Lexmark International (NYSE:LXK), a leading printing solutions and content management provider, is set to announce its Q2 results for 2012 on July 24. It has provided a weak Q2 outlook and expects revenues to decline 7% to 9% y-o-y as it expects the economies in Europe and North America to remain sluggish. 
Lexmark along with other key market players such as Canon (NYSE:CAJ) and Epson have lost significant share to market leader Hewlett-Packard (NYSE:HPQ), which further extended its dominating share to 56% in the U.S. hard-copy peripheral market. ((U.S. Hardcopy Peripherals Market, IDC). Revenues in the prior quarter declined slightly y-o-y to $933 million. This was mainly due to a drop in printer prices, sales and the company’s shift in focus toward managed printing solutions (MPS).
Trends Likely to Drive Lexmark’s Performance in 2012
Move to Managed Printing Solutions
Companies are increasingly adopting Managed Printing Solutions (MPS) mainly to cut costs and simplify printer management. Service agreements tend to be sticky and MPS is a high margin business compared to selling hardware, and we expect this to become the biggest driver for Lexmark, going forward. The company already leads the MPS space, according to research firms Gartner, IDC and U.K.-based Quocirca.
Lexmark expects that the Enterprise Content Management (ECM)and Business Process Management (BPM) market will grow at about 12% y-o-y. The market is currently worth ~$8 billion, but is poised to grow as the penetration of document and human-centric ECM and BPM solutions is still small.
Perceptive Software is a provider of ECM and BPM, which involves capturing unstructured data such as hard-copies, photographs, physical invoices, faxes, etc., into digital formats to streamline and automate processes that are currently manual in nature. We expect this to be the biggest growth market after MPS for Lexmark. The company has completed three acquisitions (Brainware, ISYS and Nolij), and these will be integrated into Perceptive Software, which will help drive the company’s software business.
Printing Hardware Industry Headed for Consolidation
The economic slowdown in Europe as well as the consolidation in printer hardware market has led to a shrinking printer market.  There is more competition from manufacturers of larger, traditional copier machines as most of them now provide systems with multiple functionality such as fax, copier and scanner. Consumers refilling cartridges and reusing cartridges and imitators are eating away further sales opportunities in the cartridge business line. This is damaging Lexmark and other printer manufacturers that sell printers at a discount and hope to make up the losses by ink and toner sales. These factors will likely lead to a slowdown in near-term hardware sales and impact short-term revenues.
Outlook for 2012
Focus on higher margin services such as MPS and Perceptive Software has led to gross profit margins rising slightly to 38.4% compared to 37.6% the same period last year. We expect this to rise further as Lexmark adds software and services to its business mix. This shift in focus will result in a short-term revenue loss. In Q1, the company’s net earnings dropped 27% to $61 million compared to $83 million same period prior year. It has also issued a lower outlook for Q2, and expects its revenue to decline 7%-9% y-o-y.
New Innovative Smart Devices
Lexmark has introduced smart devices that bundles features such as scan, fax, invoice processing, etc., into a printer. It has also introduced devices in the mid-range color segment which provides a touch-screen interface and is priced under $1,000. It sees potential in the mid-range consumer segment in the short term.
We currently have a $31.86 Trefis price estimate for Lexmark, which is about 50% over its current market price.Notes: