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Lexmark International 10-K 2007 Documents found in this filing:Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Exact name of registrant as
specified in its charter)
(859) 232-2000
(Registrant’s telephone
number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known
seasoned issuer as defined in Rule 405 of the Securities
Act. Yes þ No o
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. þ
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of “accelerated filer and large
accelerated filer” in
Rule 12b-2
of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company
(as defined by
Rule 12b-2
of the Exchange
Act) Yes o No þ
The aggregate market value of the shares of voting common stock
held by non-affiliates of the registrant was approximately
$5.6 billion based on the closing price for the
Class A Common Stock on the last business day of the
registrant’s most recently completed second fiscal quarter.
As of February 23, 2007, there were outstanding
96,007,711 shares (excluding shares held in treasury) of
the registrant’s Class A Common Stock, par value
$0.01, which is the only class of voting common stock of the
registrant, and there were no shares outstanding of the
registrant’s Class B Common Stock, par value $0.01.
Documents Incorporated by Reference
Certain information in the Company’s definitive Proxy
Statement for the 2007 Annual Meeting of Stockholders, which
will be filed with the Securities and Exchange Commission
pursuant to Regulation 14A, not later than 120 days
after the end of the fiscal year, is incorporated by reference
in Part III of this
Form 10-K.
LEXMARK
INTERNATIONAL, INC. AND SUBSIDIARIES
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This Annual Report on
Form 10-K
contains certain forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange
Act of 1934, as amended. All statements, other than
statements of historical fact, are forward-looking statements.
Forward-looking statements are made based upon information that
is currently available or management’s current expectations
and beliefs concerning future developments and their potential
effects upon the Company, speak only as of the date hereof, and
are subject to certain risks and uncertainties. We assume no
obligation to update or revise any forward-looking statements
contained or incorporated by reference herein to reflect any
change in events, conditions or circumstances, or expectations
with regard thereto, on which any such forward-looking statement
is based, in whole or in part. There can be no assurance that
future developments affecting the Company will be those
anticipated by management, and there are a number of factors
that could adversely affect the Company’s future operating
results or cause the Company’s actual results to differ
materially from the estimates or expectations reflected in such
forward-looking statements, including, without limitation, the
factors set forth under the title “Risk Factors” in
Item 1A of this report. The information referred to above
should be considered by investors when reviewing any
forward-looking statements contained in this report, in any of
the Company’s public filings or press releases or in any
oral statements made by the Company or any of its officers or
other persons acting on its behalf. The important factors that
could affect forward-looking statements are subject to change,
and the Company does not intend to update the factors set forth
in the “Risk Factors” section of this report. By means
of this cautionary note, the Company intends to avail itself of
the safe harbor from liability with respect to forward-looking
statements that is provided by Section 27A and
Section 21E referred to above.
Part I
Lexmark International, Inc., (“Lexmark” or the
“Company”) is a Delaware corporation and the surviving
company of a merger between itself and its former parent holding
company, Lexmark International Group, Inc., (“Group”)
consummated on July 1, 2000. Group was formed in July 1990
in connection with the acquisition of IBM Information Products
Corporation from International Business Machines Corporation
(“IBM”). The acquisition was completed in March 1991.
On November 15, 1995, Group completed its initial public
offering of Class A Common Stock and Lexmark now trades on
the New York Stock Exchange under the symbol “LXK.”
Lexmark makes it easier for businesses and consumers to move
information between the digital and paper worlds. Since its
inception in 1991, Lexmark has become a leading developer,
manufacturer and supplier of printing and imaging solutions for
offices and homes. Lexmark’s products include laser
printers, inkjet printers, multifunction devices, and associated
supplies, services and solutions. Lexmark develops and owns most
of the technology for its laser and inkjet products and related
solutions. Lexmark also sells dot matrix printers for printing
single and multi-part forms by business users and develops,
manufactures and markets a line of other office imaging
products. The Company operates in the office products industry.
The Company is primarily managed along Business and Consumer
market segments. Refer to Part II, Item 8,
Note 17 of the Notes to Consolidated Financial Statements
for additional information regarding the Company’s
reportable segments.
Revenue derived from international sales, including exports from
the United States of America (“U.S.”), accounts for
approximately 56% of the Company’s consolidated revenue,
with Europe accounting for approximately two-thirds of
international sales. Lexmark’s products are sold in more
than 150 countries in North and South America, Europe, the
Middle East, Africa, Asia, the Pacific Rim and the Caribbean.
This geographic diversity offers the Company opportunities to
participate in new markets, provides diversification to its
revenue stream and operations to help offset geographic economic
trends, and utilizes the technical and business expertise of a
worldwide workforce. Currency exchange rates have had
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less of an impact on international revenue in recent years.
Refer to Management’s Discussion and Analysis of Financial
Condition and Results of Operations — Effect of
Currency Exchange Rates and Exchange Rate Risk Management for
more information. As the Company’s international operations
grow, management’s attention continues to be focused on the
operation and expansion of the Company’s global business
and managing the cultural, language and legal differences
inherent in international operations. A summary of the
Company’s revenue and long-lived assets by geographic area
is found in Part II, Item 8, Note 17 of the Notes
to Consolidated Financial Statements included in this Annual
Report on
Form 10-K.
Lexmark management believes that the total distributed office
and home printing output opportunity was approximately
$90 billion in 2006, including hardware, supplies and
related services. This opportunity includes printers and
multifunction devices as well as a declining base of copiers and
fax machines that are increasingly being integrated into
multifunction devices. Based on industry analyst information,
Lexmark management estimates that this market will grow annually
at low- to mid-single digit percentage rates through 2010.
Management believes that the integration of print/copy/fax/scan
capabilities favors companies like Lexmark due to its experience
in providing industry-leading network printing solutions.
However, as the hardcopy industry matures and printer and copier
markets converge, management expects competitive pressures to
continue.
The Internet is positively impacting the distributed home and
office printing market opportunity in several ways. As more
information is available over the Internet, and new tools and
solutions are being developed to access it, more of this
information is being printed on distributed home and office
printers. Management believes that an increasing percentage of
this distributed output includes color and graphics, which tend
to increase supplies usage. Growth in high-speed Internet access
to the home, combined with the rise in digital camera sales, is
also contributing to increased photo printing on distributed
devices.
The laser product market primarily serves business customers.
Laser products can be divided into two major
categories — shared workgroup products and
lower-priced desktop products. Shared workgroup products are
typically attached directly to large workgroup networks, while
lower-priced desktop products are attached to personal computers
(“PCs”) or small workgroup networks. Both product
categories include color and monochrome laser offerings. The
shared workgroup products include laser printers and
multifunction devices that are easily upgraded to include
additional input and output capacity, additional memory and
storage, and typically include high-performance internal network
adapters. Most shared workgroup products also have sophisticated
network management tools and some printers now include
multifunction upgrades that enable copy/fax/scan to network
capabilities.
Industry laser printer unit growth in recent years has generally
exceeded the growth rate of laser printer revenue due to unit
growth in lower-priced desktop color and monochrome laser
printers and unit price reductions. Additionally, color and
multifunction laser printer units represent a more significant
component of laser unit growth. Management believes these trends
will continue. This pricing pressure is partially offset by the
tendency of customers in the shared workgroup laser market to
add higher profit margin optional features including network
adapters, document management software, additional memory, paper
handling and multifunction capabilities. Pricing pressure is
also partially offset by the opportunity to provide business
solutions and services to customers who are increasingly looking
for assistance to better manage and leverage their
document-related costs and output infrastructure.
The inkjet product market is predominantly a consumer market but
also includes business users who may choose inkjet products as a
lower-priced alternative or supplement to laser products for
personal desktop use. Additionally, over the past couple years,
the number of consumers seeking productivity-related features
has driven significant growth in
all-in-one
(“AIO”) products. Key factors promoting this trend are
greater affordability of AIOs containing productivity features
like full fax capabilities and automatic
1 Certain
information contained in the “Market Overview” section
has been obtained from industry sources, public information and
other internal and external sources. Data available from
industry analysts varies widely among sources. The Company bases
its analysis of market trends on the data available from several
different industry analysts.
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document feeders. Management believes the combination of
business features made for the home, as well as full photo
capabilities, will continue to drive AIO growth. Growth in
inkjet product revenue on an industry basis has been slower than
unit growth due to price reductions, which management expects to
continue.
Lexmark’s strategy is based on a business model of
investing in technology to develop and sell printing solutions,
including printers and multifunction products
(“MFPs”), with the objective of growing its installed
base, which drives recurring supplies sales. Supplies are the
profit engine of the business model. Supplies profit then funds
new technology investments in products and solutions, which
drive the cycle again and again. Management believes that
Lexmark has the following strengths related to this business
model:
Lexmark’s business market strategy requires that it provide
its array of high-quality, technologically-advanced products and
solutions at competitive prices. Lexmark continually enhances
its products to ensure that they function efficiently in
increasingly-complex enterprise network environments. It also
provides flexible tools to enable network administrators to
improve productivity. Lexmark’s business target markets
include large corporations, small and medium businesses
(“SMBs”) and the public sector. Lexmark’s
business market strategy also requires that it continually
identify and focus on industry-specific issues and processes so
that it can differentiate itself by offering unique industry
solutions and related services.
The Company’s consumer market strategy is to generate
demand for Lexmark products by offering high-quality,
competitively-priced products that present an exceptional value
to consumers and businesses primarily through retail channels
and original equipment manufacturer (“OEM”) partner
arrangements. Lexmark’s goal is to create printing products
and innovative solutions that make it easier for consumers and
small business owners to create, share and manage information
and images. Lexmark continues to invest in brand building
efforts that are reflected in its core product offerings,
advertising campaigns and public relations efforts, all of which
reinforce Lexmark’s value proposition.
Lexmark’s strategy involves the following core strategic
initiatives:
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In addition to investments in the Lexmark brand, the successful
execution of this strategy involves increased investment in
product and solution development. The Company increased its
research and development spending by 10% in 2006, by 8% in 2005
and by 18% in 2004. This investment has led to new products and
solutions aimed at targeted growth segments as well as a
pipeline of future products.
Because of Lexmark’s exclusive focus on printing solutions,
the Company has formed alliances and OEM arrangements with
companies such as Dell, IBM and Lenovo to pursue incremental
business opportunities through its alliance partners.
The Company’s strategy for dot matrix printers and other
office imaging products is to continue to offer high-quality
products while managing cost to maximize cash flow and profit.
Lexmark offers a wide range of monochrome and color laser
printers, MFPs, and associated features and application
solutions. In 2006, Lexmark announced several new monochrome
laser printers. The award-winning Lexmark E120 strengthened the
Company’s offerings in the personal monochrome segment and
prints at a maximum speed of 20 pages per minute
(“ppm”). The new Lexmark E250, Lexmark E350 and
Lexmark E450 series of monochrome printers combine new printhead
technology, an Instant
Warm-Up
fuser and two-sided printing standard on every model to help
customers increase productivity and reduce costs and waste. The
Lexmark E series offers maximum print speeds of up to
35 ppm and is designed for desktops and small workgroups in
home offices, SMBs and large enterprises. The Company continues
to offer the Lexmark T640 series, which includes three models
with rated print speeds ranging from up to 35 ppm to
50 ppm and are designed to support small, medium and large
workgroups. All three models have optional paper input and
output features, including a stapler and offset stacker. All
three models also come with an operator panel that includes a
USB Direct interface for convenient printing of PDF, TIFF, and
JPEG file formats from flash memory devices, and a
10-digit
numeric pad that supports workflow and security solutions
including the release of PIN-protected confidential print jobs.
The Company’s monochrome laser printer line extends into
the wide format sector of the market with the Lexmark W840. With
print speeds of up to 50 ppm, the Lexmark W840 is supported
with an array of paper handling and finishing options that make
it well-suited for departmental printing needs.
In 2006, the Company announced the new Lexmark C530 series,
which builds on award-winning color technology to offer small
businesses and enterprise workgroups the next generation of
productivity-enhancing performance, quality and reliability. The
Lexmark C530 series offers print speeds of up to 22 ppm in
color and up to 24 ppm in monochrome. The Company also
introduced the Lexmark C500n in 2006, which offers print speeds
of up to 8 ppm in color and up to 31 ppm in
monochrome. The Lexmark C500n is designed for small workgroups
in enterprises and SMBs. The Lexmark C770 and Lexmark C772 color
laser printers for medium and large workgroups were announced in
2006 as well. These models print monochrome and color pages at
speeds of up to 25 ppm. The Company continues to offer the
Lexmark C920 series. This model prints color pages at speeds of
up to 32 ppm and monochrome pages at speeds of up to
36 ppm and supports printing on tabloid-size paper.
Lexmark announced several new MFPs in 2006. The Lexmark X644e,
Lexmark X646e and Lexmark X646dte MFPs offer fast monochrome
print speeds of up to 50 ppm and feature a large,
customizable, color touch-screen interface. In addition, the
Company announced the Lexmark X850e, Lexmark X852e and Lexmark
X854e that handle A3 tabloid printing and provide advanced
workflow solution platforms for large departments. The Lexmark
X850, Lexmark X852e and Lexmark X854e feature the same color
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touch-screen interface and support finishing and monochrome
print speeds of up to 35 ppm, 45 ppm and 55 ppm,
respectively. The Company also announced the Lexmark X646ef, a
modular MFP which offers monochrome print speeds of up to
50 ppm and provides finishing capabilities and a color
touch-screen interface. The award-winning Lexmark X642e provides
monochrome print speeds of up to 45 ppm and has a
monochrome touch-screen which provides access to print, copy,
fax, and
scan-to-email
functions. The Lexmark X340 and Lexmark X342 offer monochrome
print speeds of up to 27 ppm and print, copy, scan and fax
functionality in a small space-saving design. In addition, in
2006 the Company announced the Lexmark X772e modular
multifunction device which offers color and monochrome print
speeds of up to 25 ppm and consolidates business workflow
requirements: scan, scan to
e-mail,
copy, fax and print into one
easy-to-use
office solution.
The Company continues to offer integrated networking on many of
the standard products as well as internal print server options
that support 10/100 Ethernet, Gigabit and wireless technologies.
The Lexmark N8020 Gigabit Ethernet print server has the capacity
to process print jobs through the network faster and the Lexmark
N8050 is a wireless print server that combines 802.11g
networking, WPA-Enterprise security, and IPv6 protocol support,
to provide the user more flexibility on where to place the
product from both a security and physical location perspective.
Lexmark also continues to offer external print servers: the
MarkNet N7000e, MarkNet 7002e and MarkNet 7020e, which all
feature an intuitive operator panel and allow customers to
easily connect devices to the network.
In 2006, Lexmark strengthened its position in the AIO market
with the introduction of three
3-in-1
products priced below $100 for the mainstream of the market and
three 4-in-1
products targeted for productivity-minded home and small office
users. The Company also advanced its single function line with
two new single-function printers and a new compact
4x6-inch
photo printer.
In the
3-in-1
category, Lexmark introduced three AIO printers designed to
deliver industry-leading value and
ease-of-use
for the home office. The Lexmark X3470 AIO with Premium Photo
Features provides mainstream users with a photo-capable
3-in-1
equipped with
PictBridgetm,
card slots and a scan-back proof sheet system that is capable of
delivering high quality
4x6-inch
borderless prints and outstanding color document printing speeds
all in a compact industrial design. The Lexmark X2470 and
Lexmark X1270 AIOs that were also launched in 2006 focused on
mainstream consumers converting from single function printers.
The Lexmark X2470 features direct photo printing for users with
digital cameras. By using the easily-accessible front-panel
PictBridgetm
port, users can print borderless
4x6-inch
photos without using a PC. The Lexmark X1270 AIO delivers print
speeds of up to 17 ppm black and 9 ppm
color2
and 48-bit color scanning and copying capabilities.
In the
4-in-1
inkjet category, the Company announced the Lexmark X5470 and the
Lexmark X7350
All-In-Ones
with Fax and Photo features. In addition, the Lexmark X9350
Wireless Office
All-in-One,
with two-sided printing which delivers productivity, reliability
and quality for the small office / home office segment, was
announced in late 2006.
The Lexmark X5470 delivers reliable performance and robust
features at a competitive price, representing an outstanding
value for customers. The Lexmark X5470 provides excellent office
functionality through its PC-free fax capabilities, 10-sheet
automatic document feeder, and text printing speeds of up to
25 ppm2.
The Lexmark X5470 can print PC-free borderless
4x6-inch
photos via memory cards or
PictBridgetm
cameras. This product also features a scannable photo proof
sheet that allows users to select images for printing and then
scan the proof sheet to print borderless
4x6-inch
photos automatically.
The Lexmark X7350 delivers print, copy, scan, and fax
functionality that is tailored to the home / small office
consumer. The Lexmark X7350 provides a large, 50-sheet automatic
document feeder and text printing speeds up to
25 ppm3.
In addition, the Lexmark X7350 offers photo functionality with
borderless
4x6-inch
photo prints and direct camera connection through the
PictBridgetm
port.
2 Printing
in draft mode and excluding time to first page feed.
3 Printing
in draft mode and excluding time to complete first page.
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The Company also introduced the Lexmark X9350 Wireless Office
All-in-One
with two-sided printing for the professional home office and
business inkjet segments. At the time of launch, the Lexmark
X9350 was the first inkjet under $300 to offer built-in 802.11
b/g wireless capabilities to support mobile users and automatic
duplexing for cost-efficient, two-sided printing productivity.
The Lexmark X9350 also includes new printhead technology for
print speeds of up to 32 ppm black and 27 ppm
color3,
and features Lexmark’s Evercolor
2tm
pigmented ink technology for crisp, clear results that are
resistant to water, light and markers used for highlighting
text. Additional features include a
2.4-inch
adjustable and convenient color liquid crystal display
(“LCD”),
4x6-inch
borderless photo printing capabilities, PC-free photo printing
from memory cards,
PictBridgetm
compatible cameras or USB Flash drives.
In the single function category, Lexmark introduced two new
single functions targeted at mainstream consumers. The Lexmark
Z845 High Performance Color Printer, which was the fastest
single-function printer in its class at the time of launch, is
capable of delivering print speeds of up to 24 ppm black and
18 ppm
color2
and producing borderless
4x6-inch
photos. The Lexmark Z645 offers print speeds of up to
17 ppm black and 9 ppm
color2.
In the category of dedicated photo printers, the Company
introduced the new Lexmark P350 Portable Photo Printer, a
compact
4x6-inch
photo printer capable of printing
4x6-inch
borderless photos in as little as
75 seconds.4
The Lexmark P350 also features Evercolor
2tm
ink technology and
PerfectFinishtm
Photo Paper for producing photos of exceptional quality and
durability. Additional features include a
2.4-inch LCD
and PC-free photo printing from memory cards,
PictBridgetm
compatible cameras, USB Flash drives or a Bluetooth technology
cell phone with the purchase of an optional adapter.
Lexmark continues to market several dot matrix printer models
for customers who print multi-part forms.
Lexmark designs, manufactures and distributes a variety of
cartridges and other supplies for use in its installed base of
laser, inkjet and dot matrix printers. Lexmark’s revenue
and profit growth from its supplies business is directly linked
to the Company’s ability to increase the installed base of
its laser and inkjet products and customer usage of those
products. Management believes Lexmark is an industry leader with
regard to the recovery, remanufacture, reuse and recycling of
used laser supplies cartridges, helping to keep empty cartridges
out of landfills. Attaining that leadership position was made
possible by the Company’s various empty cartridge
collection programs around the world. Lexmark continues to
launch new programs and expand existing cartridge collection
programs to further expand its remanufacturing business and this
environmental commitment.
Lexmark also offers a range of other office imaging supplies
products, applying both impact and non-impact technology.
Lexmark offers a wide range of services to bring together the
Company’s line of printing products and technology
solutions along with maintenance, consulting, systems
integration and distributed fleet management capabilities to
provide a comprehensive output solution. Lexmark Global Services
provide customers with an assessment of their current
environment and a recommendation and implementation plan for the
future state and ongoing optimization of their output
environment and document related workflow/business processes.
Managed Print Services allow organizations to outsource fleet
management, technical support, supplies replenishment and
maintenance activities to Lexmark. As an initiative to bring
value-added services to SMB, the Company announced the Lexmark
4 Printing
from a computer in normal mode, in borderless layout, excludes
time to first page feed.
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Fleet Manager program in 2006 as a managed print service
offering that utilizes Lexmark’s tools and technologies but
which is delivered by channel partners.
The Company’s printer products generally include a warranty
period of at least one year, and customers typically have the
option to purchase an extended warranty.
Lexmark employs large-account sales and marketing teams whose
mission is to generate demand for its business printing
solutions and services, primarily among large corporations as
well as the public sector. Sales and marketing teams primarily
focus on industries such as finance, services, retail,
manufacturing, public sector and health care. Those teams, in
conjunction with the Company’s development and
manufacturing teams, are able to customize printing solutions to
meet customer needs for printing electronic forms, media
handling, duplex printing and other document workflow solutions.
Lexmark also markets its laser and inkjet products increasingly
through SMB teams who work closely with channel partners. The
Company distributes and fulfills its products to business
customers primarily through its well-established distributor and
reseller network. Lexmark’s products are also sold through
solution providers, which offer custom solutions to specific
markets, and through direct response resellers.
Lexmark’s international sales and marketing activities for
the business market are organized to meet the needs of the local
jurisdictions and the size of their markets. Operations in North
America, Latin America, Asia Pacific and Western Europe focus on
large-account demand generation with orders primarily filled
through distributors and resellers.
The Company’s business printer supplies and other office
imaging products are generally available at the customer’s
preferred
point-of-purchase
through multiple channels of distribution. Although channel mix
varies somewhat depending upon the geography, most of
Lexmark’s business supplies products sold commercially in
2006 were sold through the Company’s network of
Lexmark-authorized supplies distributors and resellers, who sell
directly to end-users or to independent office supply dealers.
For the consumer market, Lexmark distributes its branded inkjet
products and supplies primarily through retail outlets
worldwide. Lexmark’s sales and marketing activities are
organized to meet the needs of the various geographies and the
size of their markets. In the U.S., products are distributed
through large discount store chains, consumer electronics
stores, office superstores and wholesale clubs. The
Company’s Western European and Latin American operations
distribute products through major information technology
resellers and in large markets through key retailers. Australian
and Canadian marketing activities focus on large retail account
demand generation, with orders filled through distributors or
resellers.
Lexmark also sells its products through numerous alliances and
OEM arrangements, including Dell, IBM and Lenovo. During 2006,
2005 and 2004, one customer, Dell, accounted for
$744 million or approximately 15%, $782 million or
approximately 15%, and $570 million or approximately 11% of
the Company’s total revenue, respectively. Sales to Dell
are included in both the Business and Consumer segments.
Lexmark launched a new advertising campaign in the third quarter
of 2006. The objective of the campaign is to gain broad
awareness of the Company’s proven track record of helping
world-class companies to be more productive. The Company
believes that this campaign continues to build brand image and
consideration, and in the long term will strengthen its position
in the industry as the printer company that makes it easy to get
more done.
Lexmark continues to develop and market new products and
innovative solutions at competitive prices. New product
announcements by the Company’s principal competitors,
however, can have, and in the past, have had, a material adverse
effect on the Company’s financial results. Such new product
announcements can quickly undermine any technological
competitive edge that one manufacturer may enjoy over another
and set new market standards for price, quality, speed and
functionality. Furthermore, knowledge in the
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marketplace about pending new product announcements by the
Company’s competitors may also have a material adverse
effect on Lexmark as purchasers of printers may defer buying
decisions until the announcement and subsequent testing of such
new products.
In recent years, Lexmark and its principal competitors, many of
which have significantly greater financial, marketing
and/or
technological resources than the Company, have regularly lowered
prices on printers and are expected to continue to do so.
Lexmark has experienced and remains vulnerable to these pricing
pressures. The Company’s ability to grow or maintain market
share has been and may continue to be affected, resulting in
lower profitability. Lexmark expects that as it competes with
larger competitors, the Company’s increased market presence
may attract more frequent challenges, both legal and commercial,
including claims of possible intellectual property infringement.
The distributed printing market is extremely competitive. The
distributed laser printing market is dominated by
Hewlett-Packard (“HP”), which has a widely-recognized
brand name and has been estimated to hold approximately 40% of
the market as measured in annual units shipped. With the
convergence of traditional printer and copier markets, major
laser competitors now include traditional copier companies such
as Canon, Ricoh and Xerox. Other laser competitors include
Brother, Samsung, Konica Minolta, Oki and Kyocera Mita.
Lexmark’s primary competitors in the inkjet product market
are HP, Epson and Canon, who together account for approximately
75% of worldwide inkjet product unit sales. The Company must
compete with these same vendors and other competitors, such as
Brother, for retail shelf space allocated to printers and their
associated supplies. Lexmark sees the possibility that new
entrants into the market could also impact the Company’s
growth and market share. The entrance of a competitor that is
also focused on printing solutions could have a material adverse
impact on the Company’s strategy and financial results.
Refill, remanufactured, clones, counterfeits and other
compatible alternatives for some of Lexmark’s cartridges
are available and compete with the Company’s supplies
business. However, these alternatives generally offer
inconsistent quality and reliability. As the installed base of
laser and inkjet products grows and matures, the Company expects
competitive supplies activity to increase. Historically, the
Company has not experienced significant supplies pricing
pressure, but if supplies pricing was to come under significant
pressure, the Company’s financial results could be
materially adversely affected.
The market for other office imaging products is also highly
competitive and the impact printing sector of the supplies
market is declining. Although Lexmark has rights to market
certain IBM-branded supplies until December 2007, there are many
independent ribbon and toner manufacturers competing to provide
compatible supplies for IBM-branded printing products. The
revenue and profitability from the Company’s other office
imaging products is less relevant than it has been historically.
Management believes that the operating income associated with
its other office imaging products will continue to decline.
Lexmark operates manufacturing control centers in Lexington,
Kentucky; Shenzhen, China; and Geneva, Switzerland; and has
manufacturing sites in Boulder, Colorado; Juarez and Chihuahua,
Mexico; and Lapu-Lapu City, Philippines. The Company also has
customization centers in each of the major geographies it
serves. Lexmark’s manufacturing strategy is to retain
control over processes that are technologically complex,
proprietary in nature and central to the Company’s business
model, such as the manufacture of inkjet cartridges, at
Lexmark-owned and operated facilities. The Company shares some
of its technical expertise with certain manufacturing partners,
many of whom have facilities located in China, which
collectively provide Lexmark with substantially all of its
printer production capacity. Lexmark oversees these
manufacturing partners to try to ensure that products meet the
Company’s quality standards and specifications. The Company
continually reviews its manufacturing capabilities and cost
structure and makes adjustments as necessary.
Lexmark’s manufacturing operations for toner and
photoconductor drums are located in Boulder, Colorado. The
Company continues to make significant capital investments in its
Juarez, Mexico
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operation to expand cartridge assembly and selected key
component manufacturing capabilities. Laser printer cartridges
are assembled by a combination of in-house and third-party
contract manufacturing in the major geographies served by the
Company. The manufacturing control center for laser printer
supplies is located in Geneva, Switzerland.
Lexmark’s manufacturing operations for inkjet printer
supplies are located in Juarez and Chihuahua, Mexico and
Lapu-Lapu City, Philippines. The manufacturing control center
for inkjet supplies is located in Geneva, Switzerland.
Lexmark procures a wide variety of components used in the
manufacturing process, including semiconductors,
electro-mechanical components and assemblies, as well as raw
materials, such as plastic resins. Although many of these
components are standard
off-the-shelf
parts that are available from multiple sources, the Company
often utilizes preferred supplier relationships, and in certain
cases sole supplier relationships, to better ensure more
consistent quality, cost and delivery. Typically, these
preferred suppliers maintain alternate processes
and/or
facilities to ensure continuity of supply. Lexmark occasionally
faces capacity constraints when there has been more demand for
its products than initially projected. From time to time,
Lexmark may be required to use air shipment to expedite product
flow, which can adversely impact the Company’s operating
results. Conversely, in difficult economic times, the
Company’s inventory can grow as market demand declines.
During 2006, the Company continued to execute supplier managed
inventory (“SMI”) agreements with its primary
suppliers to improve the efficiency of the supply chain.
Management believes these SMI agreements improve Lexmark’s
supply chain inventory pipeline and supply chain flexibility
which enhances responsiveness to our customers. In addition,
management believes these agreements improve supplier visibility
to product demand and therefore improve suppliers’
timeliness and management of their inventory pipelines. As of
December 31, 2006, a significant majority of printers were
purchased under SMI agreements. Any impact on future operations
would depend upon factors such as the Company’s ability to
negotiate new SMI agreements and future market pricing and
product costs.
Many components of the Company’s products are sourced from
sole suppliers, including certain custom chemicals,
microprocessors, electro-mechanical components, application
specific integrated circuits and other semiconductors. The
Company is making changes in sourcing and design to drive
commonality of sub components across product families while
increasing dual sourcing for key components. In addition,
Lexmark sources some printer engines and finished products from
OEMs. Although Lexmark plans in anticipation of its future
requirements, should these components not be available from any
one of these suppliers, there can be no assurance that
production of certain of the Company’s products would not
be disrupted. Such a disruption could interfere with
Lexmark’s ability to manufacture and sell products and
materially adversely affect the Company’s business.
Conversely, during economic slowdowns, the Company may build
inventory of components as demand decreases.
Lexmark’s research and development activity is focused on
laser and inkjet printers, MFPs, and associated supplies,
features and related technologies. The Company has accelerated
its investment in research and development to support new
product initiatives and to advance current technologies and
expects this to continue. Lexmark’s primary research and
development activities are conducted in Lexington, Kentucky;
Boulder, Colorado; Cebu City, Philippines; and Kolkata, India.
In the case of certain products, the Company may elect to
purchase products or key components from third-party suppliers
rather than develop them internally.
Lexmark is actively engaged in the design and development of new
products and enhancements to its existing products. Its
engineering efforts focus on laser, inkjet, connectivity and
document management technologies, as well as design features
that will increase performance, improve ease of use and lower
production costs. Lexmark also develops related applications and
tools to enable it to efficiently provide a
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broad range of services. The process of developing new products
is complex and requires innovative designs that anticipate
customer needs and technological trends. Research and
development expenditures were $371 million in 2006,
$336 million in 2005 and $313 million in 2004. The
Company must make strategic decisions from time to time as to
which technologies will produce products and solutions in market
sectors that will experience the greatest future growth. There
can be no assurance that the Company can develop the more
technologically-advanced products required to remain competitive.
Although Lexmark experiences availability constraints from time
to time for certain products, the Company generally fills its
orders within 30 days of receiving them. Therefore, Lexmark
usually has a backlog of less than 30 days at any one time,
which the Company does not consider material to its business.
During the first quarter of 2006, the Company approved a plan to
restructure its workforce. The workforce restructuring
eliminated or transferred over 1,400 positions from various
business functions and job classes, with over 850 positions
being eliminated, and over 550 positions being transferred from
various locations primarily to low-cost countries. As previously
reported in 2006, an additional 100 positions are expected to be
eliminated during 2007. Refer to Part II, Item 8,
Note 4 of the Notes to Consolidated Financial Statements
for further information.
Employee additions to primarily support the Company’s
supplies manufacturing and production initiatives have offset
these employee separations resulting in the number of company
employees worldwide going from approximately 13,600 at
December 31, 2005, to approximately 14,900 at
December 31, 2006.
As of December 31, 2006, of the approximately 14,900
employees worldwide, 3,900 are located in the U.S. and the
remaining 11,000 are located in Europe, Canada, Latin America,
Asia Pacific, the Middle East and Africa. None of the
U.S. employees are represented by a union. Employees in
France are represented by a Statutory Works Council.
Lexmark makes available, free of charge, electronic access to
all documents (including annual reports on
Form 10-K,
quarterly reports on
Form 10-Q,
current reports on
Form 8-K,
and any amendments to those reports, as well as any beneficial
ownership filings) filed with or furnished to the Securities and
Exchange Commission (“SEC” or the
“Commission”) by the Company on its website at
http://investor.lexmark.com as soon as reasonably practicable
after such documents are filed. The SEC maintains an Internet
site that contains reports, proxy and information statements,
and other information regarding issuers that file electronically
with the SEC at www.sec.gov.
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The executive officers of Lexmark and their respective ages,
positions and years of service with the Company are set forth
below.
Dr. Curlander has been a Director of the Company since
February 1997. Since April 1999, Dr. Curlander has been
Chairman of the Board of the Company. In May 1998,
Dr. Curlander was elected President and Chief Executive
Officer of the Company. Prior to such time, Dr. Curlander
served as President and Chief Operating Officer and Executive
Vice President, Operations of the Company.
Mr. Gamble has been Executive Vice President and Chief
Financial Officer of the Company since September 2005 when he
joined the Company. Prior to joining the Company and since
February 2003, Mr. Gamble served as Executive Vice
President and Chief Financial Officer of Agere Systems, Inc.
(“Agere”). From January 2003 to February 2003,
Mr. Gamble served as Senior Vice President and Business
Controller and from January 2001 to January 2003,
Mr. Gamble served as Senior Vice President and Treasurer of
Agere. Prior to joining Agere, Mr. Gamble held various
finance positions at Honeywell International, Inc. (formerly
AlliedSignal, Inc.).
Mr. Rooke has been Executive Vice President and President
of the Company’s Printing Solutions and Services Division
since October 2002. Prior to such time and since May 2001,
Mr. Rooke served as Vice President and President of the
Printing Solutions and Services Division. From December 1999 to
May 2001, Mr. Rooke was Vice President and President of the
Company’s Business Printer Division, and from June 1998 to
December 1999, Mr. Rooke was Vice President and President
of the Company’s Imaging Solutions Division.
Mr. Bahous has been Vice President and President of the
Company’s Consumer Printer Division since March 2003. Prior
to such time and since May 2001, Mr. Bahous served as Vice
President of Customer Services. From January 1999 to May 2001,
Mr. Bahous served as Vice President and General Manager,
Customer Services Europe.
Mr. Cole has been Vice President and General Counsel of the
Company since July 1996 and Corporate Secretary since February
1996.
Mr. Goodnight has been Vice President, Asia Pacific and
Latin America since June 2001. From May 1998 to June 2001,
Mr. Goodnight served as Vice President and Corporate
Controller of the Company.
Mr. Stromquist has been Vice President and Corporate
Controller of the Company since July 2001. From July 1999 to
July 2001, Mr. Stromquist served as Vice President of
Alliances/OEM in the Company’s
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Consumer Printer Division. From November 1998 to July 1999, he
served as Vice President of Finance for the Company’s
Consumer Printer Division. Mr. Stromquist is the husband of
Jeri I. Stromquist, Vice President of Human Resources of the
Company.
Ms. Stromquist has been Vice President of Human Resources
of the Company since February 2003. From January 2001 to
February 2003, Ms. Stromquist served as Vice President of
Worldwide Compensation and Resource Programs in the
Company’s Human Resources department. From November 1998 to
January 2001, she served as Vice President of Finance for the
Company’s Business Printer Division. Ms. Stromquist is
the wife of Gary D. Stromquist, Vice President and Corporate
Controller of the Company.
The Company’s intellectual property is one of its major
assets and the ownership of the technology used in its products
is important to its competitive position. Lexmark seeks to
establish and maintain the proprietary rights in its technology
and products through the use of patents, copyrights, trademarks,
trade secret laws, and confidentiality agreements.
Lexmark holds a portfolio of approximately 1,200
U.S. patents and approximately 900 pending U.S. patent
applications. The Company also holds over 2,900 foreign patents
and pending patent applications. The inventions claimed in these
patents and patent applications cover aspects of the
Company’s current and potential future products,
manufacturing processes, business methods and related
technologies. The Company is developing a portfolio of patents
that protects its product lines and offers the possibility of
entering into licensing agreements with others.
Lexmark has a variety of intellectual property licensing and
cross-licensing agreements with a number of third parties.
Certain of Lexmark’s material license agreements, including
those that permit the Company to manufacture some of its current
products, terminate as to specific products upon certain
“changes of control” of the Company.
The Company has trademark registrations or pending trademark
applications for the name LEXMARK in approximately 70 countries
for various categories of goods. Lexmark also owns a number of
trademark applications and registrations for various product
names. The Company holds worldwide copyrights in computer code,
software and publications of various types. Other proprietary
information is protected through formal procedures, which
include confidentiality agreements with employees and other
entities.
Lexmark’s success depends in part on its ability to obtain
patents, copyrights and trademarks, maintain trade secret
protection and operate without infringing the proprietary rights
of others. While Lexmark designs its products to avoid
infringing the intellectual property rights of others, current
or future claims of intellectual property infringement, and the
expenses resulting therefrom, could materially adversely affect
its business, operating results and financial condition.
Expenses incurred by the Company in obtaining licenses to use
the intellectual property rights of others and to enforce its
intellectual property rights against others also could
materially affect its business, operating results and financial
condition. In addition, the laws of some foreign countries may
not protect Lexmark’s proprietary rights to the same extent
as the laws of the U.S.
Lexmark’s operations, both domestically and
internationally, are subject to numerous laws and regulations,
particularly relating to environmental matters that impose
limitations on the discharge of pollutants into the air, water
and soil and establish standards for the treatment, storage and
disposal of solid and hazardous wastes. Over time, the Company
has implemented numerous programs to recover, remanufacture and
recycle certain of its products and intends to continue to
expand on initiatives that have a positive effect on the
environment. Lexmark is also required to have permits from a
number of governmental agencies in order to conduct various
aspects of its business. Compliance with these laws and
regulations has not had, and in the future is not expected to
have, a material effect on the capital expenditures, earnings or
competitive position of the Company. There can be no assurance,
however, that
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future changes in environmental laws or regulations, or in the
criteria required to obtain or maintain necessary permits, will
not have an adverse effect on the Company’s operations.
Item 1A. RISK
FACTORS
The following significant factors, as well as others of which we
are unaware or deem to be immaterial at this time, could
materially adversely affect our business, financial condition or
operating results in the future. Therefore, the following
information should be considered carefully together with other
information contained in this report. Past financial performance
may not be a reliable indicator of future performance, and
historical trends should not be used to anticipate results or
trends in future periods.
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Any failure by
the Company to successfully outsource the infrastructure support
of its information technology system and application maintenance
functions and centralize certain of its support functions may
disrupt these systems or functions and could have a material
adverse effect on the Company’s systems of internal control
and financial reporting.
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The failure of
information technology systems may negatively impact the
Company’s operating results.
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Not applicable.
Lexmark’s corporate headquarters and principal development
facilities are located on a 374 acre campus in Lexington,
Kentucky. At December 31, 2006, the Company owned or leased
7.9 million square feet of administrative, sales, service,
research and development, warehouse and manufacturing facilities
worldwide. The properties are used by both the Business and
Consumer segments of the Company. Approximately 4.8 million
square feet is located in the U.S. and the remainder is
located in various international locations. The Company’s
principal international manufacturing facilities are located in
Mexico and the Philippines. The principal domestic manufacturing
facility is located in Colorado. The Company leases facilities
for development in India and the Philippines. The Company owns
approximately 62 percent of the worldwide square footage
and leases the remaining 38 percent. The leased property
has various lease expiration dates. The Company believes that it
can readily obtain appropriate additional space as may be
required at competitive rates by extending expiring leases or
finding alternative space.
None of the property owned by Lexmark is held subject to any
major encumbrances and the Company believes that its facilities
are in good operating condition.
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.
Pendl Companies, Inc. (“Pendl”) and Wazana Brothers
International, Inc. (“Wazana”) were added as
additional defendants to the claims brought by the Company in
the 02 action on October 8, 2004. Pendl, Wazana and NER
Data Products, Inc., were added as additional parties to the
claims brought by the Company in the 04 action on
November 8, 2004. These two cases have been consolidated by
the District Court. Similar claims in a separate action were
filed by the Company in the District Court against David Abraham
and Clarity Imaging Technologies, Inc. (“Clarity”) on
October 8, 2004. Clarity, Pendl, SCC and Wazana have filed
counterclaims against the Company in the District Court alleging
that the Company engaged in anti-competitive and monopolistic
conduct and unfair and deceptive trade practices in violation of
the Sherman Act, the Lanham Act and state laws. SCC has stated
in its legal documents that it is seeking approximately
$17.8 million to $19.5 million in damages for the
Company’s alleged anticompetitive conduct and approximately
$1 billion for Lexmark’s alleged violation of the
Lanham Act. Wazana has stated in its legal documents that it is
seeking approximately $2.2 million to $2.8 million in
damages for the Company’s alleged anticompetitive conduct
and approximately $1 billion for Lexmark’s alleged
violation of the Lanham Act. Pendl has stated in its legal
documents that it is seeking approximately $3.7 million to
$4.1 million in damages for the Company’s alleged
anticompetitive conduct. Clarity has not stated a damage dollar
amount. All are seeking treble damages, attorney fees, costs and
injunctive relief. On September 28, 2006, the District
Court dismissed the counterclaims filed by SCC alleging that the
Company engaged in anti-competitive and monopolistic conduct and
unfair and deceptive trade practices in violation of the Sherman
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Act, the Lanham Act and state laws. On October 13, 2006,
SCC filed a Motion for Reconsideration of the District
Court’s Order dismissing SCC’s claims, or in the
alternative, to amend its pleadings. On October 13, 2006,
the District Court issued an order to stay the action brought
against David Abraham and Clarity until a final judgment or
settlement are entered into in the consolidated 02 and 04
actions. On December 15, 2006, the Company filed a summary
judgment motion with the District Court to dismiss the
counterclaims filed against the Company by Wazana and Pendl. The
Company believes that these claims filed against the Company are
without merit, and intends to vigorously defend against them.
The Company is also party to various litigation and other legal
matters, including claims of intellectual property infringement
and various purported consumer class action lawsuits alleging,
among other things, various product defects and false and
deceptive advertising claims, that are being handled in the
ordinary course of business. In addition, various governmental
authorities have from time to time initiated inquiries and
investigations, some of which are ongoing, concerning the
activities of participants in the markets for printers and
supplies. The Company intends to continue to cooperate fully
with those governmental authorities in these matters.
Although it is not reasonably possible to estimate whether a
loss will occur as a result of these legal matters, or if a loss
should occur, the amount of such loss, the Company does not
believe that any legal matters to which it is a party is likely
to have a material adverse effect on the Company’s
financial position, results of operations and cash flows.
However, there can be no assurance that any pending legal
matters or any legal matters that may arise in the future would
not have a material adverse effect on the Company’s
financial position or results of operations.
None.
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Lexmark’s Class A Common Stock is traded on the New
York Stock Exchange under the symbol LXK. As of
February 23, 2007, there were 1,307 holders of record of
the Class A Common Stock and there were no holders of
record of the Class B Common Stock. Information regarding
the market prices of the Company’s Class A Common
Stock appears in Part II, Item 8, Note 18 of the
Notes to Consolidated Financial Statements.
The Company has never declared or paid any cash dividends on the
Class A Common Stock and has no current plans to pay cash
dividends on the Class A Common Stock. The payment of any
future cash dividends will be determined by the Company’s
board of directors in light of conditions then existing,
including the Company’s earnings, financial condition and
capital requirements, restrictions in financing agreements,
business conditions, tax laws, certain corporate law
requirements and various other factors.
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The following graph compares cumulative total stockholder return
on the Company’s Class A Common Stock with a broad
performance indicator, the S&P Composite 500 Stock Index,
and an industry index, the S&P 500 Information Technology
Index, for the period from December 31, 2001 to
December 29, 2006. The graph assumes that the value of the
investment in the Class A Common Stock and each index were
$100 at December 31, 2001 and that all dividends were
reinvested.
Source: Standard & Poor’s Compustat
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The following table provides information about the
Company’s equity compensation plans as of December 31,
2006:
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The table below summarizes recent financial information for the
Company. For further information refer to the Company’s
Consolidated Financial Statements and Notes thereto presented
under Part II, Item 8 of this
Form 10-K.
(Dollars in
Millions, Except Per Share Data)
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The following discussion and analysis should be read in
conjunction with the Consolidated Financial Statements and Notes
thereto presented under Part II, Item 8 of this
Form 10-K.
OVERVIEW
Lexmark makes it easier for businesses and consumers to move
information between the digital and paper worlds. Since its
inception in 1991, Lexmark has become a leading developer,
manufacturer and supplier of printing and imaging solutions for
offices and homes. Lexmark’s products include laser
printers, inkjet printers, multifunction devices, and associated
supplies, services and solutions. Lexmark also sells dot matrix
printers for printing single and multi-part forms by business
users and develops, manufactures and markets a line of other
office imaging products.
The Company is primarily managed along Business and Consumer
market segments:
The Company also sells its products through numerous alliances
and OEM arrangements.
Refer to Part II, Item 8, Note 17 of the Notes to
Consolidated Financial Statements for additional information
regarding the Company’s reportable segments, which is
incorporated herein by reference.
To improve profitability and the Company’s cost and expense
structure, Lexmark announced a number of actions in January 2006
that were implemented during the year:
In 2006, Lexmark continued to make progress on its core
strategic initiatives in both product segment expansion and
brand development resulting in new product introductions. In
2006, the Company also experienced branded unit growth in its
key focus segments with strong growth in low-end monochrome
lasers, color lasers, laser MFPs and inkjet AIOs.
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Additionally, in late 2006, Lexmark launched the next step in
its brand development initiative with the start of a new
advertising campaign which the Company will continue in 2007 as
Lexmark’s focus in 2007 will be to drive branded unit
growth in its key growth segments.
Refer to the section entitled “RESULTS OF OPERATIONS”
that follows for a further discussion of the Company’s
results of operations.
Lexmark management believes that the total distributed office
and home printing output opportunity was approximately
$90 billion in 2006, including hardware, supplies and
related services. This opportunity includes printers and
multifunction devices as well as a declining base of copiers and
fax machines that are increasingly being integrated into
multifunction devices. Based on industry analyst information,
Lexmark management estimates that this market will grow annually
at low- to mid-single digit percentage rates through 2010.
Market trends driving long-term growth include:
As a result of these market trends, Lexmark has growth
opportunities in low-end monochrome laser printers, color
lasers, laser MFPs and inkjet AIOs.
Industry laser printer unit growth in recent years has generally
exceeded the growth rate of laser printer revenue due to unit
growth in lower-priced desktop color and monochrome laser
printers and unit price reductions. Additionally, color and
multifunction laser printer units represent a more significant
component of laser unit growth. Management believes these trends
will continue. This pricing pressure is partially offset by the
tendency of customers in the shared workgroup laser market to
add higher profit margin optional features. Pricing pressure is
also partially offset by the opportunity to provide business
solutions and services to customers.
In the inkjet product market, advances in inkjet technology have
resulted in products with higher resolution and improved
performance while increased competition has led to lower prices.
Additionally, over the past couple years, the number of
consumers seeking productivity-related features has driven
significant growth in AIO products. Key factors promoting this
trend are greater affordability of AIOs containing productivity
features like full fax capabilities and automatic document
feeders. Management believes the combination of business
features made for the home, as well as full photo capabilities,
will continue to drive AIO growth. Growth in inkjet product
revenue on an industry basis in recent years has been slower
than unit growth due to price reductions. Management expects
these trends to continue.
While profit margins on printers and MFPs have been negatively
affected by competitive pricing pressure, supplies sales are
higher margin and recurring. However, as the hardcopy industry
matures and printer and copier markets converge, management
expects competitive pressures to continue.
Lexmark’s dot matrix printers and other office imaging
products include many mature products such as supplies for
IBM-branded printers, aftermarket supplies for certain
competitors’ products and typewriter supplies that require
little ongoing investment. The Company expects that the market
for these products
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will continue to decline, and has implemented a strategy to
continue to offer high-quality products while managing cost to
maximize cash flow and profit.
In recent years, Lexmark and its principal competitors, many of
which have significantly greater financial, marketing
and/or
technological resources than the Company, have regularly lowered
prices on printers and are expected to continue to do so.
Other challenges and risks faced by Lexmark include:
Refer to the section entitled “Competition” in
Item 1, which is incorporated herein by reference, for a
further discussion of major uncertainties faced by the industry
and Company. Additionally, refer to the section entitled
“Risk Factors” in Item 1A, which is incorporated
herein by reference, for a further discussion of factors that
could impact the Company’s operating results.
Lexmark’s strategy is based on a business model of
investing in technology to develop and sell printing solutions,
including printers and MFPs, with the objective of growing its
installed base, which drives recurring supplies sales.
Management believes that Lexmark has the following strengths
related to this business model:
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Lexmark’s strategy involves the following core strategic
initiatives:
In addition to investments in the Lexmark brand, the successful
execution of this strategy involves increased investment in
product and solution development. The Company increased its
research and development spending by 10% in 2006, by 8% in 2005
and by 18% in 2004. This investment has led to new products and
solutions aimed at targeted growth segments as well as a
pipeline of future products.
The Company’s strategy for dot matrix printers and other
office imaging products is to continue to offer high-quality
products while managing cost to maximize cash flow and profit.
Refer to the section entitled “Strategy” in
Item 1, which is incorporated herein by reference, for a
further discussion of the Company’s strategies and
initiatives.
Lexmark’s discussion and analysis of its financial
condition and results of operations are based upon the
Company’s consolidated financial statements, which have
been prepared in accordance with accounting principles generally
accepted in the U.S. The preparation of consolidated
financial statements requires management to make estimates and
judgments that affect the reported amounts of assets,
liabilities, revenue and expenses, and related disclosure of
contingent assets and liabilities. On an ongoing basis, the
Company evaluates its estimates, including those related to
customer programs and incentives, product returns, doubtful
accounts, inventories, stock-based compensation, intangible
assets, income taxes, warranty obligations, copyright fees,
restructurings, pension and other postretirement benefits, and
contingencies and litigation. Lexmark bases its estimates on
historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
An accounting policy is deemed to be critical if it requires an
accounting estimate to be made based on assumptions about
matters that are uncertain at the time the estimate is made, if
different estimates reasonably could have been used, or if
changes in the estimate that are reasonably likely to occur
could materially impact the financial statements. The Company
believes the following critical accounting policies affect its
more significant judgments and estimates used in the preparation
of its consolidated financial statements.
Lexmark records estimated reductions to revenue at the time of
sale for customer programs and incentive offerings including
special pricing agreements, promotions and other volume-based
incentives. Estimated reductions in revenue are based upon
historical trends and other known factors at the time of sale.
Lexmark also records estimated reductions to revenue for price
protection, which it provides to substantially all of its
distributor and reseller customers. The amount of price
protection is limited based on the amount of dealers’ and
resellers’ inventory on hand (including in-transit
inventory) as of the date of the price change. If market
conditions were to decline, Lexmark may take actions to increase
customer incentive offerings or reduce prices, possibly
resulting in an incremental reduction of revenue at the time the
incentive is offered.
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Lexmark maintains allowances for doubtful accounts for estimated
losses resulting from the inability of its customers to make
required payments. The Company estimates the allowance for
doubtful accounts based on a variety of factors including the
length of time receivables are past due, the financial health of
its customers, unusual macroeconomic conditions and historical
experience. If the financial condition of its customers
deteriorates or other circumstances occur that result in an
impairment of customers’ ability to make payments, the
Company records additional allowances as needed.
On January 1, 2006, Lexmark implemented the provisions of
Statement of Financial Accounting Standards (“SFAS”)
No. 123 (revised 2004), Share-Based Payment
(“SFAS 123R”) and related interpretations.
SFAS 123R requires that all share-based payments to
employees, including grants of stock options, be recognized in
the financial statements based on their fair value. The Company
selected the modified prospective transition method for
implementing SFAS 123R and began recognizing compensation
expense for stock-based awards granted on or after
January 1, 2006, plus any unvested awards granted prior to
January 1, 2006. Under this transition method, prior
periods have not been restated. Stock-based compensation expense
for awards granted on or after January 1, 2006, is based on
the grant date fair value calculated in accordance with the
provisions of SFAS 123R. Stock-based compensation related
to any unvested awards granted prior to January 1, 2006, is
based on the grant date fair value calculated in accordance with
the original provisions of SFAS No. 123, Accounting
for Stock-Based Compensation. The fair value of
the Company’s stock-based awards, less estimated
forfeitures, is amortized over the awards’ vesting periods
on a straight-line basis.
Prior to the adoption of SFAS 123R on January 1, 2006,
the Company accounted for the costs of its stock-based employee
compensation plans under Accounting Principles Board
(“APB”) Opinion No. 25, Accounting for Stock
Issued to Employees (“APB 25”), and related
interpretations. Under APB 25, compensation cost was not
recognized for substantially all options granted because the
exercise price was at least equal to the market value of the
underlying common stock on the date of grant.
In March 2005, the Securities and Exchange Commission
(“SEC”) issued Staff Accounting
Bulletin No. 107 (“SAB 107”) regarding
the SEC Staff’s interpretation of SFAS 123R and
provides the Staff’s views regarding interactions between
SFAS 123R and certain SEC rules and regulations and
provides interpretations of the valuation of share-based
payments for public companies. The Company has incorporated the
provisions of SAB 107 in its adoption of SFAS 123R.
The fair value of each option award on the grant date was
estimated using the Black-Scholes option-pricing model with the
following assumptions: expected dividend yield, expected stock
price volatility, weighted average risk-free interest rate and
weighted average expected life of the options. Under
SFAS 123R, the Company’s expected volatility
assumption used in the Black-Scholes option-pricing model was
based exclusively on historical volatility and the expected life
assumption was established based upon an analysis of historical
option exercise behavior. The risk-free interest rate used in
the Black-Scholes model was based on the implied yield currently
available on U.S. Treasury zero-coupon issues with a
remaining term equal to the Company’s expected term
assumption. The Company has never declared or paid any cash
dividends on the Class A Common Stock and has no current
plans to pay cash dividends on the Class A Common Stock.
The payment of any future cash dividends will be determined by
the Company’s board of directors in light of conditions
then existing, including the Company’s earnings, financial
condition and capital requirements, restrictions in financing
agreements, business conditions, tax laws, certain corporate law
requirements and various other factors.
Lexmark records a liability for a cost associated with an exit
or disposal activity at its fair value in the period in which
the liability is incurred, except for liabilities for certain
employee termination benefit charges that are accrued over time.
Specifically for termination benefits under a one-time benefit
arrangement, the
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timing of recognition and related measurement of a liability
depends on whether employees are required to render service
until they are terminated in order to receive the termination
benefits and, if so, whether employees will be retained to
render service beyond a minimum retention period. For employees
who are not required to render service until they are terminated
in order to receive the termination benefits or employees who
will not provide service beyond the minimum retention period,
the Company records a liability for the termination benefits at
the communication date. If employees are required to render
service until they are terminated in order to receive the
termination benefits and will be retained to render service
beyond the minimum retention period, the Company measures the
liability for termination benefits at the communication date and
recognizes the expense and liability ratably over the future
service period. For contract termination costs, Lexmark records
a liability for costs to terminate a contract before the end of
its term when the Company terminates the agreement in accordance
with the contract terms or when the Company ceases using the
rights conveyed by the contract. The Company records a liability
for other costs associated with an exit or disposal activity in
the period in which the liability is incurred. Once Company
management approves an exit or disposal activity, the Company
closely monitors the expenses that are reported in association
with the activity.
Lexmark provides for the estimated cost of product warranties at
the time revenue is recognized. The amounts accrued for product
warranties is based on the quantity of units sold under
warranty, estimated product failure rates, and material usage
and service delivery costs. The estimates for product failure
rates and material usage and service delivery costs are
periodically adjusted based on actual results. For extended
warranty programs, the Company defers revenue in short-term and
long-term liability accounts (based on the extended warranty
contractual period) for amounts invoiced to customers for these
programs and recognizes the revenue ratably over the contractual
period. Costs associated with extended warranty programs are
expensed as incurred. To minimize warranty costs, the Company
engages in extensive product quality programs and processes,
including actively monitoring and evaluating the quality of its
component suppliers. Should actual product failure rates,
material usage or service delivery costs differ from the
Company’s estimates, revisions to the estimated warranty
liability may be required.
Lexmark writes down its inventory for estimated obsolescence or
unmarketable inventory equal to the difference between the cost
of inventory and the estimated market value. The Company
estimates the difference between the cost of obsolete or
unmarketable inventory and its market value based upon product
demand requirements, product life cycle, product pricing and
quality issues. Also, Lexmark records an adverse purchase
commitment liability when anticipated market sales prices are
lower than committed costs. If actual market conditions are less
favorable than those projected by management, additional
inventory write-downs and adverse purchase commitment
liabilities may be required.
Lexmark performs reviews for the impairment of long-lived assets
whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. An
impairment loss is recognized when estimated undiscounted future
cash flows expected to result from the use of the asset and its
eventual disposition are less than its carrying amount. If
future expected undiscounted cash flows are insufficient to
recover the carrying value of the assets, then an impairment
loss is recognized based upon the excess of the carrying value
of the asset over the anticipated cash flows on a discounted
basis. Such an impairment review incorporates estimates of
forecasted revenue and costs that may be associated with an
asset, expected periods that an asset may be utilized and
appropriate discount rates.
Lexmark also reviews any legal and contractual obligations
associated with the retirement of its long-lived assets and
records assets and liabilities, as necessary, related to the
cost of such obligations. Costs associated with such obligations
that are reasonably estimable and probable are accrued and
expensed,
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or capitalized as appropriate. The asset recorded is recorded
during the period in which it occurs and is amortized over the
useful life of the related long-lived tangible asset. The
liability recorded is relieved when the costs are incurred to
retire the related long-lived tangible asset. The cost of each
obligation is estimated based on current law and technology;
accordingly, such estimates could change materially as the
Company periodically evaluates and revises such estimates based
on expenditures against established reserves and the
availability of additional information. The Company’s asset
retirement obligations are currently not material.
The Company’s pension and other postretirement benefit
costs and obligations are dependent on various actuarial
assumptions used in calculating such amounts. The
non-U.S. pension
plans use economic assumptions similar to the U.S. pension
plan. Significant assumptions the Company must review and set
annually related to its pension and other postretirement benefit
obligations are:
Differences between actual and expected asset returns on equity
investments are recognized in the calculation of net periodic
benefit cost over five years. The deferred amounts resulting
from this averaging process did not have a significant impact on
current period operating results and are not expected to have a
significant effect on the Company’s results of operations
for 2007.
Actual results that differ from assumptions that fall outside
the “10% corridor”, as defined by
SFAS No. 87, Employers’ Accounting for
Pensions, are accumulated and amortized over the estimated
future service period of the plan participants. For 2006, a
25 basis point change in the assumptions for asset return
and discount rate would not have had a significant impact on the
net periodic benefit cost.
Effective December 31, 2006, the Company adopted
SFAS No. 158, Employers’ Accounting for
Defined Benefit Pension and Other Postretirement Plans, an
amendment of FASB Statements No. 87, 88, 106, and 132(R)
(“SFAS 158”). SFAS 158 requires
recognition of the funded status of a benefit plan in the
statement of financial position and recognition in other
comprehensive earnings of certain gains and losses that arise
during the period, but are deferred under pension accounting
rules.
The Company estimates its tax liability based on current tax
laws in the statutory jurisdictions in which it operates. These
estimates include judgments about deferred tax assets and
liabilities resulting from temporary differences between assets
and liabilities recognized for financial reporting purposes and
such amounts recognized for tax purposes, as well as about the
realization of deferred tax assets. If the provisions for
current or deferred taxes are not adequate, if the Company is
unable to realize certain deferred tax assets or if the tax laws
change unfavorably, the Company could potentially experience
significant losses in excess of the reserves established.
Likewise, if the provisions for current and deferred taxes are
in excess of those eventually needed, if the Company is able to
realize additional deferred tax assets or if tax laws change
favorably, the Company could potentially experience significant
gains.
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In July 2006, the Financial Accounting Standards Board
(“FASB”) issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes — an
interpretation of FASB Statement No. 109
(“FIN 48”). FIN 48 clarifies the
accounting for income taxes by prescribing the minimum
recognition threshold as “more-likely-than-not” that a
tax position must meet before being recognized in the financial
statements. FIN 48 also provides guidance on derecognition,
classification, interest and penalties, accounting for income
taxes in interim periods, financial statement disclosure and
transition rules.
The evaluation of a tax position in accordance with FIN 48
is a two-step process. The first step is recognition: The
enterprise determines whether it is more likely than not that a
tax position will be sustained upon examination, including
resolution of any litigation. The second step is measurement: A
tax position that meets the more-likely-than-not recognition
threshold is measured to determine the amount of benefit to
recognize in the financial statements. The tax position is
measured at the largest amount of benefit that is greater than
50 percent likely of being realized upon ultimate
resolution.
The Company is required to adopt the provisions of FIN 48
related to all of the Company’s tax positions for the
fiscal year beginning January 1, 2007. The cumulative
effect of applying the provisions of FIN 48 will be
reported as an adjustment to the opening balance of retained
earnings. The Company has not completed its evaluation of
FIN 48 but estimates the cumulative effect to be an
increase to retained earnings in the range of $0 to
$20 million.
Certain countries (primarily in Europe)
and/or
collecting societies representing copyright owners’
interests have taken action to impose fees on devices (such as
scanners, printers and multifunction devices) alleging the
copyright owners are entitled to compensation because these
devices enable reproducing copyrighted content. Other countries
are also considering imposing fees on certain devices. The
amount of fees, if imposed, would depend on the number of
products sold and the amounts of the fee on each product, which
will vary by product and by country. The Company has accrued
amounts that it believes are adequate to address the risks
related to the copyright fee issues currently pending. The
financial impact on the Company, which will depend in large part
upon the outcome of local legislative processes, the
Company’s and other industry participants’ outcome in
contesting the fees and the Company’s ability to mitigate
that impact by increasing prices, which ability will depend upon
competitive market conditions, remains uncertain.
In accordance with SFAS No. 5, Accounting for
Contingencies, Lexmark records a provision for a loss
contingency when management believes that it is both probable
that a liability has been incurred and the amount of loss can be
reasonably estimated. The Company believes it has adequate
provisions for any such matters.
RESULTS OF
OPERATIONS
To improve profitability and the Company’s cost and expense
structure, Lexmark announced a number of actions in January 2006
that were implemented during the year:
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In 2006, Lexmark continued to make progress on its core
strategic initiatives in both product segment expansion and
brand development resulting in new product introductions with
new families of low-end monochrome lasers, color lasers, laser
MFPs and inkjet AIOs. These new products received significant
industry recognition and awards.
In 2006, the Company also experienced branded unit growth in its
key focus segments with strong growth in low-end monochrome
lasers, color lasers, laser MFPs and inkjet AIOs.
Additionally, in late 2006, Lexmark launched the next step in
its brand development initiative with the start of a new
television advertising campaign along with radio, print and
outdoor advertising in targeted geographic and market segments.
This integrated campaign highlights Lexmark’s deep and
proven experience serving 75% of the top banks, retailers and
pharmacies while highlighting the opportunity for small and
medium businesses and consumers to benefit from our business
class expertise. The Company will continue this campaign in 2007
as Lexmark’s focus in 2007 will be to drive branded unit
growth in its key growth segments.
The following discussion and analysis should be read in
conjunction with the Consolidated Financial Statements and Notes
thereto. The following table summarizes the results of the
Company’s operations for the years ended December 31,
2006, 2005 and 2004:
During 2006, total revenue was $5.1 billion or down 2% from
2005. Laser and inkjet supplies revenue increased 3%
year-to-year
(“YTY”) as good growth in laser supplies was partially
offset by declines in inkjet supplies. Laser and inkjet hardware
revenue decreased 8% with growth in laser hardware units more
than offset by the decrease in inkjet hardware units.
During 2006, in the Business segment, revenue increased 3% YTY.
Laser unit shipments increased approximately 9% YTY. Laser
hardware average unit revenue (“AUR”), which reflects
the changes in both pricing and mix, decreased approximately 9%
YTY reflecting price declines and a mix shift to low-end
monochrome lasers.
During 2006, in the Consumer segment, revenue decreased 8% YTY.
Inkjet unit shipments decreased approximately 20% YTY. Inkjet
hardware AUR increased approximately 2% YTY as a favorable
product mix shift to AIOs was partially offset by price declines.
Additionally, the Company sees the potential for continued
erosion in end-user inkjet supplies demand due to the reduction
in inkjet hardware unit sales reflecting both the Company’s
decision to focus on more profitable printer placements and
weakness in its OEM business which it is currently experiencing.
Net earnings for the year ended December 31, 2006,
decreased 5% from the prior year due to lower operating income
partially offset by a lower effective tax rate. Net earnings in
2006 include $135.1 million of pre-tax restructuring
related charges and project costs, a $9.9 million pre-tax
pension curtailment gain, $43.2 million of pre-tax
stock-based compensation expense and a $14.3 million income
tax benefit from the reversal of previously accrued taxes
related to the finalization of certain tax audits and the
expiration of
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various domestic and foreign statutes of limitation. Net
earnings in 2005 included increased income tax expense of
$51.9 million resulting from the board approval to
repatriate $684 million of foreign dividends during 2005
under the American Jobs Creation Act of 2004. Net earnings in
2005 also included one-time pre-tax termination benefit charges
of $10.4 million related to the workforce reduction
announced in the third quarter of 2005.
Net earnings for the year ended December 31, 2005,
decreased 37% compared to 2004. The decrease in net earnings was
principally due to lower operating income as a result of lower
gross profits and increased income tax expense as discussed
above. Net earnings in 2005 also included the one-time
termination benefit charges as discussed above. Net earnings in
2004 included a $20 million tax benefit due to the
settlement of all outstanding issues with the Internal Revenue
Service on audits for the years
1997-2001.
The following tables provide a breakdown of the Company’s
revenue by product category and market segment as well as
hardware unit shipments:
Consolidated revenue decreased 2% in both 2006 and 2005 when
compared to the prior period.
During 2006, laser and inkjet supplies revenue increased 3% YTY
as good growth in laser supplies was partially offset by
declines in inkjet supplies. Laser and inkjet hardware revenue
decreased 8% with growth in laser hardware units more than
offset by the decrease in inkjet hardware units.
During 2005, laser and inkjet supplies revenue increased 5% YTY
with increases in both laser and inkjet supplies. Laser and
inkjet printer revenue decreased 10% YTY with decreases in both
laser and inkjet printer revenue.
During 2006, 2005 and 2004, one customer, Dell, accounted for
$744 million or approximately 15%, $782 million or
approximately 15%, and $570 million or approximately 11% of
the Company’s total revenue, respectively. Sales to Dell
are included in both the Business and Consumer segments.
During 2006, revenue in the Business segment increased
$94 million or 3% compared to 2005 principally due to
higher laser supplies revenue. During 2006, laser hardware unit
shipments increased approximately
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9% YTY with strong growth in branded unit sales partially offset
by declines in OEM unit sales. Laser hardware AUR decreased
approximately 9% YTY reflecting price declines and a mix shift
to low-end monochrome lasers.
During 2005, revenue in the Business segment decreased
$42 million or 1% compared to 2004. This decrease was
principally due to decreased hardware revenue attributable to
more aggressive pricing and lower than expected supplies revenue
growth. During 2005, the Company experienced a 15% unit growth
in laser unit shipments, but saw significant hardware price
declines and a continuing mix shift to low-end products. Laser
hardware AUR was down approximately 20% in 2005 compared to
2004, reflecting the impact of pricing and a continuing
unfavorable mix shift to low-end monochrome lasers.
During 2006, revenue in the Consumer segment decreased
$208 million or 8% compared to 2005 primarily due to
decline in inkjet hardware units. During 2006, inkjet unit
shipments decreased approximately 20% YTY. Inkjet hardware AUR
increased approximately 2% YTY as a favorable product mix shift
to AIOs was partially offset by price declines.
During 2005, revenue in the Consumer segment decreased
$51 million or 2% compared to 2004. This decrease was
principally due to decreased hardware revenue attributable to
more aggressive pricing and promotion activities and lower than
expected supplies revenue growth. During 2005, the Company
experienced about flat YTY unit sales and saw significant
hardware price declines. Inkjet hardware AUR was down
approximately 15% in 2005 compared to 2004, reflecting the
impact of pricing partially offset by a more favorable mix shift
to AIOs.
The following table provides a breakdown of the Company’s
revenue by geography:
During 2006, revenue decreased in the U.S. primarily due to
the previously-mentioned decline in inkjet hardware units.
Currency exchange rates did not have a material impact on
revenue in Europe and Other International geographies during
2006.
During 2005, revenue decreased in the U.S. and Europe
geographies due to the previously-mentioned aggressive pricing
and promotion activities and softer than expected supplies
growth, partially offset by the increase in revenue in the Other
International geographies when compared to 2004. Currency
exchange rates did not have a material impact on revenue in
Europe and Other International geographies during 2005.
The following table provides gross profit information:
During 2006, consolidated gross profit and gross profit as a
percentage of revenue increased when compared to the prior year.
The change in the gross profit margin over the prior period was
primarily due to a 3.3 percentage point favorable mix shift
among products, mostly from a decrease in the percentage of
inkjet hardware and an increase in laser supplies, partially
offset by a decrease in hardware margins in
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both inkjet and lasers. Gross profit in 2006 also included
$42.1 million (or a 0.8 percentage point impact) of
restructuring related charges, primarily relating to accelerated
depreciation, and project costs. See “Restructuring Related
Charges, Project Costs and Other” that follows for further
discussion. Gross profit in 2006 also included $6.0 million
of stock-based compensation expense.
During 2005, consolidated gross profit and gross profit as a
percentage of revenue decreased when compared to the prior year.
The change in the gross profit margin from 2004 was principally
due to lower product margins of 5.2 percentage points which
was mostly printer driven, partially offset by a
2.8 percentage point favorable mix shift among products
toward supplies.
During 2005, the Company continued efforts begun in 2002 to
execute supplier managed inventory (“SMI”) agreements
with its primary suppliers to improve the efficiency of the
supply chain. In instances where a non-cancelable commitment is
made to purchase product at a cost greater than the expected
sales price, the Company’s accounting policy is to
recognize a liability and related expense for future losses.
During 2005, several products transitioned to SMI agreements
that were not previously under such agreements. The pre-tax
benefit in 2005 to the Company of this transition was
approximately $49 million which was reflected as lower
adverse purchase commitment charges. The benefit of products
transitioning to SMI agreements in 2004 was approximately
$18 million. As of December 31, 2005, the significant
majority of major printer suppliers were under new SMI
agreements. There was no measurable benefit of products
transitioning to SMI agreements in 2006. Any impact on future
operations would depend upon factors such as the Company’s
ability to negotiate new SMI agreements and future market
pricing and product costs.
The following table presents information regarding the
Company’s operating expenses during the periods indicated:
Research and development increased in 2006 and 2005 compared to
the prior year due to the Company’s continued acceleration
of investment to support product and solution development. This
investment has led to new products and solutions aimed at
targeted growth segments. Additionally, research and development
in 2006 includes $6.9 million of stock-based compensation
expense.
Selling, general and administrative expense in 2006 includes
$30.3 million of stock-based compensation expense and
$11.9 million of project costs related to the 2006
restructuring. See “Restructuring Related Charges, Project
Costs and Other” that follows for further discussion.
Restructuring and other, net, in 2006 includes
$81.1 million of restructuring related charges for the 2006
restructuring plan partially offset by a $9.9 million
pension curtailment gain from the pension plan freeze. In 2005,
the Company incurred $10.4 million of one-time termination
benefit charges related to the 2005 workforce reduction. See
“Restructuring Related Charges, Project Costs and
Other” that follows for further discussion.
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The following table provides operating income by market segment:
During 2006, the decrease in consolidated operating income was
primarily attributable to a $102 million increase in
operating expenses as discussed above partially offset by a
$10 million increase in gross profit. Operating income for
the Business segment decreased $61 million due to lower
gross profits, the impact of restructuring related charges and
project costs and the increased investment in research and
development. Operating income for the Consumer segment increased
$14 million due to increased gross profits partially offset
by the impact of restructuring related charges and project costs.
During 2006, the Company incurred restructuring related charges
and project costs of $35.9 million in its Business segment,
$57.2 million in its Consumer segment and
$42.0 million in All other. All other operating income also
includes a $9.9 million pension curtailment gain from the
pension plan freeze.
During 2005, the decrease in consolidated operating income was
primarily due to a $156 million decrease in gross profit
attributable to gross profit margin erosion and a
$43 million increase in operating expenses compared to
2004. Operating income for the Business and Consumer segments
decreased $91 million and $101 million, respectively,
compared to 2004 primarily due to lower gross profits
attributable to lower revenues and lower product margins in each
segment.
During 2005, the Company incurred one-time termination benefit
charges of $10.4 million related to its 2005 Workforce
Reduction plan. For the $10.4 million of one-time
termination benefit charges, the Company recorded
$6.5 million in its Business segment, $2.6 million in
its Consumer segment and $1.3 million in All other.
The following table provides interest and other information:
Total interest and other (income) expense, net, was income of
$17 million in 2006 compared to income of $20 million
in 2005. This decrease was primarily due to lower interest
income in 2006 compared to the prior year as a result of a
decreased level of cash and marketable securities held by the
Company during the year partially offset by higher interest
rates in 2006 compared to 2005.
Total interest and other (income) expense, net, was income of
$20 million in 2005 compared to income of $14 million
in 2004. This increase was primarily due to $12 million of
additional interest income attributable to higher interest rates
in 2005 compared to 2004, partially offset by foreign exchange
losses of $4 million in 2005 compared to foreign exchange
gains of $2 million in 2004.
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The Company’s effective income tax rate was approximately
26.3%, 35.6% and 23.8% in 2006, 2005 and 2004, respectively.
The 2006 effective income tax rate included $14.3 million
from the reversal of previously accrued taxes related to the
finalization of certain tax audits and the expiration of various
domestic and foreign statutes of limitation.
The 2005 effective income tax rate was impacted by the American
Jobs Creation Act of 2004 (the “AJCA”) signed by the
President of the U.S. on October 22, 2004. The AJCA
created a temporary incentive for U.S. corporations to
repatriate accumulated income earned abroad by providing an
85 percent dividends-received deduction for certain
dividends from controlled foreign corporations. On
April 28, 2005, the Company’s board of directors
approved a Domestic Reinvestment Plan (“DRP”) under
the AJCA. Pursuant to the DRP, the Company repatriated
$684 million for which it will claim the 85 percent
dividends-received deduction provided by the AJCA. The
Company’s 2005 income tax provision included
$51.9 million to cover the Federal, State, and foreign
income taxes the Company has estimated it would owe in
connection with its repatriation of the $684 million.
During 2004, the Internal Revenue Service (“IRS”)
completed its examination of the Company’s income tax
returns for all years through 2001. As a result of the
completion of those audits, the Company reversed previously
accrued taxes, reducing the income tax provision by
$20 million in the third quarter of 2004.
The IRS has started its examination of tax years 2004 and 2005.
The Company and its subsidiaries are also subject to tax
examinations in various state and foreign jurisdictions. The
Company believes that adequate amounts have been provided for
any adjustments that may result from these examinations.
During 2006, the Company was subject to a tax holiday in
Switzerland with respect to the earnings of one of the
Company’s wholly-owned Swiss subsidiaries. The holiday
expired at the end of 2006. The benefit derived from the tax
holiday was $1.6 million in 2006, $11.5 million in
2005 and $4.9 million in 2004.
The Company has
non-U.S. tax
loss carryforwards of $123.4 million, of which
$107.3 million are subject to a valuation allowance. For
the remaining $16.1 million of loss carryforwards,
$14.9 million have an indefinite carryforward period and
$1.2 million will expire from 2009 to 2013. The Company
believes that, for all tax loss carryforwards where a valuation
allowance has not been provided, the assets will be realized
because there will be sufficient income in the future to absorb
the losses.
On November 10, 2005, the FASB issued Staff Position
(“FSP”)
No. FAS 123R-3,
Transition Election Related to Accounting for the Tax Effects
of Share-Based Payment Awards (“FSP 123R-3”). The
Company has elected to adopt the alternative transition method
provided in FSP 123R-3 for calculating the tax effects of
stock-based compensation pursuant to SFAS 123R. The
alternative transition method includes simplified methods to
establish the beginning balance of the additional paid-in
capital pool (“APIC pool”) related to the tax effects
of employee stock-based compensation, and to determine the
subsequent impact on the APIC pool and Consolidated Statement of
Cash Flows of the tax effects of employee stock-based
compensation awards that are outstanding upon the adoption of
SFAS 123R.
In July 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes
(“FIN 48”). FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with
SFAS No. 109, Accounting for Income Taxes. See
Part II, Item 8, Note 2 of the Notes to
Consolidated Financial Statements for further discussion. The
Company is required to adopt FIN 48 for the fiscal year
beginning January 1, 2007. The cumulative effect of
applying the provisions of FIN 48 will be reported as an
adjustment to the opening balance of retained earnings. The
Company has not completed its evaluation of FIN 48 but
estimates the cumulative effect to be an increase to retained
earnings in the range of $0 to $20 million.
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Net earnings for the year ended December 31, 2006,
decreased 5% from the prior year due to lower operating income
partially offset by a lower effective tax rate. Net earnings in
2006 include $135.1 million of pre-tax restructuring
related charges and project costs, a $9.9 million pre-tax
pension curtailment gain, $43.2 million of pre-tax
stock-based compensation expense and a $14.3 million income
tax benefit from the reversal of previously accrued taxes
related to the finalization of certain tax audits and the
expiration of various domestic and foreign statutes of
limitation. Net earnings in 2005 included increased income tax
expense of $51.9 million resulting from the board approval
to repatriate $684 million of foreign dividends during 2005
under the American Jobs Creation Act of 2004. Net earnings in
2005 also included one-time pre-tax termination benefit charges
of $10.4 million related to the workforce reduction
announced in the third quarter of 2005.
Net earnings for the year ended December 31, 2005,
decreased 37% compared to 2004. The decrease in net earnings was
principally due to lower operating income as a result of lower
gross profits and increased income tax expense as discussed
above. Net earnings in 2005 also included the one-time
termination benefit charges as discussed above. Net earnings in
2004 included a $20 million income tax benefit due to the
settlement of all outstanding issues with the Internal Revenue
Service on audits for the years
1997-2001.
The following table summarizes basic and diluted net earnings
per share:
For the year ended December 31, 2006, both basic and
diluted net earnings per share include the restructuring related
charges and project costs, pension curtailment gain, stock-based
compensation expense and income tax benefit as discussed above.
The increases over the prior year in basic and diluted net
earnings per share were primarily attributable to the decrease
in the average number of shares outstanding, primarily due to
the Company’s stock repurchases.
For the year ended December 31, 2005, both basic and
diluted net earnings per share included increased income tax
expense as discussed above. The decreases in basic and diluted
net earnings per share were primarily attributable to decreased
net earnings partially offset by the decrease in the average
number of shares outstanding due to the Company’s stock
repurchases. For the year ended December 31, 2004, both
basic and diluted net earnings per share included a benefit
associated with the previously-mentioned tax settlement.
RESTRUCTURING
RELATED CHARGES, PROJECT COSTS AND OTHER
During the first quarter of 2006, the Company approved a plan to
restructure its workforce, consolidate some manufacturing
capacity and make certain changes to its U.S. retirement
plans (collectively referred to as the “2006 actions”).
The workforce restructuring eliminated or transferred over 1,400
positions from various business functions and job classes, with
over 850 positions being eliminated, and over 550 positions
being transferred from various locations primarily to low-cost
countries. As previously reported in 2006, an additional 100
positions are expected to be eliminated during 2007. Lexmark
consolidated its manufacturing capacity to reduce manufacturing
costs, including the closure of its Rosyth, Scotland inkjet
cartridge manufacturing facility and Orleans, France laser toner
facilities, and reduced its operating expenses, particularly in
the areas of supply chain, general and administrative and
marketing and sales support.
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Lexmark also froze pension benefits in its defined benefit
pension plan for U.S. employees, effective April 3,
2006, and at the same time changed from a maximum Company
matching contribution of three percent of eligible compensation
to an automatic Company contribution of one percent and a
maximum Company matching contribution of five percent to
Lexmark’s existing 401(k) plan. Additionally, for 2006, the
Company is making a six percent contribution to a nonqualified
deferred compensation plan on compensation amounts in excess of
IRS qualified plan limits.
Except for the additional 100 positions mentioned above, the
restructuring related activities were substantially complete at
the end of 2006.
For the year ended December 31, 2006, the Company incurred
net charges of $111.2 million for the 2006 actions as
follows:
The accelerated depreciation charges were determined in
accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, and resulted
from the Company’s decision to close certain manufacturing
facilities in Europe. The accelerated depreciation charges are
included in Cost of revenue on the Consolidated
Statements of Earnings.
Employee termination benefit charges were accrued in accordance
with SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities
(“SFAS 146”), and
SFAS No. 112, Employers’ Accounting for
Postemployment Benefits, as appropriate. Employee
termination benefit charges include severance, medical and other
benefits. Contract termination and lease charges were also
accrued in accordance with SFAS 146. Employee termination
benefit charges, contract termination and lease charges and the
defined benefit pension plan freeze are included in
Restructuring and other, net on the Consolidated
Statements of Earnings.
The following table presents a rollforward of the liability
incurred for employee termination benefit and contract
termination and lease charges in connection with the
restructuring related activities. The liability is included in
Accrued liabilities on the Company’s Consolidated
Statements of Financial Position.
For the year ended December 31, 2006, the Company incurred
total restructuring related charges of $121.1 million. The
Company incurred restructuring related charges of
$35.2 million in its Business segment, $54.7 million
in its Consumer segment and $31.2 million in All other. All
other operating income also included a $9.9 million pension
plan freeze benefit.
The Company also incurred additional charges related to the
execution of the Company’s restructuring related activities
(referred to as “project costs”). The project costs
are incremental to the Company’s normal operating charges
and are expensed as incurred. Project costs include such items
as travel and employee relocation associated with the
Company’s restructuring related activities.
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For the year ended December 31, 2006, the Company incurred
net charges, including project costs, of $125.2 million for
the 2006 actions as follows:
For the year ended December 31, 2006, the Company incurred
restructuring related charges and project costs of
$35.9 million in its Business segment, $57.2 million
in its Consumer segment and $42.0 million in All other. All
other operating income also included a $9.9 million pension
plan freeze benefit. During 2006, the Company realized
approximately $60 million of total savings related to the
2006 actions including the pension curtailment gain, with
approximately 55% benefiting cost of revenue and 45% benefiting
operating expense.
The restructuring related activities, substantially completed at
year-end 2006, are expected to save approximately
$80 million beginning in 2007 with approximately 65%
benefiting cost of revenue and 35% benefiting operating expense.
The remaining accrued liability balance as noted above is
expected to be substantially paid out by the end of 2007. These
payments will relate primarily to employee termination benefits.
Additionally, the Company expects to sell the Rosyth, Scotland
facility to a third party in the first quarter of 2007.
In order to optimize the Company’s expense structure, the
Company approved a plan during the third quarter of 2005 that
would reduce its workforce by approximately 275 employees
worldwide from various business functions and job classes. The
separation of the affected employees was completed by
December 31, 2005.
As of December 31, 2005, the Company incurred one-time
termination benefit charges of $10.4 million related to the
plan that is included in Restructuring and other, net on
the Consolidated Statements of Earnings. For the
$10.4 million of one-time termination benefit charges, the
Company recorded $6.5 million in its Business segment,
$2.6 million in its Consumer segment and $1.3 million
in All other.
The following table provides the total pre-tax cost related to
Lexmark’s retirement plans for the years 2006, 2005 and
2004. Cost amounts are included as an addition to the
Company’s cost and expense amounts in the Consolidated
Statements of Earnings.
The increase in the cost of defined benefit pension plans in
2005 was primarily due to the recognition of previous
years’ investment losses and a curtailment loss due to
restructuring in the U.S. The decrease in
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the cost of defined benefit pension plans in 2006 was primarily
due to the $9.9 million one-time curtailment gain from the
freezing of benefit accruals in the U.S. which is not expected
to recur. Refer to Part II, Item 8, Note 4 of the
Notes to Consolidated Financial Statements for further details.
The increase in the cost of defined contribution plans in 2006
was primarily due to the enhancement of benefits in the
U.S. Refer to Part II, Item 8, Note 4 of the
Notes to Consolidated Financial Statements for further details.
The decrease in the cost of other postretirement plans in 2006
was primarily due to plan design changes.
Changes in actuarial assumptions did not have a significant
impact on the Company’s results of operations in 2006, nor
are they expected to have a material effect in 2007. Future
effects of retirement-related benefits on the operating results
of the Company depend on economic conditions, employee
demographics, mortality rates and investment performance. Refer
to Part II, Item 8, Note 14 of the Notes to
Consolidated Financial Statements for additional information
relating to the Company’s pension and other postretirement
plans.
The Pension Protection Act of 2006 (“the Act”) was
enacted on August 17, 2006. Most of its provisions will
become effective in 2008. The Act significantly changes the
funding requirements for single-employer defined benefit pension
plans. The funding requirements will now largely be based on a
plan’s calculated funded status, with faster amortization
of any shortfalls or surpluses. The Act directs the
U.S. Treasury Department to develop a new yield curve to
discount pension obligations for determining the funded status
of a plan when calculating the funding requirements. The
provisions of the Act are not expected to have material impact
on the Company’s financial position, results of operations
and cash flows.
LIQUIDITY AND
CAPITAL RESOURCES
Lexmark’s financial position remains strong at
December 31, 2006, with working capital of
$506 million compared to $936 million at
December 31, 2005. The decrease in working capital accounts
was primarily due to lower cash and cash equivalents and
marketable securities in 2006 resulting primarily from the
Company’s stock repurchase activity. At December 31,
2006, the Company had $149.8 of long-term debt and no short-term
debt outstanding. The debt to total capital ratio was 13% at
December 31, 2006, compared to 9% at December 31,
2005. The Company had no amounts outstanding under its
U.S. trade receivables financing program or its revolving
credit facility at December 31, 2006.
The following table summarizes the results of the Company’s
Consolidated Statements of Cash Flows for the years indicated:
The Company’s primary source of liquidity has been cash
generated by operations, which totaled $671 million,
$576 million and $775 million in 2006, 2005 and 2004,
respectively. Cash from operations generally has been sufficient
to allow the Company to fund its working capital needs and
finance its capital expenditures during these periods along with
the repurchase of approximately $0.9 billion,
$1.1 billion, and $0.3 billion of its Class A
Common Stock during 2006, 2005 and 2004, respectively.
Management believes that cash provided by operations will
continue to be sufficient to meet operating and capital needs.
However, in the event that cash from operations is not
sufficient, the Company
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has other potential sources of cash through utilization of its
accounts receivable financing program, revolving credit facility
or other financing sources.
The increase in cash flows from operating activities from 2005
to 2006 resulted from favorable changes in Accrued
liabilities and Accounts payable partially offset by
unfavorable changes in Inventories and various other
assets and liabilities accounts. The change noted in Accrued
liabilities was primarily due to increases in salary and
incentive compensation accruals and related payments of
$67 million, favorable changes in derivative liabilities of
$42 million and increases in restructuring related accruals
of $28 million compared to the prior year. Accounts
payable balances can fluctuate significantly between periods
due to the timing of payments to suppliers. The Company’s
days of inventory increased from 44 days at
December 31, 2005, to 46 days at December 31,
2006, primarily due to increased supplies inventory. The change
noted in the Other assets and liabilities line item in
2006 on the Consolidated Statements of Cash Flows was primarily
attributable to changes in various income tax-related accounts
from 2005. Although not a significant component of the change in
cash flows from operating activities, the Company’s days of
sales outstanding were 35 days at December 31, 2006,
compared to 39 days at December 31, 2005.
The decrease in cash flows from operating activities from 2004
to 2005 was primarily due to decreased earnings. The cash flow
changes in working capital accounts were principally due to the
Company’s continued focus on cash cycle management and
timing of payments. Trade receivables decreased from 2004
as December 2005 sales were lower than the prior year. The
Company’s days of sales outstanding were 39 days at
December 31, 2005, up slightly from 38 days at
December 31, 2004. The Company’s days of inventory
decreased from 47 days at December 31, 2004, to
44 days at December 31, 2005, due to the
Company’s continued focus on inventory management.
Accounts payable decreased from 2004 primarily due to the
timing of payments to suppliers. The changes noted in the
Accrued liabilities and Other assets and liabilities
line items in 2005 were primarily attributable to decreases
in the Company’s derivative liabilities, decreases in
compensation accruals and changes in various income tax-related
accounts from 2004.
The days of sales outstanding is calculated on a three-month
moving average based on gross accounts receivable, net of
allowances for doubtful accounts and product returns, and is
adjusted for certain accounts receivable items which have no
corresponding revenue, such as value-added taxes. The days of
inventory is calculated on a three-month moving average based on
annualized cost of goods sold excluding any restructuring
related charges and project costs. The days of sales outstanding
and days of inventory calculations are non-GAAP measures and
based on internal definitions and may not be comparable to other
companies’ calculations.
Cash flows from operations were reduced during 2006, 2005 and
2004 by $4 million, $3 million and $53 million,
respectively, due to contributions to the Company’s defined
benefit pension plans. See Part II, Item 8,
Note 14 of the Notes to Consolidated Financial Statements
for more information regarding the Company pension and other
postretirement plans.
In connection with the 2006 restructuring, the remaining accrued
liability balance at December 31, 2006, of
$30.1 million, is expected to be substantially paid out by
the end of 2007. These payments will relate primarily to
employee termination benefits.
As of December 31, 2006, the Company had accrued
approximately $98 million for pending copyright fee issues,
including litigation proceedings, local legislative initiatives
and/or
negotiations with the parties involved. These accruals are
included in Accrued liabilities on the Consolidated
Statements of Financial Position. Refer to Part II,
Item 8, Note 16 of the Notes to Consolidated Financial
Statements for additional information.
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The Company began investing in marketable securities during the
third quarter of 2003, which resulted in a net use of cash of
$490 million in 2004. The Company decreased its marketable
securities investments in 2005 by $220 million and by
$315 million in 2006 due to its share repurchase program
activity. Refer to the section, Stock Repurchase, which follows
for further discussion of the Company’s stock repurchase
program during 2006.
The Company spent $200 million, $201 million and
$198 million on capital expenditures during 2006, 2005 and
2004, respectively. The capital expenditures in 2006 were
related to new product development, infrastructure support and
manufacturing capacity expansion.
The fluctuations in the net cash flows from financing activities
were principally due to the Company’s share repurchase
activity. The Company repurchased $0.9 billion,
$1.1 billion and $0.3 billion of treasury stock during
2006, 2005 and 2004, respectively.
Effective January 20, 2005, Lexmark entered into a
$300 million
5-year
senior, unsecured, multi-currency revolving credit facility with
a group of banks. Upon entering into the credit agreement, the
Company terminated the prior $300 million unsecured,
revolving credit facility that was due to expire on May 29,
2005. There were no amounts outstanding under the prior facility
upon its termination. Under the credit facility, the Company may
borrow in dollars, euros, British pounds sterling and Japanese
yen. Under certain circumstances, the aggregate amount available
under the facility may be increased to a maximum of
$500 million. As of December 31, 2006 and 2005, there
were no amounts outstanding under the credit facility.
Lexmark’s credit agreement contains usual and customary
default provisions, leverage and interest coverage restrictions
and certain restrictions on secured and subsidiary debt,
disposition of assets, liens and mergers and acquisitions. The
$300 million credit facility has a maturity date of
January 20, 2010.
Interest on all borrowings under the facility depends upon the
type of loan, namely alternative base rate loans, swingline
loans or eurocurrency loans. Alternative base rate loans bear
interest at the greater of the prime rate or the federal funds
rate plus one-half of one percent. Swingline loans (limited to
$50 million) bear interest at an agreed upon rate at the
time of the borrowing. Eurocurrency loans bear interest at the
sum of (i) a London Interbank Offered Rate
(“LIBOR”) for the applicable currency and interest
period and (ii) an interest rate spread based upon the
Company’s debt ratings ranging from 0.18% to 0.80%. In
addition, Lexmark is required to pay a facility fee on the
$300 million line of credit of 0.07% to 0.20% based upon
the Company’s debt ratings. The interest and facility fees
are payable at least quarterly.
Lexmark has outstanding $150.0 million principal amount of
6.75% senior notes due May 15, 2008, which was
initially priced at 98.998%, to yield 6.89% to maturity. A
balance of $149.8 million (net of unamortized discount of
$0.2 million) was outstanding at December 31, 2006. At
December 31, 2005, the balance was $149.6 million (net
of unamortized discount of $0.4 million). The senior notes
contain typical restrictions on liens, sale leaseback
transactions, mergers and sales of assets. There are no sinking
fund requirements on the senior notes and they may be redeemed
at any time at the option of the Company, at a redemption price
as described in the related indenture agreement, as supplemented
and amended, in whole or in part.
During October 2003, the Company entered into interest rate swap
contracts to convert its $150.0 million principal amount of
6.75% senior notes from a fixed interest rate to a variable
interest rate. Interest rate swaps with a notional amount of
$150.0 million were executed whereby the Company will
receive interest at a fixed rate of 6.75% and pay interest at a
variable rate of approximately 2.76% above the six-month
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LIBOR. These interest rate swaps have a maturity date of
May 15, 2008, which is equivalent to the maturity date of
the senior notes.
The Company is in compliance with all covenants and other
requirements set forth in its debt agreements. The Company does
not have any rating downgrade triggers that would accelerate the
maturity dates of its revolving credit facility and public debt.
However, a downgrade in the Company’s credit rating could
adversely affect the Company’s ability to renew existing,
or obtain access to new, credit facilities in the future and
could increase the cost of such facilities.
The following table summarizes the Company’s contractual
obligations at December 31, 2006:
Purchase obligations reported in the table above include
agreements to purchase goods or services that are enforceable
and legally binding on the Company and that specify all
significant terms, including: fixed or minimum quantities to be
purchased; fixed, minimum or variable price provisions; and the
approximate timing of the transaction.
The Company’s funding policy for its pension plans is to
fund minimum amounts according to the regulatory requirements
under which the plans operate. From time to time, the Company
may choose to fund amounts in excess of the minimum for various
reasons. The annual funding of pension obligations are not
expected to be material and are not shown above.
In October 2004, the Company entered into an amended and
restated agreement to sell a portion of its trade receivables on
a limited recourse basis. The amended agreement allows for a
maximum capital availability of $200 million under this
facility. The primary purpose of the amendment was to extend the
term of the facility to October 16, 2007, with required
annual renewal of commitments in October 2005 and 2006. In
October 2006, the facility was renewed until October 5,
2007.
This facility contains customary affirmative and negative
covenants as well as specific provisions related to the quality
of the accounts receivables sold. As collections reduce
previously sold receivables, the Company may replenish these
with new receivables. Lexmark bears a limited risk of bad debt
losses on the trade receivables sold, since the Company
over-collateralizes the receivables sold with additional
eligible receivables. Lexmark addresses this risk of loss in its
allowance for doubtful accounts. Receivables sold 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 sell trade receivables. A downgrade in the
Company’s credit rating could reduce the Company’s
ability to sell trade receivables. At December 31, 2006 and
2005, there were no trade receivables outstanding under the
facility.
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At December 31, 2006 and 2005, the Company did not have any
off-balance sheet arrangements. The Company maintains a facility
whereby it may sell trade receivables to an unrelated third
party as discussed above.
In January 2006, the Company received authorization from the
board of directors to repurchase an additional $1.0 billion
of its Class A Common Stock for a total repurchase
authority of $3.9 billion. As of December 31, 2006,
there was approximately $0.5 billion of share repurchase
authority remaining. This repurchase authority allows the
Company, at management’s discretion, to selectively
repurchase its stock from time to time in the open market or in
privately negotiated transactions depending upon market price
and other factors. During 2006, the Company repurchased
approximately 16.5 million shares at a cost of
approximately $0.9 billion. As of December 31, 2006,
since the inception of the program in April 1996, the Company
had repurchased approximately 71.4 million shares for an
aggregate cost of approximately $3.4 billion. As of
December 31, 2006, the Company had reissued approximately
0.5 million shares of previously repurchased shares in
connection with certain of its employee benefit programs. As a
result of these issuances as well as the retirement of
44.0 million and 16.0 million shares of treasury stock
in 2005 and 2006, respectively, the net treasury shares
outstanding at December 31, 2006, were 10.9 million.
On December 20, 2005 and October 26, 2006, the Company
received authorization from the board of directors to retire
44.0 million and 16.0 million shares, respectively, of
the Company’s Class A Common Stock currently held in
the Company’s treasury as treasury stock. The retired
shares resumed the status of authorized but unissued shares of
Class A Common Stock. Refer to the Consolidated Statements
of Stockholders’ Equity and Comprehensive Earnings for the
effects on Common stock, Capital in excess of par,
Retained earnings and Treasury stock from the
retirement of the 44.0 million shares of Class A
Common Stock in 2005 and 16.0 million shares of
Class A Common Stock in 2006.
Capital expenditures totaled $200 million,
$201 million and $198 million in 2006, 2005 and 2004,
respectively. The capital expenditures in 2006 were attributable
to new product development, infrastructure support and
manufacturing capacity expansion. During 2007, the Company
expects capital expenditures to be approximately
$235 million, primarily attributable to new product
development, infrastructure support and manufacturing capacity
expansion. The capital expenditures are expected to be funded
through cash from operations.
Revenue derived from international sales, including exports from
the U.S., accounts for approximately 56% of the Company’s
consolidated revenue, with Europe accounting for approximately
two-thirds of international sales. Substantially all foreign
subsidiaries maintain their accounting records in their local
currencies. Consequently,
period-to-period
comparability of results of operations is affected by
fluctuations in currency exchange rates. Certain of the
Company’s Latin American and European entities use the
U.S. dollar as their functional currency.
Currency exchange rates have had less of an impact on
international revenue in recent years. In 2006 and 2005,
currency exchange rates did not have a material impact on
operating income, while the 2004 operating income was materially
positively affected by exchange rate fluctuations. The Company
acts to neutralize the effects of exchange rate fluctuations
through the use of operational hedges, such as pricing actions
and product sourcing decisions.
The Company’s exposure to exchange rate fluctuations
generally cannot be minimized solely through the use of
operational hedges. Therefore, the Company utilizes financial
instruments such as forward exchange contracts and currency
options to reduce the impact of exchange rate fluctuations on
actual
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and anticipated cash flow exposures and certain assets and
liabilities, which arise from transactions denominated in
currencies other than the functional currency. The Company does
not purchase currency-related financial instruments for purposes
other than exchange rate risk management.
In November 2004, the FASB issued SFAS No. 151,
Inventory Costs, an amendment of ARB No. 43,
Chapter 4 (“SFAS 151”). SFAS 151
amends the guidance in Accounting Research
Bulletin No. 43 (“ARB 43”), Chapter 4,
Inventory Pricing, to clarify the accounting for abnormal
amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage). Paragraph 5 of ARB 43,
Chapter 4, previously stated that
“. . .under some circumstances, items such as
idle facility expense, excessive spoilage, double freight, and
rehandling costs may be so abnormal as to require treatment as
current period charges. . .”. SFAS 151
requires that those items be recognized as current period
charges regardless of whether they meet the criterion of
“so abnormal”. In addition, SFAS 151 requires
that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production
facilities. The adoption of SFAS 151, effective
January 1, 2006, did not have a material impact on the
Company’s financial position, results of operations and
cash flows.
In December 2004, the FASB issued SFAS 123R. SFAS 123R
requires that all share-based payments to employees, including
grants of stock options, be recognized in the financial
statements based on their fair value. Refer to Note 3 of
the Notes to the Consolidated Financial Statements for further
discussion.
In September 2005, the FASB reached a final consensus on
Emerging Issues Task Force (“EITF”) Issue
No. 04-13,
Accounting for Purchases and Sales of Inventory with the Same
Counterparty (“EITF
04-13”).
EITF 04-13
concludes that two or more legally separate exchange
transactions with the same counterparty should be combined and
considered as a single arrangement for purposes of applying APB
Opinion No. 29, Accounting for Nonmonetary
Transactions, when the transactions were entered into
“in contemplation” of one another. The consensus
contains several indicators to be considered in assessing
whether two transactions are entered into in contemplation of
one another. If, based on consideration of the indicators and
the substance of the arrangement, two transactions are combined
and considered a single arrangement, an exchange of finished
goods inventory for either raw material or
work-in-process
should be accounted for at fair value. The provisions of EITF
04-13 should
be applied to transactions completed in reporting periods
beginning after March 15, 2006. The adoption of EITF
04-13,
effective April 1, 2006, did not have a material impact on
the Company’s financial position, results of operations and
cash flows.
In October 2005, the FASB issued Staff Position
(“FSP”)
No. FAS 13-1,
Accounting for Rental Costs Incurred during a Construction
Period (“FSP
13-1”).
FSP 13-1 was
issued to address the accounting for rental costs associated
with ground or building operating leases that are incurred
during a construction period. FSP
13-1
concludes that these rental costs shall be recognized as rental
expense and included in income from continuing operations. The
guidance in FSP
13-1 shall
be applied to the first reporting period beginning after
December 15, 2005. The adoption of FSP
13-1,
effective January 1, 2006, did not have a material impact
on the Company’s financial position, results of operations
and cash flows.
In November 2005, the FASB issued FSP
No. FAS 115-1
and
FAS 124-1,
The Meaning of
Other-Than-Temporary
Impairment and Its Application to Certain Investments
(collectively referred to as “FSP
115-1”).
FSP 115-1
provides guidance on determining when investments in certain
debt and equity securities are considered impaired, whether that
impairment is
other-than-temporary,
and on measuring such impairment loss. FSP
115-1 also
includes accounting considerations subsequent to the recognition
of an
other-than-temporary
impairment and requires certain disclosures about unrealized
losses that have not been recognized as
other-than-temporary
impairments. FSP
115-1 is
required to be applied to reporting periods beginning after
December 15, 2005. The adoption of FSP
115-1,
effective January 1, 2006, did not have a material impact
on the Company’s financial position, results of operations
and cash flows.
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In June 2006, the FASB ratified the consensus reached by the
EITF on Issue
No. 06-3,
How Taxes Collected from Customers and Remitted to
Governmental Authorities Should Be Presented in the Income
Statement (That Is, Gross versus Net Presentation)
(“EITF
06-3”).
EITF 06-3
includes any tax assessed by a governmental authority that is
directly imposed on a revenue-producing transaction between a
seller and a customer and may include, but is not limited to,
sales, use, value added, and some excise taxes. EITF
06-3
concludes that the presentation of taxes on either a gross
(included in revenues and costs) or a net (excluded from
revenues) basis is an accounting policy decision that should be
disclosed. In addition, for any such taxes that are reported on
a gross basis, a company should disclose the amounts of those
taxes in interim and annual financial statements for each period
for which an income statement is presented if those amounts are
significant. The provisions of EITF
06-3 should
be applied to financial reports for interim and annual reporting
periods beginning after December 15, 2006, with earlier
adoption permitted. The provisions of EITF
06-3 will
not impact the Company’s financial position, results of
operations and cash flows upon adoption.
In July 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes
(“FIN 48”). FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with FASB
Statement No. 109, Accounting for Income
Taxes. FIN 48 prescribes a recognition
threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected
to be taken in a tax return. FIN 48 also provides guidance
on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure, and transition.
FIN 48 is effective for fiscal years beginning after
December 15, 2006, with earlier adoption permitted. The
Company has not completed its evaluation of FIN 48 but
estimates the cumulative effect to be an increase to retained
earnings in the range of $0 to $20 million.
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements (“SFAS 157”).
SFAS 157 defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles
(“GAAP”) and expands disclosures about fair value
measurements. SFAS 157 applies under other accounting
pronouncements that require or permit fair value measurements,
the FASB having previously concluded in those accounting
pronouncements that fair value is the relevant measurement
attribute. Accordingly, SFAS 157 does not require any new
fair value measurements. SFAS 157 is effective for fiscal
years beginning after November 15, 2007, and interim
periods within those fiscal years, with earlier adoption
permitted. The provisions of SFAS 157 should be applied
prospectively as of the beginning of the fiscal year in which it
is initially applied, with limited exceptions. The Company is
currently evaluating the provisions of SFAS 157.
In September 2006, the SEC issued Staff Accounting
Bulletin No. 108, Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current
Year Financial Statements (“SAB 108”)
expressing the Staff’s views regarding the process of
quantifying financial statement misstatements. There have been
two widely-recognized methods for quantifying the effects of
financial statement errors: the “rollover” method and
the “iron curtain” method. The rollover method focuses
primarily on the impact of a misstatement on the income
statement, including the reversing effect of prior year
misstatements, but its use can lead to the accumulation of
misstatements in the balance sheet. The iron curtain method, on
the other hand, focuses primarily on the effect of correcting
the period-end balance sheet with less emphasis on the reversing
effects of prior year errors on the income statement.
SAB 108 establishes an approach that requires
quantification of financial statement errors based on the
effects of the error on each of the entity’s financial
statements and the related financial statement disclosures. This
model is commonly referred to as a “dual approach”
because it essentially requires quantification of errors under
both the iron curtain and the rollover methods. The provisions
of SAB 108 are applicable to annual financial statements
covering the first fiscal year ending after November 15,
2006. The adoption of SAB 108 did not have an impact on the
Company’s financial position, results of operations and
cash flows.
In September 2006, the FASB issued SFAS No. 158,
Employers’ Accounting for Defined Benefit Pension and
Other Postretirement Plans, an amendment of FASB Statements
No. 87, 88, 106, and 132(R)
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(“SFAS 158”). SFAS 158 requires an employer
that is a business entity and sponsors one or more
single-employer defined benefit plans to:
An employer with publicly traded equity securities is required
to initially recognize the funded status of a defined benefit
postretirement plan and to provide the required disclosures as
of the end of the fiscal year ending after December 15,
2006. Retrospective application is not permitted. The adoption
of SFAS 158 did not have a material impact on the
Company’s results of operations and cash flows. Refer to
Part II, Item 8, Note 14 of the Notes to the
Consolidated Financial Statements for discussion of the impact
of adoption on the Company’s financial position.
In February 2007, the FASB issued SFAS No. 159, The
Fair Value Option for Financial Assets and Liabilities
(“SFAS 159”). SFAS 159 provides entities
with the option to report selected financial assets and
liabilities at fair value. Business entities adopting
SFAS 159 will report unrealized gains and losses in
earnings at each subsequent reporting date on items for which
the fair value option has been elected. SFAS 159
establishes presentation and disclosure requirements designed to
facilitate comparisons between entities that choose different
measurement attributes for similar types of assets and
liabilities. SFAS 159 requires additional information that
will help investors and other financial statement users to
understand the effect of an entity’s choice to use fair
value on its earnings. SFAS 159 is effective for fiscal
years beginning after November 15, 2007, with earlier
adoption permitted. The Company is currently evaluating the
impact of SFAS 159.
The Company is subject to the effects of changing prices and
operates in an industry where product prices are very
competitive and subject to downward price pressures. As a
result, future increases in production costs or raw material
prices could have an adverse effect on the Company’s
business. In an effort to minimize the impact on earnings of any
such increases, the Company must continually manage its product
costs and manufacturing processes.
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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.
At December 31, 2006, the fair value of the Company’s
senior notes was estimated at $152 million using quoted
market prices and yields obtained through independent pricing
sources for the same or similar types of borrowing arrangements,
taking into consideration the underlying terms of the debt. The
fair value of the senior notes exceeded the carrying value as
recorded in the Consolidated Statements of Financial Position at
December 31, 2006, by approximately $2 million. Market
risk is estimated as the potential change in fair value
resulting from a hypothetical 10% adverse change in interest
rates and amounts to approximately $1 million at
December 31, 2006.
The Company has interest rate swaps that serve as a fair value
hedge of the Company’s senior notes. The fair value of the
interest rate swaps at December 31, 2006, was a liability
of $2 million. Market risk for the interest rate swaps is
estimated as the potential change in fair value resulting from a
hypothetical 10% adverse change in interest rates and amounts to
approximately $1 million at December 31, 2006.
The Company employs a foreign currency hedging strategy to limit
potential losses in earnings or cash flows from adverse foreign
currency exchange rate movements. Foreign currency exposures
arise from transactions denominated in a currency other than the
Company’s functional currency and from foreign denominated
revenue and profit translated into U.S. dollars. The
primary currencies to which the Company is exposed include the
euro, the Mexican peso, the Canadian dollar, the British pound,
the Australian dollar and other Asian and South American
currencies. Exposures are hedged with foreign currency forward
contracts, put options, and call options generally with maturity
dates of twelve months or less. The potential loss in fair value
at December 31, 2006, for such contracts resulting from a
hypothetical 10% adverse change in all foreign currency exchange
rates is approximately $29 million. This loss would be
mitigated by corresponding gains on the underlying exposures.
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Lexmark
International, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF EARNINGS For the years ended December 31, 2006, 2005 and 2004 (In Millions, Except Per Share Amounts)
See notes to consolidated financial statements.
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Lexmark
International, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION As of December 31, 2006 and 2005 (In Millions)
See notes to consolidated financial statements.
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Lexmark
International, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended December 31, 2006, 2005 and 2004 (In Millions)
See notes to consolidated financial statements.
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Lexmark
International, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE EARNINGS
For the years ended December 31, 2006, 2005 and 2004
(In Millions)
See notes to consolidated financial statements.
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Lexmark
International, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Millions, Except Per Share Amounts)
Since its inception in 1991, Lexmark International, Inc.
(“Lexmark” or the “Company”) has become a
leading developer, manufacturer and supplier of printing and
imaging solutions for offices and homes. The Company’s
products include laser printers, inkjet printers, multifunction
devices, and associated supplies, services and solutions.
Lexmark also sells dot matrix printers for printing single and
multi-part forms by business users and develops, manufactures
and markets a line of other office imaging products. The
principal customers for Lexmark’s products are resellers,
retailers and distributors worldwide. The Company’s
products are sold in more than 150 countries in North and South
America, Europe, the Middle East, Africa, Asia, the Pacific Rim
and the Caribbean.
The accompanying consolidated financial statements include the
accounts of the Company and its subsidiaries. All significant
intercompany accounts and transactions have been eliminated.
The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the
United States of America (“U.S.”) requires management
to make estimates and judgments that affect the reported amounts
of assets, liabilities, revenue and expenses, and related
disclosure of contingent assets and liabilities. On an ongoing
basis, the Company evaluates its estimates, including those
related to customer programs and incentives, product returns,
doubtful accounts, inventories, stock-based compensation,
intangible assets, income taxes, warranty obligations, copyright
fees, restructurings, pension and other postretirement benefits,
and contingencies and litigation. Lexmark bases its estimates on
historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
Assets and liabilities of
non-U.S. subsidiaries
that operate in a local currency environment are translated into
U.S. dollars at period-end exchange rates. Income and
expense accounts are translated at average exchange rates
prevailing during the period. Adjustments arising from the
translation of assets and liabilities are accumulated as a
separate component of Accumulated other comprehensive
earnings (loss) in stockholders’ equity.
All highly liquid investments with an original maturity of three
months or less at the Company’s date of purchase are
considered to be cash equivalents.
Based on the Company’s expected holding period, Lexmark has
classified all of its marketable securities as
available-for-sale
and reported these investments in the Consolidated Statements of
Financial Position as current assets. Lexmark reports its
available-for-sale
marketable securities at fair value with unrealized gains or
losses recorded in Accumulated other comprehensive earnings
(loss) on the Consolidated Statements of Financial Position.
The Company assesses its marketable securities for
other-than-
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temporary declines in value by considering various factors that
include, among other things, any events that may affect the
creditworthiness of a security’s issuer, the length of time
the security has been in a loss position and the Company’s
ability and intent to hold the security until a forecasted
recovery of fair value that may include holding the security to
maturity. Realized gains or losses are included in net earnings
and are derived using the specific identification method for
determining the cost of the securities.
Lexmark maintains allowances for doubtful accounts for estimated
losses resulting from the inability of its customers to make
required payments. The Company estimates the allowance for
doubtful accounts based on a variety of factors including the
length of time receivables are past due, the financial health of
its customers, unusual macroeconomic conditions and historical
experience. If the financial condition of its customers
deteriorates or other circumstances occur that result in an
impairment of customers’ ability to make payments, the
Company records additional allowances as needed.
The financial instruments of the Company consist mainly of cash
and cash equivalents, marketable securities, trade receivables,
short-term debt, long-term debt and derivatives. The fair value
of cash and cash equivalents, trade receivables and short-term
debt approximates their carrying values due to the relatively
short-term nature of the instruments. The fair value of
Lexmark’s marketable securities are based on quoted market
prices, or in some cases, the Company’s amortized cost,
which approximates fair value due to the frequent resetting of
interest rates resulting in repricing of the investments. The
fair value of long-term debt is estimated based on current rates
available to the Company for debt with similar characteristics.
The fair value of derivative financial instruments is based on
pricing models or formulas using current market data, or where
applicable, quoted market prices.
Inventories are stated at the lower of average cost or market.
The Company considers all raw materials to be in production upon
their receipt.
Lexmark writes down its inventory for estimated obsolescence or
unmarketable inventory equal to the difference between the cost
of inventory and the estimated market value. The Company
estimates the difference between the cost of obsolete or
unmarketable inventory and its market value based upon product
demand requirements, product life cycle, product pricing and
quality issues. Also, Lexmark records an adverse purchase
commitment liability when anticipated market sales prices are
lower than committed costs.
Property, plant and equipment are stated at cost and depreciated
over their estimated useful lives using the straight-line
method. Property, plant and equipment accounts are relieved of
the cost and related accumulated depreciation when assets are
disposed of or otherwise retired.
Lexmark capitalizes direct costs incurred during the application
development and implementation stages for developing,
purchasing, or otherwise acquiring software for internal use.
These software costs are included in Property, plant and
equipment, net, on the Consolidated Statements of Financial
Position and are depreciated over the estimated useful life of
the software, generally three to five years. All costs incurred
during the preliminary project stage are expensed as incurred.
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Lexmark annually reviews its goodwill for impairment and
currently does not have any indefinite-lived intangible assets.
The Company’s goodwill and intangible assets are
immaterial, and therefore are not separately presented in the
Consolidated Statements of Financial Position.
Lexmark performs reviews for the impairment of long-lived assets
whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. An
impairment loss is recognized when estimated undiscounted future
cash flows expected to result from the use of the asset and its
eventual disposition are less than its carrying amount. If
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