Lawson Software 10-Q 2011
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 2010
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
Commission file number: 000-51942
LAWSON SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
380 ST. PETER STREET
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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
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 definition of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The number of shares of the registrants common stock outstanding on December 27, 2010 was 163,620,876.
LAWSON SOFTWARE, INC.
LAWSON SOFTWARE, INC.
(in thousands, except per share data)
The accompanying Notes are an integral part of the Condensed Consolidated Financial Statements
LAWSON SOFTWARE, INC.
(in thousands, except per share data)
The accompanying Notes are an integral part of the Condensed Consolidated Financial Statements
LAWSON SOFTWARE, INC.
The accompanying Notes are an integral part of the Condensed Consolidated Financial Statements
LAWSON SOFTWARE, INC.
1. Nature of Business and Basis of Presentation
Lawson Software is a global provider of enterprise software, support and services targeting customers in specific industries; including healthcare, service industries, manufacturing & distribution, equipment service management and rental, public sector (U.S.), and consumer products. Lawson serves customers in three geographic regions: the Americas; Europe, Middle East and Africa (EMEA); and Asia-Pacific, including Australia and New Zealand (APAC). We offer a broad range of software applications and industry-specific solutions that we believe help our customers improve their business processes and reduce costs, resulting in better business or operational performance. Lawson solutions help automate and integrate business processes and promote collaboration among our customers and their partners, suppliers and employees. Through our support services, we provide ongoing maintenance and assistance to our customers. Through our consulting services, we help our customers implement, learn to use, upgrade and optimize their Lawson applications.
Basis of Presentation
Our Condensed Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States (U.S. GAAP) and include the accounts of Lawson Software, Inc.; our branches and our wholly-owned and majority-owned subsidiaries operating in the Americas, EMEA and APAC. All significant intercompany accounts and transactions have been eliminated. Our subsidiaries that are not majority-owned are accounted for under the equity method. The accompanying Condensed Consolidated Financial Statements reflect all adjustments, in the opinion of management, necessary to fairly state our financial position, results of operations and cash flows for the periods presented. These adjustments consist of normal, recurring items other than the out-of-period adjustments described below under Results of Operations.
The unaudited Condensed Consolidated Financial Statements and Notes are presented as permitted by the requirements for Form 10-Q and do not contain all the information and disclosures included in our annual Consolidated Financial Statements and Notes as required by U.S. GAAP. The Condensed Consolidated Balance Sheet data as of May 31, 2010 and other amounts presented herein as of May 31, 2010, or for the year then ended, were derived from our audited financial statements. The accompanying interim Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and related Notes for the fiscal year ended May 31, 2010 included in our Current Report on Form 8-K filed with the Securities and Exchange Commission (SEC) on October 8, 2010. The results of operations for our interim periods are not necessarily indicative of results to be achieved for our full fiscal year.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of our financial statements, the reported amounts of revenues and expenses during the reporting periods presented, as well as our disclosures of contingent assets and liabilities. On an on-going basis we evaluate our estimates and assumptions, including those related to revenue recognition, allowance for doubtful accounts and sales returns, fair value of investments, fair value of share-based compensation, fair value of acquired intangible assets and goodwill, useful lives of intangible assets and property and equipment, income taxes, restructuring obligations, contingencies and litigation, among others. We base our estimates and assumptions on our historical experience and on other information available to us at the time that these estimates and assumptions are made. We believe that these estimates and assumptions are reasonable under the circumstances and that they form a basis for making judgments about the carrying values of our assets and liabilities that are not readily apparent from other sources. Actual results and outcomes could differ from our estimates.
During fiscal 2009 and prior years, we operated as one business segment, the development and marketing of computer software and related services including consulting, maintenance and customer support. Beginning in the first quarter of fiscal 2010, we reorganized our operations to provide greater focus on and better serve our targeted vertical markets. With this strategic organizational change, including a workforce realignment, we determined that we had three reportable segments that aligned with our three industries groups: S3 Strategic Industries, M3 Strategic Industries and General Industries. We have reevaluated our vertical organizational structure and have reorganized certain management and reporting responsibilities effective June 1, 2010; consolidating our General Industries reportable segment and redistributing responsibility for management of the vertical markets that were part of this segment into our S3 and M3 business segments. We believe the consolidation of our General Industries segment will help us drive more efficiencies and better manage our operations. Commensurate with this organizational change, we have revised our segment reporting
such that we report operating results for two reportable segments beginning in the first quarter of fiscal 2011: S3 Industries and M3 Industries. Prior periods segment information has been retrospectively adjusted to reflect the two segment structure. In connection with this change in organizational structure, we also revised the measure of operating performance that we use to assess segment operating performance from segment controllable margin to segment operating income. The primary difference between segment controllable margin and segment operating income is that our segment operating income includes an allocation of expenses for non-dedicated resources. We have retrospectively adjusted our segment profit measures to reflect segment operating income. See Note 15, Segment and Geographic Information, for a description of segment operating income.
Our fiscal year is from June 1 through May 31. Unless otherwise stated, references to the years 2011 and 2010 relate to the fiscal years ended May 31, 2011 and 2010, respectively. References to future years also relate to our fiscal years ending May 31.
Results of Operations
Our fiscal 2011 and 2010 results of operations include certain out-of-period adjustments which we have determined to be immaterial in all applicable current and prior interim and annual periods and we expect them to be immaterial to our full fiscal 2011 results.
Our year-to-date results for fiscal 2011 include reductions to net income of approximately $0.9 million. In the first quarter of fiscal 2011, net income was increased by approximately $0.3 million due to 1) $0.6 million related to a pension settlement gain (see Note 13, Comprehensive Income) that should have been recorded primarily in the third quarter of fiscal 2010 and 2) $0.3 million related to a value-added tax asset write-off that should have been recorded in the second quarter of fiscal 2010. In the second quarter of fiscal 2011, net income was reduced by approximately $1.1 million due to 1) a $0.3 million reduction in net income related to the pay-off of a note receivable that should have been recorded during fiscal 2008, fiscal 2009 and fiscal 2010 and 2) a $0.8 million decrease in net income related to the currency revaluation of certain value-added tax liabilities that should have initially resulted in a reduction in net income during fiscal 2009 ($0.8 million) and fiscal 2010 ($0.7 million).
Our results for the first six months of fiscal 2010 include reductions to net income of approximately $0.9 million that should have been reported in other fiscal years. Net income was reduced due to 1) an additional $1.8 million of income tax provision recorded primarily in the first quarter of fiscal 2010 that should have been recorded as a reduction to net income in fiscal 2009 and 2) an increase of $0.9 million recorded in the first quarter of fiscal 2010 related to the reversal of a services loss reserve that should have been reversed in fiscal 2008.
2. Summary of Significant Accounting Policies
Except to the extent updated or described below, a detailed description of our significant accounting policies can be found in Lawsons Current Report on Form 8-K for the fiscal year ended May 31, 2010 filed with the SEC on October 8, 2010. The following Notes should be read in conjunction with such policies and other disclosures contained therein.
Adoption of New Accounting Pronouncements
On June 1, 2010, we adopted the Financial Accounting Standards Board (FASB) guidance on the consolidation of variable interest entities (VIEs). This guidance clarifies the determination of whether a company is required to consolidate a VIE, changes the approach to determining a VIEs primary beneficiary (the reporting entity that must consolidate the VIE), requires an ongoing reassessment of whether a company is the primary beneficiary of a VIE and requires additional disclosures about a companys involvement in VIEs. Our adoption of this guidance did not have a material impact on our financial position, results of operations or cash flows.
In January 2010, the FASB issued guidance that expands the interim and annual disclosure requirements for fair value measurements, including the information about transfers into and out of Levels 1 and 2 of the three-tier fair value hierarchy established under the FASBs fair value measurement guidance. This guidance also requires separate disclosure for purchases, sales, issuances and settlements relating to Level 3 investments. Except for the detailed disclosures related to the Level 3 reconciliation, which became effective for us on June 1, 2010, all other disclosures under this guidance became effective during the fourth quarter of fiscal 2010. The adoption of this guidance did not have a material impact on our financial position, results of operations or cash flows.
Recent Accounting Pronouncements Not Yet Adopted
In October 2009, the FASB issued guidance which amends the existing guidance for revenue recognition of non-software elements of multiple element arrangements. Under the new guidance, when vendor-specific objective evidence or third-party evidence of the fair value for deliverables in an arrangement cannot be determined, companies will be required to develop a best
estimate of the selling price to separate deliverables and allocate arrangement consideration based on the relative selling price method. The residual method of allocating arrangement consideration will no longer be permitted. This guidance is effective for fiscal years beginning on or after June 15, 2010 (our fiscal 2012), however, early adoption is permitted. We are currently evaluating how this may affect our accounting for multiple element arrangements and the impact it may have on our financial position, results of operations or cash flows.
We account for derivative instruments, consisting of foreign currency forward contracts, pursuant to the FASB guidance on accounting for derivative instruments and hedging activities. This guidance requires us to measure derivative instruments at fair value and record them in our balance sheet as either an asset or a liability. We do not use derivative instruments for trading purposes. In fiscal 2011 and prior years, we have not designated these derivative contracts as hedge transactions and have not used hedge accounting. We manage foreign currency market risk using forward contracts to offset the risk associated with the effects of certain foreign currency exposures primarily related to non-functional currency intercompany loans and advances between our international subsidiaries as well as other balance sheet accounts, particularly accounts receivable, accounts payable and certain accrual accounts. Our foreign currency forward contracts are generally short-term in nature, maturing within 90 days or less. We revalue all contracts to their current market value at the end of each reporting period and unrealized gains and losses are included in our results of operations for that period. These gains and losses largely offset gains and losses recorded from the revaluation of our non-functional currency balance sheet exposures. We expect this to mitigate some foreign currency transaction gains or losses in future periods. Our net realized gain or loss with respect to currency fluctuations will depend on the currency exchange rates and other factors in effect as the contracts mature.
We record our foreign currency forward contracts on our Condensed Consolidated Balance Sheets as either prepaid expenses and other current assets or other current liabilities depending on whether the net fair value of such contracts is a net asset or net liability, respectively. All gains and losses from foreign currency forward contracts have been included in general and administrative expense in our Condensed Consolidated Statements of Operations. Cash flows related to our foreign currency forward contracts are included in cash flows from operating activities in our Condensed Consolidated Statements of Cash Flows. See Note 9, Fair Value Measurements, for more detail. We have recorded the following net fair values of our foreign currency forward contracts and the related net realized and unrealized gains and losses as of and for the periods indicated (in thousands):
Fair Value of Financial Instruments
Our financial instruments consist primarily of cash equivalents, marketable securities, trade accounts receivable and accounts payable and foreign currency forward contracts for which the current carrying amounts approximate fair values, primarily due to their short periods to maturity. Our long-term debt is carried at its face value, net of applicable debt discount. The estimated fair value of our 2.5% senior convertible notes, including current maturities, was $243.6 million as of November 30, 2010, based on quoted market prices. The remainder of our long-term debt has fair values that are not materially different from their aggregate carrying values of $3.6 million.
Sales Returns and Allowances
We do not generally provide a contractual right of return. However, in the course of arriving at practical business solutions to various warranty and other claims, we have allowed sales returns and allowances. We record a provision against revenue for estimated sales returns and allowances on license and consulting revenues in the same period the related revenues are recorded or when current information indicates additional allowances are required (we refer to these provisions and allowances as a warranty reserve). These estimates are based on historical experience determined by analysis of return activities, specifically identified customers and other known factors. If the historical data we utilize does not reflect expected future performance, a change in the allowances would be recorded in the period such determination is made, affecting current and future results of operations.
Following is a rollforward of our warranty reserve (in thousands):
We recorded a restructuring accrual reversal of approximately $1.5 million for the six months ended November 30, 2010, compared to a restructuring charge of $4.8 million for the six months ended November 30, 2009. The following table sets forth the reserve activity related to our restructuring plans for the six months ended November 30, 2010. The remaining reserve balances for severance and related benefits and exited leased facilities are included in accrued compensation and benefits and other current liabilities, respectively, in our Condensed Consolidated Balance Sheets as of November 30, 2010 and May 31, 2010 (in thousands):
Fiscal 2010 Restructurings
Fiscal 2010 Q2. On September 30, 2009, we approved a plan to further restructure our workforce. Under this plan, we reduced our workforce by approximately 65 employees. The majority of the reductions occurred within our consulting practice in our EMEA region. These actions were undertaken as a further refinement of our vertical organization, including a resizing of our services business to leverage our partner channels, and in light of demand for our consulting and implementation services in EMEA at that time. The majority of the actions related to this plan were completed by the end of the second quarter of fiscal 2010. The restructuring action resulted in pre-tax charges of $4.6 million for severance pay and related benefits which we recorded in the second quarter of fiscal 2010. Substantially all of this amount will result in future cash expenditures. We expect that the majority of the remaining severance and related benefits will be paid by the third quarter of fiscal 2011.
Fiscal 2010 Q4. On May 27, 2010, we approved and began implementing a plan to restructure our workforce including the elimination of approximately 150 employees. The workforce reduction relates primarily to our M3 operations in Europe, the U.S. and Manila. Departures of affected personnel were substantially complete by the end of the first quarter of fiscal 2011. In connection with these actions we recorded pre-tax charges of $7.1 million in the fourth quarter of fiscal 2010 for severance pay and related benefits; substantially all of which will result in future cash expenditures. We expect that the majority of the remaining severance and related benefits will be paid by the first quarter of fiscal 2012.
In relation to the fiscal 2010 restructuring actions, we made cash payments of approximately $4.9 million for severance pay and related benefits during the first six months of fiscal 2011. In addition, we recorded a $0.7 million reduction related to the fourth quarter of fiscal 2010 accrual, primarily as a result of an increase in accruals for severed employees of $0.5 million offset by a $1.2
million reduction related to a decrease in the number of affected employees. As of November 30, 2010, we had an accrual of $3.1 million for severance and related benefits.
Fiscal 2009 Restructurings
Fiscal 2009 Q2. On November 18, 2008, we announced the implementation of cost reduction measures in light of the uncertainty in global economic conditions and in light of other operating margin improvement initiatives. These cost reduction initiatives included a restructuring plan resulting in the reduction of approximately 285 employees and the exiting of certain leased facilities. In relation to these actions we recorded a pre-tax charge of approximately $7.9 million in the second quarter of fiscal 2009 and an additional $3.4 million in the third quarter of fiscal 2009. Actions related to severance were substantially completed by February 28, 2009 and applicable cash payments were completed thereafter. Payments related to the exited facilities are expected to continue through November 2011.
Fiscal 2009 Q4. On May 18, 2009, we initiated a plan to restructure our workforce in preparation for the fiscal 2010 vertical realignment of our organization. The restructuring involved the reduction of our workforce by approximately 150 employees and the consolidation of space in certain of our leased facilities. Actions related to this plan were completed by the end of our third quarter of fiscal 2010. The plan resulted in pre-tax charges of approximately $5.3 million for severance and related benefits and the consolidation of leased facilities resulted in pre-tax charges of approximately $3.8 million which we recorded in the fourth quarter of fiscal 2009. We expect the majority of the severance and related benefits to continue through the third quarter of fiscal 2011 while the leased facilities costs will be paid through December 2011.
In relation to the fiscal 2009 restructuring actions, we made cash payments of $0.4 million relating to severance and related benefits and $0.9 million related to the exited facilities during the first six months of fiscal 2011. In addition, we recorded adjustments to the accruals of approximately $0.5 million for a reduction in expenses accrued related to exited leased facilities when the lessor agreed to reduce the period of the lease and $0.3 million relating to severance and related benefits. As of November 30, 2010, we had an accrual of $1.9 million: $0.1 million for severance and related benefits and $1.8 million for the estimated fair value of our liability for the exited facilities.
Fiscal 2006 Restructuring
On April 26, 2006, in conjunction with our business combination with Intentia International AB (Intentia), we approved a plan designed to eliminate employee redundancies in both Intentia and Legacy Lawson. These actions included the reduction of approximately 185 employees and the exit of or reduction in leased space. In the first six months of fiscal 2011 we made cash payments of $0.6 million related to exited facilities. In the first quarter of fiscal 2011, we made adjustments to reduce lease exit costs of approximately $0.3 million for changes in estimates relating to the original lease restructuring plan when the lessor agreed to reduce the period of the lease. This adjustment resulted in a reduction to acquired goodwill. The remaining accrual as of November 30, 2010, was $2.2 million for the exit of or reduction in leased space. We expect cash payments related to exited facilities or reduced space to continue through June 2012. There were no such costs incurred in the second quarter of fiscal 2011.
As a result of our restructuring plans and the realignment of our workforce, we have experienced cost savings from the lower facility expenses and reduced headcount and we expect these savings to continue.
4. Business Combination
On January 11, 2010, we completed our acquisition of Healthvision through the acquisition of all the outstanding stock of privately held Quovadx Holdings, Inc., Healthvisions parent holding company. Healthvision is a Dallas-based company providing integration and application technology and related services to hospitals and large healthcare organizations. We believe the acquisition of Healthvision is a strategic fit for our S3 Industries segment. The results of operations of Healthvision have been included in our Condensed Consolidated Statements of Operations from the date of acquisition.
The purchase consideration totaled approximately $160.0 million in cash, net of approximately $10.4 million of acquired cash. We funded the purchase price from our available cash. We used the acquisition method to account for the acquisition in accordance with the FASB guidance on accounting for business combinations. Under the acquisition method, the purchase price was allocated to, and we recognized the fair values of, Healthvisions tangible and intangible assets acquired and liabilities assumed. The excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired has been recorded as goodwill within our S3 Industries segment. See Note 7, Goodwill and Intangible Assets. We believe the goodwill arises from the
benefits we expect to achieve from the additional revenue potential provided by our expanded product offerings and increased access to customers in our healthcare vertical within our S3 Industries segment.
We are responsible for determining the fair values of the acquired assets and liabilities. These fair values of the acquired assets and liabilities were based on our estimates as of the acquisition date of January 11, 2010 and were based on a number of factors, including valuations. Identified intangible assets acquired included existing technology, existing customer relationships and trade names. We used variations of the income approach method to value the intangible assets. Under these methods, fair value is estimated based upon the present value of cash flows that the applicable asset is expected to generate. The valuation of the existing technology and trade names were based on the relief-from-royalty method and existing customer relationships were valued using the excess earnings method. The royalty rates used in the relief-from-royalty method were based on both a return-on-asset method and market comparable rates.
The following table summarizes our allocation of the Healthvision purchase consideration (in thousands):
We expect that $6.1 million of the goodwill we acquired will be deductible for income tax purposes.
The following unaudited pro forma financial information is based on historical financial information of Lawson and Healthvision, giving effect to the acquisition as if it had occurred at the beginning of fiscal 2010 and applying certain assumptions and pro forma adjustments. These pro forma adjustments primarily relate to the amortization of acquired intangibles, recognition of deferred revenues, interest income, interest expense and the estimated impact on our income tax provision. We believe that the assumptions used and the adjustments made are reasonable given the information available to us as of the date of this Form 10-Q. This pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the operating results that would have been achieved had the acquisition occurred at such earlier times or of the results that may be achieved in the future. In addition, these pro forma financial statements do not reflect the realization of any cost savings that we may achieve from operating efficiencies, synergies or other restructuring activities that may result from the acquisition.
The following table summarizes the unaudited pro forma financial information of the combined Lawson and Healthvision as if the acquisition closed at the beginning of fiscal 2010 (in thousands, except per share data):
5. Share-Based Compensation
We account for share-based compensation in accordance with the FASB guidance on share-based payments. This guidance requires us to estimate the fair value of our share-based payment awards on the date of grant using an option-pricing model. We use the Black-Scholes option-pricing model which requires the input of significant assumptions including an estimate of the average period of time employees will retain vested stock options before exercising them, the estimated volatility of our common stock price over the expected term and the applicable risk-free interest rate. The value of the portion of awards that are ultimately expected to vest is recognized as expense over the requisite service periods in our Condensed Consolidated Statements of Operations.
The fair value of restricted stock and restricted stock unit awards (together restricted stock awards) is estimated based on the grant date market value of our common stock. For service-based restricted stock awards, compensation expense is recognized on a straight-line basis over the related service period. For performance-based restricted stock awards vesting is based on obtaining certain performance targets (currently based on our non-GAAP revenues and non-GAAP net income per diluted share) and compensation expense is recognized over the related service period based on managements assessment of the probability of meeting such targets. In general, we begin to recognize applicable compensation expense when we believe it is probable that the related performance targets will be met and no compensation expense is recorded, and any previously recognized expense reversed, when achievement of the performance target is not assessed as probable. We assess the likelihood or probability of achieving the performance target for these awards at the end of each quarterly reporting period. These performance-based awards will be cancelled and forfeited if the applicable performance targets are not met.
Compensation expense related to our Employee Stock Purchase Plan (ESPP) is estimated as the 15% discount employees receive relative to the market value of our common stock at the end of the ESPPs quarterly offering periods and is recognized in the applicable fiscal quarter.
The following table presents share-based compensation expense recognized in our Condensed Consolidated Statements of Operations, by category, for the periods indicated (in thousands):
As of November 30, 2010, we had the following unrecognized share-based compensation which we expect to recognize over the weighted average periods indicated (in thousands):
6. Trade Accounts Receivable
The components of our trade accounts receivable were as follows (in thousands):
Unbilled accounts receivable represents revenue recognized on contracts for which billings have not yet been presented to our customers because the amounts were earned but not contractually billable as of the balance sheet date.
7. Goodwill and Intangible Assets
The change in the carrying amount of our goodwill by reportable segment for the six months ended November 30, 2010, was as follows (in thousands):
(1) Reflects the reporting segment structure effective beginning in the first quarter of fiscal 2011. In fiscal 2010 we operated under three segments before we refined our organizational structure. See Note 15, Segment and Geographic Information.
We recorded an adjustment of approximately $0.5 million to increase goodwill during the first six months of fiscal 2011. In the second quarter of fiscal 2011 we recorded adjustments to correct the amount of certain assets acquired and liabilities assumed related to our acquisition of Healthvision. The adjustments included a decrease in trade accounts receivable of approximately $0.7 million and a $0.1 million increase in deferred revenue, with a corresponding offset of $0.8 million increase in goodwill. These increases were somewhat offset by a first quarter adjustment reducing goodwill by $0.3 million which pertained to changes in estimates relating to our fiscal 2006 lease restructuring plan. See Note 3, Restructuring.
In accordance with the FASB guidance related to goodwill and other intangible assets, we are required to assess the carrying amount of our goodwill for potential impairment annually or more frequently if events or a change in circumstances indicate that impairment may have occurred. We conduct our annual impairment test in the fourth quarter of each fiscal year.
Testing for goodwill impairment is a two step process. The first step screens for potential impairment and if there is an indication of possible impairment the second step must be completed to measure the amount of impairment loss, if any. The first step of the goodwill impairment test used to identify potential impairment compares the fair value of a reporting unit with the carrying value of its net assets. If the fair value of the reporting unit is less than the carrying value of the reporting unit, the second step of the goodwill impairment test would be performed to measure the amount of impairment loss we would be required to record, if any. The second step, if required, would compare the implied fair value of Lawsons goodwill with the current carrying amount of our goodwill. If the implied fair value of our goodwill is less than the carrying value, an impairment charge would be recorded as a charge to our operations. The results of our most recent annual assessment performed at the end of fiscal 2010 did not indicate any impairment of our goodwill.
During the first quarter of fiscal 2011, with a revision of our vertical organizational structure, we determined that we now operate under two reportable segments: S3 Industries and M3 Industries. We consolidated our General Industries reportable segment and redistributed responsibility for management of the vertical markets that were part of this segment into our S3 Industries and M3 Industries segments. See Note 15, Segment and Geographic Information, for additional information regarding our reportable segments. These two reporting segments are also representative of our reporting units for purposes of our goodwill impairment testing. Prior to this restructuring of our business, we had four reporting units. Upon this change in the number of our reporting units to two, effective June 1, 2010, we reallocated our goodwill to each of these reporting units based upon their fair values and we performed a step one goodwill impairment test.
For purposes of allocating our recorded goodwill to our reporting units, we estimated their fair values using a combination of an income approach (discounted cash flow method) and a market approach (market comparable method). Based on the results of the first step of our impairment test, the fair value exceeded the carrying value of the net assets for each of our reporting units. As of June 1, 2010, the calculated fair values of our S3 Industries and M3 Industries reporting units substantially exceeded their carrying values by approximately 150.5% and 70.6%, respectively. Accordingly, there was no impairment of our goodwill and neither of our reporting units was at risk of impairment as of June 1, 2010. We have no accumulated impairment charges related to our goodwill.
Intangible assets subject to amortization were as follows (in thousands):
We amortize our intangible assets using underlying cash flow projections and accelerated and straight-line methods which approximate the proportion of future cash flows estimated to be generated in each period over the estimated useful life of the applicable asset. The balances reflected in the above table as of November 30, 2010, include the intangible assets acquired in our acquisition of Healthvision and applicable accumulated amortization. See Note 4, Business Combination. Net intangible assets increased from May 31, 2010 to November 30, 2010 by approximately $2.7 million due to the effect of currency translation.
Amortization expense is reported as a component of cost of revenues and as amortization of acquired intangibles in our Condensed Consolidated Statements of Operations. The following table presents amortization expense for intangible assets recognized in our Condensed Consolidated Statements of Operations for the periods indicated (in thousands):
We review our intangible assets for potential impairment whenever events or changes in circumstances indicate that their remaining carrying value may not be recoverable pursuant to the FASB guidance on accounting for the impairment or disposal of long-lived assets.
The estimated future annual amortization expense for identified intangible assets is as follows (in thousands):
8. Deferred Revenue
The components of deferred revenue were as follows (in thousands):
In general, changes in the balance of our deferred revenue are cyclical and primarily driven by the timing of our maintenance services renewal cycles. Our renewal dates occur in the third and fourth quarters of our fiscal year with revenues being recognized ratably over the applicable service periods. In addition, our conversion rate, or the rate at which revenue related to license transactions is recorded as revenue, was relatively higher contributing to the decrease in deferred license fees revenues. These decreases were somewhat offset by an increase in deferred consulting revenues, primarily related to large consulting projects in both our S3 and M3 Industries segments that were deferred in the first half of fiscal 2011 in accordance with various contract specifications and are expected to be recognized primarily over the remainder of fiscal 2011 as the services are provided.
9. Fair Value Measurements
We adopted the FASB guidance for financial assets and liabilities and nonfinancial assets and liabilities that are recognized at fair value on a recurring basis in fiscal 2009. We adopted this guidance for non-financial assets and liabilities that are recognized at fair value on a nonrecurring basis in fiscal 2010. This guidance defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Fair value is defined as an exit price which represents the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in valuing an asset or a liability. The above mentioned guidance also requires the use of valuation techniques to measure fair values that maximize the use of observable inputs and minimize the use of unobservable inputs. As a basis for considering such assumptions and inputs, the guidance establishes a fair value hierarchy which identifies and prioritizes three levels of inputs to be used in measuring fair value.
The three levels of the fair value hierarchy are as follows:
We measure certain financial assets and liabilities at fair value including our cash equivalents, available-for-sale equity securities and foreign currency forward contracts. The following table summarizes the fair value of our financial assets and liabilities that were accounted for at fair value on a recurring basis as of November 30, 2010 and May 31, 2010 (in thousands):
Cash equivalents include funds held in money market instruments and are reported at their current carrying value which approximates fair value due to the short-term nature of these instruments and are included in cash and cash equivalents in our Condensed Consolidated Balance Sheets. Our money market instruments are valued primarily using observable inputs other than quoted market prices and are included in Level 2 inputs.
Available-for-sale securities includes investments in equity securities that are reported at their current fair value and are included in prepaid expenses and other current assets in our Condensed Consolidated Balance Sheets. These equity securities are valued using quoted market prices and are included in Level 1 inputs.
Foreign currency forward contracts are valued based on observable market spot and forward rates as of our reporting date and are included in Level 2 inputs in the above table. All contracts are at fair value and marked-to-market at the end of each reporting period with realized and unrealized gains and losses included in general and administrative expenses in our Condensed Consolidated Statements of Operations.
We have had no transfers of assets/liabilities into or out of Levels 1 and 2 during the first six months of fiscal 2011.
In addition to the financial assets and liabilities included in the above table, certain of our nonfinancial assets and liabilities are to be measured at fair value on a nonrecurring basis in accordance with applicable U.S. GAAP. This includes items such as nonfinancial assets and liabilities initially measured at fair value in a business combination (but not measured at fair value in subsequent periods) and nonfinancial long-lived asset groups measured at fair value for an impairment assessment. In general, nonfinancial assets including goodwill, other intangible assets and property and equipment are measured at fair value when there is an indication of impairment and are recorded at fair value only when any impairment is recognized. As of November 30, 2010, we had not recorded any impairment related to such assets and we had no other material nonfinancial assets or liabilities requiring adjustments or write-downs to their current fair value.
We elected not to apply the FASB guidance related to the fair value option for financial assets and liabilities to any of our currently eligible financial assets or liabilities. As of November 30, 2010, our material financial assets and liabilities not carried at fair value include our trade accounts receivable and accounts payable, which are reported at their current carrying values and we believe this approximates their fair values.
10. Long-Term Debt
Long-term debt consisted of the following (in thousands):
In April 2007, we issued $240.0 million in aggregate principal amount of 2.5% senior convertible notes with net proceeds, after expenses, of approximately $233.5 million. The notes mature on April 15, 2012. The notes bear interest at a rate of 2.5% per annum, which is payable semi-annually in arrears, on April 15 and October 15 of each year, beginning October 15, 2007. The notes do not contain any restrictive financial covenants. The notes are convertible, at the holders option, into cash and, if applicable, shares of our common stock based on an initial conversion rate of approximately 83.23 shares of common stock per $1,000 principal amount of notes, which is equivalent to an initial conversion price of approximately $12.02 per share (which reflects a 35.0% conversion premium based on the closing sale price of $8.90 per share of Lawson common stock as reported by NASDAQ on April 17, 2007). In connection with the issuance of the notes, we entered into a registration rights agreement with the initial purchasers of the notes. On August 16, 2007, we filed the shelf registration statement, which became effective on that date. On October 19, 2009, all securities that remained unsold under the registration statement were deregistered as our contractual obligation to maintain the shelf registration terminated. See Note 7, Long-Term Debt and Credit Facilities, in Notes to Consolidated Financial Statements in our Current Report on Form 8-K filed with the SEC on October 8, 2010.
We had certain business relationships with Lehman Brothers OTC Derivatives Inc. (Lehman OTC), including a convertible note hedge transaction and a warrant transaction both entered into as part of the issuance of our senior convertible notes and an accelerated share repurchase transaction (see Note 16, Repurchase of Common Shares). On September 15, 2008, Lehman Brothers Holdings Inc. (Lehman Holdings) filed for protection under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court in the Southern District of New York. Subsidiaries of Lehman Holdings, including Lehman Brothers Inc. (Lehman Brothers) and Lehman OTC, were not included in the filing. On September 19, 2008, Lehman Brothers was placed in liquidation under the Securities Investor Protection Act. In addition, on October 3, 2008, Lehman OTC also filed for Chapter 11 bankruptcy.
Lehman Brothers was one of the original purchasers of our senior convertible notes. None of the net proceeds from the offering are on deposit with Lehman Brothers or any of its affiliates. In conjunction with the issuance of the notes, we also entered into a convertible note hedge transaction with Lehman OTC, an affiliate of Lehman Brothers. In a separate agreement, we entered into a warrant transaction with Lehman OTC. Together, these transactions were designed to reduce the potential dilution resulting from the potential conversion of our senior convertible notes into shares of common stock and effectively increased the conversion price of the notes to $15.58 per share from the initial conversion price of $12.02 per share. We paid $57.7 million ($35.7 million net of tax benefit) to acquire the call options and received $34.2 million as a result of the sale of the warrants. The purchase of the call options was recorded as a reduction to stockholders equity and the sale of the warrants was recorded as an increase to stockholders equity in accordance with applicable FASB guidance.
The bankruptcy filing by Lehman OTC was an event of default under the hedge transaction and warrant agreements. As a result of that default, we exercised our rights to terminate both the hedge transaction and the warrant transaction on October 10, 2008. As a result of our termination of the hedge transaction, terms of the original transaction provided us the right to seek recovery from Lehman OTC equal to the termination-date fair value of the common stock option instrument we issued in connection with the hedge transaction. At the time of termination, the instrument ceased being a hedge instrument and was effectively replaced by our claim against Lehman OTC. Accordingly, for financial reporting purposes, we recorded the estimated fair value of the related hedge transaction asset and the warrant liability during the second quarter of fiscal 2009, resulting in a decrease in our stockholders equity equal to the net amount of the recorded asset and liability. As part of the convertible note hedge transaction, Lehman OTC agreed to
have Lehman Holdings guarantee certain obligations of Lehman OTC. Based on the developments in the bankruptcy proceeding, we do not have a claim against Lehman Holdings for the guaranty agreed to by Lehman OTC.
On June 4, 2009, counsel for Lehman Holdings and Lehman OTC demanded payment from us of the termination-date fair value of the warrant, asserted that in the contracts we have waived the right to setoff against the amounts owed to us under the hedge transaction and claimed we violated the bankruptcy stay in asserting offset rights. We have refused payment and contend that the U.S. Bankruptcy Code gives us legal rights of offset in this dispute. Lehman OTC disagrees with our contention and claims that we waived our right of offset under the terms of the original transaction documents. As of the date of this filing we are continuing our discussions with representatives of Lehman OTC regarding the resolution of the offset issue as well as other issues surrounding the hedge transaction asset and the warrant liability, including their proper valuation. We continue to closely monitor the Lehman Holdings bankruptcy situation, the liquidation of Lehman Brothers, as well as the Lehman OTC bankruptcy and our legal rights under our contractual relationships with Lehman OTC and Lehman Brothers.
For financial reporting purposes, we estimated the fair value of the hedge transaction asset and the warrant liability using the Black-Scholes option pricing model and considered the credit risk of Lehman OTC. The fair value of these obligations recorded for financial reporting purposes may differ from the values ultimately determined in various legal proceedings, including actions of the U.S. bankruptcy court. If the ultimate settlement of either of these obligations differs from the recorded amounts, we will be required to recognize any related gain or loss in our results of operations in the period such settlement is known. As of November 30, 2010, our claim against Lehman OTC and Lehman OTCs claim against us have not been settled.
The terms of the senior convertible notes and the rights of note holders are not affected by the status of Lehman Holdings or Lehman OTC or by the termination of the convertible note hedge or warrant transactions. We currently believe that the Lehman Holdings bankruptcy, and its potential impact on subsidiaries of Lehman Holdings, the liquidation of LBI, and the bankruptcy of Lehman OTC, will not have a material adverse effect on our financial position, results of operations or cash flows.
We have an uncommitted credit facility that consists of a guarantee line with Skandinaviska Enskilda Banken (SEB) in the amount of $4.3 million (30.0 million Swedish Krona). We had no borrowings outstanding under this line as of November 30, 2010.
11. Income Taxes
Our quarterly income tax expense is measured using an estimated annual effective tax rate for the period. For the six months ended November 30, 2010, our estimated annual global effective tax rate was 29.6% after considering those entities for which no tax benefit from operating losses is expected to occur during the year as a result of such entities requiring a full valuation allowance against current year losses. We estimate our annual effective tax rate on a quarterly basis and make any necessary changes to adjust the rate for the applicable year-to-date period based upon the annual estimate. The estimated annual tax rate may fluctuate due to changes in forecasted annual operating income, changes in the jurisdictional mix of the forecasted annual operating income, positive or negative changes to the valuation allowance for net deferred tax assets, changes to actual or forecasted permanent book to tax differences, impacts from future tax settlements with state, federal or foreign tax authorities or impacts from enacted tax law changes. We identify items which are unusual and non-recurring in nature and treat these as discrete events. The tax effect of discrete items is recorded entirely in the quarter in which the discrete event occurs.
Our income tax expense and overall effective tax rates were as follows for the periods indicated (in thousands, except percentages):
The change in the effective tax rate for the three and six months ended November 30, 2010 compared to the similar periods last year was primarily due to the jurisdictional mix of operating income in the respective periods. In fiscal 2011 we have been profitable in certain foreign jurisdictions, which has allowed us to utilize the benefit of net operating losses which are currently offset by valuation allowances, thereby reducing our effective rate as compared to last year when we incurred unbenefitted losses in certain jurisdictions.
The effective tax rate for the quarter ended November 30, 2010 was favorably impacted by 2.2 percentage points due to the jurisdictional mix of pre-tax income (loss) in both the actual quarterly amounts and the projected annual amounts that we utilized to calculate our
income tax expense. In addition, the rate was unfavorably impacted by 0.6 percentage points for interest on uncertain tax positions, 0.2 percentage points for additional uncertain tax positions in a foreign jurisdiction and 1.8 percentage points for income tax return to income tax provision true-ups.
We have recorded liabilities for unrecognized tax benefits related to uncertain tax positions, all of which would affect our earnings and effective tax rates, if recognized. We recognize interest accrued related to unrecognized tax benefits and penalties, if incurred, as a component of our income tax expense. Unrecognized tax benefits and related accruals for the payment of interest for the periods presented were as follows (in thousands):
The following table presents interest recognized related to these unrecognized tax benefits for the periods indicated (in thousands):
We file income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years ending on or before May 31, 2006. Currently, there are ongoing audits in certain foreign jurisdictions that commenced in the fourth quarter of fiscal 2009. While we believe we have adequately provided for all tax positions under examination, amounts asserted by taxing authorities could be greater or less than the accrued provision. We do not anticipate that adjustments, if any, would result in a material change to our financial position or results of operations. Over the next 12 months, we do not expect any significant cash payments related to these uncertain tax positions but we do expect that significant amounts of uncertain tax positions will reverse as a result of lapses of statutes of limitations.
At May 31, 2010, we had valuation allowances totaling $74.7 million that were recorded against deferred tax assets at various legal entities. Based on our estimates of future profitability in some of these jurisdictions, we believe that a valuation allowance continues to be required based on the current level of uncertainty regarding our ability to realize some of our deferred tax assets. We continue to monitor and weigh both positive and negative evidence related to our future ability to realize these assets. If we determine that the evidence indicates that it is more likely than not that we will be able to realize our deferred tax assets in the future, an adjustment to the deferred tax asset valuation allowance would be recorded in the period when such determination is made.
On December 17, 2010 the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 was signed. This law retroactively reinstated the federal R&D credit and the look-through rules relating to Subpart F income for fiscal year 2011. This law was enacted subsequent to November 30, 2010 and therefore no resulting tax benefit is reflected in our effective tax rate for the six months ended November 30, 2010. We estimate that these tax changes will reduce our full year effective tax rate by approximately 1.0 percentage points. We will report the impact of these changes beginning in our income tax provision for the quarter ending February 28, 2011.
12. Per Share Data
We compute net income per share in accordance with the FASB guidance on earnings per share. Under this guidance, basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the applicable period. Diluted net income per share is computed by dividing net income by the sum of the weighted average number of common shares outstanding plus the weighted average of dilutive shares outstanding during the period. We use the treasury stock method to calculate the weighted average dilutive shares related to in-the-money stock options and warrants, unvested restricted stock awards and shares issuable under our employee stock purchase plan. The dilutive effect of our senior convertible notes is calculated based on the average market price of our common stock during the applicable period and the senior convertible notes conversion price. The senior convertible notes are excluded from our computation of diluted earnings per share when the per share conversion price is greater than the average market price of our common stock during the applicable periods.
The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):
Potentially dilutive shares of common stock related to share-based awards and warrants are excluded from the diluted net income per share computations when their exercise prices are greater than the average market price of our common stock during the applicable periods as their inclusion would be anti-dilutive. The following table sets forth potentially dilutive weighted average shares, which were excluded from our computation of diluted net income per share because their inclusion would have been anti-dilutive (in thousands):
13. Comprehensive Income
The following table summarizes the components of other comprehensive income (in thousands):
(1) The unrealized gain (loss) on investments in the above table is net of taxes (tax benefits) of less than $1 for all periods presented.
Total accumulated other comprehensive income and its components for the periods presented were as follows (in thousands):
On April 2, 2010, our Benefits Committee approved a plan to modify our defined benefit pension plan in Norway (the Plan) such that beginning on June 1, 2010, active participants in the Plan no longer accumulated benefits for their services. Assets equivalent to the accumulated benefits of all active participants in the Plan were transferred to a newly-established defined contribution plan in the first quarter of fiscal 2011. All retired participants will continue to receive benefits under the Plan. The modification of the Plan resulted in a curtailment of benefits in the fourth quarter of fiscal 2010 when the modifications were approved. Accordingly, we recorded a curtailment gain of approximately $1.8 million in the fourth quarter of fiscal 2010 related to the change in all active participants projected benefit obligations resulting from the curtailment. This gain was reflected in general and administrative expenses in our fiscal 2010 Consolidated Statements of Operations. In addition, the modification of the Plan and transfer of the participants assets to their defined contribution accounts led to a settlement of active participants projected benefit obligations in the first quarter of fiscal 2011. We recorded an additional gain of approximately $1.9 million in the first quarter of fiscal 2011, including $0.9 million that should have been recorded in fiscal 2010 (see Note 1, Nature of Business and Basis of Presentation Results of Operations), which is reflected in our results of operations for the first six months of fiscal 2011 in general and administrative expenses in the accompanying Condensed Consolidated Statements of Operations.
14. Commitments and Contingencies
Patent Infringement Lawsuit by ePlus. On May 19, 2009, ePlus, Inc. filed a lawsuit in the United States District Court for the Eastern District of Virginia against Lawson Software, Inc., Perfect Commerce, Inc., SciQuest, Inc. and Verian Technologies, Inc. The other three defendants subsequently entered into separate confidential settlements and the court dismissed their parts of the lawsuit. The May 2009 complaint alleges that Lawsons supply chain products infringe three U.S. patents owned by ePlus. In that complaint, ePlus sought damages in an undisclosed amount, enhancement of those damages, an attorneys fee award and an injunction against further infringement. In May 2010, ePlus quantified its damages claim based on an alleged 5.0% to 6.0% royalty on all license, maintenance and services revenues in the United States since November 2003 for a wide range of Lawsons supply chain products as well as service-related revenues. Those alleged royalty damages totaled $28.0 to $33.0 million or more, and all or part of that award could have been increased up to treble damages by the court, at its discretion, if ePlus proved willful infringement by Lawson. However, on September 9, 2010, the court issued an order precluding ePlus from seeking damages at trial. At the trial, which started on January 4, 2011, if ePlus proves infringement and the patents are not invalidated, ePlus can seek only post-trial relief such as an injunction during the remaining life of the patents. If ePlus proves infringement, the court also has discretion to require Lawson to reimburse ePlus for its legal fees and costs if it finds the case to be exceptional. We are vigorously defending this case because we believe we have meritorious defenses, including non-infringement and patent invalidity. If we are not successful in obtaining resolution during the trial, at the conclusion of the trial the jury will decide whether or not ePlus has proved that Lawson has infringed, and whether or not Lawson has proved that the patents are invalid. If the jury finds that Lawson failed to prove invalidity of the patents, and if the jury finds that ePlus has proved infringement, then the court will determine whether ePlus has shown a right to post-trial relief such as an injunction. Given the inherent unpredictability of litigation and jury trials, as well as the right of either party to appeal an unfavorable decision, we cannot at this time estimate the possible outcome of this lawsuit. Because patent litigation is time consuming and costly to defend, we will continue to incur significant costs defending this case. In addition, in the event of an unfavorable outcome in this matter, it could have a material adverse effect on our future results of operations or cash flows. If ePlus prevails in this lawsuit, we could by agreement or otherwise be required to pay a royalty to ePlus on the sale of certain products and services in the future, and if we could not reach agreement with ePlus on the amount or scope of that royalty, we would have to either stop the sale of those products and services or make modifications to avoid infringement and there is no assurance that those modifications will be readily possible.
Patent Infringement Lawsuit by JuxtaComm. On January 21, 2010, JuxtaComm-Texas Software, LLC filed a lawsuit in the United States District Court for the Eastern District of Texas against Lawson Software, Inc., Lawson Software Americas, Inc. and 20 other defendants. One of the defendants, Seco Tools, Inc. is a Lawson customer. Under the terms of our customer license agreement, we have agreed to defend and indemnify Seco Tools in this lawsuit. The complaint alleges that Lawson and the other defendants infringe United States Patent No. 6,195,662 entitled System for Transforming and Exchanging Data Between Distributed Heterogeneous Computer Systems. JuxtaComm seeks damages in an undisclosed amount, enhancement of those damages, an attorneys fee award and an injunction against further infringement. On April 22, 2010, JuxtaComm filed an amended complaint,
naming Lawson ProcessFlow Integrator and Lawson System Foundation, as well as any products and/or services in the Lawson S3 and Lawson M3 product lines, as allegedly infringing. We are vigorously defending this case. Given the inherent unpredictability of litigation and jury trials, we cannot at this time estimate the possible outcome of this lawsuit. Because patent litigation is time consuming and costly to defend, we could incur significant costs defending this case. In addition, in the event of an unfavorable outcome in this matter, it could have a material adverse effect on our future results of operations or cash flows.
Patent Infringement Lawsuit by Aloft Media. On May 14, 2010, Aloft Media, LLC filed a lawsuit in the United States District Court for the Eastern District of Texas against Lawson Software, Inc., Lawson Software Americas, Inc. and 12 other defendants. The complaint alleges that Lawsons Planning Workbench for Food and Beverage software product, and possibly other software products, infringe United States Patent Nos. 7,593,910 and 7,596,538, which are each entitled Decision-Making System, Method and Computer Program Product. Aloft Media sought, in undisclosed amounts, damages, costs, expenses, interest and royalties. On November 20, 2010, Lawson and Aloft Media reached a settlement with respect to this lawsuit and for certain releases and licenses. On November 30, 2010, the Court dismissed all parties claims with prejudice. The settlement of this lawsuit did not have a material impact on our financial position, results of operations or cash flows.
Class Action Overtime Lawsuit. On May 20, 2008, a putative class action lawsuit was filed against us in the United States District Court for the Southern District of New York on behalf of current and former business, systems, and technical consultants. The suit, Cruz, et. al., v. Lawson Software, Inc. et. al., alleged that we failed to pay overtime wages pursuant to the Fair Labor Standards Act (FLSA) and state law, and alleged violations of state record-keeping requirements. The suit also alleged certain violations of ERISA and unjust enrichment. Relief sought includes back wages, corresponding 401(k) plan credits, liquidated damages, penalties, interest and attorneys fees. We successfully moved the case from the United States District Court for the Southern District of New York to the District of Minnesota. The Minnesota Federal District Court conditionally certified the case under the FLSA as a collective action and granted our motion to dismiss the two ERISA counts and the state wage and hour claims. Plaintiffs moved for Rule 23 class certification but the Court denied their motion. At the present time, the size of the class is limited to the 68 consultants who elected to participate in the lawsuit by filing opt-in forms. The overtime period at issue is two years, which would be increased to three years if the plaintiffs proved that the Company intentionally violated the applicable wage and hour laws. The plaintiffs damages expert claims total aggregate damages of $10.3 million for a two year period for the 68 consultants and an additional $2.9 million in aggregate damages if the overtime period is three years. Given the inherent unpredictability of litigation and jury trials, we cannot at this time estimate the possible outcome of this lawsuit. On June 30, 2010, Lawson filed a motion to de-certify the FLSA collective action, which, if granted, would limit the action to the five named plaintiffs. On September 15, 2010, we filed a motion for summary judgment asking for dismissal of remaining class members based on their performance of exempt duties and/or making more than $100,000 per year. The court heard both of these motions on November 12, 2010, and we are waiting to receive a decision which is expected during the early part of 2011. If the court does not grant that dismissal, we have alternatively requested that the limitation period be two years instead of three. In the event of an unfavorable outcome in this matter, it could have a material adverse effect on our future results of operations or cash flows.
Intentia Premerger Claims Reserve. We have accumulated information regarding Intentia customer claims and disputes that arose before our acquisition of Intentia in April 2006. The initial purchase accounting accrual for these claims and disputes was recorded in fiscal 2006. The accrual has been adjusted since that time to reflect current estimates of the applicable reserve requirements and to record resolution and/or settlement of certain claims. In the second quarter of fiscal 2011, the remaining reserve was consumed through a combination of cash payments, accounts receivable write-offs and free services and adjusted to bring the balance to zero as of November 30, 2010. The final adjustment to this reserve resulted in an accrual reversal of approximately $0.6 million which is included in general and administrative expenses in our Condensed Consolidated Statement of Operations for the second quarter of fiscal 2011. We expense our defense costs during the period incurred. Any future accruals for these claims and disputes or any settlement costs or judgments will be expensed in the period incurred. We do not expect such future expense will be material to our future results of operations or cash flows.
Pending Audit of Lawson/IBM Reseller Agreement. We have resold a variety of IBM software products since September 2005, including certain IBM products that we sell together with Lawsons Process Flow Integrator (PFI) and other products. During 2010, IBM retained an outside audit firm to review Lawsons product sales and the payment of royalties to IBM under their agreement with respect to the PFI sales. IBMs outside audit firm has provided us with draft results of the audit which allege that Lawson may owe IBM up to $12.5 million in additional royalties. We vigorously contend that our agreement with IBM does not require additional royalties and that IBMs outside audit firm has incorrectly evaluated the terms of the agreement. We have communicated our concerns to the outside audit firm and IBM. IBM has not completed its review of the draft audit, and to date, it has neither requested additional royalties from us nor stated to Lawson that it disagrees with our position on the agreement. We are working with IBM to resolve the questions raised by the outside audit.
We are subject to various other legal proceedings and the risk of litigation by employees, customers, patent owners, suppliers, stockholders or others through private actions, class actions, administrative proceedings or other litigation. While the outcome of these claims cannot be predicted with certainty, we do not believe that the outcome of these legal matters will have a material adverse effect on our financial position, results of operations or cash flows. However, depending on the amount and the timing, an unfavorable resolution of some or all of these matters could materially affect our future results of operations or cash flows in a particular period.
Indemnification Guarantee Agreements and Employment Agreements
In the normal course of business, we license our software products to customers under end-user license agreements and to certain resellers or other business partners under business partner agreements. We also enter into services agreements with customers for the implementation of our software. We may subcontract these services to our business partners. These agreements generally include certain provisions for indemnifying our customer or business partner against losses, expenses and liabilities from damages that may be awarded against them if our software, or the third-party-owned software we resell, is found to infringe a patent, copyright,
trademark or other proprietary right of a third-party. We have also entered into various employment agreements with certain executives and other employees, which provide for severance payments subject to certain conditions and events. We believe our exposure under these various indemnification and employment agreements is minimal and accordingly, we have not accrued any liabilities related to these agreements as of November 30, 2010.
We have arrangements with certain of our customers whereby we guarantee the products and services purchased will operate materially and substantially as described in the documentation that we provided. If necessary, we provide for the estimated cost of product and service warranties based on specific warranty claims and claim history.
See Note 13, Commitments and Contingencies, in Notes to Consolidated Financial Statements in our Current Report on Form 8-K filed with the SEC on October 8, 2010, for additional detail regarding these various agreements.
15. Segment and Geographic Information
We are a global provider of enterprise software, support and services. We target customers in specific industries as well as the horizontal market for our human capital management product line. We serve customers in the Americas, EMEA and APAC geographic regions. We determine our reportable operating segments in accordance with the provisions in the FASB guidance on segment reporting, which establishes standards for, and requires disclosure of, certain financial information related to our operating segments and geographic regions. Factors used to identify our reportable operating segment(s) include the financial information regularly utilized for evaluation by our chief operating decision-maker (CODM) in making decisions about how to allocate resources and in assessing our performance. We have determined that our CODM, as defined by this segment reporting guidance, is our Chief Executive Officer (CEO).
During fiscal 2009 and prior years, we viewed our operations and managed our business as one reportable segment, the development and marketing of computer software and related services including consulting, maintenance and customer support. Beginning in the first quarter of fiscal 2010, we reorganized our operations to provide greater focus on and better serve our targeted vertical markets within each of our product lines.
With our fiscal 2010 strategic realignment, we were operationally aligned by industry vertical and our management structure and financial reporting of our operations followed this vertical structure. Based on our organizational structure and related internal financial reporting structure, we determined that we had three reportable segments in fiscal 2010 that aligned with our three industries groups: S3 Strategic Industries, M3 Strategic Industries and General Industries.
We have continued to evaluate our vertical organizational structure and have reorganized certain management and reporting responsibilities effective June 1, 2010; consolidating our General Industries reportable segment and redistributing responsibility for management of the vertical markets that were part of this segment into our S3 Industries and M3 Industries segments. We believe the consolidation of our General Industries segment will help us drive more efficiencies and better manage our operations. Commensurate with this organizational change, we revised our segment reporting such that we report operating results for two reportable segments beginning in the first quarter of fiscal 2011: S3 Industries and M3 Industries. Prior periods segment information has been retrospectively adjusted to reflect this two segment structure.
Our S3 Industries and M3 Industries segments generally align with our Lawson S3 Enterprise Management System and Lawson M3 Enterprise Management System product lines, respectively. Our S3 Industries and M3 Industries segments include key vertical industry markets and related services and support for each of our S3 and M3 product lines, respectively. The S3 Industries segment targets customers in the healthcare, services and public sector industries. The M3 Industries segment targets customers in the equipment service management & rental, manufacturing & distribution and consumer products industries as well as our APAC business unit. Our consumer products vertical includes our food & beverage and fashion customers.
Within our organization, multiple sets of information are available reflecting various views of our operations including vertical, geographic and/or functional information. However, the financial information provided to and used by our CODM to assist in making operational decisions, allocating resources and assessing our performance reflects revenues, cost of revenues, direct operating expenses and the allocation of certain other shared-services and the resulting operating income of our S3 Industries segment and M3 Industries segment.
In connection with the change in organizational structure, we also revised the measure of operating performance that we use to assess segment operating performance from segment controllable margin to segment operating income. The primary difference between segment controllable margin and segment operating income is that our segment operating income includes an allocation of
expenses for non-dedicated resources. We have retrospectively adjusted our segment profit measures to reflect segment operating income.
Segment operating income includes segment revenues net of costs of applicable license fees and other direct costs that represent those cost of resources dedicated to the business units within each industries group. Each segment is also allocated a certain portion of other non-dedicated resources that support our entire organization or other corporate shared-services. These allocated expenses relate to our functional areas or competency centers including: global sales operations, marketing, product development and product management, and general and administrative functions: executive management, finance, human resources, legal, facilities and information technology services. The resulting segment operating income is the financial measure by which each segment and managements performance is measured. There are certain other costs including share-based compensation, acquisition related transaction/integration costs and pre-merger claims reserve adjustments, among others, which are excluded from segment operating income and are included in other unallocated expenses in the table below. In addition, restructuring charges and amortization of acquired intangibles are not allocated to our reportable segments. We do not have any intercompany revenue recorded between our reportable segments. The accounting policies for all of our reportable segments are the same as those used in our consolidated financial statements as detailed in Note 2, Summary of Significant Accounting Policies, in Notes to Consolidated Financial Statements in our Current Report on Form 8-K filed with the SEC on October 8, 2010.
The following table presents financial information for our reportable segments for the periods indicated (in thousands):