UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)
þ		Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Fiscal Year Ended December 31, 2009 OR
o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

Commission File No. 1-14050

 

LEXMARK INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

 

(859) 232-2000

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 þ     No o

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

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

 

The aggregate market value of the shares of voting common stock held by non-affiliates of the registrant was approximately $1.2 billion based on the closing price for the Class A Common Stock on the last business day of the registrant’s most recently completed second fiscal quarter.

 

As of February 19, 2010, there were outstanding 78,171,263 shares (excluding shares held in treasury) of the registrant’s Class A Common Stock, par value $0.01, which is the only class of voting common stock of the registrant, and there were no shares outstanding of the registrant’s Class B Common Stock, par value $0.01.

 

Documents Incorporated by Reference

 

Certain information in the Company’s definitive Proxy Statement for the 2010 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year, is incorporated by reference in Part III of this Form 10-K.

 

 

LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

 

FORM 10-K
For the Year Ended December 31, 2009

 

Forward-Looking Statements

 

This Annual Report on Form 10-K 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 “Risk Factors” in Item 1A of this report. The information referred to above should be considered by investors when reviewing any forward-looking statements contained in this report, in any of the Company’s public filings or press releases or in any oral statements made by the Company or any of its officers or other persons acting on its behalf. The important factors that could affect forward-looking statements are subject to change, and the Company does not intend to update the factors set forth in the “Risk Factors” 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.

 

 

General

 

Lexmark International, Inc., (“Lexmark” or the “Company”) is a Delaware corporation and the surviving company of a merger between itself and its former parent holding company, Lexmark International Group, Inc., (“Group”) consummated on July 1, 2000. Group was formed in July 1990 in connection with the acquisition of IBM Information Products Corporation from International Business Machines Corporation (“IBM”). The acquisition was completed in March 1991. On November 15, 1995, Group completed its initial public offering of Class A Common Stock and Lexmark now trades on the New York Stock Exchange under the symbol “LXK.”

 

Lexmark makes it easier for businesses of all sizes 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 the office. Lexmark’s products include laser printers, inkjet printers, multifunction devices, dot matrix printers and associated supplies, services and solutions. Lexmark develops and owns most of the technology for its laser and inkjet products and related solutions. The Company operates in the office products industry. The Company is primarily managed along divisional lines: the Printing Solutions and Services Division (“PSSD”) and the Imaging Solutions Division (“ISD”). Refer to Part II, Item 8, Note 18 of the Notes to Consolidated Financial Statements for additional information regarding the Company’s reportable segments.

 

Revenue derived from international sales, including exports from the United States of America (“U.S.”), accounts for approximately 57% of the Company’s consolidated revenue, with Europe accounting for approximately two-thirds of international sales. Lexmark’s products are sold in more than 150 countries in North and South America, Europe, the Middle East, Africa, Asia, the Pacific Rim and the Caribbean. This geographic diversity offers the Company opportunities to participate in new markets, provides diversification to its revenue stream and operations to help offset geographic economic trends, and utilizes the technical and business expertise of a worldwide workforce. Currency exchange rates had an

unfavorable impact on international revenue in 2009 and a favorable impact on the Company’s costs and expenses. Refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations — Effect of Currency Exchange Rates and Exchange Rate Risk Management for more information. A summary of the Company’s revenue and long-lived assets by geographic area is found in Part II, Item 8, Note 18 of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.

 

Market Overview¹

 

Lexmark management believes that the total distributed output opportunity was between $80 and $90 billion in 2009, including hardware and supplies. This opportunity includes printers and multifunction devices as well as a declining base of copiers and fax machines that are increasingly being integrated into multifunction devices. Based on industry information, Lexmark management believes that the market declined in 2009 due to the continued global economic weakness. When global economic growth resumes, the industry could again experience low to mid single digit annual revenue growth rates with the highest growth likely to be in multifunction products (“MFPs”), color lasers and related software solutions and services and stronger emerging countries. The Company’s management believes that the integration of print/copy/fax/scan capabilities enables Lexmark to leverage strengths in network printing and document workflow solutions. In general, as the hardcopy industry matures and printer and copier markets converge, the Company’s management expects competitive pressures to continue. This convergence represents an opportunity for printer-based product and solution vendors like Lexmark to displace copier-based products in the marketplace.

 

The Internet and the deployment of Electronic Content Management (“ECM”) systems are positively impacting the distributed output market opportunity in several ways. As more information is available electronically, and new tools and solutions are being developed to access it, more of this information is being printed on distributed output devices and less on commercial and centralized printing devices. Lexmark’s management believes that an increasing percentage of this distributed output includes color and graphics, which tend to increase supplies usage. Growth in high-speed and wireless Internet access to the home is also contributing to increased printing on distributed devices.

 

The laser product market primarily serves business customers. Laser products can be divided into two major categories — shared workgroup products and lower-priced desktop products. Shared workgroup products are typically attached directly to large workgroup networks, while lower-priced desktop products are attached to personal computers (“PCs”) or small workgroup networks. Both product categories include color and monochrome laser offerings. The shared workgroup products include laser printers and multifunction devices, which typically include high-performance internal network adapters and are easily upgraded to include additional input and output capacity and finishing capabilities as well as additional memory and storage. Most shared workgroup products also have sophisticated network management tools and are available as single function printers and multifunction products that print/copy/fax and scan to network.

 

Color and multifunction products continue to represent a more significant portion of the laser market. The Company’s management believes these trends will continue. Industry pricing pressure is partially offset by the tendency of customers to purchase higher value color and multifunction products and optional paper handling and finishing features as well as to purchase output through print and document management software solutions and services that help customers to optimize their document-related infrastructure to improve productivity and cost.

 

The inkjet product market historically has been predominantly a consumer market, but there is an increasing trend toward inkjet products being designed for small office home office (“SOHO”) and other businesses. Customers are increasingly seeking productivity-related features that are found in

 

 

¹  Certain information contained in the “Market Overview” section has been obtained from industry sources, public information and other internal and external sources. Data available from industry analysts varies widely among sources. The Company bases its analysis of market trends on the data available from several different industry analysts.

inkjet multifunction products designed for office use such as wireless and ethernet connectivity, automatic document feeders and duplex capabilities, as well as web-based applications to automate print and document related work functions. This trend represents an opportunity for the Company to pursue revenue growth opportunities with its inkjet products and solutions targeted at SOHO and business market segments.

 

Strategy

 

Lexmark’s strategy is based on a business model of investing in technology to develop and sell printing solutions, including printers, multifunction products and solution software, with the objective of growing its installed base, which drives recurring supplies sales. Supplies are the profit engine of the business model. Supplies profit then funds new technology investments in products and solutions, which drive the cycle again and again. The Company’s management believes that Lexmark has the following strengths related to this business model:

 

 

Lexmark is focused on driving long-term performance by strategically investing in technology, products and solutions to secure high value product installations and capture profitable supplies and service annuities in document and print intensive segments of the distributed printing market.

 

PSSD is primarily focused on capturing profitable supplies and service annuities generated from workgroup monochrome and color laser printers and laser MFPs. The key strategic initiatives of PSSD are:

 

 

Lexmark’s PSSD strategy requires that it provide its array of high-quality, technologically-advanced products and solutions at competitive prices. Lexmark continually enhances its products to ensure that they function efficiently in increasingly-complex enterprise network environments. It also provides flexible tools to enable network administrators to improve productivity. Lexmark’s PSSD target markets include large corporations, small and medium businesses (“SMBs”) and the public sector. Lexmark’s PSSD strategy also requires that it continually identify and focus on industry-specific print and document process-

related issues so that it can differentiate itself by offering unique industry solutions and related services. With the introduction of new laser products that began in the fall of 2008 and continued through the end of 2009, the Company has announced products that represent the most extensive series of laser product introductions in the Company’s history. The new product introductions have significantly strengthened the breadth and depth of the Company’s workgroup laser line, color laser line and laser MFPs.

 

The ISD strategy is to build a profitable, growing and sustainable inkjet business derived from a more productive and higher page generating installed base of products and solutions that serve SOHO and business users. The ISD strategy is focused on growth in the higher page generating inkjet and laser products sold to SOHO and businesses through both retail and non-retail channels and original equipment manufacturer (“OEM”) partner arrangements. The ISD strategy shift that began in 2007 continues to aggressively shift its focus to geographic regions, product segments and customers that generate higher page usage. The strategy shift and related initiatives have yielded the following for the Company’s ISD segment since 2007:

 

 

Lexmark’s ISD goal is to create printing products and innovative solutions that make it easier for SOHO and business users to improve their productivity.

 

Over the last several years, the Company continues to invest in product and solution development as well as solution sales. This investment has led to new products and solutions aimed at targeted growth segments as well as a pipeline of future products.

 

Because of Lexmark’s exclusive focus on printing and document solutions, the Company has formed alliances and OEM arrangements to pursue incremental business opportunities through its alliance partners.

 

The Company’s strategy for dot matrix printers is to continue to offer high-quality products while managing cost to maximize cash flow and profit.

 

Products

 

Laser Products

 

Lexmark offers a wide range of monochrome and color laser printers and MFPs along with customized solution applications and services to help businesses move beyond printing. Lexmark solutions and services help customers optimize and manage their print environment, reduce cost and paper usage, and accelerate workflow by improving business processes and end-user productivity.

 

In 2009, Lexmark introduced 33 new product models ranging from small workgroup offerings to large departmental MFPs.

 

Monochrome Laser

 

Within the medium to large workgroup monochrome laser category, the company rounded out its successful Lexmark T650 Series and Lexmark X650 Series products with the new Lexmark T656dne, the industry’s first single-function monochrome A4 (8.5 inch x 11 inch) laser printer with a touch screen, providing businesses the ability to tap into Lexmark’s powerful solutions platform and work more efficiently. The innovative T656dne monochrome laser printer expands the usefulness of a single-function machine. Leveraging Lexmark’s award-winning Embedded Solutions Framework, the T656dne is preloaded with a Forms and Favorites application that allows for the printing of documents stored online, including web

pages without the need for a PC. It can also be configured to auto-save documents on the printer’s encrypted hard disk, allowing access to information even if the network is down.

 

The Lexmark X860 Series includes six new, A3-capable (11 inch x 17 inch) monochrome laser MFPs targeted to large workgroups and departments who have demanding document needs. These powerful, touch-screen MFPs integrate the capabilities of several standalone units and offer high performance with state-of-the-art security features, in addition to a broad selection of input and finishing options and solution applications.

 

For small and midsize workgroups, the Company enhanced its Lexmark E460 Series with the Lexmark E462dtn. The Lexmark E462dtn is compact, yet provides the largest standard input capacity and toner yield of any model within the Lexmark E Series. Additionally, the E462dtn offers two 250-sheet paper inputs, a 50-sheet multipurpose feeder, and an extra high yield replacement toner cartridge with an 18,000-page capacity.

 

Adding breadth and depth to its monochrome MFP lineup, the Company introduced 11 new compact devices: the Lexmark X264dn, Lexmark X360 Series, Lexmark X460 and the Lexmark X200 Series. The Lexmark X264dn and X360 Series unite essential office functions into one compact, high-performance solution. These devices offer competitive features to save time and money, including scanning and high-yield toner cartridges. The Lexmark X460 Series deliver a higher level of performance, with faster print speeds, advanced copying and easy user authentication for enhanced security. In addition, the high-end X466de model ships ready to run Lexmark solution applications and comes standard with a hard disk. The Lexmark X200 Series provides affordable solutions for the desktop. These ultra-compact MFPs deliver sharp text, rapid copying and handy scanning tools for all-around convenience at a great value.

 

Color Laser

 

Following the successful introduction of last year’s C540 Series and X540 Series color laser products, Lexmark bolstered its color lineup with new value-enhanced editions to both series, as well as two new color series for medium workgroups with higher-volume print requirements: the Lexmark X730 Series of color laser MFPs and the Lexmark C730 Series of color laser printers.

 

The Lexmark X546dtn and Lexmark C546dtn are designed for small to midsize workgroups or busy offices that need access to an affordable device that delivers productivity-enhancing features and professional-quality color printing. Both models feature Lexmark’s Duo Drawer standard, providing up to 900 sheets of standard input capacity, the most of any color laser printer or color laser MFP priced under $1,000. In addition, for customers who need even more paper capacity, a new optional 550-sheet drawer allows for a maximum capacity of 1,450 sheets. A new 8,000-page extra high yield black replacement toner cartridge means fewer interventions for the customer and helps reduce the cost of ownership by delivering a low cost-per-page. Both products are included in the exclusive Lexmark Rewards program, which rewards customers with free genuine Lexmark toner and imaging kits for sending their empty cartridges back to Lexmark for recycling or remanufacturing.

 

The Lexmark X730 Series of color laser MFPs combines fast, high-quality color printing, copying, faxing and scanning in one multifunction device. The series offers robust color performance at affordable prices and in a convenient size, allowing the device to be placed closer to users. The X730 Series has a large touch screen and includes Lexmark’s Embedded Solutions Framework. By adding solution applications to the device, customers can transform their workflow, helping them print less, save time, lower costs and reduce the environmental impact of printing.

 

The Lexmark C730 Series of single-function color laser printers shares the X730’s durable platform. Built for high-volume jobs, the C730 Series prints on a wide range of paper types, from envelopes and labels to card stock. For added versatility, customers can add the new Specialty Media Drawer option, which is ideal for large stacks of envelopes. They can also add up to four stackable drawers to boost capacity up to an impressive 4,300 sheets.

For large workgroups or department users, the Company continues to offer the X782e XL, X940e and X945e color laser MFPs. The X782e XL combines impressive ease of use with cost-efficient cartridge pricing for high-volume users. The X940e and X945e are color laser MFPs that support media sizes up to A3 (11 inch x 17 inch) and advanced finishing options, such as a booklet maker. The Company also continues to offer the C782 and C935 single-function printers for this segment. The C782 models are A4 (8.5 inch x 11 inch) printers that deliver up to 35 color pages per minute. The C935 models are A3 (11 inch x 17 inch) printers that deliver up to 40 color pages per minute.

 

Lexmark is vertically integrated, which gives the Company the ability to quickly respond to unique customer requirements and develop customized solutions to improve workflow. As a result of its insights into the specific processes required within industries, the Company can effectively customize the eTask interface on its MFPs to allow customers to reduce complicated, multi-step processes within these industries to the touch of an icon. The interface can easily be customized to meet each customer’s unique workflow needs.

 

Inkjet Products

 

Lexmark’s inkjet products primarily include AIO printers that offer print, copy, scan and fax functionality targeted at SOHO and business users.

 

In 2009, Lexmark continued to advance the technology and value of its inkjet product line. Lexmark introduced nine inkjet AIO printers, eight of which are Wi-Fi CERTIFIED^tm at competitive price points ranging from $99 to $399. The innovative, feature-rich line includes key advancements such as the world’s first Web-connected² line of inkjet AIOs, Lexmark’s myTouch capacitive 4.3-inch touch screen technology, Lexmark’s Vizix print technology, Wireless-N connectivity (IEEE 802.11n) and the lowest black printing cost in the inkjet industry³. The new line includes three Web-connected touch screen AIOs ranging from $199 to $399.

 

Lexmark continues to build robustly designed and feature rich products with lower operating costs to meet the demands of SOHO and business users. Lexmark’s Professional and Home Office series of products include highly desirable office features such as automatic two-sided printing, excellent document and photo print quality at competitive speeds. In addition, the Company delivers an industry leading penny-per-page option for black printing. To enhance the efficiency for business users, the Company has launched SmartSolutions which combines web-connected touch screen technology with the ability to create simple, one-touch applications. Lexmark offers a five-year warranty on all new Professional Series products and a three-year warranty for most new Home Office products demonstrating Lexmark’s commitment to reliability and productivity.

 

Leading the new line-up of Lexmark’s Professional Series is the Platinum Pro905 and the Prestige Pro805 which both feature the 4.3” Web connected touch screen with SmartSolutions technology, penny-per-page mono printing, large paper input capacity, Wireless-N (IEEE 802.11n) and Ethernet connectivity. Other Professional Series products include the Prevail Pro705 and Prospect Pro205 both of which ship with high yield cartridges and a five-year warranty.

 

The Interact S605 All-in-One leads the way for the Home Office products and also features the 4.3” Web-connected touch screen with SmartSolutions in addition to Wireless-N (IEEE 802.11n) connectivity, two-sided printing and excellent print speed and quality. The Home Office line is rounded out by the Intuition S505, the Interpret S405 and the Impact 305, all of which offer wireless connectivity.

 

For users who do not require wireless printing but need a feature-packed printer that is easy to use, the Company offers the Lexmark X2670 color AIO printer.

 

 

²  Internet access, computer and router required. Does not have Internet browser capability. Not all displayed content can be printed.

³  Based on 105XL black ink cartridges $4.99 MSRP in US dollars and a yield of 510 standard pages, estimated in accordance with ISO,IEC24711. Actual yields may vary. Actual cost in other countries may vary. “Lowest Cost” claim based on comparison with other inkjet all-in-ones as of June 1, 2009. The 105XL black ink cartridge is available on the Professional Series Platinum and Prestige models.

Dot Matrix Products

 

Lexmark continues to market several dot matrix printer models for customers who print multi-part forms.

 

Supplies

 

Lexmark designs, manufactures and distributes a variety of cartridges and other supplies for use in its installed base of laser, inkjet and dot matrix printers. Lexmark’s revenue and profit growth from its supplies business is directly linked to the Company’s ability to increase the installed base of its laser and inkjet products or the usage rate of those products. Lexmark’s management believes the Company is an industry leader with regard to the recovery, remanufacture, reuse and recycling of used laser supplies cartridges, helping to keep empty cartridges out of landfills. Attaining that leadership position was made possible by the Company’s various empty cartridge collection programs around the world. Lexmark continues to launch new programs and expand existing cartridge collection programs to further expand its remanufacturing business and this environmental commitment.

 

Service and Support

 

Lexmark offers a wide range of services covering the Company’s line of printing products and technology solutions including maintenance, consulting, systems integration and Managed Print Services (MPS) capabilities to provide a comprehensive output solution. Lexmark Global Services provide customers with an assessment of their current environment and a recommendation and implementation plan for the future state and ongoing management and optimization of their output environment and document related workflow/business processes. Managed print services allow organizations to outsource fleet management, technical support, supplies replenishment, maintenance activities and other services to Lexmark.

 

Through its MPS offerings, Lexmark provides customers with managed print services, giving them complete visibility and control over their printing environment. These services include asset lifecycle management, implementation and decommissioning services, consumables management, optimization services and utilization management. These services can be tailored to meet each customer’s unique needs and give them more extensive knowledge and optimization of their printing assets and infrastructure.

 

The Company’s printer products generally include a warranty period of at least one year, and customers typically have the option to purchase an extended warranty.

 

Marketing and Distribution

 

Lexmark employs large-account sales and marketing teams whose mission is to generate demand for its business printing solutions and services, primarily among large corporations as well as the public sector. Sales and marketing teams primarily focus on industries such as financial services, retail, manufacturing, education, government and health care. Those teams, in conjunction with the Company’s development and manufacturing teams, are able to customize printing solutions to meet customer needs for printing electronic forms, media handling, duplex printing and other document workflow solutions. Lexmark also markets its laser and inkjet products increasingly through SMB teams who work closely with channel partners. The Company distributes and fulfills its products to business customers 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.

 

Lexmark’s international sales and marketing activities for business customers are organized to meet the needs of the local jurisdictions and the size of their markets. Operations in Europe, Middle East, Africa (EMEA), North America, Latin America and Asia Pacific focus on large-account and SMB demand generation with orders primarily filled through distributors and resellers.

 

The Company’s laser printer supplies are generally available at the customer’s preferred point-of-purchase through multiple channels of distribution. Although channel mix varies somewhat depending upon the

geography, most of Lexmark’s laser supplies products sold commercially in 2009 were sold through the Company’s network of Lexmark-authorized supplies distributors and resellers, who sell directly to end-users or to independent office supply dealers.

 

Lexmark distributes its branded inkjet products and supplies through retail outlets as well as distributors and resellers worldwide. Lexmark’s sales and marketing activities are organized to meet the needs of the various geographies and the size of their markets. In North America, products are primarily distributed through large discount store chains, consumer electronics stores, office superstores, wholesale clubs, online, as well as through distributors. The Company’s EMEA, Latin American and Asia Pacific operations distribute products through major distributors and information technology resellers and in selected markets through key retailers.

 

Lexmark also sells its products through numerous alliances and OEM arrangements. During 2009, 2008 and 2007, one customer, Dell, accounted for $496 million or approximately 13%, $596 million or approximately 13%, and $717 million or approximately 14% of the Company’s total revenue, respectively. Sales to Dell are included in both PSSD and ISD.

 

Economic and Seasonal Trends

 

Lexmark’s business and results of operations have historically been affected by general economic conditions. From time to time, the Company’s sales may be negatively affected by weak economic conditions in those markets in which the Company sells its products. The recent economic recession experienced by the United States and other countries around the world have adversely impacted the Company’s sales and the severity and duration of these adverse economic conditions remains uncertain. If current economic conditions persist or worsen, the Company’s sales could continue to be adversely affected.

 

The Company experiences some seasonal market trends in the sale of its products and services. For example, sales are often stronger during the second half of the year and sales in Europe are often weaker in the summer months. The impact of these seasonal trends on Lexmark has become less predictable.

 

Competition

 

Lexmark continues to develop and market new products and innovative solutions at competitive prices. New product announcements by the Company’s principal competitors, however, can have, and in the past, have had, a material adverse effect on the Company’s financial results. Such new product announcements can quickly undermine any technological competitive edge that one manufacturer may enjoy over another and set new market standards for price, quality, speed and functionality. Furthermore, knowledge in the marketplace about pending new product announcements by the Company’s competitors may also have a material adverse effect on Lexmark as purchasers of printers may defer buying decisions until the announcement and subsequent testing of such new products.

 

In recent years, Lexmark and its principal competitors, many of which have significantly greater financial, marketing and/or technological resources than the Company, have regularly lowered prices on hardware products and are expected to continue to do so. Lexmark has experienced and remains vulnerable to these pricing pressures. The Company’s ability to grow or maintain market share has been and may continue to be affected, resulting in lower profitability. Lexmark expects that as it competes with larger competitors, the Company’s increased market presence may attract more frequent challenges, both legal and commercial, including claims of possible intellectual property infringement.

 

The distributed printing market is extremely competitive. The distributed laser printing market is dominated by Hewlett-Packard (“HP”), which has a widely-recognized brand name and has been identified as the market leader as measured in annual units shipped. With the convergence of traditional printer and copier markets, major laser competitors now include traditional copier companies such as Canon, Ricoh and Xerox. Other laser competitors include Brother, Konica Minolta, Kyocera, Okidata and Samsung.

Lexmark’s primary competitors in the inkjet product market are HP, Canon and Epson, who together account for approximately 85% of worldwide inkjet product unit sales. The Company must compete with these same vendors and other competitors, such as Brother and Kodak, for retail shelf space allocated to printing products and their associated supplies. Lexmark sees other competitors and the potential for new entrants into the market possibly having an impact on the Company’s growth and market share. The entrance of a competitor that is also focused on printing solutions could have a material adverse impact on the Company’s strategy and financial results.

 

Refill, remanufactured, clones, counterfeits and other compatible alternatives for some of Lexmark’s toner and ink cartridges are available and compete with the Company’s supplies business. However, these alternatives may result in inconsistent quality and reliability. As the installed base of laser and inkjet products matures, the Company expects competitive supplies activity to increase. Historically, the Company has not experienced significant supplies pricing pressure, but if supplies pricing were to come under significant pressure, the Company’s financial results could be materially adversely affected.

 

Manufacturing

 

Lexmark operates manufacturing control centers in Lexington, Kentucky; Shenzhen, China; and Geneva, Switzerland; and has manufacturing sites in Boulder, Colorado; Juarez, Mexico; and Lapu-Lapu City, Philippines. The Company also has customization centers in each of the major geographies it serves. Lexmark’s manufacturing strategy is to retain control over processes that are technologically complex, proprietary in nature and central to the Company’s business model, such as the manufacture of toner and photoconductors. The Company shares some of its technical expertise with certain manufacturing partners, many of whom have facilities located in China, which collectively provide Lexmark with substantially all of its printer production capacity. The Company continually reviews its manufacturing capabilities and cost structure and makes adjustments as necessary.

 

Lexmark’s manufacturing operations for toner and photoconductor drums are located in Boulder, Colorado and Juarez, Mexico. Laser printer cartridges are assembled by a combination of in-house and third-party contract manufacturing. The manufacturing control center for laser printer supplies is located in Geneva, Switzerland.

 

Lexmark’s manufacturing operations for inkjet printer supplies are located in Lapu-Lapu City, Philippines. The manufacturing control center for inkjet supplies is located in Geneva, Switzerland.

 

Materials

 

Lexmark procures a wide variety of components used in the manufacturing process, including semiconductors, electro-mechanical components and assemblies, as well as raw materials, such as plastic resins. Although many of these components are standard off-the-shelf parts that are available from multiple sources, the Company often utilizes preferred supplier relationships, and in certain cases sole supplier relationships, to better ensure more consistent quality, cost and delivery. Typically, these preferred suppliers maintain alternate processes and/or facilities to ensure continuity of supply. Lexmark occasionally faces capacity constraints when there has been more demand for its products than initially projected. From time to time, Lexmark may be required to use air shipment to expedite product flow, which can adversely impact the Company’s operating results. Conversely, in difficult economic times, the Company’s inventory can grow as market demand declines.

 

During 2009, the Company continued to execute supplier managed inventory (“SMI”) agreements with its primary suppliers to improve the efficiency of the supply chain. Lexmark’s management believes these SMI agreements improve Lexmark’s supply chain inventory pipeline and supply chain flexibility which enhances responsiveness to our customers. In addition, the Company’s management believes these agreements improve supplier visibility to product demand and therefore improve suppliers’ timeliness and management of their inventory pipelines. As of December 31, 2009, a significant majority of printers were purchased under SMI agreements. Any impact on future operations would depend upon factors such as the Company’s ability to negotiate new SMI agreements and future market pricing and product costs.

Many components of the Company’s products are sourced from sole suppliers, including certain custom chemicals, microprocessors, electro-mechanical components, application specific integrated circuits and other semiconductors. In addition, Lexmark sources some printer engines and finished products from OEMs. Although Lexmark plans in anticipation of its future requirements, should these components not be available from any one of these suppliers, there can be no assurance that production of certain of the Company’s products would not be disrupted. Such a disruption could interfere with Lexmark’s ability to manufacture and sell products and materially adversely affect the Company’s business. Conversely, during economic slowdowns, the Company may build inventory of components as demand decreases.

 

Research and Development

 

Lexmark’s research and development activity is focused on laser and inkjet printers, MFPs, and associated supplies, features, and related technologies. Lexmark’s primary research and development activities are conducted in Lexington, Kentucky; Boulder, Colorado; Cebu City, Philippines; and Kolkata, India. In the case of certain products, the Company may elect to purchase products or key components from third-party suppliers rather than develop them internally.

 

Lexmark is actively engaged in the design and development of new products and enhancements to its existing products. Its engineering efforts focus on technologies associated with laser, inkjet, connectivity, document management and other customer facing solutions, as well as design features that will increase performance, improve ease of use and lower production costs. Lexmark also develops related applications and tools to enable it to efficiently provide a broad range of services.

 

During 2007 and 2008, the Company increased its level of research and development expenditures to more significantly broaden its product offerings and advance core technologies associated with its markets. As many of these initial investments were completed and as part of a corporate effort to improve productivity and efficiency of our research and development investment, the Company reduced its expenditures in 2009. Research and development expenditures were $375 million in 2009, $423 million in 2008 and $404 million in 2007.

 

The process of developing new products is complex and requires innovative designs that anticipate customer needs and technological trends. The Company must make strategic decisions from time to time as to which technologies will produce products and solutions in market sectors that will experience the greatest future growth. There can be no assurance that the Company can develop the more technologically-advanced products required to remain competitive.

 

Backlog

 

Although Lexmark experiences availability constraints from time to time for certain products, the Company generally fills its orders within 30 days of receiving them. Therefore, Lexmark usually has a backlog of less than 30 days at any one time, which the Company does not consider material to its business.

 

Employees

 

As of December 31, 2009, of the approximately 11,900 employees worldwide, 3,400 are located in the U.S. and the remaining 8,500 are located in Europe, Canada, Latin America, Asia Pacific, the Middle East and Africa. None of the U.S. employees are represented by a union. Employees in France are represented by a Statutory Works Council.

 

Available Information

 

Lexmark makes available, free of charge, electronic access to all documents (including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as well as any beneficial ownership filings) filed with or furnished to the Securities and Exchange Commission (“SEC” or the “Commission”) by the Company on its website at http://investor.lexmark.com as soon as reasonably practicable after such documents are filed. The SEC maintains an Internet site that

contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.

 

Executive Officers of the Registrant

 

The executive officers of Lexmark and their respective ages, positions and years of service with the Company are set forth below.

 

 

Dr. Curlander has been a Director of the Company since February 1997. Since April 1999, Dr. Curlander has been Chairman of the Board of the Company. In May 1998, Dr. Curlander was elected President and Chief Executive Officer of the Company. Prior to such time, Dr. Curlander served as President and Chief Operating Officer and Executive Vice President, Operations of the Company.

 

Mr. Gamble has been Executive Vice President and Chief Financial Officer of the Company since September 2005 when he joined the Company. Prior to joining the Company, Mr. Gamble served as Executive Vice President and Chief Financial Officer of Agere Systems, Inc. from February 2003 to September 2005.

 

Mr. Rooke has been Executive Vice President and President of the Company’s Imaging Solutions Division since July 2007. From November 2002 to July 2007, Mr. Rooke served as Executive Vice President and President of PSSD.

 

Mr. Canning has been Vice President and President of PSSD since July 2007. From January 2006 to July 2007, Mr. Canning served as Vice President and General Manager, PSSD Worldwide Marketing and Lexmark Services and PSSD North American Sales and Marketing. From August 2002 to January 2006, Mr. Canning served as Vice President and General Manager, PSSD Worldwide Marketing and Lexmark Services.

 

Mr. Foresti has been Vice President of Asia Pacific and Latin America since January 2008. From May 2003 to January 2008, Mr. Foresti served as the Company’s Vice President and General Manager of Latin America.

 

Ms. Isbell has been Vice President of Human Resources of the Company since February 2003. From January 2001 to February 2003, Ms. Isbell served as Vice President of Worldwide Compensation and Resource Programs in the Company’s Human Resources department.

Mr. Patton has been Vice President, General Counsel and Secretary of the Company since October 2008. From June 2008 to October 2008, Mr. Patton served as Acting General Counsel and Secretary. From February 2001 to June 2008, Mr. Patton served as Corporate Counsel.

 

Mr. Stromquist has been Vice President, PSSD and Corporate Finance since June 2009. From July 2001 to June 2009, Mr. Stromquist served as Vice President and Corporate Controller of the Company.

 

Intellectual Property

 

The Company’s intellectual property is one of its major assets and the ownership of the technology used in its products is important to its competitive position. Lexmark seeks to establish and maintain the proprietary rights in its technology and products through the use of patents, copyrights, trademarks, trade secret laws, and confidentiality agreements.

 

Lexmark holds a portfolio of approximately 1,610 U.S. patents and approximately 860 pending U.S. patent applications. The Company also holds approximately 1,360 foreign patents and pending patent applications. The inventions claimed in these patents and patent applications cover aspects of the Company’s current and potential future products, manufacturing processes, business methods and related technologies. The Company is developing a portfolio of patents that protects its product lines and offers the possibility of entering into licensing agreements with others.

 

Lexmark has a variety of intellectual property licensing and cross-licensing agreements with a number of third parties. Certain of Lexmark’s material license agreements, including those that permit the Company to manufacture some of its current products, terminate as to specific products upon certain “changes of control” of the Company.

 

The Company has trademark registrations or pending trademark applications for the name LEXMARK in approximately 90 countries for various categories of goods and services. Lexmark also owns a number of trademark applications and registrations for various product names. The Company holds worldwide copyrights in computer code and publications of various types. Other proprietary information is protected through formal procedures, which include confidentiality agreements with employees and other entities.

 

Lexmark’s success depends in part on its ability to obtain patents, copyrights and trademarks, maintain trade secret protection and operate without infringing the proprietary rights of others. While Lexmark designs its products to avoid infringing the intellectual property rights of others, current or future claims of intellectual property infringement, and the expenses resulting therefrom, could materially adversely affect its business, operating results and financial condition. Expenses incurred by the Company in obtaining licenses to use the intellectual property rights of others and to enforce its intellectual property rights against others also could materially affect its business, operating results and financial condition. In addition, the laws of some foreign countries may not protect Lexmark’s proprietary rights to the same extent as the laws of the U.S.

 

Environmental and Regulatory Matters

 

Lexmark’s operations, both domestically and internationally, are subject to numerous laws and regulations, particularly relating to environmental matters that impose limitations on the discharge of pollutants into the air, water and soil and establish standards for the treatment, storage and disposal of solid and hazardous wastes. Lexmark could incur substantial costs, including cleanup costs, fines and civil or criminal sanctions, and third-party damage or personal injury claims, if we were to violate or become liable under environmental laws. The liability for environmental remediation and other environmental costs is accrued when Lexmark considers it probable and can reasonably estimate the costs. Environmental costs and accruals are presently not material to our operations or financial position. There is no assurance that existing or future environmental laws applicable to our operations or products will not have a material adverse effect on Lexmark’s operations or financial condition.

 

Lexmark has implemented numerous programs to recover, remanufacture and recycle certain of its products and intends to continue to expand on initiatives that have a positive effect on the environment.

Lexmark is committed to maintaining compliance with all environmental laws applicable to its operations, products and services.

 

Lexmark is also required to have permits from a number of governmental agencies in order to conduct various aspects of its business. Compliance with these laws and regulations has not had, and in the future is not expected to have, a material effect on the capital expenditures, earnings or competitive position of the Company. There can be no assurance, however, that future changes in environmental laws or regulations, or in the criteria required to obtain or maintain necessary permits, will not have an adverse effect on the Company’s operations.

 

Lexmark is subject to legislation in an increasing number of jurisdictions that makes producers of electrical goods, including printers, financially responsible for specified collection, recycling, treatment and disposal of past and future covered products (sometimes referred to as “product take-back legislation”). There is no assurance that such existing or future laws will not have a material adverse effect on Lexmark’s operations or financial condition, although Lexmark does not anticipate that effects of product take-back legislation will be different or more severe for Lexmark than the impacts on others in the electronics industry.

 

 

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.

 

Continuation of economic weakness, foreign currency exchange rate fluctuations, and uncertainty of recovery could adversely impact the Company’s revenue, operating income and other financial results.

 

 

The competitive pricing pressure in the market may negatively impact the Company’s operating results.

 

 

The Company’s ability to be successful in shifting its strategy and selling its products into the higher-usage segments of the inkjet market could adversely affect future operating results.

 

 

Any failure by the Company to execute planned cost reduction measures timely and successfully could result in total costs and expenses that are greater than expected or the failure to meet operational goals as a result of such actions.

 

 

The Company’s failure to manage inventory levels or production capacity may negatively impact the Company’s operating results.

 

 

Conflicts among various sales channels and the loss of retail shelf space may negatively impact the Company’s operating results.

 

 

The revenue and profitability of our operations have historically varied, which makes our future financial results less predictable.

 

 

The Company may experience difficulties in product transitions negatively impacting the Company’s performance and operating results.

 

 

The Company’s inability to meet customer product requirements on a cost competitive basis may negatively impact the Company’s operating results.

 

 

Decreased consumption of supplies could negatively impact the Company’s operating results.

 

 

Changes in the Company’s tax provisions or tax liabilities could negatively impact the Company’s profitability.

 

 

Due to the international nature of our business, changes in a country’s or region’s political or economic conditions or other factors could negatively impact the Company’s revenue, financial condition or operating results.

 

 

The failure of the Company’s information technology systems, or its failure to successfully implement new information technology systems, may negatively impact the Company’s operating results.

 

 

Any failure by the Company to successfully outsource the infrastructure support of its information technology system and application maintenance functions and centralize certain of its support functions may disrupt these systems or functions and could have a material adverse effect on the Company’s systems of internal control and financial reporting.

 

 

The Company’s reliance on international production facilities, international manufacturing partners and certain key suppliers could negatively impact the Company’s operating results.

 

 

The entrance of additional competitors that are focused on printing solutions could negatively impact the Company’s strategy and operating results.

 

 

The Company’s inability to perform satisfactorily under service contracts for managed print services may negatively impact the Company’s strategy and operating results.

 

 

Increased competition in the Company’s aftermarket supplies business may negatively impact the Company’s revenue and gross margins.

 

 

New legislation, fees on the Company’s products or litigation costs required to protect the Company’s rights may negatively impact the Company’s cost structure, access to components and operating results.

 

 

The Company’s inability to obtain and protect its intellectual property and defend against claims of infringement by others may negatively impact the Company’s operating results.

 

 

Cost reduction efforts associated with the Company’s compensation and benefits programs could adversely affect our ability to attract and retain employees.

 

 

Business disruptions could seriously harm our future revenue and financial condition and increase our costs and expenses.

 

 

Terrorist acts, acts of war or other political conflicts may negatively impact the Company’s ability to manufacture and sell its products.

 

 

Any variety of factors unrelated to the Company’s operating performance may negatively impact the Company’s operating results or the Company’s stock price.

 

 

 

Not applicable.

 

 

Lexmark’s corporate headquarters and principal development facilities are located on a 374 acre campus in Lexington, Kentucky. At December 31, 2009, the Company owned or leased 7.4 million square feet of administrative, sales, service, research and development, warehouse and manufacturing facilities worldwide. The Company’s properties are used by both PSSD and ISD. Approximately 3.7 million square feet is located in the U.S. and the remainder is located in various international locations. The Company’s principal international manufacturing facilities are located in Mexico and the Philippines. The principal domestic manufacturing facility is located in Colorado. The Company occupies facilities for development in the U.S., India and the Philippines. The Company owns approximately 67 percent of the worldwide square footage and leases the remaining 33 percent. The leased property has various lease expiration dates. The Company believes that it can readily obtain appropriate additional space as may be required at competitive rates by extending expiring leases or finding alternative space.

 

None of the property owned by Lexmark is held subject to any major encumbrances and the Company believes that its facilities are in good operating condition.

 

 

The information required by this item is set forth in Note 17 of the “Notes to Consolidated Financial Statements” contained in Item 8 of Part II of this report, and is incorporated herein by reference.

 

 

None.

 

 

Market Information

 

Lexmark’s Class A Common Stock is traded on the New York Stock Exchange under the symbol “LXK.” As of February 19, 2010, there were 2,877 holders of record of the Class A Common Stock and there were no holders of record of the Class B Common Stock. Information regarding the market prices of the Company’s Class A Common Stock appears in Part II, Item 8, Note 19 of the Notes to Consolidated Financial Statements.

 

Dividend Policy

 

The Company has never declared or paid any cash dividends on the Class A Common Stock and has no current plans to pay cash dividends on the Class A Common Stock. The payment of any future cash dividends will be determined by the Company’s Board of Directors in light of conditions then existing, including the Company’s earnings, financial condition and capital requirements, restrictions in financing agreements, business conditions, tax laws, certain corporate law requirements and various other factors.

 

Issuer Purchases of Equity Securities

 

 

 

Performance Graph

 

The following graph compares cumulative total stockholder return on the Company’s Class A Common Stock with a broad performance indicator, the S&P Composite 500 Stock Index, and an industry index, the S&P 500 Information Technology Index, for the period from December 31, 2004, to December 31, 2009. The graph assumes that the value of the investment in the Class A Common Stock and each index were $100 at December 31, 2004, and that all dividends were reinvested.

 

COMPARISON OF CUMULATIVE TOTAL RETURNS

 

 

 

Source: Standard & Poor’s Capital IQ

Equity Compensation Plan Information

 

The following table provides information about the Company’s equity compensation plans as of December 31, 2009:

 

(Number of Securities in Millions)

 

 

 

The table below summarizes recent financial information for the Company. For further information refer to the Company’s Consolidated Financial Statements and Notes thereto presented under Part II, Item 8 of this Form 10-K.

 

(Dollars in Millions, Except per Share Data)

 

 

 

 

 

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes thereto presented under Part II, Item 8 of this Form 10-K.

 

OVERVIEW

 

Products and Segments

 

Lexmark makes it easier for businesses of all sizes 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 the office. Lexmark’s products include laser printers, inkjet printers, multifunction devices, dot matrix printers and associated supplies, services and solutions.

 

The Company is primarily managed along divisional lines: PSSD and ISD.

 

 

The Company also sells its products through numerous alliances and OEM arrangements.

 

Refer to Part II, Item 8, Note 18 of the Notes to Consolidated Financial Statements for additional information regarding the Company’s reportable segments, which is incorporated herein by reference.

 

Operating Results Summary

 

2009

 

The weakness of the global economy continued to impact revenue and operating income in both of the Company’s segments during 2009. This included adverse effects on global demand for both hardware and supplies in both of the Company’s segments. Additionally, Lexmark’s inkjet strategy shift that began in 2007 to transition to higher usage customers and products, and reduce sales of low-end / low-price inkjet hardware, continued to impact the Company’s inkjet unit sales and supplies revenue. The objective of this transition is to move to a smaller installed base of higher page generating units. However, in the near term, the Company sees the potential for continued erosion in end-user inkjet supplies demand due to the reduction in inkjet hardware unit sales during this transition period. In addition, the Company has experienced weakness in its OEM business over the last several years, which the Company believes

could result in lower OEM inkjet and laser supplies demand. However, during 2009 the Company introduced or continued the introduction of a wide array of new hardware products in both its segments. Beginning in the fall of 2008 and continuing through the end of 2009, the Company has announced products that represent the most extensive series of laser product introductions in the Company’s history. The new product introductions have significantly strengthened the breadth and depth of the Company’s workgroup laser line, color laser line and laser MFPs. In September 2009, the Company introduced a new family of inkjet all-in-ones (including new Web-connected touch screen AIOs). This included four products in the Lexmark Professional Series, targeted for small and medium businesses. In 2009, the Company also experienced an improvement in the Company’s retail presence in U.S. Office Super Stores. The Company continues to invest in its core print technologies and product development in order to generate new Lexmark products.

 

Refer to the section entitled “RESULTS OF OPERATIONS” that follows for a further discussion of the Company’s results of operations.

 

Trends and Opportunities

 

Lexmark management believes that the total distributed output opportunity was between $80 and $90 billion in 2009, including hardware and supplies. This opportunity includes printers and multifunction devices as well as a declining base of copiers and fax machines that are increasingly being integrated into multifunction devices. Based on industry information, Lexmark management believes that the market declined in 2009 due to the continued global economic weakness. When global economic growth resumes, the industry could again experience low to mid-single digit annual revenue growth rates with highest growth likely to be in MFPs, color lasers and related software solutions and services and the stronger emerging countries.

 

Market trends driving long-term growth include:

 

 

As a result of these market trends, Lexmark has growth opportunities in monochrome laser printers, color lasers, laser MFPs and inkjet AIOs.

 

Color and multifunction products continue to represent a more significant portion of the laser market. The Company’s management believes these trends will continue. Industry pricing pressure is partially offset by the tendency of customers to purchase higher value color and multifunction products and optional paper handling and finishing features as well as to purchase output through print and document management software solutions and services that help customers to optimize their document-related infrastructure to improve productivity and cost.

 

The inkjet product market historically has been predominantly a consumer market, but there is an increasing trend toward inkjet products being designed for SOHO and other businesses. Advancements in inkjet technology are allowing inkjet devices to print at speeds and with document quality competitive with low-end lasers and meeting business standards. Customers are increasingly seeking productivity-related features that are found in inkjet multifunction products designed for office use such as wireless and ethernet connectivity, automatic document feeders and duplex capabilities, as well as

web-based applications to automate print and document related work functions. This trend represents an opportunity for the Company to pursue revenue growth opportunities with its inkjet products and solutions targeted at SOHO and business market segments.

 

While profit margins on printers and MFPs have been negatively affected by competitive pricing pressure, supplies sales are higher margin and recurring. In general, as the hardcopy industry matures and printer and copier markets converge, management expects competitive pressures to continue.

 

Lexmark’s dot matrix printers include mature products that require little ongoing investment. The Company expects that the market for these products will continue to decline, and has implemented a strategy to continue to offer high-quality products while managing cost to maximize cash flow and profit.

 

Challenges and Risks

 

In recent years, Lexmark and its principal competitors, many of which have significantly greater financial, marketing and/or technological resources than the Company, have regularly lowered prices on printers and are expected to continue to do so.

 

Other challenges and risks faced by Lexmark include:

 

 

Refer to the section entitled “Competition” in Item 1, which is incorporated herein by reference, for a further discussion of major uncertainties faced by the industry and Company. Additionally, refer to the section entitled “Risk Factors” in Item 1A, which is incorporated herein by reference, for a further discussion of factors that could impact the Company’s operating results.

 

Strategy and Initiatives

 

Lexmark’s strategy is based on a business model of investing in technology to develop and sell printing solutions, including printers and MFPs, with the objective of growing its installed base, which drives

recurring supplies sales. Management believes that Lexmark has the following strengths related to this business model:

 

 

Lexmark’s strategy involves the following core strategic initiatives:

 

 

Over the last several years, the Company continues to invest in product and solution development as well as solution sales. This investment has led to new products and solutions aimed at targeted growth segments as well as a pipeline of future products.

 

The Company’s strategy for dot matrix printers is to continue to offer high-quality products while managing cost to maximize cash flow and profit.

 

Refer to the section entitled “Strategy” in Item 1, which is incorporated herein by reference, for a further discussion of the Company’s strategies and initiatives.

 

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 financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, as well as disclosures regarding contingencies. 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, contingencies and litigation, and fair values that are based on unobservable inputs significant to the overall measurement. Lexmark bases its estimates on historical experience, market conditions, and 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 used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

 

Revenue Recognition

 

See Note 2 to the Consolidated Financial Statements in Part II, Item 8 for information regarding the Company’s policy for revenue recognition. For customer programs and incentives, Lexmark records estimated reductions to revenue at the time of sale for customer programs and incentive offerings including

special pricing agreements, promotions and other volume-based incentives. Estimated reductions in revenue are based upon historical trends and other known factors at the time of sale. Lexmark also records estimated reductions to revenue for price protection, which it provides to substantially all of its distributor and reseller customers. The amount of price protection is limited based on the amount of dealers’ and resellers’ inventory on hand (including in-transit inventory) as of the date of the price change. If market conditions were to decline, Lexmark may take actions to increase customer incentive offerings or reduce prices, possibly resulting in an incremental reduction of revenue at the time the incentive is offered.

 

The Company also records estimated reductions to revenue at the time of sale related to its customers’ right to return product. Estimated reductions in revenue are based upon historical trends of actual product returns as well as the Company’s assessment of its products in the channel. Provisions for specific returns from large customers are also recorded as necessary.

 

Allowances for Doubtful Accounts

 

Lexmark maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The Company estimates the allowance for doubtful accounts based on a variety of factors including the length of time receivables are past due, the financial health of its customers, unusual macroeconomic conditions and historical experience. If the financial condition of its customers deteriorates or other circumstances occur that result in an impairment of customers’ ability to make payments, the Company records additional allowances as needed.

 

Restructuring

 

Lexmark records a liability for a cost associated with an exit or disposal activity at its fair value in the period in which the liability is incurred, except for liabilities for certain employee termination benefit charges that are accrued over time. Employee termination benefits associated with an exit or disposal activity are accrued when the obligation is probable and estimable as a postemployment benefit obligation when local statutory requirements stipulate minimum involuntary termination benefits or, in the absence of local statutory requirements, termination benefits to be provided are similar to benefits provided in prior restructuring activities. Employee termination benefits accrued as probable and estimable often require judgment by the Company’s management as to the number of employees being separated and the related salary levels, length of employment with the Company and various other factors related to the separated employees that could affect the amount of employee termination benefits being accrued. Such estimates could change in the future as actual data regarding separated employees becomes available.

 

Specifically for termination benefits under a one-time benefit arrangement, the timing of recognition and related measurement of a liability depends on whether employees are required to render service until they are terminated in order to receive the termination benefits and, if so, whether employees will be retained to render service beyond a minimum retention period. For employees who are not required to render service until they are terminated in order to receive the termination benefits or employees who will not provide service beyond the minimum retention period, the Company records a liability for the termination benefits at the communication date. If employees are required to render service until they are terminated in order to receive the termination benefits and will be retained to render service beyond the minimum retention period, the Company measures the liability for termination benefits at the communication date and recognizes the expense and liability ratably over the future service period.

 

For contract termination costs, Lexmark records a liability for costs to terminate a contract before the end of its term when the Company terminates the agreement in accordance with the contract terms or when the Company ceases using the rights conveyed by the contract. The liability is recorded at fair value in the period in which it is incurred, taking into account the effect of estimated sublease rentals that could be reasonably obtained which may be different than company-specific intentions.

Warranty

 

Lexmark provides for the estimated cost of product warranties at the time revenue is recognized. The amounts accrued for product warranties are based on the quantity of units sold under warranty, estimated product failure rates, and material usage and service delivery costs. The estimates for product failure rates and material usage and service delivery costs are periodically adjusted based on actual results. For extended warranty programs, the Company defers revenue in short-term and long-term liability accounts (based on the extended warranty contractual period) for amounts invoiced to customers for these programs and recognizes the revenue ratably over the contractual period. Costs associated with extended warranty programs are expensed as incurred. To minimize warranty costs, the Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers. Should actual product failure rates, material usage or service delivery costs differ from the Company’s estimates, revisions to the estimated warranty liability may be required.

 

Inventory Reserves and Adverse Purchase Commitments

 

Lexmark writes down its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value. The Company estimates the difference between the cost of obsolete or unmarketable inventory and its market value based upon product demand requirements, product life cycle, product pricing and quality issues. Also, Lexmark records an adverse purchase commitment liability when anticipated market sales prices are lower than committed costs. If actual market conditions are less favorable than those projected by management, additional inventory write-downs and adverse purchase commitment liabilities may be required.

 

Pension and Other Postretirement Plans

 

The Company’s pension and other postretirement benefit costs and obligations are dependent on various actuarial assumptions used in calculating such amounts. The non-U.S. pension plans are not significant and use economic assumptions similar to the U.S. pension plan, a defined benefit plan. Significant assumptions the Company must review and set annually related to its pension and other postretirement benefit obligations are:

 

 

Plan assets are invested in equity securities, government and agency securities, mortgage-backed securities, commercial mortgage-backed securities, asset-backed securities, corporate debt, annuity contracts and other securities. The U.S. pension plan comprises a significant portion of the assets and liabilities relating to the Company’s pension plans. The investment goal of the U.S. pension plan is to achieve an adequate net investment return in order to provide for future benefit payments to its participants. Asset allocation percentages are targeted to be 65% equity and 35% fixed income investments. The U.S. pension plan employed professional investment managers during 2009 to invest in new asset classes, including international developed equity, emerging market equity, high yield bonds and emerging market debt. Each investment manager operates under an investment

management contract that includes specific investment guidelines, requiring among other actions, adequate diversification, prudent use of derivatives and standard risk management practices such as portfolio constraints relating to established benchmarks. The U.S. pension plan currently uses a combination of both active management and passive index funds to achieve its investment goals.

 

The Company has elected to primarily use the market-related value of plan assets rather than fair value to determine expense which, under the accounting guidance, allows gains and losses to be recognized in a systematic and rational manner over a period of no more than five years. As a result of this deferral process, for the U.S. pension plan, pension expense was increased by $5 million in 2009 and $4 million in 2010, due to the recognition of the gains and losses for the respective prior five years. The expected increase in the 2010 pension expense for U.S. pension plan would have been approximately $10 million had the Company not deferred the differences between actual and expected asset returns on equity investments.

 

Actual results that differ from assumptions that fall outside the “10% corridor,” as defined by accounting guidance on employers’ accounting for pensions, are accumulated and amortized over the estimated future service period of active plan participants. For 2009, a 25 basis point change in the assumptions for asset return and discount rate would not have had a significant impact on the Company’s results of operations.

 

The accounting guidance for employers’ defined benefit pension and other postretirement plans requires recognition of the funded status of a benefit plan in the statement of financial position and recognition in other comprehensive earnings of certain gains and losses that arise during the period, but are deferred under pension accounting rules.

 

Income Taxes

 

The Company estimates its tax liability based on current tax laws in the statutory jurisdictions in which it operates. These estimates include judgments about deferred tax assets and liabilities resulting from temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes, as well as about the realization of deferred tax assets. If the provisions for current or deferred taxes are not adequate, if the Company is unable to realize certain deferred tax assets or if the tax laws change unfavorably, the Company could potentially experience significant losses in excess of the reserves established. Likewise, if the provisions for current and deferred taxes are in excess of those eventually needed, if the Company is able to realize additional deferred tax assets or if tax laws change favorably, the Company could potentially experience significant gains.

 

Under the accounting guidance regarding uncertainty in income taxes, a tax position must meet the minimum recognition threshold of “more-likely-than-not” before being recognized in the financial statements. The evaluation of a tax position in accordance with this guidance is a two-step process. The first step is recognition: The enterprise determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any litigation. The second step is measurement: A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate resolution.

 

Uncertain tax positions at year-end 2009 and 2008 were evaluated using the two-step process described in the paragraphs above.

 

The Company adopted the guidance on accounting for uncertainty in income taxes on January 1, 2007. As a result, the Company reduced its liability for unrecognized tax benefits and related interest and penalties by $7.3 million, which resulted in a corresponding increase in the Company’s January 1, 2007 retained earnings balance. The Company also recorded an increase in its deferred tax assets of $8.5 million and a corresponding increase in its liability for unrecognized tax benefits as a result of adoption.

Contingencies and Litigation

 

In accordance with FASB guidance on 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.

 

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 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 represent its best estimate of the copyright fee issues currently pending. Such estimates could change as the litigation and/or local legislative processes draw closer to final resolution.

 

Environmental Remediation Obligations

 

Lexmark accrues for losses associated with environmental remediation obligations when such losses are probable and reasonably estimable. In the early stages of a remediation process, particular components of the overall obligation may not be reasonably estimable. In this circumstance, the Company recognizes a liability for the best estimate (or the minimum amount in a range if no best estimate is available) of the cost of the remedial investigation-feasibility study, related consultant and external legal fees, and for any other component remediation costs that can be reasonably estimated. Accruals are adjusted as further information develops or circumstances change. Recoveries from other parties are recorded as assets when their receipt is deemed probable.

 

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.

 

Fair value accounting guidance defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As part of the framework for measuring fair value, the guidance establishes a hierarchy of inputs to valuation techniques used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.

 

The three levels of the fair value hierarchy are:

 

 

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.

 

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 determining where measurements lie in the fair value hierarchy, the Company uses assumptions regarding the general characteristics of each type of investment as the starting point. The Company then downgrades individual investments to a lower level as necessary based on specific facts and circumstances, such as a security becoming distressed or a decrease in pricing inputs.

 

Uncertainty in the capital markets has presented additional challenges with respect to valuing certain investments the Company holds. In the case of auction rate securities in which auctions were unsuccessful, observable pricing data was not available resulting in the Company performing a discounted cash flow analysis based on assumptions that it believes market participants would use with regard to such items as expected cash flows and discount rates adjusted for liquidity premiums. The Company refined its methodology for valuing its auction rate securities in 2009 and made changes to certain assumptions significant to the valuation including (1) the auction rate market will remain illiquid and auctions will continue to fail causing the interest rate to be the maximum applicable rate and (2) the securities will not be redeemed. These assumptions resulted in discounted cash flow analysis being performed through the legal maturities of these securities, ranging from the year 2032 through 2040, or in the case of the auction rate preferred stock, through the mandatory redemption date of year-end 2021. In contrast, at year-end 2008, the company assumed redemption dates in the year 2010 for these securities. Though the change in assumptions did result in lower fair values for these securities, the fair value adjustments were not material to the Company’s overall marketable securities portfolio. Valuation of these securities as well as a smaller number of distressed debt securities and certain asset-backed and mortgaged-backed securities can be very subjective. Estimates and assumptions could be revised in the future depending on market conditions and changes in the economy.

 

In April 2009, the FASB issued guidance for determining fair value when the volume and level of activity for the asset or liability have significantly decreased and identifying transactions that are not orderly. In response to the guidance, the Company has added additional steps, starting in the second quarter of 2009, to its fair value practices described above with respect to the consensus pricing methodology used in the valuation of most of the securities in which it has invested. The Company has implemented more comprehensive procedures to review the number of pricing inputs received as well as the variability in the pricing data utilized in the overall valuation. For securities in which the number of pricing inputs used is less than expected or there is significant variability in the pricing inputs, the Company has tested that the final consensus price is within a reasonable range of fair value through corroboration with other sources of price data. The Company will likely continue to refine its fair value assurance procedures as it pursues more cost-effective methods of obtaining such assurances in the future. See Note 2 to the Consolidated Financial Statements in Part II, Item 8 for more information regarding the fair value accounting guidance issued in 2009.

 

Effective January 1, 2009, the Company began applying the valuation concepts of the fair value measurements guidance to its nonrecurring, nonfinancial fair value measurements. These measurements are most often based on inputs or assumptions that are less observable in the market, thus requiring more judgment on the part of the Company in estimating fair value. Determination of the most advantageous market (when no principal market exists) and the highest and best use of an asset from the perspective of market participants can result in fair value measurements that differ from estimates based on the Company’s specific intentions for the asset.

 

See Note 3 to the Consolidated Financial Statements in Part II, Item 8 for more information regarding the Company’s fair value measurements and valuation practices.

Other-Than-Temporary Impairment of Marketable Securities

 

The Company records its investments in marketable securities at fair value through accumulated other comprehensive earnings using the valuation practices discussed in the fair value section above. Once these investments have been marked to market, the Company must assess whether or not its individual unrealized loss positions contain other-than-temporary impairment (“OTTI”). If an unrealized position is deemed OTTI, then the unrealized loss, or a portion thereof, must be recognized in earnings. The Company’s portfolio is made up almost entirely of debt securities for which OTTI must be recognized in accordance with the FASB OTTI guidance effective in the second quarter of 2009. The model in this guidance requires that an entity recognize OTTI in earnings for the entire unrealized loss position if the entity intends to sell or it is more likely than not the entity will be required to sell the debt security before its anticipated recovery of its amortized cost basis. If the entity does not expect to sell the debt security, but the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss is deemed to exist and OTTI shall be considered to have occurred. However, in this case, the OTTI is separated into two components, the amount representing the credit loss which is recognized in earnings and the amount related to all other factors which is recognized in other comprehensive income under the new guidance. See Note 2 to the Consolidated Financial Statements in Part II, Item 8 for more details regarding this guidance. The Company’s policy considers various factors in making these two assessments.

 

In determining whether it is more likely than not that the Company will be required to sell impaired securities before recovery of net book or carrying values, the Company considers various factors that include:

 

 

If the Company determines that it does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security, the Company assesses whether it expects to recover the net book or carrying value of the security. The Company makes this assessment based on quantitative and qualitative factors of impaired securities that include a time period analysis on unrealized loss to net book value ratio; severity analysis on unrealized loss to net book value ratio; credit analysis of the security’s issuer based on rating downgrades; and other qualitative factors that may include some or all of the following criteria:

 

 

Securities that are identified through the analysis using the quantitative and qualitative factors described above are then assessed to determine whether the entire net book value basis of each identified security will be recovered. The Company performs this assessment by comparing the present value of the cash flows expected to be collected from the security with its net book value. If the present value of cash flows expected to be collected is less than the net book value basis of the security, then a credit loss is deemed to exist and an other-than-temporary impairment is considered to have occurred. There are numerous

factors to be considered when estimating whether a credit loss exists and the period over which the debt security is expected to recover, some of which have been highlighted in the preceding paragraph.

 

Given the uncertainty in the current economic environment and the level of judgment required to make the assessments above, the final outcomes of the Company’s investments in debt securities could prove to be different than the results reported. Issuers with good credit standings and relatively solid financial conditions may not be able to fulfill their obligations ultimately. Furthermore, the Company could reconsider its decision not to sell a security depending on changes in its own cash flow projections as well as changes in the regulatory and economic environment that may indicate that selling a security is advantageous to the Company. Historically, the Company has incurred a low amount of realized losses from sales of marketable securities.

 

See Note 6 to the Consolidated Financial Statements in Part II, Item 8 for more information regarding the Company’s marketable securities.

 

Goodwill

 

The Company assesses its goodwill annually or upon the occurrence of a triggering event that leads management to believe it is more likely than not that an impairment exists, such as the market capitalization of the overall Company being less than its carrying value. The Company’s goodwill assets are immaterial, and therefore are not separately presented in the Consolidated Statements of Financial Position. The fair value of each reporting unit tested at December 31, 2009 was substantially in excess of its carrying value.

 

Long-Lived Assets

 

Lexmark performs reviews for the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual disposition are insufficient to recover the carrying value of the assets, then an impairment loss is recognized based upon the excess of the carrying value of the assets over the fair value of the assets. Such an impairment review incorporates estimates of forecasted revenue and costs that may be associated with an asset as well as the expected periods that an asset may be utilized. Fair value is determined based on the highest and best use of the assets considered from the perspective of market participants, which may be different than the Company’s actual intended use of the asset.

 

Lexmark also reviews any legal and contractual obligations associated with the retirement of its long-lived assets and records assets and liabilities, as necessary, related to such obligations. The asset recorded is amortized over the useful life of the related long-lived tangible asset. The liability recorded is relieved when the costs are incurred to retire the related long-lived tangible asset. Each obligation is estimated based on current law and technology; accordingly, such estimates could change as the Company periodically evaluates and revises such estimates based on expenditures against established reserves and the availability of additional information. The Company’s asset retirement obligations are currently not material to the Company’s Consolidated Statements of Financial Position.

 

RESULTS OF OPERATIONS

 

Operations Overview

 

Key Messages

 

Lexmark is focused on driving long-term performance by strategically investing in technology, products and solutions to secure high value product installations and capture profitable supplies and service annuities in document and print intensive segments of the distributed printing market.

 

 

 

Lexmark continues to take actions to improve its cost and expense structure including continuing to implement restructuring activities of its business to lower its cost and better allow it to fund these strategic initiatives. See “Restructuring and Related Charges and Project Costs” that follows for further discussion.

 

Lexmark continues to maintain a strong financial position with good cash generation and a solid balance sheet, which positions it to prudently invest in the future of the business and successfully compete even during challenging times.

 

2009 Business Factors

 

The weakness of the global economy impacted revenue and operating income in both of the Company’s segments during 2009. Lexmark continued to take actions to reduce cost and expenses worldwide and improve the efficiency of the Company’s manufacturing operations and, as a result, the Company announced additional restructuring actions in January, April and October of 2009. See “Restructuring and Related Charges and Project Costs” that follows for further discussion.

 

PSSD

 

During 2009, Lexmark continued its investments in PSSD through new products and technology. With the introduction of new laser products that began in the fall of 2008 and continued through the end of 2009, the Company has announced products that represent the most extensive series of laser product introductions in the Company’s history. The new product introductions have significantly strengthened the breadth and depth of the Company’s monochrome laser line, color laser line and laser MFPs.

 

ISD

 

The Company undertook a significant shift in ISD strategy that began in 2007 and continued through 2009 that has aggressively shifted the Company’s ISD focus to geographic regions, product segments and customers that generate higher page usage. The strategy shift and related initiatives have yielded the following for the Company’s ISD segment since 2007:

 

 

By strengthening the Company’s focus on the sales of higher end, higher page generating inkjet devices, the longer term ISD objective is to ultimately stabilize and grow supplies revenue based on a smaller installed base of higher page generating devices.

Operating Results Summary

 

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes thereto. The following table summarizes the results of the Company’s operations for the years ended December 31, 2009, 2008 and 2007:

 

 

During 2009, total revenue was $3.9 billion or down 14% from 2008. Laser and inkjet supplies revenue decreased 12% year-to-year (“YTY”) while laser and inkjet hardware revenue decreased 22% YTY. In PSSD, revenue decreased 12% YTY while revenue in ISD decreased 19% YTY.

 

During 2008, total revenue was $4.5 billion or down 9% from 2007. Laser and inkjet supplies revenue decreased 4% YTY while laser and inkjet hardware revenue decreased 20% YTY. In PSSD, revenue decreased 1% YTY while revenue in ISD decreased 22% YTY.

 

Net earnings for the year ended December 31, 2009 decreased 39% from the prior year primarily due to lower operating income and lower interest and other income/expense, net. Net earnings in 2009 included $141.3 million of pre-tax restructuring-related charges and project costs in connection with the execution of the Company’s restructuring plans. The Company uses the term “project costs” for incremental charges related to the execution of its restructuring plans. See “Restructuring and Related Charges and Project Costs” that follows for further discussion.

 

Net earnings for the year ended December 31, 2008 decreased 20% from the prior year primarily due to lower operating income and lower interest and other income/expense, net, partially offset by a lower effective tax rate. Net earnings in 2008 included $92.7 million of pre-tax restructuring-related charges and project costs in connection with the execution of the Company’s restructuring plans. See “Restructuring and Related Charges and Project Costs” that follows for further discussion. Net earnings in 2008 also included $11.6 million of non-recurring tax benefits.

 

Revenue

 

The following tables provide a breakdown of the Company’s revenue by product category, hardware unit shipments and market segment:

 

Revenue by product:

 

 

Unit shipments:

 

During 2009, laser and inkjet supplies revenue decreased 12% YTY as the Company experienced declines in both laser and inkjet supplies. Laser and inkjet hardware revenue decreased 22% primarily due to declines in laser and inkjet units.

 

During 2008, laser and inkjet supplies revenue decreased 4% YTY as growth in laser supplies was more than offset by a decline in inkjet supplies. Laser and inkjet hardware revenue decreased 20% primarily due to declines in laser and inkjet units.

 

During 2009, 2008 and 2007, one customer, Dell, accounted for $496 million or approximately 13%, $596 million or approximately 13% and $717 million or approximately 14%, of the Company’s total revenue, respectively. Sales to Dell are included in both PSSD and ISD.

 

Revenue by division:

 

 

PSSD

 

During 2009, revenue in PSSD decreased $357 million or 12% compared to 2008 due to a 19% decline in laser hardware revenue as well as a decrease in laser supplies revenue. The lower laser hardware revenue was due to lower unit volume and negative impact of currency, partially offset by a positive mix of workgroup and MFP devices. Laser hardware unit shipments decreased approximately 21% YTY primarily due to lower low-end mono-laser units, partially offset by unit growth in laser MFPs and single function color devices. Laser hardware AUR, which reflects the changes in both pricing and mix, increased approximately 4% YTY due to a positive product mix shift toward workgroup and MFP devices.

 

During 2008, revenue in PSSD decreased $18 million or 1% compared to 2007 due to a 9% decline in laser hardware revenue, partially offset by growth in laser supplies revenue. The lower laser hardware revenue was due to lower unit volume and aggressive pricing, partially offset by a positive currency impact and positive mix of workgroup and MFP devices. Laser hardware unit shipments decreased approximately 7% YTY primarily due to lower OEM units, partially offset by unit growth in laser MFPs. Laser hardware AUR, which reflects the changes in both pricing and mix, decreased approximately 2% YTY due to aggressive pricing, partially offset by a positive currency impact.

 

ISD

 

During 2009, revenue in ISD decreased $292 million or 19% compared to 2008 due to decreased inkjet hardware and supplies revenue. Hardware revenue declined 28% YTY due to lower unit shipments and negative net price impacts as well as negative foreign currency impacts, partially offset by an improvement in mix toward higher end devices. Management believes supplies revenue declined YTY due to the impact on end-user demand of broad global economic weakness and shrinkage in the installed base of inkjet products and an associated decline in end-user demand for inkjet supplies. Inkjet hardware unit shipments declined 37% YTY principally due to the Company’s decision to prioritize certain markets, segments and customers and to reduce or eliminate others. Inkjet hardware AUR increased 13% YTY due to favorable product mix shift.

 

During 2008, revenue in ISD decreased $428 million or 22% compared to 2007 due to decreased inkjet hardware and supplies revenue. Hardware revenue declined 38% YTY due to lower unit shipments. Management believes supplies revenue declined YTY due to shrinkage in the installed base of inkjet products and an associated decline in end-user demand for inkjet supplies. Inkjet hardware unit shipments declined 45% 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 weakening market and some

lost retail shelf space. Inkjet hardware AUR increased 13% YTY due to favorable product mix shift, partially offset by a negative impact of pricing.

 

Revenue by geography:

 

The following table provides a breakdown of the Company’s revenue by geography:

 

 

During 2009, revenue decreased in all geographies due to lower laser and inkjet supplies and hardware revenue. Currency exchange rates had a 3% unfavorable impact on revenue for the year 2009.

 

During 2008, revenue decreased in all geographies primarily due to lower laser and inkjet hardware revenue as well as lower inkjet supplies revenue. Currency exchange rates had a 2% favorable impact on revenue for the year 2008.

 

Gross Profit

 

The following table provides gross profit information:

 

 

During 2009, consolidated gross profit decreased when compared to the prior year while gross profit as a percentage of revenue was relatively flat when compared to the prior year. The gross profit margin versus the prior period was impacted by a 2.4 percentage point increase due to a favorable mix shift among products, reflecting a lower relative percentage of hardware versus supplies, and a 2.1 percentage point decrease due to product margins as well as a 0.4 percentage point decrease attributable to higher YTY restructuring-related actions. Gross profit in 2009 included $51.5 million of restructuring-related charges and project costs in connection with the Company’s restructuring activities. See “Restructuring and Related Charges and Project Costs” that follows for further discussion.

 

During 2008, consolidated gross profit decreased when compared to the prior year while gross profit as a percentage of revenue increased when compared to the prior year. The change in the gross profit margin over the prior period was primarily due to a 5.3 percentage point increase due to a favorable mix shift among products, primarily less inkjet hardware and more laser supplies, partially offset by a 2.3 percentage point decrease due to product margins and a 0.5 percentage point decrease attributable to restructuring-related actions, primarily from an increase in accelerated depreciation charges YTY. Gross profit in 2008 included $42.5 million of restructuring-related charges and project costs in connection with the Company’s restructuring activities. See “Restructuring and Related Charges and Project Costs” that follows for further discussion.

Operating Expense

 

The following table presents information regarding the Company’s operating expenses during the periods indicated:

 

 

Research and development decreased in 2009 compared to the prior year primarily due to the Company’s efforts to reduce these operating expenses through platform consolidations and increased productivity. Research and development increased in 2008 compared to the prior year primarily due to the Company’s investment to support laser product and solution development.

 

Selling, general and administrative (“SG&A”) expenses in 2009 decreased YTY primarily driven by lower selling expenses along with lower general and administrative expenses. SG&A expenses in 2008 decreased YTY due to lower general and administrative expenses. The lower SG&A expenses for both years were attributable to savings realized from the Company’s restructuring actions. Additionally, SG&A expenses in 2009 and 2008 included project costs related to the Company’s restructuring activities. See discussion below of restructuring-related charges and project costs included in the Company’s operating expenses for the years presented in the table above.

 

In 2009, the Company incurred $89.8 million of restructuring-related charges and project costs due to the Company’s restructuring plans. Of the $89.8 million of total restructuring-related charges and project costs incurred in 2009, $19.2 million is included in Selling, general and administrative while $70.6 million is included in Restructuring and related charges on the Company’s Consolidated Statements of Earnings.

 

In 2008, the Company incurred $50.2 million of restructuring-related charges and project costs due to the Company’s restructuring plans. Of the $50.2 million of total restructuring-related charges and project costs incurred in 2008, $23.4 million is included in Selling, general and administrative while $26.8 million is included in Restructuring and related charges on the Company’s Consolidated Statements of Earnings.

 

In 2007, the Company incurred $35.0 million of restructuring-related charges and project costs in connection with the Company’s restructuring plans. Of the $35.0 million of total restructuring-related charges and project costs incurred in 2007, $9.3 million (net of a $3.5 million pre-tax gain on the sale of the Rosyth, Scotland facility) is included in Selling, general and administrative while $25.7 million is included in Restructuring and related charges on the Company’s Consolidated Statements of Earnings.

 

See “Restructuring and Related Charges and Project Costs” that follows for further discussion of the Company’s restructuring plans.

Operating Income (Loss)

 

The following table provides operating income by market segment:

 

 

For the year ended December 31, 2009, the decrease in consolidated operating income was due to decreased gross profits partially offset by lower operating expenses. Operating income for PSSD and ISD decreased YTY due to lower supplies revenue reflecting lower volumes, partially offset by lower operating expenses.

 

For the year ended December 31, 2008, the decrease in consolidated operating income was due to decreased gross profits and higher operating expenses. Operating income for PSSD decreased YTY due to higher operating expenses, reflecting higher product development investments, and lower hardware gross profits, reflecting the impact of aggressive pricing as well as a negative impact due to product mix. Operating income for ISD increased YTY due to increased hardware gross margin, due to lower hardware unit sales, and decreased operating expenses, partially offset by lower supplies revenue.

 

During 2009, the Company incurred total pre-tax restructuring-related charges and project costs of $64.6 million in PSSD, $44.4 million in ISD and $32.3 million in All other. During 2008, the Company incurred total pre-tax restructuring-related charges and project costs of $24.4 million in PSSD, $27.3 million in ISD and $41.0 million in All other. During 2007, the Company incurred restructuring-related charges and project costs of $12.1 million in PSSD, $12.2 million in ISD and $27.7 million in All other. See “Restructuring and Related Charges and Project Costs” that follows for further discussion.

 

Interest and Other

 

The following table provides interest and other information:

 

 

Total interest and other (income) expense, net, was expense of $29 million in 2009 compared to expense of $1 million in 2008. The 2009 net expense increase YTY was primarily due to lower interest income from declining interest rates on the Company’s investments and lower investment balances as well as increased interest expense from the $650 million debt the Company issued in May 2008.

 

Total interest and other (income) expense, net, was expense of $1 million in 2008 compared to income of $28 million in 2007. The 2008 decrease YTY was primarily due to increased interest expense from the $650 million debt the Company issued in May 2008 as well as the $8 million pre-tax gain the Company recognized in 2007 from the substantial liquidation of the Company’s Scotland entity that did not recur in 2008. Additionally, the Company recognized $8 million in net losses in 2008 related to its marketable securities.

Provision for Income Taxes and Related Matters

 

The Company’s effective income tax rate was approximately 22.0%, 12.9% and 13.9% in 2009, 2008 and 2007, respectively. See Note 12 to the Consolidated Financial Statements in Part II, Item 8 for a reconciliation of the Company’s effective tax rate to the U.S. statutory rate.

 

The 9.1 percentage point increase of the effective tax rate from 2008 to 2009 was due to a geographic shift in earnings (5.1 percentage points) toward higher tax jurisdictions in 2009 and the reversal of previously-accrued taxes (3.1 percentage points) in 2008 that did not recur in 2009, along with a variety of other factors (0.9 percentage points).

 

The 1.0 percentage point reduction of the effective tax rate from 2007 to 2008 was due to a reduction of 5.3 percentage points, primarily related to the geographic shift in earnings to lower tax jurisdictions in 2008, along with a variety of other factors, partially offset by a smaller amount of reversals and adjustments to previously accrued taxes in 2008 (increase of 4.3 percentage points) when compared to reversals and adjustments recorded in 2007. During 2008, the Company reversed $11.6 million of previously accrued taxes principally due to the settlement of the U.S. tax audit for years 2004 and 2005, while in 2007, the Company reversed a total of $29.6 million of previously accrued taxes which pertained to the settlement of a tax audit outside the U.S. and other adjustments to previously recorded tax amounts.

 

Net Earnings

 

Net earnings for the year ended December 31, 2009 decreased 39% from the prior year primarily due to lower operating income and lower interest and other income/expense, net. Net earnings in 2009 included $141.3 million of pre-tax restructuring-related charges and project costs in connection with the Company’s restructuring activities versus $92.7 million in 2008. See “Restructuring and Related Charges and Project Costs” that follows for further discussion.

 

Net earnings for the year ended December 31, 2008 decreased 20% from the prior year primarily due to lower operating income partially offset by a lower effective tax rate. Net earnings in 2008 included $92.7 million of pre-tax restructuring-related charges and project costs in connection with the Company’s restructuring activities versus $52.0 million in 2007. See “Restructuring and Related Charges and Project Costs” that follows for further discussion. Net earnings in 2008 also included $12 million of non-recurring tax benefits.

 

Net earnings in 2007 included $52.0 million (net of a $3.5 million pre-tax gain on the sale of the Rosyth, Scotland facility) of pre-tax restructuring-related charges and project costs. See “Restructuring and Related Charges and Project Costs” that follows for further discussion. Net earnings in 2007 also included an $8.1 million pre-tax foreign exchange gain realized upon the substantial liquidation of the Company’s Scotland entity and $29 million of non-recurring tax benefits.

 

Earnings per Share

 

The following table summarizes basic and diluted net earnings per share:

 

 

For the year ended December 31, 2009, the decreases in basic and diluted net earnings per share YTY were attributable to decreased earnings partially offset by the decreases in the average number of shares outstanding.

 

For the year ended December 31, 2008, the decreases in basic and diluted net earnings per share YTY were attributable to decreased earnings partially offset by the decreases in the average number of shares outstanding, primarily due to the Company’s stock repurchases.

RESTRUCTURING AND RELATED CHARGES AND PROJECT COSTS

 

Summary of Restructuring Impacts

 

The Company’s 2009 financial results are impacted by its ongoing restructuring plans and related projects and are discussed in further detail below. Project costs 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, and include such items as compensation costs for overlap staffing, travel expenses, consulting costs and training costs. The table below summarizes the 2009 financial impacts of the Company’s restructuring plans and related projects.

 

For the year ended December 31, 2009, the Company incurred charges, including project costs, of $141.3 million for the Company’s restructuring plans as follows:

 

 

 

The Company incurred $51.5 million of accelerated depreciation charges and project costs in Cost of revenue and $0.1 million in Selling, general and administrative on the Consolidated Statements of Earnings. Total employee termination benefits and contract termination and lease charges of $70.6 million are included in Restructuring and related charges while $19.1 million of related project costs are included in Selling, general and administrative on the Consolidated Statements of Earnings.

 

For the year ended December 31, 2009, the Company incurred restructuring and related charges and project costs related to its restructuring plans of $64.6 million in PSSD, $44.4 million in ISD and $32.3 million in All other.

 

In the first quarter of 2010, the Company expects savings of approximately $55 million from the 2007, 2008 and 2009 restructuring actions. In 2010 due to the 2009 restructuring actions, the Company expects restructuring and related costs and expenses to be approximately $65 million, with $17 million expected to be incurred in the first quarter.

 

October 2009 Restructuring Plan

 

General

 

As part of Lexmark’s ongoing plans to improve the efficiency and effectiveness of all of our operations, the Company announced restructuring actions (the “October 2009 Restructuring Plan”) on October 20, 2009. The Company continues its focus on refining its selling and service organization, reducing its general and administrative expenses, consolidating its cartridge manufacturing capacity, and enhancing the efficiency of its supply chain infrastructure. The actions taken will reduce cost and expense across the organization, with a focus in manufacturing and supply chain, service delivery overhead, marketing and sales support, corporate overhead and development positions as well as reducing cost through consolidation of facilities in supply chain and cartridge manufacturing. The Company expects these actions to be principally completed by the end of the first quarter of 2011.

The October 2009 Restructuring Plan is expected to impact about 825 positions worldwide and should result in total pre-tax charges of approximately $120 million. Charges of $63.5 million were incurred in 2009, with approximately $56.5 million expected to be incurred in 2010 — 2011. The company expects the total cash cost of this plan to be approximately $105 million.

 

Lexmark expects the October 2009 Restructuring Plan to generate savings of approximately $70 million in 2010, and ongoing savings beginning in 2011 of approximately $110 million. These ongoing savings should be split approximately 60% to operating expense and 40% to cost of goods sold. Ongoing cash savings of approximately $105 million are expected beginning in 2011.

 

Impact to 2009 Financial Results

 

For the year ended December 31, 2009, the Company incurred charges of $63.5 million for the October 2009 Restructuring Plan as follows:

 

 

The Company incurred $7.1 million of accelerated depreciation charges and project costs in Cost of revenue on the Consolidated Statements of Earnings. Employee termination benefit charges of $52.4 million and contract termination and lease charges of $1.0 million are included in Restructuring and related charges, and $3.0 million of related project costs are included in Selling, general and administrative on the Company’s Consolidated Statements of Earnings.

 

For the year ended December 31, 2009, the Company incurred restructuring and related charges and project costs related to the October 2009 Restructuring Plan of $47.0 million in PSSD, $4.2 million in ISD and $12.3 million in All other.

 

Liability Rollforward

 

The following table represents a rollforward of the liability incurred for employee termination benefits and contract termination and lease charges in connection with the October 2009 Restructuring Plan. Of the total $50.9 million restructuring liability, $23.6 million is included in Accrued liabilities and $27.3 million is included in Other liabilities on the Company’s Consolidated Statements of Financial Position.

 

 

April 2009 Restructuring Plan

 

General

 

As part of Lexmark’s ongoing plan to consolidate manufacturing capacity and reduce costs and expenses worldwide, the Company announced on April 21, 2009 the planned closure of its inkjet cartridge manufacturing facility in Juarez, Mexico by the end of the first quarter of 2010 as well as the continued restructuring of its worldwide workforce (the “April 2009 Restructuring Plan”). The April 2009 Restructuring Plan is expected to impact about 360 positions worldwide, with approximately 270 coming from the closure of the facility in Juarez, Mexico. The Company expects the April 2009 Restructuring Plan will result in total pre-tax charges of approximately $50.0 million with cash costs estimated at $10.0 million. The Company expects the April 2009 Restructuring Plan to be substantially completed by the end of the second quarter of 2010 and currently expects total 2010 savings of more than $20.0 million.

 

Impact to 2009 Financial Results

 

For the year ended December 31, 2009, the Company incurred charges of $44.3 million for the April 2009 Restructuring Plan as follows:

 

 

The Company incurred $37.0 million of accelerated depreciation charges and project costs in Cost of revenue on the Consolidated Statements of Earnings. Total employee termination benefit charges of $5.9 million are included in Restructuring and related charges, and $1.4 million of related project costs are included in Selling, general and administrative on the Company’s Consolidated Statements of Earnings.

 

For the year ended December 31, 2009, the Company incurred restructuring and related charges and project costs related to the April 2009 restructuring plan of $4.2 million in PSSD, $39.0 million in ISD and $1.1 million in All other.

 

Liability Rollforward

 

The following table represents a rollforward of the liability incurred for employee termination benefits in connection with the April 2009 Restructuring Plan. The liability is included in Accrued liabilities on the Company’s Consolidated Statements of Financial Position.

 

 

2009 Restructuring Plan

 

General

 

In response to global economic weakening, the Company announced a restructuring plan (the “2009 Restructuring Plan”) on January 13, 2009. The 2009 Restructuring Plan impacted about 375 positions through the end of 2009. The areas impacted include general and administrative functions, supply chain and sales support, research and development program consolidation, as well as marketing and sales management. Expected savings are $50.0 million per year, with approximately 95% of the savings expected to benefit operating expense, and the remaining 5% will impact cost of sales. The 2009 Restructuring Plan was substantially completed by the end of 2009.

 

Impact to 2009 Financial Results

 

For the year ended December 31, 2009, the Company incurred charges of $23.8 million for the 2009 Restructuring Plan as follows:

 

 

The Company incurred $4.4 million of accelerated depreciation charges and project costs in Cost of revenue on the Consolidated Statements of Earnings. Total employee termination benefit charges of $8.4 million are included in Restructuring and related charges, and $11.0 million of related project costs are included in Selling, general and administrative on the Consolidated Statements of Earnings.

 

For the year ended December 31, 2009, the Company incurred restructuring and related charges and project costs related to the 2009 Restructuring Plan of $10.9 million in PSSD, $1.5 million in ISD and $11.4 million in All other.

 

Impact to 2008 Financial Results

 

The Company incurred charges of $20.2 million related to employee termination benefits in the fourth quarter of 2008 because the charges were probable and estimable for the 2008 year-end reporting period. Including the $20.2 million charge in 2008, the Company has incurred $44.0 million of total charges for the 2009 Restructuring Plan.

Liability Rollforward

 

The following table represents a rollforward of the liability incurred for employee termination benefits in connection with the 2009 Restructuring Plan. The liability is included in Accrued liabilities on the Company’s Consolidated Statements of Financial Position.