OVERVIEW

Lexmark makes it easier for customers to move information between the digital and paper worlds. Since its inception in 1991, Lexmark has become a leading developer, manufacturer and supplier of printing and imaging solutions for the office. Lexmark's products include laser printers, inkjet printers, multifunction devices, dot matrix printers and associated supplies, services and solutions.

The Company is primarily managed along divisional lines: the Printing Solutions and Services Division ("PSSD") and the Imaging Solutions Division ("ISD").

• The Printing Solutions and Services Division primarily sells laser products and primarily serves business customers. 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 financial services, retail, manufacturing, education, government and health care. Lexmark also markets its laser and inkjet products 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 Imaging Solutions Division predominantly sells inkjet products to a range of customers, including small office home office ("SOHO") users, professionals and consumers who are heavy users, as well as business users who may choose inkjet products as a lower-priced alternative or supplement to laser products. The Imaging Solutions Division also sells select laser products in certain geographies to SOHO and business users that purchase products through retail channels. Additionally, over the past couple of years, the number of customers 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 wireless connectivity, full fax capabilities, automatic document feeders and duplex capabilities. Lexmark distributes its branded inkjet products and supplies through retail outlets as well as distributors and resellers worldwide. Lexmark's sales and marketing activities are organized to meet the needs of the various geographies and the size of their markets.

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements.

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 guidance for fair value measurements. This guidance 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, this guidance establishes a hierarchy of inputs to valuation techniques used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.

The three levels of the fair value hierarchy are:

· 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.

The Company utilizes observable market data, when available, to determine fair value. However, in certain situations, there may be little or no market data available at the measurement date thus requiring the use of significant unobservable inputs. To the extent that a valuation is based on models, inputs or assumptions that are less observable in the market, the determination of fair value requires more judgment. Such measurements are generally classified as Level 3 within the fair value hierarchy.

Uncertainty in the capital markets has presented additional challenges with respect to valuing marketable securities and pension plan assets in which the Company is invested. Because of the general decline in trading activity for some investments, the Company implemented additional steps beginning in the third quarter of 2008 to assess whether or not the pricing information it received was reasonably up to date as well as understand the nature of quotes used in the valuation of certain securities. In the case of auction rate securities in which auctions were unsuccessful, observable pricing data was not available resulting in the Company performing a discounted cash flow analysis based on assumptions that it believes market participants would use with regard to such items as expected cash flows and discount rates adjusted for illiquidity premiums. In determining where measurements lie in the fair value hierarchy, the Company uses assumptions regarding the general characteristics of each type of security as the starting point. The Company then downgrades individual securities to a lower level as necessary based on specific facts and circumstances.

In February 2008, the FASB issued guidance that deferred the effective date of the guidance on fair value measurements 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 this guidance, the Company only partially applied the provisions of the fair value measurement guidance during 2008. Effective January 1, 2009, the Company began applying the valuation concepts of the fair value measurements guidance to its nonrecurring, nonfinancial fair value measurements, including the maximization of observable inputs as well as the consideration of market participant assumptions such as highest and best use of an asset. These

measurements are most often based on inputs or assumptions that are less observable in the market, thus requiring more judgment on the part of the Company in estimating fair value. Such measurements are generally classified as Level 3 within the fair value hierarchy.

In April 2009, the FASB issued guidance for determining fair value when the volume and level of activity for the asset or liability have significantly decreased and identifying transactions that are not orderly. Based on the available evidence, an entity should determine if there has been a significant decrease in the volume and level of activity as well as assess whether or not a transaction is orderly. The weight placed on a transaction price when estimating fair value is based on these determinations as well as the sufficiency of information available to make the determinations. The guidance reaffirms the need to use judgment when determining if a price is determinative of fair value, considering all facts and circumstances including the nature of a quote (binding offer or an indicative price), whether or not the price includes an appropriate risk premium that a market participant would demand, and considering the use of a different valuation technique or multiple valuation techniques. See Note 16 to the Consolidated Condensed Financial Statements in Item 1 for details regarding this guidance. In response to the guidance, the Company has added additional steps, starting in the second quarter of 2009, to its fair value practices described above with respect to the consensus pricing methodology used in the valuation of most of the securities in which it has invested. The Company has implemented more comprehensive procedures to review the number of pricing inputs received as well as the variability in the pricing data utilized in the overall valuation. For securities in which the number of pricing inputs used is less than expected or there is significant variability in the pricing inputs, the Company has tested that the final consensus price is within a reasonable range of fair value through corroboration with other sources of price data. See Note 2 to the Consolidated Condensed Financial Statements in Item 1 for more information regarding the Company's fair value measurements.

Other-Than-Temporary Impairment - Marketable Securities

The Company records its investments in marketable securities at fair value through accumulated other comprehensive earnings using the valuation practices discussed in the previous section. Once these investments have been marked to market, the Company must assess whether or not its individual unrealized loss positions contain other-than-temporary impairment ("OTTI"). If an unrealized position is deemed OTTI, then the unrealized loss, or a portion thereof, must be recognized in earnings. The Company's portfolio is made up almost entirely of debt securities for which OTTI must be recognized in accordance with the FASB OTTI guidance effective in the second quarter of 2009. The model in this guidance requires that an entity recognize OTTI in earnings for the entire unrealized loss position if the entity intends to sell or it is more likely than not the entity will be required to sell the debt security before its anticipated recovery of its amortized cost basis. If the entity does not expect to sell the debt security, but the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss is deemed to exist and OTTI shall be considered to have occurred. However, in this case, the OTTI is separated into two components, the amount representing the credit loss which is recognized in earnings and the amount related to all other factors which is recognized in other comprehensive income under the new guidance. See Note 16 to the Consolidated Condensed Financial Statements in Item 1 for more details regarding this guidance. The Company's policy considers various factors in making these two assessments.

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

· The Company's current cash flow projections,

· Other sources of funds available to the Company such as borrowing lines,

· The value of the security relative to the Company's overall cash position,

· The length of time remaining until the security matures, and

· The potential that the security will need to be sold to raise capital.

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

· The regulatory and economic environment.

· The sector, industry and geography in which the issuer operates.

· Forecasts about the issuer's financial performance and near-term prospects, such as earnings trends and analysts' or industry specialists' forecasts.

· Failure of the issuer to make scheduled interest or principal payments.

· Material recoveries or declines in fair value subsequent to the balance sheet date.

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

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

See Note 5 to the Consolidated Condensed Financial Statements in Item 1 for more information regarding the Company's marketable securities.

Summary

Management believes that other than the adoption of the fair value measurements guidance for its nonrecurring, nonfinancial fair value measurements, the additional steps taken with respect to new accounting guidance for inactive market transactions and the pricing of its marketable securities, and the change in practice for recognizing other-than-temporary impairment under the guidance provided by the FASB, there have been no other significant changes 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, 2008.

RESULTS OF OPERATIONS

Operations Overview

Key Messages

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

· The PSSD strategy is primarily focused on capturing profitable supplies and service annuities generated from workgroup monochrome and color laser printers and laser multifunction products ("MFPs").

· The ISD strategy is to build a profitable, growing and sustainable inkjet business with good margins and returns derived from a more productive and higher page generating installed base of products and solutions that serve SOHO and SMB users.

Lexmark continues to take actions to improve its cost and expense structure including continuing to implement restructuring activities of its business to lower its cost and better allow it to fund these strategic initiatives.

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

Business Factors

The weakening of the global economy continued to impact the revenue in both of the Company's segments during the third quarter and nine months ended September 30, 2009. Lexmark continues to take actions to reduce cost and expenses worldwide and improve the efficiency of the Company's manufacturing operations and, as a result, the Company announced additional restructuring actions in October 2009. See "Restructuring and Related Charges and Project Costs" that follows for further discussion.

PSSD

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

The primary focus of PSSD is to drive long term shareholder value through workgroup laser growth and page generation. The key strategic initiatives are:

· Expand and strengthen the Company's product line of workgroup color laser and laser MFP devices;

· Advance and strengthen the Company's industry solutions and workflow capabilities to maintain and grow the Company's penetration in selected industries;

· Advance and grow the Company's managed print services business;

· Drive growth in color laser and laser MFP products.

ISD

In 2007, the Company undertook a significant shift in ISD strategy in order to maximize long-term shareholder value.

Beginning in the second quarter of 2007, the Company experienced the following issues in ISD:

· 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:

· Reposition the existing inkjet technology to focus on higher usage customers, and start to shift the mix;

· Penetrate the channels that sell to higher usage customers;

· Advance our inkjet technology to better meet the needs of SMB customers; and

· Consolidate the inkjet integrated printhead supplies manufacturing facilities to lower costs and reduce capital requirements. See "Restructuring and Related Charges and Project Costs" that follows for further discussion of the Company's various restructuring activities.

These initiatives have yielded the following for the Company's ISD segment since 2007:

· The introduction of new products such as Lexmark's Professional Series as well as the introduction in September 2009 of inkjet AIOs (including new Web-connected touch screen AIOs) targeted for small and medium businesses;

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

· An improvement in the Company's retail presence in U.S. Office Super Stores.

The transition of the business from the low-end portion of the market to higher usage devices is continuing. Due to this transition and weakness in the OEM business, Lexmark is experiencing shrinkage in its installed base of inkjet products and an associated decline in end-user page generation. The Company sees the potential for continued near term erosion in end-user page generation and inkjet supplies demand due to the transition. However, by strengthening the Company's focus on the sales of higher end, higher page generating inkjet devices, the longer term objective is to ultimately stabilize and grow the supplies revenue based on a smaller installed base of higher page generating devices.

Operating Results Summary

The following discussion and analysis should be read in conjunction with the
Consolidated 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, 2009 and 2008:

                                  Three Months Ended September 30                           Nine Months Ended September 30
                                 2009                         2008                         2009                         2008
(Dollars in millions)   Dollars       % of Rev       Dollars       % of Rev       Dollars       % of Rev       Dollars       % of Rev
Revenue                 $  958.0          100.0 %   $ 1,130.7          100.0 %   $ 2,806.7          100.0 %   $ 3,444.7          100.0 %
Gross profit               312.9           32.7         367.7           32.5         927.1           33.0       1,220.4           35.4
Operating expense          288.9           30.1         313.7           27.7         800.8           28.5         943.2           27.4
Operating income            24.0            2.5          54.0            4.8         126.3            4.5         277.2            8.0
Net earnings                10.0            1.0          36.6            3.2          86.2            3.1         222.1            6.4

Current quarter

For the third quarter of 2009, total revenue was $958 million or down 15% from 2008. Laser and inkjet supplies revenue decreased 12% YTY and laser and inkjet hardware revenue decreased 24% YTY. In PSSD, revenue decreased 14% YTY while revenue in ISD decreased 18% YTY.

Net earnings for the third quarter of 2009 decreased 73% from the prior year primarily due to higher restructuring-related charges and project costs. Net earnings for the third quarter of 2009 included $50.8 million of pre-tax restructuring-related charges and project costs. Net earnings for the third quarter of 2008 included $24.5 million of pre-tax restructuring-related charges and project costs.

Year to date

For the nine months ended September 30, 2009, consolidated revenue was $2.8 billion or down 19% YTY. Laser and inkjet supplies revenue declined 15% YTY and laser and inkjet hardware revenue declined 28% YTY. In PSSD, revenue decreased 17% YTY while revenue in ISD decreased 21% YTY.

Net earnings for the nine months ended September 30, 2009 decreased 61% from the prior year primarily due to lower operating income and higher restructuring-related charges and project costs. Net earnings for the nine months ended September 30, 2009 included $95.4 million of pre-tax restructuring-related charges and project costs. Net

earnings for the nine months ended September 30, 2008 included $46.0 million of pre-tax restructuring-related project costs and non-recurring tax benefits of $11.9 million.

Revenue

For the third quarter of 2009, consolidated revenue decreased 15% YTY. Laser and inkjet supplies revenue declined 12% YTY due to lower volume and the negative impact of foreign currency exchange rates, partially offset by supplies price increases. Laser and inkjet hardware revenue declined 24% YTY primarily driven by unit declines, as well as price declines and the negative impact of foreign currency exchange rates.

For the nine months ended September 30, 2009, consolidated revenue decreased 19% YTY. Laser and inkjet supplies revenue declined 15% YTY due to lower volume and the negative impact of foreign currency exchange rates, partially offset by supplies price increases. Laser and inkjet hardware revenue declined 28% YTY primarily driven by unit declines, as well as the negative impact of foreign currency exchange rates and price declines.

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

                               Three Months Ended September 30                      Nine Months Ended September 30
(Dollars in millions)      2009               2008             % Change          2009              2008           % Change
PSSD                    $     654.4       $       759.6            (14 ) %   $    1,876.9       $  2,263.8            (17 ) %
ISD                           303.6               371.1            (18 )            929.8          1,180.9            (21 )
Total revenue           $     958.0       $     1,130.7            (15 ) %   $    2,806.7       $  3,444.7            (19 ) %

PSSD

During the third quarter of 2009, revenue in PSSD decreased $105 million or 14% compared to 2008 due to a 22% decline in hardware revenue as well as a decline in supplies revenue. The lower hardware revenue was primarily due to lower unit volumes. PSSD laser hardware unit shipments declined 22% YTY due to the weak economic environment. PSSD laser hardware average unit revenue ("AUR"), which reflects the changes in both pricing and mix, was about flat YTY.

. . .