UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

(Mark One)

 

[X]          ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Fiscal Year Ended December 31, 2014

 

OR

 

[   ]          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Transition Period from ______ to ______.

 

Commission File No. 1-14050

 

LEXMARK INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

(859) 232-2000

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [X]   No [   ]

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes [   ]   No [X]

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  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.  [X]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes [   ]  No [X]

 

The aggregate market value of the shares of voting common stock held by non-affiliates of the registrant was approximately $3.0 billion based on the closing price for the Class A Common Stock on the last business day of the registrant’s most recently completed second fiscal quarter.

 

As of February 13, 2015, there were outstanding 60,692,719 shares (excluding shares held in treasury) of the registrant’s Class A Common Stock, par value $0.01, 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 $0.01.

 

Documents Incorporated by Reference

Certain information in the Company’s definitive Proxy Statement for the 2015 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.

LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

 

FORM 10-K

For the Year Ended December 31, 2014

 

Forward-Looking Statements

 

This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical fact, are forward-looking statements. Forward-looking statements are made based upon information that is currently available or management’s current expectations and beliefs concerning future developments and their potential effects upon the Company, speak only as of the date hereof, and are subject to certain risks and uncertainties. We assume no obligation to update or revise any forward-looking statements contained or incorporated by reference herein to reflect any change in events, conditions or circumstances, or expectations with regard thereto, on which any such forward-looking statement is based, in whole or in part. 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 under the title “Risk Factors” in Item 1A of 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 factors set forth in the “Risk Factors” section of this report. 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.

Part I

 

Item 1.          BUSINESS

 

General

 

Lexmark International, Inc. (“Lexmark” or the “Company”) is a Delaware corporation and the surviving company of a merger between itself and its former parent holding company, Lexmark International Group, Inc., (“Group”) consummated on July 1, 2000. Group was formed in July 1990 in connection with the acquisition of IBM Information Products Corporation from International Business Machines Corporation (“IBM”). The acquisition was completed in March 1991. On November 15, 1995, Group completed its initial public offering of Class A Common Stock and Lexmark now trades on the New York Stock Exchange under the symbol “LXK.”

 

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

 

The Company acquired Perceptive Software, Inc. (“Perceptive Software”), a leading provider of ECM software and document workflow solutions, in June of 2010 and acquired Pallas Athena, a leading provider of BPM, DOM and process mining and discovery software in October of 2011. The acquisitions build upon and strengthen Lexmark’s industry workflow solutions and MPS capabilities and allow the Company to compete in the faster growing content and process management software solutions markets. In keeping with this strategy and with the goal of becoming an end-to-end solutions provider, Lexmark acquired Brainware in February of 2012, and ISYS and Nolij in March of 2012. Brainware’s intelligent data capture platform extracts critical information from paper documents and electronic unstructured content enabling customers to more efficiently perform business processes. ISYS’s search solutions deliver powerful text mining and enterprise and federated search capabilities across a wide range of platforms enabling customers to facilitate rapid discovery of critical intelligence for more informed decision making. Nolij’s software is a fully web-based document imaging and workflow platform that includes innovative, native support for mobile devices and forms processing capabilities, focused on the education market. In December of 2012, Lexmark acquired Acuo Technologies, LLC (“Acuo”). Acuo is a leader in the vendor neutral archive (“VNA”) software segment that resides within the high growth enterprise clinical management and medical imaging software and services market.  Acuo, when combined with Lexmark’s Perceptive Software healthcare content and process management solutions, will enable customers to deploy a single, enterprise-wide access platform that connects unstructured clinical content and makes it easily accessible in context via a healthcare provider’s electronic medical record (“EMR”) system.

 

In March of 2013, the Company acquired AccessVia, Inc. (“AccessVia”) and Twistage, Inc. (“Twistage”). AccessVia provides industry-leading signage solutions to create and produce retail shelf-edge materials, all from a single platform, which can be directed to a variety of output devices and published to digital signs or electronic shelf tags. AccessVia, when combined with Lexmark’s MPS and expertise in delivering print and document process solutions to the retail market, will enable customers to quickly design and produce in-store signage for better and more timely merchandising in a highly distributed store environment. Twistage offers an industry-leading, cloud-enabled software platform for managing video, audio and image content. When combined with Lexmark, Twistage will enable customers to capture, manage and access all of their content, including rich media content assets, within the context of their business processes and enterprise applications.  In September of 2013, Lexmark acquired Saperion AG (“Saperion”). Saperion is a European-based leader in ECM solutions, focused on providing document archive and workflow solutions. The acquisition expands Perceptive Software’s European-based footprint in the ECM market, and will further strengthen the Company’s strategy of providing the platform, products and solutions that help companies manage their unstructured information challenges. In October of 2013, the Company acquired PACSGEAR, Inc. (“PACSGEAR”). PACSGEAR is a leading provider of connectivity solutions for healthcare providers to capture, manage and share medical images and related documents and integrate them with existing picture archiving and communication systems (“PACS”) and EMR systems. With this acquisition, Perceptive Software will be uniquely positioned to offer a vendor neutral, standards-based clinical content platform for capturing, managing, accessing and sharing patient medical imaging information and related documents within healthcare facilities through an EMR and between facilities via PACSGEAR technology.

 

In August of 2014, the Company acquired ReadSoft AB (“ReadSoft”), a leading global provider of software solutions that automate business processes, both on premise and in the cloud. Its software captures, classifies, sorts and routes both hard copy and digital business documents, provides approval workflows, and automatically extracts and verifies relevant data before depositing it into a customer’s system of record. With the addition of ReadSoft, Perceptive Software will grow its software offering with additional

document process automation capabilities and expand its footprint in Europe. In October of 2014, the Company acquired GNAX Healthcare LLC (“GNAX Health”), a provider of image exchange software technology for exchanging medical content between medical facilities. In January of 2015, Lexmark announced the acquisition of Claron Technology, Inc. (“Claron”), a leading provider of medical image viewing, distribution, sharing and collaboration software technology. Lexmark continues the transition to a solutions company as it shifts from a hardware-centric company to a solutions company providing end-to-end solutions that allow customers to bridge the paper and digital worlds and the unstructured and structured content/process worlds.

 

The Company is primarily managed along two segments: Imaging Solutions and Services (“ISS”) and Perceptive Software. The information included in this report has been prepared under the current organizational structure for all periods presented. Refer to Part II, Item 8, Note 20 of the Notes to Consolidated Financial Statements for additional information regarding the Company’s reportable segments.

 

In August 2012, the Company announced it was exiting the development and manufacturing of inkjet technology. In April of 2013, the Company and Funai Electric Co., Ltd. (“Funai”) entered into a Master Inkjet Sale Agreement of the Company’s inkjet-related technology and assets to Funai. Included in the sale were one of the Company’s subsidiaries, certain intellectual property and other assets of the Company. The sale closed in the second quarter of 2013. The Company continues to provide service, support and aftermarket supplies for its inkjet installed base.

 

Revenue derived from international sales, including exports from the United States of America (“U.S.”), accounts for approximately 57% of the Company’s consolidated revenue, with Europe, Middle East and Africa (“EMEA”) accounting for 37% of worldwide sales. Lexmark’s products are sold in various countries in North and South America, Europe, the Middle East, Africa, Asia, the Pacific Rim and the Caribbean. This geographic diversity offers the Company opportunities to participate in emerging markets, provides diversification to its revenue stream and operations to help offset geographic economic trends, and utilizes the technical and business expertise of a worldwide workforce. Currency exchange rates had a 1% unfavorable impact on 2014 revenue compared to 2013. Refer to Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations — Effect of Currency Exchange Rates and Exchange Rate Risk Management for more information. A summary of the Company’s revenue and long-lived assets by geographic area is found in Part II, Item 8, Note 20 of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.

 

Market Overview1

 

Lexmark serves both the distributed printing and imaging, and content and process management markets with a focus on business customers. Lexmark’s enterprise content and process management software platform supports traditional business content as well as rich media and industry-specific content like medical image content, and includes enterprise search, intelligent capture, DOM, and business process and case management. Lexmark’s healthcare offering includes an industry leading, standards based and highly secure, content repository and VNA that integrates all patient unstructured information across the enterprise to enable easy access including access via an EMR system. This healthcare content and process management offering also includes workflow automation and information and medical imaging study sharing within and between facilities and organizations. Lexmark management believes the total relevant market opportunity of these markets combined in 2014 was approximately $80 billion. Lexmark management believes that the total relevant distributed laser printing and imaging market opportunity was approximately $70 billion in 2014, including printing hardware, supplies and related services. This opportunity includes printers and multifunction devices as well as a declining base of copiers and fax machines that are increasingly being integrated into multifunction devices. Based on industry information, Lexmark management believes that the overall distributed printing market declined slightly in 2014. The distributed printing industry is expected to experience flat to low single digit declining  revenue overall over the next few years but continued growth is expected in MPS, multifunction products (“MFPs”), and color laser printing products which are all areas of focus for Lexmark. Based on industry analysts’ forecasts, MPS and fleet solutions are projected to continue to experience approximately 10% annual revenue growth rates over the next several years and the relevant content and process management software markets that Lexmark participates in are projected to grow in aggregate approximately 11% annually over the next several years. In 2014, the total relevant content and process management software market was approximately $10 billion, excluding related professional services. However, management believes the total addressable market is significantly larger due to relatively low penetration of content and process management software solutions worldwide.

 

In general, as the printing and imaging market matures and printer and copier-based product markets continue to converge, the Company’s management expects competitive pressures to continue. However, management believes that this convergence represents an opportunity for printer-based product and solution vendors like Lexmark to displace copier-based products in the marketplace. The Company’s management believes that the integration of print/copy/fax/scan capabilities enables Lexmark to leverage strengths in network printing and document workflow solutions. Lexmark management also believes that it is well positioned to capture faster

 

1 - Certain information contained in the “Market Overview” section has been obtained from industry sources, public information and other internal and external sources. Data available from industry analysts varies widely among sources. The Company bases its analysis of market trends on the data available from several different industry analysts.

 

growing software and services opportunities that are associated with providing MPS and content and process management software and services that are focused on streamlining and automating document-intensive business processes, as well as reducing unnecessary

print. Lexmark sees a significant opportunity to take a leadership role in providing innovative printing, imaging, content and process solutions and services to help business customers improve their productivity and business performance.

 

The content and process management software and services markets serve business customers. These markets include solutions for capturing all types of unstructured information such as hardcopy, photographs, emails, images, video, audio and faxes as well as intelligent indexing, archiving and routing of this information to streamline and automate process workflows while managing changes to both content and processes and automating governance and compliance policies. These solutions help companies leverage the value of their unstructured information by connecting it with existing enterprise applications and making it available in context within processes so that businesses can make better and faster decisions to enhance growth, improve productivity, lower costs and improve customer satisfaction. These markets also include solutions that help businesses understand existing processes, design and manage new processes, and enable the assembly of content into meaningful communications internally and with their customers and partners.

 

The continued digitization of information as well as the electronic distribution of information, has led to the rapid growth of unstructured digital information. Unstructured digital information is represented by office documents, emails, photographs, audio and video files, industry-specific content like high resolution medical images, document and image scans and other information that is not stored in a traditional structured database. Lexmark management believes that the deployment of content and process management systems and associated workflow solutions to effectively capture, manage and access this unstructured information is a significant long term opportunity. Lexmark management also believes the growth in unstructured digital information and the systems to manage it continues to positively impact the distributed printing and imaging market relative to centralized printing and imaging, as more of the information that is being printed and captured is on distributed devices and less on commercial and centralized devices. Lexmark’s customers are increasingly interested in streamlining and automating document workflows and business processes in order to reduce costs and/or improve customer service. Improving business processes includes reducing physical handling, movement and storage of hardcopy documents, as well as reducing unnecessary and wasteful printing. Lexmark sees the greatest waste in high volume centralized print which includes the need to physically transport printed materials to the point-of-need and has been traditionally associated with considerable amounts of unused and wasted printed material. Lexmark’s distributed print and enterprise content and process management solutions and services are focused on reducing centralized print and reducing unnecessary distributed print as well.

 

Laser technology based products within the distributed printing market primarily serve business customers. Laser products can be divided into two major categories — large workgroup products and lower-priced small workgroup products. Large workgroup products are typically attached directly to large workgroup networks, while small workgroup products are attached to personal computers (“PCs”) and/or small workgroup networks. Both product categories include color and monochrome laser offerings.

 

The large workgroup products include laser printers and MFP devices, which typically include high-performance internal network adapters and are easily upgraded to include additional input and output capacity and finishing capabilities as well as additional memory and storage. Most large workgroup products also have sophisticated network management tools and are available as single function printers, and as MFP devices that can print/copy/fax and scan to network.

 

Color and MFP devices continue to represent a more significant portion of the laser market. The Company’s management believes that these trends will continue. Industry pricing pressure is partially offset by the tendency of customers to purchase higher value color and MFP devices and optional paper handling and finishing features. Customers are also purchasing connected smart MFPs and content and process management software solutions and services to optimize their document-related processes and infrastructure in order to improve productivity and cost.

 

Strategy

 

Lexmark’s strategy is based on a business model of investing in technology to develop and sell printing and imaging, and content and process management solutions, including printers, multifunction devices and software solutions with the objective of growing its installed base of hardware devices and software installations, which drives recurring printing supplies sales and software subscription, maintenance and services revenue. Supplies have been the primary profit engine of the business model. Supplies profit helps fund new technology investments in products, solutions, services and software. As Lexmark continues to increase its mix of MPS and content and process management software solutions, management anticipates that the Company’s annuity mix will increasingly include software and services, in addition to printing supplies. The addition of Perceptive Software and its expansion through the acquisitions of Pallas Athena, Brainware, Isys, Nolij, Acuo, AccessVia, Twistage, Saperion, PACSGEAR, ReadSoft, GNAX Health and Claron add to Lexmark’s traditional technology strength and provide content and process management solutions for specific industries and business processes. The Company’s management believes that Lexmark has the following strengths related to this business model:

 

• First, Lexmark is highly focused on delivering printing, imaging, and content and process management software solutions and services for specific industries and business processes in distributed work environments. The Company’s management believes that this focus has enabled Lexmark to be responsive and flexible in meeting specific business customer needs.

 

• Second, Lexmark internally develops both monochrome and color laser printing technology. The Company’s monochrome laser technology platform has historically allowed Lexmark to provide one of the best values in enterprise network printer-based products and also build unique capabilities into its products that enable it to offer customized printing and document workflow solutions. Lexmark also internally develops its print and fleet management, content and process management software platforms and tools that enable it to provide leading edge MPS and content and process management solutions. Lexmark, through Perceptive Software, also internally develops content and process management software that includes DOM, intelligent capture, search, rich content management, and healthcare specific medical imaging and VNA software products as well as other industry tailored solutions to help companies manage the lifecycle of their content and business processes all in the context of their existing enterprise applications. This combination of platform, product, and solutions integrates rapidly into a customer’s existing IT infrastructure and is easy to use, which drives user adoption and accelerates the customer’s process improvements.

 

• Third, Lexmark has leveraged its technological capabilities and its commitment to flexibility and responsiveness to build strong relationships with large enterprise customers and channel partners, including distributors and value-added resellers. Lexmark’s path-to-market includes industry-focused consultative sales and services teams that deliver unique and differentiated solutions to large accounts and channel partners that sell into the Company’s target industries.

 

Lexmark is focused on driving long-term performance by strategically investing in technology, hardware and software products and solutions to secure high value product installations and capture profitable supplies, software subscriptions, and maintenance and service annuities in content-intensive industries and business processes.

 

Lexmark’s ISS segment continues to focus on capturing profitable supplies and service annuities generated from its monochrome and color laser printers and MFPs. Associated strategic initiatives include:

 

• Expanding and strengthening the Company’s product line of workgroup, color and MFP devices;

 

• Advancing and strengthening the Company’s industry solutions including integrated ECM, BPM, DOM, intelligent data capture and search solutions to maintain and grow the Company’s penetration in selected industries;

 

• Advancing and growing the Company’s MPS business; and

 

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

 

ISS’ strategy requires that it provide an array of high-quality, technologically-advanced products and solutions at competitive prices. ISS continually enhances its products to ensure that they function efficiently in increasingly-complex enterprise network environments. It also provides flexible tools to enable network administrators to improve productivity. ISS’ target markets include large corporations, small and medium businesses (“SMBs”), and the public sector. ISS’ strategy requires that it continually identify and focus on industry-specific print and document process-related issues so that it can differentiate itself by offering unique industry solutions and related services. ISS’ research and development investments continue to strengthen the breadth and depth of its workgroup laser line, color laser line and laser MFPs.

 

Because of ISS’ strength and focus on printing and document process solutions, the Company has formed alliances and original equipment manufacturer (“OEM”) arrangements to pursue incremental business opportunities through its alliance partners.

 

The acquisitions of Perceptive Software, Pallas Athena, Brainware, Isys, Nolij, Acuo, AccessVia, Twistage, Saperion, PACSGEAR, ReadSoft, GNAX Health and Claron enhance Lexmark’s capabilities as a content and process management solutions provider, expand the Company’s market opportunity, and provide a core strategic component for Lexmark’s future. Lexmark’s software strategy is to deliver affordable, industry and process specific workflow enhancing solutions through deep industry expertise and a broad content and process management software platform, with a focus on making solutions easy to integrate, use, and support. Key software strategic initiatives include:

 

• Advancing and growing the Company’s content and process management solutions business internationally;

 

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

 

• Expanding the Company’s rate of participation in content and process management software solutions for specific industries and processes.

 

Segment Information — ISS

 

•             Products — ISS

 

ISS offers a broad portfolio of monochrome and color laser printers and laser MFPs, as well as supplies, software applications, software solutions and MPS to help businesses efficiently capture, manage and access information. ISS laser products are core building blocks for enabling information on demand. They are designed to enable intelligent document capture in addition to delivering high-quality printed output on a variety of media types and sizes. When combined with innovative document management and business process workflow software, primarily from Perceptive Software, these products accelerate productivity by connecting people with the information they need.

 

•                  Monochrome Laser

 

Within the single-function monochrome laser printer category, ISS continues to offer the Lexmark MS310, MS410, MS510, MS610, MS710 and MS810 Series printers, which are designed to meet the needs of small, midsize and large workgroups. These monochrome laser printers deliver print speeds ranging from 35 pages per minute (ppm) to 70 ppm. During 2014, ISS announced the MS911 for large or departmental workgroups that require A3 (11 inch x 17 inch) paper support.

 

Within the monochrome multifunction laser printer category, ISS continues to offer the Lexmark MX310, MX410, MX510, MX610, MX710, MX810 and MX910 Series MFPs, which deliver fast scanning and print and copy speeds ranging from 35 ppm to 70 ppm. ISS also continues to offer the A3-capable X860 Series. ISS also continues to offer the MX6500e, a modular scanner option, which transforms selected high-end Lexmark A4 printers into fully featured multifunction devices.

 

•                  Color Laser

 

Within the single-function color laser printer category, ISS continues to offer the Lexmark CS310, CS410, CS510 and C740 color laser printers, which are designed to meet the needs of small and midsize workgroups. For larger workgroups, ISS continues to offer the Lexmark C790 Series single-function printers, which offer 50 pages per minute output speed and paper handling and finishing options. For departmental workgroups that require A3 paper support, ISS continues to offer the C900 Series printers.

 

Within the color laser multifunction printer category, ISS continues to offer the CX310, CX410, CX510 and X740 color laser MFPs, which are designed to meet the needs of small and midsize workgroups. Models within these series offer performance and features typically present on larger devices, such as 4.3-inch touch screens and built-in productivity tools and apps. For larger workgroups, ISS continues to offer the Lexmark X790 Series MFPs, which offer 50 pages per minute output speed and paper handling and finishing options. For departmental workgroups that require A3 paper support, ISS continues to offer the X900 Series MFPs.

 

•                  Inkjet MFPs and AIOs

 

Lexmark has ceased development and manufacturing of inkjet technology.  Lexmark will continue to provide service, support, and aftermarket supplies for its inkjet installed base.

 

•                  Dot Matrix Products

 

ISS continues to market several dot matrix printer models for customers who print multipart forms.

 

•                  Supplies and Service Parts

 

ISS designs, manufactures and distributes a variety of cartridges, service parts and other supplies for use in its installed base of laser, inkjet and dot matrix printers.  Revenue and profit growth from the ISS supplies business is directly linked to the ability to increase the installed base of ISS laser products or the usage rate of those products.  Lexmark management believes that ISS is an industry leader with regard to the recovery, remanufacture, reuse and recycling of used laser supplies cartridges and service parts, helping to keep empty cartridges and service parts out of landfills. Attaining that leadership position was made possible by various empty cartridge and used parts collection programs administered by ISS around the world. ISS continues to expand cartridge and service parts collection to further expand its remanufacturing business and this environmental commitment.

 

•                  MPS and Customer Support Services

 

ISS, both directly and through business partners, offers a wide range of services covering its line of printing products and technology solutions including maintenance, consulting, systems integration and MPS offerings to provide a comprehensive output solution. Lexmark Global Services provide customers with an assessment of their current environment and then a recommendation and implementation plan for the future state. Upon implementation, Lexmark provides management and optimization of their output

environment and document related workflow/business processes. MPS allow organizations to outsource fleet management, technical support, supplies replenishment, maintenance activities and other services.

 

Through its MPS offerings, ISS gives customers greater visibility and control of their printing environment. These services include asset lifecycle management; implementation and decommissioning services; proactive consumables management; remote device monitoring and management; and business process optimization that include industry specific and back office solutions. These services are tailored to meet each customer’s unique needs to ensure their mission-critical business processes run smoothly.

 

Lexmark Customer Support Services are comprised of authorized maintenance and repair, technical support, warranty support and parts operations. From basic service coverage to comprehensive support, Lexmark offers a range of plans to meet the specific demands of the customer’s output environment and reduce costly downtime.

 

ISS printer products generally include a warranty period of at least one year, and customers typically have the option to purchase an extended warranty. Extended warranties may be purchased at any time during the printer’s base warranty year(s) and are available on ISS laser and dot matrix devices for a total warranty period of two, three, or four years.

 

•             Marketing and Distribution — ISS

 

ISS employs large-account sales and marketing teams whose mission is to generate demand for its business printing solutions and services, primarily among large corporations, small and medium businesses, as well as the public sector. These sales and marketing teams primarily focus on industries such as financial services, retail, manufacturing, education, government and health care, and in conjunction with ISS’ development and manufacturing teams, are able to customize printing solutions to meet customer needs for printing electronic forms, media handling, duplex printing, intelligent capture and other document workflow solutions. ISS distributes and fulfills its products to business customers primarily through its well-established distributor and reseller network. The ISS distributor and reseller network includes IT Resellers, Direct Marketing Resellers, and Copier Dealers.

 

ISS’ international sales and marketing activities for business customers are organized to meet the needs of the local jurisdictions and the size of their markets. Operations in EMEA, North America, Latin America and Asia Pacific focus on large-account and SMB demand generation with orders primarily filled through distributors and resellers.

 

Supplies for both laser and inkjet products are generally available at the customer’s preferred point-of-purchase through multiple channels of distribution. Although channel mix varies somewhat depending upon the geography, most of ISS’ laser supplies products sold commercially in 2014 were sold through the ISS network of Lexmark-authorized supplies distributors and resellers, who sell directly to end-users, or to independent office supply dealers. Inkjet supplies are primarily sold through large office superstores, discount store chains, distributors, online, wholesale clubs, and consumer electronics stores.

 

ISS also sells its products through numerous alliances and OEM arrangements. During 2014, 2013 and 2012, no one customer accounted for more than 10% of the Company’s total revenues.

 

•             Competition — ISS

 

ISS continues to develop and market new products and innovative solutions at competitive prices. New product announcements by ISS’ principal competitors, however, can have, and in the past, have had, a material impact 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 price, quality, speed and functionality. Furthermore, knowledge in the marketplace about pending new product announcements by ISS’ competitors may also have a material impact on the Company as purchasers of printers may defer buying decisions until the announcement and subsequent testing of such new products.

 

In recent years, ISS and its principal competitors, many of which have significantly greater financial, marketing and/or technological resources than the Company, have regularly lowered prices on hardware products and are expected to continue to do so. ISS has experienced and remains vulnerable to these pricing pressures. ISS’ ability to grow or maintain market share has been and may continue to be affected by these pricing pressures, resulting in lower profitability. Lexmark expects that as it competes with larger competitors, ISS’ increased market presence may attract more frequent challenges, both legal and commercial, including claims of possible intellectual property infringement.

 

The distributed printing market is extremely competitive. The market share leader in the distributed laser printing market is Hewlett-Packard (“HP”), which has a widely-recognized brand name and has been identified as the market leader as measured in annual units shipped. With the convergence of traditional printer and copier markets, major laser competitors now include traditional copier companies such as Canon, Ricoh and Xerox. Other laser competitors include Brother, Konica Minolta, Kyocera, Okidata and Samsung.

 

Refill, remanufactured, clones, counterfeits and other compatible alternatives for some of ISS’ toner and ink cartridges are available and compete with ISS’ supplies business. However, these alternatives may result in inconsistent quality and reliability. As the installed base of laser and inkjet products matures, the Company expects competitive supplies activity to increase.

 

•             Manufacturing and Materials — ISS

 

ISS operates manufacturing control centers in Lexington, Kentucky; Shenzhen, China; and Geneva, Switzerland; and has company-owned manufacturing sites in Boulder, Colorado and Juarez, Mexico. ISS also has customization centers in each of the major geographies it serves. ISS retains control over manufacturing processes that are technologically complex, proprietary in nature and central to ISS’ business model, such as the manufacture of toner and photoconductors. ISS shares some of its technical expertise with certain manufacturing partners, many of whom have facilities located in China, which collectively provide ISS with substantially all of its printer production capacity. ISS continually reviews its manufacturing strategies, capabilities, and cost structure and makes adjustments as necessary.

 

Manufacturing operations for laser printer supplies are located in Boulder, Colorado; Juarez, Mexico; Zary, Poland; and Shenzhen, China. Laser printer cartridges are assembled by a combination of in-house and third-party contract manufacturing. The manufacturing control center for laser printer supplies is located in Geneva, Switzerland.

 

Manufacturing operations for inkjet printer supplies are located in Lapu-Lapu City, Philippines and Juarez, Mexico. Inkjet printer supplies are assembled by a combination of in-house and third-party manufacturing. The manufacturing control center for inkjet printer supplies is located in Geneva, Switzerland.

 

ISS 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, ISS often utilizes preferred supplier relationships, and in certain cases single sourced supplier relationships, to better ensure more consistent quality, cost and delivery. In addition, ISS sources some printer engines and finished products from OEMs. Typically, these preferred suppliers and OEMs maintain alternate processes and/or facilities to ensure continuity of supply. ISS occasionally faces capacity constraints when there has been more demand for its products than initially projected. From time to time, ISS may be required to use air shipment to expedite product flow, which can adversely impact ISS’ operating results. Conversely, in difficult economic times, ISS’ inventory can grow as market demand declines.

 

During 2014, ISS continued to execute supplier managed inventory (“SMI”) agreements with its primary suppliers to improve the efficiency of the supply chain. Lexmark’s management believes these SMI agreements improve ISS’ supply chain inventory pipeline and supply chain flexibility which enhances responsiveness to our customers. In addition, the Company’s management believes these agreements improve supplier visibility to product demand and therefore improve suppliers’ timeliness and management of their inventory pipelines. As of December 31, 2014, a significant majority of printers were purchased under SMI agreements. Any impact on future operations would depend upon factors such as ISS’ ability to negotiate new SMI agreements and future market pricing and product costs.

 

•             Backlog — ISS

 

Although ISS experiences availability constraints from time to time for certain products, ISS generally fills its orders within 30 days of receiving them. Therefore, ISS usually has a product backlog of less than 30 days at any one time, which the Company does not consider material to its business. Refer to Part II, Item 8, Note 12 of the Notes to Consolidated Financial Statements for information regarding deferred service revenue, which makes up most of the Company’s service backlog.

 

•             Seasonality — ISS

 

ISS experiences some seasonal market trends in the sale of its products and services. For example, ISS’ sales are often stronger during the second half of the year and ISS’ sales in Europe are often weaker in the summer months. The impact of these seasonal trends on ISS has become less predictable due to the exit of the inkjet business and less consumer exposure.

 

Segment Information — Perceptive Software

 

•             Products — Perceptive Software

 

Perceptive Software offers a complete suite of ECM, BPM, DOM, intelligent data capture, search software and medical imaging VNA software products and solutions.

 

•                  Software

 

Perceptive Software’s capture, content, search and process management software products and solutions, enable users to capture, manage, and collaborate on important documents, information, and business processes, protect data integrity throughout its lifecycle and access precise content in the context of the users’ everyday business processes. These components are developed and maintained by Perceptive Software.

 

In 2014, Perceptive Software acquired two new software companies to enhance the software portfolio. ReadSoft is a leading provider of document process automation worldwide.  The combination of the ReadSoft and Perceptive Software product portfolios will enhance the accounts payable automation solution with tighter integration to ERP systems, including Oracle and SAP. In October of 2014, Perceptive Software strengthened its position in the healthcare space with the acquisition of GNAX Health, a medical image sharing provider via the cloud. The combination of Perceptive Software VNA technology with GNAX Health will enable doctors at the point of care to easily share medical images across organizations for viewing and collaborating with other clinicians, in addition to storing those images. In January of 2015, the Company acquired Claron, a leading provider of medical image viewing, distribution, sharing and collaboration software technology. With the addition of Claron, Perceptive Software expands its offering to healthcare providers by enabling referring physicians and clinicians to access, view and collaborate on patient information and medical images that reside outside the EMR systems, while concurrently image-enabling the EMR and providing easy Web-based access via desktop and mobile devices.

 

Perceptive Software has continued to enhance its position in the healthcare industry by strengthening its VNA technology which will enable doctors at the point of care to easily share medical images across organizations for viewing and collaborating with other clinicians, in addition to storing those images.

 

Perceptive Software also continued to expand its content and process platform with the release of Perceptive Content 7.0. Perceptive Content 7.0 provides a zero-footprint web and mobile platform to improve user access to the system from anywhere in the world. In addition, Perceptive Content 7.0 features enhancements for mobile capture, department administration, records management, and rich media management.

 

In April of 2014, Perceptive Software announced the development of a new Evolution platform enabling all technologies in the portfolio to seamlessly interact with one another. This common platform furthers the value of the software product portfolio and allows for powerful combinations of software to solve key business process inefficiencies in shorter timeframes. Perceptive Search, Capture, VNA and BPM also had incremental product releases in 2014.

 

•                  Solutions

 

Perceptive Software offers industry specific solutions across target industries — healthcare, government, retail, manufacturing, higher education and financial services — as well as select back office functions — accounting, human resources, and contracts. These solutions are comprised of select products, best practice templates, and industry specific deployment methodologies that account for the unique differences deploying across industries. These solutions are documented and present various levels of automation based on the needs of the specific customer according to the cost, schedule, and scope of their respective projects.

 

In 2014, a number of these solutions were enhanced with emphasis on the Healthcare clinical market segment specifically related to helping manage the EMR systems and the corresponding patient chart review processes. Integrations with leading EMR providers were also enhanced in 2014. In addition, with the acquisitions of Acuo in 2012, PACSGEAR in 2013, GNAX Health in 2014 and Claron in 2015, Perceptive Software continues to strengthen and enhance its VNA and healthcare imaging solutions to healthcare customers. The merger of these technologies will also give customers a single, enterprise-wide access and workflow platform for managing patient clinical content via any EMR system.

 

Perceptive Software strengthened its leadership position in Higher Education with improvements to the Intelligent Capture for Transcripts solution. The integrated solution utilizes the intelligent data capture engine to capture student information and reduce the manual processing times of transcripts. Improvements in handwriting extraction technology enhance the value of this solution and create additional possibilities for use across Higher Education institutions.

 

Perceptive Software released multiple new solutions for the Back Office. A mobile approver app strengthens the value of Perceptive Software’s workflow for accounts payable automation, while the Intelligent Capture for Remittances solution expands our Back Office reach with a best practices package for accounts receivable.

 

In addition, Perceptive Software launched integrated connectors to major enterprise resource planning (“ERP”) and customer relationship management (“CRM”) providers including Salesforce and Colleague while creating seamless integration with the suite of Google apps.

 

Perceptive Capture and Perceptive Search, which provide the aforementioned intelligent data capture and search capabilities, enable businesses to dramatically improve the efficiency of processes in accounts payable, accounts receivable, order management and benefits processing, as well as transcript processing in higher education, by extracting needed data automatically from business documents received as paper or electronically in a variety of forms such as PDFs and TIFs.  Perceptive Capture’s very high rate of data extraction is achieved through the use of patented search and machine learning technologies that allow its extraction rate to improve with time.  This extracted data is matched against master data from existing customer systems to intelligently integrate with ERPs or other systems and speed the business process.  Perceptive Search provides business users the ability to search virtually any repository in their IT environment, to identify needed documents or information stored within those documents. This includes the creation of entities and relationships that uncover patterns related to the desired information.

 

•             Marketing and Distribution — Perceptive Software

 

Perceptive Software uses a direct to market sales and demand generation approach, employing internal sales and marketing teams that are segmented by industry sector — specifically healthcare, public sector (which includes higher education and government), and commercial, which spans areas such as retail, banking, insurance and manufacturing. With its headquarters in Lenexa, Kansas, Perceptive Software also has primary business offices in Denver, Colorado; Ashburn, Virginia; Bloomington, Minnesota; Pleasanton, California; Berlin, Germany and Helsingborg, Sweden, as well as employees co-located within ISS offices around the world. Perceptive Software also offers a channel partner program that allows authorized third-party resellers to market and sell Perceptive Software products and solutions to a distributed market, as well as an OEM program which includes Perceptive Software’s offerings within channel partners’ existing solutions to their customers.

 

Perceptive Software offers to license its software products and solutions in a variety of ways. The traditional method is to offer licenses perpetually, with customers paying up front for the software/solution and then paying for on-going maintenance and support services, generally on an annual basis. This traditional model can be hosted by the customer or Perceptive Software.

 

Perceptive Software also offers its software and solutions under a Software as a Service (“SaaS”) model where customers pay on a subscription basis. Such payments can be made quarterly or annually. Under the SaaS business model, Perceptive Software generally manages and operates the system and associated infrastructure in its secure data centers, allowing the customer to maintain focus on their business and customers. The SaaS option offers the benefit of lower initial cost to the customer and enables them to take advantage of newly available features quickly and easily. Finally, customers may also subscribe to Perceptive Software product and solution licenses on a recurring basis (quarterly or annually) with customers managing and operating the system and associated infrastructure on the customer’s premises.

 

•             Competition — Perceptive Software

 

Perceptive Software is a leading developer of content and process management products and solutions, including intelligent capture, ECM, BPM, DOM and enterprise search. Perceptive Software takes an end-to-end approach to content and process management solutions. With its Content in Context™ methodology, Perceptive Software offers the flexibility and scalability to automate virtually any business process and manage the entire lifecycle of any content elevating the value of an organization’s transactional content. Perceptive Software’s principal method of competition is to provide specific industry/sector and back office process solutions, combining its software platform and products that have the ability to be quickly and easily configured and integrated with a large number of business applications. The market for Perceptive Software’s products is highly competitive, and the Company’s management expects competition will continue to intensify as the capture, ECM and BPM markets mature. Perceptive Software competes with a large number of ECM providers, including document management and web content management businesses, as well as companies that focus on document imaging, workflow and capture. Competitors in the ECM market space include larger competitors such as EMC’s Documentum, OpenText, and IBM’s FileNet, as well as various smaller competitors, such as Hyland. Perceptive Software competes with a number of BPM competitors including Appian, IBM, OpenText and Pegasystems. Competitors in the capture market space include many of the traditional ECM providers listed above as well as smaller competitors such as Kofax. Competitors in the Search space include Google Search Appliance, HP Autonomy and Coveo.

 

•             Backlog — Perceptive Software

 

At December 31, 2014, Perceptive Software had a backlog of software license, maintenance, and professional services agreements with customers in the normal course of its business, most of which is expected to be recognized as revenue in 2015, though the terms of many SaaS deals extend for multiple years. The dollar amount of Perceptive Software backlog is not material to an understanding of the Company’s overall business.

 

Research and Development

 

Lexmark’s research and development efforts focus on technologies associated with laser printing, fleet management, connectivity, document management, ECM/BPM/DOM software, intelligent data capture, enterprise search, healthcare VNA and other customer facing solutions. Lexmark also develops related applications and tools that enable the Company to efficiently provide a broad range of

services. Lexmark is also actively engaged in the design and development of enhancements to its existing products that increase the performance, improve ease of use and lower production costs. In the case of certain products, the Company may elect to purchase products or key components from third-party suppliers rather than develop them internally.

 

Lexmark conducts research and development activities in various locations including Lexington, Kentucky; Boulder, Colorado; Lenexa, Kansas; Cebu City, Philippines; Kolkata, India; Berlin, Germany and Stockholm, Sweden. Research and development expenditures were $354 million in 2014, $287 million in 2013, and $369 million in 2012.

 

The process of developing new products is complex and requires innovative designs that anticipate customer needs and technological trends. The Company must make strategic decisions from time to time as to which technologies will produce products and solutions in market sectors that will experience the greatest future growth. There can be no assurance that the Company can develop the more technologically advanced products required to remain competitive.

 

Employees

 

As of December 31, 2014, of the approximately 12,700 Lexmark employees worldwide, 3,900 are located in the U.S. and the remaining 8,800 are located in Europe, Canada, Latin America, Asia Pacific, the Middle East and Africa. None of the U.S. employees are represented by a union. Employees in France and the Netherlands are represented by a Statutory Works Council.

 

Available Information

 

Lexmark makes available, free of charge, electronic access to all documents (including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as well as any beneficial ownership filings) filed with or furnished to the Securities and Exchange Commission (“SEC” or the “Commission”) by the Company on its website at http://investor.lexmark.com as soon as reasonably practicable after such documents are filed. The Company also posts all required XBRL exhibits to its corporate web site on the same calendar day as the date of the related filing. The public may read and copy any materials the company files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at (800) SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.

 

Executive Officers of the Registrant

 

The executive officers of Lexmark and their respective ages, positions and years of service with the Company are set forth below.

 

 

Mr. Rooke has been a Director of the Company since October 2010. Since April 2011, Mr. Rooke has been Chairman and Chief Executive Officer of the Company. From October 2010 to April 2011, Mr. Rooke served as President and Chief Executive Officer of the Company. From July 2007 to October 2010, Mr. Rooke served as Executive Vice President and President of the Company’s former Imaging Solutions Division (“ISD”). From November 2002 to July 2007, Mr. Rooke served as Executive Vice President and

President of the Company’s former Printing Solutions and Services Division (“PSSD”). Prior to such time, Mr. Rooke served as Vice President and President of PSSD and Vice President and President of the Company’s former Business Printer Division.

 

Mr. Reeder has been Vice President and Chief Financial Officer of the Company since January 2015 when he joined the Company.  Prior to joining the Company, Mr. Reeder served as Chief Financial Officer of Electronics for Imaging, Inc. from January 2014 to January 2015.  From July 2012 to January 2014, Mr. Reeder served as Vice President, Finance of Cisco Systems, Inc.’s Enterprise Networking Division. Prior to such time, Mr. Reeder served as Vice President and Managing Director, Asian Operations as well as Senior Director, Controller, for Broadcom Corporation from October 2008 to June 2012.

 

Mr. Canning has been Executive Vice President and President of ISS since November 2010. From July 2010 to November 2010, Mr. Canning served as Executive Vice President and President of PSSD and from July 2007 to July 2010 as Vice President and President of PSSD. From January 2006 to July 2007, Mr. Canning served as Vice President and General Manager, PSSD Worldwide Marketing and Lexmark Services and PSSD North American Sales and Marketing. From August 2002 to January 2006, Mr. Canning served as Vice President and General Manager, PSSD Worldwide Marketing and Lexmark Services.

 

Mr. Coons has been Vice President of the Company and President and Chief Executive Officer of Perceptive Software since June 2010 when the Company acquired Perceptive Software. Prior to the acquisition, Mr. Coons served as President and Chief Executive Officer of Perceptive Software from August 1995 to June 2010.

 

Mr. Foresti has been Vice President of Asia Pacific and Latin America since January 2008. From May 2003 to January 2008, Mr. Foresti served as the Company’s Vice President and General Manager of Latin America.

 

Ms. Isbell has been Vice President of Human Resources of the Company since February 2003. From January 2001 to February 2003, Ms. Isbell served as Vice President of Worldwide Compensation and Resource Programs in the Company’s Human Resources department.

 

Mr. Patton has been Vice President, General Counsel and Secretary of the Company since October 2008. From June 2008 to October 2008, Mr. Patton served as Acting General Counsel and Secretary. From February 2001 to June 2008, Mr. Patton served as Corporate Counsel.

 

Mr. Stromquist has been Vice President, ISS and Corporate Finance since November 2010, except from May 2014 to January 2015, when Mr. Stromquist served as Vice President and Interim Chief Financial Officer. From June 2009 to November 2010, Mr. Stromquist served as Vice President, PSSD and Corporate Finance. From July 2001 to June 2009, Mr. Stromquist served as Vice President and Corporate Controller of the Company.

 

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. Lexmark seeks to establish and maintain the proprietary rights in its technology and products through the use of patents, copyrights, trademarks, trade secret laws, and confidentiality agreements.

 

Lexmark holds a portfolio of approximately 1,439 U.S. patents and approximately 462 pending U.S. patent applications. The Company also holds approximately 757 foreign patents and pending patent applications. These patents generally have a term of twenty years from the time they are filed. As the Company’s patent portfolio has been developed over time, the remaining terms on the individual patents vary. The inventions claimed in these patents and patent applications cover aspects of the Company’s current and potential future products, manufacturing processes, business methods and related technologies. The Company is developing a portfolio of patents that protects its product lines and offers the possibility of entering into licensing agreements with others. While the Company believes that its portfolio of patents and applications have value, no single patent is in itself essential to our business as a whole or any individual segment.

 

Lexmark has a variety of intellectual property licensing and cross-licensing agreements with a number of third parties. Certain of Lexmark’s material license agreements, including those that permit the Company to manufacture some of its current products, terminate as to specific products upon certain “changes of control” of the Company.

 

The Company has trademark registrations or pending trademark applications for the name LEXMARK in approximately 90 countries for various categories of goods and services. Lexmark also owns a number of trademark applications and registrations for various product names. The Company holds worldwide copyrights in computer code and publications of various types. Other proprietary information is protected through formal procedures, which include confidentiality agreements with employees and other entities.

 

Lexmark’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. While Lexmark designs its products to avoid infringing the intellectual property rights of others, current or future claims of intellectual property infringement, and the expenses resulting there from, could

materially adversely affect its business, operating results and financial condition. Expenses incurred by the Company in obtaining licenses to use the intellectual property rights of others and to enforce its intellectual property rights against others also could materially affect its business, operating results and financial condition. In addition, the laws of some foreign countries may not protect Lexmark’s proprietary rights to the same extent as the laws of the U.S.

 

Environmental and Regulatory Matters

 

Lexmark’s operations, both domestically and internationally, are subject to numerous laws and regulations, including those 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. Lexmark could incur substantial costs, including cleanup costs, fines and civil or criminal sanctions, and third-party damage or personal injury claims, if the Company were to violate or become liable under environmental laws. The liability for environmental remediation and other environmental costs is accrued when Lexmark considers it probable and can reasonably estimate the costs. Environmental costs and accruals are presently not material to our results of operations, financial position, or cash flows. There is no assurance that existing or future environmental laws applicable to our operations or products will not have a material adverse effect on Lexmark’s results of operations, financial position or cash flows.

 

Lexmark has implemented numerous programs to recover, remanufacture and recycle certain of its products and intends to continue to expand on initiatives that have a positive effect on the environment. Lexmark is committed to maintaining compliance with all environmental laws applicable to its operations, products and services.

 

Lexmark 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 in the future 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.

 

Lexmark is subject to legislation in an increasing number of jurisdictions that makes producers of electrical goods, including printers, financially responsible for specified collection, recycling, treatment and disposal of past and future covered products (sometimes referred to as “product take-back legislation”). There is no assurance that such existing or future laws will not have a material adverse effect on Lexmark’s operations or financial condition, although Lexmark does not anticipate that effects of product take-back legislation will be different or more severe for Lexmark than the impacts on others in the electronics industry.

 

Item 1A.         Risk Factors

 

The following significant factors, as well as others of which Lexmark is unaware or deem to be immaterial at this time, could materially adversely affect the Company’s business, financial condition or operating results in the future. Therefore, the following information should be considered carefully together with other information contained in this report. Past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods.

 

Foreign currency exchange rate fluctuations, global economic weakness and uncertainty and reductions in government spending could adversely impact the Company’s revenue and other financial results.

 

• A significant portion of the Company’s revenue is generated from operations outside of the United States. The Company’s financial results may be adversely impacted by foreign currency exchange rate fluctuations, particularly the Euro, the Canadian dollar, the Brazilian real, the Australian dollar and the British Pound. Beginning in the fourth quarter of 2014, the Company entered into foreign currency option contracts as a hedge of a portion of anticipated foreign currency denominated revenue.  While these hedges are designed to partially mitigate some of the Company’s exposure to foreign currency gains and losses, additional changes in foreign currency exchange rates may adversely impact economic activity and the Company’s operating results.

 

• The Company’s revenue is largely dependent on global economic conditions and the demand for its imaging products and associated supplies, solutions and services and capture, manage and access software solutions and services in the markets in which the Company competes. Continued global economic weakness and uncertainty could adversely affect the Company’s results in future periods.  During times of economic uncertainty, demand for the Company’s products may decrease and may result in decreased revenue, operating income and other financial results.

 

• Restrictions on credit globally and credit risk associated with the Company’s customers, channel partners and the Company’s investment portfolio may also be adversely impacted by continued global economic weakness and uncertainty.

 

• Continued softness in certain markets and industries, constrained IT spending, and uncertainty about global economic conditions could result in lower demand for the Company’s products, including supplies. 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. Ongoing weakness in demand for the Company’s hardware products may also cause erosion of the installed base of products over time, thereby reducing the opportunities for supplies sales in the future.

 

• A significant portion of the Company’s revenue is derived from contracts with the U.S federal, state and local governments and their agencies, as well as international governments and their agencies.  Any reductions in U.S. or foreign government spending could significantly reduce demand for the Company’s hardware products, services and solutions and could have a material adverse effect on the Company’s revenue, operating income and financial condition.

 

If the Company cannot successfully execute on its strategy to become an end-to-end solutions provider, the Company’s revenue and gross margin may suffer.

 

• Since the Company’s acquisition of Perceptive Software in June 2010, the Company’s strategy has been based on becoming an end-to-end solutions provider of imaging and content,  process and output management solutions, enabling businesses to capture, manage and access critical unstructured information in the context of their business process.  In executing that strategy, the Company has made significant investments in complementary software companies, including ReadSoft in 2014, to enhance the Company’s solutions capabilities.  The Company needs to continue integrating these new technologies into its solutions offerings and continue to focus the Company on delivering integrated imaging and content, process and output management solutions to businesses.  Any failure to execute this strategy could adversely affect the Company’s revenue and gross margin.

 

Decreased consumption of supplies could negatively impact the Company’s operating results.

 

• Nearly two-thirds of the Company’s revenue in 2014 was derived from the sale of supplies.  The Company’s future operating results may be adversely affected if the consumption of its supplies, including consumption of supplies by the Company’s legacy inkjet installed base, by end users of its products is lower than expected or declines, if there are declines in pricing, unfavorable mix and/or increased costs.

 

• Changes of printing behavior driven by adoption of electronic processes and/or use of mobile devices such as tablets and smart phones by businesses could result in a reduction in printing, which could adversely impact consumption of supplies.

 

Any failure by the Company to execute planned cost reduction measures timely and successfully could result in total costs and expenses that are greater than expected or the failure to meet operational goals as a result of such actions.

 

• The Company expects to realize cost savings now and in the future through certain previously announced cost and expense actions and may announce future actions to further reduce its worldwide workforce and/or centralize its operations. The risks associated with these actions include potential delays in their implementation, particularly workforce reductions; increased costs associated with such actions; decreases in employee morale and the failure to meet operational targets due to unplanned departures of employees, particularly key employees and sales employees.

 

The competitive pricing pressure in the market may negatively impact the Company’s operating results.

 

• 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, the laser printer market has experienced and is expected to continue to experience significant price pressure. Price reductions on laser products, including related supplies or the inability to reduce costs and expenses, could result in lower profitability and jeopardize the Company’s ability to grow or maintain its market share. In recent years, the gross margins on the Company’s hardware products have been under pressure as a result of competitive pricing pressures in the market. If the Company is unable to reduce costs to offset this competitive pricing or product mix pressure, and the Company is unable to support declining gross margins through the sale of supplies, the Company’s operating results and future profitability may be negatively impacted.

 

• The market for Perceptive Software’s products and services is highly competitive, and the Company expects competition will continue to intensify as the enterprise content, business content and document output markets mature. Perceptive Software competes with a large number of ECM, BPM and DOM providers that have significantly greater financial, marketing and/or technological resources than the Company.  Perceptive Software could lose market share if its competitors introduce new products and services, add functionality to existing products, or reduce prices on their products and services.  If such competitors lower prices with respect to competing products and services, the Company could be forced to lower prices for

• Perceptive Software’s products and services, which could result in less revenue or reduced gross margins, which may negatively impact the Company’s operating results and future profitability.

 

Changes in the Company’s tax provisions or tax related assets or liabilities could negatively impact the Company’s profitability.

 

• The Company’s future income taxes could be adversely affected by earnings being lower than anticipated in jurisdictions where the Company has lower statutory tax rates and higher than anticipated in jurisdictions where the Company has higher statutory tax rates, by changes in the valuation of the Company’s deferred tax assets and liabilities, gains on the management of the Company’s foreign exchange risks, or changes in tax laws, regulations, and accounting principles. The Company is subject to regular review and audit by both domestic and foreign tax authorities. Any adverse outcome of such a review or audit could have a negative effect on the Company’s operating results and financial condition.

 

• In addition, the determination of the Company’s worldwide provision for income taxes and other tax related assets or liabilities requires significant judgment, and there are many transactions and calculations where the ultimate tax determination is uncertain. Although the Company, and its legal and financial advisors, believe the Company’s estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in the Company’s financial statements and may materially affect the Company’s financial results in the period or periods for which such determination is made. A material assessment by a taxing authority or a decision to repatriate foreign cash could adversely affect the Company’s profitability.

 

The Company’s failure to manage inventory levels or production capacity may negatively impact the Company’s operating results.

 

• The Company’s performance depends in part upon its ability to successfully forecast the timing and extent of customer demand and reseller demand to manage worldwide distribution and inventory levels of the Company. Unexpected fluctuations (up or down) in customer demand or in reseller inventory levels could disrupt ordering patterns and may adversely affect the Company’s financial results, inventory levels and cash flows. In addition, the financial failure or loss of a key customer, reseller or supplier could have a material adverse impact on the Company’s financial results. The Company must also be able to address production and supply constraints, including product disruptions caused by quality issues, and delays or disruptions in the supply of key components necessary for production. Such delays, disruptions or shortages may result in lost revenue or in the Company incurring additional costs to meet customer demand. The Company’s future operating results and its ability to effectively grow or maintain its market share may be adversely affected if it is unable to address these issues on a timely basis.

 

The revenue and profitability of the Company’s operations have historically varied, which makes future financial results less predictable.

 

• The Company’s revenue, gross margin and profit vary among hardware, software, supplies and services, product groups and geographic markets and therefore will likely be different in future periods than current results. Overall gross margins and profitability in any given period is dependent upon the hardware/software/supplies mix, the mix of hardware products sold, and the geographic mix reflected in that period’s revenue. Overall market trends, seasonal market trends, competitive pressures, pricing, commoditization of products, increased component or shipping costs and other factors may result in reductions in revenue or pressure on gross margins in a given period.

 

The Company may fail to realize all of the anticipated benefits of any investments, acquisitions or other significant transactions, which could harm financial results.

 

• As part of Lexmark’s strategy of becoming an end-to-end solutions provider, the Company routinely discusses, evaluates opportunities, and may enter into agreements regarding possible investments, acquisitions, and other transactions. Such transactions, including the acquisitions of Perceptive Software in 2010; Pallas Athena in 2011; Brainware, Nolij, ISYS and Acuo Technologies in 2012; AccessVia, Twistage, Saperion and Pacsgear in 2013; ReadSoft and GNAX Health in 2014, and Claron in 2015 routinely involve significant risks and challenges and the Company may not be able to realize all of the anticipated benefits of such transactions.  The Company may not be able to identify suitable opportunities on terms acceptable to the Company. The transaction may fail to advance the Company’s business strategy of becoming an end-to-end solutions provider.  The Company may not realize a satisfactory return on investment. The Company’s due diligence process may fail to identify significant issues with an acquired company’s products, financial disclosures, accounting practices or internal control deficiencies.  The Company may not be able to obtain regulatory or other approvals required for the transaction.  The future business operations of an acquired entity may not be successful. The Company may not be able to realize expense synergies and revenue expansion goals.  Disruptions from the transaction could harm relationships with the Company’s or the acquired entity’s existing customers, business partners, employees and suppliers. The Company’s acquisition or other investment may lead to litigation.  Intangible assets and goodwill recognized by the Company in the acquisition could become impaired if subsequent measurements of fair value and implied value, respectively, do not support the carrying values of such assets.

 

• The Company’s acquisitions present significant challenges and risks relating to the integration of the newly acquired business into the Company, and there can be no assurances that the Company will manage the integration of the newly acquired business successfully. The Company is in the process of integrating ReadSoft and other newly acquired businesses, and each of the Company’s acquisitions pose integration challenges, including the retention of customers and key employees, capitalizing on revenue synergies, and the difficulty of integrating business systems and technology.  The Company’s management may be required to spend a significant amount of time and resources to integrate these newly acquired businesses and the anticipated benefits of the acquisition may take longer to achieve, if at all.  If the Company fails to integrate ReadSoft and other newly acquired businesses on a timely basis, the Company may not meet its expectations regarding the profitability of such acquisitions, which could have an adverse impact on the Company’s business, financial condition and operating results.

 

If the Company’s data protection or other security measures are compromised and, as a result, the Company’s data, the Company’s customers’ data or the Company’s IT systems are accessed improperly, made unavailable, or improperly modified, the Company’s products and services may be perceived as vulnerable, its brand and reputation could be damaged, the IT services the Company provides could be disrupted, and customers may stop using the Company’s products and services, all of which could reduce the Company’s revenue and earnings and expose the Company to legal claims and regulatory actions.

 

• The Company’s products and services store, retrieve, manipulate and manage the Company’s customers’ information and data as well as the Company’s own.  The Company has invested a great deal of time and resources in protecting the integrity and security of the Company’s products, services and internal and external data being managed.  Nevertheless, computer hackers could attempt to penetrate or bypass the Company’s data protection and other security measures and gain unauthorized access to its networks, systems and data or compromise the confidential information or data of the Company’s customers. Computer hackers may be able to develop and deploy IT related viruses, worms, and other malicious software programs that could attack the Company’s products and services, exploit potential security vulnerabilities of the Company’s products and services, create system disruptions and cause shutdowns or denials of service.  Data may also be accessed or modified improperly as a result of employee or supplier error or malfeasance and third parties may attempt to fraudulently induce employees or customers into disclosing sensitive information such as user names, passwords or other information in order to gain access to the Company’s data and/or the Company’s customers’ data.

 

• These risks for the Company will increase as the Company continues to grow the Company’s cloud-based offerings and services and store and process increasingly large amounts of the Company’s customers’ confidential information and data and host or manage parts of the Company’s customers’ businesses in cloud-based IT environments, especially in customer sectors involving particularly sensitive data such as medical information, financial services and the government.

 

• If a cyberattack or other security incident described above were to allow unauthorized access to or modification of the Company’s customers’ data, the Company’s own data or the Company’s IT systems, or if the services provided to the Company’s customers were disrupted, or if its products or services are perceived as having security vulnerabilities, the Company could suffer damage to its brand and reputation. This could result in reduced revenue and earnings. The costs the Company would incur to address and fix these security incidents would increase its expenses. These types of security incidents could also lead to lawsuits, regulatory investigations and claims and increased legal liability, including in some cases contractual costs related to customer notification and fraud monitoring.

 

• Further, as regulatory focus on privacy issues continues to increase and worldwide laws and regulations concerning the protection of personal information expand and become more complex, these potential risks to the Company’s business will intensify. Changes in laws or regulations associated with the protection of certain types of data, such as healthcare data or other personally identifiable information, could greatly increase the Company’s cost of providing its products and services.

 

The Company’s inability to develop new products and enhance existing products to meet customer product requirements on a cost competitive basis may negatively impact the Company’s operating results.

 

• 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 products and associated supplies and content/process management software are aggressively competitive, especially with respect to pricing and the introduction of new technologies and products offering improved features and functionality. In addition, the introduction of any significant new and/or disruptive technology or business model by a competitor that substantially changes the markets into which the Company sells its products or demand for the products sold by the Company could severely impact sales of the Company’s products and the Company’s operating results. 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 attract and retain OEM customers and maintain or grow market share. The competitive pressure to develop technology and products and to increase the Company’s investment in research and development and marketing expenditures also could cause significant changes in the level of the Company’s operating expense.

 

The Company may experience difficulties in product transitions negatively impacting the Company’s performance and operating results.

 

• The introduction of products by the Company or its competitors, or delays in customer purchases of existing products in anticipation of new product introductions by the Company or its competitors and market acceptance of new products and pricing programs, any disruption in the supply of new or existing products as well as the costs of any product recall or increased warranty, repair or replacement costs due to quality issues, the reaction of competitors to any such new products or programs, the life cycles of the Company’s products, as well as delays in product development and manufacturing, and variations in cost, including but not limited to component parts, raw materials, commodities, energy, products, labor rates, distributors, fuel and variations in supplier terms and conditions, 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.

 

Due to the international nature of the Company’s business, changes in a country’s or region’s political or economic conditions or other factors could negatively impact the Company’s revenue, financial condition or operating results.

 

• Revenue derived from international sales made up more than half of the Company’s revenue in 2014. 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; local labor regulations; import, export or other licensing requirements; requirements related to making foreign direct investments; and unexpected changes in legal or regulatory requirements. In addition, changes in tax laws and the ability to repatriate cash accumulated outside the U.S. in a tax efficient manner may adversely affect the Company’s financial results, investment flexibility and operations. Moreover, margins on international sales tend to be lower than those on domestic sales, and the Company believes that international operations in emerging 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.

 

• In many foreign countries, particularly those with developing economies, it is common for local business practices to be prohibited by laws and regulations applicable to the Company, such as employment laws, fair trade laws or the Foreign Corrupt Practices Act. Although Lexmark implements policies and procedures designed to ensure compliance with these laws, our employees, contractors and agents, as well as those business partners to which the Company outsources certain business operations, may take actions in violation of these policies. Any such violation, even if prohibited by the Company’s policies, could have a material adverse effect on the Company’s business and reputation. Because of the challenges in managing a geographically dispersed workforce, there also may be additional opportunities for employees to commit fraud or personally engage in practices which violate the policies and procedures of the Company.

 

The failure of the Company’s information technology systems or the Company’s failure to successfully implement new information technology systems, may negatively impact the Company’s operating results.

 

• 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.   The Company also may not be successful in implementing new systems or transitioning data.  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.

 

The Company’s reliance on international production and distribution facilities, international manufacturing partners and certain key suppliers could negatively impact the Company’s operating results.

 

• The Company relies in large part on its international production facility located in Mexico and international manufacturing and distribution partners, many of which are located in China, Japan, Thailand, Brazil, Poland and the Philippines, 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, inability of the Company’s international operations or manufacturing and distribution partners to perform or supply products reliably, disruptions in international trade, trade restrictions, import duties, “Buy American” constraints, disruptions at important geographic points of exit and entry, difficulties in transitioning such manufacturing activities among the Company, its international operations and/or its manufacturing and distribution partners, or production and supply constraints which result in additional costs to the Company. The financial failure or loss of a sole supplier or significant supplier of products or key components, or their inability to produce the required quantities, could result in a material adverse impact on the Company’s operating results.

 

Business disruptions could seriously harm future revenue and financial condition and increase costs and expenses.

 

• Lexmark’s worldwide operations and those of the Company’s manufacturing partners, suppliers, and freight transporters, among others, are subject to natural and manmade disasters and other business interruptions such as earthquakes, tsunamis, floods, hurricanes, typhoons, fires, extreme weather conditions, environmental hazards, power shortages, water shortages and telecommunications failures. The occurrence of any of these business disruptions could result in significant losses to the Company, seriously harm the Company’s revenue, profitability and financial condition and increase the Company’s costs and expenses. The consolidation of certain functions into shared service centers and movement of certain functions to lower cost countries by the Company in recent year increases the probability and impact of business disruptions over time.

 

Increased competition in the Company’s aftermarket supplies business may negatively impact the Company’s revenue and gross margins.

 

• Refill, remanufactured, clones, counterfeits and other compatible alternatives for some of the Company’s cartridges are available and compete with the Company’s supplies business. The Company expects competitive supplies activity to increase. Various legal challenges and governmental activities may intensify competition for the Company’s aftermarket supplies business.

 

The Company’s inability to obtain and protect its intellectual property and defend against claims of infringement by others may negatively impact the Company’s operating results.

 

• The Company’s success depends in part on its ability to develop technology and obtain patents, copyrights and trademarks, and maintain trade secret protection, to protect its intellectual property against theft, infringement or other misuse by others. The Company must also conduct its operations 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, that the Company engages in false or deceptive practices or that its conduct is anti-competitive.

 

Ineffective internal controls could impact the Company's business and financial results:

 

• The Company's internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. If the Company fails to maintain the adequacy of its internal controls, including any failure to implement required new or improved controls, or if the Company experiences difficulties in their implementation, the Company's business and financial results could be harmed and the Company could fail to meet its financial reporting obligations. For example, in connection with management’s evaluation of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014, management determined that the Company did not maintain effective controls over the completeness, existence, accuracy and presentation and disclosure of the accounting for income taxes, including the income tax provision and related tax assets and liabilities. Management determined that the ineffective controls over income tax accounting constitutes a material weakness. See Item 9A, Controls and Procedures, for a discussion of the Company’s internal control over financial reporting, including a discussion of the material weakness. If the new controls being implemented to address the material weakness and to strengthen the overall internal control over accounting for income taxes are not designed or do not operate effectively, if the Company is unsuccessful in implementing or following these new processes or is otherwise unable to remediate this material weakness, this may result in untimely or inaccurate reporting of the Company’s financial condition or results of operations.

 

Customer demands and new regulations related to conflict-free minerals may adversely affect the Company.

 

• The Dodd-Frank Wall Street Reform and Consumer Protection Act imposes disclosure requirements regarding the use of conflict minerals mined from the Democratic Republic of Congo and adjoining countries in products, whether or not these products are manufactured by third parties. These requirements could affect the pricing, sourcing and availability of minerals used in products manufactured or contracted to manufacture by the Company. There will be additional costs associated with complying with the disclosure requirements, such as costs related to determining the source of any conflict minerals used in the Company’s products. Lexmark’s supply chain is complex and the Company may be unable to verify the origins for all metals used in the Company’s products. The Company may also encounter challenges with customers and stockholders if the Company is unable to certify that the products are conflict free.

 

New legislation, fees on the Company’s products or litigation costs required to protect the Company’s rights may negatively impact the Company’s cost structure, access to components and operating results.

 

• Certain countries (primarily in Europe) and/or collecting societies representing copyright owners’ interests have commenced proceedings to impose fees on devices (such as scanners, printers and multifunction devices) alleging the copyright owners are entitled to compensation because these devices enable reproducing copyrighted content. Other countries are also considering imposing fees on certain devices. The amount of fees, if imposed, would depend on the number of products sold and the amounts of the fee on each product, which will vary by product and by country. The financial impact on the Company, which will depend in large part upon the outcome of local legislative processes, the Company’s and other industry participants’ outcome in contesting the fees and the Company’s ability to mitigate that impact by increasing prices, which ability will depend upon competitive market conditions, remains uncertain. The outcome of the copyright fee issue could adversely affect the Company’s operating results and business.

 

The Company’s inability to perform satisfactorily under service contracts for managed print services or software services may negatively impact the Company’s strategy and operating results.

 

• 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.

 

The inability to attract, retain and motivate key employees could adversely affect the Company’s operating results.

 

• In order to compete, the Company must attract, retain, and motivate executives and other key employees, and its failure to do so could harm the Company’s results of operations. Hiring and retaining qualified executives, engineers, technical staff, sales, marketing and IT support positions are critical to the Company’s business, and competition for experienced employees in Lexmark’s industry can be intense. To help attract, retain, and motivate qualified employees, the Company must offer a competitive compensation package, including cash, cash-based incentive awards and share-based incentive awards, such as restricted stock units.  Because the cash-based and share-based incentive awards are dependent upon the performance conditions relating to the Company’s performance and the performance of the price of the Company’s common stock, the future value of such awards are uncertain.  If the anticipated value of such incentive awards does not materialize, or if the total compensation package ceases to be viewed as competitive, the Company’s ability to attract, retain, and motivate employees could be weakened, which could harm the Company’s results of operations.

 

Terrorist acts, acts of war or other political conflicts may negatively impact the Company’s ability to manufacture and sell its products.

 

• 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.

 

Any variety of factors unrelated to the Company’s operating performance may negatively impact the Company’s operating results or the Company’s stock price.

 

• 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.

 

Item 1B.         UNRESOLVED STAFF COMMENTS

 

Not applicable.

 

Item 2.         PROPERTIES

 

Lexmark’s corporate headquarters and principal development facilities are located on a 374 acre campus in Lexington, Kentucky. Perceptive Software’s headquarters is located in Lenexa, Kansas. At December 31, 2014, the Company owned or leased

approximately 5.2 million square feet of administrative, sales, service, research and development, warehouse and manufacturing facilities worldwide. Approximately 3.0 million square feet is located in the U.S. and the remainder is located in various international locations. The Company’s principal international manufacturing facility is located in Mexico. The principal domestic manufacturing facility is located in Colorado. The Company occupies facilities for development in various locations including the U.S., the Philippines, India, Germany and Sweden. The Company owns approximately 70 percent of the worldwide square footage and leases the remaining 30 percent. The leased property has various lease expiration dates. The Company believes that it can readily obtain appropriate additional space as may be required at competitive rates by extending expiring leases or finding alternative space. Included in the statements above is approximately 0.7 million square feet owned or leased for Perceptive Software.

 

None of the property owned by Lexmark is held subject to any major encumbrances and the Company believes that its facilities are in good operating condition.

 

Item 3.         LEGAL PROCEEDINGS

 

The information required by this item is set forth in Note 19 of the “Notes to Consolidated Financial Statements” contained in Item 8 of Part II of this report, and is incorporated herein by reference.

 

Item 4.         MINE SAFETY DISCLOSURES

 

Not applicable.

Part II

 

Item 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Information

 

Lexmark’s Class A Common Stock is traded on the New York Stock Exchange under the symbol “LXK.” As of February 13, 2015, there were 1,652 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, Note 22 of the Notes to Consolidated Financial Statements.

 

Dividend Policy

 

Dividends of $0.30 per common share were declared on February 21, 2013, April 25, 2013, July 25, 2013, October 24, 2013 and February 20, 2014. Dividends of $0.36 per common share were declared on April 24, 2014, July 24, 2014, October 23, 2014 and February 19, 2015. Refer to Part II, Item 8, Notes 15 and 21 of the Notes to Consolidated Financial Statements for more information regarding dividends.

 

Lexmark is continuing to execute on its stated capital allocation framework of returning, on average, more than 50 percent of free cash flow (net cash flows provided by operating activities minus purchases of property, plant and equipment plus proceeds from sale of fixed assets) to its shareholders through dividends and share repurchases while pursuing acquisitions and organic investments that support the strengthening and growth of the Company. The Company anticipates paying dividends quarterly, though future declarations of dividends are subject to Board of Directors’ approval and may be adjusted as business needs or market conditions change.

 

Issuer Purchases of Equity Securities

 

Period	Total Number of Shares Purchased (2)			Average Price Paid per Share (2)		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2)			Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (in millions) (1)(2)
October 1-31, 2014	460,591		$	40.60		460,591		$	92.2
November 1-30, 2014	62,481			52.82		62,481			88.9
December 1-31, 2014	–			–		–			88.9
Total	523,072		$	42.06		523,072

 

(1) Information regarding the Company’s share repurchases can be found in Part II, Item 8, Note 15 of the Notes to Consolidated Financial Statements.

 

(2) On October 24, 2014, the Company entered into an Accelerated Share Repurchase (“ASR”) Agreement with a financial institution counterparty. Under the terms of the ASR Agreement, the Company paid $22 million targeting approximately 0.5 million shares based on the closing price of the Company’s Class A Common Stock on October 24, 2014. On October 29, 2014, the Company took delivery of 85% of the shares, or approximately 0.5 million shares at a cost of $18.7 million. On November 21, 2014, the counterparty delivered approximately 0.1 million additional shares in final settlement of the agreement, bringing the total shares repurchased under the ASR to approximately 0.5 million shares at an average price per share of $42.06.

Performance Graph

 

The following graph compares cumulative total stockholder return on the Company’s Class A Common Stock with a broad performance indicator, the S&P MidCap 400 Index, and an industry index, the S&P 400 Information Technology Index, for the period from December 31, 2009, to December 31, 2014. The graph assumes that the value of the investment in the Class A Common Stock and each index were $100 at December 31, 2009, and that all dividends were reinvested.

 

 

Comparison of cumulative total returns	12/31/09		12/31/10		12/31/11		12/30/12		12/31/13		12/31/14
Lexmark International, Inc.	$	100	$	134	$	128	$	94	$	150	$	180
S&P MidCap 400 Index		100		127		124		147		196		215
S&P 400 Information Technology Index		100		133		117		135		174		188
Source: Standard & Poor's Capital IQ

 

 

 

 

 

 

 

 

Equity Compensation Plan Information

 

The following table provides information about the Company’s equity compensation plans as of December 31, 2014:

 

(Number of Securities in Millions)
Plan Category	Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights			Weighted Average Exercise Price of Outstanding Options, Warrants and Rights (1)			Number of Securities Remaining Available for Future Issuance Under Equity compensation Plans
Equity compensation plans approved by stockholders	4.4	(2)		$	54.93		10.1	(3)
Equity compensation plans not approved by stockholders (4)	0.1				44.19		0.0
Total	4.5			$	54.63		10.1

 

(1) The numbers in this column represent the weighted average exercise price of stock options only

 

(2) Of the approximately 4.4 million shares outstanding under the equity compensation plans approved by stockholders, there were approximately 1.8 million stock options (of which 1,627,000 are employee stock options and 137,000 are nonemployee director stock options) and approximately 2.6 million restricted stock units (“RSUs”) and deferred stock units (“DSUs”), including associated dividend equivalent units (of which 2,349,000 are employee RSUs and DSUs and 280,000 are nonemployee director RSUs and DSUs). Performance-based RSUs granted in 2012, 2013 and 2014 were included at the target level of achievement. Refer to Part II, Item 8, Note 6 of the Notes to Consolidated Financial Statements for more information.

 

(3) Of the approximately 10.1 million shares available, 9.8 million relate to employee plans (of which 4.8 million may be granted as full-value awards) and 0.3 million relate to the nonemployee director plan.

 

(4) As of December 31, 2014, approximately 52,000 shares remained outstanding (all of which are in the form of stock options) pursuant to awards made under the Lexmark International, Inc. Broad-Based Employee Stock Incentive Plan (the “Broad-Based Plan”), an equity compensation plan which had not been approved by the Company’s stockholders. On February 24, 2011, the Company’s Board of Directors terminated the Broad-Based Plan and cancelled the remaining available shares that had been authorized for issuance under the Broad-Based Plan.

Item 6.            SELECTED FINANCIAL DATA

 

The table below summarizes recent financial information for the Company. For further information refer to the Company’s Consolidated Financial Statements and Notes thereto presented under Part II, Item 8 of this Form 10-K.

 

(Dollars in Millions, Except per Share Data)

 

	2014		2013		2012		2011		2010
Statement of Earnings Data:
Revenue (1)	$	3,710.5	$	3,667.6	$	3,797.6	$	4,173.0	$	4,199.7
Operating income (1)(2)(3)	$	149.2	$	409.2	$	191.5	$	367.7	$	460.2
Net earnings (1)(2)(3)(4)	$	79.1	$	261.8	$	107.6	$	275.2	$	350.2
Net earnings per common share
Basic (1)(2)(3)(4)	$	1.28	$	4.16	$	1.57	$	3.57	$	4.46
Diluted (1)(2)(3)(4)	$	1.25	$	4.08	$	1.55	$	3.53	$	4.41
Cash dividends declared per common share	$	1.38	$	1.20	$	1.15	$	0.25	$	–
Statement of Financial Position Data:
Total assets	$	3,633.1	$	3,616.9	$	3,525.3	$	3,640.2	$	3,706.8
Total debt	$	699.7	$	699.6	$	649.6	$	649.3	$	649.1

 

(1) Refer to Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations — Acquisition-Related Adjustments and Part II, Item 8, Note 4 of the Notes to Consolidated Financial Statements for more information on the Company’s acquisitions and pre-tax charges related to amortization of intangible assets and other acquisition-related costs and integration expenses for 2014, 2013 and 2012. Refer to Part II, Item 8, Note 4 of the Notes to Consolidated Financial Statements for more information on the Company’s divestiture-related adjustments for 2013. Refer to Part II, Item 8, Note 20 of the Notes to Consolidated Financial Statements for more information on the Company’s reportable segment Revenue and Operating income (loss) for 2014, 2013 and 2012.

 

The Company acquired Pallas Athena on October 18, 2011. Perceptive Software Revenue and Operating income (loss) included in the table above for 2011 were $94.8 million and $(29.5) million, respectively. The Company incurred pre-tax charges of $24.5 million in 2011 related to acquisitions, including $21.2 million related to amortization of intangible assets and $3.3 million of other acquisition-related costs and integration expenses.

 

The Company acquired Perceptive Software in the second quarter of 2010. Perceptive Software Revenue and Operating income (loss) included in the table above for 2010 (subsequent to the acquisition) were $37.3 million and $(16.0) million, respectively. The Company incurred pre-tax charges of $19.1 million in 2010 related to acquisitions, primarily Perceptive Software, including $12.0 million related to amortization of intangible assets and $7.1 million of other acquisition-related costs and integration expenses.

 

(2) Refer to Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations — Restructuring Charges and Project Costs for more information on the Company’s restructuring charges and project costs for 2014, 2013 and 2012. Refer to Part II, Item 8, Note 5 of the Notes to Consolidated Financial Statements for more information on the Company’s restructuring charges for 2014, 2013 and 2012. Amounts in 2011 include restructuring charges and project costs of $29.9 million. Amounts in 2010 include restructuring charges and project costs of $38.6 million.

 

(3) Refer to Part II, Item 8, Note 17 of the Notes to Consolidated Financial Statements for more information on the Company’s asset and actuarial net (gain) loss on pension and other postretirement benefit plans for 2014, 2013 and 2012. Amounts in 2011 include asset and actuarial net loss on pension and other postretirement benefit plans of $94.7 million. Amounts in 2010 include asset and actuarial net loss on pension and other postretirement benefit plans of $1.9 million.

 

(4) Refer to Part II, Item 8, Note 14 of the Notes to Consolidated Financial Statements for more information on the Company’s discrete tax items for 2014, 2013 and 2012. Amounts in 2010 include a $14.7 million benefit from discrete tax items mainly related to audits concluding, statutes expiring, and true-ups of prior year tax returns.

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 presented under Part II, Item 8 of this Form 10-K.

 

OVERVIEW

 

Products and Segments

 

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

 

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

 

• ISS offers a broad portfolio of monochrome and color laser printers and laser MFPs, as well as supplies, software applications, software solutions and MPS to help businesses efficiently capture, manage and access information. Laser based products within the distributed printing market primarily serve business customers. ISS employs large-account sales and marketing teams whose mission is to generate demand for its business printing solutions and services, primarily among large corporations, small and medium businesses, as well as the public sector. These sales and marketing teams primarily focus on industries such as financial services, retail, manufacturing, education, government and health care, and in conjunction with ISS’ development and manufacturing teams, are able to customize printing solutions to meet customer needs for printing electronic forms, media handling, duplex printing, intelligent capture and other document workflow solutions. ISS distributes and fulfills its products to business customers primarily through its well-established distributor and reseller network. The ISS distributor and reseller network includes IT Resellers, Direct Marketing Resellers, and Copier Dealers. ISS also sells its products through numerous alliances and OEM arrangements.

 

• Perceptive Software offers a complete suite of ECM, BPM, DOM, intelligent data capture, search software and medical imaging VNA software products and solutions. The ECM and BPM software and services markets primarily serve business customers. Perceptive Software uses a direct to market sales and demand generation approach, employing internal sales and marketing teams that are segmented by industry sector — specifically healthcare, public sector (which includes higher education and government), and commercial, which spans areas such as retail, banking, insurance and manufacturing. Perceptive Software also offers a channel partner program that allows authorized third-party resellers to market and sell Perceptive Software products and solutions to a distributed market, as well as an OEM program which includes Perceptive Software’s offerings within channel partners’ existing solutions to their customers. Perceptive Software has two general forms of software agreements with its customers, perpetual licenses and subscription services.

 

Refer to Part II, Item 8, Note 20 of the Notes to Consolidated Financial Statements for additional information regarding the Company’s reportable segments, which is incorporated herein by reference.

 

 

Key Messages

 

2014

 

Lexmark is focused on driving long-term performance by strategically investing in technology, hardware and software products and solutions to secure high value product installations and capture profitable supplies, software maintenance and service annuities in document-intensive industries and business processes in distributed environments. The Company continues the transition to a solutions company as it shifts from a hardware-centric company to a solutions company providing end-to-end solutions that allow customers to bridge the paper and digital worlds and the unstructured and structured content/process worlds. Lexmark provides comprehensive capabilities to allow customers to manage their print and MFP environment, including MPS. The Company also continues to build its capabilities to help customers capture, manage and access unstructured content, in any form, through both organic investment and acquisitions.

 

The Company continues a strategic focus on growing its MPS offerings and the placement of high-end hardware. The Company also continues the strategic focus on expansion in solutions and software capabilities, to both strengthen its MPS offerings and grow its non-printing related software solutions business focused in the ECM, BPM and DOM markets. These strategic focus areas are

intended to increase our penetration in the business segment. The business segment tends to have higher page generating and more software intensive application requirements, which drive increasing levels of supplies and software maintenance and support revenue.

 

In order to support these strategic focus areas, and to allow Lexmark to participate in the growing market to manage unstructured data and processes, and to further strengthen the Company’s products, content/business process management solutions and MPS, the Company acquired Brainware, Nolij, ISYS and Acuo Technologies in 2012; Twistage, Access Via, Saperion and Pacsgear in 2013; ReadSoft and GNAX Health in 2014; and Claron in 2015. These acquisitions are included in the Perceptive Software segment.

 

While focusing on core strategic initiatives, Lexmark has taken actions over the last few years to improve its cost and expense structure. As a result of restructuring initiatives, significant changes have been implemented, from the consolidation and reduction of the manufacturing and support infrastructure and the increased use of shared service centers in low-cost countries, to the exit of inkjet technology. In 2012, the Company announced restructuring actions including exiting the development and manufacturing of its remaining inkjet hardware. In the second quarter of 2013, the Company and Funai entered into a Master Inkjet Sale Agreement of the Company’s inkjet-related technology and assets to Funai for total cash consideration of $100 million. Included in the sale were one of the Company’s subsidiaries, certain intellectual property and other assets of the Company. The Company will continue to provide service, support and aftermarket supplies for its current inkjet installed base. The sale closed in the second quarter of 2013. With this announcement, Lexmark has focused its printing and MFP development activities solely in laser-based technologies.

 

The Company remains committed on its stated capital allocation framework of returning, on average, more than 50 percent of free cash flow to its shareholders through dividends and share repurchases while pursuing acquisitions and organic investments that support the strengthening and growth of the Company.

 

Lexmark’s 2014 revenue was up 1% YTY, primarily due to higher laser revenue in the ISS segment and increased Perceptive Software revenue, offset by an unfavorable impact of approximately 4% due to the Company’s exit of inkjet technology and an unfavorable YTY currency impact of 1%. Operating income decreased 64% YTY primarily driven by the Gain on sale of inkjet-related technology and assets of $73.5 million recognized in the 2013 period and a pension and other postretirement benefit plan net loss of $80.5 million in 2014, compared with a net gain of $83.0 million in 2013. Operating income also reflected the revenue impacts discussed above as well as a reduction in operating expenses due to the Company’s previously announced restructuring and ongoing expense actions.

 

As in 2014, the Company is focused in 2015 on revenue and profit growth from the strategic imaging and software segments of the business, particularly MPS offerings and Perceptive Software. While this growth will be dampened by the remaining Inkjet Exit headwind in 2015, this headwind will decline over time.

 

Refer to the section entitled “RESULTS OF OPERATIONS” that follows for a further discussion of the Company’s results of operations.

 

Trends and Opportunities

 

Lexmark serves both the distributed printing and imaging, and content and process management markets with a focus on business customers. Lexmark’s enterprise content and process management software platform supports traditional business content as well as rich media and industry-specific content like medical image content, and includes enterprise search, intelligent capture, DOM, and business process and case management. Lexmark’s healthcare offering includes an industry leading, standards based and highly secure, content repository and VNA that integrates all patient unstructured information across the enterprise to enable easy access including access via an EMR system. This healthcare content and process management offering also includes workflow automation and information and medical imaging study sharing within and between facilities and organizations. Lexmark management believes the total relevant market opportunity of these markets combined in 2014 was approximately $80 billion. Lexmark management believes that the total relevant distributed laser printing and imaging market opportunity was approximately $70 billion in 2014, including printing hardware, supplies and related services. This opportunity includes printers and multifunction devices as well as a declining base of copiers and fax machines that are increasingly being integrated into multifunction devices. Based on industry information, Lexmark management believes that the overall distributed printing market declined slightly in 2014. The distributed printing industry is expected to experience flat to low single digit declining revenue overall over the next few years, but continued growth is expected in MPS, MFPs, and color laser printing products which are all areas of focus for Lexmark. Based on industry analysts’ forecasts, MPS and fleet solutions are projected to continue to experience approximately 10% annual revenue growth rates over the next several years and the relevant content and process management software markets that Lexmark participates in are projected to grow in aggregate approximately 11% annually over the next several years. In 2014, the total relevant content and process management software market was approximately $10 billion, excluding related professional services. However, management believes the total addressable market is significantly larger due to relatively low penetration of content and process management software solutions worldwide.

 

Market trends driving long-term growth include:

 

• Continued adoption of color and graphics output in business;

 

• Advancements in electronic movement of information, driving a continued shift in pages away from centralized commercial printing and document scanning to distributed printing and multi-channel capture by end users when and where it is convenient to do so, including via smart MFPs, mobile devices and the web;

 

• Continued convergence between printers, scanners, copiers and fax machines into single, integrated multifunction and all-in-one devices;

 

• Increasing ability of multi-function printing devices and mobile devices to integrate into business process workflow solutions and enterprise content management systems;

 

• Continued digitization of information and the electronic distribution of information, driving the explosive growth of unstructured digital information, such as office documents, emails, web pages, images, video and audio files;

 

• Customer desire to have a third party manage their printing and document output environment;

 

• Ongoing emphasis on improving business process efficiency and driving costs out of the organization by better managing enterprise content and associated processes;

 

• Increasing need to capture, manage and access content from any location or any web-enabled device, including mobile access and mobile workflow participation, while ensuring content security;

 

• Growing desire to unify structured data in business systems with unstructured paper and digital content to make the unstructured content more valuable and actionable within business functions; and

 

• Increasing need in the healthcare industry to unify structured patient data, that is now typically stored in an EMR system, with unstructured content, that includes medical imaging studies and other patient documents and content such as lab reports and physicians notes, to enable easy unified access by clinical staff and referring physicians, across the healthcare continuum to improve clinical and business outcomes.

 

As a result of these market trends, Lexmark has growth opportunities in monochrome and color laser printers and MFPs, MPS, as well as fleet management solutions, ECM, BPM, DOM, intelligent data capture, search, and medical imaging VNA, software products and solutions.

 

Color and MFP devices continue to represent a more significant portion of the laser market. The Company’s management believes that these trends will continue. Industry pricing pressure is partially offset by the tendency of customers to purchase higher value color and MFP devices and optional paper handling and finishing features. Customers are also purchasing connected smart MFPs and content and process management software solutions and services to optimize their document-related processes and infrastructure in order to improve productivity and cost.

 

While profit margins on printers and MFPs have been negatively affected by competitive pricing pressure, supplies sales are higher margin and recurring. In general, as the printing and imaging market matures and printer and copier-based product markets continue to converge, the Company’s management expects competitive pressures to continue.

 

Lexmark’s dot matrix printers include mature products that require little ongoing investment. The Company expects that the market for these products will continue to decline, and has implemented a strategy to continue to offer high-quality products while managing cost to maximize cash flow and profit.

 

The content and process management software and services markets serve business customers. These markets include solutions for capturing all types of unstructured information such as hardcopy, photographs, emails, images, video, audio and faxes as well as intelligent indexing, archiving and routing of this information to streamline and automate process workflows while managing changes to both content and processes and automating governance and compliance policies. These solutions help companies leverage the value of their unstructured information by connecting it with existing enterprise applications and making it available in context within processes so that businesses can make better and faster decisions to enhance growth, improve productivity, lower costs and improve customer satisfaction. These markets also include solutions that help businesses understand existing processes, design and manage new processes, and enable the assembly of content into meaningful communications internally and with their customers and partners.

 

Management sees growth opportunities in large/global enterprises with a distributed workforce, in organizations that are seeking to optimize their content-related infrastructure and reduce costs, and in functional areas where workers rely on mobile devices for productivity.

 

The demand for content and process management solutions is strong in developed and emerging markets alike, representing a considerable growth opportunity for Perceptive Software. Lexmark’s products are already installed in geographies around the world, and management believes this global customer base serves as an impetus for additional installations for Perceptive Software outside of North America. Customers continue to purchase ECM solutions that result in greater efficiency and productivity in their various lines of business and back office operations.

 

Business systems such as ERP, EMR, and CRM systems represent a mature market and remain vital applications but do not satisfy an organization’s enterprise content management needs. The Company expects organizations to continue to look to ECM and BPM solutions to complete their enterprise information infrastructure, increasing the value of their core business system investments and leading to gains in efficiency.

 

Challenges and Risks

 

In recent years, Lexmark and its principal competitors, many of which have significantly greater financial, marketing and/or technological resources than the Company, have regularly lowered prices on printers and are expected to continue to do so. Other challenges and risks faced by Lexmark include:

 

• New product announcements by ISS’ principal competitors can have, and in the past, have had, a material impact on the Company’s financial results.

 

• The Company’s future operating results may be adversely affected if the consumption of inkjet aftermarket supplies used in the Company’s legacy inkjet installed base is less than expected.

 

• With the convergence of traditional printer and copier markets, major laser competitors now include traditional copier companies

 

• The Company expects competition will continue to intensify as the ECM and BPM markets consolidate. The Company sees other competitors and the potential for new entrants into the ECM and BPM markets possibly having an impact on the Company’s strategy to expand in these markets.

 

• Lexmark expects that as it competes with larger competitors, the Company may attract more frequent challenges, both legal and commercial, including claims of possible intellectual property infringement.

 

• Refill, remanufactured, clones, counterfeits and other compatible alternatives for some of ISS’ toner and ink cartridges are available and compete with ISS’ supplies business. However, these alternatives may result in inconsistent quality and reliability. As the installed base of laser and inkjet products matures, the Company expects competitive supplies activity to increase.

 

• Historically, the Company has not experienced significant supplies pricing pressure, but if supplies pricing was to come under significant pressure, the Company’s financial results could be materially adversely affected.

 

• Global economic uncertainty, difficulties in the financial markets and unfavorable movements in currency exchange rates could impact the Company’s future operating results.

 

• Changes in printing behavior driven by adoption of electronic processes and/or use of mobile devices such as tablets and smart phones by businesses could result in a reduction in printing, which could adversely impact consumption of supplies.

 

Refer to the sections entitled “Competition – ISS” and “Competition – Perceptive Software” in Item 1, which are incorporated herein by reference, for a further discussion of major uncertainties faced by the industry and the Company. Additionally, refer to the section entitled “Risk Factors” in Item 1A, which is incorporated herein by reference, for a further discussion of factors that could impact the Company’s operating results.

 

Strategy and Initiatives

 

Lexmark’s strategy is based on a business model of investing in technology to develop and sell printing and imaging, and content and process management solutions, including printers, multifunction devices and software solutions with the objective of growing its installed base of hardware devices and software installations, which drives recurring printing supplies sales and software subscription,

maintenance and services revenue. The Company’s management believes that Lexmark has the following strengths related to this business model:

 

• Lexmark is highly focused on delivering printing, imaging, and content and process management software solutions and services for specific industries and business processes in distributed work environments.

 

• Lexmark internally develops both monochrome and color laser printing technology

 

• Lexmark, through Perceptive Software, also internally develops content and process management software that includes DOM, intelligent capture, search, rich content management, and healthcare specific medical imaging and VNA software products as well as other industry tailored solutions to help companies manage the lifecycle of their content and business processes all in the context of their existing enterprise applications.

 

• Lexmark has leveraged its technological capabilities and its commitment to flexibility and responsiveness to build strong relationships with large-account customers and channel partners.

 

Lexmark’s strategy involves the following core strategic initiatives:

 

• Invest in technology, hardware and software products and solutions to secure high value product installations and capture profitable supplies, software subscription, and maintenance and service annuities in content-intensive industries and business processes;

 

• Target and capture business customers, markets and channels that drive higher page generation and supplies usage; and

 

• Advance and grow the Company’s content and process management solutions business worldwide.

 

Refer to the section entitled “Strategy” in Item 1, which is incorporated herein by reference, for a further discussion of the Company’s strategies and initiatives.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Lexmark’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, as well as disclosures regarding contingencies. Lexmark bases its estimates on historical experience, market conditions, and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

Refer to Part II, Item 8, Note 2 of the Notes to Consolidated Financial Statements for the summary of significant accounting policies. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

 

Revenue Recognition

 

Revenue recognition may be impacted by the Company’s ability to estimate sales incentives and expected returns.

 

For customer programs and incentives, Lexmark records estimated reductions to revenue at the time of sale for customer programs and incentive offerings including special pricing agreements, promotions and other volume-based incentives. Estimated reductions in revenue are based upon historical trends and other known factors at the time of sale. Lexmark also records estimated reductions to revenue for price protection, which it provides to substantially all of its distributor and reseller customers. The amount of price protection is limited based on the amount of dealers’ and resellers’ inventory on hand (including in-transit inventory) as of the date of the price change. If market conditions were to decline, Lexmark may take actions to increase customer incentive offerings or reduce prices, possibly resulting in an incremental reduction of revenue at the time the incentive is offered.

 

The Company also records estimated reductions to revenue at the time of sale related to its customers’ right to return product. Estimated reductions in revenue are based upon historical trends of actual product returns as well as the Company’s assessment of its products in the channel. Provisions for specific returns from large customers are also recorded as necessary.

 

Multiple Element Arrangements

 

The Company also enters into multiple element agreements with customers which may involve the provisions of hardware and/or software, supplies, customized services such as installation, maintenance, and enhanced warranty services, and separately priced maintenance services. These bundled arrangements typically involve capital or operating leases, or upfront purchases of hardware or software products with services and supplies provided per contract terms or as needed.

 

The Company uses its best estimate of selling price (“BESP”) when allocating the transaction price for many of its product and service deliverables as permitted under the accounting guidance for multiple element arrangements when sufficient vendor specific objective evidence (“VSOE”) and third party evidence do not exist. BESP for the Company’s product deliverables is determined by utilizing a weighted average price approach which starts with a review of historical stand-alone sales data. Prior sales are grouped by product and key data points utilized such as the average unit price and the weighted average price in order to incorporate the frequency of each product sold at any given price. Due to the large number of product offerings, products are then grouped into common product categories (families) incorporating similarities in function and use and a BESP discount is determined by common product category. This discount is then applied to product list price to arrive at a product BESP. BESP for the Company’s service deliverables is determined primarily by utilizing a cost plus margin approach as the Company does not typically sell its services on a stand-alone basis.  The Company generally uses third party suppliers to provide the services component of its multiple element arrangements, thus the cost of services is generally that which is invoiced to the Company, but may also include cost estimates based on parts, labor, overhead and estimates of the number of service actions to be performed. A margin is applied to the cost of services in order to determine a BESP, and is primarily based on consideration of internal factors such as margin objectives and pricing practices as well as competitor pricing strategies. For those services that are offered to customers on a stand-alone basis, the Company utilizes stand-alone quotes to develop a range of prices offered. A BESP for these services has been determined as an average price per hour.

 

For multiple element agreements that include software deliverables accounted for under the industry-specific revenue recognition guidance, relative selling price must be determined by VSOE, which is based on company specific stand-alone sales data or renewal rates. For software arrangements, the Company typically uses the residual method to allocate arrangement consideration as permitted under the industry-specific revenue recognition guidance.

 

Multiple element arrangements and software and related services represent a smaller, but faster growing portion of the Company’s overall business. Pricing practices could be modified in the future as the Company’s go-to-market strategies evolve. Such changes could impact BESP and VSOE, which would change the pattern and timing of revenue recognition for individual elements but would not change the total revenue recognized for the arrangements.

 

Refer to Part II, Item 8, Note 2 of the Notes to Consolidated Financial Statements for information regarding the Company’s policy for revenue recognition.

 

Allowances for Doubtful Accounts

 

Lexmark maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The Company estimates the allowance for doubtful accounts based on a variety of factors including the length of time receivables are past due, the financial health of its customers, unusual macroeconomic conditions and historical experience. If the financial condition of its customers deteriorates or other circumstances occur that result in an impairment of customers’ ability to make payments, the Company records additional allowances as needed.

 

In spite of economic uncertainty in Eurozone economies, the Company has not experienced an increase in credit losses in EMEA and no adjustments have been recognized in the Company’s allowance for doubtful accounts specifically regarding this matter as of December 31, 2014. Approximately 27% of the Company’s trade receivables balance is related to EMEA customers.

 

Restructuring

 

Lexmark records a liability for a cost associated with an exit or disposal activity at its fair value in the period in which the liability is incurred, except for liabilities for certain employee termination benefit charges that are accrued over time. Employee termination benefits associated with an exit or disposal activity are accrued when the obligation is probable and estimable as a postemployment benefit obligation when local statutory requirements stipulate minimum involuntary termination benefits or, in the absence of local statutory requirements, termination benefits to be provided are similar to benefits provided in prior restructuring activities. Employee termination benefits accrued as probable and estimable often require judgment by the Company’s management as to the number of employees being separated and the related salary levels, length of employment with the Company and various other factors related to the separated employees that could affect the amount of employee termination benefits being accrued. Such estimates could change in the future as actual data regarding separated employees becomes available.

 

Specifically for termination benefits under a one-time benefit arrangement, the timing of recognition and related measurement of a liability depends on whether employees are required to render service until they are terminated in order to receive the termination

benefits and, if so, whether employees will be retained to render service beyond a minimum retention period. For employees who are not required to render service until they are terminated in order to receive the termination benefits or employees who will not provide service beyond the minimum retention period, the Company records a liability for the termination benefits at the communication date. If employees are required to render service until they are terminated in order to receive the termination benefits and will be retained to render service beyond the minimum retention period, the Company measures the liability for termination benefits at the communication date and recognizes the expense and liability ratably over the future service period.

 

For contract termination costs, Lexmark records a liability for costs to terminate a contract before the end of its term when the Company terminates the agreement in accordance with the contract terms or when the Company ceases using the rights conveyed by the contract. The liability is recorded at fair value in the period in which it is incurred, taking into account the effect of estimated sublease rentals that could be reasonably obtained which may be different than company-specific intentions.

 

Warranty

 

Lexmark provides for the estimated cost of product warranties at the time revenue is recognized. The amounts accrued for product warranties are based on the quantity of units sold under warranty, estimated product failure rates, and material usage and service delivery costs. The estimates for product failure rates and material usage and service delivery costs are periodically adjusted based on actual results. For extended warranty programs, the Company defers revenue in short-term and long-term liability accounts (based on the extended warranty contractual period) for amounts invoiced to customers for these programs and recognizes the revenue ratably over the contractual period. Costs associated with extended warranty programs are expensed as incurred. To minimize warranty costs, the Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers. Should actual product failure rates, material usage or service delivery costs differ from the Company’s estimates, revisions to the estimated warranty liability may be required.

 

Inventory Reserves and Adverse Purchase Commitments

 

Lexmark writes down its inventory for estimated obsolescence or unmarketable inventory by an amount equal to the difference between the cost of inventory and the estimated market value. The Company estimates the difference between the cost of obsolete or unmarketable inventory and its market value based upon product demand requirements, product life cycle, product aging, product pricing and quality issues. Also, Lexmark records an adverse purchase commitment liability when anticipated market sales prices are lower than committed costs. If actual market conditions are less favorable than those projected by management, additional inventory write-downs and adverse purchase commitment liabilities may be required.

 

Pension and Other Postretirement Plans

 

The Company’s pension and other postretirement benefit costs and obligations are dependent on various actuarial assumptions used in calculating such amounts. The non-U.S. pension plans use economic assumptions similar to the U.S. pension plan, a defined benefit plan. Significant assumptions the Company must review and set annually related to its pension and other postretirement benefit obligations are:

 

• Expected long-term return on plan assets — based on long-term historical actual asset return information, the mix of investments that comprise plan assets and future estimates of long-term investment returns by reference to external sources. The Company also includes an additional return for active management, when appropriate, and deducts various expenses. The Company uses fair value of plan assets to determine expense.

 

• Discount rate — reflects the rates at which benefits could effectively be settled and is based on current investment yields of high-quality fixed-income investments. The Company uses a yield-curve approach to determine the assumed discount rate based on the timing of the cash flows of the expected future benefit payments. The Company uses an above-mean yield curve for a more refined estimate of the benefit obligation.

 

• Rate of compensation increase — Effective April 2006, this assumption is no longer applicable to the U.S. pension plan due to the benefit accrual freeze in connection with the Company’s 2006 restructuring actions. In addition, some of the non-U.S. pension plans are also frozen.

 

Plan assets are invested in equity securities, government and agency securities, mortgage-backed securities, commercial mortgage-backed securities, asset-backed securities, corporate debt, annuity contracts and other securities. The U.S. pension plan comprises a significant portion of the assets and liabilities relating to the Company’s pension plans. The investment goal of the U.S. pension plan is to achieve an adequate net investment return in order to provide for future benefit payments to its participants. U.S. asset allocation percentages as of December 31, 2014 were 36% equity and 64% fixed income investments. The U.S. pension plan employs professional investment managers to invest in U.S. equity, global equity, international developed equity, emerging market equity, U.S. fixed income, high yield bonds and emerging market debt. Each investment manager operates under an investment management contract that includes specific investment guidelines, requiring among other actions, adequate diversification, prudent use of

derivatives and standard risk management practices such as portfolio constraints relating to established benchmarks. The U.S. pension plan currently uses a combination of both active management and passive index funds to achieve its investment goals.

 

The accounting guidance for employers’ defined benefit pension and other postretirement plans requires recognition of the funded status of a benefit plan in the statement of financial position. The change in the fair value of plan assets and net actuarial gains and losses are recognized in net periodic benefit cost in the fourth quarter of each year and whenever a remeasurement is triggered. The remaining components of pension and other postretirement benefit cost are recorded on a quarterly basis. Actuarial gains and losses may be related to actual results that differ from assumptions as well as changes in assumptions, which may occur each year. Factors that can significantly impact the amounts of such gains and losses include differences between the actual and expected return on plan assets, changes in discount rates used in the measurement of pension and other postretirement plan obligations each year, and changes in actuarial assumptions, such as plan participants’ life expectancy. Prior service cost or credit continue to be accumulated in other comprehensive earnings and amortized over the estimated future service period of active plan participants.

 

For the years ended December 31, 2014, 2013, and 2012, the asset and actuarial net gains and losses on pension and other postretirement benefit plan remeasurements reflected in operating income were a loss of  $81 million, a gain of $83 million, and a loss of $22 million, respectively. The following table summarizes the components of the asset and actuarial net gain or loss on pension and other postretirement plan measurements during each period presented:

 

(Dollars in millions)	2014			2013			2012
Change in discount rate and other actuarial assumptions	$	103		$	(66)		$	63
Actual (return) loss on plan assets		(66)			(60)			(83)
Expected return on plan assets		44			43			42
Total asset and actuarial net (gain) loss	$	81		$	(83)		$	22
Actual return on plan assets		9.7	%		9.3	%		14.4	%
Expected return on plan assets		6.7	%		6.9	%		7.2	%

 

The actuarial loss in 2014 was primarily due to a decrease in discount rates. Also increasing the loss was a change in mortality assumptions to reflect a new set of mortality tables finalized by the Society of Actuaries on October 24, 2014, which included longer life expectancies than projected by past tables. The actuarial gains in 2013 were mainly driven by increases in discount rates. The actuarial loss in 2012 was primarily due to a decrease in discount rates. For 2014, 2013, and 2012, asset returns exceeded expectations resulting in net asset gains of $22 million, $17 million and $41 million, respectively.

 

The following table illustrates the sensitivity of net periodic benefit cost and the projected benefit obligations for the Company’s U.S. pension plans to changes in the long-term discount rate and asset return assumptions. Under the Company’s accounting policy for pension plan asset gains and losses, changes in the actual return on plan assets are recognized as part of the annual fourth quarter plan remeasurement, or whenever a remeasurement is triggered. The expected return on plan assets assumption sensitivity applies to ongoing net periodic benefit cost recorded in interim periods. The impact of changing multiple factors below may not be achievable by combining the individual sensitivities provided below and such sensitivities are specific to the below time periods.

 

	Increase (Decrease) in 2014			Increase (Decrease) in Projected
	Pre-tax Net Periodic Benefit			Benefit Obligation for the U.S.
	Cost for the U.S. Pension Plans			Pension Plans as of Dec. 31, 2014
Change in Assumption	(in millions)			(in millions)
25 basis points decrease in discount rate	$	(0.8)		$	17.6
25 basis points increase in discount rate		0.8			(16.9)
50 basis points decrease in actual return on plan assets		2.7			No Impact
50 basis points increase in actual return on plan assets		(2.7)			No Impact
	Increase (Decrease) in 2014
	Pre-tax Interim Period			Increase (Decrease) in Projected
	Net Periodic Benefit Cost			Benefit Obligation for the U.S.
	for the U.S. Pension Plans			Pension Plans as of Dec. 31, 2014
	(in millions)			(in millions)
25 basis points decrease in expected return on plan assets	$	1.3			No Impact
25 basis points increase in expected return on plan assets		(1.3)			No Impact

 

Income Taxes

 

The Company estimates its tax liability based on current tax laws in the statutory jurisdictions in which it operates. These estimates include judgments about deferred tax assets and liabilities resulting from temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes, as well as about the realization of deferred tax assets. If the provisions for current or deferred taxes are not adequate, if the Company is unable to realize certain deferred tax assets or if the tax laws change unfavorably, the Company could potentially experience significant losses in excess of the reserves established. Likewise, if the provisions for current and deferred taxes are in excess of those eventually needed, if the Company is able to realize additional deferred tax assets or if tax laws change favorably, the Company could potentially experience significant gains. The Company considers historical profitability, future market growth, future taxable income, the expected timing of the reversals of existing temporary differences and tax planning strategies in determining the need for a deferred tax valuation allowance.

 

The Company is subject to ongoing tax examinations and assessments in various jurisdictions. Accordingly, the Company may incur additional tax expense based upon our assessment of the more-likely-than-not outcomes of such matters. In addition, when applicable, the Company adjusts the previously recorded tax expense to reflect examination results. Lexmark’s ongoing assessments of the more-likely-than-not outcomes of the examinations and related tax positions require judgment and can materially increase or decrease the Company’s effective tax rate, as well as impact the operating results. Refer to Part II, Item 8, Note 2 of the Notes to Consolidated Financial Statements for information regarding the Company’s policy for income taxes.

 

Litigation and Contingencies

 

In accordance with guidance on accounting for contingencies, Lexmark records a provision for a loss contingency when management has determined that it is both probable that a liability has been incurred and the amount of loss can be reasonably estimated. Although the Company believes it has adequate provisions for any such matters, litigation is inherently unpredictable. Should developments occur that result in the need to recognize a material accrual, or should any of the Company’s legal matters result in a substantial judgment against, or settlement by the Company, the resulting liability could have a material effect on the Company’s results of operations, financial condition and/or cash flows.

 

Copyright Fees

 

Certain countries (primarily in Europe) and/or collecting societies representing copyright owners’ interests have taken action to impose fees on devices (such as scanners, printers and multifunction devices) alleging the copyright owners are entitled to compensation because these devices enable reproducing copyrighted content. Other countries are also considering imposing fees on certain devices. The amount of fees would depend on the number of products sold and the amounts of the fee on each product, which will vary by product and by country. The Company has accrued amounts that represent its best estimate of the copyright fee issues currently pending. Such estimates could change as the litigation and/or local legislative processes draw closer to final resolution.

 

Environmental Remediation Obligations

 

Lexmark accrues for losses associated with environmental remediation obligations when such losses are probable and reasonably estimable. In the early stages of a remediation process, particular components of the overall obligation may not be reasonably estimable. In this circumstance, the Company recognizes a liability for the best estimate (or the minimum amount in a range if no best estimate is available) of its allocable share of the cost of the remedial investigation-feasibility study, consultant and external legal fees, corrective measures studies, monitoring, and any other component remediation costs that can be reasonably estimated. Accruals are adjusted as further information develops or circumstances change. Recoveries from other parties are recorded as assets when their receipt is deemed probable. Although environmental costs and accruals are presently not material to the Company’s results of operations, financial position, or cash flows, such estimates could change as the processes draw closer to final resolution.

 

Waste Obligation

 

Waste Electrical and Electronic Equipment (“WEEE”) Directives issued by the European Union require producers of electrical and electronic goods to be financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. The Company’s estimated liability for these costs involves a number of uncertainties and takes into account certain assumptions and judgments including collection costs, return rates and product lives. Should actual costs and activities differ from the Company’s estimates and assumptions, revisions to the estimated liability may be required.

 

Fair Value

 

The Company currently uses recurring fair value measurements in several areas including marketable securities, pension plan assets and derivatives. The Company also uses fair value measurements on a nonrecurring basis when testing goodwill and long-lived assets for impairment.

 

The Company uses third parties to report the fair values of its marketable securities and pension plan assets, though the responsibility remains with the Company’s management. The Company utilizes various sources of pricing as well as trading and other market data in its process of corroborating fair values and testing default level assumptions for these investments. The Company also uses third parties to assist with the valuation of certain illiquid securities as well as the valuation of certain assets acquired and liabilities assumed in business combinations when it is determined that an income approach is the most appropriate method to determine fair value.

 

In certain situations, there may be little or no market data available at the measurement date for the Company’s fair value measurements, thus requiring the use of significant unobservable inputs. Such measurements require more judgment and are generally classified as Level 3 within the fair value hierarchy.

 

The Company’s Level 3 recurring fair value measurements are related to certain corporate debt, asset-backed and mortgage-backed securities. The fair values are classified as Level 3 due to (1) a low number of observed trades or pricing sources or (2) variability in the pricing data is higher than expected. There is less certainty that the fair values of these securities would be realized in the market due to the low level of observable market data.

 

Nonrecurring, nonfinancial fair value measurements are most often based on inputs or assumptions that are less observable in the market, thus requiring more judgment on the part of the Company in estimating fair value. Determination of the highest and best use of an asset from the perspective of market participants can result in fair value measurements that differ from estimates based on the Company’s specific intentions for the asset.

 

Refer to Part II, Item 8, Notes 2 and 3 of the Notes to Consolidated Financial Statements for information regarding the Company’s fair value accounting policies and fair value measurements, respectively. Refer to Part II, Item 8, Note 17 of the Notes to Consolidated Financial Statements for information regarding pension plan assets.

 

Other-Than-Temporary Impairment of Marketable Securities

 

The Company records its investments in marketable securities at fair value through accumulated other comprehensive earnings in accordance with the accounting guidance for available-for-sale securities. Once these investments have been marked to market, the Company must assess whether or not its individual unrealized loss positions contain other-than-temporary impairment (“OTTI”). If an unrealized position is deemed OTTI, then the unrealized loss, or a portion thereof, must be recognized in earnings. The Company’s portfolio is made up almost entirely of debt securities for which OTTI must be recognized in accordance with the FASB OTTI guidance. The model in this guidance requires that an entity recognize OTTI in earnings for the entire unrealized loss position if the entity intends to sell or it is more likely than not the entity will be required to sell the debt security before its anticipated recovery of its amortized cost basis. If the entity does not expect to sell the debt security, but the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss is deemed to exist and OTTI shall be considered to have occurred. The OTTI is separated into two components, the amount representing the credit loss which is recognized in earnings and the amount related to all

other factors which is recognized in other comprehensive income. Refer to Part II, Item 8, Note 2 of the Notes to Consolidated Financial Statements for more details regarding this guidance. The Company’s policy considers various factors in making these two assessments.

 

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

 

Refer to Part II, Item 8, Note 7 of the Notes to Consolidated Financial Statements for more information regarding the Company’s marketable securities.

 

Business Combinations

 

The application of the acquisition method of accounting for business combinations requires the use of significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed in order to properly allocate purchase price consideration between identifiable intangible assets and goodwill. The fair values of identifiable intangible assets are estimated using an income approach, including the excess earnings, relief from royalty and with-and-without methods. These estimations are conducted using market participant assumptions and require projected financial information, including assumptions about future revenue growth and costs necessary to facilitate the projected growth. Other key inputs include assumptions about technological obsolescence, customer attrition rates, brand recognition and discount rates. The Company also considers market participant assumptions in its valuations of deferred revenue acquired in a business combination, including estimated costs to fulfill the obligation as well as a profit markup that would exist in the case of a hypothetical third-party servicing firm.

 

Goodwill and Intangible Assets

 

Lexmark performs an assessment of its goodwill for impairment each fiscal year as of December 31 or between annual tests if an event occurs or circumstances change that lead management to believe it is more likely than not that an impairment exists. Examples of such events or circumstances include a deterioration in general economic conditions, increased competitive environment, or a decline in overall financial performance of the Company. Goodwill is tested at the reporting unit level, which is an operating segment or one level below an operating segment (a "component") if the component constitutes a business for which discrete financial information is available and regularly reviewed by segment management. Components are aggregated as a single reporting unit if they have similar economic characteristics. Goodwill is assigned to reporting units of the Company that are expected to benefit from the synergies of the related acquisition.

 

Although the qualitative assessment for goodwill impairment testing is available to Lexmark, the Company performed a quantitative test of impairment in 2014 and 2013. In estimating the fair value of its reporting units, the Company generally considers a discounted cash flow analysis, which requires judgments such as projected future earnings and weighted average cost of capital, and market based measurements analysis, which include multiples developed from prices paid in observed market transactions of comparable companies. For its estimation of the fair value of the Perceptive Software reporting unit, the Company used an equally-weighted measure based on a discounted cash flow analysis and a market based measurement analysis. For its estimation of the fair value of the ISS reporting unit, the Company used a discounted cash flow analysis.

 

Goodwill recognized by the Company at December 31, 2014 was $605.8 million and was allocated to the Perceptive Software and ISS reporting units in the amount of $587.0 million and $18.8 million, respectively. The fair values of these reporting units were substantially in excess of their carrying values on this date. The values of Perceptive Software and ISS were heavily reliant on forecasted financial information. Key assumptions to the valuation of Perceptive Software include its ability to strengthen its channel presence and expand internationally and the revenue growth that would result therefrom.  Other key inputs to the fair value calculations include operating margin assumptions and discount rates.

 

Intangible assets with finite lives are amortized over their estimated useful lives using the straight-line method. In certain instances where consumption could be greater in the earlier years of the asset’s life, the Company has selected, as a compensating measure, a shorter period over which to amortize the asset. The Company’s intangible assets with finite lives are tested for impairment in accordance with its policy for long-lived assets below.

 

Long-Lived Assets Held and Used

 

Lexmark reviews for impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset (or asset group) may not be recoverable. If the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual disposition are insufficient to recover the carrying value of the assets, then an impairment loss is

recognized based upon the excess of the carrying value of the assets over the fair value of the assets. The determination of the asset group to be tested for recoverability is based on company-specific operating characteristics, including shared cost structures and interdependency of revenues between assets. An impairment review incorporates estimates of forecasted revenue and costs that may be associated with an asset as well as the expected periods that the asset (or asset group) may be utilized. Fair value is determined based on the highest and best use of the assets considered from the perspective of market participants, which may be different than the Company’s actual intended use of the asset (or asset group).

 

Lexmark also reviews any legal and contractual obligations associated with the retirement of its long-lived assets and records assets and liabilities, as necessary, related to such obligations. The asset recorded is amortized over the useful life of the related long-lived tangible asset. The liability recorded is relieved when the costs are incurred to retire the related long-lived tangible asset. Each obligation is estimated based on current law and technology; accordingly, such estimates could change as the Company periodically evaluates and revises such estimates based on expenditures against established reserves and the availability of additional information. The Company’s asset retirement obligations are currently not material to the Company’s Consolidated Statements of Financial Position.

 

RESULTS OF OPERATIONS

 

Operating Results Summary

 

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes thereto.

 

The following table summarizes the results of the Company’s operations for the years ended December 31, 2014, 2013 and 2012:

 

	2014					2013					2012
(Dollars in millions)	Dollars		% of Rev			Dollars		% of Rev			Dollars		% of Rev
Revenue	$	3,710.5	100	%		$	3,667.6	100	%		$	3,797.6	100	%
Gross profit		1,409.8	38	%			1,443.9	39	%			1,401.8	37	%
Operating expense		1,260.6	34	%			1,034.7	28	%			1,210.3	32	%
Operating income		149.2	4	%			409.2	11	%			191.5	5	%
Net earnings		79.1	2	%			261.8	7	%			107.6	3	%

 

During 2014, consolidated revenue increased 1% compared to prior year. Gross profit decreased 2%, Operating expense increased 22% and Operating income decreased 64% when compared to the same period in 2013.

 

Net earnings for the year ended December 31, 2014 declined 70% from the prior year primarily due to lower operating income. Operating income for the year ended December 31, 2014 included $119.1 million of pre-tax acquisition-related adjustments, a pension and other postretirement benefit plan asset and actuarial net loss of $80.5 million, $45.8 million of pre-tax restructuring charges and project costs and $1.7 million of pre-tax divestiture-related cost. The Company uses the term “project costs” for incremental charges related to the execution of its restructuring plans. The Company uses the term “acquisition-related adjustments” for purchase accounting adjustments and incremental acquisition and integration costs related to acquisitions.

 

During 2013, consolidated revenue declined 3% compared to 2012. Gross profit increased 3%, Operating expense decreased 15% and Operating income increased 114% when compared to the same period in 2012.

 

Net earnings for the year ended December 31, 2013 increased 143% from the prior year primarily due to higher operating income. Operating income in 2013 included a pension and other postretirement benefit plan asset and actuarial net gain of $83.0 million, $69.2 million of pre-tax divestiture-related benefit, $90.4 million of pre-tax acquisition-related adjustments and $54.5 million of pre-tax restructuring charges and project costs.

 

Revenue

 

For the year ended December 31, 2014, consolidated revenue increased 1% YTY, reflecting higher laser revenue in the ISS segment and increased Perceptive Software revenue, offset by an unfavorable impact of approximately 4% due to the Company’s exit of inkjet technology and an unfavorable YTY currency impact of 1%.