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LXK > SEC Filings for LXK > Form 10-Q on 9-May-2013All Recent SEC Filings

Show all filings for LEXMARK INTERNATIONAL INC /KY/ | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for LEXMARK INTERNATIONAL INC /KY/


9-May-2013

Quarterly Report


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

LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

OVERVIEW

Lexmark makes it easier for businesses of all sizes to improve their business processes by enabling them to capture, manage and access critical unstructured business information in the context of their business process while speeding the movement and management of information between the paper and digital worlds. Since its inception in 1991, Lexmark has become a leading developer, manufacturer and supplier of printing, imaging, device management, managed print services, document workflow, and more recently business process and content management solutions. The Company operates in the office printing and imaging, and ECM, BPM, DOM, intelligent data capture and search software markets. Lexmark's products include laser printers and multifunction devices, dot matrix printers and the associated supplies/solutions/services, as well as ECM, BPM, DOM, intelligent data capture, search and the associated workflow software solutions and services.

The Company is primarily managed along two segments: ISS and Perceptive Software.

ISS offers a broad portfolio of monochrome and color laser printers and laser multifunction products ("MFPs"), as well as supplies, fleet management software and managed print services. Laser based products within the distributed printing market primarily serve business customers. ISS employs large-account sales and marketing teams whose mission is to generate demand for its business printing solutions and services, primarily among large corporations, small and medium businesses ("SMB"), as well as the public sector. These sales and marketing teams primarily focus on industries such as banking, insurance, retail, manufacturing, education, government and health care. ISS distributes and fulfills its products to business customers primarily through its well-established distributor and reseller network. The ISS distributor and reseller network includes IT Resellers, Direct Marketing Resellers, and Copier Dealers. ISS also sells its products through numerous alliances and original equipment manufacturer ("OEM") arrangements.

Perceptive Software offers a complete suite of ECM, BPM, DOM, intelligent data capture and search software products and solutions. The ECM and BPM software and services markets primarily serve business customers. Perceptive Software uses a direct to market sales and broad lead generation approach, employing internal sales and marketing teams that are segmented by industry sector - specifically healthcare, education, public sector/government, and cross industry, which includes areas such as retail, banking and insurance. Perceptive Software also offers a direct channel partner program that allows authorized third-party resellers to market and sell Perceptive Software products and solutions to a distributed market. Perceptive Software has two general forms of software agreements with its customers, perpetual licenses and subscription services.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Lexmark's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated condensed financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of consolidated condensed financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, as well as disclosures regarding contingencies. 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, goodwill and intangible assets, income taxes, warranty obligations, copyright fees, restructurings, pension and other postretirement benefits, contingencies and litigation, and fair values that are based on unobservable inputs significant to the overall measurement. Lexmark bases its estimates on historical experience, market conditions, and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.


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

Management believes that there have been no significant changes during 2013 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, 2012.

RESULTS OF OPERATIONS

Operations Overview

Key Messages

Lexmark is focused on driving long-term performance by strategically investing in technology, hardware, software, services and solutions to secure high usage and high value product installations and associated profitable supplies, software maintenance and service annuities in document-intensive industries and business processes in distributed environments.

The ISS strategy is primarily focused on capturing profitable supplies and service annuities generated from its managed print services, industry specific solutions and hardware sales of large and small workgroup devices.

The Perceptive Software strategy is to deliver affordable, industry and process specific solutions through deep industry expertise and a broad ECM and BPM software platform, imbedding intelligent data capture and enterprise search capabilities, in a model that is easy to integrate, use, and support.

While focusing on core strategic initiatives, Lexmark has taken actions to improve its cost and expense structure. As a result of the Company's restructuring initiatives, significant changes have been implemented, from the consolidation and reduction of the manufacturing and support infrastructure and the increased use of shared service centers in low-cost countries, to the announced exit of the development and manufacture of the Company's inkjet hardware.

The Company remains committed to its capital allocation framework of returning more than 50 percent of free cash flow (net cash flows provided by operating activities minus purchases of property, plant and equipment plus proceeds from sale of fixed assets) to shareholders through share repurchases and dividends while building and growing its solutions and software business through expansion and acquisitions.

Business Factors

For the first quarter of 2013, total Lexmark revenue was down 11% YTY, primarily due to the Company's planned exit from inkjet technologies and the weak global demand environment. On April 2, 2013, subsequent to the date of the financial statements, Lexmark announced the sale of inkjet-related technology and assets for $100 million. The transaction closed later in the second quarter of 2013, and no material impact on the ramp-down of the Company's inkjet exit revenue is expected due to the transaction. Operating income decreased 40% YTY primarily due to the decline in inkjet and laser supplies revenue, as well as by an increase in costs associated with acquisition-related adjustments, partially offset by reduced operating expenses due to the Company's 2012 restructuring actions. The Company uses the term "inkjet exit" to include consumer and business inkjet hardware and supplies.

ISS

Lexmark continues its investments in ISS to broaden its line of large and small workgroup devices and solutions and service offerings, targeting the higher usage segments of the imaging market.


ISS continues to focus on capturing profitable supplies and service annuities generated from managed print services, industry specific solutions and hardware sales of large and small workgroup devices. Associated strategic initiatives include:

Expanding and strengthening the Company's product line;

Advancing and strengthening the Company's industry solutions to maintain and grow the Company's penetration in selected industries;

Advancing and expanding the Company's managed print services business; and

Expanding the Company's rate of participation in market opportunities and channels.

Perceptive Software

Perceptive Software enhances Lexmark's capabilities as a content and process management solutions provider, expands the Company's market opportunity, and provides a core strategic component for Lexmark's future. Perceptive Software's strategy is to deliver affordable, industry and process specific solutions through deep industry expertise and an integrated software platform featuring ECM, BPM, DOM, intelligent data capture, enterprise search and process mining technologies that are easy to install, use and support. In keeping with this strategy, Lexmark acquired Pallas Athena in October of 2011, Brainware in February of 2012, ISYS and Nolij in March of 2012, Acuo in December of 2012, and Twistage and AccessVia in March of 2013. These acquisitions enhance Lexmark's capabilities as a content and process management solutions provider, expand the Company's market opportunity, and provide a core strategic component for Lexmark's future. Lexmark's software strategy is to deliver affordable, industry and process specific workflow enhancing solutions through deep industry expertise and a broad content and process management software platform, in a model that is easy to integrate, use, and support. Key software strategic initiatives include:

Advancing and growing the Company's content and process management solutions business internationally,

Expanding and strengthening the Company's content and process management software product line; and

Expanding the Company's rate of participation in content management, business process management and case management software market opportunities.

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 months
ended March 31, 2013 and 2012:

                                Three Months Ended March 31
                              2013                      2012
(Dollars in millions) Dollars     % of Rev      Dollars     % of Rev
Revenue               $  884.3        100.0 %   $  992.5        100.0 %
Gross profit             334.6         37.8        381.4         38.4
Operating expense        280.6         31.7        292.0         29.4
Operating income          54.0          6.1         89.4          9.0
Net earnings              34.8          3.9         60.8          6.1

For the first quarter of 2013, total revenue was $884.3 million, down 11% from 2012. Gross profit decreased 12%, Operating expense decreased 4% and Operating income decreased 40% when compared to the same period in 2012.

Net earnings for the first quarter of 2013 decreased 43% from the prior year primarily due to lower operating income offset partially by a lower effective tax rate. Net earnings for the first quarter of 2013 included $9.1 million of pre-tax restructuring-related charges and project costs as well as $17.8 million of pre-tax acquisition-related


adjustments. Net earnings for the first quarter of 2012 included $10.0 million of pre-tax restructuring-related charges and project costs as well as $9.7 million of pre-tax acquisition-related adjustments.

Revenue

Revenue declined YTY driven by the planned exit from inkjet technologies, lower laser supplies revenue and a global general weaker demand environment.

For the first quarter of 2013, consolidated revenue decreased 11% YTY, of which approximately 6% was due to the Company's exit of inkjet technology and 1% was due to the negative impact of currency.

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

                         Three Months Ended March 31
(Dollars in millions)    2013         2012     % Change
ISS                   $    840.1    $  963.0   (12.8 ) %
Perceptive Software         44.2        29.5    49.8
Total revenue         $    884.3    $  992.5   (10.9 ) %

ISS

During the first quarter of 2013, ISS revenue decreased 13% compared to prior year, of which approximately 6% was due to the Company's exit of inkjet technology and 1% was due to the negative impact of currency. Hardware revenue declined 9% YTY and laser hardware revenue declined 5% YTY. Large workgroup laser hardware revenue, which represented about 83% of total hardware revenue for the quarter ended March 31, 2013, was down 2% YTY reflecting a 4% decline in units, partially offset by a 2% increase in average unit revenue ("AUR"). Small workgroup laser hardware revenue, which for the quarter ended March 31, 2013 represented 16% of total hardware revenue, declined 19% YTY driven by an 18% decline in units. Small workgroup AUR declined 1%. Inkjet exit hardware revenue, which for the quarter ended March 31, 2013 represented 1% of total hardware revenue, declined 78% YTY as the Company exits inkjet technology. Supplies revenue for the quarter ended March 31, 2013 was down 16% compared to the same period in 2012 with laser supplies revenue declining 11% YTY. Inkjet exit supplies revenue declined 31% YTY due to ongoing and expected declines in the inkjet install base as the Company exits inkjet technology. The Company uses the term "large workgroup" to include departmental, large workgroup, and medium workgroup lasers, dot matrix printers and options. The term "small workgroup" includes small workgroup and personal lasers.

Perceptive Software

Reductions in revenue result from business combination accounting rules when deferred revenue balances assumed as part of acquisitions are adjusted down to fair value. Fair value approximates the cost of fulfilling the service obligation, plus a reasonable profit margin. Subsequent to acquisitions, the Company analyzes the amount of amortized revenue that would have been recognized had the acquired company remained independent and had the deferred revenue balances not been adjusted to fair value.

For the quarter ended March 31, 2013, revenue for Perceptive Software increased 50% compared to the same period in 2012. During the quarter, Perceptive Software saw strong placements of content and intelligent capture solutions. Excluding the impact of acquisition-related adjustments, revenue for Perceptive Software for the quarter ended March 31, 2013 increased 54% YTY. The 2013 and 2012 financial results for the Perceptive Software reportable segment include only the activity occurring after the dates of acquisitions.

See "Acquisition-related Adjustments" section that follows for further discussion.

Revenue by geography

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


                                             Three Months Ended March 31
(Dollars in millions)                        2013         2012     % Change
United States                             $    375.4    $  423.0   (11.3 ) %
Europe, the Middle East & Africa ("EMEA")      335.1       368.1    (9.0 )
Other International                            173.8       201.4   (13.7 )
Total revenue                             $    884.3    $  992.5   (10.9 ) %

For the quarter ended March 31, 2013, the decline in revenues compared to the same period in 2012, for all regions, principally reflects the impact of the Company's planned exit from inkjet technologies and the weakened global demand environment. For the three months ended March 31, 2013, currency exchange rates had a 1%, YTY unfavorable impact on Total revenue.

Gross Profit

The following table provides gross profit information:

                          Three Months Ended March 31
(Dollars in millions)   2013          2012          Change
Gross profit dollars  $   334.6      $ 381.4        (12.3 ) %
% of revenue               37.8 %       38.4 %   -0.6 pts

For the three months ended March 31, 2013, consolidated gross profit decreased 12% while gross profit as a percentage of revenue decreased only slightly by 0.6 percentage points compared to the same period in 2012. Gross profit for the three months ended March 31, 2013 included $7.4 million of pre-tax restructuring-related charges and project costs as well as $10.6 million of pre-tax acquisition-related adjustments. Gross profit for the three months ended March 31, 2012 included $4.3 million of pre-tax restructuring-related charges and project costs as well as $5.7 million of pre-tax acquisition-related adjustments.

Gross profit margin versus the same period in 2012 was impacted by a 2.0 percentage point YTY increase due to a favorable mix shift driven by lower inkjet hardware volume and higher license and subscriptions revenue, offset by a 1.6 percentage point decrease YTY due to unfavorable product margins, as well as by a 1.0 percentage point decrease due to higher YTY cost of restructuring and acquisition-related activities.

See "Restructuring and Related Charges and Project Costs" and "Acquisition-related Adjustments" sections that follow for further discussion.

Operating Expense

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

                                                        Three Months Ended March 31
                                                      2013                      2012
(Dollars in millions)                          Dollars     % of Rev      Dollars     % of Rev
Research and development                      $     81.6        9.2 %   $     96.7        9.7 %
Selling, general & administrative                  203.0       23.0          190.6       19.2
Restructuring and related charges (reversals)       (4.0 )     (0.5 )          4.7        0.5
Total operating expense                       $    280.6       31.7 %   $    292.0       29.4 %

For the quarter ended March 31, 2013, Total operating expense decreased 4% compared to the same period in 2012. The decrease was primarily due to lower research and development expenses in the ISS segment driven by the Company's 2012 restructuring actions and solid overall expense management, partially offset by increased investment in Perceptive Software.

Selling, general and administrative ("SG&A") expenses for the three months ended March 31, 2013 increased YTY due to increases in the Perceptive Software segment. The increase was driven by recent acquisitions as well as


investments made to grow Perceptive Software. The increase in Perceptive Software segment SG&A was partially offset by lower SG&A spending in the ISS segment, principally due to the Company's 2012 restructuring actions.

See discussion below of restructuring and related charges and project costs and acquisition-related adjustments included in the Company's operating expenses for the periods presented in the table above.

For the three months ended March 31, 2013, the Company incurred $1.7 million of pre-tax restructuring and related charges and project costs due to the Company's restructuring plans. Of that amount, $5.7 million is included in Selling, general and administrative while $(4.0) million is included in Restructuring and related (reversals) charges on the Company's Consolidated Condensed Statements of Earnings. Additionally, the Company incurred $7.2 million of pre-tax costs associated with its recent acquisitions, of which $7.0 million is included in Selling, general, and administrative and $0.2 million is included in Research and development on the Company's Consolidated Condensed Statements of Earnings.

For the three months ended March 31, 2012, the Company incurred $5.7 million of pre-tax restructuring and related charges and project costs due to the Company's restructuring plans. Of that amount, $1.0 million is included in Selling, general and administrative while $4.7 million is included in Restructuring and related (reversals) charges on the Company's Consolidated Condensed Statements of Earnings. Additionally, the Company incurred $4.0 million of pre-tax costs associated with its recent acquisitions, of which $3.9 million is included in Selling, general, and administrative and $0.1 million is included in Research and development on the Company's Consolidated Condensed Statements of Earnings.

See "Restructuring and Related Charges and Project Costs" and "Acquisition-related Adjustments" sections that follow for further discussion.

Operating Income (Loss)

The following table provides operating income by segment:

                                  Three Months Ended March 31
(Dollars in millions)            2013         2012        Change
ISS                           $ 156.5      $ 178.0      (12.1 )%
% of segment revenue             18.6 %       18.5 %      0.1  pts

Perceptive Software             (22.8 )      (15.9 )    (43.4 )%
% of segment revenue            (51.6 )%     (53.9 )%     2.3  pts

All other                       (79.7 )      (72.7 )     (9.6 )%
Total operating income (loss) $  54.0      $  89.4      (39.6 )%
% of total revenue                6.1 %        9.0 %     -2.9  pts

For the three months ended March 31, 2013, the decrease in consolidated operating income from the same period in 2012 reflected lower operating income in both the ISS and Perceptive Software segments and in All other. The lower ISS operating income is driven by the decline in inkjet supplies as the Company exits the Inkjet technology as well as by lower laser supplies revenue, partially offset by reduced operating expenses due to the Company's 2012 restructuring actions. The increase in operating loss for Perceptive Software reflects greater operating expense in both research and development and SG&A, as acquisitions and investments are made to expand software and solutions offerings, and sales and marketing capabilities.

For the three months ended March 31, 2013, the Company incurred total pre-tax restructuring-related charges and project costs related to the Company's restructuring plans of $6.1 million in ISS and $3.0 million in All other as well as pre-tax acquisition-related items of $15.1 million primarily in the Perceptive Software and $2.7 million primarily in All other.

For the three months ended March 31, 2012, the Company incurred total pre-tax restructuring-related charges and project costs related to the Company's restructuring plans of $9.6 million in ISS and $0.4 million in All other as well


as pre-tax acquisition-related items of $8.1 million primarily in the Perceptive Software and $1.6 million in All other.

See "Restructuring and Related Charges and Project Costs" and "Acquisition-related Adjustments" sections that follow for further discussion.

Interest and Other

The following table provides interest and other information:

                                                                Three Months Ended March 31
(Dollars in millions)                                             2013               2012
Interest expense (income), net                                $          9.5      $        7.1
Other expense (income), net                                              1.0               0.2
Loss on extinguishment of debt                                           3.3                 -
Total interest and other expense (income), net                $         13.8      $        7.3

During the first quarter of 2013, total interest and other expense (income), net, was an expense of $13.8 million, an 89% increase compared to expense of $7.3 million in the first quarter of 2012. The loss of $3.3 million on extinguishment of debt is comprised of $3.2 million of premium paid upon repayment of the Company's 2013 senior notes and $0.1 million related to the write-off of related debt issuance costs. The YTY increase in interest expense is primarily due to the addition of $400 million in debt outstanding related to the Company's public debt offering in March 2013.

Provision for Income Taxes and Related Matters

The Provision for income taxes for the three months ended March 31, 2013, was an expense of $5.4 million or an effective tax rate of 13.5%, compared to an expense of $21.3 million or an effective tax rate of 26.0% for the three months ended March 31, 2012. The difference in these rates (excluding discrete items) is primarily due to a shift in the expected geographic distribution of earnings for 2013. For the three months ended March 31, 2013, the Company decreased income tax expense by $5.2 million in recognition of several discrete items. Of this amount, $6.0 million is related to the reenactment of the research and experimentation credit for the year 2012. The remaining $0.8 million increase in tax expense is primarily related to years prior to 2013. For the three months ended March 31, 2012, the Company increased income tax expense by $1.0 million in recognition of several discrete items, all of which were adjustments to amounts accrued for tax years prior to 2012.

Net Earnings and Earnings per Share

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

                                                   Three Months Ended March 31
(Dollars in millions, except per share amounts)      2013               2012
Net earnings                                     $        34.8      $        60.8

Basic earnings per share                         $        0.55      $        0.85
Diluted earnings per share                       $        0.54      $        0.84

Net earnings for the three months ended March 31, 2013 decreased 43% from the prior year primarily due to decreased operating income offset partially by a lower effective tax rate.

For the three months ended March 31, 2013, the YTY decrease in basic and diluted earnings per share was primarily due to decreased earnings partially offset by an 11% reduction in shares outstanding.


RESTRUCTURING AND RELATED CHARGES AND PROJECT COSTS

Summary of Restructuring Impacts

The Company's 2013 financial results are impacted by its restructuring plans and related projects. Project costs consist of additional charges related to the execution of the restructuring plans. These project costs are incremental to the Company's normal operating charges and are expensed as incurred, and include . . .

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