Issue #0603/1 - Having had a rough ride, Lexmark’s 2005 did not look good with worsening results as the year progressed. As it enters 2006, the company attempts to position itself for recovery.
Last year was probably Lexmark’s worst year since it was split off as an independent company from IBM in 1991, not just with revenue growth declining but revenue itself in the doldrums – down by 2% year-on-year both in Q4 and also for the year as a whole.
Once the golden boy of the industry, Lexmark has recently become increasingly entrenched in a low priced/high usage cost strategy (based on hardware with quality issues) that is now showing signs of falling apart as demand declines.
As reported in TCPglobal Issue #0537 - "In desperation, Lexmark pushes business consumables prices even higher", Lexmark is the only company known to be recording declining revenues in supplies – the absolute mainstay of the printer industry. Any company that is experiencing ‘softening’ demand and dwindling revenues in this area is in serious trouble.
Lexmark’s supplies revenue dropped 1% year-on-year in Q4, representing a slide over the year that saw growth of only 1% in the previous quarter even though growth for the whole year managed a relatively healthy 5%.
In fact, this 5% growth for the year is the only positive figure in the entire report from Lexmark. In every other area, Lexmark has suffered revenue losses in Q4 and over the whole year. With supplies also heading into revenue decline by the end of the year, Lexmark must be feeling desperate. Certainly the tone of the earnings announcement indicates a significant degree of despondency. Gone is the bullishness of past years, replaced with an thin attempt to promote an expectation of recovery.
Revenue as a whole in Q4 was down by 12%; Printer revenues were down a disastrous 25%; supplies revenues by 1%; the business sector was down 12% and the consumer sector by 11%.
Declining revenues have been driven by unit sales of laser printers being 7% lower than in Q4 the previous year and inkjet sales (including the growth area – inkjet AiO!) being down by 8% - combined with ongoing unit price erosion, of course.
Over the year as a whole, laser printer unit growth was only 18% compared to 31% the previous year, while inkjet unit sales grew by only half of one percent. Lexmark has not given a figure for unit sales of supplies but we can assume from comments made that this has actually declined. Certainly, for revenues to fall when unit prices have been on the increase must indicate a fall in unit sales.
In all cases, the reason for declining sales has been put down to a ‘softening in user demand’ but there has been no indication that Lexmark has considered why there might have been a softening in demand. In particular, the workgroup segment has been weakening.
Another area that is described as ‘slowing’ is sales into the OEM market, especially supplies, a trend that could have disastrous consequences for Lexmark with its major reliance on this market - remember, Dell was responsible for 41% of Lexmark’s inkjet unit sales in the US during 2004 (Dell branded as opposed to Lexmark branded)!
To rub salt in the wound, Lexmark is suffering from a 30% fall in its operating income margin, from 12.8% to 8.3%. The company has been working hard to reduce costs but the declining revenue has more than eaten away the savings made with gross margin falling by two points. Operating income was down by 27% overall in 2005, comprising 12% decline in the business markets and 30% in the consumer markets.
Lexmark does admit to having made an error of judgement regarding its usage-over-life assumptions for inkjet machines. There appears to have been a higher than expected front-end usage and, therefore, purchase of supplies. What this means in practice is that ongoing revenue for Lexmark is truncated as demand for supplies literally fizzles out with time.
Does the up-front usage, followed by slowing supplies sales, indicate that users are buying cheap equipment (or receiving a printer free with other hardware) and, on discovering that they’ve made an error of judgement of their own, are ditching the hardware early, switching vendors for higher quality hardware?
Again for the whole year, total revenue for Lexmark was down 2%, the result of negative growth in the business segment of 1% and 2% in the consumer segment. Printer revenue fell 10% and revenue in other segments (including services) fell by 10%. It was only the whole year picture of a 5% growth in supplies revenue the prevented the overall picture from looking even worse.
So, looking to the future, Lexmark indicates that it expects this slowing in demand to continue through 2006 causing revenues to continue to decline, by as much as 10%, and for gross margins and operation income margin to fall a little further year-on-year.
In order to counter this position, the company has announced that it is taking action to improve its cost and expense structure in the hope of saving $80m per year. As part of this restructuring, around 825 jobs will be shed with a further 525 positions being moved to ‘low-cost geographies’. In practice, this probably means that most of the 1,350 individuals will loose their jobs with most of the 525 staff for the new geographies being recruited locally at lower cost.
One of the more drastic actions being taken to reduce costs is the closure of the inkjet cartridge manufacturing plant in Scotland as part of a manufacturing consolidation process. Certainly bad news for Scotland, it also does not bode well for Lexmark.
Another drastic action that is sure to be every bit as unpopular, and maybe more so, is the freezing of the company’s pension plan in the US.
All in all, Lexmark plans to spend $130m in order to achieve this $80m per year operating cost reduction.
Customers however, will be pleased to learn that Lexmark plans high profile promotional activity in some geographies, through modified channel strategies, in a bid to increase the volume of its hardware sales.
On a more positive note, cash generation is said to be ‘strong’ for the quarter. In fact, Lexmark has repurchased just over a billion Dollars’ worth of its own stock and has approved the purchase of a further $1bn.
Earnings per share might have been ‘better than expected’ but, nonetheless, the share price has fallen steadily over the last 20 months, at one point to less than 50% of its value of a year ago, and having fallen by about 57% since early 2004.
Traditionally, repurchasing stock means that the company considers it to be undervalued and can find no better investment for its cash than its own stock. A side-effect of the repurchase is to elevate the value of the remaining stock on the open market.
With Lexmark clearly not in the happiest of situations at the current time, could it also have implications that the company is using cash while it is available to set the scene for a majority investor to step in and take control at a price that is beneficial to Lexmark?
Although Lexmark is attempting to be positive, telling its investors that the hard copy market is growing and that there are a number of areas in which Lexmark is ‘underrepresented’, the big question hanging over the company is, “can Lexmark perform in these markets at a time when it appears to be under-performing in high-growth areas”?
~End~
