Intermec, Inc. 10-K 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission file number 001-13279
(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code:(425) 265-2400
Securities registered pursuant to Section 12(b) of the Act:
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. Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. Yes o No x
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and ”smaller reporting company” in Rule 12b-2 of the Exchange
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of July 1, 2007, which was the last business day of the registrant’s most recent second fiscal quarter, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was approximately $1.5 billion, based on the closing sale price as reported on the New York Stock Exchange.
On February 21, 2008, there were 60,934,808 shares of Common Stock outstanding, exclusive of treasury shares.
Documents Incorporated by Reference
Certain information required to be reported in Part III of this Annual report on Form 10-K is herein incorporated by reference from the registrant’s Definitive Proxy Statement to be filed with the Securities and Exchange Commission with respect to the registrant’s Annual Meeting of Shareholders scheduled to be held on May 23, 2008.
TABLE OF CONTENTS TO ANNUAL REPORT
ON FORM 10-K
Forward-looking statements contained in this filing are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995 (alternatively: Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934) and are dependent upon a variety of important factors that could cause actual results to differ materially from those reflected in such forward-looking statements. These factors include, but are not limited to, our ability to maintain or to improve the revenues and profits of our continuing operations, maintain or reduce expenses, maintain or improve operational efficiency, use our investment in research and development to generate future revenue, maintain or improve year-over-year growth in the revenues and profits of our continuing operations and the other factors described in Part I, “Item 1A, Risk Factors,” and in Part II, “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operation,” of this filing. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances or any other reason after the date of this report on Form 10-K.
Such forward-looking statements involve and are dependent upon certain risks and uncertainties. When used in this document and in documents it refers to, the words “anticipate,” “believe,” “will,” “intend,” “project” and “expect” and similar expressions as they relate to us or our management are intended to identify such forward-looking statements.
Forward-looking statements are not guarantees of future performance. A number of factors can impact our business and determine whether we can or will achieve any forward-looking statement made in this report. Any one of these factors could cause our actual results to differ materially from those discussed in a forward-looking statement. We outline these risk factors in reports that we file with the SEC, in press releases and on our website, www.intermec.com.
Intermec, Inc., formerly UNOVA, Inc. (“Intermec”, “us”, “we”, “our”), became an independent public company when our common stock was distributed to the shareholders of Western Atlas Inc., our former parent company, on October 31, 1997. Intermec is a Delaware corporation and our headquarters are in Everett, Washington. Our major offices and manufacturing facilities are in the states of Washington, Iowa, North Carolina and Ohio and internationally in the United Kingdom, the Netherlands, France, Canada, Mexico, Brazil and Singapore.
Information on our company may be found at the Internet website www.intermec.com. Our annual reports on Form 10-K and certain of our other filings with the Securities and Exchange Commission (“SEC”) are available in PDF format through our Investor Relations website at www.intermec.com/IntermecInc/investorinfo.asp. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are also available on the SEC website at www.sec.gov. The contents of these websites are not incorporated by reference into this report or in any other report or document we file. Our references to the addresses of these websites are intended to be inactive textual references only. Shareholders may request a free copy of the annual reports on Form 10-K and quarterly reports on Form 10-Q from:
Attention: Investor Relations
6001 36th Avenue West
Everett, WA 98203-1264
We design, develop, manufacture, integrate, sell, resell and service wired and wireless automated identification and data collection (“AIDC”) products. These products include radio frequency identification (“RFID”) products, mobile computing products, bar code scanners, wired and wireless bar code printers and label media products. Our products are sold to customers within and outside of the United States in industries that include industrial goods, transportation and logistics, consumer goods and retail and in applications such as warehouse operations, enterprise asset management, in-transit visibility and direct store delivery. Our products are used by customers to improve the productivity, quality and responsiveness of their business operations including supply chain management, enterprise resource planning, asset tracking and field sales and service.
We have the following primary revenue sources:
In 2005, we divested our Industrial Automation Systems ("IAS") businesses, which comprised the Cincinnati Lamb and Landis Grinding Systems divisions. The IAS businesses are classified as discontinued operations for accounting purposes in our consolidated financial statements and related notes. The IAS businesses are producers of manufacturing products and services, including integrated manufacturing systems, machining systems, stand-alone machine tools and precision grinding and abrasives operations primarily serving the global aerospace, automotive, off-road vehicle and diesel engine industries as well as the industrial components, heavy equipment and general job shop markets.
Products and Services
We sell wired and wireless AIDC products, including RFID products, mobile computing products, bar code scanners, wired and wireless barcode printers, label media and related services. These products and services allow customers to identify, track and manage their assets and other resources and improve the efficiency and effectiveness of their business operations.
Mobile Computing Products
Our mobile computing products include handheld and vehicle-mounted mobile computers and accessories and related services that facilitate local-area and wide-area wireless and wired data communications. These products typically contain multiple wireless technologies (such as wide-area GPRS and CDMA, with 802.11 and Bluetooth) that can operate simultaneously in a mobile computer. This allows customers to communicate remotely with their field employees. We also develop and sell handheld computer software tools that can integrate the information into customers’ enterprise management systems.
We have developed a client framework that resides on our products allowing enhanced control by third-party device management software that can interoperate with a customer’s existing system management software. This allows centralized management and control of remote devices such as mobile computers. Our mobile computing portfolio also includes AIDC devices, specialized peripherals and printer products.
To assist our customers with the automation of business processes, we provide professional services such as installation, maintenance, site security and systems integration. Our line of handheld and vehicle-mounted computers use Microsoft Windows®, Windows® CE and Windows Mobile®, and embedded Windows XP operating systems, as well as scanning and Internet Protocol-based data communication capabilities. Our mobile computing product families range from relatively low-cost, handheld batch and wireless data collection devices to higher-cost pen-based computers with wired and wireless network capabilities and flexible vehicle-mount communications.
Our mobile computing products allow a customer’s remote workers to access centralized computer applications and databases, automatically collect data and send and receive data on a real-time basis. We and our partners offer mobile computing application software for workforce automation, customer-level sales ordering, pricing and forecasting, account settlement and other software products that manage workforce automation and order dispatching, “total field asset” visibility, real-time proof of delivery, and other customer information.
Bar Code Scanners
Our bar code scanning products include fixed, mobile and vehicle-mounted laser scanners and linear and area imagers. These products are able to collect and decode bar codes and to transmit the resulting data to standard enterprise resource planning ("ERP") systems, warehouse management systems ("WMS"), order fulfillment, transportation, logistics systems and other business intelligence applications.
Printer and Label Media Products
We sell wired and wireless barcode and RFID printers ranging from relatively low-cost, light-duty models to higher-cost, heavy-duty, industrial models. Our specialty printers provide custom capabilities, including color printing, a global language enabler and high resolution (400 DPI) printing that ensures sharp fonts and precise graphics even on small labels such as those used by the electronics industry. Our media products include pressure-sensitive bar code labels and thermal transfer ribbons, which are sold to customers worldwide. We also design and manufacture specialized labels to meet customer requirements for extreme environments such as clean rooms, chemical baths and high humidity.
Radio Frequency Identification (RFID) Products
RFID facilitates wireless communication of product information that exceeds the information available from a barcode. This communication occurs between a RFID reader and RFID tags comprising a computer chip and antenna encased in a protective covering. RFID tags are programmed by users to contain identification, serial numbers, history and other product data. Certain RFID tags contain read/write memory to allow updates and tag reuse. Unlike laser-scanned bar codes, RFID tags do not require “line of sight” to be read. Customers are increasingly using RFID technology to track pallets, cartons, containers and individual items through their supply chains and for enterprise asset management.
Our RFID product line is focused on passive UHF technology and consists of RFID tags, readers, software and related equipment sold under the Intermec trade name. Our RFID products comply with the EPCglobal Generation 2 UHF standard (the “Gen 2 Standard”) and with other EPCglobal and International Standards Organization (“ISO”) standards being adopted by customers worldwide.
We have approximately 149 RFID patents and more than 20 companies have taken royalty-bearing licenses under those patents, including but not limited to Cisco, Motorola, Inc., Texas Instruments, Avery Dennison, Honeywell Corporation and Zebra Technologies, Inc.
With our large variety of customer support services, professional services and installation services, we help customers design, implement and deploy AIDC systems in their businesses. Our project management teams create strategic plans that identify the customer’s operational goals and AIDC solutions that will accomplish our customers’ business objectives. Our project management teams further define the functional requirements for implementing AIDC products and systems in the customer’s business environment.
Our project management teams prepare an implementation plan, evaluate ADIC products and integrate new AIDC products into the customer’s existing system. Because we have relationships with many vendors that provide complementary AIDC products, systems and services, we offer customers a “one-stop shopping” service experience and comprehensive AIDC solutions.
We provide technical support and repair services through a global network of service and technical support. Through our global education services unit, we also provide AIDC training services, including the design and delivery of training programs for our customers’ employees.
The key elements of our strategy are to target high growth opportunities in selected industry and application markets; focus on developing and selling differentiated new products; emphasize channel fulfillment; concentrate on global market expansion opportunities; and, continue our supply chain transformation.
We are focused on private and public sector customers in the following vertical markets:
We are focused on the following applications:
Markets and Customers
Because AIDC solutions can be used by a company of any size, the AIDC market is large. Market growth is driven by the need for technologies and solutions that improve quality, productivity and cost. We cover the market through a combination of a globally coordinated dedicated sales and service organization, two-tier distributors, resellers and independent hardware, software and service vendors.
Our direct sales organization serves customers from offices throughout the Americas, Europe, the Middle East and Africa and in selected Asia Pacific countries, including China and Australia. Our indirect sales channel is also global and includes preferred and non-exclusive relationships with value-added distributors and resellers. We have a field-based business development function, which identifies new market opportunities and supports the sales effort in those new areas.
International sales opportunities exist in countries where communications infrastructure, mobile computing practices and other systems and applications are similar to those in the U.S or that are in the process of creating such infrastructure. The extent of wireless systems opportunities in any particular country is based on the level of industrialization, the condition of communication infrastructure, the level of computerization, the status of bar code implementation, and the regulatory environment for wireless communication technologies.
Our customer base consists of private and public entities of many sizes. In 2007 and 2006, one customer accounted for more than 10% of our revenues. Total sales to this customer were $108.7 million and $99.8 million for the years ended December 31, 2007 and 2006, respectively. No single customer accounted for more than 10% of our revenues in 2005.
The market for AIDC products is fragmented, highly competitive and rapidly changing. Independent market surveys suggest that we are one of the larger participants measured by revenues. Motorola, Inc. and its wholly-owned subsidiary, Symbol Technologies, Inc., are major competitors, supplying a range of barcode, RFID and mobile computing products and services. We also face strong competition in individual AIDC product lines from suppliers such as Zebra Technologies Corporation, which supplies barcode and RFID printers, and Hand Held Products, recently acquired by Honeywell Corporation, which supplies barcode imagers. In the label media area, we face competition from a large number of large and small media producers, including, among many others, Avery Denison and Brady.
We compete primarily on the basis of our technology and expertise in our target vertical markets, but our support services, product functionality, performance, ruggedness and overall product quality, are also important elements of our competitive offerings.
Research and Development
Research and development expenditures related to our continuing operations amounted to $65.6 million, $72.4 million and $66.5 million, all of which we sponsored in the years ended December 31, 2007, 2006 and 2005, respectively.
We strive to protect our investment in technology and to secure competitive advantage by obtaining IP protection within and outside of the United States. We have obtained approximately 595 patents and a number of trademarks, copyrights and trade secrets. When appropriate, we have obtained licenses to use IP controlled by other organizations. The combination of our IP and our licenses to use third-party IP has been of value in the growth of our business and is expected to be of value in the future. However, we do not believe that our business depends on any single patent, trademark, copyright, trade secret or on any single IP license agreement. We do not believe that our business would be materially affected by the expiration or termination of any particular intellectual property rights.
We believe that the duration of our patents is adequate relative to the expected lives of our products. Because of the fast pace of innovation and product development in the AIDC industry, our products may become obsolete before the patents related to them expire, and sometimes become obsolete before the patents related to them are even granted. As we expand our product offerings, we try to obtain patents related to such offerings and, when appropriate, seek licenses to use inventions patented by third parties.
To distinguish our products and services from those of our competitors, we have obtained certain trademarks and trade names, and as we expand our product and service offerings, we try to obtain trademarks and trade names to cover those new offerings. We protect certain details of our processes, products and strategies as trade secrets by restricting access to that information. We have ongoing programs designed to maintain the confidentiality of such information.
From time to time, we license our IP to generate revenue or to facilitate our effort to market and sell our products and services. While such licenses have been of value in the growth of our business in the past and are expected to be of value in the future, we do not believe that our business is dependent upon any single IP license and would not be materially affected by the expiration or termination thereof.
We try to protect our investment in technology, generate revenue and secure competitive advantage by enforcing our IP rights. The nature, timing and geographic location of these efforts depends, in part, on the types of legal protection given to different types of IP rights in various countries.
Seasonality and Backlog
Our quarterly results reflect seasonality in the sale of our products and services, since our revenues are typically highest in the fourth fiscal quarter and the lowest in the first fiscal quarter. See “Quarterly Financial Information” on page 88 of this Form 10-K for quarterly revenues and expenses.
Sales backlog from our continuing operations was $71.1 million, $42.9 million and $64.3 million at December 31, 2007, 2006 and 2005, respectively. Our business typically operates without a significant backlog of firm orders, and we do not consider backlog to be a significant measure for indicating future sales.
At December 31, 2007, we had 2,308 full-time employees, of which 2,299 were engaged in our wholly-owned subsidiary, Intermec Technologies Corporation, and 9 were engaged in our holding company, Intermec, Inc. Approximately 70% of our full-time employees are in the United States, approximately 18% are in Europe, the Middle East and Africa (“EMEA”), and the remaining are employed throughout the rest of the world, including the Asia Pacific region, South America, Canada and Mexico.
EXECUTIVE OFFICERS OF THE REGISTRANT.
Our executive officers are elected each year by the Board of Directors at its first meeting following the Annual Meeting of Stockholders to serve during the ensuing year and until their respective successors are elected and qualified or until their earlier resignation or removal. Newly-hired executive officers are elected at the time of their employment to serve until the next Board of Directors meeting first following an Annual Meeting of Stockholders and until their successors are elected and qualified or until their earlier resignation or removal. There are no family relationships between any of our executive officers and any director or other executive officer. The following information indicates the positions and ages of our executive officers on February 22, 2008, and their business experience during the prior five years.
Environmental and Regulatory Matters
In January 2003, the European Parliament and Council adopted Directive 2002/95/EC on the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (the “RoHS Directive”). The RoHS Directive went into effect on July 1, 2006, and prohibits firms from putting on the European Union ("EU") market new electrical and electronic equipment that contains more than permitted levels of lead, cadmium, hexavalent chromium, polybrominated biphenyl ("PBB") and polybrominated diphenyl ether ("PBDE"). The RoHS Directive does not apply to units of equipment already placed on the EU market prior to July 1, 2006. In addition, the RoHS Directive contains exemptions for (a) certain types of equipment; (b) reuse of equipment placed on the EU market prior to July 1, 2006; and (c) spare parts for the repair of equipment placed on the EU market prior to July 1, 2006.
The State of California also has adopted restrictions on the use of certain materials in electronic products that are intended to harmonize with the RoHS Directive. Those restrictions went into effect in 2007. Other U.S. states are considering similar legislation or in the process of implementing enacted legislation. Similarly, China has promulgated environmental regulations covering the same substances as the RoHS Directive. China’s regulations became effective on March 1, 2007 and imposed various marking and substance content disclosures (above defined thresholds) of electronic products imported into China. We have implemented a program to comply with these requirements. China has not yet defined the list of specific products for which the substance content will be restricted or the effective date of any imposed restrictions. It is unclear whether China’s use restrictions will be consistent with the use restrictions set forth in the RoHS Directive. Other countries outside of the EU and China are in various stages of establishing RoHS requirements and may adopt RoHS-type regulations in the future.
In addition, the State of California adopted restrictions on the energy efficiency of external alternating current power supplies used with many of the products we manufacture and sell. In 2007, we spent $0.2 million for our product and system re-certification to US requirements due to migration to newer, more efficient power supplies. Additional certification costs may be incurred in 2008 and beyond as similar requirements are adopted in other countries in which we sell or intend to sell.
We have redesigned some of our current products to bring them into compliance with the RoHS Directive and similar regulations in other jurisdictions. In other cases, we are replacing non-compliant products with new products that comply with these regulations. During 2007, we spent $1.2 million, primarily related to redesigning products, to comply with these regulations. We expect to incur additional costs in the future for compliance with the RoHS Directive and similar regulations in other jurisdictions. The amount and timing of such expenditures are uncertain due to uncertainties about the effective date and final content of RoHS-type regulations in various jurisdictions and the possibility that RoHS-type regulations in one jurisdiction will not be consistent with RoHS-type regulations in other jurisdictions.
Radio emissions are the subject of governmental regulation in all countries in which we currently conduct or expect to conduct business. In North America, both the Canadian and U.S. governments publish radio emission regulations and changes thereto after public hearings. In other countries, regulatory changes can be introduced with little or no grace period for implementation. Furthermore, there is little consistency among the regulations of various countries. Future regulatory changes in North America, China and other jurisdictions are possible. These conditions introduce uncertainty into our product-planning process and could have an adverse effect on our ability to sell our wireless products in a given country or adversely affect our cost of supplying wireless products in a given country.
We use a variety of raw materials in the manufacture of our products and we obtain such raw materials from a variety of suppliers. In general, the raw materials we use are available from numerous alternative sources. As is customary for our industry, we at various times enter into certain single-source component part supply agreements. We believe these agreements will be renewed in the ordinary course of business.
You are encouraged to review the discussion of Forward Looking Statements and Risk Factors appearing in this report at Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation.”
In addition to the other information set forth in this report, you should carefully consider the following factors, which could materially affect our business, financial condition or operating results. The risks described in this report are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or operating results.
A deterioration of political or economic conditions in a given country or region could affect potential customers in a way that reduces demand for our products and disrupts our manufacturing and sales plans. In addition, our sales are typically made on unsecured credit terms that are generally consistent with the prevailing business practices in the country in which the customer is located. A deterioration of political or economic conditions in a given country or region could reduce or eliminate our ability to collect on accounts receivable in that country or region. In any of these events, our results of operations could be materially and adversely affected.
A significant percentage of our products and components for those products are designed, manufactured, produced, delivered, serviced or supported in countries outside of the U.S. From time to time, we contract with companies outside of the U.S. to perform one or more of these activities, or portions of these activities. For operational, legal or other reasons, we may have to change the mix of domestic and international operations or move outsourced activities from one overseas vendor to another. In addition, U.S. or foreign government actions or economic or political instability and potentially weaker foreign intellectual property protections may disrupt or require changes in our international operations or international outsourcing arrangements. The process of implementing such changes and dealing with such disruptions is complex and can be expensive. There is no assurance that we will be able to accomplish these tasks in an efficient or cost-effective manner, if at all. If we encounter difficulties in making such transitions, our revenues, gross profit margins and results of operations could be materially and adversely affected.
Rapid technological change, whether through our or our competitors’ introduction of new products or technologies, could also render our products obsolete and result in substantial excess inventories. In such event, we might have to sell all or a portion of the excess or obsolete inventory at a substantial discount to the planned resale price or the cost of making or acquiring that inventory and write off the difference. If our response to technological changes and our ability to introduce new products and product enhancements is not effective, and we do not mitigate the risk of product obsolescence, our financial results could be materially and adversely affected.
To protect our patent portfolio, we may be required to initiate patent infringement lawsuits. Patent lawsuits are complex proceedings and the results are very difficult to predict. There is no assurance that we will prevail in all or any of these cases. Adverse results in such patent lawsuits could give competitors the legal right to compete with us and with our licensees using technology that is similar to or the same as ours. Adverse outcomes in patent lawsuits could also reduce our royalty revenues. In some periods, patent litigation recoveries and expenses could result in large fluctuations from prior periods, increasing the volatility of our financial results and possibly impacting our earnings per share.
Since our business strategy includes global expansion, we are operating in developing countries (e.g., China) where the institutional structures for creating and enforcing intellectual property rights are very new and where government agencies, courts and market participants have little experience with intellectual property rights. There is no assurance that we will be able to protect our technology in such countries because we may not be able to obtain or enforce patents or other intellectual property rights in those jurisdictions and alternative methods of protecting our technology may not be effective. Our inability to prevent competitors in these developing markets from misappropriating our technology could materially and adversely affect our sales, revenues and results of operations.
Our competitors, potential competitors and companies that purchase and enforce patents may have patents covering AIDC products and services similar to those we market and sell. These firms may try to use their patents to prevent us from selling some of our AIDC products, to collect royalties from us with respect to sales of products they claim are covered by their patents, or to deter us from enforcing our patents against them. As part of this effort, the patent-holders may initiate patent infringement lawsuits against us or our customers. These lawsuits are complex proceedings with uncertain outcomes. There is no assurance that we or our customers will prevail in any patent lawsuits initiated by third party patent-holders. If the results of such litigation are adverse to us or our customers, we could be enjoined from practicing an invention covered by the patent in question. We could also be required to pay damages for past infringement, which might have a material adverse effect on our results of operations. If an injunction is issued, we may not be able to sell a particular product or product line, which could materially and adversely impact our sales, revenues and results of operations. If third party patent-holders are willing to license or sell their patents to us, or if we must redesign the affected products, the associated costs could have a material and adverse effect on our sales, revenues or results of operations.
Our currency exchange gains or losses (net of hedges) may materially and adversely impact our cash flows and earnings. Additionally, adverse movements in currency exchange rates could result in increases in our cost of goods sold or reduction in growth in international orders, materially impacting our cash flows and earnings.
In these cases, we may experience unexpected disruptions in our ability to supply customers with our products or may have to incur unexpected costs to bring our products into compliance. Due to these uncertainties and compliance burdens, our customers may postpone or cancel purchases of our products. As a result, global regulation and compliance could have an adverse effect on our revenues, gross profit margins and results of operations and increase the volatility of our financial results.
Our executive offices are located at 6001 36th Avenue West, Everett, Washington. Our continuing operations have an aggregate floor area of approximately 762,724 square feet, of which 578,410 square feet, or 76%, are located in the United States, and 184,314 square feet, or 24%, are located outside the United States, primarily in the Netherlands, France, Spain, Germany and Canada.
Approximately 43,260 square feet, or 6%, of our principal plant, office and commercial floor area, is owned by us, and the balance is held under lease.
The U.S. plants and offices associated with our continuing operations are located in the following states (in square feet):
The above-mentioned facilities are in satisfactory condition and suitable for the particular purposes for which they were acquired, constructed or leased and are adequate for present operations.
The foregoing information excludes the following properties:
We currently, and from time to time, are involved in claims, lawsuits and other proceedings, including, but not limited to, intellectual property, commercial, and employment matters, which arise in the ordinary course of business. We do not expect the ultimate resolution of currently pending matters to be material in relation to our business, financial condition, results of operations or liquidity.
No matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended December 31, 2007.
The high and low sales prices of our common stock, by quarter, in the years ended December 31, 2007 and 2006, are as follows:
Our common stock is traded on the New York Stock Exchange under the symbol IN. As of February 21, 2008, there were approximately 11,400 holders of record and 28,300 beneficial owners of our common stock. No cash dividends were paid during 2007 or 2006.
Common stock repurchases in the fourth quarter of 2007 were as follows:
The purchased shares indicated in the above table were surrendered to us to satisfy tax withholding obligations in connection with the vesting of restricted stock by employees in our foreign operations.
STOCK PERFORMANCE GRAPH
Set forth below is a line graph comparing the percentage change in the cumulative total shareholder return on our common stock for the five-year period ended December 31, 2007, with the cumulative total return for the same period of the Standard & Poor’s Midcap 400 Index and the Standard & Poor’s 1500 Electronic Equipment and Instruments index. The graph assumes an investment of $100 at the beginning of the period in our common stock, in the S&P Midcap 400 Index and in the companies included in the Standard & Poor’s 1500 Electronic Equipment and Instruments index. Total shareholder return was calculated on the basis that in each case all dividends were reinvested. The stock price performance shown in the graph is not necessarily indicative of future price performance.
(Millions of dollars, except per share data)
The following discussion should be read in conjunction with the Consolidated Financial Statements and the notes thereto that appear in Item 8 of this annual report on Form 10-K.
Intermec, Inc. (“Intermec”, “us”, “we”, “our”), formerly UNOVA, Inc., designs, develops, manufactures, integrates, sells, resells and services wired and wireless automated identification and data collection (“AIDC”) products and systems including radio frequency identification (“RFID”) products and systems, mobile computing products and systems, wired and wireless bar code printers and label media. Our products and services are used by customers within and outside of the United States to improve the productivity, quality and responsiveness of their business operations, including supply chain management, enterprise resource planning and field sales and service. Customers for our products and services operate in market segments that include manufacturing, warehousing, direct store delivery, retail, consumer packaged goods, field service, government, and transportation and logistics.
Our strategy consists of: market focus, differentiated new products, channel fulfillment, global expansion and supply chain transformation.
Our strategy is focused on customers in certain vertical markets, including: industrial goods, transportation and logistics, consumer goods and retail.
Our strategy is also focused on certain application markets, including: warehouse operations, enterprise asset management, in-transit visibility and direct store delivery.
Results of Operations
The following discussion compares our historical results of operations for the years ended December 31, 2007, 2006 and 2005. The results of operations and percentage of revenues were as follows (millions of dollars):
Revenues by category and as a percentage of total revenues from continuing operations for the years ended December 31, 2007, 2006 and 2005, as well as the year-over-year product and service revenue growth were as follows (millions of dollars):
Revenues by geographic region and as a percentage of related revenues from continuing operations for the years ended December 31, 2007, 2006 and 2005, as well as the year-over-year geographic region revenue growth were as follows (millions of dollars):
Product revenues in 2007 were flat compared to 2006. The growth in our system and solutions revenues of $8.4 million, or 1.8%, compared to 2006, was offset by an $8.8 million, or 4.1%, decline in our printer and media revenue for the comparable periods. The growth in systems and solutions resulted from 2007 growth rates of 31.2% and 14.7% in Europe, the Middle East and Africa (EMEA) and the Rest of the World (“ROW”), respectively, partially offset by a 16.2% decrease in North America. The higher systems and solutions revenue in EMEA during 2007 was primarily attributable to strong market acceptance of new product introductions and a refreshed product line to be in compliance with the European Union’s Reduction of Hazardous Substances (“RoHS”) directive. The growth in EMEA revenue also includes approximately $12.0 million, or 9.0%, from favorable changes in currency exchange rates in 2007 compared to 2006. The lower systems and solutions revenue in North America during 2007 compared to 2006 reflects declining revenues in the first half of 2007, as a result of lower enterprise sales and delays in customer purchases during our transition to newly introduced products, partially offset by 20% growth in the fourth quarter of 2007 compared to the corresponding 2006 period.
Product revenues in 2006 decreased $28.6 million, or 4.0%, compared to 2005. The decline in product revenue was primarily attributable to a 5.4% decrease in systems and solutions products. Our analysis of the causal factors for the decline in product revenue suggests that the most significant factor was the announcement and availability of several new products in the third quarter of 2006. In the second half of the year, we introduced three new major products. In light of this announcement, it is our belief that certain customers delayed orders awaiting the availability of the new products. The second factor negatively impacting product revenue was the RoHS ("Restriction of Hazardous Substances") Directive, which became effective July 1, 2006, within the European Union (“EU”). The third factor that contributed to the product revenue decline is the increase in competitive programs and pricing.
Service revenues of $157.2 million for 2007 are essentially flat with 2006. We experienced higher service revenue in EMEA and Latin America during 2007, primarily from the regional growth in product revenues, which was offset by a decrease in US Government professional services and declines in time-and-material repairs.
Service revenues in 2006 increased $3.1 million, or 2%, compared to 2005. The increase in service revenue was primarily due to an increase in revenue from the U.S. government contracts of $1.0 million. Also, service revenues in Canada and Mexico increased approximately $1.0 million and $0.5 million, respectively.
Geographically, for the year ended December 31, 2007, product and service revenue decreased in North America by 14.4%, while EMEA and ROW increased 20.4 % and 18.5%, respectively. The growth in EMEA revenue is primarily attributable to strong market acceptance of new products and $21.5 million, or 9.0%, from favorable changes in currency exchange rates in 2007 compared to 2006. The revenue growth in ROW is primarily attributable to several large enterprise sales in Latin American and approximately $3.6 million, or 3.1%, due to favorable changes in currency exchange rates.
Geographically, for the year ended December 31, 2006, product and service revenue decreased in North America by 3.7% and in EMEA by 7.4%, offset partially by a 12.8% increase in the ROW. The decrease in EMEA revenues compared to 2005 is primarily attributable to the RoHS Directive.
Gross profit and gross margin by revenue category for the years ended December 31, 2007, 2006 and 2005, were as follows (millions of dollars):
Total gross profit for the year ended December 31, 2007, decreased $5.1 million, or 1.6%, compared to the prior year. Product gross profit decreased by $2.8 million in 2007 compared to 2006, as a result of the 30 basis point reduction in related gross margin. Service gross profit decreased by $2.3 million, or 3.3%, in 2007 compared to 2006 due to the 140 basis point reduction in gross margin. The decrease in gross margin percentage is due to the regional mix change, as lower service revenues in North America were offset by increases in lower margin service revenues in Latin America.
Total gross profit for the year ended December 31, 2006, decreased $30.9 million, or 8.5%, compared to the prior year end. Product gross profit decreased by $37.6 million, or 12.5%, in 2006 compared to 2005, due primarily to the 2.3% decrease in gross margin percentage. The decrease in gross margins is primarily due to lower average selling prices, with lower absorption on lower volumes.
The increase in service gross margin percentage for 2006 of 3.5% compared to 2005 is primarily due to lower operating expenses and improved margins in Latin America due to a higher mix of professional service sales.
Research and Development Expense (In millions)
Research and development expense decreased $6.8 million in 2007 compared to 2006. The decrease primarily reflects the elimination of $7.7 million of incremental expense incurred during 2006 to redesign our current products and bring them into compliance with the European Parliament and Council Directive 2002/95/EC on the Restrictions of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (the “RoHS Directive”).
Research and development expense increased $5.9 million in 2006 compared to 2005, primarily as a result of the $7.7 million of expense related to the RoHS Directive.
Selling, General and Administrative Expense (In millions)
The decrease in SG&A of $4.1 million in 2007 compared to 2006 primarily reflects a $4.5 million reduction in our US pension and post-retirement expense as a result of the changes to our US plans in 2006.
The decrease in SG&A of $9.9 million in 2006 compared to 2005 primarily reflects the decrease in legal expense of $7.2 million and a $2.1 million curtailment gain from the changes to our US pension and post-retirement plans.
Gains on Intellectual Property Settlements
In March 2006, we settled an intellectual property (“IP”) lawsuit relating to our battery power-management patents. IP settlements relating to the battery power-management patents have been reached to date with companies that, in the aggregate, represent over ninety percent of U.S. laptop sales. We are involved in various other patent infringement lawsuits that may result in future revenue or gains and operating profit. Management cannot predict the outcome, timing or amount of future settlements or judgments in IP lawsuits. There were no IP settlements for the years ended December 31, 2007 or 2005. Net pretax gains from IP settlements included in operating profits were $16.5 million in 2006.
In March 2006, we announced our plan to close our design centers in Goteborg and Lund, Sweden. The activities previously assigned to the design centers in Sweden have been reassigned to other parts of our business or moved to third-party vendors to improve efficiencies and benefit from reduced costs. In addition to the anticipated cost savings, this realignment of resources is expected to increase new product development capacity. This restructuring, which was substantially completed by the end of 2006, resulted in charges for severance of $3.1 million for the elimination of 65 positions in Sweden. The restructuring costs also included facility closure costs of $1.3 million, and other related costs of $0.3 million.
On November 15, 2006, we committed to a business restructuring plan intended to reduce costs, streamline operations and improve productivity. The restructuring included headcount reductions and consolidation of certain facilities on a regional and/or global basis. The restructuring was substantially completed by the end of 2006. During the fourth quarter of 2006, we recorded charges for severance of $6.8 million for the termination of 205 employees and $0.1 of other exit costs in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” As of December 31, 2006, 86 employees had been terminated and $1.6 million in severance costs had been paid. The total restructuring costs of $8.0 million include employee termination expense of $7.3 million, facility closure costs of $0.6 million and other exit costs of $0.1 million.
Interest, Net (In millions)
Net interest income for the year ended December 31, 2007, was $1.8 million, compared to net interest income of $6.5 million in the prior year. The decrease in net interest income reflects decreased interest rates and average invested cash in 2007 when compared to 2006.
Net interest income for the year ended December 31, 2006, was $6.5 million, compared to net interest expense of $4.0 million in the prior year. The improvement in net interest income reflects the reduction in outstanding debt balance, as well as higher investment returns. During 2005, we retired bonds totaling $108.5 million.
Provision for Income Taxes (In millions)
The provision for income taxes for the year ended December 31, 2007, reflects an effective tax rate for continuing operations of 37.9%, compared to a U.S. statutory provision rate of 35.0%. The effective tax rate exceeded the statutory tax rate primarily due to state taxes and non deductible incentive stock based compensation, which was partially offset by research tax credit benefits.
The provision for income taxes for the year ended December 31, 2006, reflects an effective tax rate for continuing operations of 23.2%, compared to a U.S. statutory provision rate of 35.0%. The reduction in the effective tax rate is primarily due to settlement of foreign tax audits.
The provision for income taxes for the year ended December 31, 2005, reflects an effective tax rate for continuing operations of 25.5%, compared to a U.S. statutory provision rate of 35.0%. The reduction in the effective tax rate is primarily due to reductions in U.S. and foreign tax contingency accruals. The reduction in the U.S. tax contingency accrual relates to Credit for Increasing Research Activities, resulting from the resolution of a U.S. tax audit of a former parent for the same issue. The reduction from the resolution of foreign tax contingency accrual relates to the favorable resolution of a German tax audit.
Gain (Loss) from Discontinued Operations
During 2005, we divested of our IAS businesses, comprised of Cincinnati Lamb and Landis Grinding Systems. The following table sets forth the components of earnings (loss) from discontinued operations, net of tax, for the years ended December 31, 2007, 2006 and 2005 (thousands of dollars):
We are subject to the effects of currency fluctuations due to the global nature of our operations. Currency exposures are hedged as part of our global risk management program, which is designed to minimize short-term exposure to currency fluctuations. Movements in exchange rates, net of hedging activities, resulted in net currency transaction gains (losses) of $(1.5) million, $(1.3) million, $0.7 million for the years ended December 31, 2007, 2006 and 2005, respectively.
For fiscal year 2007, our continuing operations derived approximately 51.6% of revenues from non-U.S. customers. At December 31, 2007, long-lived assets attributable to countries outside of the U.S. comprised 15.9% of total long-lived assets. The largest components of these assets are attributable to European nations, primarily the Netherlands and the United Kingdom.
Liquidity and Capital Resources
At December 31, 2007, cash, cash equivalents and short-term investments totaled $265.5 million, an increase of $81.0 million compared to the December 31, 2006 balance of $184.5 million. Due to the nature of these instruments, we consider it reasonable to expect that their fair market values will not be significantly impacted by a change in interest rates, and that they can be liquidated for cash upon demand.
In 2007, cash provided by operating activities of continuing operations was primarily due to customer receipts of $864.5 million, which was offset by payments to vendors and employees of $804.1 million. In 2006, cash provided by operating activities of continuing operations was primarily due to net earnings from continuing operations of $35.0 million and a $28.3 million decrease in accounts receivable, offset partially by an increase in inventory of $35.5 million. Included in earnings from continuing operations is $16.5 million of net proceeds before tax from an IP settlement. In 2005, cash provided by operating activities of continuing operations of $62.4 million was primarily due to operating profit of $40.6 million and cash proceeds recorded as deferred revenue from our 2005 Rapid Start intellectual licensing program of approximately $21.4 million.
In 2007, investing activities of continuing operations used $17.4 million of cash primarily due to capital expenditures of $15.8 million. In 2006, investing activities of continuing operations primarily included capital expenditures of $22.4 million and net investment purchases of $26.6 million, reflecting a net use of $49.0 million in cash. Investing activities of continuing operations in 2005 provided $51.6 million of net cash primarily due to the release of $50.0 million of unrestricted cash and $11.0 million in proceeds from the sale of property, plant and equipment, which was principally offset by capital expenditures of $10.1 million.
Capital expenditures were $15.8 million, $22.4 million and $10.1 million for 2007, 2006 and 2005, respectively. Proceeds from sales of property, plant and equipment were $0.7 million and $11.0 million in 2007 and 2005, respectively. There were no proceeds from sales of property, plant and equipment for 2006.
Financing activities of continuing operations in 2007 provided $12.8 million primarily due to $8.4 million in proceeds from stock option exercises and $2.1 million in excess tax benefits from stock based payment arrangements. Financing activities of continuing operations in 2006, included $100.0 million of common stock repurchased, offset by $8.1 million in proceeds from stock option exercises and $4.7 million in excess tax benefits from stock based payment arrangements, with a net use of $84.4 million in cash. Financing activities of continuing operations in 2005 included $18.0 million in proceeds from stock option exercises and the repayment of long-term debt of $108.5 million, reflecting a net use of $88.3 million in cash.
Net cash used by operating activities of discontinued operations was $52.6 million in 2005. The net cash used by operating activities in 2005 was primarily due to a $13.5 million settlement of a lawsuit, a contribution of $11.1 million made to our non-U.S. pension plan covering retirees of the divested IAS businesses, as well as an increase in net working assets prior to the divestures.
Net cash provided by investing activities of discontinued operations was $20.2 million in 2007, related primarily to note receivable maturities.Net cash provided by investing activities of discontinued operations was $5.7 million in 2006, related primarily to cash received as part of the sale of the IAS businesses. Net cash provided by investing activities of discontinued operations of $70.4 million in 2005 was due primarily to sale of the IAS businesses.
On September 27, 2007 we closed on a new unsecured Revolving Credit Facility (the “Revolving Facility”) with a maximum amount available under the Revolving Facility of $50.0 million. Net of outstanding letters of credit and limitations on availability, we had borrowing capacity at December 31, 2007, of $47.6 million under the Revolving Facility. We made no borrowings under the Revolving Facility as of December 31, 2007. As of December 31, 2007, we were in compliance with the financial covenants of the Revolving Facility. The Revolving Facility matures in October 2012.
The key terms of the Revolving Facility are as follows:
We also have maintained a secured Credit Agreement (the “Secured Revolving Facility”), dated as of September 30, 2004. We terminated the Secured Revolving Facility on September 27, 2007 in connection with entering into the Revolving Facility. The Secured Revolving Facility was scheduled to expire on September 30, 2007. We have no material continuing obligations under the terminated Secured Revolving Facility, and we incurred no material early termination fees in connection with the termination. We believe that the termination of the Secured Revolving Facility will not have any adverse effect on our financial condition or liquidity.
We also have maintained a secured long-term revolving facility and related overdraft facility (collectively, the “UK Facility”). In accordance with its terms, the UK Facility terminated on February 9, 2006, and we did not extend the term of the facility. We believe that the termination of the UK Facility will not have any adverse effect on our financial condition or liquidity.
In March 1998, we sold $200.0 million principal amount of senior unsecured debt in an underwritten offering. The debt comprised $100.0 million of 6.875% seven-year notes and $100.0 million of 7.00% ten-year notes. On March 15, 2005, we retired the $100.0 million of seven-year notes. Interest payments on the ten-year notes are due semi-annually in March and September. Including underwriting fees, discounts and other issuance costs, the effective interest rates on the ten-year notes is 7.175%. The ten-year notes mature in March 2008.
We believe that cash, cash equivalents and short-term investments, combined with projected cash flow from operations, will provide adequate funding to meet our expected working capital, capital expenditure and restructuring cost requirements for the for the foreseeable future, in addition to working capital, capital expenditure and debt repayment obligations. Projected cash flows from operations are largely based on our revenue estimates, cost estimates, and the related timing of cash receipts and cash disbursements. If actual performance differs from estimated performance, cash flow from operations could be positively or negatively impacted. Additional sources of liquidity include our Revolving Facility.
The following table summarizes our significant contractual commitments for continuing operations as of December 31, 2007 (millions of dollars). The table does not include amounts recorded on our consolidated balance sheet as current liabilities. Operating leases are discussed in the indicated Note to our consolidated financial statements.
Purchase orders or contracts for the purchase of raw materials and other goods and services are not included in the table above. We are not able to determine the aggregate amount of such purchase orders that represent contractual obligations, as purchase orders may represent authorizations to purchase rather than binding agreements. For the purposes of this table, contractual obligations for the purchase of goods or services are defined as agreements that are enforceable and legally binding on us and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Our purchase orders are based on current manufacturing needs and are fulfilled by vendors within short time horizons.
Our liability for unrecognized tax benefits of $20.0 million at December 31, 2007 has been omitted from the table above, because we cannot determine with certainty when this liability will be settled.
Expected future benefit payments by our pension and other postretirement benefit plans are $8.6 million in 2008, $19.4 million for 2009 and 2010 combined, $22.6 million for 2011 and 2012 combined, and $71.9 million for the subsequent five-year period 2013 through 2017.
Off-Balance Sheet Arrangements
At December 31, 2007, we had aggregate off-balance-sheet letter-of-credit reimbursement agreements totaling $3.9 million, compared to $7.4 million at December 31, 2006. We do not believe that these letter-of-credit reimbursement agreements have a material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
In our opinion, inflation has not been a significant factor in the markets in which we operate in 2007, 2006 or 2005 and has not had a significant impact upon the results of our operations during these fiscal years.
Critical Accounting Policies and Estimates
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”). The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses. Actual amounts could differ from those estimates under different assumptions or conditions. Significant estimates and assumptions were used to determine the provisions for uncollectible accounts receivable, excess and obsolete inventory, tax valuation allowances, uncertain tax positions, recoverability of other intangible assets, warranty costs, pension and post retirement obligations, fair value of pension assets, and stock-based compensation. Despite these inherent limitations, we believe that Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) and our financial statements and related footnotes provide a meaningful and fair perspective.
A summary of our significant accounting policies is included in Note A to the consolidated financial statements. We believe that the application of these policies on a consistent basis enables us to provide the users of the financial statements with useful and reliable information about our operating results and financial position. We believe that the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition. Revenues are generally recognized when products are shipped or services are rendered, the title and risk of loss has passed to the customer, the sales price is fixed or determinable and collectibility is reasonably assured. Royalty revenue is recorded when the revenue is earned, the amount due is fixed or determinable and collectibility is reasonably assured. Service and maintenance revenue is recognized as services are rendered, generally over the contract term, and collectibility is reasonably assured. When a sale involves multiple elements, such as sales of products that include services, the entire revenue from the arrangement is allocated to each respective element based on its relative fair value and is recognized when the revenue recognition criteria for each element are met. Fair value for each element is established based on the sales price charged when the same element is sold separately. We reduce revenue for estimated customer returns, price protection, rebates and other offerings that occur under sales programs established by us directly or with our distributors and resellers. We accrue the estimated cost of post-sale obligations, including basic product warranties, based on historical experience at the time we recognize revenue.
We typically do not sell our software products without the related hardware. Our typical products require no significant production, modification or customization of the software or hardware after they are shipped. For software sales, and hardware sales where the software is more than incidental, revenue is recognized upon shipment, delivery, installation or customer acceptance of the product, as defined in the customer contract.
Under our Rapid Start RFID intellectual property (“RFID IP”) licensing program, we license rights to use portions of our IP portfolio, including certain patents essential to and/or useful in the manufacture and sale of certain RFID products and systems. As a result of our RFID IP licensing program, which ended on August 31, 2005, we have expanded our revenue recognition policy to include the license fees from this program. Licensees participating in the Rapid Start program typically paid a nonrefundable up-front fee and agreed to pay ongoing royalties based on their sales of products incorporating or using our licensed RFID IP. Under the terms of such Rapid Start RFID license agreements, the licensees receive the right to certain future divisions, continuations and continuations-in-part of the licensed RFID patents. Non-refundable up-front fees and license transfer fees related to our Rapid Start RFID IP licensing program are recorded as deferred revenue and recognized over five years, representing the estimated future period we expect to receive patents on certain divisions, continuations and/or continuations-in-part for the licensed RFID patents and our estimate of the average technology lifecycle for the AIDC industry. We earn royalties on licensed RFID products sold by our licensees at the time that the licensees’ sales occur. Our licensees report and pay royalties owed for sales made in any given quarter after the conclusion of that quarter. We recognize such royalty revenue in the period earned and reported from licensees.
Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Changes in the financial condition of our customers could result in upward or downward adjustments to the allowance for doubtful accounts.
Inventory Obsolescence. We write down our inventory for estimated obsolete or unsalable inventory based on assumptions about future demand for our products and market conditions. If future demand and market conditions are less favorable than our assumptions, additional inventory write-downs could be required. Likewise, favorable future demand and market conditions could positively impact future operating results if previously written-off inventory is sold.
Income Taxes. We consider future market growth, forecasted earnings, future taxable income, the mix of earnings in the jurisdictions in which we operate and prudent, feasible and permissible tax planning strategies in determining the realizability of deferred tax assets. If we were to determine that we would not be able to realize a portion of our net deferred tax asset in the future for which there is currently no valuation allowance, an adjustment to the valuation allowance would be charged to earnings in the period such determination was made. Conversely, if we were to make a determination that it is more likely than not that the deferred tax assets for which there is currently a valuation allowance would be realized, the related valuation allowance would be reduced and a benefit to earnings would be recorded.
We conduct business in various countries throughout the world and are subject to tax in numerous jurisdictions. As a result of our business activities, we file a significant number of tax returns that are subject to audit by various tax authorities. Tax audits are often complex and may require several years to resolve. We also record benefits from uncertain tax positions in accordance with FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.” Accordingly, we recognize the largest amount of benefit greater than 50% determined by cumulative probability of being realized upon ultimate settlement with the tax authority. Such amounts are based on management’s judgment and best estimate as to the ultimate outcome of tax audits. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved or when statutes of limitation on potential assessments expire. As a result, our effective tax rate may fluctuate significantly on a quarterly basis.
Intangible Assets. Intangible assets with finite useful lives are amortized generally on a straight-line basis over the periods benefited. A majority of our finite-lived intangible assets pertain to our patent portfolio and have estimated useful lives of 18 years. See Note E to the consolidated financial statements for additional information.
The carrying values of intangible assets with indefinite useful lives are tested for impairment annually or when events or circumstances indicate the carrying value of an asset may not be recoverable. If the carrying value of a reporting unit’s intangible asset exceeds its fair value, an impairment loss is recognized. Fair value is estimated based on discounted expected future cash flows.
Warranty Costs. Provisions for estimated expenses related to product warranties are made at the time products are sold. These estimates are established using historical information on the nature, frequency, and average cost of warranty claims. Management actively studies trends of warranty claims and takes action to improve product quality and minimize warranty claims.
Impairment of Long-lived Assets. We assess the recoverability of long-lived assets when events or circumstances indicate that the carrying amount of an asset may not be fully recoverable. If undiscounted expected cash flows to be generated by a long-lived asset or asset group are less than its carrying amount, we record an impairment to write down the long-lived asset or asset group to its estimated fair value. Fair value is estimated based on discounted expected future cash flows.
Discontinued Operations. Divested businesses are classified in the consolidated financial statements as discontinued operations. For businesses classified as discontinued operations, the balance sheet amounts and income statement results and cash flows are reclassified from their historical presentation to assets and liabilities of discontinued operations on the consolidated balance sheets, to profit or loss from discontinued operations in the consolidated statements of operations, and to cash flows from discontinued operations on the consolidated statements of cash flows for all periods presented. Additionally, segment information does not include the results of businesses classified as discontinued operations.
Patent Costs. We capitalize external legal costs incurred in the defense of our patents where we believe that the future economic benefit of the patent will be increased in accordance with Statement of Financial Accounting Concepts 6, “Elements of Financial Statements.” We monitor the legal costs incurred and the anticipated outcome of the legal action and, if changes in the anticipated outcome occur, capitalized costs are charged to in the period the change is determined. Patent costs are amortized over the remaining life of the patents. During 2007 and 2006, we capitalized $2.5 million and $0.7 million, respectively, in external legal costs incurred in the defense of our patents.
Pension and Other Postretirement Benefits. We have retirement plans that cover most of our employees. Some of these plans were frozen June 2006. Annual employer contributions are made to the extent such contributions are actuarially determined to adequately fund the plans, and to match a portion of the employees’ contribution. Retiree benefits are based on the amount of participant contributions over the term of the participant’s employment.
Assumptions used in determining projected benefit obligations and the fair values of plan assets for our pension plans and other postretirement benefits are evaluated periodically by management. Changes in assumptions are based on relevant internal data, such as the rate of increase in compensation levels and the expected long-term rate of return on plan assets. Critical assumptions such as the discount rate used to measure the benefit obligations, the expected long-term rate of return on plan assets and health care cost projections are evaluated and updated annually. Note K to the consolidated financial statements includes disclosure of these rates for our domestic and foreign plans. We believe the assumptions are appropriate. However, these assumptions could vary materially from actual results due to economic events or different rates of retirement, mortality or withdrawal, positively or negatively impacting future results of operations.
The discount rate, used to discount future cash flows of benefit obligations back to the measurement date, reflects the market rate for high-quality fixed-income debt instruments. The discount rates for domestic and foreign plans as of December 31, 2007 were 6.35% and 5.90%, respectively, compared to 5.95% and 5.00% as of December 31, 2006. The increase in the discount rate used for domestic plans reflects higher interest rates in the current market. A one-half percentage point decrease in our discount rate on pension cost would result in an increase in benefit obligation of $14.0 million. To determine the expected long-term rate of return, we use historic market trends combined with current market conditions. The weighted average expected long-term rate of return on our domestic and foreign plans was 8.75% and 6.40%, respectively. The effect on our pension cost of a one-half percentage point decrease in the expected long-term rate of return would be an increase of $0.5 million. We determine the expected rate of compensation increase based on historic trends and comparisons to external rates. For domestic plans, we concluded that no adjustment to the expected rate of compensation increase was necessary and continued to use 4.00%. For foreign plans, we concluded that no adjustment to the expected rate of compensation was necessary as there are no active employees covered under the plans.
Actuarial assumptions used to measure the accumulated benefit obligation for other postretirement benefits include a discount rate of 6.10%, and 5.70% at December 31, 2007, and 2006, respectively. The effect on our postretirement benefit cost of one-half percentage point decrease in the discount rate would be immaterial. The assumed health care cost trend rate for fiscal year 2007 was 8.50% and is projected to decrease over seven years to 5.00%, where it is expected to remain thereafter. The effect of a one-percentage-point increase or decrease in the assumed health care cost trend rate on the service cost and interest cost components of the net periodic postretirement benefit cost is not material. A one-percentage-point increase in the assumed health care cost trend rate on the postretirement benefit obligation would result in an increase of approximately $0.2 million, while a one-percentage point decrease would result in a decrease of $0.2 million.
Effective December 31, 2006, we adopted SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106 and 132(R) (SFAS No. 158), which requires that the consolidated statements of financial position reflect the funded status of the pension and postretirement plans (See Note K, Pension and Other Postretirement Benefit Plans). In future reporting periods, the difference between actual amounts and estimates based on actuarial assumptions will be recognized in other comprehensive loss in the period in which they occur.
Contingencies. We assess our exposure to loss contingencies, including environmental, legal and income tax matters, and provide for an exposure if it is judged to be probable and estimable. If the actual loss from a contingency differs from our estimates, results of operations are adjusted upward or downward.
Stock-Based Compensation. As of December 31, 2007, we had four stock-based compensation plans available for future grants. Prior to January 1, 2006, these plans are accounted for under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. During the first quarter of 2006, we began expensing stock options as required under SFAS No. 123(R), Share-Based Payments.
Stock-based compensation represents the cost related to stock-based awards granted to employees. We measure stock-based compensation cost at grant date, based on the estimated fair value of the award, and recognize the cost as expense on a straight-line basis (net of estimated forfeitures) over the employee’s requisite service period. We estimate the fair value of stock options using a Black-Scholes valuation model. The expense is recorded in cost of revenues and SG&A in the consolidated statement of operations based on the employees’ respective functions. We record deferred tax assets for awards that result in deductions on our income tax returns, based on the amount of compensation cost recognized and our statutory tax rate in the jurisdiction in which we will receive a deduction. Differences between the deferred tax assets recognized for financial reporting purposes and the actual tax deduction reported on our income tax return are recorded in Additional Paid-In Capital (if the tax deduction exceeds the deferred tax asset) or in the consolidated statement of earnings (if the deferred tax asset exceeds the tax deduction and no additional paid-in capital exists from previous awards).