[March 13, 2013] IMATION CORP - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations. Tweet (Edgar Glimpses Via Acquire Media NewsEdge) Imation is a global scalable storage and data security company. Our portfolio includes commercial and consumer data storage and security products as well as products designed to manage audio and video information in the home. Imation reaches customers in more than 100 countries through a global distribution network and well recognized brands. The following discussion is intended to be read in conjunction with Item 1. Business and our Consolidated Financial Statements and related Notes that appear elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Imation's actual results could differ materially from those anticipated due to various factors discussed below under "Cautionary Statements Regarding Forward-Looking Statements" in Item 1A. Risk Factors of this Annual Report on Form 10-K. Basis of Presentation The financial statements in this Annual Report on Form 10-K are presented on a consolidated basis and include the accounts of the Company and our subsidiaries. See Note 2 - Summary of Significant Accounting Policies in our Notes to Consolidated Financial Statements for further information regarding consolidation. References to "Imation," the "Company," "we," "us" and "our" are to Imation Corp, and its subsidiaries and consolidated entities. Our Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Overview Following is a summary of significant items impacting the Company during the year that impacted our operating results, liquidity and capital structure in 2012: Strategic Transformation During the fourth quarter of 2012, we announced the acceleration of our strategic transformation, including the planned realignment of our global business into two new business units, a cost reduction program and our increased focus on data storage and security including exploring strategic options for our consumer electronics brands and businesses. As our traditional media businesses decline, we are accelerating our business transformation to further focus on data storage and data security. Further, on February 13, 2013, we announced our plans to divest our XtremeMac and Memorex consumer electronics businesses. We will continue our TDK Life on Record business on a more selective basis. The realignment of our global business into two new business units will better align the Company with our key commercial and consumer channels. The two business units will consist of Tiered Storage and Security Solutions (TSS), which will focus on small and medium business and enterprise and government customers; and Consumer Storage and Accessories (CSA), which will focus on retail channels. We continued to manage and evaluate results through December 31, 2012 under our historic regional segment presentation but will report segment information under the new structure beginning with the first quarter of 2013. See Note 14 - Business Segment Information and Geographical Data in our Notes to Consolidated Financial Statements for more information on our business segments. In October 2012, the Board of Directors approved a restructuring program in order to realign our business structure and reduce operating expenses by more than 25 percent over time. This restructuring program addresses product line rationalization and infrastructure, and includes a reduction of approximately 20 percent of our global workforce. These actions are being implemented beginning in 2013. We anticipate we will incur cash charges up to $40 million, with total charges between $50 million and $60 million (excluding charges associated with goodwill and intangible asset impairments), the majority of which will occur in 2013. See Note 7 - Restructuring and Other Expense in our Notes to Consolidated Financial Statements for more information on the restructuring program. In conjunction with the acceleration of our strategic transformation in the fourth quarter of 2012, we evaluated our intangible assets, including goodwill, for impairment and recorded non-cash impairment charges of $283.8 million in the quarter. The intangible asset charges are primarily due to an accelerated secular optical market decline. See Note 6 - Intangible Assets and Goodwill in our Notes to Consolidated Financial Statements for further information on the impairment charges. Product Overview Optical media product revenue comprised 38.8 percent, 39.6 percent and 42.4 percent of our total 19-------------------------------------------------------------------------------- Table of Contents consolidated revenue in 2012, 2011 and 2010, respectively. The optical media market continues to contract and such contractions accelerated in 2012 as consumers continued to adopt alternatives such as digital streaming, hard disk and flash media, resulting in decreasing revenues. We believe we are generally maintaining our worldwide market share. During 2011 and 2010 we saw significant price increases for the raw materials required to produce optical media, particularly polycarbonate which is made out of oil and silver. These raw materials price increases were passed on to us in 2011 by our suppliers and although they were subsequently mitigated in part by successfully negotiated price increases with our customers, they resulted in gross margin pressures. The contracting optical media market size and increasing raw materials prices impacted all of our segments resulting in decreasing revenues and gross margins. During 2011, we reversed $7.8 million of accruals related to prior year European optical media copyright levies payable for which we considered payment remote due to the European Court of Justice (ECJ) ruling on the European Copyright Directive, which became effective in 2002. See Note 15 - Litigation, Commitments and Contingencies in our Notes to Consolidated Financial Statements for further information regarding levies. Magnetic product revenue comprised 26.0 percent, 25.4 percent and 23.8 percent of our total consolidated revenue in 2012, 2011 and 2010, respectively. While we expect the demand for data storage capacity to increase, advances in technology allow increasingly more data to be stored on a single unit of magnetic tape and thus, over the recent past, the market has declined each year. While the market is getting smaller, we believe we are maintaining our market share in all of our regional business segments. We discontinued tape coating operations at our Weatherford, Oklahoma facility in 2011 in order to gain efficiencies and reduce manufacturing costs. We signed a strategic agreement with TDK Corporation to jointly develop and manufacture magnetic tape technologies. Under the agreement, we are collaborating on the research and development of future tape formats in both companies' research centers in the United States and Japan and we consolidated tape coating operations to the TDK Yamanashi manufacturing facility. The contracting magnetic tape market size impacted all of our segments resulting in decreasing revenues, and we expect these trends to continue into 2013. Other traditional storage product revenue comprised 1.4 percent, 3.7 percent and 4.3 percent of our total consolidated revenue in 2012, 2011 and 2010, respectively. We expect the demand for audio video tape and optical drives, the products which comprise the majority of the revenue in this category, to decrease over time. Secure and scalable storage product revenue comprised 19.1 percent, 16.3 percent and 14.2 percent of our total consolidated revenue in 2012, 2011 and 2010, respectively. The increase as a percent of total revenue for this component reflects our investment in secure and scalable storage products through our acquisitions in 2011. We continued our strategy of investing in growth platforms in data storage and security solutions with the acquisition of Nexsan Corporation (Nexsan) on December 31, 2012. The acquisition of Nexsan brings us a proven technology platform and a robust portfolio of disk-based and hybrid disk-and-solid-state storage systems and is expected to significantly accelerate our growth in the small and medium-sized business and distributed enterprise storage markets. Imation will provide the Nexsan business with global scale and a well-known storage brand for global expansion. We expect growth in these secure and scalable products as a result of the businesses we acquired in 2011 and 2012. Audio and video information product revenue comprised 14.7 percent, 15.0 percent and 15.3 percent of our total consolidated revenue in 2012, 2011 and 2010, respectively. Declines in these products were driven by decreased revenue in the United States as we continued to experience a very difficult retail environment for the products we sell. As a part of the acceleration of our strategic transformation and our increased focus on data storage and security, on February 13, 2013, we announced our plans to divest our XtremeMac and Memorex consumer electronics businesses, which represent a significant portion of this product group. We will continue our TDK Life on Record business on a more focused basis. Executive Summary Consolidated Results of Operations for the Twelve Months Ended December 31, 2012 • Revenue of $1,099.6 million in 2012 was down 14.8 percent compared with revenue of $1,290.4 million in 2011. • Gross margin of 18.4% percent in 2012 was up from 16.8% percent in 2011. • Selling, general and administrative expense was $210.7 million in 2012, up $7.0 million, compared with $203.7 million in 2011. • Research and development expense was $22.8 million in 2012, up $1.8 million, compared with $21.0 million in 2011. 20-------------------------------------------------------------------------------- Table of Contents • We recorded non-cash goodwill impairment charges of $23.3 million in 2012 and $1.6 million in 2011 and recorded non-cash intangible impairment charges of $260.5 million in 2012. • Restructuring and other expense was $21.1 million in 2012 and $21.5 million in 2011, from previously announced restructuring programs. • Other (income) expense was $5.0 million in 2012, down $4.8 million, compared with $9.8 million in 2011. • Operating loss was $336.1 million in 2012 compared with an operating loss of $33.1 million in 2011. • The income tax benefit was $0.4 million in 2012 compared with an income tax provision of $3.8 million in 2011. Cash Flow/Financial Condition for the Twelve Months Ended December 31, 2012 • Cash and cash equivalents totaled $108.7 million as of December 31, 2012 compared with $223.1 million at December 31, 2011. The reduction was due mainly to the Nexsan acquisition. • Cash used in operating activities was $8.5 million for the twelve months ended December 31, 2012 compared with cash used in operating activities of $16.3 million for the twelve months ended December 31, 2011. Results of Operations Net Revenue Years Ended December 31, Percent Change 2012 2011 2010 2012 vs. 2011 2011 vs. 2010 (In millions) Net revenue $ 1,099.6 $ 1,290.4 $ 1,460.9 (14.8 )% (11.7 )% Our worldwide revenue in 2012 decreased compared with 2011, driven by declines in our maturing traditional storage products and our audio and video information products. Several continuing macro-economic factors, including the broad-based European economic downturn, a soft global IT environment and a weak U.S. retail environment for the products we sell, had an impact on our revenue in 2012. From a product perspective, the decrease in revenue included declines in traditional storage products of $158.6 million comprising $85.1 million from optical products, $41.2 million from magnetic products and $32.3 million from other traditional storage products, as well as decreased revenue from audio and video information products of $32.2 million. Secure and scalable products remained flat in 2012 compared to 2011 as a $20.4 million decline in commodity flash products, driven by continued market place price degradation, was offset by a $14.3 million increase in our mobile security products as well as increases in our other secure and scalable products. Revenue for 2012 compared to 2011 was negatively impacted by foreign currency translation of one percent. Our worldwide revenue in 2011 decreased compared with 2010 due to declines in traditional storage products of $142.9 million, including $107.4 million from optical products and $20.4 million from magnetic products, as well as $30.2 million from audio and video information products, driven by planned rationalization of our video products, offset partially by increases in secure and scalable storage products of $2.6 million. Revenue was positively impacted by foreign currency translation of four percent. Gross Profit Years Ended December 31, Percent Change 2012 2011 2010 2012 vs. 2011 2011 vs. 2010 (In millions) Gross profit $ 202.3 $ 216.7 $ 226.4 (6.6 )% (4.3 )% Gross margin 18.4 % 16.8 % 15.5 % Gross profit decreased in 2012 compared with 2011 due primarily to lower revenue from all major product categories, as well as lower gross margins on traditional storage products, partially offset by higher gross margins on secure and scalable storage products. Gross profit in 2012 benefited from lower inventory write-offs compared to 2011 with write-offs of $2.3 million and $9.1 million recorded in 2012 and 2011, respectively. Gross profit during 21-------------------------------------------------------------------------------- Table of Contents 2011 benefited from $7.8 million related to the reversal of European levies accrued in prior years for which we considered payment remote. Gross profit decreased in 2011 compared with 2010 due primarily to lower revenues from optical products and magnetic products, as well as inventory write-offs of $9.1 million which were part of our restructuring programs, offset partially by higher gross margins on all product categories. Optical gross profit benefited from the $7.8 million reversal of European levies and price increases which were partially offset by optical supplier price increases of $12.8 million. Total gross margins increased in 2012 compared with 2011 due primarily to a shift in product mix to higher gross margin products along with improved gross margins in secure and scalable storage and audio and video information. Gross margins for traditional storage products were flat at 19.0 percent compared with 2011. Gross margins for secure and scalable storage products rose 3.7 points to 18.8 percent compared with 2011 due to favorable changes in product mix as a result of revenue growth in our mobile security products. Gross margins for audio and video information products rose 3.4 points to 16.4 percent compared with 2011 due to favorable changes in product mix as a result of revenue growth in higher margin headphones, cases and other accessories. Total gross margins increased in 2011 compared with 2010 due primarily to the reversal of European levies accrued as well as price increases, offset partially by optical supplier cost increases along with changes in product mix. Selling, General and Administrative (SG&A) Years Ended December 31, Percent Change 2012 2011 2010 2012 vs. 2011 2011 vs. 2010 (In millions) Selling, general and administrative $ 210.7 $ 203.7 $ 202.5 3.4 % 0.6 % As a percent of revenue 19.2 % 15.8 % 13.9 % SG&A expense increased in 2012 compared with 2011 due primarily to the additional ongoing SG&A expense of $12.2 million and intangible amortization of $2.3 million related to our acquired businesses partially offset by cost reductions achieved. SG&A expense was essentially flat in 2011 compared with 2010 and was impacted by lower compensation expense, the reversal of a bad debt reserve of $2.7 million and cost control actions, offset by additional ongoing SG&A expenses related to our acquired businesses. This resulted in an increase in our SG&A expense as a percent of revenue in 2011 compared to 2010. Research and Development (R&D) Years Ended December 31, Percent Change 2012 2011 2010 2012 vs. 2011 2011 vs. 2010 (In millions) Research and development $ 22.8 $ 21.0 $ 16.4 8.6 % 28.0 % As a percent of revenue 2.1 % 1.6 % 1.1 % R&D expense increased in 2012 compared with 2011 due to our acquisitions and investment to support growth initiatives in secure and scalable storage products. R&D expense increased in 2011 compared with 2010 due to our investment to support growth initiatives in secure and scalable storage products. During 2011 we refocused our R&D effort to invest in four core product technology areas: secure storage, scalable storage, wireless/connectivity and magnetic tape. This resulted in an increase in our R&D expense as a percent of revenue in 2011 compared with 2010. Goodwill Impairment Years Ended December 31, 2012 2011 2010 (In millions) Goodwill impairment $ 23.3 $ 1.6 $ 23.5 22-------------------------------------------------------------------------------- Table of Contents We test the carrying amount of a reporting unit's goodwill for impairment on an annual basis during the fourth quarter of each year or if an event occurs or circumstances change that would warrant impairment testing during an interim period. During 2011, we acquired the assets of MXI Security, from Memory Experts International Inc., (MXI) and the secure data storage hardware business of IronKey Systems Inc. (IronKey) which resulted in goodwill of $21.9 million and $9.4 million, respectively. These businesses, along with our Imation Defender brand, make up our Americas-Mobile Security reporting unit. The carrying value of our Mobile Security reporting unit included $31.3 million of goodwill prior to our 2012 impairment testing. During the second and third quarters of 2012, we adjusted our internal financial forecast for our Americas-Mobile Security reporting unit due to changes in timing of expected cash flows and lower expected short-term revenues and lower gross margins. As we considered these factors to be an event that warranted an interim test as to whether the goodwill was impaired, we performed an impairment test as of each of these periods. These impairment tests resulted in no impairment of goodwill as the estimated fair value of the reporting units exceeded the carrying value in step 1 of the impairment tests by 43.3 percent and 17.7 percent, during the second and third quarter of 2012, respectively. During the fourth quarter of 2012, our internal financial forecast for our Americas-Mobile Security reporting unit was again adjusted with further declines in our revenue and gross margin projections resulting from lower expectations in the high-security market segment. In accordance with our policy, we performed our annual assessment of goodwill in the Americas-Mobile Security reporting unit during the fourth quarter of 2012 and, as a result of this assessment, it was determined that the fair value of our Mobile Security reporting unit was impaired. We recorded an impairment charge of $23.3 million to the Americas reporting segment in the Consolidated Statements of Operations. In determining the estimated fair value of the reporting unit, we used the income approach, a valuation technique under which we estimate future cash flows using the reporting unit's financial forecasts. Our expected cash flows are affected by various significant assumptions, including the discount rate, revenue and gross margin expectations and terminal value growth rate. Our analysis utilized discounted forecasted cash flows over a 10 year period with an estimation of residual growth rates thereafter. We use our business plans and projections as the basis for expected future cash flows. The significant assumptions used include a discount rate of 16.0 percent to reflect the relevant risks of the higher growth assumed for the Americas-Mobile Security reporting unit, revenue growth rates, which were forecasted to be significant, and a terminal growth rate of 2.5 percent. An increase in the discount rate of one percent would have decreased the reporting unit's fair value by approximately 4.0 percent while a decrease in the discount rate by one percent would have increased the reporting unit's fair value by 4.7 percent. The revenue growth rates in 2013 through 2015 are significant assumptions within the projections. During 2011, we acquired substantially all of the assets of BeCompliant Corporation, doing business as Encryptx (Encryptx) which resulted in goodwill of $1.6 million. The goodwill was allocated to our existing Americas-Commercial reporting unit. Based on an interim goodwill impairment test performed at March 31, 2011, we determined that the goodwill in the Americas-Commercial reporting unit, including the assets of Encryptx, exceeded the implied fair value and, therefore, the goodwill was fully impaired. As a result, a $1.6 million charge was recorded in 2011 in restructuring and other in the Consolidated Statements of Operations. During 2010, we made certain changes to our business segments. As a result of the segment change in 2010, the $23.5 million of goodwill which was previously allocated to the Electronics Products segment was merged into the Americas-Consumer reporting unit. The Americas-Consumer reporting unit had a fair value that was significantly less than its carrying amount prior to the combination, which is a triggering event for an interim goodwill impairment test. A two-step impairment test was performed to identify a potential impairment and measure an impairment loss to be recognized. Based on the goodwill test performed in the second quarter of 2010, we determined that the carrying amount of the reporting unit significantly exceeded its fair value and that the $23.5 million of goodwill was fully impaired. See Note 2 - Summary of Significant Accounting Policies and Note 6 - Intangible Assets and Goodwill in our Notes to Consolidated Financial Statements as well as Critical Accounting Policies and Estimates for further background and information on goodwill impairments. Intangible Impairments During the fourth quarter of 2012, we determined that the results of our revised internal financial forecast, which was finalized during the quarter and took into account the expected actions and outcomes associated with the 23-------------------------------------------------------------------------------- Table of Contents acceleration of our strategic transformation (as further described in above), qualified as a triggering event for impairment testing. This required the assessment of the recoverability of the long-lived assets (including definite-lived intangible assets) included in all of our asset groups with the exception of the recent acquisition of Nexsan. As a result of this event, we compared the carrying value of our asset groups with their estimated undiscounted future cash flows and determined that the carrying value of certain intangible asset groups exceeded their fair value. We generally determined our asset groups to be associated with our various brands as that is the lowest level for which identifiable cash flows are largely independent of one another. We then calculated the impairment of these asset groups as the excess of their carrying value over their discounted fair value and as a result we recorded an impairment loss of $260.5 million which was recorded in the Consolidated Statements of Operations. In calculating the discounted fair value of the asset groups, we used the income approach, a valuation technique under which we estimate future cash flows using our financial forecasts associated with the asset groups. Our expected cash flows are affected by various significant assumptions, including projected sales, gross margin and expense expectations as well as a discount rate. Our analysis utilized forecasted cash flows ranging from a four year to a 10 year period depending on the asset group, and our business plans served as the basis for these cash flow assumptions. The analysis utilized discount rates ranging from 15.0 percent to 15.5 percent depending on the asset group. An increase in the discount rate of one percent would have decreased the intangible asset fair value by approximately 3.0 percent while a decrease in the discount rate by one percent would have increased the intangible asset fair value by 3.0 percent. Litigation Settlements A litigation settlement charge of $2.0 million was recognized in 2011. We entered into a settlement with Advanced Research Corp. (ARC) under which we agreed to pay ARC $2.0 million to settle a dispute relating to a supply agreement under which we purchased magnetic heads to write servo patterns on magnetic tape. A litigation settlement charge of $2.6 million was recognized in 2010. On January 11, 2011, we signed a patent cross-license agreement with SanDisk Corporation (SanDisk) to settle two patent cases filed by SanDisk in Federal District Court against our flash memory products, including USB drives and solid state disk drives. Under the terms of the cross-license, we will pay SanDisk royalties on certain flash memory products that were previously not licensed. The specific terms of the cross-license are confidential. The cross-license agreement required us to make a one-time payment of $2.6 million in 2011, which was included in litigation settlement expense in the Consolidated Statements of Operations during 2010. See Note 15 - Litigation, Commitments and Contingencies in our Notes to Consolidated Financial Statements for further information. Restructuring and Other The components of our restructuring and other expense included in the Consolidated Statements of Operations were as follows: 24-------------------------------------------------------------------------------- Table of Contents Years Ended December 31, 2012 2011 2010 (In millions) Restructuring Severance and related $ 16.9 $ 7.0 $ 13.0 Lease termination costs 0.6 3.3 1.7 Other 2.2 1.1 - Gain on sale of fixed assets held for sale (0.7 ) - - Total restructuring $ 19.0 $ 11.4 $ 14.7 Other Contingent consideration fair value adjustment (Note 4) (8.6 ) - - Intangible asset abandonment (Note 6) 1.9 - - Acquisition and integration related costs 3.7 2.6 - Pension settlement/curtailment (Note 9) 2.4 2.5 2.8 Asset disposals - 7.0 - Asset impairments - - 31.2 Other 2.7 (2.0 ) 2.4 Total $ 21.1 $ 21.5 $ 51.1 2012 Global Processing Improvement Restructuring Program On October 22, 2012, the Board of Directors approved the Global Processing Improvement Restructuring Program (GPI Program) relating to the realignment of our business structure and reduction of our operating expenses in excess of 25 percent over time. This program addresses product line rationalization and infrastructure, and is anticipated to include a reduction of approximately 20 percent of our global workforce. As it pertains to this restructuring program, we anticipate we will incur cash payments up to $40 million, with total charges to our Statement of Operations between $50 million and $60 million (excluding charges associated with goodwill and intangible asset impairments), the majority of which will occur in 2013. This restructuring action is anticipated to include between $15 million and $25 million for severance and one-time termination benefits, between $5 million and $15 million for asset impairments, excluding goodwill and intangible asset impairments recorded in 2012, and between $20 million and $25 million for other charges. This program was required due to current and future expected revenue declines. These actions are being implemented beginning in 2013. During 2012, we recorded restructuring charges of $14.9 million associated with this program. These charges were primarily associated with severance related activity and were included in restructuring and other in our Consolidated Statements of Operations. 2011 Corporate Strategy Restructuring Program On January 31, 2011, the Board of Directors approved the 2011 Corporate Strategy Restructuring Program (2011 Corporate Program) to rationalize certain product lines, increase efficiency and gain greater focus in support of our go-forward strategy. Major components of the program included charges associated with certain benefit plans, improvements to our global sourcing and distribution network, costs associated with further rationalization of our product lines and evolution of our skill sets to align with our announced strategy. Since the inception of this program, we have recorded a total of $13.4 million of severance and related expenses, $3.5 million of lease termination and modification costs, $1.6 million of inventory write-offs, $0.3 million related to a pension curtailment charge and $0.9 million of other charges. Inventory write-offs are included in cost of goods sold in our Consolidated Statements of Operations. At December 31, 2012, we had approximately $15 million of authorized spending amounts remaining related to this program. At December 31, 2012, this remaining authorization was transferred and added to the GPI program and any future charges as well as the remaining spend relating to the 2011 Corporate Program will be accounted for under the 2012 GPI Program. During 2012, we recorded restructuring charges of $4.2 million associated with this program. These charges were primarily associated with severance and were included in restructuring and other in our Consolidated Statements of Operations. During 2011, we recorded restructuring charges of $10.2 million primarily related to severance and lease 25-------------------------------------------------------------------------------- Table of Contents termination costs. In addition, we also recorded inventory write-offs of $1.6 million related to the planned rationalization of certain product lines as part of this program, which are included in cost of goods sold in our Consolidated Statements of Operations. During 2010, we recorded restructuring charges of $3.4 million for severance and related expenses. Other Prior Programs Substantially Complete We have had activity related to two programs, as described further below, that were initiated in prior years and are now substantially complete. The 2011 Manufacturing Redesign Restructuring Program (2011 Manufacturing Program) was initiated during the first quarter of 2011 to rationalize certain product lines and discontinue tape coating operations at our Weatherford, Oklahoma facility and subsequently close the facility. The 2008 Corporate Redesign Restructuring Program (2008 Corporate Program) was initiated during the fourth quarter of 2008 and aligned our cost structure by reducing SG&A expenses. We reduced costs by rationalizing key accounts and products and by simplifying our corporate structure globally. During 2012, we recorded a gain on the sale of assets from the Weatherford facility of $0.7 million and charges of $0.6 million related to our 2011 Manufacturing Program. These costs were included in restructuring and other in our Consolidated Statements of Operations. During 2011, we recorded restructuring charges of $0.3 million for lease termination and modification costs and $0.9 million of site clean-up expenses related to our 2011 Manufacturing Program. These costs were included in restructuring and other in our Consolidated Statements of Operations. We also recorded non-cash inventory write-offs of $7.5 million, relating to our 2011 Manufacturing Program, which were included in cost of goods sold in our Consolidated Statements of Operations. During 2010, we recorded restructuring charges of $3.2 million for severance and related expenses and non-cash inventory write-offs of $14.2 million in connection with our 2011 Manufacturing Program. The inventory write-offs are included in cost of goods sold in our Consolidated Statements of Operations. During 2010, we recorded $6.4 million of severance and related expenses and $1.7 million of lease termination costs related to our 2008 Corporate Program. Other Certain amounts recorded in Other are discussed elsewhere in our Notes to Consolidated Financial Statements. See note references in table above. During 2012, we recorded acquisition and integration related costs of $3.7 million and other costs of $2.7 million. These costs were recorded in restructuring and other expense in the Consolidated Statements of Operations. In addition, we recorded inventory write-offs of $2.3 million related to the planned rationalization of certain product lines, which are included in cost of goods sold in our Consolidated Statements of Operations. During 2011, we recorded acquisition and integration related costs as a result of our acquisition activities of $2.6 million. Additionally, we amended a long-term disability benefit plan, resulting in a $2.0 million gain. These items were recorded in restructuring and other expense in our Consolidated Statements of Operations. Our Camarillo, California manufacturing facility ceased operations on December 31, 2008 and the facility, comprised of a building and property, was classified as held for sale. During 2011, in an effort to increase the salability of the property, we demolished the building which resulted in a $7.0 million loss on disposal during the period. The land related to the facility continues to meet the criteria for held for sale accounting and, therefore, remains classified in other current assets on the Consolidated Balance Sheet as of December 31, 2012 at a book value of $0.2 million. On October 7, 2011 we entered into an agreement to sell the land for $10.5 million, contingent upon the change of certain zoning requirements for the land as well as other standard conditions. If these conditions are met, the sale is expected to close in 2013. During 2010 we recorded $0.2 million of other charges related to the 2008 Corporate Program. Additionally during 2010, other expenses included costs associated with the announced retirement of our former Vice Chairman and Chief Executive Officer, including a severance related charge of $1.4 million and a charge of $0.8 million related to the accelerated vesting of his unvested options and restricted stock. In 2010, certain assets held primarily at our Weatherford, Oklahoma facility were determined to be impaired in accordance with the provisions of impairment of long-lived assets. These long-lived assets held and used include the property, building and equipment primarily related to the manufacturing of magnetic tape which was consolidated to the TDK Group Yamanashi manufacturing facility in 2011 as a part of our 2011 Manufacturing Program. The land and building had a carrying amount of $17.0 million and were written down to their fair value of 26-------------------------------------------------------------------------------- Table of Contents $2.3 million, resulting in an impairment charge of $14.7 million during 2010. The fair value of the equipment was assessed based upon sales proceeds from similar equipment sold as part of the closing of our Camarillo, California facility. The Weatherford equipment had a carrying amount of $17.4 million and was written down to its fair value of $0.9 million resulting in an impairment charge of $16.5 million during 2010. The impairments were recorded as part of restructuring and other charges in our Consolidated Statements of Operations in 2010. As of June 30, 2011, our Weatherford facility met the criteria for classification as held for sale outlined in the accounting guidance for the sale of a long-lived asset. Accordingly, the book values of the building and property of $2.3 million were transferred into other current assets on our Consolidated Balance Sheets and are no longer being depreciated. Operating Loss Years Ended December 31, Percent Change 2012 2011 2010 2012 vs. 2011 2011 vs. 2010 (In millions) Operating loss $ (336.1 ) $ (33.1 ) $ (69.7 ) NM (52.5 )% As a percent of revenue (30.6 )% (2.6 )% (4.8 )% _______________________________________ NM - Not meaningful Operating loss increased in 2012 compared with 2011 due primarily to intangible asset impairment losses of $260.5 million and a goodwill impairment charge of $23.3 million. Operating loss decreased in 2011 compared with 2010 due primarily to lower restructuring and other charges of $29.6 million and lower goodwill impairment charges of $21.9 million, partially offset by lower revenue resulting in lower gross profit of $9.7 million as well as higher R&D expense of $4.6 million, each as discussed above. Other (Income) and Expense Years Ended December 31, Percent Change 2012 2011 2010 2012 vs. 2011 2011 vs. 2010 (In millions) Interest income $ (0.5 ) $ (0.9 ) $ (0.8 ) (44.4 )% 12.5 % Interest expense 2.9 3.7 4.2 (21.6 )% (11.9 )% Other, net 2.6 7.0 3.3 (62.9 )% 112.1 % Total $ 5.0 $ 9.8 $ 6.7 (49.0 )% 46.3 % As a percent of revenue 0.5 % 0.8 % 0.5 % Other expense decreased in 2012 compared with 2011. Interest expense decreased compared with 2011 due to lower amortization of capitalized fees related to securing our credit facility and decreased imputed interest related to our liability for the Philips litigation settlement, while interest income decreased slightly compared with 2011. Other, net includes foreign currency losses and gains or losses from investments. Other expense decreased in 2012 compared with 2011 due to decreases in foreign currency losses of $3.0 million. We attempt to mitigate the exposure to foreign currency volatility through our hedging program; however, our program is not designed to fully hedge our risk, and as a result, we experience some volatility, especially in periods of significant foreign currency fluctuation. Other, net in 2012 also includes an investment recovery of $0.9 million. Other expense increased in 2011 compared with 2010. Interest income remained relatively constant in 2011 compared with 2010. Our interest expense decreased in 2011 compared with 2010 due to decreased amortization of capitalized fees related to securing our credit facility and decreased imputed interest related to our liability for the Philips litigation settlement. Other expense increased in 2011 compared with 2010 due to increases in foreign currency losses of $2.4 million. Other expense in 2010 benefited $2.0 million from a recovery of a note receivable from a commercial partner. Income Tax Provision (Benefit) 27-------------------------------------------------------------------------------- Table of Contents Years Ended December 31, 2012 2011 2010 (In millions)Income tax provision (benefit) $ (0.4 ) $ 3.8 $ 81.9 Effective tax rate NM NM NM _______________________________________ NM - Not meaningful The 2012 income tax benefit primarily represents tax expense related to operations outside the United States, offset by tax benefit from settlements with taxing authorities during 2012 and activity in other comprehensive income. We maintain a valuation allowance related to our U.S. deferred tax assets and certain foreign net operating losses. Because of the valuation allowances, the effective tax rates for 2012, 2011 and 2010 are not meaningful. The change in our income tax benefit for 2012, as compared to our 2011 tax provision, was primarily due to lower withholding tax expense incurred during 2012, settlements with taxing authorities concluded during 2012, the impact of activity in other comprehensive income and the mix of taxable income (loss) by country. The change in our income tax provision for 2011, as compared to 2010, was primarily due to the establishment of a valuation allowance in 2010 on our U.S. deferred tax assets, a $5.0 million benefit for the reversal of a foreign net operating loss valuation allowance in 2011 and changes in the mix of income/loss by jurisdiction. Other items that had an impact on the 2010 effective tax rate included a change in the state tax effective rate, reserves for uncertain tax positions, foreign earnings subject to U.S. taxation, and changes in the mix of income by jurisdiction. See Note 10 - Income Taxes in our Notes to Consolidated Financial Statements for further information. As of December 31, 2012 and 2011, we had valuation allowances of $239.1 million and $141.1 million, respectively, to account for deferred tax assets we have concluded are not considered to be more-likely-than-not to be realized in the future due to our cumulative losses in recent years. The deferred tax assets subject to valuation allowance include certain U.S. and foreign operating loss carryforwards, certain U.S. deferred tax deductions and certain tax credit carryforwards. Segment Results Our business is organized, managed and internally and externally reported as segments differentiated by the regional markets we serve: Americas, Europe, North Asia and South Asia. Each of these geographic segments has responsibility for selling all of our product lines. • Our Americas segment includes North America, Central America and South America. • Our Europe segment includes Europe and parts of Africa. • Our North Asia segment includes Japan, China, Hong Kong, Korea and Taiwan. • Our South Asia segment includes Australia, Singapore, India, the Middle East and parts of Africa We evaluate segment performance based on revenue and operating income (loss). Revenue for each segment is generally based on customer location where the product is shipped. The operating income (loss) reported in our segments excludes corporate and other unallocated amounts. Although such amounts are excluded from the business segment results, they are included in reported consolidated results. Corporate and unallocated amounts include litigation settlement expense, goodwill impairment, intangible asset impairments, research and development expense, corporate expense, stock-based compensation expense, inventory write-offs related to our restructuring programs and restructuring and other expenses which are not allocated to the segments. In 2012, all of our segments were impacted by several macro-economic factors including the broad-based European economic downturn and its effect on the rest of the world, a soft global IT environment as well as a weak U.S. retail environment related to the products we sell. Information related to our segments is as follows: Americas 28-------------------------------------------------------------------------------- Table of Contents Years Ended December 31, Percent Change 2012 2011 2010 2012 vs. 2011 2011 vs. 2010 (In millions) Net revenue $ 504.7 $ 595.9 $ 712.9 (15.3 )% (16.4 )% Operating income 2.9 8.4 36.8 (65.5 )% (77.2 )% As a percent of revenue 0.6 % 1.4 % 5.2 % The Americas segment is our largest segment comprising 45.9 percent, 46.2 percent and 48.8 percent of our total consolidated revenue in 2012, 2011 and 2010, respectively. The decrease in the Americas segment revenue in 2012 compared with 2011 was primarily due to declines in our maturing traditional storage products and our audio and video information products. From a product perspective, the decrease in revenue was primarily comprised of lower revenue from audio and video information products of $41.1 million and optical products of $38.4 million as well as lower revenue from magnetic products of $17.5 million. These declines were partially offset by higher revenue from secure and scalable storage products of $12.5 million. Operating income decreased in 2012 compared with 2011 driven primarily by lower gross profit due to lower revenues in our traditional storage products and audio and video information products and higher SG&A and R&D expenses, partially offset by higher gross profit due to higher gross margins on optical media and secure and scalable storage products. The Americas segment revenue decreased in 2011 compared with 2010 driven primarily by the decreases in revenue from optical products of $57.3 million, audio and video information products of $41.1 million due to planned rationalization of certain product lines and magnetic products of $25.7 million. Operating income decreased in 2011 compared with 2010 driven primarily by decreases in revenue and lower gross margins on optical and magnetic products and decreases in revenue on audio and video information products, partially offset by higher gross margins on secure and scalable storage products. Europe Years Ended December 31, Percent Change 2012 2011 2010 2012 vs. 2011 2011 vs. 2010 (In millions) Net revenue $ 208.8 $ 248.0 $ 289.8 (15.8 )% (14.4 )% Operating (loss) income (3.9 ) 10.3 (0.6 ) (137.9 )% NM As a percent of revenue (1.9 )% 4.2 % (0.2 )% _______________________________________ NM - Not meaningful The Europe segment revenue comprised 19.0 percent, 19.2 percent and 19.8 percent of our total consolidated revenue in 2012, 2011 and 2010, respectively. The decrease in the Europe segment revenue in 2012 compared with 2011 was driven primarily by declines in our maturing traditional storage products of $37.8 million. From a product perspective, the decrease in revenue in our traditional storage products was composed primarily of lower revenue from optical products of $20.2 million and magnetic products of $12.2 million. Secure and scalable storage products declined $4.3 million, driven principally by commodity flash products. These revenue declines were offset by an increase in audio and video information products revenues of $3.1 million from 2011. Revenue was impacted by unfavorable foreign currency of approximately six percent. Operating loss in 2012 compared with operating income in 2011 was driven primarily by lower gross profit due to lower revenue. Operating income during 2011 benefited from levy accrual reversals of $7.8 million The Europe segment revenue decreased in 2011 compared with 2010 driven primarily by decreases in revenue from optical products of $31.4 million. Operating income increased in 2011 compared with 2010 driven primarily by the higher gross margins on optical products mainly due to the reversal of prior year European optical media copyright levy payables of $7.8 million for which we considered payment remote. Revenue was benefited by foreign currency impacts of approximately six percent. North Asia 29-------------------------------------------------------------------------------- Table of Contents Years Ended December 31, Percent Change 2012 2011 2010 2012 vs. 2011 2011 vs. 2010 (In millions) Net revenue $ 272.5 $ 307.2 $ 315.2 (11.3 )% (2.5 )% Operating income 5.9 12.5 14.9 (52.8 )% (16.1 )% As a percent of revenue 2.2 % 4.1 % 4.7 % The North Asia segment revenue comprised 24.8 percent, 23.8 percent and 21.6 percent of our total consolidated revenue in 2012, 2011 and 2010, respectively. North Asia segment revenue decreased in 2012 compared with 2011 driven primarily by declines in our maturing traditional storage products. From a product perspective, the decrease in revenue was composed primarily of lower revenue from optical products of $21.4 million and magnetic products of $8.5 million and was partially offset by a $7.3 million increase in audio and video information products. Revenue was not impacted by foreign currency. Operating income decreased in 2012 compared to 2011 driven primarily by lower gross profit due to lower revenues from traditional data storage products as well as higher SG&A expense. The North Asia segment revenue decreased in 2011 compared with 2010 driven primarily by declines in revenue from optical products of $14.4 million, partially offset by higher revenue from audio and video information products of $5.3 million. Operating income decreased in 2011 compared with 2010 driven primarily by decreases in revenue and lower gross margins on optical products and higher SG&A expense, partially offset by the reversal of a bad debt reserve of $2.7 million and higher gross margins on secure and scalable products. Revenue was benefited by foreign currency impacts of approximately eight percent. South Asia Years Ended December 31, Percent Change 2012 2011 2010 2012 vs. 2011 2011 vs. 2010 (In millions) Net revenue $ 113.6 $ 139.3 $ 143.0 (18.4 )% (2.6 )% Operating income 0.6 4.0 4.0 (85.0 )% - % As a percent of revenue 0.5 % 2.9 % 2.8 % The South Asia segment revenue comprised 10.3 percent, 10.8 percent and 9.8 percent of our total consolidated revenue in 2012, 2011 and 2010, respectively. The South Asia segment revenue decreased in 2012 compared with 2011 driven primarily by declines in our maturing traditional storage products. From a product perspective, the decrease in revenue was composed primarily of lower revenue from traditional data storage products of $18.6 million, primarily consisting of declines in optical media of $10.7 million and audio video tape of $4.7 million. Secure and scalable products, principally commodity flash products, declined $5.2 million. Revenue was not impacted by foreign currency. Operating income decreased in 2012 compared with 2011 driven by lower gross profit due to lower revenues from all major product categories and lower gross margins from traditional storage products. The South Asia segment revenue decreased in 2011 compared with 2010 driven primarily by decreases in revenue from optical products of $4.6 million and other traditional storage products of $2.8 million, partially offset by higher revenue from audio and video information of $4.4 million. Operating income remained unchanged in 2011 compared with 2010, impacted by higher gross margins on audio and video information products offset by higher SG&A costs. Revenue was benefited by foreign currency impacts of approximately six percent. Corporate and Unallocated Years Ended December 31, Percent Change 2012 2011 2010 2012 vs. 2011 2011 vs. 2010 (In millions) Operating loss $ (341.6 ) $ (68.3 ) $ (124.8 ) NM (45.3 )% _______________________________________ 30-------------------------------------------------------------------------------- Table of Contents NM - Not meaningful The corporate and unallocated operating loss includes costs which are not allocated to the business segments in management's evaluation of segment performance such as litigation settlement expense, intangible asset impairments, goodwill impairment, research and development expense, corporate expense, stock-based compensation expense and restructuring and other expense. The 2012 operating loss in Corporate and Unallocated included intangible asset impairment losses of $260.5 million and a goodwill impairment loss of $23.3 million as discussed above. The operating loss decreased in 2011 compared with 2010 driven primarily by an asset impairment charge during 2010 of $31.2 million and a goodwill impairment charge during 2010 of $23.5 million, offset partially by increased restructuring and other expense related to our previously announced programs and the $7.0 million charge relating to the demolition of our Camarillo, California facility during 2011. Financial Position Our cash and cash equivalents balance as of December 31, 2012 was $108.7 million, a decrease of $114.4 million from $223.1 million as of December 31, 2011. The decrease was primarily attributable to $103.8 million of cash paid in the acquisition of Nexsan, net of cash acquired, capital expenditures of $10.2 million, restructuring payments of $8.0 million, pension contributions of $5.1 million, share repurchases of $6.5 million, litigation settlement payments of $18.5 million, contingent consideration payments related to acquisitions of $1.2 million and other changes in working capital, partially offset by net borrowings on our credit facility of $20.0 million and proceeds of $1.4 million from the sale of some of our assets held for sale. Our accounts receivable balance as of December 31, 2012 was $220.8 million, a decrease of $14.1 million from $234.9 million as of December 31, 2011 as a result of lower sales during the period. Days sales outstanding was 59 days as of December 31, 2012, up 1 day from December 31, 2011. Days sales outstanding is calculated using the count-back method, which calculates the number of days of most recent revenue that is reflected in the net accounts receivable balance. Our inventory balance as of December 31, 2012 was $166.0 million, a decrease of $42.8 million from $208.8 million as of December 31, 2011. Days of inventory supply was 89 days as of December 31, 2012, up 4 days from December 31, 2011. Days of inventory supply is calculated using the current period inventory balance divided by an estimate of the inventoriable portion of cost of goods sold expressed in days. Our accounts payable balance as of December 31, 2012 was $162.7 million, a decrease of $42.5 million from $205.2 million as of December 31, 2011. The decrease in accounts payable was mainly due to reduced purchases compared to the previous year, as well as the timing of payments. Liquidity and Capital Resources We have various resources available to us for purposes of managing liquidity and capital needs, including our credit facility and letters of credit. Our primary sources of liquidity include cash flows generated by the sale of our products, our cash and cash equivalents and credit capacity under our credit facility. Our primary operating liquidity needs relate to our costs of goods sold and general operating expenses. Cash and Cash Equivalents Cash equivalents consist of highly liquid investments purchased with original maturities of three months or less. Restricted cash that is related to contractual obligations or restricted by management is included in other assets on our Consolidated Balance Sheets. At December 31, 2012 restricted cash primarily includes cash acquired from Nexsan that was previously restricted to specifically fulfill certain obligations of Nexsan. Analysis of Cash Flows Cash Flows Used In Operating Activities: 31-------------------------------------------------------------------------------- Table of Contents Years Ended December 31, 2012 2011 2010 (In millions) Net loss $ (340.7 ) $ (46.7 ) $ (158.5 ) Adjustments to reconcile net loss to net cash provided by operating activities 333.5 73.9 185.4 Changes in operating assets and liabilities (1.3 ) (43.5 ) 124.5 Net cash used in operating activities $ (8.5 ) $ (16.3 ) $ 151.4 Cash flows from operating activities can fluctuate significantly from period to period as many items can significantly impact cash flows. In 2012, 2011 and 2010 we contributed $5.1 million, $14.2 million and $9.9 million to our pensions worldwide, respectively. Operating cash outflows included restructuring payments of $8.0 million, $16.9 million and $9.5 million in 2012, 2011 and 2010, respectively, and litigation settlement payments of $18.5 million, $10.9 million and $8.2 million in 2012, 2011 and 2010, respectively. During 2012 we recorded a non-cash goodwill impairment charge of $23.3 million and intangible asset impairment charges of $260.5 million. Cash provided by operating activities in 2010 was primarily a result of initiatives to improve working capital by lowering levels of inventory and changing payable and receivable terms. During 2010 we recorded a non-cash goodwill impairment charge of $23.5 million, asset impairment charges of $31.2 million, inventory impairment charges of $14.2 million and a valuation allowance against our U.S. deferred tax assets of $105.6 million. Cash Flows Used in Investing Activities: Years Ended December 31, 2012 2011 2010 (In millions) Capital expenditures $ (10.2 ) $ (7.3 ) $ (8.3 ) Acquisitions, net of cash acquired (103.8 ) (47.0 ) - Proceeds from sale of assets 1.4 - 0.2 Purchase of tradename (4.0 ) - - Recovery of investments 0.9 - - License agreement - - (5.0 ) Net cash used in investing activities $ (115.7 ) $ (54.3 ) $ (13.1 ) In 2012, we paid $104.6 million related to the acquisition of Nexsan. Cash used in investing activities was also impacted by $10.2 million of capital expenditures and $4.0 million for the acquisition of the IronKey brand. In 2011, we paid $47.0 million related to the acquisitions of certain assets of MXI Security for $24.5 million, IronKey for $19.0 million, Nine Technology for $2.0 million, Encryptx for $1.0 million and ProStor Systems for $0.5 million. Cash used in investing activities was also impacted by $7.3 million of capital expenditures. See Note 4 - Acquisitions in our Notes to Consolidated Financial Statements for further information regarding our acquisitions. In 2010, we paid $5.0 million to extend our license agreement with ProStor Systems related to RDX removable hard disk systems. The acquisition of certain ProStor assets in 2011 excluded the portion of the business to which this license relates. Cash Flows Used in Financing Activities: 32-------------------------------------------------------------------------------- Table of Contents Years Ended December 31, 2012 2011 2010 (In millions) Purchase of treasury stock $ (6.5 ) $ (9.7 ) $ - Debt issuance costs (2.4 ) - (1.0 ) Debt borrowings 25.0 - - Debt repayments (5.0 ) - - Contingent consideration payments (1.2 ) - - Exercise of stock options - 0.6 - Net cash used in financing activities $ 9.9 $ (9.1 ) $ (1.0 ) On May, 2, 2012 our Board of Directors authorized a share repurchase program of 5.0 million shares of common stock. The Company's previous authorization, which had 1.2 million shares remaining for purchase, was canceled with the new authorization. Since the inception of this authorization, we have repurchased 1.2 million shares of common stock at an average price of $5.30 per share and as of December 31, 2012 we had remaining authorization to repurchase up to 3.8 million shares. We repurchased 1.1 million shares in 2011. We did not repurchase shares during 2010. No dividends were declared or paid during 2012, 2011 or 2010. Any future dividends are at the discretion of and subject to the approval of our Board of Directors. Cash used in financing activities during 2012 included borrowings of $25.0 million and repayments of $5.0 million on our credit facility primarily for the use in financing our working capital seasonal needs. Debt issuance costs of $2.4 million and $1.0 million during 2012 and 2010, respectively, were due to cash payments made to amend and extend our line of credit. These issuance costs were capitalized in our Consolidated Balance Sheets. Credit Facility On March 30, 2006, we entered into a credit agreement with a group of banks (the Credit Agreement). Subsequently, we entered into various amendments which, among other things, added Imation Europe B.V. as a borrower (European Borrower). On May 18, 2012, we entered into an amendment (the Amendment) to the Credit Agreement (as amended to date, the Amended Credit Agreement). The Amendment modified the Credit Agreement by extending the expiration date of the borrowing arrangement to May 18, 2017, requiring that the equity interests of material foreign subsidiaries be pledged to support the obligations, if any, of the European Borrower, lowered the applicable margin on interest, lowered the Company's minimum required Consolidated Fixed Charge Coverage Ratio (as defined in the Amended Credit Agreement) to be maintained as well as provided for certain other less significant changes. The Amended Credit Agreement includes a senior revolving credit facility that allows for the borrowing of amounts up to a maximum of $200 million, including sublimits of $150 million in the United States and $50 million in Europe. Borrowings in both the United States and Europe are limited to the lesser of the sublimit(s) and the borrowing base as defined in the Amended Credit Agreement and are payable upon expiration of the Amended Credit Agreement or immediately, but only to the extent the applicable sublimit(s) are reduced to an amount less than the amount borrowed at that time. Our borrowing base is calculated each quarter unless our outstanding loan amount is greater than $5.0 million in which our borrowing base is calculated monthly. Our borrowing base is based on our amounts of receivables, inventories and other factors that influence the borrowing base and, to the extent any outstanding borrowing exceed the borrowing base, any such excess is due and payable immediately. As of December 31, 2012, our borrowing capacity under this arrangement was $76.4 million in the United States and $13.9 million in Europe. Prior to August 15, 2012, borrowings bore interest at an interest rate equal to (1) the Eurodollar Rate (as defined in the Amended Credit Agreement) plus 2.00 percent or (2) the Base Rate (as defined in the Amended Credit Agreement) plus 1.00 percent. After August 15, 2012, the applicable margins for the Eurodollar Rate and the Base Rate are subject to adjustments based on average daily availability (as defined in the Amended Credit Agreement). Our U.S. obligations under the Amended Credit Agreement are guaranteed by the material domestic subsidiaries of Imation Corp. (the Guarantors) and are secured by a first priority lien (subject to customary exceptions) on the real property comprising Imation Corp.'s corporate headquarters and all of the personal property 33-------------------------------------------------------------------------------- Table of Contents of Imation Corp., its subsidiary Imation Enterprises Corp., which is also an obligor under the Amended Credit Agreement, and the Guarantors. Borrowings under the U.S. portion of the Credit Facility are limited to the lesser of (a) $150 million and (b) the "U.S. borrowing base." The U.S. borrowing base is equal to the following: • up to 85 percent of eligible accounts receivable; plus • up to the lesser of 65 percent of eligible inventory or 85 percent of the appraised net orderly liquidation value of eligible inventory; plus • up to 60 percent of the appraised fair market value of eligible real estate (the Original Real Estate Value), such Original Real Estate Value to be reduced each calendar month by 1/120th, provided, that the Original Real Estate Value shall not exceed $40 million; plus • such other classes of collateral as may be mutually agreed upon and at advance rates as may be determined by the Agent; minus • such reserves as the Agent may establish in good faith. Our European obligations under the Credit Agreement are secured by a first priority lien on substantially all of the material personal property of the European Borrower. Borrowings under the European portion of the Credit Facility are limited to the lesser of (a) $50 million and (b) the "European borrowing base." The European borrowing base calculation is fundamentally the same as the U.S. borrowing base, subject to certain differences to account for European law and other similar issues. As of December 31, 2012, we had $20 million of borrowings outstanding under the Amended Credit Agreement, all of which was borrowed in the United States. Outstanding borrowings in the United States bear interest of 2.25 percent as of December 31, 2012. As of December 31, 2012, our total remaining borrowing capacity under the Credit Facility was $90.3 million. The Amended Credit Agreement contains covenants which are customary for similar credit agreements, including covenants related to financial reporting and notification, payment of indebtedness, taxes and other obligations; compliance with applicable laws; and limitations regarding additional liens, indebtedness, certain acquisitions, investments and dispositions of assets. The Amended Credit Agreement contains a conditional financial covenant that requires Imation Corp. to have a Consolidated Fixed Charge Coverage Ratio (as defined in the Amended Credit Agreement) of not less than 1.00 or a liquidity requirement of $30.0 million of domestic borrowing availability. We were in compliance with the liquidity requirement as of December 31, 2012. As of December 31, 2012 and 2011 we had outstanding standby letters of credit of $0.4 million and $0.6 million, respectively. The outstanding standby letters of credit are required by our insurance companies to cover potential deductibles and reduce our allowed borrowing capacity under the Amended Credit Agreement. We had $62 million of cash outside the U.S. at December 31, 2012. We also have significant net operating loss carryforwards offset by a full valuation allowance in the U.S. The calculation of a deferred tax liability on the repatriation of the cash outside the U.S. is impractical. However, because of the valuation allowance in the U.S., we do not believe there would be any significant impact to earnings if we were to remit this foreign held cash. Our liquidity needs for 2013 include the following: restructuring payments of approximately $35 million to $40 million, $20 million repayment on our credit facility, capital expenditures of approximately $8 million to $12 million, pension funding of approximately $2 million to $4 million, operating lease payments of approximately $8 million, any amounts associated with strategic acquisitions, any amounts associated with organic investment opportunities and any amounts associated with the repurchase of common stock under the authorization discussed above. We expect that our cash positions in the U.S. and outside the U.S., together with cash flow from operations and availability of borrowings under our Amended Credit Agreement, will provide liquidity sufficient to meet our needs for our operations and our obligations in the countries in which we operate. Off-Balance Sheet Arrangements Other than the operating lease commitments discussed in Note 15 - Litigation, Commitments and Contingencies in our Notes to the Consolidated Financial Statements, we are not using off-balance sheet arrangements, including special purpose entities. Summary of Contractual Obligations 34-------------------------------------------------------------------------------- Table of Contents Payments Due by Period Less Than More Than Total 1 Year 1-3 Years 3-5 Years 5 Years (In millions)Operating lease obligations $ 18.8 $ 8.0 $ 7.0 $ 2.2 $ 1.6 Purchase obligations(1) 168.8 162.8 6.0 - - Short-term debt 20.0 20.0 - - - Other liabilities(2) 23.8 - - - 23.8 Total $ 231.4 $ 190.8 $ 13.0 $ 2.2 $ 25.4 _______________________________________ (1) The majority of the purchase obligations consist of 90-day rolling estimates. In most cases, we provide suppliers with a three to six month rolling forecast of our demand. The forecasted amounts are generally not binding on us. However, it may take up to 60 days from the purchase order issuance to receipt, depending on supplier and inbound lead time. Effective December 8, 2009, we began an agreement with a third party to outsource certain aspects of our information technology support. While the agreement is cancelable at any time with certain cash penalties, our obligation through the expected termination date of December 2016 is included above. (2) Timing of payments for the vast majority of other liabilities cannot be reasonably determined and, as such, have been included in the "More Than 5 Years" category. This amount includes $4.1 million of reserves for uncertain tax positions including accrued interest and penalties. The table above does not include payments for non-contributory defined benefit pension plans. It is our general practice, at a minimum, to fund amounts sufficient to meet the requirements set forth in applicable benefits laws and local tax laws. From time to time, we contribute additional amounts, as we deem appropriate. We expect to contribute approximately $2 million to $4 million to our pension plans in 2013 and have $28.1 million recorded in other liabilities related to pension plans as of December 31, 2012. Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates to ensure they are consistent with historical experience and the various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions and could materially impact our results of operations. We believe the following critical accounting policies are affected by significant judgments and estimates used in the preparation of our Consolidated Financial Statements: Income Tax Accruals and Valuation Allowances. We are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax obligations based on expected taxable income, statutory tax rates and tax credits allowed in the various jurisdictions in which we operate. Tax laws require certain items to be included in our tax returns at different times than the items are reflected in our results of operations. Some of these differences are permanent, such as expenses that are not deductible in our tax returns, and some are temporary differences that will reverse over time. Temporary differences result in deferred tax assets and liabilities, which are included within our Consolidated Balance Sheets. We must assess the likelihood that our deferred tax assets will be realized and establish a valuation allowance to the extent necessary. Significant judgment is required in evaluating our tax positions, and in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We record income taxes using the asset and liability approach. Under this approach, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the book and tax basis of assets and liabilities. We measure deferred tax assets and liabilities using the enacted statutory tax rates that are expected to apply in the years in which the temporary differences are expected to be recovered or paid. We regularly assess the likelihood that our deferred tax assets will be recovered in the future. A valuation 35-------------------------------------------------------------------------------- Table of Contents allowance is recorded to the extent we conclude a deferred tax asset is not considered to be more-likely-than-not to be realized. We consider all positive and negative evidence related to the realization of the deferred tax assets in assessing the need for a valuation allowance. If we determine we will not realize all or part of our deferred tax assets, an adjustment to the deferred tax asset will be charged to earnings in the period such determination is made. During the fourth quarter of 2010, we recognized significant restructuring charges related to our U.S. operations. Due to these charges and cumulative losses incurred in recent years, we were no longer able to conclude that it was more-likely-than-not that our U.S. deferred tax assets would be fully realized. Therefore, during 2010, we recorded a charge to establish a valuation allowance of $105.6 million related to our U.S. deferred tax assets. The valuation allowance charge in 2010 is included in income tax provision on our Consolidated Statement of Operations. In 2012 and 2011 we have concluded that it is necessary to maintain a valuation allowance on our U.S. deferred tax assets. The accounting estimate for valuation allowances against deferred tax assets is a critical accounting estimate because judgment is required in assessing the likely future tax consequences of events that have been recognized in our financial statements or tax returns. Our accounting for deferred tax consequences represents our best estimate of future events. A valuation allowance established or revised as a result of our assessment is recorded through income tax provision (benefit) in our Consolidated Statements of Operations. Changes in our current estimates due to unanticipated events, or other factors, could have a material effect on our financial condition and results of operations. At December 31, 2012, our net deferred tax asset, net of valuation allowances of $239.1 million, was $11.6 million. The valuation allowance primarily relates to our U.S. deferred tax assets not expected to be utilized in the future. Our income tax returns are subject to review by various U.S. and foreign taxing authorities. As such, we record accruals for items that we believe may be challenged by these taxing authorities. The threshold for recognizing the benefit of a tax return position in the financial statements is that the position must be more-likely-than-not to be sustained by the taxing authorities based solely on the technical merits of the position. If the recognition threshold is met, the tax benefit is measured and recognized as the largest amount of tax benefit that, in our judgment, is greater than 50 percent likely to be realized. The total amount of unrecognized tax benefits as of December 31, 2012 was $4.4 million, excluding accrued interest and penalties described below. If the unrecognized tax benefits were recognized in our Consolidated Financial Statements, $4.4 million would affect income tax expense and our related effective tax rate. Interest and penalties recorded for uncertain tax positions are included in our income tax provision. As of December 31, 2012, $0.3 million of interest and penalties was accrued, excluding the tax benefit of deductible interest. The reversal of accrued interest and penalties would affect income tax expense and our related effective tax rate. Our U.S. federal income tax returns for 2010 and 2011 are subject to examination by the Internal Revenue Service. With few exceptions, we are no longer subject to examination by foreign tax jurisdictions, or state and city tax jurisdictions for years before 2006. In the event that we have determined not to file tax returns with a particular state or city, all years remain subject to examination by the tax jurisdiction. The ultimate outcome of tax matters may differ from our estimates and assumptions. Unfavorable settlement of any particular issue may require the use of cash and could result in increased income tax expense. Favorable resolution could result in reduced income tax expense. It is reasonably possible that our unrecognized tax benefits could increase or decrease significantly during the next twelve months due to the resolution of certain U.S. and international tax uncertainties; however it is not possible to estimate the potential change at this time. Litigation. We record a liability when a loss from litigation is known or considered probable and the amount can be reasonably estimated. Our current estimated range of liability related to pending litigation is based on claims for which we can estimate the amount or range of loss. Based upon information presently available, we believe that accruals for these claims are adequate. Due to uncertainties related to both the amount and range of loss on the remaining pending litigation, we are unable to make a reasonable estimate of the liability that could result from an unfavorable outcome. While these matters could materially affect operating results in future periods depending on the final resolution, it is our opinion that after final disposition, any monetary liability to us beyond that provided in the Consolidated Balance Sheet as of December 31, 2012, would not be material to our financial position. As additional information becomes available, the potential liability related to pending litigation will be assessed and estimates will be revised as necessary. 36-------------------------------------------------------------------------------- Table of Contents Intangibles. We record all assets and liabilities acquired in purchase acquisitions, including intangibles, at estimated fair value. Intangible assets with a definite life are amortized based on a pattern in which the economic benefits of the assets are consumed, typically with useful lives ranging from one to 30 years. The initial recognition of intangible assets, the determination of useful lives and, if necessary, subsequent impairment analysis require management to make subjective judgments concerning estimates of how the acquired assets will perform in the future using certain valuation methods including discounted cash flow analysis. We evaluate assets on our balance sheet, including such intangible assets, whenever events or changes in circumstances indicate that their carrying value may not be recoverable. Factors such as unfavorable variances from forecasted cash flows, established business plans or volatility inherent to external markets and industries may indicate a possible impairment that would require an impairment test. While we believe that the current carrying value of these assets is not impaired, materially different assumptions regarding future performance of our businesses, which in many cases require subjective judgments concerning estimates, could result in significant impairment losses. The test for impairment requires a comparison of the carrying value of the asset or asset group with their estimated undiscounted future cash flows. If the carrying value of the asset or asset group is considered impaired, an impairment charge is recorded for the amount by which the carrying value of the asset or asset group exceeds its fair value. In conjunction with the acceleration of our strategic transformation in the fourth quarter of 2012, we evaluated our intangible assets for impairment and recorded non-cash impairment charges of $260.5 million in the quarter. The intangible asset charges are primarily due to an accelerated secular optical market decline. See Intangible Impairments for further discussion of the impairment test performed. After this impairment loss, and our acquisition of Nexsan, as of December 31, 2012, we had had $80.2 million of definite-lived intangible assets subject to amortization. While we believe that the current carrying value of these assets is not impaired, materially different assumptions regarding future performance of our businesses could result in significant impairment losses. Goodwill. We record all assets and liabilities acquired in purchase acquisitions, including goodwill, at fair value. The initial recognition of goodwill and subsequent impairment analysis require management to make subjective judgments concerning estimates of how the acquired assets will perform in the future using valuation methods including discounted cash flow analysis. Goodwill is the excess of the cost of an acquired entity over the amounts assigned to assets acquired and liabilities assumed in a business combination. Goodwill is not amortized. We test the carrying amount of a reporting unit's goodwill for impairment on an annual basis during the fourth quarter of each year or if an event occurs or circumstances change that would warrant impairment testing during an interim period. Goodwill is considered impaired when its carrying amount exceeds its implied fair value. The first step of the impairment test involves comparing the fair value of the reporting unit to which goodwill was assigned to its carrying amount. The second step of the impairment test compares the implied fair value of the reporting unit's goodwill with the carrying amount of the reporting unit's goodwill. If the carrying amount of the reporting unit's goodwill is greater than the implied fair value of the reporting unit's goodwill an impairment loss must be recognized for the excess. This involves measuring the fair value of the reporting unit's assets and liabilities (both recognized and unrecognized) at the time of the impairment test. The difference between the reporting unit's fair value and the fair values assigned to the reporting unit's individual assets and liabilities is the implied fair value of the reporting unit's goodwill. Our reporting units for goodwill are our operating segments (Americas, Europe, North Asia and South Asia) with the exception of the Americas segment which is further divided between the Americas-Consumer, Americas-Commercial and Mobile Security reporting units as determined by sales channel. During 2011, we acquired the assets of MXI Security, from Memory Experts International Inc., (MXI) and the secure data storage hardware business of IronKey Systems Inc. (IronKey) which resulted in goodwill of $21.9 million and $9.4 million, respectively. These businesses, along with our Imation Defender brand, make up our Americas-Mobile Security reporting unit. The carrying value of our Mobile Security reporting unit included $31.3 million of goodwill prior to our 2012 impairment testing. During the second and third quarters of 2012, we adjusted our internal financial forecast for our Americas-Mobile Security reporting unit due to changes in timing of expected cash flows and lower expected short-term revenues and lower gross margins. As we considered these factors to be an event that warranted an interim test as to whether the goodwill was impaired, we performed an impairment test as of each of these periods. The impairment test resulted in no impairment of goodwill as there was an excess in fair value over carrying value in step 1 of the impairment test performed for the second and third quarters of 2012 of 43.3 percent and 17.7 percent, respectively. During the fourth quarter of 2012 our internal financial forecast for our Americas-Mobile Security reporting unit was again adjusted with further changes in our revenue and gross margin resulting from lower 37-------------------------------------------------------------------------------- Table of Contents expectations in the high-security market segment. In accordance with our policy, we performed an annual assessment of goodwill in the Americas-Mobile Security reporting unit during the fourth quarter of 2012 and as a result of the annual assessment, it was determined that the fair value of our Mobile Security reporting unit was impaired. We recorded an impairment charge of $23.3 million to the Americas reporting segment in restructuring and other in the Consolidated Statements of Operations. See Goodwill for further discussion of the impairment test performed. Excess Inventory and Obsolescence. We write down our inventory for excess, slow moving and obsolescence to the net realizable value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those we project, additional write-downs may be required. As of December 31, 2012, the estimated inventory write-downs for excess inventory and obsolescence for inventory on hand was $35.9 million. Rebates. We maintain an accrual for customer rebates that totaled $44.8 million as of December 31, 2012 included in other current liabilities. This accrual requires a program-by-program estimation of outcomes based on a variety of factors including customer unit sell-through volumes and end user redemption rates. In the event that actual volumes and redemption rates differ from the estimates used in the accrual calculation, adjustments to the accrual, upward or downward, may be necessary. Restructuring Reserves. Employee-related severance charges are largely based upon distributed employment policies and substantive severance plans. Generally, these charges are reflected in the quarter in which the Board approves the associated actions, the actions are probable and the amounts are estimable. In the event that the Board approves the associated actions post the balance sheet date, but ultimately confirms the existence of a probable liability as of the balance sheet date, a reasonable estimate of these charges are recorded in the period in which the probable liability existed. This estimate takes into account all information available as of the date the financial statements are issued. Severance amounts for which affected employees were required to render service in order to receive benefits at their termination dates were measured at the date such benefits were communicated to the applicable employees and recognized as expense over the employees' remaining service periods. Copyright Levies. In many European Union (EU) member countries, the sale of recordable optical media is subject to a private copyright levy. The levies are intended to compensate copyright holders for "fair compensation" for the harm caused by private copies made by natural persons of protected works under the European Copyright Directive, which became effective in 2002 (Directive). Levies are generally charged directly to the importer of the product upon the sale of the products. Payers of levies remit levy payments to collecting societies which, in turn, are intended to distribute funds to copyright holders. Levy systems of EU member countries must comply with the Directive, but individual member countries are responsible for administering their own systems. Since implementation, the levy systems have been the subject of numerous litigation and law making activities. On October 21, 2010, the European Court of Justice (ECJ) ruled that fair compensation is an autonomous European law concept that was introduced by the Directive and must be uniformly applied in all EU member states. The ECJ stated that fair compensation must be calculated based on the harm caused to the authors of protected works by private copying. The ECJ also stated that the indiscriminate application of the private copying levy to devices not made available to private users and clearly reserved for uses other than private copying is incompatible with the Directive. The ECJ ruling made clear that copyright holders are only entitled to fair compensation payments (funded by levy payments made by the Company) when sales of optical media are made to natural persons intending to make private copies. Since the Directive was implemented in 2002, we have paid approximately $100 million in levies to various ongoing collecting societies related to professional and commercial sales. Based on the ECJ's October 2010 ruling and subsequent litigation and law making activities, we believe that these payments were not consistent with the Directive and should not have been paid to the various collecting societies. Accordingly, in 2010 we began withholding levy payments on consumer product sales to the various collecting societies. However, we continued to accrue a liability for levies arising from consumer product sales. As of December 31, 2012 and 2011, we had recorded a liability of $27.7 million and $19.7 million, respectively, associated with levies related to consumer product sales for which we are withholding payment. At December 31, 2012, the recovery of some or all of the approximately $100 million of copyright levies previously paid on professional and commercial sales represents gain contingency that has not yet met the required criteria for recognition in our financial statements. There is no assurance that we will realize any of this gain contingency. Since the October 2010 ECJ ruling, we quarterly evaluate on a country-by-country basis whether (i) levies should be accrued on current period commercial and/or consumer channel sales; and, (ii) accrued, but unpaid, copyright levies on prior period consumer product sales should be reversed. Our evaluation is made on a 38-------------------------------------------------------------------------------- Table of Contents jurisdiction-by-jurisdiction basis and considers ongoing and cumulative developments related to levy litigation and law making activities within each jurisdiction as well as throughout the EU. Cost of goods sold for the year ended December 31, 2011 was reduced by $7.8 million due to reversal of prior year obligations that were determined to be remote. Other Accrued Liabilities. We also have other accrued liabilities, including uninsured claims and pensions. These accruals are based on a variety of factors including past experience and various actuarial assumptions and, in many cases, require estimates of events not yet reported to us. If future experience differs from these estimates, operating results in future periods would be impacted. Defined Benefit Pension Plans. We sponsor defined benefit pension plans in both U.S. and foreign entities. Expenses and liabilities for the pension plans are actuarially calculated. These calculations are based on our assumptions related to the discount rate, expected return on plan assets and mortality rates. The annual measurement date for these assumptions is December 31. Note 9 - Retirement Plans in our Notes to Consolidated Financial Statements includes disclosures of these assumptions for both the U.S. and international plans. The discount rate assumptions are tied to portfolios of long-term high quality bonds and are, therefore, subject to annual fluctuations. A lower discount rate increases the present value of the pension obligations, which results in higher pension expense. The discount rate used in calculating the benefit obligation in the United States was 3.50 percent at December 31, 2012, as compared with 3.75 percent at December 31, 2011. A discount rate reduction of 0.25 percent increases U.S. pension plan expense (pre-tax) by approximately $0.1 million. The expected return on assets assumptions on the investment portfolios for the pension plans are based on the long-term expected returns for the investment mix of assets currently in the respective portfolio. Because the rate of return is a long-term assumption, it generally does not change each year. We use historic return trends of the asset portfolio combined with recent market conditions to estimate the future rate of return. The rate of return used in calculating the U.S. pension plan expense for 2012, 2011 and 2010 was 8.0 percent. A reduction of 0.25 percent for the expected return on plan assets assumption will increase United States net pension plan expense (pre-tax) by $0.2 million. Expected returns on asset assumptions for non-U.S. plans are determined in a manner consistent with the United States plan. The projected salary increase assumption is based on historic trends and comparisons to the external market. Higher rates of increase result in higher pension expenses. In the United States, we used the rate of 4.75 percent for 2010. Beginning in 2011, the projected salary increase assumption was not applicable in the United States due to the elimination of benefit accruals as of January 1, 2011. See Note 9 - Retirement Plans in our Notes to Consolidated Financial Statements for further information regarding this change in benefits. Mortality assumptions were obtained from the IRS 2012 Static Mortality Table. Recently Issued Accounting Standards See Note 2 - Summary of Significant Accounting Policies in our Notes to Consolidated Financial Statements for disclosure related to recently issued accounting standards. Cautionary Statements Regarding Forward-Looking Statements We may from time to time make written or oral forward-looking statements with respect to our future goals, including statements contained in this Form 10-K, in our other filings with the SEC and in our reports to shareholders. Certain information which does not relate to historical financial information may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words or phrases "is targeting," "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," "believe," or similar expressions identify "forward looking statements." Such statements are subject to certain risks and uncertainties that could cause our actual results in the future to differ materially from our historical results and those presently anticipated or projected. We wish to caution investors not to place undue reliance on any such forward-looking statements. Any forward-looking statements speak only as of the date on which such statements are made, and we undertake no obligation to update such statements to reflect events or circumstances arising after such date. Risk factors include our ability to successfully implement our strategy including our global restructuring plan; our ability to grow our business in new products with profitable margins and the rate of revenue decline for certain existing products; the ability to quickly develop, source, introduce and deliver differentiated and innovative products; our potential dependence on third parties for new product introductions or technologies in order to introduce our own new products; the ready availability and price of energy and key raw materials or critical components including the effects of natural disasters and our ability to pass along raw materials price increases to our customers; continuing uncertainty in global and regional economic conditions including adverse effects of the 39-------------------------------------------------------------------------------- Table of Contents ongoing sovereign debt crisis in Europe, increased Euro currency exchange rate volatility, and related austerity measures and their potential impact on European economic growth; our ability to identify, value, integrate and realize the expected benefits from any acquisition which has occurred or may occur in connection with our strategy; the possibility that our goodwill and intangible assets or any goodwill or intangible assets that we acquire may become impaired; the ability of our security products to withstand cyber-attacks; the seasonality and volatility of the markets in which we operate; foreign currency fluctuations; changes in European law or practice related to the imposition or collectability of optical levies; significant changes in discount rates and other assumptions used in the valuation of our pension plans; changes in tax laws, regulations and results of inspections by various tax authorities; our ability to successfully defend our intellectual property rights and the ability or willingness of our suppliers to provide adequate protection against third party intellectual property or product liability claims; the outcome of any pending or future litigation; ability to access financing to achieve strategic objectives and growth due to changes in the capital and credit markets; limitations in our operations that could arise from compliance with the debt covenants in our credit facility; increased compliance with changing laws and regulations potentially affecting our operating results; failure to adequately protect our information systems from cyber-attacks; our ability to meet our revenue growth, gross margin and earnings targets and the volatility of our stock price due to our results or market trends, as well as various factors set forth from time to time in Item 1A of this Form 10-K and from time to time in our filings with the SEC. 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