Lexmark International (NYSE:LXK) released its Q2 earnings on July 23. Lexmark reported a 3% decline in revenues to $890 million for Q2 CY13.  This was mainly due to the exit from the ink-jet division, which negatively impacted revenue by 7%.
However, revenues excluding inkjet, comprised of laser-based Imaging and Perceptive Software revenue grew 4% y-o-y and 3% sequentially. Within the imaging solution services (ISS) division, Managed Print Services (MPS) revenue grew by 12% y-o-y to $170 million, non-MPS revenue was flat at $559 million and inkjet revenue declined by 38% to $99 million. Perceptive software revenue grew 34% y-o-y to $62 million.
Outlook For 2013
For Q3 FY13, the company expects revenues to decline by 4% to 6% y-o-y, and earnings per share to be in $0.85 to $0.95 range. Lexmark has revised its revenue guidance for FY 2013 upwards and expects revenue to decline at a slower rate by 6% to 7%. However, it continues to maintain its earnings per share for the full year to be in the $3.90 to $4.10 range.
Q2 Revenue At Higher End Of Guidance
In Q2, Lexmark reported revenues at the high end of their guidance range as both Perceptive and ISS performed better than expected. While Perceptive’s revenue grew by 34% due to record license and subscription revenue, ISS revenue (excluding inkjet business) grew by 2% y-o-y due to 5% growth in laser supplies and 12% growth in MPS. Moreover, Lexmark continued to increase its market share in large workgroup laser hardware that drives supplies revenues. Lexmark reported 18% growth in the number of large workgroup laser unit sold in Q2, and since Lexmark’s share in this segment is improving, we expect this will bolster its supplies revenues in the future.
In our pre-earnings article published earlier, we argued that Lexmark’s shift in its business mix will positively impact its margins.  In the past few years, Lexmark has exited from its low margin inkjet printer business and increased its focus on laser printers, high margin managed print services (MPS) and process management vertical. While declining margins from the printer hardware segment negatively impacted Lexmark’s gross margins by 3.4%, higher margins from high-end laser supplies, MPS and software division positively impacted gross margins by 3.2%. As a result, Lexmark’s gross margins improved to 40.2% in Q2 from 36.8% in FY 2012. We expect this trend to continue in this fiscal year, and Lexmark to report higher gross margins in the coming quarters.
MPS Lifts Laser Printer Division
Laser printer and cartridge division is its biggest business unit and makes up over 80% of Lexmark’s estimated value. While revenues from the hardware division declined by 14% y-o-y, MPS revenues grew by 17% and offset the decline in non-MPS revenues of ISS. In the last two quarters, Lexmark has bagged 20 new content and process software deals across a range of industries such as banking, retail, manufacturing, government and healthcare. Moreover, cross selling to Perceptive’s healthcare clients also bolstered revenues for MPS division. We believe that MPS integrated with Perceptive’s solutions will deliver value to Lexmark’s growing client base. We expect MPS to become the biggest driver of revenue for ISS division going forward.
Perceptive Reports Profits On The Back Of Large Deals
The Perceptive Software division is the second biggest business unit and makes up nearly 9% of Lexmark’s estimated value. As Lexmark plans to become an end-to-end solution provider, Perceptive Software is becoming an increasingly important division for Lexmark and is helping the company manage the downturn in the printer and peripherals market.
In Q2 2013, Perceptive reported 34% y-o-y increase in revenue to $62 million. In our pre-earnings article, we had stated that we expected profitability from this division to improve in Q2. Lexmark did deliver improvement in Perceptive Software profitability as profits increased by $10 million sequentially and $4 million y-o-y to $2 million. The primary reason for growth in profitability was growth in licensing revenues for the division as Lexmark closed several large enterprise customer licensing deals in the quarter. This increased licensing revenue contributed to an increase in gross profit margin for the division. Lexmark has guided 15% growth in Perceptive’s revenue for FY13. We also expect the seamless integration of Perceptive’s array of solution with MPS to bolster revenue for the company. We, therefore, expect Perceptive’s revenues to increase from $156 million in 2012 to over $400 million by the end of our forecast period.
We are in the process of updating our Lexmark model. At present, we have a $33 Trefis price estimate for Lexmark, which is 10% below its current market price.