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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended September 30, 2004
OR
|_| Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
Commission File No. 1-14050
LEXMARK INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-1308215
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
One Lexmark Centre Drive
740 West New Circle Road
Lexington, Kentucky 40550
(Address of principal executive offices) (Zip Code)
(859) 232-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes X No
--- ---
The registrant had 129,087,592 shares outstanding (excluding shares held in
treasury) of Class A common stock, par value $0.01 per share, as of the close of
business on October 29, 2004.
LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX
Page of
Form 10-Q
---------
Part I
ITEM 1. Financial Statements
CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS (Unaudited)
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003......2
CONSOLIDATED CONDENSED STATEMENTS OF FINANCIAL POSITION (Unaudited)
AS OF SEPTEMBER 30, 2004 AND DECEMBER 31, 2003......................3
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003......................4
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited)....5-10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Unaudited).............................11-16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............17
ITEM 4. CONTROLS AND PROCEDURES...............................................17
Part II
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES
OF EQUITY SECURITIES.................................................18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..................19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.....................................19
1
Part I - Financial Information
Item 1. Financial Statements
LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS
(In Millions, Except Per Share Amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30 September 30
------------------------------ ------------------------------
2004 2003 2004 2003
----- ---- ---- ----
Revenue $1,266.2 $1,157.1 $3,769.9 $3,385.2
Cost of revenue 819.9 785.7 2,472.5 2,276.8
-------- -------- -------- --------
Gross profit 446.3 371.4 1,297.4 1,108.4
-------- -------- -------- --------
Research and development 78.3 66.5 227.0 195.3
Selling, general and administrative 183.7 164.4 535.1 507.0
-------- -------- -------- --------
Operating expense 262.0 230.9 762.1 702.3
-------- -------- -------- --------
Operating income 184.3 140.5 535.3 406.1
Interest (income)/expense, net (4.1) (0.3) (8.7) 0.3
Other 0.6 - 0.9 (0.2)
-------- -------- -------- --------
Earnings before income taxes 187.8 140.8 543.1 406.0
Provision for income taxes 31.7 36.7 129.4 105.6
-------- -------- -------- --------
Net earnings $ 156.1 $ 104.1 $ 413.7 $ 300.4
======== ======== ======== ========
Net earnings per share:
Basic $ 1.20 $ 0.81 $ 3.18 $ 2.35
======== ======== ======== ========
Diluted $ 1.17 $ 0.79 $ 3.10 $ 2.29
======== ======== ======== ========
Shares used in per share calculation:
Basic 129.8 128.5 129.9 127.8
======== ======== ======== ========
Diluted 133.0 131.5 133.4 131.1
======== ======== ======== ========
See notes to consolidated condensed financial statements.
2
LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF FINANCIAL POSITION
(In Millions, Except Par Value)
(Unaudited)
September 30 December 31
2004 2003
-------------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 534.3 $ 744.6
Marketable securities 956.8 451.5
Trade receivables, net of allowance of $40.1 in 2004 and $48.1 in 2003 652.9 615.4
Inventories 540.5 437.0
Prepaid expenses and other current assets 240.0 195.3
-------- ---------
Total current assets 2,924.5 2,443.8
Property, plant and equipment, net 738.5 715.9
Other assets 301.5 290.7
--------- ---------
Total assets $ 3,964.5 $ 3,450.4
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt $ - $ 1.1
Accounts payable 607.3 465.7
Accrued liabilities 739.3 716.5
--------- ---------
Total current liabilities 1,346.6 1,183.3
Long-term debt 149.5 149.3
Other liabilities 426.1 474.8
--------- ---------
Total liabilities 1,922.2 1,807.4
--------- ---------
Stockholders' equity:
Preferred stock, $.01 par value, 1.6 shares authorized;
no shares issued and outstanding - -
Common stock, $.01 par value:
Class A, 900.0 shares authorized; 129.0 and
128.6 shares outstanding in 2004 and 2003, respectively 1.6 1.6
Class B, 10.0 shares authorized; no shares issued and outstanding - -
Capital in excess of par 1,060.3 956.4
Retained earnings 2,508.7 2,095.0
Treasury stock, at cost; 35.9 and 34.5 shares in 2004
and 2003, respectively (1,354.4) (1,213.5)
Accumulated other comprehensive loss (173.9) (196.5)
--------- ---------
Total stockholders' equity 2,042.3 1,643.0
--------- ---------
Total liabilities and stockholders' equity $ 3,964.5 $ 3,450.4
========= =========
See notes to consolidated condensed financial statements.
3
LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In Millions)
(Unaudited)
Nine Months Ended
September 30
------------------------------
2004 2003
---- ----
Cash flows from operating activities:
Net earnings $ 413.7 $ 300.4
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 99.4 109.8
Deferred taxes (6.5) (5.5)
Other 7.9 16.7
--------- ---------
514.5 421.4
Change in assets and liabilities:
Trade receivables (37.5) 14.2
Inventories (103.5) (17.0)
Accounts payable 141.6 44.4
Accrued liabilities 22.8 31.8
Tax benefits from employee stock plans 33.8 27.4
Other assets and liabilities (80.5) (43.8)
--------- ---------
Net cash provided by operating activities 491.2 478.4
--------- ---------
Cash flows from investing activities:
Purchases of property, plant and equipment (119.5) (54.9)
Purchases of marketable securities (2,407.7) (469.6)
Proceeds from marketable securities 1,902.3 79.8
Other 0.1 1.3
--------- ---------
Net cash used for investing activities (624.8) (443.4)
--------- ---------
Cash flows from financing activities:
Decrease in short-term debt (1.1) (13.3)
Issuance of treasury stock 1.4 1.0
Purchase of treasury stock (142.3) -
Proceeds from employee stock plans 66.2 45.7
Other (0.7) -
--------- ---------
Net cash (used for) provided by financing activities (76.5) 33.4
--------- ---------
Effect of exchange rate changes on cash (0.2) 3.8
--------- ---------
Net (decrease) increase in cash and cash equivalents (210.3) 72.2
Cash and cash equivalents - beginning of period 744.6 497.7
--------- ---------
Cash and cash equivalents - end of period $ 534.3 $ 569.9
========= =========
See notes to consolidated condensed financial statements.
4
LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying interim consolidated condensed financial statements are
unaudited; however, in the opinion of management of Lexmark International,
Inc. (together with its subsidiaries, the "company"), all adjustments
(which comprise only normal and recurring accruals) necessary for a fair
presentation of the interim financial results have been included. The
results for the interim periods are not necessarily indicative of results
to be expected for the entire year. These financial statements and notes
should be read in conjunction with the company's audited annual
consolidated financial statements for the year ended December 31, 2003.
2. STOCK-BASED COMPENSATION
(In millions, except per share amounts)
The company accounts for its stock-based employee compensation plans under
APB Opinion 25, Accounting for Stock Issued to Employees, and related
interpretations. Accordingly, no compensation cost is reflected in net
earnings as all options granted have an exercise price at least equal to
the market value of the underlying common stock on the date of grant. The
following table is provided in accordance with the disclosure requirements
of SFAS No. 148, Accounting for Stock-Based Compensation --Transition and
Disclosure - an Amendment of SFAS 123, and illustrates the effect on net
earnings and earnings per share if the company had applied the fair value
recognition provisions of SFAS 123 to stock-based employee compensation.
Three Months Nine Months
Ended Ended
September 30 September 30
-------------------------- ---------------------------
2004 2003 2004 2003
---- ---- ---- ----
Net earnings, as reported $156.1 $104.1 $413.7 $300.4
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects (10.9) (10.1) (33.4) (31.1)
------ ------ ------ ------
Pro forma net income $145.2 $ 94.0 $380.3 $269.3
====== ====== ====== ======
Net earnings per share:
Basic - as reported $ 1.20 $ 0.81 $ 3.18 $ 2.35
Basic - pro forma $ 1.12 $ 0.73 $ 2.93 $ 2.11
Diluted - as reported $ 1.17 $ 0.79 $ 3.10 $ 2.29
Diluted - pro forma $ 1.09 $ 0.72 $ 2.85 $ 2.05
5
3. INVENTORIES
(Dollars in millions)
Inventories consist of the following:
September 30 December 31
2004 2003
---------------- ---------------
Work in process $165.8 $139.4
Finished goods 374.7 297.6
------ ------
$540.5 $437.0
====== ======
4. AGGREGATE WARRANTY LIABILITY
(Dollars in millions)
Changes in the company's aggregate warranty liability, which includes both
warranty and extended warranty (deferred revenue), are presented below.
-----------------------------------------------------------------------------
2004 2003
-----------------------------------------------------------------------------
Balance at January 1 $172.7 $147.0
Accruals for warranties issued 158.1 168.2
Accruals related to pre-existing warranties
(including amortization of deferred revenue
for extended warranties and changes in (46.8) (32.2)
estimates)
Settlements made (in cash or in kind) (121.6) (122.6)
-----------------------------------------------------------------------------
Balance at September 30 $162.4 $160.4
-----------------------------------------------------------------------------
Both warranty and the short-term portion of extended warranty are included
on the accrued liabilities line in the Consolidated Condensed Statements of
Financial Position. The long-term portion of extended warranty is included
on the other liabilities line in the Consolidated Condensed Statements of
Financial Position.
5. INCOME TAXES
During the third quarter of 2004, the company settled all outstanding
issues with the Internal Revenue Service on audits for the tax years
1997-2001. As a result of these settlements, the company has reversed
previously accrued taxes, reducing the income tax provision by $20 million,
which reduced the effective tax rate to 16.8% for the third quarter of
2004. Excluding the $20 million tax benefit, the effective income tax rate
was 27.5% in 2004 compared to 26.0% in 2003.
While the company is currently studying the impact of the one-time
favorable foreign dividend provisions recently enacted as part of the
American Jobs Creation Act of 2004, as of September 30, 2004, and based on
the tax laws in effect at that time, it was the company's intention to
continue to indefinitely reinvest its undistributed foreign earnings and,
accordingly, no deferred tax liability has been recorded in connection
therewith.
6
6. STOCKHOLDERS' EQUITY
In October 2004, the company received authorization from the board of
directors to repurchase an additional $1 billion of its Class A common
stock for a total repurchase authority of $2.4 billion. As of October 29,
2004, there was approximately $1.04 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 the third quarter of 2004, the company
repurchased approximately 0.9 million shares, at a cost of approximately
$73 million, pursuant to a share repurchase program in compliance with Rule
10b5-1 and Rule 10b-18 under the Securities Exchange Act of 1934. During
the first nine months of 2004, the company repurchased approximately 1.6
million shares, at a cost of approximately $142 million. As of October 29,
2004, the company had repurchased approximately 36.4 million shares for an
aggregate cost of approximately $1.36 billion.
7. OTHER COMPREHENSIVE EARNINGS (LOSS)
(Dollars in millions)
Comprehensive earnings, net of taxes, consists of the following:
Three Months Ended Nine Months Ended
September 30 September 30
---------------------------- -------------------------
2004 2003 2004 2003
---- ---- ---- ----
Net earnings $ 156.1 $ 104.1 $ 413.7 $ 300.4
Other comprehensive earnings (loss):
Foreign currency translation adjustment 2.1 (1.2) (0.8) 14.1
Cash flow hedging, net of reclassifications (4.9) 4.4 24.3 2.5
Minimum pension liability adjustment - (0.1) (0.8) (0.1)
Net unrealized gain (loss) on marketable
securities (0.1) - (0.1) -
------- ------- ------- -------
Comprehensive earnings $ 153.2 $ 107.2 $ 436.3 $ 316.9
======= ======= ======= =======
Accumulated other comprehensive loss consists of the following:
Net Unrealized Accumulated
Minimum Gain (Loss) on Other
Translation Cash Flow Pension Marketable Comprehensive
Adjustment Hedges Liability Securities Loss
----------- --------- ----------- -------------- -------------
Balance, 12/31/2003 $(15.2) $(36.5) $(144.8) $ - $(196.5)
1st Qtr 2004 change 0.2 22.4 (1.6) - 21.0
------ ------ ------- ------ -------
Balance, 3/31/2004 (15.0) (14.1) (146.4) - (175.5)
2nd Qtr 2004 change (3.1) 6.8 0.8 - 4.5
------ ------ ------- ------ -------
Balance, 6/30/2004 (18.1) (7.3) (145.6) - (171.0)
3rd Qtr 2004 change 2.1 (4.9) - (0.1) (2.9)
------ ------ ------- ------ -------
Balance, 9/30/2004 $(16.0) $(12.2) $(145.6) $ (0.1) $(173.9)
====== ====== ======= ====== =======
7
8. EARNINGS PER SHARE (EPS)
(In millions, except per share amounts)
The following table presents a reconciliation of the numerators and
denominators of the basic and diluted EPS calculations:
Three Months Ended Nine Months Ended
September 30 September 30
--------------------------- --------------------------
2004 2003 2004 2003
---- ---- ---- ----
Numerator:
Net earnings $156.1 $104.1 $413.7 $300.4
====== ====== ====== ======
Denominator:
Weighted average shares used
to compute basic EPS 129.8 128.5 129.9 127.8
Effect of dilutive securities
Stock options 3.2 3.0 3.5 3.3
------ ------ ------ ------
Weighted average shares used
to compute diluted EPS 133.0 131.5 133.4 131.1
====== ====== ====== ======
Basic net EPS $ 1.20 $ 0.81 $ 3.18 $ 2.35
Diluted net EPS $ 1.17 $ 0.79 $ 3.10 $ 2.29
Options to purchase an additional 1.4 million and 1.6 million shares of
Class A common stock for the three month periods and 1.3 million and 1.4
million shares for the nine month periods ended September 30, 2004 and
September 30, 2003, respectively, were outstanding but were not included in
the computation of diluted earnings per share because the options' exercise
prices were greater than the average market price of the common shares and,
therefore, the effect would have been antidilutive.
9. EMPLOYEE PENSION AND POSTRETIREMENT PLANS
(Dollars in millions)
The components of the net periodic benefit cost for both the pension and
postretirement plans were as follows:
Three Months Ended Nine Months Ended
Pension Benefits: September 30 September 30
-------------------------- --------------------------
2004 2003 2004 2003
---- ---- ---- ----
Service cost $ 3.7 $ 3.5 $ 11.1 $ 10.2
Interest cost 10.4 10.3 30.9 30.2
Expected return on plan assets (13.2) (12.7) (39.1) (36.4)
Amortization of prior service (benefit) (0.6) (0.4) (1.8) (1.0)
Amortization of net loss 2.7 2.7 7.3 6.0
Settlement or curtailment losses - 0.4 - 0.8
------ ------ ------- --------
Net periodic benefit cost $ 3.0 $ 3.8 $ 8.4 $ 9.8
====== ====== ======= ========
8
Three Months Ended Nine Months Ended
Other Postretirement Benefits: September 30 September 30
----------------------- ----------------------
2004 2003 2004 2003
---- ------ ---- ----
Service cost $ 0.5 $ - $ 1.5 $ 1.4
Interest cost 0.9 0.6 2.5 2.3
Amortization of prior service (benefit) (0.1) - (0.2) (0.2)
Amortization of net (gain) loss - (0.1) 0.1 -
Settlement or curtailment (gains) losses - (1.6) - (1.6)
------ ------ ------ ------
Net periodic benefit cost (income) $ 1.3 $ (1.1) $ 3.9 $ 1.9
====== ====== ====== ======
As discussed in Note 11 of the Notes to Consolidated Condensed Financial
Statements, FASB Staff Position No. 106-2 ("FSP 106-2"), Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug
Improvement and Modernization Act of 2003 (the "Act"), was effective for
the first interim or annual period beginning after June 15, 2004. The
company is eligible to receive the subsidy, but only for a limited number
of retired individuals who are receiving benefits under a plan provision
that is no longer offered to employees. The effects of the Act were not
significant for the company and therefore, will be incorporated at the next
regular plan measurement date of January 1, 2005.
The company previously disclosed in its financial statements for the year
ended December 31, 2003, that it expected to contribute approximately $45
million to its pension and postretirement plans in 2004. As of September
30, 2004, approximately $55 million of contributions have been made to the
company's European and U.S. pension plans. The company presently
anticipates contributing an additional $3 million during the remainder of
2004, primarily to the European pension plans, for a total of $58 million.
10. SEGMENT DATA
(Dollars in millions)
The company manufactures and sells a variety of printing products and
related supplies and services. The company is primarily managed along
business and consumer market segments. The company evaluates the
performance of its segments based on revenue and operating income, and does
not include segment assets or other income and expense items for management
reporting purposes. Segment operating income includes selling, general and
administrative, research and development and other expenses, certain of
which are allocated to the respective segments based on internal measures
and may not be indicative of amounts that would be incurred on a stand
alone basis or may not be indicative of results of other enterprises in
similar businesses. Additionally, segment operating income excludes
significant expenses that are managed outside of the reporting segments.
9
The following table includes information about the company's reportable
segments:
Three Months Ended Nine Months Ended
September 30 September 30
------------------------ -------------------------
2004 2003 2004 2003
---- ---- ---- ----
Revenue:
Business $ 676.0 $ 617.9 $2,031.7 $1,908.8
Consumer 590.2 539.0 1,738.2 1,476.2
All other - 0.2 - 0.2
-------- -------- -------- --------
Total revenue $1,266.2 $1,157.1 $3,769.9 $3,385.2
======== ======== ======== ========
Operating income/(loss):
Business $ 184.0 $ 157.6 $ 546.0 $ 492.6
Consumer 86.5 62.0 247.6 149.5
All other (86.2) (79.1) (258.3) (236.0)
-------- -------- -------- --------
Total operating income/(loss) $ 184.3 $ 140.5 $ 535.3 $ 406.1
======== ======== ======== ========
11. NEW ACCOUNTING STANDARDS
In May 2004, the Financial Accounting Standards Board ("FASB") issued FSP
106-2, Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug Improvement and Modernization Act of 2003 (the "Act").
The Act introduced a prescription drug benefit under Medicare as well as a
federal subsidy to sponsors of post-retirement health care benefit plans
that provide a benefit that is at least actuarially equivalent to Medicare
Part D. FSP 106-2 superceded FSP 106-1, which was issued in January 2004
and permitted a sponsor of a post-retirement health care plan that provides
a prescription drug benefit to make a one-time election to defer accounting
for the effects of the Act until more authoritative guidance on the
accounting for the federal subsidy was issued. The company elected to defer
accounting for the effects of the Act under FSP 106-1. FSP 106-2 was
effective for the first interim or annual period beginning after June 15,
2004. The company has evaluated the provisions of FSP 106-2 and concluded
that it will not have a material impact on the company's financial
position, results of operations and cash flows.
12. SUBSEQUENT EVENT
In October 2004, the company entered into an amended and restated agreement
to sell its U.S. trade receivables on a limited recourse basis. The amended
agreement allows for a maximum financing availability of $200 million under
this facility. At September 30, 2004, the facility had no U.S. trade
receivables sold and outstanding. 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. This facility
contains customary affirmative and negative covenants as well as specific
provisions related to the quality of the accounts receivable balances. The
company bears a limited risk of bad debt losses on U.S. trade receivables
sold, since the company over-collateralizes the receivables sold with
additional eligible receivables. The company addresses this risk of loss in
its allowance for doubtful accounts. Receivables sold may not include
amounts over 90 days past due or concentration over certain limits with any
one customer.
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Unaudited)
LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES
Results of Operations
- ---------------------
Consolidated revenue for the three months ended September 30, 2004, was $1,266
million, an increase of 9% over the same period of 2003. Revenue in the business
market segment was $676 million for the third quarter of 2004 and increased 9%
over the same period of 2003. This growth was principally due to increases in
unit volumes. Revenue in the consumer market segment was $590 million for the
third quarter of 2004 and increased 9% over the same period of 2003. This growth
was also principally due to increases in unit volumes. Total U.S. revenue
increased $52 million or 9% and international revenue, including exports from
the U.S., increased $57 million or 9%.
For the nine months ended September 30, 2004, consolidated revenue was $3,770
million, an increase of 11% over the same period of 2003. Revenue in the
business market segment was $2,032 million for the nine months ended September
30, 2004, and increased 6% over the same period of 2003. This growth was
principally due to increases in unit volumes. Revenue in the consumer market
segment was $1,738 million for the nine months ended September 30, 2004, and
increased 18% over the same period of 2003. This growth was also principally due
to increases in unit volumes. Total U.S. revenue increased $143 million or 9%
and international revenue, including exports from the U.S., increased $242
million or 13%.
Consolidated gross profit was $446 million for the third quarter of 2004, an
increase of 20% from the same period of 2003. For the nine months ended
September 30, 2004, consolidated gross profit was $1,297 million, an increase of
17% from the same period of 2003. Gross profit as a percentage of revenue for
the quarter ended September 30, 2004, increased to 35.2% from 32.1% in the third
quarter of 2003, an increase of 3.1 percentage points. Gross profit as a
percentage of revenue for the nine months ended September 30, 2004, increased to
34.4% from 32.7% in the same period of 2003, an increase of 1.7 percentage
points. The improvement in the gross profit margin for both the three and nine
month periods of 2004 over the same periods of 2003 was principally due to
improved product margins (3.2 and 2.3 percentage points, respectively) which was
mostly printer driven, partially offset by a negative mix shift among products
(0.1 and 0.6 percentage points, respectively).
Total operating expense was $262 million for the quarter ended September 30,
2004, compared to $231 million for the same period of 2003. Total operating
expense was $762 million for the nine months ended September 30, 2004, compared
to $702 million for the same period of 2003. Operating expense as a percentage
of revenue for the quarter was 20.7% compared to 20.0% for the corresponding
period in 2003. The increase in the operating expense as a percentage of revenue
for the third quarter over the same period in 2003 was primarily driven by
increased spending in research and development to support new product
initiatives as well as an increase in selling, general and administrative
expense. Management expects spending in research and development as well as in
selling, general and administrative expense to continue to increase in the
fourth quarter of 2004. Operating expense as a percentage of revenue for the
nine months ended September 30, 2004, was 20.2% compared to 20.7% for the
corresponding period of 2003. The decrease in the operating expense as a
percentage of revenue for the nine months ended September 30, 2004, was
primarily due to revenue growing at a faster rate than selling, general and
administrative expense, slightly offset by higher research and development
spending.
Consolidated operating income was $184 million for the third quarter of 2004 and
increased 31% from 2003. The increase in the consolidated operating income was
due to a $75 million increase in gross profit, partially offset by a $31 million
increase in operating expense. Operating income for the business market segment
increased $26 million in the third quarter of 2004, compared to the same
11
period in the prior year. Operating income for the consumer market segment
increased $24 million in the third quarter of 2004, compared to the same period
in 2003. The increases in operating income for both the business and consumer
market segments were principally due to improvements in the gross profit for
those segments.
For the nine months ended September 30, 2004, consolidated operating income was
$535 million and increased 32% from 2003. The increase in consolidated operating
income was due to a $189 million increase in gross profit, partially offset by a
$60 million increase in operating expense. Operating income for the business
market segment increased $53 million for the nine months ended September 30,
2004, compared to the same period in the prior year. Operating income for the
consumer market segment increased $98 million for the nine months ended
September 30, 2004, compared to the same period in 2003. The increases in
operating income for both the business and consumer market segments were
primarily due to improvements in the gross profit for those segments.
Non-operating income increased approximately $3 million in the third quarter of
2004, compared to the same period in 2003. Non-operating income increased
approximately $8 million for the nine months ended September 30, 2004, compared
to the prior year. These increases were principally due to additional interest
income in 2004 as a result of an increase in the level of cash and marketable
securities held by the company.
During the third quarter of 2004, the company settled all outstanding issues
with the Internal Revenue Service on audits for the tax years 1997-2001. As a
result of these settlements, the company has reversed previously accrued taxes,
reducing the income tax provision by $20 million, which reduced the effective
tax rate to 16.8% for the third quarter of 2004.
Net earnings for the third quarter of 2004 were $156 million, compared to $104
million in the third quarter of 2003. Net earnings for the nine months ended
September 30, 2004, were $414 million compared to $300 million in 2003. Included
in both the three and nine month periods ending September 30, 2004, was the $20
million tax benefit discussed previously. After adjusting for the tax benefit,
the increase in net earnings for both the three and nine month periods ending
September 30, 2004, was principally due to the improved operating income.
Excluding the $20 million tax benefit, the effective income tax rate was 27.5%
in 2004 compared to 26.0% in 2003. During the fourth quarter of 2004, the
company expects to reduce its effective income tax rate from 27.5% to 26.5% as a
result of the retroactive extension of a federal research and development tax
credit and an extension of a non-U.S. tax holiday. While the company is
currently studying the impact of the one-time favorable foreign dividend
provisions recently enacted as part of the American Jobs Creation Act of 2004,
as of September 30, 2004, and based on the tax laws in effect at that time, it
was the company's intention to continue to indefinitely reinvest its
undistributed foreign earnings and, accordingly, no deferred tax liability has
been recorded in connection therewith.
Basic net earnings per share were $1.20 for the third quarter of 2004 compared
to $0.81 in the corresponding period in 2003. Diluted net earnings per share
were $1.17 in the third quarter of 2004, compared to $0.79 in 2003, an increase
of 48%. Basic net earnings per share were $3.18 for the nine months ended
September 30, 2004, compared to $2.35 in the corresponding period in 2003.
Diluted net earnings per share were $3.10 for the nine months ended September
30, 2004, compared to $2.29 in 2003, an increase of 35%. Both basic and diluted
earnings per share for the three and nine months ended September 30, 2004,
included a $0.15 benefit associated with the previously mentioned tax
settlement. Excluding this tax benefit, the increases in earnings per share were
primarily due to the increases in net earnings.
Financial Condition
- -------------------
The company's financial position remains strong at September 30, 2004, with
working capital of $1,578 million compared to $1,261 million at December 31,
2003. At September 30, 2004, the
12
company had $150 million of long-term debt outstanding. The debt to total
capital ratio was 7% at September 30, 2004, compared to 8% at December 31, 2003.
The company had no amounts outstanding under its U.S. trade receivables
financing program or its revolving credit facility at September 30, 2004.
Cash provided by operating activities for the nine months ended September 30,
2004, was $491 million, compared to $478 million for the same period of 2003.
The increase in cash flows from operating activities was primarily due to
increased earnings and favorable cash flow changes in accounts payable,
partially offset by unfavorable cash flow changes in trade receivables,
inventories and other assets and liabilities accounts. Management believes that
cash provided by operations will continue to be sufficient to meet operating and
capital needs.
Cash used for investing activities for the nine months ended September 30, 2004,
was $625 million, compared to $443 million for the same period in 2003. The
company began investing in marketable securities during the third quarter of
2003. For the nine months ended September 30, 2004, investments in marketable
securities resulted in a net use of cash of $505 million compared to $390
million in the same period of 2003. The company spent $120 million on capital
expenditures during the nine months ended September 30, 2004, compared to $55
million during the same period of 2003. The capital expenditures for 2004
principally related to infrastructure support, new product development and
manufacturing capacity expansion. It is anticipated that capital expenditures
for 2004 will be approximately $200 million and are expected to be funded
through cash flows from operations.
Cash used for financing activities was $77 million for the nine months ended
September 30, 2004, compared to $33 million of cash provided by financing
activities for the same period of 2003. The $110 million decrease in cash flows
from financing activities was principally due to the purchase of $142 million of
treasury stock in 2004 compared to no purchases in 2003, offset somewhat by a
$21 million increase in proceeds from employee stock plans during 2004.
In October 2004, the company received authorization from the board of directors
to repurchase an additional $1 billion of its Class A common stock for a total
repurchase authority of $2.4 billion. As of October 29, 2004, there was
approximately $1.04 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 the third quarter of 2004, the company repurchased approximately 0.9
million shares, at a cost of approximately $73 million, pursuant to a share
repurchase program in compliance with Rule 10b5-1 and Rule 10b-18 under the
Securities Exchange Act of 1934. During the first nine months of 2004, the
company repurchased approximately 1.6 million shares, at a cost of approximately
$142 million. As of October 29, 2004, the company had repurchased approximately
36.4 million shares for an aggregate cost of approximately $1.36 billion.
New Accounting Standards
- ------------------------
In May 2004, the Financial Accounting Standards Board ("FASB") issued FASB Staff
Position No. 106-2 ("FSP 106-2"), Accounting and Disclosure Requirements Related
to the Medicare Prescription Drug Improvement and Modernization Act of 2003 (the
"Act"). The Act introduced a prescription drug benefit under Medicare as well as
a federal subsidy to sponsors of post-retirement health care benefit plans that
provide a benefit that is at least actuarially equivalent to Medicare Part D.
FSP 106-2 superceded FSP106-1, which was issued in January 2004 and permitted a
sponsor of a post-retirement health care plan that provides a prescription drug
benefit to make a one-time election to defer accounting for the effects of the
Act until more authoritative guidance on the accounting for the federal subsidy
was issued. The company elected to defer accounting for the effects of the Act
under FSP 106-1. FSP 106-2 was effective for the first interim or annual period
beginning after June 15, 2004. The company has evaluated the provisions of FSP
106-2 and concluded that it will not have a material impact on the company's
financial position, results of operations and cash flows.
13
Factors That May Affect Future Results and Information Concerning Forward -
- --------------------------------------------------------------------------------
Looking Statements
- ------------------
Statements contained in this report which are not statements of historical fact
are forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Forward-looking statements are made based upon management's current expectations
and beliefs concerning future developments and their potential effects upon the
company. 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 below:
o The introduction of products by the company or its competitors, or delays in
customer purchases of existing products in anticipation of new product
introductions by the company or its competitors and market acceptance of new
products and pricing programs, any disruption in the supply of new or existing
products due to quality issues, the reaction of competitors to any such new
products or programs, the life cycles of the company's products, as well as
delays in product development and manufacturing, and variations in the cost of
component parts, may impact sales, may cause a buildup in the company's
inventories, make the transition from current products to new products difficult
and could adversely affect the company's future operating results. The
competitive pressure to develop technology and products and to increase
marketing expenditures also could cause significant changes in the level of the
company's operating expenses.
o The company's performance depends in part upon its ability to successfully
forecast the timing and extent of customer demand and manage worldwide
distribution and inventory levels of the company and its resellers. Unexpected
fluctuations in reseller inventory levels could disrupt ordering patterns and
may adversely affect the company's financial results. In addition, the financial
failure or loss of a key customer or reseller could have a material adverse
impact on the company's financial results. The company must also be able to
address production and supply constraints, including product disruptions caused
by quality issues, and delays or disruptions in the supply of key components
necessary for production, including without limitation component shortages due
to increasing global demand in the company's industry and other industries. Such
delays, disruptions or shortages may result in lost revenue or in the company
incurring additional costs to meet customer demand. The company's future
operating results and its ability to effectively grow or maintain its market
share may be adversely affected if it is unable to address these issues on a
timely basis.
o Unfavorable global economic conditions may adversely impact the company's
future operating results. The company continues to experience weak markets for
its products, and although the company has seen some indications of market
improvement, continued softness in these markets and uncertainty about global
economic conditions could result in lower demand for the company's products.
Weakness in demand has resulted in intense price competition and may result in
excessive inventory for the company and/or its reseller channel, which may
adversely affect sales, pricing, risk of obsolescence and/or other elements of
the company's operating results.
o The company and its major competitors, many of which have significantly
greater financial, marketing and/or technological resources than the company,
have regularly lowered prices on their products and are expected to continue to
do so. In particular, both the inkjet and laser printer markets have experienced
and are expected to continue to experience significant price pressure. Price
reductions on inkjet or laser products or the inability to reduce costs,
including warranty costs, contain expenses or increase or maintain sales as
currently expected, as well as price protection measures or a shift in the mix
of products sold, could result in lower profitability and jeopardize the
company's ability to grow or maintain its market share.
14
o The company's future operating results may be adversely affected if it is
unable to continue to develop, manufacture and market products that are
reliable, competitive, and meet customers' needs. The markets for laser and
inkjet products and associated supplies are aggressively competitive, especially
with respect to pricing and the introduction of new technologies and products
offering improved features and functionality. The impact of competitive
activities on the sales volumes or revenue of the company, or the company's
inability to effectively deal with these competitive issues, could have a
material adverse effect on the company's ability to maintain or grow retail
shelf space or market share and on its financial results.
o Revenue derived from international sales make up about half of the company's
revenue. Accordingly, the company's future results could be adversely affected
by a variety of factors, including changes in a specific country's or region's
political or economic conditions, foreign currency exchange rate fluctuations,
trade protection measures and unexpected changes in regulatory requirements. In
addition, changes in tax laws and the ability to repatriate cash accumulated
outside the United States in a tax efficient manner may adversely affect the
company's financial results, investment flexibility and operations. Moreover,
margins on international sales tend to be lower than those on domestic sales,
and the company believes that international operations in new geographic markets
will be less profitable than operations in the U.S. and European markets, in
part, because of the higher investment levels for marketing, selling and
distribution required to enter these markets.
o The company relies in large part on its international production facilities
and international manufacturing partners for the manufacture of its products and
key components of its products. Future operating results may be adversely
affected by several factors, including, without limitation, if the company's
international operations or manufacturing partners are unable to perform or
supply products reliably, if there are disruptions in international trade,
disruptions at important geographic points of exit and entry, if there are
difficulties in transitioning such manufacturing activities among the company,
its international operations and/or its manufacturing partners, or if there
arise production and supply constraints which result in additional costs to the
company. The financial failure or loss of a key supplier could result in a
material adverse impact on the company's financial results.
o The company's effective tax rate could be adversely affected by changes in the
mix of earnings in countries with differing statutory tax rates. In addition,
the amount of income tax the company pays is subject to ongoing audits in
various jurisdictions and a material assessment by a taxing authority could
adversely affect the company's profitability.
o The company markets and sells its products through several sales channels. The
company has also advanced a strategy of forming alliances and OEM arrangements
with many companies. The company's future operating results may be adversely
affected by any conflicts that might arise between or among its various sales
channels, the loss of any alliance or OEM arrangement or the loss of retail
shelf space. Aggressive pricing on laser and inkjet products and/or associated
supplies from customers and resellers, including, without limitation, OEM
customers, could result in a material adverse impact on the company's strategy
and financial results.
o Although the company is currently the exclusive supplier of new cartridges for
its laser and inkjet products, there can be no assurance that other companies
will not develop new compatible cartridges for the company's products. In
addition, refill and remanufactured alternatives for some of the company's
cartridges are available and compete with the company's supplies business. The
company expects competitive refill and remanufacturing activity to increase.
Various legal challenges and governmental activities may intensify competition
for the company's aftermarket supplies business.
o The company'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.
15
Current or future claims of intellectual property infringement could prevent the
company from obtaining technology of others and could otherwise materially and
adversely affect its operating results or business, as could expenses incurred
by the company in obtaining intellectual property rights, enforcing its
intellectual property rights against others or defending against claims that the
company's products infringe the intellectual property rights of others.
Furthermore, the imposition of copyright fees or similar fees by copyright
owners or collecting societies in certain jurisdictions, primarily in Europe,
could adversely affect the company's operating results or business.
o The company's inability to perform satisfactorily under service contracts for
managed print services and other customer services may result in the loss of
customers, loss of reputation and/or financial consequences that may have a
material adverse impact on the company's financial results and strategy.
o The company depends on its information technology systems for the development,
manufacture, distribution, marketing, sales and support of its products and
services. Any failure in such systems, or the systems of a partner or supplier,
may adversely affect the company's operating results. Furthermore, because vast
quantities of the company's products flow through only a few distribution
centers to provide product to various geographic regions, the failure of
information technology systems or any other disruption affecting those product
distribution centers could have a material adverse impact on the company's
ability to deliver product and on the company's financial results.
o Terrorist attacks and the potential for future terrorist attacks have created
many political and economic uncertainties, some of which may affect the
company's future operating results. Future terrorist attacks, the national and
international responses to such attacks, and other acts of war or hostility may
affect the company's facilities, employees, suppliers, customers, transportation
networks and supply chains, or may affect the company in ways that are not
capable of being predicted presently.
o The entrance of additional competitors that are focused on printing solutions
could further intensify competition in the inkjet and laser printer markets and
could have a material adverse impact on the company's strategy and financial
results.
o Factors unrelated to the company's operating performance, including the
financial failure or loss of significant customers, resellers, manufacturing
partners or suppliers; the outcome of pending and future litigation or
governmental proceedings; and the ability to retain and attract key personnel,
could also adversely affect the company's operating results. In addition, the
company's stock price, like that of other technology companies, can be volatile.
Trading activity in the company's common stock, particularly the trading of
large blocks and intraday trading in the company's common stock, may affect the
company's common stock price.
While the company reassesses material trends and uncertainties affecting the
company's financial condition and results of operations in connection with the
preparation of its quarterly and annual reports, the company does not intend to
review or revise, in light of future events, any particular forward-looking
statement contained in 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 foregoing list of certain
important factors. 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.
16
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The market risk inherent in the company's financial instruments and positions
represents the potential loss arising from adverse changes in interest rates and
foreign currency exchange rates.
Interest Rates
- --------------
At September 30, 2004, the fair value of the company's senior notes is estimated
at $164 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 Condensed Statements of Financial Position at September 30, 2004,
by approximately $14 million. Market risk is estimated as the potential change
in fair value resulting from a hypothetical 10% adverse change in interest rates
and amounted to approximately $2 million at September 30, 2004.
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 September
30, 2004, was an asset of $0.7 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 amounted to approximately $2 million at
September 30, 2004.
Foreign Currency Exchange Rates
- -------------------------------
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 expenses translated into U.S. dollars. The primary
currencies to which the company is exposed include the euro, the Canadian
dollar, the Japanese yen, the Mexican peso, the Australian dollar, the British
pound and other Asian and South American currencies. Exposures are hedged with
foreign currency forward contracts, put options, and call options with maturity
dates of less than eighteen months. The potential loss in fair value at
September 30, 2004, for such contracts resulting from a hypothetical 10% adverse
change in all foreign currency exchange rates was approximately $69 million.
This loss would be mitigated by corresponding gains on the underlying exposures.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
- ------------------------------------------------
The company's management, with the participation of the company's Chairman and
Chief Executive Officer and Executive Vice President and Chief Financial
Officer, have evaluated the effectiveness of the company's disclosure controls
and procedures as of the end of the period covered by this report. Based upon
that evaluation, the company's Chairman and Chief Executive Officer and
Executive Vice President and Chief Financial Officer have concluded that the
company's disclosure controls and procedures are effective in providing
reasonable assurance that the information required to be disclosed by the
company in the reports that it files under the Securities Exchange Act of 1934,
as amended, is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.
Changes in Internal Control over Financial Reporting
- ----------------------------------------------------
There has been no change in the company's internal control over financial
reporting that occurred during the period covered by this report that has
materially affected, or is reasonably likely to materially affect, the company's
internal control over financial reporting.
17
LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES
Part II. Other Information
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
- ---------------------------------------------------------------------------------------------------------------------------
Total Total Number of Shares Approximate Dollar Value of
Number of Average Price Paid Purchased as Part of Shares that May Yet Be
Period Shares per Share Publicly Announced Plans Purchased Under the Plans or
Purchased or Programs Programs (in millions) (1)
- ---------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
July 1-31, 2004 226,000 $85.95 226,000 $93.7
- ---------------------------------------------------------------------------------------------------------------------------
August 1-31, 2004 367,800 $86.08 367,800 $62.0
- ---------------------------------------------------------------------------------------------------------------------------
September 1-30, 2004 256,200 $84.73 256,200 $40.3
- ---------------------------------------------------------------------------------------------------------------------------
Total 850,000 $85.64 850,000 ---
- ---------------------------------------------------------------------------------------------------------------------------
(1) In October 2004, the company received authorization from the board of
directors to repurchase an additional $1 billion of its Class A common
stock for a total repurchase authority of $2.4 billion. As of October 29,
2004, there was approximately $1.04 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 the third quarter of 2004, the company
repurchased approximately 0.9 million shares, at a cost of approximately
$73 million, pursuant to a share repurchase program in compliance with Rule
10b5-1 and Rule 10b-18 under the Securities Exchange Act of 1934. During
the first nine months of 2004, the company repurchased approximately 1.6
million shares, at a cost of approximately $142 million. As of October 29,
2004, the company had repurchased approximately 36.4 million shares for an
aggregate cost of approximately $1.36 billion.
18
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
A list of exhibits is set forth in the Exhibit Index found on
page 21 of this report.
(b) Reports on Form 8-K:
A Current Report on Form 8-K was filed by the company with
the Securities and Exchange Commission dated July 19, 2004, to
announce the company's second quarter 2004 financial results.
19
LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, both on behalf of the registrant and in
his capacity as principal accounting officer of the registrant.
Lexmark International, Inc.
(Registrant)
Date: November 5, 2004 By: /s/ Gary D. Stromquist
--------------------------
Gary D. Stromquist
Vice President and Corporate Controller
(Chief Accounting Officer)
20
EXHIBIT INDEX
Exhibits:
10.1 Amended and Restated Receivables Purchase Agreement, dated as of October 8,
2004, by and among Lexmark Receivables Corporation, as Seller, CIESCO, LLC
and Gotham Funding Corporation, as the Investors, Citibank, N.A. and The
Bank of Tokyo-Mitsubishi, Ltd., New York Branch, as the Banks, Citicorp
North America, Inc. and The Bank of Tokyo-Mitsubishi, Ltd., New York
Branch, as the Investor Agents, Citicorp North America, Inc., as Program
Agent for the Investors and Banks and the company, as Collection Agent and
Originator. (1)
10.2 Amendment No. 3 to Purchase and Contribution Agreement, dated as of October
8, 2004, by and between the company, as Seller, and Lexmark Receivables
Corporation, as Purchaser. (1)
10.3 Endorsement to the Employment Contract of Najib Bahous entered into as of
July 1, 2004, by and between Lexmark Europe SARL and Najib Bahous. +
31.1 Certification of Chairman and Chief Executive Officer Pursuant to Rule
13a-14(a) and 15d-14(a), As Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Executive Vice President and Chief Financial Officer
Pursuant to Rule 13a-14(a) and 15d-14(a), As Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chairman and Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
32.2 Certification of Executive Vice President and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
(1) Incorporated by reference to the company's Current Report on Form 8-K filed
with the Commission on October 13, 2004 (Commission File No. 1-14050).
+ Indicates management contract or compensatory plan, contract or
arrangement.
21