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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
(Mark One)
X For the Fiscal Year Ended December 31, 1997
OR
Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
Commission File No.1-14050
LEXMARK INTERNATIONAL GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 22-3074422
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
One Lexmark Centre Drive
740 New Circle Road NW
Lexington, Kentucky 40550
(Address of principal executive offices) (Zip Code)
(606) 232-2000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
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Class A common stock, $.01 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
As of February 28, 1998, there were outstanding 68,281,134 shares (excluding
shares held in treasury) of the registrant's Class A common stock, par value
$.01, which is the only class of voting common stock of the registrant, and
there were no shares outstanding of the registrant's Class B common stock, par
value $.01. As of that date, the aggregate market value of the shares of voting
common stock held by non-affiliates of the registrant (based on the closing
price for the Class A common stock on the New York Stock Exchange on February
28, 1998) was approximately $2,610,055,123.
Documents Incorporated by Reference
Certain information in the company's definitive Proxy Statement for the 1998
Annual Meeting of Stockholders, which will be filed with the Securities and
Exchange Commission pursuant to Regulation 14A, not later than 120 days after
the end of the fiscal year, is incorporated by reference in Part III of this
Form 10-K.
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LEXMARK INTERNATIONAL GROUP, INC.
FORM 10-K
For the Year Ended December 31, 1997
Page of
Form 10-K
PART I
ITEM 1. BUSINESS............................................................3
ITEM 2. PROPERTIES.........................................................17
ITEM 3. LEGAL PROCEEDINGS..................................................18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................18
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.............................................19
ITEM 6. SELECTED FINANCIAL DATA...........................................20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.......................................21
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........33
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.......................34
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE........................................60
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................61
ITEM 11. EXECUTIVE COMPENSATION............................................63
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT....63
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................63
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K...64
Part I
Item 1. Business
Lexmark International Group, Inc. ("LIG") is a Delaware corporation that has as
its only significant asset all the outstanding common stock of Lexmark
International, Inc., a Delaware corporation ("Lexmark International").
Hereinafter, "the company" and "Lexmark" will refer to LIG, or to LIG and
Lexmark International, including its subsidiaries, as the context requires. LIG
was formed in 1990 by Clayton, Dubilier & Rice, Inc., a private investment firm
("CD&R"), in connection with the acquisition (the "Acquisition") of IBM
Information Products Corporation (renamed Lexmark International) from IBM. The
Acquisition was completed in March 1991.
General
Lexmark is a global developer, manufacturer and supplier of laser and inkjet
printers and associated consumable supplies for the office and home markets.
Lexmark also sells dot matrix printers for printing single and multi-part forms
by business users. In 1997, revenues from the sale of printers and associated
printer supplies increased 10% from 1996 and accounted for 81% of total company
revenues of approximately $2.5 billion.
The company's installed base of printers supports a large and profitable printer
supplies business. Because consumable supplies must be replaced on average one
to three times a year, depending on type of printer and usage, demand for laser
and inkjet print cartridges is increasing at a higher rate than their associated
printer shipments. This is a relatively high margin, recurring business that
management expects to contribute to the stability of Lexmark's earnings over
time.
In addition to its core printer business, Lexmark develops, manufactures and
markets a broad line of other office imaging products which include supplies for
IBM branded printers, after-market supplies for original equipment manufacturer
("OEM") products, and typewriters and typewriter supplies that are sold under
the IBM trademark. In 1997, revenues from the sale of other office imaging
products decreased 7% from 1996, primarily as a result of lower typewriter sales
and lower typewriter and impact printing supplies volumes reflecting the
continued decline of these markets, and accounted for 19% of total company
revenues.
The company operates in the office products industry segment. Revenues by major
product line are found in Part II, Item 7, Results of Operations.
Revenues derived from international sales, including exports from the United
States, make up over half of the company's revenues. Lexmark's products are sold
in over 150 countries in North and South America, Europe, the Middle East,
Africa, Asia, the Pacific Rim and the Caribbean. While currency translation has
significantly affected international revenues and cost of revenues, it did not
have a material impact on operating income through 1997. Although the company
manages its net exposure to exchange rate fluctuations through operational
hedges, such as pricing actions and product sourcing changes, and financial
instruments, such as forward exchange contracts and currency options, there can
be no assurances that currency fluctuations will not have a material impact on
operating income in the future. As the company's international operations
continue to grow, more management effort will be required to focus on the
operation and expansion of the company's global business and to manage the
cultural, language and legal differences inherent in international operations. A
summary of the company's revenues, operating income and total assets by
geographic area is found in Part II, Item 8, Notes to Consolidated Financial
Statements, Note 18.
3
Printers and Associated Supplies
Lexmark competes primarily in the markets for office desktop laser and color
inkjet printers--two of the fastest growing printer categories. Sales of office
desktop laser and color inkjet printers and their associated supplies together
represented approximately 87% and 86% of Lexmark's total printer and associated
supplies revenues in 1997 and 1996, respectively.
Laser Printers. Network laser printer growth is being driven by the office
migration from large mainframe computers to local area networks that link
various types of computers using a variety of protocols and operating systems.
This shift has created strong demand for office desktop laser printers with
network connectivity attributes. Laser printers that print at speeds of 11-30
pages per minute ("ppm") are referred to herein as "office desktop" or "network"
printers, while lower-speed (1-10 ppm) laser printers and inkjet printers are
referred to herein as "personal" printers. With its Optra S laser printers, a
majority of the company's laser printers are office desktop printers, which the
company believes is one of the fastest growing segments of the laser printer
market. For further discussion of the evolving nature of laser printer
classifications, see "Market Overview and Strategy-Printers and Associated
Supplies".
Lexmark develops and owns most of the technology for its desktop laser printers
and consumable supplies, which differentiates the company from a number of its
major competitors, including Hewlett-Packard Company ("HP") which purchases its
laser engines from a third party. Lexmark's integration of research and
development, manufacturing and marketing has enabled the company to design laser
printers with features desired by specific customer groups and has resulted in
substantial market presence for Lexmark within certain industry segments such as
banking, retail/pharmacy, automobile distribution and health care. The company's
critical technology and manufacturing capabilities have allowed Lexmark to
effectively manage quality and to reduce its typical new product introduction
cycle times, for example, in the case of laser printers from 24 months to
approximately 12 to 16 months. Management believes its cycle times are among the
fastest in the industry and that these capabilities have contributed to the
company's success over the last several years.
Inkjet Printers. The color inkjet printer market, the fastest growing segment of
the personal printer market, is expanding rapidly due to growth in personal
computers at home and in business and the development of easy-to-use color
inkjet technology with high quality color and black print capability at low
prices. Based on data from industry analysts, management believes that the
inkjet market grew from 4 million units in 1992 to 33 million units in 1997 and
will continue to grow substantially as a result of the increase in the number of
personal computers and as the inkjet market continues to shift from monochrome
to color and as inkjet printers continue to replace low-speed laser printers.
Lexmark introduced its first color inkjet printer using its own technology in
1994 and has experienced strong sales growth through retail outlets. The company
has increased its product distribution through retail outlets, with the number
of such outlets worldwide rising from approximately 5,000 retail outlets in 1995
to more than 15,000 in 1996, and remaining relatively constant during 1997. The
company's ability to increase or maintain its presence in the retail marketplace
with its branded products may be adversely affected as the company becomes more
successful in its sales and marketing efforts for OEM opportunities. The company
has made substantial capital investments in its inkjet production capacity in
1995 and 1996 to address the growing demand for its color inkjet printers.
Supplies. The company is currently the exclusive source for new print cartridges
for the laser and inkjet printers it manufactures. Management expects that an
increasing percentage of future company earnings will come from its consumable
supplies business due to the consumer's continual usage and replacement of
cartridges. In 1996, the company substantially expanded its inkjet cartridge
manufacturing capacity in both North America and Europe.
4
Other Office Imaging Products
The company's other office imaging products category includes many mature
products such as supplies for IBM printers, typewriters and typewriter supplies
and other impact supplies that require little investment but provide a
significant source of cash flow. The company introduced after-market laser
cartridges in May 1995 for the large installed base of a range of laser printers
sold by other manufacturers. Management believes that the potential for an
after-market laser cartridge business is significant. The company's strategy for
other office imaging products is to pursue the after-market OEM laser supplies
opportunity while at the same time managing its mature businesses for cash flow.
Keyboards and Other
In the first quarter of 1996, the company completed the phase-out of its
keyboard business. Keyboard sales accounted for 8% and 3%, respectively, of the
company's revenue and gross profit for 1995.
Market Overview and Strategy
Printers and Associated Supplies
Market Overview
In 1997, estimated industry-wide revenue for printer hardware in the 1-30 ppm
speed category, including network, personal and dot matrix, was approximately
$27 billion. Management believes, based on industry analysts' estimates, that
this market will in the aggregate continue to experience modest growth through
2000. However, the company believes that certain product categories within this
market that it has targeted, such as office desktop laser printers and color
inkjet printers, will experience double-digit growth in volume. An overview of
the printer markets in which the company competes is summarized below:
U.S. Primary Paper
Speed Price Range Print Quality Market Media
----- ----------- ------------- ------- -----
Color Laser 2-5 ppm $3,000-8,000 Better/Best (300-600 dpi) Office Plain
Mono Laser: $ 400-4,000 Best (1200 x 1200 dpi) Office Plain
Personal 1-10 ppm
Office Desktop/
Network 11-30 ppm
Color Inkjet 1-9 ppm $ 140-3,000 Better (300-1440 dpi) Home Plain/Coated/
Specialty
Dot Matrix 2-4 ppm $ 100-600 Good (240-360 dpi) Office Plain/Multi Parts
5
Laser Printers. The laser printer market is categorized by print speeds. Office
desktop or network monochrome laser printers are those that print 11-30 ppm
while low-speed lasers typically print 1-10 ppm*. Management believes that the
overall printer market is bifurcating into two principal segments: office
desktop printers suitable for an office environment and low-speed, lower cost
printers suitable for recreational and home office use by individuals.
In recent years, businesses have shifted from relying on large mainframe
computers to using local area networks ("LAN") that connect various types of
computers using a variety of protocols and operating systems. With this shift
has come the need for network printers that can communicate with, and adapt to,
the various configurations of the computers they serve. The ability to process
jobs quickly is also important. Most printers employed in the network
environment are office desktop printers with sophisticated software management
tools. Management expects network printers to continue to increase in speed and
that special features will proliferate to enhance network connectivity.
Low-speed laser printers are generally used as personal printers and are not
connected to networks. This segment is characterized by intense price pressure
and is vulnerable to replacement by low cost, color inkjet printers.
Based on the available market data, management believes that between 1991 and
1997 there was steady growth in overall shipments of network and personal laser
printers (1-30 ppm), although different segments of the market experienced
different growth rates. The company's shipments of network and personal laser
printers taken as a whole during 1991 to 1997 increased at a compound annual
rate, which management believes reflected the overall rate of growth of the
market as a whole. Within the office desktop network laser printer category,
Lexmark shipments increased at a rate which enabled the company to gain market
share. Lexmark shipments of low-speed laser printers also grew during the same
period but not as fast as the market growth within that category. Management
expects the market unit volume for low-speed laser printers to grow moderately
but that the market for office desktop laser printers--which includes the
company's Optra S line of laser printers--will experience, on average,
double-digit growth through 2001.
Laser printer unit growth in recent years has generally exceeded the growth rate
of laser printer revenues due to unit price pressure. This is partially offset
by the tendency for customers in the network segment of the market to trade up
to models with faster speeds, greater network connectivity, and other new
features. New models with such enhanced features generally sell at higher price
points and carry higher gross profit margins than the models they replace.
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* Data available from industry analysts as to the size of the laser and inkjet
printer market varies widely. The variance in laser printer market data is
caused in part by the rapid pace of change in laser printer speeds which makes
comparative analyses based on comparable product categories difficult over a
recent historical period. The company bases its analysis of historical market
trends on the data available from several different industry analysts. The
ranges of printing speed used to define and distinguish between laser printer
categories described herein are based on the company's own internal analysis of
the laser printer categories currently used by certain industry analysts to
measure the laser printer market.
6
Inkjet Printers. Growth in the market for inkjet printers, which are mainly used
as personal printers, reflects increased penetration of personal computers for
recreational and home office use. Strong market demand also reflects the
availability of low-cost technology capable of providing customers with good
quality printing at affordable prices. Lexmark's shipments of inkjet printers
increased at or near triple-digit rates annually from 1993 through 1996 and at
double-digit rates for 1997 which has enabled the company to gain market share.
Lexmark entered the color inkjet printer market with its own technology in 1994.
Growth in inkjet printer revenue has been slower than unit growth due to rapidly
declining prices. The greater affordability of color inkjet printers has been an
important factor in the explosive growth of this market.
Dot Matrix Printers. The market for dot matrix printers has been declining for
several years and volumes are expected to continue to decline in the future due
in large part to replacement by inkjet printers with higher print quality.
Associated Printer Supplies. Printer supplies products are defined by the
printing technology. Impact supplies are used in printers and typewriters that
put marks on paper through the use of some form of physical force, usually a
wire or hammer which applies force to a ribbon. The majority of impact supplies
are either fabric or film ribbons. Non-impact supplies are used in printers that
do not use force to put marks on paper. For example, the laser printer uses
electrophotography to place toner on paper. Non-impact supplies include toner
and photoconductor as well as ink cartridges used in inkjet printers.
The principal supply product for laser printers is a laser cartridge, which
includes toner and photoconductor. The principal supply product for inkjet
printers is an inkjet print cartridge, which includes ink and a circuit
assembly. The principal supply product for Lexmark's dot matrix printers is an
inked fabric ribbon. As the installed base of Lexmark laser and inkjet printers
continues to grow, the market for their associated supplies will grow as such
supplies are continually purchased throughout the life of the printers.
Strategy
Lexmark's laser printer strategy is to target fast growing industry segments of
the network printer market and to increase market share by providing high
quality, technologically advanced products at competitive prices. To promote
Lexmark brand awareness and market penetration, Lexmark will continue to
identify and focus on customer segments where Lexmark can differentiate itself
by supplying laser printers with features that meet specific customer needs and
represent the best total cost of printing solution. Management intends to
continue to develop and market products with more functions and capabilities
than comparably priced HP printers. The company's inkjet printer strategy is to
generate demand for the Lexmark color inkjet printer by offering high-quality
products at competitive prices to retail, business and OEM customers. Management
expects that the company's associated printer supplies business will continue to
grow as its installed base of laser and inkjet printers increases.
For the business customer, Lexmark expects to continue to offer an array of
advanced laser printer products with superior features and functions, higher
speeds and better print resolution at competitive prices. The company believes
that it is well-positioned to take advantage of the growth potential of LAN
printers due to its development and ownership of both the software and hardware
features that provide network connectivity and management tools. Lexmark has
targeted the office desktop laser printer markets and, as it has with the 1,200
dpi Optra S family, intends to remain one of the few printer companies that
create industry-wide standards for laser printer performance. Lexmark focuses
continually on enhancing the network capability of its laser printers by
introducing new products, like its MarkVision printer management utility, that
enhance the ability of its printers to function efficiently in a LAN environment
and provide significant flexibility to the LAN user.
7
Lexmark's large account marketing team focuses on demand generation in Fortune
1000 companies, other large corporations globally and specific industries where
Lexmark can differentiate itself by supplying high function products with
customized features to meet specific needs. These marketing teams work with
Lexmark's development teams to design features requested by large account
customers for specific functions. Lexmark has had recent success in its large
account marketing team's target markets, such as in the finance sector (whose
customers are served by Lexmark's duplex (double-sided printing) and "flash
memory" feature which permits instantaneous printing and updating of forms in
all locations). Another of the company's strategies is to offer its advanced
network management software in products to enable these financial institutions
to more efficiently manage and control their network printing activities.
Lexmark expects that its marketing strategy focusing on significant industry
segments will promote Lexmark brand awareness and provide a platform for greater
penetration of the laser printer market through sales by dealers and
distributors.
For the office and home user, Lexmark focuses on manufacturing well-priced,
reliable, easy-to-use color inkjet printers. The company expects that hardware
improvements in this market will result in faster printing and better print
quality. On the software side, the company expects that enhanced compatibility
with standard PC operating systems, such as Microsoft Windows 95 and Windows NT,
and software features that take advantage of the computing power of the PC for
printing functions will permit the company to reduce manufacturing costs for the
printers and to produce a product that is easier to use. Lexmark believes that
its core product offerings in this market will also permit it to build brand
recognition in the retail channels. The company has increased its product
distribution through retail outlets, with the number of such outlets worldwide
rising from approximately 5,000 retail outlets in 1995 to more than 15,000 in
1996, and remaining relatively constant during 1997. The company's ability to
increase or maintain its presence in the retail marketplace with its branded
products may be adversely affected as the company becomes more successful in its
sales and marketing efforts for OEM opportunities.
On the manufacturing side, the company is continually focusing on ways to reduce
costs and expand capacity while maintaining high quality. The company will also
consider strategic acquisitions in the future to leverage its technological
expertise.
Other Office Imaging Products
Market Overview
Other office imaging products include typewriters for office use and associated
supplies sold under the IBM name, impact supplies for Lexmark printers that are
no longer in production, supplies for IBM branded printers and after-market
printer supplies for other OEM printers. The markets for most of the company's
other office imaging products are generally declining, other than the market for
after-market laser cartridges for other OEM printers, which the company believes
is a market with significant growth potential.
In 1997, non-impact supplies were estimated to be an approximately $31 billion
opportunity worldwide, compared to the impact supplies opportunity of
approximately $2 billion. Based on available industry data, the company
estimates that worldwide impact supplies revenue will decline steadily in future
years, while non-impact supplies revenue will continue to grow.
Management expects that office typewriter market revenue will continue to
decline.
8
Strategy
In view of declining revenues and profit margins from sales of typewriters and
typewriter supplies and sales of other office imaging products for IBM printers,
the company's strategy for other office imaging products is to focus on the
after-market OEM supplies opportunity while managing its mature businesses for
cash flow. The company will continue to compete with other OEMs to provide
supplies for their installed bases of laser printers. The company may pursue
selected acquisitions of other office imaging products companies.
Lexmark will make minimal further investment in impact supplies and management
expects profit margins on such products to decline as a result of new agreements
with IBM that generally became effective on March 27, 1996. As a result of its
high quality products, the company benefits from customer loyalty, which has
historically permitted it to continue its premium pricing strategy.
Keyboards and Other
The company historically manufactured keyboards primarily for IBM. Following the
expiration in March 1996 of the company's keyboard agreement with IBM and
management's expectation that the keyboard industry will continue to experience
price declines resulting in low margins and a low return on assets, the company
completed its transition out of the keyboard business by the end of the first
quarter of 1996. Keyboard sales accounted for 8% and 3%, respectively, of the
company's revenue and gross profit for 1995.
Products
The company's current product offerings consist primarily of the Lexmark Optra S
laser printer product line and Optra SC color laser printer, the Optra E+
personal laser printer, a wide range of inkjet printers, a family of network
print servers, typewriters and dot matrix printers. The company also designs,
manufactures and distributes a variety of print cartridges for use in its laser
and inkjet printers as well as approximately 900 other office imaging products,
including typewriter supplies and supplies for other printers, including IBM
printers.
Lexmark's main printer products are listed below:
Category Products U.S. Price Range
-------- -------- ----------------
Office Desktop/Network
Mono Laser Optra S 1250 $1,050-1,400
Optra S 1650/1620 $1,050-1,500
Optra S 2450/2420 $1,600-2,500
Optra N $2,500-3,100
Color Laser Optra SC 1275 $3,900-4,600
Personal Laser Optra E+ $ 400-700
Color Inkjet Color Jetprinter 1000, 2030 & 2050 $ 140-200
Color Jetprinter 3000 $ 200-300
Color Jetprinter 5700 $ 249
Color Jetprinter 7000, 7200 & 7200V $ 300-500
Color Jetprinter 4079+ $2,650-3,000
Dot Matrix 23XX $ 300-600
4227 $1,300-1,800
9
The company has upgraded and improved its laser printer product offerings
significantly since the Acquisition with the introduction of several models
adding functionality and performance at lower prices. The company's current
network laser family, the Optra S line, was introduced in the second quarter of
1997 and offers ten products at various price ranges. The Optra S line includes
models at 12, 16 and 24 ppm and include 1,200 dpi printing, high performance
RISC processors and a wide range of paper handling options. The Optra SC color
laser printers offer high quality business color printing at 12 ppm black and 3
ppm color. Another standard feature of the product line is MarkVision, Lexmark's
printer management program, which permits bi-directional communication for
status management between the user or LAN administrator and the printer.
In addition to offering connectivity solutions and management tools as features
on its laser printers, Lexmark also designs and manufactures network print
servers. These products provide a means to connect virtually any printer to a
local or wide area network. The company's current product offering is the
MarkNet Pro series, a family of print servers capable of simultaneous support of
multiple networking environments. The MarkNet Pro 3 provides direct network
connection for multiple printers and can also connect an external fax modem for
printing incoming fax. The MarkNet Pro 1 provides direct network connection for
a single printer at a lower cost.
The company currently markets a number of personal color inkjet printers for
individual home and office use. These printers generally retail in a range of
$140-$500 and offer sharp color printing, fast performance, compatibility with
leading software applications, and ease of installation and use.
The company also markets five dot matrix printers in the $300-$1,800 price range
for customers who print large volumes of multi-part forms.
The company designs, manufactures and distributes a variety of cartridges for
use in its installed base of laser and inkjet printers. Lexmark is currently the
exclusive source for new print cartridges for the printers it manufactures.
The company's other office imaging products include approximately 900 products,
including typewriter products and products for IBM and other OEM printers using
both impact and non-impact technology. The company continues to offer a broad
line of typewriters with the IBM logo, which remain the industry leaders. The
company also provides a wide range of supplies for the large installed base of
IBM printers including toners, ribbons, photoconductors and other printer
accessories. Lexmark also manufacturers and sells after-market laser cartridges
for laser printers sold by other manufacturers.
Marketing and Distribution
Printers and Associated Supplies
The company markets and distributes its laser printers primarily through its
well-established dealer network, which includes such dealers as Microage
Computers, Ameridata, Vanstar, Tech Data, Merisel, Ingram Micro, Computer 2000,
North Amber and Inacom. The company's products are also sold through value-added
resellers, who offer custom solutions to specific markets.
The company employs large account marketing teams whose mission is to generate
demand for Lexmark printers primarily among Fortune 1000 companies and other
large corporations globally. In recent years, marketing teams have begun to
focus on industry segments such as banking, retail/pharmacy, automobile
distribution and health care. Those teams, in conjunction with the company's
development and manufacturing teams, are able to design products to meet
customer specifications for printing electronic forms, media handling, duplex
printing and other
10
custom solutions. Almost all customer orders solicited by these marketing teams
are filled through dealers or resellers.
The company distributes its personal inkjet printers primarily through more than
15,000 retail outlets worldwide including office superstores such as Office
Depot, Office Max and Staples, computer superstores such as Computer City,
consumer electronics stores such as Circuit City, Best Buy and Radio Shack,
other large regional chains and overseas stores such as Dixons, Carrefour,
Harvey Norman and Vobis. The company's ability to increase or maintain its
presence in the retail marketplace with its branded products may be adversely
affected as the company becomes more successful in its sales and marketing
efforts for OEM opportunities.
The company's international sales are an important component of its operations.
The company's sales and marketing activities in its global markets are organized
to meet the needs of the local jurisdictions and the size of their markets. The
company's European marketing operation is structured similarly to its domestic
marketing activity. The company's products are available from major information
technology resellers such as Northamber and in large markets from key retailers
such as Media Markt in Germany, Dixons in the United Kingdom and Carrefour in
France. Canadian marketing activities, like those in the United States, focus on
large account demand generation and vertical markets, with orders filled through
distributors and retailers. The company's Latin American and Asian Pacific
markets are served through a combination of Lexmark sales offices, strategic
partnerships and distributors. The company also has sales and marketing efforts
for OEM opportunities. To the extent these efforts become successful, there may
be an adverse affect on the company's ability to increase or maintain its
presence in the retail marketplace with its branded products.
The company's printer supplies and other office imaging products are generally
available at the customer's preferred point of purchase through multiple
channels of distribution. Although channel mix varies somewhat depending on the
geography, substantially all of the company's supplies products sold
commercially in 1997 were sold through the company's network of
Lexmark-authorized supplies distributors and resellers who sell directly to end
users or to independent office supply dealers. Lexmark's supplies are also
available at office and computer superstores, consumer electronics stores and
mass merchandisers.
Competition
Printers and Associated Supplies
The markets for printers and associated supplies are highly competitive,
especially with respect to pricing and the introduction of new products and
features. The office desktop laser printer market is dominated by HP, which has
a widely recognized brand name and has been estimated to have an approximate 65%
to 70% market share. Several other large manufacturers such as Canon, Apple,
Xerox and IBM also compete in the laser printer market.
The company's strategy is to target fast growing segments of the network printer
market and to increase market share by providing high quality, technologically
advanced products at competitive prices. This strategy requires that the company
continue to develop and market new and innovative products at competitive
prices. New product announcements by the company's principal competitors,
however, can have and in the past have had a material adverse effect on the
company's financial results. Such new product announcements can quickly
undermine any technological competitive edge that one manufacturer may enjoy
over another and set new market standards for quality, speed and function.
Furthermore, knowledge in the marketplace about pending new product
announcements by the company's competitors may also have a material adverse
effect on the company inasmuch
11
as purchasers of printers may defer purchasing decisions until the announcement
and subsequent testing of such new products.
In recent years, the company and its principal competitors, all of which have
significantly greater financial, marketing and technological resources than the
company, have regularly lowered prices on printers and are expected to continue
to do so. The company is vulnerable to these pricing pressures which, if not
mitigated by cost and expense reductions, may result in lower profitability and
could jeopardize the company's ability to grow or maintain market share and
build an installed base of Lexmark printers. The company expects that, as it
competes more successfully with its larger competitors, the company's increased
market presence may attract more frequent challenges, both legal and commercial,
from its competitors, including claims of possible intellectual property
infringement.
HP is also the market leader in the personal color inkjet printer market and,
with Canon and Epson, has been estimated to account for approximately 80% to 90%
of worldwide personal color inkjet printer sales. As with laser printers, if
pricing pressures are not mitigated by cost and expense reductions, the
company's ability to maintain or build market share and its profitability could
be adversely affected. In addition, as a relatively new entrant to the retail
marketplace with a less widely recognized brand name, the company must compete
with HP, Canon and Epson for retail shelf space for its inkjet printers. The
company's ability to increase or maintain its presence in the retail marketplace
with its branded products may be adversely affected as the company becomes more
successful in its sales and marketing efforts for OEM opportunities.
Like certain of its competitors (including Xerox), the company is a supplier of
after-market laser cartridges for laser printers using certain models of Canon
engines. There is no assurance that the company will be able to compete
effectively for a share of the after-market cartridge business for its
competitors' base of laser printers. The company's participation in this market
may have an adverse effect on the company's relations with certain of its
suppliers. Although Lexmark is currently the exclusive supplier of new print
cartridges for its laser printers, there can be no assurance that other
companies will not develop new compatible cartridges for Lexmark laser printers.
In addition, refill and remanufactured alternatives for the company's cartridges
are available from independent suppliers and, although generally offering lower
print quality, compete with the company's supplies business. As the installed
base of laser and inkjet printers grows and ages, the company expects
competitive refill and remanufacturing activity to increase.
Other Office Imaging Products
The market for other office imaging products is extremely competitive and the
impact segment of the supplies market is declining. Although the company has
exclusive rights to market certain IBM branded supplies until April 1999, there
are more than 100 independent ribbon manufacturers and more than 25 independent
toner manufacturers competing to provide compatible supplies for IBM branded
printing products. Independent manufacturers compete for the after-market ribbon
business under either their own brand, private label, or both, using price,
aggressive marketing programs, and flexible terms and conditions to attract
customers. Depending on the product, prices for compatible products produced by
independent manufacturers generally range from 15% to 70% below the company's
prices.
The company is less dependent on revenue and profitability from its other office
imaging products business than it has been historically and intends to focus on
the growing portions of that market such as the after-market laser cartridge
supplies category. There is no assurance that the company will be able to
compete in the after-market laser supplies business effectively or that the
declining market areas in its other office imaging products business will not
adversely affect the company's operating results.
12
The company does not expect any major new entrants into the ribbon market.
However, in response to the declining impact supplies opportunity, many
established competitors are investing in non-impact capacity and joining forces
through acquisitions on a worldwide basis. The company's primary U.S.
competitors in the overall supplies market include Nu-kote, Turbon, GRC and NER.
Internationally, the company's primary competitors are Turbon, Armor, TBS, and
Pelikan (acquired by Nu-kote) in Europe and Fullmark in the Far East.
The company is increasing its efforts to provide laser supplies for other OEM
printers. As an after-market supplier in the all-in-one laser cartridge
business, the company faces competition from both the OEMs and cartridge
remanufacturers. In order to become an effective worldwide supplier of
after-market cartridges, the company will need to compete with HP, Canon and
Xerox.
The company believes the current number of competitors in the declining
worldwide office typewriter market is fewer than 10, down significantly from
over 40 in the mid-1980's. The three primary competitors in the U.S. market are
Canon, Nakajima and Swintec. The company believes that it is dominant in the
U.S. office typewriter market. Remaining office typewriter competitors with
multiple product lines continue to shift focus to other products in their
portfolios (copier, fax, PC, multifunction, etc.). No significant new office
typewriter product announcements have been made by any key competitor since
1993.
Manufacturing
The company's manufacturing facilities are located in Lexington, Kentucky,
Boulder, Colorado, Orleans, France and Sydney, Australia, all of which are ISO
9000 certified. The company opened new facilities during 1996 in Rosyth,
Scotland, which is ISO 9000 certified and Juarez, Mexico. Most of the company's
laser and inkjet technologies are developed in Lexington and Boulder. The
company's manufacturing strategy is to keep processes that are technologically
complex, proprietary in nature and higher value added, such as the manufacture
of inkjet cartridges, at the company's own facilities. Stable technology, labor
intensive and non-strategic operations, such as the manufacture of dot matrix
printers, are typically performed by lower-cost vendors.
Management believes that the Lexington manufacturing facility employs some of
the most modern techniques in the industry. In order to make its facility
capable of implementing new products with a shorter cycle time, the company
revamped the Lexington facility from a fully automated plant to a more flexible
facility. Accordingly, the company has the ability to adapt the plant to the
requirements of a new product and to adopt more efficient manufacturing
techniques as they are developed. The plant's electronic card assembly and test
facility with surface mount technologies also enhances the company's
manufacturing capability.
The company's development and manufacturing operations for laser printer
supplies which include toners, photoconductor drums, developers, charge rolls
and fuser rolls, are located in Boulder. The company has made significant
capital investments in the Boulder facility to expand toner and photoconductor
drum processes.
Raw Materials
The company procures a wide variety of components used in the manufacturing
process, including semiconductors, electro-mechanical components and assemblies,
as well as raw materials, such as plastic resins. Although many of these
components are standard off-the-shelf parts that are available from multiple
sources, the company often utilizes preferred supplier relationships to better
ensure more consistent quality, cost, and delivery. Typically, these preferred
suppliers maintain alternate processes and/or facilities to ensure continuity of
supply. The company generally must place commitments for its projected component
needs approximately three to six months in advance. The company occasionally
faces capacity constraints when there has been more demand for its printers and
associated supplies than initially projected.
13
Some components of the company's products are only available from one supplier,
including certain custom chemicals, microprocessors, application specific
integrated circuits and other semiconductors. In addition, the company sources
some printer engines and finished products from OEMs. Although the company
purchases in anticipation of its future requirements, should these components
not be available from any one of these suppliers, there can be no assurance that
production of certain of the company's products would not be disrupted. Such a
disruption could interfere with the company's ability to manufacture and sell
products and materially adversely affect the company's business.
Research and Development
The company's research and development activity for the past four years has
focused on laser and inkjet printers and associated supplies and on network
connectivity products. The company is selective in targeting its research and
development efforts. For example, anticipating the industry trend, the company
minimized investing in dot matrix technology in 1991 and has instead devoted its
research and development resources to the faster growing markets for laser and
inkjet printers. The company has been able to keep pace with product development
and improvement while spending less than its larger competitors on research and
development. It has even been able to achieve significant productivity
improvements and minimize research and development costs. In the case of certain
products, the company may elect to purchase products and key components from
third party suppliers.
The company is committed to being a technology leader in its targeted areas and
is actively engaged in the design and development of additional products and
enhancements to its existing products. Its engineering effort focuses on laser,
inkjet, and connectivity technologies as well as design features that will
increase efficiency and lower production costs. The process of developing new
technology products is complex and requires innovative designs that anticipate
customer needs and technological trends. Research and development expenditures
were $129 million in 1997, $124 million in 1996 and $116 million in 1995. In
addition, the company must make strategic decisions from time to time as to
which new technologies will produce products in market segments that will
experience the greatest future growth. There can be no assurance that the
company can continue to develop the more technologically advanced products
required to remain competitive.
IBM Relationship
In connection with the Acquisition, IBM entered into numerous agreements to
support the company's operations for a five-year term. These agreements, which
expired on March 27, 1996, included a keyboard supply agreement (which obligated
IBM to acquire essentially all of its desktop keyboard requirements from the
company), an internal use agreement (which obligated IBM to acquire
substantially all of its requirements for desktop printers, typewriters and
associated supplies from the company), an IBM trademark license agreement (which
permitted the company to use the IBM trademark on certain of its products) and a
non-competition agreement (pursuant to which IBM was prohibited from competing
with the company's products).
The company completed its transition out of the keyboard business by the end of
the first quarter of 1996 and entered into an agreement with IBM providing for
the orderly transition of the company's keyboard business to IBM or other
vendors. Under this agreement with IBM, IBM paid the company $36.5 million of
which $24 million related to amounts recorded by the company through September
30, 1995, $6 million of profit recorded through March 1996, and $6.5 million for
the purchase of certain keyboard assets. The company's keyboard business, of
which IBM represented approximately 95%, accounted for revenues of $32 million
and $177 million for the years 1996 and 1995, respectively. Under the original
agreement with IBM, the company's keyboard business was guaranteed a minimum
gross profit, and in the years ended 1996 and 1995 the keyboard business
contributed $6 million and $18 million, respectively, toward the company's
consolidated gross profit.
14
Sales to IBM (excluding sales of keyboards) were $103 million, $163 million and
$258 million for the years 1997, 1996 and 1995, respectively. The company
believes IBM will continue to be a significant customer but that future revenue
and profitability from IBM sales will continue to decline as the company's core
printer and associated supplies business represents a larger percentage of the
company's total business.
In the third quarter of 1995, the company entered into a profit sharing supplies
agreement with IBM and a related agreement for an extension of the IBM trademark
agreement that allows the company to continue to use the IBM logo on certain
existing printer supplies in its other office imaging products line through
March 31, 1999. Under these agreements, Lexmark has been required since April
1996 to share the profits from the company's sale of certain products bearing
the IBM logo. The company also entered into a royalty agreement for an extension
of the right to use the IBM logo on typewriters, typewriter supplies and certain
other IBM branded printer supplies through March 27, 2001. Since these new
arrangements became effective on March 27, 1996, the company estimates that
operating income has been reduced approximately $7 million to $9 million a
quarter.
Since March 27, 1996, IBM is no longer required to purchase its desktop printers
and typewriters from the company. However, IBM subsequently entered into an
agreement to use its best efforts to buy its printer and typewriter supplies
from the company through March 31, 1999. In addition, since March 27, 1996, IBM
is no longer prohibited from competing with the company's printer business, and
in June 1996, IBM introduced laser printer products that compete with the
company's products.
Although the company and IBM have entered into agreements providing for an
ongoing relationship, the company expects that future revenue and profit
received from IBM will decline significantly and that such decline could have a
material adverse effect on the company. However, the company anticipated the
expiration of these agreements and has redeployed the resources previously
utilized on the declining keyboard and other businesses associated with the
majority of the IBM agreements to the company's strategically important
businesses.
Large Customers
No customer other than IBM has accounted for more than 10% of the company's
consolidated revenues since 1995.
Backlog
The company generally ships its products within 30 days of receiving orders and
therefore has a backlog of generally less than 30 days at any time, which
backlog the company does not consider material to its business.
Employees
As of December 31, 1997, the company had approximately 8,000 employees worldwide
of which 5,500 are located in the U.S. and the remaining 2,500 in Europe,
Canada, Latin America and Asia Pacific. None of the U.S. employees are
represented by any union. Employees in France, Germany and the Netherlands are
represented by Statutory Works Councils. Substantially all regular employees
have stock options. The company's employees have been organized in employee
teams that are able to make rapid decisions and to implement those decisions to
achieve faster development and manufacturing cycle times.
15
Intellectual Property
The company's intellectual property is one of its major assets and the ownership
of the technology used in its products is important to its competitive position.
The company has about 120 patent cross-license agreements of various types with
various third parties. These license agreements include agreements with, for
example, Canon and HP. Most of these license agreements provide cross-licenses
to patents arising from patent applications first filed by the parties to the
agreements before certain dates in the early 1990s, with the date varying from
agreement to agreement. Each of the IBM, Canon and HP cross-licenses grants
worldwide, royalty-free, non-exclusive rights to the company to use the covered
patents to manufacture certain of its products. Certain of the company's
material license agreements, including those that permit the company to
manufacture its current design of laser and inkjet printers and after-market
laser cartridges for certain OEM printers, terminate as to future products upon
certain "changes of control" of the company. The company also holds a number of
specific patent licenses obtained from third parties to permit the production of
particular features in products.
The company holds approximately 1,350 patents worldwide and has approximately
900 pending patent applications worldwide covering a range of subject matter.
The company has filed over 1,000 worldwide patent applications since its
inception in 1991. The company's patent strategy includes obtaining patents on
key features of new products which it develops and patenting a range of
inventions contained in new supply products such as toner and ink cartridges for
printers. Where appropriate, the company seeks patents on inventions flowing
from its general research and development activities. While no single patent or
series of patents is material to the company, the company's patent portfolio in
the aggregate serves to protect its product lines and offers the possibility of
entering into license agreements with others.
The company designs its products to avoid infringing the intellectual property
rights of others. The company's major competitors, such as HP and Canon, have
extensive, ongoing worldwide patenting programs. As is typical in technology
industries, disputes arise from time to time about whether the company's
products infringe the patents or other intellectual property rights of major
competitors and others. As the company competes more successfully with its
larger competitors, more frequent claims of infringement may be asserted.
In October 1996, Lexmark International entered into an agreement with HP to
cross-license each other's patents filed prior to a specified date (the "HP
Agreement"). The HP Agreement generally gives both parties a worldwide
non-exclusive license under the licensed patents for the manufacture and sale of
printers, as well as accessories and consumable supplies designed for use with
each party's own printers. In addition, the HP Agreement resolves issues of
patent infringement that had been raised by both companies and does not involve
any royalty or other payment by either party. The HP Agreement generally permits
licenses granted thereunder to be terminated in the event of a "change of
control," which includes, in very limited circumstances, an acquisition of
substantially less than 50% of the LIG's or Lexmark International's voting
shares.
The company has trademark registrations or pending trademark applications for
the name LEXMARK in approximately 70 countries for various categories of goods.
The company also owns a number of trademark applications and registrations for
product names, such as the OPTRA laser printer name. Although the company
believes the LEXMARK trademark is material to its business, it does not believe
any other trademarks are material.
The company holds worldwide copyrights in computer code, software and
publications of various types.
16
Environmental and Regulatory Matters
The company's operations, both domestically and internationally, are subject to
numerous laws and regulations, particularly relating to environmental matters
that impose limitations on the discharge of pollutants into the air, water and
soil and establish standards for the treatment, storage and disposal of solid
and hazardous wastes. The company is also required to have permits from a number
of governmental agencies in order to conduct various aspects of its business.
Compliance with these laws and regulations has not had and is not expected to
have a material effect on the capital expenditures, earnings or competitive
position of the company. There can be no assurance, however, that future changes
in environmental laws or regulations, or in the criteria required to obtain or
maintain necessary permits, will not have an adverse effect on the company's
operations.
Item 2. Properties
The company's manufacturing and other material operations are conducted at the
facilities set forth below:
Location Square Feet Activities Status
-------- ----------- ---------- ------
Lexington, KY 2,966,000 Headquarters, Manufacturing,
Development, Administrative,
Distribution, Warehouse,
Marketing Owned
266,000 Warehouses, Development Leased(1)
Boulder, CO 332,000 Manufacturing, Development,
Warehouse Leased(2)
Dietzenbach, Germany 49,000 Administrative, Warehouse Leased(3)
Juarez, Mexico 95,000 Manufacturing, Administrative Owned
Markham, Ontario 31,000 Administrative, Marketing,
Warehouse Leased(4)
Orleans, France 452,000 Manufacturing, Administrative,
Warehouse Owned
Ormes, France 192,000 Warehouse Leased(5)
Paris, France 48,000 Administrative, Marketing Leased(6)
Rosyth, Scotland 92,000 Manufacturing, Administrative Owned
Sydney, Australia 64,000 Manufacturing, Administrative,
Warehouse, Marketing Leased(7)
- --------------------------------------------------
(1) Leases covering 151,000 square feet expire September 1998 and carry one-year
renewal options. Lease covering 115,000 square feet expires August 1998 and
carries five three-year renewal options.
(2) Lease covering 278,000 square feet expires May 2001 and carries three five-
year renewal options. Lease covering 54,000 square feet expires December
1998 and carries two one-year renewal options.
(3) Leases covering this property expire September 2004 and there are no renewal
options.
(4) Lease covering this property expires September 2001 and carries
two five-year renewal options.
(5) Lease covering this property expires
February 1999 and carries one three-year renewal option.
(6) Leases covering
this property expire December 2006 and there are no renewal options.
(7) Lease covering this property expires March 2002 and carries one six-year
renewal option.
The company believes its facilities are in good operating condition.
17
Item 3. Legal Proceedings
The company is party to various litigation and other legal matters that are
being handled in the ordinary course of business. The company does not believe
that any legal proceedings to which it is a party or to which any of its
property is subject will have a material adverse effect on the company's
financial position or results of operations. As the company competes more
successfully with its larger competitors, the company's increased market
presence may attract more frequent legal challenges from its competitors,
including claims of possible intellectual property infringement. Although the
company does not believe that the outcome of any current claims of intellectual
property infringement is likely to have a material adverse effect on the
company's future operating results and financial condition, there can be no
assurance that such claims will not result in litigation. In addition, there can
be no assurance that any litigation that may result from the current claims or
any future claims by these parties or others would not have a material adverse
effect on the company's business.
Item 4. Submission of Matters to a Vote of Security Holders
None
18
Part II
Item 5. Market For Registrant's Common Equity and Related Stockholder Matters
Lexmark International Group's Class A common stock is traded on the New York
Stock Exchange under the symbol LXK. As of February 28, 1998, there were
approximately 1,207 holders of record of the Class A common stock and there were
no holders of record of the Class B common stock. Information regarding the
market prices of the company's Class A common stock appears in Part II, Item 8,
Notes to Consolidated Financial Statements, Note 19.
Other than the dividend to stockholders of record on April 3, 1998 of one right
to purchase under certain circumstances one one-hundredth of a share of Series A
Junior Participating preferred stock, the company has never declared or paid any
cash dividends on the Class A common stock and has no current plans to pay cash
dividends on the Class A common stock. The payment of any future cash dividends
will be determined by the company's Board of Directors in light of conditions
then existing, including the company's earnings, financial condition and capital
requirements, restrictions in financing agreements, business conditions, certain
corporate law requirements and other factors.
The company is a holding company and thus its ability to pay cash dividends on
the Class A common stock depends on the company's subsidiaries' ability to pay
cash dividends to the company.
19
Item 6. Selected Financial Data
The table below summarizes recent financial information for the company. For
further information, refer to the company's financial statements and notes
thereto presented under Part II, Item 8 of this Form 10-K.
(Dollars in Millions, Except Share Data)
- -------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Statement of Earnings Data:
- -----------------------------------------------------------------------------------------------------------------
Revenues $2,493.5 $2,377.6 $2,157.8 $1,852.3 $1,675.7
Cost of revenues 1,623.5 1,630.2 1,487.9 1,298.8 1,107.4
- -----------------------------------------------------------------------------------------------------------------
Gross profit 870.0 747.4 669.9 553.5 568.3
Research and development 128.9 123.9 116.1 101.0 111.7
Selling, general and administrative 466.5 388.0 359.1 292.9 322.0
Option compensation related to IPO (1) - - 60.6 - -
Amortization of intangibles (2) - 5.1 25.6 44.7 64.0
- -----------------------------------------------------------------------------------------------------------------
Operating income 274.6 230.4 108.5 114.9 70.6
Interest expense 10.8 20.9 35.1 50.6 63.9
Amortization of deferred financing costs
and other 9.1 7.9 10.1 13.6 13.1
- -----------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes 254.7 201.6 63.3 50.7 (6.4)
Provision for income taxes 91.7 73.8 15.2 6.1 3.0
- -----------------------------------------------------------------------------------------------------------------
Earnings (loss) before extraordinary item 163.0 127.8 48.1 44.6 (9.4)
Extraordinary loss (14.0) - (15.7) - -
(3)
- -----------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ 149.0 $ 127.8 $ 32.4 $ 44.6 $ (9.4)
Diluted earnings (loss) per common share
before extraordinary item (4) (11) $ 2.17 $ 1.69 $ 0.65 $ (0.46) $ (0.34)
Diluted net earnings (loss) per common
share (4) (11) $ 1.98 $ 1.69 $ 0.44 $ (0.46) $ (0.34)
Shares used in per share calculation 75,168,776 75,665,734 74,200,279 61,430,896 61,458,241
Statement of Financial Position Data:
- -----------------------------------------------------------------------------------------------------------------
Working capital $ 228.6 $ 343.8 $ 227.7 $ 237.5 $ 293.6
Total assets 1,208.2 1,221.5 1,142.9 960.9 1,215.0
Total long-term debt (including current
portion) 75.0 165.3 195.0 290.0 650.7
Redeemable senior preferred stock (5) - - - - 85.0
Stockholders' equity (5) 500.7 540.3 390.2 295.5 173.7
Other Key Data:
- -----------------------------------------------------------------------------------------------------------------
Operating income before amortization and
unusual item (6) $ 274.6 $ 235.5 $ 194.7 $ 159.6 $ 134.6
Diluted earnings (loss) per share before
unusual items (7) (11) $ 2.17 $ 1.69 $ 1.17 $ 0.51 $ (0.34)
Cash from operations (8) 274.9 118.0 307.5 361.9 176.4
Capital expenditures 69.5 145.0 106.8 58.1 62.4
Debt to total capital ratio 13% 23% 33% 50% 72%
Return on average equity before unusual
items (9) 30% 27% 25% 21% (6%)
Number of employees (10) 7,985 6,573 7,477 5,934 5,885
- -----------------------------------------------------------------------------------------------------------------
(1) The company recognized a non-cash compensation charge of $60.6 million
($38.5 million net of tax benefit) in the fourth quarter of 1995 for
certain of the company's outstanding employee stock options upon the
consummation of the initial public offerings.
(2) Acquisition-related intangibles were fully amortized by March 31, 1996.
(3) In 1997, represents extraordinary after-tax loss caused by the early
extinguishment of the Company's senior subordinated notes and in 1995,
represents extraordinary after-tax loss caused by an early extinguishment
of debt related to the refinancing of the company's term loan.
20
(4) Earnings (loss) per common share are net of dividends of $11.8 million and
$11.5 million paid on the company's redeemable senior preferred stock in
1994 and 1993. Earnings attributable to common stock in 1994 are also net
of a $61.3 million preferred stock redemption premium related to the
exchange of redeemable senior preferred stock for Class A common stock
on December 30, 1994.
(5) Redeemable senior preferred stock with a liquidation preference of $85.0
million was exchanged for 9,750,000 shares of Class A common stock on
December 30, 1994.
(6) Unusual item in 1995 reflects the non-cash compensation charge discussed
in (1) above.
(7) Unusual item in 1997 represents the extraordinary after-tax loss discussed
in (3) above. Unusual items in 1995 includes the non-cash compensation
charge discussed in (1) above and the extraordinary after-tax loss
discussed in (3) above. The unusual item in 1994 represents the preferred
stock redemption premium discussed in (4) above.
(8) Cash flows from investing and financing activities, which are not
presented, are integral components of total cash flow activity.
(9) Unusual item in 1997 represents the extraordinary loss discussed in (3)
above. Unusual items in 1995 includes the non-cash compensation charge
discussed in (1) above and the extraordinary after-tax loss discussed in
(3) above.
(10) Represent the number of full-time equivalent employees at December 31st of
each year.
(11) Earnings per share amounts have been calculated and presented under the
provisions of SFAS No. 128.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis should be read in conjunction with the
consolidated financial statements and notes thereto.
OVERVIEW
Lexmark International Group, Inc. (together with its subsidiaries, the "company"
or "Lexmark") is a global developer, manufacturer and supplier of laser and
inkjet printers and associated consumable supplies. The company also sells dot
matrix printers for printing single and multi-part forms by business users. The
company's core printer business targets the office and home markets. In addition
to its core printer business, Lexmark develops, manufactures and markets a broad
line of other office imaging products which include supplies for International
Business Machines Corporation ("IBM") branded printers, after-market supplies
for other original equipment manufacturer ("OEM") products, and typewriters and
typewriter supplies that are sold under the IBM trademark. The company's
"keyboard and other" product category was phased out by the end of the first
quarter of 1996.
In the past few years, the worldwide printer industry has seen substantial
growth in demand for laser and inkjet printers as a result of increasing
penetration of personal computers into the office and home markets. During this
period, the company's own product mix has evolved, with its laser and inkjet
printers and associated supplies representing an increasingly larger percentage
of its sales volume and revenues, particularly as the increasing base of
installed Lexmark printers generates additional revenues from recurring sales of
supplies for those printers (primarily laser and inkjet cartridges). In 1997,
revenues from the sale of printers and associated printer supplies increased 10%
from 1996 and accounted for 81% of total company revenues of approximately $2.5
billion. Most of this growth was derived from increasing sales of laser and
inkjet printers and printer cartridge supplies, offset in part by slowing demand
for dot matrix printers which depend on older impact-printing technology and
declines in the traditional IBM branded supplies business.
Lexmark believes that its total revenues will continue to grow due to overall
market growth and increases in the company's market share in both the network
and color inkjet printer categories. Management believes that this growth will
more than offset reduced demand for dot matrix impact printers which depend on
older impact-printing technology and declines in the traditional IBM branded
supplies business.
In recent years, the company's growth rate in sales of printer units generally
exceeded the growth rate of its printer revenues due to price pressures and the
introduction of new lower priced products in both the laser and inkjet printer
markets. In the laser printer market, unit price pressure is partially offset by
the tendency of
21
customers to move up to higher priced printer models with faster speeds, greater
network connectivity and other new features. In the inkjet printer market,
advances in color inkjet technology have resulted in lower prices for printers
with sharper resolution and improved performance. The greater affordability of
color inkjet printers has been an important factor in the recent growth of this
market.
The company's other office imaging products category includes many mature
products such as supplies for IBM printers, typewriters and typewriter supplies
and other impact supplies that require little investment but provide a
significant source of cash flow. The company expects that the market for these
products and the profitability from the sale of these products will continue to
decline, but the company will attempt to mitigate these declines through the
introduction of new supplies for non-impact technologies, such as after-market
laser cartridges. Lexmark introduced its first after-market laser cartridges in
May 1995 for the large installed base of a range of laser printers sold by other
manufacturers. The company's strategy for other office imaging products is to
pursue the after-market OEM laser supplies opportunity while managing its mature
businesses for cash flow.
The company expects that its overall margins will remain relatively stable as
its associated printer supplies business becomes an increasingly larger part of
its business, offsetting the decline in the company's other office imaging
products supplies business. Although the company expects continuing declines in
printer prices, it expects to reduce costs in line with price decreases.
The company's operations have been significantly impacted by a number of key
agreements with IBM which were negotiated as part of the acquisition of
Information Products Corporation from IBM in March 1991. In general, these
agreements expired on March 27, 1996. Although the company and IBM have entered
into a number of new agreements, which extend some of the original agreements
(although on less favorable terms) and provide for an ongoing relationship in
other areas, management expects that future revenue and profit attributable to
sales to IBM will continue to decline.
In February 1997, the public offering of 10,148,100 shares of the company's
Class A common stock by certain of its stockholders was completed at a public
offering price of $24.875 per share. In November 1997, the public offering of
10,145,000 shares of the company's Class A common stock by certain of its
stockholders was completed at a public offering price of $31.00 per share. The
company and current members of management chose not to sell any shares in either
offering and, therefore, did not receive any of the proceeds from the sale of
the shares.
In November 1997, the company repurchased an additional 3 million shares (the
"Repurchase Shares") from certain of the stockholders participating in the
November 1997 offering at a price of $29.90 per share (which was equal to the
net proceeds per share received by the selling stockholders participating in the
offering) for an aggregate purchase price of approximately $90 million. See
"Liquidity and Capital Resources".
In January 1998, the company entered into a new $300 million unsecured,
revolving credit facility with a group of banks. Upon entering the new
agreement, the company repaid the amounts outstanding on its existing term loan
and revolving credit facility.
RESULTS OF OPERATIONS
1997 compared to 1996
Consolidated revenues in 1997 were $2,494 million, an increase of 5% over 1996.
Revenues were adversely affected by foreign currency exchange rates due to the
strengthening of the U.S. dollar. Without the currency
22
effect, year-to-year revenue growth would have been 10%. Printers and associated
supplies revenues were $2,017 million, an increase of 10%, and revenues from
other office imaging products were $477 million, a decrease of 7%. Excluding the
keyboard business in 1996, revenues for 1997 were up $149 million or 6% from
1996. Total U.S. revenues were up slightly and international revenues were up
$115 million or 11%.
[GRAPH APPEARS HERE]
. REVENUES
... printers and associated supplies represen an increasingly larger
proportion of company's operations
in percent
1994 1995 1996 1997
---- ---- ---- ----
Printers and associated supplies 58.5% 68.5% 77.0% 80.9%
Other 41.5 31.5 23.0 19.1
The company's results were primarily driven by printers and associated supplies.
The company introduced the Optra S family of monochrome and color laser printers
in May 1997, and also made inkjet product announcements in the second and third
quarters of 1997, with the introduction of the 1000, 3000 and 7000 Color
Jetprinters, along with the 7200 series of Color Jetprinters. Even though the
product line was in transition, printer volumes grew at double-digit rates and
printer supplies revenues increased during 1997 as compared to 1996 due
primarily to the continued growth of the company's installed printer base.
The color inkjet market, the fastest growing segment of the personal printer
market (printers in the 1-10 pages per minute ("ppm") category), expanded
rapidly due to growth in personal computers and home offices, and the
development of easy-to-use color inkjet technology with good quality color print
capability at low prices. Lexmark introduced its first color inkjet printer
using its own technology in 1994 and experienced strong sales growth through
retail outlets. The company increased its product distribution through retail
outlets, with the number of such outlets worldwide rising from approximately
5,000 retail outlets in 1995 to more than 15,000 in 1996, and remaining
relatively constant during 1997. The company's ability to increase or maintain
its presence in the retail marketplace with its branded products may be
adversely affected as the company becomes more successful in its sales and
marketing efforts for OEM opportunities. The company made substantial capital
investments in its inkjet production capacity in 1995 and 1996 to address the
growing demand for its color inkjet printers.
With its Optra S laser printers, a majority of the company's laser printers are
office desktop printers (laser printers that print at speeds of 11-30 ppm),
which the company believes is one of the fastest growing segments of the laser
printer market. Office desktop laser printer growth is being driven by the
office migration from large mainframe computers to local area networks that link
various types of computers using a variety of protocols and operating systems.
The company's installed base of printers supports a large and profitable printer
supplies business. Because consumable supplies must be replaced on average one
to three times a year, depending on type of printer and usage, demand for laser
and inkjet print cartridges is increasing at a higher rate than printer
shipments. The company expects this recurring and relatively high margin
business to contribute to the stability of the company's earnings over time.
23
Consolidated gross profit was $870 million for 1997, an increase of 16% from
1996. This was mainly driven by improved printer margins and a richer mix of
supplies versus printer hardware. Gross profit as a percentage of revenues for
1997 increased to 34.9% from 31.4% in 1996. Gross profit attributable to
printers and associated supplies increased 24%, principally due to reductions in
product costs and growth in higher margin associated consumable supplies.
Total operating expenses increased 15% for 1997 compared to 1996. Expenses as a
percentage of revenues were 23.9% in 1997 compared to 21.5% (excluding the
amortization of intangibles) in 1996. These increases versus 1996 principally
reflect planned increases in marketing and sales expenses to launch new products
and provide continuing support for Lexmark's products in the marketplace.
Consolidated operating income was $275 million for 1997, an increase of 19% over
1996. This increase was due principally to product cost reductions, growth in
associated consumable supplies and the absence of amortization of intangibles,
which were fully amortized in the first quarter of 1996.
[GRAPH APPEARS HERE]
. OPERATING INCOME BEFORE AMORTIZATION
dollars in millions
1994 1995 1996 1997
---- ---- ---- ----
After unusual item $159.6 $134.1 $235.5 $274.6
Before unusual item 159.6 194.7 235.5 274.6
The following table sets forth the percentage of total revenues represented by
certain items reflected in the company's statements of earnings.
1997 1996 1995 1994
- ---------------------------------------------------------------------------
Revenues 100% 100% 100% 100%
Cost of revenues 65 69 69 70
- ---------------------------------------------------------------------------
Gross profit 35 31 31 30
Research and development 5 5 5 6
Selling, general & administrative 19 16 17 16
Option compensation related to IPO - - 3 -
Amortization of intangibles - - 1 2
- ---------------------------------------------------------------------------
Operating income 11% 10% 5% 6%
- ---------------------------------------------------------------------------
Earnings before income taxes and extraordinary item were $255 million, an
increase of 26% over 1996, principally due to the operating performance and
lower interest expense resulting from lower debt levels and lower interest
rates.
Earnings before extraordinary item were $163 million, an increase of 28% over
1996. The income tax provision was 36% of earnings before tax in 1997 as
compared to approximately 37% in 1996.
Net earnings were $149 million, up 17% over 1996 net earnings. Net earnings for
1997 were affected by an extraordinary charge of $22 million ($14 million net of
tax benefit) caused by a prepayment premium and other fees associated with the
prepayment of the company's senior subordinated notes in the first quarter of
1997.
24
Basic net earnings per share were $2.09 for 1997, or $2.29 before extraordinary
item, compared to $1.78 in 1996, an increase of 17% and 28%, respectively.
Diluted net earnings per share were $1.98 in 1997, or $2.17 before extraordinary
item, compared to $1.69 in 1996, an increase of 17% and 28%, respectively.
[GRAPH APPEARS HERE]
. IMPACT OF UNUSUAL ITEMS
in dollars
1994 1995 1996 1997
---- ---- ---- ----
Diluted net earnings per share
after unusual items $(0.46) $0.44 $1.69 $1.98
Diluted net earnings per share
before unusual items 0.51 1.17 1.69 2.17
1996 compared to 1995
Consolidated revenues in 1996 were $2,378 million, an increase of 10% over 1995.
Printers and associated supplies revenues were $1,832 million, an increase of
24%, and revenues from other office imaging products were $513 million, an
increase of 2%. The transition out of the keyboard business was completed in
March 1996 and, excluding this business, revenues were up $365 million or 18%.
Total U.S. revenues increased $10 million or 1%, and excluding the keyboard
business, were up 14%. International revenues were up $210 million or 24%.
The increase in consolidated revenues was principally due to growth in the core
printer and associated supplies business. Hardware volumes have shown
significant growth in the sales of inkjet printers while printer supplies
revenues increased due to the continued growth of the company's installed
printer base. These revenue increases more than offset price reductions on
certain printers. Foreign currency translation effects were slightly unfavorable
for 1996 compared to 1995.
Revenues from other office imaging products increased primarily due to the
growth of the after-market laser cartridge business which more than offset the
declines in the traditional IBM branded supplies business.
The company increased its product distribution through retail outlets, with the
number of such outlets worldwide rising from approximately 5,000 retail outlets
in 1995 to more than 15,000 in 1996. The company has made substantial capital
investments in its inkjet production capacity in 1995 and 1996 to address the
growing demand for its color inkjet products.
Consolidated gross profit was $747 million for 1996, an increase of 12% from
1995, principally due to increased printer and associated supplies volumes,
lower costs through better cost management, the absence of the lower-margin
keyboard business in 1996 and more favorable product sales mix. Gross profit as
a percentage of revenues was 31.4% in 1996, slightly better than 31.0% in 1995.
Gross profit attributable to printers and associated supplies increased 25%,
principally due to higher revenues and the mix of these revenues. Gross profit
margin held steady as competitive price pressures on printers were offset by
lower costs and growth in the higher margin associated consumable supplies.
25
Total operating expenses decreased 8% for 1996 compared to 1995. In 1995,
operating expenses included a non-cash option compensation charge of $61 million
($39 million net of tax benefit) recognized for certain of the company's
outstanding employee stock options upon the consummation of the initial public
offering in November 1995. Operating expense comparisons were also affected by
amortization of intangible assets, which were fully amortized by March 1996.
Excluding the 1995 non-cash option compensation charge and the amortization of
intangibles, operating expenses as a percentage of revenues were 21.5% in 1996
versus 22.0% in 1995.
Consolidated operating income was $230 million for 1996, an increase of 112%
over 1995. Excluding the non-cash option compensation charge and the
amortization of intangibles, consolidated operating income was up 21%. This
increase was due to stronger 1996 sales volumes and cost and expense controls.
Earnings before income taxes and extraordinary item were $202 million, up 218%
over 1995 and up 63% before the non-cash option compensation charge, principally
due to the stronger operating performance and lower interest expense as a result
of lower debt levels and lower interest rates.
The income tax provision was approximately 37% of earnings before tax for 1996
as compared to 24% in 1995. The effective tax rate for 1995 was favorably
impacted by research and development tax credits and the benefit of a foreign
sales corporation.
Net earnings were $128 million, up 294%, and up 166% over earnings before
extraordinary item in 1995. Excluding the non-cash option compensation charge,
earnings before extraordinary item were up 48% to $128 million, up from $87
million in 1995. Net earnings per share were $1.69 for 1996, compared to $0.44,
or $0.65 before extraordinary item in 1995, an increase of 287% and 161%,
respectively.
LIQUIDITY AND CAPITAL RESOURCES
Lexmark's primary source of liquidity has been cash generated by operations,
which totaled $275 million, $118 million and $307 million in 1997, 1996 and
1995, respectively. Cash from operations has been sufficient to allow the
company to repay significant amounts of debt, fund the company's working capital
needs and finance its capital expenditures during these periods along with the
repurchase of $182 million of its Class A common stock during 1997.
The increase in cash provided by operating activities for 1997 was principally
due to stronger earnings before extraordinary loss, the increase in amounts
outstanding under the trade accounts receivable programs, the increase of net
deferred tax liabilities and favorable changes in working capital accounts. The
decrease in cash provided by operating activities for 1996 primarily reflects
higher working capital requirements in support of sales growth. Trade
receivables were up principally due to higher revenues while accounts payable
and accrued liabilities were down primarily due to the timing of payments. The
1996 cash from operations was reduced by $21 million due to lower trade
receivables outstanding under the trade receivables financing programs than in
1995. Cash from operations was favorably impacted by $25 million due to
effective management of inventory levels. Cash from operations in 1995 was
unusually high. Cash from operations for 1995 was favorably impacted by $30
million due to increased sales of trade receivables in an accounts receivable
financing program and increases in accounts payable and accrued liabilities of
$148 million, primarily due to the timing of payments.
26
Cash flows from operations in 1998 may be less than in 1997 due primarily to
higher working capital requirements in support of sales growth and higher
capital expenditures to support continued new product introductions. Increased
cash flow from earnings is expected to partially offset this decrease.
At December 31, 1997, the company's term loan had a balance of $37 million and
the company had $20 million outstanding under its revolving credit facility. The
revolving credit facility and term loan at December 31, 1997 were classified as
long-term, as the company had the intent and ability, supported by the terms of
the new revolving credit facility mentioned below, to obtain long-term
financing. In January 1998, the company entered into a new $300 million
unsecured, revolving credit facility with a group of banks. Upon entering the
agreement, the company repaid the amounts outstanding on its existing term loan
and revolving credit facility. The interest rate on the new credit facility
ranges from 0.2% to 0.7% above the London Interbank Offered Rate ("LIBOR"), as
adjusted under certain limited circumstances, based upon the company's debt
rating, if available, or based upon certain performance ratios. Any amounts
outstanding under the new revolving credit facility are due upon the maturity of
the facility on January 27, 2003. The new revolving credit facility is available
for general corporate purposes, including acquisitions and share repurchases,
and is expected to be sufficient to meet the company's working capital and
capital expenditure requirements. See "Capital Expenditures".
[GRAPH APPEARS HERE]
. CAPITAL STRUCTURE
in percent
1994 1995 1996 1997
---- ---- ---- ----
Equity 50.5% 66.7% 76.6% 87.0%
Debt 49.5 33.3 23.4 13.0
As of December 31, 1997, the company had short-term debt outstanding of $18
million.
In March 1997, the company prepaid its $120 million 14.25% senior subordinated
notes due in 2001. The prepayment resulted in an extraordinary charge of $22
million ($14 million net of tax benefit) caused by a prepayment premium and
other fees. Senior notes in the principal amount of $20 million were redeemed in
March 1996.
In March 1997, the company entered into three-year interest rate swaps with a
total notional amount of $60 million, whereby the company pays interest at a
fixed rate of approximately 6.5% and receives interest at a floating rate equal
to the three-month LIBOR. The swaps serve as a hedge of financings based on
floating interest rates.
Through its hedging programs, the company attempts to insulate a portion of its
foreign denominated cash flows from the impact of exchange rate fluctuations.
The company utilizes interest rate/currency swaps and has utilized interest rate
caps to reduce its interest rate risks. Interest expense incurred in connection
with these instruments amounted to $1 million, $1 million and $8 million in
1997, 1996 and 1995, respectively.
At December 31, 1997, substantially all tangible and intangible assets of the
company (including shares of capital stock of the company's subsidiaries) served
as collateral for the term loan and revolving credit facility. This credit
agreement contained customary covenant restrictions with which the company was
in compliance as of December 31, 1997. The new revolving credit facility that
the company entered into in January 1998, is an unsecured credit facility which
also contains customary default provisions, leverage and interest coverage
27
restrictions and certain restrictions on the incurrence of additional debt,
liens, mergers or consolidations and investments.
The company is party to an agreement to sell, on a limited recourse basis, up to
$100 million of its U.S. trade receivables under a revolving arrangement.
Proceeds from any such sales are available for general corporate purposes. At
December 31, 1997, trade receivables of $100 million were outstanding under this
program and, as collections reduce previously sold receivables, the company may
replenish these with new receivables. The agreement, which contains net worth
and fixed charge coverage restrictions, must be renewed annually and is expected
to be renewed upon its expiration in April 1998. This arrangement provides the
company with lower cost funding than is currently available under its revolving
credit facility.
The company is also a party to an agreement to sell up to 22 million deutsche
marks of Germany trade receivables on a limited recourse basis. At December 31,
1997, 22 million deutsche marks of receivables (approximately $12 million at
December 31, 1997 exchange rates) were outstanding under this program and, as
collections reduce previously sold receivables, the company may replenish these
with new receivables.
In April 1996, the company's board of directors authorized the repurchase of up
to $50 million of its Class A common stock. In May 1997, the company's board of
directors authorized the repurchase of an additional $150 million of its Class A
common stock. As of December 31, 1997, the company had repurchased 6,438,114
shares at prices ranging from $21.25 to $33.75 per share for an aggregate cost
of approximately $182 million, including the Repurchase Shares mentioned
earlier. In February 1998, the company's board of directors authorized the
repurchase of up to an additional $200 million of its Class A common stock. This
repurchase authority, like the prior authorizations, 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.
In October 1995, 50,000 shares of junior preferred stock owned by the company's
savings plan were exchanged for 750,000 shares of Class A common stock. The
junior preferred stock was then retired.
CAPITAL EXPENDITURES
Capital expenditures totaled $70 million, $145 million and $107 million in 1997,
1996 and 1995, respectively. The 1997 expenditures were mostly made in support
of new products. Both 1996 and 1995 expenditures were higher due to expansion of
the inkjet printer products manufacturing capacity, which included the
conversion of a Lexington facility and the establishment of facilities in Mexico
and Scotland to manufacture inkjet cartridges. Looking forward to 1998, the
company expects capital expenditures to be between $90 and $100 million and to
be funded primarily through cash from operations.
EFFECT OF CURRENCY EXCHANGE RATES AND EXCHANGE RATE RISK MANAGEMENT
Revenues derived from international operations, including exports from the
United States, make up over half of the company's consolidated revenues, with
European revenues accounting for about 69% of international revenues.
Substantially all foreign subsidiaries maintain their accounting records in
their local currencies. Consequently, period-to-period comparability of results
of operations is affected by fluctuations in exchange rates. While currency
translation has significantly affected international revenues and cost of
revenues, it did not have a material impact on operating income for the years
1995 - 1997. The company attempts to reduce its
28
exposure to exchange rate fluctuations through the use of operational hedges,
such as pricing actions and product sourcing decisions.
[GRAPH APPEARS HERE]
. REVENUES BY GEOGRAPHIC AREA*
dollars in millions
1994 1995 1996 1997
---- ---- ---- ----
U.S $1,023 $1,112 $1,100 $1,110
Europe 615 791 896 951
Other Intl. 214 255 382 433
*International revenues include exports from the U.S.
The company's exposure to exchange rate fluctuations generally cannot be
minimized solely through the use of operational hedges. Therefore, the company
utilizes financial instruments such as forward exchange contracts and currency
options to reduce the impact of exchange rate fluctuations on firm and
anticipated cash flow exposures and certain assets and liabilities which arise
from transactions denominated in currencies other than the functional currency.
The company does not purchase currency related financial instruments for
purposes other than exchange rate risk management.
The company believes that international operations in new geographic markets
will be less profitable than operations in U.S. and European markets as a
result, in part, of the higher investment levels for marketing, selling and
distribution required to enter these markets. Although the current economic
conditions in some of the Asian geographies may adversely affect the company's
growth in that region, management does not expect the impact will result in the
company's not being able to achieve its 1998 operating income growth objective.
TAX MATTERS
The company's effective tax rate for 1997 was 36%, for 1996 was approximately
37%, and for 1995 was 24%. The effective tax rate in 1995 was favorably impacted
by research and development tax credits and the benefit of a foreign sales
corporation.
As of December 31, 1997, the company had non-U.S. tax loss carryforwards of $53
million, including $20 million which expire between the years 2000 and 2004.
Portions of these non-U.S. tax loss carryforwards (approximately $13 million)
are not expected to provide a future benefit because they are attributable to
income of certain non-U.S. entities that are also taxable in the U.S.
INFLATION
The company is subject to the effects of changing prices. The company operates
in an industry where product prices are very competitive and subject to downward
price pressures. As a result, future increases in production costs or raw
material prices could have an adverse effect on the company's business. However,
the company actively manages its product costs and manufacturing processes in an
effort to minimize the impact on earnings of any such increases.
29
IMPACT OF THE YEAR 2000 ISSUE
The company has conducted a comprehensive review of its computer systems to
identify the systems that could be affected by the Year 2000 Issue and has
developed a comprehensive plan to resolve the issue. The Year 2000 Issue is the
result of computer programs that fail to utilize the full four-digit
representation of a year which would cause date-sensitive software to recognize
a date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculation causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities. The company
plans to complete the Year 2000 Issue Project by December 31, 1998.
Due to the company's major information technology systems operating in a client
server environment, the total cost associated with the required modifications
and conversions is not expected to be material to the company's financial
position or results of operations and is being expensed as incurred.
The company is communicating with its significant suppliers, customers and
others with which it conducts business to help them identify and resolve their
own Year 2000 Issue. If necessary modifications and conversions by the company
and those with which it conducts business are not completed timely, the Year
2000 Issue may have a material adverse effect on the company's results of
operations.
The costs of the project and the date on which the company expects to complete
the Year 2000 Issue modifications are based on management's best estimates,
which were derived utilizing numerous assumptions of future events, including
the continued availability of certain resources, third party modification plans
and other factors. However, there can be no guarantee that these estimates will
be achieved and actual results could differ materially from expectations.
NEW ACCOUNTING STANDARDS
Effective January 1, 1997, the company adopted Statement of Financial Accounting
Standard ("SFAS") No. 125, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities. SFAS No. 125 provides standards for
distinguishing transfers of financial assets that are sales from transfers that
are secured borrowings and addresses programs such as the company's trade
receivables programs in the U.S. and Germany. With the adoption of SFAS No. 125,
the company continues to account for the transfer of receivables under both
programs as sale transactions. In response to SFAS No. 125 for purposes of the
U.S. program, the company formed and sells its receivables to a wholly owned
subsidiary, Lexmark Receivables Corporation ("LRC"), which then sells the
receivables to an unrelated third party. LRC is a separate legal entity with its
own separate creditors who, in a liquidation of LRC, would be entitled to be
satisfied out of LRC's assets prior to any value in LRC becoming available for
equity claims of an LRC stockholder.
In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 128, Earnings per Share. Effective December 15, 1997, the company adopted
this statement and has restated all prior period earnings per share ("EPS") data
presented. This statement replaces the presentation of primary EPS and fully
diluted EPS with a presentation of basic EPS and diluted EPS, respectively.
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income,
effective for fiscal years beginning after December 15, 1997. This statement
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. This statement does not require a specific
30
format for that financial statement but requires that an entity display an
amount representing total comprehensive income for the period in that financial
statement. This statement requires that an entity classify items of other
comprehensive income by their nature in a financial statement. For example,
other comprehensive income may include foreign currency items, minimum pension
liability adjustments, and unrealized gains and losses on certain investments in
debt and equity securities. In addition, the accumulated balance of other
comprehensive income must be displayed separately from retained earnings and
additional paid-in capital in the equity section of a statement of financial
position. Reclassification of financial statements for earlier periods, provided
for comparative purposes, is required. Based on current accounting standards,
this new accounting standard is not expected to have a material impact on the
company's financial position, results of operations or liquidity. The company
will adopt this accounting standard on January 1, 1998, as required.
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, effective for fiscal years beginning after
December 15, 1997. This statement establishes standards for reporting
information about operating segments in annual financial statements and requires
selected information about operating segments in interim financial reports
issued to stockholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. Operating
segments are defined as components of an enterprise about which separate
financial information is available that is evaluated regularly by the
enterprise's chief operating decision maker in deciding how to allocate
resources and in assessing performance. This statement requires reporting
segment profit or loss, certain specific revenue and expense items and segment
assets. It also requires reconciliations of total segment revenues, total
segment profit or loss, total segment assets, and other amounts disclosed for
segments to corresponding amounts reported in the consolidated financial
statements. Restatement of comparative information for earlier periods presented
is required in the initial year of application. Interim information is not
required until the second year of application, at which time comparative
information is required. This statement's requirements are disclosure oriented
and, therefore, will not have a material impact on the company's financial
position, results of operations or liquidity. The company will adopt this
accounting standard on January 1, 1998, as required.
Factors That May Affect Future Results and Information Concerning
Forward-Looking Statements
Certain of the statements contained in this Report may be considered
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, including,
without limitation, (i) statements in this "Management's Discussion and Analysis
of Financial Condition and Results of Operations" concerning (a) the company's
belief that its total revenues will continue to grow due to overall market
growth and increases in the company's market share in both the network and color
inkjet printer categories and that this growth will more than offset reduced
demand in sales of certain of its products, (b) the company's expectation that
printer prices will continue to decline and that it expects to reduce costs in
line with price decreases, (c) the company's expectation that its overall
margins will remain relatively stable as new product introductions contribute to
growth in printer unit volumes and the associated printer supplies business
becomes a larger part of the company's business, offsetting the decline in sales
of certain of the company's other office imaging products, (d) the company's
belief that office desktop printers are one of the fastest growing segments of
the laser printer market, (e) the company's statement that higher working
capital requirements are expected to be partially offset by earnings growth, (f)
the company's expectations with respect to its 1998 capital expenditures, (ii)
the statements in "Item 1. Business -- Market Overview and Strategy -- Printers
and Associated Supplies -- Market Overview" concerning the company's belief
about growth in the printer hardware market, including double-digit growth in
volume of certain product categories such as office desktop laser printers and
color inkjet printers, continued growth in the company's associated printer
supplies business, and the after-market laser cartridge market being a market
with significant growth potential and "-- Environmental and Regulatory Matters"
concerning the company's belief that compliance with all laws and
31
regulations applicable to it is not expected to have a material effect on its
capital expenditures, earnings and competitive position, (iii) the statements in
"Item 3. Legal Proceedings" concerning the company's belief with respect to the
possible effect of certain legal proceedings, and current or future claims of
intellectual property infringement on its financial position or results of
operations, (iv) other statements as to management's expectations and belief
presented in this "Management's Discussion and Analysis of Financial Condition
and Results of Operations", (v) other statements as to management's expectations
and belief presented elsewhere in this Report and (vi) variations in the
foregoing statements whenever they appear in this Report. Forward-looking
statements are made based upon management's current expectations and belief
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. There are a number of factors that could cause
actual results to differ materially from estimates or expectations reflected in
such forward-looking statements, including, without limitation, the factors set
forth below:
~ The company's future operating results may be adversely affected if it is
unable to continue to develop, manufacture and market products that meet
customers' needs. The markets for printers and associated supplies are highly
competitive, especially with respect to pricing and the introduction of new
technologies and products offering improved features and functionality. The
company and its major competitors, all of which have significantly greater
financial, marketing and technological resources than the company, have
regularly lowered prices on their printers and are expected to continue to do
so. In particular, the inkjet printer market has experienced and is expected to
continue to experience significant printer price pressure from the company's
major competitors. Price reductions beyond expectations or the inability to
reduce costs, contain expenses or increase sales as currently expected, as well
as price protection measures, could result in lower profitability and jeopardize
the company's ability to grow or maintain its market share.
~ The life cycles of the company's products, as well as delays in product
development and manufacturing, variations in the cost of component parts, 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 programs, 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. Further, some of the
company's newly developed products replace or compete with some of the company's
existing products. The competitive pressure to develop technology and products
also could cause significant changes in the level of the company's operating
expenses.
~ Revenues derived from international sales, including exports from the United
States, make up over half of the company's revenues. Accordingly, the company's
future results could be adversely affected by a variety of factors, including
foreign currency exchange rate fluctuations, trade protection measures, changes
in a specific country's or region's political or economic conditions and
unexpected changes in regulatory requirements. 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 as a result, in
part, of the higher investment levels for marketing, selling and distribution
required to enter these markets.
~ 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. Current or future claims of
intellectual property infringement could prevent the company from obtaining
technology of others and could otherwise adversely affect its operating results,
cash flows, financial position or business, as could expenses incurred by the
company in enforcing its intellectual property rights against others.
32
~ Part of the company's business strategy is to expand its business through the
acquisition of related businesses. There can be no assurance that suitable
acquisitions can be accomplished on terms favorable to the company. Further,
there can be no assurance that the company will be able to operate profitably
any businesses or other assets it may acquire, effectively integrate the
operations of such acquisitions or otherwise achieve the intended benefits of
such acquisitions.
~ Factors unrelated to the company's operating performance, including economic
and business conditions, both national and international; the loss of
significant customers or suppliers; changes in and execution of the company's
business strategy; and the ability to retain and attract key personnel, could
also adversely affect the company's operating results. In addition, trading
activity in the company's common stock, particularly in light of the substantial
number of shares owned by the original investor group that are available for
resale, 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 its
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.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable
33
Item 8. Financial Statements and Supplementary Data
Lexmark International Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF EARNINGS
For the years ended December 31, 1997, 1996 and 1995
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
Revenues $2,493.5 $2,377.6 $2,157.8
Cost of revenues 1,623.5 1,630.2 1,487.9
- --------------------------------------------------------------------------------
Gross profit 870.0 747.4 669.9
Research and development 128.9 123.9 116.1
Selling, general and administrative 466.5 388.0 359.1
Option compensation related to IPO - - 60.6
Amortization of intangibles - 5.1 25.6
- --------------------------------------------------------------------------------
Operating expenses 595.4 517.0 561.4
- --------------------------------------------------------------------------------
Operating income 274.6 230.4 108.5
Interest expense 10.8 20.9 35.1
Amortization of deferred financing
costs and other 9.1 7.9 10.1
- --------------------------------------------------------------------------------
Earnings before income taxes
and extraordinary item 254.7 201.6 63.3
Provision for income taxes 91.7 73.8 15.2
- --------------------------------------------------------------------------------
Earnings before extraordinary
item 163.0 127.8 48.1
Extraordinary loss on extinguishment of
debt
(net of related tax benefit of $8.4
in 1997 and $6.4 in 1995) (14.0) - (15.7)
- --------------------------------------------------------------------------------
Net earnings $ 149.0 $ 127.8 $ 32.4
Basic earnings per share:
Before extraordinary item $ 2.29 $ 1.78 $ 0.70
Extraordinary loss (0.20) - (0.23)
- --------------------------------------------------------------------------------
Net earnings per share $ 2.09 $ 1.78 $ 0.47
Diluted earnings per share:
Before extraordinary item $ 2.17 $ 1.69 $ 0.65
Extraordinary loss (0.19) - (0.21)
- --------------------------------------------------------------------------------
Net earnings per share $ 1.98 $ 1.69 $ 0.44
Shares used in per share calculation:
Basic 71,314,311 71,629,572 68,859,900
Diluted 75,168,776 75,665,734 74,200,279
- --------------------------------------------------------------------------------
See notes to consolidated financial statements.
34
Lexmark International Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
As of December 31, 1997 and 1996
(Dollars in Millions, Except Share Amounts)
- --------------------------------------------------------------------------------
1997 1996
---- ----
ASSETS
Current assets:
Cash and cash equivalents $ 43.0 $ 119.3
Trade receivables, net of allowance of
$19 in 1997 and $18 in 1996 318.9 304.7
Inventories 353.8 271.0
Prepaid expenses and other current assets 60.4 70.1
- --------------------------------------------------------------------------------
Total current assets 776.1 765.1
Property, plant and equipment, net 409.6 434.1
Other assets 22.5 22.3
- --------------------------------------------------------------------------------
Total assets $1,208.2 $1,221.5
- --------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt $ 18.0 $ 2.1
Accounts payable 302.0 197.2
Accrued liabilities 227.5 222.0
- --------------------------------------------------------------------------------
Total current liabilities 547.5 421.3
Long-term debt 57.0 163.2
Other liabilities 103.0 96.7
- --------------------------------------------------------------------------------
Total liabilities 707.5 681.2
- --------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock, $.01 par value,
1,600,000 shares authorized, no shares
issued and outstanding - -
Common stock, $.01 par value:
Class A, 160,000,000 shares authorized;
67,539,935 and 70,213,603 outstanding
in 1997 and 1996, respectively 0.7 0.7
Class B, 10,000,000 shares authorized;
410,537 and 2,446,523 outstanding
in 1997 and 1996, respectively - -
Capital in excess of par 537.2 519.3
Retained earnings 168.8 19.8
Accumulated translation adjustment (23.8) 0.5
Treasury stock, at cost; 6,438,114 shares
in 1997 (182.2) -
- --------------------------------------------------------------------------------
Total stockholders' equity 500.7 540.3
- --------------------------------------------------------------------------------
Total liabilities and stockholders'
equity $1,208.2 $1,221.5
- --------------------------------------------------------------------------------
See notes to consolidated financial statements.
35
Lexmark International Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 1997, 1996 and 1995
(Dollars In Millions)
- --------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
Net earnings $149.0 $127.8 $ 32.4
Adjustments to reconcile net earnings
to net cash
provided by operating activities:
Depreciation and amortization 77.5 69.2 99.1
Option compensation related to IPO - - 60.6
Extraordinary loss on extinguishment
of debt 22.4 - 15.7
Deferred taxes 40.7 12.3 (30.8)
Other non-cash charges to operations 24.6 22.6 45.5
- --------------------------------------------------------------------------------
314.2 231.9 222.5
Change in assets and liabilities:
Trade receivables (47.5) (70.1) (52.5)
Trade receivables programs 33.3 (21.0) 30.0
Inventories (82.8) 25.3 (17.3)
Accounts payable 104.8 (12.4) 71.3
Accrued liabilities 5.5 (36.4) 76.5
Other assets and liabilities (52.6) 0.7 (23.0)
- --------------------------------------------------------------------------------
Net cash provided by operating
activities 274.9 118.0 307.5
Cash flows from investing activities:
Purchases of property, plant and
equipment (69.5) (145.0) (106.8)
Proceeds from sale of property,
plant and equipment 1.1 3.6 6.6
- --------------------------------------------------------------------------------
Net cash used for investing
activities (68.4) (141.4) (100.2)
Cash flows from financing activities:
Increase in short-term debt 35.8 2.1 -
Proceeds from issuance of long-term debt,
net of issue costs of $2.8 in 1995 0.2 5.7 147.2
Principal payments on long-term debt (125.5) (38.0) (245.0)
Charges related to extinguishment of debt (22.4) - -
Purchase of treasury stock (182.2) - -
Exercise of stock options and warrants 15.2 23.0 -
Preferred dividends paid - - (2.2)
- --------------------------------------------------------------------------------
Net cash used for financing
activities (278.9) (7.2) (100.0)
Effect of exchange rate changes on cash (3.9) (0.6) 1.2
- --------------------------------------------------------------------------------
Net increase (decrease) in cash and cash
equivalents (76.3) (31.2) 108.5
Cash and cash equivalents - beginning of
period 119.3 150.5 42.0
- --------------------------------------------------------------------------------
Cash and cash equivalents - end of period $ 43.0 $119.3 $150.5
- --------------------------------------------------------------------------------
See notes to consolidated financial statements.
36
Lexmark International Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended December 31, 1997, 1996 and 1995
(Dollars in Millions, Except Share Amounts)
- --------------------------------------------------------------------------------------------------------------
Junior Class A
Preferred Stock Common Stock
--------------- ------------
Shares Amount Shares Amount
------ ------ ------ ------
Balance at December 31, 1994 50,000 $ 5.0 60,387,105 $0.6
Issuance of common stock less notes receivable of $0.1 3,600
Conversion of Class B to Class A common stock 2,361,377
Conversion of junior preferred stock to Class A common stock (50,000) (5.0) 750,000
Shares issued upon exercise of warrants 254,385
Option compensation related to IPO
Long-term incentive plan compensation
Net shares issued upon exercise of options 547,152
Cash received for payments on notes receivable for common
stock issued to management and certain other individuals
Translation adjustment
Net earnings
- --------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 ---- ---- 64,303,619 0.6
Conversion of Class B to Class A common stock 3,442,100 0.1
Option compensation expense
Long-term incentive plan compensation
Net shares issued upon exercise of options 2,467,884
Tax benefit related to stock options and warrants
Cash received for payments on notes receivable for common
stock issued to management and certain other individuals
Translation adjustment
Net earnings
- --------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 ---- ---- 70,213,603 0.7
Conversion of Class B to Class A common stock 2,035,986
Shares issued upon exercise of warrants 531,284
Option compensation expense
Long-term incentive plan compensation
Deferred stock plan compensation
Shares issued upon exercise of options 1,197,176
Tax benefit related to stock options and warrants
Treasury shares repurchased
Cash received for payments on notes receivable for common
stock issued to management and certain other individuals
Translation adjustment
Net earnings
- --------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 ---- $---- 73,978,049 $0.7
- --------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
37
- -----------------------------------------------------------------------------------------------------------------
Class B
Common Stock
-------------------- Retained Accumulated
Capital in Earnings Translation Treasury
Shares Amount Excess of Par (Deficit) Adjustment Stock Total
------ ------ ------------- --------- ----------- -------- -------
8,250,000 $ 0.1 $430.2 $(140.4) $---- $---- $295.5
----
(2,361,377) ----
5.0 ----
1.7 1.7
58.7 58.7
0.6 0.6
(1.8) (1.8)
0.2 0.2
2.9 2.9
32.4 32.4
- -----------------------------------------------------------------------------------------------------------------
5,888,623 0.1 494.6 (108.0) 2.9 ---- 390.2
(3,442,100) (0.1) ----
1.2 1.2
0.8 0.8
15.1 15.1
7.4 7.4
0.2 0.2
(2.4) (2.4)
127.8 127.8
- -----------------------------------------------------------------------------------------------------------------
2,446,523 ---- 519.3 19.8 0.5 ---- 540.3
(2,035,986) ----
1.1 1.1
0.6 0.6
0.1 0.1
1.8 1.8
7.8 7.8
6.4 6.4
(182.2) (182.2)
0.1 0.1
(24.3) (24.3)
149.0 149.0
- -----------------------------------------------------------------------------------------------------------------
410,537 $---- $537.2 $168.8 $(23.8) $(182.2) $500.7
- -----------------------------------------------------------------------------------------------------------------
38
Lexmark International Group, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Share Amounts)
1. ORGANIZATION AND BUSINESS
Lexmark International Group, Inc. (together with its subsidiaries, the
"company") is a global developer, manufacturer and supplier of laser and inkjet
printers and associated consumable supplies. The company also sells dot matrix
printers for printing single and multi-part forms by business users. The
company's core printer business targets the office and home markets. In addition
to its core printer business, the company develops, manufactures and markets a
broad line of other office imaging products which include supplies for
International Business Machines Corporation ("IBM") branded printers,
after-market supplies for other original equipment manufacturer ("OEM")
products, and typewriters and typewriter supplies that are sold under the IBM
trademark. The principal customers for the company's products are dealers,
retailers and distributors worldwide. The company employs marketing teams which
target large accounts to generate demand in selected industries worldwide. The
company's products are sold in over 150 countries in North and South America,
Europe, the Middle East, Africa, Asia, the Pacific Rim and the Caribbean.
2. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation:
The accompanying consolidated financial statements include the accounts
of Lexmark International Group, Inc. and its subsidiaries. All significant
intercompany accounts and transactions have been eliminated.
Foreign Currency Translation:
Assets and liabilities of non-U.S. subsidiaries that operate in a local
currency environment are translated into U.S. dollars at period-end exchange
rates. Income and expense accounts are translated at average exchange rates
prevailing during the period. Adjustments arising from the translation of assets
and liabilities are accumulated as a separate component of stockholders' equity.
Use of Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions. These estimates and assumptions affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. Estimates are used when accounting for such items as the allowance
for doubtful accounts, inventory reserves, product warranty, depreciation,
employee benefit plans and taxes.
39
Cash Equivalents:
All highly liquid investments with an original maturity of three months
or less at the company's date of purchase are considered to be cash equivalents.
Inventories:
Inventories are stated at the lower of average cost or market. The
company considers all raw materials to be in production upon their receipt.
Property, Plant and Equipment:
Property, plant and equipment are stated at cost and depreciated over
their estimated useful lives using the straight-line method. Property, plant and
equipment accounts are relieved of the cost and related accumulated depreciation
when assets are disposed of or otherwise retired.
Revenue Recognition:
Sales are recognized when products are shipped to customers. A
provision for estimated sales returns is recorded in the period in which related
sales are recognized.
Advertising Costs:
The company expenses advertising costs when incurred. Advertising
expense was approximately $56.9 million, $49.3 million and $43.0 million in
1997, 1996 and 1995, respectively.
Income Taxes:
The company utilizes the liability method of accounting for income
taxes. This method requires recognition of deferred tax assets and liabilities
for the expected future tax consequences of events that have been included in
the financial statements or tax returns. Under this method, deferred tax assets
and liabilities are determined based on the difference between the financial
statement carrying amounts and tax bases of assets and liabilities using enacted
tax rates in effect for the year in which the differences are expected to
reverse.
Earnings Per Share:
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard ("SFAS") No. 128, Earnings per
Share. Under SFAS No. 128, the company presents two earnings per share ("EPS")
amounts. Basic EPS are computed by dividing earnings available to common
stockholders by the weighted average number of common shares outstanding for the
period. Diluted EPS reflect the potential dilution of securities that could
share in the earnings, including stock options and warrants. EPS amounts have
been calculated and presented under the provisions of SFAS No. 128.
40
3. INVENTORIES
Inventories consisted of the following at December 31:
1997 1996
- ----------------------------------------------------
Work in process $211.2 $144.6
Finished goods 142.6 126.4
- ----------------------------------------------------
$353.8 $271.0
- ----------------------------------------------------
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following at December
31:
1997 1996
- ---------------------------------------------------
Land and improvements $ 16.2 $ 15.9
Buildings and improvements 171.9 184.9
Machinery and equipment 428.9 392.2
Information systems and furniture 124.4 118.7
- ---------------------------------------------------
741.4 711.7
Less accumulated depreciation 331.8 277.6
- ---------------------------------------------------
$409.6 $434.1
- ---------------------------------------------------
Depreciation expense was $76.8 million, $62.3 million and $71.2 million
for 1997, 1996 and 1995, respectively.
5. ACCRUED LIABILITIES
Accrued liabilities consisted of the following at December 31:
1997 1996
- -------------------------------------------------------
Compensation $ 58.7 $ 57.6
Income taxes payable 9.5 7.0
Fixed assets 9.0 26.8
Warranty 30.6 31.0
Value added tax 6.6 15.5
Deferred revenue 27.8 17.4
Other 85.3 66.7
- -------------------------------------------------------
$227.5 $222.0
- -------------------------------------------------------
41
6. DEBT
Long-term debt consisted of the following at December 31:
1997 1996
- ---------------------------------------------------------
Revolving credit facility
refinanced $20.0 $ -
Term loan refinanced 37.0 37.0
Senior subordinated notes, 14.25%
interest rate, due in 2001 - 120.0
Other - 6.2
- ---------------------------------------------------------
$57.0 $163.2
- ---------------------------------------------------------
In March 1997, the company prepaid its $120.0 million, 14.25 percent
senior subordinated notes due in 2001. The prepayment resulted in an
extraordinary charge of $22.4 million ($14.0 million net of tax benefit) caused
by a prepayment premium and other fees. In 1995, the company refinanced its term
loan and revolving credit facility. This early extinguishment of debt resulted
in an extraordinary charge of $22.1 million ($15.7 million net of tax benefit)
caused by the mark to market of a related hedging instrument and other fees.
In March 1997, the company entered into three-year interest rate swaps
with a total notional amount of $60.0 million, whereby the company pays interest
at a fixed rate of approximately 6.5% and receives interest at a floating rate
equal to the three-month London Inter Bank Offered Rate (LIBOR). The swaps serve
as a hedge of financings based on floating interest rates. The company also has
an interest rate/currency swap with a notional amount remaining of $36.7
million. The interest rate/currency swap matures on March 27, 1998. The
effective rate of interest on the term loan (after giving effect to the interest
rate/currency swap) was 6.7% at December 31, 1997.
In January 1998, the company entered into a new $300.0 million
unsecured, revolving credit facility with a group of banks. Upon entering the
new agreement, the company repaid the amounts outstanding on its existing term
loan and revolving credit facility. The revolving credit facility and term loan
at December 31, 1997 were classified as long-term, as the company had the intent
and ability, supported by the terms of the new revolving credit facility, to
obtain long-term financing.
The interest rate on the new credit facility ranges from 0.2% to 0.7%
above LIBOR, as adjusted under certain limited circumstances, based upon the
company's debt rating, if available, or based upon certain performance ratios.
In addition, the company pays a facility fee on the $300.0 million of 0.1% to
0.3% based upon the company's debt rating, if available, or based upon certain
performance ratios. The interest and facility fee rates are calculated
quarterly.
The $300.0 million credit agreement contains customary default
provisions, leverage and interest coverage restrictions and certain restrictions
on the incurrence of additional debt, liens, mergers or consolidations and
investments. Any amounts outstanding under the $300.0 million credit facility
are due upon the maturity of the facility on January 27, 2003.
Interest expense of $0.9 million, $1.2 million and $7.7 million in
1997, 1996 and 1995, respectively, related to the swaps discussed above,
previously outstanding interest rate/currency swaps and interest rate caps and
options is included in interest expense in the statement of earnings.
42
Total cash paid for interest amounted to $13.2 million, $24.2 million
and $41.4 million in 1997, 1996 and 1995, respectively.
7. STOCKHOLDERS' EQUITY
The Class A common stock is voting and exchangeable for Class B common
stock in very limited circumstances. The Class B common stock is non-voting and
is convertible, subject to certain limitations, into Class A common stock.
At December 31, 1997, approximately 77,300,000 and 1,750,000 shares of
Class A and Class B common stock were unissued and unreserved. These shares are
available for a variety of general corporate purposes, including future public
offerings to raise additional capital and for facilitating acquisitions.
The remaining warrants outstanding in connection with a technology
agreement with an unrelated party to purchase 634,365 shares of Class A common
stock at $6.67 per share were exercised during 1997.
In April 1996, the company's board of directors authorized the
repurchase of up to $50 million of its Class A common stock. In May 1997, the
company's board of directors authorized the repurchase of an additional $150
million of its Class A common stock. The 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 year ended December 31, 1997, the company
repurchased 6,438,114 shares at prices ranging from $21.25 to $33.75 per share
for an aggregate cost of approximately $182.2 million. In February 1998, the
company's board of directors authorized the repurchase of up to an additional
$200 million of its Class A common stock. This repurchase authority, like the
prior authorizations, 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.
In February 1998, the company's board of directors adopted a
stockholder rights plan (the "Rights Plan") which provides existing stockholders
with the right to purchase one one-hundredth (0.01) of a share of Series A
Junior Participating preferred stock for each share of common stock held in the
event of certain changes in the company's ownership. The Rights Plan may serve
as a deterrent to certain abusive takeover tactics which are not in the best
interest of stockholders. The rights will expire on January 31, 2008, unless
earlier redeemed by the company.
8. STOCK INCENTIVE PLANS
The company has established various stock incentive plans to encourage
employees and non-employee directors to remain with the company and to more
closely align their interests with those of the company's stockholders. Under
the employee plans, as of December 31, 1997 approximately 1,300,000 shares of
Class A common stock are reserved for future grants in the form of stock
options, stock appreciation rights, restricted stock, performance shares or
deferred stock units. Under the director plan, as of December 31, 1997
approximately 42,000 shares of Class A common stock are reserved for future
grants in the form of stock options and deferred stock units. As of December 31,
1997, awards under the programs have been limited to stock options, restricted
stock, performance shares and deferred stock units.
43
The exercise price of options awarded under these plans is equal to the
fair market value of the underlying common stock on the date of grant. All
options expire ten years from the date of grant and become fully vested at the
end of five years based upon continued employment or the completion of three
years of service on the board of directors.
The company recognized a non-cash compensation charge in 1995 of $60.6
million ($38.5 million net of tax benefit) for certain stock options outstanding
prior to the initial public offering in November 1995.
The company applies APB Opinion 25, Accounting for Stock Issued to
Employees, and related interpretations in accounting for its plans. Accordingly,
no compensation expense has been recognized for its stock-based compensation
plans other than for restricted stock, performance-based awards and the non-cash
compensation charge mentioned in the preceding paragraph. Had compensation
expense for the company's stock-based compensation plans been determined based
on the fair value at the grant date for awards under these plans consistent with
the methodology prescribed under SFAS No. 123, Accounting for Stock-Based
Compensation, net earnings and earnings per share would have been reduced to the
pro forma amounts indicated in the table below:
1997 1996 1995
- -----------------------------------------------------------------------------
Net earnings - as reported $149.0 $127.8 $32.4
Net earnings - pro forma 145.1 125.0 29.9
Basic EPS - as reported $ 2.09 $ 1.78 $0.47
Basic EPS - pro forma 2.04 1.74 0.44
Diluted EPS - as reported $ 1.98 $ 1.69 $ 0.44
Diluted EPS - pro forma 1.93 1.65 0.40
- -----------------------------------------------------------------------------
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions:
1997 1996 1995
- -------------------------------------------------------------------------
Expected dividend yield - - -
Expected stock price volatility 44% 45% 45%
Weighted average risk-free 6.2% 5.8% 5.9%
interest rate
Weighted average expected life of options
(years) 4.8 3.9 4.4
- -------------------------------------------------------------------------
The weighted average fair value of options granted during 1997, 1996
and 1995 was $11.84, $7.67 and $8.16 per share, respectively.
The pro forma effects on net income for 1997, 1996 and 1995 are not
representative of the pro forma effect on net income in future years because
they do not take into consideration pro forma compensation expense related to
grants made prior to 1995.
A summary of the status of all of the company's stock incentive plans
as of December 31, 1997, 1996 and 1995 and changes during the years then ended
is presented below:
44
Weighted
Average
Exercise
Number Price
- ---------------------------------------------------------------
Outstanding at January 1, 1995 8,048,010 $ 7.26
Granted 2,609,007 19.14
Exercised (987,108) 7.09
Forfeited or canceled (241,128) 8.20
- ---------------------------------------------------------------
Outstanding at December 31, 1995 9,428,781 10.54
Granted 508,532 19.39
Exercised (2,664,363) 7.11
Forfeited or canceled (321,088) 14.81
- ---------------------------------------------------------------
Outstanding at December 31, 1996 6,951,862 12.31
Granted 1,355,755 25.67
Exercised (1,276,408) 7.82
Forfeited or canceled (239,284) 18.40
- ---------------------------------------------------------------
Outstanding at December 31, 1997 6,791,925 $15.58
- ---------------------------------------------------------------
As of December 31, 1997, 1996, and 1995 there were 3,678,324, 4,574,734
and 6,787,426 options exercisable, respectively.
The following tables summarize information about stock options
outstanding at December 31, 1997:
Options Outstanding
- ------------------------------------------------------------------------
Number Weighted-Average
Range of Outstanding Remaining Weighted-Average
Exercise Prices at Contractual Exercise Price
12/31/97 Life
- ------------------------------------------------------------------------
$ 6.67 to $14.75 2,817,330 4.0 years $ 7.52
15.00 to 19.75 603,574 7.3 16.19
20.00 to 36.44 3,371,021 8.4 22.25
- ------------------------------------------------------------------------
$ 6.67 to $36.44 6,791,925 6.5 $15.58
- ------------------------------------------------------------------------
Options Exercisable
- ----------------------------------------------------
Number
Range of Exercisable Weighted-Average
Exercise Prices at 12/31/97 Exercise Price
- ----------------------------------------------------
$ 6.67 to $14.75 2,701,118 $ 7.37
15.00 to 19.75 282,646 16.07
20.00 to 36.44 694,560 20.40
- ----------------------------------------------------
$ 6.67 to $36.44 3,678,324 $10.50
- ----------------------------------------------------
45
9. INCOME TAXES
The provision for income taxes consisted of the following:
1997 1996 1995
- --------------------------------------------------------
Currently payable:
Federal $37.8 $50.0 $32.3
Non-U.S. 9.9 5.3 5.1
State and local 3.3 6.2 8.6
- --------------------------------------------------------
51.0 61.5 46.0
Deferred payable (benefit):
Federal 34.1 12.0 (23.9)
Non-U.S. 2.6 0.1 (0.4)
State and local 4.0 0.2 (6.5)
- --------------------------------------------------------
40.7 12.3 (30.8)
- --------------------------------------------------------
Provision for income taxes $91.7 $73.8 $15.2
- --------------------------------------------------------
Earnings before income taxes were as follows:
1997 1996 1995
- ---------------------------------------------------------
U.S. $166.7 $129.6 $27.3
Non-U.S. 88.0 72.0 36.0
- ----------------------------------------------------------
Earnings before income taxes $254.7 $201.6 $63.3
- ----------------------------------------------------------
The U.S. and non-U.S. earnings before income taxes reflect write-offs
of certain intercompany obligations owed to the U.S. totaling $10.6 million in
1995.
The company realized an income tax benefit from the exercise of certain
stock options and warrants in 1997 and 1996 of $6.4 million and $7.4 million,
respectively. This benefit resulted in a decrease in current income taxes
payable and an increase in capital in excess of par.
Significant components of deferred income taxes were as follows:
1997 1996
- --------------------------------------------------------
Deferred tax assets:
Tax loss carryforwards $ 14.9 $ 24.2
Intangible assets 7.0 10.3
Alternative minimum tax credits - 6.3
Unexercised stock options 6.4 12.4
Inventories 17.5 20.2
Valuation allowance (20.8) (32.3)
- --------------------------------------------------------
Total deferred tax assets 25.0 41.1
- --------------------------------------------------------
Deferred tax liabilities:
Prepaid expenses 3.1 4.6
Property, plant and equipment 19.9 17.2
Other 24.1 0.7
- --------------------------------------------------------
Total deferred tax liabilities 47.1 22.5
- --------------------------------------------------------
Net deferred tax asset (liability) $(22.1) $ 18.6
- --------------------------------------------------------
46
The net decrease in the total valuation allowance for the years ended
December 31, 1997 and 1996 was $11.5 million and $44.9 million, respectively.
The company has non-U.S. tax loss carryforwards of $53.0 million including $19.7
million which expire between the years 2000 and 2004. Of these non-U.S. tax loss
carryforwards, $13.4 million are not expected to provide a future benefit
because they are attributable to certain non-U.S. entities that are also taxable
in the U.S.
A reconciliation of the provision for income taxes using the U.S.
statutory rate and the company's effective tax rate was as follows:
1997 1996 1995
---------------- --------------- ---------------
Amount % Amount % Amount %
- ------------------------------------------------------------------------------------------------
Provision for income taxes at
statutory rate $89.2 35.0% $70.5 35.0% $22.2 35.0%
State and local income taxes, net of
federal tax benefi 7.3 2.9 6.4 3.2 1.4 2.2
Losses providing no tax benefit 5.8 2.3 45.1 22.3 31.2 49.3
Change in the beginning-of-the-year
balance of the valuation allowance
for deferred tax assets affecting
provision (11.5) (4.5) (44.9) (22.3) (33.6) (53.1)
Research and development credit (5.5) (2.2) (2.9) (1.4) (3.8) (6.0)
Foreign sales corporation (2.6) (1.0) (5.0) (2.5) (2.3) (3.6)
Non-U.S. income exempt from tax - - - - (3.7) (5.8)
Other 9.0 3.5 4.6 2.3 3.8 6.0
- ------------------------------------------------------------------------------------------------
Provision for income taxes $91.7 36.0% $73.8 36.6% $15.2 24.0%
- ------------------------------------------------------------------------------------------------
Cash paid for income taxes was $36.3 million, $60.7 million and $24.1
million in 1997, 1996 and 1995, respectively.
10. EMPLOYEE PENSION PLANS
The company and its subsidiaries have retirement plans covering
substantially all regular employees. The total pension expense of all defined
benefit plans is determined using the projected unit credit actuarial method.
Plan assets are invested in government securities, corporate debt,
annuity contracts and equity securities. It is the company's policy to fund
amounts for pensions sufficient to meet the minimum requirements prescribed by
various government regulations and such additional amounts as the company may
determine to be appropriate.
U.S. Plans: Regular full-time employees in the U.S. are covered by a
noncontributory defined benefit plan, which is funded by company contributions
to an irrevocable trust fund held for the sole benefit of employees. Monthly
retirement benefits are based on service and compensation. Benefits become
vested upon completion of five years of service. The company has a supplemental
retirement plan for employees whose benefits under the defined benefit plan are
limited because of restrictions imposed by federal tax laws.
Non-U.S. Plans: Most subsidiaries have retirement plans covering
substantially all employees funded through various fiduciary-type arrangements.
Retirement benefits are generally based on years of service and compensation
during a fixed number of years immediately prior to retirement.
47
Net periodic pension expense included the following components:
U.S. Plans Non-U.S. Plans
--------------------------- -------------------------
1997 1996 1995 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------
Service cost $10.9 $15.5 $12.3 $2.1 $2.0 $1.9
Interest cost 24.3 23.0 20.3 4.2 4.5 4.5
Actual (gain) loss return on
plan assets (70.2) (27.2) (82.4) (4.7) (4.3) (4.9)
Net amortization and deferral 38.3 (5.8) 56.3 1.1 0.6 1.3
Settlement/curtailment losses - - - 0.3 0.9 -
- ----------------------------------------------------------------------------------------------------------
Net periodic pension expense $ 3.3 $ 5.5 $ 6.5 $3.0 $3.7 $2.8
- ----------------------------------------------------------------------------------------------------------
The funded status at December 31 was as follows:
U.S. Plans Non-U.S. Plans
-------------------- ---------------------
1997 1996 1997 1996
- ----------------------------------------------------------------------------------------------------------
Actuarial present value of benefit obligations:
Vested benefit obligation $266.2 $218.5 $ 57.7 $ 53.7
- ----------------------------------------------------------------------------------------------------------
Accumulated benefit obligation $305.8 $256.0 $ 61.1 $ 57.3
- ----------------------------------------------------------------------------------------------------------
Plan assets at fair value $386.5 $322.8 $ 56.3 $ 54.9
Projected benefit obligation 380.3 303.2 70.6 66.7
- ----------------------------------------------------------------------------------------------------------
Plan assets in excess of (or less than) projected
benefit obligation 6.2 19.6 (14.3) (11.8)
Unrecognized net (gain) loss (1.6) (11.8) 7.1 3.9
Additional minimum liability - - (3.1) (2.5)
- ----------------------------------------------------------------------------------------------------------
Prepaid pension cost (pension liability) $ 4.6 $ 7.8 $(10.3) $(10.4)
- ----------------------------------------------------------------------------------------------------------
Significant actuarial assumptions used to determine the projected
benefit obligation and to compute the expected long-term return on assets were
as follows:
U.S. Plans Non-U.S. Plans
----------------------------- ------------------------------
1997 1996 1995 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------
Discount rate 7.0% 7.5% 7.0% 6.3% 6.8% 7.5%
Long-term rate of compensation increase 4.5% 5.0% 4.5% 3.9% 4.3% 4.8%
Expected long-term rate of return on
plan assets 10.0% 10.0% 10.0% 7.2% 7.4% 8.1%
- ------------------------------------------------------------------------------------------------------------
The actuarial assumptions for non-U.S. plans represent weighted
averages reflecting the combined assumptions for all non-U.S. plans.
The company also sponsors various defined contribution plans for
employees in certain countries. Company contributions are based upon a
percentage of employees' contributions. The company's expense under these plans
amounted to $4.5 million, $4.4 million and $2.9 million in 1997, 1996 and 1995,
respectively.
48
11. OTHER POSTRETIREMENT BENEFIT PLANS
The company and certain of its non-U.S. subsidiaries have medical,
dental and life insurance plans for retirees. Most retirees outside the U.S. are
covered by government-sponsored programs. The company provides U.S. retirees
with medical benefits similar to those provided to full-time employees, subject
to certain maximums. The company does not fund its postretirement benefit plans.
All U.S. full-time employees who meet certain years of service requirements are
eligible for postretirement benefits.
Net periodic U.S. postretirement benefit expense included the following
components:
1997 1996 1995
- --------------------------------------------------------
Service cost $3.0 $3.1 $1.7
Interest cost 2.0 1.8 1.4
Amortization of net loss
from earlier periods - 0.2 -
- --------------------------------------------------------
Net periodic U.S.
postretirement benefit expense $5.0 $5.1 $3.1
- --------------------------------------------------------
The U.S. postretirement benefit liability at December 31 was as follows:
1997 1996
- -----------------------------------------------------------
Active employees, not fully eligible
for benefits $23.2 $22.3
Fully eligible active plan participants 9.8 4.8
- -----------------------------------------------------------
Accumulated postretirement benefit
obligation 33.0 27.1
Unrecognized net loss (4.3) (3.0)
- -----------------------------------------------------------
Postretirement benefit liability $28.7 $24.1
- -----------------------------------------------------------
Assumed medical cost inflation for 1998, 1999, and 2000 is projected to
be 8.7%, 7.9% and 4.0%, respectively, for an average annual medical cost
increase over the next three years of 6.9%. No medical inflation is assumed
after 2000, by which time medical costs are assumed to have doubled from 1991
levels. Since the plan caps medical costs at twice the 1991 levels, the effect
of a 1% increase in the assumed medical inflation rate is not material. The
assumed discount rate for postretirement medical benefits is 7.2%, 7.7% and 7.2%
for 1997, 1996 and 1995, respectively.
IBM agreed to pay for its pro rata share (currently estimated at $66.5
million) of future postretirement benefits for all company employees based on
relative years of service with IBM and the company.
12. COMMITMENTS
The company is committed under operating leases (containing various
renewal options) for rental of office and manufacturing space and equipment.
Rent expense (net of rental income of $5.6 million, $5.8 million and $5.6
million) was $16.0 million, $13.0 million and $9.9 million in 1997, 1996 and
1995, respectively. Future minimum rentals under terms of non-cancelable
operating leases at December 31 are: 1998-$18.3 million; 1999-$15.2 million;
2000-$11.5 million; 2001-$7.6 million; 2002-$4.3 million and thereafter-$3.2
million.
49
13. DERIVATIVE FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
The company manages risk arising from fluctuations in interest rates
and currency exchange rates by using derivative financial instruments. The
company manages exposure to counterparty credit risk by entering into derivative
financial instruments with highly rated institutions that can be expected to
fully perform under the terms of such agreements. The company does not hold or
issue financial instruments for trading purposes. Where appropriate, the company
arranges master netting agreements.
Instruments used as hedges must be effective at reducing the risk
associated with the exposure being hedged and must be designated as a hedge at
the inception of the contract. Accordingly, changes in market values of hedge
instruments must be highly correlated with changes in market values of
underlying hedged items both at inception of the hedge and over the life of the
hedge contract. Any instrument not qualifying as a hedge or designated but
ineffective as a hedge is marked to market and recognized in earnings
immediately.
Interest Rate Risk Management: The company has, from time to time,
utilized interest rate swaps, caps and options to maintain an appropriate
balance between fixed and floating rate debt in order to minimize the effect of
changing interest rates on earnings.
Interest rate swaps and interest rate/currency swaps are included in
the statement of financial position as accrued liabilities and other
liabilities, respectively. Interest differentials resulting from interest rate
swap agreements used to change the interest rate characteristics of debt are
recorded on an accrual basis as an adjustment to interest expense. Premiums paid
for interest rate cap and option agreements are included in the statement of
financial position as current assets and non-current assets and are charged to
interest expense over the terms of the agreements or when written off, if the
option expires unexercised. Amounts receivable under cap agreements and gains
realized on options are recognized as reductions of interest expense over the
terms of the agreements. In the event of an early termination of an interest
rate swap agreement designated as a hedge, the gain or loss is deferred,
recorded in non-current assets or liabilities, and recognized as an adjustment
to interest expense over the remaining term of the contract.
For additional information related to derivative financial instruments
used to manage interest rate risk, see Note 6.
Foreign Exchange Risk Management: The company enters into foreign
currency swaps, options, and forward exchange contracts in its management of
foreign currency exposures. Realized and unrealized gains and losses on
contracts that are designated as hedges are recognized in earnings in the same
period as the underlying hedged transactions. Contracts that do not qualify as
hedges for accounting purposes are marked to market and the resulting gains and
losses are recognized in current earnings. The cash flows resulting from hedge
contracts are classified as cash flows from operating activities.
Notional amounts at December 31 were as follows:
1997 1996
- ---------------------------------------------------
Forward contracts $205.7 $102.4
Options purchased 249.8 241.3
Options written (104.9) (97.3)
- ---------------------------------------------------
Forward contracts and purchased options are used to hedge firm and
anticipated purchases of inventory and are included in the statement of
financial position as current assets and accrued liabilities. These instruments
50
typically have remaining terms of one year or less. Gains and losses receiving
hedge accounting treatment are recognized in earnings in the same period as the
underlying hedged transactions. In the event of an early termination of a
currency exchange agreement designated as a hedge, the gain or loss and any fees
paid continue to be deferred and are included in the settlement of the
underlying transaction.
The company purchases and writes offsetting foreign currency options,
which do not qualify for hedge accounting treatment, for the purpose of reducing
the net cost of its hedging strategies. These instruments are included in the
statement of financial position as current assets and accrued liabilities,
respectively.
Concentrations of Credit Risk: The company's main concentrations of
credit risk consist primarily of temporary cash investments and trade
receivables. Temporary cash investments are placed with various financial
institutions. Company guidelines have been established relating to the amount of
deposits or investments that may be held by each financial institution. IBM is
the most significant trade customer of the company (see Note 16); otherwise,
credit risk related to trade receivables is dispersed across a large number of
customers located in various geographic areas. The company also has off-balance
sheet credit risk for the reimbursement from IBM of its pro rata share of
postretirement benefits to be paid by the company (see Note 11).
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table summarizes the carrying amounts and fair values of
financial instruments with fair values different than their carrying amounts at
December 31:
1997 1996
Asset (Liability) Asset(Liability)
- -------------------------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
Non-derivatives:
Long-term debt (senior subordinated notes) $- $- $(120.0) (129.0)
Derivatives:
Prepaid expenses and other current assets 1.4 3.0 1.5 2.2
Accrued liabilities - (0.7) - (0.6)
Other assets (liabilities) 0.4 0.6 (6.0) (7.7)
- --------------------------------------------------------------------------------
The carrying amounts in the table are included in the statement of
financial position under the indicated captions. The amounts in the table are
presented net of amounts offset in accordance with FASB Interpretation No. 39,
Offsetting of Amounts Related to Certain Contracts.
Cash and cash equivalents and trade receivables are valued at their
carrying amounts as recorded in the statement of financial position, and are
reasonable estimates of fair value given the relatively short period to maturity
for these instruments. The carrying value of the term loan approximates its fair
value given its variable rate interest provisions. Derivative financial
instruments which do not qualify for hedge accounting are recorded in the
statement of financial position at their fair value. The fair value of the
senior subordinated notes was estimated based on current rates available to the
company for debt with similar characteristics. Fair values for the company's
derivative financial instruments are based on quoted market prices of comparable
instruments or, if none are available, on pricing models or formulas using
current assumptions.
51
15. SALES OF RECEIVABLES
The company entered into an agreement to sell up to $100.0 million of
U.S. trade receivables on a limited recourse basis. As collections reduce
previously sold receivables, the company may replenish these with new
receivables. At December 31, 1997, U.S. trade receivables of $100.0 million had
been sold and, due to the revolving nature of the agreement, $100.0 million also
remained outstanding. At December 31, 1996, trade receivables of $65.0 million
were sold and outstanding. The agreement, which contains net worth and fixed
charge coverage restrictions, must be renewed annually, and is expected to be
renewed upon its expiration in April 1998. The risk the company bears from bad
debt losses on U.S. trade receivables sold is limited to approximately 10% of
the outstanding balance of receivables sold. The company addresses this risk of
loss in its allowance for doubtful accounts. Receivables sold may not include
amounts over 60 days past due or concentrations over certain limits with any one
customer.
The company entered into an agreement to sell up to 22 million deutsche
marks of Germany trade receivables on a limited recourse basis. At December 31,
1997, Germany trade receivables of 21.8 million deutsche marks ($12.3 million at
December 31, 1997 exchange rates) were outstanding under this program and, as
collections reduce previously sold receivables, the company may replenish these
with new receivables. At December 31, 1996, German trade receivables of 21.8
million deutsche marks ($14.0 million at December 31, 1996 exchange rates) were
sold and outstanding.
During 1997, the company adopted SFAS No. 125, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No.
125 provides standards for distinguishing transfers of financial assets that are
sales from transfers that are secured borrowings and addresses programs such as
the company's trade receivables programs in the U.S. and Germany. With the
adoption of SFAS No. 125, the company continues to account for the transfer of
receivables under both programs as sale transactions. In response to SFAS No.
125 for purposes of the U.S. program, the company formed and sells its
receivables to a wholly owned subsidiary, Lexmark Receivables Corporation
("LRC"), which then sells the receivables to an unrelated third party. LRC is a
separate legal entity with its own separate creditors who, in a liquidation of
LRC, would be entitled to be satisfied out of LRC's assets prior to any value in
LRC becoming available for equity claims of an LRC stockholder.
The company sells a portion of its non-U.S. trade receivables on a
recourse basis. Proceeds from these sales totaled $18.6 million, $48.9 million
and $86.9 million in 1997, 1996 and 1995, respectively. All amounts had been
collected at December 31, 1997 and approximately $5.3 million remained
uncollected at December 31, 1996.
Expenses incurred under these programs totaling $5.2 million, $5.4
million and $3.5 million for 1997, 1996 and 1995 respectively, are included in
other non-operating expense.
16. MAJOR CUSTOMER
IBM was considered a major customer prior to 1996, and accounted for
approximately 4%, 8% and 20% of the company's total revenues in 1997, 1996 and
1995, respectively.
52
17. EARNINGS PER SHARE
For the Year Ended December 31, 1997
--------------------------------------------
Earnings Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Earnings before extraordinary item $ 163.0
Basic EPS
Earnings available to common
stockholders 163.0 71,314,311 $ 2.29
Effect of Dilutive Securities
Warrants - 324,238
Long-term incentive plan - 10,430
Stock options - 3,519,797
------- ----------
Diluted EPS
Earnings available to common
stockholders plus assumed
conversions $ 163.0 75,168,776 $ 2.17
--------------------------------------------
Options to purchase an additional 42,948 shares of Class A common stock at
prices between $32.56 and $36.44 per share were outstanding at December 31, 1997
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.
For the Year Ended December 31, 1996
--------------------------------------------
Earnings Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Earnings before extraordinary item $127.8
Basic EPS
Earnings available to common
stockholders 127.8 71,629,572 $1.78
Effect of Dilutive Securities
Warrants - 424,285
Long-term incentive plan - 34,563
Stock options - 3,577,314
------ ----------
Diluted EPS
Earnings available to common
stockholders plus assumed
conversions $127.8 75,665,734 $1.69
--------------------------------------------
Options to purchase an additional 25,124 shares of Class A common stock at
prices between $24.75 and $26.75 per share were outstanding at December 31, 1996
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.
53
For the Year Ended December 31, 1995
--------------------------------------------
Earnings Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Earnings before extraordinary item $48.1
Basic EPS
Earnings available to common
stockholders 48.1 68,859,900 $0.70
Effect of Dilutive Securities
Warrants - 548,421
Long-term incentive plan - 37,165
Stock options - 4,754,793
----- ----------
Diluted EPS
Earnings available to common
stockholders plus assumed
conversions $48.1 74,200,279 $ 0.65
--------------------------------------------
Options to purchase an additional 2,114,321 shares of Class A common stock at
prices between $19.75 and $22.25 per share were outstanding at December 31, 1995
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.
54
18. INTERNATIONAL OPERATIONS
The company operates in the office products industry segment and
manufactures its products in the U.S., France, Australia, Mexico and Scotland
and markets them throughout the world. Intergeographic transfers are accounted
for on an arm's length pricing basis. Revenues from international operations,
including exports from the U.S., represent approximately half of consolidated
revenues. Summarized financial data by region follows:
1997 1996 1995
- ------------------------------------------------------------------------------
Revenues:
U.S.
Trade (1) $1,283.6 $1,282.5 $1,278.4
Intercompany 575.7 546.6 443.7
- ------------------------------------------------------------------------------
Total U.S. 1,859.3 1,829.1 1,722.1
Europe
Trade 919.1 858.7 731.7
Intercompany 100.5 23.1 3.2
- ------------------------------------------------------------------------------
Total Europe 1,019.6 881.8 734.9
Other international
Trade 290.8 236.4 147.7
Intercompany 7.2 2.9 2.8
- ------------------------------------------------------------------------------
Total other international 298.0 239.3 150.5
- ------------------------------------------------------------------------------
3,176.9 2,950.2 2,607.5
Eliminations (683.4) (572.6) (449.7)
- ------------------------------------------------------------------------------
Total $2,493.5 $2,377.6 $2,157.8
- ------------------------------------------------------------------------------
Operating income: (2)
U.S. $ 178.0 $ 154.3 $ 65.8
Europe 96.4 77.5 46.2
Other international (1.1) 3.5 2.3
Eliminations 1.3 (4.9) (5.8)
- ------------------------------------------------------------------------------
Total $ 274.6 $ 230.4 $ 108.5
- ------------------------------------------------------------------------------
Total assets:
U.S. $1,024.4 $1,034.3 $1,016.1
Europe 545.9 385.9 319.8
Other international 119.8 92.7 53.8
Eliminations (481.9) (291.4) (246.8)
- ------------------------------------------------------------------------------
Total $1,208.2 $1,221.5 $1,142.9
- ------------------------------------------------------------------------------
(1) U.S. trade revenues include exports to international locations.
(2) Includes non-cash compensation charge in 1995 of $45.7 million, $13.6
million and $1.3 million for the U.S., Europe, and other international,
respectively.
55
19. QUARTERLY FINANCIAL DATA (UNAUDITED)
First Second Third Fourth
Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------------
1997:
Revenues $583.4 $556.3 $618.3 $735.5
Gross profit 199.8 193.4 215.6 261.2
Operating income 55.7 57.5 67.0 94.4
Earnings before extraordinary item 30.7 34.3 41.0 57.0
Net earnings 16.7 34.3 41.0 57.0
Basic EPS before extraordinary item* $ 0.42 $ 0.48 $ 0.57 $ 0.83
Diluted EPS before extraordinary item* 0.40 0.45 0.54 0.78
Basic EPS* 0.23 0.48 0.57 0.83
Diluted EPS* 0.22 0.45 0.54 0.78
Stock prices:
High $29.63 $30.50 $36.31 $38.00
Low 22.00 19.13 26.88 29.56
1996:
Revenues $587.8 $555.3 $547.6 $686.9
Gross profit 182.4 172.2 173.9 218.9
Operating income 44.0 52.9 55.1 78.4
Net earnings 21.6 30.8 30.2 45.2
Basic EPS* $ 0.31 $ 0.42 $ 0.42 $ 0.62
Diluted EPS* 0.29 0.40 0.40 0.59
Stock prices:
High $23.25 $23.13 $20.88 $27.75
Low 16.00 17.88 13.38 18.88
- --------------------------------------------------------------------------------
*The sum of the quarterly earnings per share amounts do not equal the
year-to-date earnings per share due to changes in average share calculations.
This is in accordance with prescribed reporting requirements.
First quarter 1997 net earnings were reduced by an extraordinary charge
of $22.4 million ($14.0 million net of tax benefit) caused by an early
extinguishment of the company's senior subordinated notes.
20. NEW ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive
Income, effective for fiscal years beginning after December 15, 1997. This
statement requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. This statement does not require a specific format for that
financial statement but requires that an entity display an amount representing
total comprehensive income for the period in that financial statement. This
statement requires that an entity classify items of other comprehensive income
by their nature in a financial statement. For example, other comprehensive
income may include foreign currency items, minimum pension liability
adjustments, and unrealized gains and losses on certain investments in debt and
equity securities. In addition, the accumulated balance of other comprehensive
income must be displayed separately from retained earnings and additional
56
paid-in capital in the equity section of a statement of financial position.
Reclassification of financial statements for earlier periods, provided for
comparative purposes, is required. Based on current accounting standards, this
new accounting standard is not expected to have a material impact on the
company's consolidated financial statements. The company will adopt this
accounting standard on January 1, 1998, as required.
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments
of an Enterprise and Related Information, effective for fiscal years beginning
after December 15, 1997. This statement establishes standards for reporting
information about operating segments in annual financial statements and requires
selected information about operating segments in interim financial reports
issued to stockholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. Operating
segments are defined as components of an enterprise about which separate
financial information is available that is evaluated regularly by the
enterprise's chief operating decision maker in deciding how to allocate
resources and in assessing performance. This statement requires reporting
segment profit or loss, certain specific revenue and expense items and segment
assets. It also requires reconciliations of total segment revenues, total
segment profit or loss, total segment assets, and other amounts disclosed for
segments to corresponding amounts reported in the consolidated financial
statements. Restatement of comparative information for earlier periods presented
is required in the initial year of application. Interim information is not
required until the second year of application, at which time comparative
information is required. This statement's requirements are disclosure oriented
and, therefore, will not have a material impact on the company's financial
position, results of operations or liquidity. The company will adopt this
accounting standard on January 1, 1998, as required.
57
MANAGEMENT'S REPORT ON
FINANCIAL STATEMENTS
The consolidated financial statements and related information included in this
Financial Report are the responsibility of management and have been reported in
conformity with generally accepted accounting principles. All other financial
data in this Annual Report have been presented on a basis consistent with the
information included in the consolidated financial statements. Lexmark
International Group, Inc. maintains a system of financial controls and
procedures, which includes the work of corporate auditors, which we believe
provides reasonable assurance that the financial records are reliable in all
material respects for preparing the consolidated financial statements and
maintaining accountability for assets. The concept of reasonable assurance is
based on the recognition that the cost of a system of financial controls must be
related to the benefits derived and that the balancing of those factors requires
estimates and judgment. This system of financial controls is reviewed, modified
and improved as changes occur in business conditions and operations, and as a
result of suggestions from the corporate auditors and Coopers & Lybrand L.L.P.
The Finance & Audit Committee, composed of outside members of the Board of
Directors, meets periodically with management, the independent accountants and
the corporate auditors, for the purpose of monitoring their activities to ensure
that each is properly discharging its responsibilities. The Finance & Audit
Committee, independent accountants, and corporate auditors have free access to
one another to discuss their findings.
/s/ Marvin L. Mann
Marvin L. Mann
Chairman and chief executive officer
/s/ Gary E. Morin
Gary E. Morin
Vice president and chief financial officer
58
REPORT OF INDEPENDENT ACCOUNTANTS
To the board of directors of Lexmark International Group, Inc.
We have audited the accompanying consolidated statements of financial
position of Lexmark International Group, Inc. and subsidiaries as of December
31, 1997 and 1996, and the related consolidated statements of earnings, cash
flows and stockholders' equity for each of the three years in the period ended
December 31, 1997. These consolidated financial statements are the
responsibility of the company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Lexmark International Group, Inc. and subsidiaries as of December 31, 1997 and
1996, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 1997, in conformity
with generally accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
Coopers & Lybrand L.L.P.
Lexington, Kentucky
February 18, 1998
59
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
60
Part III
Item 10. Directors and Executive Officers of the Registrant
Information required by Part III, Item 10 of this Form 10-K is incorporated by
reference from the company's definitive Proxy Statement for its 1998 Annual
Meeting of Stockholders, which will be filed with the Securities and Exchange
Commission, pursuant to Regulation 14A, not later that 120 days after the end of
the fiscal year, and of which information is hereby incorporated by reference
in, and made part of, this Form 10-K, except that the information with respect
to executive officers of the Registrant is presented below.
The executive officers of the company and their respective ages, positions and
years of service with the company are set forth below.
Years With
Name of Individual Age Position The Company
- ------------------ --- -------- -----------
Marvin L. Mann 65 Chairman of the Board and Chief Executive Officer 7
Paul J. Curlander 45 Director, President and Chief Operating Officer 7
Gary E. Morin 49 Vice President and Chief Financial Officer 2
Kathleen J. Affeldt 49 Vice President, Human Resources 7
Daniel P. Bork 46 Director of Taxes 1
Vincent J. Cole, Esq. 41 Vice President, General Counsel and Secretary 7
David L. Goodnight 45 Corporate Controller 4
Clifford D. Gookin 40 Vice President, Corporate Development 2
Thomas B. Lamb 40 Vice President 2
Bernard V. Masson 50 Vice President 2
John C. Mitchell 51 Vice President 1
Donald C. Shropshire, Jr. 59 Vice President and General Manager 7
John A. Stanley 60 Vice President and President of Lexmark Europe 7
Alfred A. Traversi 46 Vice President, Information Technology and Operations 1
Mr. Mann has been Chairman of the Board and Chief Executive Officer of the
company since March 1991 and President of the company from March 1991 to
February 1997. Prior to such time, Mr. Mann held numerous positions with IBM,
which he joined in 1958. During his IBM career, Mr. Mann held executive
positions in marketing, research and development, manufacturing and general
management, including President of the Information Products Division and
President and Chief Executive Officer of Satellite Business Systems. He was
elected an IBM Vice President in 1985. Mr. Mann also serves on the board of
directors of M.A. Hanna Company and Imation Corp. and is a member of the board
of trustees of Fidelity Investments.
Dr. Curlander has been a Director, President and Chief Operating Officer of the
company since February 1997 and Executive Vice President, Operations of Lexmark
International, Inc. ("Lexmark International") from January 1995 to February
1997. In 1993, Dr. Curlander became a Vice President of Lexmark International.
Prior to such time, commencing in March 1991, Dr. Curlander served as General
Manager of Lexmark International's Printing Systems Business. Prior to joining
the company, Dr. Curlander was employed with IBM, which he joined in 1974. He
received a Ph.D. in Electrical Engineering from MIT in 1979 while on leave of
absence from IBM. After returning to IBM, Dr. Curlander held management and
executive positions in development, manufacturing
61
and general management, including leading the development of IBM's first LED
printer and the company's first desktop laser printer.
Mr. Morin has been Vice President and Chief Financial Officer of the company
since January 1996. Prior to joining the company, Mr. Morin held various
executive and senior management positions with Huffy Corporation, including most
recently, the position of Executive Vice President and Chief Operating Officer.
Ms. Affeldt has been Vice President of Human Resources since July 1996. Prior to
such time and since 1991, Ms. Affeldt served as Director of Human Resources.
Prior to 1991, Ms. Affeldt held various human resource management positions with
IBM.
Mr. Bork has been Director of Taxes of the company since he joined the company
in October 1996. Prior to joining the company, Mr. Bork was Director of Taxes
with Cray Research, Inc. Prior to his tenure at Cray Research, Inc., Mr. Bork
was with the accounting firm of Coopers & Lybrand, most recently serving as
Director of International Tax in Coopers & Lybrand's Minneapolis office.
Mr. Cole has been Vice President and General Counsel of the company since July
1996 and Corporate Secretary since February 1996. Prior to such time, commencing
in March 1991, Mr. Cole served as Corporate Counsel and then Assistant General
Counsel. Prior to joining the company, Mr. Cole was associated with the law firm
of Cahill Gordon & Reindel.
Mr. Goodnight has been Controller of the company since February 1997. Prior to
such time and since January 1994, when he joined the company, Mr. Goodnight
served as CFO for the Company's Business Printer Division. Prior to joining the
company, Mr. Goodnight held various Controller positions with Calcomp, Inc.
Mr. Gookin has been Vice President of Corporate Development of Lexmark
International since November 1995. Prior to joining the company, Mr. Gookin
served as managing director of the Mergers and Acquisition Group at Rauscher
Pierce Refsnes, Inc. Prior to 1991, Mr. Gookin held positions in the Investment
Banking Department of CS First Boston Corporation.
Mr. Lamb has been Vice President and President of the Imaging Solutions Division
of Lexmark International since August 1997. He served as Vice President and
General Manager of the Imaging Solutions Division from January 1996 up to his
appointment as division president. Prior to joining the company, Mr. Lamb held
various senior management positions with General Chemical Corporation, including
most recently, the position of Vice President and General Manager of the
Industrial Chemicals Division.
Mr. Masson has been Vice President and President of the Consumer Printer
Division of Lexmark International since August 1997. He served as Vice President
and General Manager of the Consumer Printer Division from December 1995 up to
his appointment as division president. Prior to joining the company, Mr. Masson
was Vice President and General Manager of DH Technology's DHPRINT unit, a
publicly-held manufacturer of specialty printers, primarily for the financial,
retail and gaming markets worldwide. Prior to 1992, Mr. Masson served as Senior
Vice President and General Manager - Plotter Division of Calcomp, Inc.
Mr. Mitchell has been Vice President and President of the Business Printer
Division of Lexmark International since August 1997. He served as Vice President
and General Manager of the Business Printer Division from the time he joined the
company in January 1997 up to his appointment as division president. Prior to
joining the company, Mr. Mitchell held various executive and senior management
positions with Nabisco, including most recently, the position of President -
Planters and Lifesavers Companies.
62
Mr. Shropshire has been Vice President and General Manager of Lexmark
International since October 1994. Prior to such time, he served as Vice
President and General Manager, Asia Pacific, Canada, and Latin America and
Information Technology. When he joined the company in 1991, Mr. Shropshire
served as Vice President, Marketing and Sales, U.S., Canada, Latin America, and
Asia Pacific. In his prior 27 years with IBM, he held various executive
positions in marketing, development and general management.
Mr. Stanley has been Vice President of Lexmark International and President of
Lexmark Europe since March 1991. Prior to such time, Mr. Stanley worked for IBM,
which he originally joined in the United Kingdom in 1968. He held several
executive positions with IBM in Europe and the U.S. in marketing, human
resources and operations. Immediately before joining the company, he was the
director of marketing and services for IBM Europe.
Mr. Traversi has been President of Customer Services since October 1997. He
served as Vice President of Information Technology and Operations of Lexmark
International from the time he joined the company in October 1996 up to his
appointment as President of Customer Services. Prior to joining the company, Mr.
Traversi was Vice President - Operations Services with Taco Bell Corporation.
Prior to 1994, Mr. Traversi held various senior management positions with
Digital Equipment Corporation.
Item 11. Executive Compensation
Information required by Part III, Item 11 of this Form 10-K is incorporated by
reference from the company's definitive Proxy Statement for its 1998 Annual
Meeting of Stockholders, which will be filed with the Securities and Exchange
Commission, pursuant to Regulation 14A, not later that 120 days after the end of
the fiscal year, and of which information is hereby incorporated by reference
in, and made part of, this Form 10-K.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by Part III, Item 12 of this Form 10-K is incorporated by
reference from the company's definitive Proxy Statement for its 1998 Annual
Meeting of Stockholders, which will be filed with the Securities and Exchange
Commission, pursuant to Regulation 14A, not later that 120 days after the end of
the fiscal year, and of which information is hereby incorporated by reference
in, and made part of, this Form 10-K.
Item 13. Certain Relationships and Related Transactions
Information required by Part III, Item 13 of this Form 10-K is incorporated by
reference from the company's definitive Proxy Statement for its 1998 Annual
Meeting of Stockholders, which will be filed with the Securities and Exchange
Commission, pursuant to Regulation 14A, not later that 120 days after the end of
the fiscal year, and of which information is hereby incorporated by reference
in, and made part of, this Form 10-K.
63
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) 1 Financial Statements:
Financial statements filed as part of this Form 10-K are included under
Part II, Item 8.
(a) 2 Financial Statement Schedules: Pages In Form 10-K
------------------
Report of Independent Accountants 65
For the years ended December 31, 1997, 1996, and 1995:
Schedule II - Valuation and Qualifying Accounts 66
All other schedules are omitted as the required information is inapplicable or
the information is presented in the Consolidated Financial Statements or related
notes.
64
REPORT OF INDEPENDENT ACCOUNTANTS
Our report on the consolidated financial statements of Lexmark International
Group, Inc. and subsidiaries as of December 31, 1997 and 1996 and for each of
the years in the three year period ended December 31, 1997 is included on page
59 of this Form 10-K. In connection with our audits of such financial
statements, we have also audited the related financial statement schedule listed
in the index on page 66 of this Form 10-K.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
/s/ Coopers & Lybrand L.L.P.
Coopers & Lybrand L.L.P.
Lexington, Kentucky
February 18, 1998
65
LEXMARK INTERNATIONAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 1995, 1996, and 1997
(Dollars in Millions)
(A) (B) (C) (D) (E)
Additions
--------------------------
Balance at Charged to Charged to Balance at
Beginning Costs and other End of
Description of Period Expenses Accounts Deductions Period
- -------------------------------------- ---------- ---------- ---------- ---------- ----------
1995:
Allowance for doubtful accounts $19.4 $13.2 $ - $ (5.5) $27.1
Inventory reserves 36.0 36.9 - (27.9) 45.0
Deferred tax assets valuation
allowance 110.8 4.5 - (38.1) 77.2
1996:
Allowance for doubtful accounts $27.1 $ 3.0 $ - $(12.1) $18.0
Inventory reserves 45.0 30.0 - (41.4) 33.6
Deferred tax assets valuation
allowance 77.2 0.8 - (45.7) 32.3
1997:
Allowance for doubtful accounts $18.0 $ 5.1 $ - $ (3.7) $19.4
Inventory reserves 33.6 26.5 - (20.5) 39.6
Deferred tax assets valuation
allowance 32.3 3.8 - (15.3) 20.8
66
Item 14(a)(3). Exhibits
Exhibits for the company are listed in the Index to Exhibits beginning on page
E-1.
(b) Reports on Form 8-K
A Current Report on Form 8-K dated October 20, 1997, with respect to a press
release announcing the company's financial results for the three and nine months
ended September 30, 1997, was filed with the Securities and Exchange Commission
by the company.
A Current Report on Form 8-K dated October 21, 1997, with respect to the company
entering into an agreement, and issuing a press release announcing its agreement
to repurchase three million shares of its outstanding Class A common stock from
certain of its stockholders participating in the secondary offering of shares of
the company's Class A common stock, was filed with the Securities and Exchange
Commission by the company.
67
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 in the City of Lexington,
State of Kentucky, on March 6, 1998.
LEXMARK INTERNATIONAL GROUP, INC.
By /s/ Marvin L. Mann
-------------------------------
Name: Marvin L. Mann
Title: Chairman of the Board &
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the following capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Marvin L. Mann Chairman of the March 6, 1998
- ------------------------ Board/Chief Executive
Marvin L. Mann Officer (Principal
Executive Officer)
/s/ Gary E. Morin Vice President/Chief March 6, 1998
- ------------------------ Financial Officer
Gary E. Morin (Principal Financial
Officer)
/s/ David L. Goodnight Corporate Controller March 6, 1998
- ------------------------ (Principal Accounting
David L. Goodnight Officer)
/s/ B. Charles Ames Director March 6, 1998
- ------------------------
B. Charles Ames
/s/ Roderick H. Carnegie Director March 6, 1998
- ------------------------
Roderick H. Carnegie
Signature Title Date
--------- ----- ----
/s/ Frank T. Cary Director March 6, 1998
- ------------------------
Frank T. Cary
/s/ Paul J. Curlander Director March 6, 1998
- ------------------------
Paul J. Curlander
/s/ William R. Fields Director March 6, 1998
- ------------------------
William R. Fields
/s/ Donald J. Gogel Director March 6, 1998
- ------------------------
Donald J. Gogel
/s/ Ralph E. Gomory Director March 6, 1998
- ------------------------
Ralph E. Gomory
/s/ Stephen R. Hardis Director March 6, 1998
- ------------------------
Stephen R. Hardis
/s/ Michael J. Maples Director March 6, 1998
- ------------------------
Michael J. Maples
/s/ Martin D. Walker Director March 6, 1998
- ------------------------
Martin D. Walker
Index to Exhibits
Number Description of Exhibits
- ------ -----------------------
3.1 Third Restated Certificate of Incorporation of Lexmark
International Group, Inc. (the "company"). (1)
3.2 Company By-Laws, as Amended and Restated as of October 26,
1995, and Amended by Amendment No. 1 dated as of February 13,
1997. (7)
4.1 Amended and Restated Secured U.S. Credit Agreement, dated as
of April 21, 1995 (the "U.S. Credit Agreement"), among Lexmark
International, Inc. ("International"), the company, the
Lenders listed therein ("Lenders") and Morgan Guaranty Trust,
as agent (the "Agent"). (2)
4.2 Amendment No. 1 to the U.S. Credit Agreement, dated as of
September 26, 1995, among International, the company, the
Lenders and the Agent. (3)
4.3 Amendment No. 2 to the U.S. Credit Agreement, dated as of
April 3, 1996, among International, the company, the Lenders
and the Agent. (4)
4.4 Amendment No. 3 to the U.S. Credit Agreement, dated as of
March 14, 1997, among International, the company, the Lenders
and the Agent. (8)
4.5 Amendment No. 4 to the U.S. Credit Agreement, dated as of May
1, 1997, among International, the company, the Lenders and the
Agent. (8)
4.6 Rights Agreement, dated as of February 18, 1998, between the
company and ChaseMellon Shareholder Services, L.L.C., as
Rights Agent. (9)
4.7 Registration and Participation Agreement, dated as of March
27, 1991, among the company, The Clayton & Dubilier Private
Equity Fund IV Limited Partnership ("C&D Fund IV"), and the
stockholders of the company named therein. (2)
4.8 Amendment, Waiver and Consent Under Registration and
Participation Agreement, dated as of December 21, 1994,
executed by C&D Fund IV, Leeway & Co., Mellon Bank N.A., as
Trustee for First Plaza Group Trust ("Mellon Bank", and with
Leeway & Co., the "Institutional Investors"), and the
Equitable Investors. (2)
4.9 Registration Agreement, dated as of March 27, 1991, among the
company, International, the Equitable Investors and the
Institutional Investors. (2)
4.10 Amendment No. 1 to the Registration Agreement, dated as of
December 31, 1991, among the company, International, the
Equitable Investors and the Institutional Investors. (2)
4.11 Letter Agreement, dated as of March 27, 1991, among the
company, C&D Fund IV and International Business Machines
Corporation ("IBM"). (1)
E-1
4.12 Securities Purchase Agreement, dated as of March 27, 1991,
among the company and the Institutional Investors. (2)
4.13 Amendment No. 1 to the Securities Purchase Agreement, dated
as of March 27, 1991, among the company and the Institutional
Investors. (2)
4.14 Amendment No. 2 to the Securities Purchase Agreement, dated
as of December 21, 1992, among the company and the
Institutional Investors. (2)
4.15 Specimen of Class A common stock certificate. (1)
4.16 Warrant Agreement, dated as of April 1, 1991, among
International, Spectrum Sciences B.V., a Netherlands
corporation, and the company. (2)
4.17 Letter Agreement, dated December 31, 1992, from Keys
Foundation to the company. (2)
9.1 Voting Trust Agreement, dated as of August 28, 1991, among
Clayton & Dubilier Associates IV Limited Partnership ("C&D
Associates IV"), as voting trustee, the company and Larry H.
Holswade, Thomas L. Millner, Tadd C. Seitz and Peter C. Valli.
(2)
9.2 Voting Trust Agreement, dated as of March 27, 1991, among C&D
Associates IV, as voting trustee, the company and M. Lee
Pearce. (2)
10.1 Supplies Agreement, dated August 14, 1995, between IBM and
International. (3)*
10.1A Category I Supplies Trademark Agreement, dated as of August
16, 1995 and effective as of March 27, 1996, between IBM and
International. (1)
10.2 Agreement, dated as of August 1, 1990, between IBM and
International, and Amendment thereto. (3)*
10.3 Agreement, dated as of May 31, 1990, between International
and Canon Inc., and Amendment thereto. (3)*
10.4 Agreement, dated as of March 26, 1991, between International
and Hewlett-Packard Company. (3)*
10.5 Patent Cross-License Agreement, effective October 1, 1996,
between Hewlett-Packard Company and International. (5)*
10.6 Amended and Restated Lease Agreement, dated as of January 1,
1991, between IBM and Lexmark, and First Amendment thereto.
(2)
10.7 Board Investor Promissory Note and Pledge Agreement, dated as
of December 19, 1994,
between the company and Sir Roderick H. Carnegie. (2)
10.8 Receivables Purchase Agreement, dated as of January 31, 1994,
among International, Delaware Funding Corporation and J.P.
Morgan Delaware, as Administrative Agent. (2)
E-2
10.9 Purchase Agreement, dated as of March 31, 1997, between
International, as Originator, and Lexmark Receivables
Corporation ("LRC"), as Buyer. (8)
10.10 Receivables Purchase Agreement, dated as of March 31, 1997,
among LRC, as Seller, International, as Servicer and in its
individual capacity, Delaware Funding Corporation, as Buyer,
and Morgan Guaranty Trust Company of New York, as
Administrative Agent. (8)
10.11 Indemnification Agreement, dated as of March 27, 1991, among
the company, International, Clayton & Dubilier, Inc. and C&D
Fund IV. (2)
10.12 Form of Stock Subscription Agreement, between the company and
Board investors (including a schedule of Board investors,
purchase dates and number of shares purchased). (1)
10.13 Form of Management Stock Subscription Agreement, among the
company, International and Named Executive Officers (including
a schedule of Named Executive Officers, purchase dates and
number of shares purchased). (1) +
10.14 Lexmark International Group, Inc. Stock Option Plan for
Executives and Senior Officers. (2) +
10.15 First Amendment to the Stock Option Plan for Executives and
Senior Officers, dated as of October 31, 1994. (1) +
10.16 Second Amendment to the Stock Option Plan for Executive and
Senior Officers, dated as of September 13, 1995. (1) +
10.17 Form of Management Stock Option Agreement, among the company,
International and Named Executive Officers (including a
schedule of Named Executive Officers, grant dates and number
of shares granted pursuant to options). (1) +
10.18 First Amendment to Management Stock Option Agreement, dated
as of October 31, 1994, between the company and Marvin L.
Mann. (1) +
10.19 Lexmark International Group, Inc. Stock Incentive Plan. (1) +
10.20 Form of Non-Qualified Stock Option Agreement, pursuant to the
company's Stock Incentive Plan. (1) +
10.21 Lexmark International Group, Inc. Stock Incentive Plan,
Amended and Restated Effective May 2, 1997, as amended by
Amendment No. 1 thereto dated as of July 31, 1997. (8)+
10.22 1995-1997 Long Term Incentive Plan. (2) +
10.23 Form of Management Stock Subscription Agreement, among the
company, International and Named Executive Officers (including
a schedule of Named Executive Officers, grant dates and number
of shares granted pursuant to options). (1) +
10.24 Employment Agreement, dated as of March 18, 1997, between
Marvin L. Mann and International. +
E-3
10.25 Employment Agreement, dated as of March 18, 1997, between
Paul J. Curlander and International. +
10.26 Employment Agreement, dated as of March 18, 1997, between
Donald C. Shropshire and International. +
10.27 Employment Agreement, dated as of September 13, 1995, between
John A. Stanley and International U.K. Ltd. (1) +
10.28 Amendment, dated April 1, 1997, to the John A. Stanley
Employment Agreement. +
10.29 Employment Agreement, dated as of March 18, 1997, between
Gary E. Morin and International. +
10.30 Lexmark International Group, Inc. Non-Employee Director Stock
Plan, Amended and Restated Effective December 12, 1996. (6) +
10.31 Lexmark International Group, Inc. Nonemployee Director Stock
Plan, Amended and Restated Effective May 2, 1997, as amended
by Amendment No. 1 thereto dated as of July 31, 1997. (8)+
10.32 Credit Agreement, dated as of January 27, 1998, among the
company, as Parent Guarantor, International, as Borrower, the
Lenders party thereto, Fleet National Bank, as Documentation
Agent, Morgan Guaranty Trust Company of New York, as
Syndication Agent, and The Chase Manhattan Bank, as
Administrative Agent.
21 Subsidiaries of the company as of December 31, 1997.
23 Consent of Coopers & Lybrand L.L.P.
27 Financial Data Schedule.
- ----------
*Confidential treatment previously granted by the Securities and Exchange
Commission.
+ Indicates management contract or compensatory plan, contract or arrangement.
(1) Incorporated by reference to company's Form S-1 Registration
Statement, Amendment No. 1 (Registration No. 33-97218) filed
with the Commission on October 27, 1995.
(2) Incorporated by reference to company's Form S-1 Registration
Statement, (Registration No. 33-97218) filed with the
Commission on September 22, 1995.
(3) Incorporated by reference to company's Form S-1 Registration
Statement, Amendment No. 2 (Registration No. 33-97218) filed
with the Commission on November 13, 1995.
(4) Incorporated by reference to company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1996 (Commission
File No. 1-14050).
(5) Incorporated by reference to company's Quarterly Report on
Form 10-Q/A for the quarter ended September 30, 1996
(Commission File No. 1-14050).
(6) Incorporated by reference to company's Form S-3 Registration
Statement (Registration No. 333-19377) filed with the
Commission on January 8, 1997.
(7) Incorporated by reference to the company's Annual Report on
Form 10-K for the fiscal year end December 31, 1996
(Commission File No. 1-14050).
E-4
(8) Incorporated by reference to the company's Quarterly Report
on Form 10-Q for the quarter ended June 30, 1997 (Commission
File No. 1-14050).
(9) Incorporated by reference to the company's Current Report on
Form 8-K dated February 27, 1998 (Commission File No.
1-14050).
E-5