Dentsply 10-Q3


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
 
x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2012
OR
 
o    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ______________ to _______________
 
Commission File Number 0-16211
 
DENTSPLY International Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
 
39-1434669
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
  
Identification No.)
 
221 West Philadelphia Street, York, PA
 
17405-0872
(Address of principal executive offices)
  
(Zip Code)
 
(717) 845-7511
(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   o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes   x No   o

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   

Yes   o No   x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  At October 22, 2012, DENTSPLY International Inc. had 141,928,671 shares of Common Stock outstanding, with a par value of $.01 per share.




DENTSPLY International Inc.

TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2



PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

DENTSPLY INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(unaudited)

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Net sales
$
695,734

 
$
619,759

 
$
2,175,141

 
$
1,799,705

Cost of products sold
331,619

 
322,111

 
1,010,807

 
887,222

 
 
 
 
 
 
 
 
Gross profit
364,115

 
297,648

 
1,164,334

 
912,483

Selling, general and administrative expenses
260,352

 
231,493

 
860,740

 
643,244

Restructuring and other costs
15,097

 
26,353

 
18,862

 
33,849

 
 
 
 
 
 
 
 
Operating income
88,666

 
39,802

 
284,732

 
235,390

 
 
 
 
 
 
 
 
Other income and expenses:
 

 
 

 
 

 
 

Interest expense
14,488

 
16,062

 
44,854

 
27,975

Interest income
(2,342
)
 
(2,418
)
 
(6,650
)
 
(6,676
)
Other expense (income), net
739

 
7,182

 
1,969

 
8,686

 
 
 
 
 
 
 
 
Income before income taxes
75,781

 
18,976

 
244,559

 
205,405

Provision for (benefit from) income taxes
18,960

 
(40,627
)
 
48,550

 
1,042

Equity in net (loss) earnings of unconsolidated affiliated company
(2,529
)
 
1,597

 
(5,448
)
 
1,690

 
 
 
 
 
 
 
 
Net income
54,292

 
61,200

 
190,561

 
206,053

Less: Net income attributable to noncontrolling interests
928

 
603

 
3,148

 
2,136

 
 
 
 
 
 
 
 
Net income attributable to DENTSPLY International
$
53,364

 
$
60,597

 
$
187,413

 
$
203,917

 
 
 
 
 
 
 
 
Earnings per common share:
 

 
 

 
 

 
 

Basic
$
0.38

 
$
0.43

 
$
1.32

 
$
1.44

Diluted
$
0.37

 
$
0.42

 
$
1.30

 
$
1.42

 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 

 
 

 
 

 
 

Basic
141,843

 
141,349

 
141,767

 
141,337

Diluted
143,884

 
143,395

 
143,885

 
143,578


See accompanying Notes to Unaudited Interim Consolidated Financial Statements.

3




DENTSPLY INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(unaudited)

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Net income
$
54,292

 
$
61,200

 
$
190,561

 
$
206,053

 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
104,168

 
(279,384
)
 
58,893

 
(126,617
)
Net (loss) gain on derivative financial instruments
(11,214
)
 
33,115

 
3,743

 
(30,288
)
Net unrealized holding gain (loss) on available-for-sale securities
15,373

 
(9,136
)
 
30,419

 
(11,167
)
Pension liability adjustments
44

 
2,370

 
1,710

 
337

Total other comprehensive income (loss)
108,371

 
(253,035
)
 
94,765

 
(167,735
)
 
 
 
 
 
 
 
 
Total comprehensive income (loss)
162,663

 
(191,835
)
 
285,326

 
38,318

 
 
 
 
 
 
 
 
Less: Comprehensive income (loss) attributable
 

 
 

 
 

 
 

to noncontrolling interests
1,366

 
(4,098
)
 
2,722

 
3,378

 
 
 
 
 
 
 
 
Comprehensive income (loss) attributable to
 
 
 
 
 
 
 
DENTSPLY International
$
161,297

 
$
(187,737
)
 
282,604

 
34,940

 


 


 


 



See accompanying Notes to Unaudited Interim Consolidated Financial Statements.

4




DENTSPLY INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
(unaudited)
 
September 30, 2012
 
December 31, 2011
Assets
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
56,075

 
$
77,128

Accounts and notes receivables-trade, net
467,296

 
427,709

Inventories, net
415,922

 
361,762

Prepaid expenses and other current assets
189,685

 
146,304

 
 
 
 
Total Current Assets
1,128,978

 
1,012,903

 
 
 
 
Property, plant and equipment, net
602,670

 
591,445

Identifiable intangible assets, net
841,751

 
791,100

Goodwill, net
2,207,413

 
2,190,063

Other noncurrent assets, net
196,610

 
169,887

 
 
 
 
Total Assets
$
4,977,422

 
$
4,755,398

 
 
 
 
Liabilities and Equity
 

 
 

Current Liabilities:
 

 
 

Accounts payable
$
137,669

 
$
149,117

Accrued liabilities
373,005

 
289,201

Income taxes payable
18,206

 
9,054

Notes payable and current portion of long-term debt
411,840

 
276,701

 
 
 
 
Total Current Liabilities
940,720

 
724,073

 
 
 
 
Long-term debt
1,237,244

 
1,490,010

Deferred income taxes
319,834

 
249,822

Other noncurrent liabilities
318,757

 
407,342

 
 
 
 
Total Liabilities
2,816,555

 
2,871,247

 
 
 
 
Commitments and contingencies


 


 
 
 
 
Equity:
 

 
 

Preferred stock, $.01 par value; .25 million shares authorized; no shares issued

 

Common stock, $.01 par value; 200.0 million shares authorized; 162.8 million shares issued at September 30, 2012 and December 31, 2011.
1,628

 
1,628

Capital in excess of par value
241,844

 
229,687

Retained earnings
2,699,546

 
2,535,709

Accumulated other comprehensive loss
(95,779
)
 
(190,970
)
Treasury stock, at cost, 20.8 million and 21.1 million shares at September 30, 2012 and December 31, 2011, respectively.
(725,168
)
 
(727,977
)
Total DENTSPLY International Equity
2,122,071

 
1,848,077

 
 
 
 
Noncontrolling interests
38,796

 
36,074

 
 
 
 
Total Equity
2,160,867

 
1,884,151

 
 
 
 
Total Liabilities and Equity
$
4,977,422

 
$
4,755,398

See accompanying Notes to Unaudited Interim Consolidated Financial Statements.

5



DENTSPLY INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
 
Nine Months Ended
September 30,
 
2012
 
2011
Cash flows from operating activities:
 
 
 
 
 
 
 
Net income
$
190,561

 
$
206,053

 
 
 
 
Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation
59,509

 
47,058

Amortization
37,289

 
16,830

Amortization of deferred financing costs
5,749

 

Deferred income taxes
(2,702
)
 
(28,953
)
Share-based compensation expense
17,248

 
15,659

Restructuring and other costs - noncash
14,207

 
725

Stock option income tax benefit
(11,201
)
 
(6,704
)
Net interest expense on derivatives with an other-than-insignificant financing element
1,229

 
2,687

Equity in earnings from unconsolidated affiliates
5,448

 
(1,690
)
Other non-cash expense
(8,354
)
 
3,266

Changes in operating assets and liabilities, net of acquisitions:
 

 
 

Accounts and notes receivable-trade, net
(41,943
)
 
(27,005
)
Inventories, net
(54,329
)
 
(2,609
)
Prepaid expenses and other current assets
(21,781
)
 
(8,016
)
Other noncurrent assets, net
(2,743
)
 
(308
)
Accounts payable
(11,557
)
 
4,668

Accrued liabilities
6,242

 
34,959

Income taxes payable
17,802

 
(4,701
)
Other noncurrent liabilities
1,391

 
2,913

 
 
 
 
Net cash provided by operating activities
202,065

 
254,832

 
 
 
 
Cash flows from investing activities:
 

 
 

 
 
 
 
Capital expenditures
(64,859
)
 
(45,458
)
Cash paid for acquisitions of businesses, net of cash acquired

 
(1,797,919
)
Payments on settlements of net investment hedges
(14,221
)
 
(2,462
)
Expenditures for identifiable intangible assets
(196
)
 
(337
)
Purchase of Company-owned life insurance policies
(1,577
)
 

Proceeds from sale of property, plant and equipment, net
553

 
593

 
 
 
 
Net cash used by investing activities
(80,300
)
 
(1,845,583
)
 
 
 
 
Cash flows from financing activities:
 

 
 

 
 
 
 
Net change in short-term borrowings
(115,468
)
 
413

Cash paid for treasury stock
(38,839
)
 
(79,500
)
Cash dividends paid
(23,561
)
 
(21,512
)
Cash paid for contingent consideration on prior acquisitions
(2,519
)
 
(1,780
)
Cash paid for acquisition of noncontrolling interests of consolidated subsidiaries

 
(16,431
)
Proceeds from long-term borrowings

 
1,446,414

Repayments of long-term borrowings

 
(251,336
)
Payment on terminated derivative instruments

 
(34,628
)
Proceeds from exercise of stock options
24,830

 
36,293

Excess tax benefits from share-based compensation
11,201

 
6,704

Net interest payments on derivatives with an other-than-insignificant financing element
(1,229
)
 
(2,687
)
 
 
 
 
Net cash (used) provided by financing activities
(145,585
)
 
1,081,950

 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
2,767

 
50,629

 
 
 
 
Net decrease in cash and cash equivalents
(21,053
)
 
(458,172
)
 
 
 
 
Cash and cash equivalents at beginning of period
77,128

 
540,038

 
 
 
 
Cash and cash equivalents at end of period
$
56,075

 
$
81,866

 
See accompanying Notes to Unaudited Interim Consolidated Financial Statements.

6



DENTSPLY INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATMENTS OF CHANGES IN EQUITY
(In thousands)
(unaudited)

 
Common
Stock
 
Capital in
Excess of
Par Value
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Treasury
Stock
 
Total DENTSPLY
International
Equity
 
Noncontrolling
Interests
 
Total
Equity
Balance at December 31, 2010
$
1,628

 
$
204,902

 
$
2,320,350

 
$
24,156

 
$
(711,650
)
 
$
1,839,386

 
$
70,526

 
$
1,909,912

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Net income

 

 
203,917

 

 

 
203,917

 
2,136

 
206,053

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income
 

 
 

 
 

 
(168,977
)
 
 

 
(168,977
)
 
1,242

 
(167,735
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquisition of noncontrolling interest

 
22,439

 

 
(1,862
)
 

 
20,577

 
(37,008
)
 
(16,431
)
Exercise of stock options

 
(12,439
)
 

 

 
48,982

 
36,543

 

 
36,543

Tax benefit from stock options exercised

 
6,704

 

 

 

 
6,704

 

 
6,704

Share based compensation expense

 
15,410

 

 

 

 
15,410

 

 
15,410

Funding of Employee Stock Ownership Plan

 
379

 

 

 
2,595

 
2,974

 

 
2,974

Treasury shares purchased

 

 

 

 
(79,500
)
 
(79,500
)
 

 
(79,500
)
Dividends paid by noncontrolling interest

 

 

 

 

 

 
(174
)
 
(174
)
RSU distributions

 
(5,707
)
 

 

 
3,550

 
(2,157
)
 

 
(2,157
)
RSU dividends

 
137

 
(137
)
 

 

 

 

 

Cash dividends ($0.15 per share)

 

 
(21,185
)
 

 

 
(21,185
)
 

 
(21,185
)
Balance at September 30, 2011
$
1,628

 
$
231,825

 
$
2,502,945

 
$
(146,683
)
 
$
(736,023
)
 
$
1,853,692

 
$
36,722

 
$
1,890,414


 
Common
Stock
 
Capital in
Excess of
Par Value
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Treasury
Stock
 
Total DENTSPLY
International
Equity
 
Noncontrolling
Interests
 
Total
Equity
Balance at December 31, 2011
$
1,628

 
$
229,687

 
$
2,535,709

 
$
(190,970
)
 
$
(727,977
)
 
$
1,848,077

 
$
36,074

 
$
1,884,151

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Net income

 

 
187,413

 

 

 
187,413

 
3,148

 
190,561

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive loss

 

 

 
95,191

 

 
95,191

 
(426
)
 
94,765

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of stock options

 
(8,449
)
 

 

 
33,279

 
24,830

 

 
24,830

Tax benefit from stock options exercised

 
11,201

 

 

 

 
11,201

 

 
11,201

Share based compensation expense

 
17,248

 

 

 

 
17,248

 

 
17,248

Funding of Employee Stock Ownership Plan

 
370

 

 

 
3,272

 
3,642

 

 
3,642

Treasury shares purchased

 

 

 

 
(38,839
)
 
(38,839
)
 

 
(38,839
)
RSU distributions

 
(8,386
)
 

 

 
5,097

 
(3,289
)
 

 
(3,289
)
RSU dividends

 
173

 
(173
)
 

 

 

 

 

Cash dividends ($0.165 per share)

 

 
(23,403
)
 

 

 
(23,403
)
 

 
(23,403
)
Balance at September 30, 2012
$
1,628

 
$
241,844

 
$
2,699,546

 
$
(95,779
)
 
$
(725,168
)
 
$
2,122,071

 
$
38,796

 
$
2,160,867


See accompanying Notes to Unaudited Interim Consolidated Financial Statements.

7



DENTSPLY International Inc. and Subsidiaries

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) and the rules of the United States Securities and Exchange Commission (“SEC”).  The year-end consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by US GAAP. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair statement of the results for interim periods have been included. Results for interim periods should not be considered indicative of results for a full year. These financial statements and related notes contain the accounts of DENTSPLY International Inc. and Subsidiaries (“DENTSPLY” or the “Company”) on a consolidated basis and should be read in conjunction with the consolidated financial statements and notes included in the Company’s most recent Form 10-K for the year ended December 31, 2011.

NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES

The accounting policies of the Company, as applied in the interim consolidated financial statements presented herein are substantially the same as presented in the Company’s Form 10-K for the year ended December 31, 2011, except as may be indicated below:

Accounts and Notes Receivable

The Company sells dental and certain healthcare products through a worldwide network of distributors and directly to end users.  For customers on credit terms, the Company performs ongoing credit evaluations of those customers' financial condition and generally does not require collateral from them.  The Company establishes allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments based on historical averages of aged receivable balances and the Company’s experience in collecting those balances, customer specific circumstances, as well as changes in the economic and political environments.  The Company records a provision for doubtful accounts, which is included in “Selling, general and administrative expenses.”

Accounts and notes receivables – trade, net are stated net of allowances for doubtful accounts and trade discounts, which was $16.3 million at September 30, 2012 and $15.8 million at December 31, 2011.

Marketable Securities

The Company’s marketable securities consist of corporate convertible bonds that are classified as available-for-sale in “Other noncurrent assets, net” on the consolidated balance sheets as the instruments mature in December 2015. The Company determined the appropriate classification at the time of purchase and will re-evaluate such designation as of each balance sheet date. In addition, the Company reviews the securities each quarter for indications of possible impairment. If an impairment is identified, the determination of whether the impairment is temporary or other-than-temporary requires significant judgment. The primary factors that the Company considers in making this judgment include the extent and time the fair value of each investment has been below cost and the existence of a credit loss. If a decline in fair value is judged other-than-temporary, the basis of the securities is written down to fair value and the amount of the write-down is included as a realized loss in the consolidated statement of operations. Changes in fair value are reported in accumulated other comprehensive income (“AOCI”).

 The convertible feature of the bonds has not been bifurcated from the underlying bonds as the feature does not contain a net-settlement feature, nor would the Company be able to achieve a hypothetical net-settlement that would substantially place the Company in a comparable cash settlement position.  As such, the derivative is not accounted for separately from the bond.  The cash paid by the Company was equal to the face value of the bonds issued, and therefore, the Company has not recorded any bond premium or discount on acquiring the bonds.  The fair value of the bonds was $91.2 million and $47.8 million at September 30, 2012 and December 31, 2011, respectively.  At September 30, 2012 and December 31, 2011, an unrealized holding gain of $29.9 million and a unrealized holding loss of $0.5 million, respectively, on available-for-sale securities, net of tax, had been recorded in AOCI. 

New Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board (“FASB”) amended its rules regarding the presentation of comprehensive income.  The objective of this amendment is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income.  Specifically, this amendment requires

8



that all non-owner changes in shareholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  The new rules became effective during interim and annual periods beginning after December 15, 2011, with the exception of the requirement to present reclassification adjustments from other comprehensive income to net income on the face of the financial statements, which has been deferred pending further deliberation by the FASB.  Because the standard only impacts the presentation of comprehensive income and does not impact what is included in comprehensive income, the standard does not have a significant impact on the Company's consolidated financial statements. The Company adopted this accounting standard during the quarter ended March 31, 2012.

In September 2011, the FASB issued Accounting Standards Update ("ASU") No. 2011-08, “Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment”. This newly issued accounting standard is intended to reduce the cost and complexity of the annual goodwill impairment test by providing entities an option to perform a "qualitative" assessment to determine whether further impairment testing is necessary. Under the revised standard, an entity has the option to first assess qualitative factors to determine whether it is necessary to perform the current two-step impairment test. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required; otherwise, no further testing is required. Prior to the issuance of the revised standard, an entity was required to perform step one of the impairment test at least annually by calculating and comparing the fair value of a reporting unit to its carrying amount. Under the revised standard, if an entity determines that step one is necessary and the fair value of the reporting unit is less than its carrying amount, then step two of the test will continue to be required to measure the amount of the impairment loss, if any. These amendments do not change the current guidance for testing other indefinite-lived intangible assets for impairment. This ASU is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The Company adopted this standard for the quarter ended June 30, 2012 and it did not impact the Company’s financial position or results from operations.

In July 2012, the FASB issued ASU No. 2012-02, "Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment". This newly issued accounting standard is intended to reduce the cost and complexity of the annual indefinite-lived intangible asset impairment test by providing entities an option to perform a qualitative assessment to determine whether further impairment testing is necessary. Under the revised standard, an entity has the option to first assess qualitative factors to determine whether it is necessary to perform the current two-step impairment test. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not that an indefinite-lived intangible asset is less than its carrying amount, the quantitative impairment test is required; otherwise, no further testing is required. Prior to the issuance of the revised standard, an entity was required to perform step one of the impairment test at least annually by calculating and comparing the fair value of an indefinite-lived intangible asset to its carrying amount. Under the revised standard, if an entity determines that step one is necessary and the indefinite-lived intangible asset is less than its carrying amount, then step two of the test will continue to be required to measure the amount of the impairment loss, if any. This ASU is effective for annual and interim indefinite-lived intangible asset impairment tests performed for fiscal years beginning after September 15, 2012. The Company expects to adopt this standard for the quarter ended March 31, 2013. The adoption of this standard will not impact the Company's financial position or results of operations.

NOTE 2 – STOCK COMPENSATION

The following table represents total stock based compensation expense for non-qualified stock options, restricted stock units (“RSU”) and the tax related benefit for the three and nine months ended September 30, 2012 and 2011:

 
Three Months Ended
 
Nine Months Ended
(in thousands)
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Stock option expense
$
3,027

 
$
2,833

 
$
8,706

 
$
8,206

RSU expense
2,839

 
2,204

 
7,480

 
6,551

Total stock based compensation expense
$
5,866

 
$
5,037

 
$
16,186

 
$
14,757

 
 
 
 
 
 
 
 
Total related tax benefit
$
1,692

 
$
1,430

 
$
4,406

 
$
4,302


At September 30, 2012, the remaining unamortized compensation cost related to non-qualified stock options is $16.3 million, which will be expensed over the weighted average remaining vesting period of the options, or 1.6 years. At September 30, 2012, the unamortized compensation cost related to RSU is $17.8 million, which will be expensed over the remaining restricted period of the RSU, or 1.5 years.


9





The following table reflects the non-qualified stock option transactions from December 31, 2011 through September 30, 2012:
 
Outstanding
 
Exercisable
(in thousands, except per share data)
Shares
 
Weighted
Average
Exercise
Price
 
Aggregate
Intrinsic
Value
 
Shares
 
Weighted
Average
Exercise
Price
 
Aggregate
Intrinsic
Value
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2011
10,148

 
$
31.23

 
$
51,402

 
8,049

 
$
30.06

 
$
50,365

Granted
1,343

 
38.63

 
 

 
 

 
 

 
 

Exercised
(1,047
)
 
23.72

 
 

 
 

 
 

 
 

Cancelled
(35
)
 
41.84

 
 

 
 

 
 

 
 

Forfeited
(63
)
 
36.43

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2012
10,346

 
$
32.88

 
$
62,151

 
7,546

 
$
31.32

 
$
58,445


At September 30, 2012, the weighted average remaining contractual term of all outstanding options is 5.8 years and the weighted average remaining contractual term of exercisable options is 4.8 years.

The following table summarizes the unvested RSU transactions from December 31, 2011 through September 30, 2012:

(in thousands, except per share data)
Shares
 
Weighted Average
Grant Date
Fair Value
 
 
 
 
December 31, 2011
897

 
$
32.50

Granted
422

 
38.66

Vested
(245
)
 
26.33

Forfeited
(34
)
 
35.87

 
 
 
 
September 30, 2012
1,040

 
$
36.34


NOTE 3 – COMPREHENSIVE INCOME

During the quarter ended September 30, 2012, foreign currency translation adjustments included currency translation gains of $106.5 million and losses on the Company’s loans designated as hedges of net investments of $2.8 million.  During the quarter ended September 30, 2011, foreign currency translation adjustments included currency translation losses of $256.1 million and losses of $21.9 million on the Company’s loans designated as hedges of net investments.  During the nine months ended September 30, 2012, foreign currency translation adjustments included currency translation gains of $58.0 million and gains on the Company's loans designated as hedges of net investments of $1.3 million. During the nine months ended September 30, 2011, foreign currency translation adjustments included currency translation losses of $115.4 million and losses on the Company's loans designated as hedges as investments of $11.2 million. These foreign currency translation adjustments were offset by movements on derivative financial instruments, which are discussed in Note 10, Financial Instruments and Derivatives.

The balances included in AOCI, net of tax, in the consolidated balance sheets are as follows:

(in thousands)
September 30, 2012
 
December 31, 2011
 
 
 
 
Foreign currency translation adjustments
$
20,241

 
$
(39,078
)
Net loss on derivative financial instruments
(113,647
)
 
(117,390
)
Net unrealized holding gains (losses) on available-for-sale securities
29,903

 
(516
)
Pension liability adjustments
(32,276
)
 
(33,986
)
 
$
(95,779
)
 
$
(190,970
)

10





The cumulative foreign currency translation adjustments included translation gains of $154.4 million and $96.3 million at September 30, 2012 and December 31, 2011, respectively, was offset by losses of $132.3 million and $133.5 million, respectively, on loans designated as hedges of net investments.  These foreign currency translation adjustments were partially offset by movements on derivatives financial instruments, which are discussed in Note 10, Financial Instruments and Derivatives.

NOTE 4 – EARNINGS PER COMMON SHARE

The dilutive effect of outstanding non-qualified stock options and RSU is reflected in diluted earnings per share by application of the treasury stock method. The following table sets forth the computation of basic and diluted earnings per common share for the three and nine months ended September 30, 2012 and 2011:

Basic Earnings Per Common Share Computation
Three Months Ended
 
Nine Months Ended
(in thousands, except per share amounts)
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Net income attributable to DENTSPLY International
$
53,364

 
$
60,597

 
$
187,413

 
$
203,917

 
 
 
 
 
 
 
 
Common shares outstanding
141,843

 
141,349

 
141,767

 
141,337

 
 
 
 
 
 
 
 
Earnings per common share - basic
$
0.38

 
$
0.43

 
$
1.32

 
$
1.44

 
 
 
 
 
 
 
 
Diluted Earnings Per Common Share Computation
 

 
 

 
 

 
 

(in thousands, except per share amounts)
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
Net income attributable to DENTSPLY International
$
53,364

 
$
60,597

 
$
187,413

 
$
203,917

 
 
 
 
 
 
 
 
Common shares outstanding
141,843

 
141,349

 
141,767

 
141,337

Incremental shares from assumed exercise of dilutive options from stock-based compensation awards
2,041

 
2,046

 
2,118

 
2,241

Total shares
143,884

 
143,395

 
143,885

 
143,578

 
 
 
 
 
 
 
 
Earnings per common share - diluted
$
0.37

 
$
0.42

 
$
1.30

 
$
1.42


Options to purchase 3.8 million and 4.1 million shares of common stock that were outstanding during the three and nine months ended September 30, 2012, respectively, were not included in the computation of diluted earnings per share since the exercise prices for these options was greater than the average market price of the common shares and, therefore, the effect would be antidilutive.  There were 3.2 million and 3.5 million antidilutive shares of common stock outstanding during the three and nine months ended September 30, 2011, respectively.

NOTE 5 – BUSINESS ACQUISITIONS

On August 31, 2011, the Company acquired 100% of the outstanding common shares of Astra Tech, a leading developer, manufacturer and marketer of dental implants, customized implant abutments and consumable medical devices in the urology and surgery market segments. The acquisition was recorded in accordance with the business combinations provisions of US GAAP.  











11



The following table summarizes the final fair value of identifiable assets and liabilities assumed at the date of the acquisition. This table has been updated during the first nine months of 2012 to reflect the final fair value. The final valuation change resulted in increases to identifiable intangible assets relating mostly to customer relationships and deferred tax liabilities with a decrease to goodwill. The Company determined that it was not necessary to retroactively revise prior period financial statements as the changes were not material to the Company's consolidated financial statements.

(in thousands)
 
 
 
Inventory
$
84,659

Other Current assets
141,261

Property, plant and equipment
178,495

Identifiable intangible assets
844,100

Goodwill
947,150

Other long-term assets
14,963

Total assets
2,210,628

 
 
Current liabilities
107,243

Long-term liabilities
312,595

Total liabilities
419,838

 
 
Net assets
$
1,790,790


Other current assets consist primarily of trade accounts receivable of $101.9 million.  Current liabilities assumed are primarily comprised of accrued and other current liabilities of $80.1 million and trade accounts payable of $27.1 million.  Long-term liabilities assumed are primarily comprised of noncurrent deferred tax liabilities of $263.3 million and pension obligations of $49.3 million.

Inventory held by Astra Tech includes a fair value adjustment of $32.8 million.  The Company expensed this amount by December 31, 2011 as the acquired inventory was sold.

The valuation of tangible assets was derived using the combination of the income approach, the market approach and the cost approach. Significant judgments used in valuing tangible assets include estimated reproduction or replacement cost, useful lives of assets, estimated selling prices, costs to complete and reasonable profit.

Property, plant and equipment includes a fair value adjustment of $28.7 million and consists of land, buildings, plant and equipment.  Depreciable lives are estimated at 40 years for buildings and range from 5 to 15 years for plant and equipment.

The fair values assigned to identifiable intangible assets were determined through the use of the income approach, specifically the relief from royalty method and the multi-period excess earnings method. Both valuation methods rely on management’s judgments, including expected future cash flows resulting from existing customer relationships, customer attrition rates, contributory effects of other assets utilized in the business, peer group cost of capital and royalty rates as well as other factors.
       
Useful lives for identifiable intangible assets were determined based upon the remaining useful economic lives of the identifiable intangible assets that are expected to contribute to future cash flows.  The acquired identifiable intangible assets are being amortized on a straight-line basis over their expected useful lives.

Identifiable intangible assets acquired consist of the following:
(in thousands, except for useful life)
Amount
 
Useful Life
(in years)
 
 
 
 
Customer relationships
$
494,700

 
15 - 18
Developed technology and patents
116,500

 
10
Trade names and trademarks
229,100

 
Indefinite
In-process research and development
3,800

 
Total
$
844,100

 
 


12



The $947.2 million of goodwill is attributable to the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired and liabilities assumed. The goodwill recognized is primarily attributable to cost savings and other synergies that the Company expects to realize through operational efficiencies.  All of the goodwill has been assigned to the Company's Implants/Endodontics/Healthcare/Pacific Rim segment and is not deductible for tax purposes.

The following unaudited pro forma financial information reflects the consolidated results of operations of the Company had the Astra Tech acquisition occurred on January 1, 2010.  These amounts were calculated after conversion to US GAAP, applying the Company’s accounting policies and adjusting Astra Tech’s results to reflect the additional depreciation and amortization that would have been charged assuming the fair value adjustments to property, plant and equipment, inventory and intangible assets had been applied from January 1, 2010, together with the consequential tax effects at the statutory rate.  These adjustments also reflect the additional interest expense incurred on the debt to finance the acquisition.
 
Three Months Ended
September 30,
 
Nine Months Ended September 30,
(in thousands, except per share data)
2011
 
2011
 
 
 
 
Net sales
$
707,683

 
$
2,184,998

Net income attributable to DENTSPLY
$
52,903

 
$
195,602

Diluted earnings per common share
$
0.37

 
$
1.36


The pro forma financial information is based on the Company's final assignment of purchase price of the fair value of identifiable assets acquired and liabilities assumed. The Astra Tech financial information has been compiled in a manner consistent with the accounting policies adopted by DENTSPLY. Pro forma results do not include any anticipated synergies or other anticipated benefits of the acquisition. Accordingly, the unaudited pro forma financial information is not necessarily indicative of either future results of operations or results that might have been achieved had the acquisition occurred on January 1, 2010.  While the Company completed other transactions during the pro forma periods presented above, these transactions were immaterial to the Company’s net sales and net income attributable to DENTSPLY.

NOTE 6 - SEGMENT INFORMATION

The Company has numerous operating businesses covering a wide range of dental and certain healthcare products and geographic regions, primarily serving the professional dental market. Professional dental products represented approximately 88% and 93% of sales for the three months ended September 30, 2012 and 2011, respectively, and 89% and 95% of sales for the nine months ended September 30, 2012 and 2011, respectively.

The operating businesses are combined into operating groups, which have overlapping product offerings, geographical presence, customer bases, distribution channels, and regulatory oversight. These operating groups are considered the Company’s reportable segments as the Company’s chief operating decision-maker regularly reviews financial results at the operating group level and uses this information to manage the Company’s operations. The accounting policies of the groups are consistent with those described in the Company’s most recently filed Form 10-K in the summary of significant accounting policies.  The Company measures segment income for reporting purposes as operating income before restructuring and other costs, interest expense, interest income, other income and expenses and income taxes.

During the first quarter of 2012, the Company realigned reporting responsibilities for multiple locations as a result of changes to the management structure. These changes also helped the Company gain operating efficiencies and effectiveness. The segment information below reflects the revised structure for all periods shown.

Dental Consumable and Laboratory Businesses

This business group includes responsibility for the design, manufacturing, sales and distribution of certain small equipment and chairside consumable products in the United States, Germany and certain other European regions.  It also has responsibility for the sales and distribution of certain Endodontic products in Germany. This business group also includes the responsibility for the design, manufacture, sales and distribution of most dental laboratory products, excluding certain countries. This business group is also responsible for most of the Company’s non-dental business excluding healthcare products.

Orthodontics/Canada/Mexico/Japan

  This business group is responsible for the world-wide manufacturing, sales and distribution of the Company’s Orthodontic

13



products. It also has responsibility for the sales and distribution of most of the Company’s dental products sold in Japan, Canada and Mexico.

Select Distribution Businesses

This business group includes responsibility for the sales and distribution for most of the Company's dental products sold in France, United Kingdom, Italy, Austria and certain other European countries, Middle Eastern countries, India and Africa.

Implants/Endodontics/Healthcare/Pacific Rim

This business group includes the responsibility for the design, manufacture, sales and distribution of most of the Company’s dental implant and related products. This business group also includes the responsibility for the design and manufacturing of Endodontic products and is responsible for the sales and distribution of the Company’s Endodontic products in the United States, Switzerland, and locations not covered by other selling divisions.  In addition, this business group is also responsible for sales and distribution of certain Endodontic products in Germany, Asia and other parts of the world. Additionally, this business group is responsible for the design and manufacture of certain dental consumables and dental laboratory products and the sales and distribution of most dental products sold in Brazil, Latin America (excluding Mexico), Australia and most of Asia (excluding India and Japan). This business group is also responsible for the world-wide design, manufacturing, sales and distribution of the Company's healthcare products (non-dental) throughout most of the world.

Significant interdependencies exist among the Company’s operations in certain geographic areas. Inter-group sales are at prices intended to provide a reasonable profit to the manufacturing unit after recovery of all manufacturing costs and to provide a reasonable profit for purchasing locations after coverage of marketing and general and administrative costs.

Generally, the Company evaluates performance of the operating groups based on the groups’ operating income, excluding restructuring and other costs, and net third party sales, excluding precious metal content.

The following tables set forth information about the Company’s operating groups for the three and nine months ended September 30, 2012 and 2011:

Third Party Net Sales
 
Three Months Ended
 
Nine Months Ended
(in thousands)
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Dental Consumable and Laboratory Businesses
$
236,473

 
$
245,682

 
$
742,190

 
$
722,864

Orthodontics/Canada/Mexico/Japan
81,390

 
71,377

 
240,609

 
245,550

Select Distribution Businesses
68,397

 
70,770

 
212,585

 
220,276

Implants/Endodontics/Healthcare/Pacific Rim
309,941

 
232,611

 
984,393

 
614,376

All Other (a)
(467
)
 
(681
)
 
(4,636
)
 
(3,361
)
Total
$
695,734

 
$
619,759

 
$
2,175,141

 
$
1,799,705

(a) Includes amounts recorded at Corporate headquarters.
















14




Third Party Net Sales, Excluding Precious Metal Content
 
Three Months Ended
 
Nine Months Ended
(in thousands)
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Dental Consumable and Laboratory Businesses
$
199,786

 
$
203,307

 
$
614,133

 
$
618,596

Orthodontics/Canada/Mexico/Japan
73,305

 
62,665

 
216,183

 
220,573

Select Distribution Businesses
66,644

 
68,648

 
207,930

 
213,627

Implants/Endodontics/Healthcare/Pacific Rim
307,853

 
229,812

 
977,617

 
605,312

All Other (a)
(467
)
 
(681
)
 
(4,637
)
 
(3,362
)
Total excluding precious metal content
647,121

 
563,751

 
2,011,226

 
1,654,746

Precious metal content
48,613

 
56,008

 
163,915

 
144,959

Total including precious metal content
$
695,734

 
$
619,759

 
$
2,175,141

 
$
1,799,705

(a) Includes amounts recorded at Corporate headquarters.

Inter-segment Net Sales
 
Three Months Ended
 
Nine Months Ended
(in thousands)
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Dental Consumable and Laboratory Businesses
$
55,093

 
$
53,637

 
$
167,980

 
$
164,643

Orthodontics/Canada/Mexico/Japan
989

 
972

 
3,221

 
2,909

Select Distribution Businesses
2,608

 
4,432

 
8,899

 
11,909

Implants/Endodontics/Healthcare/Pacific Rim
35,468

 
37,597

 
116,216

 
119,395

All Other (a)
52,809

 
51,325

 
163,118

 
158,160

Eliminations
(146,967
)
 
(147,963
)
 
(459,434
)
 
(457,016
)
Total
$

 
$

 
$

 
$

(a) Includes amounts recorded at Corporate headquarters and one distribution warehouse not managed by named segments.

Segment Operating Income
 
Three Months Ended
 
Nine Months Ended
(in thousands)
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Dental Consumable and Laboratory Businesses
$
59,721

 
$
54,191

 
$
184,486

 
$
171,710

Orthodontics/Canada/Mexico/Japan
5,268

 
(1,437
)
 
9,531

 
12,156

Select Distribution Businesses
83

 
1,145

 
(797
)
 
1,503

Implants/Endodontics/Healthcare/Pacific Rim
63,337

 
38,593

 
206,750

 
156,293

All Other (a)
(24,646
)
 
(26,337
)
 
(96,376
)
 
(72,423
)
Segment operating income
103,763

 
66,155

 
303,594

 
269,239

 
 
 
 
 
 
 
 
Reconciling Items:
 

 
 

 
 

 
 

Restructuring and other costs
15,097

 
26,353

 
18,862

 
33,849

Interest expense
14,488

 
16,062

 
44,854

 
27,975

Interest income
(2,342
)
 
(2,418
)
 
(6,650
)
 
(6,676
)
Other expense (income), net
739

 
7,182

 
1,969

 
8,686

Income before income taxes
$
75,781

 
$
18,976

 
$
244,559

 
$
205,405

(a) Includes the results of Corporate headquarters, inter-segment eliminations and one distribution warehouse not managed by named segments.

15



Assets
 
 
 
(in thousands)
September 30, 2012
 
December 31, 2011
 
 
 
 
Dental Consumable and Laboratory Businesses
$
1,032,321

 
$
1,180,001

Orthodontics/Canada/Mexico/Japan
297,524

 
328,376

Select Distribution Businesses
205,985

 
168,500

Implants/Endodontics/Healthcare/Pacific Rim
3,179,994

 
2,881,591

All Other (a)
261,598

 
196,930

Total
$
4,977,422

 
$
4,755,398

(a) Includes the assets of Corporate headquarters, inter-segment eliminations and one distribution warehouse not managed by named segments.

NOTE 7 - INVENTORIES

Inventories are stated at the lower of cost or market.  At September 30, 2012 and December 31, 2011, inventories with a cost of $8.6 million, or 2.1% and $7.1 million, or 2.1%, respectively, were determined using the last-in, first-out (“LIFO”) method. The cost of the remaining inventories was determined using the first-in, first-out (“FIFO”) or average cost methods. If the FIFO method had been used to determine the cost of LIFO inventories, the amounts at which net inventories are stated would be higher than reported at September 30, 2012 and December 31, 2011 by $5.6 million and $5.6 million, respectively.

The Company establishes reserves for inventory in order to present inventories at net realizable value.  The inventory valuation reserves were $34.7 million and $35.1 million at September 30, 2012 and December 31, 2011, respectively.

Inventories, net of inventory valuation reserves, consist of the following:
(in thousands)
September 30, 2012
 
December 31, 2011
 
 
 
 
Finished goods
$
259,263

 
$
218,814

Work-in-process
69,264

 
66,952

Raw materials and supplies
87,395

 
75,996

 
$
415,922

 
$
361,762


NOTE 8 - BENEFIT PLANS

The following sets forth the components of net periodic benefit cost of the Company’s defined benefit plans and for the Company’s other postretirement employee benefit plans for the three and nine months ended September 30, 2012 and 2011:

Defined Benefit Plans 
Three Months Ended
 
Nine Months Ended
(in thousands)
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Service cost
$
3,004

 
$
2,799

 
$
9,014

 
$
7,811

Interest cost
2,608

 
2,453

 
7,926

 
6,945

Expected return on plan assets
(1,180
)
 
(1,350
)
 
(3,594
)
 
(3,856
)
Amortization of prior service cost
(34
)
 
20

 
(104
)
 
61

Amortization of net loss
486

 
407

 
1,478

 
1,195

 
 
 
 
 
 
 
 
Net periodic benefit cost
$
4,884

 
$
4,329

 
$
14,720

 
$
12,156



16



Other Postretirement Plans
Three Months Ended
 
Nine Months Ended
(in thousands)
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Service cost
$
18

 
$
16

 
$
55

 
$
48

Interest cost
117

 
137

 
352

 
414

Amortization of net loss
58

 
49

 
173

 
147

 
 
 
 
 
 
 
 
Net periodic benefit cost
$
193

 
$
202

 
$
580

 
$
609


The following sets forth the information related to the contributions to the Company’s benefit plans for 2012:
(in thousands)
Pension
Benefits
 
Other
Postretirement
Benefits
 
 
 
 
Actual contributions through September 30, 2012
$
9,451

 
$
630

Projected for the remainder of the year
3,221

 
348

Total projected contributions
$
12,672

 
$
978



NOTE 9 – RESTRUCTURING AND OTHER COSTS

Restructuring Costs

During the three and nine months ended September 30, 2012, the Company recorded restructuring costs of $10.0 million and $13.4 million, respectively. During 2012, the Company initiated several restructuring plans primarily related to the integration, reorganization and closure or consolidation of certain production and selling facilities in order to better leverage the Company’s resources by minimizing costs and obtaining operational efficiencies. During the three and nine months ended September 30, 2011, the Company recorded restructuring costs of $0.8 million and $1.5 million, respectively, related to employee severance costs.  These costs are recorded in “Restructuring and other costs” in the consolidated statements of operations and the associated liabilities are recorded in "Accrued liabilities" in the consolidated balance sheets.

At September 30, 2012, the Company’s restructuring accruals were as follows:
 
Severance
(in thousands)
2010 and
Prior Plans
 
2011 Plans
 
2012 Plans
 
Total
 
 
 
 
 
 
 
 
Balance at December 31, 2011
$
3,380

 
$
1,281

 
$

 
$
4,661

Provisions and adjustments

 
564

 
11,847

 
12,411

Amounts applied
(1,000
)
 
(982
)
 
(2,414
)
 
(4,396
)
Balance at September 30, 2012
$
2,380

 
$
863

 
$
9,433

 
$
12,676

 
 
Lease/Contract Terminations
(in thousands)
2010 and
Prior Plans
 
2012 Plans
 
Total
 
 
 
 
 
 
Balance at December 31, 2011
$
1,011

 
$

 
$
1,011

Provisions and adjustments

 
296

 
296

Amounts applied
(189
)
 
(127
)
 
(316
)
Balance at September 30, 2012
$
822

 
$
169

 
$
991



17



 
Other Restructuring Costs
(in thousands)
2010 and
Prior Plans
 
2012 Plans
 
Total
 
 
 
 
 
 
Balance at December 31, 2011
$
34

 
$

 
$
34

Provisions and adjustments

 
728

 
728

Amounts applied

 
(722
)
 
(722
)
Balance at September 30, 2012
$
34

 
$
6

 
$
40


The following table provides the year-to-date changes in the restructuring accruals by segment:
(in thousands)
December 31,
2011
 
Provisions and
Adjustments
 
Amounts
Applied
 
September 30, 2012
 
 
 
 
 
 
 
 
Dental Consumable and Laboratory Businesses
$
3,601

 
$
8,938

 
$
(1,389
)
 
$
11,150

Orthodontics/Canada/Mexico/Japan
240

 
1,118

 
(951
)
 
407

Implants/Endodontics/Healthcare/Pacific Rim
1,865

 
3,379

 
(3,094
)
 
2,150

 
$
5,706

 
$
13,435

 
$
(5,434
)
 
$
13,707


Other Costs

Other costs for the three and nine months ended September 30, 2012, were $5.1 million and $5.5 million, respectively. The other costs included impairments of certain previously acquired technologies, the impact of the U.S. presidential executive order updating trade sanctions and settlement of legal matters. On October 9, 2012, President Obama issued an executive order making it illegal for non-U.S. subsidiaries of U.S. companies to engage in certain transactions involving Iran without a license.  The Company has reserved appropriate allowances against accounts receivable of its controlled foreign subsidiaries and have discontinued such sales.  There can be no assurance as to when such sales may be resumed to this region. During the three and nine months ended September 30, 2011, the Company recorded other costs of $25.5 million and $32.3 million, respectively, which were related to the Astra Tech acquisition, legal settlement costs and impairments of certain previously acquired technology.

NOTE 10 – FINANCIAL INSTRUMENTS AND DERIVATIVES

Derivative Instruments and Hedging Activities

The Company's activities expose it to a variety of market risks, which primarily include the risks related to the effects of changes in foreign currency exchange rates, interest rates and commodity prices. These financial exposures are monitored and managed by the Company as part of its overall risk management program. The objective of this risk management program is to reduce the volatility that these market risks may have on the Company's operating results and equity. The Company employs derivative financial instruments to hedge certain anticipated transactions, firm commitments, or assets and liabilities denominated in foreign currencies. Additionally, the Company utilizes interest rate swaps to convert variable rate debt to fixed rate debt and to convert fixed rate debt to variable rate debt, cross currency basis swaps to convert debt denominated in one currency to another currency and commodity swaps to fix certain variable raw material costs.

Derivative Instruments Not Designated as Hedging

The Company enters into derivative financial instruments to hedge the foreign exchange revaluation risk associated with recorded assets and liabilities that are denominated in a non-functional currency. The gains and losses on these derivative transactions offset the gains and losses generated by the revaluation of the underlying non-functional currency balances and are recorded in “Other expense (income), net” on the consolidated statements of operations. The Company primarily uses forward foreign exchange contracts and cross currency basis swaps to hedge these risks. The Company's significant contracts outstanding as of September 30, 2012 are summarized in the tables that follow.
 
The Company wrote DIO equity option contracts ("equity options") to the original sellers of the DIO investment for the remaining DIO common shares held by the sellers. The equity options provide the sellers the ability to require the Company to purchase their remaining shares on hand at a price based on an agreed-upon formula at specific time frames in the future. The sellers are also allowed to sell their remaining shares on the open market. Changes in the fair value of the equity options are reported in “Other expense (income), net” on the consolidated statements of operations. This derivative is further discussed in Note 11, Fair Value Measurement.

18




Cash Flow Hedges

Foreign Exchange Risk Management
 
The Company uses a layered hedging program to hedge select anticipated foreign currency cash flows to reduce volatility in both cash flows and reported earnings of the consolidated Company. The Company accounts for the foreign exchange forward contracts as cash flow hedges. As a result, the Company records the fair value of the contracts primarily through AOCI based on the tested effectiveness of the foreign exchange forward contracts. The Company measures the effectiveness of cash flow hedges of anticipated transactions on a spot-to-spot basis rather than on a forward-to-forward basis. Accordingly, the spot-to-spot change in the derivative fair value will be deferred in AOCI and released and recorded on the consolidated statements of operations in the same period that the hedged transaction is recorded. The time value component of the fair value of the derivative is deemed ineffective and is reported currently in “Other expense (income), net” on the consolidated statements of operations in the period which it is applicable. Any cash flows associated with these instruments are included in cash from operations in accordance with the Company's policy of classifying the cash flows from these instruments in the same category as the cash flows from the items being hedged.
 
These foreign exchange forward contracts generally have maturities up to eighteen months and the counterparties to the transactions are typically large international financial institutions. The Company's significant contracts outstanding as of September 30, 2012 are summarized in the tables that follow.

Interest Rate Risk Management
 
The Company uses interest rate swaps to convert a portion of its variable interest rate debt to fixed interest rate debt. As of September 30, 2012, the Company has two groups of significant interest rate swaps. One of the groups of swaps has notional amounts totaling 12.6 billion Japanese yen, and effectively converts the underlying variable interest rates to an average fixed interest rate of 0.2% for a term of three years, ending in September 2014. Another swap has a notional amount of 65.0 million Swiss francs, and effectively converts the underlying variable interest rates to a fixed interest rate of 0.7% for a term of five years, ending in September 2016.
The Company enters into interest rate swap contracts infrequently as they are only used to manage interest rate risk on long-term debt instruments and not for speculative purposes. The Company's significant contracts outstanding as of September 30, 2012 are summarized in the tables that follow.
Commodity Risk Management
 
The Company selectively enters into commodity swaps to effectively fix certain variable raw material costs. These swaps are used purely to stabilize the cost of components used in the production of certain of the Company's products. The Company generally accounts for the commodity swaps as cash flow hedges. As a result, the Company records the fair value of the contracts primarily through AOCI based on the tested effectiveness of the commodity swaps. The Company measures the effectiveness of cash flow hedges of anticipated transactions on a spot-to-spot basis rather than on a forward-to-forward basis. Accordingly, the spot-to-spot change in the derivative fair value will be deferred in AOCI and released and recorded on the consolidated statements of operations in the same period that the hedged transaction is recorded. The time value component of the fair value of the derivative is deemed ineffective and is reported currently in “Interest expense” on the consolidated statements of operations in the period which it is applicable. Any cash flows associated with these instruments are included in cash from operations in accordance with the Company's policy of classifying the cash flows from these instruments in the same category as the cash flows from the items being hedged.
At September 30, 2012, the Company had swaps in place to purchase 550 troy ounces of platinum bullion for use in production at an average fixed rate of $1,466 per troy ounce.  In addition, the Company had swaps in place to purchase 48,170 troy ounces of silver bullion for use in production at an average fixed rate of $28 per troy ounce.
 









19





The following tables summarize the notional amounts and fair value of the Company's cash flow hedges and non-designated derivatives at September 30, 2012:
Foreign Exchange Forward Contracts
 
Notional Amounts Maturing in the Year
 
Fair Value Net
Asset (Liability)
(in thousands)  
 
2012
 
2013
 
2014
 
September 30, 2012
 
 
 
 
 
 
 
 
 
Forward sale, 10.5 million Australian dollars
 
$
4,293

 
$
5,410

 
$
754

 
$
(229
)
Forward purchase, 6.6 million British pounds
 
(10,404
)
 
(199
)
 

 
18

Forward sale, 44.4 million Canadian dollars
 
13,856

 
26,851

 
4,022

 
(650
)
Forward purchase, 21.1 million Danish kroner
 
(3,646