Lexmark Q3 2008 Earnings Call Transcript

Lexmark International, Inc. (LXK)

Q3 2008 Earnings Call

October 21, 2008 8:30 am ET

Executives

John Morgan - Director, Investor Relations

Paul J. Curlander - Chairman of the Board, Chief Executive Officer

John W. Gamble Jr. - Chief Financial Officer, Executive Vice President

Analysts

Kathryn Huberty - Morgan Stanley

Shannon Cross - Cross Research

Bill Shope - Credit Suisse

Richard Gardner - Citigroup

Bill Fearnley - FTN Midwest Research

Min Park - Goldman Sachs

Mark Moskowitz - J.P. Morgan

Toni Sacconaghi - Sanford C. Bernstein

Jeff Fidacaro - Merrill Lynch

Ananda Baruah - Bank of America

Presentation

Operator

Thank you for standing by and welcome to the Lexmark International third quarter 2008 earnings conference call. (Operator Instructions) I would now like to turn the call over to John Morgan, Lexmark's Director of Investor Relations. Please go ahead, John.

John Morgan

Good morning and thank you for joining us today. With me for Lexmark's third quarter 2008 earnings conference call are Lexmark's Chairman and CEO, Paul Curlander; and Lexmark EVP and CFO, John Gamble. After their prepared remarks, we’ll open the call for questions as time permits. We ask that you please limit yourself to one question and if needed, one follow-up so that we can get to everyone’s question. Later today, a replay of this call will be available on our investor relations website located at http://investor.lexmark.com.

Currently on the homepage of this website you will find today’s earnings release, as well as the supplemental slide deck for the third quarter, which includes the reconciliations of GAAP and non-GAAP financial information.

You will also find details on upcoming events which includes our participation at the Credit Suisse annual technology conference on December 3rd.

As a reminder, any of today’s remarks that are not statements of historical fact are forward-looking statements and involve certain risks and uncertainties that are disclosed in the Safe Harbor section of our earnings releases and SEC filings. Actual results may differ materially from such statements and Lexmark undertakes no obligation to update any forward-looking statements.

With that, I’ll turn it over to Paul.

Paul J. Curlander

Thank you, John. Today we are announcing third quarter financial results that despite impacts from the weakening global economic environment, were still in line with the expectations we had at the beginning of the quarter.

Beyond the weakness we have previously described in the U.S. market demand, we saw increased weakening in international market demand as we went through the quarter. For the third quarter, many of these impacts were offset by an improved performance in our U.S. business market segment. However, as we look into the fourth quarter, we are expecting to see a more difficult market environment globally.

Let’s talk first about the third quarter. Revenue for the quarter was $1.13 billion, down 5% year to year. Earnings per share in the third quarter were $0.42 and excluding restructuring and related charges, earnings per share in the third quarter would have been $0.63, up 5% year to year.

During the quarter, we continued to have good cash generation with third quarter 2008 net cash from operating activities of $117 million. Also during the quarter we repurchased about 7.7 million shares of Lexmark stock with a total expenditure of $274 million.

Hardware revenue for the third quarter was down 14% year to year due to the ongoing decline in our inkjet units. However, this third quarter hardware revenue decline of 14% is an improvement from the second quarter decline of 19%, primarily driven by an improvement in laser hardware revenue year to year.

Supplies revenue was down 1% year to year in the third quarter and came in about as expected with good growth in laser supplies being more than offset by a decline in inkjet supplies.

While supplies revenue sell-in was about as expected, sell-out was less than expected in the quarter for both laser and inkjet supplies, resulting in an increase in the channel inventory of supplies.

As we look ahead into the fourth quarter, we see a couple of factors negatively impacting our year to year supplies growth estimate. The first is a significant channel load from an OEM customer in the fourth quarter of 2007 that is not expected to repeat. The second is the possible sequential reduction of channel inventory due to the third quarter channel build.

In the fourth quarter of 2008, our current expectation for supplies revenue is a high-single-digit year to year decline as growth in laser supplies is more than offset by a decline in inkjet supplies.

During the third quarter, we continued to shift our consumer strategy to focus on devices, customers, and countries that drive a higher page usage. As a result, our consumer segment revenue was $371 million, down 21% year to year, and consumer segment operating income excluding restructuring was $26 million, a significant improvement from the segment loss incurred in the third quarter of 2007.

For the third quarter, inkjet unit sales were down 46% year to year as we continued to implement our change in consumer strategy and have ongoing impact from less U.S. retail shelf space year to year, as described in our previous quarterly calls.

Inkjet unit sales for the quarter were below our expectation, primarily due to a miss in our OEM unit sales and increasing market weakness, particularly in international geographies and the associated aggressive competitive price and promotion activities.

Now in the U.S., while we experienced a weak back-to-school market overall, branded inkjet hardware revenue came in above expectation as we executed some very strong wireless campaigns at key retailers.

From available NPD data for the U.S. in the third quarter, we continue to see strong growth year to year in the sales out of our wireless inkjet devices. For the quarter, inkjet average unit revenue was up 15% year to year despite aggressive market pricing, reflecting our strategy to prioritize high-end units which drive stronger usage while reducing entry level units.

Now as we look back to the third quarter, while we are not satisfied with the level of inkjet unit sales, this is just one part of a broad set of initiatives we are executing to shift the consumer strategy and turn this business around.

We are shifting our marketing focus and targeted customer segments to the heavier usage segments of student and professional users. We are shifting our investments in R&D to better design products and technology that will be attractive to these segments, and you are starting to see us deliver these targeted new products with the introduction of our new professional series and home and student series of inkjet products earlier this year.

We are reengineering our supply chain to reduce costs and eliminate touches between the factory and the customers and we are working on our supplies to lower costs and consolidate our manufacturing capacity but also to improve our supplies technology, increase the customer value and improve our win rate in the after market.

Now in the business market segment in the third quarter, revenue was $760 million, up 4% year to year with growth in both laser hardware and supplies revenue. Operating income excluding restructuring was $128 million, down 115 year to year primarily due to higher R&D and demand generation investments year to year as well as lower product margins.

Laser units for the quarter were down 1% year to year as a decline in OEM unit sales more than offset good growth in branded units. Branded unit growth was driven by strong growth in laser MFPs and in our managed print services business.

During the quarter, we saw increasing market weakness in our international geographies but overall our laser hardware revenue performance improved in the quarter as we saw a significant improvement in our U.S. branded hardware sales with double-digit growth in both units and hardware revenue.

Now yesterday we announced the introduction of 38 new laser models, representing a broad range of new color and mono laser printers and multi-function products. Highlights include the new small footprint compact Lexmark C540 and X540 series of color laser printers and MFPs, featuring built-in two-sided printing, instant warm-up fusing for lower energy consumption and a fast time to first page, best-in-class color print speeds of up to 25 pages per minute, with prices starting at $399 for a color single function device and at $599 for a color multi-function device.

We also introduced a new X658 series of high-end mono MFPs which were designed to be very competitive with higher end digital copier printers and feature a unique, smaller space saving footprint with fully integrated finishing, including stapling and mailboxes, and speeds of up to 55 pages per minute, with prices starting at about $3,800.

Let’s talk about the fourth quarter 2008 -- as we look forward, we are expecting a more difficult global market environment than we saw in the third quarter that we believe will negatively impact sales, including weaker market demand and potentially more aggressive market pricing. In addition, we’ve described several factors that we expect to negatively impact our fourth quarter 2008 year to year supplies comparison. As a result, we expect fourth quarter 2008 revenue to decline in the low- to mid-teens percentage range year to year and we expect earnings per share to be in the range of $0.70 to $0.80, excluding restructuring and related charges.

And while our near-term results are not where we would like them to be, we continue to focus on the long-term growth and success of the company and the creation of shareholder value. Our new product announcements yesterday show the impact of our continuing R&D investment in our business market segment. This is producing a steady stream of new product introductions, as well as ongoing product awards and industry recognition for our laser products.

We will continue our focus on the expansion of our managed print services and industry sales initiatives and are seeing success with some of the world’s largest enterprises. We also made a significant investment in our enterprise sales force in 2007 to improve our coverage and expand the reach of our solutions and services propositions. We are seeing the benefit of that investment in our improved third quarter 2008 laser hardware revenue performance in the U.S.

Now the focus of all these business market investments is to drive workgroup laser growth and page generation.

On the consumer side, we are driving a significant change in our market strategy. Although we are seeing significant near-term impacts in our units, we believe that with these changes, we will be much better positioned for the future. This strategy shift increases our focus on higher price points and higher usage devices and the investments to better meet the needs of these customers and product segments.

Now this strategy is driving strong growth year to year and the retail sell-out of our wireless inkjet units, an improvement in our inkjet average unit revenue despite an aggressive pricing environment, the introduction of new products such as our professional series and home and student series, and an increasing amount of industry recognition and awards for our inkjet products. We are also continuing to implement a restructuring of our business to lower our costs and better allow us to fund these strategic initiatives.

Now in closing, we continue to have a strong financial position with net cash at the end of third quarter, and by this I mean our cash balance minus debt, of about $435 million, and we continue to produce a good cash flow from operations.

I will now turn it over to John Gamble for his more detailed comments on our financials.

John W. Gamble Jr.

Thank you, Paul and good morning. Consistent with previous calls, I will first discuss our results of the third quarter of 2008 relative to the prior year, then relative to the second quarter of 2008. Next I will discuss selected changes on the balance sheet and certain items of cash flow. Finally I will finish with more detail regarding our guidance for the fourth quarter.

I will call out the impact of restructuring related expense as we walk through the P&L. In the supplemental slide deck posted on our investor relations website, we have included details on the income statement line items impacted by the restructuring related activities.

Now let me begin with the P&L -- total revenue for the quarter was $1.13 billion, down 5% compared to last year, down 1% sequentially from 2Q, and at the upper end of the guidance we provided in July. The year-on-year revenue decline was driven by the decline in consumer segment revenue.

Geographically for the third quarter, U.S. revenue of $494 million declined about 6% year to year but was up 14% sequentially. Revenue of $402 million in Europe declined about 5% year to year and was down 12% sequentially. The remaining geographies declined about 4% versus a year ago and 7% sequentially.

Laser and inkjet supplies revenue in the third quarter was down 1% year to year with good growth in laser supplies revenue being more than offset by an ongoing decline in inkjet supplies. In the quarter, we believe supplies channel inventories increased, with this increase resulting in higher supplies revenue of about 2% versus 3Q07. This increase in channel inventories impacted both laser and inkjet supplies. Supplies revenue in 3Q08 was at the positive end of the single-digit decline that we indicated on the July earnings call.

Laser and inkjet printer revenue in the third quarter declined 14% year to year. This hardware revenue decline was due to lower inkjet hardware revenue due to a 40% decline in inkjet units -- 46% decline in inkjet units.

Laser hardware unit shipments declined 1% in the third quarter versus the prior year. Despite the decline in overall unit sales, we saw good growth in our branded unit shipments, driven by continued strong growth in both mono and color MFP unit shipments.

Laser average unit revenue was up 2% year to year in the third quarter as the negative impact of pricing was offset by currency and favorable product mix with MFPs.

Inkjet hardware unit shipments declined 46% year to year in the third quarter. The decline was due to our previously announced strategy to aggressively shift focus to geographic regions, market segments, and customers with higher page generation as well as the impact of weaker U.S. shelf space, as we have discussed in previous quarters. Inkjet unit sales in 3Q08 were weaker than expected, primarily due to a miss in OEM unit sales and increasing market weakness, particularly in international geographies and the associated aggressive competitive pricing and promotion activity.

Inkjet AURs increased 15% versus the prior year due to an improved mix reflecting more AIOs and currency benefits, partially offset by negative price.

Business segment revenue for the quarter of $760 million grew approximately 4% from the same quarter in 2007 and was approximately flat sequentially from 2Q08. Year to year growth was delivered in the third quarter by all regions except Asia-Pacific and was primarily driven by good year-on-year growth in supplies.

Hardware revenue growth was driven by strong growth in North America and Latin America regions, mostly offset by weakness in EMEA and Asia-Pacific. Sequentially, the business segment revenue in 3Q08 was driven by good growth in hardware revenue, offset by a decline in supplies revenue, which has been the typical seasonal pattern for supplies.

Consumer segment revenue for the quarter was $371 million, down 21% compared to a year ago and down 1% sequentially. The third quarter year to year decline was driven by both inkjet hardware and supplies revenue. The sequential decline was driven by inkjet supplies offset partially by growth in hardware revenue.

Gross profit margin for 3Q was 32.5%. Excluding restructuring related charges of approximately $17 million, gross profit margin would have been 34.1%, up 590 basis points versus the prior year, and down 290 basis points sequentially. The 590 basis point third quarter increase versus last year was principally due to a 560 basis point increase in product mix, the largest factors of which were the impact from the decline in inkjet hardware shipments and increased laser supplies.

Sequentially, the 290 basis point decline was principally due to 180 basis point decrease from lower product margins and a 120 basis point unfavorable impact of mix. The lower product margins reflected weaker hardware margins and a less favorable impact of APC LCM in the quarter. The unfavorable mix was primarily due to more hardware relative to supplies.

Operating expense for the quarter was $314 million. Restructuring related expense of approximately $7 million impacted operating expense this quarter. Excluding this impact, operating expense was $307 million, an increase of $5 million year to year.

SG&A in the quarter was $197 million, a decrease of $4 million, as increased marketing and sales spending was more than offset by lower G&A. G&A in the quarter also reflected a $4 million benefit from a favorable settlement in a legal proceeding. The increase in marketing and sales expense in the quarter was demand generation investment, including media.

R&D in the quarter was $110 million, an increase of $9 million from 2007. The impact of currency on operating expense versus 2007 was an increase of at least $5 million.

Sequentially versus 2Q, operating expense excluding restructuring related expenses decreased $5 million. SG&A decreased $12 million, principally driven by a decrease in marketing and sales expense due to a favorable currency and seasonality of media, as well as the $4 million legal fees reimbursement as I previously mentioned.

R&D expense increased $7 million sequentially due to our continued investment in technology.

The operating expense to revenue ratio excluding restructuring related expense was 27.1% in 3Q.

Operating income in 3Q was $54 million. Excluding total restructuring and related costs and expenses of $25 million, operating income was $79 million, up $43 million from 3Q07 and down $31 million sequentially from 2Q08. Excluding restructuring related activities, business segment operating income in 3Q08 of $128 million was down $16 million versus last year and down $29 million sequentially. The decline versus 3Q07 is principally due to increased marketing and sales and product development expenses, as well as the impact of lower product margins.

Again excluding restructuring related expenses, consumer segment operating income in 3Q08 of $26 million was up $42 million versus last year and down $1 million sequentially. The $42 million increase in 3Q08 versus last year reflects favorable product mix reflecting less hardware and favorable APC LCM, partially offset by less supplies.

Other expenses consisting primarily of costs related to centralized supply chain, IT, and other operating expenses, primarily G&A, were $76 million in 3Q08 excluding restructuring related activities, a decline of $18 million from 3Q07, reflecting lower operating expenses, the recovery of litigation fees, and less negative transaction effect of foreign exchange, offset by unfavorable currency. Sequentially, other expenses increased $1 million.

Operating income margin in 3Q was 4.8%. Excluding the restructuring related expenses, operating income margin was 6.9%, an increase of 400 basis points from the third quarter of 2007 and a decrease of 270 basis points sequentially.

Concerning financing and non-operating costs, the net interest and other generated expense of $5.1 million, up approximately $11.6 million from 2007. This increase was driven by increased interest expense related to the $650 million bond issuance we completed last quarter, as well as a loss of $4.4 million on Lehman Brothers bonds held in Lexmark's investment portfolio. Sequentially, net interest and other resulted in increased expense of approximately $7.8 million driven by the same factors.

In 3Q08, we had an effective tax rate of 25.2%, in line with our expectation before any discrete items. The U.S. R&D tax credit has been extended effective January 1, 2008. With this extension, we believe our effective tax rate in 2008 to be about 23% before any discrete events.

Net earnings for the quarter were $37 million. Excluding the $18 million after-tax cost from restructuring related activities, net earnings in 3Q08 were $55 million. 3Q07 net earnings were $45 million, or $57 million excluding after tax restructuring related charges.

GAAP earnings per share for the quarter were $0.42. Excluding restructuring related activities, EPS would have been $0.63 per share. This compares to 3Q07 GAAP earnings per share of $0.48, or $0.60 excluding restructuring related activities.

Earnings per share for 3Q08 of $0.63 excluding restructuring related activities of $0.21 per share were in line with our guidance of $0.53 to $0.63 per share that we provided in July.

Now moving to the balance sheet and cash flow items, cash flow from operations for the quarter was $117 million, down $26 million compared to 3Q07 and down $19 million sequentially. Excluding restructuring related cash outflows, cash flow from operations was $131 million this quarter, a decrease of $6 million from 3Q07 and a decrease sequentially of $12 million from 2Q08.

Since the end of June, accounts receivable decreased $16 million, inventory increased $19 million, accounts payable increased $10 million, and accrued liabilities increased $39 million, principally driven by an increase in accrued salaries, taxes payable, and interest payable.

For the quarter, capital spending was $58 million. Depreciation in the quarter was $56 million and includes $11 million of restructuring related accelerated depreciation. Currency of the Euro was accounted for at $1.51 compared to $1.37 in 3Q07 and $1.56 in 2Q08.

Cash and current marketable securities at the end of 3Q was $1.086 billion, down $241 million since June. Our cash portfolio is invested in short-term instruments with a majority of the portfolio in U.S. government or U.S. government guaranteed instruments. We do have investments in asset-backed securities and instruments issued by financial institutions; however, virtually all of our investments remain very highly rated. The loss incurred on the investment in Lehman securities reflects the majority of the losses incurred by Lexmark in the last 24 months.

Total debt at the end of 3Q08 was $650 million, with maturities on the debt in 2013 and 2018.

In 3Q, we repurchased 7.7 million Lexmark shares for $274 million at an average price of $35.35. This includes $127.5 million, or 3.5 million shares delivered to Lexmark under an accelerated share repurchase agreement. At quarter end, we had $613 million of share repurchase authority outstanding.

Now let me move to restructuring. Regarding the restructurings we announced in October 2007 and last quarter, we continue to expect the overall program parameters, costs, and benefits to be about the same as discussed last quarter. For 2008, total restructuring and related costs and expenses are expected to be approximately $75 million and savings related to these restructurings are expected to exceed $40 million. More details are available in the supplemental slide deck.

Annualized full-year savings from the 2007 and 2008 restructuring announcements are expected to be about $70 million in 2009. As pointed out last quarter, movements in foreign exchange may result in changes in the cost and benefits of both the 2007 and 2008 restructuring actions.

In 3Q08, we continued to make good progress on restructuring actions. Total restructuring and related costs and expenses were $25 million, $17 million in gross profit and $7 million in operating expense. Savings in 3Q08 were about $12 million.

In 4Q08, restructuring and related costs and expenses due to restructuring actions are expected to be approximately $30 million. Savings in 4Q08 are expected to be about $16 million.

Now for my forward-looking comments concerning 4Q08 -- as we look ahead, the current financial situation impacting world markets and related economic slowdown is impacting the markets for printers, MFPs, and supplies. We believe the restriction of credit globally and the swings in currencies we have seen in emerging markets is impacting economic activity and our end markets. It is difficult to tell the specific size or duration of this impact but we expect an impact on 4Q08.

We expect fourth quarter revenue to be down in the low- to mid-teens percentage range year over year. Total supplies revenue is expected to be down in the high-single-digit percentage range versus 4Q07. GAAP EPS is expected to be $0.40 to $0.50 per share in 4Q08. GAAP EPS includes expected restructuring charges of $0.30 per share. Non-GAAP EPS, which excludes restructuring and related costs and expenses, is expected to be $0.70 to $0.80 per share. GAAP EPS in the fourth quarter of 2007 were $1.04, which includes restructuring charges of $0.25 per share. Non-GAAP EPS in 4Q07 were $1.29.

The supplies revenue guidance we are providing of down high-single-digit percentage versus 4Q07 is significantly lower than the down approximately 1% we have achieved year-to-date in 2008. The lower supplies revenue is driven by several main factors. In 4Q07, we discussed the unexpected build of channel inventory by an OEM partner. As we indicated at the time, this channel inventory build resulted in increased supplies revenue in 4Q07 of three to four percentage points. We do not expect this OEM channel inventory build to recur in 4Q08.

In addition, as I indicated earlier, we believe channel inventories in 3Q08 increased, resulting in higher supplies revenue of about two percentage points. We believe these factors, as well as the general economic situation as we discussed earlier, drives the percent point difference in our 4Q08 guidance versus the supplies revenue results achieved year-to-date. It is important to note that this guidance continues to reflect growth in laser supplies in 4Q08.

Also included in our revenue guidance is the expectation that inkjet hardware units will be down significantly versus 4Q07. Although we believe the relative performance of inkjet hardware in 4Q08 versus the first nine months of 2008 will improve, we expect to see declines in inkjet hardware units and revenue versus 4Q07 reflecting our continuing focus on moving to higher page generating placements, the weaker economic environment, and the expected very aggressive competitive environment, as well as the impact of lower U.S. retail shelf space we have discussed in earlier quarters.

Our guidance for 4Q08 shows a significant reduction from 4Q07 non-GAAP EPS of $1.29. This reduction is driven primarily by the expected lower supplies revenue year-on-year, as I just described, and expected lower hardware margins year-on-year due to aggressive market pricing in both inkjet and laser and the strengthening dollar, which we project to be somewhat offset by the positive impact of lower inkjet hardware units and lower OpEx year-on-year.

In terms of our specific discussion of financial information, both the 3Q and 4Q data provided that I am comparing to are non-GAAP and exclude the impact of restructuring related charges. In the fourth quarter, we expect gross margin percentage to be down versus the 34.1% we achieved in 3Q08. Operating expense is expected to be down compared to the $307 million incurred in 3Q08 and $301 million incurred in 4Q07. Operating income margin in the fourth quarter is expected to be up slightly from the 6.9% achieved in the third quarter of 2008.

For 4Q08 and the full year, the U.S. R&D tax credit has been extended by congress retroactive to January 1, 2008. This results in a tax benefit to Lexmark that will be reflected in 4Q08 of approximately $6 million. This will result in a 4Q 2008 effective tax rate to be about 15% and our full-year and ongoing effective tax rate to be about 23% before discrete events.

We project full-year 2008 capital spending to be approximately $230 million and we expect full-year depreciation to be approximately $210 million. This includes $36 million of accelerated depreciation.

Now before opening the call up for your questions, I would like to point out that our financial position remains strong. We continue to have a solid balance sheet and good liquidity with over $1 billion in cash and current marketable securities, a revolver of $300 million that does not expire until the first quarter of 2010, and an AR facility of $100 million which we renewed on October 3rd. Further, we have a long track record of good cash generation that has continued this year with over $400 million in cash flow from operations through the end of the third quarter. So our strong financial structure continues to position us well to invest in the future and compete effectively, even during challenging times like these.

With that, we’ll go ahead and open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is coming from Katy Huberty, Morgan Stanley.

Kathryn Huberty - Morgan Stanley

Good morning, thanks. Paul, how broad-based was the supplies inventory increase? Did you see that across regions and products or was it specific to some of the partners?

Paul J. Curlander

Katy, what we saw was on the inkjet side, the major issue was really in Europe so it was kind of geographically isolated. On the laser side, we saw some weak sell-out primarily in the month of August and it really kind of went through all geos. But in both inkjet and laser, we saw the supplies come back to our expectation in the September timeframe.

Kathryn Huberty - Morgan Stanley

And then John, given the expectations for more aggressive pricing in the fourth quarter, why didn’t we see a more significant APC LCM charge on the inventory?

John W. Gamble Jr.

In the third quarter?

Kathryn Huberty - Morgan Stanley

In the third quarter.

John W. Gamble Jr.

So again, it’s really dependent on the inventory balance that exists at the time, right? And so we take LCM charges on the inventory balance, so that is the only way that you would see a big change in APC LCM in the third quarter.

Kathryn Huberty - Morgan Stanley

Okay, thanks.

Operator

Thank you. Our next question is coming from Shannon Cross, Cross Research.

Shannon Cross - Cross Research

Good morning. A question just on cash and how we should think about cash. You know, you spent -- you bought 7.7 million shares back at $35. The stock is obviously going to be well below that today. How should we think about your cash balance, how much is domestic versus overseas? I would assume there’s still about half that’s domestic, given your recent debt raising but just sort of macro, how do you sort of think about managing the cash? Do you want to be as aggressive with share repurchase? Are there other ways to maybe reinvest back into the business? Any commentary you can give, thanks.

John W. Gamble Jr.

I can address specifically where the cash is -- obviously the bulk of the cash does continue to be overseas and that is where our largest cash balance remains. If you take a look at what we’ve done in the past six months, we did a net borrowing of about $500 million in the second quarter. We had a $150 million maturity and did a $650 million issuance. Since then, we’ve repurchased over $400 million worth of stock. I think a little over 12 million shares so if you think about the repurchases versus the borrowing we did, we’ve already repurchased $400 million versus the net $500 million of borrowings that we executed.

Shannon Cross - Cross Research

Okay, so I guess going forward, how aggressive should we expect you to be in terms of share repurchase and the ability to draw cash back from overseas -- just any clarity you can give us there.

John W. Gamble Jr.

Well we really don’t forecast our share repurchases. There certainly currently is a U.S. cash balance but we don’t forecast our share repurchases and I guess that’s about all I can specifically address in terms of share buy-back.

Shannon Cross - Cross Research

Okay, and then just one question for Paul, please -- can you give us some thoughts on the inkjet business from the standpoint of channels? Any issues with Circuit City? I mean, obviously they are in the news every other day. Thanks.

Paul J. Curlander

Well, I would tell you that certainly in the U.S. overall, we are not at the level of distribution that we would like to have. In the professional series, as an example, what’s interesting to us there is even though we haven’t gotten the shelf space yet that we’d like to have, where we are on shelf and well displayed, well merchandised, we do very, very well on the sell out and that product is very good. So we are going to continue to work to expand distribution in the U.S. and that’s an ongoing effort.

You know, relative to Circuit City specifically, there’s not much we can say about an individual retailer. I mean, clearly we watch the situation very closely but we do continue to do business with them.

Shannon Cross - Cross Research

Have you taken any reserves for them?

Paul J. Curlander

Again, it’s not appropriate for us to talk about any individual retailer.

Operator

Thank you. Our next question is coming from Bill Shope with Credit Suisse.

Bill Shope - Credit Suisse

Do you guys anticipate any impact on consumables usage rates across the product line in inkjets and lasers from macro pressures? And I guess looking back historically, have you seen any evidence of any significant changes in the usage rates during prior downturns?

Paul J. Curlander

As we’ve gone back and looked historically, we really have not seen impact in usage rates on supplies during an economic downturn. Typically you see impacts on hardware sales, you see impacts certainly on hardware pricing and margins but we’ve not necessarily all seen that on the supplies side.

I think that as we go into the fourth quarter, we’ve never quite seen a global economic turn down like this. Usually it’s much more localized in certain geographies. The credit crisis is also a concern to us, primarily because of the channel and what that might do to the level of inventory they hold or even potential bankruptcies in the channel. So we think that there probably is some potential impact there. That’s kind of hard to forecast but overall on usage, historically we’ve not seen an impact in an economic downturn.

Bill Shope - Credit Suisse

How about the use of remans or clone cartridges during a downturn? Do you think you will see any increasing shift towards the reman or clone market in both laser and inkjets?

Paul J. Curlander

Well you know, I think that’s always possible. People are always very price sensitive but that’s the usual thing every day. People are very price sensitive. This is one of the reasons why at Lexmark we aggressively collect up our empty cartridges and that we are actively participating in the reman business, either with the Lexmark logo or with a private label logo product. So we do expect that trend to continue and we expect to compete for that opportunity.

Bill Shope - Credit Suisse

Okay, great. Thank you.

Operator

Thank you. Our next question is coming from Richard Gardner, Citigroup.

Richard Gardner - Citigroup

Thank you. Good morning. Just a simple question -- I was wondering if you had any plans to change supplies pricing, like some of your large competitors have announced here recently? Thank you.

Paul J. Curlander

Yes, we have raised some supplies prices and some of these will be going into effect here during the fourth quarter, so we’ve already done that.

Richard Gardner - Citigroup

Okay, and can you talk about on which particular supplies products, Paul?

Paul J. Curlander

We’ve done it pretty broadly across the board in both laser and inkjet products.

Richard Gardner - Citigroup

And on a global basis?

Paul J. Curlander

Yes, on a global basis.

Richard Gardner - Citigroup

Okay, and any sense of magnitude that you can provide?

Paul J. Curlander

I would say it’s comparable to what you’ve seen other vendors in the marketplace do.

Richard Gardner - Citigroup

Okay. All right, thank you, Paul.

Operator

Thank you. Our next question is coming from Bill Fearnley at FTN Midwest Research.

Bill Fearnley - FTN Midwest Research

When you take a look at demand guidance -- when you look at revenue guidance, your guidance for revenue is lower than our previous estimate in the mean. What are the bigger levers here for the lower guidance? Is it hardware or supplies? Is it business or consumer? Is it specific geographies? I mean, I think the mean estimates are likely to come down quite a bit. What are the biggest levers here? And then I have a quick follow-up, if I could.

Paul J. Curlander

I think the easiest way to think about this as you look at the fourth quarter is the biggest impact is the movement in the supplies guidance, and this was driven by the factors that John talked about relative to the year-on-year comparison to a big load of supplies in the channel last year by an OEM customer, as well as the channel inventory build during the third quarter this year.

So if you take a look at where we were in the third quarter with a minus 5% year to year revenue decline, supplies were at minus 1, as you envision supplies moving to a high-single-digit year to year decline as we just talked about in the fourth quarter, this is what is leading us to talk about the low- to mid-teens in terms of overall revenue guidance.

Bill Fearnley - FTN Midwest Research

And then a follow-up on the supplies, if I could -- you are basically talking about a channel build to supplies. Did you telegraph some of the price changes which would have incented the channel to bulk up on supplies here in the third quarter, preparing for the upcoming holiday season?

Paul J. Curlander

We certainly had communicated the supplies increases. It’s hard for us to say if the increase in channel build was due to that. We really don’t think so. We think it was just some shortfall in sell-out that occurred during the quarter but the reality is in the supplies, this happens quite often. Your expectations in a given quarter tend to move a little bit. You don’t have complete reporting in terms of the actual channel inventory. Certainly you don’t get second tier reporting in the channel and outside the U.S., that can be a significant factor. So it’s always a little hard to know exactly what you are going to see in any given quarter but we don’t think it was the price increases, just some less sell-out or at least less inventory in the channel side that we actually get reporting on.

Bill Fearnley - FTN Midwest Research

Thanks, guys.

Operator

Thank you. Our next question is coming from Min Park of Goldman Sachs.

Min Park - Goldman Sachs

Thank you. Just on your business segment, despite the reduction in your exposure to the low-end printer segment and as well as the growth in your supplies revenue, you op margins were down roughly 300 basis points year over year, so can you please provide some more additional detail behind the margin decline? You know, how much was it due to the lower product margins versus higher OpEx and to what extent is the lower margins a more permanent fixture versus a more temporary shift in the quarter?

Paul J. Curlander

Well, if you take a look at year-to-date in the business market segment, essentially all the margin erosion has been driven by the increase in operating expenses. Clearly we are seeing some product margin pressure here in the second half of the year as we’ve seen inflation in commodity costs, as we’ve seen higher labor rates in Asia and a very aggressive pricing environment globally. But primarily what we’ve seen in 2008 is due to the operating expense. And the operating expense is really both on the R&D side and on the marketing and sales side. On the R&D side, this is the ongoing effort that we’ve made over the last three or four years to really increase our investment focused around color and laser multi-function devices. I think that we’ve seen a significant impact in our product line as a result of this investment -- not just the 30-day products that we introduced yesterday on the laser side but if you look at our laser multi-function product line, three years ago we didn’t have anything and now we have a pretty good line on both mono and color laser MFPs and getting strong growth in laser MFPs this year.

If you take a look on the color side, over the last three years we’ve gone from really one technology platform that was Lexmark technology to now three technology platforms that are Lexmark technology, so it’s been a significant improvement in the product set. I would also point out that as you can see in our supplemental slide deck, according to our count we continue to win more awards in laser printers than any other vendor and that’s not just this year but it was last year and also the year before. So we think we are seeing a good impact on that.

Over on the marketing and sales side, the increase really was an increase in coverage that we did in 2007, so we hired additional sales people in 2007. You are seeing an increase in 2008 because as we did that through the year on a year to year basis, you get an increase in 2008 from that. You know, our focus there was really to focus on incremental coverage, to winning new accounts. We have seen a good result from that obviously coming off a small base but we’ve seen steady growth in the revenue generated by those additional reps. And I think here in the third quarter in the U.S., we saw significant improvement in our performance. We saw good growth in our laser units, good growth in our laser hardware revenue and I think certainly the additional coverage helped that, as well as some improvements on the enterprise side of our business in managed print services.

So I think that’s really the issue that’s caused the erosion in the margin that we’ve seen this year.

Min Park - Goldman Sachs

Okay, and as we go forward, as we see ongoing pressure on the top line, what should be the right operating margin target that we should be focused on on the segment and what can you do to kind of get it back up to the 20s, if possible?

Paul J. Curlander

Well, we have never given any guidance relative to the margins in the segments and actually we haven’t given any forward-looking guidance beyond the next quarter. But I think that as we go forward in time, we still have a little bit more work to do in the laser product line relative to what we would like to do. We don’t yet have everything that we would quite like to have. Obviously as you look at our guidance in the fourth quarter, we’ve talked about operating expenses for the corporation sequentially being down versus the third quarter and being down on a year to year basis. And I think that’s really the result of the work that we’ve done in restructuring. We’ve done a lot of work I think through the years. Through this year, we’ve seen unfortunately some of that offset by currency impacts but certainly there is savings that’s there. And 2009, we’ve not yet set our plans in place. Obviously as we do that we will be considering not only the additional things we’d like to get into our product line but we will also be focused on the global economic environment as well.

Min Park - Goldman Sachs

Thank you.

Operator

Thank you. Our next question is coming from Mark Moskowitz with J.P. Morgan.

Mark Moskowitz - J.P. Morgan

Thank you. Good morning. Paul, a question on just your general commentary around the prospects of more aggressive pricing competition in the fourth quarter -- how much of that is in the high-end inkjet where you’ve been trying to shift Lexmark's focus? Is this really driven by demand being weaker or is it really just competitors now responding toward your foray into that market segment?

Paul J. Curlander

Well, I think we are seeing both. I mean, we are seeing aggressive price competition in every segment. In retail, you tend to see it not just in price moves but in very aggressive promotions and this continues whenever the market is weak, and certainly the market in the U.S. retail channel has been very weak this year with overall market hardware revenue declines in excess of 10%, 10% to 15%, just looking at the NPD data that’s out there. This is when you start to see more aggressive pricing, people have excess inventory, people aren’t making the sales outlooks that they had anticipated and this is what happens. So we see it in low-end, we see it in high-end.

If you take a look even up at the enterprise side, obviously we see very aggressive bidding in enterprise accounts and if you look in the channel, small and medium business, we see very aggressive promotions that have been running throughout the year as the market has been weak.

You know, we’re now seeing weaker markets internationally so that what we are reflecting certainly in our discussions around the fourth quarter outlooks and certainly what we are seeing in the product margins is the impact of this aggressive environment.

Mark Moskowitz - J.P. Morgan

Okay, and then my second question gets to the laser refresh, clearly a pretty impressive bevy of products yesterday but can you help us understand two points -- one, do you have a little more wiggle room in terms of maybe pulling back on R&D in some of the OpEx pieces in the next couple of quarters with that refresh gone? And then two, what about the guidance? How much of the guidance is really supported by this refresh or if the refresh does well, is that all incremental?

Paul J. Curlander

Well, the second part first -- certainly our guidance anticipated the launch of our new products and so we’ve rolled that into the outlook that we have for the fourth quarter.

On the operating expense side, I think that this is what we are in the middle of right now, is trying to decide what our plans are for 2009. Obviously we’ve put a lot of products out, we’ve dramatically improved our color and multi-function line over the last three years. There is more that we would like to do, so we are focused on that. We are also looking at the global economic environment and as you pointed out, the impact on the top line potentially from weaker hardware sales globally. So we’ve not yet put those plans in place but this is the thing that we are considering as we complete this year.

Mark Moskowitz - J.P. Morgan

Thank you.

Operator

Thank you. Our next question is coming from Toni Sacconaghi with Sanford Bernstein.

Toni Sacconaghi - Sanford C. Bernstein

Thank you. I wanted to revisit the supplies question, please -- Paul, your supplies growth was about 1% last year, about minus 1% in the first half of the year. And it sounds like on a sell-out basis, it was probably about minus 3% this quarter. So we’ve seen some deceleration in the supplies growth rate. Now you’ve said you don’t think it’s economic driven, that you typically don’t see that so is this a reflection that your installed base effective supplies generation capability is deteriorating? And if so, shouldn’t we expect that to continue?

Paul J. Curlander

I think it’s a reflection, Toni, of what’s going on in our inkjet business and what we are seeing in the inkjet business is a decline year to year in our supplies. And the reality is that what you pointed out is exactly right -- it was plus one last year, minus 1% year-to-date, I think about 3% sell-out in the third quarter. I think that’s about right. And what we are seeing is a slow eroding on the supplies year to year until we turn around the inkjet business. That’s kind of what we are seeing.

Toni Sacconaghi - Sanford C. Bernstein

Now, if I think about your guidance and the forces at work on supplies for next quarter, I’m having trouble reconciling it so let’s say you got a 3-point boost last year in the fourth quarter from your OEM build, so that’s a 3-point headwind, effectively. And then for this quarter, you basically said there was a 2-point supply inventory build, so that’s another 2-point headwind. So you have a 5-point headwind looking into next quarter, but you just raised prices 5%. So if we think about those offsetting forces, why unless you are expecting a dramatic deceleration in usage of supplies, which again you said is not tethered to the economy, why are you guiding for such a weak supplies outlook going forward, given that the price increase should ostensibly and analytically offset the inventory builds in both Q4 last year and the one this quarter?

Paul J. Curlander

Well, I think as John went through the bridge, he talked about 5% to 6% number, so you can put that on top of the minus 1 and that puts you into a high-single-digit range. You know, I think beyond that, historically we’ve not seen downturn impacts on supplies usage and sell-out. But what we are seeing and what we do have concerns about is that in this credit crisis, we depend on the channel for carrying inventory and to the extent that they don’t have as much credit -- we don’t know what that will do to channel inventory levels so we wonder about that a little bit. As the currency moved aggressively in the first two weeks of this quarter, what we saw was that what happens is we very often internationally deal in dollars into distributors in these countries and when the currency rates move very quickly, what happens then is that the prices in local currency fluctuate pretty significantly going up and what people owe us goes up in local currencies and what happens is the business tends to slow down or stop as people try to figure out what it is they are going to do.

So the economic impact is out there relative certainly I think on the channel and on our partners and what level of channel inventory could potentially be carried.

We also have issues and concerns around what it will mean for our OEM partners who are also an important piece of what we do in supply, so these are some of the uncertainties.

So I think that when we talk about usage, economically historically we’ve not seen that but as we talked about these other aspects, certainly we think there could potentially be impacts and we’ve seen impacts in the first two weeks of the fourth quarter.

So these are the thoughts that go into the guidance that we gave.

Toni Sacconaghi - Sanford C. Bernstein

Thank you.

Operator

Thank you. Our next question is coming from Jeff Fidacaro, Merrill Lynch.

Jeff Fidacaro - Merrill Lynch

Good morning. I wonder if we could talk a look at this on the laser side -- your units are down 1% and pricing was up 2%. I wonder if you can give us more color on the breakdown by enterprise versus SMB and if you saw a more pronounced change in one of those markets. And as you look at sort of the laser segments, can you give us a little bit more color on the competitive pricing by low-end versus high-end, if that has changed quarter over quarter?

Paul J. Curlander

Okay, relative to the competitive pricing, I would say it’s been very aggressive, certainly year-to-date and in the third quarter. You know, on the low-end, what we have seen primarily is a set of price wars going on in low-end color lasers, to a lesser extent mono-lasers but certainly very aggressive pricing and HP and Samsung have been very aggressive going after that market.

On the high-end and enterprise, what we’ve seen certainly as the market has weakened is very aggressive pricing in enterprise deals. It’s just been surprisingly aggressive as we’ve gotten into some of these deals.

I think that as we look at the laser results for the quarter, laser units were down 1% year to year but that was driven by a decline in our OEM units. On the branded side, we had laser unit growth, we had good laser unit growth. If you take a look at the U.S. in particular and you asked about enterprise versus SMB, we had a very good quarter in the U.S. in terms of units, in terms of hardware revenue, branded units, branded hardware revenue on a year to year basis and that picked up. A lot of the pick-up came on the enterprise side, driven by our management services success and initiatives by our increased coverage, as we talked about the focus on getting into additional accounts. So I think that we feel pretty good about the enterprise propositions that we have and the growth there. SMB, we’re getting some good results. Obviously we are concerned a little bit about the global economic situation here in the fourth quarter but in the U.S., we are still expecting to have a good quarter in the fourth quarter in laser.

Jeff Fidacaro - Merrill Lynch

Thank you.

Operator

Thank you. Our next question is coming from Ananda Baruah, Bank of America.

Ananda Baruah - Bank of America

I just want to go back to OpEx for a moment. Can you at least give us a sense for sort of maybe anecdotally how we should think about the potential for OpEx growth going into ’09, or at least what you are thinking going into ’09? I mean, the point was made earlier, there’s been a lot of investment so far to this point in ’08. On the laser side, it sounds like you guys want to do some more. It sounds like you are mulling over sort of what you might do, what you might not do but don’t you have some more work to do from a sales and marketing perspective on the inkjet side as well, now that you’ve got that product portfolio pretty well refreshed and you need to get back -- you increased your retail distribution as well on the inkjet side. And I guess is -- I mean, what I’m wondering is as revenue growth continues to slow and just sort of anecdotally your comments around, I mean, your guidance notwithstanding, your comments around the headwinds that are kind of creeping in or have crept in relative to revenue growth seem to be a little bit more concerning than previously. So can you give us some sense at least anecdotally where you might have some room to maybe pull back on some things for OpEx as you go into ’09? Or is it sort of well look, we really can’t and we are going to sort of just keep going with our plans and try to move through this thing while putting the infrastructure into place we feel we need to have in place?

Paul J. Curlander

Well, I think your question really is just a good summary of everything we are looking at right now, what we are trying to figure out as we go into 2009. I mean, I think that if you look at what we’ve done in 2008, our focus there was really to the restructuring, really put a focus on trying to reduce expense in the areas of G&A and supply chain and marketing and sales support -- all the back office kinds of things, so that we could have some money to invest in our marketing and sales side and R&D side to drive the strategic initiatives. And that’s what we’ve done, that’s what we’ve tried to do.

As we go into 2009, obviously we are looking at the things that we think that we need and you’ve hit on a couple of key things we are very focused on. One is around laser R&D, a second one is certainly around the inkjet side as we expand channel distribution. Obviously there will be some expense pressures there in 2009.

And our focus as we look at this, we continue to think about back office expense, we continue to think about overhead, we continue to think about can we make stronger utilization of the low cost countries. We now have a pretty substantial facilities capability in the Philippines, in China, and Eastern Europe. And are there things that we can do to make better leverage of the low cost countries as well as focus on the opportunities to eliminate or cut back in again things like supply chain, marketing and sales support, corporate expenses, G&A, these kinds of things.

So that’s the focus that we are on right now and we continue to be very aware of the global economic situation and what that might mean to the top line, so these are all the considerations as we look at 2009.

Ananda Baruah - Bank of America

And is there, as we just sort of think about it generally, I mean, do you have some wiggle room to pull back on some things that might make a difference in 2009 depending on how sort of revenue growth as the demand environment plays out, while still executing on your plans?

Paul J. Curlander

Well, I think that that’s what we are trying to figure out. I’ve kind of given you all the thoughts I have on it at the moment. Obviously we’ll be looking at this as we complete the year. I think you have a good feel for what the pressures are in both directions for us and obviously we are looking to figure out what’s the right long-term thing for the company as well as the best short-term result as well, so that’s what we are working on.

Ananda Baruah - Bank of America

Okay and just one quick follow-up, just on AURs, it sounds like kind of like-for-like pricing, for lack of a better term, is getting pretty aggressive across the board. You are still obviously seeing the benefit from mix up but I guess it sounds like -- I mean, how concerned should we be, given the price aggression and like-for-like product segments that your AUR growth, you know, begins to dampen from where it’s been say the last two or three quarters as we move into ’09? Should we begin to expect, you know, the same [inaudible] say kind of mid-single-digits, high-single-digits?

Paul J. Curlander

Well, it’s a little hard to project exactly what it might be and obviously we don’t give guidance on that but I think you are on a good point -- that obviously as we continue to have price pressure in some areas, like in the inkjet business, as the mix improvement starts to lap itself on a year to year basis, obviously you are going to see some changes there in the level of AUR movement that we’ve been seeing.

You know, our focus continues to be on driving the high-end and to the extent that we can do that, it’s again a little hard to gauge just what the market may look like here over the next 12, 14 weeks. But I think that your point is right, that there can be some pressure there.

Operator

Thank you. That does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day.

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