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Lexmark International Inc. (LXK - Analyst Report) posted non-GAAP fourth-quarter 2013 earnings per share (EPS) of $1.18 per share, beating the Zacks Consensus Estimate of $1.09 per share. 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. Non-GAAP earnings (excluding restructuring-related charges & project costs, acquisition and divestiture-related adjustments and actuarial gain on pension plan) surpassed the company’s guided range of $1.07–$1.17 per share.

Revenues

Lexmark’s fourth-quarter non-GAAP revenues (excluding acquisition and divestiture-related adjustments) of $1.011billion not only increased 4.5% from the year-ago quarter but were also higher than the Zacks Consensus Estimate of $925.0 million. The year-over-year revenue increase was in contrast to the company’s expectations of a 3.0% – 5.0% decline. On a GAAP basis, revenues came in at $1.00 billion, up 4.0% from the year-ago quarter. The year-over-year increase was due to strong growth across all its business segments and improved Imaging Solutions and Services (ISS) performance.

Perceptive Software and Managed Printing Services (MPS) provided good support for the year-over-year increase in revenues.

On a year-over-year basis, Hardware revenues and Supplies increased 3.0% and 1.0%, respectively. Moreover, other revenues climbed 31.0% from the year-ago quarter.

Revenues from the ISS segment increased 1.0% year over year to $939.0 million. Within ISS, revenues from MPS grew 22.0%, while non-MPS revenues increased4.0% on a year-over-year basis, which partially offset a 32.0% decline in Inkjet Exit revenue. Perceptive Software revenues (excluding acquisition-related adjustments) grew 70.0% year over year to $72.0 million.

Operating Results

Non-GAAP gross margin in the quarter was 41.6%, up 540 basis points (bps) from the year-ago quarter due to favorable mix.

Non-GAAP operating margin increased 266 bps to 11.1% from the year-ago quarter. Total non-GAAP operating expense increased 14.2% from the year-ago quarter to $307.1 million, primarily due to higher employee compensation expenses.

Non-GAAP net income was $75.0 million or $1.18 per share compared with $44.3 million or $1.09 per share in the year-ago quarter. Non-GAAP net income excludes restructuring-related charges, acquisition-related adjustments and Actuarial gain on pension plan.

Balance Sheet & Cash Flow

Lexmark ended the quarter with $1.05billion in cash, cash equivalents and marketable securities, up from $973.6 million in the previous quarter. Trade receivables were $452.3 million and inventories were $268.2 million. The company’s long-term debt balance was $699.6 million, flat sequentially.


The company generated $205.0 million in cash from operations, up from $143.0 million in the previous quarter. Free cash flow was $164 million. Capital expenditure totaled $41.0 million compared with $45.0 million in the prior quarter.

Lexmark paid a dividend of 30 cents per share during the fourth-quarter totaling $19.0 million. Moreover, the company repurchased $20.0 million shares in the quarter.

Guidance

For the first-quarter of 2014, management expects revenues to decline 3.0% to 5.0% year over year. Revenues excluding 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 80-90 cents. The Zacks Consensus Estimate is pegged at 83 cents.

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 31.5%.

For fiscal year 2014, Lexmark expects revenues to decline 3.0% to 4.0% 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 $3.80–$4.00 per share. The Zacks Consensus Estimate is pegged at $3.68 per share. For the long term, the company expects operating margin in the range of 11% to 13%.

Our Take

Lexmark’s fourth-quarter results were impressive with both the top and bottom lines beating the Zacks Consensus Estimate. Both revenues and earnings came above the year-ago period and were better than expected. Guidance for the first 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 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 - Snapshot Report).

Though constant pricing pressure from competitors such as Canon Inc., Xerox Corp. (XRX - Analyst Report) and Hewlett-Packard Co. (HPQ - Analyst Report) and a high debt burden will be a concern, 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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