Lexmark Down Despite Q1 Earnings Beat - Analyst Blog

Shares of Lexmark International Inc. LXK went down 11.2% in after-hours trading following its first quarter 2014 results. Shares tumbled as a result of year-over-year declines in the top and bottom lines and a tepid second quarter earnings guidance provided by the company.

Lexmark posted non-GAAP first-quarter 2014 earnings per share EPS of 92 cents per share, beating the Zacks Consensus Estimate of 87 cents per share. The beat was mainly attributable to better-than-expected operating income and lower share count.

Non-GAAP earnings (excluding restructuring-related charges & project costs and, acquisition and divestiture-related adjustments) surpassed the company's guided range of 80 cents–90 cents per share. However, earnings per share decreased 4.0% from the year-ago quarter.

Revenues

Although Lexmark's first-quarter non-GAAP revenues (excluding acquisition and divestiture-related adjustments) of $880.7 million decreased a marginal 0.6% from the year-ago quarter, it came ahead of the Zacks Consensus Estimate of $844.0 million..

On a GAAP basis, revenues came in at $877.7 million, down 0.7% from the year-ago quarter. The year-over-year decline was primarily attributed to a decline in Inkjet Exit revenues. Decrease in hardware and supplies revenues also led to the year-over-year drop in revenues.

On a year-over-year basis, Hardware revenues and Supplies decreased 8.0% and 1.0%, respectively. However, Software and other revenues climbed 13.0% from the year-ago quarter.

Revenues from the Imaging Solutions and Services ISS segment decreased 3.0% year over year to $817.0 million. Within ISS, revenues from Managed Print Services (MPS) grew 12.0%, while non-MPS revenues increased 1.0% on a year-over-year basis, which was offset by a 40.0% decline in Inkjet Exit revenue. Perceptive Software revenues (excluding acquisition-related adjustments) grew 38.0% year over year to $64.0 million driven by higher license and subscription revenue.

Operating Results

Non-GAAP gross margin in the quarter was 41.2%, up 112 basis points (bps) from the year-ago quarter due to favorable mix.

Non-GAAP operating margin increased 37 bps to 10.5% from the year-ago quarter primarily due to growth in Perceptive Software business and efficient cost management. Total non-GAAP operating expense increased 1.7% from the year-ago quarter to $269.7 million, primarily due to acquisitions related expenses and higher investments.

Non-GAAP net income was $58.3 million or 92 cents per share compared with $62.0 million or 95 cents per share in the year-ago quarter. Non-GAAP net income excludes restructuring-related charges and acquisition-related adjustments.

Balance Sheet & Cash Flow

Lexmark exited the quarter with $985.2 million in cash, cash equivalents and marketable securities, down from $1.05 billion in the previous quarter. Trade receivables were $429.4 million and inventories were $277.9 million. The company's long-term debt balance was $699.7 million, flat sequentially.

The company generated $10.0 million in cash from operations, down significantly from $205.0 million in the previous quarter. Free cash flow was ($34.0) million. Capital expenditure totaled $44.0 million compared with $41.0 million in the previous quarter.

Lexmark paid dividends of $19.0 million and repurchased shares worth $21.0 million during the quarter.

Guidance

For the second-quarter, management expects revenues to decline 2.0% to 4.0% (previous guidance 3.0% to 5.0% decline) year over year. Revenues excluding the Inkjet Exit are expected to be up 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 85-95 cents (mid-point 90 cents). The Zacks Consensus Estimate is pegged at 91 cents.

Management expects Laser supplies to be roughly flat to positive 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 30.5%.

Moreover, Lexmark expects gross margin to increase on a year-over-year basis. Operating expense is expected to be flat sequentially while operating margin is expected to be down marginally.

For full year 2014, Lexmark expects revenues to decline 2.0% to 4.0% (previous guidance 3.0% to 4.0%) year over year, primarily due to the adverse effect of the Inkjet business exit and shift to high margin solutions business.

Excluding restructuring charges and acquisition-related adjustments, non-GAAP earnings are expected in the range of $3.80–$4.00 per share. The Zacks Consensus Estimate is pegged at $3.89 per share. For the long term, the company expects operating margin in the range of 11% to 13%.

Our Take

Lexmark's first-quarter results were better-than-expected wherein both the top and bottom lines beat the Zacks Consensus Estimate. However, both revenues and earnings declined on a year-over-year basis.

Guidance for the second quarter was tepid, reflecting the Inkjet exit and macro uncertainty. Though synergies from the acquisitions and renewed focus on the software space could set it back on the growth path, their impact on results could still take some time to materialize.

Nonetheless, 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. Moreover, Lexmark is doing really well in the MPS market and is winning deals continuously.

Though 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 to expand its hardware solutions business. 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.

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

Currently, Lexmark has a Zacks Rank #3 (Hold). A better ranked stock in the technology sector is Rambus Inc. RMBS, carrying a Zacks Rank #1 (Strong Buy).