10-Q 1 sub3q10q03.txt LEXMARK INTERNATIONAL, INC. FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) |X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended September 30, 2003 OR |_| Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission File No. 1-14050 LEXMARK INTERNATIONAL, INC. (Exact name of registrant as specified in its charter) Delaware 06-1308215 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) One Lexmark Centre Drive 740 West New Circle Road Lexington, Kentucky 40550 (Address of principal executive offices) (Zip Code) (859) 232-2000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes X No __ The registrant had 128,477,110 shares outstanding (excluding shares held in treasury) of Class A common stock, par value $0.01 per share, as of the close of business on November 6, 2003. LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES INDEX Page of Form 10-Q --------- Part I ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS (Unaudited) THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002......2 CONSOLIDATED CONDENSED STATEMENTS OF FINANCIAL POSITION (Unaudited) AS OF SEPTEMBER 30, 2003 AND DECEMBER 31, 2002......................3 CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002.......................4 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited)....5-9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Unaudited)...........................10-15 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...........16 ITEM 4. CONTROLS AND PROCEDURES.............................................16 Part II ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..................17 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.....................................17 1 Part I - Financial Information Item 1. Financial Statements LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS (In Millions, Except Per Share Amounts) (Unaudited)
Three Months Ended Nine Months Ended September 30 September 30 -------------------------------- ------------------------------ 2003 2002 2003 2002 ----- ----- ----- ----- Revenue $1,157.1 $1,041.0 $3,385.2 $3,149.1 Cost of revenue 785.7 702.7 2,276.8 2,162.3 -------- -------- -------- -------- Gross profit 371.4 338.3 1,108.4 986.8 -------- -------- -------- -------- Research and development 66.5 57.9 195.3 182.6 Selling, general and administrative 164.4 156.7 507.0 453.2 -------- -------- -------- -------- Operating expense 230.9 214.6 702.3 635.8 -------- -------- -------- -------- Operating income 140.5 123.7 406.1 351.0 Interest (income)/expense, net (0.3) 2.5 0.3 7.9 Other - (0.2) (0.2) 4.7 -------- -------- -------- -------- Earnings before income taxes 140.8 121.4 406.0 338.4 Provision for income taxes 36.7 31.6 105.6 88.0 -------- -------- -------- -------- Net earnings $ 104.1 $ 89.8 $ 300.4 $ 250.4 ======== ======== ======== ======== Net earnings per share: Basic $ 0.81 $ 0.71 $ 2.35 $ 1.94 ======== ======== ======== ======== Diluted $ 0.79 $ 0.70 $ 2.29 $ 1.89 ======== ======== ======== ======== Shares used in per share calculation: Basic 128.5 126.8 127.8 129.1 ======== ======== ======== ======== Diluted 131.5 129.2 131.1 132.2 ======== ======== ======== ========
See notes to consolidated condensed financial statements. 2 LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF FINANCIAL POSITION (In Millions, Except Par Value) (Unaudited)
September 30 December 31 2003 2002 ----------- ----------- ASSETS Current assets: Cash and cash equivalents $ 569.9 $ 497.7 Marketable securities 389.8 - Trade receivables, net of allowance of $53.0 in 2003 and $46.0 in 2002 586.1 600.3 Inventories 427.3 410.3 Prepaid expenses and other current assets 243.1 290.5 --------- ---------- Total current assets 2,216.2 1,798.8 Property, plant and equipment, net 692.9 747.6 Other assets 366.5 261.7 --------- ---------- Total assets $ 3,275.6 $ 2,808.1 ========= ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term debt $ 0.1 $ 12.3 Accounts payable 422.9 378.5 Accrued liabilities 740.0 708.2 --------- ---------- Total current liabilities 1,163.0 1,099.0 Long-term debt 149.3 149.2 Other liabilities 488.0 478.3 --------- ---------- Total liabilities 1,800.3 1,726.5 --------- ---------- Stockholders' equity: Preferred stock, $.01 par value, 1.6 shares authorized; no shares issued and outstanding - - Common stock, $.01 par value: Class A, 900.0 shares authorized; 128.3 and 126.2 shares outstanding in 2003 and 2002, respectively 1.6 1.6 Class B, 10.0 shares authorized; no shares issued and outstanding - - Capital in excess of par 939.3 863.5 Retained earnings 1,956.2 1,655.8 Treasury stock, at cost; 34.4 and 34.5 shares in 2003 and 2002, respectively (1,208.6) (1,209.6) Accumulated other comprehensive loss (213.2) (229.7) --------- --------- Total stockholders' equity 1,475.3 1,081.6 --------- --------- Total liabilities and stockholders' equity $ 3,275.6 $ 2,808.1 ========= =========
See notes to consolidated condensed financial statements. 3 LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (In Millions) (Unaudited)
Nine Months Ended September 30 ------------------------------------- 2003 2002 ---- ---- Cash flows from operating activities: Net earnings $ 300.4 $ 250.4 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 109.8 103.5 Deferred taxes (5.5) 1.3 Other 16.7 37.9 ------- ------- 421.4 393.1 Change in assets and liabilities: Trade receivables 14.2 152.5 Trade receivables program - (55.0) Inventories (17.0) (56.0) Accounts payable 44.4 39.6 Accrued liabilities 31.8 126.9 Tax benefits from employee stock plans 27.4 17.9 Other assets and liabilities (43.8) (86.9) ------- ------- Net cash provided by operating activities 478.4 532.1 ------- ------- Cash flows from investing activities: Purchases of property, plant and equipment (54.9) (71.2) Purchases of marketable securities (469.6) - Proceeds from marketable securities 79.8 - Other 1.3 (2.1) ------- ------- Net cash used for investing activities (443.4) (73.3) ------- ------- Cash flows from financing activities: (Decrease) increase in short-term debt (13.3) 8.3 Issuance of treasury stock 1.0 0.6 Purchase of treasury stock - (330.7) Proceeds from employee stock plans 45.7 17.4 ------- ------- Net cash provided by (used for) financing activities 33.4 (304.4) ------- ------- Effect of exchange rate changes on cash 3.8 3.3 ------- ------- Net increase in cash and cash equivalents 72.2 157.7 Cash and cash equivalents - beginning of period 497.7 90.7 ------- ------- Cash and cash equivalents - end of period $ 569.9 $ 248.4 ======= =======
See notes to consolidated condensed financial statements. 4 LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION The accompanying interim financial statements are unaudited; however, in the opinion of management of Lexmark International, Inc. (together with its subsidiaries, the "company"), all adjustments (which comprise only normal and recurring accruals) necessary for a fair presentation of the interim financial results have been included. The results for the interim periods are not necessarily indicative of results to be expected for the entire year. These financial statements and notes should be read in conjunction with the company's audited annual consolidated financial statements for the year ended December 31, 2002. 2. STOCK-BASED COMPENSATION (In millions, except per share amounts) In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation --Transition and Disclosure - an Amendment of SFAS 123, which provided alternative methods for a voluntary change to the fair value method of accounting for stock-based employee compensation and amended the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation. The company has elected to continue to account for its stock-based employee compensation plans under APB Opinion 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, no compensation cost is reflected in net earnings as all options granted have an exercise price equal to the market value of the underlying common stock on the date of grant. The following table is provided in accordance with the disclosure requirements of SFAS 148 and illustrates the effect on net earnings and earnings per share if the company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation.
Three Months Nine Months Ended Ended September 30 September 30 ------------------------ ---------------------- 2003 2002 2003 2002 ---- ---- ---- ---- Net earnings, as reported $104.1 $89.8 $300.4 $250.4 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (10.1) (8.1) (31.1) (24.1) ------ ----- ------- ------ Pro forma net income $ 94.0 $81.7 $269.3 $226.3 ====== ===== ====== ====== Net earnings per share: Basic - as reported $ 0.81 $0.71 $ 2.35 $ 1.94 Basic - pro forma $ 0.73 $0.64 $ 2.11 $ 1.75 Diluted - as reported $ 0.79 $0.70 $ 2.29 $ 1.89 Diluted - pro forma $ 0.72 $0.63 $ 2.05 $ 1.71
5 3. RESTRUCTURING AND RELATED CHARGES As of December 31, 2002, the company had substantially completed all restructuring activities. The restructuring liability of $4.7 million remaining at December 31, 2002 was principally associated with severance payments, which continued into 2003 for employees who had exited the business. As of September 30, 2003, all severance payments have been made. 4. MARKETABLE SECURITIES During September 2003, the company began investing in marketable securities. The company evaluated its marketable securities in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and determined that all of its investments in marketable securities to date should be classified as available-for-sale and reported at fair value, with unrealized gains and losses recorded in other comprehensive earnings (loss). The fair value of the company's available-for-sale marketable securities approximates the company's amortized cost. As of September 30, 2003, there were no realized or unrealized gains or losses related to marketable securities. The company expects to use the specific identification method when accounting for the costs of its available-for-sale marketable securities as sold. At September 30, 2003, the company's available-for-sale marketable securities consist of the following:
Gross Gross Amortized Unrealized Unrealized Estimated (Dollars in Millions) Cost Gains Losses Fair Value ------------------------------------ ------------------- -------------------- ------------------ ------------------ Municipal debt securities $ 260.1 $ - $ - $ 260.1 Preferred securities 129.7 - - 129.7 ----- ---- ---- ------- Total marketable securities $ 389.8 $ - $ - $ 389.8 ===================================================================================================================
Although contractual maturities of the company's debt securities are generally greater than one year, the investments are classified as current assets in the consolidated statements of financial position due to the company's expected holding period of less than one year. The contractual maturities of the company's available-for-sale marketable debt securities noted above were as follows:
Amortized Estimated Fair (Dollars in Millions) Cost Value --------------------------------------------------------------------------------------------------------------- Due in less than one year $ 4.2 $ 4.2 Due in 1 - 5 years 2.1 2.1 Due after 5 years 253.8 253.8 ------ ------ Total available-for-sale marketable debt securities $260.1 $260.1 ===============================================================================================================
5. INVENTORIES (Dollars in millions) Inventories consist of the following:
September 30 December 31 2003 2002 ---------------- ----------------- Work in process $118.5 $121.0 Finished goods 308.8 289.3 ------ ------ $427.3 $410.3 ====== ======
6 6. AGGREGATE WARRANTY LIABILITY (Dollars in millions) Changes in the company's aggregate warranty liability, which includes both warranty and extended warranty (deferred revenue), during the nine months ended September 30, 2003 are presented below.
------------------------------------------------------------ Balance as of December 31, 2002 $147.0 Accruals for warranties issued during 2003 168.2 Accruals related to pre-existing warranties (including amortization of deferred revenue for extended warranties and changes in estimates) (32.2) Settlements made (in cash or in kind) during 2003 (122.6) ------------------------------------------------------------ Balance as of September 30, 2003 $160.4 ------------------------------------------------------------
Both warranty and the short-term portion of extended warranty are included on the accrued liabilities line in the consolidated statements of financial position. The long-term portion of extended warranty is included on the other liabilities line in the consolidated statements of financial position. 7. OTHER COMPREHENSIVE EARNINGS (LOSS) (Dollars in millions) Comprehensive earnings, net of taxes, consists of the following:
Three Months Ended Nine Months Ended September 30 September 30 -------------------- ------------------ 2003 2002 2003 2002 ---- ---- ---- ---- Net earnings $104.1 $89.8 $300.4 $250.4 Other comprehensive earnings (loss): Foreign currency translation adjustment (1.2) (3.1) 14.1 10.9 Cash flow hedging, net of reclassifications 4.4 5.9 2.5 (4.7) Minimum pension liability adjustment (0.1) - (0.1) (0.2) ------ ----- ------ ------ Comprehensive earnings $107.2 $92.6 $316.9 $256.4 ====== ===== ====== ======
Accumulated other comprehensive loss consists of the following:
Accumulated Minimum Other Translation Cash Flow Pension Comprehensive Adjustment Hedges Liability Loss ---------- --------- --------- ------------- Balance, December 31, 2002 $(43.8) $(20.9) $(165.0) $(229.7) First quarter 2003 change 2.6 (2.2) 0.5 0.9 ------ ------ ------- ------- Balance, March 31, 2003 (41.2) (23.1) (164.5) (228.8) Second quarter 2003 change 12.7 0.3 (0.5) 12.5 ------ ------ ------- ------- Balance, June 30, 2003 (28.5) (22.8) (165.0) (216.3) Third quarter 2003 change (1.2) 4.4 (0.1) 3.1 ------ ------ ------- ------- Balance, September 30, 2003 $(29.7) $(18.4) $(165.1) $(213.2) ====== ====== ======= =======
7 8. EARNINGS PER SHARE (EPS) (In millions, except per share amounts) The following table presents a reconciliation of the numerators and denominators of the basic and diluted EPS calculations:
Three Months Ended Nine Months Ended September 30 September 30 ------------ ------------ 2003 2002 2003 2002 ---- ---- ---- ---- Numerator: Net earnings $104.1 $89.8 $300.4 $250.4 ====== ===== ====== ====== Denominator: Weighted average shares used to compute basic EPS 128.5 126.8 127.8 129.1 Effect of dilutive securities Stock options 3.0 2.4 3.3 3.1 ------ ----- ------ ------ Weighted average shares used to compute diluted EPS 131.5 129.2 131.1 132.2 ====== ===== ====== ====== Basic net EPS $0.81 $0.71 $2.35 $1.94 Diluted net EPS $0.79 $0.70 $2.29 $1.89
Options to purchase an additional 1.6 million and 7.8 million shares of Class A common stock for the three month periods and 1.4 million and 2.2 million shares for the nine month periods ended September 30, 2003 and September 30, 2002, respectively, were outstanding but were not included in the computation of diluted earnings per share because their exercise price was greater than the average market price of the common stock, and therefore, their effect would be antidilutive. 9. EMPLOYEE PENSION PLANS During the third quarter of 2003, the company's board of directors authorized, and the company then made, a contribution to the company's U.S. pension plan of approximately $108 million. This contribution was made to improve the funding status of the plan following the negative returns in capital markets over the past few years, which decreased the value of pension plan assets. The increase in the other assets line in the consolidated statements of financial position was due to the pension plan contribution. Unless there are significant changes to the current assumptions, no additional contribution is expected through 2004. 10. NEW ACCOUNTING STANDARDS In November 2002, the Financial Accounting Standards Board ("FASB") issued EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables, which addresses revenue recognition accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. The provisions of this pronouncement are effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The company has evaluated the provisions of this pronouncement and determined that the pronouncement does not have a material impact on its financial position, results of operations and cash flows. In November 2002, the FASB issued FIN 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 elaborates on 8 required disclosures by a guarantor in its financial statements about obligations under certain guarantees it has issued and clarifies the need for a guarantor to recognize, at the inception of certain guarantees, a liability for the fair value of the obligation undertaken in issuing the guarantee. The interpretation is effective for qualified guarantees entered into or modified after December 31, 2002. The company has evaluated the provisions of this interpretation and determined that the interpretation does not have a material impact on its financial position, results of operations and cash flows. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. Refer to note 6 of the notes to consolidated financial statements for the quarterly disclosures required by this pronouncement. In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after December 15, 2003. The company has evaluated the provisions of this interpretation and determined that the interpretation has no impact on its financial position, results of operations and cash flows. In April 2003, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 149, Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities. SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under Statement No. 133. SFAS 149 is generally effective for contracts entered into or modified after June 30, 2003. This statement is not expected to have a material impact on the company's financial position, results of operations and cash flows. 11. SUBSEQUENT EVENT During October 2003, the company entered into interest rate swap contracts to convert its $150.0 million principal amount of 6.75% senior notes due 2008 from a fixed interest rate to a variable interest rate. Interest rate swaps with a total notional amount of $150.0 million were executed whereby the company will receive interest at a fixed rate of 6.75% and pay interest at a variable rate of approximately 2.76% above the six-month London Interbank Offered Rate (LIBOR). These interest rate swaps have a maturity date of May 15, 2008, which is equivalent to the maturity date of the senior notes. 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Unaudited) LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES Results of Operations --------------------- Consolidated revenue for the three months ended September 30, 2003 was $1,157 million, an increase of 11% over the same period of 2002. Total U.S. revenue increased $50 million or 10% and international revenue, including exports from the U.S., increased $66 million or 12%. The quarterly revenue growth was driven by increased sales of both laser and inkjet supplies and printers. Laser and inkjet supplies revenue was $641 million for the third quarter of 2003, versus $568 million for the same period in 2002, a 13% increase. Laser and inkjet printer revenue was $430 million for the third quarter of 2003, a 13% increase from $381 million in 2002. For the nine months ended September 30, 2003, consolidated revenue was $3,385 million, an increase of 7% over the same period of 2002. Total U.S. revenue increased $47 million or 3% and international revenue, including exports from the U.S., increased $189 million or 12%. The revenue growth for the first nine months of 2003 was primarily driven by increased sales of laser and inkjet supplies whose revenue increased 14% over 2002. Laser and inkjet supplies revenue was $1,913 million for the nine months ended September 30, 2003, versus $1,681 million for the same period in 2002, and represented 57% of total revenue versus 53% in 2002. Laser and inkjet printer revenue was $1,200 million for the nine months ended September 30, 2003, an increase of 2% over the same period of 2002. Consolidated gross profit was $371 million for the three months ended September 30, 2003, an increase of 10% from the same period of 2002. For the nine months ended September 30, 2003, consolidated gross profit was $1,108 million, an increase of 12% from the same period of 2002. Gross profit as a percentage of revenue for the quarter ended September 30, 2003 decreased to 32.1% from 32.5% in the third quarter of 2002, a decline of 0.4 percentage points. The decrease was principally due to lower printer margins (3.2 percentage points), offset somewhat by the absence of an asset impairment write-off in 2002 (1.5 percentage points) and higher supplies margins (1.2 percentage points). The 2002 asset impairment write-off of $15.8 million ($11.7 million, net of taxes) related to the abandonment of a customer relationship management software project. Gross profit as a percentage of revenue for the nine months ended September 30, 2003 increased to 32.7% from 31.3% for the same period in 2002, an increase of 1.4 percentage points. The improvement in the gross profit margin was due to an increase of supplies in the product mix (2.3 percentage points) and higher supplies margins (1.4 percentage points), somewhat offset by lower printer margins (2.8 percentage points). Total operating expense was $231 million for the quarter ended September 30, 2003 compared to $215 million for the same period of 2002. Total operating expense was $702 million for the nine months ended September 30, 2003 compared to $636 million for the same period of 2002. Operating expense as a percentage of revenue for the quarter was 20.0% compared to 20.6% for the corresponding period in 2002. The 0.6 percentage point decrease in 2003 was due to selling, general and administrative expenses increasing at a rate below the revenue growth rate despite the strengthening of the euro against the U.S. dollar. Also contributing to the decrease was the absence of a $3.7 million write-off of design costs related to a proposed manufacturing facility in the third quarter of 2002. Operating expense as a percentage of revenue for the first nine months of 2003 was 20.7% compared to 20.2% for the same period of 2002. This increase of 0.5 percentage points in 2003 principally reflects a strengthening of the euro against the U.S. dollar and an increased investment in marketing and sales. Consolidated operating income was $141 million for the third quarter of 2003, an increase of $17 million from 2002. This increase was due to $33 million higher gross profit, partially offset by a $16 million increase in operating expense. For the nine months ended September 30, 2003, consolidated operating income was 10 $406 million, an increase of $55 million from the same period of 2002. This increase was due to a $122 million increase in gross profit, partially offset by a $67 million increase in operating expense. Non-operating income was $0.3 million for the third quarter of 2003, compared to non-operating expenses of $2.3 million for the same period of 2002. The increase was primarily due to increased interest income on short-term investments. Non-operating expenses were $0.1 million for the nine months ended September 30, 2003, a $13 million decrease from the same period of 2002. The decrease was principally due to a $3.6 million write-down of a private equity investment in 2002 and additional interest income during the first nine months of 2003 compared to the same period in 2002. Net earnings for the third quarter of 2003 were $104 million, compared to $90 million in the third quarter of 2002. The increase in net earnings was primarily due to the improved operating income. The effective income tax rate was 26.0% in 2003 and 2002. Basic net earnings per share were $0.81 for the third quarter of 2003 compared to $0.71 in the corresponding period in 2002. Diluted net earnings per share were $0.79 in the third quarter of 2003, compared to $0.70 in 2002, an increase of 14%. The 2002 basic and net earnings per share were both adversely impacted by approximately $0.09 as a result of the previously mentioned $15.8 million asset impairment write-off. Net earnings for the first nine months of 2003 were $300 million, compared to $250 million for the same period of 2002. The increase in net earnings was primarily due to improved operating income and lower non-operating expenses. The effective income tax rate remained at 26.0% for both nine-month periods. Basic net earnings per share were $2.35 for the first nine months of 2003, compared to $1.94 in the corresponding period of 2002. Diluted net earnings per share were $2.29 for the first nine months of 2003, compared to $1.89 in the same period of 2002. These increases were primarily due to the increase in net earnings. Financial Condition ------------------- The company's financial position remains strong at September 30, 2003, with working capital of $1,053 million compared to $700 million at December 31, 2002. At September 30, 2003, the company had outstanding $0.1 million of short-term debt and $149 million of long-term debt. The debt to total capital ratio was 9% at September 30, 2003, compared to 13% at December 31, 2002. The company had no amounts outstanding under its U.S. trade receivables financing program or its revolving credit facility at September 30, 2003. Cash provided by operating activities for the nine months ended September 30, 2003 was $478 million, compared to $532 million for the same period of 2002. These amounts were reduced during 2003 and 2002 by $108 million and $50 million, respectively, due to contributions to the U.S. pension plan. See note 9 of the notes to consolidated financial statements for more information regarding the 2003 pension contribution. Also contributing to the change in cash flows from operating activities were unfavorable cash flow changes in trade receivables, offset somewhat by favorable cash flow changes in inventories as well as increased earnings. Management believes that cash provided by operations will continue to be sufficient to meet operating needs. Cash used for investing activities for the nine months ended September 30, 2003 was $443 million, compared to $73 million for the same period of 2002. The company began investing in marketable securities during the third quarter of 2003, which resulted in a net use of cash of $390 million on a year-to-date basis. The company spent $55 million on capital expenditures during the first nine months of 2003, compared to $71 million during the same period of 2002. The 2003 capital expenditures were principally related to infrastructure support and new product development. It is anticipated that capital expenditures for 2003 will be under $100 million, and they are expected to be funded through cash from operations. 11 Cash provided by financing activities was $33 million for the nine months ended September 30, 2003, compared to $304 million cash used for financing activities for the same period of 2002. This $337 million increase in cash from financing activities was due to the purchase of $331 million of treasury stock in 2002, but no purchases of treasury stock in 2003, on a year-to-date basis. As of September 30, 2003, the company's board of directors had authorized a total repurchase of $1.4 billion of its Class A common stock and there was approximately $188 million of share repurchase authority remaining. This repurchase authority allows the company, at management's discretion, to selectively repurchase its stock from time to time in the open market or in privately negotiated transactions depending upon market price and other factors. No shares have been repurchased during 2003. As of September 30, 2003, the company had repurchased approximately 34.7 million shares at prices ranging from $10.63 per share to $105.38 per share for an aggregate cost of approximately $1.2 billion. Restructuring and related charges --------------------------------- As of December 31, 2002, the company had substantially completed all restructuring activities. The restructuring liability of $4.7 million remaining at December 31, 2002 was principally associated with severance payments, which continued into 2003 for employees who had exited the business. As of September 30, 2003, all severance payments have been made. New Accounting Standards ------------------------ In November 2002, the Financial Accounting Standards Board ("FASB") issued EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables, which addresses revenue recognition accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. The provisions of this pronouncement are effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The company has evaluated the provisions of this pronouncement and determined that the pronouncement does not have a material impact on its financial position, results of operations and cash flows. In November 2002, the FASB issued FIN 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 elaborates on required disclosures by a guarantor in its financial statements about obligations under certain guarantees it has issued and clarifies the need for a guarantor to recognize, at the inception of certain guarantees, a liability for the fair value of the obligation undertaken in issuing the guarantee. The interpretation is effective for qualified guarantees entered into or modified after December 31, 2002. The company has evaluated the provisions of this interpretation and determined that the interpretation does not have a material impact on its financial position, results of operations and cash flows. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. Refer to note 6 of the notes to consolidated financial statements for the quarterly disclosures required by this pronouncement. In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after December 15, 2003. The company has evaluated the provisions of this interpretation and determined that the interpretation has no impact on its financial position, results of operations and cash flows. In April 2003, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 149, Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities. SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative 12 instruments embedded in other contracts and for hedging activities under Statement No. 133. SFAS 149 is generally effective for contracts entered into or modified after June 30, 2003. This statement is not expected to have a material impact on the company's financial position, results of operations and cash flows. Factors That May Affect Future Results and Information Concerning Forward - --------------------------------------------------------------------------- Looking Statements ------------------ Statements contained in this report which are not statements of historical fact are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are made based upon management's current expectations and beliefs concerning future developments and their potential effects upon the company. There can be no assurance that future developments affecting the company will be those anticipated by management, and there are a number of factors that could adversely affect the company's future operating results or cause the company's actual results to differ materially from the estimates or expectations reflected in such forward-looking statements, including without limitation, the factors set forth below: o The company and its major competitors, many of which have significantly greater financial, marketing and/or technological resources than the company, have regularly lowered prices on their products and are expected to continue to do so. In particular, both the inkjet and laser printer markets have experienced and are expected to continue to experience significant price pressure. Price reductions on inkjet or laser products or the inability to reduce costs, including warranty costs, contain expenses or increase or maintain sales as currently expected, as well as price protection measures, could result in lower profitability and jeopardize the company's ability to grow or maintain its market share. o The company's performance depends in part upon its ability to successfully forecast the timing and extent of customer demand and manage worldwide distribution and inventory levels of the company and its resellers. Unexpected fluctuations in reseller inventory levels could disrupt ordering patterns and may adversely affect the company's financial results. In addition, the financial failure or loss of a key customer or reseller could have a material adverse impact on the company's financial results. The company must also be able to address production and supply constraints, particularly delays or disruptions in the supply of key components necessary for production, which may result in lost revenue or in the company incurring additional costs to meet customer demand. The company's future operating results and its ability to effectively grow or maintain its market share may be adversely affected if it is unable to address these issues on a timely basis. o The company's future operating results may be adversely affected if it is unable to continue to develop, manufacture and market products that are reliable, competitive, and meet customers' needs. The markets for laser and inkjet products and associated supplies are aggressively competitive, especially with respect to pricing and the introduction of new technologies and products offering improved features and functionality. The impact of competitive activities on the sales volumes or revenue of the company, or the company's inability to effectively deal with these competitive issues, could have a material adverse effect on the company's ability to maintain or grow retail shelf space or market share and on its financial results. o The introduction of products by the company or its competitors, or delays in customer purchases of existing products in anticipation of new product introductions by the company or its competitors and market acceptance of new products and pricing programs, the reaction of competitors to any such new products or programs, the life cycles of the company's products, as well as delays in product development and manufacturing, and variations in the cost of component parts, may impact sales, may cause a buildup in the company's inventories, make the transition from current products to new products difficult and could adversely affect the company's future operating results. The competitive pressure to develop technology and products and to increase marketing expenditures also could cause significant changes in the level of the company's operating expenses. 13 o Unfavorable global economic conditions may adversely impact the company's future operating results. Since the second quarter of 2001, the company has experienced weak markets for its products. Continued softness in these markets and uncertainty about the timing and extent of the global economic downturn by both corporate and consumer purchasers of the company's products could result in lower demand for the company's products. Weakness in demand has resulted in intense price competition and may result in excessive inventory for the company and/or its reseller channel, which may adversely affect sales, pricing, risk of obsolescence and/or other elements of the company's operating results. o The company markets and sells its products through several sales channels. The company has also advanced a strategy of forming alliances and OEM arrangements with many companies. The company's future operating results may be adversely affected by any conflicts that might arise between or among its various sales channels, the loss of any alliance or OEM arrangement or the loss of retail shelf space. Aggressive pricing on laser and inkjet products and/or associated supplies from customers and resellers, including, without limitation, OEM customers, could result in a material adverse impact on the company's strategy and financial results. o Terrorist attacks and the potential for future terrorist attacks have created many political and economic uncertainties, some of which may affect the company's future operating results. Future terrorist attacks, the national and international responses to such attacks, and other acts of war or hostility may affect the company's facilities, employees, suppliers, customers, transportation networks and supply chains, or may affect the company in ways that are not capable of being predicted presently. o Revenue derived from international sales make up about half of the company's revenue. Accordingly, the company's future results could be adversely affected by a variety of factors, including changes in a specific country's or region's political or economic conditions, foreign currency exchange rate fluctuations, trade protection measures and unexpected changes in regulatory requirements. Moreover, margins on international sales tend to be lower than those on domestic sales, and the company believes that international operations in new geographic markets will be less profitable than operations in the U.S. and European markets, in part, because of the higher investment levels for marketing, selling and distribution required to enter these markets. o The company relies in large part on its international production facilities and international manufacturing partners for the manufacture of its products and key components of its products. Future operating results may be adversely affected by several factors, including, without limitation, if the company's international operations or manufacturing partners are unable to supply products reliably, if there are disruptions in international trade, disruptions at important geographic points of exit and entry, if there are difficulties in transitioning such manufacturing activities among the company, its international operations and/or its manufacturing partners, or if there arise production and supply constraints which result in additional costs to the company. The financial failure or loss of a key supplier could result in a material adverse impact on the company's financial results. o The company depends on its information technology systems for the development, manufacture, distribution, marketing, sales and support of its products and services. Any failure in such systems, or the systems of a partner or supplier, may adversely affect the company's operating results. Furthermore, because vast quantities of the company's products flow through only a few distribution centers to provide product to various geographic regions, the failure of information technology systems or any other disruption affecting those product distribution centers could have a material adverse impact on the company's ability to deliver product and on the company's financial results. o The entrance of additional competitors that are focused on printing solutions could further intensify competition in the inkjet and laser printer markets and could have a material adverse impact on the company's strategy and financial results. o Although the company is currently the exclusive supplier of new cartridges for its laser and inkjet 14 products, there can be no assurance that other companies will not develop new compatible cartridges for the company's products. In addition, refill and remanufactured alternatives for some of the company's cartridges are available and compete with the company's supplies business. The company expects competitive refill and remanufacturing activity to increase. Various legal challenges and governmental activities may intensify competition for the company's aftermarket supplies business. o The company's success depends in part on its ability to obtain patents, copyrights and trademarks, maintain trade secret protection and operate without infringing the proprietary rights of others. Current or future claims of intellectual property infringement could prevent the company from obtaining technology of others and could otherwise materially and adversely affect its operating results or business, as could expenses incurred by the company in obtaining intellectual property rights, enforcing its intellectual property rights against others or defending against claims that the company's products infringe the intellectual property rights of others. o The company's inability to perform satisfactorily under service contracts for managed print services and other customer services may result in the loss of customers, loss of reputation and/or financial consequences that may have a material adverse impact on the company's financial results and strategy. o Factors unrelated to the company's operating performance, including the financial failure or loss of significant customers, resellers, manufacturing partners or suppliers; the outcome of pending and future litigation or governmental proceedings; and the ability to retain and attract key personnel, could also adversely affect the company's operating results. In addition, the company's stock price, like that of other technology companies, can be volatile. Trading activity in the company's common stock, particularly the trading of large blocks and intraday trading in the company's common stock, may affect the company's common stock price. While the company reassesses material trends and uncertainties affecting the company's financial condition and results of operations in connection with the preparation of its quarterly and annual reports, the company does not intend to review or revise, in light of future events, any particular forward-looking statement contained in this report. The information referred to above should be considered by investors when reviewing any forward-looking statements contained in this report, in any of the company's public filings or press releases or in any oral statements made by the company or any of its officers or other persons acting on its behalf. The important factors that could affect forward-looking statements are subject to change, and the company does not intend to update the foregoing list of certain important factors. By means of this cautionary note, the company intends to avail itself of the safe harbor from liability with respect to forward-looking statements that is provided by Section 27A and Section 21E referred to above. 15 Item 3. Quantitative and Qualitative Disclosures About Market Risk The market risk inherent in the company's financial instruments and positions represents the potential loss arising from adverse changes in interest rates and foreign currency exchange rates. Interest Rates -------------- At September 30, 2003, the fair value of the company's senior notes is estimated at $168 million using quoted market prices and yields obtained through independent pricing sources for the same or similar types of borrowing arrangements, taking into consideration the underlying terms of the debt. The fair value of the senior notes exceeded the carrying value as recorded in the statements of financial position at September 30, 2003 by approximately $18 million. Market risk is estimated as the potential change in fair value resulting from a hypothetical 10% adverse change in interest rates and amounted to approximately $3 million at September 30, 2003. Foreign Currency Exchange Rates The company employs a foreign currency hedging strategy to limit potential losses in earnings or cash flows from adverse foreign currency exchange rate movements. Foreign currency exposures arise from transactions denominated in a currency other than the company's functional currency and from foreign denominated revenue and profit translated into U.S. dollars. The primary currencies to which the company is exposed include the euro, the Canadian dollar, the Japanese yen, the British pound and other Asian and South American currencies. Exposures are hedged with foreign currency forward contracts, put options, and call options with maturity dates of less than eighteen months. The potential loss in fair value at September 30, 2003, for such contracts resulting from a hypothetical 10% adverse change in all foreign currency exchange rates was approximately $60 million. This loss would be mitigated by corresponding gains on the underlying exposures. Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures ------------------------------------------------ The company's management, with the participation of the company's Chairman and Chief Executive Officer and Executive Vice President and Chief Financial Officer, have evaluated the effectiveness of the company's disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the company's Chairman and Chief Executive Officer and Executive Vice President and Chief Financial Officer have concluded that the company's disclosure controls and procedures are effective in providing reasonable assurance that the information required to be disclosed by the company in the reports that it files under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. Changes in Internal Control over Financial Reporting There has been no change in the company's internal control over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the company's internal control over financial reporting. 16 LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES Part II. Other Information Item 4. Submission of Matters to a Vote of Security Holders None. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: A list of exhibits is set forth in the Exhibit Index found on page 19 of this report. (b) Reports on Form 8-K: A Current Report on Form 8-K was filed by the company with the Securities and Exchange Commission on July 21, 2003 to announce the company's second quarter 2003 financial results. 17 LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES SIGNATURE --------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, both on behalf of the registrant and in his capacity as principal accounting officer of the registrant. Lexmark International, Inc. (Registrant) Date: November 10, 2003 By: /s/ Gary D. Stromquist ------------------------ Gary D. Stromquist Vice President and Corporate Controller (Chief Accounting Officer) 18 EXHIBIT INDEX Exhibits: 10.1 Amendment No. 2 to Receivables Purchase Agreement, dated as of October 20, 2003, by and among Lexmark Receivables Corporation ("LRC"), as Seller, CIESCO, LLC (as successor to CIESCO L.P.), as Investor, Citibank, N.A., Citicorp North America, Inc., as Agent, and the company, as Collection Agent and Originator. 10.2 Amendment No. 2 to Purchase and Contribution Agreement, dated as of October 20, 2003, by and between the company, as Seller, and LRC, as Purchaser. 12 Computation of Ratio of Earnings to Fixed Charges. 31.1 Certification of Chairman and Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Executive Vice President and Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chairman and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Executive Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 19