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Lexmark International 10-Q 2012 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the Quarterly Period Ended March 31, 2012
OR
Commission File No. 1-14050
LEXMARK INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
(859) 232-2000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R 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 R 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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No R
The registrant had 71,135,180 shares outstanding (excluding shares held in treasury) of Class A Common Stock, par value $0.01 per share, as of the close of business on April 30, 2012.
LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical fact, are forward-looking statements. Forward-looking statements are made based upon information that is currently available or management’s current expectations and beliefs concerning future developments and their potential effects upon the Company, speak only as of the date hereof, and are subject to certain risks and uncertainties. We assume no obligation to update or revise any forward-looking statements contained or incorporated by reference herein to reflect any change in events, conditions or circumstances, or expectations with regard thereto, on which any such forward-looking statement is based, in whole or in part. There can be no assurance that future developments affecting the Company will be those anticipated by management, and there are a number of factors that could adversely affect the Company’s future operating results or cause the Company’s actual results to differ materially from the estimates or expectations reflected in such forward-looking statements, including, without limitation, the factors set forth under the “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections of this report. The information referred to above should be considered by investors when reviewing any forward-looking statements contained in this report, in any of the Company’s public filings or press releases or in any oral statements made by the Company or any of its officers or other persons acting on its behalf. The important factors that could affect forward-looking statements are subject to change, and the Company does not intend to update the factors set forth in the “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections of this report. By means of this cautionary note, the Company intends to avail itself of the safe harbor from liability with respect to forward-looking statements that is provided by Section 27A and Section 21E referred to above.
PART I – FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS
(In Millions, Except Per Share Amounts)
(Unaudited)
See Notes to Consolidated Condensed Financial Statements.
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LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE EARNINGS
(In Millions)
(Unaudited)
*Other-than-temporary impairment (“OTTI”)
See Notes to Consolidated Condensed Financial Statements.
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LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF FINANCIAL POSITION
(In Millions, Except Par Value)
(Unaudited)
See Notes to Consolidated Condensed Financial Statements.
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LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In Millions)
(Unaudited)
See Notes to Consolidated Condensed Financial Statements.
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LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(In Millions, Except Per Share Amounts)
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying interim Consolidated Condensed Financial Statements are unaudited; however, in the opinion of management of Lexmark International, Inc. (together with its subsidiaries, the “Company” or “Lexmark”), all adjustments necessary for a fair statement of the interim financial results have been included. All adjustments included were of a normal recurring nature. The results for the interim periods are not necessarily indicative of results to be expected for the entire year. The Consolidated Condensed Statements of Financial Position data as of December 31, 2011 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S.”). The Company filed with the Securities and Exchange Commission audited consolidated financial statements for the year ended December 31, 2011, on Form 10-K, which included all information and notes necessary for such presentation. Accordingly, these financial statements and notes should be read in conjunction with the Company’s audited annual consolidated financial statements for the year ended December 31, 2011.
Refer to Note 16 for a discussion of accounting changes in the first quarter of 2012 required by updates to the Accounting Standards Codification (“ASC”). The updates are related to the presentation of comprehensive income and fair value measurements and disclosures.
General
The accounting guidance for fair value measurements defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles (“GAAP”), and requires disclosures about fair value measurements. The guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As part of the framework for measuring fair value, the guidance establishes a hierarchy of inputs to valuation techniques used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.
Fair Value Hierarchy
The three levels of the fair value hierarchy are:
Fair value measurements of assets and liabilities are assigned a level within the fair value hierarchy based on the lowest level of any input that is significant to the fair value measurement in its entirety.
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Assets and Liabilities Measured at Fair Value on a Recurring Basis
(1) Foreign currency derivative assets and foreign currency derivative liabilities are included in Prepaid expenses and other current assets and Accrued liabilities, respectively, on the Consolidated Condensed Statements of Financial Position. See Note 13 for disclosure of derivative assets and liabilities on a gross basis.
Excluded from the 2012 table above were financial instruments included in Cash and cash equivalents on the Consolidated Condensed Statements of Financial Position. The Company’s policy is to consider all highly liquid investments with an original maturity of three months or less at the Company’s date of purchase to be cash equivalents. Investments considered cash equivalents included approximately $74.6 million of money market funds categorized as Level 2, $8.1 million of U.S. government and agency securities categorized as Level 1 and $1.2 million of corporate debt securities categorized as Level 2 at March 31, 2012. Excluded from the 2011 table above were financial instruments included in Cash and cash equivalents on the Consolidated Condensed Statements of Financial Position. Investments considered cash equivalents included approximately $235.9 million of money market funds, $6.5 million of U.S. government and agency debt securities and $2.0 million of corporate debt securities at December 31, 2011. The amortized cost of these investments closely approximates fair value in accordance with the Company’s policy regarding cash equivalents. Fair value of these instruments is readily determinable using the methods described below for marketable securities and money market funds.
The following table presents additional information about Level 3 assets measured at fair value on a recurring basis for the quarter ended March 31, 2012:
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Of the realized and unrealized losses included in earnings during the first quarter of 2012, none were related to Level 3 securities held by the Company at March 31, 2012.
For purposes of comparison, the following table presents additional information about Level 3 assets measured at fair value on a recurring basis for the quarter ended March 31, 2011:
Of the realized and unrealized losses included in earnings during the first quarter of 2011, none were related to Level 3 securities held by the Company at March 31, 2011.
Transfers
In determining where measurements lie in the fair value hierarchy, the Company uses default assumptions regarding the general characteristics of the financial instrument as the starting point. The Company then adjusts the level assigned to the fair value measurement for financial instruments held at the end of the reporting period, as necessary, based on the weight of the evidence obtained by the Company. For most financial instruments, the Company reviews the levels assigned to its fair value measurements on a quarterly basis and recognizes transfers between levels of the fair value hierarchy as of the beginning of the quarter in which the transfer occurs.
2012
The Company transferred, on a gross basis, $10.1 million from Level 1 to Level 2 due to lower levels of market activity for certain U.S. agency debt securities noted during the first quarter of 2012. The fair values of the Company’s U.S. agency debt securities are generally categorized as Level 1 but may be downgraded based on the Company’s assessment of market activity for individual securities. The Company also transferred from Level 2 to Level 1, on a gross basis, $8.4 million of corporate debt securities and $9.8 million of U.S. agency debt securities due to trading volumes sufficient to indicate an active market for the securities.
Additionally, as indicated in the table above, the Company transferred, on a gross basis, $0.3 million of asset-backed securities, $5.7 million of corporate debt securities and $1.5 million of U.S. agency debt securities from Level 3 to Level 2 as the Company was able to obtain information demonstrating that the prices were observable in the market as of March 31, 2012.
2011
The Company transferred, on a gross basis, $22.2 million from Level 1 to Level 2 due to lower levels of market activity for certain U.S. agency debt securities noted during the first quarter of 2011. The fair values of the Company’s U.S. agency debt securities are generally categorized as Level 1 but may be downgraded based on the Company’s assessment of market activity for individual securities. The Company also transferred from Level 2 to Level 1, on a gross basis, $15.9 million of corporate debt securities due to trading volumes sufficient to indicate an active market for the securities.
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Valuation Techniques
Marketable Securities - General
The Company evaluates its marketable securities in accordance with Financial Accounting Standards Board (“FASB”) guidance on accounting for investments in debt and equity securities, and has determined that all of its investments in marketable securities should be classified as available-for-sale and reported at fair value. The Company generally employs a market approach in valuing its marketable securities, using quoted market prices or other observable market data when available. In certain instances, when observable market data is lacking, fair values are determined using valuations techniques consistent with the income approach whereby future cash flows are converted to a single discounted amount.
Marketable Securities - Valuation Process
The Company uses multiple third parties to report the fair values of the securities in which Lexmark is invested, though the responsibility of valuation remains with the Company’s management. Most of the securities’ fair values are based upon a consensus price method, whereby prices from a variety of industry data providers are input into a distribution-curve based algorithm to determine the most appropriate fair value. For securities valued using this method the Company compares the consensus prices provided by the third party to additional pricing data the Company obtains from other available sources. Each quarter the Company utilizes multiple sources of pricing as well as broker quotes, trading and other market data in its process of assessing the reasonableness of consensus prices provided by the third party and testing default level assumptions. The Company assesses the quantity of pricing sources available, variability in the prices provided, trading activity and other relevant data to reasonably determine that the price provided is consistent with the accounting guidance for fair value measurements.
The fair values reported for securities classified as Level 3 in the fair value hierarchy are less likely to be transacted upon than the fair values reported for securities classified in other levels of the fair value hierarchy.
Government and agency debt securities
The Company’s government and agency debt securities are generally highly liquid investments having multiple sources of pricing with low variability among the data providers. The consensus price method, described previously, is used to select the most appropriate price. Fair value measurements for U.S. government and agency debt securities are most often based on quoted market prices in active markets and are categorized as Level 1. Securities with lower levels of market activity, including certain U.S. agency debt securities and international government debt securities, are classified as Level 2.
Corporate debt securities
The corporate debt securities in which the Company is invested most often have multiple sources of pricing with relatively low dispersion and are valued using the consensus price method. The fair values of these securities are generally classified as Level 2. Certain of these securities, however, are classified as Level 3 because the Company was unable to corroborate the consensus price of these securities with a sufficient level of observable market data due to a low number of observed trades or pricing sources. In addition, certain corporate debt securities are classified as Level 1 due to trading volumes sufficient to indicate an active market for the securities.
Smaller amounts of commercial paper and certificates of deposit, which generally have shorter maturities and less frequent trades, are also grouped into this fixed income sector. Such securities are valued via mathematical calculations using observable inputs until such time that market activity reflects an updated price. The fair values of these securities are typically classified as Level 2 measurements.
Asset-backed and mortgage-backed securities
Securities in this group include asset-backed securities, U.S. agency mortgage-backed securities, and other mortgage-backed securities. These securities generally have lower levels of trading activity than government and agency debt securities and corporate debt securities and, therefore, their fair values may be based on other inputs, such as spread data. The consensus price method is generally used to determine the most appropriate price in the range provided. Fair value measurements of these investments are most often categorized as Level 2; however, these
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securities are categorized as Level 3 when there is higher variability in the pricing data, a low number of pricing sources, or the Company is otherwise unable to gather supporting information to conclude that the price can be transacted upon in the market at the reporting date.
Money market funds
The money market funds in which the Company is invested are considered cash equivalents and are generally highly liquid investments. Money market funds are valued at the per share (unit) published as the basis for current transactions.
Auction Rate Securities
The Company’s auction rate securities for which recent auctions were unsuccessful are made up of student loan revenue bonds valued at $2.9 million, municipal sewer and airport revenue bonds valued at $5.4 million, and auction rate preferred stock valued at $3.4 million at March 31, 2012. The Company’s auction rate securities for which recent auctions were unsuccessful are made up of student loan revenue bonds valued at $2.7 million, municipal sewer and airport revenue bonds valued at $5.5 million, and auction rate preferred stock valued at $3.3 million at December 31, 2011.
At March 31, 2012, the Company’s auction rate securities for which recent auctions were unsuccessful were valued by a third party using a discounted cash flow model based on the characteristics of the individual securities, which the Company believes yields the best estimate of fair value. The first step in the valuation included a credit analysis of the security which considered various factors including the credit quality of the issuer (and insurer if applicable), the instrument’s position within the capital structure of the issuing authority, and the composition of the authority’s assets including the effect of insurance and/or government guarantees. Next, the future cash flows of the instruments were projected based on certain assumptions regarding the auction rate market significant to the valuation including (1) the auction rate market will remain illiquid and auctions will continue to fail causing the interest rate to be the maximum applicable rate and (2) the securities will not be redeemed prior to any scheduled redemption dates. These assumptions resulted in discounted cash flow analysis being performed through the legal maturities of most of the securities, ranging from July 2032 through December 2037, or in the case of the auction rate preferred stock, through the mandatory redemption date of December 2021. The projected cash flows were then discounted using the applicable yield curve plus a 250 basis point liquidity premium added to the applicable discount rate. Quantitative disclosures of key unobservable inputs for auction rate securities appear in the table below.
Different assumptions were used for one of the Company’s municipal bonds due to the distressed financial conditions of both the issuer and the insurer. The fair value of this security at March 31, 2012 was $2.3 million, and was primarily based on an estimated 65% recovery that holders could realize from bankruptcy proceedings after a likely work out period of one year.
The significant unobservable inputs used in the fair value measurement of the Company’s investments in auction rate securities include the estimated forward rates and discount rates used in the discounted cash flow analysis as well as the basis point liquidity premium. In addition to the discount rate, the estimated recovery percentage and work out period are significant unobservable inputs used in the fair value measurement of the distressed security. A significant increase in the estimated forward rates, or the estimated recovery percentage in the case of the distressed security, in isolation, would lead to a significantly higher fair value measurement. A significant increase in the basis point liquidity premium or discount rate, or work out period in the case of the distressed security, in isolation, would lead to a significantly lower fair value measurement. In certain cases a change in the estimated forward rates could be accompanied by a directionally similar change in the discount rate or basis point liquidity premium. Each quarter the Company investigates material changes in the fair value measurements of auction rate securities.
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Derivatives
The Company employs a foreign currency risk management strategy that periodically utilizes derivative instruments to protect its interests from unanticipated fluctuations in earnings and cash flows caused by volatility in currency exchange rates. Fair values for the Company's derivative financial instruments are based on pricing models or formulas using current market data. Variables used in the calculations include forward points and spot rates at the time of valuation. Because of the very short duration of the Company's transactional hedges there is minimal risk of nonperformance. At March 31, 2012 and December 31, 2011, all of the Company's forward exchange contracts were designated as Level 2 measurements in the fair value hierarchy. Refer to Note 13 to the Consolidated Condensed Financial Statements for more information regarding the Company’s derivatives.
Senior Notes
In May 2008, the Company issued $350 million of five-year fixed rate senior unsecured notes and $300 million of ten-year fixed rate senior unsecured notes.
The fair values shown in the table below are based on the prices the bonds have recently traded in the market as well as the overall market conditions on the date of valuation, stated coupon rates, the number of coupon payments each year and the maturity dates. The fair value of the debt is not recorded on the Company’s Consolidated Condensed Statements of Financial Position and is therefore excluded from the fair value table above. This fair value measurement is classified as Level 3 within the fair value hierarchy.
Other Financial Instruments
The fair values of cash and cash equivalents, trade receivables and accounts payable approximate their carrying values due to the relatively short-term nature of the instruments.
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis Subsequent to Initial Recognition
There were no material fair value adjustments to assets or liabilities measured at fair value on a nonrecurring basis subsequent to initial recognition during the first quarter of 2012. For comparison purposes, measurements recorded in the first quarter of 2011 are shown below.
2011
*Pertains to measurements during the quarter ended March 31, 2011.
Long-lived assets held for sale
Related to the April 2009 restructuring plan, the Company’s inkjet cartridge manufacturing facility in Juarez, Mexico qualified as held for sale in the first quarter of 2010. During the first quarter of 2011, in accordance with the guidance on accounting for the impairment or disposal of long-lived assets, the building and land with a carrying value of $4 million were written down to their fair value less cost to sell of $3 million, resulting in a loss of $1 million for the quarter ended March 31, 2011. The loss was included in Selling, general and administrative on the Consolidated Condensed Statements of Earnings. Fair value was estimated using a market approach, based on
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available data for transactions in the region as well as the asking price of a comparable property. The decrease in fair value during the first quarter of 2011 was driven by the worsening of the industrial market in Juarez. Subsequent to the recognition of the loss during the first quarter of 2011, the Company received an offer to purchase the facility comparable to the estimated fair value. The sale was completed later in 2011.
Related to the 2007 restructuring plan, the Company's Orleans, France facility is currently held for sale. Due to certain developments subsequent to the time the facility qualified as held for sale, negotiations with a potential buyer ceased in the fourth quarter of 2011. Fair value less cost to sell has been estimated at $3 million using an income approach considering, from a market participant standpoint, discounted cash flows associated with developing, leasing and ultimately selling the facility. The facility is included in Property, plant and equipment, net on the Consolidated Condensed Statements of Financial Position. The Company is actively marketing the facility for sale and is taking steps to minimize recurring expenses associated with the facility. The carrying value of the building and land held for sale was approximately $3 million at March 31, 2012. The facility has been vacated by the Company and, due to the restructuring action noted above, is not being employed by the Company in its highest and best use. There were no fair value adjustments related to the facility in the first quarters of 2012 and 2011.
3. BUSINESS COMBINATIONS
The Company announced a series of acquisitions in the first quarter of 2012. These acquisitions provide key technologies and customer bases as the Company continues to build upon its solutions capabilities.
Acquisition of BDGB Enterprise Software (Lux) S.C.A.
On February 29, 2012, the Company acquired all of the issued and outstanding shares in BDGB Enterprise Software (Lux) S.C.A. (“Brainware”). Brainware is a leading provider of intelligent data capture software. The acquisition builds upon and strengthens Lexmark’s managed print services (“MPS”) and end-to-end business process solutions and expands the reach of Perceptive Software’s portfolio of leading content management and business process management (“BPM”) solutions. Due to the timing of this acquisition, as well as the other acquisitions that occurred in the first quarter of 2012, the purchase accounting for the acquisition of Brainware has not been finalized.
Of the total cash payment of $148.2 million, $147.3 million was paid to acquire the outstanding shares of Brainware, $0.6 million of which related to the payment of a promissory note and accrued interest owed to the shareholders of Brainware. Additionally, $0.8 million of the total cash payment was used to pay certain transaction costs of the seller and $0.1 million was accounted for as a post-combination expense in the Company’s financial statements.
The following table summarizes, on a provisional basis, the assets acquired and liabilities assumed as of the acquisition date:
* Deferred tax liability, net primarily relates to purchased identifiable intangible assets and is shown net of deferred tax assets.
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A change to the acquisition date provisional value of the identifiable net assets during the measurement period (up to one year from the acquisition date) will affect the amount of the purchase price allocated to goodwill. Adjustments during the measurement period may affect items reported on the Consolidated Condensed Statements of Earnings. Topics to re-examine in the future periods include identifiable intangible assets, income tax matters and deferred revenue.
The fair value of trade receivables approximated the carrying value of $6.6 million. The gross amount due from customers is $10.0 million, of which $3.4 million is estimated to be uncollectible.
The following table summarizes the provisional assessment of identifiable intangible assets recognized in the acquisition of Brainware. The intangible assets subject to amortization are being amortized on a straight-line basis over their estimated useful lives as of the acquisition date, according to the following schedule.
The Company assumed $4.0 million of short term debt in the acquisition. The debt was repaid in the first quarter of 2012 after the acquisition date and is included in Repayment of assumed debt in the financing section of the Company’s Consolidated Condensed Statements of Cash Flows. There was no gain or loss recognized on the extinguishment of the debt.
Provisional goodwill of $102.7 million arising from the acquisition was assigned to the Perceptive Software segment. The goodwill recognized comprises the value of expected synergies arising from the acquisition that are complementary to the Perceptive Software business. None of the goodwill recognized is expected to be deductible for income tax purposes.
The acquisition of Brainware is included in Purchases of businesses net of cash acquired in the investing section of the Consolidated Condensed Statements of Cash Flows for the period ended March 31, 2012 in the amount of $147 million, which is the total purchase price less cash acquired of $0.3 million. Of the total purchase price $11.3 million was placed in escrow for a period of 18 months to secure indemnification obligations of the sellers relating to the accuracy of representations and warranties and the satisfaction of covenants. The purchase consideration held in escrow does not meet the definition of contingent consideration as provided under the accounting guidance for business combinations. The amount held in escrow was included in the acquisition accounting as part of the consideration transferred by the Company.
During the first quarter of 2012, certain employees of Brainware were granted restricted stock units by the Company. Because the Company was not obligated to issue replacement share-based payment awards to the employees, the awards are accounted for as a separate transaction and recognized as post-combination expense over the requisite service period. These awards are not material for separate disclosure.
Certain income tax-related contingencies totaling $5.7 million were recognized by the Company. The Company is indemnified for this matter in the purchase agreement for an amount not to exceed the proceeds actually received by the selling shareholders in consummation of the acquisition. An indemnification asset of $2.5 million was recognized and measured on the same basis as the indemnified item, taking into account factors such as collectability. The measurement of the indemnification asset is subject to changes in management’s assessment of changes in both the indemnified item and collectability, including measurement period adjustments.
Because Brainware’s current levels of revenue and net earnings are not material to the Company’s Consolidated Condensed Statements of Earnings, supplemental pro forma revenue and net earnings disclosures have been omitted.
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Determination of Fair Value – Brainware
The total amount recognized for the acquired identifiable net assets was driven by the fair values of intangible assets. Valuation techniques and key inputs and assumptions used to value the most significant identifiable intangible assets are discussed below.
Customer relationships and purchased technology, or developed technology, were valued using the excess earnings method under the income approach, which estimates the value of the intangible assets by calculating the present value of the incremental after-tax cash flows, or excess earnings, attributable solely to the assets over the estimated periods that they generate revenues. After-tax cash flows were calculated by applying cost, expense, income tax, and contributory asset charge assumptions to the estimated customer relationships and developed technology revenue streams. Contributory asset charges included net working capital, net fixed assets, assembled workforce, trade name and trademarks, and non-compete agreements. The analysis of the developed technology was performed over a technology migration period of 11 years.
Trade name and trademarks were valued using the relief from royalty method under the income approach, which estimates the value of the intangible asset by discounting to fair value the hypothetical royalty payments a market participant would be willing to pay to enjoy the benefits of the asset. The royalty rate assumption was developed taking into account data regarding third party license agreements as well as certain characteristics of Brainware and its operations. Royalty rates of 0.5% and 1.5% were used in the valuation of the Brainware trade name and trademarks.
The after-tax cash flows for the intangible assets discussed directly above were discounted to fair value utilizing a required return of 16%.
The fair value of deferred revenue was determined based on the direct and incremental costs to fulfill the performance obligation plus a profit mark-up of 20% based on the consideration of a hypothetical third-party servicing firm which the Company believes is representative of market participant assumptions.
Other Acquisitions
On March 13, and 16, 2012 the Company acquired all of the issued and outstanding shares of Nolij Corporation (“Nolij”) and ISYS Search Software Pty Ltd. (“ISYS”), respectively, in cash transactions valued at $31.9 million and $29.6 million, respectively. Nolij is a prominent provider of web-based imaging, document management and workflow solutions for the higher education market. The acquisition of Nolij deepens Perceptive Software’s domain expertise in education, while also providing innovative web-based solutions that can be extended to apply to other industries. ISYS is a leading provider of high performance enterprise and federated search and document filtering software. The acquisition of ISYS strengthens Perceptive Software’s enterprise content management (“ECM”) and BPM solutions, allowing customers to seamlessly access needed content, stored anywhere in the enterprise, in the context of the business process in which they are working. This broadening and deepening of Lexmark’s capabilities further enhances the solutions expertise offered to its MPS customers. Due to the limited amount of time since the consummation of the acquisitions of Nolij and ISYS, the accounting for these business combinations has not been finalized.
Assets acquired, net of liabilities assumed amounted to a provisional value of $11.1 million and consisted primarily of identifiable intangible assets. Provisional goodwill of $50.4 million resulted from the acquisitions, none of which is expected to be deductible for income tax purposes. The acquired companies consisted mostly of technology and other related assets and processes to be utilized by the Company’s Perceptive Software segment.
The purchases of Nolij and ISYS are included in Purchases of businesses net of cash acquired in the Consolidated Condensed Statements of Cash Flows for the quarter ended March 31, 2012 in the amount of $57.6 million. Total cash acquired in the acquisitions of Nolij and ISYS was $2.0 million. Included in Cash and cash equivalents on the Company’s Consolidated Condensed Statements of Financial Position is $1.9 million which is restricted in use as it is due to a former shareholder of Nolij. This amount has been recognized as a liability incurred to a former shareholder.
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A change to the acquisition date provisional value of the identifiable net assets during the measurement period (up to one year from the acquisition date) will affect the amount of the purchase price allocated to goodwill. Adjustments during the measurement period may affect items reported on the Consolidated Condensed Statements of Earnings.
Because current levels of revenue and net earnings for Nolij and ISYS are not material to the Company’s Consolidated Condensed Statements of Earnings, supplemental pro forma revenue and net earnings disclosures have been omitted.
As discussed in Note 3 to the Consolidated Condensed Financial Statements the disclosures of goodwill and intangible assets shown below include provisional amounts that are subject to measurement period adjustments.
Goodwill
The following table summarizes the changes in the carrying amount of goodwill for each reportable segment and in total during the three months ended March 31, 2012.
The Company has recorded, on a provisional basis, $153.1 million of goodwill related to the acquisitions of Brainware, Nolij and ISYS in the quarter ended March 31, 2012. Refer to Note 3 for additional details regarding business combinations occurring in the quarter ended March 31, 2012. The Company does not have any accumulated impairment charges as of March 31, 2012.
Intangible Assets
The following table summarizes the gross carrying amounts and accumulated amortization of the Company’s intangible assets.
The year-to-date increases in the intangible assets above were driven by business combinations discussed in Note 3. Amortization expense related to intangible assets was $8.2 million and $5.6 million for the three months ended March 31, 2012 and 2011, respectively. The following table summarizes the estimated future amortization expense for intangible assets that are currently being amortized.
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The Perceptive Software trade name and trademarks valued at $32.3 million are considered to have an indefinite life taking into account their substantial recognition among customers, the intellectual property rights are secure and can be maintained with relatively little cost and effort, and there are no current plans to change or abandon usage of them. Costs to renew these registrations are insignificant and will be expensed as incurred. The Company does not intend to use the Pallas Athena, Brainware, Nolij and ISYS trade names and trademarks indefinitely, and has accordingly begun amortizing these assets.
The Company accounts for its internal-use software, an intangible asset by nature, in Property, plant and equipment, net on the Consolidated Condensed Statements of Financial Position and therefore has excluded these assets and amortization from the disclosures above. The gross and net carrying amounts of internal-use software at March 31, 2012 were $490.2 million and $230.9 million, respectively. The gross and net carrying amounts of internal-use software at December 31, 2011 were $479.2 million and $236.9 million, respectively.
5. RESTRUCTURING AND RELATED CHARGES
January 2012 Restructuring Plan
General
As part of Lexmark’s ongoing strategy to increase the focus of its talent and resources on higher usage business platforms, the Company announced restructuring actions (the “January 2012 Restructuring Plan”) on January 31, 2012. This action will better align the Company’s sales and marketing resources with its business customer focus, adjust manufacturing capacity in its declining legacy product lines, and align and reduce its support structure consistent with its focus on business customers. The Company expects to redeploy a significant portion of the savings from these initiatives towards business products, solutions and channels. The January 2012 Restructuring Plan includes reductions primarily in the areas of manufacturing, marketing, sales and other infrastructure. The Company expects these actions to be principally complete by the end of the first quarter of 2013.
The January 2012 Restructuring Plan is expected to impact about 625 positions worldwide. Total pre-tax charges of approximately $27 million are expected for the January 2012 Restructuring Plan with approximately $16.0 million incurred to date. Approximately $11.0 million of remaining charges are expected to be incurred in 2012. The Company expects the total cash cost of the January 2012 Restructuring Plan to be approximately $16 million.
The Company expects to incur total charges related to the January 2012 Restructuring Plan of approximately $24 million in Imaging Solutions and Services (“ISS”) and approximately $3 million in All other.
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Impact to 2012 Financial Results
For the three months ended March 31, 2012 the Company incurred charges for the Company’s January 2012 Restructuring Plan as follows:
Accelerated depreciation charges for the January 2012 Restructuring Plan and all of the other restructuring plans were determined in accordance with FASB guidance on accounting for the impairment or disposal of long-lived assets. For the three months ended March 31, 2012, the Company incurred $4.3 million of accelerated depreciation charges in Cost of revenue on the Consolidated Condensed Statements of Earnings.
Employee termination benefit charges for the January 2012 Restructuring Plan and all of the other restructuring plans were recorded in accordance with FASB guidance on employers’ accounting for postemployment benefits and guidance on accounting for costs associated with exit or disposal activities, as appropriate. For the three months ended March 31, 2012, employee termination benefit charges of $4.1 million, which include severance, medical and other benefits are included in Restructuring and related charges (reversals) on the Consolidated Condensed Statements of Earnings.
For the three months ended March 31, 2012, the Company incurred restructuring-related charges of $8.4 million related to the January 2012 Restructuring Plan in ISS. Including $7.6 million of restructuring-related charges in the fourth quarter of 2011, the Company has incurred cumulative restructuring-related charges of $16 million related to the January 2012 Restructuring Plan in ISS.
Liability Rollforward
The following table represents a rollforward of the liability incurred for employee termination benefits in connection with the January 2012 Restructuring Plan. The liability is included in Accrued liabilities on the Company’s Consolidated Condensed Statements of Financial Position.
October 2009 Restructuring Plan
General
On October 20, 2009, the Company announced the October 2009 Restructuring Plan as part of its ongoing plans to improve the efficiency and effectiveness of its operations. The Company continues its focus on refining its selling and service organization, reducing its general and administrative expenses, consolidating its cartridge manufacturing capacity, and enhancing the efficiency of its supply chain infrastructure. The actions taken will reduce cost and expense across the organization, with a focus in manufacturing and supply chain, service delivery overhead, marketing and sales support, corporate overhead and development positions as well as reducing cost through consolidation of facilities in supply chain and cartridge manufacturing. The October 2009 Restructuring Plan is considered substantially completed and any remaining charges to be incurred are expected to be immaterial.
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The October 2009 Restructuring Plan is expected to impact about 770 positions worldwide. Total pre-tax charges of approximately $70 million are expected for the October 2009 Restructuring Plan with $69.8 million of total charges incurred to date. The Company expects the total cash cost of the October 2009 Restructuring Plan to be approximately $57 million.
The Company expects to incur total charges related to the October 2009 Restructuring Plan of approximately $56 million in ISS and approximately $14 million in All other.
Impact to 2012 and 2011 Financial Results
For the three months ended March 31, 2012 and 2011, the Company incurred charges (reversals) for the October 2009 Restructuring Plan as follows:
For the three months ended March 31, 2012 and 2011, the Company recorded $0.2 million and $0.1 million of accelerated depreciation charges in Selling, general and administrative, respectively, on the Consolidated Condensed Statements of Earnings.
For the three months ended March 31, 2012 and 2011, employee termination benefit charges (reversals) of $0.6 million and $(1.6) million, respectively, are included in Restructuring and related charges (reversals) on the Consolidated Condensed Statements of Earnings. The $(1.6) million reversal for employee termination benefits is due primarily to revisions in assumptions.
For the three months ended March 31, 2012, the Company incurred restructuring-related charges of $0.6 million in ISS and $0.2 million in All Other. For the three months ended March 31, 2011, the Company incurred restructuring-related charges (reversals) of $(1.4) million in ISS and $(0.1) million in All other.
Liability Rollforward
The following table represents a rollforward of the liability incurred for employee termination benefits in connection with the October 2009 Restructuring Plan. Of the total $6.1 million restructuring liability, $3.3 million is included in Accrued liabilities and $2.8 million is included in Other liabilities on the Company’s Consolidated Condensed Statements of Financial Position.
Summary of Other Restructuring Actions
General
In response to global economic weakening, to enhance the efficiency of the Company’s inkjet cartridge manufacturing operations and to reduce the Company’s business support cost and expense structure, the Company announced various restructuring actions (“Other Restructuring Actions”) from 2006 to April 2009. The Other Restructuring Actions include the closure of inkjet supplies manufacturing facilities in Mexico as well as impacting positions in the Company’s general and administrative functions, supply chain and sales support, marketing and sales management, and consolidation of the Company’s research and development programs. The Other
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Restructuring Actions are considered substantially completed and any remaining charges to be incurred from these actions are expected to be immaterial.
Impact to 2012 and 2011 Financial Results
For the three months ended March 31, 2012 and 2011, the Company incurred charges for the Company’s Other Restructuring Actions as follows:
In the three months ended March 31, 2011, the Company recorded an impairment charge of $1.0 million related to its manufacturing facility in Juarez, Mexico held for sale for which the current fair value has fallen below the carrying value. The asset impairment charge was determined in accordance with the FASB guidance on accounting for the impairment or disposal of long-lived assets and is included in Selling, general and administrative on the Company’s Consolidated Condensed Statements of Earnings. The Company incurred no restructuring-related charges in the first quarter of 2012 related to its Other Restructuring Actions.
For the three months ended March 31, 2011, the Company incurred restructuring-related charges of $1.0 million in ISS.
Liability Rollforward
The following table represents a rollforward of the liability incurred for employee termination benefits in connection with the Company’s Other Restructuring Actions. The liability is included in Accrued liabilities on the Company’s Consolidated Condensed Statements of Financial Position.
6. MARKETABLE SECURITIES
The Company evaluates its marketable securities in accordance with authoritative guidance on accounting for investments in debt and equity securities, and has determined that all of its investments in marketable securities should be classified as available-for-sale and reported at fair value, with unrealized gains and losses recorded in Accumulated other comprehensive loss. The fair values of the Company’s available-for-sale marketable securities are based on quoted market prices or other observable market data, discount cash flow analyses, or in some cases, the Company’s amortized cost which approximates fair value.
Money market funds included in Cash and cash equivalents on the Consolidated Condensed Statements of Financial Position are excluded from the information contained in this Note. Refer to Note 2 of the Notes to the Consolidated Condensed Financial Statements for information regarding these investments.
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As of March 31, 2012, the Company’s available-for-sale Marketable securities had gross unrealized gains and losses of $4.4 million and $2.7 million, respectively, and consisted of the following:
At December 31, 2011, the Company’s available-for-sale Marketable securities had gross unrealized gains and losses of $3.9 million and $4.2 million, respectively, with an estimated fair value of $804.8 million excluding $8.5 million of cash equivalents.
Although contractual maturities of the Company’s investment in debt securities may be greater than one year, the majority of investments are classified as Current assets in the Consolidated Condensed Statements of Financial Position due to the Company’s ability to use these investments for current liquidity needs if required. As of March 31, 2012, and December 31, 2011, auction rate securities of $11.7 million and $11.5 million, respectively, are classified in noncurrent assets due to the fact that the securities have experienced unsuccessful auctions and that poor debt market conditions have reduced the likelihood that the securities will successfully auction within the next 12 months. The contractual maturities of the Company’s available-for-sale marketable securities noted above are shown below. Expected maturities may differ from final contractual maturities for certain securities that allow for call or prepayment provisions. Proceeds from calls and prepayments are included in Proceeds from maturities of marketable securities on the Consolidated Condensed Statements of Cash Flow.
For the three months ended March 31, 2012 and 2011, the Company recognized $1.2 million and $0.5 million, respectively, in net gains on its marketable securities; all of which is realized gains due to sales and maturities and is included in Other (income) expense, net on the Consolidated Condensed Statements of Earnings. The Company uses the specific identification method when accounting for the costs of its available-for-sale marketable securities sold.
Impairment
The FASB guidance on the recognition and presentation of OTTI requires that credit related OTTI on debt securities be recognized in earnings while noncredit related OTTI of debt securities not expected to be sold be recognized in other comprehensive income. For the three months ended March 31, 2012 and 2011, the Company incurred no OTTI on its debt securities.
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The table below presents a cumulative rollforward of the amount related to credit losses recognized in earnings for other-than-temporary impairments:
The following table provides information at March 31, 2012, about the Company’s marketable securities with gross unrealized losses for which no other-than-temporary impairment has been incurred, and the length of time that individual securities have been in a continuous unrealized loss position. The gross unrealized loss of $2.6 million, pre-tax, is recognized in accumulated other comprehensive income:
The table below provides information at March 31, 2012, about the Company’s marketable securities with gross unrealized losses for which other-than-temporary impairment has been incurred, and the length of time that individual securities have been in a continuous unrealized loss position. The gross unrealized loss of $0.1 million, pre-tax, is recognized in accumulated other comprehensive income:
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