Lexmark announces change in pension accounting method and accrual for legal contingency

The mark-to-market (MTM) adjustment related to the company’s pension and other post-retirement benefit plans described below, which will be determined in January 2014, will impact 2013 GAAP results only. Excluding the annual MTM adjustment, the combined accounting method and legal accrual adjustments, as compared to October 2013 guidance, would have decreased fourth quarter GAAP and non-GAAP EPS guidance by $0.03 and increased full-year 2013 GAAP and non-GAAP EPS guidance by $0.21.

These changes and adjustment have no impact to cash flows for the fourth quarter and full-year 2013.

Pension accounting change

Lexmark announced that it changed its method of accounting for asset and actuarial gains and losses for its pension and other post-retirement plans (Post-retirement Plans) in the fourth quarter of 2013. The company believes the new accounting method will improve transparency of its operating performance and the various drivers of Post-retirement Plan expenses.

This change does not affect Lexmark’s funding requirements nor does it impact existing benefits to the participants in the company’s Post-retirement Plans.

Under this new method, MTM asset and actuarial gains and losses will be recognized in earnings in the year in which they occur, as permitted under United States generally accepted accounting principles (GAAP), rather than amortized over time. Lexmark’s ongoing Post-retirement Plan costs will be recognized in quarterly earnings. MTM gains and losses will typically be recorded in the fourth quarter and will be excluded from non-GAAP financial measures, as these gains and losses do not directly arise from the company’s core operations. Any interim remeasurements triggered by significant one-time events, such as plan settlements or curtailments, will be recognized as an MTM gain or loss in the quarter in which they occur and will also be excluded from non-GAAP financial measures. Other components of Post-retirement Plan costs will be included in GAAP and non-GAAP results.

In addition, in the fourth quarter of 2013, Lexmark changed its method of allocating the elements of net periodic Post-retirement Plan costs to reporting segments for internal management evaluation purposes. Historically, total net periodic Post-retirement Plan costs were allocated to reporting segments. Under the new allocation method, service cost, amortization of prior service cost and credit, and Post-retirement Plan settlements and curtailments will continue to be allocated to reporting segments. Interest cost, expected return on plan assets, and MTM gains and losses will be included in all other results. The company believes that these items are related to corporate financing and treasury decisions regarding the composition of pension assets and other factors, such as discount rates and actuarial assumptions, which are not related to the operations of Lexmark’s reportable segments. The new allocation method will, therefore, better reflect reporting segment operating results.

These changes in accounting and in the calculation segment profitability results will be applied retrospectively to prior periods, as set forth in the attached exhibits. Excluding the annual MTM adjustment, as compared to October 2013 guidance, these accounting method adjustments would have increased fourth quarter and full-year 2013 GAAP and non-GAAP EPS guidance by $0.08 and $0.32, respectively.

Legal contingency

On Dec. 11, 2013, in the matter of Molina v. Lexmark, the California Supreme Court denied acceptance of Lexmark’s Petition for Review. As a result of the California Supreme Court’s decision, the company expects to record an additional $11.1 million loss provision. This increased accrual for legal contingency, as compared to the October 2013 guidance, would have decreased fourth quarter and full-year 2013 GAAP and non-GAAP EPS guidance by $0.11.

As previously reported in Lexmark’s quarterly and annual reports filed with the Securities and Exchange Commission (SEC), this matter is a class action lawsuit that was filed in the California Superior Court for Los Angeles under a California employment statute, which in effect prohibits the forfeiture of vacation time accrued. The trial court found that Lexmark’s then existing policies violated this California statute and awarded the class $7.8 million in damages and $5.7 million in attorneys’ fees. The California Court of Appeals upheld the rulings of the trial court except for the use of gross pay rather than base rate of pay in the calculation of damages. The company’s Petition for Review with the California Supreme Court, which was recently denied, was on certain issues that were upheld by the California Court of Appeals. This matter will now be remanded back to the trial court to recalculate damages using the base rate of pay, additional attorneys’ fee and interest.

The increased accrual reflects an adjustment to Lexmark’s estimate of its liability, in compliance with GAAP. Under GAAP, companies are required to estimate and recognize a liability when a potential loss is determined by a company to be probable and the amount of the loss can be reasonably estimated. Lexmark notes that its total accrual reflects an estimate and that any final adjudication or settlement of this matter could possibly be less than or more than the liability accrued. This adjustment is consistent with Lexmark’s policy of reviewing regularly the status of pending actions and making adjustments as appropriate. Lexmark has previously disclosed information about this matter in its SEC filings, including Lexmark’s most recent quarterly report on Form 10-Q for the period ending Sept. 30, 2013.