LEXMARK INTERNATIONAL INC /KY/ - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

[February 26, 2013]

LEXMARK INTERNATIONAL INC /KY/ - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) 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 process 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, document workflow, and more recently business process and content management solutions. The Company operates in the office printing and imaging, and 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 managed print services 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. 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 and search 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 broad lead generation approach, employing internal sales and marketing teams that are segmented by industry sector - specifically healthcare, education, public sector/government, and cross industry, which includes areas such as retail, financial services and insurance. Perceptive Software also offers a direct channel partner program that allows authorized third-party resellers to market and sell Perceptive Software products and solutions to a distributed market. Perceptive Software has two general forms of software agreements with its customers, perpetual licenses and subscription services.

In August 2012, the Company announced it will exit the development and manufacturing of inkjet technology. The Company will continue to provide service, support and aftermarket supplies for its inkjet installed base.

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.

32-------------------------------------------------------------------------------- Table of Contents Operating Results Summary 2012 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 managed print services. 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. In 2012, Lexmark launched the largest series of new print and MFP products in its history substantially improving print and capture capabilities. Also in 2012, the Company completed the acquisitions of Brainware, Isys, Nolij and Acuo. These acquisitions provide advanced capture and search technology, as well as medical imaging specific vendor neutral archive technology.

In 2012, Lexmark announced it would complete its exit of inkjet technologies. In 2007, the Company exited the "consumer inkjet" business, and in August 2012 announced its exit from the "business inkjet" market as well as the development and manufacture of all inkjet technologies. The Company will continue to provide service, support and aftermarket supplies for its inkjet installed base. With this announcement, Lexmark has focused its printing and MFP development activities in laser based technologies.

Lexmark's 2012 revenue was down 9% YTY, primarily due to the negative impact on revenue of weakening foreign currencies, and the decline in business and consumer inkjet revenue related to the decision to exit inkjet technology.

Revenue in the second half of 2012 was also negatively impacted by economic weakness outside of the U.S., particularly in EMEA. Operating income decreased 57.8% YTY primarily due to unfavorable currency movements, and also an increase in restructuring related charges and project costs due to the Company's 2012 restructuring actions, as well as by an increase in costs associated with acquisition-related adjustments due to its recent acquisitions.

The Company continues a strategic focus on growing its Managed Print Services 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 Managed Print Services 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 managed print services, the Company acquired Brainware, Nolij, ISYS and Acuo Technologies in 2012. These acquisitions are included in the Perceptive Software segment.

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 imaging and content/process software markets (ECM, BPM, search, DOM and intelligent capture) with a focus on business customers. Lexmark management believes the total relevant market opportunity of these markets combined in 2012 was approximately $80 billion. Lexmark management believes that the total relevant distributed printing and imaging 33-------------------------------------------------------------------------------- Table of Contents market opportunity was approximately $70 billion in 2012, 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 2012. The distributed printing industry is expected to experience flat to slightly declining revenue overall over the next few years but growth is likely in managed print services, multifunction products ("MFPs") and color lasers which are all areas of focus for Lexmark. In fact, managed print services and fleet solutions are expected to continue to experience double digit annual revenue growth rates over the next few years.

Based on industry analyst estimates, the content and process management software markets that Lexmark participates in, are projected to grow approximately 10% annually over the next few years and in 2012 had a market size that exceeded $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 to distributed printing by end users when and where it is convenient to do so; • 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 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 and image files; • Customer desire to have a third party manage their 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 device, including mobile access and mobile workflow participation, while ensuring content security; and • Growing desire to unify structured data in business systems with unstructured digital content to make the unstructured content more valuable and actionable within business functions.

As a result of these market trends, Lexmark has growth opportunities in monochrome and color laser printers and MFPs, managed print services, as well as fleet management, ECM, BPM, DOM, intelligent data capture, search and medical imaging vendor neutral archive 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 document 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 34-------------------------------------------------------------------------------- Table of Contents market matures and printer and copier-based product markets continue to converge, the Company's management expects competitive pressures on product prices to continue.

In August 2012, the Company announced the exiting of the development and manufacturing of the Company's inkjet technology. While the Company will continue to provide aftermarket supplies for its inkjet installed base, the Company expects continued year on year declines in inkjet aftermarket supplies sales as the installed base of the Company's inkjet printers decline due to customer retirements of the Company's inkjet printers.

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, video, audio and faxes, and the intelligent tagging of this information in order to streamline and automate process workflows while managing changes to both content and processes in support of governance and compliance policies. 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 with their customers and partners. These solutions help companies leverage the value of their content, processes, and people by seamlessly integrating the user experience with existing enterprise systems, with the result being higher productivity, lower costs, and increased customer satisfaction. Management believes the deployment of ECM and BPM systems and associated workflow solutions to effectively capture, manage and access unstructured information is a significant long term opportunity.

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 ECM 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 enterprise resource planning ("ERP"), EMR, and customer relationship management ("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 the Company's principal competitors can have, and in the past, have had, a material negative effect on the Company's financial results.

35 -------------------------------------------------------------------------------- Table of Contents • The Company's future operating results may be adversely affected by the Company's exit from future hardware development and manufacturing of inkjet printers 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 the Company's cartridges are available and compete with the Company's supplies business. 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 and difficulties in the financial markets could impact the Company's future operating results.

• 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.

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 imaging and process solutions, including printers, multifunction devices and software solutions including enterprise content and business process management software, with the objective of growing its installed base of hardware devices and software installations, which drives recurring supplies sales as well as 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 solutions and services for specific industries and business processes in distributed environments.

• Lexmark internally develops both monochrome and color laser printing technology.

• Lexmark, through Perceptive Software, provides ECM, BPM, DOM, intelligent capture, search and healthcare specific medical imaging and vendor neutral archive software products and corresponding industry tailored solutions to help companies manage the lifecycle of their content and business processes all in the context of their existing enterprise applications.

36 -------------------------------------------------------------------------------- Table of Contents • 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 document-intensive industries and business processes in distributed environments; • Target and capture business customers, markets and channels that drive higher page generation and supplies usage; and • Advance and grow the Company's ECM and BPM 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. 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, contingencies and litigation, long-lived assets and fair values that are based on unobservable inputs significant to the overall measurement. 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.

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

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 37-------------------------------------------------------------------------------- Table of Contents 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 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 standalone 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. Best estimate of selling price for the Company's service deliverables is determined by utilizing a cost plus margin approach as the Company does not typically sell its services on a standalone basis. The Company generally uses third party suppliers to provide the services component of its multiple element arrangements, thus the cost of services is that which is invoiced to the Company. A margin is applied to the cost of services in order to determine a best estimate of selling price, and is primarily determined by considering third party prices of similar services to consumers and geographic factors. In the absence of third party data the Company considers other factors such as historical margins and margins on similar deals as well as cost drivers that could affect future margins.

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 standalone 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.

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 38-------------------------------------------------------------------------------- Table of Contents 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 stemming from the European debt crisis, 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, 2012.

Approximately 34% 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.

39-------------------------------------------------------------------------------- Table of Contents 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 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 are not significant and 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.

• 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. Effective December 31, 2012, the Company changed from using a more broad-based yield curve to a newly developed 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 are targeted to be 60% equity and 40% 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 Company has elected to primarily use the market-related value of plan assets rather than fair value to determine expense which, under the accounting guidance, allows gains and losses to be recognized in a systematic and rational manner over a period of no more than five years. As a result of this deferral process, for the U.S. pension plan, pension expense was increased by $5 million in 2012 and is expected to increase $3 million in 2013, due to the recognition of the gains and losses for the 40-------------------------------------------------------------------------------- Table of Contents respective prior five years. The expected decrease in the 2013 pension expense for the U.S. pension plan would have been approximately $4 million had the Company not deferred the differences between actual and expected asset returns on equity investments.

Actual results that differ from assumptions that fall outside the "10% corridor," as defined by accounting guidance on employers' accounting for pensions, are accumulated and amortized over the estimated future service period of active plan participants. For 2012, a 25 basis point change in the assumptions for asset return and discount rate would not have had a significant impact on the Company's results of operations.

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 and recognition in other comprehensive earnings of certain gains and losses that arise during the period, but are deferred under pension accounting rules.

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.

Under the accounting guidance regarding uncertainty in income taxes, a tax position must meet the minimum recognition threshold of "more-likely-than-not" before being recognized in the financial statements. The evaluation of a tax position in accordance with this guidance 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. The Company recognizes accrued interest and penalties associated with uncertain tax positions as part of its income tax provision.

Litigation and Contingencies In accordance with FASB 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 41-------------------------------------------------------------------------------- Table of Contents 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 average collection costs, return rates and product lives. During 2012, the Company reduced its estimated liability and recognized a $9.6 million net benefit to Cost of revenue. The adjustment was driven by the lower number of products actually returned and collected compared to the return rate assumption used in the original estimate.

In the future, 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 uses fair value in measuring certain nonrecurring items as well, such as long-lived assets held for sale.

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.

42-------------------------------------------------------------------------------- Table of Contents The Company's Level 3 recurring fair value measurements are related mostly to its investments, including auction rate securities for which recent auctions were unsuccessful. For these securities, observable pricing data was not available resulting in the Company performing a discounted cash flow analysis based on inputs that it believes market participants would use with regard to such items as expected cash flows and discount rates adjusted for liquidity premiums or credit risk. Assumptions significant to the valuation include assumptions regarding the financial health of the issuer as well as assumptions regarding the auction rate market in general, such as the market will remain illiquid and auctions will continue to fail. Valuation of these securities can be very subjective and estimates and assumptions could be revised in the future depending on market conditions and changes in the economy or credit standing of the issuer. Fair values of other marketable securities, mainly certain corporate debt securities and asset-backed and mortgaged-backed securities, are also 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.

See Notes 2 and 3 of the Notes to the Consolidated Financial Statements in Part II, Item 8 for information regarding the Company's fair value accounting policies and fair value measurements, respectively. Refer to Note 17 of the Notes to the Consolidated Financial Statements in Part II, Item 8 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 under the new guidance. See Note 2 of the Notes to the Consolidated Financial Statements in Part II, Item 8 for more details regarding this guidance. The Company's policy considers various factors in making these two assessments.

In determining whether it is more likely than not that the Company will be required to sell impaired securities before recovery of net book or carrying values, the Company considers various factors that include: • The Company's current cash flow projections, • Other sources of funds available to the Company such as borrowing lines, • The value of the security relative to the Company's overall cash position, 43 -------------------------------------------------------------------------------- Table of Contents • The length of time remaining until the security matures, and • The potential that the security will need to be sold to raise capital.

If the Company determines that it does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security, the Company assesses whether it expects to recover the net book or carrying value of the security. The Company makes this assessment based on quantitative and qualitative factors of impaired securities that include a time period analysis on unrealized loss to net book value ratio; severity analysis on unrealized loss to net book value ratio; credit analysis of the security's issuer based on rating downgrades; and other qualitative factors that may include some or all of the following criteria: • The regulatory and economic environment.

• The sector, industry and geography in which the issuer operates.

• Forecasts about the issuer's financial performance and near-term prospects, such as earnings trends and analysts' or industry specialists' forecasts.

• Failure of the issuer to make scheduled interest or principal payments.

• Material recoveries or declines in fair value subsequent to the balance sheet date.

Securities that are identified through the analysis using the quantitative and qualitative factors described above are then assessed to determine whether the entire net book value basis of each identified security will be recovered. The Company performs this assessment by comparing the present value of the cash flows expected to be collected from the security with its net book value. If the present value of cash flows expected to be collected is less than the net book value basis of the security, then a credit loss is deemed to exist and an other-than-temporary impairment is considered to have occurred. There are numerous factors to be considered when estimating whether a credit loss exists and the period over which the debt security is expected to recover, some of which have been highlighted in the preceding paragraph.

Given the level of judgment required to make the assessments above, 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.

See Note 7 of the Notes to the Consolidated Financial Statements in Part II, Item 8 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 were determined using an income approach, which requires projected financial information and market participant assumptions. See Note 4 of the Notes to the Consolidated Financial Statements in Part II, Item 8 for information regarding the methods employed and significant inputs used to determine fair value related to the Company's business acquisitions.

44-------------------------------------------------------------------------------- Table of Contents Goodwill and Intangible Assets Lexmark assesses its goodwill and indefinite-lived intangible assets 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 as determined under the accounting guidance for goodwill impairment testing. The Company generally considers both a discounted cash flow analysis, which requires judgments such as projected future earnings and weighted average cost of capital, as well as certain market-based measurements, including multiples developed from prices paid in observed market transactions of comparable companies, in its estimation of fair value for goodwill impairment testing. The Company estimates the fair value of acquired trade names and trademarks indefinite-lived intangible asset using the relief from royalty method.

Goodwill recognized by the Company at December 31, 2012 was $376.8 million and was allocated to the Perceptive Software and ISS reporting units in the amount of $353.6 million and $23.2 million, respectively. The fair values of these reporting units were substantially in excess of their carrying values on this date. The value of Perceptive Software was heavily reliant on forecasted financial information as the Company's investments in research and development and marketing outpaced its revenue growth in 2012. Key assumptions to the valuation of Perceptive Software include its ability to expand internationally and the revenue growth that would be accelerated by such expansion. Applying a hypothetical 10% decrease to the fair value of each reporting unit would not result in the Company failing step one of the goodwill impairment test.

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 performs reviews for the 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.

45 -------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS Operations Overview Key Messages 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.

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.

The Company remains committed to its capital allocation framework of returning more than 50 percent of free cash flow to shareholders through share repurchases and dividends while building and growing its solutions and software business through expansion and acquisitions.

Business Factors Lexmark's 2012 revenue was down 9% YTY, primarily due to the negative impact on revenue of weakening foreign currencies, and the decline in business and consumer inkjet revenue related to the decision to exit inkjet technology.

Revenue in the second half of 2012 was also negatively impacted by economic weakness outside the U.S., particularly in EMEA. Operating income decreased 57.8% YTY primarily due to unfavorable currency movements, and also an increase in restructuring related charges and project costs due to the Company's 2012 restructuring actions, as well as by an increase in costs associated with acquisition-related adjustments due to its recent acquisitions.

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, 2012, 2011 and 2010: 2012 2011 2010 (Dollars in Millions) Dollars % of Rev Dollars % of Rev Dollars % of Rev Revenue $ 3,797.6 100.0 % $ 4,173.0 100.0 % $ 4,199.7 100.0 % Gross profit 1,400.0 36.9 % 1,580.6 37.9 % 1,519.5 36.2 % Operating expense 1,212.9 31.9 % 1,137.7 27.3 % 1,072.6 25.5 % Operating income 187.1 4.9 % 442.9 10.6 % 446.9 10.6 % Net earnings 106.3 2.8 % 320.9 7.7 % 340.0 8.1 % During 2012, consolidated revenue was $3.8 billion, down 9.0% compared to prior year. Gross profit decreased 11.4%, Operating expense increased 6.6% and Operating income decreased 57.8% when compared to the same period in 2011.

Net earnings for the year ended December 31, 2012 decreased 66.9% from the prior year primarily due to lower operating income. Operating income for the year ended December 31, 2012 included $121.8 million of pre-tax restructuring-related charges and project costs as well as $65.8 million of pre-tax acquisition-related adjustments. The Company uses the term "project costs" for incremental charges related to the execution of its restructuring plans. The Company uses the term 46 -------------------------------------------------------------------------------- Table of Contents "acquisition-related adjustments" for purchase accounting adjustments and incremental acquisition and integration costs related to acquisitions.

During 2011, consolidated revenue was $4.2 billion, down less than 1% compared to 2010. Gross profit increased 4.0%, Operating expense increased 6.1% and Operating income decreased less than 1% when compared to the same period in 2010.

Net earnings for the year ended December 31, 2011 decreased 6% from the prior year primarily due to an increase in income taxes combined with a 1% decrease in operating income. The Company recorded discrete tax items in 2011 that resulted in a higher tax provision and thus a higher effective tax rate compared to prior year. Operating income in 2011 included $29.9 million of pre-tax restructuring-related charges and project costs along with $29.4 million of pre-tax acquisition-related adjustments.

Revenue For the year ended December 31, 2012, consolidated revenue decreased 9% YTY, of which approximately 6% was due to the Company's exit of inkjet technology and 3% was due to the negative impact of currency. Total revenue was further impacted by economic weakness outside of North America.

Revenue by reportable segment: (Dollars in Millions) 2012 2011 % Change 2011 2010 % Change ISS $ 3,641.6 $ 4,078.2 -11 % $ 4,078.2 $ 4,162.4 -2 % Perceptive Software 156.0 94.8 65 % 94.8 37.3 154 % Total revenue $ 3,797.6 $ 4,173.0 -9 % $ 4,173.0 $ 4,199.7 -1 % ISS For the year ended December 31, 2012, ISS revenue decreased 11% compared to prior year, of which approximately 6% was due to the Company's exit of inkjet technology and 3% was due to the negative impact of currency. Hardware revenue declined 17% YTY and laser hardware revenue declined 10% YTY. Large workgroup laser hardware revenue, which represented about 76% of total hardware revenue for the year ended December 31, 2012 was down 9% YTY reflecting a 9% decline in average unit revenue ("AUR"), driven by a 3% currency impact and discounting to sell prior generation laser product ahead of new product launch. Small workgroup laser hardware revenue, which for the year ended December 31, 2012 represented 18% of total hardware revenue, declined 10% YTY driven by a 9% decline in units.

Small workgroup AUR declined 1%. Inkjet exit hardware revenue, which for the year ended December 31, 2012 represented 6% of total hardware revenue, declined 62% YTY as the Company exits inkjet technology. Supplies revenue for the year ended December 31, 2012 was down 9% compared to the same period in 2011. Laser supplies revenue declined 5% YTY driven by a 3% negative currency impact. Inkjet exit supplies revenue declined 21% YTY due to ongoing and expected declines in the inkjet install base as the Company exits inkjet technology.

For the year ended December 31, 2011, revenue in ISS decreased $84.2 million or 2% compared to 2010 due to the 7% decrease in hardware revenue. Strong revenue growth in high-end hardware was more than offset by the decline in low-end hardware, principally in inkjet. Supplies revenue during 2011 was essentially flat with 2010. The decrease in hardware revenue was driven by a 40% reduction in inkjet hardware revenue. Inkjet units declined 37% as the Company continues to exit the inkjet product line. Inkjet AUR decreased 4% YTY. Laser hardware revenue increased 2% YTY, driven by a 6% increase in AUR, again driven by improved product mix toward high-end laser devices, which was 47-------------------------------------------------------------------------------- Table of Contents partially offset by a 3% reduction in units due to lower unit sales of low-end laser units. Supplies revenue was flat YTY as the 11% growth in business laser and inkjet supplies was more than offset by a 32% decline in consumer inkjet supplies.

Perceptive Software Segment Reductions in revenue result from business combination accounting rules when deferred revenue balances assumed as part of acquisitions are adjusted down to fair value. Fair value approximates the cost of fulfilling the service obligation, plus a reasonable profit margin. Subsequent to acquisitions, the Company analyzes the amount of amortized revenue that would have been recognized had the acquired company remained independent and had the deferred revenue balances not been adjusted to fair value.

For the year ended December 31, 2012, revenue for Perceptive Software increased 65% compared to the same period in 2011. Excluding the impact of acquisition-related adjustments, revenue for Perceptive Software for the year ended December 31, 2012 increased 62% compared to the same period in 2011. The YTY increases are due to the acquisitions of Pallas Athena in the fourth quarter of 2011, Brainware, ISYS and Nolij in the first quarter of 2012 as well as organic growth of 21% in Perceptive Software. The 2012 and 2011 financial results for the Perceptive Software reportable segment include only the activity occurring after the dates of acquisition.

Perceptive Software was acquired by the Company on June 7, 2010. The 2010 financial results for Perceptive Software include only the activity occurring after the acquisition and is the primary reason behind the 154% increase in revenue in 2011 compared to 2010. Excluding the impact of acquisition-related adjustments, revenue for 2011 increased 98% compared to 2010.

See "Acquisition-related Adjustments" section that follows for further discussion.

The following table provides a breakdown of the Company's revenue by product: (Dollars in Millions) 2012 2011 % Change 2011 2010 % Change Laser and Inkjet Hardware (1) $ 826.5 $ 990.4 -17 % $ 990.4 $ 1,061.6 -7 % Laser and Inkjet Supplies (2) 2,640.1 2,910.6 -9 % 2,910.6 2,914.3 0 % Software and Other (3) 331.0 272.0 22 % 272.0 223.8 22 % Total revenue $ 3,797.6 $ 4,173.0 -9 % $ 4,173.0 $ 4,199.7 -1 % 1) Includes laser, inkjet, and dot matrix hardware and the associated features sold on a unit basis or through a managed service agreement 2) Includes laser, inkjet, and dot matrix supplies and associated supplies services sold on a unit basis or through a managed service agreement 3) Includes parts and service related to hardware maintenance and includes software licenses and the associated software maintenance services sold on a unit basis or as a subscription service For the year ended December 31, 2012, hardware revenue decreased 17% and supplies revenue decreased 9% YTY, partially offset by an increase of 22% in revenue from software and other driven by the YTY growth in Perceptive Software.

Revenue by product category for prior years has been adjusted to reflect changes in the methods used to identify product categories during 2012. Laser and Inkjet printers has been updated to include scanners and printers sold in conjunction with software solutions previously included in Software and Other. Software and Other has been updated to include parts revenue that was previously included in either Laser and Inkjet hardware or Laser and Inkjet supplies.

For the year ended December 31, 2011, consolidated revenue decreased 1% YTY, driven primarily by a 7% decrease in hardware revenue, primarily reflecting a decline in consumer inkjet hardware. This 48-------------------------------------------------------------------------------- Table of Contents decline was partially offset by a 22% YTY increase in Software and Other reflecting strong growth in Perceptive Software. Supplies revenue was essentially flat YTY.

During 2012, no one customer accounted for more than 10% of the Company's total revenues. In 2011 and 2010, one customer, Dell, accounted for $415 million or approximately 10% and $461 million or approximately 11% of the Company's total revenue, respectively. Sales to Dell are included primarily in the ISS reportable segment.

Revenue by geography: The following table provides a breakdown of the Company's revenue by geography: (Dollars in Millions) 2012 % of Total 2011 % of Total %Change 2011 2010 % of Total %Change United States $ 1,695.5 45 % $ 1,755.4 42 % -3 % $ 1,755.4 $ 1,790.9 43 % -2 % EMEA (Europe, the Middle East & Africa) 1,320.3 35 % 1,531.6 37 % -14 % 1,531.6 1,510.2 36 % 1 % Other International 781.8 20 % 886.0 21 % -12 % 886.0 898.6 21 % -1 % Total revenue $ 3,797.6 100 % $ 4,173.0 100 % -9 % $ 4,173.0 $ 4,199.7 100 % -1 % For the year ended December 31, 2012, the decline in revenues compared to the same period in 2011, for all regions, principally reflects the impact of the Company's planned exit from inkjet technologies and the weakened demand environment. Declines in EMEA, Latin America and Asia Pacific also reflect the impact of the stronger dollar. For 2012 currency exchange rates had a 3% unfavorable YTY impact on revenue. For 2011 currency exchange rates had a 2% favorable YTY impact on revenue.

Gross Profit The following table provides gross profit information: (Dollars in Millions) 2012 2011 % Change 2011 2010 % Change Gross profit dollars $ 1,400.0 $ 1,580.6 -11% $ 1,580.6 $ 1,519.5 4% % of revenue 36.9% 37.9% -1.0 pts 37.9% 36.2% 1.7 pts For the year ended December 31, 2012, consolidated gross profit decreased 11% while gross profit as a percentage of revenue decreased 1 percentage point compared to the same period in 2011. Gross profit margin versus the same period in 2011 was impacted by a 3.0 percentage point decrease YTY due to lower product margins, principally hardware pricing and the impact of currency. Gross profit margin was also impacted by a 1.5 percentage point decrease due to higher YTY cost of restructuring and acquisition-related activities. These were partially offset by a 3.5 percentage point YTY increase due to a favorable mix shift driven by relatively less inkjet hardware and relatively more laser supplies and software. Gross profit for the year ended December 31, 2012 included $47.8 million of pre-tax restructuring-related charges and project costs along with $32.7 million of pre-tax acquisition-related adjustments.

During 2011, consolidated gross profit increased when compared to the prior year as did gross profit as a percentage of revenue. The gross profit margin versus the prior year was impacted by a 2.9 percentage point increase due to a favorable mix shift among products, driven by relatively less inkjet hardware, and growth in laser supplies and software. Partially offsetting this was a 1.5 percentage point decrease YTY due to unfavorable product margins, predominately inkjet hardware. Gross profit margin was also impacted by a 0.3 percentage point increase due to lower YTY cost of restructuring and acquisition-related activities. Gross profit in 2011 included $5.2 million of restructuring-related charges and project costs in connection with the Company's restructuring activities as well as 49 -------------------------------------------------------------------------------- Table of Contents $20.4 million of pre-tax acquisition-related adjustments. Gross profit for 2011 includes the first full year of Perceptive Software financial results.

Gross profit in 2010 included $17.4 million of restructuring-related charges and project costs in connection with the Company's restructuring activities as well as $22.1 million of pre-tax acquisition-related adjustments.

See "Restructuring and Related Charges and Project Costs" and "Acquisition-related Adjustments" sections that follow for further discussion.

Operating Expense The following table presents information regarding the Company's operating expenses during the periods indicated: 2012 2011 2010 (Dollars in Millions) Dollars % of Rev Dollars % of Rev Dollars % of Rev Research and development $ 372.7 9.8 % $ 374.5 9.0 % $ 369.0 8.8 % Selling, general & administrative 804.1 21.2 % 761.2 18.2 % 701.2 16.7 % Restructuring and related charges 36.1 1.0 % 2.0 0.0 % 2.4 0.0 % Total operating expense $ 1,212.9 31.9 % $ 1,137.7 27.3 % $ 1,072.6 25.5 % For the year ended December 31, 2012, Total operating expense increased 6.6% compared to the same period in 2011. The increase was primarily due to higher pre-tax restructuring and related charges and related project costs. The remaining increases were primarily in the Perceptive Software segment and were driven by marketing and development expenditures as well as pre-tax acquisition related costs and adjustments from companies acquired over the last four quarters. ISS operating expenses were lower YTY despite the increase in restructuring and related charges as the charges were more than offset by the savings reflecting expense reductions from the Company's 2012 restructuring actions. Restructuring and related charges increased YTY primarily in the ISS segment and in All Other, and were driven by the Company's latest restructuring actions announced in 2012 related to the Company's exiting of the development and manufacture of inkjet technology.

Research and development expenses increased in 2011 compared to 2010 primarily reflecting expenses due to Perceptive Software and the fact that 2011 contains full year results of Perceptive Software operating expenses, offset slightly by a decrease in ISS development spending. Selling, general and administrative expenses in 2011 increased compared to 2010 due principally to the acquisition of Perceptive Software, as well as increased expenses in ISS and All other, principally due to currency.

See discussion below of restructuring and related charges and project costs and acquisition-related adjustments included in the Company's operating expenses for the periods presented in the table above.

In 2012, the Company incurred $74.0 million of pre-tax restructuring and related charges and project costs in operating expense due to the Company's restructuring plans. Of the $74.0 million incurred in 2012, $37.9 million is included in Selling, general and administrative while $36.1 million is included in Restructuring and related charges on the Company's Consolidated Statements of Earnings. Additionally, the Company incurred $33.1 million of pre-tax costs associated with acquisition related adjustments. Of the $33.1 million incurred in 2012, $0.9 million is included in Research and development, and $32.2 million is included in Selling, general, and administrative on the Company's Consolidated Statements of Earnings.

In 2011, the Company incurred $24.7 million of pre-tax restructuring and related charges and project costs in operating expense due to the Company's restructuring plans. Of the $24.7 million incurred in 50-------------------------------------------------------------------------------- Table of Contents 2011, $22.7 million is included in Selling, general and administrative while $2.0 million is included in Restructuring and related charges on the Company's Consolidated Statements of Earnings. Additionally, the Company incurred $9.0 million of pre-tax costs associated with acquisition related adjustments. Of the $9.0 million incurred in 2011, $0.4 million is included in Research and development, and $8.6 million is included in Selling, general and administrative on the Company's Consolidated Statements of Earnings.

In 2010, the Company recognized $21.2 million of restructuring-related charges and project costs in operating expense due to the Company's restructuring plans.

Of the $21.2 million incurred in 2010, $18.8 million is included in Selling, general and administrative while $2.4 million is included in Restructuring and related charges on the Company's Consolidated Statements of Earnings.

Additionally, the Company incurred $10.0 million of pre-tax costs associated with the acquisition of Perceptive Software included in Selling, general, and administrative on the Company's Consolidated Statements of Earnings.

See "Restructuring and Related Charges and Project Costs" and "Acquisition-related Adjustments" sections that follow for further discussion of the Company's restructuring plans and acquisitions.

Operating Income (Loss) The following table provides operating income by reportable segment: (Dollars in Millions) 2012 2011 Change 2011 2010 Change ISS $ 584.0 $ 764.5 -24% $ 764.5 $ 744.6 3% % of revenue 16.0% 18.7% -2.7 pts 18.7% 17.9% 0.8 pts Perceptive Software (72.2 ) (29.6 ) -144% (29.6 ) (16.1 ) -84% % of revenue -46.3% -31.2% -15.1 pts -31.2% -43.2% 12.0 pts All other (324.7 ) (292.0 ) -11% (292.0 ) (281.6 ) -4% Total operating income (loss) $ 187.1 $ 442.9 -58% $ 442.9 $ 446.9 -1% % of total revenue 4.9% 10.6% -5.7 pts 10.6% 10.6% 0 pts For the year ended December 31, 2012, the decrease in consolidated operating income compared to the same period in 2011, reflected lower operating income in the ISS and Perceptive Software segments and in All other. Lower ISS segment operating income drove the majority of YTY decline in consolidated operating income, reflecting primarily unfavorable currency movements and an increase in restructuring and related expenses and project costs. The YTY increase in operating loss for Perceptive Software reflects YTY increases in marketing and development expenditures and pre-tax acquisition-related costs and adjustments.

The YTY increase in expenses included in All other reflects the YTY increase in acquisition-related items and restructuring related charges and project costs.

For the year ended December 31, 2011, the decrease in consolidated operating income was primarily in the Perceptive Software segment, offset slightly by improvement in operating income (loss) for the ISS segment due to laser hardware revenue growth and improved margins, as well as improved hardware mix. The operating loss on the Perceptive Software segment was driven by an increase in both development and marketing and sales expense ahead of revenue growth. For Perceptive Software, operating income (loss) includes the full year results for 2011 as well as activities subsequent to the acquisition for 2010. The Company acquired Perceptive Software on June 7, 2010.

During 2012, the Company incurred total pre-tax restructuring-related charges and project costs of $92.6 million in ISS, $28.5 million in All other and $0.7 million in Perceptive Software, as well as pre-tax acquisition-related items of $46.9 million primarily in Perceptive Software and $18.9 million in All other.

During 2011, the Company incurred total pre-tax restructuring-related charges and project costs of $16.6 million in ISS and $13.3 million in All other, as well as pre-tax acquisition-related items of $26.1 million primarily in Perceptive Software and $3.3 million in All other. During 2010, the Company 51-------------------------------------------------------------------------------- Table of Contents incurred total pre-tax restructuring-related charges and project costs of $29.4 million in ISS and $9.2 million in All other as well as pre-tax acquisition-related items of $25.0 million primarily in Perceptive Software and $7.1 million in All other.

See "Restructuring and Related Charges and Project Costs" and "Acquisition-related Adjustments" sections that follow for further discussion.

Interest and Other The following table provides interest and other information: (Dollars in Millions) 2012 2011 2010 Interest (income) expense, net $ 29.6 $ 29.9 $ 26.3 Other (income) expense, net (0.5 ) (0.6 ) (1.2 ) Net impairment losses on securities - - 0.3 Total interest and other (income) expense, net $ 29.1 $ 29.3 $ 25.4 During 2012, total interest and other (income) expense, net, was an expense of $29.1 million, a 1% decrease compared to the same period in 2011.

During 2011, total interest and other (income) expense, net, was an expense of $29.3 million, a 15% increase compared to the same period in 2010. The 2011 net expense increase YTY was primarily due to lower interest income from declining interest rates on the Company's investments.

Provision for Income Taxes and Related Matters The Company's effective income tax rate was approximately 32.7%, 22.4% and 19.3% in 2012, 2011 and 2010, respectively. See Note 14 of the Notes to the Consolidated Financial Statements in Part II, Item 8 for a reconciliation of the Company's effective tax rate to the U.S. statutory rate.

The 10.3 percentage point increase of the effective tax rate from 2011 to 2012 was due primarily to a geographic shift in earnings toward higher tax jurisdictions in 2012 compared to 2011, and to the lack of the U.S. research and experimentation tax credit in 2012.

The 3.1 percentage point increase of the effective tax rate from 2010 to 2011 was due to the adjustments to previously accrued taxes in 2011 compared to 2010, a geographic shift in earnings toward higher tax jurisdictions in 2011, the U.S.

R&E credit being a larger percentage of consolidated earnings before income taxes in 2011, and a variety of other factors.

In January of 2013, the President signed into law The American Taxpayer Relief Act of 2012, which contained provisions that retroactively extended the U.S.

research and experimentation tax credit to 2012 and 2013. Because the extension did not happen by December 31, 2012, the Company's effective income tax rate for 2012 did not include the benefit of the credit for 2012. However, because the credit was retroactively extended to include 2012, the Company expects to recognize the full benefit of the 2012 credit in the first quarter of 2013. The Company estimates that its credit for 2012 is $6.0 million. That amount will be reported as a discrete income tax benefit in the first quarter of 2013.

Net Earnings and Earnings per Share The following table summarizes net earnings and basic and diluted net earnings per share: (Dollars in millions, except per share amounts) 2012 2011 2010 Net Earnings $ 106.3 $ 320.9 $ 340.0 Basic earnings per share $ 1.55 $ 4.16 $ 4.33 Diluted earnings per share $ 1.53 $ 4.12 $ 4.28 52 -------------------------------------------------------------------------------- Table of Contents Net earnings for the year ended December 31, 2012 decreased 66.9% from the prior year primarily due to lower operating income combined with a higher effective tax rate when compared to the same period in 2011. For 2012, the YTY change in basic and diluted earnings per share was primarily due to the change in net earnings partially offset by the decreases in the average number of shares outstanding, due to the Company's share repurchases.

Net earnings for the year ended December 31, 2011 decreased 6% from the prior year primarily due to an increase in the effective tax rate as well as lower operating income and higher net interest expense. For 2011, the YTY decreases in basic and diluted earnings per share were primarily attributable to decreased earnings offset partially by the decreases in the average number of shares outstanding, due to the Company's share repurchases.

RESTRUCTURING AND RELATED CHARGES AND PROJECT COSTS Summary of Restructuring Impacts The Company's 2012 financial results are impacted by its restructuring plans and related projects. As part of Lexmark's ongoing strategy to increase the focus of its talent and resources on higher usage business platforms, the Company announced restructuring actions (the "2012 Restructuring Actions") on January 31 and August 28, 2012. These actions better align the Company's sales, marketing and development resources, and align and reduce its support structure consistent with its focus on business customers. The 2012 Restructuring Actions include exiting the development and manufacturing of the Company's inkjet technology, with reductions primarily in the areas of inkjet-related manufacturing, research and development, supply chain, marketing and sales as well as other support functions. The Company will continue to provide service, support and aftermarket supplies for its inkjet installed base.

At the close of 2012, the Company was in the process of identifying potential buyers and gauging interest in certain inkjet technology and intellectual property. The asset group did not qualify as held for sale under the FASB guidance on accounting for the impairment or disposal of long-lived assets at December 31, 2012.

The 2012 Restructuring Actions are expected to impact about 2,325 positions worldwide, including 1,100 manufacturing positions. The 2012 Restructuring Actions will result in total pre-tax charges, including project costs, of approximately $192 million with $126.7 million incurred to date, approximately $40 million to be incurred in 2013 and the remaining $25.3 million to be incurred in 2014 and 2015. The Company expects the total cash costs of the 2012 Restructuring Actions to be approximately $93 million with $59.4 million incurred to date, $30.6 million impacting 2013, and the remaining $3 million impacting 2014 and 2015. The anticipated timing of cash outlays for the 2012 Restructuring Actions is $38 million in 2013 and $17 million in 2014 and 2015, with cash outlays of approximately $38 million in 2012. Lexmark expects the 2012 Restructuring Actions to generate savings of approximately $18 million in 2012, approximately $113 million in 2013 and ongoing annual savings beginning in 2015 of approximately $123 million, of which approximately $85 million will be cash savings. These ongoing savings should be split approximately 65% to operating expense and 35% to cost of revenue. The Company expects these actions to be principally complete by the end of 2015.

Refer to Part II, Item 8, Note 5 of the Notes to Consolidated Financial Statements for a description of the Company's Other Restructuring Actions. The Other Restructuring Actions are substantially completed and any remaining charges to be incurred are expected to be immaterial.

Refer to Part II, Item 8, Note 5 of the Notes to Consolidated Financial Statements for a rollforward of the liability incurred for the 2012 Restructuring Actions and the Other Restructuring Actions.

53 -------------------------------------------------------------------------------- Table of Contents Project costs consist of additional charges related to the execution of the restructuring plans. These project costs are incremental to the Company's normal operating charges and are expensed as incurred, and include such items as compensation costs for overlap staffing, travel expenses, consulting costs and training costs.

Impact to 2012 Financial Results For the year ended December 31, 2012, the Company incurred charges (reversals), including project costs, of $121.8 million for the Company's restructuring plans as follows: 2012 2012 Actions 2012 Other Actions Restructuring- Actions Actions Other Restructuring- related Restructuring- Restructuring- Actions related Pension related 2012 related Restructuring- Other Charges Costs Project Actions Charges related Actions (Dollars in millions) (Note 5) (Note 17) Costs Total (Note 5) Project Costs Total Total Accelerated depreciation charges $ 49.3 $ - $ - $ 49.3 $ 0.1 $ - $ 0.1 $ 49.4 Excess components and other inventory-related charges 17.7 - - 17.7 - - - 17.7 Impairments on long-lived assets held for sale 0.6 - - 0.6 1.5 - 1.5 2.1 Employee termination benefit charges 31.1 - - 31.1 (0.1 ) - (0.1 ) 31.0 Contract termination and lease charges 4.2 - - 4.2 0.9 - 0.9 5.1 Pension and postretirement curtailment loss and termination benefits - 7.9 - 7.9 - - - 7.9 Project costs - - 8.3 8.3 - 0.3 0.3 8.6 Total restructuring-related charges/project costs $ 102.9 $ 7.9 $ 8.3 $ 119.1 $ 2.4 $ 0.3 $ 2.7 $ 121.8 The Company incurred accelerated depreciation charges of $29.5 million and $19.9 million in Cost of revenue and Selling, general and administrative, respectively, on the Consolidated Statements of Earnings. Excess components and other inventory-related charges of $17.7 million were incurred in Cost of revenue, and $0.6 million and $1.5 million, respectively, of impairment charges related to long-lived assets held for sale were incurred in Cost of revenue and Selling, general and administrative on the Consolidated Statements of Earnings.

Total employee termination benefit and contract termination and lease charges of $31.0 million and $5.1 million, respectively, are included in Restructuring and related charges, and restructuring-related project costs and pension and postretirement related expenses of $8.6 million and $7.9 million, respectively, are included in Selling, general and administrative on the Company's Consolidated Statements of Earnings.

For the year ended December 31, 2012, the Company incurred restructuring and related charges and project costs related to the 2012 Restructuring Actions of $91.8 million in ISS, $26.6 million in All other and $0.7 million in Perceptive Software. The Company incurred restructuring and related charges and project costs related to the Other Restructuring Actions of $0.8 million in ISS and $1.9 million in All other.

54 -------------------------------------------------------------------------------- Table of Contents Impact to 2011 Financial Results For the year ended December 31, 2011, the Company incurred charges (reversals), including project costs, of $29.9 million for the Company's restructuring plans as follows: 2012 2012 Other Other Actions Actions Actions Actions Restructuring Restructuring Restructuring Restructuring - related - related 2012 - related - related Other Charges Project Actions Charges Project Actions (Dollars in millions) (Note 5) Costs Total (Note 5) Costs Total Total Accelerated depreciation charges $ 4.5 $ - $ 4.5 $ 2.4 $ - $ 2.4 $ 6.9 Impairments on long-lived assets held for sale - - - 4.6 - 4.6 4.6 Employee termination benefit charges 3.1 - 3.1 (1.0 ) - (1.0 ) 2.1 Contract termination and lease charges - - - (0.1 ) - (0.1 ) (0.1 ) Project costs - - - - 16.4 16.4 16.4 Total restructuring-related charges/project costs $ 7.6 $ - $ 7.6 $ 5.9 $ 16.4 $ 22.3 $ 29.9 The Company incurred accelerated depreciation charges of $4.5 million and $2.4 million, respectively, in Cost of revenue and Selling, general and administrative on the Consolidated Statements of Earnings. Impairment charges of $4.6 million related to long-lived assets held for sale are included in Selling, general and administrative, and total employee termination benefit and contract termination and lease charges of $2.0 million are included in Restructuring and related charges on the Consolidated Statements of Earnings.

Restructuring-related project costs of $0.7 million and $15.7 million, respectively, are included in Cost of revenue and Selling, general and administrative on the Company's Consolidated Statements of Earnings.

For the year ended December 31, 2011, the Company incurred restructuring and related charges and project costs related to the 2012 Restructuring Plan of $7.6 million in ISS. The Company incurred restructuring and related charges and project costs related to the Other Restructuring Actions of $9.0 million in ISS and $13.3 million in All other.

In 2011, the Company recorded impairment charges of $1.0 million related to its manufacturing facility in Juarez, Mexico, and $3.6 million related to one of its support facilities in Boigny, France for which the current fair values had fallen below the carrying values. The asset impairment charges are included in Selling, general and administrative on the Company's Consolidated Statements of Earnings. Subsequent to the impairment charge, the Juarez, Mexico facility was sold and the Company recognized a $0.6 million pre-tax gain on the sale that is included in Selling, general and administrative on the Company's Consolidated Statements of Earnings. This gain is included in the $29.9 million total restructuring-related charges presented above as project costs related to the Company's Other Restructuring Actions.

55-------------------------------------------------------------------------------- Table of Contents Impact to 2010 Financial Results For the year ended December 31, 2010, the Company incurred charges (reversals), including project costs, of $38.6 million for the Company's restructuring plans as follows: Other Actions Other Actions Restructuring- Restructuring- Other related Charges related Project Actions (Dollars in millions) (Note 5) Costs Total Accelerated depreciation charges $ 5.9 $ - $ 5.9 Employee termination benefit charges (0.1 ) - (0.1 ) Contract termination and lease charges 2.5 - 2.5 Project costs - 30.3 30.3 Total restructuring-related charges/project costs $ 8.3 $ 30.3 $ 38.6 The Company incurred accelerated depreciation charges of $4.1 million and $1.8 million, respectively, in Cost of revenue and Selling, general and administrative on the Consolidated Statements of Earnings. Employee termination benefit and contract termination and lease charges of $2.4 million are included in Restructuring and related charges, and $13.3 million and $17.0 million, respectively, of restructuring-related project costs are included in Cost of revenue and Selling, general and administrative on the Company's Consolidated Statements of Earnings.

For the year ended December 31, 2010, the Company incurred restructuring and related charges (reversals) and project costs related to the Other Restructuring Actions of $29.4 million in ISS and $9.2 million in All other.

In 2010, the Company sold one of its inkjet supplies manufacturing facilities in Chihuahua, Mexico for $5.6 million and recognized a $0.5 million pre-tax gain on the sale that is included in Selling, general and administrative on the Consolidated Statements of Earnings. This gain is included in the $38.6 million total restructuring-related charges presented above as project costs related to the Company's Other Restructuring Actions.

ACQUISITION-RELATED ADJUSTMENTS In connection with acquisitions, Lexmark incurs costs and adjustments (referred to as "acquisition-related adjustments") that affect the Company's financial results. These acquisition-related adjustments result from business combination accounting rules as well as expenses that would otherwise have not been incurred by the Company if acquisitions had not taken place.

The following pre-tax acquisition-related adjustments affected the Company's financial results.

(Dollars in Millions) 2012 2011 2010 Reduction in revenue $ 5.5 $ 4.9 $ 13.0 Amortization of intangible assets 41.4 21.2 12.0 Acquisition and integration costs 18.9 3.3 7.1 Total acquisition-related adjustments $ 65.8 $ 29.4 $ 32.1 Reductions in revenue result from business combination accounting rules when deferred revenue balances assumed as part of acquisitions are adjusted down to fair value. Fair value approximates the cost of fulfilling the service obligation, plus a reasonable profit margin. Subsequent to acquisitions, the Company analyzes the amount of amortized revenue that would have been recognized had the acquired company remained independent and had the deferred revenue balances not been adjusted to fair value. The $5.5 million, $4.9 million and $13.0 million downward adjustments to revenue for 2012, 56-------------------------------------------------------------------------------- Table of Contents 2011 and 2010, respectively, are reflected in Revenue presented on the Company's Consolidated Statements of Earnings. With respect to the acquisitions completed in 2012 and 2011, the Company expects future pre-tax reductions in revenue of approximately $10 million for 2013.

Due to business combination accounting rules, intangible assets are recognized as a result of acquisitions which were not previously presented on the balance sheet of the acquired company. These intangible assets consist primarily of purchased technology, customer relationships, trade names, in-process R&D and non-compete agreements. Subsequent to the acquisition date, some of these intangible assets begin amortizing and represent an expense that would not have been recorded had the acquired company remained independent. The Company incurred the following on the Consolidated Statements of Earnings for the amortization of intangible assets.

Amortization of intangible assets (Dollars in Millions) 2012 2011 2010 Recorded in Cost of revenue $ 27.2 $ 15.5 $ 9.1 Recorded in Research and development 0.9 0.4 - Recorded in Selling, general and administrative 13.3 5.3 2.9 Total amortization of intangible assets $ 41.4 $ 21.2 $ 12.0 For 2013, the Company expects pre-tax charges for the amortization of intangible assets to be approximately $51 million.

In connection with its acquisitions, the Company incurs acquisition and integration expenses that would not have been incurred otherwise. The acquisition costs include items such as investment banking fees, legal and accounting fees, and costs of retention bonus programs for the senior management of the acquired company. Integration costs may consist of information technology expenses, consulting costs and travel expenses as well as non-cash charges related to the abandonment of assets under construction by the Company that are determined to be duplicative of assets of the acquired company. The costs are expensed as incurred and can vary substantially in size from one period to the next.

During 2012, 2011 and 2010 the Company incurred $18.9 million, $3.3 million and $7.1 million, respectively, in Selling, general and administrative on the Company's Consolidated Statements of Earnings for acquisition and integration costs. The Company expects pre-tax adjustments for acquisition and integration expenses of approximately $4 million for 2013.

Adjustments to revenue and amortization of intangible assets were recognized primarily in the Perceptive Software reportable segment. Acquisition and integration costs were recognized primarily in All other.

PENSION AND OTHER POSTRETIREMENT PLANS The following table provides the total pre-tax cost related to Lexmark's pension and other postretirement plans for the years 2012, 2011, and 2010. Cost amounts are included as an addition to the Company's cost and expense amounts in the Consolidated Statements of Earnings.

(Dollars in Millions) 2012 2011 2010 Total cost of pension and other postretirement plans $ 57.1 $ 42.9 $ 38.8 Comprised of: Defined benefit pension plans $ 28.4 $ 18.0 $ 15.4 Defined contribution plans 26.0 25.6 23.6 Other postretirement plans 2.7 (0.7 ) (0.2 ) 57 -------------------------------------------------------------------------------- Table of Contents Changes in actuarial assumptions did not have a significant impact on the Company's results of operations in 2010, 2011 and 2012, nor are they expected to have a material effect in 2013. Future effects of retirement-related benefits on the operating results of the Company depend on economic conditions, employee demographics, mortality rates and investment performance. Refer to Part II, Item 8, Note 17 of the Notes to Consolidated Financial Statements for additional information relating to the Company's pension and other postretirement plans.

Defined benefit pension expense increased $10.4 million in 2012 primarily due to restructuring charges and higher amortization of deferred losses in the U.S. The $3.4 million increase in postretirement expense in 2012 was largely due to the final amortization of a prior plan amendment benefit in 2011. Because the Company defers current year differences between actual and expected asset returns on equity and high-yield bond investments over the subsequent five years in accordance with prescribed accounting guidelines, pension expense for 2012 and 2011 was impacted $5 million and $3 million, respectively.

The funding requirement for single-employer defined pension plans under the Pension Protection Act of 2006 ("the Act") are largely based on a plan's calculated funded status, with faster amortization of any shortfalls. The Act directs the U.S. Treasury Department to develop a new yield curve to discount pension obligations for determining the funded status of a plan when calculating the funding requirements.

LIQUIDITY AND CAPITAL RESOURCES Financial Position Lexmark's financial position remains strong at December 31, 2012, with working capital of $478.5 million compared to $1,085.5 million at December 31, 2011. The $607.0 million decrease in working capital accounts was primarily due to acquisitions, share repurchases and dividend payments, and the reclassification of certain debt securities from long term liabilities to short term liabilities in 2012. Cash and cash equivalents and current Marketable securities decreased $243.6 million and was driven by business acquisitions, which shifted a substantial amount of current assets to noncurrent assets, primarily intangible assets and goodwill. Additionally, the Company repurchased shares in the amount of $190.0 million and made cash dividend payments of $78.6 million during the year. The Company also reclassified $350.0 million of long-term debt with a maturity date of June 1, 2013, to a current liability during 2012. The Company anticipates issuing additional debt in 2013 to primarily refinance the $350.0 million due in 2013.

At December 31, 2012 and December 31, 2011, the Company had senior note debt of $649.6 million and $649.3 million, respectively. Of the $649.6 million, $350.0 million was classified as the current portion at December 31, 2012. The Company had no amounts outstanding under its U.S. trade receivables financing program or its revolving credit facility at December 31, 2012 or December 31, 2011.

The debt to total capital ratio was stable at 34% at December 31, 2012 and 32% at December 31, 2011. The debt to total capital ratio is calculated by dividing the Company's outstanding debt by the sum of its outstanding debt and total stockholders' equity.

58 -------------------------------------------------------------------------------- Table of Contents Liquidity The following table summarizes the Company's Consolidated Statements of Cash Flows for the years indicated: (Dollars in Millions) 2012 2011 2010 Net cash flows provided by (used for): Operating activities $ 413.1 $ 391.0 $ 520.4 Investing activities (294.3 ) (96.9 ) (630.6 ) Financing activities (263.4 ) (272.3 ) (12.3 ) Effect of exchange rate changes on cash 0.9 (3.2 ) 0.7 Net (decrease) increase in cash and cash equivalents $ (143.7 ) $ 18.6 $ (121.8 ) The Company's primary source of liquidity has been cash generated by operations, which totaled $413.1 million, $391.0 million, and $520.4 million in 2012, 2011, and 2010, respectively. Cash from operations generally has been sufficient to allow the Company to fund its working capital needs and finance its capital expenditures and acquisitions. Management believes that cash provided by operations will continue to be sufficient on a worldwide basis to meet operating and capital needs as well as the funding of expected dividends and share repurchases for the next twelve months. However, in the event that cash from operations is not sufficient, the Company has substantial cash and cash equivalents and current marketable securities balances and other potential sources of liquidity through utilization of its trade receivables financing program and revolving credit facility or access to the private and public debt markets. The Company may choose to use these sources of liquidity from time to time, including during 2013, to fund strategic acquisitions, dividends, and/or share repurchases.

As of December 31, 2012, the Company held $905.8 million in Cash and cash equivalents and current Marketable securities. The Company's ability to fund operations from this balance could be limited by the liquidity in the market as well as possible tax implications of moving proceeds across jurisdictions. Of this amount, approximately $869.8 million of Cash and cash equivalents and current Marketable securities were held by foreign subsidiaries. The Company utilizes a variety of financing strategies with the objective of having its worldwide cash available in the locations where it is needed. However, if amounts held by foreign subsidiaries were needed to fund operations in the U.S., the Company could be required to accrue and pay taxes to repatriate a large portion of these funds. The Company's intent is to permanently reinvest undistributed earnings of low tax rate foreign subsidiaries and current plans do not demonstrate a need to repatriate them to fund operations in the U.S.

As of December 31, 2011, the Company held $1,149.4 million in Cash and cash equivalents and current Marketable securities. Of this amount, approximately $988.4 million of Cash and cash equivalents and current Marketable securities were held by foreign subsidiaries.

A discussion of the Company's additional sources of liquidity is included in the Financing activities section to follow.

Operating activities The Company continues to generate significant annual cash flow from operations.

After the decrease in earnings and in cash flows in 2011 versus 2010, cash flow from operations in 2012 increased to $413.1 million, reflecting lower cash outlays, partially offset by the decline in net earnings.

The $22.1 million increase in cash flow from operating activities from 2011 to 2012 was driven by the following factors.

59-------------------------------------------------------------------------------- Table of Contents The favorable YTY change in Accrued liabilities and in Other assets and liabilities, collectively, was $175.4 comparing 2012 to 2011. The largest factors behind the YTY movement included cash paid for income taxes, annual incentive compensation payments, less increase in capital lease receivables, and pension and postretirement funding. Refer to Part II, Item 8, Note 14 of the Notes to the Consolidated Financial Statements for information related to cash paid for income taxes. Annual incentive compensation payments were approximately $10 million in 2012 compared to $65 million in 2011. The decrease of capital lease receivables YTY generated a favorable impact of $20.1 million. The Company also made approximately $39 million of pension and post retirement plan payments in 2012 compared to the net contribution of $31 million in 2011.

Changes in Accounts payable balances contributed $72.6 million to the increase in cash flow from operating activities from 2011 to 2012. Accounts payable increased $22.0 million in 2012 while they decreased $50.6 million in 2011. The increase in 2012 is driven by the longer payment cycle.

Inventories decreased $58.2 million in 2012 while they decreased $30.6 million in 2011. This $27.6 million improvement reflects improved inventory management.

The activities above were partially offset by the following factors.

Net Earnings decreased $214.6 million for the full year 2012 as compared to the full year 2011. However, the YTY decrease in Net Earnings was affected by a YTY increase in depreciation and amortization as well as other charges related to restructuring actions not funded during 2012.

Trade receivables balances increased $57.2 million in 2012 while they decreased $24.0 million in 2011, excluding receivables recognized from business combinations. This $81.2 million fluctuation between the activity in 2012 and that of 2011 is driven largely by increased delinquencies as well as an increase in days sales outstanding. The increase in days sales outstanding reflects the changing mix of the Companies business toward solutions, software and managed print services, which have longer collection periods than traditional hardware and supplies.

Refer to the contractual cash obligations table that follows for additional information regarding items that will likely impact the Company's future cash flows.

The $129.4 million decrease in cash flow from operating activities from 2010 to 2011 was driven by the following factors.

The decrease in Accrued liabilities and unfavorable change in Other assets and liabilities, collectively, was $191.6 million more in 2011 than in 2010. The largest factors behind the YTY movement included annual incentive compensation payments, cash paid for income taxes, pension funding and increase in capital lease receivable.

Annual incentive compensation payments were approximately $65 million in 2011 compared to $29 million in 2010, driven by the improvement in 2010 full year results compared to that of 2009. Cash paid for income taxes was $93 million in 2011, compared to $77 million in 2010. The Company also made approximately $31 million of pension and post retirement plan payments in 2011 compared to the net contribution of $9 million in 2010. The increase of capital lease receivable YTY generated an additional unfavorable impact of $32 million and is due to the growth in managed print services arrangements in 2011.

Accounts payable decreased $50.6 million in 2011 while they increased $22.7 million in 2010. The decrease in 2011 is driven by the shorter payment cycle along with decreased spending levels.

The activities above were partially offset by the following factors.

60-------------------------------------------------------------------------------- Table of Contents Trade receivables balances decreased $24 million in 2011 while they increased $28.5 million in 2010, excluding receivables recognized on the date of acquisitions. This $52.5 million fluctuation between the activity in 2011 and that of 2010 is driven by the timing of revenue in the fourth quarter as well as less delinquencies.

Inventories decreased $30.6 million in 2011 while they increased $8.8 million in 2010. This $39.4 million fluctuation results from decreased spending in 2011 relative to 2010.

Cash conversion days 2012 2011 2010 Days of sales outstanding 49 39 39 Days of inventory 39 45 46 Days of payables 72 66 68 Cash conversion days 16 18 18 Cash conversion days represent the number of days that elapse between the day the Company pays for materials and the day it collects cash from its customers.

Cash conversion days are equal to the days of sales outstanding plus days of inventory less days of payables.

The days of sales outstanding are calculated using the period-end Trade receivables balance, net of allowances, and the average daily revenue for the quarter.

The days of inventory are calculated using the period-end net Inventories balance and the average daily cost of revenue for the quarter.

The days of payables are calculated using the period-end Accounts payable balance and the average daily cost of revenue for the quarter.

Please note that cash conversion days presented above may not be comparable to similarly titled measures reported by other registrants. The cash conversion days in the table above may not foot due to rounding.

Other Notable Operating Activities As of December 31, 2012 and December 31, 2011, the Company had accrued approximately $64.4 million and $63.3 million, respectively, 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 Statements of Financial Position. Refer to Part II, Item 8, Note 19 of the Notes to Consolidated Financial Statements for additional information. The payment(s) of these fees could have a material impact on the Company's future operating cash flows.

Investing activities The $197.4 million increase in net cash flows used for investing activities during 2012 compared to that of 2011 was driven by the $204.0 million increase in business acquisitions.

The $533.7 million decrease in net cash flows used for investing activities during 2011 compared to that of 2010 was driven by the $298.5 million YTY net decrease in marketable securities investments as well as the $232.1 million decrease in business acquisitions.

61-------------------------------------------------------------------------------- Table of Contents The Company's business acquisitions, marketable securities and capital expenditures are discussed below.

Business acquisitions In 2012, cash flow used to acquire businesses was higher than 2011 due to the additional acquisitions of Brainware, ISYS, Nolij, and Acuo at a total purchase price of $245.4 million compared to Pallas Athena, which was acquired in 2011.

Brainware is a leading provider of intelligent data capture software which builds upon and strengthens Lexmark's unique, industry-leading end-to-end products, solutions and services with a broader range of software that enables customers to capture, manage and access information and business process workflows. ISYS is a leader in high performance enterprise and federated search and universal information access solutions. Nolij is a prominent provider of Web-based imaging, document management and workflow solutions for the higher education market. Acuo is a leading provider of software for the healthcare sector, including clinical content management, data migration, and vendor neutral archives.

In 2011, cash flow used to acquire businesses was lower than 2010 due to the relatively smaller acquisition of Pallas Athena compared to Perceptive Software.

Pallas Athena, which was acquired at a purchase price of $41.4 million, is a BPM, DOM, and process mining software company that complements the product range offered by Perceptive Software.

Refer to Part II, Item 8, Note 4 of the Notes to Consolidated Financial Statements for additional information regarding business combinations.

Marketable securities The Company decreased its marketable securities investments in 2012 by $113.6 million. The Company decreased its marketable securities investments in 2011 by $96.4 million. The Company increased its marketable securities investments in 2010 by $202.1 million. The Company decreased its investment in marketable securities in 2012 in order to fund the business acquisitions, share repurchases, and dividend payments.

The Company's investments in marketable securities are classified and accounted for as available-for-sale and reported at fair value. At December 31, 2012 and December 31, 2011, the Company's marketable securities portfolio consisted of asset-backed and mortgage-backed securities, corporate debt securities, preferred and municipal debt securities, U.S. government and agency debt securities, international government securities, certificates of deposit and commercial paper. The Company's auction rate securities, valued at $6.3 million and $11.5 at December 31, 2012 and December 31, 2011, respectively, were reported in the noncurrent assets section of the Company's Consolidated Statements of Financial Position. During 2012, the Company received $6.5 million related to the Company's auction rate securities, some of which were fully redeemed at par by the issuers.

The marketable securities portfolio held by the Company contains market risk (including interest rate risk) and credit risk. These risks are managed through the Company's investment policy and investment management contracts with professional asset managers which require sector diversification, limitations on maturity and duration, minimum credit quality and other criteria. The Company also maintains adequate issuer diversification through strict issuer limits except for securities issued by the U.S. government or its agencies. The Company's ability to access the portfolio to fund operations could be limited by the liquidity in the market as well as possible tax implications of moving proceeds across jurisdictions.

The Company assesses its marketable securities for other-than-temporary declines in value in accordance with the model provided under the FASB's amended guidance, which was adopted in the second quarter of 2009. The Company has disclosed in the Critical Accounting Policies and Estimates 62-------------------------------------------------------------------------------- Table of Contents portion of Management's Discussion and Analysis its policy regarding the factors it considers and significant judgments made in applying the amended guidance.

There were no major developments during 2012 with respect to OTTI of the Company's marketable securities. Specifically regarding the Company's auction rate securities, the most illiquid securities in the portfolio, Lexmark has previously recognized OTTI on only one security due to credit events involving the issuer and the insurer. Because of the Company's liquidity position, it is not more likely than not that the Company will be required to sell the auction rate securities until liquidity in the market or optional issuer redemption occurs. The Company could also hold the securities to maturity if it chooses.

Additionally, if Lexmark required capital, the Company has available liquidity through its trade receivables facility and revolving credit facility. Given these circumstances, the Company would only have to recognize OTTI on its auction rate securities if the present value of the expected cash flows is less than the amortized cost of the individual security.

Level 3 fair value measurements are based on inputs that are unobservable and significant to the overall valuation. Level 3 measurements were 2.1% of the Company's total available-for-sale marketable securities portfolio at December 31, 2012 compared to 4.5% at December 31, 2011.

Refer to Part II, Item 8, Note 3 of the Notes to Consolidated Financial Statements for additional information regarding fair value measurements. Refer to Part II, Item 8, Note 7 of the Notes to Consolidated Financial Statements for additional information regarding marketable securities.

Capital expenditures The Company invested $162.2 million, $156.5 million, and $161.2 million into Property, plant and equipment for the years 2012, 2011 and 2010, respectively.

Further discussion regarding 2012 capital expenditures as well as anticipated spending for 2013 are provided near the end of Item 7.

Financing activities The fluctuations in the net cash flows provided by financing activities were principally due to the Company's share repurchases and proceeds from employee stock plans, partially offset by dividend payments. In 2012, cash flows used for financing activities were $263.4 million, due mainly to share repurchases of $190.0 million, and dividend payments of $78.6 million, less proceeds from employee stock plans of 5.8 million. In 2011, cash flows used for financing activities were $272.3 million, due mainly to share repurchases of $250 million, dividend payment of $18 million as well as the $7.1 million repayment of debt assumed by the Company in the fourth quarter acquisition of Pallas Athena. In 2010, cash flows used for financing activities were $12.3 million due mainly to the decrease in bank overdrafts of $10.0 million included in Other as well as the $3.1 million repayment of long term debt that was assumed by the Company in the second quarter acquisition of Perceptive Software.

Intra-period financing activities Bank overdrafts and other financing sources were utilized to supplement daily cash needs of the Company and its subsidiaries in 2012. Such borrowings were repaid in very short periods of time, generally in a matter of few days, and were not material to the Company's overall liquidity position or its financial statements.

Share repurchases and dividend payments The Company's capital return framework is to return, on average, more than 50 percent of free cash flow to its shareholders through dividends and share repurchases. During 2012, the Company repurchased approximately 8.1 million shares of its Class A Common Stock at a cost of $190 million through four accelerated share repurchase agreements executed during the period. As of 63-------------------------------------------------------------------------------- Table of Contents December 31, 2012, there was approximately $251 million of remaining share repurchase authority from the Board of Directors. 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. Refer to Part II, Item 8, Note 15 of the Notes to Consolidated Financial Statements for additional information regarding share repurchases. During 2011, the Company repurchased approximately 7.9 million shares of its Class A Common Stock at a cost of $250 million through two accelerated share repurchase agreements executed during the period. The Company did not repurchase any shares of its Class A Common Stock in 2010.

The Company's board declared dividends each quarter during 2012. Refer to Part II, Item 8, Note 15 of the Notes to Consolidated Financial Statements for additional information.

On February 21, 2013, subsequent to the date of the financial statements, the Company's Board of Directors declared a cash dividend of $0.30 per share. The cash dividend will be paid on March 15, 2013, to shareholders of record as of the close of business on March 4, 2013. Future declarations of quarterly dividends are subject to approval by the Board of Directors and may be adjusted as business needs or market conditions change.

After the close of the markets on January 29, 2013, the Company entered into an ASR Agreement with a financial institution counterparty to repurchase additional shares of the Company's Class A Common Stock. Refer to Part II, Item 8, Note 21 of the Notes to Consolidated Financial Statements for additional information.

Senior Note Debt In May 2008, the Company completed a public debt offering of $650 million aggregate principal amount of fixed rate senior unsecured notes. The notes are split into two tranches of five- and ten-year notes respectively. The five-year notes with an aggregate principal amount of $350 million and 5.9% coupon were priced at 99.83% to have an effective yield to maturity of 5.939% and will mature June 1, 2013 (referred to as the "2013 senior notes"). Consequently, the aggregate principal amount of $350 million was reclassified from non-current to a current liability during 2012. The ten-year notes with an aggregate principal amount of $300 million and 6.65% coupon were priced at 99.73% to have an effective yield to maturity of 6.687% and will mature June 1, 2018 (referred to as the "2018 senior notes"). At December 31, 2012 and December 31, 2011, the outstanding balance of senior note debt was $649.6 million and $649.3 million, respectively, net of discount.

The 2013 and 2018 senior notes (collectively referred to as the "senior notes") pay interest on June 1 and December 1 of each year. The interest rate payable on the notes of each series is subject to adjustments from time to time if either Moody's Investors Service, Inc. or Standard and Poor's Ratings Services downgrades the debt rating assigned to the notes to a level below investment grade, or subsequently upgrades the ratings.

The senior notes contain typical restrictions on liens, sale leaseback transactions, mergers and sales of assets. There are no sinking fund requirements on the senior notes and they may be redeemed at any time at the option of the Company, at a redemption price as described in the related indenture agreement, as supplemented and amended, in whole or in part. If a "change of control triggering event" as defined below occurs, the Company will be required to make an offer to repurchase the notes in cash from the holders at a price equal to 101% of their aggregate principal amount plus accrued and unpaid interest to, but not including, the date of repurchase. A "change of control triggering event" is defined as the occurrence of both a change of control and a downgrade in the debt rating assigned to the notes to a level below investment grade.

64 -------------------------------------------------------------------------------- Table of Contents Net proceeds from the senior notes have been used for general corporate purposes, such as to fund share repurchases, finance capital expenditures and operating expenses and invest in subsidiaries.

The Company anticipates issuing additional debt in 2013 to primarily refinance the $350.0 million due in 2013. Should the Company choose to repay the 2013 senior notes prior to maturity, a gain or loss could be recognized upon extinguishment.

Additional sources of liquidity The Company has additional liquidity available through its trade receivables facility and revolving credit facility. These sources can be accessed domestically if the Company is unable to satisfy its cash needs in the United States with cash flows provided by operations and existing cash and cash equivalents and marketable securities.

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 transfer the receivables on a limited recourse basis to an unrelated third party. The financial results of LRC are included in the Company's consolidated financial results since it is a wholly owned subsidiary. 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. The Company accounts for transfers of receivables from LRC to the unrelated third party as a secured borrowing with the pledge of its receivables as collateral since LRC has the ability to repurchase the receivables interests at a determinable price.

In September 2012, the agreement was amended by extending the term of the facility to September 27, 2013. The maximum capital availability under the facility remains at $125 million under the amended agreement. There were no secured borrowings outstanding under the trade receivables facility at December 31, 2012 or December 31, 2011.

This facility contains customary affirmative and negative covenants as well as specific provisions related to the quality of the accounts receivables transferred. Receivables transferred to the unrelated third party may not include amounts over 90 days past due or concentrations over certain limits with any one customer. The facility also contains customary cash control triggering events which, if triggered, could adversely affect the Company's liquidity and/or its ability to obtain secured borrowings.

Revolving Credit Facility Effective January 18, 2012, Lexmark entered into a $350 million 5-year senior, unsecured, multicurrency revolving credit facility that includes the availability of swingline loans and multicurrency letters of credit. The Credit Agreement replaces the Company's $300 million 3-year Multicurrency Revolving Credit Agreement entered into on August 17, 2009. Please refer to Part II, Item 8, Note 13 of the Notes to Consolidated Financial Statements for more information on the facility in place as of December 31, 2012.

The new credit facility contains customary affirmative and negative covenants and also contains certain financial covenants, including those relating to a minimum interest coverage ratio of not less than 3.0 to 1.0 and a maximum leverage ratio of not more than 3.0 to 1.0 as defined in the agreement. The new credit facility also limits, among other things, the Company's indebtedness, liens and fundamental changes to its structure and business.

Additional information related to the 2012 revolving credit facility can be found in the Form 8-K report that was filed with the SEC by the Company on January 23, 2012.

65 -------------------------------------------------------------------------------- Table of Contents As of December 31, 2012 and December 31, 2011, there were no amounts outstanding under the revolving credit facilities.

Credit Ratings and Other Information The Company's credit ratings by Standard & Poor's Ratings Services and Moody's Investors Service, Inc. are BBB- and Baa3, respectively. The ratings remain investment grade.

The Company's credit rating can be influenced by a number of factors, including overall economic conditions, demand for the Company's products and services and ability to generate sufficient cash flow to service the Company's debt. A downgrade in the Company's credit rating to non-investment grade would decrease the maximum availability under its trade receivables facility, potentially increase the cost of borrowing under the revolving credit facility and increase the coupon payments on the Company's public debt, and likely have an adverse effect on the Company's ability to obtain access to new financings in the future. The Company does not have any rating downgrade triggers that accelerate the maturity dates of its revolving credit facility or public debt.

The Company was in compliance with all covenants and other requirements set forth in its debt agreements at December 31, 2012. The Company believes that it is reasonably likely that it will continue to be in compliance with such covenants in the near future.

Off-Balance Sheet Arrangements At December 31, 2012 and 2011, the Company did not have any off-balance sheet arrangements.

Contractual Cash Obligations The following table summarizes the Company's contractual obligations at December 31, 2012: Less than 1-3 3-5 More than (Dollars in Millions) Total 1 Year Years Years 5 Years Long-term debt (1) $ 770 $ 380 $ 40 $ 40 $ 310 Operating leases 100 28 41 17 14 Purchase obligations 125 125 - - - Uncertain tax positions 24 2 13 4 5 Pension and other postretirement plan contributions 25 25 - - - Other long-term liabilities (2) 41 18 8 1 14 Total contractual obligations $ 1,085 $ 578 $ 102 $ 62 $ 343 (1) includes interest payments (2) includes current portion of other long-term liabilities Long-term debt reported in the table above includes principal repayments of $350.0 million and $300.0 million in the Less than 1 Year and More than 5 Years columns, respectively. All other amounts represent interest payments. The Company anticipates replacing the debt due in 2013. If this occurs, interest payments will occur that are not reflected in the table above.

Purchase obligations reported in the table above include agreements to purchase goods or services that are enforceable and legally binding on the Company and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction.

Other long-term liabilities reported in the table above is made up of various items including asset retirement obligations and restructuring reserves.

66-------------------------------------------------------------------------------- Table of Contents The Company's funding policy for its pension and other postretirement plans is to fund minimum amounts according to the regulatory requirements under which the plans operate. From time to time, the Company may choose to fund amounts in excess of the minimum for various reasons. The Company is currently expecting to contribute approximately $25 million to its pension and other postretirement plans in 2013, as noted in the table above. The Company anticipates similar levels of funding for 2014 and 2015 based on factors that were present as of December 31, 2012. Actual future funding requirements beyond 2013 will be impacted by various factors, including actual pension asset returns and interest rates used for discounting future liabilities and are, therefore, not included in the table above. The effect of any future contributions the Company may be obligated or otherwise choose to make could be material to the Company's future cash flows from operations.

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 financial obligation related to WEEE Directives is not shown in the table above due to the lack of historical data necessary to project future dates of payment. At December 31, 2012, the Company's estimated liability for this obligation was a current liability of $1.0 million and a long-term liability of $9.2 million.

These amounts were included in Accrued liabilities and Other liabilities, respectively, on the Consolidated Statements of Financial Position.

As of December 31, 2012, the Company had accrued approximately $64.4 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 Statements of Financial Position. The liability is not included in the table above due to the level of uncertainty regarding the timing of payments and ultimate settlement of the litigation. Refer to Part II, Item 8, Note 19 of the Notes to Consolidated Financial Statements for additional information. Payment of such potential obligations could have a material impact on the Company's future operating cash flows.

Capital Expenditures Capital expenditures totaled $162.2 million, $156.5 million, and $161.2 million in 2012, 2011 and 2010, respectively. The capital expenditures for 2012 principally related to infrastructure support (including internal-use software expenditures) and new product development. The Company expects capital expenditures to be approximately $185 million for full year 2013, attributable mostly to infrastructure support and new product development. Capital expenditures in 2013 are expected to be funded through cash from operations; however, if necessary, the Company may use existing cash and cash equivalents, proceeds from sales of marketable securities or additional sources of liquidity as discussed in the preceding sections.

EFFECT OF CURRENCY EXCHANGE RATES AND EXCHANGE RATE RISK MANAGEMENT Revenue derived from international sales, including exports from the U.S., accounts for approximately 55% of the Company's consolidated revenue, with EMEA accounting for 35% of worldwide sales. Substantially all foreign subsidiaries maintain their accounting records in their local currencies. Consequently, period-to-period comparability of results of operations is affected by fluctuations in currency exchange rates. Certain of the Company's Latin American and European entities use the U.S. dollar as their functional currency.

Currency exchange rates had a 3% unfavorable impact on international revenue in 2012 when compared to 2011. Currency exchange rates had a 2% favorable impact on international revenue in 2011 when compared to 2010. The Company may act to mitigate the effects of exchange rate fluctuations through the use of operational hedges, such as pricing actions and product sourcing decisions.

67-------------------------------------------------------------------------------- Table of Contents The Company's exposure to exchange rate fluctuations generally cannot be minimized solely through the use of operational hedges. Therefore, the Company utilizes financial instruments such as forward exchange contracts to reduce the impact of exchange rate fluctuations on certain assets and liabilities, which arise from transactions denominated in currencies other than the functional currency. The Company does not purchase currency-related financial instruments for purposes other than exchange rate risk management.

RECENT ACCOUNTING PRONOUNCEMENTS Refer to Part II, Item 8, Note 2 of the Notes to Consolidated Financial Statements for a discussion of recent accounting pronouncements which is incorporated herein by reference. There are no known material changes and trends nor any recognized future impact of new accounting guidance beyond the disclosures provided in Note 2.

INFLATION The Company is subject to the effects of changing prices and operates in an industry where product prices are very competitive and subject to downward price pressures. As a result, future increases in production costs or raw material prices could have an adverse effect on the Company's business. In an effort to minimize the impact on earnings of any such increases, the Company must continually manage its product costs and manufacturing processes. Additionally, monetary assets such as cash, cash equivalents and marketable securities lose purchasing power during inflationary periods and thus, the Company's cash and marketable securities balances could be more susceptible to the effects of increasing inflation.

68 -------------------------------------------------------------------------------- Table of Contents

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