Lexmark International (NYSE:LXK) released its Q2 earnings on July 22 and the company posted yet another quarter of solid results, as its managed printer services (MPS) and Perceptive software businesses delivered growth. For the first time in many quarters, the company reported slight growth in revenues to $894 million even as the exit from inkjet division tempered results. The revenues and earnings per share exceeded the guidance range. The stock market reacted positively to the results and the stock price increased by 2.62%, reflecting market sentiment. It’s imaging solutions and services (ISS) revenues, excluding the inkjet business, grew by 5%, buoyed by growth in sales of laser hardware. Within the ISS division, managed print services (MPS) revenue grew by 14% year over year to $195 million, non-MPS revenue grew marginally by 2% to $569 million and inkjet revenue declined by 33% to $67 million. Additionally, Lexmark’s Perceptive software division continued to post growth as revenues grew by 3% to $64 million.
Outlook For 2014
For Q3 FY14, the company expects revenues to decline by 2% 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, specifically by 2% or less. Non-GAAP EPS guidance has also been revised upwards to $3.95 to $4.15 range.
MPS Revenues Boost Laser Printer 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 grew for the third quarter in a row to 26.4 million units shipped in the first quarter of 2014 (1Q14) resulting in 2.1% year-over-year growth.  However, most of the growth in this industry came from increasing sales of laser printers and MPS services. This trend seems to have prevailed in Q2 as well, and Lexmark’s result indicate that it gained the most in laser printer related sales.
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 revenues. As the MPS revenues grew by 14% to $195 million during the quarter, it also boosted laser revenues, which grew by 5% year over year during the quarter. 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. We expect it to become the biggest driver for Lexmark going forward.
Perceptive Business Revenues Grow, Albeit at a Lower Pace
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 Q2, revenues from this division grew modestly by 3% to $64 million. The primary reason for slowdown in growth was a decline in perpetual licensing. However, we are not worried since some of the million dollar perpetual licensing deals that were to be signed in Q2 have now been pushed back to Q3 and Q4. Furthermore, some of the clients chose to sign up for Perceptive’s evolution subscription service rather than the perpetual license, deferring recognition of the revenue from the second quarter. As a result, the company did witness a growth across subscription, maintenance and professional services.
The company expects the electronic content management (ECM) and business process management (BPM) segments, which serve 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 costs inflated selling, general and administrative (SG&A) expense for this division by $13 million in Q2. As a result, the Perceptive software division posted an operational loss of $2 million. We expect this expansion effort to likely suppress 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 commoditization of inkjet printer 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 its process management offering (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.
The company’s revenue mix from high margin business (MPS and Perceptive software) grew by 11% and accounted for 29% of its revenues in Q2 2013. As a result of the change in revenue mix, in favor of high-margin laser printers, license and subscriptions revenue, the gross profit margins improved by 40 bps to 40.8%, during the quarter. Furthermore, ISS gross margins increased by 30% to 39.6%, while Perceptive Software’s gross margins improved on a sequential basis to 69.2% 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.
We are in the process of updating our Lexmark model. At present we have a $39 Trefis price estimate for Lexmark, which is 15% below its current market price.
- Worldwide Hardcopy Peripherals Market Maintains Its Growth Trajectory in the First Quarter of 2014, June 4 2014, www.idc.com [↩]
- 8-K [↩]