Lexmark International 10Q 2007 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended March 31, 2007


o	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File No. 1-14050

LEXMARK INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)


Delaware	06-1308215
(State or other jurisdiction	(I.R.S. Employer
of incorporation or organization)	Identification No.)

One Lexmark Centre Drive
740 West New Circle Road
Lexington, Kentucky	40550
(Address of principal executive offices)	(Zip Code)

(859) 232-2000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

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

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

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

The registrant had 94,565,825 shares outstanding (excluding shares held in treasury) of Class A Common Stock, par value $0.01 per share, as of the close of business on April 30, 2007.

LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

INDEX

		Page of Form 10-Q
	PART I - FINANCIAL INFORMATION
Item 1.	FINANCIAL STATEMENTS

	Consolidated Condensed Statements of Earnings
	Three Months Ended March 31, 2007 and 2006	2

	Consolidated Condensed Statements of Financial Position
	As of March 31, 2007 and December 31, 2006	3

	Consolidated Condensed Statements of Cash Flows
	Three Months Ended March 31, 2007 and 2006	4

	Notes to Consolidated Condensed Financial Statements	5 - 13

Item 2.	MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	14 - 28

Item 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	29

Item 4.	CONTROLS AND PROCEDURES	30

	PART II - OTHER INFORMATION

Item 1.	LEGAL PROCEEDINGS	30

Item 1A.	RISK FACTORS	31

Item 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	31

Item 3.	DEFAULTS UPON SENIOR SECURITIES	31

Item 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	32

Item 5.	OTHER INFORMATION	32

Item 6.	EXHIBITS	32

Forward-Looking Statements

This Quarterly Report on Form 10-Q 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 “Factors That May Affect Future Results And Information Concerning Forward-Looking Statements” in Part I, Item 2 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 “Factors That May Affect Future Results and Information Concerning Forward-Looking Statements” 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 - FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS

(In Millions, Except Per Share Amounts)

(Unaudited)


	Three Months Ended March 31
	2007			2006

Revenue	$	1,260.6		$	1,275.3
Cost of revenue		837.8			871.5
Gross profit		422.8			403.8

Research and development		99.9			87.4
Selling, general and administrative		201.8			174.8
Restructuring and other, net		-			21.1
Operating expense		301.7			283.3
Operating income		121.1			120.5

Interest (income) expense, net		(4.4	)		(6.3	)
Other expense (income), net		1.2			0.8
Earnings before income taxes		124.3			126.0

Provision for income taxes		31.9			39.8
Net earnings	$	92.4		$	86.2

Net earnings per share:
Basic	$	0.96		$	0.79
Diluted	$	0.95		$	0.78

Shares used in per share calculation:
Basic		96.5			109.8
Diluted		97.5			110.2

See Notes to Consolidated Condensed Financial Statements.

LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF FINANCIAL POSITION

(In Millions, Except Par Value)

(Unaudited)


	March 31 2007			December 31 2006
ASSETS
Current assets:
Cash and cash equivalents	$	120.3		$	144.6
Marketable securities		322.4			406.3
Trade receivables, net of allowances of $36.5 in 2007 and $38.0 in 2006		601.2			584.3
Inventories		433.3			457.8
Prepaid expenses and other current assets		243.2			237.0
Total current assets		1,720.4			1,830.0

Property, plant and equipment, net		842.8			846.8
Other assets		173.8			172.2
Total assets	$	2,737.0		$	2,849.0

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	574.4		$	600.3
Accrued liabilities		704.2			723.7
Total current liabilities		1,278.6			1,324.0

Long-term debt		149.8			149.8
Other liabilities		311.4			340.0
Total liabilities		1,739.8			1,813.8

Contingencies

Stockholders' equity:
Preferred stock, $.01 par value, 1.6 shares authorized; no shares issued and outstanding		-			-
Common stock, $.01 par value:
Class A, 900.0 shares authorized; 94.5 and 97.0 outstanding in 2007 and 2006, respectively		1.1			1.1
Class B, 10.0 shares authorized; no shares issued and outstanding		-			-
Capital in excess of par		850.8			827.3
Retained earnings		727.2			627.5
Treasury stock, net; at cost;13.6 and 10.9 shares in 2007 and 2006, respectively		(454.7	)		(289.8	)
Accumulated other comprehensive loss		(127.2	)		(130.9	)
Total stockholders' equity		997.2			1,035.2
Total liabilities and stockholders' equity	$	2,737.0		$	2,849.0

See Notes to Consolidated Condensed Financial Statements.

LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(In Millions)

(Unaudited)


	Three Months Ended March 31
	2007			2006
Cash flows from operating activities:
Net earnings	$	92.4		$	86.2
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization		41.1			61.5
Deferred taxes		(9.2	)		(1.5	)
Stock-based compensation expense		12.5			10.6
Tax shortfall from employee stock plans		(0.1	)		-
Other		(5.9	)		(7.5	)
		130.8			149.3
Change in assets and liabilities:
Trade receivables		(16.9	)		66.9
Inventories		24.5			10.2
Accounts payable		(25.9	)		(19.4	)
Accrued liabilities		(10.7	)		15.5
Other assets and liabilities		(15.2	)		(3.0	)
Net cash flows provided by operating activities		86.6			219.5

Cash flows from investing activities:
Purchases of property, plant and equipment		(49.0	)		(46.8	)
Purchases of marketable securities		(327.0	)		(475.8	)
Proceeds from marketable securities		411.0			637.7
Proceeds from sale of Scotland facility		8.1			-
Other		-			(1.2	)
Net cash flows provided by investing activities		43.1			113.9

Cash flows from financing activities:
Issuance of treasury stock		0.1			-
Purchase of treasury stock		(165.0	)		(300.0	)
Proceeds from employee stock plans		9.6			4.3
Tax windfall from employee stock plans		1.4			1.1
Other		(0.2	)		(0.8	)
Net cash flows used for financing activities		(154.1	)		(295.4	)
Effect of exchange rate changes on cash		0.1			0.9
Net change in cash and cash equivalents		(24.3	)		38.9
Cash and cash equivalents - beginning of period		144.6			168.3
Cash and cash equivalents - end of period	$	120.3		$	207.2

See Notes to Consolidated Condensed Financial Statements.

LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In Millions, Except Per Share Amounts)

(Unaudited)

1. BASIS OF PRESENTATION

The accompanying interim Consolidated Condensed Financial Statements are unaudited; however, in the opinion of management of Lexmark International, Inc. (together with its subsidiaries, the “Company” or “Lexmark”), all adjustments necessary for a fair statement of the interim financial results have been included. The results for the interim periods are not necessarily indicative of results to be expected for the entire year. The Condensed Consolidated Statement of Financial Position data as of December 31, 2006, was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S.”). The Company filed with the Securities and Exchange Commission audited consolidated financial statements for the year ended December 31, 2006, on Form 10-K, which included all information and notes necessary for such presentation. Accordingly, these financial statements and notes should be read in conjunction with the Company’s audited annual consolidated financial statements for the year ended December 31, 2006.

2. RESTRUCTURING-RELATED CHARGES AND OTHER

During the first quarter of 2006, the Company approved a plan to restructure its workforce, consolidate some manufacturing capacity and make certain changes to its U.S. retirement plans (collectively referred to as the “2006 actions”). The workforce restructuring eliminated or transferred over 1,400 positions from various business functions and job classes, with over 850 positions being eliminated, and over 550 positions being transferred from various locations primarily to low-cost countries. Lexmark consolidated its manufacturing capacity to reduce manufacturing costs, including the closure of its Rosyth, Scotland inkjet cartridge manufacturing facility and Orleans, France laser toner facilities, and reduced its operating expenses, particularly in the areas of supply chain, general and administrative and marketing and sales support. Lexmark also froze pension benefits in its defined benefit pension plan for U.S. employees, effective April 3, 2006, and at the same time changed from a maximum Company matching contribution of three percent of eligible compensation to an automatic Company contribution of one percent and a maximum Company matching contribution of five percent to Lexmark’s existing 401(k) plan. Except for approximately 100 positions to be eliminated in 2007, activities related to the 2006 actions were substantially completed at the end of 2006.

For the three months ended March 31, 2006, the Company incurred pre-tax charges of $49.6 million related to the 2006 actions which were partially offset by a $9.8 million pre-tax pension curtailment gain. Of the $39.8 million of net charges incurred for the three months ended March 31, 2006, related to the 2006 actions, $18.7 million is included in Cost of revenue and $21.1 million in Restructuring and other, net on the Company’s Consolidated Condensed Statements of Earnings.

The following table presents a rollforward of the liability incurred for employee termination benefit and contract termination and lease charges in connection with the 2006 actions. The liability is included in Accrued liabilities on the Company’s Consolidated Condensed Statements of Financial Position.

	Employee Termination Benefits			Contract Termination & Lease Charges			Total
Balance at December 31, 2006	$	25.3		$	4.8		$	30.1
Payments & other ⁽¹⁾		(6.9	)		(0.3	)		(7.2	)
Reversals		(0.2	)		-			(0.2	)
Balance at March 31, 2007	$	18.2		$	4.5		$	22.7

⁽¹⁾ Other consists of changes in the liability balance due to foreign currency translations.

During the first quarter of 2007, the Company sold its Rosyth, Scotland facility for $8.1 million and recognized a $3.5 million pre-tax gain on the sale.

3. TRADE RECEIVABLES FACILITY

In the U.S., the Company transfers a majority of its receivables to its wholly-owned subsidiary, Lexmark Receivables Corporation (“LRC”), which then may sell the receivables to an unrelated third party. The financial results of LRC are included in the Company’s consolidated financial results. LRC is a separate legal entity with its own separate creditors who, in a liquidation of LRC, would be entitled to be satisfied out of LRC’s assets prior to any value in LRC becoming available for equity claims of the Company.

During the first quarter of 2007, the Company amended the facility to allow LRC to repurchase previously sold receivables from the unrelated third party. Prior to the 2007 amendment, the Company accounted for the transfer of receivables from LRC to the unrelated third party as sales of receivables. As a result of the 2007 amendment, the Company will account for the transfers of receivables from LRC to the unrelated third party as a secured borrowing with a pledge of its receivables as collateral.

At March 31, 2007 and December 31, 2006, there were no receivables or borrowings outstanding under the facility.

4. INVENTORIES

Inventories consist of the following:


	March 31 2007		December 31 2006
Work in process	$	120.2	$	119.7
Finished goods		313.1		338.1
Inventories	$	433.3	$	457.8

5. AGGREGATE WARRANTY LIABILITY

Changes in the Company’s aggregate warranty liability, which includes both warranty and extended warranty (deferred revenue), are presented below:

	2007			2006
Balance at January 1	$	212.4		$	195.0
Accruals for warranties issued		68.7			50.2
Accruals related to pre-existing warranties (including amortization of deferred revenue for extended warranties and changes in estimates)		(13.3	)		(8.8	)
Settlements made (in cash or in kind)		(44.5	)		(43.7	)
Balance at March 31	$	223.3		$	192.7

Both warranty and the short-term portion of extended warranty are included in Accrued liabilities on the Consolidated Condensed Statements of Financial Position. The long-term portion of extended warranty is included in Other liabilities on the Consolidated Condensed Statements of Financial Position.

6. INCOME TAXES

Current year provision

The effective income tax rate was 25.7% for the three months ended March 31, 2007, compared to 31.6% for the first quarter of 2006. The difference in these rates is due principally to the fact that the U.S. Research and Experimentation tax credit had not been reinstated by Congress as of the first quarter of 2006 (2.8%) and the impact of the restructuring in 2006 (1.9%).

Critical Accounting Policy

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.

In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold as “more-likely-than-not” that a tax position must meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting for income taxes in interim periods, financial statement disclosure and transition rules.

The evaluation of a tax position in accordance with FIN 48 is a two-step process. The first step is recognition: The enterprise determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any litigation. The second step is measurement: A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate resolution.

Adoption of FIN 48

The Company adopted the provisions of FIN 48 and related guidance on January 1, 2007. As a result of the implementation of FIN 48, the Company reduced its liability for unrecognized tax benefits and related interest and penalties by $7.3 million, which resulted in a corresponding increase in the Company’s January 1, 2007, retained earnings balance. The Company also recorded an increase in its deferred tax assets of $8.5 million and a corresponding increase in its liability for unrecognized tax benefits as a result of adopting FIN 48.

The amount of unrecognized tax benefits at January 1, 2007, was $59.8 million, of which $46.3 million would affect the Company’s effective tax rate if recognized. The Company recognizes accrued interest and penalties associated with uncertain tax positions as part of its income tax provision. As of January 1, 2007, the Company had $18.9 million of accrued interest and penalties.

It is reasonably possible that the total amount of unrecognized tax benefits will increase or decrease in the next 12 months. Such changes would occur based on the results of ongoing tax audits in various jurisdictions around the world. At this time, an estimate of the range of reasonably possible outcomes cannot be made.

Several tax years are subject to examination by major tax jurisdictions. In the U.S., federal tax years 2004 and after are subject to examination. The Internal Revenue Service is currently auditing tax years 2004 and 2005. In France, tax years 2004 and after are subject to examination. The French Tax Administration is currently auditing tax years 2004 and 2005. In Switzerland, tax years 2001 and after are subject to examination. In most of the other countries where the Company files income tax returns, 2001 is the earliest tax year that is subject to examination.

7. STOCKHOLDERS’ EQUITY

In January 2006, the Company received authorization from the board of directors to repurchase an additional $1.0 billion of its Class A Common Stock for a total repurchase authority of $3.9 billion. As of March 31, 2007, there was approximately $0.3 billion of share repurchase authority remaining. This repurchase authority allows the Company, at management’s discretion, to selectively repurchase its stock from time to time in the open market or in privately negotiated transactions depending upon market price and other factors. During the first quarter of 2007, the Company repurchased approximately 2.7 million shares at a cost of approximately $165 million. As of March 31, 2007, since the inception of the program in April 1996, the Company had repurchased approximately 74.1 million shares for an aggregate cost of approximately $3.6 billion. As of March 31, 2007, the Company had reissued approximately 0.5 million shares of previously repurchased shares in connection with certain of its employee benefit programs. As a result of these issuances as well as the retirement of 44.0 million and 16.0 million shares of treasury stock in 2005 and 2006, respectively, the net treasury shares outstanding at March 31, 2007, were 13.6 million.

8. OTHER COMPREHENSIVE EARNINGS (LOSS)

Comprehensive earnings (loss), net of taxes, consist of the following:

	Three Months Ended March 31
	2007			2006
Net earnings	$	92.4		$	86.2
Other comprehensive earnings (loss):
Foreign currency translation adjustment		0.7			4.5
Cash flow hedging		(0.1	)		(6.2	)
Pension or other postretirement benefits adjustment		3.0			-
Minimum pension liability adjustment		-			3.7
Net unrealized gain on marketable securities		0.1			0.2
Comprehensive earnings	$	96.1		$	88.4

Accumulated other comprehensive (loss) earnings consist of the following:

	Foreign Currency Translation Adjustment		Cash Flow Hedges			Pension or Other Postretirement Benefits			Net Unrealized Gain on Marketable Securities		Accumulated Other Comprehensive (Loss) Earnings
Balance at 12/31/06	$	7.1	$	0.7		$	(138.7	)	$	-	$	(130.9	)
1^st Qtr 2007 change		0.7		(0.1	)		3.0			0.1		3.7
Balance at 3/31/07	$	7.8	$	0.6		$	(135.7	)	$	0.1	$	(127.2	)

9. EARNINGS PER SHARE (“EPS”)

The following table presents a reconciliation of the numerators and denominators of the basic and diluted EPS calculations:

	Three Months Ended March 31
	2007		2006
Numerator:
Net earnings	$	92.4	$	86.2
Denominator:
Weighted average shares used to compute basic EPS		96.5		109.8
Effect of dilutive securities -
Employee stock plans		1.0		0.4
Weighted average shares used to compute diluted EPS		97.5		110.2

Basic net EPS	$	0.96	$	0.79
Diluted net EPS	$	0.95	$	0.78

Restricted stock units and stock options totaling an additional 5.8 million and 11.8 million shares of Class A Common Stock for the three month periods ended March 31, 2007 and 2006, respectively, were outstanding but were not included in the computation of diluted earnings per share because the effect would have been antidilutive.

10. EMPLOYEE PENSION AND POSTRETIREMENT PLANS

The components of the net periodic benefit cost for both the pension and postretirement plans for the three month periods ended March 31, 2007 and 2006, were as follows:

Pension Benefits:	Three Months Ended March 31
	2007			2006
Service cost	$	0.7		$	1.9
Interest cost		10.6			10.4
Expected return on plan assets		(12.3	)		(12.3	)
Amortization of net loss		3.7			4.3
Settlement, curtailment or special termination gains, net		-			(8.4	)
Net periodic benefit cost (credit)	$	2.7		$	(4.1	)

Other Postretirement Benefits:	Three Months Ended March 31
	2007			2006
Service cost	$	0.5		$	0.5
Interest cost		0.6			0.6
Amortization of prior service (benefit) cost		(1.0	)		(0.9	)
Amortization of net loss		0.2			0.2
Settlement, curtailment or special termination gains, net		-			(0.1	)
Net periodic benefit cost	$	0.3		$	0.3

The $8.5 million Settlement, curtailment or special termination gains, net recognized in the first quarter of 2006 consisted of a $9.8 million pension curtailment gain due to the freezing of plan benefit accruals in the U.S. and $1.3 million of special termination benefit charges related to restructuring activities. See Note 2 for further discussion.

The Company currently expects to contribute approximately $7 million to its pension and other postretirement plans in 2007. As of March 31, 2007, $1.4 million of contributions have been made.

11. SEGMENT DATA

Lexmark manufactures and sells a variety of printing and multifunction products and related supplies and services and is primarily managed along Business and Consumer market segments. The Company evaluates the performance of its segments based on revenue and operating income, and does not include segment assets or other income and expense items for management reporting purposes. Segment operating income (loss) includes: selling, general and administrative; research and development; restructuring and other, net; and other expenses, certain of which are allocated to the respective segments based on internal measures and may not be indicative of amounts that would be incurred on a stand alone basis or may not be indicative of results of other enterprises in similar businesses. All other operating income (loss) includes significant expenses that are managed outside of the reporting segments. These unallocated costs include such items as information technology expenses, occupancy costs, stock-based compensation and certain other corporate and regional general and administrative expenses such as finance, legal and human resources.

The following table includes information about the Company’s reportable segments:

	Three Months Ended March 31
	2007			2006
Revenue:
Business	$	737.4		$	688.4
Consumer		523.2			586.9
Total revenue	$	1,260.6		$	1,275.3

Operating income (loss):
Business	$	153.9		$	147.5
Consumer		64.5			64.8
All other		(97.3	)		(91.8	)
Total operating income (loss)	$	121.1		$	120.5

In connection with the 2006 restructuring, operating income (loss) noted above included restructuring-related charges of $7.9 million in its Business segment, $31.3 million in its Consumer segment and $10.4 million in All other. All other operating income also included a $9.8 million pension curtailment gain from the pension plan freeze.

12. CONTINGENCIES

In accordance with SFAS No. 5, Accounting for Contingencies, Lexmark records a provision for a loss contingency when management believes that it is both probable that a liability has been incurred and the amount of loss can be reasonably estimated. The Company believes it has adequate provisions for any such matters.

Legal proceedings

On December 30, 2002 (“02 action”) and March 16, 2004 (“04 action”), the Company filed claims against Static Control Components, Inc. (“SCC”) in the U.S. District Court for the Eastern District of Kentucky (the “District Court”) alleging violation of the Company’s intellectual property and state law rights. Pendl Companies, Inc. (“Pendl”) and Wazana Brothers International, Inc. (“Wazana”) were added as additional defendants to the claims brought by the Company in the 02 action on October 8, 2004. Pendl, Wazana and NER Data Products, Inc. (“NER”), were added as additional parties to the claims brought by the Company in the 04 action on November 8, 2004. These two cases have been consolidated by the District Court. Similar claims in a separate action were filed by the Company in the District Court against David Abraham and Clarity Imaging Technologies, Inc. (“Clarity”) on October 8, 2004. Clarity, Pendl, SCC and Wazana have filed counterclaims against the Company in the District Court alleging that the Company engaged in anti-competitive and monopolistic conduct and unfair and deceptive trade practices in violation of the Sherman Act, the Lanham Act and state laws. SCC has stated in its legal documents that it is seeking approximately $17.8 million to $19.5 million in damages for the Company’s alleged anticompetitive conduct and approximately $1 billion for Lexmark’s alleged violation of the Lanham Act. Wazana has stated in its legal documents that it is seeking approximately $2.2 million to $2.8 million in damages for the Company’s alleged anticompetitive conduct and approximately $1 billion for Lexmark’s alleged violation of the Lanham Act. Pendl has stated in its legal documents that it is seeking approximately $3.7 million to $4.1 million in damages for the Company’s alleged anticompetitive conduct. Clarity has not stated a damage dollar amount. All are seeking treble damages, attorney fees, costs and injunctive relief. On September 28, 2006, the District Court dismissed the counterclaims filed by SCC alleging that the Company engaged in anti-competitive and monopolistic conduct and unfair and deceptive trade practices in violation of the Sherman Act, the Lanham Act and state laws. On October 13, 2006, SCC filed a Motion for Reconsideration of the District Court’s Order dismissing SCC’s claims, or in the alternative, to amend its pleadings. On October 13, 2006, the District Court issued an order to stay the action brought against David Abraham and Clarity until a final judgment or settlement are entered into in the consolidated 02 and 04 actions. On March 23, 2007, the Company entered into a

Settlement Agreement with NER pursuant to which each party released the other from any and all claims, NER acknowledged the validity and enforceability of the Company's patents-in-suit and the validity and enforceability of the Company's single use license agreement applicable to its "Return Program" cartridges (formerly known as "Prebate" cartridges) and agreed to no longer remanufacture such cartridges. On April 27, 2007, the District Court granted the Company's motion to dismiss its state law claims against SCC, Pendl and Wazana. On May 2, 2007, the District Court denied the Company's motion for summary judgment to dismiss the counterclaims filed against the Company by Wazana and Pendl alleging that the Company engaged in anti-competitive and monopolistic conduct and unfair and deceptive trade practices in violation of the Sherman Act and the Lanham Act. The trial of this case is scheduled to begin on May 15, 2007. The Company believes that these claims filed against the Company are without merit, and intends to vigorously defend against them.

The Company is also party to various litigation and other legal matters, including claims of intellectual property infringement and various purported consumer class action lawsuits alleging, among other things, various product defects and false and deceptive advertising claims, that are being handled in the ordinary course of business. In addition, various governmental authorities have from time to time initiated inquiries and investigations, some of which are ongoing, concerning the activities of participants in the markets for printers and supplies. The Company intends to continue to cooperate fully with those governmental authorities in these matters.

Although it is not reasonably possible to estimate whether a loss will occur as a result of these legal matters, or if a loss should occur, the amount of such loss, the Company does not believe that any legal matters to which it is a party is likely to have a material adverse effect on the Company’s financial position, results of operations and cash flows. However, there can be no assurance that any pending legal matters or any legal matters that may arise in the future would not have a material adverse effect on the Company’s financial position, results of operations 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, 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 Company has accrued amounts that it believes are adequate to address the risks related to the copyright fee issues currently pending. 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. As of March 31, 2007, the Company has accrued approximately $100 million for the pending copyright fee issues, including litigation proceedings, local legislative initiatives and/or negotiations with the parties involved. These accruals are included in Accrued liabilities on the Consolidated Condensed Statements of Financial Position.

13. RECENT ACCOUNTING PRONOUNCEMENTS

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). The adoption of FIN 48 did not have a material impact on the Company’s results of operations and cash flows. Refer to Note 6 of the Notes to the Consolidated Condensed Financial Statements for discussion of the impact of adoption on the Company’s financial position.

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”) and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS 157 does not require any new fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with earlier adoption permitted. The provisions of SFAS 157 should be applied prospectively as of the beginning of the fiscal year in which it is initially applied, with limited exceptions. The Company is currently evaluating the provisions of SFAS 157.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Liabilities (“SFAS 159”). SFAS 159 provides entities with the option to report selected financial assets and liabilities at fair value. Business entities adopting SFAS 159 will report unrealized gains and losses in earnings at each subsequent reporting date on items for which the fair value option has been elected. SFAS 159 establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 requires additional information that will help investors and other financial statement users to understand the effect of an entity’s choice to use fair value on its earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007, with earlier adoption permitted. The Company is currently evaluating the impact of SFAS 159.

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

LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

OVERVIEW

Lexmark makes it easier for businesses and consumers to move information between the digital and paper worlds. Since its inception in 1991, Lexmark has become a leading developer, manufacturer and supplier of printing and imaging solutions for offices and homes. Lexmark’s products include laser printers, inkjet printers, multifunction devices, and associated supplies, services and solutions. Lexmark also sells dot matrix printers for printing single and multi-part forms by business users and develops, manufactures and markets a line of other office imaging products.

The Company is primarily managed along Business and Consumer market segments:

•

The Business market segment primarily sells laser products and primarily serves business customers, but also include consumers who choose laser products. Laser products can be divided into two major categories — shared workgroup products and lower-priced desktop products. Lexmark employs large-account sales and marketing teams, closely supported by its development and product marketing teams, to generate demand for its business printing solutions and services. The sales and marketing teams primarily focus on customers who fall into six specific industry groups: finance, services, retail, manufacturing, public sector and health care. Lexmark also markets its laser and inkjet products increasingly through small and medium business (“SMB”) teams who work closely with channel partners. The Company distributes and fulfills its laser products primarily through its well-established distributor and reseller network. Lexmark’s products are also sold through solution providers, which offer custom solutions to specific markets, and through direct response resellers.

•

The Consumer market segment predominantly sells inkjet products to consumers but also includes business users who may choose inkjet products as a lower-priced alternative or supplement to laser products for personal desktop use. For the consumer market, Lexmark distributes its branded inkjet products and supplies primarily through retail outlets worldwide.

The Company also sells its products through numerous alliances and original equipment manufacturer (“OEM”) arrangements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Lexmark’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated condensed financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of consolidated condensed financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to customer programs and incentives, product returns, doubtful accounts, inventories, stock-based compensation, intangible assets, income taxes, warranty obligations, copyright fees, restructurings, pension and other postretirement benefits, and contingencies and litigation. Lexmark bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are uncertain at the time the estimate is made, if different estimates

reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements.

Management believes that other than the adoption of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”) during the first quarter of 2007, there have been no significant changes during the three months ended March 31, 2007, to the items that were disclosed as critical accounting policies and estimates in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

Income Taxes

RESULTS OF OPERATIONS

Summary

Executive Summary

The following discussion and analysis should be read in conjunction with the Consolidated Condensed Financial Statements and Notes thereto. The following table summarizes the results of the Company’s operations for the three months ended March 31, 2007 and 2006:

Three Months Ended March 31

2007

2006

(Dollars in millions)

Dollars

% of Rev

Dollars

% of Rev

Revenue

1,260.6

100.0

1,275.3

100.0

Gross profit

422.8

33.5

403.8

31.7

Operating expense

301.7

23.9

283.3

22.2

Operating income

121.1

9.6

120.5

9.5

Net earnings

92.4

7.3

86.2

6.8

For the first quarter of 2007, consolidated revenue was $1.3 billion down 1% year-to-year (“YTY”). Laser and inkjet supplies revenue was about flat YTY as growth in laser supplies was offset by a decline in inkjet supplies. Laser and inkjet hardware revenue declined 3% YTY, as a decline in inkjet printer revenue was partially offset by growth in laser printer revenue.

In the Business segment, revenue increased 7% YTY. Laser hardware average unit revenue (“AUR”), which reflects the changes in both pricing and mix, increased approximately 11% from the prior year. Laser hardware unit shipments declined approximately 6% YTY. In the Consumer segment, revenue declined 11% YTY. Inkjet hardware unit shipments declined 10% YTY and inkjet hardware AUR decreased 5% YTY.

For the first quarter of 2007, net earnings increased 7% from the prior year primarily due to a reduction in pre-tax restructuring-related charges and project costs and a lower effective tax rate partially offset by higher operating expenses. Net earnings for the first quarter of 2007 also included the settlement of a patent dispute. Net earnings for the first quarter of 2006 included $49.6 million of pre-tax restructuring-related charges and a $9.8 million pre-tax pension curtailment gain as discussed below.

2006 actions

For the three months ended March 31, 2006, the Company incurred pre-tax charges of $49.6 million related to the 2006 actions which were partially offset by a $9.8 million pre-tax pension curtailment gain from the pension plan freeze. Of the $39.8 million of net charges incurred for the three months ended March 31, 2006, related to the 2006 actions, $18.7 million is included in Cost of revenue and $21.1 million in Restructuring and other, net on the Company’s Consolidated Condensed Statements of Earnings.

2007 Items

During 2007, the Company expects to incur approximately $5 million per quarter of additional costs related to the Company’s ongoing efforts to reduce operating costs (collectively referred to as “2007 project costs”). The 2007 project costs will be incremental to the Company’s normal operating charges and will be expensed as incurred.

For the first quarter of 2007, the Company incurred approximately $6 million of 2007 project costs. Also, during the first quarter of 2007, the Company sold its Rosyth, Scotland facility for $8.1 million and recognized a $3.5 million pre-tax gain on the sale.

The Company plans to substantially liquidate the remaining operations of the Scotland entity in the second quarter of 2007. In accordance with SFAS No. 52, Foreign Currency Translation, upon substantial liquidation of the Scotland entity, the Company anticipates recognizing a pre-tax gain of approximately $7 million as a result of realizing the accumulated translation adjustment (i.e., the foreign exchange gain) generated on the investment in the entity during its operating life.

Additionally, the Company sees the potential for continued erosion in end-user inkjet supplies demand due to the reduction in inkjet hardware unit sales reflecting both the Company’s decision to focus on more profitable printer placements and the weakness in its OEM business.

Revenue

For the first quarter of 2007, consolidated revenue decreased 1% YTY. Laser and inkjet supplies revenue was about flat YTY as growth in laser supplies was offset by a decline in inkjet supplies. Laser and inkjet hardware revenue declined 3% YTY, as a decline in inkjet printer revenue was partially offset by growth in laser printer revenue.

Revenue by market segment

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

	Three Months Ended March 31
*(Dollars in millions)*	2007		2006		*% Change*
Business	$	737.4	$	688.4		7	%
Consumer		523.2		586.9		(11	)
Total revenue	$	1,260.6	$	1,275.3		(1	)%

Business segment

During the first quarter of 2007, Business segment revenue increased $49 million or 7% YTY primarily due to growth in laser supplies revenue and increased laser hardware revenue. Laser hardware AUR increased approximately 11% from the prior year due to a mix shift to more color lasers and laser multifunction products (“MFPs”) partially offset by price declines. Laser hardware unit shipments declined approximately 6% YTY as strong growth in color lasers and laser MFPs were more than offset by declines in low-end monochrome laser printers and OEM hardware units. During the first quarter of 2007, Lexmark’s laser unit shipments and laser hardware revenue were both negatively impacted by

limited availability of its low-end monochrome lasers. This availability issue was resolved prior to the end of the quarter.

Consumer segment

During the first quarter of 2007, Consumer segment revenue decreased $64 million or 11% YTY primarily due to decreased inkjet supplies and hardware revenue. Inkjet hardware unit shipments declined 10% YTY as growth in branded hardware, due to strong growth in all-in-ones (“AIOs”), was more than offset by a decline in OEM hardware units. Inkjet hardware AUR decreased 5% YTY as price declines were partially offset by a favorable mix shift to branded AIOs.

Revenue by geography

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

	Three Months Ended March 31
*(Dollars in millions)*	2007		2006		*% Change*
United States	$	544.9	$	573.7		(5	)%
EMEA (Europe, the Middle East & Africa)		481.7		465.4		4
Other International		234.0		236.2		(1	)
Total revenue	$	1,260.6	$	1,275.3		(1	)%

During the first quarter of 2007, revenue decreased in the U.S. due to a decline in inkjet hardware and supplies. Revenue in EMEA increased due to higher laser hardware and supplies partially offset by a decline in inkjet hardware.

Gross Profit

The following table provides gross profit information:

	Three Months Ended March 31
*(Dollars in millions)*	2007			2006			*Change*
Gross profit dollars	$	422.8		$	403.8			5	%
% of revenue		33.5	%		31.7	%		1.8	pts

During the first quarter of 2007, consolidated gross profit and gross profit as a percentage of revenue increased when compared to the prior year. Gross profit in the first quarter of 2007 and 2006 was impacted by $1.6 million (or a 0.2 percentage point impact) of 2007 project costs and $18.7 million (or a 1.4 percentage point impact) of accelerated depreciation charges relating to its 2006 actions, respectively. This resulted in a net improvement to gross profit of $17.1 million, or 1.2 percentage points.

The remaining improvement of 0.6 percentage points was due to a 1.4 percentage point favorable mix shift among products, mostly from a decrease in the percentage of inkjet hardware, partially offset by a 0.8 percentage point decrease in product margins.

Operating Expense

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

	Three Months Ended March 31
	2007					2006
*(Dollars in millions)*	Dollars		*% of Rev*			Dollars		*% of Rev*
Research and development	$	99.9		7.9	%	$	87.4		6.9	%
Selling, general & administrative		201.8		16.0			174.8		13.7
Restructuring and other, net		-		-			21.1		1.6
Total operating expense	$	301.7		23.9	%	$	283.3		22.2	%

During the first quarter of 2007, research and development expenses increased YTY due to the Company’s continued acceleration of investment to support product and solution development. This investment has led to new products and solutions aimed at targeted growth segments.

During the first quarter of 2007, selling, general and administrative expenses increased YTY as the Company increased spending on marketing and sales activities. In the first quarter of 2007, demand generation activities, which include the brand development marketing campaign launched in late 2006, increased YTY. The initiative includes a new television advertising campaign along with radio, print and outdoor advertising in targeted geographic and market segments. The Company will continue the increased demand generation activity in 2007 as Lexmark’s focus continues to be to drive branded hardware growth. Additionally, selling, general and administrative expenses for the first quarter of 2007 includes $4.1 million of 2007 project costs and a $3.5 million gain on the sale of its Rosyth, Scotland facility.

During the first quarter of 2006, restructuring and other, net, impacting operating expense, included $30.9 million of restructuring-related charges and a $9.8 million pension curtailment gain from its 2006 actions.

Operating Income (Loss)

The following table provides operating income by market segment:

	Three Months Ended March 31
*(Dollars in millions)*	2007			2006			*Change*
Business	$	153.9		$	147.5			4	%
% of segment revenue		20.9	%		21.4	%		(0.5	)pts

Consumer		64.5			64.8			(0	)%
% of segment revenue		12.3	%		11.0	%		1.3	pts

All other		(97.3	)		(91.8	)		(6	)%
Total operating income (loss)	$	121.1		$	120.5			0	%
% of total revenue		9.6	%		9.5	%		0.1	pts

During the first quarter of 2007, consolidated operating income was flat YTY. For the first quarter of 2007, the Company incurred approximately $6 million of 2007 project costs partially offset by a $3.5 million pre-tax gain on the sale of its Rosyth, Scotland facility. In the first quarter of 2006, restructuring-related expenses of $49.6 million and a pension curtailment gain of $9.8 million were incurred resulting in a net cost of $39.8 million. This YTY decrease in restructuring-related charges and projects costs of approximately $38 million was offset by increased operating expenses of $39 million.

During the first quarter of 2006, the Company incurred restructuring-related charges of $7.9 million in its Business segment, $31.3 million in its Consumer segment and $10.4 million in All other. All other operating income also included a $9.8 million pension curtailment gain from the pension plan freeze.

Interest and Other

The following table provides interest and other information:

	Three Months Ended March 31
*(Dollars in millions)*	2007			2006
Interest (income) expense, net	$	(4.4	)	$	(6.3	)
Other expense (income), net		1.2			0.8
Total interest and other (income) expense, net	$	(3.2	)	$	(5.5	)

During the first quarter of 2007, total interest and other (income) expense, net, was income of $3 million compared to income of $5 million in 2006. This decrease was primarily due to lower interest income in 2007 compared to the prior year as a result of a decreased level of cash and marketable securities held by the Company during the year partially offset by higher interest rates in 2007 compared to 2006.

Provision for Income Taxes

Net Earnings

Earnings per Share

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

	Three Months Ended March 31
	2007		2006
Basic earnings per share	$	0.96	$	0.79
Diluted earnings per share	$	0.95	$	0.78

For the first quarter of 2007, the increases YTY in basic and diluted net earnings per share were attributable to the decrease in the average number of shares outstanding, primarily due to the Company’s stock repurchases, and increased net earnings.

For the first quarter of 2006, both basic and diluted net earnings per share include the restructuring-related charges and pension curtailment gain as discussed above.

FINANCIAL CONDITION

Lexmark’s financial position remains strong at March 31, 2007, with working capital of $442 million compared to $506 million at December 31, 2006. The decrease in working capital accounts was primarily due to lower cash and cash equivalents and marketable securities resulting primarily from the Company’s stock repurchase activity. At both March 31, 2007 and December 31, 2006, the Company had $149.8 of long-term debt and no short-term debt outstanding. The debt to total capital ratio was 13% at both March 31, 2007, and December 31, 2006. The Company had no amounts outstanding under its U.S. trade receivables financing program or its revolving credit facility at March 31, 2007.

The following table summarizes the results of the Company’s Consolidated Condensed Statements of Cash Flows for the three months ended March 31, 2007 and 2006:

	Three Months Ended March 31
	2007			2006
Net cash flow provided by (used for):
Operating activities	$	86.6		$	219.5
Investing activities		43.1			113.9
Financing activities		(154.1	)		(295.4	)
Effect of exchange rate changes on cash		0.1			0.9
Net change in cash and cash equivalents	$	(24.3	)	$	38.9

The Company’s primary source of liquidity has been cash generated by operations, which totaled $87 million and $220 million for the three months ended March 31, 2007 and 2006, respectively. Cash from operations generally has been sufficient to allow the Company to fund its working capital needs and finance its capital expenditures during these periods along with the repurchase of approximately $0.2 billion and $0.3 billion of its Class A Common Stock during the three months ended March 31, 2007 and 2006, respectively. Management believes that cash provided by operations will continue to be sufficient to meet operating and capital needs; however, in the event that cash from operations is not sufficient, the Company has other potential sources of cash through utilization of its trade receivables financing program, revolving credit facility or other financing sources.

Operating activities:

The decrease in cash flows from operating activities from 2006 to 2007 primarily resulted from unfavorable changes of $84 million in trade receivables and $26 million in accrued liabilities.

The change noted in trade receivables was primarily due to the timing of sales within the quarter and the related cash collections compared to the prior year. The Company’s days of sales outstanding were 36 days at March 31, 2007, compared to 35 days at December 31, 2006, and 38 days at March 31, 2006, compared to 39 days at December 31, 2005. The days of sales outstanding is calculated on a three-month moving average based on gross trade receivables, net of allowances for doubtful accounts and product returns, and is adjusted for certain trade receivables items which have no corresponding revenue, such as value-added taxes.

The change noted in accrued liabilities was primarily due to decreases in salary and incentive compensation accruals of $21 million during the first quarter of 2007 compared to the prior year.

Although not a significant component of the change in cash flows from operating activities, the Company’s days of inventory increased from 44 days at March 31, 2006, to 49 days at March 31, 2007. The days of inventory is calculated on a three-month moving average based on annualized cost of goods sold excluding any restructuring-related charges and project costs. The days of sales outstanding and days of inventory calculations are non-GAAP measures and based on internal definitions and may not be comparable to other companies’ calculations.

In connection with the 2006 restructuring, the remaining accrued liability balance at March 31, 2007, of $22.7 million, is expected to be substantially paid out by the end of 2007. These payments will relate primarily to employee termination benefits.

As of March 31, 2007, the Company had accrued approximately $100 million for pending copyright fee issues, including litigation proceedings, local legislative initiatives and/or negotiations with the parties involved. These accruals are included in Accrued liabilities on the Consolidated Condensed Statements of Financial Position. Refer to Part I, Item 1, Note 12 of the Notes to Consolidated Condensed Financial Statements for additional information.

Investing activities:

The Company decreased its marketable securities investments by $84 million and $162 million for the three months ended March 31, 2007 and 2006, respectively, due to its share repurchase program activity.

For the three months ended March 31, 2007 and 2006, the Company spent $49 million and $47 million, respectively, on capital expenditures. The capital expenditures for 2007 principally related to new product support, infrastructure support and manufacturing capacity expansion. The Company continues to make significant capital investments in its manufacturing facilities. It is anticipated that total capital expenditures for 2007 will be approximately $235 million and are expected to be funded through cash from operations.

During the first quarter of 2007, the Company sold its Rosyth, Scotland facility for $8.1 million and recognized a $3.5 million pre-tax gain on the sale.

Financing activities:

The change in the net cash flows from financing activities was due to the Company’s share repurchase activity.

TRADE RECEIVABLES FACILITY

At March 31, 2007 and December 31, 2006, there were no receivables or borrowings outstanding under the facility.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note 13 to the Consolidated Condensed Financial Statements in Item 1 for a description of recent accounting pronouncements which is incorporated herein by reference.

FACTORS THAT MAY AFFECT FUTURE RESULTS AND INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS

The following significant factors, as well as others of which we are unaware or deem to be immaterial at this time, could materially adversely affect our 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.

The Company’s future operating results may be adversely affected if it is unable to continue to develop, manufacture and market products that are reliable, competitive, and meet customers’ needs. The markets for laser and inkjet products and associated supplies are aggressively competitive, especially with respect to pricing and the introduction of new technologies and products offering improved features and functionality. 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, maintain or grow retail shelf space or maintain or grow market share. The competitive pressure to develop technology and products and to increase marketing expenditures also could cause significant changes in the level of the Company’s operating expenses.

The Company and its major competitors, many of which have significantly greater financial, marketing and/or technological resources than the Company, have regularly lowered prices on their products and are expected to continue to do so. In particular, both the inkjet and laser printer markets have experienced and are expected to continue to experience significant price pressure. Price reductions on inkjet or laser products or the inability to reduce costs, including warranty costs, to contain expenses or to increase or maintain sales as currently expected, as well as price protection measures, could result in lower profitability and jeopardize the Company’s ability to grow or maintain its market share. 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 if 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. 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.

·	The entrance of additional competitors that are focused on printing solutions could further intensify competition in the inkjet and laser printer markets and could have a material adverse impact on the Company’s strategy and financial results.

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, 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.

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 Company’s future operating results may be adversely affected if the consumption of its supplies by end users of its products is lower than expected or declines.

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.

Our revenue, gross margin and profit vary among our hardware, supplies and services, product groups and geographic markets and therefore will likely be different in future periods than our current results. Overall gross margins and profitability in any given period is dependent upon the hardware/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, 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 has migrated the infrastructure support of its information technology system and application maintenance functions to new third-party service providers. The Company is in the process of centralizing certain of its accounting and other finance functions and order-to-cash functions from various countries to shared service centers. The Company is also in the process of reducing, consolidating and moving various parts of its general and administrative resource, supply chain resource and marketing and sales support structure. Any disruption in these systems or functions could have a material adverse impact on the Company’s operations, its systems of internal controls and its ability to accurately record and report transactions and financial 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 in reseller inventory levels could disrupt ordering patterns and may adversely affect the Company’s financial results. In addition, the financial failure or loss of a key customer or reseller could have a material adverse impact on the Company’s financial results. The Company must also be able to address production and supply constraints, including product disruptions caused by quality issues, and delays or disruptions in the supply of key components necessary for production, including without limitation component shortages due to increasing global demand in the Company’s industry and other industries. Such delays, disruptions or shortages may result in lost revenue or in the Company incurring additional costs to meet customer demand. The Company’s future operating results and its ability to effectively grow or maintain its market share may be adversely affected if it is unable to address these issues on a timely basis.

Unfavorable global economic conditions may adversely impact the Company’s future operating results. The Company continues to experience some weak markets for its products. Continued softness in certain markets and uncertainty about global economic conditions could result in lower demand for the Company’s products, particularly 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.

The European Union has adopted the Waste Electrical and Electronic Equipment Directive (the “Directive”) which requires producers of electrical and electronic goods, including printing devices, to be financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. The deadline for enacting and implementing the Directive by individual European Union governments was August 13, 2004 (such legislation, together with the Directive, the “WEEE Legislation”), although extensions were granted to some countries. Producers were to be financially responsible under the WEEE Legislation beginning in August 2005. Similar legislation may be enacted in the future in other jurisdictions as well. The impact of this legislation could adversely affect the Company’s operating results and profitability.

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 European Union has adopted the “RoHS” Directive (Restriction of use of certain Hazardous Substances) which restricts the use of nine substances in electrical and electronic equipment placed on the market on or after July 1, 2006. Compliance with the RoHS Directive could create shortages of certain components or impact continuity of supply that could adversely affect the Company’s operating results and profitability.

The Company has undertaken cost reduction measures over the last few years in an effort to optimize the Company’s expense structure. Such actions have included workforce reductions, the consolidation of manufacturing capacity, and the centralization of support functions to shared service centers in each geography. The Company expects to realize cost savings in the future through these 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, due to regulatory requirements; increased costs associated with such actions; decreases in employee morale and the failure to meet operational targets due to unplanned departures of employees, particularly sales employees.

The Company relies in large part on its international production facilities and international manufacturing partners, many of which are located in China, for the manufacture of its products and key components of its products. China’s revaluation of its currency to no longer peg its currency to the U.S. dollar may have an adverse impact on the Company’s cost of goods acquired from China, and could have a material adverse impact on the Company’s financial results. Future operating results may also be adversely affected by several other factors, including, without limitation, if the Company’s international operations or manufacturing partners are unable to perform or supply products reliably, if there are disruptions in international trade, disruptions at important geographic points of exit and entry, if there are difficulties in transitioning such manufacturing activities among the Company, its international operations and/or its manufacturing partners, or if there arise production and supply constraints which result in additional costs to the Company. The financial failure or loss of a 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.

Revenue derived from international sales make up about half of the Company’s revenue. Accordingly, the Company’s future results could be adversely affected by a variety of factors, including changes in a specific country’s or region’s political or economic conditions, foreign currency exchange rate fluctuations, trade protection measures and unexpected changes in regulatory requirements. In addition, changes in tax laws and the ability to repatriate cash accumulated outside the 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 new geographic markets will be less profitable than operations in the U.S. and European markets, in part, because of the higher investment levels for marketing, selling and distribution required to enter these markets.

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 the Company implements policies and procedures designed to ensure compliance with these laws, our employees, contractors and agents, as well as those business partners to which we outsource certain of our business operations, may take actions in violation of our policies. Any such violation, even if prohibited by our policies, could have a material adverse effect on our business and our 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 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.

The Company markets and sells its products through several sales channels. The Company has also advanced a strategy of forming alliances and OEM arrangements with many companies. The Company’s future operating results may be adversely affected by any conflicts that might arise between or among its various sales channels, the volume reduction in or loss of any alliance or OEM arrangement or the loss of retail shelf space. Aggressive pricing on laser and inkjet products and/or associated supplies from customers and resellers, including, without limitation, OEM customers, could result in a material adverse impact on the Company’s strategy and financial results.

The Company depends on its information technology systems for the development, manufacture, distribution, marketing, sales and support of its products and services. Any failure in such systems, or the systems of a partner or supplier, may adversely affect the Company’s operating results. Furthermore, because vast quantities of the Company’s products flow through only a few distribution centers to provide product to various geographic regions, the failure of information technology systems or any other disruption affecting those product distribution centers could have a material adverse impact on the Company’s ability to deliver product and on the Company’s financial results.

The Company’s effective tax rate could be adversely affected by changes in the mix of earnings in countries with differing statutory tax rates. In addition, the amount of income tax the Company pays is subject to ongoing audits in various jurisdictions. A material assessment by a taxing authority or a decision to repatriate foreign cash could adversely affect the Company’s profitability.

Our worldwide operations and those of our 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 seriously harm our revenue and financial condition and increase our costs and expenses. As the Company continues its consolidation of certain functions into shared service centers and movement of certain functions to lower cost countries, the probability and impact of business disruptions may be increased over time.

The Company has historically used stock options and other forms of share-based payment awards as key components of the total rewards program for employee compensation in order to align employees’ interests with the interests of stockholders, motivate employees, encourage employee retention and provide competitive compensation and benefits packages. As a result of Statement of Financial Accounting Standards No. 123R, the Company would incur increased compensation costs associated with its share-based compensation programs and as a result has reviewed its compensation strategy in light of the current regulatory and competitive environment and has decided to change the form of its share-based awards. Due to this change in compensation strategy, combined with other benefit plan changes undertaken to reduce costs, the Company may find it difficult to attract, retain and motivate employees, and any such difficulty could materially adversely affect its operating results.

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.

·	The Company relies heavily on the health and welfare of its employees and the employees of its manufacturing partners. The widespread outbreak of any form of communicable disease affecting a large number of workers could adversely impact the Company’s operating results.

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, including claims of intellectual property infringement, false or deceptive practices or anticompetitive conduct; 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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The market risk inherent in the Company’s financial instruments and positions represents the potential loss arising from adverse changes in interest rates and foreign currency exchange rates.

Interest Rates

At March 31, 2007, the fair value of the Company’s senior notes was estimated at $152 million using quoted market prices and yields obtained through independent pricing sources for the same or similar types of borrowing arrangements, taking into consideration the underlying terms of the debt. The fair value of the senior notes exceeded the carrying value as recorded in the Consolidated Condensed Statements of Financial Position at March 31, 2007, by approximately $2 million. Market risk is estimated as the potential change in fair value resulting from a hypothetical 10% adverse change in interest rates and amounts to approximately $1 million at March 31, 2007.

The Company has interest rate swaps that serve as a fair value hedge of the Company’s senior notes. The fair value of the interest rate swaps at March 31, 2007, was a liability of $2 million. Market risk for the interest rate swaps is estimated as the potential change in fair value resulting from a hypothetical 10% adverse change in interest rates and amounts to approximately $1 million at March 31, 2007.

Foreign Currency Exchange Rates

The Company employs a foreign currency hedging strategy to limit potential losses in earnings or cash flows from adverse foreign currency exchange rate movements. Foreign currency exposures arise from transactions denominated in a currency other than the Company’s functional currency and from foreign denominated revenue and profit translated into U.S. dollars. The primary currencies to which the Company is exposed include the euro, the Mexican peso, the Canadian dollar, the British pound, the Australian dollar and other Asian and South American currencies. Exposures are hedged with foreign currency forward contracts, put options, and call options generally with maturity dates of twelve months or less. The potential loss in fair value at March 31, 2007, for such contracts resulting from a hypothetical 10% adverse change in all foreign currency exchange rates is approximately $25 million. This loss would be mitigated by corresponding gains on the underlying exposures.

Item 4. CONTROLS AND POCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management, with the participation of the Company’s Chairman and Chief Executive Officer and Executive Vice President and Chief Financial Officer, have evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Company’s Chairman and Chief Executive Officer and Executive Vice President and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective in providing reasonable assurance that the information required to be disclosed by the Company in the reports that it files under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and were effective as of the end of the period covered by this report, to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decision regarding required disclosure.

Changes in Internal Control over Financial Reporting

During the first quarter of 2007, the Company outsourced the infrastructure support of its information technology system and its application maintenance functions for the EMEA geography to a third-party service provider. Additionally, during the first quarter of 2007, the Company continued its process of centralizing certain of its accounting and other finance functions and order-to-cash functions from various countries to shared service centers. As a result, certain changes in basic processes and internal controls and procedures for day-to-day accounting functions and financial reporting were made. While management believes the changed controls relating to financial reporting are adequate and effective, management is continuing to evaluate and monitor the changes in controls and procedures as processes in each of these areas evolve.

Except for implementing the changes noted above, there has been no change in the Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2007, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

On March 23, 2007, the Company entered into a Settlement Agreement with NER Data Products, Inc. ("NER") pursuant to which each party released the other from any and all claims, NER acknowledged the validity and enforceability of the Company's patents-in-suit and the validity and enforceability of the Company's single use license agreement applicable to its "Return Program" cartridges (formerly known as "Prebate" cartridges) and agreed to no longer remanufacture such cartridges. On April 27, 2007, the U.S. District Court for the Eastern District of Kentucky (the "District Court") granted the Company's motion to dismiss its state law claims against Static Control Components, Inc. ("SCC"), Pendl Companies, Inc. ("Pendl") and Wazana Brothers International, Inc. ("Wazana"). On May 2, 2007, the District Court denied the Company's motion for summary judgment to dismiss the counterclaims filed against the Company by Wazana and Pendl alleging that the Company engaged in anti-competitive and monopolistic conduct and unfair and deceptive trade practices in violation of the Sherman Act and the Lanham Act. The trial of this case is scheduled to begin on May 15, 2007. There have been no other material developments to the legal proceedings previously disclosed in Part I, Item 3 of the Company's 2006 Annual Report on Form 10-K.

Item 1A. RISK FACTORS

A description of the risk factors associated with the Company’s business is included under “Factors That May Affect Future Results And Information Concerning Forward-Looking Statements” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contained in Item 2 of Part I of this report. There have been no material changes to the risk factors associated with the business previously disclosed in Part I, Item 1A of the Company’s 2006 Annual Report on Form 10-K.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table summarizes the repurchases of the Company’s Common Stock in the quarter ended March 31, 2007:

Period	Total Number of Shares Purchased		Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (in millions) (1)
January 1 - 31, 2007	-	$	-	-	$	460.5
February 1 - 28, 2007	1,355,600		62.48	1,355,600		375.8
March 1 - 31, 2007	1,346,556		59.63	1,346,556		295.5
Total	2,702,156	$	61.06	2,702,156		-

(1)

Item 3. DEFAULTS UPON SENIOR SECURITIES

None.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

(a) The Company’s Annual Meeting of Stockholders was held on April 26, 2007.

(b) Paul J. Curlander, James F. Hardymon, Kathi P. Seifert and Jean-Paul L. Montupet were each elected as Directors of the Company for terms expiring in 2010. The terms of office of each of Teresa Beck, William R. Fields, Ralph E. Gomory, Stephen R. Hardis, Robert Holland, Jr., Marvin L. Mann and Michael J. Maples as Directors of the Company continued after the meeting.

(i)	The election of four Directors for terms expiring in 2010. The stockholders elected the Directors by the following votes:

Directors	Votes For	Votes Against	Abstentions

Paul J. Curlander	80,240,218	3,024,258	836,917
James F. Hardymon	77,780,134	5,812,569	508,690
Kathi P. Seifert	77,983,951	6,048,524	68,918
Jean-Paul L. Montupet	82,121,932	1,453,234	526,227

(ii)	The ratification of the appointment of PricewaterhouseCoopers LLP (“PwC”) as the Company’s independent registered public accounting firm for the Company’s fiscal year ending December 31, 2007. The stockholders ratified the appointment of PwC by the following votes:

Votes For	Votes Against	Abstentions

81,790,500	1,808,207	502,689

Item 5. OTHER INFORMATION

None.

Item 6. EXHIBITS

A list of exhibits is set forth in the Exhibit Index found on page 34 of this report.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, both on behalf of the registrant and in his capacity as principal accounting officer of the registrant.

	Lexmark International, Inc.
	(Registrant)

May 8, 2007
	/s/ Gary D. Stromquist
	Gary D. Stromquist Vice President and Corporate Controller (Chief Accounting Officer)

EXHIBIT INDEX

Exhibits:

4.1	Second Supplemental Indenture, dated as of March 26, 2007, by and between the Company, as Issuer, to The Bank of New York Trust Company, N.A., as Trustee.

10.1

Amendment No. 1, dated as of December 22, 2006, to Credit Agreement, dated as of January 20, 2005, by and among the Company, as Borrower, the Lenders party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent, Fleet National Bank and Citibank, N.A., as Co-Syndication Agents, and KeyBank National Association and SunTrust Bank, as Co-Documentation Agents.

10.2

Amendment No. 3 to Receivables Purchase Agreement, dated as of March 30, 2007, by and among Lexmark Receivables Corporation, as Seller, CIESCO, LLC and Gotham Funding Corporation, as the Investors, Citibank, N.A. and The Bank of Tokyo-Mitsubishi UFJ, Ltd., New York Branch (“BTMUFJ”), Citicorp North America, Inc. (“CNAI”), as Program Agent, CNAI and BTMUFJ, as Investor Agents and the Company, as Collection Agent and Originator.

10.3	Amendment No. 1 to the Lexmark Supplemental Savings and Deferred Compensation Plan, dated as of February 27, 2007. +

31.1	Certification of Chairman and Chief Executive Officer Pursuant to Rule 13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2	Certification of Executive Vice President and Chief Financial Officer Pursuant to Rule 13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1	Certification of Chairman and Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2	Certification of Executive Vice President and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

+ Indicates management contract or compensatory plan, contract or arrangement.

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. sophomore Avg

Lexmark International Inactive 10-Q2007 Q1 Quarterly report

Content analysis