6 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

The overall decrease in operating expenses in 2011 was primarily attributable to the cost reductions achieved with the completion of restructuring activities in 2010, a decrease in variable compensation, and tight cost controls, partially offset by unfavorable foreign exchange due to the strengthening of the Euro and Swiss Franc. The effect of foreign exchange rates increased operating expenses by $3.9 million when compared to 2010 rates, which was offset by the ongoing benefit of prior restructuring initiatives and cost control measures.

Selling and marketing expenses consist primarily of wages, commissions, facility costs, travel, advertising, trade shows, media and product promotion costs. The increase in selling and marketing expenses is in line with the organizational growth and strategic investment in developing markets. The increase is also attributable to increased headcount, unfavorable foreign exchange, partially offset by lower variable compensation.

Research, development and engineering (RD&E) expenses include compensation, facility costs, consulting fees, and travel for the Company’s engineering staff. These costs are incurred primarily in the United States and Switzerland for both new product development and the support and refinement of existing product lines. The decrease in RD&E expenses is attributable to lower variable compensation as a result of Company performance, partially offset by unfavorable foreign exchange due to the steep strengthening of the Swiss Franc. The Company intends to make investments in RD&E in the range of 10 to 15 percent of net sales for the foreseeable future. In addition to the RD&E costs reported as operating expenses, certain costs to develop new software products were capitalized, totaling $7.3 million and $6.5 million in 2011 and 2010, respectively. The related amortization expense is included in cost of sales (as discussed in “Notes to Consolidated Financial Statements” in Item 8 of this report).

General and administrative (G&A) expenses include compensation, facility costs, and travel for the Company’s executive, finance, human resources and administrative functions, as well as legal and consulting costs. The decrease in G&A expenses is primarily attributable to ongoing cost control measures and a stabilized organization footprint.

Operating Expenses—2010 Versus 2009

The following table compares operating expense components as a percentage of net sales (in millions):

 

     2010     2009     Change  

Selling and marketing

   $ 56.4         25.3   $ 51.9         27.1   $ 4.5        8.9

Research, development and engineering

     23.7         10.7        22.6         11.8        1.1        4.8   

General and administrative

     22.0         9.9        27.9         14.5        (5.9     (21.1

Restructuring and other related charges

     2.0         0.9        4.4         2.3        (2.4     (54.9
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

Total

   $ 104.1         46.8   $ 106.8         55.7   $ (2.7     (2.5 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

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The overall decrease was primarily attributable to a decrease in amortization expense for certain intangible assets that became fully amortized in 2009. The Company’s restructuring plans were completed as of the end of 2010. The effect of foreign exchange rates increased operating expenses by $1.1 million in 2010 compared to 2009 rates.

Selling and marketing expenses increased due to an increase in compensation expenses for the suspension of furloughs and benefits reductions implemented in 2009, as well as investment in the Company’s strategic market initiatives for the development of new products plus increased variable compensation expenses related to the increase in sales and improved financial performance of the Company.

RD&E expenses increased primarily related to an increase in compensation expenses for the suspension of furloughs and benefits reductions implemented in 2009, as well as investment in the Company’s strategic market initiatives for the development of new products. In addition to the RD&E costs reported as operating expenses, certain costs to develop new software products were capitalized which totaled $6.5 million and $4.4 million in 2010 and 2009, respectively. The increase in capital development costs reflected an increase in compensation expense for the suspension of furloughs and benefits reductions implemented in 2009, as well as investment in the Company’s strategic market initiatives for the development of new products. The related amortization expense is included in cost of sales (as discussed in “Notes to Consolidated Financial Statements” in Item 8 of this report).

G&A expenses decreased primarily due to the reduction in intangible asset amortization related to assets that became fully amortized in 2009, partially offset by an increase in compensation expenses for the suspension of furloughs and benefits reductions implemented in 2009.

Restructuring and other related charges include the costs the Company incurred to execute various corporate restructuring activities. These charges included cash costs, accrued liabilities, asset write-offs, lease termination costs, and employee severance pay resulting from layoffs. The decline in restructuring and other related charges is due to the completion of the Company’s restructuring efforts in 2010.

Operating Income

Significant improvements have taken place with operating income over the past three years. It has been favorably impacted by the increase in net sales across most product lines coupled with the previously announced profit improvement actions and cost controls put in place during 2009 that continued into 2011.

Other Income (Expense)

The following table compares the components of Other Income (expense) as a percentage of net sales (in millions):

 

     2011     2010     2009  

Interest expense

   $ (12.4     (5.2)   $ (28.0     (12.6)   $ (33.5     (17.5)

Loss on redemption of preferred shares and debt refinancing costs

   $ (13.8     (5.8)   $ (1.1     (0.5)   $ (2.3     (1.2)

Other income

   $ 1.6        0.6    $ 1.5        0.7    $ 2.1        1.1 

Interest Expense

Total interest expense incurred by the Company in 2011, 2010, and 2009 was $12.4, $28.0, and $33.5 million, respectively, including expense related to deferred financing fees, terminated swap agreements and the de-designated interest rate cap. The decreases are largely attributable to the debt refinancing that occurred in 2011, coupled with the pay down of debt that occurred over the past three years.

 

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Cash based interest on secured debt during 2011, 2010, and 2009 totaled $7.3 million, $13.3 million, and $21.8 million, respectively. In the third quarter of 2010, the Company paid cash of $3.3 million for interest on its MRPS. The 2011 decrease in cash based interest was principally due to savings on the MRPS and lower overall interest rates resulting from the debt refinancing. The 2010 decrease is largely attributable to the significant pay downs of debt and the sale of the former corporate headquarters, sale of the Italian manufacturing facility, sale of equity investments previously written off and excess cash from continuing operations throughout 2009.

As of December 31, 2011 and January 1, 2011, the credit facilities’ variable rates ranged from 3.63 to 5.50 percent per annum and 5.75 percent per annum, respectively. As of these dates, the weighted average interest rates for all of the Company’s debt were 3.73 percent per annum and 8.00 percent per annum, respectively, exclusive of amortization of deferred financing costs and the effect of derivative instruments.

Loss on redemption of preferred shares and debt refinancing costs

In 2011, the Company recorded a loss on redemption of preferred shares and debt refinancing cost of $13.8 million, which was related to the previous first lien credit facility refinancing and redemption of the MRPS. These charges consisted primarily of a $9.8 million unamortized discount related to the MRPS, an early redemption fee of $2.3 million related to the MRPS, fees to creditors and third parties of $1.0 million, and unamortized deferred financing costs associated with the MRPS of $0.7 million.

In 2010, the Company entered into an amendment of the first lien credit agreement in order to obtain authorization to repay the outstanding balance of the second lien credit facility. As a result of the second lien extinguishment, the Company wrote off $1.1 million of previously existing deferred financing costs.

In 2009, the Company entered into an Exchange Agreement to effectively exchange $41.6 million of the second lien term loan principal outstanding to 41,561 shares of newly issued Series A Preferred Stock. As a result of the second lien debt exchange, the Company wrote off $2.3 million of previously existing deferred financing costs.

Other, net

Other income (expense), net consists primarily of gains and losses from foreign exchange translations.

Income Taxes

Our effective income tax rate on earnings was (264.4) percent, (159.5) percent, and 15.7 percent in fiscal years 2011, 2010, and 2009 respectively. The effective income tax rate for 2011 includes the release of a substantial portion of the U.S. valuation allowance against deferred tax assets, charges for uncertain income tax positions, and the reduction of foreign withholding tax obligations in Switzerland. The effective income tax rate for 2010 includes the impact of amortization of intangible assets, reductions of reserves for uncertain income tax positions, and the reduction of foreign withholding tax obligations in Switzerland. The effective income tax rate for 2009 includes the impact of amortization of intangible assets, refund claims associated with the recapture of U.S. federal income taxes paid in 2003 through 2005 that resulted from carry-back opportunities created through current year legislative changes, reductions in reserves for uncertain income tax positions, and adjustments to valuation allowances against deferred tax assets.

Deferred tax assets and liabilities are recognized based on the estimated future tax consequences attributable to temporary differences that exist between the financial statement carrying value of assets and liabilities and their respective tax bases along with operating loss and tax credit carry-forwards on a jurisdictional basis. These assets and liabilities are measured using the enacted tax rates that will apply for the years in which the temporary differences are expected to reverse or the operating loss and tax credit carry-forwards are expected to be utilized.

 

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Recognition of deferred tax assets is dependent on the likelihood that the future benefits will be realized. If based on the available evidence it is not a more likely than not that the assets will be realized a valuation allowance must be established. In evaluating our ability to realize the future benefits associated with deferred tax assets, we consider all positive and negative evidence. This analysis includes assumptions that require significant judgment and the weight given to the positive and negative evidence is commensurate with the extent to which the evidence may be objectively verified. As such, it is generally difficult for positive evidence regarding projected future taxable income exclusive of reversing taxable temporary differences to outweigh objective evidence of recent financial reporting losses.

Prior to December 31, 2011, the amount of objectively-measured negative evidence related to cumulative losses in the most recent three-year period outweighed the available positive evidence. By the end of 2011, the cumulative loss of our U.S. operations was offset by recent operating performance, which included positive income for both 2010 and 2011. The improvement in profitability has been driven by the complete refinancing of our debt with significant reductions in borrowing costs and improved operational performance through restructuring and cost controls. The historical factors that drive the minimal cumulative loss have reduced significance because of the significant reduction in current finance costs resulting from the debt refinancing. The Company concluded that the trend of earnings, the elimination of substantial finance costs through the refinancing, and our aligned cost structure results in the more likely than not realization of the deferred future tax benefits. Hence, the Company recorded a $47.2 million income tax benefit for the reversal of valuation allowances previously established against deferred tax assets.

Net Income (Loss)

As a result of the year over year improvements in financial performance and the income tax benefit discussed above, the Company recorded net income (loss) of $49.4, $3.6, and $(25.2) million for 2011, 2010, and 2009, respectively. Basic and diluted income (loss) per share saw similar improvements at $0.57, $0.04, and $(0.33) and $0.56, $0.04, and $(0.33) for 2011, 2010, and 2009, respectively. The 2011 results were significantly impacted by the reversal of tax valuation allowances as described above.

FINANCIAL CONDITION AND LIQUIDITY

Liquidity and Capital Resources

The Company’s liquidity and available capital resources are impacted by four key components: (i) available cash, (ii) operating activities, (iii) investing activities and (iv) financing activities. These components are summarized below (in millions):

 

                       Change  
     2011     2010     2009     2011 / 2010     2010 / 2009  

Net cash flow provided by (used in):

          

Operating activities

   $ 48.0      $ 42.9      $ 20.3        11.9     111.3

Investing activities

     (12.5     (11.5     4.0        8.9        (387.5

Financing activities

     (39.5     (46.4     (48.4     (14.9     (4.1

Effect of exchange rate changes on cash

     (1.4     (2.4     2.4        (40.5     (200.0
  

 

 

   

 

 

   

 

 

     

Net decrease in cash

     (5.4     (17.4     (21.7     (69.0     (19.8

Cash, beginning of year

     11.7        29.1        50.8        (59.8     (42.7
  

 

 

   

 

 

   

 

 

     

Cash, end of year

   $ 6.3      $ 11.7      $ 29.1        (46.2 )%      (59.8 )% 
  

 

 

   

 

 

   

 

 

     

 

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Cash

The overall reduction of ending cash balances in 2011 and 2010 is due to improved cash management. As of December 31, 2011, approximately $6.2 million of cash was held by subsidiaries outside of the United States. Cash is generated primarily from the Company’s operating activities.

Operating Activities

The increase in operating cash flow in 2011 is directly attributable to the improvement in net income, adjusted for non-cash items (depreciation and amortization, stock-based compensation, pension expense, debt refinancing and deferred income taxes) which partially offset the $(7.0) million increase in working capital. The net of accounts receivable, inventory, and payroll related liabilities primarily accounted for this change. Accounts receivable consumed $(3.7) million attributable to increased sales and a slight increase in days sales outstanding (DSO). Inventory provided $1.5 million, consistent with a slight improvement in turns in the current year. Payroll related liabilities consumed $(4.8) million primarily as a result of the 2010 accrued employee bonus that was paid in 2011.

The 2010 operating cash flow increase reflects the current year net income as adjusted for significant non-cash items (depreciation and amortization, stock-based compensation, pension expense, debt refinancing and deferred income taxes) and a reduction in working capital of $2.3 million. This is primarily attributable to increases in accounts payable balances of $2.2 million and also includes offsetting changes in the accounts receivable and inventory balances which yielded a negligible impact on working capital as both the DSO and inventory turns remained largely unchanged in 2010.

Investing Activities

Net investing activities in 2011 and 2010 consumed cash for capital expenditures of $5.6 and $5.3 million, respectively, for the ongoing support of existing infrastructure and consumed cash for capitalized software of $7.3 and $6.5 million, respectively, in line with the Company’s continued commitment to the development of new products and technology. In both years this capital spending was partially offset by minimal proceeds from the sale of assets. The 2010 decrease compared to 2009 was primarily related to proceeds from sales of assets in 2009.

Financing Activities

Cash used for financing activities has decreased in both 2011 and 2010. The 2011 activity includes the proceeds from the initial borrowing under the new 2011 first lien debt facility of $185.0 million which was offset by $(47.0) for the redemption of the MRPS, $(142.2) million to extinguish the previous secured credit facility, and further reduced by payments against the 2011 facility of $(35.2) (as discussed in “Notes to Consolidated Financial Statements” in Item 8 of this report). The 2010 decrease compared to 2009 is due primarily to the net interest rate cap impact in 2009 for $(1.1) million which did not recur in 2010.

Adequacy of Liquidity

The Company believes its current liquidity and cash position, future cash flows, and availability under its current credit facility should provide the necessary financial resources to meet its expected operating requirements for the foreseeable future. The Company had $53.6 million available under its current credit facility as of December 31, 2011.

Guarantees

We do not have guarantees of a magnitude that we believe could have a material impact on our financial condition or liquidity.

 

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Restrictive Covenants

Under the Company’s credit agreement the leverage ratio covenant is the most restrictive covenant to the Company. The credit agreement provides that the Company must not exceed a ratio of total debt to Adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization). As of December 31, 2011, the Company was in compliance with the covenants under its credit facility. The calculation of Adjusted EBIDTA is as follows:

Adjusted EBITDA as defined by Credit Agreement

(in thousands)

 

     Twelve Months Ended  
     December 31,
2011
    January 1,
2011
    January 2,
2010
 

Net income (loss)

   $ 49,361      $ 3,641      $ (25,242

EBITDA Adjustments:

      

Depreciation

     6,475        6,164        6,388   

Amortization

     16,470        16,217        20,129   

Restructuring and other related charges

     —          2,008        5,024   

Share-based compensation

     2,091        2,736        4,904   

Net interest expense and write-off of deferred financing costs

     26,246        29,072        35,788   

Currency gain (loss)

     (1,409     (1,629     2,537   

Income tax benefit

     (35,816     (2,238     (4,692

(Gain) loss on sale of assets

     (262     280        (4,429

Other non-recurring adjustments

     —          —          4,227   
  

 

 

   

 

 

   

 

 

 
     13,795        52,610        69,876   
  

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 63,156      $ 56,251      $ 44,634   
  

 

 

   

 

 

   

 

 

 

Adjusted EBITDA is considered a financial measure that is not in accordance with generally accepted accounting principles (GAAP) followed in the United States. Management believes these measures are useful and relevant to management and investors in their analysis of the Company’s underlying business and operating performance. Management also uses this information for operational planning and decision-making purposes. Non-GAAP financial measures should not be considered a substitute for any GAAP measures. Additionally, non-GAAP measures as presented may not be comparable to similarly titled measures reported by other companies.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company strives to report its financial results in a clear and understandable manner. It follows accounting principles generally accepted in the United States in preparing its Consolidated Financial Statements, which requires management to make certain estimates and apply judgments that affect its financial position and results of operations. The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires management to adopt accounting policies and make significant judgments and estimates to develop amounts reflected and disclosed in the financial statements. In some instances, there may be alternative policies or estimation techniques that could be used. Management maintains a thorough process to review the application of accounting policies and to evaluate the appropriateness of the many estimates that are required to prepare the financial statements. However, even under optimal circumstances, estimates routinely require adjustment based on changing circumstances and the receipt of new or better information.

 

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The policies and estimates discussed below include the financial statement elements that are either the most judgmental or involve the selection or application of alternative accounting policies and are material to the financial statements. Management has discussed the development and selection of these accounting policies with the Audit Committee of the Board of Directors.

Accounts Receivable Allowances

Accounts receivable allowances are based on known customer exposures, historic credit experience, and the specific identification of potentially uncollectible accounts. In addition to known or judgmental components, a policy that consistently applies reserve rates based on the age of outstanding accounts receivable is followed. Actual collections may differ, requiring adjustments to the reserves.

Inventory Reserves

Inventories are stated at the lower of cost or market. In assessing the ultimate realization of inventories, judgments are made as to future demand requirements and compared with current inventory levels. Reserves are established for excess and obsolete inventory based on material movement, market conditions, and technological advancements.

Long-Lived Assets

Evaluations are periodically made of long-lived assets for indicators of impairment when events or circumstances indicate that this risk may be present. Judgments regarding the existence of impairment are based on several factors including but not limited to, market conditions, operational performance, technological advancements, and estimated future cash flows. If the carrying value of a long-lived asset is considered impaired, an impairment charge is recorded to adjust the asset to its fair value.

Software Development Costs

Development costs incurred for research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility is achieved. Technological feasibility is established upon completion of a detail program design or, in its absence, completion of a working model. After technological feasibility is achieved, any additional development costs are capitalized until the product is available for general release to customers and then amortized using the straight-line method over a three-year period.

Goodwill and Indefinite-Lived Intangibles

The Company accounts for goodwill and other indefinite-lived intangible assets in accordance with ASC 350, Goodwill and Other Intangible Assets. ASC 350 requires companies to evaluate goodwill and intangible assets with indefinite useful lives for impairment annually, or more frequently if indicators of impairment occur. Impairment indicators could include a significant adverse change in the business climate, operating performance indicators, or the decision to sell or dispose of a reporting unit.

The Company early adopted Accounting Standards Update No. 2011-08: Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment (ASU 2011-08). ASU 2011-08 permits the Company to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the quantitative two-step goodwill impairment test.

If the Company determines it is more likely than not that its fair value is less than its carrying value, the Company is required to quantitatively test the carrying value of goodwill for impairment at the reporting unit

 

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level, using a discounted cash flow method to estimate fair value. An impairment charge is recognized for any amount by which the carrying amount of a reporting unit’s goodwill exceeds its implied fair value. Changes in forecasted operations and changes in discount rates can materially affect these estimates. Once an impairment of goodwill has been recorded, it cannot be reversed.

The indefinite-lived intangible asset impairment review consists of a comparison of the fair value of the indefinite-lived intangible asset with its carrying amount. If the carrying amount exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. If the fair value exceeds its carrying amount, the indefinite-lived intangible asset is not considered impaired. ASC 350 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives, and reviewed for impairment in accordance with ASC 360, Accounting for the Impairment or Disposal of Long-Lived Assets.

The Company did not recognize an impairment loss on its goodwill or indefinite-lived intangible assets in 2011, 2010 or 2009.

Financial Instruments

The Company's financial instruments consist of cash, accounts receivable, accounts payable, debt interest rate caps, interest rate swaps, and foreign exchange forward contracts. The Company's estimates of fair value for financial instruments approximate their carrying amounts as of December 31, 2011 and January 1, 2011.

The Company applies the fair value measurement guidance in ASC 820, Fair Value Measurements and Disclosures, for financial assets and liabilities measured on a recurring basis. ASC 820 applies to all financial assets and financial liabilities that are being measured and reported on a fair value basis and provides the framework for measuring fair value of assets and liabilities.

The Company uses derivative financial instruments to manage its exposure to movements in interest rates on its long term debt and to manage its exposure to short term fluctuations in the Euro and Swiss Franc exchange rates. Derivatives are not used for speculative or trading purposes. The Company accounts for derivative financial instruments in accordance with ASC 815, Derivatives and Hedging. As a result the Company recognizes derivative financial instruments in its Consolidated Financial Statements at fair value regardless of the purpose or intent of the instruments. Changes in fair values of derivatives accounted for as cash flow hedges, to the extent they are effective hedges, are originally recorded as a component of other comprehensive income, net of tax, and subsequently reclassified into earnings when the hedged exposure affects earnings. Changes in fair values of derivatives not qualifying as hedges are reported in earnings immediately.

Deferred Income Tax Valuation Allowance

During 2011, the Company released the valuation allowance that was previously established related to a significant portion of its deferred tax assets in the United States. The basis for realizing the benefits of these deferred tax assets is the Company’s trend in recent earnings, the elimination of substantial costs through our refinancing, and the properly aligned cost structure. The Company continues to maintain a valuation allowance against a portion of its U.S. and non-U.S. deferred tax asset positions as of December 31, 2011, as it is not more likely than not that such assets will be realized prior to expiration. In conjunction with the Company’s ongoing review of its actual results and anticipated future earnings, the Company will continue to reassess the possibility of releasing all or part of the valuation allowances currently in place when they are deemed to be realizable.

Uncertain Tax Positions

The Company applies the provisions of ASC 740, Income Taxes, as it relates to uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a threshold of more likely than not to be sustained upon examination. The Company deems the estimates related to this provision to be reasonable, however no assurance can be given that the final outcome of these matters will not vary from what is reflected in the historical income tax provisions and accruals.

 

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Self-Insurance Reserves

The Company is self insured up to certain limits for costs associated with benefits paid under employee health care programs. The measurement of these costs requires the consideration of historic loss experience and judgments about the present and expected levels of costs per claim. These costs are accounted for by developing estimates of the undiscounted liability for claims incurred, including those claims incurred but not reported. This method provides estimates of future ultimate claim costs based on claims incurred as of the balance sheet date.

Revenue Recognition

Revenue is recognized when earned in accordance with ASC 605, Revenue Recognition. Revenue from sales of products and services is recognized when a purchase order has been received, the product has been shipped or the service has been performed, the sales price is fixed and determinable, and collection of any resulting receivable is probable.

For transactions involving the sale of software which is not incidental to the product, revenue is recognized in accordance with ASC 985, Software Revenue Recognition. The Company recognizes revenue when there is persuasive evidence of an arrangement, delivery has occurred, the sales price is fixed or determinable and collection is probable. In instances where an arrangement contains multiple elements, the arrangement consideration is allocated to each deliverable based on the relative selling price. The selling price for each deliverable is based on vendor-specific objective evidence (VSOE) if available, third-party evidence if VSOE is not available, or estimated selling price if neither VSOE or third-party evidence is available.

Share Based Compensation

The Company accounts for share based compensation in accordance with ASC 718, Compensation-Stock Compensation, which requires the measurement and recognition of compensation expense for all share based payment awards based on estimated fair values.

OFF BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS

The Company has no significant off balance sheet transactions other than operating leases for equipment, real estate, and vehicles. The following table sets forth information about the Company’s long-term contractual obligations outstanding at December 31, 2011, using data from the Consolidated Balance Sheet and the Notes to Consolidated Financial Statements:

Contractual Obligations

 

     Payments Due by Period
(in thousands)
 
     Total      Less Than 1
Year
     1-3 Years      3-5 Years      After 5
Years
 

Long-term debt

   $ 149,814       $ 7,783       $ 25,293       $ 116,738       $ —     

Interest on long-term debt

     20,700         6,100         8,900         5,700         —     

Operating leases

     12,035         4,646         5,252         1,490         647   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 182,549       $ 18,529       $ 39,445       $ 123,928       $ 647   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At this time the Company is unable to make a reasonable estimate of the timing of tax payments in individual years beyond 12 months due to uncertainties in the timing of tax audit outcomes. The Company expects to contribute $1.5 million to its pension plan in 2012. Funding amounts are calculated on an annual basis and no required or planned funding beyond one year has been determined.

 

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OTHER MATTERS

In November 2001, the Company's Board of Directors adopted a Shareholder Protection Rights Plan (the Plan), which became effective in the first quarter of 2002. The Plan is designed to protect shareholders against unsolicited attempts to acquire control of the Company in a manner that does not offer a fair price to all shareholders.

Under the Plan, one Purchase Right (Right) automatically trades with each share of the Company's common stock. Each Right entitles a shareholder to purchase 1/100 of a share of junior participating preferred stock at a price of $30.00, if any person or group attempts certain hostile takeover tactics toward the Company. Under certain hostile circumstances, each Right may entitle the holder to purchase the Company's common stock at one-half its market value or to purchase the securities of any acquiring entity at one-half their market value. Rights are subject to redemption by the Company at $.005 per Right and, unless earlier redeemed, will expire on March 29, 2012. Rights beneficially owned by holders of 15 percent or more of the Company's common stock, or their transferees and affiliates, automatically become void. In August 2008, the Company amended the Plan to render it inapplicable to the transactions contemplated by the Corporate Recapitalization Plan. The plan was further amended in August 2009, to render it inapplicable to the transactions contemplated by the Exchange.

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to a variety of risks including foreign currency exchange fluctuations, and market volatility in its derivative and insurance portfolios. In the normal course of business, the Company employs established procedures to evaluate its risks and take corrective actions when necessary to manage these exposures.

The Company does not trade in financial instruments for speculative purposes.

Interest Rates

The Company is subject to interest rate risk principally in relation to variable-rate debt. The Company utilizes interest rate swaps to manage the potential variability in interest rates associated with its debt. The interest rate swaps limit the Company’s exposure to an increase in the 3 month LIBOR rate. The notional amount of the swaps at December 31, 2011 was $60.0 million.

A hypothetical 25 basis point increase in interest rates during the year ended December 31, 2011 would have increased the interest expense reported in the Consolidated Financial Statements by $0.2 million.

Foreign Currency Exchange

Foreign currency exchange risks arise from transactions denominated in a currency other than the entity’s functional currency and from foreign denominated transactions translated into U.S. dollars. The Company’s largest exposures are to the Euro and Swiss Franc. As these currencies fluctuate relative to the dollar, such fluctuations may cause profitability to increase or decrease accordingly. The hypothetical effect on net income (loss) caused by a 10 percent change in all foreign currencies would be approximately $0.3 million and $1.1 million for the years ended December 31, 2011 and January 1, 2011, respectively.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following reports, financial statements, and notes are included with this report:

 

Management’s Report on Internal Control over Financial Reporting

     35   

Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

     36   

Report of Independent Registered Public Accounting Firm on Financial Statements

     37   

Consolidated Balance Sheets

     38   

Consolidated Statements of Operations

     40   

Consolidated Statements of Shareholders’ Investment

     41   

Consolidated Statements of Cash Flows

     42   

Notes to Consolidated Financial Statements

     43   

 

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Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2011 based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

Based on this evaluation and those criteria, our management concluded that our internal control over financial reporting was effective as of December 31, 2011.

Our independent registered public accounting firm, Ernst & Young LLP, has issued an attestation report on the effectiveness of our internal control over financial reporting, as stated in their report which appears on page 35.

 

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Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

The Board of Directors and Shareholders of X-Rite, Incorporated

We have audited X-Rite, Incorporated and subsidiaries’ internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). X-Rite Incorporated and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, X-Rite, Incorporated and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of X-Rite, Incorporated and subsidiaries as of December 31, 2011 and January 1, 2011 and the related consolidated statements of operations, shareholders’ investment, and cash flows for each of the three years in the period ended December 31, 2011 and our report dated March 15, 2012 expressed an unqualified opinion thereon.

/s/    Ernst & Young LLP

Grand Rapids, Michigan

March 15, 2012

 

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Report of Independent Registered Public Accounting Firm on Financial Statements

The Board of Directors and Shareholders of X-Rite, Incorporated

We have audited the accompanying consolidated balance sheets of X-Rite, Incorporated and subsidiaries (the Company) as of December 31, 2011 and January 1, 2011, and the related consolidated statements of operations, shareholders' investment, and cash flows for each of the three years in the period ended December 31, 2011. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of X-Rite, Incorporated and subsidiaries at December 31, 2011 and January 1, 2011, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), X-Rite, Incorporated and subsidiaries' internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 15, 2012 expressed an unqualified opinion thereon.

/s/    Ernst & Young LLP

Grand Rapids, Michigan

March 15, 2012

 

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X-RITE, INCORPORATED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

 

     December 31,
2011
    January 1,
2011
 

ASSETS

    

Current assets:

    

Cash

   $ 6,323      $ 11,709   

Accounts receivable, net of allowance of $1,203 in 2011 and $1,780 in 2010

     35,740        32,154   

Inventories, net

     26,192        27,670   

Deferred income taxes

     12,767        697   

Prepaid expenses and other current assets

     4,403        4,601   
  

 

 

   

 

 

 
     85,425        76,831   

Property, plant and equipment:

    

Land

     2,796        2,796   

Buildings and improvements

     23,802        23,213   

Machinery and equipment

     37,967        33,570   

Furniture and office equipment

     24,984        25,560   

Construction in progress

     5,300        5,063   
  

 

 

   

 

 

 
     94,849        90,202   

Less accumulated depreciation

     (56,121     (50,037
  

 

 

   

 

 

 
     38,728        40,165   

Other assets:

    

Goodwill

     233,941        233,952   

Indefinite-lived intangibles

     13,433        13,433   

Other intangibles, net

     43,646        55,439   

Deferred income taxes

     25,914        —     

Other noncurrent assets

     22,041        19,275   
  

 

 

   

 

 

 
     338,975        322,099   
  

 

 

   

 

 

 
   $ 463,128      $ 439,095   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these statements.

 

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X-RITE, INCORPORATED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS—Continued

(in thousands, except share and per share data)

 

     December 31,
2011
    January 1,
2011
 

LIABILITIES AND SHAREHOLDERS' INVESTMENT

    

Current liabilities:

    

Current portion of long-term debt

     11,783      $ 1,350   

Accounts payable

     11,685        12,948   

Accrued liabilities:

    

Payroll and employee benefits

     9,221        14,017   

Income taxes

     809        292   

Deferred income taxes

     885        —     

Deferred revenue

     3,251        2,674   

Other

     4,821        3,546   
  

 

 

   

 

 

 
     42,455        34,827   

Long-term liabilities:

    

Long-term debt, less current portion

     138,031        135,248   

Mandatorily redeemable preferred stock, $.10 par value 84,729 shares authorized; 46,980 shares issued and outstanding, with stated redemption amount of $46,980 presented net of warrant discount of $10,615 in 2010

     —          36,402   

Deferred income taxes

     1,500        3,182   

Accrued income taxes

     7,764        6,611   

Other

     6,764        1,285   
  

 

 

   

 

 

 
     154,059        182,728   

Shareholders’ investment:

    

Common stock, $.10 par value, 150,000,000 and 100,000,000 shares authorized; 85,374,669 and 84,805,040 shares issued and outstanding, in 2011 and 2010, respectively

     8,538        8,481   

Additional paid-in capital

     276,983        274,697   

Retained deficit

     (23,750     (73,111

Accumulated other comprehensive income

     4,843        11,473   
  

 

 

   

 

 

 
     266,614        221,540   
  

 

 

   

 

 

 
   $ 463,128      $ 439,095   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these statements.

 

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X-RITE, INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

 

     For the Year Ended  
     December 31,
2011
    January 1,
2011
    January 2,
2010
 

Net Sales

   $ 237,552      $ 222,740      $ 191,667   

Cost of sales

     96,837        89,659        81,064   
  

 

 

   

 

 

   

 

 

 

Gross profit

     140,715        133,081        110,603   

Operating expenses:

      

Selling and marketing

     58,230        56,448        51,853   

Research, development, and engineering

     23,185        23,686        22,593   

General and administrative

     21,103        22,010        27,888   

Restructuring and other related charges

     —          2,008        4,448   
  

 

 

   

 

 

   

 

 

 
     102,518        104,152        106,782   
  

 

 

   

 

 

   

 

 

 

Operating income

     38,197        28,929        3,821   

Interest expense

     (12,418     (27,981     (33,523

Loss on redemption of preferred shares and debt refinancing costs

     (13,828     (1,091     (2,265

Other, net

     1,594        1,546        2,033   
  

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     13,545        1,403        (29,934

Income tax benefit

     (35,816     (2,238     (4,692
  

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 49,361      $ 3,641      $ (25,242
  

 

 

   

 

 

   

 

 

 

Net income (loss) per share:

      

Basic

   $ 0.57      $ 0.04      $ (0.33

Diluted

     0.56        0.04        (0.33

The accompanying notes are an integral part of these statements.

 

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X-RITE, INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ INVESTMENT

(in thousands)

 

    Shares     Common
Stock
    Additional
Paid-in
Capital
    Retained
Earnings
(Deficit)
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Shareholders'
Investment
 

BALANCES, JANUARY 3, 2009

    76,423        7,642        251,199        (51,510     1,961        209,292   

Net loss

    —          —          —          (25,242     —          (25,242

Translation adjustment

    —          —          —          —          3,115        3,115   

Unrealized gain on derivative financial instruments (net of tax benefits of $1,243)

    —          —          —          —          4,550        4,550   

Pension adjustments

    —          —          —          —          (226     (226

Other

    —          —          —          —          46        46   
           

 

 

 

Total comprehensive loss

              (17,757

Share-based compensation

    —          —          4,904        —          —          4,904   

Issuance / release of shares under employee benefit plans, including tax benefits

    198        20        92        —          —          112   

Issuance of shares pursuant to warrant exercise

    7,500        750        14,850        —          —          15,600   

Other

    —          —          (32     —          —          (32
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCES, JANUARY 2, 2010

    84,121        8,412        271,013        (76,752     9,446        212,119   

Net income

    —          —          —          3,641        —          3,641   

Translation adjustment

    —          —          —          —          (730     (730

Unrealized gain on derivative financial instruments (net of tax benefits of $538)

    —          —          —          —          999        999   

Pension adjustments

    —          —          —          —          1,758        1,758   
           

 

 

 

Total comprehensive income

              5,668   

Share-based compensation

    —          —          2,736        —          —          2,736   

Issuance / release of shares under employee benefit plans, including tax benefits

    684        69        948        —          —          1,017   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCES, JANUARY 1, 2011

    84,805        8,481        274,697        (73,111     11,473        221,540   

Net income

    —          —          —          49,361        —          49,361   

Translation adjustment

    —          —          —          —          (1,492     (1,492

Unrealized loss on derivative financial instruments (net of tax expense of $6)

    —          —          —          —          (12     (12

Pension adjustments

    —          —          —          —          (5,126     (5,126
           

 

 

 

Total comprehensive income

              42,731   

Share-based compensation

    —          —          2,091        —          —          2,091   

Issuance / release of shares under employee benefit plans, including tax benefits

    570        57        195        —          —          252   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCES, DECEMBER 31, 2011

    85,375      $ 8,538      $ 276,983      $ (23,750   $ 4,843      $ 266,614   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these statements.

 

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X-RITE, INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

     For the Year Ended  
     December 31,
2011
    January 1,
2011
    January 2,
2010
 

CASH FLOWS FROM OPERATING ACTIVITIES:

      

Net income (loss)

   $ 49,361      $ 3,641      $ (25,242

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

      

Depreciation

     6,475        6,164        6,388   

Amortization

     16,470        16,217        20,129   

Amortization of deferred financing costs

     1,594        2,765        2,907   

Paid-in-kind interest accrued

     —          3,188        2,422   

Amortization of discount on mandatorily redeemable preferred stock

     863        3,450        1,460   

Deferred income tax credit

     (38,756     (4,898     (2,734

Pension and postretirement benefit expense

     2,100        2,409        1,850   

Share-based compensation

     2,091        2,736        4,904   

(Gain) loss on sale of assets

     (262     280        (4,429

Restructuring and other related charges

     —          2,008        4,591   

Loss on redemption of preferred shares and debt refinancing costs

     13,828        1,091        2,265   

Derivative fair value adjustments and charges

     908        1,692        4,987   

Other

     307        (102     46   

Changes in operating assets and liabilities:

      

Accounts receivable

     (3,711     (433     9,761   

Inventories

     1,518        389        10,788   

Prepaid expenses and other current assets

     (1,407     2,599        2,037   

Accounts payable

     (1,272     2,216        (2,988

Income taxes

     1,708        (702     (9,883

Other current and non-current liabilities

     (3,844     (1,763     (9,006
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     47,971        42,947        20,253   

CASH FLOWS FROM INVESTING ACTIVITIES:

      

Capital expenditures

     (5,561     (5,286     (4,732

Increase in capitalized software

     (7,256     (6,483     (4,372

Proceeds from sale of assets

     319        294        13,045   
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used for) investing activities

     (12,498     (11,475     3,941   

CASH FLOWS FROM FINANCING ACTIVITIES:

      

Proceeds from long-term debt

     185,196        16,500        —     

Payment of long-term debt

     (172,288     (63,536     (45,892

Purchase of interest rate cap

     —          —          (1,565

Debt amendment and refinancing costs

     (5,625     (429     (1,603

Redemption of mandatorily redeemable preferred stock

     (46,980     —          —     

Other

     252        1,031        670   
  

 

 

   

 

 

   

 

 

 

Net cash used for financing activities

     (39,445     (46,434     (48,390
  

 

 

   

 

 

   

 

 

 

EFFECT OF EXCHANGE RATE CHANGES ON CASH

     (1,414     (2,379     2,411   
  

 

 

   

 

 

   

 

 

 

NET DECREASE IN CASH

     (5,386     (17,341     (21,785

CASH AT BEGINNING OF YEAR

     11,709        29,050        50,835   
  

 

 

   

 

 

   

 

 

 

CASH AT END OF YEAR

   $ 6,323      $ 11,709      $ 29,050   
  

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these statements.

 

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X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

X-Rite, Incorporated is a global leader in color science and color technology. The Company develops, manufactures, markets, and supports innovative color solutions through measurement instrumentation systems, software, color standards, and services. X-Rite’s expertise in inspiring, selecting, measuring, formulating, communicating and matching color helps users get color right the first time and every time, which translates to better quality and reduced costs. X-Rite serves a range of markets including printing, packaging, photography, graphic design, video, automotive, paints, plastics, and textiles. The Company serves these markets through its core product lines of Imaging and Media, Industrial, Standards, Support Services, and Retail.

Products are sold worldwide through the Company's own sales personnel and independent sales representatives and dealers. The Company is headquartered in Grand Rapids, Michigan and has other domestic facilities in New Jersey, North Carolina, and Massachusetts. In addition, the Company has locations in Switzerland, Germany, England, France, Italy, Spain, the Czech Republic, Russia, India, China, Hong Kong, and Japan. Manufacturing facilities are located in the United States, Switzerland, and Germany.

Principles of Consolidation

The Consolidated Financial Statements include the accounts of X-Rite, Incorporated and its subsidiaries. All inter-company accounts and transactions have been eliminated.

Fiscal Year

The Company reports its operations and cash flows on a 52-53 week basis ending on the Saturday closest to December 31. The fiscal years ended December 31, 2011 (fiscal year 2011), January 1, 2011 (fiscal year 2010) and January 2, 2010 (fiscal year 2009) each contained 52 weeks.

Financial Instruments

The Company's financial instruments consist of cash, accounts receivable, accounts payable, debt interest rate caps, interest rate swaps, and foreign exchange forward contracts. The Company's estimates of fair value for financial instruments approximate their carrying amounts as of December 31, 2011 and January 1, 2011.

The Company applies the fair value measurement guidance in Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures, for financial assets and liabilities measured on a recurring basis. ASC 820 applies to all financial assets and financial liabilities that are being measured and reported on a fair value basis and provides the framework for measuring fair value of assets and liabilities.

The Company uses derivative financial instruments to manage its exposure to movements in interest rates on its long term debt and to manage its exposure to short term fluctuations in the Euro and Swiss Franc exchange rates. Derivatives are not used for speculative or trading purposes. The Company accounts for derivative financial instruments in accordance with ASC 815, Derivatives and Hedging. As a result the Company recognizes derivative financial instruments in its Consolidated Financial Statements at fair value regardless of the purpose or intent of the instruments. Changes in fair values of derivatives accounted for as cash flow hedges, to the extent they are effective hedges, are originally recorded as a component of other comprehensive income, net of tax, and subsequently reclassified into earnings when the hedged exposure affects earnings. Changes in fair values of derivatives not qualifying as hedges are reported in earnings immediately.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—continued

 

Accounts Receivable Allowance

The carrying amount of accounts receivable is reduced by a valuation allowance that reflects an estimate of the amounts that will not be collected. In addition to reviewing delinquent accounts receivable, other factors are considered in estimating the allowance, including historical data, customer types, credit worthiness and economic trends. Actual collections may differ, requiring adjustments to the allowance.

Inventories

Inventories are stated at the lower of cost, determined on a first-in, first-out basis, or market. Reserves are established for excess and obsolete inventory, based on the Company’s on hand inventory levels versus historical demand. Components of inventories are summarized as follows (in thousands):

 

     December 31,
2011
    January 1,
2011
 

Raw materials

   $ 19,369      $ 16,309   

Work in process

     11,726        14,491   

Finished goods

     8,601        8,697   
  

 

 

   

 

 

 

Gross Inventories

     39,696        39,497   

Reserves

     (13,504     (11,827
  

 

 

   

 

 

 

Inventories, net

   $ 26,192      $ 27,670   
  

 

 

   

 

 

 

Property, Plant, and Equipment and Depreciation

Property, plant and equipment are stated at cost and include expenditures for major renewals and improvements. Maintenance and repairs that do not extend the lives of the respective assets are charged to expense as incurred. Depreciation expense is computed using the straight-line method over the estimated useful lives of the related assets. Estimated depreciable lives are as follows: buildings and improvements, 1 to 40 years; machinery and equipment, 1 to 11 years; and furniture and office equipment, 1 to 13 years.

Software Development Costs

Development costs incurred for research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility is achieved. Technological feasibility is established upon completion of a detail program design or, in its absence, completion of a working model. After technological feasibility is achieved, any additional development costs are capitalized until the product is available for general release to customers and then amortized using the straight-line method over a three-year period.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—continued

 

The following amounts were included in Other noncurrent assets as of December 31, 2011 and January 1, 2011 (in thousands):

 

     Capitalized
Software
    Accumulated
Amortization
    Capitalized
Software, net
 

Balance on January 3, 2009

   $ 14,852      $ (6,821     8,031   

Additions

     4,372        (3,345     1,027   

Disposals

     (2,079     2,079        —     

Foreign currency adjustments

     221        (179     42   
  

 

 

   

 

 

   

 

 

 

Balance on January 2, 2010

     17,366        (8,266     9,100   

Additions

     6,483        (3,700     2,783   

Disposals

     (2,993     2,993        —     

Foreign currency adjustments

     453        (256     197   
  

 

 

   

 

 

   

 

 

 

Balance on January 1, 2011

     21,309        (9,229     12,080   

Additions

     7,256        (4,185     3,071   

Disposals

     (6,417     6,417        —     

Foreign currency adjustments

     6        (35     (29
  

 

 

   

 

 

   

 

 

 

Balance on December 31, 2011

   $ 22,154      $ (7,032   $ 15,122   
  

 

 

   

 

 

   

 

 

 

At December 31, 2011, in process capitalized software was $4.9 million.

Long-Lived Assets

In accordance with ASC 360, when there are indicators of impairment, the Company evaluates the recoverability of its long-lived assets by determining whether unamortized balances could be recovered through undiscounted future operating cash flows over the remaining lives of the assets. The estimated fair value is determined by discounting the expected future cash flows at a rate that is required for a similar investment with like risks. If the sum of the expected future cash flows is less than the carrying value of the assets, an impairment loss would be recognized for the excess of the carrying value over the fair value. Long-lived assets were considered fully recoverable in 2011 and 2010.

Goodwill and Indefinite-Lived Intangibles

The Company accounts for goodwill and other indefinite-lived intangible assets in accordance with ASC 350, Goodwill and Other Intangible Assets. ASC 350 requires companies to review goodwill and intangible assets with indefinite useful lives for impairment annually, or more frequently if indicators of impairment occur. Impairment indicators could include a significant adverse change in the business climate, operating performance indicators, or the decision to sell or dispose of a reporting unit.

The Company early adopted Accounting Standards Update No. 2011-08: Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment (ASU 2011-08). ASU 2011-08 permits the Company to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the quantitative two-step goodwill impairment test.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—continued

 

If the Company determines it is more likely than not that its fair value is less than its carrying value, the Company is required to quantitatively test the carrying value of goodwill for impairment at the reporting unit level using a discounted cash flow method to estimate fair value. An impairment charge is recognized for any amount by which the carrying amount of a reporting unit’s goodwill exceeds its implied fair value. Changes in forecasted operations and changes in discount rates can materially affect these estimates. Once an impairment of goodwill has been recorded, it cannot be reversed.

The indefinite-lived intangible asset impairment review consists of a comparison of the fair value of the indefinite-lived intangible asset with its carrying amount. If the carrying amount exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. If the fair value exceeds its carrying amount, the indefinite-lived intangible asset is not considered impaired. ASC 350 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives, and reviewed for impairment in accordance with ASC 360, Accounting for the Impairment or Disposal of Long-Lived Assets as discussed below.

Mandatorily Redeemable Preferred Stock

In accordance with ASC 480, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, the mandatorily redeemable preferred stock is classified as a noncurrent liability in the accompanying Consolidated Balance Sheets due to its mandatory redemption feature. On March 30, 2011, the Company redeemed all the outstanding mandatorily redeemable preferred stock (“MRPS”) for an aggregate redemption amount of $49.3 million, which included a $2.3 million early redemption charge.

Deferred Financing Costs

The Company capitalizes costs incurred in connection with the establishment of credit facilities and related borrowings. These costs are amortized to interest expense over the life of the borrowing or life of the credit facility using the straight-line method, which approximates the interest method. In the case of early debt principal repayments, the Company adjusts the value of the corresponding deferred financing costs with a charge to interest expense, and similarly adjusts the future amortization expense.

Self-Insurance Reserves

The Company is self insured up to certain limits for costs associated with benefits paid under health care programs for its domestic employees. The measurement of these costs requires the consideration of historic loss experience and judgments about the present and expected levels of costs per claim. These costs are accounted for through actuarial methods, which develop estimates of the undiscounted liability for claims incurred, including those claims incurred but not reported. This method provides estimates of future ultimate claim costs based on claims incurred as of the balance sheet date.

 

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X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—continued

 

Accumulated Other Comprehensive Income

The components of ending accumulated other comprehensive income (loss) are as follows (in thousands):

 

     Foreign
currency
translation
adjustments
    Net unrealized
income (loss) on
derivative financial
instruments (net of
tax effects)
    Pension
adjustments
(net of tax
effects)
    Total
Accumulated
Other
Comprehensive
Income (Loss)
 

Balance on January 2, 2010

   $ 12,271      $ (1,899   $ (926   $ 9,446   

Other comprehensive income (loss)

     (730     999        1,758        2,027   

Balance on January 1, 2011

     11,541        (900     832        11,473   

Other comprehensive income (loss)

     (1,492     (12     (5,126     (6,630
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance on December 31, 2011

   $ 10,049      $ (912   $ (4,294   $ 4,843   
  

 

 

   

 

 

   

 

 

   

 

 

 

Revenue Recognition

Revenue is recognized when earned in accordance with ASC 605, Revenue Recognition. Revenue from sales of products and services is recognized when a purchase order has been received, the product has been shipped or the service has been performed, the sales price is fixed and determinable, and collection of any resulting receivable is probable. To the extent customer payment is received before all recognition criteria has been met these revenues are initially deferred and later recognized in the period that all recognition criteria has been met.

The Company executes sales through various channels including distributors, e-commerce, end user, and a direct sales force. The Company offers standard payment terms which vary from net 30 to net 90 days, based on regional practice. The Company does not offer return rights, price protection or exchange provisions. In certain instances the Company provides volume based discounts.

For transactions involving the sale of software which is not incidental to the product, revenue is recognized in accordance with ASC 985, Software Revenue Recognition. The Company recognizes revenue when there is persuasive evidence of an arrangement, delivery has occurred, the sales price is fixed or determinable and collection is probable. In instances where an arrangement contains multiple elements, the arrangement consideration is allocated to each deliverable based on the relative selling price. The selling price for each deliverable is based on vendor-specific objective evidence (VSOE) if available, third-party evidence if VSOE is not available, or estimated selling price if neither VSOE or third-party evidence is available.

Shipping and Handling

The Company records shipping and handling charged to customers in net sales and the related expenses in cost of sales in the Consolidated Statements of Operations.

Advertising Costs

Advertising costs are charged to operations in the period incurred and totaled $0.6, $0.5, and $0.6 million in 2011, 2010 and 2009, respectively.

 

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X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—continued

 

Income Taxes

Income taxes are accounted for in accordance with ASC 740, Accounting for Income Taxes. Income tax expense includes the current tax obligation or benefit and the change in deferred income tax balance for the period. Deferred income taxes result from the temporary differences between financial and income tax bases of certain assets and liabilities and are measured using the statutory tax rates expected to apply to the taxable income in the years in which those temporary differences are expected to reverse. The Company records valuation allowances on its deferred income tax assets for which it is not more likely than not that a future benefit will be received. Uncertain tax positions are recognized at the largest amount of benefit that is more likely than not of being recognized upon ultimate settlement with the tax authority.

Stock Option Plans

The Company accounts for its employee and outside director share-based compensation plans in accordance with ASC 718, Share-Based Payment, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options and employee stock purchases under the Employee Stock Purchase Plan, based on estimated fair values. The Company’s employee and outside director stock option plans are disclosed in Note 8.

Per Share Data

Basic earnings per share (EPS) is computed by dividing net income (loss) by the weighted average number of common shares outstanding in each year. Diluted EPS is computed by dividing net income (loss) by the weighted average number of common shares outstanding plus all shares that would have been outstanding if every potentially dilutive common share had been issued. The following table reconciles the numerators and denominators used in the calculations of basic and diluted EPS for each of the last three years (in thousands, except per share data):

 

     2011     2010     2009  

Numerators:

      

Net income (loss)

   $ 49,361      $ 3,641      $ (25,242

Adjustment for earnings allocated to restricted common stock

     (414     (33     —     
  

 

 

   

 

 

   

 

 

 

Net income (loss) used in calculating basic EPS

     48,947        3,608        (25,242

Adjustment for earnings reallocated to nonvested restricted common stock

     406        33        —     
  

 

 

   

 

 

   

 

 

 

Net income (loss) used in calculating diluted EPS

   $ 49,353      $ 3,641      $ (25,242
  

 

 

   

 

 

   

 

 

 

Denominators:

      

Weighted average shares outstanding

     85,997        85,189        77,500   

Adjustment for non-vested restricted common stock

     (722     (775     —     
  

 

 

   

 

 

   

 

 

 

Shares used in calculating basic EPS

     85,275        84,414        77,500   

Effect of dilutive stock options and units

     2,082        1,385        —     
  

 

 

   

 

 

   

 

 

 

Shares used in calculating diluted EPS

     87,357        85,799        77,500   
  

 

 

   

 

 

   

 

 

 

Net income (loss) per share:

      

Basic

   $ 0.57      $ 0.04      $ (0.33

Diluted

   $ 0.56      $ 0.04      $ (0.33

 

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X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—continued

 

The number of stock options, awards, and warrants that were not included in the diluted earnings per share calculation because the effect would have been anti-dilutive was approximately 1,764,000 in 2011, 3,090,000 in 2010, and 7,555,000 in 2009.

Foreign Currency Translation

Most of the Company’s foreign operations use their local currency as their functional currency. Accordingly, foreign currency balance sheet accounts are translated into U.S. dollars at the exchange rate in effect at year-end, and income statement accounts are translated at the weighted average rate of exchange in effect during the year. The resulting translation adjustments are recorded as a component of accumulated other comprehensive income in the Consolidated Statements of Shareholders’ Investment. Gains and losses arising from re-measuring foreign currency transactions into the functional currency are included in the determination of net income (loss). Net gains and (losses) from re-measurement of foreign currency transactions were $1.4, $1.6, and $(2.5) million for 2011, 2010, and 2009, respectively.

Use of Estimates

The preparation of the Company’s Consolidated Financial Statements requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, the reported amounts of revenues and expenses and the disclosure of contingent liabilities. Management makes its best estimate of the ultimate outcome for these items based on the historic trends and other information available when the financial statements are prepared. Changes in estimates are recognized in accordance with the accounting rules for the estimate, which is typically in the period when new information becomes available to management. Actual results could differ from those estimates; however, management believes that any subsequent revisions to estimates used would not have a material effect on the financial condition or results of operations of the Company.

New Accounting Standards

In January 2010, the FASB issued ASU No. 2010-06 Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This standard requires disclosure on the amount and reason for transfers in and out of Level 1 and 2 fair value measurements. The standard also requires disclosure of activities, including purchases, sales, issuances, and settlements within the Level 3 fair value measurement. The standard also clarifies existing disclosure requirements on levels of disaggregation and disclosures about inputs and valuation techniques. We adopted the disclosure requirements of this standard on January 3, 2010, except for the disclosures about purchases, sales, issuances and settlements in the Level 3 reconciliation, which were adopted January 2, 2011. The adoption of the required disclosures did not have an impact on our financial position, results of operations, or cash flows.

In April 2010, the FASB issued ASU No. 2010-17, Revenue Recognition—Milestone Method (Topic 605): Milestone Method of Revenue Recognition. The ASU provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. Consideration that is contingent on achievement of a milestone in its entirety may be recognized as revenue in the period in which the milestone is achieved only if the milestone is judged to meet certain criteria to be considered substantive. Milestones are considered substantive in their entirety and may not be bifurcated. An arrangement may contain both substantive and nonsubstantive milestones, and each milestone should be evaluated individually to determine if it is substantive. The ASU is effective on a prospective basis for milestones

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—continued

 

achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010 (fiscal 2011 for the Company). The adoption of this new guidance in the first quarter of 2011 did not impact our financial position, results of operations, or cash flows.

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU represents the converged guidance of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board on fair value measurement. The guidance clarifies how a principal market is determined, addresses the fair value measurement of instruments with offsetting market or counterparty credit risks, addresses the concept of valuation premise and highest and best use, extends the prohibition on blockage factors to all three levels of the fair value hierarchy and requires additional disclosures. ASU No. 2011-04 is effective for interim and annual periods beginning after December 15, 2011 (the first quarter of fiscal 2012 for the Company) and is applied prospectively. This standard impacts disclosure only and therefore adoption will not have an impact on our financial position, results of operations, or cash flows.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income and amended its guidance on the presentation of comprehensive income in financial statements to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items that are recorded in other comprehensive income. The new accounting guidance requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. The provisions of this new guidance must be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 (the first quarter of fiscal 2012 for the Company). This standard impacts presentation and disclosure only and therefore adoption will not have an impact on our financial position, results of operations, or cash flows.

In September 2011, the FASB issued ASU 2011-08, Goodwill and Other (Topic 350): Testing Goodwill for Impairment and amended its guidance on the annual testing of goodwill for impairment. The amended guidance will allow companies to assess qualitative factors to determine if it is more-likely-than-not that goodwill might be impaired and whether it is necessary to perform the two-step goodwill impairment test required under current accounting standards. The amendments are effective for annual and interim goodwill impairment test performed for fiscal years beginning after December 15, 2011 (the first quarter of fiscal 2012 for the Company) and early adoption is permitted. The Company early adopted this new guidance. The adoption of ASU 2011-08 did not have any impact on our financial position or results of operations as of December 31, 2011 as it is a change in application of the goodwill impairment test only.

Reclassifications

Certain prior year information has been reclassified to conform to the current year presentation.

NOTE 2—BUSINESS SEGMENTS

The Company has one operating segment as defined by ASC 280, Segment Reporting (ASC 280). As a result, the financial statement information provided has been presented as one reportable segment, reflecting the Company’s consolidated results.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 2—BUSINESS SEGMENTS—continued

 

The following table summarizes net sales from continuing operations by product line (in thousands):

 

     2011      2010      2009  

Imaging and Media

   $ 90,845       $ 87,308       $ 74,066   

Industrial

     50,011         47,302         38,621   

Standards

     46,867         42,140         35,925   

Support Services

     29,075         25,837         23,251   

Retail

     16,101         15,325         14,277   

Other

     4,653         4,828         5,527   
  

 

 

    

 

 

    

 

 

 

Total Net Sales

   $ 237,552       $ 222,740       $ 191,667   
  

 

 

    

 

 

    

 

 

 

The following is a summary of geographic information for the respective fiscal years indicated. Individual foreign country information is not provided as none of the individual foreign countries in which we operate are considered material for separate disclosure based on quantitative and qualitative considerations.

Sales by geographic area, based on the location of the customer, are as follows (in thousands):

 

     2011      2010      2009  

Domestic sales

   $ 74,579       $ 73,676       $ 67,631   

International sales:

        

Europe

     93,858         83,162         68,930   

Asia

     57,477         54,004         46,109   

Other Countries

     11,638         11,898         8,997   
  

 

 

    

 

 

    

 

 

 
     162,973         149,064         124,036   
  

 

 

    

 

 

    

 

 

 

Total net sales from continuing operations

   $ 237,552       $ 222,740       $ 191,667   
  

 

 

    

 

 

    

 

 

 

Long-lived tangible assets consist of long-term assets of the Company, excluding financial instruments and deferred tax assets. The Company’s long-lived tangible assets are as follows (in thousands):

 

     2011      2010  

Long-lived assets:

     

U.S. operations

   $ 29,067       $ 30,759   

International

     10,011         9,831   
  

 

 

    

 

 

 
   $ 39,078       $ 40,590   
  

 

 

    

 

 

 

No single customer accounted for more than 10 percent of total consolidated net sales in 2011, 2010 or 2009.

NOTE 3—RESTRUCTURING AND OTHER RELATED CHARGES

Restructuring and other related charges include the costs the Company incurred to execute various corporate restructuring activities. These charges include cash costs, accrued liabilities, asset write-offs, lease termination costs, and employee severance pay resulting from layoffs. The Company has fully executed all corporate restructuring plans.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 3—RESTRUCTURING AND OTHER RELATED CHARGES—continued

 

A summary of the activity in the restructuring accounts and a reconciliation of the liability for, and as of, the years ended January 1, 2011 and January 2, 2010, are as follows (in thousands):

 

     Severance     Other     Asset
Write
Downs
    Facility Exit
and Lease
Termination
Costs
    Total  

Balance at January 3, 2009

     2,028        36        —          —          2,064   

Charges incurred in 2009

     2,653        1,380        143        415        4,591   

Amounts paid or utilized in 2009

     (4,058     (1,141     (143     (415     (5,757
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at January 2, 2010

     623        275        —          —          898   

Charges incurred in 2010

     1,164        844        —          —          2,008   

Amounts paid or utilized in 2010

     (1,787     (1,119     —          —          (2,906
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at January 1, 2011

   $ —        $ —        $ —        $ —        $ —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

In 2010, the Company incurred $2.0 million in restructuring charges which were recorded in operating expenses. In 2009, the Company incurred $4.5 million in restructuring charges of which $4.4 million were recorded in operating expenses and $0.1 million were recorded in cost of sales.

NOTE 4—GOODWILL AND OTHER INTANGIBLE ASSETS

A summary of changes in goodwill and indefinite-lived intangible assets for the years ending December 31, 2011 and January 1, 2011 is as follows (in thousands):

 

     Goodwill     Indefinite-lived
intangible
assets
     Total  

January 2, 2010

   $ 234,020      $ 13,433       $ 247,453   

Foreign currency and other adjustments

     (68     —           (68
  

 

 

   

 

 

    

 

 

 

January 1, 2011

     233,952        13,433         247,385   

Foreign currency and other adjustments

     (11     —           (11
  

 

 

   

 

 

    

 

 

 

December 31, 2011

   $ 233,941      $ 13,433       $ 247,374   
  

 

 

   

 

 

    

 

 

 

As discussed in Note 1, the Company accounts for goodwill and indefinite-lived intangible assets in accordance with ASC 350, which requires the Company to evaluate the recorded amount of goodwill and indefinite-lived intangibles for impairment on an annual basis, or more frequently if a triggering event occurs.

Goodwill Impairment Analysis

The Company early adopted the provisions of ASU 2011-08 and conducted a qualitative goodwill impairment assessment in the fourth quarter of 2011. The qualitative assessment considered the primary factors and indicators that impact our reporting unit’s fair value. After assessing the totality of these factors and indicators for the qualitative impairment assessment, we determined that the fair value of our reporting unit more likely than not exceeds its carrying value. Accordingly, no further quantitative two-step goodwill impairment test was necessary, and no goodwill impairment was recognized in 2011.

 

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X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 4—GOODWILL AND OTHER INTANGIBLE ASSETS—continued

 

Additionally based on the results of our 2010 and 2009 annual assessment of the recoverability of goodwill, the fair values exceeded book value, and accordingly, there was no impairment of goodwill as of and for the years ended January 1, 2011 and January 2, 2010.

Indefinite-Lived Intangible Impairment Analysis

Indefinite-lived intangible assets are evaluated for recoverability utilizing an income approach that estimates the fair value of the discounted cash flows. The fair value of the indefinite-lived intangible asset is compared to its carrying value, and an impairment loss is recognized if the fair value is less than the carrying value.

The following valuation methodologies and assumptions were used in the analysis of the indefinite-lived intangible asset:

 

   

The income approach, utilizing the relief from royalty method, was used to estimate fair value.

 

   

Relief from royalty rate considered publicly disclosed arm’s length licensing agreements, review of internal licensing agreements, and other factors.

 

   

Future projections are based on past performance and expected market growth

 

   

Expected synergies

 

   

Weighted average cost of equity

The methodology for valuing indefinite-lived intangible assets is applied consistently. The Company believes the discounted cash flow valuation model provides the most reasonable and meaningful fair value estimate based upon the indefinite-lived intangible assets projected future cash flows and replicates how market participants would value the company’s intangible assets in an orderly transaction.

The Company did not recognize an impairment loss on its indefinite-lived intangible assets in 2011, 2010 or 2009.

The following amounts were included in other intangibles as of December 31, 2011 and January 1, 2011 (in thousands):

 

     2011     2010  
     Assets      Accumulated
Amortization
    Assets      Accumulated
Amortization
 

Technology and patents

   $ 41,387       $ (27,607   $ 55,529       $ (34,742

Customer relationships

     44,489         (17,744     46,543         (16,109

Trademarks and trade names

     8,691         (5,570     9,614         (5,396
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 94,567       $ (50,921   $ 111,686       $ (56,247
  

 

 

    

 

 

   

 

 

    

 

 

 

ASC 350 also requires that intangible assets with determinable useful lives be amortized over their respective estimated useful lives and reviewed for impairment if indications of impairment are present in accordance with ASC 360. During 2011, 2010, and 2009 there were no triggering events warranting an impairment analysis.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 4—GOODWILL AND OTHER INTANGIBLE ASSETS—continued

 

Amortization expense is computed using the straight-line method over the estimated useful lives of the intangible assets as follows:

 

Customer and distribution relationships

   7 to 15 years

Trademarks and trade names

   7 to 10 years

Technology and patents

   7 to 15 years

Amortization expense was $11.8 million for 2011, $12.0 million for 2010, and $15.9 million for 2009. Estimated amortization expense for intangible assets for each of the succeeding five years is as follows (in thousands):

 

2012

     11,793   

2013

     4,954   

2014

     4,610   

2015

     4,610   

2016

     2,985   

Thereafter

     14,694   

NOTE 5—LONG-TERM DEBT

As of December 31, 2011 and January 1, 2011, the Company’s long-term debt consisted of the following (in thousands):

 

     2011     2010  

Senior secured credit facilities

   $ 149,814      $ 130,598   

Revolving line of credit

     —          6,000   
  

 

 

   

 

 

 
     149,814        136,598   

Less current portion

     (11,783     (1,350
  

 

 

   

 

 

 

Total long-term debt

   $ 138,031      $ 135,248   
  

 

 

   

 

 

 

Long-term debt matures as follows (in thousands):

 

2012

   $ 11,783   

2013

     10,701   

2014

     14,592   

2015

     21,402   

2016

     91,336   
  

 

 

 
   $ 149,814   
  

 

 

 

Senior Secured Credit Agreement

On March 30, 2011, the Company entered into a new senior secured credit agreement (the 2011 credit agreement) which provided for aggregate principal borrowings of up to $225 million. This credit agreement repaid in full and replaced the Company’s previous credit facilities and funded the redemption of all outstanding MRPS. The 2011 credit agreement initially consisted of a $170 million term loan and an available $55 million

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 5—LONG-TERM DEBT—continued

 

revolving credit facility, which both mature on March 30, 2016. Obligations under the 2011 credit agreement are secured by essentially all of the tangible and identifiable intangible assets of the Company, with the exception of real estate. The 2011 credit agreement provides variable interest rate options from which the Company may select, as described below, and the unused portion of the revolving credit facility is subject to a fee of 0.45 percent per annum. The 2011 credit agreement contains operational and financial covenants that, in addition to obligating the Company to deliver financial reports and maintain certain financial ratios, limits the Company’s ability to create liens, incur indebtedness, make fundamental changes involving the Company and its subsidiaries, make investments or acquisitions, and make certain capital expenditures, among other things. As of December 31, 2011, the Company was in compliance with the covenants contained in its 2011 credit agreement.

In connection with the refinancing of the previous credit facilities and MRPS, the Company recorded a loss on redemption of preferred shares and debt refinancing costs of $13.8 million. These charges consisted primarily of a $9.8 million unamortized discount related to the MRPS, an early redemption fee of $2.3 million related to the MRPS, fees to creditors and third parties of $1.0 million, and unamortized deferred financing costs associated with the MRPS of $0.7 million.

Outstanding borrowings under the 2011 credit agreement bear interest at a rate per annum equal to LIBOR or Prime interest rate, plus a 3.25 and 2.25 percent margin, respectively (subject to adjustments based on the Company’s consolidated leverage ratio), payable in arrears on the last day of the applicable interest period, but in no event less frequently than every three months. As of December 31, 2011, the weighted average interest rate in effect under the terms of the 2011 credit agreement was 3.73 percent. The Company holds interest rate swaps to limit a portion of its LIBOR exposure (see Note 7 for further discussion).

Prior to entering the 2011 credit agreement, the Company’s previous secured credit facilities consisted of a $310 million first lien loan, which included a $270 million five-year term loan and a $40 million five-year revolving credit facility. These credit facilities were repaid in full in connection with the refinancing described above.

Under the previous credit agreement, the Company had the option to choose LIBOR or Prime interest rate indices. The LIBOR index was subject to a floor of 3.0 percent plus a 3.5 percent margin and the Prime index was based on the Prime Rate plus a 2.5 percent margin during the quarter. Prior to entering into the 2011 credit agreement, the Company had designated its borrowings under the Prime interest rate, with an effective interest rate of 5.75 percent. As of January 1, 2011, the weighted average interest rate in effect for all of the Company’s debt was 8.0 percent per annum, exclusive of amortization of deferred financing costs and the effect of derivative instruments. Interest payments on the Prime Rate based borrowings were paid in full at the time the loan was repaid.

Total interest expense incurred by the Company in 2011 was $12.4 million, including $1.7 million of amortization of deferred financing fees. Total interest expense incurred by the Company in 2010 was $28.0 million, including $2.8 million of amortization of deferred financing fees. Total interest expense incurred by the Company in 2009 was $33.5 million, including $2.9 million of amortization of deferred financing fees. Cash based interest on secured debt during 2011, 2010, and 2009 totaled $7.3 million, $13.3 million and $21.8 million, respectively. Effective the third quarter of 2010, the Company paid cash of $3.3 million for interest on its Series A preferred stock.

Subsequent to the year ended December 31, 2011, the Company made voluntary payments of $4.0 million against its senior secured borrowings which are classified in the current portion of long term debt at December 31, 2011.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 5—LONG-TERM DEBT—continued

 

Deferred Financing Fees

In connection with the 2011 credit agreement, the Company has $6.2 million of deferred financing costs, consisting of $2.3 million of current fees to creditors and third parties and $3.9 million of unamortized deferred financing costs associated with the previous credit facility. Deferred financing costs at January 1, 2011 were established in connection with the previous credit agreement. These costs are being amortized over the life of the related agreement. Unamortized deferred financing costs were $5.2 million, as of both December 31, 2011 and January 1, 2011, net of accumulated amortization of $0.9 and $6.6 million as of the same periods, respectively.

NOTE 6—MANDATORILY REDEEMABLE PREFERRED STOCK AND WARRANTS

On March 30, 2011, the Company redeemed all of the issued and outstanding MRPS in connection with the entry into its 2011 credit agreement, as described in Note 5. The Company’s MRPS had a stated value of $1,000 per share. At January 1, 2011, of the Company’s 5.0 million, $0.10 par value preferred shares, 84,729 were authorized as MRPS of which 46,980 were issued and outstanding. The MRPS is presented net of the warrant discount of $10.6 million in the Company’s consolidated balance sheet as of January 1, 2011. The preferred stock ranked senior to the Company’s common stock in respect of payment of dividends and the distribution of assets upon liquidation of the Company. Dividends could be paid in cash or paid in kind (PIK) in additional shares of preferred stock, at the discretion of the Board of Directors.

The MRPS entitled the holders to dividends at a fixed annual rate of 14.375 percent compounded quarterly and was mandatorily redeemable on January 23, 2014. Upon redemption on March 30, 2011, the MRPS holders received the stated value of $1,000 per share plus all accrued dividends. According to the terms of the agreement with such holders, the early redemption of the MRPS was subject to an early redemption multiplier fee of 5.0 percent. This fee was $2.3 million and is included in the loss on redemption of preferred shares and debt refinancing costs.

At the time of issuance of the MRPS the Company issued freestanding warrants to acquire 7.5 million shares of the Company’s common stock (the Warrants) at an exercise price of $0.01 per share. The Warrants required shareholder approval prior to exercise, and shareholder approval was obtained at a special meeting of the shareholders on October 28, 2009. In November 2009, the Company issued 7.5 million shares of common stock upon the exercise of the Warrants by the holders. The Company determined the fair value of the Warrants was $15.5 million on the issuance date using the Black-Scholes Option Pricing model, which was classified as a discount on the MRPS. The discount was accreted to interest expense in the accompanying consolidated condensed statement of operations over the period of issuance to the mandatory redemption date of the MRPS. The accretion for the years ended December 31, 2011, January 1, 2011, and January 2, 2010 was $0.9 million, $3.5 million, and $1.5 million, respectively. Unamortized discount on MRPS of $9.8 million was included in the loss on redemption of preferred shares and debt refinancing costs recorded in connection with the entry into 2011 credit agreement, as described in Note 5.

NOTE 7—FINANCIAL INSTRUMENTS

The Company applies the provisions of ASC 820, Fair Value Measurements (ASC 820) to assets and liabilities measured at fair value. This Statement requires fair value measurements be classified and disclosed in one of the following three categories:

 

  Level 1: Financial instruments with unadjusted, quoted prices listed on active market exchanges.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 7—FINANCIAL INSTRUMENTS—continued

 

  Level 2: Financial instruments lacking unadjusted, quoted prices from active market exchanges, including over-the- counter traded financial instruments. The prices for the financial instruments are determined using prices for recently traded financial instruments with similar underlying terms as well as directly or indirectly observable inputs, such as interest rates and yield curves that are observable at commonly quoted intervals.

 

  Level 3: Financial instruments that are not actively traded on a market exchange. This category includes situations where there is little, if any, market activity for the financial instrument. The prices are determined using significant unobservable inputs or valuation techniques.

The Company has classified certain marketable securities held in a trust for a former employee within Level 1 of the fair value hierarchy, recognized as an other noncurrent asset of $0.6 million and $0.8 million as of December 31, 2011 and January 1, 2011, respectively.

The Company has classified its interest rate swaps, currency forward contracts, and interest rate caps within Level 2 of the fair value hierarchy. Fair values are measured as the present value of all expected future cash flows adjusted to reflect the credit quality of the party bearing the cash flow obligation to pay if significant.

Accounting for Derivative Financial Instruments

The Company accounts for derivative financial instruments in accordance with ASC 815, Accounting for Derivative Instruments and Hedging Activities (ASC 815), as amended. As a result, the Company recognizes derivative financial instruments in the condensed consolidated financial statements at fair value regardless of the purpose or intent for holding the instruments. Changes in the fair value of derivative financial instruments are either recorded in income or in shareholders’ investment as a component of accumulated other comprehensive income depending on whether the derivative financial instrument qualifies for hedge accounting, and if so, whether it qualifies as a fair value hedge or cash flow hedge.

Changes in fair values of derivatives accounted for as fair value hedges are recorded in earnings along with the portions of the changes in the fair values of the hedged items that relate to the hedged risk. Changes in fair values of derivatives accounted for as cash flow hedges, to the extent they are effective hedges, are recorded in other comprehensive income. Changes in fair values of derivatives not qualifying as hedges are reported in earnings.

Interest Rate Swaps

The Company utilizes interest rate swap agreements to limit its exposure to fluctuations in the base lending rate under the Company’s credit facility. These agreements result in the Company paying or receiving the difference between three month LIBOR and fixed interest rates at specified intervals, calculated based on the notional amounts. The interest rate differential to be paid or received is recorded as interest income or expense. Under ASC 815, these swap transactions are designated as cash flow hedges, therefore the effective portion of the derivative’s gain or loss is initially recorded as a component of accumulated other comprehensive income and subsequently reclassified into earnings when the hedged interest expense affects earnings.

On May 24, 2011, the Company entered into two interest rate swap agreements (swaps), each with a notional value of $30.0 million. The swaps became effective on June 30, 2011 and will terminate on March 30, 2014. As of December 31, 2011, the fair value of the swaps was a liability of $0.9 million classified in other current liabilities. For the year ended December 31, 2011, the change in fair value recorded as a component of accumulated other comprehensive income was $0.9 million.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 7—FINANCIAL INSTRUMENTS—continued

 

On April 21, 2008, the Company terminated its 2006 series of interest rate swap agreements. Due to termination of the interest rate swap contracts in April 2008, related accumulated other comprehensive loss balances have been frozen and will be recognized as interest expense over the period of the original hedged cash flows. Interest expense recorded related to the terminated swaps during the year ended December 31, 2011 totaled $0.4 million. These terminated swaps were fully amortized as of December 31, 2011.

Currency Forward Contracts

During 2011 the Company entered into a series of short term currency forward contracts (the forwards) to limit its exposure to fluctuations between the Euro and the Swiss Franc. At December 31, 2011, the Company maintained one €0.5 million net settle contract (total notional amount of $0.6 million), that matures monthly through January 2012.

At inception, the forwards were not designated as a hedge under ASC 815, therefore adjustments to fair value are recorded to the balance sheet with a corresponding change to foreign currency transaction gains and losses included in other income (expense) in the statement of operations. For the year ended December 31, 2011, the currency gains and losses associated with forward contracts were nominal.

Interest Rate Cap

On December 30, 2008, the Company purchased an interest rate cap to limit its exposure to increases in the 3-month LIBOR rate above 3 percent per annum. The cost of the interest rate cap was $1.6 million, payment for which was made in January 2009. The cap became effective January 6, 2009, at a notional amount of $256.0 million. The notional amount amortizes downward every six months through the termination of the contract.

At inception, this interest rate cap was designated as a cash flow hedge under ASC 815. The Company assessed hedge effectiveness based on the total changes in cash flows on its interest rate cap as described by the Derivative Implementation Group (DIG) Issue G20, Cash Flow Hedges: Assessing and Measuring the Effectiveness of a Purchased Option Used in a Cash Flow Hedge, and recorded subsequent changes in fair value in other comprehensive income, including changes in the option’s time value. Gains or losses on interest rate caps used to hedge interest rate risk on variable-rate debt were reclassified out of accumulated other comprehensive income and into earnings (as interest expense) when the forecasted transactions occur. The current market value of the interest rate cap is reported on the condensed consolidated balance sheets in other current and long-term assets.

On April 4, 2010, the interest rate cap was de-designated as a cash flow hedge by the Company. The fair value of the cap as of the de-designation date was an asset of $0.2 million. Due to the de-designation of the cap in April 2010, related accumulated other comprehensive loss balances have been frozen and will be recognized as interest expense over the period of the original hedged cash flows. Interest expense recorded related to the amortization of unrealized losses frozen in accumulated other comprehensive loss during the year ended December 31, 2011 was $0.5 million. The balance in accumulated other comprehensive income related to the cap was fully amortized in 2011.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

NOTE 8—SHARE-BASED COMPENSATION

Description of Share-Based Compensation Plans

Employee Stock Purchase Plan—The Company may sell up to one million shares of common stock to its employees under an employee stock purchase plan. Eligible employees who participate purchase shares quarterly at 85 percent of the market price on the date purchased.

Stock Option and Restricted Stock Plan—The Company has a stock incentive plan authorizing 7 million shares of common stock. This plan became effective on October 28, 2008, and replaced the Company’s previous option and restricted stock plans. The new plan permits stock options, stock appreciation rights, restricted stock awards, and restricted stock units to be granted to employees, the Company’s Board of Directors, and consultants and advisors to the Company. To date, stock options, restricted stock awards, and restricted stock units have been granted under this plan. Stock option exercise prices and vesting schedules are determined at the time of grant, which range from immediate to five year vesting. No options are exercisable later than ten years after the date of grant. Restricted shares awarded under this plan entitle the shareholder to all rights of common stock ownership except that the shares may not be sold, transferred, pledged, exchanged, or otherwise disposed of during the restriction period. Restricted share units awarded under this plan do not entitle the holder to the rights of common stock ownership and may not be sold, transferred, pledged, exchanged, or otherwise disposed of during the restriction period. Restriction periods for restricted shares and restricted share units are determined by a committee appointed by the Board of Directors and range from immediate to five years.

Valuation of Share-Based Compensation

Valuation and Amortization Method—The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing model. Restricted stock awards and units are valued at closing market price on the date of grant. Options and awards either cliff vest or are subject to graded vesting based upon either service or performance conditions. Compensation expense related to options and awards is recognized on a straight-line basis over their requisite service or performance periods. Compensation expense for shares issued under the Employee Stock Purchase Plan is recognized for 15 percent of the market value of shares purchased, in the quarter to which the purchases relate.

Expected Term—Expected term estimates for employee options are based upon prior exercise, cancellation, and expiration history, which the Company believes to be representative of future behavior. The Company has considered the effects of analyzing expected term separately for different groups of employees, and has concluded that historical exercise patterns are not significantly different between groups. Therefore, one expected term is used for all employee options.

Expected Volatility—The expected volatility is based upon historical volatility of the Company’s stock for a period of time equivalent to that of the expected term of the option. Consideration is given to unusual factors that might cause the historical period to be unrepresentative of future expectations.

Risk-Free Interest Rate—The risk-free interest rate is based on the U.S. Treasury yield in effect at the time of option grant for zero-coupon issues with terms equivalent to the expected term of the options.

Dividends—The Company’s dividend yield is calculated as the percentage of dividends issued on shares relative to the average market price of those shares and is calculated over an historical period equivalent to that of the expected term of the option. Beginning in 2007, the Company suspended its quarterly dividend payment, therefore options granted after 2006 have been valued using a zero percent dividend yield.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 8—SHARE-BASED COMPENSATION—continued

 

Forfeitures—The Company applies an estimated forfeiture rate to options as they vest. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience.

The Company used the following assumptions in valuing employee options granted during 2011, 2010, and 2009:

 

     2011    2010    2009

Dividend yield

   0.0%    0.0%    0.0%

Volatility

   56 - 57%    55 - 56%    56 - 58%

Risk-free interest rates

   1.5 - 2.6%    1.8 - 3.1%    2.3 - 3.2%

Expected term of options

   7 years         7 years         7 years     

Stock Option and Award Activity

Stock Options

Stock option activity for 2011, 2010 and 2009 was as follows:

 

     Shares     Weighted
Average
Exercise
Price
     Weighted
Average
Remaining
Contractual
Term (years)
     Average
Intrinsic
Value
(thousands)
 

Outstanding at January 3, 2009

     3,985,762      $ 7.53         7.02       $ 28   

Granted

     2,381,631        1.49         

Exercised

     (1,350     1.29         

Forfeited

     (158,824     3.23         

Expired

     (143,706     11.26         
  

 

 

         

Outstanding at January 2, 2010

     6,063,513      $ 5.18         7.01       $ 1,727   
  

 

 

         

Granted

     492,435        3.16         

Exercised

     (302,223     2.64         

Forfeited

     (27,016     2.27         

Expired

     (708,500     11.57         
  

 

 

         

Outstanding at January 1, 2011

     5,518,209      $ 4.34         7.30       $ 9,542   
  

 

 

         

Granted

     463,055        4.22         

Exercised

     (101,310     1.36         

Forfeited

     (89,379     3.42         

Expired

     (142,279     9.31         
  

 

 

         

Outstanding at December 31, 2011

     5,648,296      $ 4.27         6.66       $ 9,581   
  

 

 

         

Vested and expected to vest as of December 31, 2011

     5,602,703      $ 4.28         6.65       $ 9,529   
  

 

 

         

Exercisable at December 31, 2011

     4,471,314      $ 4.56         6.27       $ 7,859   
  

 

 

         

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 8—SHARE-BASED COMPENSATION—continued

 

The aggregate intrinsic value of options outstanding was calculated as the difference between the exercise price of the underlying options and the market price of the Company’s common stock for options that were in-the-money. Options that were not in-the-money as of that date, and therefore have a negative intrinsic value, have been excluded from this figure.

The weighted average grant date fair value of options granted during 2011 was $2.44. The total intrinsic value of options exercised, determined as of the exercise date, during the same period was $0.3 million. During 2010 and 2009, the weighted average grant date fair value of options granted was $1.84 and $0.89 per share, respectively, and the total intrinsic value of options exercised, determined as of the exercise date, was $0.4 million in 2010 and nominal in 2009.

Restricted Stock Awards

Restricted stock award activity for 2011, 2010, and 2009 was as follows:

 

     Shares     Weighted
Average
Grant Date
Fair Value
     Weighted
Average
Remaining
Contractual
Term (years)
 

Unvested balance at January 3, 2009

     948,999      $ 5.25      

Granted

     559,335        2.03      

Vested

     (114,440     9.99      

Forfeited

     (81,651     3.68      
  

 

 

      

Unvested balance at January 2, 2010

     1,312,243      $ 3.37         2.24   
  

 

 

      

Granted

     141,064        3.25      

Vested

     (345,609     2.82      

Forfeited

     (65,412     12.50      
  

 

 

      

Unvested balance at January 1, 2011

     1,042,286      $ 3.20         1.99   
  

 

 

      

Granted

     89,726        4.63      

Vested

     (303,713     3.16      

Forfeited

     (96,483     6.08      
  

 

 

      

Unvested balance at December 31, 2011

     731,816      $ 3.24         0.96   
  

 

 

      

Of the 731,816 restricted shares outstanding at the end of 2011, 684,153 vest based upon achievement of performance targets over periods ranging from one to five years. Of the 1,042,286 restricted shares outstanding at the end of 2010, 727,483 vest upon achievement of performance targets over periods ranging from one to five years. Of the 1,312,243 restricted shares outstanding at the end of 2009, 728,634 vest upon achievement of performance targets over periods ranging from one to five years.

The total fair value of shares vested, determined as of the release date was $1.4, $1.1, and $0.2 million during 2011, 2010 and 2009, respectively. The tax benefit that was recognized related to these releases was $0.4, $0.2, and $0.1 million in 2011, 2010, and 2009, respectively.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 8—SHARE-BASED COMPENSATION—continued

 

Restricted Stock Units

Restricted stock unit activity for 2011 and 2010 was as follows:

 

     Units     Weighted
Average
Remaining
Contractual
Term (years)
 

Unvested balance at January 2, 2010

     519,000        3.0   
  

 

 

   

Unvested balance at January 1, 2011

     519,000        2.0   
  

 

 

   

Vested

     (135,516  
  

 

 

   

Unvested balance at December 31, 2011

     383,484        0.72   
  

 

 

   

Vested and expected to vest as of December 31, 2011

     372,515        0.70   
  

 

 

   

Vested at December 31, 2011

     —          —     
  

 

 

   

All restricted stock units vest based upon achievement of performance targets over periods ranging from three to five years. All outstanding restricted stock units were granted in 2008. The weighted average grant date fair value of units granted during 2008 was $3.19 per share.

Share-Based Compensation Expense

Total share-based compensation expense recognized in the Consolidated Statements of Operations for the years ended December 31, 2011, January 1, 2011, and January 2, 2010 was as follows (in thousands):

 

     2011      2010      2009  

Stock options

   $ 1,266       $ 1,706       $ 2,981   

Restricted stock awards

     603         659         1,556   

Restricted stock units

     202         350         350   

Employee stock purchase plan

     20         21         17   
  

 

 

    

 

 

    

 

 

 

Total share-based compensation expense

   $ 2,091       $ 2,736       $ 4,904   
  

 

 

    

 

 

    

 

 

 

All share-based compensation expense was recorded in the Consolidated Statements of Operations in the line in which the salary of the individual receiving the benefit was recorded. The total income tax benefit recognized related to this compensation was $0.5 million for the year ended December 31, 2011, $0.8 million for the year ended January 1, 2011, and $1.2 million for the year ended January 2, 2010. As of December 31, 2011, there was unrecognized compensation cost for non-vested share-based compensation of $1.5 million related to options, $0.8 million related to restricted share awards, and $0.4 million related to restricted stock units. These costs are expected to be recognized over remaining weighted average periods of 1.46, 0.96, and 0.72 years, respectively.

Cash received from options exercised during 2011 was $0.1 million.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

NOTE 9—EMPLOYEE BENEFIT PLANS

401(k) Retirement Savings Plan

The Company maintains a 401(k) retirement savings plan for the benefit of substantially all full time U.S. employees. Investment decisions are made by individual employees. Investments in Company stock are not allowed under the plans. Participant contributions are matched by the Company based on applicable matching formulas. The matching contributions of the Company are discretionary and, in conjunction with its restructuring efforts, the Company suspended the match in the first quarter of 2009. The Company reinstated the matching of contributions in the second quarter of 2010. The Company’s matching expense for the plans was $0.8 million in 2011 and $0.5 million in 2010.

Swiss Pension Plan

The Company maintains a pension plan for employees of its X-Rite Europe GmbH subsidiary in Switzerland. The plan is part of an independent collective fund which provides pensions combined with life and disability insurance. The assets of the funded plans are held independently of X-Rite’s assets in a legally distinct and independent collective trust fund which serves various unrelated employers. The Fund’s benefit obligations are fully reinsured through a contract with Swiss Life Insurance Company. Based on the Fund’s design, the Company maintains the right to cancel the contract with Swiss Life Insurance Company and assume full administration of the Fund assets and obligations. The Company has not historically exercised this right and does not anticipate exercising this right in the foreseeable future. Regardless of intent, according to ASC 715 Compensation—Retirement Benefits (ASC 715), because of this right the Company is required to account for this plan as a defined benefit plan. The plan is valued annually using the projected unit credit method. The liabilities correspond to the projected benefit obligations of which the discounted net present value is calculated based on years of employment, expected salary increases, and pension adjustments.

The last actuarial valuation was carried out as of December 31, 2011. The unfunded status recognized in the Consolidated Balance Sheets, shown in other non-current liabilities, as of December 31, 2011 and January 1, 2011, were determined as follows (in thousands):

 

     2011     2010  

Fair value of plan assets

   $ 33,426      $ 31,426   

Projected benefit obligation

     (39,211     (31,601
  

 

 

   

 

 

 

Unfunded status

   $ (5,785   $ (175
  

 

 

   

 

 

 

The following weighted-average assumptions were used in accounting for the defined benefit plan:

 

         2011             2010      

Discount rate

     2.35     2.75

Expected return on plan assets

     3.00     3.00

Future salary increases

     1.50     1.00

Future pension increases

     0.25     0.25

Future benefits, to the extent that they are based on compensation, include assumed salary increases, as presented above, consistent with past experience and estimates of future increases in the Swiss industrial labor market.

 

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X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 9—EMPLOYEE BENEFIT PLANS—continued

 

The expected return on plan assets assumption was developed by management with input from third party pension plan asset managers, including a review of asset class return expectations, long-term inflation assumptions, and historical average return.

Net periodic pension cost during 2011, 2010, and 2009 includes the following (in thousands):

 

     2011     2010     2009  

Service cost

   $ 2,187      $ 2,458      $ 2,032   

Interest

     920        735        767   

Expected return on plan assets

     (1,007     (784     (949
  

 

 

   

 

 

   

 

 

 

Net periodic pension cost

   $ 2,100      $ 2,409      $ 1,850   
  

 

 

   

 

 

   

 

 

 

The Company recorded a loss of $(5.1) million, a gain of $1.7 million, and a loss of $(0.2) million in 2011, 2010, and 2009 respectively, in Other Comprehensive Income related to net actuarial gains and losses. This is the only amount in Accumulated Other Comprehensive Income related to the Swiss pension.

Changes in projected benefit obligations during 2011 and 2010 were as follows (in thousands):

 

     2011     2010  

Projected obligations at beginning of period

   $ 31,601      $ 26,984   

Service cost

     2,187        2,458   

Interest cost

     920        735   

Participant contributions

     1,123        800   

Actuarial (gain) loss

     5,961        (1,574

Benefit payments

     (1,972     (705

Foreign exchange translation effect

     (609     2,903   
  

 

 

   

 

 

 

Projected obligations at end of period

   $ 39,211      $ 31,601   
  

 

 

   

 

 

 

Accumulated benefit obligations

   $ 37,336      $ 30,589   
  

 

 

   

 

 

 

The accumulated benefit obligations are the present value of all benefits based on current and past compensation levels excluding consideration for any future increases in these compensation levels.

The assets held under the collective reinsurance contract by the Plan’s re-insurer Swiss Life Insurance Company are invested in a mix of Swiss and international bond and equity securities within the limits prescribed by the Swiss Pension Law. The following table presents a rollforward of pension plan assets measured at fair value on a recurring basis using unobservable inputs (Level 3). Changes in the fair value of plan assets for 2011 and 2010 were as follows (in thousands):

 

     2011     2010  

Fair value at beginning of period

   $ 31,426      $ 26,320   

Benefit payments

     (1,972     (705

Employer contributions

     1,684        1,362   

Participant contributions

     1,123        800   

Gain on plan assets

     1,421        756   

Foreign exchange translation effect

     (256     2,893   
  

 

 

   

 

 

 

Fair value at end of period

   $ 33,426      $ 31,426   
  

 

 

   

 

 

 

 

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X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 9—EMPLOYEE BENEFIT PLANS—continued

 

The weighted average actual asset allocations, by asset category, for the pension plan assets as of December 31, 2011 and January 1, 2011 were as follows:

 

         2011             2010      

Reinsurance contract with Swiss Life

     99.4     99.3

Real estate

     0.0     0.0

Other

     0.6     0.7
  

 

 

   

 

 

 

Total

     100.0     100.0
  

 

 

   

 

 

 

The following estimated future benefit payments, which reflect expected future service, are expected to be paid in the years indicated (in thousands):

 

2012

   $ 1,490   

2013

     1,715   

2014

     1,736   

2015

     1,912   

2016

     1,832   

2017 - 2021

     10,494   

The Company expects to contribute $1.6 million to the Plan during 2012.

NOTE 10—INCOME TAXES

The provision (benefit) for income taxes associated with continuing operations consisted of the following (in thousands):

 

     2011     2010     2009  

Current:

      

Federal

   $ 3,369      $ 168      $ (2,786

State

     (424     3        14   

Foreign

     1,239        2,489        814   
  

 

 

   

 

 

   

 

 

 
     4,184        2,660        (1,958

Deferred:

      

Federal