Lexmark International (NYSE:LXK) released its Q1 earnings on April 22, and the company posted yet another quarter of solid results, as its managed printer services (MPS) and Perceptive software businesses delivered growth. The company reported 1% decline in revenues to $881 million as the exit from the ink-jet division tempered results. On a pro forma basis, revenue grew 6%. Although, the revenues exceeded the guidance range, the guidance for Q2 failed to enthuse the market. As a result, the stock price declined by 11.5%, reflecting market sentiment. Lexmark’s Perceptive software division continued to post health growth as revenues grew by 38% to $64 million. Additionally, imaging solutions and services (ISS) revenues, excluding inkjet business, grew by 4%, buoyed by growth in laser supplies. Within the ISS division, Managed Print Services (MPS) revenue grew by 12% year over year to $180 million, non-MPS revenue grew marginally by 1% to $565 million and inkjet revenue declined by 40% to $73 million.
Outlook For 2014
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For Q2 FY14, the company expects revenues to decline by 2% to 4% year over year, and non-GAAP earnings per share to be in the $0.85 to $0.95 range. Lexmark has revised its revenue guidance for FY 2014 upwards and expects revenue to decline at a slower rate by 2% to 4%. However, EPS will be flat in the $3.80 to $4.00 range.
MPS Revenues Boost Supplies Revenues
Laser printer and cartridge division is its biggest business unit and makes up for over 77% of Lexmark’s estimated value. According to IDC, the worldwide hardcopy peripherals market showed encouraging signs of recovery in the fourth quarter of 2013 as units sales grew by 2% to 31.7 million.  However, most of the growth in this industry came from increasing sales of laser printers and MPS services.
According to research firms such as Gartner and IDC, Lexmark is a leader in the MPS business.  MPS contracts for the company have increased over the past 24 months and offset the decline in non-MPS revenues in the previous quarters. In our pre-earnings note published earlier, we had stated that we expect MPS to propel the supplies revenues as most of MPS contracts also contain a clause for supplying printer stationery and cartridges. As the MPS revenues grew by 12% to $180 million during the quarter, it also boosted laser supplies revenues, which grew by 9% year over year during the quarter. This increase in laser supplies revenues positively impacted non-MPS revenues, which grew by 1% to$564 million.
Going ahead, we believe that MPS integrated with Perceptive’s solutions will deliver value to Lexmark’s growing client base. Service contracts tend to be sticky, and MPS is a high margin business compared to selling hardware, and we expect it to become the biggest driver for Lexmark, going forward.
Perceptive Business Continues To Deliver Growth
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. During Q1, revenues from this division grew by 38% to $ 64 million. The division reported strong growth across licenses, subscription, maintenance and professional services.
The company expects the electronic content management (ECM) and business process management (BPM), a $10 billion dollar industry, to grow about 10% year over year. The company is targeting this segment through Perceptive software, and it continues to build Perceptive’s product portfolio through organic and inorganic means. However, acquisition cost inflated the selling, general and administrative (SG&A) expense for this division by $11.6 million in Q1. As a result, the Perceptive software division posted an operational loss of $2 million. We expect this expansion effort might supress profitability in the short-term, but will continue to drive growth in software licensing revenue, and thus boost Lexmark’s revenues in the long-term. We also expect the seamless integration of Perceptive’s array of solutions with MPS to bolster revenue for the company.
Margins Improve Due To Revenue Growth In High Margin Businesses
Lexmark has been restructuring its business in light of the emerging trends in the printer hardware industry, which is witnessing growth in laser printers and MPS services. Lexmark is exiting from the low margin inkjet printer business and increasing its focus on laser printers, high margin MPS and process management vertical (Perceptive software). Lexmark expects that its higher value solutions portfolio revenue, comprised of Managed Print Services (MPS) and Perceptive Software, will exceed $1 billion in revenues for FY2014.
Company’s revenue mix from high margin business (MPS, Laser and Perceptive software) has grown from 79% in 2011 to 89% in 2013. This revenue mix further improved to 92% in Q1. The change in revenue mix, principally due to improved mix of high-margin license and subscriptions revenue, resulted in 1.1% improvement in gross profit margins to 41.0%, during the quarter. Furthermore, ISS gross margins increased by 20% to 39.9%, while Perceptive Software’s gross margins were flat at 68.7% during the quarter.  We expect this trend to continue in the future and the growth in high margin revenues to contribute to the increase in EBITDA margins going ahead.
At present we have a $39 Trefis price estimate for Lexmark, which is in line with its current market price.