(Exact
name of registrant as specified in its charter)
Delaware
06-1308215
(State
or other jurisdiction
(I.R.S.
Employer
of
incorporation or organization)
Identification
No.)
One
Lexmark Centre Drive
740
West New Circle Road
Lexington,
Kentucky
40550
(Address
of principal executive offices)
(Zip
Code)
(859)
232-2000
(Registrant’s
telephone number, including area code)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes x No
o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definitions of “large accelerated filer,”“accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.
Large
accelerated filer R
Accelerated
filer £
Non-accelerated
filer £
(Do
not check if a smaller
reporting
company)
Smaller
reporting company £
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No
x
The
registrant had 87,976,138 shares outstanding (excluding shares held in
treasury) of Class A Common Stock, par value $0.01 per share, as of the close of
business on July 31, 2008.
Notes
to Consolidated Condensed Financial Statements
5
ITEM
2.
MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
22
ITEM
3.
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
46
ITEM
4.
CONTROLS
AND PROCEDURES
47
PART
II – OTHER INFORMATION
ITEM
1.
LEGAL
PROCEEDINGS
48
ITEM 1A.
RISK
FACTORS
48
ITEM 2.
UNREGISTERED
SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
48
ITEM
3.
DEFAULTS
UPON SENIOR SECURITIES
49
ITEM
4.
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
49
ITEM
5.
OTHER
INFORMATION
49
ITEM
6.
EXHIBITS
49
Forward-Looking
Statements
This
Quarterly Report on Form 10-Q contains certain forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. All statements,
other than statements of historical fact, are forward-looking statements.
Forward-looking statements are made based upon information that is currently
available or management’s current expectations and beliefs concerning future
developments and their potential effects upon the Company, speak only as of the
date hereof, and are subject to certain risks and uncertainties. We assume no
obligation to update or revise any forward-looking statements contained or
incorporated by reference herein to reflect any change in events, conditions or
circumstances, or expectations with regard thereto, on which any such
forward-looking statement is based, in whole or in part. There can be no
assurance that future developments affecting the Company will be those
anticipated by management, and there are a number of factors that could
adversely affect the Company’s future operating results or cause the Company’s
actual results to differ materially from the estimates or expectations reflected
in such forward-looking statements, including, without limitation, the factors
set forth under the title “Factors That May Affect Future Results And
Information Concerning Forward-Looking Statements” in Part I, Item 2 of this
report. The information referred to above should be considered by investors when
reviewing any forward-looking statements contained in this report, in any of the
Company’s public filings or press releases or in any oral statements made by the
Company or any of its officers or other persons acting on its behalf. The
important factors that could affect forward-looking statements are subject to
change, and the Company does not intend to update the factors set forth in the
“Factors That May Affect Future Results and Information Concerning
Forward-Looking Statements” section of this report. By means of this cautionary
note, the Company intends to avail itself of the safe harbor from liability with
respect to forward-looking statements that is provided by Section 27A and
Section 21E referred to above.
NOTES
TO THE CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(In
Millions, Except Per Share Amounts)
(Unaudited)
1. BASIS
OF PRESENTATION
The
accompanying interim Consolidated Condensed Financial Statements are unaudited;
however, in the opinion of management of Lexmark International, Inc. (together
with its subsidiaries, the “Company” or “Lexmark”), all adjustments necessary
for a fair statement of the interim financial results have been included. The
results for the interim periods are not necessarily indicative of results to be
expected for the entire year. The Consolidated Condensed Statement of
Financial Position data as of December 31, 2007, was derived from audited
financial statements, but does not include all disclosures required by
accounting principles generally accepted in the United States of America
(“U.S.”). The Company filed with the Securities and Exchange Commission audited
consolidated financial statements for the year ended December 31, 2007, on Form
10-K, which included all information and notes necessary for such presentation.
Accordingly, these financial statements and notes should be read in conjunction
with the Company’s audited annual consolidated financial statements for the year
ended December 31, 2007.
2. FAIR
VALUE
General
The
Company adopted the provisions of Statement of Financial Accounting Standards
(“SFAS”) No. 157, Fair Value
Measurements ("FAS 157") effective January 1, 2008. FAS 157 defines fair
value, establishes a framework for measuring fair value in generally accepted
accounting principles ("GAAP") and expands disclosures about fair value
measurements. The standard defines fair value as the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. As part of the
framework for measuring fair value, FAS 157 establishes a hierarchy of inputs to
valuation techniques used in measuring fair value that maximizes the use of
observable inputs and minimizes the use of unobservable inputs by requiring that
the most observable inputs be used when available.
The
Company has not applied the provisions of FAS 157 to any nonrecurring,
nonfinancial fair value measurements as permitted under Financial Accounting
Standards Board (“FASB”) Staff Position No. 157-2 ("FSP FAS 157-2"). Refer to
Note 15 of the Notes to Consolidated Condensed Financial Statements for
additional information regarding FSP FAS 157-2. The Company is in the process of
evaluating the inputs and techniques used in these measurements, including such
items as impairment assessments of fixed assets, initial recognition of asset
retirement obligations, and goodwill impairment testing. There were no material
adjustments of this nature recorded in the second quarter of 2008.
Fair
Value Hierarchy
The three
levels of the fair value hierarchy under FAS 157 are:
·
Level
1 -- Quoted prices (unadjusted) in active markets for identical,
unrestricted assets or liabilities that the Company has the ability to
access at the measurement date.
·
Level
2 -- Inputs other than quoted prices included in Level 1 that are
observable for the asset or liability, either directly or
indirectly.
·
Level
3 -- Unobservable inputs used in valuations in which there is little
market activity for the asset or liability at the measurement
date.
Fair
value measurements of assets and liabilities are assigned a level within the
fair value hierarchy based on the lowest level of any input that is significant
to the fair value measurement in its entirety.
5
Assets
and (Liabilities) Measured at Fair Value on a Recurring Basis
Assets
measured at fair value on a recurring basis:
Available-for-sale
marketable securities - ST
$
579.6
$
247.9
$
331.1
$
0.6
Foreign
currency derivatives (1)
0.2
-
0.2
-
Available-for-sale
marketable securities - LT
31.3
-
-
31.3
Total
$
611.1
$
247.9
$
331.3
$
31.9
(1)
Foreign currency derivative
assets are included in Prepaid
expenses and other current assets on the Consolidated Condensed
Statements of Financial
Position.
Liabilities
measured at fair value on a recurring basis had no outstanding balances as of
June 30, 2008.
The
following table presents additional information about Level 3 assets measured at
fair value on a recurring basis for the quarter ended June 30,2008:
Available-for-sale
marketable securities
Three
Months
Ended
Six
Months
Ended
June
30
2008
June
30
2008
Balance,
beginning of period
$
60.0
$
31.9
Realized
and unrealized gains/(losses) included in earnings
-
(0.4
)
Unrealized
gains/(losses) included in comprehensive income
-
-
Purchases,
issuances, and settlements
(24.0
)
4.5
Transfers
in and/or out of Level 3
(4.1
)
(4.1
)
Balance,
end of period
$
31.9
$
31.9
For the
three months ended June 30, 2008, there were no material realized or unrealized
gains/(losses) included in earnings. For the six months ended June 30, 2008,
realized and unrealized gains and (losses) of $(0.4) million were included in
Other (income) expense,
net on the Consolidated Condensed Statements of Earnings. Losses of $0.4
million included in earnings for the six month period are attributable to the
change in fair value of certain distressed corporate bonds and mortgage-backed
securities held at June 30, 2008, deemed to be other than temporarily impaired,
and are reported in Other
(income) expense, net.
Interest
rate swap contracts, which served as a fair value hedge of the Company's senior
notes that matured in May 2008, were also considered a Level 3 fair value
measurement. Because the short-cut method of FAS 133 was used to record the fair
value of the interest rate swaps, the Company feels it is clearer to describe
the activity in narrative form than to include the change in fair value in the
Level 3 rollforward table. The fair value of the interest rate swaps at December31, 2007 and March 31, 2008 was an asset of $0.1 million and $0.3 million,
respectively. Final settlement occurred in May 2008, resulting in net cash
proceeds of $0.8 million. As of June 30, 2008, the Company has not entered into
any new interest rate swap contracts.
6
Valuation
Techniques
The
Company generally uses a market approach, when practicable, in valuing the
financial instruments below.
Marketable
Securities
The
Company evaluates its marketable securities in accordance with SFAS No. 115,
Accounting for Certain
Investments in Debt and Equity Securities, and has determined that all of
its investments in marketable securities should be classified as
available-for-sale and reported at fair value. The fair values of the
Company's available-for-sale marketable securities are based on quoted market
prices or other observable market data, or in some cases, the Company's
amortized cost, which approximates fair value due to the frequent resetting of
interest rates resulting in re-pricing of the investments.
Level 1
fair value measurements are based on quoted market prices in active markets and
include U.S. government and agency securities. These valuations are
performed using a consensus price method, whereby prices from a variety of
industry data providers are input into a distribution-curve based algorithm to
determine daily market values.
Level 2
fair value measurements are based on quoted prices in markets that are not
active, broker dealer quotations, or other methods by which all significant
inputs are observable, either directly or indirectly. Securities utilizing Level
2 inputs are primarily corporate bonds, asset-backed securities and
mortgage-backed securities, all of which are valued using the consensus price
method described previously. Level 2 fair value measurements also include
smaller amounts of commercial paper and certificates of deposit which generally
have shorter maturities and less frequent market trades. Such
securities are valued via mathematical calculations until such time that market
activity reflects an updated price.
Level 3
fair value measurements are based on inputs that are unobservable and
significant to the overall valuation. Level 3 fair value measurements include
security types that do not have readily determinable market values and/or are
not priced by independent data sources, including auction rate securities for
which recent auctions were unsuccessful valued at $31.3 million and a small
number of certain distressed debt instruments valued at $0.6
million. Nearly all of the auction rate securities held by the
Company are highly rated and the Company believes it has sufficient liquidity to
hold these securities until sold or repurchased at par. Therefore, the fair
values of the Company's auction rate securities for which recent auctions were
unsuccessful are based on current expected settlement prices, which closely
approximates the face value of each security and in the aggregate. The
securities issuers have the legal option to redeem the securities at par plus
accrued interest at each auction rate reset date and the securities are being
made available for sale at par at auctions every 7 to 49 days. Nearly all of the
auction rate securities held by the Company at June 30, 2008, are paying penalty
rates that carry an economic incentive for alternative investors to buy the
securities at upcoming auctions and issuers to refinance these securities in the
capital markets prior to maturity. During the second quarter of 2008, the
Company sold $24.0 million of its Level 3 auction rate securities resulting in
no realized losses. In addition, the Company has performed its own valuation,
using a discounted cash flow model that supports the assertion that the expected
settlement price is a reasonable measure of fair value for its unsuccessful
auction rate securities.
Derivatives
The
Company maintains a foreign currency risk management strategy that uses
derivative instruments to protect its interests from unanticipated fluctuations
in earnings and cash flows caused by volatility in currency exchange
rates. Fair values for the Company’s derivative financial instruments
are based on pricing models or formulas using current market data. Variables
used in the calculations include forward points and spot rates at the time of
valuation. At June 30, 2008, all of the Company's forward exchange contracts
have been designated as Level 2 measurements in the FAS 157 fair value
hierarchy.
Senior
Notes
In the
second quarter of 2008, the Company repaid its $150 million of senior note debt
that matured on May 15, 2008, and subsequently issued $350 million of five-year
fixed rate senior unsecured notes as well as $300 million of ten-year fixed rate
senior unsecured notes. At June 30, 2008, the fair values of the Company's
five-year and ten-year notes were estimated to be $343.4 million and $291.5
million, respectively, using quoted market prices obtained
7
from an independent broker. The $634.9 million total fair
value of the debt is not recorded on the Company's Consolidated Condensed
Statements of Financial Position and is therefore excluded from the fair value
table above. The total carrying value of the senior notes, net of
$1.4 million discount, is $648.6 million on the Consolidated Condensed
Statements of Financial Position. Refer to Part I, Item 1, Note 4 of the Notes
to Consolidated Condensed Financial Statements for additional information
regarding the senior notes.
Assets
and (Liabilities) Measured at Fair Value on a Nonrecurring Basis Subsequent to
Initial Recognition
In the
second quarter of 2008, there were no material nonrecurring adjustments to
disclose under the provisions of FAS 157 partially adopted by the Company. The
Company has not applied the provisions of FAS 157 to any nonrecurring,
nonfinancial fair value measurements as permitted under FSP FAS 157-2. Related
to the 2007 restructuring plan, one of the Company’s inkjet supplies assembly
plants located in Juarez, Mexico has been made available for sale. The asset is
included in Property, plant
and equipment, net on the Consolidated Condensed Statements of Financial
Position at the lower of its carrying amount or fair value less costs to sell in
accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. The carrying value of the building and
land available for sale is $3 million. It is estimated that the fair value of
the site is $5 million based on orderly dealings with potential
buyers.
3. RESTRUCTURING
AND RELATED CHARGES (REVERSALS)
2008
Restructuring
General
To
enhance the efficiency of the Company’s inkjet cartridge manufacturing
operations, the Company announced a plan (the “2008 Restructuring Plan”) on July22, 2008, that will result in the closure of one of the Company’s inkjet
supplies manufacturing facilities in Mexico.
The 2008
Restructuring Plan is expected to impact approximately 650 positions by the end
of 2008 with most of the impacted positions being moved to a lower-cost country.
The Company expects the 2008 Restructuring Plan will result in pre-tax charges
of approximately $20 million, of which $3 million will require cash.
The charges for the 2008 Restructuring Plan will impact the Company’s Consumer
segment. The Company expects the 2008 Restructuring Plan to be substantially
completed by the end of 2008.
Impact to Financial
Results
For the
three and six months ended June 30, 2008, the Company incurred $3.4 million
for the 2008 Restructuring Plan as follows:
Employee
termination benefit charges
$
3.4
Total
restructuring-related charges
$
3.4
Employee
termination benefit charges were accrued in accordance with
SFAS No. 112, Employers’ Accounting for
Postemployment Benefits and SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities, as appropriate.
Employee termination benefit charges include severance, medical and other
benefits and are included in Restructuring and related charges
on the Consolidated Condensed Statements of Earnings.
For the
three and six months ended June 30, 2008, the Company incurred the $3.4 million
of pre-tax restructuring and related charges in its Consumer
segment.
8
Liability
Rollforward
The
following table presents a rollforward of the liability incurred for employee
termination benefits in connection with the 2008 Restructuring Plan. The
liability is included in Accrued liabilities on the
Company’s Consolidated Condensed Statements of Financial Position.
As part
of the Company’s ongoing efforts to optimize its cost and expense structure, the
Company continually reviews its resources in light of a variety of factors. On
October 23, 2007, the Company announced a plan (the “2007 Restructuring
Plan”) which includes:
•
Closing
one of the Company’s inkjet supplies manufacturing facilities in Mexico
and additional optimization measures at the remaining inkjet facilities in
Mexico and the Philippines.
•
Reducing
the Company’s business support cost and expense structure by further
consolidating activity globally and expanding the use of shared service
centers in lower-cost regions. The areas impacted are supply chain,
service delivery, general and administrative expense, as well as marketing
and sales support functions.
•
Focusing
consumer segment marketing and sales efforts into countries or geographic
regions that have the highest supplies
usage.
The 2007
Restructuring Plan is expected to impact approximately 1,650 positions by the
end of 2008. Most of the impacted positions are being moved to lower-cost
countries. The Company expects the 2007 Restructuring Plan will result in
pre-tax charges of approximately $55 million, of which $40 million
will require cash. The Company expects to incur charges related to the 2007
Restructuring Plan of approximately $14 million in its Business segment,
approximately $19 million in its Consumer segment and approximately
$22 million in All other. The Company expects the 2007 Restructuring Plan
to be substantially completed by the end of 2008.
Impact to Financial
Results
For the
three and six months ended June 30, 2008, the Company incurred charges of
$0.6 million and $9.7 million, respectively, for the 2007 Restructuring
Plan as follows:
Three
Months
Ended
June
30
Six
Months
Ended
June
30
2008
2008
Accelerated
depreciation charges
$
1.8
$
12.1
Employee
termination benefit charges (reversals)
(1.2
)
(2.4
)
Total
restructuring-related charges
$
0.6
$
9.7
The
accelerated depreciation charges were determined in accordance with
SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. For the three months ended June 30, 2008,
the accelerated depreciation charges are included in Cost of revenue on the
Consolidated Condensed Statements of Earnings. For the six months
ended June 30, 2008, the Company incurred $5.7 million of accelerated
depreciation charges in Cost
9
of revenue and $6.4 million
in Selling, general and
administrative on the Consolidated Condensed Statements of
Earnings.
Employee
termination benefit charges were accrued in accordance with
SFAS No. 112, Employers’ Accounting for
Postemployment Benefits and SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities, as appropriate.
Employee termination benefit charges include severance, medical and other
benefits and are included in Restructuring and related charges
on the Consolidated Condensed Statements of Earnings.
For the
three months ended June 30, 2008, the Company incurred pre-tax restructuring and
related charges (reversals) of $0.6 million in its Business segment,
($0.6) million in its Consumer segment and $0.6 million in All
other.
For the
six months ended June 30, 2008, the Company incurred pre-tax restructuring and
related charges of $0.4 million in its Business segment, $0.5 million
in its Consumer segment and $8.8 million in All other.
Liability
Rollforward
The
following table presents a rollforward of the liability incurred for employee
termination benefits in connection with the 2007 Restructuring Plan. The
liability is included in Accrued liabilities on the
Company’s Consolidated Condensed Statements of Financial Position.
(1) Other
consists of changes in the liability balance due to foreign currency
translations.
(2) Reversals
due to changes in estimates for employee termination
benefits.
2006
Restructuring
During
the first quarter of 2006, the Company approved a plan to restructure its
workforce, consolidate some manufacturing capacity and make certain changes to
its U.S. retirement plans (collectively referred to as the “2006
actions”).
Impact to Financial
Results
Except
for approximately 100 positions that were eliminated in 2007, activities related
to the 2006 actions were substantially completed at the end of 2006. During the
first quarter of 2007, the Company sold its Rosyth, Scotland facility for $8.1
million and recognized a $3.5 million pre-tax gain on the sale that is included
in Selling, general, and
administrative on the Consolidated Condensed Statements of
Earnings.
During
the second quarter of 2007, the Company substantially liquidated the remaining
operations of its Scotland entity and recognized an $8.1 million pre-tax gain
from the realization of the entity’s accumulated foreign currency translation
adjustment generated on the investment in the entity during its operating life.
This gain is included in Other
expense (income), net on the Company’s Consolidated Condensed Statements
of Earnings.
10
Liability
Rollforward
The
following table presents a rollforward of the liability incurred for employee
termination benefits and contract termination and lease charges in connection
with the 2006 actions. The liability is included in Accrued liabilities on the
Company’s Consolidated Condensed Statements of Financial Position.
(1)
Other consists of changes in the liability balance due to foreign currency
translations.
(2) Reversals
due to changes in estimates for employee termination
benefits.
4. Debt
Senior
Notes – Long-term Debt
In May
2008, the Company repaid its $150.0 million principal amount of 6.75% senior
notes that were due on May 15, 2008. Additionally, in May 2008, the Company
completed a public debt offering of $650.0 million aggregate principal amount of
fixed rate senior unsecured notes. The notes are split into two tranches of
five- and ten-year notes, respectively. The five-year notes with an
aggregate principal amount of $350.0 million and 5.90% coupon were priced at
99.83% to have an effective yield to maturity of 5.939% and will mature June 1,2013 (referred to as the “2013 senior notes”). The ten-year notes with an
aggregate principal amount of $300 million and 6.65% coupon were priced at
99.73% to have an effective yield to maturity of 6.687% and will mature June 1,2018 (referred to as the “2018 senior notes”).
The 2013
and 2018 senior notes (collectively referred to as the “senior notes”) will pay
interest on June 1 and December 1 of each year, beginning December 1, 2008. The
interest rate payable on the notes of each series will be subject to adjustments
from time to time if either Moody’s Investors Service, Inc. or Standard and
Poor’s Ratings Services downgrades the debt rating assigned to the notes to
a level below investment grade, or subsequently upgrades the
ratings.
The
senior notes contain typical restrictions on liens, sale leaseback transactions,
mergers and sales of assets. There are no sinking fund requirements on the
senior notes and they may be redeemed at any time at the option of the Company,
at a redemption price as described in the related indenture agreement, as
supplemented and amended, in whole or in part. If a “change of
control triggering event” as defined below occurs, the Company will be required
to make an offer to repurchase the notes in cash from the holders at a price
equal to 101% of their aggregate principal amount, plus accrued and unpaid
interest to but not including, the date of repurchase. A “change of
control triggering event” is defined as the occurrence of both a change of
control and a downgrade in the debt rating assigned to the notes to a level
below investment grade.
The
Company intends to use the net proceeds from the offering for general corporate
purposes, including to fund share repurchases, repay debt, finance acquisitions,
finance capital expenditures and operating expenses and invest in any
subsidiaries.
11
5. MARKETABLE
SECURITIES
Lexmark
has investments in marketable securities which are classified and accounted for
as available-for-sale. At June 30, 2008 and December 31, 2007, the
Company’s marketable securities portfolio consisted of asset-backed and
mortgage-backed securities, corporate debt securities, municipal debt
securities, U.S. government and agency debt securities, commercial paper,
certificates of deposit, and preferred securities, including approximately $35
million and $79 million, respectively, of auction rate
securities.
Market
conditions continue to indicate significant uncertainty on the part of investors
on the economic outlook for the U.S. and for financial institutions that have
potential exposure to the housing market. This uncertainty has created reduced
liquidity across the fixed income investment market, including the securities in
which Lexmark is invested. As a result, some of the Company’s investments have
experienced reduced liquidity including unsuccessful auctions for its auction
rate security holdings. Auction rate securities that do not successfully auction
reset to the maximum rate as prescribed in the underlying offering statement.
During the first quarter of 2008, the Company reclassified $59.4 million in
auction rate fixed income securities from Current assets to Noncurrent assets on its
Consolidated Condensed Statement of Financial Position due to the fact that the
securities had experienced unsuccessful auctions and poor debt market conditions
had reduced the likelihood that the securities would successfully auction within
the next 12 months.
During
the second quarter of 2008, approximately $24 million of auction rate fixed
income securities were either sold or redeemed at par. As of June 30, 2008, the
remaining balance of auction rate fixed income securities classified in Noncurrent assets is $31.3
million. All of the Company’s auction rate securities continue to be current
with their interest and dividend payments. The remaining $4.1 million of auction
rate securities continued to be classified in Current assets as of June 30,2008, as the Company had been notified by the issuer that the securities would
be called at par.
Based on
Lexmark’s assessment of the credit quality of the underlying collateral and
credit support available to each of the auction rate securities in which the
Company is invested, it believes no impairment has occurred. This is further
corroborated by an internal valuation based on discounted cash flows. The
Company has the ability to hold these securities until liquidity in the market
or optional issuer payment occurs and could also hold the securities to
maturity. Additionally, if Lexmark required capital, the Company has available
liquidity through its accounts receivable program, revolving credit facility and
incremental debt capacity in the capital markets. As of August 5, 2008, the
Company does not believe that it has a material risk in its current portfolio of
investments that would impact its financial condition or liquidity.
6. INVENTORIES
Inventories
consist of the following:
June
30
2008
December
31
2007
Work
in process
$
102.2
$
127.2
Finished
goods
325.0
337.2
Inventories
$
427.2
$
464.4
12
7. AGGREGATE
WARRANTY LIABILITY
Changes
in the Company’s aggregate warranty liability, which includes both warranty and
extended warranty (deferred revenue), are presented below:
2008
2007
Balance
at January 1
$
251.2
$
212.4
Accruals
for warranties issued
110.6
135.8
Accruals
related to pre-existing warranties (including amortization of deferred
revenue for extended warranties and changes in estimates)
(17.1
)
(26.9
)
Settlements
made (in cash or in kind)
(89.2
)
(89.2
)
Balance
at June 30
$
255.5
$
232.1
Both the
short-term portion of warranty and the short-term portion of extended warranty
are included in Accrued
liabilities on the Consolidated Condensed Statements of Financial
Position. Both the long-term portion of warranty and the long-term portion of
extended warranty are included in Other liabilities on the
Consolidated Condensed Statements of Financial Position.
8. INCOME
TAXES
The Provision for income taxes
for the three months ended June 30, 2008, was an expense of $20 million, or an
effective tax rate of 19.2%. For that period the Company reduced tax
expense by $5.1 million due to the recognition of a previously unrecognized tax
benefit related to a tax position taken in a prior period. For the
three months ended June 30, 2007, the Company’s tax expense was $13 million, or
an effective tax rate of 16.4%. For that period the Company reduced
tax expense by $4.8 million as the result of an adjustment made to the Company’s
deferred tax asset related to depreciation.
The Provision for income taxes
for the six months ended June 30, 2008, was an expense of $47 million, or an
effective tax rate of 20.1%. For that period the Company reduced tax
expense by $11.9 million, primarily due to settling various tax audits and to
the recognition of a previously unrecognized tax benefit related to a tax
position taken in a prior period. The Company’s tax expense was $44
million, or an effective tax rate of 22.1%, for the same period in 2007. For
that period the Company reduced tax expense by $6.0 million as the result of
adjustments made to the Company’s deferred tax assets.
The
Company’s effective tax rate for the three and six months ended June 30, 2008,
differs from the U.S. federal statutory rate of 35% generally because a portion
of the Company’s earnings outside the U.S. is taxed at an effective rate that is
lower than the U.S. federal statutory rate.
The
Company’s effective tax rate for the three and six months ended June 30, 2007,
differed from the U.S. federal statutory rate of 35% generally because (1) a
portion of the Company’s earnings outside the U.S. was taxed at an effective
rate lower than the U.S. federal statutory rate and (2) the U.S. Research and
Experimentation tax credit was in effect during 2007.
13
9. STOCKHOLDERS’
EQUITY
In May
2008, the Company received authorization from the Board of Directors to
repurchase an additional $750 million of its Class A Common Stock for a
total repurchase authority of $4.65 billion. As of June 30, 2008, there was
approximately $0.9 billion of share repurchase authority remaining. This
repurchase authority allows the Company, at management’s discretion, to
selectively repurchase its stock from time to time in the open market or in
privately negotiated transactions depending upon market price and other factors.
For the three and six months ended June 30, 2008, the Company repurchased
approximately 4.5 million shares at a cost of approximately $158 million. As of
June 30, 2008, since the inception of the program in April 1996, the Company had
repurchased approximately 78.7 million shares for an aggregate cost of
approximately $3.8 billion. As of June 30, 2008, the Company had reissued
approximately 0.5 million shares of previously repurchased shares in
connection with certain of its employee benefit programs. As a result of these
issuances as well as the retirement of 44.0 million and 16.0 million
shares of treasury stock in 2005 and 2006, respectively, the net treasury shares
held at June 30, 2008, were 18.2 million.
10. OTHER
COMPREHENSIVE EARNINGS (LOSS)
Comprehensive
earnings (loss), net of taxes, consist of the following:
Three
Months Ended June 30
Six
Months Ended June 30
2008
2007
2008
2007
Net
earnings
$
83.7
$
64.2
$
185.5
$
156.6
Other
comprehensive earnings (loss):
Foreign
currency translation adjustment
3.9
3.5
12.1
4.2
Cash
flow hedging
-
(0.3
)
-
(0.4
)
Pension
or other postretirement benefits
1.1
1.7
1.7
4.7
Net
unrealized loss on marketable securities
(1.8
)
(0.4
)
(1.1
)
(0.3
)
Comprehensive
earnings
$
86.9
$
68.7
$
198.2
$
164.8
Accumulated
other comprehensive (loss) earnings consist of the following:
Foreign
Currency Translation Adjustment
Pension
or Other Postretirement Benefits
Net
Unrealized Gain (Loss) on Marketable Securities
The
following table presents a reconciliation of the numerators and denominators of
the basic and diluted EPS calculations:
Three
Months Ended June 30
Six
Months Ended June 30
2008
2007
2008
2007
Numerator:
Net
earnings
$
83.7
$
64.2
$
185.5
$
156.6
Denominator:
Weighted
average shares used to compute basic EPS
94.0
94.8
94.6
95.6
Effect
of dilutive securities -
Employee
stock plans
0.2
0.7
0.2
0.9
Weighted
average shares used to compute diluted EPS
94.2
95.5
94.8
96.5
Basic
net EPS
$
0.89
$
0.68
$
1.96
$
1.64
Diluted
net EPS
$
0.89
$
0.67
$
1.96
$
1.62
Restricted
stock units and stock options totaling an additional 11.0 million and 7.8
million shares of Class A Common Stock for the three month periods and 11.0
million and 5.2 million shares of Class A Common Stock for the six month periods
ended June 30, 2008 and 2007, respectively, were outstanding but were not
included in the computation of diluted earnings per share because the effect
would have been antidilutive.
15
12. EMPLOYEE
PENSION AND POSTRETIREMENT PLANS
The
components of the net periodic benefit cost for both the pension and
postretirement plans for the three month and six month periods ended June 30,2008 and 2007, were as follows:
Pension
Benefits:
Three
Months Ended June 30
Six
Months Ended June 30
2008
2007
2008
2007
Service
cost
$
0.9
$
0.6
$
1.7
$
1.3
Interest
cost
11.2
10.5
22.6
21.1
Expected
return on plan assets
(12.6
)
(12.0
)
(25.2
)
(24.3
)
Amortization
of net loss
2.9
3.9
5.7
7.6
Curtailment
or special termination losses
1.0
-
1.0
-
Net
periodic benefit cost
$
3.4
$
3.0
$
5.8
$
5.7
Other
Postretirement Benefits:
Three
Months Ended June 30
Six
Months Ended June 30
2008
2007
2008
2007
Service
cost
$
0.2
$
0.4
$
0.7
$
0.9
Interest
cost
0.6
0.7
1.3
1.3
Amortization
of prior service (benefit) cost
(0.9
)
(1.0
)
(1.9
)
(2.0
)
Amortization
of net loss
0.1
0.2
0.3
0.4
Net
periodic benefit cost
$
-
$
0.3
$
0.4
$
0.6
The
Company currently expects to contribute approximately $7 million to its pension
and other postretirement plans in 2008. As of June 30, 2008, $3.4 million of
contributions have been made.
16
13. SEGMENT
DATA
Lexmark
manufactures and sells a variety of printing and multifunction products and
related supplies and services and is primarily managed along Business and
Consumer market segments. The Company evaluates the performance of its segments
based on revenue and operating income, and does not include segment assets or
other income and expense items for management reporting purposes. Segment
operating income (loss) includes: selling, general and administrative; research
and development; restructuring and related charges; and other expenses, certain
of which are allocated to the respective segments based on internal measures and
may not be indicative of amounts that would be incurred on a stand alone basis
or may not be indicative of results of other enterprises in similar businesses.
All other operating income (loss) includes significant expenses that are managed
outside of the reporting segments. These unallocated costs include such items as
information technology expenses, occupancy costs, stock-based compensation and
certain other corporate and regional general and administrative expenses such as
finance, legal and human resources.
The
following table includes information about the Company’s reportable
segments:
Three
Months Ended June 30
Six
Months Ended June
30
2008
2007
2008
2007
Revenue:
Business
$
762.8
$
733.7
$
1,504.2
$
1,471.1
Consumer
376.0
474.5
809.8
997.7
Total
revenue
$
1,138.8
$
1,208.2
$
2,314.0
$
2,468.8
Operating
income (loss):
Business
$
155.6
$
148.8
$
299.5
$
302.7
Consumer
23.1
13.8
101.8
78.3
All
other
(77.8
)
(97.0
)
(178.1
)
(194.3
)
Total
operating income (loss)
$
100.9
$
65.6
$
223.2
$
186.7
Operating
income (loss) noted above for the three months ended June 30, 2008, includes
restructuring and related charges of $0.6 million in the Business segment,
$2.8 million in the Consumer segment and $0.6 million in All other.
Operating income (loss) noted above for the six months ended June 30, 2008,
includes restructuring and related charges of $0.4 million in the Business
segment, $3.9 million in the Consumer segment and $8.8 million in All
other.
Operating
income (loss) noted above for the Consumer segment for the six months ended June30, 2007, included a $3.5 million gain on the sale of the Company’s Scotland
facility.
17
14. CONTINGENCIES
In
accordance with SFAS No. 5, Accounting for Contingencies,
Lexmark records a provision for a loss contingency when management believes that
it is both probable that a liability has been incurred and the amount of loss
can be reasonably estimated. The Company believes it has adequate provisions for
any such matters.
Legal
proceedings
On
December 30, 2002 (“02 action”) and March 16, 2004 (“04 action”), the
Company filed claims against Static Control Components, Inc. (“SCC”) in the
U.S. District Court for the Eastern District of Kentucky (the “District
Court”) alleging violation of the Company’s intellectual property and state law
rights. At various times in 2004, Pendl Companies, Inc. (“Pendl”), Wazana
Brothers International, Inc. (“Wazana”) and NER Data Products, Inc. (“NER”),
were added as additional defendants to the claims brought by the Company in the
02 action and/or the 04 action. The Company entered into separate settlement
agreements with each of NER, Pendl and Wazana pursuant to which the Company
released each party, and each party released the Company, from any and all
claims, and at various times in May 2007 the District Court entered orders
dismissing with prejudice all such litigation. Similar claims in a separate
action were filed by the Company in the District Court against David Abraham and
Clarity Imaging Technologies, Inc. (“Clarity”) on October 8, 2004. SCC and
Clarity have filed counterclaims against the Company in the District Court
alleging that the Company engaged in anti-competitive and monopolistic conduct
and unfair and deceptive trade practices in violation of the Sherman Act, the
Lanham Act and state laws. SCC has stated in its legal documents that it is
seeking approximately $17.8 million to $19.5 million in damages for
the Company’s alleged anticompetitive conduct and approximately $1 billion
for Lexmark’s alleged violation of the Lanham Act. Clarity has not stated a
damage dollar amount. SCC and Clarity are seeking treble damages, attorney fees,
costs and injunctive relief. On September 28, 2006, the District Court
dismissed the counterclaims filed by SCC alleging that the Company engaged in
anti-competitive and monopolistic conduct and unfair and deceptive trade
practices in violation of the Sherman Act, the Lanham Act and state laws. On
October 13, 2006, SCC filed a Motion for Reconsideration of the District
Court’s Order dismissing SCC’s claims, or in the alternative, to amend its
pleadings, which the District Court denied on June 1, 2007. On
October 13, 2006, the District Court issued an order to stay the action
brought against David Abraham and Clarity until a final judgment or settlement
are entered into in the consolidated 02 and 04 actions. On June 20, 2007,
the District Court Judge ruled that SCC directly infringed one of Lexmark’s
patents-in-suit. On June 22, 2007, the jury returned a verdict that SCC did
not induce infringement of Lexmark’s patents-in-suit. As to SCC’s defense that
the Company has committed patent misuse, in an advisory, non-binding capacity,
the jury did find some Company conduct constituted misuse. In the jury’s
advisory, non-binding findings, the jury also found that the relevant market was
the cartridge market rather than the printer market and that the Company had
unreasonably restrained competition in that market. The misuse defense will be
decided by the District Court Judge at a later date. A final judgment for the 02
action and the 04 action has not yet been entered by the District Court. SCC
filed an appeal of the 02 action and the 04 action with the United States Court
of Appeals for the Sixth Circuit Court (“Sixth Circuit”) on November 14,2007. On December 21, 2007, the Clerk of the Sixth Circuit ordered that SCC
show cause why its appeal should not be dismissed for lack of appellate
jurisdiction since a final judgment has not been entered by the District Court.
On January 18, 2008, SCC amended its civil appeals statement to confine its
appeal to orders entered in the 02 action. On May 1, 2008, the Sixth Circuit
dismissed without prejudice SCC's appeal for lack of appellate jurisdiction
until the entry of the final judgment by the District Court.
The
Company is also party to various litigation and other legal matters, including
claims of intellectual property infringement and various purported consumer
class action lawsuits alleging, among other things, various product defects and
false and deceptive advertising claims, that are being handled in the ordinary
course of business. In addition, various governmental authorities have from time
to time initiated inquiries and investigations, some of which are ongoing,
concerning the activities of participants in the markets for printers and
supplies. The Company intends to continue to cooperate fully with those
governmental authorities in these matters.
Although
it is not reasonably possible to estimate whether a loss will occur as a result
of these legal matters, or if a loss should occur, the amount of such loss, the
Company does not believe that any legal matters to which it is a party is likely
to have a material adverse effect on the Company’s financial position, results
of operations and cash flows. However, there can be no assurance that any
pending legal matters or any legal matters that may arise in the future would
not have a material adverse effect on the Company’s financial position, results
of operations or cash flows.
18
Copyright
fees
Certain
countries (primarily in Europe) and/or collecting societies representing
copyright owners’ interests have taken action to impose fees on devices (such as
scanners, printers and multifunction devices) alleging the copyright owners are
entitled to compensation because these devices enable reproducing copyrighted
content. Other countries are also considering imposing fees on certain devices.
The amount of fees, if imposed, would depend on the number of products sold and
the amounts of the fee on each product, which will vary by product and by
country. The Company has accrued amounts that it believes are adequate to
address the risks related to the copyright fee issues currently pending. The
financial impact on the Company, which will depend in large part upon the
outcome of local legislative processes, the Company’s and other industry
participants’ outcome in contesting the fees and the Company’s ability to
mitigate that impact by increasing prices, which ability will depend upon
competitive market conditions, remains uncertain. As of June 30, 2008, the
Company has accrued approximately $134 million for the pending copyright
fee issues, including litigation proceedings, local legislative initiatives
and/or negotiations with the parties involved.
As of
June 30, 2008, approximately $63 million of the $134 million accrued
for the copyright fee issues was related to single function printer devices sold
in Germany prior to December 31, 2007. On December 6, 2007, the
Bundesgerichtshof (the “German Federal Supreme Court”) issued a judgment in
litigation brought by VerwertungsGesellschaft Wort (“VG Wort”), a collection
society representing certain copyright holders, against Hewlett-Packard Company
(“HP”), finding that single function printer devices sold in Germany prior to
December 31, 2007 were not subject to the law authorizing the German
copyright fee levy (German Federal Supreme Court, file reference I ZR 94/05).
The Company and VG Wort entered into an agreement pursuant to which both VG Wort
and the Company agreed to be bound by the outcome of the VG Wort/HP litigation.
VG Wort filed a claim with the German Federal Constitutional Court
(Bundesverfassungsgericht, the “Constitutional Court”) challenging the
decision(s) of the German Federal Supreme Court. Pending a review of any
arguments VG Wort or HP may make, the Company believes the amount accrued
represents its best estimate of the copyright fee issues currently
pending.
As of
June 30, 2008, approximately $0.4 million of the $134 million accrued
for copyright fee issues was related to all-in-one and/or multifunction devices
(“AIO/MFDs”) sold in Germany prior to December 31, 2001. On
January 30, 2008, the German Federal Supreme Court issued a judgment in
litigation brought by VG Wort against HP seeking to impose copyright levies, at
the statutory rates published for photocopier devices, on AIO/MFDs, which
judgment confirmed the claim of VG Wort that the statutory copyright rates for
photocopier devices shall be applied to certain AIO/MFDs sold prior to
December 31, 2001 without any reduction (German Federal Supreme Court, file
reference I ZR 131/05). The Company is not a party to this litigation and has
not agreed to be bound by the outcome of this litigation. The German Federal
Supreme Court issued its formal written decision supporting the judgment during
July 2008. HP has 30 days from receipt of the German Federal Supreme
Court’s formal written decision to file a claim with the Constitutional Court
challenging the decision(s) of the German Federal Supreme Court. Pending a
review of any arguments HP or VG Wort may make if HP should decide to challenge
the German Federal Supreme Court’s ruling, the Company believes the amount
accrued represents its best estimate of the copyright fee issues currently
pending.
For those
AIO/MFDs sold in Germany after December 31, 2001 through December 31, 2007, VG
Wort instituted non-binding arbitration proceedings against the Company in
December 2006 before the arbitration board of the Patent and Trademark Office
relating to whether and to what extent copyright levies should be imposed on
such AIO/MFDs.
The
Company believes the amounts accrued represent its best estimate of the
copyright fee issues currently pending and these accruals are included in Accrued liabilities on the
Consolidated Condensed Statements of Financial Position.
19
15. RECENT
ACCOUNTING PRONOUNCEMENTS
In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. FAS
157 defines fair value, establishes a framework for measuring fair value in GAAP
and expands disclosures about fair value measurements. The adoption of FAS 157
in the first quarter of 2008 did not have a material impact on the Company’s
financial position, results of operations or cash flows. Refer to Note 2 of the
Notes to the Consolidated Condensed Financial Statements for the Company’s FAS
157 fair value disclosures. In February 2008, the FASB issued FASB Staff
Position No. FAS 157-2 (“FSP FAS 157-2”) which defers the effective date of FAS
157 to fiscal years beginning after November 15, 2008 for nonfinancial assets
and nonfinancial liabilities that are recognized or disclosed at fair value in
the financial statements on a nonrecurring basis. As permitted by FSP FAS 157-2,
the Company has only partially applied the provisions of FAS 157. The Company is
in the process of evaluating the inputs and techniques used in its nonrecurring,
nonfinancial fair value measurements.
In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Liabilities (“FAS 159”). FAS 159 provides entities with the
option to report selected financial assets and liabilities at fair value.
Business entities adopting FAS 159 will report unrealized gains and losses in
earnings at each subsequent reporting date on items for which the fair value
option has been elected. The Company has not elected the fair value option for
any of its assets or liabilities.
In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations
(“FAS 141R”), replacing FAS No. 141, Business Combinations (“FAS
141”). FAS 141R retains the fundamental requirements of purchase method
accounting for acquisitions as set forth previously in FAS 141. However,
this statement defines the acquirer as the entity that obtains control of a
business in the business combination, thus broadening the scope of FAS 141
which applied only to business combinations in which control was obtained
through transfer of consideration. FAS 141R also requires several changes
in the way assets and liabilities are recognized and measured in purchase
accounting including expensing acquisition-related costs as incurred,
recognizing assets and liabilities arising from contractual contingencies at the
acquisition date, and capitalizing in-process research and development.
FAS 141R also requires the acquirer to recognize a gain in earnings for
bargain purchases, or the excess of the fair value of net assets over the
consideration transferred plus any noncontrolling interest in the acquiree, a
departure from the concept of “negative goodwill” previously recognized under
FAS 141. FAS 141R is effective for the Company beginning
January 1, 2009, and will apply prospectively to business combinations
completed on or after that date.
In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial
Statements, an amendment of ARB 51 (“FAS 160”). FAS 160 applies
to all companies that prepare consolidated financial statements but will only
affect companies that have a noncontrolling interest in a subsidiary or that
deconsolidate a subsidiary. FAS 160 clarifies that noncontrolling interests
be reported as a component separate from the parent’s equity and that changes in
the parent’s ownership interest in a subsidiary be recorded as equity
transactions if the parent retains its controlling interest in the subsidiary.
The statement also requires consolidated net income to include amounts
attributable to both the parent and the noncontrolling interest on the face of
the income statement. In addition, FAS 160 requires a parent to recognize a
gain or loss in net income on the date the parent deconsolidates a subsidiary,
or ceases to have a controlling financial interest in a subsidiary. FAS 160
is effective for the Company beginning January 1, 2009, and will apply
prospectively, except for the presentation of disclosure requirements, which
must be applied retrospectively. The Company does not expect the adoption of
FAS 160 will have a material impact on its financial position, results of
operations or cash flows.
In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities—an amendment of FASB Statement No. 133
(“FAS 161”). FAS
161 changes the disclosure requirements for derivative instruments and hedging
activities. Entities are required to provide enhanced disclosures about (a) how
and why an entity uses derivative instruments, (b) how derivative instruments
and related hedged items are accounted for under Statement 133 and its related
interpretations, and (c) how derivative instruments and related hedged items
affect an entity’s financial position, financial performance, and cash flows.
FAS 161 is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008, with early application
encouraged. FAS 161 encourages, but does not require, comparative disclosures
for earlier periods at initial adoption. The Company is currently evaluating the
provisions of FAS 161.
20
In April
2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 142-3, Determination of the Useful Life of
Intangible Assets (“FSP FAS 142-3”). The FSP amends the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under FASB Statement
No. 142, Goodwill and Other
Intangible Assets (“FAS 142”). Specifically, an entity shall consider its
own historical experience in renewing or extending similar arrangements in
developing such assumptions or, in the absence of that experience, consider the
assumptions that market participants would use (highest and best use of the
asset) about renewal or extension. All assumptions must be adjusted for
entity-specific factors as provided in FAS 142. An entity will now use its own
assumptions about renewal or extension even when there is likely to be
substantial cost or material modifications of existing terms and conditions. FSP
FAS 142-3 also requires additional disclosures in order to enable users to
better assess the extent to which the expected future cash flows associated with
the asset are affected by the entity’s intent and/or ability to renew or extend
the arrangement. The FSP is effective for financial statements issued for fiscal
years beginning after December 15, 2008. For intangible assets acquired after
the effective date, the guidance for determining the useful life of the
recognized intangible asset shall be applied prospectively. The additional
disclosure requirements shall be applied prospectively to intangible assets
recognized as of, and subsequent to, the effective date. The Company is
currently evaluating the provisions of FSP FAS 142-3.
In May
2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles (“FAS 162”). FAS 162 identifies the sources of
accounting principles and the framework for selecting principles to be used in
the preparation of financial statements that are presented in conformity with
United States GAAP. The GAAP hierarchy was previously set forth in the American
Institute of Certified Public Accountants (“AICPA”) Statement on Auditing
Standards No. 69, The Meaning
of Present Fairly in Conformity With Generally Accepted Accounting
Principles. Though the FASB does not expect a change in current practice,
the Board issued this statement in order for the U.S. GAAP hierarchy to reside
in the accounting literature established by the FASB. FAS 162 is effective 60
days following the SEC’s approval of the Public Company Accounting Oversight
Board amendments to AU Section 411, The Meaning of Present Fairly in
Conformity With Generally Accepted Accounting Principles. Any effect of
applying the provisions of FAS 162 shall be reported as a change in accounting
principle in accordance with SFAS No. 154, Accounting Changes and Error
Corrections. The Company does not expect FAS 162 to have a material
impact on its financial statements.
In June
2008, the FASB issued FSP No. EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities
(“FSP EITF 03-6-1”). The FASB concluded in this FSP that unvested share-based
payment awards that contain nonforfeitable rights to dividends or dividend
equivalents are participating securities and shall be included in the
calculation of earnings per share pursuant to the two-class method. This FSP is
effective for financial statements issued for fiscal years beginning after
December 15, 2008, requiring all prior-period earnings per share data presented
to be adjusted retrospectively. The Company does not expect FSP EITF 03-6-1 to
have a material impact on its calculation of earnings per share.
16. SUBSEQUENT
EVENT
Refer to
Note 3 of the Notes to the Consolidated Condensed Financial Statements for
discussion of the Company’s 2008 Restructuring Plan.
21
Item
2. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
Lexmark
makes it easier for businesses and consumers to move information between the
digital and paper worlds. Since its inception in 1991, Lexmark has become a
leading developer, manufacturer and supplier of printing and imaging solutions
for offices and homes. Lexmark’s products include laser printers, inkjet
printers, multifunction devices, and associated supplies, services and
solutions. Lexmark also sells dot matrix printers for printing single and
multi-part forms by business users.
The
Company is primarily managed along Business and Consumer market
segments:
•
The
Business market segment primarily sells laser products and serves business
customers but also include consumers who choose laser products. Laser
products can be divided into two major categories — shared workgroup
products and lower-priced desktop products. Lexmark employs large-account
sales and marketing teams, closely supported by its development and
product marketing teams, to generate demand for its business printing
solutions and services. The sales and marketing teams primarily focus on
industries such as finance, education, retail, manufacturing, government
and health care. Lexmark also markets its laser and inkjet products
increasingly through small and medium business (“SMB”) teams who work
closely with channel partners. The Company distributes and fulfills its
laser products primarily through its well-established distributor and
reseller network. Lexmark’s products are also sold through solution
providers, which offer custom solutions to specific markets, and through
direct response resellers.
•
The
Consumer market segment predominantly sells inkjet products to consumers
but also includes business users who may choose inkjet products as a
lower-priced alternative or supplement to laser products for personal
desktop use. Also, there is an increasing trend in inkjet products being
designed for business purposes such as small office home office (“SOHO”),
small business, student and home offices. Additionally, over the past
couple years, the number of consumers seeking productivity-related
features has driven significant growth in all-in-one (“AIO”) products. For
the consumer market, Lexmark distributes its branded inkjet products and
supplies primarily through retail outlets worldwide. Lexmark’s sales and
marketing activities are organized to meet the needs of the various
geographies and the size of their
markets.
The
Company also sells its products through numerous alliances and original
equipment manufacturer (“OEM”) arrangements.
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
Lexmark’s
discussion and analysis of its financial condition and results of operations are
based upon the Company’s consolidated condensed financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
U.S. The preparation of consolidated condensed financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenue and expenses, and related disclosure of contingent
assets and liabilities. On an ongoing basis, the Company evaluates its
estimates, including those related to customer programs and incentives, product
returns, doubtful accounts, inventories, stock-based compensation, intangible
assets, income taxes, warranty obligations, copyright fees, restructurings,
pension and other postretirement benefits, and contingencies and litigation.
Lexmark bases its estimates on historical experience and on various other
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.
An
accounting policy is deemed to be critical if it requires an accounting estimate
to be made based on assumptions about matters that are uncertain at the time the
estimate is made, if different estimates reasonably could have been
22
used, or
if changes in the estimate that are reasonably likely to occur could materially
impact the financial statements.
Management
believes that other than the partial adoption of SFAS No. 157, Fair Value Measurements (“FAS
157”) during the first quarter of 2008, there have been no significant changes
during the six months ended June 30, 2008, to the items that were disclosed as
critical accounting policies and estimates in Item 7. Management’s Discussion
and Analysis of Financial Condition and Results of Operations in the Company’s
Annual Report on Form 10-K for the fiscal year ended December 31,2007.
Fair
Value
The
Company currently uses recurring fair value measurements in several areas
including marketable securities, pension plan assets and derivatives. The
Company uses fair value in measuring certain nonrecurring items as well, as
instructed under existing authoritative accounting guidance.
In
September 2006, the FASB issued FAS 157. FAS 157 defines fair value, establishes
a framework for measuring fair value in GAAP and expands disclosures about fair
value measurements. The standard defines fair value as the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. As part of the
framework for measuring fair value, FAS 157 establishes a hierarchy of inputs to
valuation techniques used in measuring fair value that maximizes the use of
observable inputs and minimizes the use of unobservable inputs by requiring that
the most observable inputs be used when available.
The three
levels of the fair value hierarchy under FAS 157 are:
·
Level
1 -- Quoted prices (unadjusted) in active markets for identical,
unrestricted assets or liabilities that the Company has the ability to
access at the measurement date.
·
Level
2 -- Inputs other than quoted prices included in Level 1 that are
observable for the asset or liability, either directly or
indirectly.
·
Level
3 -- Unobservable inputs used in valuations in which there is little
market activity for the asset or liability at the measurement
date.
Fair
value measurements of assets and liabilities are assigned a level within the
fair value hierarchy based on the lowest level of any input that is significant
to the fair value measurement in its entirety.
In
February 2008, the FASB issued FASB Staff Position No. FAS 157-2 (“FSP FAS
157-2”) which defers the effective date of FAS 157 to fiscal years beginning
after November 15, 2008 for nonfinancial assets and nonfinancial liabilities
that are recognized or disclosed at fair value in the financial statements on a
nonrecurring basis. As permitted by FSP FAS 157-2, the Company has only
partially applied the provisions of FAS 157 as of June 30, 2008. The Company is
in the process of evaluating the inputs and techniques used in its nonrecurring,
nonfinancial fair value measurements.
The
Company utilizes observable market data, when available, to determine fair
value. However, in certain situations, there may be little or no market data
available at the measurement date thus requiring the use of significant
unobservable inputs. To the extent that a valuation is based on models, inputs
or assumptions that are less observable in the market, the determination of fair
value requires more judgment. Such measurements are generally classified as
Level 3 within the fair value hierarchy. Refer to Part I, Item 1, Note 2 of the
Notes to Consolidated Condensed Financial Statements for the Company’s
disclosures regarding fair value. Also, refer to the Financial Condition section
of Item 2 for additional information regarding the Company’s significant Level 3
valuations.
23
RESULTS
OF OPERATIONS
Operations
Overview
Key
Messages
Lexmark
is focused on driving long-term value by strategically investing in technology,
demand generation and brand development to enable the Company to profitably
capture supplies in high page-growth segments of the distributed printing
market.
•
The
Business market segment strategy is focused on growth in higher
page-generating workgroup class lasers including monochrome and color
laser printers and laser MFPs.
•
The
Company is aggressively shifting its focus in the Consumer market segment
to geographic regions, product segments, and customers that generate
higher page usage. This strategy shift will increase the Company’s focus
on higher priced, higher usage devices, customers and countries and will
focus its investments to better meet the needs of those customers and
product segments.
Lexmark
is taking actions to improve certain portions of its manufacturing and business
support cost and expense structure. These actions will better allow the Company
to fund these strategic initiatives.
Lexmark
continues to maintain a strong financial position with a long track record of
good cash generation and a solid balance sheet, which positions it well to
invest in the future and compete effectively, even during challenging
times.
Business
Factors
Business
segment
During
the second quarter of 2008, Lexmark continued its investments in new products
and technology in the Business market segment. The Company expects these
investments to produce a steady stream of new products.
The
Company continued its investment in its managed print services and industry
sales initiatives. Lexmark also made a significant investment in its enterprise
sales force in 2007 to improve its coverage and expand the reach of its
solutions and services proposition.
The
primary focus of the Business market investments is to drive workgroup laser
growth and page generation.
Consumer
segment
Lexmark
believes it is experiencing shrinkage in its installed base of inkjet products
and an associated decline in end-user demand for inkjet supplies. The Company
sees the potential for continued erosion in end-user inkjet supplies demand due
to the reduction in inkjet hardware unit sales reflecting the Company’s decision
to focus on more profitable, higher usage printer placements and the weakness
the Company is experiencing in its OEM business.
Beginning
in the second quarter of 2007, the Company experienced the following issues in
its Consumer segment:
·
On-going
declines in inkjet supplies and OEM unit
sales.
·
Lower
average unit revenues due to aggressive pricing and
promotion.
·
Additional
costs in its new products.
As the
Company analyzed the situation, it saw the following:
·
Some
of its unit sales were not generating adequate lifetime profitability due
to lower prices, higher costs and supplies usage below its
model.
·
Some
markets and channels were on the low-end of the supplies generation
distribution curve.
·
Its
business was too skewed to the low-end versus the market, resulting in
lower supplies generation per unit.
24
As a
result, Lexmark decided to take the following actions beginning in
2007:
·
The
Company decided to more aggressively shift its focus to geographic
regions, market segments and customers that generate higher page
usage.
·
The
Company continues working to minimize the unit sales that do not generate
an acceptable profit over their
life.
The above
actions entail several initiatives, which were begun in 2007 and have continued
through the current period:
·
Shifting
the Company’s marketing focus and targeted customer segments and working
to fully understand the needs and application requirements of the heavier
usage segments of student and professional
users.
·
Shifting
the Company’s investment in research and development to better design
products and technology that will be attractive to these
segments.
·
Re-engineering
the Company’s supply chain to reduce costs and eliminate touches between
the factory and the customers.
·
Working
on supplies to lower cost and consolidate manufacturing capacity. In 2007,
the Company announced a restructuring plan to reduce its cost and
infrastructure, including the closure of one of its inkjet supplies
manufacturing facilities in Mexico and additional optimization measures at
the remaining inkjet facilities in Mexico and the Philippines. In July
2008, the Company announced a plan that will result in the closure of an
additional one of the Company’s inkjet supplies manufacturing facilities
in Mexico. See
“RESTRUCTURING AND RELATED CHARGES (REVERSALS) AND PROJECT
COSTS” that follows for
further discussion.
These
initiatives have yielded the following for the Company’s Consumer
segment:
·
Strong
growth YTY in wireless inkjet
units.
·
An
improvement in the Company’s inkjet AUR, despite an aggressive pricing
environment.
·
The
introduction of new products such as Lexmark’s Professional Series and its
Home & Student Series.
·
An
increasing amount of industry recognition and awards for its inkjet
products.
25
Operating
Results Summary
The
following discussion and analysis should be read in conjunction with the
Consolidated Condensed Financial Statements and Notes thereto. The following
table summarizes the results of the Company’s operations for the three and six
months ended June 30, 2008 and 2007:
Three
Months Ended June 30
Six
Months Ended June 30
2008
2007
2008
2007
(Dollars
in millions)
Dollars
%
of Rev
Dollars
%
of Rev
Dollars
%
of Rev
Dollars
%
of Rev
Revenue
$
1,138.8
100.0
%
$
1,208.2
100.0
%
$
2,314.0
100.0
%
$
2,468.8
100.0
%
Gross
profit
417.2
36.6
370.2
30.6
852.7
36.9
793.0
32.1
Operating
expense
316.3
27.8
304.6
25.2
629.5
27.2
606.3
24.6
Operating
income
100.9
8.9
65.6
5.4
223.2
9.6
186.7
7.6
Net
earnings
83.7
7.4
64.2
5.3
185.5
8.0
156.6
6.3
Current
quarter
For the
second quarter of 2008, total revenue was $1.1 billion or down 6% from
2007. Laser and inkjet supplies revenue was flat year-to-year (“YTY”) and laser
and inkjet hardware revenue decreased 19% YTY. In the Business segment, revenue
increased 4% YTY while revenue in the Consumer segment decreased 21%
YTY.
Net
earnings for the second quarter of 2008 increased 30% from the prior year
primarily due to higher operating income partially offset by lower other
non-operating income and a higher effective tax rate. Net earnings for the
second quarter of 2008 included $8.8 million of pre-tax restructuring-related
charges and project costs and a non-recurring tax benefit of $5.1 million. Net
earnings for the second quarter of 2007 included $5.1 million of pre-tax
restructuring-related project costs, an $8.1 million pre-tax foreign exchange
gain realized upon the substantial liquidation of the Company’s Scotland entity
as the assets were sold in the first quarter of 2007 and a one-time tax benefit
of $4.8 million.
Year
to date
For the
six months ended June 30, 2008, consolidated revenue was $2.3 billion or down 6%
YTY. Laser and inkjet supplies revenue declined 1% YTY and laser and inkjet
hardware revenue declined 18% YTY. In the Business segment, revenue increased 2%
YTY while revenue in the Consumer segment decreased 19% YTY.
Net
earnings for the six months ended June 30, 2008, increased 18% from the prior
year primarily due to higher operating income partially offset by lower other
non-operating income. Net earnings for the six months ended June 30, 2008,
included $21.4 million of pre-tax restructuring-related charges and project
costs and non-recurring tax benefits of $11.9 million. Net earnings for the six
months ended June 30, 2007, included $10.8 million of restructuring-related
project costs, a $3.5 million gain on the sale of the Company's Scotland
facility, an $8.1 million pre-tax foreign exchange gain as noted above and
one-time tax benefits of $6.0 million.
26
Revenue
For the
second quarter of 2008, consolidated revenue decreased 6% YTY. Laser and inkjet
supplies revenue was flat YTY as growth in laser supplies was offset by a
decline in inkjet supplies. Laser and inkjet hardware revenue declined 19% YTY
primarily driven by unit declines particularly in inkjet units.
For the
six months ended June 30, 2008, consolidated revenue decreased 6% YTY. Laser and
inkjet supplies revenue decreased 1% YTY as growth in laser supplies was more
than offset by a decline in inkjet supplies. Laser and inkjet hardware revenue
declined 18% YTY primarily driven by the shift in inkjet strategy.
The
following table provides a breakdown of the Company’s revenue by market
segment:
Three
Months Ended June 30
Six
Months Ended June 30
(Dollars
in millions)
2008
2007
%
Change
2008
2007
%
Change
Business
$
762.8
$
733.7
4
%
$
1,504.2
$
1,471.1
2
%
Consumer
376.0
474.5
(21
)
809.8
997.7
(19
)
Total
revenue
$
1,138.8
$
1,208.2
(6
)
%
$
2,314.0
$
2,468.8
(6
)
%
Business
segment
During
the second quarter of 2008, revenue in the Business segment increased
$29 million or 4% compared to 2007 due to growth in laser supplies revenue
partially offset by a decline in laser hardware revenue. Laser hardware unit
shipments declined 12% YTY. The decline in laser units was attributable to 1)
declines in the Company’s low end laser units as the Company has held the line
on price and is not chasing entry level devices with low page usage and 2)
workgroup unit declines in the Company’s North American enterprise sales,
including the government, retail and financial services sectors, due to the
current weak market conditions. Laser hardware average unit revenue (“AUR”),
which reflects the changes in both pricing and mix, increased 4% YTY as the
negative impact of pricing was offset by currency and favorable product
mix.
For the
six months ended June 30, 2008, Business segment revenue increased $33 million
or 2% YTY primarily due to growth in laser supplies revenue partially offset by
a decline in laser hardware revenue. Laser hardware unit shipments decreased 10%
YTY while laser hardware AUR increased 2% YTY.
Consumer
segment
During
the second quarter of 2008, revenue in the Consumer segment decreased
$98 million or 21% compared to 2007 due to decreased inkjet hardware and
supplies revenue. Hardware revenue declined YTY due to lower unit shipments
partially offset by increased AURs. Inkjet hardware unit shipments declined 49%
YTY principally due to the Company’s decision to prioritize certain markets,
segments and customers and to reduce or eliminate others. Units were also
impacted by the Company’s decision to focus on more profitable printer
placements in every geography. Inkjet unit sales are being further impacted by
market weakness in the U.S. and Europe and aggressive competitive
pricing/promotion activities. In the U.S., inkjet unit sales are also being
impacted by reduced shelf space as compared to the prior year. Inkjet hardware
AUR increased 24% YTY as price declines were more than offset due to a
significantly improved mix reflecting a shift towards higher-end devices, as
well as currency benefits.
For the
six months ended June 30, 2008, Consumer segment revenue decreased $188 million
or 19% compared to 2007 due to decreased inkjet hardware and supplies revenue.
Inkjet hardware unit shipments declined 45% YTY while inkjet hardware AUR
increased 19% YTY.
27
Revenue by
geography:
The
following table provides a breakdown of the Company’s revenue by
geography:
Three
Months Ended June 30
Six
Months Ended June 30
(Dollars
in millions)
2008
2007
%
Change
2008
2007
%
Change
United
States
$
432.4
$
508.2
(15
)
%
$
920.2
$
1,053.1
(13
)
%
EMEA
(Europe, the Middle East & Africa)
454.9
445.9
2
909.8
927.6
(2
)
Other
International
251.5
254.1
(1
)
484.0
488.1
(1
)
Total
revenue
$
1,138.8
$
1,208.2
(6
)
%
$
2,314.0
$
2,468.8
(6
)
%
For the
three and six months ended June 30, 2008, revenue decreased in the U.S.
primarily due to the previously-mentioned decline in Consumer segment revenues.
Additionally, revenue in the U.S. was negatively impacted by weakness in the
Company’s Business segment enterprise hardware sales.
Gross
Profit
The
following table provides gross profit information:
Three
Months Ended June 30
Six
Months Ended June 30
(Dollars
in millions)
2008
2007
Change
2008
2007
Change
Gross
profit dollars
$
417.2
$
370.2
13
%
$
852.7
$
793.0
8
%
%
of revenue
36.6
%
30.6
%
6.0
pts
36.9
%
32.1
%
4.8
pts
For the
three and six months ended June 30, 2008, consolidated gross profit and gross
profit as a percentage of revenue increased YTY. The changes in the gross profit
margin YTY for the three and six months ended June 30, 2008, were primarily due
to favorable mix shifts among products of 6.1 percentage points and 5.2
percentage points, respectively, primarily driven by the decline in inkjet
hardware units and the increased laser supplies.
Gross
profit for the three and six months ended June 30, 2008, included
$4.5 million and $9.8 million, respectively, of restructuring-related
charges and project costs. Gross profit for the three and six months ended June30, 2007, included $4.5 million and $6.1 million, respectively, of
restructuring-related project costs. See “RESTRUCTURING AND
RELATED CHARGES (REVERSALS) AND PROJECT COSTS” that follows for further
discussion.
28
Operating
Expense
The
following table presents information regarding the Company’s operating expenses
during the periods indicated:
Three
Months Ended June 30
Six
Months Ended June 30
2008
2007
2008
2007
(Dollars
in millions)
Dollars
%
of Rev
Dollars
%
of Rev
Dollars
%
of Rev
Dollars
%
of Rev
Research
and development
$
102.9
9.1
%
$
102.2
8.5
%
$
208.4
9.0
%
$
202.1
8.2
%
Selling,
general & administrative
211.2
18.5
202.4
16.7
420.1
18.2
404.2
16.4
Restructuring
and related charges
2.2
0.2
-
-
1.0
-
-
-
Total
operating expense
$
316.3
27.8
%
$
304.6
25.2
%
$
629.5
27.2
%
$
606.3
24.6
%
For the
three and six months ended June 30, 2008, research and development increased YTY
due to the Company’s continued investment to support product and solution
development in the Business segment. These continuing investments are primarily
focused on new products and solutions aimed at targeted high page generation
segments.
Selling,
general and administrative (“SG&A”) expenses for the three and six months
ended June 30, 2008, increased YTY as the Company continued to increase spending
on marketing and sales activities, partially offset by lower general and
administrative expenses. Additionally, SG&A expenses for the three and six
months ended June 30, 2008, included $2.1 million and $10.6 million,
respectively, of restructuring-related charges and project costs. SG&A
expenses for the three and six months ended June 30, 2007, included $0.6 million
and $1.2 million, respectively, of net restructuring-related charges and project
costs. See
“RESTRUCTURING AND RELATED CHARGES (REVERSALS) AND PROJECT COSTS” that follows for further
discussion.
29
Operating
Income (Loss)
The
following table provides operating income by market segment:
Three
Months Ended June 30
Six
Months Ended June 30
(Dollars
in millions)
2008
2007
Change
2008
2007
Change
Business
$
155.6
$
148.8
5
%
$
299.5
$
302.7
(1
)
%
%
of segment revenue
20.4
%
20.3
%
0.1
pts
19.9
%
20.6
%
(0.7
)
pts
Consumer
23.1
13.8
68
%
101.8
78.3
30
%
%
of segment revenue
6.2
%
2.9
%
3.3
pts
12.6
%
7.8
%
4.8
pts
All
other
(77.8
)
(97.0
)
20
%
(178.1
)
(194.3
)
8
%
Total
operating income (loss)
$
100.9
$
65.6
54
%
$
223.2
$
186.7
20
%
%
of total revenue
8.9
%
5.4
%
3.5
pts
9.6
%
7.6
%
2.0
pts
For the
three and six months ended June 30, 2008, the increases in consolidated
operating income were due to higher gross profit partially offset by higher
operating expenses.
For the
second quarter of 2008, Business segment operating income increased YTY due to
higher gross profit, reflecting a more favorable product mix, partially offset
by increased operating expense, principally due to increased marketing and sales
and product development. For the six months ended June 30, 2008, Business
segment operating income decreased YTY as higher gross profit was more than
offset by increased operating expense.
For the
second quarter of 2008, Consumer segment operating income increased YTY due to
higher gross profit resulting from a favorable product mix shift reflecting less
hardware partially offset by less supplies revenue. For the six months ended
June 30, 2008, Consumer segment operating income increased YTY due to higher
gross profit and lower operating expense.
For the
three months ended June 30, 2008, the Company incurred restructuring and
related charges and project costs related to the Company’s restructuring plans
of $1.2 million in its Business segment, $4.3 million in its Consumer
segment and $3.3 million in All other. For the six months ended
June 30, 2008, the Company incurred restructuring and related charges and
project costs related to the Company’s restructuring plans of $1.2 million
in its Business segment, $5.8 million in its Consumer segment and
$14.4 million in All other. See “RESTRUCTURING AND
RELATED CHARGES (REVERSALS) AND PROJECT COSTS” that follows for further
discussion.
For the
three months ended June 30, 2007, the Company incurred total pre-tax
restructuring-related project costs of $0.7 million in its Business segment
and $4.4 million in All other while the Company did not incur significant
charges in its Consumer segment. For the six months ended June 30, 2007, the
Company incurred total pre-tax restructuring-related project costs of
$1.2 million in its Business segment and $9.4 million in All other
that were offset by a $3.3 million benefit in the Consumer segment. See “RESTRUCTURING AND
RELATED CHARGES (REVERSALS) AND PROJECT COSTS” that follows for further
discussion.
30
Interest
and Other
The
following table provides interest and other information:
Three
Months Ended June 30
Six
Months Ended June
30
(Dollars
in millions)
2008
2007
2008
2007
Interest
(income) expense, net
$
(2.9
)
$
(3.8
)
$
(10.4
)
$
(8.2
)
Other
expense (income), net
0.2
(7.4
)
1.5
(6.2
)
Total
interest and other (income) expense, net
$
(2.7
)
$
(11.2
)
$
(8.9
)
$
(14.4
)
During
the second quarter of 2008, total interest and other (income) expense, net, was
income of $3 million compared to income of $11 million in 2007. For
the six months ended June 30, 2008, total interest and other (income) expense,
net, was income of $9 million compared to income of $14 million in
2007.
During
the second quarter of 2007, the Company substantially liquidated the remaining
operations of its Scotland entity and recognized an $8.1 million pre-tax gain
from the realization of the entity’s accumulated foreign currency translation
adjustment generated on the investment in the entity during its operating
life.
Provision
for Income Taxes and Related Matters
The Provision for income taxes
for the three months ended June 30, 2008, was an expense of $20 million, or an
effective tax rate of 19.2%. For that period the Company reduced tax
expense by $5.1 million due to the recognition of a previously unrecognized tax
benefit related to a tax position taken in a prior period. For the
three months ended June 30, 2007, the Company’s tax expense was $13 million, or
an effective tax rate of 16.4%. For that period the Company reduced
tax expense by $4.8 million as the result of an adjustment made to the Company’s
deferred tax asset related to depreciation.
The Provision for income taxes
for the six months ended June 30, 2008, was an expense of $47 million, or an
effective tax rate of 20.1%. For that period the Company reduced tax
expense by $11.9 million, primarily due to settling various tax audits and to
the recognition of a previously unrecognized tax benefit related to a tax
position taken in a prior period. The Company’s tax expense was $44
million, or an effective tax rate of 22.1%, for the same period in 2007. For
that period the Company reduced tax expense by $6.0 million as the result of
adjustments made to the Company’s deferred tax assets.
The
Company’s effective tax rate for the three and six months ended June 30, 2008,
differs from the U.S. federal statutory rate of 35% generally because a portion
of the Company’s earnings outside the U.S. is taxed at an effective rate that is
lower than the U.S. federal statutory rate.
The
Company’s effective tax rate for the three and six months ended June 30, 2007,
differed from the U.S. federal statutory rate of 35% generally because (1) a
portion of the Company’s earnings outside the U.S. was taxed at an effective
rate lower than the U.S. federal statutory rate and (2) the U.S. Research and
Experimentation tax credit was in effect during 2007.
31
Net
Earnings and Earnings per Share
The
following table summarizes net earnings and basic and diluted net earnings per
share:
Three
Months Ended June
30
Six
Months Ended June
30
( (Dollars
in millions, except per share amounts)
2008
2007
2008
2007
Net
earnings
$
83.7
$
64.2
$
185.5
$
156.6
Basic
earnings per share
$
0.89
$
0.68
$
1.96
$
1.64
Diluted
earnings per share
$
0.89
$
0.67
$
1.96
$
1.62
Net
earnings for the second quarter of 2008 increased 30% from the prior year
primarily due to higher operating income partially offset by lower non-operating
income and a higher effective tax rate. Net earnings for the six months ended
June 30, 2008, increased 18% from the prior year primarily due to higher
operating income partially offset by lower other non-operating
income.
For the
three and six months ended June 20, 2008, the increases YTY in basic and diluted
earnings per share were primarily attributable to increased net
earnings.
32
RESTRUCTURING
AND RELATED CHARGES (REVERSALS) AND PROJECT COSTS
Summary
of restructuring impacts
This
quarter, after the recent announcement of the new 2008 Plan, the Company is now
conducting two restructuring plans (and related projects) that are discussed in
detail further below. The following tables summarize the second quarter and the
year-to-date (“YTD”) June financial impacts of the Company’s restructuring plans
(and related projects). The project costs presented below consist of additional
charges related to the execution of the restructuring plans. These project costs
are incremental to the Company’s normal operating charges and are expensed as
incurred. The project costs include such items as compensation costs for overlap
staffing, travel expenses, consulting costs and training costs.
For the
three months ended June 30, 2008, the Company incurred charges, including
project costs, of $8.8 million for the Company’s restructuring plans as
follows:
For the
three months ended June 30, 2008, the $4.5 million of accelerated depreciation
charges and project costs are included in Cost of revenue on the
Consolidated Condensed Statements of Earnings. The $2.2 million of total
employee termination benefit charges are included in Restructuring and related charges while the
$2.1 million of related project costs are included in Selling, general and administrative
on the Consolidated Condensed Statements of Earnings.
For the
three months ended June 30, 2008, the Company incurred restructuring and
related charges and project costs related to the Company’s restructuring plans
of $1.2 million in its Business segment, $4.3 million in its Consumer
segment and $3.3 million in All other.
For the
six months ended June 30, 2008, the Company incurred charges, including
project costs, of $21.4 million for the Company’s restructuring plans as
follows:
For the
six months ended June 30, 2008, the Company incurred $9.8 million of accelerated
depreciation charges and project costs in Cost of revenue and $6.4
million in Selling, general
and administrative on the Consolidated Condensed Statements of
Earnings. The $1.0 million of total employee termination benefit
charges are included in Restructuring and related charges while the
$4.2 million of related project costs are included in Selling, general and administrative
on the Consolidated Condensed Statements of Earnings.
For the
six months ended June 30, 2008, the Company incurred restructuring and
related charges and project costs related to the Company’s restructuring plans
of $1.2 million in its Business segment, $5.8 million in its Consumer
segment and $14.4 million in All other.
33
In
connection with the 2007 Restructuring Plan and the recently announced 2008
Restructuring Plan, the Company expects to incur $54 million of pre-tax
restructuring and related charges and project costs during the remainder of 2008
with approximately $32 million expected in the third quarter of
2008.
2008
Restructuring Plan
General
To
enhance the efficiency of the Company’s inkjet cartridge manufacturing
operations, the Company announced a plan (the “2008 Restructuring Plan”) on July22, 2008, that will result in the closure of one of the Company’s inkjet
supplies manufacturing facilities in Mexico.
The 2008
Restructuring Plan is expected to impact approximately 650 positions by the end
of 2008 with most of the impacted positions being moved to a lower-cost country.
The Company expects the 2008 Restructuring Plan will result in pre-tax charges
of approximately $24 million, of which $20 million are restructuring and related
charges and $4 million are project costs, as defined at the beginning of
this section. Expected cash payments for the restructuring and related charges
and project costs are approximately $8 million. The charges for the 2008
Restructuring Plan will impact the Company’s Consumer segment. The Company
expects the 2008 Restructuring Plan to be substantially completed by the end of
2008.
Of the
total pre-tax restructuring and related charges and project costs of
approximately $24 million for the 2008 Restructuring Plan, approximately
$21 million will impact cost of revenue and $3 million will impact
operating expense. The 2008 Restructuring Plan (including related projects) is
expected to save approximately $9 million annually beginning in 2009 and
will benefit cost of revenue.
Impact to Financial
Results
For the
three and six months ended June 30, 2008, the Company incurred $3.4 million
for the 2008 Restructuring Plan as follows:
(In
millions)
Employee
termination benefit charges
$
3.4
Total
restructuring-related charges
$
3.4
For the
three and six months ended June 30, 2008, the Company incurred the $3.4 million
of pre-tax restructuring and related charges in its Consumer
segment.
Liability
Rollforward
The
following table presents a rollforward of the liability incurred for employee
termination benefits in connection with the 2008 Restructuring Plan. The
liability is included in Accrued liabilities on the
Company’s Consolidated Condensed Statements of Financial Position.
As part
of the Company’s ongoing efforts to optimize its cost and expense structure, the
Company continually reviews its resources in light of a variety of factors. On
October 23, 2007, the Company announced a plan (the “2007 Restructuring
Plan”) which includes:
•
Closing
one of the Company’s inkjet supplies manufacturing facilities in Mexico
and additional optimization measures at the remaining inkjet facilities in
Mexico and the Philippines.
•
Reducing
the Company’s business support cost and expense structure by further
consolidating activity globally and expanding the use of shared service
centers in lower-cost regions. The areas impacted are supply chain,
service delivery, general and administrative expense, as well as marketing
and sales support functions.
•
Focusing
consumer segment marketing and sales efforts into countries or geographic
regions that have the highest supplies
usage.
The 2007
Restructuring Plan is expected to impact approximately 1,650 positions by the
end of 2008. Most of the impacted positions are being moved to lower-cost
countries. The Company expects the 2007 Restructuring Plan will result in
pre-tax charges of approximately $90 million, of which $55 million are
restructuring and related charges and $35 million are project costs, as defined
at the beginning of this section, Expected cash payments for the restructuring
and related charges and project costs are approximately
$75 million. The Company expects to incur total restructuring
and related charges and project costs for the 2007 Restructuring Plan of
$24 million in its Business segment, $29 million in its Consumer
segment and $37 million in All other. Since the inception of the program in
2007, the Company has incurred a total of $52.2 million charges, of which $40.5
million were restructuring and related charges and $11.7 million were project
costs. The Company expects the 2007 Restructuring Plan to be
substantially completed by the end of 2008.
Of the
total pre-tax restructuring and related charges and project costs of
approximately $90 million for the 2007 Restructuring Plan, approximately
$15 million will impact cost of revenue and $75 million will impact
operating expense. The 2007 Restructuring Plan (including related projects) is
expected to save approximately $40 million in 2008 with approximately 50%
benefiting cost of revenue and 50% benefiting operating expense. Annual savings
beginning in 2009 are expected to approximate $60 million.
Impact to Financial
Results
For the
three and six months ended June 30, 2008, the Company incurred a total of
$5.4 million and $18.0 million, respectively, for the 2007 Restructuring
Plan as presented below:
For the
three months ended June 30, 2008, the $4.5 million of accelerated depreciation
charges and project costs are included in Cost of revenue on the
Consolidated Condensed Statements of Earnings. The $(1.2) million of total
employee termination benefit charges are included in Restructuring and related charges while the
$2.1 million of related project costs are included in Selling, general and administrative
on the Consolidated Condensed Statements of Earnings.
35
For the
three months ended June 30, 2008, the Company incurred restructuring and
related charges and project costs related to the Company’s 2007 restructuring
plan of $1.2 million in its Business segment, $0.9 million in its
Consumer segment and $3.3 million in All other.
For the
six months ended June 30, 2008, the Company incurred $9.8 million of accelerated
depreciation charges and project costs in Cost of revenue and $6.4
million in Selling, general
and administrative on the Consolidated Condensed Statements of
Earnings. The $(2.4) million of total employee termination benefit
charges are included in Restructuring and related charges while the
$4.2 million of related project costs are included in Selling, general and administrative
on the Consolidated Condensed Statements of Earnings.
For the
six months ended June 30, 2008, the Company incurred restructuring and
related charges and project costs related to the Company’s 2007 Restructuring
Plan of $1.2 million in its Business segment, $2.4 million in its
Consumer segment and $14.4 million in All other.
Liability
Rollforward
The
following table presents a rollforward of the liability incurred for employee
termination benefits in connection with the 2007 Restructuring Plan. The
liability is included in Accrued liabilities on the
Company’s Consolidated Condensed Statements of Financial Position.
(1) Other
consists of changes in the liability balance due to foreign currency
translations.
(2) Reversals
due to changes in estimates for employee termination
benefits.
2006
Actions
During
the first quarter of 2006, the Company approved a plan to restructure its
workforce, consolidate some manufacturing capacity and make certain changes to
its U.S. retirement plans (collectively referred to as the “2006
actions”).
Impact to 2007 Financial
Results
Except
for approximately 100 positions that were eliminated in 2007, activities related
to the 2006 actions were substantially completed at the end of
2006.
During
the first quarter of 2007, the Company sold its Rosyth, Scotland facility for
$8.1 million and recognized a $3.5 million pre-tax gain on the sale that is
included in Selling, general,
and administrative on the Consolidated Condensed Statements of
Earnings.
36
During
the second quarter of 2007, the Company substantially liquidated the remaining
operations of its Scotland entity and recognized an $8.1 million pre-tax gain
from the realization of the entity’s accumulated foreign currency translation
adjustment generated on the investment in the entity during its operating life.
This gain is included in Other
expense (income), net on the Company’s Consolidated Condensed Statements
of Earnings.
For the
three months ended June 30, 2007, the Company incurred approximately $5.1
million of project costs related to the Company’s 2006 actions. Of the
$5.1 million of project costs incurred, $4.5 million is included in
Cost of revenue and
$0.6 million in Selling,
general and administrative on the Company’s Consolidated Condensed
Statements of Earnings. For the three months ended June 30, 2007, the Company
incurred total pre-tax project costs of $0.7 million in its Business
segment and $4.4 million in All other while the Company did not incur
significant charges in its Consumer segment.
For the
six months ended June 30, 2007, the Company incurred approximately $7.3 million
of project costs related to the Company’s 2006 actions. The $7.3 million of
project costs is the net amount incurred after including the gain recognized on
the sale of the Rosyth, Scotland facility during the first quarter of 2007 that
was mentioned earlier. Of the $7.3 million of project costs
incurred, $6.1 million is included in Cost of revenue and
$1.2 million in Selling,
general and administrative on the Company’s Consolidated Condensed
Statements of Earnings. For the six months ended June 30, 2007, the Company
incurred total pre-tax project costs of $1.2 million in its Business
segment and $9.4 million in All other that were offset by a $3.3 million
benefit in the Consumer segment.
Liability
Rollforward
The
following table presents a rollforward of the liability incurred for employee
termination benefits and contract termination and lease charges in connection
with the 2006 actions. The liability is included in Accrued liabilities on the
Company’s Consolidated Condensed Statements of Financial Position.
(1)
Other consists of changes in the liability balance due to foreign currency
translations.
(2) Reversals
due to changes in estimates for employee termination
benefits.
37
FINANCIAL
CONDITION
Lexmark’s
financial position remained strong at June 30, 2008, with working capital of
$1,235 million compared to $570 million at December 31, 2007. The increase in
working capital accounts was primarily due to $644.5 million net proceeds
received from the issuance of long-term debt in the second quarter.
The
following table summarizes the results of the Company’s Consolidated Condensed
Statements of Cash Flows for the six months ended June 30, 2008 and
2007:
Six
Months Ended
June
30
(Dollars
in millions)
2008
2007
Net
cash flow provided by (used for):
Operating
activities
$
312.8
$
210.2
Investing
activities
(186.7
)
(40.3
)
Financing
activities
343.4
(150.9
)
Effect
of exchange rate changes on cash
1.4
1.0
Net
change in cash and cash equivalents
$
470.9
$
20.0
Generally,
the Company’s primary source of liquidity has been cash generated by operations,
which totaled $312.8 million and $210.2 million for the six months ended June30, 2008 and 2007, respectively. Refer to the Financing activities section
which follows for information regarding the issuance of long-term debt in the
second quarter of 2008.
Operating
activities:
The
$102.6 million increase in cash flow from operating activities from 2007 to 2008
was driven by the favorable YTY change in Trade receivables of $86.1
million, due mainly to collections in excess of revenues in the first and second
quarter of 2008. Collections of sales were quicker in the first six months of
2008 versus the first six months of 2007, due to both improvements in
delinquency in 2008 as well as differences in the timing of revenues within the
quarters. The Company’s days of sales outstanding were 38 days at June 30, 2008,
and 40 days at December 31, 2007, compared to 42 days at June 30, 2007, and 38
days at December 31, 2006. The days of sales outstanding are calculated using
the quarter-end trade receivables balance, net of allowances, and the average
daily revenue for the quarter.
Other
significant changes include the $61.7 million unfavorable YTY change in Accounts payable, which was
largely due to payment of prior year purchases and the fact that a higher
accounts payable balance existed at December 31, 2007, compared to that of
December 31, 2006. The unfavorable change in Accounts payable was offset
by various items including favorable YTY movements in inventories as well as
higher net earnings excluding depreciation and certain non-cash items in 2007
related to the liquidation of the Scotland facility. In addition, there were two
notable YTY movements within Accrued liabilities that were
offsetting, accrued compensation favorable change of $24.1 million and income
taxes payable unfavorable change of $26.7 million. The favorable impact of
accrued compensation was driven by lower payout of annual bonuses in the first
quarter of 2008 versus annual bonus payments made in the first quarter of
2007. The unfavorable impact of income taxes payable was largely due
to a $21.8 million payment to the IRS occurring in the second quarter of 2008 in
settlement of the 2004-2005 income tax audit.
The
Company’s days of inventory were 53 days at June 30, 2008, and 48 days at
December 31, 2007, compared to 47 days at June 30, 2007, and 44 days at December31, 2006. The days of inventory are calculated using the quarter-end net
inventories balance and the average daily cost of revenue for the
quarter.
38
To
enhance the efficiency of the Company’s inkjet cartridge manufacturing
operations, the Company announced the 2008 Restructuring Plan on July 22, 2008,
that will result in the closure of one of the Company’s inkjet supplies
manufacturing facilities in Mexico. Employee termination benefits of $3.4
million related to the new plan were recorded in the second quarter of 2008. The
Company expects the 2008 Restructuring Plan to be substantially completed by the
end of 2008. In connection with the 2007 restructuring, the remaining accrued
liability balance at June 30, 2008, of $14.4 million, is expected to be paid out
primarily over 2008 and 2009. These payments will relate mainly to employee
termination benefits. In connection with the 2006 restructuring, the
remaining accrued liability balance at June 30, 2008 was $5.1 million. It is
expected that the majority of this liability, which consists of employee
termination benefits and contract termination and lease charges, will be paid by
the end of 2008.
As of
June 30, 2008, the Company had accrued approximately $134 million for pending
copyright fee issues, including litigation proceedings, local legislative
initiatives and/or negotiations with the parties involved. These accruals are
included in Accrued
liabilities on the Consolidated Condensed Statements of Financial
Position. Refer to Part I, Item 1, Note 14 of the Notes to Consolidated
Condensed Financial Statements for additional information.
Investing
activities:
The
Company increased its marketable securities investments by $93.8 million for the
six months ended June 30, 2008. The Company decreased its marketable securities
by $44.0 million for the six months ended June 30, 2007. The $146.4 million YTY
increase in the net cash flows used for investing activities for the periods
provided were principally due to the Company’s marketable securities investing
activities as well as the $8.1 million proceeds received from the sale of the
Scotland facility that occurred in the first quarter of 2007.
The
Company’s investments in marketable securities are classified and accounted for
as available-for-sale. At June 30, 2008 and December 31, 2007, the
Company’s marketable securities portfolio consisted of asset-backed and
mortgage-backed securities, corporate debt securities, municipal debt
securities, U.S. government and agency debt securities, commercial paper,
certificates of deposit, and preferred securities, including approximately $35
million and $79 million, respectively, of auction rate
securities.
Market
conditions continue to indicate significant uncertainty on the part of investors
on the economic outlook for the U.S. and for financial institutions that have
potential exposure to the housing market. This uncertainty has created
reduced liquidity across the fixed income investment market, including the
securities in which Lexmark has invested. As a result, some of the Company’s
investments have experienced reduced liquidity including unsuccessful auctions
for its auction rate security holdings. During the first quarter of 2008, the
Company reclassified $59.4 million in auction rate fixed income securities from
Current assets to Noncurrent assets on its
Consolidated Condensed Statements of Financial Position due to the fact that the
securities were currently not trading, and current conditions in the general
debt markets reduced the likelihood that the securities will successfully
auction within the next 12 months. As of June 30, 2008, the amount of auction
rate securities remaining in Noncurrent assets has been
reduced to $31.3 million, primarily due to $24.0 million of successful
auctions and redemptions by the issuers at par in the second quarter. The
remaining $4.1 million of auction rate securities were reclassified to Current assets as of June 30,2008, as the Company had been notified by the issuer that the securities would
be called at par. Auction rate securities that did not successfully auction
reset to the maximum rate as prescribed in the underlying offering statement and
all of the Company’s auction rate securities continue to be current with their
interest and dividend payments.
Based on
Lexmark’s assessment of the credit quality of the underlying collateral and
credit support available to each of the auction rate securities in which the
Company is invested, it believes no impairment has occurred. This is further
corroborated by an internal valuation based on discounted cash flows. Given the
level of judgment required to make a determination of fair value, the auction
rate securities for which recent auctions were unsuccessful of $31.3 million
have been classified as a Level 3 fair value measurement. Refer to Part I, Item
1, Note 2 of the Notes to Consolidated Condensed Financial Statements for
additional information regarding FAS 157. Lexmark experienced no realized losses
on the sales of its auction rate securities during the first or second quarter
of 2008, nor were there any unrealized losses related to Level 3 unsuccessful
auction rate securities held on the balance sheet at June 30, 2008. The Company
has the ability to hold these securities until liquidity in the market or
optional issuer payment occurs and could also hold the securities to maturity.
Additionally, if Lexmark required capital, the Company has available liquidity
through its accounts receivable program, revolving credit facility and
incremental debt capacity in the capital markets. As of August 5, 2008, the
Company does not believe that it has a material risk in its current portfolio of
investments that would impact its financial condition or liquidity.
39
For the
six months ended June 30, 2008 and 2007, the Company spent $92.4 million and
$92.4 million, respectively, on capital expenditures. The capital expenditures
for 2008 principally related to infrastructure support, new product support and
manufacturing capacity expansion. The Company continues to make significant
capital investments in its manufacturing facilities. It is anticipated that
total capital expenditures for 2008 will be approximately $225 million and are
expected to be funded primarily through cash from operations and proceeds from
issuance of long-term debt.
Financing
activities:
The
$494.3 million YTY increase in the net cash flows from financing activities was
primarily due to the changes in the Company’s outstanding debt occurring in
2008. In the second quarter of 2008, the Company repaid $150.0
million of senior note debt that matured on May 15,2008. Subsequently, the Company issued $350.0 million of five-year
fixed rate senior unsecured notes and $300 million of ten-year fixed rate senior
unsecured notes, resulting in total cash proceeds of $644.5 million, net of
discount and issuance costs. Interest will be paid semi-annually at annual
interest rates of 5.90% and 6.65% on the five- and ten-year notes, respectively.
Refer to Part I, Item 1, Note 4 of the Notes to Consolidated Condensed Financial
Statements for additional information regarding the senior notes.
In May
2008, the Company received authorization from the Board of Directors to
repurchase an additional $750 million of its Class A Common Stock for a
total repurchase authority of $4.65 billion. As of June 30, 2008, there was
approximately $0.9 billion of share repurchase authority remaining. This
repurchase authority allows the Company, at management’s discretion, to
selectively repurchase its stock from time to time in the open market or in
privately negotiated transactions depending upon market price and other factors.
For the three and six months ended June 30, 2008, the Company repurchased
approximately 4.5 million shares at a cost of approximately $158 million. As of
June 30, 2008, since the inception of the program in April 1996, the Company had
repurchased approximately 78.7 million shares for an aggregate cost of
approximately $3.8 billion. As of June 30, 2008, the Company had reissued
approximately 0.5 million shares of previously repurchased shares in
connection with certain of its employee benefit programs. As a result of these
issuances as well as the retirement of 44.0 million and 16.0 million
shares of treasury stock in 2005 and 2006, respectively, the net treasury shares
held at June 30, 2008, were 18.2 million.
TRADE
RECEIVABLES FACILITY
In the
U.S., the Company transfers a majority of its receivables to its wholly-owned
subsidiary, Lexmark Receivables Corporation (“LRC”), which then may transfer the
receivables on a limited recourse basis to an unrelated third party. In October
2004, the Company entered into an amended and restated agreement to sell a
portion of its trade receivables on a limited recourse basis. The amended
agreement allows for a maximum capital availability of $200 million under this
facility. The primary purpose of the amendment was to extend the term of the
facility to October 16, 2007, with required annual renewal of
commitments.
During
the first quarter of 2007, the Company amended the facility to allow LRC to
repurchase receivables previously transferred to the unrelated third party.
Prior to the 2007 amendment, the Company accounted for the transfer of
receivables from LRC to the unrelated third party as sales of receivables. As a
result of the 2007 amendment, the Company accounts for the transfers of
receivables from LRC to the unrelated third party as a secured borrowing with a
pledge of its receivables as collateral. The amendment became effective in the
second quarter of 2007. In October 2007, the facility was renewed until October3, 2008.
This
facility contains customary affirmative and negative covenants as well as
specific provisions related to the quality of the accounts receivables
transferred. As collections reduce previously transferred receivables, the
Company may replenish these with new receivables. Lexmark bears a limited risk
of bad debt losses on the trade receivables transferred, since the Company
over-collateralizes the receivables transferred with additional eligible
receivables. Lexmark addresses this risk of loss in its allowance for doubtful
accounts. Receivables transferred to the unrelated third-party may not include
amounts over 90 days past due or concentrations over certain limits with any one
customer. The facility also contains customary cash control
triggering events which, if triggered, could adversely affect the Company’s
liquidity and/or its ability to transfer trade receivables. A
downgrade in the Company’s credit rating could reduce the Company’s ability to
transfer trade receivables.
At June30, 2008, there were no secured borrowings outstanding under the
facility.
40
RECENT
ACCOUNTING PRONOUNCEMENTS
See Note
15 to the Consolidated Condensed Financial Statements in Item 1 for a
description of recent accounting pronouncements which is incorporated herein by
reference.
FACTORS
THAT MAY AFFECT FUTURE RESULTS AND INFORMATION CONCERNING FORWARD-LOOKING
STATEMENTS
The
following significant factors, as well as others of which we are unaware or deem
to be immaterial at this time, could materially adversely affect our business,
financial condition or operating results in the future. Therefore, the following
information should be considered carefully together with other information
contained in this report. Past financial performance may not be a reliable
indicator of future performance, and historical trends should not be used to
anticipate results or trends in future periods.
·
Unfavorable
global economic conditions may adversely impact the Company’s future
operating results. The Company continues to experience some weak markets
for its products. Continued softness in certain markets and uncertainty
about global economic conditions could result in lower demand for the
Company’s products, particularly supplies. Weakness in demand has resulted
in intense price competition and may result in excessive inventory for the
Company and/or its reseller channel, which may adversely affect sales,
pricing, risk of obsolescence and/or other elements of the Company’s
operating results. Ongoing weakness in demand for the Company’s hardware
products may also cause erosion of the installed base of products over
time, thereby reducing the opportunities for supplies sales in the
future.
·
The
Company and its major competitors, many of which have significantly
greater financial, marketing and/or technological resources than the
Company, have regularly lowered prices on their products and are expected
to continue to do so. In particular, both the inkjet and laser printer
markets have experienced and are expected to continue to experience
significant price pressure. Price reductions on inkjet or laser products
or the inability to reduce costs, including warranty costs, to contain
expenses or to increase or maintain sales as currently expected, as well
as price protection measures, could result in lower profitability and
jeopardize the Company’s ability to grow or maintain its market share. In
recent years, the gross margins on the Company’s hardware products have
been under pressure as a result of competitive pricing pressures in the
market. If the Company is unable to reduce costs to offset this
competitive pricing or product mix pressure, and the Company is unable to
support declining gross margins through the sale of supplies, the
Company’s operating results and future profitability may be negatively
impacted. Historically, the Company has not experienced significant
supplies pricing pressure, but if supplies pricing was to come under
significant pressure, the Company’s financial results could be materially
adversely affected.
·
The
Company’s future operating results may be adversely affected if it is
unable to successfully develop, manufacture, market and sell products into
the geographic and customer and product segments of the inkjet market that
support higher usage of supplies.
·
The
Company markets and sells its products through several sales channels. The
Company has also advanced a strategy of forming alliances and OEM
arrangements with many companies. The Company’s future operating results
may be adversely affected by any conflicts that might arise between or
among its various sales channels, the volume reduction in or loss of any
alliance or OEM arrangement or the loss of retail shelf space. Aggressive
pricing on laser and inkjet products and/or associated supplies from
customers and resellers, including, without limitation, OEM customers,
could result in a material adverse impact on the Company’s strategy and
financial results.
41
·
The
Company relies in large part on its international production facilities
and international manufacturing partners, many of which are located in
China and the Philippines, for the manufacture of its products and key
components of its products. Future operating results may also be adversely
affected by several other factors, including, without limitation, if the
Company’s international operations or manufacturing partners are unable to
perform or supply products reliably, if there are disruptions in
international trade, disruptions at important geographic points of exit
and entry, if there are difficulties in transitioning such manufacturing
activities among the Company, its international operations and/or its
manufacturing partners, or if there arise production and supply
constraints which result in additional costs to the Company. The financial
failure or loss of a sole supplier or significant supplier of products or
key components, or their inability to produce the required quantities,
could result in a material adverse impact on the Company’s operating
results.
·
The
introduction of products by the Company or its competitors, or delays in
customer purchases of existing products in anticipation of new product
introductions by the Company or its competitors and market acceptance of
new products and pricing programs, any disruption in the supply of new or
existing products as well as the costs of any product recall or increased
warranty, repair or replacement costs due to quality issues, the reaction
of competitors to any such new products or programs, the life cycles of
the Company’s products, as well as delays in product development and
manufacturing, and variations in cost, including but not limited to
component parts, raw materials, commodities, energy, products,
distributors, fuel and variations in supplier terms and conditions, may
impact sales, may cause a buildup in the Company’s inventories, make the
transition from current products to new products difficult and could
adversely affect the Company’s future operating
results.
·
Our
revenue, gross margin and profit vary among our hardware, supplies and
services, product groups and geographic markets and therefore will likely
be different in future periods than our current results. Overall gross
margins and profitability in any given period is dependent upon the
hardware/supplies mix, the mix of hardware products sold, and the
geographic mix reflected in that period’s revenue. Overall market trends,
seasonal market trends, competitive pressures, pricing, commoditization of
products, increased component or shipping costs and other factors may
result in reductions in revenue or pressure on gross margins in a given
period.
·
The
Company’s future operating results may be adversely affected if it is
unable to continue to develop, manufacture and market products that are
reliable, competitive, and meet customers’ needs. The markets for laser
and inkjet products and associated supplies are aggressively competitive,
especially with respect to pricing and the introduction of new
technologies and products offering improved features and functionality. In
addition, the introduction of any significant new and/or disruptive
technology or business model by a competitor that substantially changes
the markets into which the Company sells its products or demand for the
products sold by the Company could severely impact sales of the Company’s
products and the Company’s operating results. The impact of competitive
activities on the sales volumes or revenue of the Company, or the
Company’s inability to effectively deal with these competitive issues,
could have a material adverse effect on the Company’s ability to attract
and retain OEM customers, maintain or grow retail shelf space or maintain
or grow market share. The competitive pressure to develop technology and
products and to increase the Company’s investment in research and
development and marketing expenditures also could cause significant
changes in the level of the Company’s operating
expense.
·
The
Company has undertaken cost reduction measures over the last few years in
an effort to optimize the Company’s expense structure. Such actions have
included workforce reductions, the consolidation of manufacturing
capacity, and the centralization of support functions to regional and
global shared service centers. In particular, the Company’s manufacturing
and support functions are becoming more heavily concentrated in China and
the Philippines. The Company expects to realize cost savings in the future
through these actions and may announce future actions to further reduce
its worldwide workforce and/or centralize its operations. The risks
associated with these actions include potential delays in their
implementation, particularly workforce reductions, due to regulatory
requirements; increased costs associated with such actions; decreases in
employee morale and the failure to meet operational targets due to
unplanned departures of employees, particularly key employees and sales
employees.
42
·
The
entrance of additional competitors that are focused on printing solutions
could further intensify competition in the inkjet and laser printer
markets and could have a material adverse impact on the Company’s strategy
and financial results.
·
The
Company’s inability to perform satisfactorily under service contracts for
managed print services and other customer services may result in the loss
of customers, loss of reputation and/or financial consequences that may
have a material adverse impact on the Company’s financial results and
strategy.
·
The
Company’s future operating results may be adversely affected if the
consumption of its supplies by end users of its products is lower than
expected or declines, if there are declines in pricing, unfavorable mix
and/or increased costs.
·
Refill,
remanufactured, clones, counterfeits and other compatible alternatives for
some of the Company’s cartridges are available and compete with the
Company’s supplies business. The Company expects competitive supplies
activity to increase. Various legal challenges and governmental activities
may intensify competition for the Company’s aftermarket supplies
business.
·
The
Company has migrated the infrastructure support of its information
technology system and application maintenance functions to new third-party
service providers. The Company is in the process of centralizing certain
of its accounting and other finance functions and order-to-cash functions
from various countries to shared service centers. The Company is also in
the process of reducing, consolidating and moving various parts of its
general and administrative resource, supply chain resource and marketing
and sales support structure. Many of these processes and functions are
moving to lower-cost countries, including China, India and the
Philippines. Any disruption in these systems, processes or functions could
have a material adverse impact on the Company’s operations, its financial
results, its systems of internal controls and its ability to accurately
record and report transactions and financial
results.
·
The
Company’s performance depends in part upon its ability to successfully
forecast the timing and extent of customer demand and reseller demand to
manage worldwide distribution and inventory levels of the Company.
Unexpected fluctuations in reseller inventory levels could disrupt
ordering patterns and may adversely affect the Company’s financial
results. In addition, the financial failure or loss of a key customer or
reseller could have a material adverse impact on the Company’s financial
results. The Company must also be able to address production and supply
constraints, including product disruptions caused by quality issues, and
delays or disruptions in the supply of key components necessary for
production, including without limitation component shortages due to
increasing global demand in the Company’s industry and other industries.
Such delays, disruptions or shortages may result in lost revenue or in the
Company incurring additional costs to meet customer demand. The Company’s
future operating results and its ability to effectively grow or maintain
its market share may be adversely affected if it is unable to address
these issues on a timely basis.
·
Revenue
derived from international sales make up more than half of the Company’s
revenue. Accordingly, the Company’s future results could be adversely
affected by a variety of factors, including changes in a specific
country’s or region’s political or economic conditions, foreign currency
exchange rate fluctuations, trade protection measures and unexpected
changes in regulatory requirements. In addition, changes in tax laws and
the ability to repatriate cash accumulated outside the U.S. in a tax
efficient manner may adversely affect the Company’s financial results,
investment flexibility and operations. Moreover, margins on international
sales tend to be lower than those on domestic sales, and the Company
believes that international operations in emerging geographic markets will
be less profitable than operations in the U.S. and European markets,
in part, because of the higher investment levels for marketing, selling
and distribution required to enter these
markets.
43
·
The
European Union has adopted the Waste Electrical and Electronic Equipment
Directive (the “Directive”) which requires producers of electrical and
electronic goods, including printing devices, to be financially
responsible for specified collection, recycling, treatment and disposal of
past and future covered products. The deadline for enacting and
implementing the Directive by individual European Union governments was
August 13, 2004 (such legislation, together with the Directive, the
“WEEE Legislation”), although extensions were granted to some countries.
Producers were to be financially responsible under the WEEE Legislation
beginning in August 2005. Similar legislation may be enacted in the future
in other jurisdictions as well. The impact of this legislation could
adversely affect the Company’s operating results and
profitability.
·
Certain
countries (primarily in Europe) and/or collecting societies representing
copyright owners’ interests have commenced proceedings to impose fees on
devices (such as scanners, printers and multifunction devices) alleging
the copyright owners are entitled to compensation because these devices
enable reproducing copyrighted content. Other countries are also
considering imposing fees on certain devices. The amount of fees, if
imposed, would depend on the number of products sold and the amounts of
the fee on each product, which will vary by product and by country. The
financial impact on the Company, which will depend in large part upon the
outcome of local legislative processes, the Company’s and other industry
participants’ outcome in contesting the fees and the Company’s ability to
mitigate that impact by increasing prices, which ability will depend upon
competitive market conditions, remains uncertain. The outcome of the
copyright fee issue could adversely affect the Company’s operating results
and business.
·
The
European Union has adopted the “RoHS” Directive (Restriction of use of
certain Hazardous Substances) which restricts the use of nine substances
in electrical and electronic equipment placed on the market on or after
July 1, 2006. Compliance with the RoHS Directive could create
shortages of certain components or impact continuity of supply that could
adversely affect the Company’s operating results and
profitability.
·
In
many foreign countries, particularly those with developing economies, it
is common for local business practices to be prohibited by laws and
regulations applicable to the Company, such as employment laws, fair trade
laws or the Foreign Corrupt Practices Act. Although the Company implements
policies and procedures designed to ensure compliance with these laws, our
employees, contractors and agents, as well as those business partners to
which we outsource certain of our business operations, may take actions in
violation of our policies. Any such violation, even if prohibited by our
policies, could have a material adverse effect on our business and our
reputation. Because of the challenges in managing a geographically
dispersed workforce, there also may be additional opportunities for
employees to commit fraud or personally engage in practices which violate
the policies and procedures of the
Company.
·
The
Company’s success depends in part on its ability to develop technology and
obtain patents, copyrights and trademarks, and maintain trade secret
protection, to protect its intellectual property against theft,
infringement or other misuse by others. The Company must also conduct its
operations without infringing the proprietary rights of others. Current or
future claims of intellectual property infringement could prevent the
Company from obtaining technology of others and could otherwise materially
and adversely affect its operating results or business, as could expenses
incurred by the Company in obtaining intellectual property rights,
enforcing its intellectual property rights against others or defending
against claims that the Company’s products infringe the intellectual
property rights of others, that the Company engages in false or deceptive
practices or that its conduct is
anti-competitive.
·
The
Company depends on its information technology systems for the development,
manufacture, distribution, marketing, sales and support of its products
and services. Any failure in such systems, or the systems of a partner or
supplier, may adversely affect the Company’s operating results.
Furthermore, because vast quantities of the Company’s products flow
through only a few distribution centers to provide product to various
geographic regions, the failure of information technology systems or any
other disruption affecting those product distribution centers could have a
material adverse impact on the Company’s ability to deliver product and on
the Company’s financial results.
44
·
The
Company’s effective tax rate could be adversely affected by changes in the
mix of earnings in countries with differing statutory tax rates. In
addition, the amount of income tax the Company pays is subject to ongoing
audits in various jurisdictions. A material assessment by a taxing
authority or a decision to repatriate foreign cash could adversely affect
the Company’s profitability.
·
Our
worldwide operations and those of our manufacturing partners, suppliers,
and freight transporters, among others, are subject to natural and manmade
disasters and other business interruptions such as earthquakes, tsunamis,
floods, hurricanes, typhoons, fires, extreme weather conditions,
environmental hazards, power shortages, water shortages and
telecommunications failures. The occurrence of any of these business
disruptions could seriously harm our revenue and financial condition and
increase our costs and expenses. As the Company continues its
consolidation of certain functions into shared service centers and
movement of certain functions to lower cost countries, the probability and
impact of business disruptions may be increased over
time.
·
The
Company has historically used stock options and other forms of share-based
payment awards as key components of the total rewards program for employee
compensation in order to align employees’ interests with the interests of
stockholders, motivate employees, encourage employee retention and provide
competitive compensation and benefits packages. As a result of Statement
of Financial Accounting Standards No. 123R, the Company would incur
increased compensation costs associated with its share-based compensation
programs and as a result has reviewed its compensation strategy in light
of the current regulatory and competitive environment and has decided to
change the form of its share-based awards. Due to this change in
compensation strategy, combined with other benefit plan changes undertaken
to reduce costs, the Company may find it difficult to attract, retain and
motivate employees, and any such difficulty could materially adversely
affect its operating results.
·
Terrorist
attacks and the potential for future terrorist attacks have created many
political and economic uncertainties, some of which may affect the
Company’s future operating results. Future terrorist attacks, the national
and international responses to such attacks, and other acts of war or
hostility may affect the Company’s facilities, employees, suppliers,
customers, transportation networks and supply chains, or may affect the
Company in ways that are not capable of being predicted
presently.
·
The
Company relies heavily on the health and welfare of its employees, the
employees of its manufacturing and distribution partners and customers.
The widespread outbreak of any form of communicable disease affecting a
large number of workers could adversely impact the Company’s operating
results.
·
Factors
unrelated to the Company’s operating performance, including the financial
failure or loss of significant customers, resellers, manufacturing
partners or suppliers; the outcome of pending and future litigation or
governmental proceedings; and the ability to retain and attract key
personnel, could also adversely affect the Company’s operating results. In
addition, the Company’s stock price, like that of other technology
companies, can be volatile. Trading activity in the Company’s common
stock, particularly the trading of large blocks and intraday trading in
the Company’s common stock, may affect the Company’s common stock
price.
45
Item
3. QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The
market risk inherent in the Company’s financial instruments and positions
represents the potential loss arising from adverse changes in interest rates and
foreign currency exchange rates.
Interest
Rates
At June30, 2008, the fair value of the Company’s senior notes was estimated at
$634.9 million using quoted market prices obtained from an independent
broker. The carrying value as recorded in the Consolidated Condensed Statements
of Financial Position at June 30, 2008 exceeded the fair value of the senior
notes, by approximately $13.7 million. Market risk is estimated as the
potential change in fair value resulting from a hypothetical 10% adverse change
in interest rates and amounts to approximately $23.2 million at June 30,2008.
See the
section titled “FINANCIAL CONDITION - Investing activities:” in
Item 2 of this report for a discussion of the Company’s auction rate securities
portfolio which is incorporated herein by reference.
Foreign
Currency Exchange Rates
The
Company has employed, from time to time, a foreign currency hedging strategy to
limit potential losses in earnings or cash flows from adverse foreign currency
exchange rate movements. Foreign currency exposures arise from transactions
denominated in a currency other than the Company’s functional currency and from
foreign denominated revenue and profit translated into U.S. dollars. The
primary currencies to which the Company is exposed include the Euro, the Mexican
peso, the British pound, the Philippine peso, the Australian dollar and other
Asian and South American currencies. Exposures may be hedged with foreign
currency forward contracts, put options, and call options generally with
maturity dates of twelve months or less. The potential gain in fair value at
June 30, 2008, for such contracts resulting from a hypothetical 10% adverse
change in all foreign currency exchange rates is approximately
$8.8 million. This gain would be mitigated by corresponding lossess on the
underlying exposures.
46
Item
4. CONTROLS
AND PROCEDURES
Evaluation
of Disclosure Controls and Procedures
The
Company’s management, with the participation of the Company’s Chairman and Chief
Executive Officer and Executive Vice President and Chief Financial Officer, have
evaluated the effectiveness of the Company’s disclosure controls and procedures
as of the end of the period covered by this report. Based upon that evaluation,
the Company’s Chairman and Chief Executive Officer and Executive Vice President
and Chief Financial Officer have concluded that the Company’s disclosure
controls and procedures are effective in providing reasonable assurance that the
information required to be disclosed by the Company in the reports that it files
under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission’s rules and forms and were effective
as of the end of the period covered by this report, to ensure that information
required to be disclosed by the Company in the reports that it files or submits
under the Exchange Act is accumulated and communicated to the Company’s
management including its principal executive and principal financial officers,
or persons performing similar functions, as appropriate to allow timely
decisions regarding required disclosure.
Changes
in Internal Control over Financial Reporting
Beginning
in the third quarter of 2006 and continuing through the second quarter of 2008,
the Company has been centralizing certain of its accounting and other finance
functions and order-to-cash functions from various countries to shared service
centers. As a result, certain changes in basic processes and internal controls
and procedures for day-to-day accounting functions and financial reporting have
been made. In the second quarter of 2007, the Company migrated the majority of
the transaction processing for after-sales service activities in the United
States to a new software system. While management believes the changed controls
along with additional compensating controls relating to financial reporting for
affected processes are adequate and effective, management is continuing to
evaluate and monitor the changes in controls and procedures as processes in each
of these areas evolve.
Except
for implementing the changes noted above, there has been no change in the
Company’s internal control over financial reporting that occurred during the
quarter ended June 30, 2008, that has materially affected, or is reasonably
likely to materially affect, the Company’s internal control over financial
reporting.
47
PART
II. OTHER INFORMATION
Item
1. LEGAL
PROCEEDINGS
There
have been no material developments to the legal proceedings previously disclosed
in Part I, Item 3 of the Company's 2007 Annual Report on Form 10-K, other than
those reported in the Company’s 10-Q for the first quarter ending March 31,2008.
Item
1A. RISK FACTORS
A
description of the risk factors associated with the Company’s business is
included under “Factors That May Affect Future Results And Information
Concerning Forward-Looking Statements” in “Management’s Discussion and Analysis
of Financial Condition and Results of Operations,” contained in Item 2 of Part I
of this report. There have been no material changes to the risk factors
associated with the business previously disclosed in Part I, Item 1A of the
Company’s 2007 Annual Report on Form 10-K.
Item
2. UNREGISTERED
SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The
following table summarizes the repurchases of the Company’s Common Stock in the
quarter ended June 30, 2008:
Total
Number of Shares Purchased as Part of Publicly Announced Plans or
Programs
Approximate
Dollar Value of Shares that May Yet Be Purchased Under the Plans or
Programs (in millions) (1)
April
1 - 30, 2008
-
$
-
-
$
295.5
May
1- 31, 2008
1,835,526
33.61
1,835,526
983.8
June
1 - 30, 2008
2,704,000
35.69
2,704,000
887.3
Total
4,539,526
$
34.85
4,539,526
(1)
In
May 2008, the Company received authorization from the Board of Directors
to repurchase an additional $750 million of its Class A Common Stock
for a total repurchase authority of $4.65 billion. As of June 30,2008, there was approximately $0.9 billion of share repurchase
authority remaining. This repurchase authority allows the Company, at
management’s discretion, to selectively repurchase its stock from time to
time in the open market or in privately negotiated transactions depending
upon market price and other factors. For the three and six months ended
June 30, 2008, the Company repurchased approximately 4.5 million shares at
a cost of approximately $158 million. As of June 30, 2008, since the
inception of the program in April 1996, the Company had repurchased
approximately 78.7 million shares for an aggregate cost of
approximately $3.8 billion. As of June 30, 2008, the Company had
reissued approximately 0.5 million shares of previously repurchased
shares in connection with certain of its employee benefit programs. As a
result of these issuances as well as the retirement of 44.0 million
and 16.0 million shares of treasury stock in 2005 and 2006,
respectively, the net treasury shares held at June 30, 2008, were
18.2 million.
48
Item
3. DEFAULTS
UPON SENIOR SECURITIES
None.
Item
4. SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
Item
5. OTHER
INFORMATION
None.
Item
6. EXHIBITS
A list of
exhibits is set forth in the Exhibit Index found on page 51 of this
report.
49
SIGNATURE
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized, both on behalf of the registrant and in his capacity as
principal accounting officer of the registrant.
Underwriting
Agreement dated as of May 19, 2008 among Lexmark International, Inc.
and J.P. Morgan Securities Inc. and Citigroup Global Markets Inc., as the
representatives of the several underwriters named therein.
(1)
4.1
Form
of Indenture between Lexmark International, Inc. and The Bank of New York
Trust Company, N.A., as Trustee.
(1)
4.2
Form
of First Supplemental Indenture between Lexmark International, Inc. and
The Bank of New York Trust Company, N.A., as Trustee.
(1)
4.3
Form
of Global Note of the Company’s 5.900% Senior Notes due 2013
(included in Exhibit 4.2). (1)
4.4
Form
of Global Note of the Company’s 6.650% Senior Notes due 2018
(included in Exhibit 4.2). (1)
10.1
General
Release And Covenant Not To Sue. +
25.1
Statement
of Eligibility on Form T-1 under the Trust Indenture Act of 1939 of
The Bank of New York. (1)
31.1
Certification
of Chairman and Chief Executive Officer Pursuant to Rule 13a-14(a) and
15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2
Certification
of Executive Vice President and Chief Financial Officer Pursuant to Rule
13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1
Certification
of Chairman and Chief Executive Officer Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2
Certification
of Executive Vice President and Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
+
Indicates
management contract or compensatory plan, contract or
arrangement.
(1) Incorporated
by reference to the Company’s Current Report on Form 8-K filed with the
Commission on May 22, 2008 (Commission File No. 1-14050).
51
Dates Referenced Herein and Documents Incorporated by Reference
