XRIT X-Rite, Incorporated (MM)

 

 

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

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

For The Quarterly Period Ended October 1, 2011

Commission file number 0-14800

 

 

X-RITE, INCORPORATED

(Name of registrant as specified in charter)

 

 

 

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

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

(Address of principal executive offices)

616-803-2100

(Registrant’s telephone number, including area code)

 

 

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   ¨

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

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

 

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

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

On November 1, 2011, the number of outstanding shares of the registrant’s common stock, par value $.10 per share, was 86,028,099.

 

 

 

---

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

X-RITE, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in thousands)

 

		October 1, 2011				January 1, 2011
ASSETS
Current assets:
Cash		$	7,673			$	11,709
Accounts receivable, net of allowance of $1,463 in 2011 and $1,780 in 2010			33,934				31,796
Inventories, net			28,380				27,670
Deferred income taxes			—				697
Prepaid expenses and other current assets			4,809				4,959
			74,796				76,831
Property plant and equipment:
Land			2,796				2,796
Buildings and improvements			23,534				23,213
Machinery and equipment			37,891				33,570
Furniture and office equipment			26,229				25,560
Construction in progress			3,949				5,063
			94,399				90,202
Less accumulated depreciation			(55,404	)			(50,037	)
			38,995				40,165
Other assets:
Goodwill			233,958				233,952
Indefinite-lived intangibles			13,433				13,433
Other intangibles, net of accumulated amortization of $47,974 in 2011 and $56,247 in 2010			46,594				55,439
Capitalized software, net of accumulated amortization of $12,580 in 2011 and $9,229 in 2010			14,565				12,080
Deferred financing costs, net of accumulated amortization of $617 in 2011 and $6,609 in 2010			5,550				5,202
Deferred income taxes			5,467				—
Other noncurrent assets			1,712				1,993
			321,279				322,099
		$	435,070			$	439,095

 

The accompanying notes are an integral part of these statements.

2

---

X-RITE, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) - Continued

(in thousands, except share and per share data)

 

		October 1, 2011				January 1, 2011
LIABILITIES AND SHAREHOLDERS’ INVESTMENT
Current liabilities:
Current portion of long-term debt		$	9,597			$	1,350
Accounts payable			12,380				12,948
Accrued liabilities:
Payroll and employee benefits			10,064				14,017
Income taxes			1,166				292
Deferred income taxes			1,995				—
Deferred revenue			3,036				2,673
Derivative financial instruments			1,181				—
Other			3,736				3,547
			43,155				34,827
Other liabilities:
Long-term debt, less current portion			150,216				135,248
Mandatorily redeemable preferred stock			—				36,402
Long-term compensation and benefits			994				1,109
Deferred income taxes			2,462				3,182
Accrued income taxes			9,671				6,611
Other			740				176
			164,083				182,728
Shareholders’ investment:
Common stock, $.10 par value, 150,000,000 and 100,000,000 shares authorized; 85,338,346 and 84,805,040 issued and outstanding, in 2011 and 2010, respectively			8,534				8,481
Additional paid-in capital			276,514				274,697
Retained deficit			(68,585	)			(73,111	)
Accumulated other comprehensive income			11,369				11,473
			227,832				221,540
		$	435,070			$	439,095

The accompanying notes are an integral part of these statements.

 

3

---

X-RITE, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(in thousands, except per share data)

 

		Three Months Ended								Nine Months Ended
		October 1, 2011				October 2, 2010				October 1, 2011				October 2, 2010
Net Sales		$	57,003			$	55,428			$	179,136			$	163,782
Cost of sales			23,083				22,683				72,711				65,703
Gross profit			33,920				32,745				106,425				98,079
Operating expenses:
Selling and marketing			14,435				14,330				44,418				41,606
Research, development and engineering			5,749				6,128				18,055				17,628
General and administrative			5,377				5,335				15,803				16,829
Restructuring and other related charges			—				17				—				2,008
			25,561				25,810				78,276				78,071
Operating income			8,359				6,935				28,149				20,008
Interest expense			(2,262	)			(6,744	)			(10,297	)			(22,136	)
Loss on redemption of preferred shares and debt refinancing costs			—				(1,091	)			(13,828	)			(1,091	)
Other income (expense), net			1,913				(1,233	)			1,147				1,295
Income (loss) before income taxes			8,010				(2,133	)			5,171				(1,924	)
Income tax (benefit) expense			1,005				(2,001	)			645				(1,585	)
Net income (loss)		$	7,005			$	(132	)		$	4,526			$	(339	)
Basic and diluted net income (loss) per share		$	0.08			$	(0.00	)		$	0.05			$	(0.00	)

The accompanying notes are an integral part of these statements.

 

4

---

X-RITE, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)

 

		Nine Months Ended
		October 1, 2011				October 2, 2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)		$	4,526			$	(339	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation			4,850				4,594
Amortization			12,411				12,161
Amortization of deferred financing costs			1,285				2,118
Paid-in-kind interest accrued			—				3,188
Amortization of discount on mandatorily redeemable preferred stock			863				2,587
Deferred income tax credit			(3,484	)			(2,153	)
Share-based compensation			1,682				2,402
(Gain) loss on sale of assets			(199	)			329
Restructuring and other related charges			—				2,008
Loss on redemption of preferred shares and debt refinancing costs			13,828				1,091
Pension and postretirement benefit expense			1,663				1,730
Derivative fair value adjustments and charges			803				1,336
Changes in operating assets and liabilities:
Accounts receivable			(1,295	)			537
Inventories			(425	)			303
Prepaid expenses and other current assets			(1,618	)			(133	)
Accounts payable			(685	)			2,387
Income taxes			3,934				(885	)
Accrued payroll and employee benefits			(4,236	)			5,655
Other current and non-current liabilities			914				(7,693	)
Net cash provided by operating activities			34,817				31,223
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures			(3,648	)			(3,226	)
Increase in capitalized software			(5,644	)			(4,034	)
Proceeds from sales of assets			240				292
Net cash used for investing activities			(9,052	)			(6,968	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt			185,196				16,500
Payment of long-term debt			(162,346	)			(52,698	)
Redemption of mandatorily redeemable preferred stock			(46,980	)			—
Debt amendment and refinancing costs			(5,625	)			(430	)
Other			188				251
Net cash used for financing activities			(29,567	)			(36,377	)
EFFECT OF EXCHANGE RATE CHANGES ON CASH			(234	)			(2,161	)
NET DECREASE IN CASH			(4,036	)			(14,283	)
CASH AT BEGINNING OF YEAR			11,709				29,050
CASH AT END OF PERIOD		$	7,673			$	14,767

The accompanying notes are an integral part of these statements.

 

5

---

X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1—BASIS OF PRESENTATION

The unaudited condensed consolidated financial statements included herein have been prepared by X-Rite, Incorporated (“X-Rite” or the “Company”), pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2010 Annual Report on Form 10-K.

In the opinion of management, all adjustments considered necessary for fair presentation have been included in the accompanying unaudited condensed consolidated financial statements. All such adjustments were of a normal and recurring nature. The balance sheet at January 1, 2011 (fiscal year 2010) has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. Certain prior year information has been reclassified to conform with current year presentation.

The condensed consolidated financial statements include the accounts of X-Rite, Incorporated and its Subsidiaries. The Company has one operating segment as defined by ASC 280, Segment Reporting (ASC 280). As a result, the financial statement information provided has been presented to reflect one reportable segment, consisting of the Company’s consolidated results. All inter-company accounts and transactions have been eliminated. The Company reports its operations and cash flows on a 52-53 week basis ending on the Saturday closest to December 31. Both the current fiscal year ending December 31, 2011 (fiscal year 2011) and the prior fiscal year ending January 1, 2011 (fiscal year 2010) contain 52 weeks.

NOTE 2—NEW ACCOUNTING STANDARDS

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

In April 2010, the FASB issued ASU No. 2010-17, Revenue Recognition – Milestone Method (Topic 605): Milestone Method of Revenue Recognition. The ASU provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. Consideration that is contingent on achievement of a milestone in its entirety may be recognized as revenue in the period in which the milestone is achieved only if the milestone is judged to meet certain criteria to be considered substantive. Milestones are considered substantive in their entirety and may not be bifurcated. An arrangement may contain both substantive and nonsubstantive milestones, and each milestone should be evaluated individually to determine if it is substantive. The ASU is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010 (fiscal 2011 for the Company). The adoption of this new guidance in the first quarter of 2011 did not impact our financial position, results of operations, or cash flows.

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

 

6

---

X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

NOTE 2—NEW ACCOUNTING STANDARDS - continued

 

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

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

NOTE 3—INVENTORIES

Inventories consisted of the following (in thousands):

 

		October 1, 2011				January 1, 2011
Raw materials		$	19,603			$	16,309
Work in process			12,551				14,491
Finished goods			9,233				8,697
Gross Inventories			41,387				39,497
Reserves			(13,007	)			(11,827	)
Inventories, net		$	28,380			$	27,670

NOTE 4—GOODWILL, INDEFINITE-LIVED INTANGIBLES, AND OTHER AMORTIZABLE INTANGIBLE ASSETS

A summary of changes in goodwill and indefinite-lived intangibles for the nine months ended October 1, 2011, consisted of the following (in thousands):

 

		Goodwill				Indefinite-lived intangibles				Total
January 1, 2011		$	233,952			$	13,433			$	247,385
Foreign currency adjustments			6				—				6
October 1, 2011		$	233,958			$	13,433			$	247,391

The following is a summary of changes in net amortizable intangible assets for the nine months ended October 1, 2011 (in thousands):

 

		January 1, 2011				Amortization Expense				October 1, 2011
Technology and patents		$	20,787			$	(5,255	)		$	15,532
Customer relationships			30,434				(2,767	)			27,667
Trademarks and trade names			4,218				(823	)			3,395
Total		$	55,439			$	(8,845	)		$	46,594

 

7

---

X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

NOTE 4—GOODWILL, INDEFINITE-LIVED INTANGIBLES, AND OTHER AMORTIZABLE INTANGIBLE ASSETS - continued

 

Estimated future amortization expense for intangible assets as of October 1, 2011, for the succeeding years is as follows (in thousands):

 

Remaining 2011		$	2,948
2012			11,793
2013			4,954
2014			4,610
2015			4,610
Thereafter			17,679

NOTE 5—LONG-TERM DEBT

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

 

Senior secured term note, due March 30, 2016		$	159,813
Revolving credit facility, due March 30, 2016			—
			159,813
Less current portion			(9,597	)
Total long-term debt		$	150,216

Principal maturities on long-term debt are as follows (in thousands):

 

Remaining 2011		$	2,049
2012			8,195
2013			11,269
2014			15,367
2015			22,538
2016			100,395
		$	159,813

Senior Secured Credit Agreement

On March 30, 2011, the Company entered into a new senior secured credit agreement (the 2011 credit agreement) which provides for aggregate principal borrowings of up to $225 million. This credit agreement repaid in full and replaced the Company’s previous credit facilities and funded the redemption of all outstanding Series A Preferred Stock (mandatorily redeemable preferred stock or MRPS). The 2011 credit agreement consists of a $170 million term loan and an available $55 million revolving credit facility, which both mature on March 30, 2016. Obligations under the 2011 credit agreement are secured by essentially all of the tangible and identifiable intangible assets of the Company, with the exception of real estate. The 2011 credit agreement provides variable interest rate options from which the Company may select, as described below, and the unused portion of the revolving credit facility is subject to a fee of 0.5 percent per annum. The 2011 credit agreement contains operational and financial covenants that, in addition to obligating the Company to deliver financial reports and maintain certain financial ratios, limits the Company’s ability to create liens, incur indebtedness, make fundamental changes involving the Company and its subsidiaries, make investments or acquisitions, and make certain capital expenditures, among other things. As of October 1, 2011, the Company was in compliance with the covenants contained in its 2011 credit agreement.

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

 

8

---

X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

NOTE 5—LONG-TERM DEBT - continued

 

Outstanding borrowings under the 2011 credit agreement bear interest at a rate per annum equal to LIBOR or Prime interest rate, plus a 3.25 and 2.25 percent margin, respectively (subject to adjustments based on the Company’s consolidated leverage ratio), payable in arrears on the last day of the applicable interest period but in no event less frequently than every three months. As of October 1, 2011, the weighted average interest rate in effect under the terms of the 2011 credit agreement was 3.94 percent. The Company holds interest rate swaps to limit a portion of its LIBOR exposure (see Note 7 for further discussion).

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

Under the previous credit agreement, the Company had the option to choose LIBOR or Prime interest rate indices. The LIBOR index was based on the three month LIBOR (subject to a floor of 3.0 percent) plus a 3.5 percent margin and the Prime index was based on the Prime Rate plus a 2.5 percent margin during the quarter. Prior to entering into the 2011 credit agreement, the Company had designated its borrowings under the Prime interest rate, with an effective interest rate of 5.75 percent. Interest payments on the Prime Rate based borrowings were paid in full at the time the loan was repaid.

The Company’s estimate of fair value for debt approximates its carrying amount as of October 1, 2011.

Subsequent to the quarter ended October 1, 2011, the Company made voluntary payments of $1.4 million against its senior secured borrowings.

Deferred Financing Costs

In connection with the 2011 credit agreement, the Company has $6.2 million of deferred financing costs, consisting of $2.3 million of current fees to creditors and third parties and $3.9 million of unamortized deferred financing costs associated with the previous credit facility. These costs are being amortized over the life of the related agreement.

NOTE 6—MANDATORILY REDEEMABLE PREFERRED STOCK AND WARRANTS

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

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

At the time of issuance of the MRPS the Company issued freestanding warrants to acquire 7.5 million shares of the Company’s common stock (the Warrants) at an exercise price of $0.01 per share. The Warrants required shareholder approval prior to exercise, and shareholder approval was obtained at a special meeting of the shareholders on October 28, 2009. In November 2009, the Company issued 7.5 million shares of common stock upon the exercise of the Warrants by the holders. The Company determined the fair value of the Warrants was $15.5 million on the issuance date using the Black-Scholes Option Pricing model, which was classified as a discount on the MRPS. The discount was accreted to interest expense in the accompanying consolidated condensed statement of operations over the period of issuance to the mandatory redemption date of the MRPS. There was no accretion for the three months ended October 1, 2011 and the accretion was $0.9 million for the nine months ended October 1, 2011. The accretion for the three and nine month periods ended October 2, 2010 was $0.9 million and $2.6 million, respectively. Unamortized discount on MRPS of $9.8 million was included in the loss on redemption of preferred shares and debt refinancing costs recorded in connection with the entry into 2011 credit agreement, as described in Note 5.

 

9

---

X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

NOTE 7—FINANCIAL INSTRUMENTS

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

 

		Level 1:		Financial instruments with unadjusted, quoted prices listed on active market exchanges.
		Level 2:		Financial instruments lacking unadjusted, quoted prices from active market exchanges, including over-the- counter traded financial instruments. The prices for the financial instruments are determined using prices for recently traded financial instruments with similar underlying terms as well as directly or indirectly observable inputs, such as interest rates and yield curves that are observable at commonly quoted intervals.
		Level 3:		Financial instruments that are not actively traded on a market exchange. This category includes situations where there is little, if any, market activity for the financial instrument. The prices are determined using significant unobservable inputs or valuation techniques.

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

The Company has classified its interest rate swaps, currency forward contracts, and interest rate caps within Level 2 of the fair value hierarchy. As of October 1, 2011 and January 1, 2011, the net carrying value of these instruments was $(1.2) million and a nominal amount, respectively, classified in other current assets (liabilities) in the Company’s consolidated balance sheet. Fair values are measured as the present value of all expected future cash flows adjusted to reflect the credit quality of the party bearing the cash flow obligation to pay if significant.

Accounting for Derivative Financial Instruments

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

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

Interest Rate Swaps

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

On May 24, 2011, the Company entered into two interest rate swap agreements (swaps), each with a notional value of $30.0 million. The swaps became effective on June 30, 2011 and will terminate on March 30, 2014. As of October 1, 2011, the fair value of the swaps was a liability of $1.1 million. For the three and nine month periods ended October 1, 2011, the change in fair value recorded as a component of accumulated other comprehensive income was $0.7 million and $1.1 million, respectively.

 

10

---

X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

NOTE 7—FINANCIAL INSTRUMENTS - continued

 

On April 21, 2008, the Company terminated its 2006 series of interest rate swap agreements. Due to termination of the interest rate swap contracts in April 2008, related accumulated other comprehensive loss balances have been frozen and will be recognized as interest expense over the period of the original hedged cash flows. Interest expense recorded related to the terminated swaps during the three and nine months ended October 1, 2011 totaled $0.1 million and $0.4 million, respectively. The remaining balance in accumulated other comprehensive income related to these terminated swaps was nominal as of October 1, 2011.

Currency Forward Contracts

During 2011 the Company has entered into a series of short term currency forward contracts (the forwards) to limit its exposure to fluctuations between the Euro and the Swiss Franc. At October 1, 2011, the Company maintained two €0.5 million net settle contracts (total notional amount of $1.4 million), that mature monthly through November 2011.

At inception, the forwards were not designated as a hedge under ASC 815, therefore adjustments to fair value are recorded to the balance sheet with a corresponding change to foreign currency transaction gains and losses included in other income (expense) in the statement of operations. For both the three and nine month periods ended October 1, 2011, the currency gains and losses associated with the forward contracts were $0.1 million.

Interest Rate Cap

On December 30, 2008, the Company purchased an interest rate cap to limit its exposure to increases in the 3 month LIBOR rate above 3 percent per annum. The cost of the interest rate cap was $1.6 million, payment for which was made in January 2009. The cap became effective January 6, 2009, at a notional amount of $256.0 million. The notional amount amortizes downward every six months through January 6, 2012.

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

On April 4, 2010, the interest rate cap was de-designated as a cash flow hedge by the Company. The fair value of the cap as of the de-designation date was an asset of $0.2 million. Due to the de-designation of the cap in April 2010, related accumulated other comprehensive loss balances have been frozen and will be recognized as interest expense over the period of the original hedged cash flows. Interest expense recorded related to the amortization of unrealized losses frozen in accumulated other comprehensive loss during the three and nine months ended October 1, 2011 was $0.1 million and $0.4 million, respectively. The remaining balance in accumulated other comprehensive income related to the cap was $0.1 million as of October 1, 2011, all of which is expected to be reclassified to earnings during the next three months.

Because LIBOR was not above the capped rate, the Company did not receive cash from the existing interest rate cap agreements during the three and nine month periods ended October 1, 2011.

NOTE 8—SHARE-BASED COMPENSATION

The Company accounts for share-based compensation in accordance with ASC 718, Share-Based Payment (ASC 718). Share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense on a straight-line basis over the requisite service or performance periods.

The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing model. The valuation model relies on subjective assumptions that can materially affect the estimated value of options and it may not provide an accurate measure of the fair value of the Company’s stock options. Restricted stock awards and units are valued at closing market price on the date of the grant. Compensation expense for shares issued under the Employee Stock Purchase Plan is recognized for 15 percent of the market value of shares purchased, using the purchase date closing market price. This expense is recognized in the quarter to which the purchases relate.

 

11

---

X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

NOTE 8—SHARE-BASED COMPENSATION - continued

 

Valuation of Share-Based Compensation

The Company used the following assumptions in valuing employee options granted during the three and nine months ended October 1, 2011 and October 2, 2010:

 

		Three Months Ended				Nine Months Ended
		October 1, 2011				October 1, 2011				October 2, 2010
Dividend yield			0	%			0	%			0	%
Volatility			56	%			56	%			56	%
Risk-free interest rates			1.5 -1.8	%			1.5 -2.6	%			2.8 -3.1	%
Expected term of options			7 years				7 years				7 years

Share-Based Compensation Expense

Total share-based compensation expense recognized in the condensed consolidated statements of operations for the three and nine month periods ended October 1, 2011 and October 2, 2010 were as follows (in thousands):

 

		Three Months Ended								Nine Months Ended
		October 1, 2011				October 2, 2010				October 1, 2011				October 2, 2010
Stock options		$	335			$	402			$	960			$	1,287
Restricted stock awards			194				210				530				834
Restricted stock units			79				88				175				264
Employee stock purchase plan			4				4				17				17
Total share-based compensation expense		$	612			$	704			$	1,682			$	2,402

All share-based compensation expense was recorded in the Condensed Consolidated Statements of Operations in the line in which the salary of the individual receiving the benefit was recorded. As of October 1, 2011, there was unrecognized compensation cost for non-vested share-based compensation of $1.6 million related to options, $1.1 million related to restricted share awards, and $0.6 million related to restricted share units. These costs are expected to be recognized over remaining weighted average periods of 1.5, 1.1, and 1.0 years, respectively.

NOTE 9—EMPLOYEE BENEFIT PLANS

401(k) Retirement Savings Plan

The Company maintains a 401(k) retirement savings plan for the benefit of substantially all full time U.S. employees. Investment decisions are made by individual employees. Investment in Company stock is not allowed under the plan. The matching contributions of the Company are discretionary. In conjunction with its restructuring efforts, the Company suspended its match of employee contributions under this plan in the first quarter of 2009. The Company reinstated the matching of contributions in the second quarter of 2010. The Company’s matching expense for the plan was $0.2 million and $0.7 million for the three and nine months ended October 1, 2011 and $0.2 million and $0.4 million for the three and nine months ended October 2, 2010, respectively.

Defined Benefit Plan

The Company maintains a defined benefit plan for employees of its X-Rite Europe GmbH subsidiary in Switzerland. The plan is part of an independent collective fund which provides pensions combined with life and disability insurance. The assets of the funded plans are held independently of X-Rite’s assets in a legally distinct and independent collective trust fund which serves various unrelated employers. The Fund’s benefit obligations are fully reinsured by Swiss Life Insurance Company. The plan is valued by independent actuaries using the projected unit credit method. The liabilities correspond to the projected benefit obligations of which the discounted net present value is calculated based on years of employment, expected salary increases, and pension adjustments.

 

12

---

X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

NOTE 9—EMPLOYEE BENEFIT PLANS - continued

 

Net projected periodic pension cost of the plan includes the following components (in thousands):

 

		Three Months Ended								Nine Months Ended
		October 1, 2011				October 2, 2010				October 1, 2011				October 2, 2010
Service cost		$	839			$	831			$	2,424			$	2,398
Interest			233				188				672				541
Expected return on plan assets			(232	)			(200	)			(680	)			(576	)
Less contributions paid by employees			(260	)			(219	)			(753	)			(633	)
Net periodic pension cost		$	580			$	600			$	1,663			$	1,730

The Company is currently evaluating what additional contributions, if any, will be made to the pension plan during the remainder of 2011. Actual contributions will be dependent upon investment returns, changes in pension obligations, and other economic and regulatory factors.

NOTE 10—INCOME TAXES

For the three and nine month periods ended October 1, 2011, the Company recorded tax expense of $1.1 million and $0.7 million against pre-tax income of $8.1 million and $5.2 million, respectively, resulting in an effective income tax rate of 12.5 percent for both periods. In the three month period ended October 1, 2011, the Company recorded income tax expense of $1.6 million related primarily to income tax in foreign countries offset by income tax benefits of $0.4 million primarily related to foreign tax deductions on intangible asset amortization charges and $0.1 million related primarily to its liability for uncertain tax positions. For the nine months ended October 1, 2011, the Company recorded income tax expense of $1.9 million related primarily to income tax in foreign countries offset by income tax benefits of $1.1 million primarily related to foreign tax deductions on intangible asset amortization charges and $0.1 million related primarily to a state tax refunds received and anticipated.

For the three and nine month periods ended October 2, 2010, the Company recorded tax benefit of $2.0 million and $1.6 million against pre-tax losses of $2.1 million and $1.9 million, respectively, resulting in an effective income tax rate of 93.8 percent and 82.4 percent. In the three month period ended October 2, 2010, the Company recorded income tax benefit of $1.2 million related to foreign operations, $0.4 million representing interest charges related to its liability for uncertain tax positions, and an income tax benefit of $0.4 million primarily related to foreign tax deductions on intangible asset amortization charges. For the nine month period ended October 2, 2010, the Company recorded income tax expense of $0.3 million for tax examination adjustments to a previously filed refund claim, $0.1 million related to share-based compensation, and income tax benefits of $0.4 million related to its liability for uncertain tax positions, $0.4 million related to foreign operations, and $1.2 million primarily related to foreign tax deductions on intangible asset amortization charges.

The U.S. statutory rate for both tax years was 35.0 percent. The Company cannot currently recognize future potential tax benefits associated with its U.S. domestic operating losses and has valuation allowances recorded against related net federal deferred income tax assets. In addition, the income tax provision reflects the fact that foreign taxes are currently not subject to foreign tax credit offsets given the net operating losses accumulated domestically.

The Company maintains income tax accruals related to uncertain tax benefits, inclusive of accrued interest, totaling $9.7 million and $6.6 million as of October 1, 2011 and January 1, 2011, respectively. The Company enters into intercompany transactions that the various taxing jurisdictions require to be maintained at arm’s length pricing. While the Company believes the transaction as reported are appropriate, due to the related party nature of the transaction, it is common for uncertainty related to appropriate pricing to exist. Therefore, the Company has increased its uncertain tax benefit accrual primarily due to tax positions the Company reported related to these allocations among the various jurisdictions. The $3.1 million increase was offset by available net operating loss carryovers, the benefit of which has not previously been recognized because of the existing valuation allowances and is included in the tax expense reported for three and nine month periods as presented above.

For the majority of tax jurisdictions, the Company is no longer subject to U.S. federal, state, and local, or non-U.S. income tax examinations by tax authorities for years before 2007.

 

13

---

X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

NOTE 11—RESTRUCTURING AND OTHER RELATED CHARGES

Restructuring and other related charges include the costs the Company incurred to execute various corporate restructuring activities. These charges included cash costs, accrued liabilities, asset write-offs, lease termination costs, and employee severance pay resulting from layoffs. All restructuring activities were completed in fiscal 2010.

For the three months ended October 2, 2010, the Company recorded a nominal amount of restructuring charges in operating expenses. For the nine months ended October 2, 2011, the Company incurred $2.0 million in restructuring charges, all of which were recorded in operating expenses. Approximately $1.2 million of the restructuring expense consisted of severance costs and $0.8 million of other related charges. All restructuring obligations were paid as of January 1, 2011.

NOTE 12—EARNINGS PER SHARE

The following table reconciles the numerators and denominators used in the calculations of basic and diluted earnings (loss) per share (EPS) (in thousands):

 

		Three Months Ended								Nine Months Ended
		October 1, 2011				October 2, 2010				October 1, 2011				October 2, 2010
Numerators:
Net income (loss) for both basic and diluted EPS		$	7,005			$	(132	)		$	4,526			$	(339	)
Denominators:
Denominators for basic EPS: weighted-average common shares outstanding			85,329				84,510				85,169				84,318
Dilutive potential shares			1,394				—				1,474				—
Denominators for diluted EPS			86,723				84,510				86,643				84,318

The number of stock options and awards that were not included in the diluted earnings (loss) per share calculation because the effect would have been anti-dilutive was approximately 1,798 and 1,743, respectively, for the three and nine month periods ended October 1, 2011 and 6,360 and 6,554, respectively, for the three and nine month periods ended October 2, 2010. The number of performance shares and units that were excluded from the diluted earnings (loss) per share calculation because the performance targets were not met was 1,026 and 1,118, respectively, for the three and nine month periods ended October 1, 2011 and 1,182 and 1,198, respectively, for the three and nine month periods ended October 2, 2010.

NOTE 13—COMPREHENSIVE INCOME

Comprehensive income (loss) was $3.1 million and $3.6 million for the three months ended October 1, 2011 and October 2, 2010, respectively. Comprehensive income (loss) was $4.4 million and $(1.4) million for the nine months ended October 1, 2011 and October 2, 2010, respectively. The components of ending accumulated other comprehensive income (loss) are as follows (in thousands):

 

		Foreign currency translation adjustments				Net unrealized income (loss) on derivative financial instruments (net of tax effects)				Pension adjustments (net of tax effects)				Total Accumulated Other Comprehensive Income (Loss)
Balance on January 1, 2011		$	11,541			$	(900	)		$	832			$	11,473
Other comprehensive income for the nine months ended October 1, 2011			202				(338	)			32				(104	)
Balance on October 1, 2011		$	11,743			$	(1,238	)		$	864			$	11,369

 

14

---

X-RITE, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

NOTE 14—CONTINGENCIES, COMMITMENTS, AND GUARANTEES

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

The Company has provided to third parties standby letters of credit and performance guarantees with face amounts of $0.8 million and $0.7 million, respectively. The terms of these agreements, including renewal provisions and expected performance periods, expire at various dates through January 2013.

The Company offers standard product warranties ranging from one to three years.

 

15

---

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

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

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

OVERVIEW OF THE COMPANY

X-Rite, Incorporated is a technology company that develops a full range of color management systems. The Company develops, manufactures, markets and supports innovative color solutions through measurement systems, software, color standards and services. The Company’s technologies assist manufacturers, retailers and distributors in achieving precise color appearance throughout their global supply chain. X-Rite products also assist printing companies, graphic designers, and professional photographers in achieving precise color reproduction of images across a wide range of devices and from the first to the last print. The Company’s products also provide retailers color harmony solutions at point of purchase. The key markets served through the Company’s product lines include Imaging and Media, Industrial, and Retail. X-Rite generates revenue by selling products and services through a direct sales force as well as select distributors. The Company has sales and service facilities located in the Americas, Europe, and Asia.

Third Quarter 2011 Highlights:

 

•

Net sales of $57.0 million, up 2.8 percent from the third quarter 2010

 

•

Operating income of $8.4 million, up $1.5 million or 20.5 percent from the third quarter 2010

 

•

Net income of $7.0 million, up $7.1 million from the third quarter 2010

 

•

Fully diluted earnings of $0.08 per share, up from $0.00 per share in the third quarter 2010

 

•

Debt re-payments of $11.8 million in the third quarter 2011

 

16

---

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - continued

 

RESULTS OF OPERATIONS

The following table summarizes the results of the Company’s operations for the three and nine month periods ended October 1, 2011 and October 2, 2010 (in millions):

 

		Three Months Ended																Nine Months Ended
		October 1, 2011								October 2, 2010								October 1, 2011								October 2, 2010
Net sales		$	57.0				100.0	%		$	55.4				100.0	%		$	179.1				100.0	%		$	163.7				100.0	%
Cost of sales			23.1				40.5				22.7				40.9				72.7				40.6				65.7				40.1
Gross profit			33.9				59.5				32.7				59.1				106.4				59.4				98.0				59.9
Operating expenses			25.5				44.8				25.8				46.6				78.2				43.7				78.0				47.7
Operating income			8.4				14.7				6.9				12.5				28.2				15.7				20.0				12.2
Interest expense			(2.3	)			(4.0	)			(6.7	)			(12.2	)			(10.3	)			(5.7	)			(22.1	)			(13.5	)
Loss on redemption of preferred shares and debt refinancing cost			—				—				(1.1	)			(2.0	)			(13.8	)			(7.7	)			(1.1	)			(0.7	)
Other income (expense), net			2.0				3.4				(1.2	)			(2.2	)			1.1				0.6				1.3				0.8
Income (loss) before income taxes			8.1				14.1				(2.1	)			(3.9	)			5.2				2.9				(1.9	)			(1.2	)
Income tax (benefit) expense			1.1				1.8				(2.0	)			(3.6	)			0.7				0.4				(1.6	)			(1.0	)
Net income (loss)		$	7.0				12.3	%		$	(0.1	)			(0.3	)%		$	4.5				2.5	%		$	(0.3	)			(0.2	)%

Net Sales

The following table denotes net sales by product line for the three and nine month periods ended October 1, 2011 and October 2, 2010 (in millions):

 

		Three Months Ended																Nine Months Ended
		October 1, 2011								October 2, 2010								October 1, 2011								October 2, 2010
Imaging and Media		$	21.7				38.1	%		$	23.0				41.5	%		$	67.7				37.8	%		$	64.9				39.6	%
Industrial			11.6				20.4				10.5				18.9				38.6				21.5				33.5				20.5
Standards			11.8				20.7				10.9				19.6				35.8				20.0				31.5				19.3
Support Services			7.2				12.6				6.4				11.5				22.0				12.3				19.4				11.8
Retail			3.5				6.1				3.5				6.5				11.5				6.4				10.8				6.6
Other			1.2				2.1				1.1				2.0				3.5				2.0				3.6				2.2
Total		$	57.0				100.0	%		$	55.4				100.0	%		$	179.1				100.0	%		$	163.7				100.0	%

Net sales for the three and nine month periods ended October 1, 2011 increased $1.6 million and $15.4 million, or 2.8 percent and 9.4 percent, respectively, over the comparable periods in 2010. For the three months ended October 1, 2011, all product lines realized net sales growth with the exception of Imaging and Media. All of the product lines realized net sales increases for the nine months ended October 1, 2011 with the exception of Other. The Company’s sales growth was the result of recently launched product and marketing initiatives and the positive effect of exchange rate changes.

The Company’s primary foreign exchange exposures are from the Euro and the Swiss Franc. The impact of fluctuations in these currencies was reflected mainly in the Company’s European operations. Foreign currency fluctuations had a $2.2 million favorable effect on net sales for the three months ended October 1, 2011 and a $6.5 million favorable effect on net sales for the nine months ended October 1, 2011, as compared to the same periods in 2010.

 

17

---

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - continued

 

The Imaging and Media product lines provide solutions for commercial and package printing applications, digital printing and photo processing, photographic, graphic design and pre-press service bureaus in the imaging industries. Imaging and Media product line net sales were down $1.3 million or 5.8 percent for the three months ended October 1, 2011 and up $2.8 million or 4.2 percent for the nine months ended October 1, 2011, over strong double digit growth performance in the comparable periods in 2010. The performance for the three months ended October 1, 2011 was heavily influenced by a slowdown in demand for printing solutions into large press manufacturers. This slowdown, along with volatile after-market channel demand for printing solutions, was too significant in the period to be fully offset by strong digital printing sales in the OEM channel. Recently released new imaging products designed for the creative markets (e.g. photographers and designers) enjoyed continued year over year sales growth in the period. The increase in net sales for the nine month period ended October 1, 2011, was driven by multiple factors including demand in the Company’s OEM channel, focused sales programs for printing markets in Asia Pacific, and growing demand for recently released new products, particularly the new i1 Professional product family, including the i1 Profiler, i1 Display 3 and ColorMunki Display products.

The Industrial product line provides color measurement solutions for the quality control, process control and global supply chain markets. The Company’s products are an integral part of the manufacturing process for automotive interiors and exteriors, as well as textiles, plastics, and dyes. Industrial product line net sales continued to see double digit growth and were up $1.1 million or 10.9 percent for the three months ended October 1, 2011 and up $5.1 million or 15.1 percent for the nine months ended October 1, 2011, over the comparable periods of 2010. These results reflect strong growth for the three and nine month periods ended October 1, 2011 in Asia Pacific and Europe. Multiple products in various regions reported strong sales growth year over year. New products such as the Company’s Multi-Angle instruments are setting the pace in the Industrial product line. In the three months ended October 1, 2011, the Company also reported increased sales for online quality control solutions.

The Standards product line includes products for the accurate communication and reproduction of color, servicing worldwide customers in a variety of industries including imaging and media, textiles, digital technology, plastics and paint. Standards product line net sales were up $0.9 million or 7.9 percent for the three months ended October 1, 2011 and up $4.3 million or 13.4 percent for the nine months ended October 1, 2011, over the comparable periods of 2010. The year to date growth was paced by strong sales of new products. Key contributors to such growth include the new Pantone Matching System (PMS+), the recent addition of 175 new colors in Pantone’s Fashion & Home product portfolio, and Pantone edition of the CAPSURE ^TM platform for designers.

The Support Services product line provides professional color training and support worldwide through seminar training, classroom workshops, on-site consulting, technical support and interactive media development. This group also manages the Company’s global service repair departments. The products repaired by the service department include the Company’s products currently covered by our warranty program as well as those products which have expired warranties. Support Services product line net sales were up $0.8 million or 13.4 percent for the three months ended October 1, 2011 and up $2.6 million or 13.7 percent for the nine months ended October 1, 2011, over the comparable periods of 2010. The Company is continuing to see the strong demand for repair and professional services that it experienced in 2010. New service programs, expanding the installed base through new sales growth in Asia Pacific, and selected price increases contributed to the growth experienced in the three and nine months ended October 1, 2011.

The Retail product line markets paint matching products under the Match-Rite name to home improvement centers, mass merchants, paint retailers, and paint manufacturers. Retail product line net sales were flat for three months ended October 1, 2011 and were up $0.7 million or 6.3 percent for the nine months ended October 1, 2011, over the comparable periods of 2010. For the nine months ended October 1, 2011, a majority of the growth was experienced in Europe. As the Retail business tends to be large project oriented, the static sales for the three months ended October 1, 2011 is primarily related to timing of our large projects during this period.

The Company’s products denoted as Other primarily serve the Medical and Dental markets. The Medical product line provides instrumentation designed for use in controlling variables in the processing of x-ray film and other applications. The Dental product line provides shade matching technology to the cosmetic dental industry through X-Rite’s ShadeVision and Shade-X systems. Other product line net sales for the three and nine months ended October 1, 2011, were relatively unchanged when compared to the same periods of 2010 due to limited market demand for these products.

 

18

---

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - continued

 

The Company primarily experienced net sales increases in the three and nine month periods ended October 1, 2011, when compared to the three and nine month periods ended October 2, 2010, in all of the major geographic regions of the world where it conducts business:

Americas- Net sales were down $0.4 million or 2.0 percent for the three months ended October 1, 2011 and up $1.9 million or 3.0 percent for the nine months ended October 1, 2011, over the comparable periods of 2010. For the nine month period ended October 1, 2011, improved sales in the Standards and Support Services lines were offset by lower sales in Imaging and Media and Industrial markets. While the decrease for the three months ended October 1, 2011 was marginally impacted by most product lines. North America growth was primarily impacted by sluggish sales in the printing product line and timing of large project sales in the retail product line. Shipments during the three months ended October 1, 2011 in the America’s Industrial business were lower than last year, and delayed project rollouts to architectural paint companies and big box retailers contributed to the year over year shortfall as well. New product demand was robust in the Imaging product family including sales to photographers and other creative professionals.

Europe- Net sales were up $0.9 million or 4.1 percent for the three months ended October 1, 2011 and up $9.9 million or 16.5 percent for the nine months ended October 1, 2011, over the comparable periods of 2010. The growth is broad based with Industrial, Printing, and Standards product lines contributing most substantially. The Retail/paint product line also recorded strong sales growth in the three months ended October 1, 2011. These positive results were negatively influenced by the slowdown in printing solutions sales to a major press manufacturer based in Europe. Currency exchange rates in the three and nine months ended October 1, 2011 versus 2010 provided a favorable impact on sales.

Asia Pacific- Net sales were up $1.1 million or 8.4 percent for the three months ended October 1, 2011 and up $3.5 million or 8.7 percent for the nine months ended October 1, 2011, over the comparable periods of 2010. In both the three and nine month periods ended October 1, 2011, strong growth in the Industrial, Standards, and Support Services product lines, more than offset a slowdown in shipments to our OEM partners in the region for the three months ended October 1, 2011. Increased investments in the Company’s organizational capabilities and partnerships have been made in Asia over the last year with the expectation that future growth in Asia will outperform other markets.

Cost of Sales and Gross Profit

Gross profit for the three months ended October 1, 2011 was $33.9 million or 59.5 percent of sales, compared with $32.7 million or 59.1 percent of sales, for the three months ended October 2, 2010. Gross profit for the nine months ended October 1, 2011 was $106.4 million or 59.4 percent of sales, compared with $98.0 million or 59.9 percent of sales, for the nine months ended October 2, 2010. The year to date decrease in gross margin was primarily due to the impact of currency exchange rate changes with a small negative impact related to customer and product sales mix.

Operating Expenses

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

 

		Three Months Ended																Nine Months Ended
		October 1, 2011								October 2, 2010								October 1, 2011								October 2, 2010
Selling and marketing		$	14.4				25.3	%		$	14.3				25.9	%		$	44.4				24.8	%		$	41.6				25.4	%
Research, development and engineering			5.7				10.0				6.1				11.1				18.0				10.1				17.6				10.8
General and administrative			5.4				9.5				5.4				9.6				15.8				8.8				16.8				10.3
Restructuring and other related charges			—				—				—				—				—				—				2.0				1.2
Total		$	25.5				44.8	%		$	25.8				46.6	%		$	78.2				43.7	%		$	78.0				47.7	%

For the three and nine month periods ended October 1, 2011, selling and marketing expenses increased by $0.1 million or 0.7 percent and $2.8 million or 6.8 percent, respectively, over the comparable periods of 2010. For the three and nine month periods ended October 1, 2011, research, development and engineering expenses decreased by $0.4 million or 6.2 percent and increased by $0.4 million or 2.4 percent, respectively, as compared with the same periods of 2010. For the three and nine month periods ended October 1, 2011, general and administrative expenses remained flat and decreased by $1.0 million or 6.1 percent, respectively, as compared with the same periods of 2010.

 

19

---

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - continued

 

The overall changes in operating expenses for the three and nine month periods ended October 1, 2011 is primarily related to currency fluctuations and the strategic growth initiatives of the Company. The increase in selling and marketing expense for the three and nine month periods ended October 1, 2011 is attributable to the Company’s strategic market initiatives in the Asia Pacific region and Standards product line. Research, development, and engineering expense decreased for the three month period ended October 1, 2011 due to a reduction in employee benefits and variable compensation. Research, development, and engineering expense increased for the nine month period ended October 1, 2011 due to acceleration of new product development and higher software development costs. For the three month period ended October 1, 2011, general and administrative expenses remained flat due to continued cost management actions. For the nine month period ended October 1, 2011, general and administrative expenses decreased primarily due to lower share based compensation expense.

Operating Income (Loss)

Operating income was $8.4 million and $28.2 million for the three and nine months ended October 1, 2011, as compared to operating income of $6.9 million and $20.0 million in the comparable periods of 2010. Operating income was favorably impacted by the increase in net sales across several product lines. The improved operating income is also a reflection of the Company’s profit margins and continued cost management.

Other Income (Expense)

Interest Expense

Total interest expense incurred by the Company for the three and nine month periods ended October 1, 2011 was $2.3 million and $10.3 million, respectively, including expense related to deferred financing fees, terminated swap agreements, and the de-designated interest rate cap. For the three and nine month periods ended October 1, 2011, this is an improvement of 66.5 percent and 53.5 percent , respectively, over the comparable periods in 2010 and is largely attributable to the pay down of debt that occurred during 2010 and 2011, coupled with the debt refinancing in the first quarter of 2011. Cash based interest on long-term debt was $1.7 million and $5.5 million for the three and nine month periods ended October 1, 2011, respectively, which is an improvement of 45.6 percent and 59.0 percent over the comparable periods of 2010. The decrease in cash based interest was principally due to savings on the MRPS redeemed effective March 30, 2011 and lower overall interest rates.

Loss on redemption of preferred shares and debt refinancing costs

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

Other Income (Expense), Net

Other income (expense), net consists primarily of gains and losses from foreign exchange translations. Other income (expense), net was $2.0 million and $1.1 million for the three and nine months ended October 1, 2011, compared to $(1.2) million and $1.3 million in the same periods of 2010.

Income Tax (Benefit) Expense

For the three months ended October 1, 2011, income tax expense was $1.1 million, compared to a $2.0 million tax benefit for the comparable period in 2010. For the nine months ended October 1, 2011 income tax expense was $0.7 million, compared to a $1.6 million tax benefit for the comparable period in 2010. The income tax expense for both three and nine month periods ended October 1, 2011 is primarily related to earnings in foreign countries. The Company’s effective tax rate for the three months ended October 1, 2011 was 12.5 percent compared to 93.8 percent for the three months ended October 2, 2010. For the nine months ended October 1, 2011, the Company’s effective tax rate was 12.5 percent compared to 82.4 for nine months ended October 2, 2010.

Net Income (Loss)

The Company recorded net income of $7.0 million and $4.5 million for the three and nine month periods ended October 1, 2011, respectively, compared to net loss of $(0.1) million and $(0.3) million for the comparable periods in 2010. On a per share basis, fully diluted net income (loss) per share was $0.08 and $0.05 for the three and nine month periods ended October 1, 2011, compared to $(0.00) and $(0.00) per share for the comparable periods of 2010.

 

20

---

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - continued

 

FINANCIAL CONDITION AND LIQUIDITY

Liquidity and Capital Resources

As highlighted in the condensed consolidated statements of cash flows, the Company’s liquidity and available capital resources were impacted by four key components: (i) current cash, (ii) operating activities, (iii) investing activities and (iv) financing activities. These components are summarized below (in millions):

 

		Nine Months Ended
		October 1, 2011				October 2, 2010				Increase (Decrease)
Net cash flow provided by (used for):
Operating activities		$	34.8			$	31.2			$	3.6
Investing activities			(9.1	)			(7.0	)			(2.1	)
Financing activities			(29.5	)			(36.4	)			6.9
Effect of exchange rate changes on cash			(0.2	)			(2.1	)			1.9
Net increase (decrease) in cash			(4.0	)			(14.3	)			10.3
Cash, beginning of period			11.7				29.1				(17.4	)
Cash, end of period		$	7.7			$	14.8			$	(7.1	)

Cash

At October 1, 2011, the Company had cash of $7.7 million, compared with $11.7 million at January 1, 2011 for a decrease of $4.0 million. At October 1, 2011, approximately $7.7 million in cash was held by subsidiaries outside of the United States.

Operating Activities

Net cash provided by operating activities was $34.8 million and $31.2 million for nine months ended October 1, 2011 and October 2, 2010, respectively.

For the nine months ended October 1, 2011, cash provided by operating activities consisted of a net income of $4.5 million and non-cash items totaling $33.7 million. Significant non-cash items were the loss on redemption of preferred shares and debt refinancing costs of $13.8 million, amortization of intangibles and capitalized software costs of $12.4 million, and depreciation of $4.9 million. Net cash used for operating assets and liabilities was $3.4 million, which primarily consisted of accrued payroll and employee benefits of $4.2 million for 2010 variable compensation which was paid in the first quarter of 2011, partially offset by income taxes of $3.9 million.

For the nine months ended October 2, 2010, cash provided by operating activities consisted of a net loss $(0.3) million, offset by non-cash items of $31.4 million. Significant non-cash transactions included amortization of intangibles and capitalized software costs of $12.2 million, restructuring of $2.0 million, depreciation of $4.6 million, paid-in-kind interest of $3.2 million, amortization of the discount on mandatorily redeemable preferred stock of $2.6 million, and share-based compensation expense of $2.4 million. Net cash provided by operating assets and liabilities was $0.2 million, which included accounts receivable, inventories, accounts payable and accrued payroll and employee benefits of $8.9 million, partially offset by income taxes, prepaid expenses and other current assets, and other current and non-current liabilities of $8.7 million.

Investing Activities

The components of the Company’s investment activities are (i) proceeds from sales of assets, (ii) capital expenditures, and (iii) increase in capitalized software. Net cash used for investing activities during the nine months ended October 1, 2011 and October 2, 2010 was $9.1 million and $7.0 million, respectively.

During the nine months ended October 1, 2011 and October 2, 2010, capital expenditures were $3.6 million and $3.2 million. The expenditures relate primarily to machinery, equipment, and tooling used in connection with the Company’s manufacturing operations. For the nine months ended October 1, 2011 and October 2, 2010 capitalized software costs were $5.6 million and $4.0 million, respectively.

 

21

---

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - continued

 

Financing Activities

The primary components of the Company’s financing activities are (i) the proceeds from long-term debt, (ii) the payment of debt, (iii) redemption of mandatorily redeemable preferred stock, and (iv) debt amendment and refinancing charges. Net cash used for financing activities for the nine months ended October 1, 2011 and October 2, 2010 was $29.5 and $36.4 million, respectively.

On March 30, 2011, the Company entered into a new senior secured credit agreement which provides for aggregate principal borrowings of up to $225 million. This agreement replaced the Company’s previous credit facilities and funded the redemption of all outstanding mandatorily redeemable preferred stock for the stated value of $47.0 million. Proceeds from the new credit agreement of $185 million were also used to repay in full the outstanding obligations under the previous credit agreement of $136.6 million. Fees incurred related to the debt amendment and refinancing were $5.6 million, which consisted of $3.3 million of fees to creditors and third parties, of which $2.3 million were capitalized as deferred financing costs and $1.0 million were expensed, and a $2.3 million early redemption fee related to the MRPS.

The Company believes its current liquidity and cash position, future cash flows, and availability under its current credit facility should provide the necessary financial resources to meet its expected operating requirements for the foreseeable future.

Restrictive Covenants

Under the Company’s credit agreement the leverage ratio covenant is the most restrictive covenant to the Company. The credit agreement provides that the Company must not exceed a ratio of total debt to Adjusted EBITDA. As of October 1, 2011, the Company was in compliance with the covenants under its credit facility. The calculation of the Adjusted EBIDTA is as follows:

Adjusted EBITDA as defined by Credit Agreement

(in thousands)

 

		Three Months Ended								Nine Months Ended
		October 1, 2011				October 2, 2010				October 1, 2011				October 2, 2010
Net income (loss)		$	7,005			$	(132	)		$	4,526			$	(339	)
EBITDA Adjustments:
Depreciation			1,641				1,519				4,850				4,594
Amortization			4,236				4,112				12,411				12,161
Restructuring and other related charges			—				17				—				2,008
Share-based compensation			612				704				1,682				2,402
Net interest expense and loss on redemption of preferred shares and debt refinancing costs			2,262				7,835				24,125				23,227
Currency gain (loss)			(1,832	)			1,320				(903	)			(1,555	)
Income tax (benefit) expense			1,005				(2,001	)			645				(1,585	)
(Gain) loss on sale of assets			(77	)			(56	)			(199	)			329
			7,847				13,450				42,611				41,581
Adjusted EBITDA		$	14,852			$	13,318			$	47,137			$	41,242

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

 

22

---

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - continued

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company strives to report its financial results in a clear and understandable manner. It follows accounting principles generally accepted in the United States in preparing its consolidated financial statements, which requires management to make certain estimates and apply judgments that affect its financial position and results of operations. There have been no material changes in the Company’s policies or estimates since January 1, 2011.

The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires management to adopt accounting policies and make significant judgments and estimates to develop amounts reflected and disclosed in the financial statements. In some instances, there may be alternative policies or estimation techniques that could be used. Management maintains a thorough process to review the application of accounting policies and to evaluate the appropriateness of the many estimates that are required to prepare the financial statements. However, even under optimal circumstances, estimates routinely require adjustment based on changing circumstances and the receipt of new or better information.

NEW ACCOUNTING STANDARDS

There are no recently issued accounting standards that are expected to have a material effect on the Company’s financial position, results of operations, or cash flows.

OFF BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS

The Company has no significant off balance sheet transactions, other than operating leases for equipment, real estate, and vehicles.

Management has discussed the development and selection of the Company’s accounting policies with the Audit Committee of the Board of Directors.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

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

Interest Rates

The Company is subject to interest rate risk principally in relation to variable-rate debt. The Company utilizes interest rate swaps to manage the potential variability in interest rates associated with its debt. The interest rate swaps limit the Company’s exposure to an increase in the 3 month LIBOR rate. The notional amount of the swaps at October 1, 2011 was $60.0 million.

A hypothetical 25 basis point increase in interest rates year to date through October 1, 2011 would have increased the interest expense reported in the condensed consolidated financial statements by $0.3 million, for the nine months ended October 1, 2011.

Foreign Exchange

Foreign currency exchange risks arise from transactions denominated in a currency other than the entity’s functional currency and from foreign denominated transactions translated into U.S. dollars. The Company’s largest exposures are to the Euro and Swiss Franc. As these currencies fluctuate relative to the dollar and relative to each other, such fluctuations may cause profitability to increase or decrease accordingly.

A hypothetical 10 percent increase or decrease in all quoted currency exchange rates moving in tandem, would have increased or decreased net income by approximately $0.3 million for the nine months ended October 1, 2011.

 

23

---

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of the Company’s senior management, including the Chief Executive Officer and Chief Financial Officer, the Company conducted an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act), as of the end of the period covered by this quarterly report (the Evaluation Date). Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded as of the Evaluation Date that the Company’s disclosure controls and procedures were effective such that the information relating to the Company, including consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission (SEC) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal controls over financial reporting, during the quarter ended October 1, 2011, that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

There have been no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended January 1, 2011.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Reserved

Item 5. Other Information

Amendments to the 2008 Omnibus Long Term Incentive Plan and the 2011 Omnibus Long Term Incentive Plan:

On November 8, 2011, our Board of Directors amended the 2008 Omnibus Long Term Incentive Plan and the 2011 Omnibus Long Term Incentive Plan, as more fully set forth in Exhibits 10.1 and 10.2. Please refer to the full text of Exhibits 10.1 and 10.2 for a description of such amendments.

 

24

---

PART II OTHER INFORMATION - continued

 

Item 6 Exhibits

(a)  Exhibit Index

 

*10.1**		Amendment No. 1 to X-Rite, Incorporated 2008 Omnibus Long Term Incentive Plan
*10.2**		Amendment No. 1 to X-Rite, Incorporated 2011 Omnibus Long Term Incentive Plan
*31.1		Certification of the Chief Executive Officer and President of X-Rite, Incorporated pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
*31.2		Certification of the Chief Financial Officer of X-Rite, Incorporated pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
*32.1		Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
*101		Financial statements from the quarterly report on Form 10-Q of the Company for the quarter ended October 1, 2011, formatted in XBRL: (i) the Condensed Consolidated Balance Sheets; (ii) the Condensed Consolidated Statements of Operations; (iii) the Condensed Consolidated Statements of Cash Flows; and (iv) the Notes to Condensed Consolidated Financial Statements furnished herewith.

 

*	Filed herewith

**	Compensatory plan or arrangement

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

				X-RITE, INCORPORATED
November 10, 2011						/s/    T HOMAS J. V ACCHIANO J R .
						Thomas J. Vacchiano Jr.,
						Chief Executive Officer (principal executive officer)
November 10, 2011						/s/    R AJESH K. S HAH
						Rajesh K. Shah,
						Chief Financial Officer (principal financial officer)
November 10, 2011						/s/    J EFFREY D. M C K EE
						Jeffrey D. McKee,
						Corporate Controller (principal accounting officer)

 

25