Lexmark's Earnings & Rev Beat Estimates

Lexmark International Inc. (LXK) posted adjusted third-quarter 2013 earnings per share (EPS) of 95 cents, beating the Zacks Consensus Estimate of 92 cents. The beat was mainly attributable to better-than-expected operating income from the Imaging Solutions and Services (ISS) segment, strong revenue growth and lower operating expenses. Adjusted earnings matched the high end of the company’s guided range of 85–95 cents.

Revenues

Lexmark’s third-quarter revenues of $890.5 million dropped 3.1% from $919.2 million in the year-ago quarter but were higher than the Zacks Consensus Estimate of $874.0 million. The year-over-year decline was due to macro-economic weakness and its exit from the Inkjet business.

Perceptive Software and Managed Printing Services (:MPS) provided good support as the year-over-year decline was lower than the company’s expectations of a 4.0% – 6.0% decline. Currency headwinds were limited.

On a year-over-year basis, Hardware revenues declined 11.0% while Supplies dropped 4.0%. However, Software and Other revenues climbed 21.0%.

Revenues from the ISS segment decreased 5.0% year over year to $837.0 million. Within ISS, revenues from MPS grew 18.0%, which was offset by 1.0% decline in non-MPS revenues and sale of the Inkjet business. Perceptive Software revenues (excluding acquisition-related adjustments) grew 38.0% year over year to $59.0 million.

Operating Results

Non-GAAP gross margin in the quarter was 40.5%, up 68 basis points (bps) from 39.8% in the year-ago quarter due to favorable mix.

Pro forma operating margin dropped 39 bps to 10.1% from 10.5% in the year-ago quarter. Total operating expense increased marginally (up 0.4%) from the year-ago quarter to $270.1 million.

Non-GAAP net income was $60.5 million or 95 cents compared with $65.0 million or 94 cents in the year-ago quarter. Adjusted net income includes restructuring-related charges as well as acquisition-related adjustments.

Balance Sheet & Cash Flow

Lexmark ended the quarter with $973.6 million in cash, cash equivalents and marketable securities, down from $981.2 million in the previous quarter. Trade receivables were $488.0 million and inventories were $295.0 million. The company’s long-term debt balance was $699.6 million, flat sequentially.

The company generated $143.0 million in cash from operations, up from $87.0 million in the previous quarter. Capital expenditure totaled $45.0 million compared with $39.0 million in the prior quarter.

Lexmark bought back 0.5 million shares worth $21.0 million during the third-quarter. Moreover, the company paid a quarterly dividend of 30 cents per share, totaling $19.0 million.

Guidance

For the fourth-quarter of 2013, management expects revenues to decline 3.0% to 5.0% year over year. The weak guidance reflects the negative impact from the exit of the Inkjet business.

Excluding restructuring charges and acquisition-related adjustments, non-GAAP earnings are expected in the range of $1.07–$1.17 per share.

Management expects Laser supplies to be roughly flat on a year-over-year basis. It also affirmed its view to return 50.0% of free cash flow to shareholders through share buybacks and dividends. Management also expects the effective tax rate to be approximately 30%.

For fiscal year 2013, Lexmark expects revenues to decline 5.0% to 6.0% year over year, primarily due to the adverse effect of the Inkjet business exit. Excluding restructuring charges and acquisition-related adjustments, non-GAAP earnings are expected in the range of $3.85–$3.95 per share. For the long term, the company expects operating margin in the range of 11% to 13%.

Our Take

Lexmark’s third-quarter results were impressive with both the top and bottom lines beating the Zacks Consensus Estimate. Revenues came in below the year-ago period but were better than expected. Guidance for the fourth quarter was disappointing, reflecting the inkjet exit and macro uncertainty. Though synergies from the recent acquisitions and renewed focus on the software space could set it back on the growth path, their impact on results could still be some way off.

But we see the Inkjet exit as a positive. Lexmark will now be able to focus more on MPS and the software business where growth prospects are better.

Though the restructuring and share buyback plans could boost share prices in the near term, the overall outlook for the printing industry remains bearish. Demand for printers is slowing down due to increasing usage of digital content through mobile devices.

We see good growth prospects for Lexmark in the software sector although the company is also trying its luck at new hardware solutions. But the overall macro uncertainty could have an effect on product demand. Lexmark has a strong market position, but reduced demand for traditional printing hardware has impacted pricing in the computer peripherals market.

Lexmark is doing really well in the MPS market and is winning deals continuously. It has been declared a leader in this market by research firms IDC and Gartner Inc. (IT).

Though constant pricing pressure from competitors such as Canon Inc., Xerox Corp. (XRX) and Hewlett-Packard Co. (HPQ) and a high debt burden will be concerns, we expect Lexmark to turn the tables with an increased focus on software and services.

Currently, Lexmark has a Zacks Rank #3 (Hold).

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