LEXMARK INTERNATIONAL INC /KY/ - FORM 10-Q - November 4, 2016

Attached files

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EX-32.1 - EXHIBIT 32.1 - LEXMARK INTERNATIONAL INC /KY/exhibit321.htm
EX-32.2 - EXHIBIT 32.2 - LEXMARK INTERNATIONAL INC /KY/exhibit322.htm
EX-31.2 - EXHIBIT 31.2 - LEXMARK INTERNATIONAL INC /KY/exhibit312.htm
EX-31.1 - EXHIBIT 31.1 - LEXMARK INTERNATIONAL INC /KY/exhibit311.htm

 

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

[X]     QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended September 30, 2016

 

OR

 

[   ]     TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _______to _______.

 

Commission File No. 1-14050

 

LEXMARK INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware

06-1308215

(State or other jurisdiction

(I.R.S. Employer

of incorporation or organization)

Identification No.)

 

 

One Lexmark Centre Drive

 

740 West New Circle Road

 

Lexington, Kentucky

40550

(Address of principal executive offices)

(Zip Code)

 

 

(859) 232-2000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes [X]    No [   ]

 

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 [X]    No [   ]

 

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

 

Large accelerated filer  [X]

Accelerated filer  [   ]

Non-accelerated filer [   ]

(Do not check if a smaller reporting company)

Smaller reporting company [   ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes [   ]    No [X]

 

The registrant had 62,910,737 shares outstanding (excluding shares held in treasury) of Class A Common Stock, par value $0.01 per share, as of the close of business on October 28, 2016.


 

 




LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

 

INDEX

 

 

 

 

 

 

 

 

Page of

Form 10-Q

 

PART I – FINANCIAL INFORMATION

 

 

Item 1.

FINANCIAL STATEMENTS (Unaudited)

 

 

Consolidated Condensed Statements of Earnings

 

 

      Three and Nine Months Ended September 30, 2016 and 2015

2

 

Consolidated Condensed Statements of Comprehensive Earnings

 

 

      Three and Nine Months Ended September 30, 2016 and 2015

3

 

Consolidated Condensed Statements of Financial Position

 

 

      As of September 30, 2016 and December 31, 2015

4

 

Consolidated Condensed Statements of Cash Flows

 

 

      Nine Months Ended September 30, 2016 and 2015

5

 

Notes to Consolidated Condensed Financial Statements

6

Item 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

30

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

49

Item 4.

CONTROLS AND PROCEDURES

50

 

 

 

 

PART II – OTHER INFORMATION

 

 

 

 

Item 1.

LEGAL PROCEEDINGS

52

Item 1A.

RISK FACTORS

52

Item 6.

EXHIBITS

53


 

 




Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical fact, are forward-looking statements. Forward-looking statements are made based upon information that is currently available or management’s current expectations and beliefs concerning future developments and their potential effects upon the Company, speak only as of the date hereof, and are subject to certain risks and uncertainties. We assume no obligation to update or revise any forward-looking statements contained or incorporated by reference herein to reflect any change in events, conditions or circumstances, or expectations with regard thereto, on which any such forward-looking statement is based, in whole or in part. There can be no assurance that future developments affecting the Company will be those anticipated by management, and there are a number of factors that could adversely affect the Company’s future operating results or cause the Company’s actual results to differ materially from the estimates or expectations reflected in such forward-looking statements, including, without limitation, the factors set forth under the “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections 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” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections 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.


1




PART I – FINANCIAL INFORMATION

 

Item 1.           FINANCIAL STATEMENTS

 

LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS

(In Millions, Except Per Share Amounts)

(Unaudited)

 

 

Three Months Ended

 

 

Nine Months Ended

 

September 30

 

 

September 30

 

2016

 

2015

 

 

2016

 

2015

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Product

$

647.8 

 

$

669.0 

 

 

$

1,940.0 

 

$

2,103.6 

Service

 

196.1 

 

 

182.1 

 

 

 

572.7 

 

 

478.8 

Total Revenue

 

843.9 

 

 

851.1 

 

 

 

2,512.7 

 

 

2,582.4 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

415.8 

 

 

423.8 

 

 

 

1,236.9 

 

 

1,267.9 

Service

 

98.7 

 

 

107.7 

 

 

 

303.0 

 

 

302.1 

Restructuring-related costs

 

– 

 

 

– 

 

 

 

– 

 

 

0.8 

Total Cost of revenue

 

514.5 

 

 

531.5 

 

 

 

1,539.9 

 

 

1,570.8 

Gross profit

 

329.4 

 

 

319.6 

 

 

 

972.8 

 

 

1,011.6 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

68.5 

 

 

81.6 

 

 

 

228.0 

 

 

244.9 

Selling, general and administrative

 

228.5 

 

 

261.0 

 

 

 

743.1 

 

 

736.0 

Restructuring and related (reversals) charges

 

(3.5)

 

 

(1.4)

 

 

 

(18.6)

 

 

32.2 

Operating expense

 

293.5 

 

 

341.2 

 

 

 

952.5 

 

 

1,013.1 

Operating income (loss)

 

35.9 

 

 

(21.6)

 

 

 

20.3 

 

 

(1.5)

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense (income), net

 

11.5 

 

 

10.4 

 

 

 

33.8 

 

 

28.1 

Other expense (income), net

 

1.3 

 

 

3.4 

 

 

 

2.5 

 

 

3.6 

Earnings (loss) before income taxes

 

23.1 

 

 

(35.4)

 

 

 

(16.0)

 

 

(33.2)

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision (benefit) for income taxes

 

4.8 

 

 

(20.2)

 

 

 

40.5 

 

 

(3.5)

Net earnings (loss)

$

18.3 

 

$

(15.2)

 

 

$

(56.5)

 

$

(29.7)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings (loss) per share:

 

 

 

 

 

 

 

 

 

 

 

 

Basic

$

0.29 

 

$

(0.25)

 

 

$

(0.90)

 

$

(0.48)

Diluted

$

0.28 

 

$

(0.25)

 

 

$

(0.90)

 

$

(0.48)

Shares used in per share calculation:

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

63.0 

 

 

61.7 

 

 

 

62.8 

 

 

61.5 

Diluted

 

64.2 

 

 

61.7 

 

 

 

62.8 

 

 

61.5 

Cash dividends declared per common share

$

0.36 

 

$

0.36 

 

 

$

1.08 

 

$

1.08 

 

See Notes to Consolidated Condensed Financial Statements.

 

 

 

 

 

 

 

 

 


2



LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE EARNINGS

(In Millions)

(Unaudited)

 

 

Three Months Ended

 

 

Nine Months Ended

 

September 30

 

 

September 30

 

2016

 

2015

 

 

2016

 

2015

Net earnings (loss)

$

18.3 

 

$

(15.2)

 

 

$

(56.5)

 

$

(29.7)

Other comprehensive loss, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

(6.9)

 

 

(29.3)

 

 

 

(15.8)

 

 

(65.0)

Recognition of pension and other postretirement benefit plans prior service credit, net of (amortization)

 

(0.1)

 

 

(0.2)

 

 

 

(0.3)

 

 

(0.4)

Net unrealized loss on marketable securities

 

– 

 

 

– 

 

 

 

– 

 

 

(0.1)

Unrealized loss on cash flow hedges

 

(4.5)

 

 

(14.6)

 

 

 

(10.1)

 

 

(0.9)

Total other comprehensive loss, net of tax

 

(11.5)

 

 

(44.1)

 

 

 

(26.2)

 

 

(66.4)

Comprehensive earnings (loss)

$

6.8 

 

$

(59.3)

 

 

$

(82.7)

 

$

(96.1)

 

See Notes to Consolidated Condensed Financial Statements.

 

 

 

 

 

 

 

 

 

 

 

 

 



3



LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF FINANCIAL POSITION

(In Millions, Except Par Value)

(Unaudited)

 

 

September 30,

 

December 31,

 

2016

 

2015

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

$

117.7 

 

$

158.3 

Trade receivables, net of allowances of $26.7 in 2016 and $24.4 in 2015

 

397.5 

 

 

434.2 

Inventories

 

238.9 

 

 

231.9 

Prepaid expenses and other current assets

 

169.2 

 

 

204.9 

Total current assets

 

923.3 

 

 

1,029.3 

 

 

 

 

 

 

Property, plant and equipment, net

 

683.2 

 

 

740.2 

Goodwill

 

1,323.0 

 

 

1,325.1 

Intangibles, net

 

432.6 

 

 

532.5 

Other assets

 

275.2 

 

 

285.3 

Total assets

$

3,637.3 

 

$

3,912.4 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

$

398.9 

 

$

501.7 

Accrued liabilities

 

645.4 

 

 

669.8 

Total current liabilities

 

1,044.3 

 

 

1,171.5 

 

 

 

 

 

 

Long-term debt, net of unamortized discounts and issuance costs

 

1,017.9 

 

 

1,061.3 

Other liabilities

 

571.6 

 

 

561.6 

Total liabilities

 

2,633.8 

 

 

2,794.4 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders' equity:

 

 

 

 

 

Preferred stock, $.01 par value, 1.6 shares authorized; no shares issued and outstanding

 

– 

 

 

– 

Common stock, $.01 par value:

 

 

 

 

 

Class A, 900.0 shares authorized; 62.8 and 61.9 outstanding in 2016 and 2015, respectively

 

1.0 

 

 

1.0 

Class B, 10.0 shares authorized; no shares issued and outstanding

 

– 

 

 

– 

Capital in excess of par

 

1,068.4 

 

 

1,025.9 

Retained earnings

 

1,165.7 

 

 

1,292.8 

Treasury stock, net; at cost; 36.5 and 36.4 shares in 2016 and 2015, respectively

 

(1,040.4)

 

 

(1,036.7)

Accumulated other comprehensive loss

 

(191.2)

 

 

(165.0)

Total stockholders' equity

 

1,003.5 

 

 

1,118.0 

Total liabilities and stockholders' equity

$

3,637.3 

 

$

3,912.4 

 

See Notes to Consolidated Condensed Financial Statements.

 

 

 

 

 

 

 



4



LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(In Millions)

(Unaudited)

 

 

Nine Months Ended

 

September 30

 

2016

 

2015

Cash flows from operating activities:

 

 

 

 

 

Net loss

$

(56.5)

 

$

(29.7)

Adjustments to reconcile net loss to net cash flows provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

212.6 

 

 

222.6 

Deferred taxes

 

(1.4)

 

 

8.6 

Stock-based compensation expense

 

38.4 

 

 

25.6 

Pension and other postretirement expense (income)

 

25.2 

 

 

(5.6)

Other

 

(1.3)

 

 

1.8 

Change in assets and liabilities, net of acquisitions:

 

 

 

 

 

Trade receivables

 

36.3 

 

 

22.2 

Inventories

 

(7.0)

 

 

(3.3)

Accounts payable

 

(102.8)

 

 

(62.5)

Accrued liabilities

 

(10.4)

 

 

(68.8)

Other assets and liabilities

 

1.0 

 

 

(96.9)

Pension and other postretirement contributions

 

(6.0)

 

 

(9.3)

Net cash flows provided by operating activities

 

128.1 

 

 

4.7 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of property, plant and equipment

 

(57.1)

 

 

(84.1)

Purchases of marketable securities

 

– 

 

 

(284.2)

Proceeds from sales of marketable securities

 

– 

 

 

881.9 

Proceeds from maturities of marketable securities

 

– 

 

 

27.7 

Purchase of businesses, net of cash acquired

 

– 

 

 

(1,004.8)

Other

 

4.9 

 

 

(1.4)

Net cash flows used for investing activities

 

(52.2)

 

 

(464.9)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Repayment of assumed debt

 

– 

 

 

(1.3)

Proceeds from long-term debt

 

29.0 

 

 

447.0 

Payments on long-term debt

 

(73.0)

 

 

(50.0)

Purchase of shares from noncontrolling interest

 

– 

 

 

(4.6)

Payment of cash dividend

 

(67.7)

 

 

(66.3)

Purchase of treasury stock

 

(4.0)

 

 

(30.0)

Proceeds from employee stock plans

 

0.7 

 

 

5.7 

Other

 

(3.0)

 

 

1.5 

Net cash flows (used for) provided by financing activities

 

(118.0)

 

 

302.0 

Effect of exchange rate changes on cash and cash equivalents

 

1.5 

 

 

(8.2)

Net change in cash and cash equivalents

 

(40.6)

 

 

(166.4)

Cash and cash equivalents - beginning of period

 

158.3 

 

 

309.3 

Cash and cash equivalents - end of period

$

117.7 

 

$

142.9 

 

See Notes to Consolidated Condensed Financial Statements.


5




LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In Millions, Except Per Share Amounts)

(Unaudited)

 

 

1.          BASIS OF PRESENTATION

 

The accompanying interim Consolidated Condensed Financial Statements are unaudited; however, in the opinion of management of Lexmark International, Inc. (together with its subsidiaries, the “Company” or “Lexmark”), all adjustments necessary for a fair statement of the interim financial results have been included. All adjustments included were of a normal recurring nature. The results for the interim periods are not necessarily indicative of results to be expected for the entire year. The Consolidated Condensed Statements of Financial Position data as of December 31, 2015 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S.”). The Company filed with the Securities and Exchange Commission (“SEC”) audited consolidated financial statements for the year ended December 31, 2015, on Form 10-K, which included all information and notes necessary for such presentation. Accordingly, these financial statements and notes should be read in conjunction with the Company’s audited annual consolidated financial statements for the year ended December 31, 2015.

 

2.           BUSINESS COMBINATIONS

 

Pending Acquisition of Lexmark International, Inc.

 

In 2015, the Company announced that its Board of Directors authorized the exploration of strategic alternatives to enhance shareholder value. On April 19, 2016, the Company entered into an Agreement and Plan of Merger (“Merger Agreement”) providing for the acquisition of the Company by a consortium composed of Apex Technology Co., Ltd., PAG Asia Capital and Legend Capital Management Co., Ltd. (the “Consortium”) in a cash transaction for $40.50 per share. The Company’s shareholders approved the Merger Agreement on July 22, 2016. On September 30, 2016, the Company and the Consortium announced that they have received clearance from the Committee on Foreign Investment in the United States (“CFIUS”) to proceed with the proposed transaction. As a precondition to CFIUS clearance of the transaction, CFIUS required that the Company and the Consortium enter into a National Security Agreement with the Departments of Defense and Homeland Security. The merger remains subject to certain regulatory approvals and other customary closing conditions. While there can be no certainty that the merger will be successfully consummated, the Company expects the merger to close in 2016.

 

Kofax Limited

 

The Company completed its acquisition of Kofax Limited (“Kofax”) on May 21, 2015. The purchase of Kofax is included in Purchase of businesses, net of cash acquired in the Consolidated Condensed Statements of Cash Flows for the nine months ended September 30, 2015 in the amount of $974.5 million.

 

In the six months ended June 30, 2016 the Company recorded measurement period adjustments that increased Accrued expenses and other current liabilities by $2.1 million, decreased Deferred tax liability, net by $3.0 million, increased Other long-term liabilities by $0.1 million, and decreased Goodwill by $0.8 million. The measurement period adjustments to the previously recorded amounts reflect facts and circumstances that existed as of the acquisition date primarily arising from additional analysis of tax attributes and tax returns during the six months ended June 30, 2016, and were reflected in the financial statements during the six months ended June 30, 2016. The portion of the adjustment recorded in earnings during the six months ended June 30, 2016 that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date was not significant. The Company’s accounting for the acquisition of Kofax is now complete.

 

The unaudited pro forma results presented below include the effects of the acquisition of Kofax as if it had been completed as of January 1, 2014, the beginning of the comparable annual reporting period prior to the year of acquisition. Such unaudited pro forma financial results do not give pro forma effect to any other transaction or event. In addition, the unaudited pro forma results do not include any anticipated synergies or other expected benefits of the acquisition or costs necessary to obtain the anticipated synergies and benefits. Accordingly, the unaudited pro forma financial information below is not necessarily indicative of either future results of operations or results that might have been achieved had the acquisition been completed as of January 1, 2014.

 

The unaudited pro forma results include the amortization associated with an estimate for the acquired intangible assets and interest expense associated with debt used to fund the acquisition, as well as fair value adjustments for deferred revenue. The unaudited pro forma provision for income taxes has also been adjusted for all periods, based upon the foregoing and following adjustments to historical results and using a 37.8% blended tax rate representing the combined U.S. federal and state statutory rates. There is no material effect to the unaudited pro forma results presented below related to retrospectively adjusting Kofax’s historical results for the


6



change in accounting methodology for pension and other postretirement benefit plans adopted by Lexmark in the fourth quarter of 2013.

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30, 2015

 

September 30, 2015

Unaudited pro forma revenue

 

$

851.1 

 

$

2,687.7 

Unaudited pro forma earnings

 

$

(14.4)

 

$

(40.0)

 

Unaudited pro forma earnings for the three and nine months ended September 30, 2015 do not reflect acquisition-related costs of $1.3 million and $37.8 million that were historically recognized by Lexmark and Kofax in these respective periods. Unaudited pro forma earnings for the nine months ended September 30, 2015 do not reflect $8.7 million of acquisition-related compensation expenses. The acquisition-related costs and acquisition-related compensation expenses will not have an ongoing effect on the results of the combined entity.

 

Claron Technology, Inc.

 

The Company’s acquisition of Claron Technology, Inc. (“Claron”) in 2015 is included in Purchase of businesses, net of cash acquired in the Consolidated Condensed Statements of Cash Flows for the nine months ended September 30, 2015 in the amount of $30.3 million.

 

3.          RESTRUCTURING CHARGES

 

2016 Restructuring Actions

 

General

 

On February 23, 2016, the Company announced restructuring actions (the “2016 Restructuring Actions”) designed to increase profitability and operational efficiency primarily in its ISS segment. These restructuring actions are focused on optimizing the Company’s ISS structure, primarily in reaction to the continued strength of the U.S. dollar, and are also aligned with the previously announced strategic alternatives process.

 

The 2016 Restructuring Actions are expected to impact about 550 positions worldwide through December 2016, with a portion of the positions being shifted to low-cost countries. The 2016 Restructuring Actions will result in total pre-tax charges of approximately $32 million, with approximately $29 million incurred to date and the remainder to be incurred in 2016. The total cash costs of the 2016 Restructuring Actions will be approximately $30 million, of which $29 million has been incurred to date and the remainder to be incurred in 2016.

 

The Company expects to incur total pre-tax charges upon completion of the 2016 Restructuring Actions of approximately $30 million in ISS and approximately $2 million in All Other.

 

Impact to 2016 Financial Results

 

For the three months ended September 30, 2016, reversals of the Company’s 2016 Restructuring Actions were recorded in the Consolidated Condensed Statements of Earnings as follows:

 

 

Restructuring

 

Impact on

 

and related

 

Operating

 

reversals

 

income

Employee termination benefit reversals

$

(1.9)

 

$

(1.9)

 

For the nine months ended September 30, 2016, reversals for the Company’s 2016 Restructuring Actions were recorded in the Consolidated Condensed Statements of Earnings as follows:

 

 

Restructuring

 

Impact on

 

and related

 

Operating

 

reversals

 

income

Employee termination benefit reversals

$

(11.5)

 

$

(11.5)

 


7



For the three and nine months ended September 30, 2016, the Company incurred restructuring charges (reversals) in connection with the 2016 Restructuring Actions in the Company’s segments as follows:

 

 

Three Months Ended

 

Nine Months Ended

 

September 30, 2016

 

September 30, 2016

ISS

$

(1.9)

 

$

(13.9)

All other

 

– 

 

 

2.4 

Total reversals

$

(1.9)

 

$

(11.5)

 

For the three and nine months ended September 30, 2016, the Company incurred employee termination benefit charges (reversals), which include severance, medical and other benefits. The Company experienced higher levels of attrition than expected during the first nine months of 2016 as a result of the strategic alternatives process as well as announced restructuring programs.  These higher levels of attrition reduced the expected termination benefits resulting in the reversals.  The Company’s cost savings and headcount reduction targets have not changed related to these restructuring actions.  Charges (reversals) for the 2016 Restructuring Actions and all of the other restructuring actions were recorded in accordance with FASB guidance on employers’ accounting for postemployment benefits and guidance on accounting for costs associated with exit or disposal activities, as appropriate.

 

Pension and postretirement plan curtailment and termination benefit losses (gains) related to the 2016 Restructuring Actions were not included in the tables above. Refer to Note 10 of the Notes to Consolidated Condensed Financial Statements for more information.

 

Liability Rollforward

 

The following table represents a rollforward of the liability incurred for employee termination benefits in connection with the 2016 Restructuring Actions. The total restructuring liability as of September 30, 2016 is included in Accrued liabilities on the Company’s Consolidated Condensed Statements of Financial Position.

 

 

Employee

 

Termination

 

Benefits

Balance at January 1, 2016

$

40.4 

Costs incurred

 

– 

Reversals (1)

 

(11.5)

Total restructuring (reversals) charges, net

 

(11.5)

Payments and other (2)

 

(24.5)

Balance at September 30, 2016

$

4.4 

 

(1) Reversals due to changes in estimates for employee termination benefits and attrition.

(2) Other consists of changes in the liability balance due to foreign currency translations.

 

2015 Restructuring Actions

 

General

 

On July 21, 2015, the Company announced restructuring actions (the “2015 Restructuring Actions”) designed to increase profitability and operational efficiency. These Company-wide restructuring actions are broad-based but primarily capture the anticipated cost and expense synergies from the Kofax and ReadSoft AB (“ReadSoft”) acquisitions. Primary Company-wide impact will be general and administrative, marketing and development positions as well as the consolidation of regional facilities.

 

The 2015 Restructuring Actions are expected to impact about 500 positions worldwide through December 2016, with a portion of the positions being shifted to low-cost countries. The 2015 Restructuring Actions will result in total pre-tax charges of approximately $30 million, all of which has been incurred to date. The total cash costs of the 2015 Restructuring Actions will be approximately $28 million, all of which has been incurred to date.

 

The Company expects to incur total pre-tax charges upon completion of the 2015 Restructuring Actions of approximately $8 million in ISS, approximately $3 million in All Other and approximately $19 million in Enterprise Software.

 


8



Impact to 2016 and 2015 Financial Results

 

For the three months ended September 30, 2016 and 2015, charges (reversals) for the Company’s 2015 Restructuring Actions were recorded in the Consolidated Condensed Statements of Earnings as follows:

 

 

Three Months Ended

 

September 30, 2016

 

September 30, 2015

 

Restructuring

 

 

 

Restructuring

 

 

 

and related

 

Impact on

 

and related

 

Impact on

 

charges

 

Operating

 

charges

 

Operating

 

(reversals)

 

income

 

(reversals)

 

income

Employee termination benefit charges (reversals)

$

(1.7)

 

$

(1.7)

 

$

0.1 

 

$

0.1 

Contract termination and lease charges

 

0.1 

 

 

0.1 

 

 

– 

 

 

– 

Total restructuring charges (reversals)

$

(1.6)

 

$

(1.6)

 

$

0.1 

 

$

0.1 

 

For the nine months ended September 30, 2016 and 2015, charges (reversals) for the Company’s 2015 Restructuring Actions were recorded in the Consolidated Condensed Statements of Earnings as follows:

 

 

Nine Months Ended

 

September 30, 2016

 

September 30, 2015

 

Selling,

 

Restructuring

 

 

 

Restructuring

 

 

 

general

 

and related

 

Impact on

 

and related

 

Impact on

 

and

 

charges

 

Operating

 

charges

 

Operating

 

administrative

 

(reversals)

 

income

 

(reversals)

 

income

Accelerated depreciation charges

$

1.0 

 

$

– 

 

$

1.0 

 

$

– 

 

$

– 

Employee termination benefit charges (reversals)

 

– 

 

 

(6.8)

 

 

(6.8)

 

 

32.2 

 

 

32.2 

Contract termination and lease charges

 

– 

 

 

0.2 

 

 

0.2 

 

 

0.1 

 

 

0.1 

Total restructuring charges (reversals)

$

1.0 

 

$

(6.6)

 

$

(5.6)

 

$

32.3 

 

$

32.3 

 

For the periods indicated above, the Company incurred employee termination benefit charges (reversals), which include severance, medical and other benefits. The Company experienced higher levels of attrition than expected during the first nine months of 2016 as a result of the strategic alternatives process as well as announced restructuring programs. These higher levels of attrition reduced the expected termination benefits resulting in the reversals.  The Company’s cost savings and headcount reduction targets have not changed related to these restructuring actions.  Charges (reversals) for the 2015 Restructuring Actions and all of the other restructuring actions were recorded in accordance with FASB guidance on employers’ accounting for postemployment benefits and guidance on accounting for costs associated with exit or disposal activities, as appropriate.

 

For the three and nine months ended September 30, 2016 and 2015, the Company incurred restructuring charges (reversals) in connection with the 2015 Restructuring Actions in the Company’s segments as follows:

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

 

2016

 

2015

 

2016

 

2015

ISS

$

1.0 

 

$

7.0 

 

$

(2.9)

 

$

10.6 

Enterprise Software

 

(2.1)

 

 

(2.3)

 

 

(1.9)

 

 

16.2 

All other

 

(0.5)

 

 

(4.6)

 

 

(0.8)

 

 

5.5 

Total charges (reversals)

$

(1.6)

 

$

0.1 

 

$

(5.6)

 

$

32.3 

 


9



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 2015 Restructuring Actions.

 

 

Employee

 

Contract

 

 

 

 

Termination

 

Termination &

 

 

 

 

Benefits

 

Lease Charges

 

Total

Balance at January 1, 2016

$

28.1 

 

$

– 

 

$

28.1 

Costs incurred

 

2.5 

 

 

0.2 

 

 

2.7 

Reversals (1)

 

(9.3)

 

 

– 

 

 

(9.3)

Total restructuring (reversals) charges, net

 

(6.8)

 

 

0.2 

 

 

(6.6)

Payments and other (2)

 

(16.9)

 

 

(0.2)

 

 

(17.1)

Balance at September 30, 2016

$

4.4 

 

$

– 

 

$

4.4 

 

(1) Reversals due to changes in estimates for employee termination benefits and attrition.

(2) Other consists of changes in the liability balance due to foreign currency translations.

 

Summary of Other Restructuring Actions

 

General

 

As part of Lexmark’s ongoing strategy to increase the focus of its talent and resources on higher usage business platforms, the Company announced various restructuring actions (“Other Restructuring Actions”) over the past several years. The Other Restructuring Actions primarily include exiting the development and manufacturing of the Company’s remaining inkjet hardware, with reductions primarily in the areas of inkjet-related manufacturing, research and development, supply chain, marketing and sales as well as other support functions. The Other Restructuring Actions are considered substantially completed and any remaining charges to be incurred from these actions are expected to be immaterial.

 

Impact to 2016 and 2015 Financial Results

 

For the three months ended September 30, 2016 and 2015 charges (reversals) for the Company’s Other Restructuring Actions were recorded in the Consolidated Condensed Statements of Earnings as follows:

 

 

Three Months Ended

 

September 30, 2016

 

September 30, 2015

 

Restructuring

 

 

 

Selling,

 

Restructuring

 

 

 

and related

 

Impact on

 

general

 

and related

 

Impact on

 

charges

 

Operating

 

and

 

charges

 

Operating

 

(reversals)

 

income

 

administrative

 

(reversals)

 

income

Accelerated depreciation charges

$

– 

 

$

– 

 

$

0.1 

 

$

– 

 

$

0.1 

Employee termination benefit charges (reversals)

 

– 

 

 

– 

 

 

– 

 

 

(1.4)

 

 

(1.4)

Contract termination and lease charges (reversals)

 

– 

 

 

– 

 

 

– 

 

 

(0.1)

 

 

(0.1)

Total restructuring charges (reversals)

$

– 

 

$

– 

 

$

0.1 

 

$

(1.5)

 

$

(1.4)

 


10



For the nine months ended September 30, 2016 and 2015 charges (reversals) for the Company’s Other Restructuring Actions were recorded in the Consolidated Condensed Statements of Earnings as follows:

 

 

Nine Months Ended

 

September 30, 2016

 

September 30, 2015

 

Restructuring

 

 

 

 

 

Selling,

Restructuring

 

 

 

and related

Impact on

 

 

 

 

 

general

and related

Impact on

 

charges

Operating

 

Restructuring-

Impact on

and

charges

Operating

 

(reversals)

income

 

related costs

Gross profit

administrative

(reversals)

income

Accelerated depreciation charges

$

– 

$

– 

 

$

0.1 

$

0.1 

$

0.6 

$

– 

$

0.7 

Excess components and other inventory-related charges

 

– 

 

– 

 

 

0.7 

 

0.7 

 

– 

 

– 

 

0.7 

Employee termination benefit charges (reversals)

 

(0.2)

 

(0.2)

 

 

– 

 

– 

 

– 

 

0.2 

 

0.2 

Contract termination and lease charges (reversals)

 

(0.3)

 

(0.3)

 

 

– 

 

– 

 

– 

 

(0.3)

 

(0.3)

Total restructuring charges (reversals)

$

(0.5)

$

(0.5)

 

$

0.8 

$

0.8 

$

0.6 

$

(0.1)

$

1.3 

 

For the three and nine months ended September 30, 2016 and 2015, the Company incurred restructuring charges (reversals) in connection with the Other Restructuring Actions in the Company’s segments as follows:

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

 

2016

 

2015

 

2016

 

2015

ISS

$

– 

 

$

(1.1)

 

$

– 

 

$

0.8 

Enterprise Software

 

– 

 

 

(0.2)

 

 

(0.3)

 

 

0.3 

All other

 

– 

 

 

(0.1)

 

 

(0.2)

 

 

0.2 

Total charges (reversals)

$

– 

 

$

(1.4)

 

$

(0.5)

 

$

1.3 

 

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 Company’s Other Restructuring Actions.

 

 

Employee

 

Contract

 

 

 

 

Termination

 

Termination &

 

 

 

 

Benefits

 

Lease Charges

 

Total

Balance at January 1, 2016

$

0.4 

 

$

0.5 

 

$

0.9 

Costs incurred

 

0.1 

 

 

– 

 

 

0.1 

Reversals (1)

 

(0.3)

 

 

– 

 

 

(0.3)

Total restructuring (reversals) charges , net

 

(0.2)

 

 

– 

 

 

(0.2)

Payments and other (2)

 

(0.2)

 

 

(0.5)

 

 

(0.7)

Balance at September 30, 2016

$

– 

 

$

– 

 

$

– 

 

(1) Reversals due to changes in estimates for employee termination benefits.

(2) Other consists of changes in the liability balance due to foreign currency translations.

 


11



4.          DEBT

 

The carrying value of the Company’s outstanding long-term debt consists of the following:

 

 

September 30,

 

December 31,

 

2016

 

2015

Trade receivables facility

$

12.0 

 

$

76.0 

Revolving credit facility

 

308.0 

 

 

288.0 

Senior notes, due 2018

 

300.0 

 

 

300.0 

Senior notes, due 2020

 

400.0 

 

 

400.0 

 

$

1,020.0 

 

$

1,064.0 

Less: Unamortized discounts

 

(0.1)

 

 

(0.2)

Less: Unamortized issuance costs

 

(2.0)

 

 

(2.5)

Total long-term debt, net of unamortized discounts and issuance costs

$

1,017.9 

 

$

1,061.3 

 

In addition to the information in the table above, during 2016 the Company borrowed an additional $29.0 million and repaid $73.0 million of borrowings which is presented gross on the Consolidated Condensed Statements of Cash Flows. The Company presents borrowings and repayments of less than 90 days on a net basis on the Consolidated Statements of Cash Flows and such amounts were $543.0 million and $543.0 million, respectively, for the nine months ended September 30, 2016 and $390.0 million and $361.0 million, respectively, for the nine months ended September 30, 2015.

 

Trade Receivables Facility

 

In the U.S., the Company, Lexmark Enterprise Software, LLC (“LESL”) and Kofax, Inc. transfer a majority of their receivables to a wholly-owned subsidiary, Lexmark Receivables Corporation (“LRC”), which then may transfer the receivables on a limited recourse basis to an unrelated third party. The financial results of LRC are included in the Company’s consolidated financial results since it is a wholly-owned subsidiary. LRC is a separate legal entity with its own separate creditors who, in a liquidation of LRC, would be entitled to be satisfied out of LRC’s assets prior to any value in LRC becoming available for equity claims of the Company. The Company accounts for transfers of receivables from LRC to the unrelated third party as a secured borrowing with the pledge of its receivables as collateral since LRC has the ability to repurchase the receivables interests at a determinable price. At September 30, 2016, the Company had total accounts receivable pledged as collateral of $23.2 million held by LRC which were included in Trade receivables in the Company’s Consolidated Condensed Statements of Financial Position.

 

On August 27, 2015, the trade receivables facility was amended by extending the term of the facility to October 6, 2017. In addition, Kofax, Inc. became a new originator under the facility, permitting advancements under the facility as accounts receivables are originated by Kofax, Inc. and sold to LRC. The maximum capital availability under the facility remains at $125 million under the amended agreement. Interest on borrowings is calculated using daily 1-month LIBOR index or conduit commercial paper rates plus a spread of 0.40% along with a liquidity fee of 0.40%.

 

This facility contains customary affirmative and negative covenants as well as specific provisions related to the quality of the accounts receivables transferred. As collections reduce previously transferred receivables, the Company, LESL and Kofax, Inc. may replenish these with new receivables. Lexmark, LESL and Kofax, Inc. bear a limited risk of bad debt losses on the trade receivables transferred, since the Company, LESL and Kofax, Inc. over-collateralize the receivables transferred with additional eligible receivables. Lexmark, LESL and Kofax, Inc. address this risk of loss in the allowance for doubtful accounts. Receivables transferred to the unrelated third-party may not include amounts over 90 days past due or concentrations over certain limits with any one customer. The facility also contains customary cash control triggering events which, if triggered, could adversely affect the Company’s liquidity and/or its ability to obtain secured borrowings. A downgrade in the Company’s credit rating would reduce the amount of secured borrowings available under the facility.

 

Revolving Credit Facility

 

The Company currently has a $500 million, 5-year senior, unsecured, multicurrency revolving credit facility with a maturity date of February 5, 2019. The outstanding balance of the revolving credit facility was $308.0 million as of September 30, 2016 and $288.0 million as of December 31, 2015.

 

The facility provides for the availability of swingline loans and multicurrency letters of credit. Under certain circumstances and subject to certain conditions, the aggregate amount available under the facility may be increased to a maximum of $650 million. Interest on swingline borrowings under the facility is determined based on the offered rate at the time of the loan. Interest on ABR and Eurocurrency borrowings are based on the Adjusted Base Rate and Adjusted LIBO Rate, respectively, plus in each case a margin that is adjusted on the basis of a combination of the Company’s consolidated leverage ratio and the Company’s index debt rating. The


12



commitment fee was 0.25% as of September 30, 2016.  As of September 30, 2016 and December 31, 2015 there were no swingline loans outstanding.

 

The amended credit facility contains customary affirmative and negative covenants and also contains certain financial covenants, including those relating to a minimum interest coverage ratio of not less than 3.0 to 1.0 and a maximum leverage ratio of not more than 3.0 to 1.0 as defined in the agreement. The amended credit facility also limits, among other things, the Company’s indebtedness, liens and fundamental changes to its structure and business. The Company was in compliance with all covenants and other requirements set forth in the facility agreement at September 30, 2016 and December 31, 2015.

 

The revolving credit facility contains a “change of control” provision in which if there is an acquisition of the Company, the administrative agent and/or the lenders may terminate the commitments and declare the principal and accrued interest on any loans then outstanding immediately due and payable.

 

On March 24, 2016, the revolving credit facility was amended for purposes of calculating the minimum interest coverage ratio, the maximum leverage ratio and the maximum permitted indebtedness of the Company by reducing the impact of certain cash restructuring charges, incurred by the Company prior to September 30, 2016, in the calculation of “Consolidated EBITDA”.

 

Senior Notes

 

In March 2013, the Company completed a public debt offering of $400.0 million aggregate principal amount of fixed rate senior unsecured notes. The notes with an aggregate principal amount of $400.0 million and 5.125% coupon were priced at 99.998% to have an effective yield to maturity of 5.125% and will mature March 15, 2020 (referred to as the “2020 senior notes”). The 2020 senior notes rank equally with all existing and future senior unsecured indebtedness. The notes from the May 2008 public debt offering with an aggregate principal amount of $300.0 million and 6.65% coupon were priced at 99.73% to have an effective yield to maturity of 6.687% and will mature June 1, 2018 (referred to as the “2018 senior notes”). At September 30, 2016, the outstanding balance of senior note debt was $697.9 million (net of unamortized issuance costs of $2.0 million and unamortized discount of $0.1 million). At December 31, 2015, the outstanding balance was $697.3 million (net of unamortized issuance costs of $2.5 million and unamortized discount of $0.2 million).

 

The 2020 senior notes pay interest on March 15 and September 15 of each year. The 2018 senior notes pay interest on June 1 and December 1 of each year. The interest rate payable on the notes of each series is subject to adjustments from time to time if either Moody’s Investors Service, Inc. or Standard and Poor’s Ratings Services downgrades the debt rating assigned to the notes to a level below investment grade, or subsequently upgrades the ratings.

 

The senior notes contain typical restrictions on liens, sale leaseback transactions, mergers and sales of assets. There are no sinking fund requirements on the senior notes and they may be redeemed at any time at the option of the Company, at a redemption price as described in the related indenture agreements, as supplemented and amended, in whole or in part. If a “change of control triggering event” as defined below occurs, the Company will be required to make an offer to repurchase the notes in cash from the holders at a price equal to 101% of their aggregate principal amount plus accrued and unpaid interest to, but not including, the date of repurchase. A “change of control triggering event” is defined as the occurrence of both a change of control and a downgrade in the debt rating assigned to the notes to a level below investment grade.

 

Short-Term Debt

 

In June 2015, the Company entered into an agreement for an uncommitted revolving credit facility. Under the agreement, the Company may borrow up to a total of $100 million. There were no outstanding borrowings under the uncommitted revolving credit facility at September 30, 2016 and December 31, 2015.

 

5.          INVENTORIES

 

Inventories consist of the following:

 

 

September 30,

 

December 31,

 

2016

 

2015

Raw materials

$

25.8 

 

$

28.3 

Work in process

 

39.5 

 

 

32.7 

Finished goods

 

173.6 

 

 

170.9 

Inventories

$

238.9 

 

$

231.9 

 


13



6.          ACCRUED LIABILITIES AND OTHER LIABILITIES

 

Changes in the Company’s warranty liability for standard warranties and deferred revenue for extended warranties are presented in the tables below:

 

Warranty Liability:

 

 

2016

 

2015

Balance at January 1

$

19.7 

 

$

22.4 

Accruals for warranties issued

 

27.8 

 

 

32.1 

Accruals related to pre-existing warranties (including

 

 

 

 

 

changes in estimates)

 

3.7 

 

 

7.2 

Settlements made (in cash or in kind)

 

(34.6)

 

 

(42.9)

Balance at September 30

$

16.6 

 

$

18.8 

 

Deferred Extended Warranty Revenue:

 

 

2016

 

2015

Balance at January 1

$

171.1 

 

$

180.3 

Revenue deferred for new extended warranty contracts

 

54.7 

 

 

55.7 

Revenue recognized

 

(67.6)

 

 

(68.6)

Balance at September 30

$

158.2 

 

$

167.4 

Current portion

 

69.4 

 

 

73.5 

Non-current portion

 

88.8 

 

 

93.9 

Balance at September 30

$

158.2 

 

$

167.4 

 

Both the current portion of warranty and the current portion of extended warranty are included in Accrued liabilities on the Consolidated Condensed Statements of Financial Position. Both the non-current portion of warranty and the non-current portion of extended warranty are included in Other liabilities on the Consolidated Condensed Statements of Financial Position. The split between the current and non-current portion of the warranty liability is not disclosed separately above due to immaterial amounts in the non-current portion.

 

Restructuring liabilities, included in Accrued liabilities on the Consolidated Condensed Statements of Financial Position, were $8.8 million as of September 30, 2016 and $69.4 million as of December 31, 2015, a decrease of $60.6 million. This decrease was driven primarily by severance payments of $42.3 million and a net reduction in the estimate, primarily due to employee attrition, of $18.3 million.

 

7.            INCOME TAXES

 

The Provision for income taxes for the three months ended September 30, 2016 was an expense of $4.8 million or an effective tax rate of 20.6%, compared to a benefit of $20.2 million or an effective tax rate of 57.1% for the three months ended September 30, 2015. The difference in these rates is primarily due to a shift in the expected geographic distribution of earnings for 2016 compared to 2015 and discrete items recorded in the respective periods.  Additionally, for the three months ended September 30, 2016, the Company increased income tax benefit by $0.3 million in recognition of several discrete items, which primarily included a tax benefit related to the release of uncertain tax position accruals and provision-to-return adjustments for 2015 returns filed during the quarter.  The three months ended September 30, 2015 included discrete items related to changes in estimates associated with filing 2014 tax returns, obtaining certification for certain state tax credits, and re-measuring certain non-functional currency foreign deferred tax liabilities totaling a benefit of $10.4 million.

 

The Provision for income taxes for the nine months ended September 30, 2016 was an expense of $40.5 million or an effective tax rate of (252.2)%, compared to a benefit of $3.5 million or an effective tax rate of 10.5% for the nine months ended September 30, 2015. The difference in these rates is primarily due to discrete items totaling $39.7 million. At reporting period end, the Company reassesses its uncertain tax positions. During the second quarter of 2016, the Company determined it was no longer more likely than not that a previously recognized uncertain tax benefit will be sustained and therefore increased its reserve for uncertain tax positions and accrued interest by $34.9 million during the period ending June 30, 2016. The remaining portion of discrete items is primarily related to deferred tax expense associated with a change in the Switzerland applicable tax rate and provision-to-return adjustments for 2015 returns. The nine months ended September 30, 2015 included discrete items related to changes in estimates associated with filing 2014 tax returns, obtaining certification for certain state tax credits, resolving certain tax uncertainties, and re-measuring certain non-functional currency foreign deferred tax liabilities totaling a benefit of $7.9 million.


14



 

It is reasonably possible that the total amount of unrecognized tax benefits will increase or decrease in the next 12 months. Such changes could occur based on the expiration of various statutes of limitations or the conclusion of ongoing tax audits in various jurisdictions around the world. Accordingly, within the next 12 months, the Company estimates that its unrecognized tax benefits amount could decrease by an amount in the range of $2.5 million to $48.0 million. The Company is unable to reasonably estimate a range of the possible increase in the amount of unrecognized tax benefits that could occur within the next 12 months. However, any such increase is not expected to be material to the Company.

 

The Company’s effective tax rate generally differs from the U.S. federal statutory rate of 35% as a result of U.S. state taxes on U.S. earnings and lower tax rates applicable to foreign earnings in most foreign jurisdictions in which the Company operates, most notably, Switzerland.

 

8.          STOCKHOLDERS’ EQUITY AND ACCUMULATED OTHER COMPREHENSIVE EARNINGS (LOSS)

 

In August 2012, the Company received authorization from the Board of Directors to repurchase an additional $200 million of its Class A Common Stock for a total repurchase authority of $4.85 billion. As of September 30, 2016, there was approximately $55 million of share repurchase authority remaining. This repurchase authority allows the Company, at management’s discretion, to selectively repurchase its stock from time to time in the open market or in privately negotiated transactions depending upon market price and other factors. The Company paused share repurchases in the second quarter of 2015 following the acquisition of Kofax.  Additionally, the merger agreement includes restrictions prohibiting the Company from repurchasing shares without the prior consent of the buying consortium.

 

Treasury Stock

 

The Company did not repurchase any shares of its Class A Common Stock during the three and nine months ended September 30, 2016 via accelerated share repurchase agreements (“ASR”). The Company did not repurchase any shares of its Class A Common Stock during the three months ended September 30, 2015. During the nine months ended September 30, 2015, the Company repurchased approximately 0.7 million shares at a cost of $30 million. As of September 30, 2016, the Company had repurchased approximately 113.0 million shares of its Class A Common Stock for an aggregate cost of approximately $4.80 billion since the inception of the program in April 1996. As of September 30, 2016, the Company had reissued approximately 0.5 million previously repurchased shares in connection with certain of its employee benefit programs. As a result of these issuances as well as the retirement of 44.0 million, 16.0 million and 16.0 million shares of treasury stock in 2005, 2006 and 2008, respectively, the net treasury shares outstanding at September 30, 2016 were 36.5 million. Share repurchases for the nine months ended September 30, 2015 were executed via an ASR agreement.

 

During the nine months ended September 30, 2016, the Company withheld $3.7 million of restricted shares to satisfy the minimum amount of its income tax withholding requirements related to certain officer’s vested restricted stock units (“RSUs”). The fair value of the restricted shares withheld was determined on the date that the restricted shares vested and resulted in the withholding of 122,806 shares of the Company’s Common Stock during the nine months ended September 30, 2016. The shares have been classified as Treasury stock on the Consolidated Condensed Statements of Financial Position. The Company currently expects to satisfy share-based awards with registered shares available to be issued.

 

Dividends

 

The Company’s dividend activity during the nine months ended September 30, 2016 was as follows:

 

 

 

 

 

 

 

Lexmark International, Inc.

 

 

 

 

 

 

Class A Common Stock

Declaration Date

 

Record Date

 

Payment Date

 

Dividend Per Share

 

Cash Outlay

February 18, 2016

 

February 29, 2016

 

March 11, 2016

 

$

0.36 

 

$

22.5 

April 19, 2016

 

June 03, 2016

 

June 17, 2016

 

$

0.36 

 

$

22.6 

July 29, 2016

 

September 02, 2016

 

September 16, 2016

 

$

0.36 

 

$

22.6 

 

The payment of the cash dividends also resulted in the issuance of dividend equivalent units to certain holders of RSUs, excluding replacement RSUs for the Kofax Long-term Incentive Plan restricted stock awards (“LTIPs”), which did not provide for dividend equivalent units. Diluted weighted-average Lexmark Class A Common Stock share amounts presented reflect this issuance. All cash dividends and dividend equivalent units are accounted for as reductions of Retained earnings.

 


15



Accumulated Other Comprehensive Loss

 

The following tables provide the tax benefit or expense attributed to each component of Other comprehensive (loss) earnings:

 

 

Three Months Ended

 

September 30, 2016

 

September 30, 2015

 

Change,

 

Tax benefit

 

Change,

 

Change,

 

Tax benefit

 

Change,

 

net of tax

 

(liability)

 

pre-tax

 

net of tax

 

(liability)

 

pre-tax

Components of other comprehensive (loss) earnings:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

$

(6.9)

 

$

– 

 

$

(6.9)

 

$

(29.3)

 

$

– 

 

$

(29.3)

Recognition of pension and other postretirement benefit plans prior service credit, net of (amortization)

 

(0.1)

 

 

0.1 

 

 

(0.2)

 

 

(0.2)

 

 

0.1 

 

 

(0.3)

Net unrealized (loss) gain on marketable securities 

 

– 

 

 

– 

 

 

– 

 

 

– 

 

 

– 

 

 

– 

Unrealized gain (loss) on cash flow hedges

 

(4.5)

 

 

0.5 

 

 

(5.0)

 

 

(14.6)

 

 

1.6 

 

 

(16.2)

Total other comprehensive (loss) earnings

$

(11.5)

 

$

0.6 

 

$

(12.1)

 

$

(44.1)

 

$

1.7 

 

$

(45.8)

 

 

Nine Months Ended

 

September 30, 2016

 

September 30, 2015

 

Change,

 

Tax benefit

 

Change,

 

Change,

 

Tax benefit

 

Change,

 

net of tax

 

(liability)

 

pre-tax

 

net of tax

 

(liability)

 

pre-tax

Components of other comprehensive (loss) earnings:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

$

(15.8)

 

$

– 

 

$

(15.8)

 

$

(65.0)

 

$

– 

 

$

(65.0)

Recognition of pension and other postretirement benefit plans prior service credit, net of (amortization)

 

(0.3)

 

 

0.2 

 

 

(0.5)

 

 

(0.4)

 

 

0.1 

 

 

(0.5)

Net unrealized (loss) on marketable securities

 

– 

 

 

– 

 

 

– 

 

 

(0.1)

 

 

– 

 

 

(0.1)

Unrealized (loss) gain on cash flow hedges

 

(10.1)

 

 

1.1 

 

 

(11.2)

 

 

(0.9)

 

 

0.1 

 

 

(1.0)

Total other comprehensive (loss) earnings

$

(26.2)

 

$

1.3 

 

$

(27.5)

 

$

(66.4)

 

$

0.2 

 

$

(66.6)

 

The change in Accumulated other comprehensive loss, net of tax, for the three and nine months ended September 30, 2016, consists of the following:

 

 

 

 

 

Recognition of

 

 

 

 

 

 

 

 

 

Pension and Other

 

 

 

 

 

 

Foreign

 

Postretirement

 

Unrealized

 

Accumulated

 

Currency

 

Benefit Plans

 

Gain (Loss) on

 

Other

 

Translation

 

Prior Service Credit,

 

Cash Flow

 

Comprehensive

 

Adjustment

 

Net of (Amortization)

 

Hedges

 

(Loss) Earnings

Balance at June 30, 2016

$

(184.5)

 

$

0.5 

 

$

4.3 

 

$

(179.7)

Other comprehensive (loss) earnings before reclassifications

 

(6.9)

 

 

– 

 

 

(3.4)

 

 

(10.3)

Amounts reclassified from accumulated other comprehensive (loss) earnings

 

– 

 

 

(0.1)

 

 

(1.1)

 

 

(1.2)

Net current-period other comprehensive (loss) earnings

 

(6.9)

 

 

(0.1)

 

 

(4.5)

 

 

(11.5)

Balance at September 30, 2016

$

(191.4)

 

$

0.4 

 

$

(0.2)

 

$

(191.2)

 

 

 

 

Recognition of

 

 

 

 

 

 

 

Pension and Other

 

 

 

Accumulated

 

Foreign

 

Postretirement

 

Unrealized

 

Other

 

Currency

 

Benefit Plans

 

(Loss) Gain on

 

Comprehensive

 

Translation

 

Prior Service Credit,

 

Cash Flow

 

(Loss)

 

Adjustment

 

Net of (Amortization)

 

Hedges

 

Earnings

Balance at December 31, 2015

$

(175.6)

 

$

0.7 

 

$

9.9 

 

$

(165.0)

Other comprehensive (loss) earnings before reclassifications

 

(15.8)

 

 

– 

 

 

(9.0)

 

 

(24.8)

Amounts reclassified from accumulated other comprehensive (loss) earnings

 

– 

 

 

(0.3)

 

 

(1.1)

 

 

(1.4)

Net current-period other comprehensive (loss) earnings

 

(15.8)

 

 

(0.3)

 

 

(10.1)

 

 

(26.2)

Balance at September 30, 2016

$

(191.4)

 

$

0.4 

 

$

(0.2)

 

$

(191.2)

 


16



The change in Accumulated other comprehensive loss, net of tax, for the three and nine months ended September 30, 2015, consists of the following:

 

 

 

 

 

Recognition of

 

 

 

 

 

 

 

 

Pension and Other

 

Unrealized

 

Accumulated

 

 

Foreign

 

Postretirement

 

(Loss) Gain

 

Other

 

 

Currency

 

Benefit Plans

 

on

 

Comprehensive

 

 

Translation

 

Prior Service Credit,

 

Cash Flow

 

(Loss)

 

 

Adjustment

 

Net of (Amortization)

 

Hedges

 

Earnings

Balance at June 30, 2015

 

$

(137.6)

 

$

1.0 

 

$

29.6 

 

$

(107.0)

Other comprehensive (loss) earnings before reclassifications

 

 

(29.3)

 

 

(0.1)

 

 

0.8 

 

 

(28.6)

Amounts reclassified from accumulated other comprehensive (loss) earnings

 

 

– 

 

 

(0.1)

 

 

(15.4)

 

 

(15.5)

Net current-period other comprehensive (loss) earnings

 

 

(29.3)

 

 

(0.2)

 

 

(14.6)

 

 

(44.1)

Balance at September 30, 2015

 

$

(166.9)

 

$

0.8 

 

$

15.0 

 

$

(151.1)

 

 

 

 

Recognition of

 

 

 

 

 

 

 

 

 

 

Pension and Other

 

Net

 

Unrealized

 

Accumulated

 

Foreign

 

Postretirement

 

Unrealized

 

(Loss) Gain

 

Other

 

Currency

 

Benefit Plans

 

Gain (Loss) on

 

on

 

Comprehensive

 

Translation

 

Prior Service Credit,

 

Marketable

 

Cash Flow

 

(Loss)

 

Adjustment

 

Net of (Amortization)

 

Securities

 

Hedges

 

Earnings

Balance at December 31, 2014

$

(101.9)

 

$

1.2 

 

$

0.1 

 

$

15.9 

 

$

(84.7)

Other comprehensive (loss) earnings before reclassifications

 

(65.0)

 

 

(0.1)

 

 

1.4 

 

 

46.5 

 

 

(17.2)

Amounts reclassified from accumulated other comprehensive (loss) earnings

 

– 

 

 

(0.3)

 

 

(1.5)

 

 

(47.4)

 

 

(49.2)

Net current-period other comprehensive (loss) earnings

 

(65.0)

 

 

(0.4)

 

 

(0.1)

 

 

(0.9)

 

 

(66.4)

Balance at September 30, 2015

$

(166.9)

 

$

0.8 

 

$

– 

 

$

15.0 

 

$

(151.1)

 

The following tables provide details of amounts reclassified from Accumulated other comprehensive loss:

 

 

Amount Reclassified from

 

 

 

Accumulated Other

 

 

 

Comprehensive (Loss) Earnings

 

 

Details about Accumulated Other

Three Months Ended

 

 

Comprehensive (Loss) Earnings

September 30,

 

September 30,

 

 

Components

2016

 

2015

 

Affected Line Item in the Statements of Earnings

Recognition of pension and  other postretirement benefit plans prior service credit

 

 

 

 

 

 

 

Amortization of prior service benefit

$

0.2 

 

$

0.2 

 

Note 10, Employee Pension and Postretirement Plans

 

 

(0.1)

 

 

(0.1)

 

Tax benefit (liability)

 

$

0.1 

 

$

0.1 

 

Net of tax

 

 

 

 

 

 

 

 

Unrealized (loss) gain on cash flow hedges

 

 

 

 

 

 

 

 

$

1.2 

 

$

17.1 

 

Revenue

 

 

(0.1)

 

 

(1.7)

 

Tax (liability) benefit

 

$

1.1 

 

$

15.4 

 

Net of tax

 

 

 

 

 

 

 

 

Total reclassifications for the period

$

1.2 

 

$

15.5 

 

Net of tax

 


17



 

Amount Reclassified from

 

 

 

Accumulated Other

 

 

 

Comprehensive (Loss) Earnings

 

 

Details about Accumulated Other

Nine Months Ended

 

 

Comprehensive (Loss) Earnings

September 30,

 

September 30,

 

 

Components

2016

 

2015

 

Affected Line Item in the Statements of Earnings

Recognition of pension and  other postretirement benefit plans prior service credit

 

 

 

 

 

 

 

Amortization of prior service benefit

$

0.5 

 

$

0.5 

 

Note 10, Employee Pension and Postretirement Plans

 

 

(0.2)

 

 

(0.2)

 

Tax (liability) benefit

 

$

0.3 

 

$

0.3 

 

Net of tax

 

 

 

 

 

 

 

 

Unrealized gains and (losses) on marketable securities

 

 

 

 

 

 

 

Non-OTTI

$

– 

 

$

1.7 

 

Other expense (income), net

 

 

– 

 

 

(0.2)

 

Tax (liability) benefit

 

$

– 

 

$

1.5 

 

Net of tax

 

 

 

 

 

 

 

 

Unrealized gain (loss) on cash flow hedges

 

 

 

 

 

 

 

 

$

1.2 

 

$

51.8 

 

Revenue

 

 

– 

 

 

0.9 

 

Other expense (income), net

 

 

(0.1)

 

 

(5.3)

 

Tax (liability) benefit

 

$

1.1 

 

$

47.4 

 

Net of tax

 

 

 

 

 

 

 

 

Total reclassifications for the period

$

1.4 

 

$

49.2 

 

Net of tax

 

9.          EARNINGS PER SHARE (“EPS”)

 

The following table presents a reconciliation of the numerators and denominators of the basic and diluted EPS calculations:

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

 

2016

 

2015

 

2016

 

2015

Numerator:

 

 

 

 

 

 

 

 

 

 

 

Net earnings (loss)

$

18.3 

 

$

(15.2)

 

$

(56.5)

 

$

(29.7)

Denominator:

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares used to compute basic EPS

 

63.0 

 

 

61.7 

 

 

62.8 

 

 

61.5 

Effect of dilutive securities -

 

 

 

 

 

 

 

 

 

 

 

Employee stock plans

 

1.2 

 

 

– 

 

 

– 

 

 

– 

Weighted average shares used to compute diluted EPS

 

64.2 

 

 

61.7 

 

 

62.8 

 

 

61.5 

 

 

 

 

 

 

 

 

 

 

 

 

Basic net EPS

$

0.29 

 

$

(0.25)

 

$

(0.90)

 

$

(0.48)

Diluted net EPS

$

0.28 

 

$

(0.25)

 

$

(0.90)

 

$

(0.48)

 

RSUs, stock options, and dividend equivalent units totaling an additional 0.7 million of Class A Common Stock for the three months ended September 30, 2016 were outstanding but were not included in the computation of diluted earnings per share because the effect would have been antidilutive. Outstanding stock based compensation awards were not considered in the diluted EPS calculation due to the Company’s net loss position for the nine months ended September 30, 2016 as well as the three and nine months ended September 30, 2015.

 

Under the terms of Lexmark’s RSU agreements, other than replacement RSU agreements for Kofax LTIPs, unvested RSU awards contain forfeitable rights to dividends and dividend equivalent units. Because the dividend equivalent units are forfeitable, they are defined as non-participating securities. As of September 30, 2016, there were 0.2 million dividend equivalent units outstanding, which will vest at the time that the underlying RSU vests.

 

In addition to the 0.7 million antidilutive shares for the three months ended September 30, 2016, mentioned above, unvested RSUs with a performance condition that were granted in the first quarter of 2016, 2015 and 2014 were also excluded from the computation of diluted earnings per share. According to FASB guidance on earnings per share, contingently issuable shares are excluded from the computation of diluted EPS if, based on current period results, the shares would not be issuable if the end of the reporting period were the end of the contingency period. If the performance condition were to become satisfied based on actual financial results and the


18



performance awards would have a dilutive impact on EPS, the performance awards included in the diluted EPS calculation would be in the range of 0.3 million to 1.2 million shares depending on the level of achievement.

 

10.          EMPLOYEE PENSION AND POSTRETIREMENT PLANS

 

The components of the net periodic benefit cost for both the pension and postretirement plans for the three and nine months ended September 30, 2016 and 2015 were as follows:

 

Pension Benefits:

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

 

2016

 

2015

 

2016

 

2015

Service cost

$

1.5 

 

$

1.5 

 

$

4.5 

 

$

4.6 

Interest cost

 

7.7 

 

 

7.7 

 

 

23.2 

 

 

22.9 

Expected return on plan assets

 

(10.0)

 

 

(11.3)

 

 

(30.1)

 

 

(33.8)

Actuarial net loss

 

– 

 

 

– 

 

 

26.0 

 

 

0.9 

Curtailment and termination benefit net loss

 

– 

 

 

– 

 

 

0.3 

 

 

– 

Net periodic benefit cost (credit)

$

(0.8)

 

$

(2.1)

 

$

23.9 

 

$

(5.4)

 

Other Postretirement Benefits:

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

 

2016

 

2015

 

2016

 

2015

Service cost

$

0.1 

 

$

0.1 

 

$

0.2 

 

$

0.2 

Interest cost

 

0.2 

 

 

0.2 

 

 

0.6 

 

 

0.6 

Amortization of prior service (benefit) cost

 

(0.2)

 

 

(0.2)

 

 

(0.5)

 

 

(0.5)

Actuarial net loss (gain)

 

– 

 

 

– 

 

 

0.4 

 

 

(0.5)

Curtailment and termination benefit net loss

 

– 

 

 

– 

 

 

0.6 

 

 

– 

Net periodic benefit cost (credit)

$

0.1 

 

$

0.1 

 

$

1.3 

 

$

(0.2)

 

The Company was required to remeasure U.S. and Switzerland pension and other postretirement plan assets and obligations due to the curtailments.  The basis for the remeasurements remained unchanged from prior periods and included updating assumptions such as the discount rate and demographic data and testing fair values of related plan assets. The remeasurements resulted in the recognition of $26.4 million in actuarial net losses.

 

The pension and other postretirement curtailment and termination benefit net losses of $0.9 million are related to the 2016 Restructuring Actions in the U.S. and Switzerland.  Curtailment and termination benefit gains are recognized when the event occurs whereas curtailment and termination benefit losses are recognized when the obligation is probable and estimable.

 

For the nine months ended September 30, 2016, $6.0 million of contributions have been made to the Company’s pension and postretirement plans. The Company currently expects to contribute approximately $3 million to its pension and other postretirement plans for the remainder of 2016.

 

11.          DERIVATIVES

 

Derivative Instruments and Hedging Activities

 

Lexmark’s activities expose it to a variety of market risks, including the effects of changes in foreign currency exchange rates and interest rates. The Company’s risk management program seeks to reduce the potentially adverse effects that market risks may have on its operating results.

 

Lexmark maintains a foreign currency risk management strategy that uses derivative instruments to protect its interests from unanticipated fluctuations in earnings caused by volatility in currency exchange rates. The Company does not hold or issue financial instruments for trading purposes nor does it hold or issue leveraged derivative instruments. Lexmark maintains an interest rate risk management strategy that may, from time to time use derivative instruments to minimize significant, unanticipated earnings


19



fluctuations caused by interest rate volatility. By using derivative financial instruments to hedge exposures to changes in exchange rates and interest rates, the Company exposes itself to credit risk and market risk. Lexmark manages exposure to counterparty credit risk by entering into derivative financial instruments with highly rated institutions that can be expected to fully perform under the terms of the agreement. Market risk is the adverse effect on the value of a financial instrument that results from a change in currency exchange rates or interest rates. The Company manages exposure to market risk associated with interest rate and foreign exchange contracts by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.

 

Fair Value Hedges

 

Lexmark uses fair value hedges to reduce the potentially adverse effects that market volatility may have on its operating results. Fair value hedges are hedges of recognized assets or liabilities. Lexmark enters into forward exchange contracts to hedge accounts receivable, accounts payable and other monetary assets and liabilities. The forward contracts used in this program generally mature in three months or less, consistent with the underlying asset or liability. Foreign exchange forward contracts may be used as fair value hedges in situations where derivative instruments expose earnings to further changes in exchange rates.

 

Cash Flow Hedges

 

Cash flow hedges are hedges of forecasted transactions or of the variability of cash flows to be received or paid related to a recognized asset or liability. Lexmark regularly enters into foreign exchange options generally expiring approximately twelve months from execution as hedges of anticipated sales that are denominated in foreign currencies. These contracts are entered into to protect against the risk that the eventual cash flows resulting from such transactions will be adversely affected by changes in exchange rates.

 

Accounting for Derivatives and Hedging Activities

 

All derivatives are recognized in the Consolidated Condensed Statements of Financial Position at their fair value. Fair values for Lexmark’s derivative financial instruments are based on pricing models or formulas using current market data, or where applicable, quoted market prices. On the date the derivative contract is entered into, the Company designates the derivative as a fair value hedge or a cash flow hedge, based upon the nature of the underlying hedged item. Changes in the fair value of a derivative that is highly effective as — and that is designated and qualifies as — a fair value hedge, along with the loss or gain on the hedged asset or liability are recorded in current period earnings in Cost of revenue or Other expense (income), net on the Consolidated Condensed Statements of Earnings. Changes in the fair value of a derivative that is highly effective as — and that is designated and qualifies as — a cash flow hedge of a forecasted sale is recorded in Accumulated other comprehensive loss on the Consolidated Condensed Statements of Financial Position, until the underlying transactions occur, at which time the loss or gain on the derivative is recorded in current period earnings in Revenue on the Consolidated Condensed Statements of Earnings. Cash flows of derivatives qualifying as hedges are included in the same section of the Consolidated Condensed Statements of Cash Flows as the cash flows of the underlying assets and liabilities being hedged.

 

Lexmark formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge items. This process includes linking all derivatives that are designated as fair value and cash flow hedges to specific assets and liabilities on the balance sheet or to forecasted transactions, as appropriate. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair value or cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively, as discussed below.

 

Lexmark discontinues hedge accounting prospectively when (1) it is determined that a derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item, (2) the derivative expires or is sold, terminated or exercised, or (3) the derivative is discontinued as a hedge instrument, because it is unlikely that a forecasted transaction will occur. When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair value hedge, the derivative will continue to be carried on the Consolidated Condensed Statements of Financial Position at its fair value. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative will continue to be carried on the Consolidated Condensed Statements of Financial Position at its fair value, and gains and losses that were recorded in Accumulated other comprehensive loss are recognized immediately in earnings. In all other situations in which hedge accounting is discontinued, the derivative will be carried at its fair value on the Consolidated Condensed Statements of Financial Position, with changes in its fair value recognized in current period earnings.

 


20



Fair Value Hedges

 

Net outstanding notional amount of derivative positions as of September 30, 2016 is in the table that follows. These positions were driven by fair value hedges of recognized assets and liabilities primarily denominated in the currencies below:

 

 

September 30,

Long (Short) Positions by Currency (in USD)

2016

EUR / USD

$

210.1 

EUR / GBP

 

(56.7)

GBP / USD

 

47.9 

CHF / USD

 

(31.4)

PHP / USD

 

(25.3)

CNY / USD

 

(19.2)

SGD / USD

 

18.7 

Other, net

 

9.8 

Total

$

153.9 

 

As of September 30, 2016 and December 31, 2015, the Company had the following net derivative assets (liabilities) recorded at fair value in Prepaid expenses and other current assets (Accrued liabilities) on the Consolidated Condensed Statements of Financial Position:

 

 

Net Asset Position

 

 

Net (Liability) Position

Foreign Exchange

September 30,

 

December 31,

 

 

September 30,

 

December 31,

Contracts

2016

 

2015

 

 

2016

 

2015

Gross asset position

$

1.2 

 

$

2.2 

 

 

$

– 

 

$

– 

Gross (liability) position

 

– 

 

 

– 

 

 

 

(0.3)

 

 

(2.4)

Net asset (liability) position (1)

 

1.2 

 

 

2.2 

 

 

 

(0.3)

 

 

(2.4)

Gross amounts not offset (2)

 

– 

 

 

– 

 

 

 

– 

 

 

– 

Net amounts

$

1.2 

 

$

2.2 

 

 

$

(0.3)

 

$

(2.4)

 

(1) Amounts presented in the Consolidated Condensed Statements of Financial Position

(2) Amounts not offset in the Consolidated Condensed Statements of Financial Position

 

The Company had the following (gains) and losses related to derivative instruments qualifying and designated as hedging instruments in fair value hedges and related hedged items recorded on the Consolidated Condensed Statements of Earnings:

 

 

Recorded in

 

Cost of revenue*

 

Other expense (income), net

 

Three Months Ended

 

Nine Months Ended

 

Three Months Ended

 

Nine Months Ended

Fair Value Hedging

September 30

 

September 30

 

September 30

 

September 30

Relationships

2016

 

2015

 

2016

 

2015

 

2016

 

2015

 

2016

 

2015

Foreign exchange contracts

$

(1.0)

 

$

(1.8)

 

$

(5.9)

 

$

1.3 

 

$

0.2 

 

$

– 

 

$

1.7 

 

$

0.6 

Underlying

 

0.7 

 

 

3.6 

 

 

7.6 

 

 

0.9 

 

 

– 

 

 

1.1 

 

 

(1.2)

 

 

1.2 

Total

$

(0.3)

 

$

1.8 

 

$

1.7 

 

$

2.2 

 

$

0.2 

 

$

1.1 

 

$

0.5 

 

$

1.8 

 

* Gains and losses recorded in Cost of revenue are included in Product on the Consolidated Condensed Statements of Earnings

 


21



Cash Flow Hedges

 

The Company’s cash flow hedging contracts are not subject to master netting agreements or other terms under U.S. GAAP that allow net presentation in the Consolidated Condensed Statements of Financial Position. The total notional amounts as of September 30, 2016 of the Company’s foreign exchange options designated as cash flow hedges of anticipated Euro and British pound denominated sales were $575.9 million and $24.2 million, respectively. As of September 30, 2016 and December 31, 2015, the Company had the following gross derivative assets (liabilities) recorded at fair value in Prepaid expenses and other current assets (Accrued liabilities) on the Consolidated Condensed Statements of Financial Position for its cash flow hedges:

 

Foreign Exchange

September 30,

 

December 31,

Contracts

2016

 

2015

Gross asset position

$

9.2 

 

$

20.5 

Gross (liability) position

 

(9.4)

 

 

(9.5)

 

The Company had the following gains and (losses) related to derivative instruments qualifying and designated as cash flow hedging instruments and related hedged items recorded on the Consolidated Condensed Statements of Comprehensive Earnings:

 

 

 

 

 

 

 

 

 

 

 

 

 

Location of gain

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(loss) reclassified

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

from

Pre-tax amount of gain (loss)

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated other

reclassified from

 

Amount of after-tax

comprehensive loss

Accumulated other comprehensive loss

 

(loss) gain recognized in

into

into

 

Other comprehensive (loss) earnings

Net (loss) earnings

Net (loss) earnings

 

(effective portion)

(effective portion)

(effective portion)

 

Three Months Ended

 

Nine Months Ended

 

Three Months Ended

 

Nine Months Ended

Cash Flow Hedging

September 30,

 

September 30,

 

September 30,

 

September 30,

Relationships

2016

 

2015

 

2016

 

2015

 

2016

 

2015

 

2016

 

2015

Foreign Exchange

Contracts

$

(4.5)

 

$

(14.6)

 

$

(10.1)

 

$

(0.9)

Revenue

$

1.2 

 

$

17.1 

 

$

1.2 

 

$

51.8 

 

The Company did not discontinue hedge accounting for any derivative instruments designated as cash flow hedges during the three and nine months ended September 30, 2016. During the nine months ended September 30, 2015, the Company discontinued hedge accounting for certain derivative instruments previously designated as cash flow hedges because it was probable that the underlying forecasted transaction would not occur. As a result, gains of $0.9 million were reclassified into earnings during the nine months ended September 30, 2015, and recognized as a component of Other expense (income), net on the Consolidated Condensed Statements of Earnings.  No such amounts were reclassified into earnings during the three months ended September 30, 2015.

 

As of September 30, 2016 and December 31, 2015, deferred net (losses) gains on derivative instruments recorded in Accumulated other comprehensive loss were $(0.3) million and $11.0 million respectively, pre-tax. If realized, all amounts as of September 30, 2016 will be reclassified into earnings during the next 12 months. Ineffective portions of hedges are immediately recognized in current period earnings. There were no material gains or losses related to the ineffective portion of hedges recognized in the three and nine months ended September 30, 2016 or 2015.

 

Additional information regarding derivatives can be referenced in Note 12 of the Notes to Consolidated Condensed Financial Statements.

 

12.           FAIR VALUE

 

General

 

The accounting guidance for fair value measurements defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles (“GAAP”), and requires disclosures about fair value measurements. The guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As part of the framework for measuring fair value, 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.

 


22



Fair Value Hierarchy

 

The three levels of the fair value hierarchy are:

 

 

 

 

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.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2016

 

December 31, 2015

 

 

 

 

Based on

 

 

 

 

Based on

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

prices in

 

Other

 

 

 

 

 

 

 

prices in

 

Other

 

 

 

 

 

 

 

active

 

observable

 

Unobservable

 

 

 

 

active

 

observable

 

Unobservable

 

 

 

 

markets

 

inputs

 

inputs

 

 

 

 

markets

 

inputs

 

inputs

 

Fair value

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Fair value

 

(Level 1)

 

(Level 2)

 

(Level 3)

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash equivalents - money market funds (1)

$

2.1 

 

$

– 

 

$

2.1 

 

$

– 

 

$

34.9 

 

$

– 

 

$

34.9 

 

$

– 

Foreign currency derivatives (2)

 

10.4 

 

 

– 

 

 

10.4 

 

 

– 

 

 

22.7 

 

 

– 

 

 

22.7 

 

 

– 

Total

$

12.5 

 

$

– 

 

$

12.5 

 

$

– 

 

$

57.6 

 

$

– 

 

$

57.6 

 

$

– 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency derivatives (2)

$

9.7 

 

$

– 

 

$

9.7 

 

$

– 

 

$

11.9 

 

$

– 

 

$

11.9 

 

$

– 

Contingent consideration

 

– 

 

 

– 

 

 

– 

 

 

– 

 

 

1.0 

 

 

– 

 

 

– 

 

 

1.0 

Total

$

9.7 

 

$

– 

 

$

9.7 

 

$

– 

 

$

12.9 

 

$

– 

 

$

11.9 

 

$

1.0 

 

(1) Included in Cash and cash equivalents on the Consolidated Condensed Statements of Financial Position.

(2) Foreign currency derivative assets and foreign currency derivative liabilities are included in Prepaid expenses and other current assets and Accrued liabilities, respectively, on the Consolidated Condensed Statements of Financial Position. Refer to Note 11 for disclosure of derivative assets and liabilities on a gross basis.

 

The Company’s policy is to consider all highly liquid investments with an original maturity of three months or less at the Company’s date of purchase to be cash equivalents. The amortized cost of these investments closely approximates fair value in accordance with the Company’s policy regarding cash equivalents. Fair value of these instruments is readily determinable using the methods described below for money market funds.

 

Transfers

 

In determining where measurements lie in the fair value hierarchy, the Company uses default assumptions regarding the general characteristics of the financial instrument as the starting point. The Company then adjusts the level assigned to the fair value measurement for financial instruments held at the end of the reporting period, as necessary, based on the weight of the evidence obtained by the Company. Except for the levels assigned to its pension plan assets, which are reviewed annually, the Company reviews the levels assigned to its fair value measurements on a quarterly basis and recognizes transfers between levels of the fair value hierarchy as of the beginning of the quarter in which the transfer occurs. There were no transfers between levels of the fair value hierarchy during the first nine months of 2016 or 2015.

 

Valuation Techniques

 

Money Market Funds

 

The money market funds in which the Company is invested are considered cash equivalents and are generally highly liquid investments. Money market funds are valued at the per share (unit) published as the basis for current transactions.

 

Derivatives

 

The Company employs foreign currency and interest rate risk management strategies that periodically utilize derivative instruments to protect its interests from unanticipated fluctuations in earnings and cash flows caused by volatility in currency exchange rates and interest rates. Fair values for the Company’s derivative financial instruments are based on pricing models or formulas using current market data. Variables used in the calculations include forward points, spot rates, volatility assumptions and benchmark interest rates at the time of valuation, as well as the frequency of payments to and from counterparties and effective and termination dates. The Company believes there is minimal risk of nonperformance. At September 30, 2016 and December 31, 2015, all of the Company’s


23



derivative instruments were designated as Level 2 measurements in the fair value hierarchy. Refer to Note 11 of the Notes to Consolidated Condensed Financial Statements for more information on the Company’s derivatives.

 

Senior Notes

 

The Company’s outstanding senior notes consist of $300 million of fixed rate senior unsecured notes issued in a public debt offering in May 2008 and due on June 1, 2018 (the “2018 senior notes”) and $400 million of fixed rate senior unsecured notes issued in a public debt offering completed in March 2013 and due on March 15, 2020 (the “2020 senior notes”).

 

The fair values shown in the table below are based on the prices at which the bonds have recently traded in the market as well as the overall market conditions on the date of valuation, stated coupon rates, the number of coupon payments each year and the maturity dates. The fair value of the debt is not recorded on the Company’s Consolidated Condensed Statements of Financial Position and is therefore excluded from the fair value table above. This fair value measurement is classified as Level 2 within the fair value hierarchy. Carrying values shown in the table below are net of unamortized discount and debt issuance costs.

 

 

September 30, 2016

 

December 31, 2015

 

 

 

 

 

 

Unamortized

 

 

 

 

 

 

Unamortized

 

 

 

 

Carrying

 

discount and

 

 

 

 

Carrying

 

discount and

 

Fair value

 

value

 

issuance costs

 

Fair value

 

value

 

issuance costs

2018 senior notes

$

318.1 

 

$

299.5 

 

$

0.5 

 

$

322.4 

 

$

299.2 

 

$

0.8 

2020 senior notes

 

419.1 

 

 

398.4 

 

 

1.6 

 

 

413.2 

 

 

398.1 

 

 

1.9 

Total

$

737.2 

 

$

697.9 

 

$

2.1 

 

$

735.6 

 

$

697.3 

 

$

2.7 

 

Refer to Note 4 of the Notes to Consolidated Condensed Financial Statements for more information on the senior notes.

 

Contingent Consideration

 

In the first quarter of 2016 the Company settled the contingent consideration liability for the amount at which it had been accrued as of December 31, 2015.

 

Other Financial Instruments

 

The fair values of cash and cash equivalents, trade receivables and accounts payable approximate their carrying values due to the relatively short-term nature of the instruments. Since the borrowings under the revolving credit facility and the accounts receivable program utilize variable interest rate setting mechanisms such as one-month LIBOR, the fair value of these borrowings is deemed to approximate the carrying values. Refer to Note 4 of the Notes to Consolidated Condensed Financial Statements for more information on the accounts receivable and revolving credit facilities.

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis Subsequent to Initial Recognition

 

There were no material fair value adjustments to assets or liabilities measured at fair value on a nonrecurring basis subsequent to initial recognition during the first nine months of 2016 or 2015.

 

13.          SEGMENT DATA

 

Lexmark operates in the office imaging and enterprise content and business process management markets. The Company is managed along two operating segments: ISS and Enterprise Software.

 

ISS offers a broad portfolio of monochrome and color laser printers and laser multifunction products as well as a wide range of supplies and services covering its printing products and technology solutions.

 

Enterprise Software offers an integrated suite of enterprise content management (“ECM”), business process management (“BPM”), document output management (“DOM”)/customer communications management (“CCM”) that includes case management, electronic signature, process analytics, information and application integration, intelligent content capture and data extraction, enterprise search software and medical imaging vendor neutral archive (“VNA”) software products and solutions. The Company acquired Claron on January 2, 2015 and Kofax on May 21, 2015. These acquisitions further expanded and strengthened the solutions available in the Enterprise Software segment.

 

The Company evaluates the performance of its segments based on revenue and operating income and does not include segment assets or non-operating income/expense items for management reporting purposes. Segment operating (loss) income includes: selling, general and administrative; research and development; restructuring and related charges; and other expenses, certain of which are allocated to the respective segments based on internal measures and may not be indicative of amounts that would be incurred on a


24



stand-alone basis or may not be indicative of results of other enterprises in similar businesses. All other operating (loss) income includes significant expenses that are managed outside of the reporting segments. These unallocated costs include such items as information technology expenses, certain occupancy costs, certain pension and other postretirement benefit plan costs, stock-based compensation and certain other corporate and regional general and administrative expenses such as finance, legal and human resources. Acquisition-related costs and integration expenses are also included primarily in All other.

 

The following table includes information about the Company’s reportable segments:

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

 

2016

 

2015

 

2016

 

2015

Revenue:

 

 

 

 

 

 

 

 

 

 

 

ISS

$

688.3 

 

$

703.0 

 

$

2,055.2 

 

$

2,209.0 

Enterprise Software

 

155.6 

 

 

148.1 

 

 

457.5 

 

 

373.4 

Total revenue

$

843.9 

 

$

851.1 

 

$

2,512.7 

 

$

2,582.4 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss):

 

 

 

 

 

 

 

 

 

 

 

ISS

$

113.6 

 

$

95.2 

 

$

345.2 

 

$

372.4 

Enterprise Software

 

9.2 

 

 

(21.6)

 

 

(15.3)

 

 

(74.4)

All other

 

(86.9)

 

 

(95.2)

 

 

(309.6)

 

 

(299.5)

Total operating income (loss)

$

35.9 

 

$

(21.6)

 

$

20.3 

 

$

(1.5)

 

Operating (loss) income noted above for the three months ended September 30, 2016 includes restructuring (reversals) charges of $(0.9) million in ISS, $(2.1) million in Enterprise Software and $(0.5) million in All other. Operating (loss) income related to Enterprise Software for the three months ended September 30, 2016 also included $29.0 million of amortization expenses related to intangible assets acquired by the Company.  Operating (loss) income noted above for the nine months ended September 30, 2016 includes restructuring (reversals) charges of $(16.8) million in ISS, $(2.2) million in Enterprise Software and $1.4 million in All other.  Operating (loss) income related to Enterprise Software for the nine months ended September 30, 2016 also includes $88.1 million of amortization expense related to intangible assets acquired by the Company. All other for the nine months ended September 30, 2016 includes a pension and other postretirement benefit plan asset and actuarial net loss of $26.4 million and $0.9 million in curtailment and termination benefit losses.

 

Operating (loss) income noted above for the three months ended September 30, 2015 includes restructuring charges of $5.9 million in ISS, $(2.5) million in Enterprise Software and $(4.7) million in All other. Operating (loss) income related to Enterprise Software for the three months ended September 30, 2015 also includes $37.2 million of amortization expense related to intangible assets acquired by the Company. Operating (loss) income noted above for the nine months ended September 30, 2015 includes restructuring charges of $11.4 million in ISS, $16.5 million in Enterprise Software and $5.7 million in All other. Operating (loss) income related to Enterprise Software for the nine months ended September 30, 2015 also includes $91.3 million of amortization expense related to intangible assets acquired by the Company.  Operating (loss) income related to All other for the nine months ended September 30, 2015 also includes pension and other postretirement benefit plan actuarial loss of $0.3 million.

 

14.          COMMITMENTS AND CONTINGENCIES

 

Guarantees and Indemnifications

 

In the ordinary course of business, the Company may provide performance guarantees to certain customers pursuant to which Lexmark has guaranteed the performance obligation of third parties. Some of those agreements may be backed by bank guarantees provided by the third parties. In general, Lexmark would be obligated to perform over the term of the guarantee in the event a specified triggering event occurs as defined by the guarantee. The Company believes the likelihood of having to perform under a guarantee is remote.

 

In most transactions with customers of the Company’s products, software, services or solutions, including resellers, the Company enters into contractual arrangements under which the Company may agree to indemnify the customer from certain events as defined within the particular contract, which may include, for example, litigation or claims relating to patent or copyright infringement. These indemnities do not always include limits on the claims, provided the claim is made pursuant to the procedures required in the contract. Historically, payments made related to these indemnifications have been immaterial.

 


25



Contingencies

 

The Company is involved in lawsuits, claims, investigations and proceedings, including those identified below, consisting of intellectual property, commercial, employment, employee benefits and environmental matters that arise in the ordinary course of business. In addition, various governmental authorities have from time to time initiated inquiries and investigations, some of which are ongoing. The Company intends to continue to cooperate fully with those governmental authorities in these matters.

 

Pursuant to the accounting guidance for contingencies, the Company regularly evaluates the probability of a potential loss of its material litigation, claims or assessments to determine whether a liability has been incurred and whether it is probable that one or more future events will occur confirming the loss. If a potential loss is determined by the Company to be probable, and the amount of the loss can be reasonably estimated, the Company establishes an accrual for the litigation, claim or assessment. If it is determined that a potential loss for the litigation, claim or assessment is less than probable, the Company assesses whether a potential loss is reasonably possible, and will disclose an estimate of the possible loss or range of loss; provided, however, if a reasonable estimate cannot be made, the Company will provide disclosure to that effect. On at least a quarterly basis, management confers with outside counsel to evaluate all current litigation, claims or assessments in which the Company is involved. Management then meets internally to evaluate all of the Company’s current litigation, claims or assessments. During these meetings, management discusses all existing and new matters, including, but not limited to, (i) the nature of the proceeding; (ii) the status of each proceeding; (iii) the opinions of legal counsel and other advisors related to each proceeding; (iv) the Company’s experience or experience of other entities in similar proceedings; (v) the damages sought for each proceeding; (vi) whether the damages are unsupported and/or exaggerated; (vii) substantive rulings by the court; (viii) information gleaned through settlement discussions; (ix) whether there is uncertainty as to the outcome of pending appeals or motions; (x) whether there are significant factual issues to be resolved; and/or (xi) whether the matters involve novel legal issues or unsettled legal theories. At these meetings, management concludes whether accruals are required for each matter because a potential loss is determined to be probable and the amount of loss can be reasonably estimated; whether an estimate of the possible loss or range of loss can be made for matters in which a potential loss is not probable, but reasonably possible; or whether a reasonable estimate cannot be made for a matter.

 

Litigation is inherently unpredictable and may result in adverse rulings or decisions. In the event that any one or more of these litigation matters, claims or assessments result in a substantial judgment against, or settlement by, the Company, the resulting liability could also have a material effect on the Company’s financial condition, cash flows and results of operations.

 

Legal Proceedings

 

Lexmark v. Static Control Components, Inc.

 

On December 30, 2002 (“02 action”) and March 16, 2004 (“04 action”), the Company filed claims against Static Control Components, Inc. (“SCC”) in the U.S. District Court for the Eastern District of Kentucky (the “District Court”) alleging violation of the Company’s intellectual property and state law rights. SCC filed counterclaims against the Company in the District Court alleging that the Company engaged in anti-competitive and monopolistic conduct and unfair and deceptive trade practices in violation of the Sherman Act, the Lanham Act and state laws. SCC has stated in its legal documents that it is seeking approximately $17.8 million to $19.5 million in damages for the Company’s alleged anticompetitive conduct and approximately $1 billion for Lexmark’s alleged violation of the Lanham Act. SCC is also seeking treble damages, attorney fees, costs and injunctive relief. On September 28, 2006, the District Court dismissed the counterclaims filed by SCC that alleged the Company engaged in anti-competitive and monopolistic conduct and unfair and deceptive trade practices in violation of the Sherman Act, the Lanham Act and state laws. On June 20, 2007, the District Court Judge ruled that SCC directly infringed one of Lexmark’s patents-in-suit. On June 22, 2007, the jury returned a verdict that SCC did not induce infringement of Lexmark’s patents-in-suit.

 

Appeal briefs for the 02 and 04 actions were filed with the U.S. Court of Appeals for the Sixth Circuit (“Sixth Circuit”) by SCC and the Company. In a decision dated August 29, 2012, the Sixth Circuit upheld the jury’s decision that SCC did not induce patent infringement and the District Court’s dismissal of SCC’s federal antitrust claims. The procedural dismissal of Static Control’s Lanham Act claim and state law unfair competition claims by the District Court were reversed and remanded to the District Court. A writ of certiorari was requested by the Company with the U.S. Supreme Court over the Sixth Circuit’s decision regarding the Lanham Act. On June 3, 2013, the Company was notified that the U.S. Supreme Court granted the Company’s writ of certiorari. The U.S. Supreme Court issued its opinion on March 25, 2014 affirming the judgment of the Sixth Circuit. The case has been remanded to the District Court for further proceedings on SCC’s Lanham Act and state law unfair competition claims against the Company.

 

The Company has not established an accrual for the SCC litigation, because it has not determined that a loss with respect to such litigation is probable. Although there is a reasonable possibility of a potential loss with respect to the SCC litigation, with SCC’s Lanham Act and state law claims being dismissed in the early stages of the litigation and now remanded to the District Court, the Company does not believe a reasonable estimate of the range of possible loss is currently possible in view of the uncertainty regarding the amount of damages, if any, that could be awarded in this matter.

 


26



Philippines Donor Tax

 

In the second quarter of 2013, as part of the Company’s sale of inkjet-related technology and assets, 100% of the shares of the legal entity owning the inkjet manufacturing facility in Cebu, Philippines were sold. The Philippines internal revenue bureau (“BIR”) subsequently assessed approximately $6.5 million of Philippines donor tax related to this share sale transaction. Lexmark has submitted additional tax declarations to the BIR to have this amount reduced to less than $1 million, which is currently pending.  In addition to challenging the amount of donor tax that may be owed, Lexmark filed a request for ruling on exemption for donor tax which was denied by the BIR. During the third quarter of 2015, Lexmark filed a request to review the BIR’s decision with the Philippines Secretary of Finance. This decision is currently pending.  Lexmark continues to reserve the right to challenge these rulings in Philippine courts.

 

Based on these developments, Lexmark continues to believe that a minimum of $0.5 million is probable to resolve this matter. Depending on the interpretation by the BIR, Philippine Secretary of Finance and/or Philippine courts, Lexmark may be required to pay the most recent BIR calculated amount of approximately $6.5 million plus accrued interest. Because the Company continues to believe that at this stage of the dispute that no single amount of the range is a better estimate than any other amount, the Company has accrued $0.5 million, which represents the low end of the range.

 

Copyright Fees

 

Certain countries (primarily in Europe) and/or collecting societies representing copyright owners’ interests have taken action to impose fees on devices (such as scanners, printers and multifunction devices) alleging the copyright owners are entitled to compensation because these devices enable reproducing copyrighted content. Other countries are also considering imposing fees on certain devices. The amount of fees, if imposed, would depend on the number of products sold and the amounts of the fee on each product, which will vary by product and by country.

 

Reprobel, a collection society with the authority to collect and distribute the remuneration for reprography to Belgian copyright holders, commenced legal proceedings against Lexmark Belgium in March of 2010 before the Civil Court of First Instance of Brussels, Belgium to collect copyright levies calculated based on the generally higher copying speed when multi-function devices are operated in draft print mode rather than when operated in normal print mode.  The Company defended the action by claiming that no copyright levies are payable on sales of multi-function devices in Belgium or, alternatively, that copyright levies payable on such multi-function devices must be lower.  On June 12, 2014, the Court of First Instance rejected Reprobel's claim for copyright levies from the Company, based primarily on a finding that the Belgian reprography legislation violated European Union law. Further, in light of the above, the Court also decided that it must acknowledge Lexmark's reservation of right with respect to a possible reimbursement of the levies previously paid to Reprobel. Reprobel has appealed that court decision to the Courts of Appeal in Brussels.

 

In a related industry case, on November 12, 2015 the Court of Justice of the European Union (“CJEU”) declared the Belgian reprography levy collection system incompatible with EU law, thereby further strengthening Lexmark’s case (HP Belgium vs. Reprobel, C-572/13). As a result of these significant legal decisions, Lexmark reversed its accrual for this matter in the fourth quarter of 2015 because it has determined that a loss with respect to such litigation is no longer probable given the decision of the Civil Court of First Instance of Brussels in favor of the Company and the CJEU’s November decision declaring the Belgian copyright levy system incompatible with European Union law.

 

Other Litigation

 

There are various other lawsuits, claims, investigations and proceedings involving the Company that are currently pending. The Company has determined that although a potential loss is reasonably possible for certain matters, that for such matters in which it is possible to estimate a loss or range of loss, the estimate of the loss or estimate of the range of loss are not material to the Company’s consolidated results of operations, cash flows or financial position.

 

15.          RECENT ACCOUNTING PRONOUNCEMENTS

 

Accounting Standards Updates Recently Issued But Not Yet Effective

 

In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 is a new comprehensive standard for revenue recognition that is based on the core principle that revenue be recognized in a manner that depicts the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Under the new standard, a good or service is transferred to the customer when (or as) the customer obtains control of the good or service, which differs from the risk and rewards approach under current guidance. The new standard provides guidance for transactions that were not previously addressed


27



comprehensively, including service revenue and contract modifications, eliminates the software industry revenue recognition guidance, and requires enhanced disclosures about revenue.

 

ASU 2014-09 may be adopted through either retrospective application to all periods presented in the financial statements or through a cumulative effect adjustment to retained earnings at the effective date. In August 2015, the FASB issued Accounting Standards Update No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date to provide a one year delay in the effective date of ASU 2014-09. The effective date of the new guidance for the Company is now January 1, 2018; however, early application is permitted for the Company’s 2017 fiscal year. The FASB also issued Accounting Standards Update No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), Accounting Standards Update No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, and Accounting Standards Update No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients to help reduce complexity and clarify certain aspects of ASU 2014-09. These ASUs have the same effective date and transition requirements as described above.

 

The Company is in the process of evaluating a sample of its contracts with customers under the new standard and cannot currently estimate the financial statement impact of adoption. The Company hopes to complete its accounting policy assessment by year-end 2016.

 

Areas of potential change for the Company include, but are not limited to:

 

 

 

 

 

 

 

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 requires that lessees recognize all leases (other than leases with a term of twelve months or less) on the balance sheet as lease liabilities, based upon the present value of the lease payments, with corresponding right of use assets. ASU 2016-02 also makes targeted changes to other aspects of current guidance, including identifying a lease and lease classification criteria as well as the lessor accounting model, including guidance on separating components of a contract and consideration in the contract. The amendments in ASU 2016-02 will be effective for the Company on January 1, 2019 and will require modified retrospective application as of the beginning of the earliest period presented in the financial statements. Early application is permitted. The Company is currently evaluating this guidance.

 

In March 2016, the FASB issued Accounting Standards Update No. 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 requires that all excess tax benefits and tax deficiencies be recognized as income tax expense or benefit in the income statement rather than stockholders’ equity and may increase volatility in net earnings. The tax effects of exercised or vested awards should be treated as discrete items in the reporting period in which they occur under the new guidance. Under ASU 2016-09, excess tax benefits or tax deficiencies will no longer be included in the assumed proceeds under the treasury stock method for calculating diluted earnings per share and excess tax benefits will be included in the determination of operating cash flows and no longer classified as a financing inflow on the statement of cash flows. Furthermore, the Company will be permitted to account for forfeitures as they occur or continue its practice of estimating forfeitures as required under current guidance. ASU 2016-09 is effective for the Company on January 1, 2017; however, early adoption is permitted. The transition requirements for ASU 2016-09 vary by topic. The Company is currently evaluating this guidance.

 

In June 2016, the FASB issued Accounting Standards Update No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 replaces the incurred loss approach under current guidance with an expected loss model for financial instruments measured at amortized cost. This change eliminates the probable initial recognition threshold under current guidance and requires that an entity estimate its lifetime expected credit loss and record the full amount in net earnings with a corresponding allowance upon initial recognition of a financial asset. The estimate should consider historical information, current conditions, and reasonable and supportable forecasts and must be updated through net earnings


28



each reporting period. ASU 2016-13 also makes targeted changes to current accounting guidance for determining credit losses for available-for-sale debt securities, including requiring certain credit-related losses to be presented as an allowance rather than as a direct reduction of amortized cost and permitting improvements to such estimated credit losses to be recognized immediately in net earnings. The amendments in ASU 2016-13 will be effective for the Company on January 1, 2020 and will require a cumulative effect adjust to retained earnings (with certain exceptions) as of this date. Early application is permitted for the Company as of January 1, 2019. The Company presently has trade receivables and sales-type lease receivables and has historically held available-for-sale debt securities, all of which are in scope of ASU 2016-13. The Company is currently evaluating this guidance.

 

In August 2016, the FASB issued Accounting Standards Update No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). ASU 2016-15 provides guidance on eight cash flow issues, including debt prepayment or debt extinguishment costs. Although the Company does not anticipate a material impact to its statement of cash flows, the ASU requires that cash payments related to debt prepayments or debt extinguishments, excluding accrued interest, be classified as a financing activity rather than an operating activity even when the effects enter into the determination of net income. Thus, debt extinguishments may be presented differently than the Company’s debt extinguishment that occurred in 2013. The amendments in ASU 2016-15 will be effective on January 1, 2018 and must be applied retrospectively. Early application is permitted. The Company is currently evaluating this guidance.

 

In October 2016, the FASB issued Accounting Standards Update No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory (“ASU 2016-16”). ASU 2016-16 requires the recognition of current and deferred income taxes resulting from an intra-entity transfer of assets other than inventory when the transfer occurs. The ASU will continue to prohibit the recognition of income tax consequences for intra-entity transfers of inventory until the asset is sold to an outside party consistent with current guidance. The amendments in ASU 2016-16 will be effective on January 1, 2018 and must be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. Early adoption is permitted. The Company is currently evaluating this guidance.

 

The FASB issued other accounting guidance during the period that is not applicable to the Company’s financial statements and, therefore, is not discussed above.

 

16.          SUBSEQUENT EVENTS

 

On October 28, 2016, the Company’s Board of Directors approved a quarterly dividend of $0.36 per share of Class A Common Stock. The dividend is payable December 16, 2016 to stockholders of record on December 2, 2016. In the event the closing of the acquisition of Lexmark by the Consortium occurs prior to the record date, no quarterly cash dividend will be paid. Under the terms of the Merger Agreement with the Consortium, any regular quarterly dividends must be declared and paid with usual record and payment dates in accordance with past dividend practice.


29




Item 2.          MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Unaudited)

 

LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

 

 

OVERVIEW

 

On April 19, 2016, the Company entered into an Agreement and Plan of Merger (“Merger Agreement”) providing for the acquisition of the Company by a consortium composed of Apex Technology Co., Ltd., PAG Asia Capital and Legend Capital Management Co., Ltd. (the “Consortium”) in a cash transaction for $40.50 per share. Refer to Part I, Item 1, Note 2 of the Notes to Consolidated Condensed Financial Statements for more information.

 

Lexmark makes it easier for businesses of all sizes to improve their business processes by enabling them to capture, manage and access critical unstructured business information in the context of their business processes while speeding the movement and management of information between the paper and digital worlds. Since its inception in 1991, Lexmark has become a leading developer, manufacturer and supplier of printing, imaging, device management, managed print services (“MPS”), document workflow and, more recently, business process and content management solutions. The Company operates in the office printing and imaging, ECM, BPM, DOM/ CCM, intelligent content capture and data extraction and enterprise search software markets. Lexmark’s products include laser printers and multifunction devices, dot matrix printers and the associated supplies/solutions/services. The Company’s products also include an integrated suite of ECM, BPM and DOM/CCM. This suite of products include case management, electronic signature, process analytics, information and application integration, intelligent content capture and data extraction, enterprise search and medical imaging vendor neutral archive (“VNA”) software products and solutions. Lexmark develops and owns most of the technology for its printing and imaging products and its software related to MPS and content and process management solutions.

 

The Company is managed along two operating segments: ISS and Enterprise Software.

 

 

 

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Lexmark’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated condensed financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of consolidated condensed financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, as well as disclosures regarding contingencies. 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.

 


30



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.

 

Except for the item discussed below, management believes that there have been no significant changes during 2016 to the items that were disclosed as critical accounting policies and estimates within Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Company’s 2015 Annual Report on Form 10-K.

 

Goodwill and Intangible Assets

 

Goodwill assigned to the ISS and Enterprise Software reporting units as of September 30, 2016 was $17.1 million and $1,305.9 million, respectively. In the third quarter of 2016 the Company determined that it was more-likely-than-not that the Company would be sold as part of the pending merger with the Consortium, and consequently tested goodwill for impairment as of September 30, 2016. The Company performed a qualitative assessment for the ISS reporting unit. The fair value of the ISS reporting unit was substantially in excess of its carrying value on this date. The Company performed a quantitative assessment for the Enterprise Software reporting unit based on multiples developed from prices paid in observed market transactions and public company trading multiples. The fair value of the Enterprise Software reporting unit was in excess of its carrying value on this date. The carrying value of the Enterprise Software reporting unit includes goodwill and intangible assets from recently acquired businesses such as Kofax, that were recently recorded at fair value based on business operating plans and macroeconomic conditions at the time of acquisition. Consequently, the Enterprise Software reporting unit is more susceptible to potential impairment charges resulting from adverse changes. The Enterprise Software reporting unit’s operating results fell short of expectation during the first nine months of 2016; however, the Company’s long-term projected operating results remain unchanged. If the Company is not able to achieve the projected performance levels, future impairments could be possible, which would negatively impact the Company’s earnings.

 

RESULTS OF OPERATIONS

 

Operations Overview

 

Key Messages

 

Lexmark is focused on increasing its participation in the growing market for higher value solutions to customers’ unstructured information challenges. The Company will drive long-term performance by strategically investing in technology, hardware and software products and solutions to secure high-value product installations and capture profitable supplies, software maintenance and service annuities in document and unstructured information-intensive industries and business processes in distributed environments.

 

 

 

 

While focusing on core strategic initiatives, Lexmark has taken actions over the last few years to improve its cost and expense structure. As a result of restructuring initiatives, significant changes have been implemented, from the consolidation and reduction of the manufacturing and support infrastructure and the increased use of shared service centers in low-cost countries, to the exit of inkjet technology. In July 2015 and February 2016, the Company announced restructuring actions designed to increase profitability and operational efficiency. In 2012, the Company announced restructuring actions including exiting the development and manufacturing of its remaining inkjet hardware. As previously reported, in the second quarter of 2013, the Company sold its inkjet-related technology and assets.

 

Lexmark is committed to growing a more predictable annuity revenue base and transforming to a higher value portfolio through expansion of its current MPS and software product offerings. Refer to Part I, Item 1, Note 2 of the Notes to Consolidated Condensed Financial Statements for more information on the Merger Agreement entered into by the Company.

 


31



ISS

 

Lexmark’s ISS segment continues to focus on capturing profitable supplies and service annuities generated from its monochrome and color laser printers and MFPs. Associated strategic initiatives include:

 

 

 

 

 

Enterprise Software

 

Lexmark’s software strategy is to deliver affordable, industry and process-specific workflow enhancing solutions through deep industry expertise and a broad content and process management software platform, in a model that is easy to integrate, use and support. The Company acquired Perceptive Software, Inc. in 2010; Pallas Athena Holdings B.V. in 2011; BDGB Enterprise Software (Lux) S.C.A., ISYS Search Software Pty Ltd., Nolij Corporation and Acuo Technologies, LLC in 2012; AccessVia, Inc., Twistage, Inc., Saperion AG and PACSGEAR, Inc. in 2013, ReadSoft and GNAX Healthcare LLC in 2014 and Claron and Kofax in 2015. These acquisitions enhance Lexmark’s capabilities as a content and process management solutions provider, expand the Company’s market opportunity and provide a core strategic component for the Company’s future.

 

Key software strategic initiatives include:

 

 

 

 

 

Operating Results Summary

 

The following discussion and analysis should be read in conjunction with the Consolidated Condensed Financial Statements and Notes thereto. The following table summarizes the results of the Company’s operations for the three and nine months ended September 30, 2016 and 2015:

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

 

2016

 

2015

 

2016

 

2015

(Dollars in millions)

Dollars

% of Rev

 

Dollars

% of Rev

 

Dollars

% of Rev

 

Dollars

% of Rev

Revenue

$

843.9 

100 

%

 

$

851.1 

100 

%

 

$

2,512.7 

100 

%

 

$

2,582.4 

100 

%

Gross profit

 

329.4 

39 

 

 

 

319.6 

38 

 

 

 

972.8 

39 

 

 

 

1,011.6 

39 

 

Operating expense

 

293.5 

35 

 

 

 

341.2 

40 

 

 

 

952.5 

38 

 

 

 

1,013.1 

39 

 

Operating income (loss)

 

35.9 

4 

 

 

 

(21.6)

(3)

 

 

 

20.3 

1 

 

 

 

(1.5)

– 

 

Net earnings (loss)

 

18.3 

2 

 

 

 

(15.2)

(2)

 

 

 

(56.5)

(2)

 

 

 

(29.7)

(1)

 

 

Current Quarter

 

For the three months ended September 30, 2016, total Lexmark revenue declined 1% YTY, driven by an unfavorable YTY currency impact of 2% and an unfavorable YTY impact of 2% due to the Company’s exit of inkjet technology. These factors were partially offset by a positive impact of 1% from laser supplies revenue growth and 1% from Enterprise Software revenue growth.

 


32



For the three months ended September 30, 2016, operating income increased $57.5 million or 266% YTY primarily due to lower operating expenses driven by a decrease of $20.4 million of acquisition, strategic alternatives, and divestiture-related adjustments and overall expense management.

 

Net earnings for the three months ended September 30, 2016 increased $33.5 million or 220% from the prior year, due to an increase in operating income and the impact of a lower effective tax rate. Net earnings for the three months ended September 30, 2016 included $45.6 million of pre-tax acquisition and strategic alternatives-related adjustments, $0.5 million of pre-tax restructuring charges and project costs and $1.5 million in pre-tax remediation-related charges. Net earnings for the three months ended September 30, 2015 included $81.5 million of pre-tax acquisition and divestiture-related adjustments, $0.9 million of pre-tax restructuring charges and project costs and $3.2 million in pre-tax remediation-related charges.

 

Year-to-Date

 

For the nine months ended September 30, 2016, total Lexmark revenue declined 3% YTY, driven by an unfavorable YTY currency impact of 4% and an unfavorable YTY impact of 3% due to the Company’s exit of inkjet technology. These factors were partially offset by a positive impact of 3% from Enterprise Software revenue growth, reflecting a favorable impact of 4% due to the acquisition of Kofax.

 

For the nine months ended September 30, 2016, operating income increased $21.8 million or 1,453% YTY primarily due to lower operating expenses of $60.6 million, partially offset by a decrease in gross profit of $38.8 million compared to the same period in 2015. The decrease in gross profit was driven by the unfavorable impact from a partial reversal of an accrued contingency of $23.5 million in the comparative period and YTY lower acquisition-related adjustments of $14.8 million. The lower operating expenses were driven by a decrease in restructuring charges and project costs of $50.0 million, a decrease in acquisition, strategic alternatives, and divestiture-related adjustments of $32.9 million and overall expense management. This was partially offset by an increase in the pension and other postretirement benefit plan actuarial net loss of $20.2 million.

 

Net earnings for the nine months ended September 30, 2016 declined $26.8 million or 90% from the prior year, primarily due to an increase in the Company’s reserve for uncertain tax positions and accrued interest partially offset by an increase in operating income. Net earnings for the nine months ended September 30, 2016 included $150.2 million of pre-tax acquisition and strategic alternatives-related adjustments, a pension and other postretirement benefit plan actuarial net loss of $26.4 million, $(10.8) million of pre-tax restructuring reversals and project costs, and $10.4 million in remediation-related charges. Net earnings for the nine months ended September 30, 2015 included $197.9 million of pre-tax acquisition and divestiture-related adjustments, $40.0 million of pre-tax restructuring charges and project costs, a pension and other postretirement benefit plan actuarial net loss of $0.3 million and $3.2 million in remediation-related charges.

 

The Company uses the term “acquisition, strategic alternatives, and divestiture-related adjustments” for purchase accounting adjustments, incremental acquisition and integration costs related to acquisitions, costs related to the strategic alternatives process, and costs related to the sale of inkjet-related technology and assets. The Company uses the term “project costs” for incremental charges related to the execution of its restructuring plans. The Company uses the term “remediation-related charges” for professional fees associated with analysis and remediation of the Company’s previously disclosed material weakness in internal controls over income tax accounting.

 

Revenue

 

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

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

(Dollars in millions)

2016

 

2015

 

% Change

 

2016

 

2015

 

% Change

ISS

$

688.3 

 

$

703.0 

 

(2)

%

 

$

2,055.2 

 

$

2,209.0 

 

(7)

%

Enterprise Software

 

155.6 

 

 

148.1 

 

5 

 

 

 

457.5 

 

 

373.4 

 

23 

 

Total revenue

$

843.9 

 

$

851.1 

 

(1)

%

 

$

2,512.7 

 

$

2,582.4 

 

(3)

%

 

ISS

 

For the three months ended September 30, 2016, ISS revenue declined 2% compared to the same period in 2015, which reflected unfavorable currency and inkjet exit impacts of approximately 3% and 3%, respectively. Large workgroup laser hardware revenue, which represented about 85% of total hardware revenue for the three months ended September 30, 2016, declined 5% YTY reflecting a decrease of 10% YTY in average unit revenue (“AUR”), driven by unfavorable currency movements and unfavorable product mix. Units increased by 5%, driven by higher sales volumes. Small workgroup laser hardware revenue, which for the three months ended


33



September 30, 2016 represented about 15% of total hardware revenue, increased 5% YTY reflecting a 4% increase in units, driven by higher sales volumes and a 1% increase in AUR YTY reflecting a favorable product mix.

 

Supplies revenue for the three months ended September 30, 2016 was down 1% compared to the same period in 2015, reflecting unfavorable currency and inkjet exit impacts of 3% and 4%, respectively. These factors were partially offset by YTY growth of 2% in laser supplies revenue driven by higher sales volumes and YTY growth in MPS laser supplies revenue. Inkjet exit supplies revenue declined 56% YTY due to ongoing and expected declines in the inkjet installed base as the Company has exited inkjet technology.

 

For the nine months ended September 30, 2016, ISS revenue declined 7% compared to the same period in 2015, including unfavorable currency and inkjet exit impacts of approximately 4% and 3%, respectively. Large workgroup laser hardware revenue, which represented about 85% of total hardware revenue for the nine months ended September 30, 2016, declined 11% YTY reflecting a 3% decline in units, primarily driven by competitive pressures, and a 8% decline in AUR, reflecting unfavorable currency movements and an unfavorable product mix during 2016. Small workgroup laser hardware revenue, which for the nine months ended September 30, 2016 represented about 15% of total hardware revenue, declined 8% YTY due to a 9% decrease in units driven by competitive pressures. AUR increased 1% YTY reflecting a favorable product mix during 2016. The Company uses the term “large workgroup” to include departmental, large workgroup and medium workgroup lasers, which are typically attached directly to large workgroup networks, as well as dot matrix printers and options. The term “small workgroup” includes small workgroup lasers and personal lasers, which are attached to small workgroup networks and/or personal computers. The Company uses the term “inkjet exit” to include consumer and business inkjet supplies.

 

Supplies revenue for the nine months ended September 30, 2016 was down 6% compared to the same period in 2015, reflecting unfavorable currency and inkjet exit impacts of 4% and 4%, respectively. Laser supplies revenue decreased 2% YTY primarily due to unfavorable currency impact of 4% partially offset by YTY growth in MPS laser supplies revenue. Inkjet exit supplies revenue declined 57% YTY due to ongoing and expected declines in the inkjet installed base as the Company has exited inkjet technology.

 

Enterprise Software

 

For the three months ended September 30, 2016, revenue for Enterprise Software increased 5% primarily due to a greater unfavorable impact of fair value adjustments recorded in purchase accounting during the comparative period and a YTY increase in maintenance and support revenue. This was partially offset by a YTY decrease in license revenue due to higher than anticipated levels of attrition in the sales force as a result of the strategic alternatives process as well as an unfavorable currency impact of 1%.

 

For the nine months ended September 30, 2016, revenue for Enterprise Software increased 23% primarily driven by the acquisition of Kofax in the second quarter of 2015. The YTY increases in license and maintenance and support revenue reflected a favorable impact of 31% due to the acquisition of Kofax. This was partially offset by a slight decrease in professional services revenue due to higher than anticipated levels of attrition in the sales force as a result of the strategic alternatives process as well as an unfavorable currency impact of 1%.

 

See “Acquisition, Strategic Alternatives, and Divestiture-Related Adjustments” section that follows for further discussion.

 

Revenue by Geography

 

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

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

(Dollars in millions)

2016

 

2015

 

% Change

 

2016

 

2015

 

% Change

United States

$

400.3 

 

$

409.3 

 

(2)

%

 

$

1,190.1 

 

$

1,197.6 

 

(1)

%

Europe, the Middle East, & Africa ("EMEA")

 

292.2 

 

 

279.7 

 

4 

 

 

 

885.2 

 

 

898.8 

 

(2)

 

Other international

 

151.4 

 

 

162.1 

 

(7)

 

 

 

437.4 

 

 

486.0 

 

(10)

 

Total revenue

$

843.9 

 

$

851.1 

 

(1)

%

 

$

2,512.7 

 

$

2,582.4 

 

(3)

%

 

For the three months ended September 30, 2016, revenues in the United States declined slightly compared to the same period in 2015 primarily due to lower laser supplies revenue and lower Enterprise Software revenue as well as the negative impact of the Company’s planned exit from inkjet technologies partially offset by higher laser hardware revenue. Revenues in EMEA increased slightly compared to the same period in 2015 primarily due to higher laser supplies revenue. These factors were partially offset by lower laser hardware revenue, which reflected unfavorable currency impact, the negative impact of the Company’s planned exit from inkjet technologies and lower Enterprise Software revenue. The YTY decline in revenues in other international regions was primarily due to lower laser supplies and laser hardware revenue in Latin America and Asia Pacific, partially offset by growth in Enterprise Software revenue in Asia Pacific. For the three months ended September 30, 2016, currency exchange rates had an unfavorable YTY impact on total revenue of 2%.


34



 

For the nine months ended September 30, 2016, revenues in the United States decreased slightly compared to the same period in 2015 primarily due to lower laser supplies revenue as well as the negative impact of the Company’s planned exit from inkjet technologies, partially offset by higher services and Enterprise Software revenue. Revenues in EMEA declined slightly compared to the same period in 2015 primarily due to lower laser hardware revenue, which reflected unfavorable currency impact, and the negative impact of the Company’s planned exit from inkjet technologies. These factors were partially offset by growth in Enterprise Software revenue. The YTY decline in revenues in other international regions was primarily due to lower laser hardware and laser supplies revenues in Latin America and Asia Pacific, partially offset by growth in Enterprise Software revenue in Asia Pacific. For the nine months ended September 30, 2016, currency exchange rates had an unfavorable YTY impact on total revenue of 4%.

 

Gross Profit

 

The following table provides gross profit information:

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

(Dollars in millions)

2016

 

2015

 

Change

 

2016

 

2015

 

Change

Gross profit dollars

$

329.4 

 

 

$

319.6 

 

 

3 

%

 

$

972.8 

 

 

$

1,011.6 

 

 

(4)

%

% of revenue

 

39 

%

 

 

38 

%

 

1 

pts

 

 

39 

% 

 

 

39 

% 

 

– 

pts

 

For the three months ended September 30, 2016, consolidated gross profit increased 3% and gross profit as a percentage of revenue increased 1 percentage point compared to the same period in 2015. Gross profit as a percentage of revenue for the three months ended September 30, 2016 versus the same period in 2015 reflected favorable impacts of 2 percentage points for lower acquisition-related costs and 1 percentage point for supplies and services margins. These favorable impacts were partially offset by a 1 percentage point impact for lower hardware margins, reflecting an unfavorable impact for currency movements. Gross profit for the three months ended September 30, 2016 included $19.6 million of pre-tax acquisition-related adjustments. Gross profit for the three months ended September 30, 2015 included $35.1 million of pre-tax acquisition-related adjustments.

 

For the nine months ended September 30, 2016, consolidated gross profit decreased 4% and gross profit as a percentage of revenue was flat compared to the same period in 2015. Gross profit as a percentage of revenue for the nine months ended September 30, 2016 versus the same period in 2015 reflected favorable impacts of 1 percentage point for lower acquisition-related costs, 1 percentage point for higher services margins and a 1 percentage point mix impact. The mix impact reflected the benefit of a lower relative proportion of laser hardware revenue. These favorable impacts were partially offset by unfavorable impacts of 1 percentage points for hardware driven by partial reversal of an accrued contingency in the comparative period and a negative impact of 2 percentage points for product margins, reflecting an unfavorable impact for currency movements. Gross profit for the nine months ended September 30, 2016 included $64.4 million of pre-tax acquisition-related adjustments and a pension and other postretirement benefit plan actuarial net loss of $6.0 million. Gross profit for the nine months ended September 30, 2015 included $79.2 million of pre-tax acquisition-related adjustments, $0.8 million of pre-tax restructuring charges, and a pension and other postretirement benefit plan actuarial net loss of $0.1 million.

 

See “Restructuring Charges and Project Costs” and “Acquisition, Strategic Alternatives, and Divestiture-Related Adjustments” sections that follow for further discussion.

 

Operating Expense

 

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

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

(Dollars in millions)

2016

 

2015

 

% Change

 

2016

 

2015

 

% Change

Research and development

$

68.5 

 

$

81.6 

 

(16)

%

 

$

228.0 

 

$

244.9 

 

(7)

%

Selling, general and administrative

 

228.5 

 

 

261.0 

 

(12)

 

 

 

743.1 

 

 

736.0 

 

1 

 

Restructuring and related (reversals) charges

 

(3.5)

 

 

(1.4)

 

(150)

 

 

 

(18.6)

 

 

32.2 

 

(158)

 

Total operating expense

$

293.5 

 

$

341.2 

 

(14)

%

 

$

952.5 

 

$

1,013.1 

 

(6)

%

 

For the three months ended September 30, 2016, total operating expense decreased 14% compared to the same period in 2015. Research and development expenses for the three months ended September 30, 2016 decreased 16% compared with the same period in 2015 driven by expense reductions in ISS and Enterprise Software due to the Company’s restructuring actions, overall expense management and favorable currency movements. Selling, general and administrative expenses for the three months ended September 30, 2016 decreased 12% compared with the same period in 2015, reflecting lower acquisition-related adjustments, expense reductions in ISS and Enterprise Software due to the Company’s restructuring actions and favorable currency movements.


35



 

For the nine months ended September 30, 2016, total operating expense decreased 6% compared to the same period in 2015. Research and development expenses for the nine months ended September 30, 2016 decreased 7% compared with the same period in 2015 driven by expense reductions in ISS and Enterprise Software due to the Company’s restructuring actions, overall expense management and favorable currency movements, partially offset by increases related to the acquisition of Kofax and the impact of the pension and other postretirement benefit plan actuarial net loss. Selling, general and administrative expenses for the nine months ended September 30, 2016 increased 1% compared with the same period in 2015, reflecting increases related to the acquisition of Kofax and the impact of the pension and other postretirement benefit plan actuarial net loss. These factors were partially offset by expense reductions in ISS and Enterprise Software due to the Company’s restructuring actions, overall expense management and favorable currency movements. Restructuring and related charges for the nine months ended September 30, 2016 decreased $50.8 million or 158% compared with the same period in 2015, reflecting an accrual of $32.2 million established in the comparative period for the 2015 Restructuring Actions along with reversals of $(18.6) million during the current period primarily due to the higher than expected levels of attrition as a result of the strategic alternatives process as well as the announced restructuring programs in 2015 and 2016. These higher levels of attrition reduced the expected termination benefits required resulting in the reversals.

 

The following table provides restructuring (reversals) charges and project costs, acquisition, strategic alternatives, and divestiture-related adjustments, the impact of the pension and other postretirement benefit plan actuarial net loss and remediation-related charges included in the Company’s operating expense for the periods presented:

 

 

Three Months Ended

 

September 30

 

2016

 

2015

 

 

 

 

 

 

 

 

 

Restructuring

Acquisition and

 

 

Restructuring

 

 

 

charges

strategic

 

 

charges

Acquisition and

 

 

(reversals)

alternatives-

Remediation-

 

(reversals)

divestiture-

Remediation-

 

and

related

related

 

and

related

related

(Dollars in millions)

project costs

adjustments

charges

 

project costs

adjustments

charges

Research and development

$

– 

$

0.3 

$

– 

 

$

– 

$

0.4 

$

– 

Selling, general and administrative

 

4.0 

 

25.7 

 

1.5 

 

 

2.3 

 

46.0 

 

3.2 

Restructuring and related reversals

 

(3.5)

 

– 

 

– 

 

 

(1.4)

 

– 

 

– 

Total

$

0.5 

$

26.0 

$

1.5 

 

$

0.9 

$

46.4 

$

3.2 

 

 

Nine Months Ended

 

September 30

 

2016

 

2015

 

 

 

Pension and

 

 

 

 

Pension and

 

 

Restructuring

Acquisition and

other

 

 

 

 

other

 

 

charges

strategic

postretirement

 

 

Restructuring

Acquisition and

postretirement

 

 

(reversals)

alternatives-

benefit plan

Remediation-

 

charges

divestiture-

benefit plan

Remediation-

(Dollars in

and

related

actuarial

related

 

and

related

actuarial

related

millions)

project costs

adjustments

net loss

charges

 

project costs

adjustments

net loss

charges

Research and development

$

– 

$

0.9 

$

4.3 

$

– 

 

$

– 

$

0.9 

$

0.1 

$

– 

Selling, general and administrative

 

7.8 

 

84.9 

 

16.1 

 

10.4 

 

 

7.0 

 

117.8 

 

0.2 

 

3.2 

Restructuring and related (reversals) charges

 

(18.6)

 

– 

 

– 

 

– 

 

 

32.2 

 

– 

 

– 

 

– 

Total

$

(10.8)

$

85.8 

$

20.4 

$

10.4 

 

$

39.2 

$

118.7 

$

0.3 

$

3.2 

 

See “Restructuring Charges and Project Costs” and “Acquisition, Strategic Alternatives, and Divestiture-Related Adjustments” sections that follow for further discussion.

 

Operating Income (Loss)

 

The following table provides operating income (loss) by segment:

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

(Dollars in millions)

2016

 

2015

 

Change

 

2016

 

2015

 

Change

ISS

$

113.6 

 

 

$

95.2 

 

 

19 

%

 

$

345.2 

 

 

$

372.4 

 

 

(7)

%

% of segment revenue

 

17 

%

 

 

14 

%

 

3 

pt

 

 

17 

%

 

 

17 

%

 

– 

pt

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Enterprise Software

 

9.2 

 

 

 

(21.6)

 

 

143 

%

 

 

(15.3)

 

 

 

(74.4)

 

 

79 

%

% of segment revenue

 

6 

%

 

 

(15)

%

 

21 

pt

 

 

(3)

%

 

 

(20)

%

 

17 

pt

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

All other

 

(86.9)

 

 

 

(95.2)

 

 

9 

%

 

 

(309.6)

 

 

 

(299.5)

 

 

(3)

%

Total operating income (loss)

$

35.9 

 

 

$

(21.6)

 

 

266 

%

 

$

20.3 

 

 

$

(1.5)

 

 

1,453 

%

% of total revenue

 

4 

%

 

 

(3)

%

 

7 

pt

 

 

1 

%

 

 

– 

%

 

1 

pt

 


36



For the three months ended September 30, 2016, the increase in consolidated operating income from the same period in 2015 reflected higher operating income in the Enterprise Software and ISS segments. All other reflected lower acquisition and strategic alternatives-related adjustments and a favorable currency impact. The higher ISS operating income for the three months ended September 30, 2016 reflected lower operating expenses due to cost reductions from the announced restructuring programs and a favorable currency impact, partially offset by lower revenues primarily due to the unfavorable currency movements and the inkjet exit. The higher Enterprise Software operating income for the three months ended September 30, 2016 was primarily driven by higher as well as lower acquisition-related adjustments and lower other operating expenses.

 

For the nine months ended September 30, 2016, the increase in consolidated operating income from the same period in 2015 reflected lower operating losses in Enterprise Software partially offset by lower operating income in the ISS segment. All other reflected higher operating expenses related to the acquisition of Kofax, the unfavorable impact of the pension and other postretirement benefit plan actuarial net loss and higher remediation-related charges. These factors were partially offset by lower acquisition and strategic alternatives-related adjustments, lower restructuring charges and project costs and a favorable currency impact. The lower ISS operating income for the nine months ended September 30, 2016 reflected lower revenues primarily due to unfavorable currency movements, lower laser hardware and laser supplies revenues, and the inkjet exit as well as the unfavorable impact on gross profit from a partial reversal of an accrued contingency in the comparative period, partially offset by lower operating expenses due to cost reductions and reversals of restructuring charges and project costs and a favorable currency impact. The lower operating losses in Enterprise Software for the nine months ended September 30, 2016 were driven by higher revenues primarily due to the acquisition of Kofax as well as slightly lower acquisition-related adjustments and lower restructuring-related charges. These factors were partially offset by higher other operating expenses primarily due to the acquisition of Kofax.

 

The following tables provide restructuring (reversals) charges and project costs, acquisition, strategic alternatives and divestiture-related adjustments, the impact of the pension and other postretirement benefit plan actuarial net loss and remediation-related charges included in the Company’s operating income for the periods presented:

 

 

Three Months Ended

 

September 30

 

2016

 

2015

 

 

 

 

 

 

 

 

 

Restructuring

Acquisition and

 

 

Restructuring

 

 

 

charges

strategic

 

 

charges

Acquisition and

 

 

(reversals)

alternatives-

Remediation-

 

(reversals)

divestiture-

Remediation-

 

and

related

related

 

and

related

related

(Dollars in millions)

project costs

adjustments

charges

 

project costs

adjustments

charges

ISS

$

0.3 

$

0.1 

$

– 

 

$

5.9 

$

0.4 

$

– 

Enterprise Software

 

(1.8)

 

31.0 

 

– 

 

 

(2.5)

 

54.1 

 

– 

All other

 

2.0 

 

14.5 

 

1.5 

 

 

(2.5)

 

27.0 

 

3.2 

Total

$

0.5 

$

45.6 

$

1.5 

 

$

0.9 

$

81.5 

$

3.2 

 

 

Nine Months Ended

 

September 30

 

2016

 

2015

 

 

 

 

Pension and

 

 

 

 

Pension and

 

 

Restructuring

Acquisition and

other

 

 

 

 

other

 

 

(reversals)

strategic

postretirement

 

 

Restructuring

Acquisition and

postretirement

 

 

charges

alternatives-

benefit plan

Remediation-

 

charges

divestiture-

benefit plan

Remediation-

(Dollars in

and

related

actuarial

related

 

and

related

actuarial

related

millions)

project costs

adjustments

net loss

charges

 

project costs

adjustments

net loss

charges

ISS

$

(14.5)

$

0.5 

$

– 

$

– 

 

$

11.8 

$

1.1 

$

– 

$

– 

Enterprise Software

 

(1.5)

 

98.8 

 

– 

 

– 

 

 

16.8 

 

126.0 

 

– 

 

– 

All other

 

5.2 

 

50.9 

 

26.4 

 

10.4 

 

 

11.4 

 

70.8 

 

0.3 

 

3.2 

Total

$

(10.8)

$

150.2 

$

26.4 

$

10.4 

 

$

40.0 

$

197.9 

$

0.3 

$

3.2 

 

See “Restructuring Charges and Project Costs” and “Acquisition, Strategic Alternatives, and Divestiture-Related Adjustments” sections that follow for further discussion.

 

Interest and Other

 

The following table provides interest and other information:

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

(Dollars in millions)

2016

 

2015

 

2016

 

2015

Interest expense (income), net

$

11.5 

 

$

10.4 

 

$

33.8 

 

$

28.1 

Other expense (income), net

 

1.3 

 

 

3.4 

 

 

2.5 

 

 

3.6 

Total interest and other expense (income), net

$

12.8 

 

$

13.8 

 

$

36.3 

 

$

31.7 

 


37



For the three months ended September 30, 2016, total interest and other expense (income), net decreased compared to the same period in 2015 due to lower other expense during the period.

 

For the nine months ended September 30, 2016, total interest and other (income) expense increased compared to the same period in 2015 reflecting higher interest expense for borrowings related to the acquisition of Kofax and reduced interest income due to lower cash, cash equivalents and marketable securities balances.

 

Provision for Income Taxes and Related Matters

 

The Provision for income taxes for the three months ended September 30, 2016 was an expense of $4.8 million or an effective tax rate of 20.6%, compared to a benefit of $20.2 million or an effective tax rate of 57.1% for the three months ended September 30, 2015. The difference in these rates is primarily due to a shift in the expected geographic distribution of earnings for 2016 compared to 2015 and discrete items recorded in the respective periods.  Additionally, for the three months ended September 30, 2016, the Company increased income tax benefit by $0.3 million in recognition of several discrete items, which primarily included a tax benefit related to the release of uncertain tax position accruals and provision-to-return adjustments for 2015 returns filed during the quarter.  The three months ended September 30, 2015 included discrete items related to changes in estimates associated with filing 2014 tax returns, obtaining certification for certain state tax credits, and re-measuring certain non-functional currency foreign deferred tax liabilities totaling a benefit of $10.4 million.

 

The Provision for income taxes for the nine months ended September 30, 2016 was an expense of $40.5 million or an effective tax rate of (252.2)%, compared to a benefit of $3.5 million or an effective tax rate of 10.5% for the nine months ended September 30, 2015. The difference in these rates is primarily due to discrete items totaling $39.7 million. At reporting period end, the Company reassesses its uncertain tax positions. During the second quarter of 2016, the Company determined it was no longer more likely than not that a previously recognized uncertain tax benefit will be sustained and therefore increased its reserve for uncertain tax positions and accrued interest by $34.9 million during the period ending June 30, 2016. The remaining portion of discrete items is primarily related to deferred tax expense associated with a change in the Switzerland applicable tax rate and provision-to-return adjustments for 2015 returns. The nine months ended September 30, 2015 included discrete items related to changes in estimates associated with filing 2014 tax returns, obtaining certification for certain state tax credits, resolving certain tax uncertainties, and re-measuring certain non-functional currency foreign deferred tax liabilities totaling a benefit of $7.9 million.

 

It is reasonably possible that the total amount of unrecognized tax benefits will increase or decrease in the next 12 months. Such changes could occur based on the expiration of various statutes of limitations or the conclusion of ongoing tax audits in various jurisdictions around the world. Accordingly, within the next 12 months, the Company estimates that its unrecognized tax benefits amount could decrease by an amount in the range of $2.5 million to $48.0 million. The Company is unable to reasonably estimate a range of the possible increase in the amount of unrecognized tax benefits that could occur within the next 12 months. However, any such increase is not expected to be material to the Company.

 

The Company’s effective tax rate generally differs from the U.S. federal statutory rate of 35% as a result of U.S. state taxes on U.S. earnings and lower tax rates applicable to foreign earnings in most foreign jurisdictions in which the Company operates, most notably, Switzerland.

 

Net Earnings (Loss) and Earnings (Loss) per Share

 

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

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

(Dollars in millions, except per share amounts)

2016

 

2015

 

2016

 

2015

Net earnings (loss)

$

18.3 

 

$

(15.2)

 

$

(56.5)

 

$

(29.7)

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings (loss) per share

$

0.29 

 

$

(0.25)

 

$

(0.90)

 

$

(0.48)

Diluted earnings (loss) per share

$

0.28 

 

$

(0.25)

 

$

(0.90)

 

$

(0.48)

 

Net earnings for the three months ended September 30, 2016 increased from the prior year primarily due to increased operating income and the impact of a lower effective tax rate. For the three months ended September 30, 2016, the YTY increase in basic and diluted earnings per share was primarily due to higher earnings partially offset by higher weighted average shares outstanding.

 

Net loss for the nine months ended September 30, 2016 increased from the prior year primarily due to an increase in the Company’s income tax provision driven by an increase in the reserve for uncertain tax positions and accrued interest partially offset by higher operating income. For the nine months ended September 30, 2016, the YTY increase in loss per share was primarily due to a higher net loss.


38



 

RESTRUCTURING CHARGES AND PROJECT COSTS

 

Summary of Restructuring Impacts

 

The Company’s 2016 financial results are impacted by its restructuring plans and related projects. 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.

 

Summary of Restructuring Actions

 

2016 Restructuring Actions

 

On February 23, 2016, the Company announced restructuring actions (the “2016” Restructuring Actions”) designed to increase profitability and operational efficiency primarily in its ISS Segment. These restructuring actions are focused on optimizing the Company’s ISS structure, primarily as a result of the continued strong U.S. dollar, and are also aligned with the previously announced strategic alternatives process.

 

The 2016 Restructuring Actions will impact about 550 positions worldwide through December 2016, with a portion of the positions being shifted to low-cost countries. The 2016 Restructuring Actions will result in total pre-tax charges, including project costs of approximately $46 million, with $33 million incurred to date, and the remainder to be incurred in 2016. The total cash costs of the 2016 Restructuring Actions will be approximately $43 million, of which $32 million has been incurred to date, and the remainder to be incurred in 2016. The cash outlays for the 2016 Restructuring Actions were $27 million through the third quarter 2016 and are anticipated to be approximately $16 million for the remainder of 2016.

 

The 2016 Restructuring Actions will generate cash savings of approximately $67 million in 2016 and ongoing annual savings of approximately $100 million in 2017, all of which will be cash savings. These ongoing savings will be split approximately 90% to Operating expense and approximately 10% to Cost of revenue. The Company expects these actions to be complete by the end of 2016.

 

2015 Restructuring Actions

 

On July 21, 2015, the Company announced restructuring actions (the “2015 Restructuring Actions”) designed to increase profitability and operational efficiency. These Company-wide restructuring actions are broad-based but capture the cost and expense synergies from the Kofax and ReadSoft acquisitions. Primary Company-wide impacts are general and administrative, marketing and development positions, as well as the consolidation of regional facilities.

 

The 2015 Restructuring Actions impact about 500 positions worldwide through December 2016, with a portion of the positions being shifted to low-cost countries. The 2015 Restructuring Actions will result in total pre-tax charges, including project costs, of approximately $40 million, with $35 million incurred to date and approximately $5 million remaining to be incurred in 2016. The total cash costs of the 2015 Restructuring Actions will be approximately $39 million, with $33 million incurred to date and approximately $6 million remaining to be incurred in 2016. The cash outlays for the 2015 Restructuring Actions were $30 million through the third quarter 2016 and are anticipated to be approximately $9 million for the remainder of 2016.

 

The 2015 Restructuring Actions will generate cash savings of approximately $55 million in 2016 and ongoing annual savings of approximately $65 million beginning in 2017, all of which will be cash savings. These ongoing savings will be split approximately 90% to Operating expense and approximately 10% to Cost of revenue. The Company expects these actions to be complete by the end of 2016.

 

Other Restructuring Actions

 

As part of Lexmark’s ongoing strategy to increase the focus of its talent and resources on higher usage business platforms, the Company announced various restructuring actions (the “Other Restructuring Actions”) over the past several years. The Other Restructuring Actions primarily include exiting the development and manufacturing of the Company’s remaining inkjet hardware, with reductions primarily in the areas of inkjet-related manufacturing, research and development, supply chain, marketing and sales, as well as other support functions. The Other Restructuring Actions are considered substantially completed and any remaining charges to be incurred from these actions are expected to be immaterial. 

 

Refer to Note 3 of the Notes to Consolidated Condensed Financial Statements for a rollforward of the liability incurred for the 2016, 2015 and Other Restructuring Actions.

 


39



Impact to 2016 Financial Results

 

For the three months ended September 30, 2016, the Company incurred charges (reversals), including project costs, for its restructuring plans as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2015 Actions

 

 

 

 

2016 Actions

2016 Actions

 

 

Restructuring

2015 Actions

 

 

 

Restructuring

Restructuring

2016

Charges

Restructuring

2015

Total

 

Reversals

Project

Actions

(Reversals)

Project

Actions

All

(Dollars in millions)

(Note 3)

Costs

Total

(Note 3)

Costs

Total

Actions

Employee termination benefit (reversals) charges

$

(1.9)

$

– 

$

(1.9)

$

(1.7)

$

– 

$

(1.7)

$

(3.6)

Contract termination and lease charges

 

– 

 

– 

 

– 

 

0.1 

 

– 

 

0.1 

 

0.1 

Project costs

 

– 

 

2.6 

 

2.6 

 

– 

 

1.4 

 

1.4 

 

4.0 

Total restructuring (reversals) charges and project costs

$

(1.9)

$

2.6 

$

0.7 

$

(1.6)

$

1.4 

$

(0.2)

$

0.5 

 

The Company experienced higher levels of attrition than expected during the first nine months of 2016 as a result of the strategic alternatives process as well as announced restructuring programs. The Company’s cost savings and headcount reduction targets have not changed.

 

Restructuring charges (reversals) and project costs are recorded in the Company’s Consolidated Condensed Statements of Earnings for the three months ended September 30, 2016 as follows:

 

 

 

Selling, general

 

Restructuring

 

Impact on

 

 

and

 

and related

 

Operating

(Dollars in millions)

 

administrative

 

reversals

 

income

Employee termination benefit (reversals) charges

 

$

– 

 

$

(3.6)

 

$

(3.6)

Contract termination and lease charges

 

 

– 

 

 

0.1 

 

 

0.1 

Project costs

 

 

4.0 

 

 

– 

 

 

4.0 

Total restructuring reversals and project costs

 

$

4.0 

 

$

(3.5)

 

$

0.5 

 

For the three months ended September 30, 2016, restructuring charges (reversals) and project costs were incurred in the Company’s segments as follows:

 

 

 

2016

 

2015

 

 

(Dollars in millions)

 

Actions

 

Actions

 

Total

ISS

 

$

(1.4)

 

$

1.9 

 

$

0.5 

Enterprise Software

 

 

– 

 

 

(1.9)

 

 

(1.9)

All other

 

 

2.1 

 

 

(0.2)

 

 

1.9 

Total restructuring (reversals) charges and project costs

 

$

0.7 

 

$

(0.2)

 

$

0.5 

 

For the nine months ended September 30, 2016, the Company incurred charges (reversals), including project costs, for its restructuring plans as follows:

 

 

 

2016 Actions

 

 

 

 

2015 Actions

 

 

 

 

 

 

 

 

 

2016 Actions

Restructuring

2016 Actions

 

 

Restructuring

2015 Actions

 

 

Other Actions

Other Actions

 

 

 

 

 

Restructuring

related

Restructuring

2016

Charges

Restructuring

2015

Restructuring

Restructuring

Other

Total

 

Reversals

Pension Costs

Project

Actions

(Reversals)

Project

Actions

Reversals

Project

Actions

All

(Dollars in millions)

(Note 3)

(Note 10)

Costs

Total

(Note 3)

Costs

Total

(Note 3)

Costs

Total

Actions

Accelerated depreciation charges

$

– 

$

– 

$

– 

$

– 

$

1.0 

$

– 

$

1.0 

$

– 

$

– 

$

– 

$

1.0 

Employee termination benefit (reversals) charges

 

(11.5)

 

– 

 

– 

 

(11.5)

 

(6.8)

 

– 

 

(6.8)

 

(0.2)

 

– 

 

(0.2)

 

(18.5)

Contract termination and lease (reversals) charges

 

– 

 

– 

 

– 

 

– 

 

0.2 

 

– 

 

0.2 

 

(0.3)

 

– 

 

(0.3)

 

(0.1)

Pension and other postretirement curtailment and termination benefit loss

 

– 

 

0.9 

 

– 

 

0.9 

 

– 

 

– 

 

– 

 

– 

 

– 

 

– 

 

0.9 

Project costs

 

– 

 

– 

 

3.3 

 

3.3 

 

– 

 

3.8 

 

3.8 

 

– 

 

(1.2)

 

(1.2)

 

5.9 

Total restructuring (reversals) charges and project costs

$

(11.5)

$

0.9 

$

3.3 

$

(7.3)

$

(5.6)

$

3.8 

$

(1.8)

$

(0.5)

$

(1.2)

$

(1.7)

$

(10.8)

 


40



Restructuring charges (reversals) and project costs are recorded in the Company’s Consolidated Condensed Statements of Earnings for the nine months ended September 30, 2016 as follows:

 

 

 

Selling, general

 

Restructuring

 

Impact on

 

 

and

 

and related

 

Operating

(Dollars in millions)

 

administrative

 

reversals

 

income

Accelerated depreciation charges

 

$

1.0 

 

$

– 

 

$

1.0 

Employee termination benefit (reversals) charges

 

 

– 

 

 

(18.5)

 

 

(18.5)

Contract termination and lease (reversals) charges

 

 

– 

 

 

(0.1)

 

 

(0.1)

Pension and postretirement curtailment loss and termination benefits loss

 

 

0.9 

 

 

– 

 

 

0.9 

Project costs

 

 

5.9 

 

 

– 

 

 

5.9 

Total restructuring charges and project costs

 

$

7.8 

 

$

(18.6)

 

$

(10.8)

 

For the nine months ended September 30, 2016, restructuring charges (reversals) and project costs were incurred in the Company’s segments as follows:

 

(Dollars in millions)

 

2016 Actions

 

2015 Actions

 

Other Actions

 

Total

ISS

 

$

(12.8)

 

$

(1.6)

 

$

– 

 

$

(14.4)

Enterprise Software

 

 

– 

 

 

(1.3)

 

 

(0.3)

 

 

(1.6)

All other

 

 

5.5 

 

 

1.1 

 

 

(1.4)

 

 

5.2 

Total restructuring reversals and project costs

 

$

(7.3)

 

$

(1.8)

 

$

(1.7)

 

$

(10.8)

 

Impact to 2015 Financial Results

 

For the three months ended September 30, 2015, the Company incurred charges (reversals), including project costs, for its restructuring plans as follows:

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

2015 Actions

2015 Actions

 

Restructuring

Other

 

 

 

 

 

Restructuring

Restructuring

2015

Charges

Restructuring

Other

 

 

 

Charges

Project

Actions

(Reversals)

Project

Actions

Total

(Dollars in millions)

(Note 3)

Costs

Total

(Note 3)

Costs

Total

All Actions

Accelerated depreciation charges

$

– 

$

– 

$

– 

$

0.1 

$

– 

$

0.1 

$

0.1 

Employee termination benefit charges (reversals)

 

0.1 

 

– 

 

0.1 

 

(1.4)

 

– 

 

(1.4)

 

(1.3)

Contract termination and lease charges (reversals)

 

– 

 

– 

 

– 

 

(0.1)

 

– 

 

(0.1)

 

(0.1)

Project costs

 

– 

 

0.1 

 

0.1 

 

– 

 

2.1 

 

2.1 

 

2.2 

Total restructuring charges (reversals) and project costs

$

0.1 

$

0.1 

$

0.2 

$

(1.4)

$

2.1 

$

0.7 

$

0.9 

 

Restructuring charges (reversals) and project costs are recorded in the Company’s Consolidated Condensed Statements of Earnings for the three months ended September 30, 2015 as follows:

 

 

 

 

 

Restructuring

 

 

 

 

Selling, general

 

and related

 

Impact on

 

 

and

 

charges

 

Operating

(Dollars in millions)

 

administrative

 

(reversals)

 

income

Accelerated depreciation charges

 

$

0.1 

 

$

– 

 

$

0.1 

Employee termination benefit reversals

 

 

– 

 

 

(1.3)

 

 

(1.3)

Contract termination and lease reversals

 

 

– 

 

 

(0.1)

 

 

(0.1)

Project costs

 

 

2.2 

 

 

– 

 

 

2.2 

Total restructuring charges (reversals) and project costs

 

$

2.3 

 

$

(1.4)

 

$

0.9 

 


41



For the three months ended September 30, 2015, restructuring charges (reversals) and project costs were incurred in the Company’s segments as follows:

 

 

 

2015

 

Other

 

 

(Dollars in millions)

 

Actions

 

Actions

 

Total

ISS

 

$

7.0 

 

$

(1.1)

 

$

5.9 

Enterprise Software

 

 

(2.3)

 

 

(0.2)

 

 

(2.5)

All other

 

 

(4.5)

 

 

2.0 

 

 

(2.5)

Total restructuring charges and project costs

 

$

0.2 

 

$

0.7 

 

$

0.9 

 

For the nine months ended September 30, 2015, the Company incurred charges (reversals), including project costs, for its restructuring plans as follows:

 

 

 

 

 

 

Other

 

 

 

 

 

 

2015 Actions

2015 Actions

 

Restructuring

 

 

 

 

 

 

Restructuring

Restructuring

2015

Charges

Other

Other

Total

 

Charges

Project

Actions

(Reversals)

Restructuring

Actions

All

(Dollars in millions)

(Note 3)

Costs

Total

(Note 3)

Project Costs

Total

Actions

Accelerated depreciation charges

$

– 

$

– 

$

– 

$

0.7 

$

– 

$

0.7 

$

0.7 

Excess components and other inventory-related charges

 

– 

 

– 

 

– 

 

0.7 

 

– 

 

0.7 

 

0.7 

Employee termination benefit charges

 

32.2 

 

– 

 

32.2 

 

0.2 

 

– 

 

0.2 

 

32.4 

Contract termination and lease charges (reversals)

 

0.1 

 

– 

 

0.1 

 

(0.3)

 

– 

 

(0.3)

 

(0.2)

Project costs

 

– 

 

0.1 

 

0.1 

 

– 

 

6.3 

 

6.3 

 

6.4 

Total restructuring charges and project costs

$

32.3 

$

0.1 

$

32.4 

$

1.3 

$

6.3 

$

7.6 

$

40.0 

 

Restructuring charges (reversals) and project costs are recorded in the Company’s Consolidated Condensed Statements of Earnings for the nine months ended September 30, 2015 as follows:

 

 

 

 

 

 

 

 

 

Restructuring

 

 

 

 

 

 

 

 

Selling, general

 

and related

 

Impact on

 

 

Restructuring-

 

Impact on

 

and

 

charges

 

Operating

(Dollars in millions)

 

related costs

 

Gross profit

 

administrative

 

(reversals)

 

income

Accelerated depreciation charges

 

$

0.1 

 

$

0.1 

 

$

0.6 

 

$

– 

 

$

0.7 

Excess components and other inventory-related charges

 

 

0.7 

 

 

0.7 

 

 

– 

 

 

– 

 

 

0.7 

Employee termination benefit charges

 

 

– 

 

 

– 

 

 

– 

 

 

32.4 

 

 

32.4 

Contract termination and lease reversals

 

 

– 

 

 

– 

 

 

– 

 

 

(0.2)

 

 

(0.2)

Project costs

 

 

– 

 

 

– 

 

 

6.4 

 

 

– 

 

 

6.4 

Total restructuring charges and project costs

 

$

0.8 

 

$

0.8 

 

$

7.0 

 

$

32.2 

 

$

40.0 

 

For the nine months ended September 30, 2015, restructuring charges (reversals) and project costs were incurred in the Company’s segments as follows:

 

(Dollars in millions)

 

2015 Actions

 

Other Actions

 

Total

ISS

 

$

10.6 

 

$

1.2 

 

$

11.8 

Enterprise Software

 

 

16.2 

 

 

0.6 

 

 

16.8 

All other

 

 

5.6 

 

 

5.8 

 

 

11.4 

Total restructuring charges and project costs

 

$

32.4 

 

$

7.6 

 

$

40.0 

 


42



ACQUISITION, STRATEGIC ALTERNATIVES, AND DIVESTITURE-RELATED ADJUSTMENTS

 

Pre-tax acquisition and strategic alternatives-related adjustments affected the Company’s financial results as follows:

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

(Dollars in millions)

2016

 

2015

 

2016

 

2015

Reduction in revenue

$

1.8 

 

$

16.9 

 

$

10.3 

 

$

31.6 

Amortization of intangible assets

 

29.1 

 

 

37.3 

 

 

88.6 

 

 

91.7 

Acquisition and integration costs

 

9.6 

 

 

27.1 

 

 

33.5 

 

 

74.0 

Total acquisition-related adjustments

$

40.5 

 

$

81.3 

 

$

132.4 

 

$

197.3 

Strategic alternatives-related adjustments

 

5.1 

 

 

– 

 

 

17.8 

 

 

– 

Divestiture-related adjustments

 

– 

 

 

0.2 

 

 

– 

 

 

0.6 

Acquisition, strategic alternatives and divestiture-related adjustments

$

45.6 

 

$

81.5 

 

$

150.2 

 

$

197.9 

 

Reductions in revenue and amortization of intangible assets were recognized primarily in the Enterprise Software reportable segment. Acquisition and integration costs and costs related to the exploration of strategic alternatives were recognized primarily in All other.

 

Acquisitions

 

In connection with acquisitions, the Company incurs costs and adjustments (referred to as “acquisition-related adjustments”) that affect the Company’s financial results. These acquisition-related adjustments result from business combination accounting rules as well as expenses that would otherwise have not been incurred by the Company if acquisitions had not taken place.

 

Reductions in revenue result from business combination accounting rules when deferred revenue balances assumed as part of acquisitions are adjusted down to fair value. Fair value approximates the cost of fulfilling the service obligation, plus a reasonable profit margin. Subsequent to acquisitions, the Company analyzes the amount of amortized revenue that would have been recognized had the acquired company remained independent and had the deferred revenue balances not been adjusted to fair value. Reductions in revenue are reflected in Revenue presented on the Company’s Consolidated Condensed Statements of Earnings. The Company expects future pre-tax reductions in revenue of approximately $2 million for the remainder of 2016. For full year 2017, the Company expects pre-tax reductions in revenue of approximately $5 million.

 

Due to business combination accounting rules, intangible assets are recognized as a result of acquisitions which were not previously presented on the balance sheet of the acquired company. These intangible assets consist primarily of purchased technology, customer relationships, trade names, in-process research and development and non-compete agreements. Subsequent to the acquisition date, some of these intangible assets begin amortizing and represent an expense that would not have been recorded had the acquired company remained independent. The Company incurred the following on the Consolidated Condensed Statements of Earnings for the amortization of intangible assets.

 

 

Three Months Ended

 

Nine Months Ended

 

September 30

 

September 30

(Dollars in millions)

2016

 

2015

 

2016

 

2015

Recorded in Cost of product revenue

$

17.8 

 

$

18.2 

 

$

54.1 

 

$

47.6 

Recorded in Research and development

 

0.3 

 

 

0.4 

 

 

0.9 

 

 

0.9 

Recorded in Selling, general and administrative

 

11.0 

 

 

18.7 

 

 

33.6 

 

 

43.2 

Total amortization of intangible assets

$

29.1 

 

$

37.3 

 

$

88.6 

 

$

91.7 

 

The Company expects future pre-tax charges for the amortization of intangible assets of approximately $28 million for the remainder of 2016. For full year 2017, the Company expects pre-tax charges for the amortization of intangible assets of approximately $100 million.

 

In connection with its acquisitions, the Company incurs acquisition and integration expenses that would not have been incurred otherwise. The acquisition costs include items such as investment banking fees, legal and accounting fees, stock based compensation expense related to replacement awards issued to employees of acquired companies and costs of retention bonus programs for the senior management of the acquired company. Integration costs may consist of information technology expenses including certain costs for software and systems to be implemented in acquired companies, consulting costs and travel expenses. Integration costs may also include non-cash charges related to the abandonment of assets under construction by the Company that are determined to be duplicative of assets of the acquired company and non-cash charges related to certain assets which are abandoned as systems are integrated across the combined entity. Acquisition and integration expenses also include costs associated with the Company’s


43



rebranding announced in April 2015 as well as related non-cash charges for the abandonment of certain obsolete marketing assets. The costs are expensed as incurred, and can vary substantially in size from one period to the next.

 

Acquisition and integration costs were recognized in Selling, general and administrative on the Company’s Consolidated Condensed Statements of Earnings. The Company expects pre-tax adjustments for acquisition and integration expenses of approximately $13 million for the remainder of 2016 and approximately $15 million for 2017.

 

Strategic alternatives

 

In 2015, the Company announced that its Board of Directors authorized the exploration of strategic alternatives to enhance shareholder value. The Company has incurred costs related to the exploration of strategic alternatives, and may incur additional costs, which may be material, such as investment banking fees, legal and accounting fees, employee travel expenses and compensation, and consulting costs. Some of these costs will become payable upon a change in control of the Company and will require cash settlement. These costs are incremental to normal operating charges, are expensed as incurred and are reflected in Selling, general and administrative on the Company’s Consolidated Condensed Statements of Earnings. Refer to Part I, Item 1, Note 2 of the Notes to Consolidated Condensed Financial Statements and the definitive proxy statement filed on June 17, 2016 for more information on the definitive merger agreement the Company has entered into as a result of the exploration of strategic alternatives process.

 

Divestiture

 

In connection with the sale of the Company’s inkjet-related technology and assets, the Company incurred expenses that would not have been incurred otherwise. Divestiture-related costs consist of employee travel expenses and compensation, consulting costs, training costs and transition services including non-cash charges related to assets used in providing the transition services. These costs are incremental to normal operating charges and are expensed as incurred. Divestiture-related costs were recognized in Selling, general and administrative on the Company’s Consolidated Condensed Statements of Earnings. The Company expects future divestiture-related expenses to be immaterial.

 

FINANCIAL CONDITION

 

Lexmark’s financial position at September 30, 2016 and December 31, 2015, reflects the Company’s investment into the Enterprise Software segment with negative working capital of $121.0 million and $142.2 million, respectively. The increase in working capital is mainly driven by improved cash provided by operations. For the nine months ended September 30, 2016, cash flows provided by operations of $128.1 million was partially offset by plant and equipment purchases of approximately $57.1 million and net debt repayments of $44.0 million.

 

At September 30, 2016 and December 31, 2015, the Company had senior note debt, net of debt issuance costs, of $697.9 million and $697.3 million, respectively. The Company also had $12.0 million outstanding under its U.S. trade receivables facility and $308.0 under its revolving credit facility at September 30, 2016. The Company had $76.0 million outstanding under its U.S. trade receivables facility and $288.0 under its revolving credit facility at December 31, 2015.

 

The debt to capital ratio at September 30, 2016 of 50% increased slightly compared to 49% at December 31, 2015. The debt to total capital ratio is calculated by dividing the Company’s outstanding debt by the sum of its outstanding debt and total stockholders’ equity.

 

The following table summarizes the results of the Company’s Consolidated Condensed Statements of Cash Flows for the nine months ended September 30, 2016 and 2015:

 

 

Nine Months Ended

 

September 30

(Dollars in millions)

2016

2015

Net cash flow provided by (used for):

 

 

 

 

Operating activities

$

128.1 

$

4.7 

Investing activities

 

(52.2)

 

(464.9)

Financing activities

 

(118.0)

 

302.0 

Effect of exchange rate changes on cash and cash equivalents

 

1.5 

 

(8.2)

Net change in cash and cash equivalents

$

(40.6)

$

(166.4)

 

The Company’s primary source of liquidity has been cash generated by operations, which generally has been sufficient to allow the Company to fund its working capital needs and finance its capital expenditures. Refer to the Financing Activities section which follows for information regarding the Company’s debt activity during the nine months ended September 30, 2016. Management


44



believes that cash provided by operations will be sufficient on a worldwide basis to meet operating and capital needs. However, in the event that cash from operations is not sufficient, the Company has cash and cash equivalents and other potential sources of liquidity through further utilization of its trade receivables financing program and committed revolving credit facilities. The Company may also choose to use these sources of liquidity from time to time to fund strategic acquisitions and dividends.

 

As of September 30, 2016, the Company held $117.7 million in Cash and cash equivalents. The Company’s ability to fund operations from these balances could be limited by possible tax implications of moving proceeds across jurisdictions. Of this amount, approximately $104.9 million of Cash and cash equivalents was held by foreign subsidiaries. The Company utilizes a variety of strategies to deploy available cash in locations where it is needed. The Company’s intent is to permanently reinvest undistributed earnings of its foreign subsidiaries, and the Company’s current plans do not demonstrate a need to repatriate earnings of foreign subsidiaries to fund U.S. operations. However, if earnings of foreign subsidiaries were needed to fund U.S. operations, the Company may incur income and withholding taxes to repatriate a large portion of the earnings of foreign subsidiaries.

 

As of December 31, 2015, the Company held $158.3 million in Cash and cash equivalents and current Marketable securities. Of this amount, approximately $107.9 million of Cash and cash equivalents and current Marketable securities was held by foreign subsidiaries.

 

A discussion of the Company’s additional sources of liquidity is included in the Financing Activities section to follow.

 

Operating Activities

 

The $123.4 million increase in cash flows from operating activities for the nine months ended September 30, 2016, as compared to the nine months ended September 30, 2015, was driven by the following factors.

 

The changes in Accrued liabilities and Other assets and liabilities, collectively, for the nine months ended September 30, 2016 compared to 2015, resulted in a favorable YTY impact of $156.3 million. This was primarily driven by higher net income tax payments in 2015, reversal of copyright fees in the comparative period and lower cash expenditures for incentive compensation for the first nine months of 2016 versus 2015, offset by cash paid for employee termination severance benefits. Refer to Note 7 of the Notes to Consolidated Condensed Financial Statements for additional information on the Company’s income taxes.

 

Trade receivables increased $36.3 million and $22.2 million during in the nine months ended September 30, 2016 and September 30, 2015, respectively. This $14.1 million fluctuation year over year was primarily driven by timing of sales, a decrease in customers utilizing discount payment terms and successful collection initiatives during the prior year.

 

Contributions for pension and other postretirement benefit plans decreased YTY with contributions of $6.0 million and $9.3 million during the nine months ended September 30, 2016 and 2015, respectively, resulting in a favorable YTY cash impact of $3.3 million. This was primarily driven by favorable investment performance on plan assets.

 

The activities above were offset by the following factors.

 

Accounts payable decreased $102.8 million for the nine months ended September 30, 2016 compared to a decrease of $62.5 million for the nine months ended September 30, 2015 which resulted in an unfavorable YTY impact of $40.3 million. The YTY change in Accounts payable was primarily driven by timing of payments and decreased purchasing activity.

 

Net earnings decreased $26.8 million for the nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015. Refer to the Results of Operations section of Management's Discussion and Analysis of Financial Condition and Results of Operations for additional details. The unfavorable YTY change in Net earnings includes increases in non-cash expenses of $30.8 million of pension and postretirement expenses related to actuarial net losses and curtailment losses and stock based compensation expenses of $12.8 million. This is offset by decreases in non-cash expenses of depreciation and amortization of $10.0 million and deferred taxes of $10.0 million.

 

Cash Conversion Days

 

 

 

SEP 2016

 

DEC 2015

 

SEP 2015

 

DEC 2014

Days of sales outstanding

 

42 

 

40 

 

47 

 

37 

Days of inventory

 

42 

 

36 

 

44 

 

34 

Days of payables

 

70 

 

77 

 

81 

 

72 

Cash conversion days

 

14 

 

(1)

 

9 

 

(1)

 

Cash conversion days represent the number of days that elapse between the day the Company pays for materials and the day it collects cash from its customers. Cash conversion days are equal to the days of sales outstanding plus days of inventory less days of payables.


45



 

The days of sales outstanding are calculated using the period-end Trade receivables balance, net of allowances, and the average daily revenue for the quarter.

 

The days of inventory are calculated using the period-end net Inventories balance and the average daily cost of revenue for the quarter.

 

The days of payables are calculated using the period-end Accounts payable balance and the average daily cost of revenue for the quarter.

 

Please note that cash conversion days presented above may not be comparable to similarly titled measures reported by other registrants. The cash conversion days in the table above may not foot due to rounding.

 

Investing Activities

 

The $412.7 million decrease in net cash flows used for investing activities for the nine months ended September 30, 2016, compared to the nine months ended September 30, 2015, was driven by the YTY net decrease in cash flows used for business acquisitions of $1,004.8 million and decreased purchases of property, plant and equipment of $27.0 million. This was partially offset by the YTY net decrease of $625.4 million in cash flows provided by marketable securities investment activities, which were fully liquidated in 2015.

 

The Company’s business acquisitions, marketable securities and capital expenditures are discussed below.

 

Business Acquisitions

 

During the nine months ended September 30, 2016, the Company did not purchase any businesses. During the nine months ended September 30, 2015, the Company completed the acquisition of Kofax for approximately $1 billion. The Company funded the acquisition with its non-U.S. cash on hand and its existing credit facility programs. The addition of Kofax enhanced the Company’s industry-leading ECM and BPM offerings and strengthened the Company’s portfolio of capture solutions in the market, ranging from Web portals and mobile devices to MFP’s.

 

During the nine months ended September 30, 2015, the Company also acquired substantially all the assets of Claron for $30.3 million. Claron is a leading provider of medical image viewing, distribution, sharing and collaboration software technology, and its solutions help healthcare delivery organizations provide universal access to patient imaging studies and other content across and between healthcare enterprises. The Company also obtained pre-title to all remaining shares of ReadSoft. The $4.6 million payment for the ReadSoft non-controlling interest shares can be found in Net cash flows (used for) provided by financing activities section of the Consolidated Condensed Statements of Cash Flows. ReadSoft is a leading global provider of software solutions that automate business processes, both on premise and in the cloud.

 

Marketable Securities

 

The Company had no Marketable securities activity during the nine months ended September 30, 2016 compared to $625.4 million net cash provided by Marketable securities for the nine months ended September 30, 2015. During the nine months ended September 30, 2015, the Company liquidated all of its marketable securities to fund the purchases of Kofax and Claron and to fund its dividend and treasury share repurchase activities. 

 

Capital Expenditures

 

For the nine months ended September 30, 2016 and 2015, the Company spent $57.1 million and $84.1 million, respectively, on capital expenditures. The capital expenditures for 2016 principally related to infrastructure support (including internal-use software expenditures) and machinery and equipment related to new product development. The Company expects capital expenditures to be approximately $80.0 million for full year 2016, compared to full year 2015 capital expenditures of $112.6 million. Capital expenditures for 2016 are expected to be funded through cash from operations; however, if necessary, the Company may use existing cash and cash equivalents or additional sources of liquidity, as discussed below.

 

Financing Activities

 

Cash flows used for financing activities were $118.0 million during the nine months ended September 30, 2016 compared to cash flows provided by financing activities of $302.0 million during the nine months ended September 30, 2015. The YTY fluctuation of $420.0 million was primarily driven by a decrease in net debt proceeds of $395.7 million in 2016 and net debt payments of $44.0 million. This was partially offset by treasury stock repurchases of $4.0 million during the nine months ended September 30, 2016 as compared to $30.0 million during the nine months ended September 30, 2015. The Company paused its share repurchases in the second quarter of 2015 which resulted in favorable cash flows of $26.0 million year over year.

 


46



Additional information regarding the Company’s senior note debt, intra-period financing activities and certain historical financing activities of the Company are included in the sections below.

 

The Merger Agreement includes certain restrictions, limitations and prohibitions as to actions the Company may or may not take in the period prior to completion of the merger without the prior consent of the buying consortium.  Among other restrictions, the Merger Agreement limits, beyond previously budgeted amounts and allowed exceptions, the Company’s total capital spending, limits the extent to which the Company can obtain new financing through debt and equity, and prohibits the payment of cash dividends in excess of specified amounts.

 

Dividend Payments and Share Repurchases

 

For the nine months ended September 30, 2016, the Company paid cash dividends of $1.08 per common share for $67.7 million. Refer to Note 8 of the Notes to Consolidated Condensed Financial Statements for information regarding dividend activity during the year. Future declarations of quarterly dividends are subject to approval by the Board of Directors and may be adjusted as business needs or market conditions change. Under the terms of the merger agreement with the Consortium, any regular quarterly dividends must be declared and paid with usual record and payment dates in accordance with past dividend practice. In the event the closing of the acquisition of Lexmark by the Consortium occurs prior to the record date, no quarterly cash dividend will be paid. For the nine months ended September 30, 2015, the Company paid cash dividends of $1.08 per common share for $66.3 million.

 

Refer to Note 16 of the Notes to Consolidated Condensed Financial Statements for information regarding dividend activity that occurred subsequent to the date of the financial statements.

 

Shares were withheld to satisfy the minimum amount of its income tax withholding requirements related to certain officer’s vested RSUs. The fair value of the restricted shares withheld was determined on the date that the restricted shares vested. For the nine months ended September 30, 2016, the Company withheld approximately 0.1 million restricted shares at a cost of approximately $4.0 million. The shares have been classified as Treasury stock on the Consolidated Condensed Statements of Financial Position. The Company currently expects to satisfy share-based awards with registered shares available to be issued. For the nine months ended September 30, 2015, the Company repurchased approximately 0.7 million shares at a cost of $30.0 million. As of September 30, 2016, there was approximately $55 million of share repurchase authority remaining. This repurchase authority allows the Company, at management’s discretion, to selectively repurchase its stock from time to time in the open market or in privately negotiated transactions depending upon market price and other factors. The Merger Agreement includes certain restrictions, limitations and prohibitions as to actions the Company may or may not take in the period prior to completion of the merger without the prior consent of the buying consortium.  Among other restrictions, the Merger Agreement limits, beyond previously budgeted amounts and allowed exceptions, the Company’s total capital spending, limits the extent to which the Company can obtain new financing through debt and equity, and prohibits the payment of cash dividends in excess of specified amounts.

 

Intra-Period Financing Activities

 

The Company used its trade receivables facility, bank overdrafts and committed and uncommitted revolving credit facilities to supplement daily cash needs of the Company and its subsidiaries during the first nine months of 2016 and 2015. The Company expects to continue to utilize the trade receivables and committed revolving credit facilities in the near future to help fund its operations and strategic business combinations, if any, as discussed previously.

 

Senior Note Debt

 

In March 2013, the Company completed a public debt offering of $400.0 million aggregate principal amount of fixed rate senior unsecured notes. The notes with an aggregate principal amount of $400.0 million and 5.125% coupon were priced at 99.998% to have an effective yield to maturity of 5.125% and will mature March 15, 2020 (referred to as the “2020 senior notes”). The notes rank equally with all existing and future senior unsecured indebtedness. The notes from the May 2008 public debt offering with an aggregate principal amount of $300.0 million and 6.65% coupon were priced at 99.73% to have an effective yield to maturity of 6.687% and will mature June 1, 2018 (referred to as the “2018 senior notes”). At September 30, 2016, the outstanding balance of senior note debt was $697.9 million (net of unamortized issuance costs of $2.0 million and unamortized discount of $0.1 million).

 

The 2020 senior notes pay interest on March 15 and September 15 of each year. The 2018 senior notes pay interest on June 1 and December 1 of each year. The interest rate payable on the notes of each series is subject to adjustments from time to time if either Moody’s Investors Service, Inc. or Standard and Poor’s Ratings Services downgrades the debt rating assigned to the notes to a level below investment grade, or subsequently upgrades the ratings.

 

The senior notes contain typical restrictions on liens, sale leaseback transactions, mergers and sales of assets. There are no sinking fund requirements on the senior notes and they may be redeemed at any time at the option of the Company, at a redemption price as described in the related indenture agreements, as supplemented and amended, in whole or in part. If a “change of control triggering event” as defined below occurs, the Company will be required to make an offer to repurchase the notes in cash from the holders at a


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price equal to 101% of their aggregate principal amount plus accrued and unpaid interest to, but not including, the date of repurchase. A “change of control triggering event” is defined as the occurrence of both a change of control and a downgrade in the debt rating assigned to the notes to a level below investment grade.

 

Additional Sources of Liquidity

 

The Company has additional liquidity available through its trade receivables facility and committed revolving credit facility. These sources can be accessed domestically if the Company is unable to satisfy its cash needs in the U.S. with cash flows provided by operations and existing cash and cash equivalents.

 

Trade Receivables Facility

 

In the U.S., the Company, Lexmark Enterprise Software, LLC and Kofax, Inc. transfer a majority of their receivables to a wholly-owned subsidiary, Lexmark Receivables Corporation (“LRC”), which then may transfer the receivables on a limited recourse basis to an unrelated third party. The financial results of LRC are included in the Company’s consolidated financial results since it is a wholly-owned subsidiary. LRC is a separate legal entity with its own separate creditors who, in a liquidation of LRC, would be entitled to be satisfied out of LRC’s assets prior to any value in LRC becoming available for equity claims of the Company. The Company accounts for transfers of receivables from LRC to the unrelated third party as a secured borrowing with the pledge of its receivables as collateral since LRC has the ability to repurchase the receivables interests at a determinable price.

 

On August 27, 2015, the trade receivables facility was amended by extending the term of the facility to October 6, 2017. In addition, Kofax, Inc. became a new originator under the facility, permitting advancements under the facility as accounts receivables are originated by Kofax, Inc. and sold to LRC. The maximum capital availability under the facility remains at $125.0 million under the amended agreement. At September 30, 2016, the outstanding balance of the trade receivables facility was $12.0 million. At December 31, 2015, the outstanding balance of the trade receivables facility was $76.0 million. The average daily balance under the trade receivables facility during the first nine months of 2016 and 2015 was $100.5 million and $74.1 million, respectively.

 

This facility contains customary affirmative and negative covenants as well as specific provisions related to the quality of the accounts receivables transferred. Receivables transferred to the unrelated third party may not include amounts over 90 days past due or concentrations over certain limits with any one customer. The facility also contains customary cash control triggering events which, if triggered, could adversely affect the Company’s liquidity and/or its ability to obtain secured borrowings.

 

Revolving Credit Facility

 

The Company currently has a $500 million, 5-year senior, unsecured, multicurrency revolving credit facility with a maturity date of February 5, 2019. The outstanding balance of the revolving credit facility was $308.0 million as of September 30, 2016. The outstanding balance of the revolving credit facility was $288.0 million as of December 31, 2015. The average daily balance under the revolving credit facility during the first nine months of 2016 and 2015 was $226.1 million and $139.6 million, respectively.

 

The revolving credit facility contains customary affirmative and negative covenants and also contains certain financial covenants, including those relating to a minimum interest coverage ratio of not less than 3.0 to 1.0 and a maximum leverage ratio of not more than 3.0 to 1.0 as defined in the agreement. The revolving credit facility also limits, among other things, the Company’s indebtedness, liens and fundamental changes to its structure and business.

 

The revolving credit facility contains a “change of control” provision in which if there is an acquisition of the Company, the administrative agent and/or the lenders may terminate the commitments and declare the principal and accrued interest on any loans then outstanding immediately due and payable. Additional information is available on the Company’s Current Report on Form 8-K filed January 23, 2012.

 

On March 24, 2016, the revolving credit facility was amended for purposes of calculating the minimum interest coverage ratio, the maximum leverage ratio and the maximum permitted indebtedness of the Company by reducing the impact of certain cash restructuring charges, incurred by the Company prior to September 30, 2016, in the calculation of “Consolidated EBITDA”. Additional information related to the amendment can be found in the Form 8-K report that was filed with the SEC by the Company on March 25, 2016.

 

Uncommitted Revolving Credit Facility

 

On June 10, 2015, the Company entered into an agreement for an uncommitted revolving credit facility. Under this agreement, the Company may borrow up to a total of $100.0 million. There were no outstanding borrowings under the uncommitted revolving credit facility at September 30, 2016 and December 31, 2015. Due to the uncommitted nature of this agreement, the Company does not regard the uncommitted revolving credit facility as a source of future liquidity. The average daily balance under the uncommitted revolving credit facility during the nine months ending September 30, 2016 and September 30, 2015 was $53.4 million and $54.0


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million, respectively. The prior year average daily balance is calculated based on inception date of June 10, 2015 to period end of September 30, 2015.

 

Credit Ratings and Other Information

 

The Company’s credit ratings by S&P, Fitch Ratings, Inc. and Moody’s are BBB-, BBB- and Baa3, respectively. The ratings remain investment grade.

 

The Company’s credit rating can be influenced by a number of factors, including overall economic conditions, the pending Merger Agreement, demand for the Company’s products and services and ability to generate sufficient cash flow to service the Company’s debt. A downgrade in the Company’s credit rating to non-investment grade would decrease the maximum availability under its trade receivables facility, potentially increase the cost of borrowing under the revolving credit facility and increase the coupon payments on the Company’s public debt, and likely have an adverse effect on the Company’s ability to obtain access to new financings in the future. The Company does not have any rating downgrade triggers that accelerate the maturity dates of its revolving credit facility or public debt.

 

The Company was in compliance with all covenants and other requirements set forth in its debt agreements as of September 30, 2016. The Company believes that it is reasonably likely that it will continue to be in compliance with such covenants in the near future.

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

Refer to Note 15 of the Notes to Consolidated Condensed Financial Statements in Item 1 for a description of recent accounting pronouncements which is incorporated herein by reference. There are no known material changes and trends nor any recognized future impact of new accounting guidance beyond the disclosures provided in Note 15.

 

Item 3.          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The market risk inherent in the Company’s financial instruments and positions represents the potential loss arising from adverse changes in interest rates and foreign currency exchange rates.

 

Interest Rates

 

At September 30, 2016, the fair value of the Company’s senior notes was estimated at $737.2 million based on the prices the bonds have recently traded at in the market as well as the overall market conditions on the date of valuation, stated coupon rates, the number of coupon payments each year and the maturity dates. The fair value of the senior notes exceeded the carrying value as recorded in the Consolidated Condensed Statements of Financial Position at September 30, 2016 by $39.3 million. Market risk is estimated as the potential change in fair value resulting from a hypothetical 10% adverse change in interest rates and amounts to $6.3 million at September 30, 2016.

 

Since the borrowings under the revolving credit facility and the accounts receivable program utilize variable interest rate setting mechanisms such as one-month LIBOR, the fair value of these borrowings is deemed to be at par and the sensitivity of these borrowings to changes in interest rates is deemed to be immaterial.

 

Foreign Currency Exchange Rates

 

Foreign currency exposures arise from transactions denominated in a currency other than the functional currency of the Company or the respective functional currency of each of the Company’s subsidiaries as well as foreign currency denominated revenue and profit translated into the functional currency of the Company. The primary currencies to which the Company was exposed on a transaction basis as of September 30, 2016 include the Euro, the British pound, the Swiss franc, the Philippine peso, the Chinese renminbi, the Singapore dollar, the Australian dollar and the Norweigian krone. The Company primarily hedges its transaction foreign exchange exposures with foreign currency forward contracts (“transaction hedge contracts”) with maturity dates of approximately three months or less, though all foreign currency exposures may not be fully hedged. The Company hedges anticipated foreign currency denominated sales with foreign exchange option contracts (“cash flow hedge contracts”). The potential loss in fair value at September 30, 2016 for transaction hedge contracts and cash flow hedge contracts resulting from a hypothetical 10% adverse change in all foreign currency exchange rates versus the U.S. dollar is $35.3 million. This loss would be mitigated by corresponding gains on the underlying exposures.

 


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Item 4.          CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

The Company’s management, with the participation of the Company’s Chairman and Chief Executive Officer (“CEO”) and Vice President and Chief Financial Officer (“CFO”), has evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Company’s Chairman and CEO and Vice President and CFO have concluded that the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, were not effective because of the material weakness in our internal control over financial reporting, as described in Management’s Report On Internal Control Over Financial Reporting in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2015, which continues to exist as of September 30, 2016.

 

Remediation of Material Weakness in Internal Control over Financial Reporting

 

 

With the oversight of the Company’s Finance and Audit Committee, the Company continued to take steps during the first nine months of 2016 to remediate its material weakness in internal control over accounting for income taxes. Building on its efforts during 2015, the Company made progress to remediate the material weakness and further enhance its internal controls. The Company continued to implement activities and improvements during the first nine months of 2016 which include:

 

 

 

 

 

 

The Company has continued to make progress toward refining its design and operating effectiveness of internal control during the first nine months of 2016. The Company expects to make additional improvements in internal control during the remainder of 2016. Given the annual nature of internal controls over accounting for income taxes, time is critical to fully integrate the new and redesigned controls into our processes and confirm them as effective and sustainable.

 

Lexmark and our Board of Directors are committed to maintaining a strong and sustainable internal control environment. The Company believes that the remediation work completed to date has significantly improved our internal control over the accounting for income taxes. The Company believes it is important to finalize remediation efforts in 2016 and confirm that the new processes and controls that were put in place as part of the remediation are fully operational and consistently applied for a sufficient period of time in order to provide the Company with adequate assurance of a sustainable and reliable control environment related to income tax accounting.

 

Changes in Internal Control over Financial Reporting

 

There has been no change in the Company’s internal control over financial reporting that occurred during the third quarter of 2016 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting other than the efforts discussed immediately above in Remediation of the Material Weakness in Internal Control over Financial Reporting.


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Inherent Limitations on Effectiveness of Controls

 

The Company’s management, including the Company’s Chairman and CEO and Vice President and CFO, does not expect that the Company’s disclosure controls and procedures or the Company’s internal control over financial reporting will prevent or detect all error and all fraud. A control system, regardless of how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system will be met.  These inherent limitations include the following:

 

 

 

 

 

Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.


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PART II.  OTHER INFORMATION

 

Item 1.  LEGAL PROCEEDINGS

 

The information required by this item is set forth in Note 14 of the Notes to Consolidated Condensed Financial Statements, and is incorporated herein by reference. Other than developments reported in Note 14, there have been no other developments to the legal proceedings previously disclosed in Part II, Item 8, Note 19 of the Company’s 2015 Annual Report on Form 10-K.

 

Item 1A.  RISK FACTORS

 

Other than the risk factor set forth, below, there have been no material changes in the Company’s risk factors that have been previously disclosed in Part I, Item 1A of the Company’s 2015 Annual Report on Form 10-K.

 

The Company recently announced that it has entered into a definitive agreement to be acquired by a consortium of investors composed of Apex Technology Co., Ltd. and investment funds managed by PAG Asia Capital and Legend Capital.  The Company continues to expect the transaction to close in 2016.  The Company’s operating results may be adversely affected by the pendency of the transaction, and a failure to consummate the transaction could have an adverse effect on the share price of the Company’s Class A Common Stock.

 

The Company’s pending acquisition by a consortium of investors composed of Apex Technology Co., Ltd. and investment funds managed by PAG Asia Capital and Legend Capital (collectively, the “Consortium”) creates various risks that could negatively impact the Company’s operating results or the price of the Company’s Class A Common Stock, including the following:

 

 

If the Merger is not consummated, and there are no other parties willing and able to acquire the Company at a price of $40.50 per share or higher on terms acceptable to the Company, the Company’s share price will likely decline, as our stock has recently traded at prices linked to the proposed per share consideration for the Merger. 

 

Additionally, the Company has incurred, and will continue to incur throughout the pendency of the Merger, certain costs, expenses and fees for professional services and other transaction costs in connection with the proposed Merger, for which the Company will have received little or no benefit if the Merger is not completed.  Many of these fees and costs will be payable by the Company even if the Merger is not completed and may relate to activities that the Company would not have undertaken other than to complete the Merger.

 

The Merger Agreement contains provisions that could discourage or make it difficult for a third party to acquire the Company prior to the completion of the proposed Merger.

 

The Merger Agreement contains provisions that significantly restrict the Company’s ability to entertain a third-party acquisition proposal during the pendency of the Merger. These provisions include a general prohibition on soliciting or engaging in discussions or negotiations regarding any alternative acquisition proposal, subject to certain exceptions, and the requirement that the Company pay a termination fee of $95 million if the Merger Agreement is terminated in specified circumstances, such as because our board of directors changes its recommendation to stockholders to vote in favor of the Merger. These provisions might discourage an otherwise-interested third party from considering or proposing an acquisition transaction, even one that may be deemed of greater value than the proposed Merger to our stockholders. Furthermore, even if a third party elects to propose an acquisition, the requirement on our part to pay a termination fee may result in that third party offering a lower value to our stockholders than such third party might otherwise have offered.


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Item 6.  EXHIBITS

 

A list of exhibits is set forth in the Exhibit Index found on page 55 of this report.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, both on behalf of the registrant and in his capacity as principal accounting officer of the registrant.

 

 

 

Lexmark International, Inc.

 

(Registrant)

 

 

November 4, 2016

 

 

 

 

/s/ David Reeder

 

David Reeder

 

Vice President and Chief Financial Officer

 

 


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EXHIBIT INDEX

 

Exhibits:

 

31.1       Certification of Chairman and Chief Executive Officer Pursuant to Rule 13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2       Certification of Vice President and Chief Financial Officer Pursuant to Rule 13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1       Certification of Chairman and Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2       Certification of Vice President and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

101       Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Condensed Statements of Earnings for the three and nine months ended September 30, 2016 and 2015, (ii) the Consolidated Condensed Statements of Comprehensive Earnings for the three and nine months ended September 30, 2016 and 2015, (iii) the Consolidated Condensed Statements of Financial Position at September 30, 2016 and December 31, 2015, (iv) the Consolidated Condensed Statements of Cash Flows for the nine months ended September 30, 2016 and 2015 and (v) the Notes to Consolidated Condensed Financial Statements.

 


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LEXMARK INTERNATIONAL INC /KY/ Reports