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.

The Company is primarily managed along Business and Consumer market segments:

• The Business market segment primarily sells laser products and serves business customers but also includes consumers who choose laser products. Laser products can be divided into two major categories - shared workgroup products and lower-priced desktop products. Lexmark employs large-account sales and marketing teams, closely supported by its development and product marketing teams, to generate demand for its business printing solutions and services. The sales and marketing teams primarily focus on industries such as finance, education, retail, manufacturing, government and healthcare. Lexmark also markets its laser and inkjet products increasingly through small and medium business ("SMB") teams who work closely with channel partners. The Company distributes and fulfills its laser products primarily through its well-established distributor and reseller network. Lexmark's products are also sold through solution providers, which offer custom solutions to specific markets, and through direct response resellers.

• The Consumer market segment predominantly sells inkjet products to consumers, but also includes business users who may choose inkjet products as a lower-priced alternative or supplement to laser products for personal desktop use. Also, there is an increasing trend in inkjet products being designed for business purposes such as small office home office ("SOHO") and small business. Additionally, over the past couple years, the number of consumers seeking productivity-related features has driven significant growth in all-in-one ("AIO") products. For the consumer market, Lexmark distributes its branded inkjet products and supplies primarily through retail outlets worldwide. Lexmark's sales and marketing activities are organized to meet the needs of the various geographies and the size of their markets.

The Company also sells its products through numerous alliances and original equipment manufacturer ("OEM") arrangements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Lexmark's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated condensed financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of consolidated condensed financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to customer programs and incentives, product returns, doubtful accounts, inventories, stock-based compensation, intangible assets, income taxes, warranty obligations, copyright fees, restructurings, pension and other postretirement benefits, and contingencies and litigation. Lexmark bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Management believes that other than the partial adoption of SFAS No. 157, Fair Value Measurements ("FAS 157") during the first quarter of 2008, there have been no significant changes during the nine months ended September 30, 2008, to the items that were disclosed as critical accounting policies and estimates in Item
7. Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

Fair Value

The Company currently uses recurring fair value measurements in several areas including marketable securities, pension plan assets and derivatives. The Company uses fair value in measuring certain nonrecurring items as well, as instructed under existing authoritative accounting guidance.

In September 2006, the FASB issued FAS 157. FAS 157 defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. The standard defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As part of the framework for measuring fair value, FAS 157 establishes a hierarchy of inputs to valuation techniques used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.

The three levels of the fair value hierarchy under FAS 157 are:

· Level 1 -- Quoted prices (unadjusted) in active markets for identical, unrestricted assets or liabilities that the Company has the ability to access at the measurement date;

· Level 2 -- Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly; and

· Level 3 -- Unobservable inputs used in valuations in which there is little market activity for the asset or liability at the measurement date.

Fair value measurements of assets and liabilities are assigned a level within the fair value hierarchy based on the lowest level of any input that is significant to the fair value measurement in its entirety.

In February 2008, the FASB issued FASB Staff Position No. FAS 157-2 ("FSP FAS 157-2") which defers the effective date of FAS 157 to fiscal years beginning after November 15, 2008 for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. As permitted by FSP FAS 157-2, the Company has only partially applied the provisions of FAS 157 as of September 30, 2008. The Company is in the process of evaluating the inputs and techniques used in its nonrecurring, nonfinancial fair value measurements.

In October 2008, the FASB issued FASB Staff Position No. FAS 157-3 ("FSP FAS 157-3") Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active in response to the financial community's concerns about how to conduct fair value accounting in a time of significant market distress. The Company has considered the additional guidance with respect to the valuation of its marketable securities portfolio and the designation of its investments within the fair value hierarchy in the Company's third quarter 2008 financial statements and footnotes. Refer to Part I, Item 1, Note 15 of the Notes to Consolidated Condensed Financial Statements for additional information regarding FSP FAS 157-3.

The Company utilizes observable market data, when available, to determine fair value. However, in certain situations, there may be little or no market data available at the measurement date thus requiring the use of significant unobservable inputs. To the extent that a valuation is based on models, inputs or assumptions that are less observable in the market, the determination of fair value requires more judgment. Such measurements are generally

RESULTS OF OPERATIONS

Operations Overview

Key Messages

Lexmark is focused on driving long-term value by strategically investing in technology, demand generation and brand development to enable the Company to profitably capture supplies in high page growth segments of the distributed printing market.

• The Business market segment strategy is focused on growth in high page generating workgroup lasers, including monochrome, color and laser MFPs.

• The Company is aggressively shifting its focus in the Consumer market segment to geographic regions, product segments, and customers that generate high page usage. This strategy shift will increase the Company's focus on investments to better meet the needs of those customers and product segments.

Lexmark continues to take actions to improve certain portions of its manufacturing and business support cost and expense structure. These actions will better allow the Company to fund these strategic initiatives.

Lexmark continues to maintain a strong financial position with a long track record of good cash generation and a solid balance sheet, which positions it well to invest in the future and compete effectively, even during challenging times.

Business Factors

Business segment

During the third quarter of 2008, Lexmark continued its investments in new products and technology in the Business market segment. The Company expects these investments to produce a steady stream of new products.

The Company continued its investment in its managed print services and industry sales initiatives. Lexmark also made a significant investment in its enterprise sales force in 2007 to improve its coverage and expand the reach of its solutions and services proposition.

The primary focus of the Business market investments is to drive workgroup laser growth and page generation.

Consumer segment

Lexmark believes it is experiencing shrinkage in its installed base of inkjet products and an associated decline in end-user demand for inkjet supplies. The Company sees the potential for continued erosion in end-user inkjet supplies demand due to the reduction in inkjet hardware unit sales. The reduction in inkjet hardware unit sales reflects the Company's decision to focus on more profitable, higher usage printer placements and the weakness the Company is experiencing in its OEM business.

Beginning in the second quarter of 2007, the Company experienced the following issues in its Consumer segment:

· On-going declines in inkjet supplies and OEM unit sales;

· Lower average unit revenues due to aggressive pricing and promotion; and

· Additional costs in its new products.

As the Company analyzed the situation, it saw the following:

· Some of its unit sales were not generating adequate lifetime profitability due to lower prices, higher costs and supplies usage below its model;

· Some markets and channels were on the low-end of the supplies generation distribution curve; and

· Its business was too skewed to the low-end versus the market, resulting in lower supplies generation per unit.

As a result, Lexmark decided to take the following actions beginning in 2007:

· The Company decided to more aggressively shift its focus to geographic regions, market segments and customers that generate higher page usage.

· The Company continues working to minimize the unit sales that do not generate an acceptable profit over their life.

The above actions entail several initiatives, which were begun in 2007 and have continued through the current period:

· Shifting the Company's marketing focus and targeted customer segments to the heavier usage segments of student and professional users;

· Shifting the Company's investment in research and development to better design products and technology that will be attractive to these segments;

· Re-engineering the Company's supply chain to reduce costs and eliminate touches between the factory and the customers; and

· Working on supplies to lower cost and consolidate manufacturing capacity. In 2007, the Company announced a restructuring plan to reduce its cost and infrastructure, including the closure of one of its inkjet supplies manufacturing facilities in Mexico and additional optimization measures at the remaining inkjet facilities in Mexico and the Philippines. In July 2008, the Company announced a plan that will result in the closure of an additional inkjet supplies manufacturing facility in Mexico. See "RESTRUCTURING AND RELATED CHARGES (REVERSALS) AND PROJECT COSTS" that follows for further discussion.

These initiatives have yielded the following for the Company's Consumer segment:
· An improvement in the Company's inkjet AUR, despite an aggressive pricing environment;

· The introduction of new products such as Lexmark's Professional Series and its Home & Student Series; and

· An increasing amount of industry recognition and awards for its inkjet products.

Operating Results Summary

The following discussion and analysis should be read in conjunction with the
Consolidated Condensed Financial Statements and Notes thereto. The following
table summarizes the results of the Company's operations for the three and nine
months ended September 30, 2008 and 2007:

                                   Three Months Ended September 30                              Nine Months Ended September 30
                                  2008                          2007                          2008                          2007
(Dollars in millions)    Dollars       % of Rev        Dollars       % of Rev        Dollars       % of Rev        Dollars       % of Rev
Revenue                 $ 1,130.7            100  %   $ 1,195.4            100  %   $ 3,444.7            100  %   $ 3,664.2            100  %
Gross profit                367.7           32.5          332.6           27.8        1,220.4           35.4        1,125.6           30.7
Operating expense           313.7           27.7          312.1           26.1          943.2           27.4          918.4           25.1
Operating income             54.0            4.8           20.5            1.7          277.2            8.0          207.2            5.7
Net earnings                 36.6            3.2           45.2            3.8          222.1            6.4          201.8            5.5

For the third quarter of 2008, total revenue was $1.1 billion or down 5% from 2007. Laser and inkjet supplies revenue decreased 1% year-to-year ("YTY") and laser and inkjet hardware revenue decreased 14% YTY. In the Business segment, revenue increased 4% YTY while revenue in the Consumer segment decreased 21% YTY.

Net earnings for the third quarter of 2008 decreased 19% from the prior year primarily due to a benefit in the provision for income taxes in the third quarter of 2007 as compared to an expense in the provision for income taxes in the third quarter of 2008, partially offset by higher operating income. Net earnings for the third quarter of 2008 included $24.5 million of pre-tax restructuring-related charges and project costs. Net earnings for the third quarter of 2007 included $14.6 million of pre-tax restructuring-related charges and project costs and a one-time tax benefit of $13 million that contributed to the benefit in the provision for income taxes mentioned above.

Year to date

For the nine months ended September 30, 2008, consolidated revenue was $3.4 billion or down 6% YTY. Laser and inkjet supplies revenue declined 1% YTY and laser and inkjet hardware revenue declined 17% YTY. In the Business segment, revenue increased 3% YTY while revenue in the Consumer segment decreased 19% YTY.

Net earnings for the nine months ended September 30, 2008 increased 10% from the prior year primarily due to higher operating income partially offset by lower other non-operating income and higher provision for income taxes. Net earnings for the nine months ended September 30, 2008 included $46.0 million of pre-tax restructuring-related charges and project costs and non-recurring tax benefits of $11.9 million. Net earnings for the nine months ended September 30, 2007, included $25.4 million of restructuring-related charges and project costs, a $3.5 million gain on the sale of the Company's Scotland facility, an $8.1 million pre-tax foreign exchange gain realized upon the substantial liquidation of the Company's Scotland entity and one-time tax benefits of $19 million.

Revenue

For the third quarter of 2008, consolidated revenue decreased 5% YTY. Laser and inkjet supplies revenue declined 1% YTY as growth in laser supplies was offset by a decline in inkjet supplies. Laser and inkjet hardware revenue declined 14% YTY primarily driven by unit declines, particularly in inkjet units.

For the nine months ended September 30, 2008, consolidated revenue decreased 6% YTY. Laser and inkjet supplies revenue declined 1% YTY as growth in laser supplies was more than offset by a decline in inkjet supplies. Laser and inkjet hardware revenue declined 17% YTY primarily driven by the shift in inkjet strategy.

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

                              Three Months Ended September 30                   Nine Months Ended September 30
(Dollars in millions)       2008              2007          % Change          2008             2007          % Change
Business                $      759.6       $    727.7              4  %   $    2,263.8       $ 2,198.8              3  %
Consumer                       371.1            467.7           (21)           1,180.9         1,465.4           (19)
Total revenue           $    1,130.7       $  1,195.4            (5)  %   $    3,444.7       $ 3,664.2            (6)  %

Business segment

During the third quarter of 2008, revenue in the Business segment increased $32 million or 4% compared to 2007 primarily due to growth in laser supplies revenue. Laser hardware unit shipments declined 1% YTY. Laser hardware average unit revenue ("AUR"), which reflects the changes in both pricing and mix, increased 2% YTY as the negative impact of pricing was offset by currency and favorable product mix.

For the nine months ended September 30, 2008, Business segment revenue increased $65 million or 3% YTY primarily due to growth in laser supplies revenue partially offset by a decline in laser hardware revenue. Laser hardware unit shipments decreased 7% YTY while laser hardware AUR increased 2% YTY.

During the third quarter of 2008, revenue in the Consumer segment decreased $97 million or 21% compared to 2007 due to decreased inkjet hardware and supplies revenue. Hardware revenue declined YTY due to lower unit shipments partially offset by increased AURs. Inkjet hardware unit shipments declined 46% YTY principally due to the Company's decision to prioritize certain markets, segments and customers and to reduce or eliminate others. Units were also impacted by the Company's decision to focus on more profitable printer placements in every geography. Inkjet unit sales are being further impacted by market weakness in the U.S. and Europe and aggressive competitive pricing/promotion activities. In the U.S., inkjet unit sales are also being impacted by reduced shelf space as compared to the prior year. Inkjet hardware AUR increased 15% YTY as price declines were more than offset by a significantly improved mix reflecting a shift towards higher-end devices, as well as currency benefits.

For the nine months ended September 30, 2008, Consumer segment revenue decreased $284 million or 19% compared to 2007 due to decreased inkjet hardware and supplies revenue. Inkjet hardware unit shipments declined 46% YTY while inkjet hardware AUR increased 18% YTY.

Revenue by geography:

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

                               Three Months Ended September 30                   Nine Months Ended September 30
(Dollars in millions)       2008               2007         % Change           2008             2007         % Change
United States           $       493.5       $    526.0            (6)  %   $    1,413.7       $ 1,579.1           (10)  %
EMEA (Europe, the
Middle East & Africa)           402.4            424.8            (5)           1,312.2         1,352.4            (3)
Other International             234.8            244.6            (4)             718.8           732.7            (2)
Total revenue           $     1,130.7       $  1,195.4            (5)  %   $    3,444.7       $ 3,664.2            (6)  %

For the three and nine months ended September 30, 2008, revenue decreased in all geographies primarily due to the previously-mentioned decline in Consumer segment revenues.

Gross Profit

The following table provides gross profit information:

Three Months Ended September 30 Nine Months Ended September 30 (Dollars in millions) 2008 2007 Change 2008 2007 Change Gross profit dollars $ 367.7 $ 332.6 11 % $ 1,220.4 $ 1,125.6 8 % % of revenue 32.5 % 27.8 % 4.7 pts 35.4 % 30.7 % 4.7 pts

For the three and nine months ended September 30, 2008, consolidated gross profit and gross profit as a percentage of revenue increased YTY. The changes in the gross profit margin YTY for the three and nine months ended September 30, 2008 were primarily due to favorable mix shifts among products of 5.6 percentage points and 5.3 percentage points, respectively, primarily driven by the decline in inkjet hardware units and the increased laser supplies.

Gross profit for the three and nine months ended September 30, 2008, included $17.5 million and $27.3 million, respectively, of restructuring-related charges and project costs. Gross profit for the three and nine months ended September 30, 2007, included $4.1 million and $10.2 million, respectively, of restructuring-related charges and project costs. See "RESTRUCTURING AND RELATED CHARGES (REVERSALS) AND PROJECT COSTS" that follows for further discussion.

Operating Expense

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

                              Three Months Ended September 30                            Nine Months Ended September 30
                             2008                         2007                         2008                         2007
(Dollars in
millions)           Dollars       % of Rev       Dollars       % of Rev       Dollars       % of Rev       Dollars       % of Rev
Research and
development        $   109.9            9.7  %   $  101.2            8.5  %   $  318.3            9.2 %    $  303.3            8.3  %
Selling, general
& administrative       197.1           17.4         204.3           17.1         617.2           18.0         608.5           16.6
Restructuring
and related
charges                  6.7            0.6           6.6            0.5           7.7            0.2           6.6            0.2
Total operating
expense            $   313.7           27.7  %   $  312.1           26.1  %   $  943.2           27.4  %   $  918.4           25.1 %

For the three and nine months ended September 30, 2008, research and development increased YTY due to the Company's continued investment in technology to support product development. These continuing investments are primarily focused on new products aimed at targeted high page generation segments.

Selling, general and administrative ("SG&A") expenses for the three months ended September 30, 2008 decreased YTY due to lower general and administrative expenses, partially offset by increased spending on marketing and sales activities. SG&A expenses for the nine months ended September 30, 2008 increased YTY as the Company continued to increase spending on marketing and sales activities, partially offset by lower general and administrative expenses. Additionally, SG&A expenses for the three and nine months ended September 30, 2008 included $0.3 million and $11.0 million, respectively, of restructuring-related charges and project costs. SG&A expenses for the three and nine months ended September 30, 2007 included $3.9 million and $5.1 million, respectively, of net restructuring-related charges and project costs. See "RESTRUCTURING AND RELATED CHARGES (REVERSALS) AND PROJECT COSTS" that follows for further discussion.

Operating Income (Loss)

The following table provides operating income by market segment:

                       Three Months Ended September 30                     Nine Months Ended September 30
(Dollars in
millions)        2008           2007               Change            2008           2007              Change
Business      $    124.4      $   143.0            (13)   %       $    423.9      $   445.7             (5 )  %
% of
segment
revenue             16.4  %        19.7  %        (3.3)   pts           18.7  %        20.3  %        (1.6 )  pts

Consumer            16.5          (22.2 )           n/a   %            118.3           56.1            111    %
% of
segment
revenue              4.4  %        (4.7 ) %         n/a   pts           10.0  %         3.8  %         6.2    pts

All other          (86.9 )       (100.3 )            13   %             (265 )       (294.6 )           10    %
Total
operating
income
(loss)        $     54.0      $    20.5             164   %       $    277.2      $   207.2             34    %
% of total
revenue              4.8  %         1.7  %          3.1   pts            8.0  %         5.7  %         2.3    pts

For the three and nine months ended September 30, 2008, the increases in consolidated operating income were due to higher gross profit partially offset by higher operating expenses.

For the third quarter of 2008, Consumer segment operating income increased YTY due to higher gross profit resulting from a favorable product mix shift reflecting less hardware partially offset by less supplies revenue. For the nine . . .