Lexmark International, Inc. Q4 2008 Earnings Call Transcript

Lexmark International, Inc. (LXK)

Q4 2008 Earnings Call

January 27, 2009 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

Eric Garfunkel - Sanford Bernstein

Min Park - Goldman Sachs

Shannon Cross - Cross Research

Richard Gardner - Citigroup

Benjamin Bollin - Cleveland Research Company

Bill Fearnley - FTN Midwest Research

Matt Whitaker - FTN Midwest Research

Jeff Embersits - Shareholder Value Management

Presentation

Operator

Thank you for standing by and welcome to the Lexmark International fourth 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. Chairman and CEO Paul Curlander and EVP and EVP John Gamble are with me this morning.

After their remarks we'll open the call for your questions as time permits. We ask that you please limit yourself to one question and one follow up if needed so we can get to everyone.

Following the conclusion of this conference call, a complete replay will be made available on our Investor Relations website located at http://investor.Lexmark.com.

We'd also like to mention two of our upcoming events. On February 26 we'll be participating in the Goldman Sachs Technology Conference. In addition, our analysts day is scheduled for March 27th at the New York Stock Exchange. You can learn more about our upcoming events through our Investor Relations website.

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.

Well, today we're announcing fourth quarter financial results which are consistent with what we discussed on January 13th. As we went through the fourth quarter, we saw a weaker than expected market demand for both hardware and supplies across all geographies and a broad weakening of currencies versus the dollar which together resulted in lower than expected revenue for both hardware and supplies and lower than expected operating income.

Revenue for the quarter was $1.084 billion, down 17% year-to-year. Hardware revenue in the fourth quarter was down 29% year-to-year primarily due to unit declines in both inkjet and laser units, negative currency impact, and lower pricing. Supplies revenue in the fourth quarter was down 12% year-to-year with declines in both laser and inkjet supplies.

Earnings per share in the quarter were $0.23. Excluding restructuring related charges, earnings per share in the fourth quarter would have been $0.75, down 41% year-to-year. Earnings per share in the fourth quarter contained a $0.29 tax benefit primarily due to an adjustment in the full year 2008 income tax rate. Earnings per share excluding restructuring compared to the fourth quarter of 2007 were impacted by several factors, primarily year-to-year declines in inkjet supplies revenue due to the ongoing transition of our inkjet strategy, the negative impact of year-to-year currency changes, lower product gross margins, and a $0.29 tax benefit in the quarter.

In the fourth quarter net cash from operating activities was $53 million and during the fourth quarter we completed the repurchase of 5.2 million shares of Lexmark stock for about $123 million.

Our fourth quarter supplies revenue decline of 12% year-to-year is a higher percent decline than our October guidance outlook of a high single-digit decline. During the quarter we saw a weaker than expected end user supplies demand in both laser and inkjet supplies as well as the negative impact of currency shifts. Because of the rapid strengthening of the dollar, we increased supplies pricing in all geographies; however, due to the normal lags between the announced dates and effective dates of price increases, we still had a significant negative currency impact on supplies revenue in the quarter.

As often happens with supplies price increases, we saw channel buy ahead. The combination of the channel buy ahead and the weakness in end user demand resulted in an increase in supplies channel inventory which we expect to be worked off over the next quarter or two.

Inkjet supplies revenue in the quarter declined year-to-year and came in about as expected as the negative impacts of weaker end user demand and currency shifts were about offset by the channel buy ahead due to the price increases.

Laser supplies revenue in the quarter also declined year-to-year; however, even with less than expected end user demand there was still ongoing sellout growth year-to-year in laser pages as branded page growth was partially offset by a decline OEM. The major issue in our laser supplies revenue for the quarter was a reduction in price per page primarily due to the currency rate shifts.

As we look forward into the first quarter of 2009, we expect overall supplies revenue to decline at about the same rate as in the fourth quarter of 2008 as supplies sell in for both laser and inkjet supplies is reduced by the anticipated shrinkage of channel inventory, the relative strength of the U.S. dollar year-to-year, and the expectation of ongoing weakness in end user demand.

Now for laser supplies in the first quarter of 2009, although we expect laser supplies revenue to decline year-to-year primarily due to the shrinkage in channel inventory and the adverse effects of currency rate shifts, we do expect an ongoing sell out growth in branded pages in the first quarter partially offset by continuing sell out decline in laser OEM supplies.

Let's talk about the Consumer segment. In the fourth quarter, we continued the shift of our inkjet strategy to focus on devices, customers and countries that drive a higher page usage. As a result, our Consumer segment revenue was $366 million, down 28% year-to-year. Consumer segment revenue was less than expected primarily due to lower sales of inkjet units and the negative effects of year-to-year currency changes.

Consumer segment operating income excluding restructuring was $30 million, down 34% yearto-year as lower supplies revenue was only partially offset by fewer hardware units and lower operating expenses. Consumer segment operating income in the fourth quarter was about in line with expectations as the weaker hardware unit sales channel buy ahead of supplies due to the price increases and lower operating expenses acted to offset the impact of currency and weaker end user supplies demand.

For the fourth quarter, inkjet unit sales were down 43% year-to-year due to impacts from the weak global market, the ongoing shift in our inkjet strategy, and the ongoing impacts 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 increasing market weakness and the associated aggressive competitive price promotion activities.

Now in the U.S., despite a very weak holiday season, branded inkjet hardware revenue came in about on expectation as we continued to see improving sell out of our professional series inkjet products.

In the quarter we continued to see ongoing recognition and awards for our new wireless and professional series products.

In the Business market segment in the fourth quarter, revenue was $718 million, down 10% year-to-year, driven by declines in both laser hardware and laser supplies. The lower laser hardware revenue was due to lower units, lower prices, and the negative impact of currency year-to-year. Business segment operating income was $93 million, down 47% year-to-year primarily due to the negative impact of currency year-to-year and lower product margins.

Laser units for the quarter were down 8% year-to-year and were less than expected due to the weaker end user demand in all geographies in both enterprise and small and medium business. Despite the unit decline, we continued to see good growth in both color lasers, laser MFPs, and also in our managed print services business.

During the quarter we received a significant number of product awards on our 38 new lasers that we announced in October, including the PC Magazine Editor's Choice Award and Better Buys for Business 2008 Innovative Product of the Year Award on our new C544 workgroup color laser.

Also during the fourth quarter we signed a multi-year extension of our OEM agreement with Dell that covers both our inkjet products and mono laser products.

As we look into the first quarter, we expect the continuing weakness of the global economy, with weakness in end user demand in both hardware and supplies to negatively impact revenue, with unit declines year-to-year in our sales of both inkjet and laser hardware. We also expect the dollar to continue its relative strength versus the first quarter of 2008, negatively impacting revenue and product margins. In addition, for supplies we are also expecting the shrinkage of the current high channel inventory levels to negatively impact revenue.

These factors are driving our expectation of a year-to-year decline in revenue in the first quarter in the mid to high teens percent, with declines in both segments, but with a larger percentage decline in the Consumer segment.

In the first quarter, we're currently expecting GAAP earnings per share to be in the range of $0.52 to $0.62, with about $0.13 per share in restructuring-related charges. Earnings per share excluding restructuring-related charges is expected to be in the range of $0.65 to $0.75.

Now as we look back on 2008, clearly this was a challenging year for Lexmark that started with weakness in the U.S. enterprise market and ended with the beginning of the global economic slowdown. Also as we entered 2008 we were beginning our inkjet strategy transition to higher usage customers and products, significantly impacting our inkjet unit sales and supplies revenue. However, despite the current economic weakness, in the Business market we had strong growth for the year in our laser and multifunction products reflecting the impact of our R&D investments in these products.

We had strong growth in our managed print services business and signed a number of new contracts with our enterprise customers. We continued to strengthen our customer value propositions with the launch of over 40 new laser products in 2008, significantly strengthening our mono laser line, our color laser line, our laser MFPs, and driving a larger number of laser product awards in the U.S. than any of our competitors. And we believe that our enterprise value proposition to help our customers to print less and to significantly reduce the cost and improve the sustainability of distributed printing is a powerful proposition for these economic times as our customers are looking to lower their cost and expense.

In our inkjet business, while we're still transitioning the business, we continue to be encouraged by the increase in inkjet average unit revenue of 13% this year, reflecting our efforts to move to higher-priced, higher-usage devices. We're encouraged by the advancement of our inkjet product line with the introduction of additional new wireless models and our professional series inkjets and the corresponding increase in industry recognition and awards. The continuing sequential increases in the sell out of our professional series inkjets here in the U.S. is also encouraging, as well as our number two overall wireless in market share position and the ongoing good growth in the sell out of our wireless inkjets in our top six countries.

In both laser and inkjet, we continued to invest in our core print technology and product development and are driving a strong pipeline of future Lexmark products.

While our near-term results are clearly not where we would like them to be, we're moving to better align ourselves with the current market environment, including continuing to take actions to reduce our fixed infrastructure and business support costs, which are projected to generate savings of over $100 million this year, continuing to maintain a conservative capital structure and a solid balance sheet, and we currently hold nearly $1 billion in cash and current marketable securities, all of which positions us well to prudently invest in the future and successfully compete.

I'll 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'll first discuss our results in the fourth quarter of 2008 relative to the prior year then relative to the third quarter of 2008. Next, I'll indicate our full year results. I'll then discuss selected changes in the balance sheet and certain items of cash flow. Finally, I'll finish with more detail regarding our guidance for the first 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 $1.08 billion, down 17% compared to last year, down 4% sequentially from 3Q. Full year 2008 revenue was $4.53 billion, down 9% compared to 2007.

Geographically for the fourth quarter, U.S. revenue of $451 million declined about 20% year-to-year. Revenue of $431 million in Europe declined about 9% year-to-year. The remaining geographies declined about 26% versus a year ago. European revenue declined less than U.S. revenue as hardware unit sales in EMEA were stronger than the U.S., particularly for laser hardware that showed growth in the quarter.

Also, as Paul referenced, we saw supplies channel inventories increase in the quarter. This increase was greater in EMEA than the U.S. as we believe channel partners purchased supplies ahead of price increases executed in EMEA as the U.S. dollar strengthened.

Geographically for the full year of 2008, revenue in the U.S. was $1.865 billion and declined approximately 13%, Europe revenue of $1.743 billion declined about 5%, and the remaining geographies declined about 9%.

In 2008, Dell represented about 13% of revenue. In 2007, Dell represented 14% of revenue. They were the only customer at 10% or more of revenue in 2008 or 2007.

Laser and inkjet supplies revenue in the fourth quarter declined 12% year-to-year and 4% for the full year of 2008. The decline in the quarter was more than explained by two main factors, each of which had similar impact - lower inkjet supplies volume and the negative impact on foreign currency denominated inkjet and laser supplies revenue of the strengthening U.S. dollar.

We do act to harmonize pricing of our non-dollar price supplies to the U.S. dollar; however, due to the speed and size of the currency movements and the fact that about half of our laser supplies are sold under contract, we are only able to recover a small percent of the currency move in the quarter through foreign currency price increases.

For the full year, supplies declined 4% as laser supplies growth was more than offset by the decline in inkjet supplies.

Laser and inkjet printer revenue in the fourth quarter declined 29% year-to-year and declined 20% for the full year of 2008 compared to 2007. Laser hardware unit shipments declined 8% in the fourth quarter versus the prior year. The decline in the quarter was primarily due to lower OEM shipments. In the quarter, we had good growth in color lasers and laser MFPs. Laser average unit revenue declined 14% year-to-year in the fourth quarter. Laser hardware revenue declined 21% versus 4Q '07. This decline was driven by lower unit volume and aggressive pricing, as well as the negative impact on revenue of weakening foreign currencies.

Full year 2008 laser hardware shipments of $1.9 million units declined 7% year-to-year. Again, this decline was primarily driven by lower OEM units. In the year we saw strong growth in branded MFPs. Full year 2008 laser AUR was down 2% compared to 2007. Laser hardware revenue was down 9% versus 2007. This lower revenue was due to lower unit volume and aggressive pricing, partially offset by a positive currency impact and positive mix of workgroup and MFP devices.

Inkjet hardware unit shipments declined 43% year-to-year in the fourth quarter. In the quarter we were impacted both by the weak global market for inkjet printers as well as the company's previously announced strategy to aggressively shift its focus to geographic regions, market segments and customers with higher page generation. Inkjet AUR in the quarter was about flat versus the prior year. Inkjet hardware revenue was down 43% versus 4Q '07. AURs were about flat as positive mix offset the negative impact of currency and aggressive global pricing.

Inkjet hardware shipments of 6.6 million units for full year declined 45% year-to-year. Full year 2008 inkjet AUR was up about 13% compared to 2007. Inkjet hardware revenue was down 38% versus 2007. Mix was also positive in 2008 and exceeded the negative impact of pricing, resulting in the AUR increase.

Business segment revenue for the quarter of $718 million declined 10% from the same quarter in 2007, primarily due to the 21% decline in hardware revenue. Revenue in the Business segment declined 6% sequentially from 3Q '08. The decline in the fourth quarter from 3Q '08 was primarily driven by the impact of weakened foreign currencies and price decreases.

Full year 2008 Business segment revenue of $2.982 billion declined 1% compared to 2007. The reduction was due to the 9% reduction in laser hardware revenue, mostly offset by growth in supplies revenue.

Consumer segment revenue for the quarter was $366 million, down 28% compared to a year ago. The decline was due both to lower supplies revenue and the 43% reduction in inkjet hardware revenue. Segment revenue was down 1% sequentially. The sequential decline in 4Q '08 was due to lower hardware revenue and is more than explained by the impact of weakening foreign currencies.

Full year 2008 Consumer segment revenue of $1.547 billion declined 22% compared to 2007. Segment hardware and supplies revenue declines both contributed to the reduction.

Gross profit margin for 4Q was 29.0%. Excluding restructuring-related charges of approximately $15 million, gross profit margin would have been 30.4%, down 360 basis points versus the prior year and down 370 basis points sequentially. The 360 basis point fourth quarter decline versus last year was principally due to an 880 basis point decline in product margins primarily due to the negative impact of weakening foreign currencies. This was partially offset by a 520 basis point favorable mix driven by less inkjet hardware and relatively more laser supplies.

Sequentially, the 370 basis point decline was due to a 530 basis point decline in product margins, more than explained by impact of weakening foreign currencies. This was partially offset by 160 basis points of favorable mix driven by relatively more laser and inkjet supplies.

Gross profit margin for the year was 33.9%. Excluding restructuring-related charges of approximately $42 million, gross profit margin for 2008 would have been 34.8%, up 300 basis points from 2007. The 300 basis point increase was due to 530 basis points of favorable mix, primarily less inkjet hardware and more laser supplies. This was partially offset by 230 basis points of negative product margin.

Operating expense for the quarter was $314 million. Restructuring-related expense of approximately $32 million impacted operating expense this quarter. Excluding this impact, operating expense was $283 million, a reduction of $18 million versus 4Q '07. SG&A in the quarter was $178 million, a reduction of $23 million from 2007, reflecting lower expense levels in both marketing and G&A. Expenses were lower on demand generation and G&A as well as the favorable impact on expense of weakened foreign currencies.

R&D in the quarter was $105 million, an increase of $5 million from 2007. Sequentially, operating expense excluding restructuring-related expenses declined $24 million versus the third quarter driven by sequential reductions in marketing, G&A and R&D and the positive impact from currency.

For the full year of 2008 compared to 2007, excluding restructuring-related expenses of $50 million and $35 million, respectively, operating expense was flat as reductions due to restructuring actions and lower G&A were offset by increases due to currency and R&D investment. R&D increased about $20 million, offset by an SG&A decline of about $20 million driven by reductions in G&A. The operating expense to revenue ratio excluding restructuring-related expenses was 26.1% in 4Q and 26.7% for the year.

Operating income in 4Q was zero. Excluding total restructuring and related costs and expenses, operating income was $47 million, down $97 million from 4Q '07 and down $32 million sequentially from 3Q '08. The reduction in 4Q operating income versus both 4Q '07 and 3Q '08 was primarily in the Business segment, which I will discuss more fully in a moment. Full year 2008 operating income was $277 million. Excluding restructuring and related costs and expenses of approximately $93 million, operating income was $370 million, down $3 million compared to 2007.

Excluding restructuring-related activities, Business segment operating income in 4Q '08 of $93 million was down $83 million versus last year and down $35 million sequentially. Full year 2008 Business segment operating income of $522 million declined $103 million compared to 2007.

Business segment operating income in 4Q '08 has been impacted significantly by both the weak hardware demand environment, resulting in both lower unit sales and aggressive pricing, as well as the significant impact of currency movements on both hardware and laser supplies revenue and income. Lower hardware gross margin dollars represent the majority of the operating income decline as the net impact of aggressive price reductions and currency impacts, as well as negative mix partially due to a higher mix of color placements, and lower unit volume all negatively impact hardware gross margin dollars.

Supplies gross margin dollars are also down and reflect the remainder of the operating income reduction; however, this is directly attributable to the negative net impact of the negative effect of currency, partially offset by the in-period benefit of laser supplies price increases. Excluding this impact, laser supplies gross margin dollars would have shown growth in the quarter.

The decline in full year 2008 Business segment operating income is due to higher operating expense, reflecting higher marketing and sales and product development investments, and lower hardware gross profit, reflecting the fourth quarter hardware impact I just described.

Again, excluding restructuring-related expenses, Consumer segment operating income in 4Q '08 of $30 million was down $60 million versus last year and up $4 million sequentially. Full year 2008 Consumer segment operating income of $164 million increased $59 million compared to 2007.

Consumer segment 4Q '08 revenue has also been significant impacted by the current weak operating environment and the impact of currency. Consumer segment operating income was negatively impacted by lower inkjet supplies and the negative impact of currency movements, partially offset by the positive impact of lower inkjet hardware volume and lower operating expense.

The increase in full year 2008 Consumer segment operating income was driven by increased hardware gross margin dollars due to lower hardware unit sales and decreased operating expenses, partially offset by the impact of lower supplies volume.

Other expenses, consisting primarily of costs related to centralized supply chain IT and other operating expenses - primarily G&A - were $76 million in 4Q '08 excluding restructuring related activities, about flat from both 4Q '07 and 3Q '08.

Operating income margin in 4Q was zero. Excluding the restructuring-related expenses, operating income margin was 4.3%, a decline of 670 basis points from the fourth quarter of 2007 and a decline of 260 basis points sequentially. Full year 2008 operating income margin was 6.1%. Excluding restructuring-related expenses, 2008 operating income margin was 8.2%, up 70 basis points versus 2007.

Concerning financing and non-operating costs, in the fourth quarter of '08 the net interest and other was an expense of $5.2 million, up from income of $7.4 million in the fourth quarter of 2007 primarily driven by increased interest expense related to the 2Q '08 debt issuance. Sequentially, net interest and other was about flat. Full year 2008 interest and other was an expense of $1.3 million compared to income of $28.3 million due primarily to the $650 million of debt issued in 2Q '08.

Now let me discuss income tax. In 4Q '08 we booked a $22 million benefit in our provision for income taxes. This compares to an expense of $23 million booked in our provision for income taxes in 4Q '07.

The significant changes in operating income we discussed today for 4Q '08 versus our expectations resulted in a change in our geographic mix of income. This also acted to reduce our international tax rate versus our expectations. This resulted in a lower effective tax rate for Lexmark for all of fiscal 2008. Also, the R&D tax credit was extended by Congress in October and this resulted in a credit to our 4Q taxes of $7 million. These factors lowered our required tax expense for fiscal 2008 with the result being that the provision for income taxes is a net benefit in the fourth quarter.

For all of 2008, our tax rate was 12.9% compared to 13.9% last year. Our ongoing tax rate for 2008 excluding discrete items was approximately 17% in 2008.

Net earnings for the quarter were $18 million. Excluding the $42 million after-tax cost from restructuring-related activities, net earnings in 4Q '08 were $60 million. 4Q '07 net earnings were $99 million or $123 million excluding after-tax restructuring-related expenses.

GAAP earnings per share for the quarter were $0.23. Excluding restructuring-related activities, EPS would have been $0.75 per share. This compares to 4Q '07 GAAP earnings per share of $1.04 or $1.29 excluding restructuring-related activities. GAAP earnings per share for the full year were $2.69. Excluding restructuring-related activities, EPS would have been $3.55 per share. This compares to full year 2007 GAAP earnings per share of $3.14 or $3.50 excluding restructuring-related activities.

Now moving to the balance sheet and cash flow items, cash flow from operations for the quarter was $53 million, down $159 million compared to 4Q '07 and down $64 million sequentially. Excluding restructuring-related cash outflows, cash flow from operations was $70 million this quarter, a decrease of $156 million from 4Q '07 and a decrease sequentially of $61 million from 3Q '08.

Full year cash flow from operations was $482 million, down $82 million compared to 2007. Cash flow from operations was down in 4Q '08 versus last year mostly due to lower income as well as increased interest payments reflecting a semi-annual payment on the debt issued in May.

Since the end of September, accounts receivable decreased $33 million, inventory decreased $8 million, accounts payable decreased $16 million and accrued liabilities declined $23 million.

For the quarter, capital spending was $67 million and for the full year of 2008 was $218 million.

Depreciation in the quarter was $53 million and totaled $205 million in 2008.

Currency of the euro was accounted for at 1.32 compared to 1.45 in 4Q 2007.

Cash and current marketable securities at the end of 4Q '08 was $973 million, down $113 million since September.

Total long-term debt at the end of 4Q '08 was $649 million, with maturities on the debt in 2013 and 2018.

In 4Q we completed the repurchase of $122.5 million or 5.2 million shares of our stock. At quarter end we had $491 million of share repurchase authority outstanding.

Now let me move to restructuring. In response to the weakening economic environment, two weeks ago we announced a 2009 restructuring action. This 2009 action is a continuation of our actions to reduce support activities, including all G&A functions as well as supply chain and sales support. We are also streamlining our marketing and sales management structure to improve costs while maintaining the expanded enterprise account coverage we implemented in late 2007. We are also consolidating some product development programs.

We are expecting to save $40 million from this action in 2009 and about $50 million annualized beginning in 2010. About 95% of these savings are expected to benefit operating expenses and the remaining 5% will impact cost of sales. The total pre-tax cost of implementing this action is projected to be $45 million, of which $20 million was reflected in our 4Q '08 results. These actions are expected to impact about 375 positions and be substantially completed by the end of 2009.

The restructurings announced in October 2007 and July 2008 to reduce costs in all G&A functions as well as supply chain and sales support and to close two inkjet supplies manufacturing facilities are expected to be substantially completed by end 1Q '09. For 2008, total restructuring and related costs and expenses were $93 million, of which $20 million was related to the 2009 restructuring announced on January 13.

Restructuring cash outflow was $51 million and savings related to the October 2007 and July 2008 restructurings were $43 million. In 4Q '08, total pre-tax restructuring and related costs and expenses were $47 million. Of this amount, $20 million was related to the restructuring announced on January 13, 2009. In 4Q '08, restructuring cash outflow was $18 million and savings from our 2007 and 2008 restructuring actions were $16 million.

In 1Q '09, restructuring and related costs and expenses due to the restructuring actions are expected to be $13 million. This amount is related to the 2007, 2008 and 2009 restructuring programs. Savings in 1Q '09 are expected to be about $23 million related to the 2007, 2008 and 2009 restructuring programs.

More details regarding the breakdown of costs are available in the supplemental slide deck.

Before providing my forward-looking comments, I will cover several other areas on which we have received questions recently.

Lexmark's estimated pension funding requirement for 2009 is approximately $90 million, of which approximately $75 million will be made in 1Q '09. We expect to make this contribution out of available U.S. cash. Pension expense is expected to increase marginally in 2009 versus 2008, up about $5 million. 2010 pension funding using an asset return and other assumptions to be outlined in our 10-K is expected to be about $35 million. Lexmark pension plans in the U.S. were frozen in 2006.

The currency impact on Lexmark revenue was as follows: For 4Q '08 versus 4Q '07, revenue declined 17%. Excluding the currency effect of over negative 5%, the revenue would have declined just under 12%. For full year 2008 versus 2007, revenue declined 9%. Excluding the effect of currency, a positive 2%, revenue would have declined 11%.

Now for my forward-looking comments concerning 1Q '09, we expect first quarter revenue to be down in the mid to high teens percentage range year-over-year. This reflects our expectation for the continuing weakness of the global economy to negatively impact hardware unit sales, with unit declines year-to-year in our sales of both inkjet and laser hardware. We also expect the dollar to continue its relative strength versus 1Q '08, negatively impacting hardware gross margins.

For supplies, we are expecting the continued economic weakness and the shrinkage of the current high-channel inventory levels to negatively impact revenue. Supplies revenue is expected to decline year-to-year in 1Q '09 at about the same rate as 4Q '08. We expect revenue in both segments to be down year-on-year, but with a larger percentage decline in the Consumer market segment.

GAAP EPS is expected to be $0.52 to $0.62 in 1Q '09. GAAP EPS includes expected restructuring charges of $0.13 per share. Non-GAAP EPS excluding restructuring and related costs and expenses is expected to $0.65 to $0.75. GAAP EPS in the first quarter of 2008 were $1.07 per share, which includes restructuring charges of $0.09 per share. Non-GAAP EPS in 1Q '08 were $1.15 per share.

All of the comparisons that follow exclude the impact of restructuring. In the first quarter we expect gross profit margin to be up versus the 30.4% we achieved in 4Q '08. Operating expense is expected to be down compared to the $283 million incurred in 4Q '08, primarily driven by reduced SG&A expense. For the full year of 2009, we will decrease our overall operating expense. We currently expect a reduction of at least 10% compared to 2008 driven by a decline in marketing and G&A.

Operating income margin in the first quarter is expected to be above the 4.3% achieved in the fourth quarter of 2008. For 1Q '09 and the full year we expect our ongoing effective tax rate to be about 17% before any discrete items. We project full year 2009 capital spending to be approximately $225 million and we expect full year depreciation to be approximately $185 million.

The guidance provided is based on foreign exchange rates as of 12/31/08.

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 nearly $1 billion in cash and current marketable securities, a revolver of $300 million which does not expire until 1Q 2010, an A/R 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, delivering over $450 million in cash flow from operations for the seventh consecutive year. 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

Thank you. (Operator Instructions) Your first question comes from Eric Garfunkel - Sanford Bernstein.

Eric Garfunkel - Sanford Bernstein

My question is according to our checks, HP pushed through another 5% supplies price increase in the U.S. effective January 1st and that all other vendors matched. First, can you confirm that Lexmark has now put two supplies price increases into effective since last fall? And second, can you help us understand the timing and rollout, particularly to international markets?

Paul J. Curlander

Okay. Well, let me say this. We've gone through and implemented the first 5%. We were a little behind HP in doing that. That pretty much was effective late in the fourth quarter, both in the U.S. as well as internationally, as a general price increase.

On the laser supplies, in the U.S. we have taken the second 5% price increase. That was effective last week. From a European standpoint, I think we're moving on that within the next week, and that will be effective within the next week and we'll be following with the other geographies around the world.

On the Consumer side, we're a little later than that on that second 5% price increase, probably looking for an effective date somewhere around the 1st of April right now.

Eric Garfunkel - Sanford Bernstein

And is that in both the U.S. and then internationally or that's just for the U.S. beginning in April.

Paul J. Curlander

Yes, that would the U.S. and international.

Operator

Your next question comes from Min Park - Goldman Sachs.

Min Park - Goldman Sachs

Just a quick question on your tax rate. I believe you indicated that your full year tax rate was going to be 20% or 21% in the last call, so is it going down to 17% for the full year in 2009 or just 17% for Q1?

John W. Gamble Jr.

No, it's 17% for Q1 and the full year.

Min Park - Goldman Sachs

And what is causing the tax rate to be coming down by 300 to 400 basis points since your last call?

John W. Gamble Jr.

When we were speaking at the last call, we were asked what tax rate did we assume in the guidance that we provided and we simply indicated what that was. Obviously, as we completed our full year results and completed all the work we do at year end, our tax rate's a bit lower so we're assuming that that tax rate will continue.

Min Park - Goldman Sachs

And then just with your net cash moving to $320 million this quarter, can you just give us your thoughts on your share buyback plan going forward?

John W. Gamble Jr.

Well, we don't really give a forecast on our share buyback plan, but obviously given the economic environment, we're, as many companies are, looking very closely at all cash flow items.

Operator

Your next question comes from Shannon Cross - Cross Research.

Shannon Cross - Cross Research

Based on your comments about the OPEX dollars being down about 10% year-over-year, can you give us any more color into how you're going to get there? When I look back, I mean, that's about $120 million. If you look back over the last several years, your OPEX has been sort of flat to actually up, even with restructuring programs. So what makes what's going on now different from prior and your confidence level in the approximately $120 million?

Paul J. Curlander

Well, I think a couple of things, Shannon. First, we're very focused on taking the operating expense down given the economic situation. And as we look at the restructurings that we have done - 2007 and 2008 - with what we've now announced in 2009, that's our expectation, to be driving over $100 million of impact this year, not all of that in operating expense, but certainly overall.

Part of the issue - and John mentioned it in his comments - in 2008 is that a lot of the impact that we had expected to get in our operating expense in 2008 was offset by the positive currency impact, the weak dollar, in the first part of the year. So as you look at our operating expenses overall for the year it was about flat, but really currency offset that savings we had from the restructuring that we took. And as the dollar has now strengthened, we're going to see that savings coming through as it would have had the currency not moved in a positive way for Lexmark.

So I think those currency differences, I think the additional restructuring that we're doing, this is what we're thinking is going to drive the savings.

Shannon Cross - Cross Research

And then, John, a question for you with regard to balance sheet. Can you talk about what drove accounts receivable down? Is it just weaker revenue?

And then also can you talk about the increase in other liabilities?

John W. Gamble Jr.

In terms of accounts receivable, collections continue to be good and also, obviously, our revenue was down, right, so it was both of those things.

And then other liabilities, other liabilities is a large series of specific actions. It'd be hard to describe specifically what drove other liabilities. Obviously, it did move in the quarter.

Operator

Your next question comes from Richard Gardner - Citigroup.

Richard Gardner - Citigroup

In speaking with some of your competition post the pre-announcement call, it sounds like there are several things that they do differently. One is they hedge supplies revenue and I know it's a little more expensive, but it seems like it might be a better strategy, especially during a period of a strengthening dollar or when there's significant currency volatility, so I'm just wondering why you don't do that.

And also I was wondering if you limit the amount of supplies inventory that your channel partners can buy forward ahead of price increases?

Paul J. Curlander

Well, let me talk to the second piece of that. I'll let John talk to the first piece.

Historically, we have not limited the buy ahead from our supplies partners. You know, we have ongoing relationships with key partners and what we try to do is keep them informed as to what's going on, why we're doing things, and we let them manage their own business. So that's pretty much what we've seen.

I can't speak for the competitors, but I'm not convinced that the majority of them actually limit channel buy ahead. Some may, but I would think the majority probably do not.

John W. Gamble Jr.

And in terms of currency, I think what we believe is that hedging activity could potentially smooth impacts on currency, but it's really the only effect that it has is an effective smoothing. So I think we believe over the long term the policy that we have is the most effective and we think has been beneficial and reduces the costs related to managing our overall business. So I think we're going to act the way we have.

Operator

Your next question comes from Benjamin Bollin - Cleveland Research Company.

Benjamin Bollin - Cleveland Research Company

When you look at the non-U.S., non-European geography, you saw real material weakening in revenue in the quarter. What were the contributing factors to that?

Paul J. Curlander

Well, the major things that we saw in the quarter is that as the currency shifted as much as it did  I'll take Latin America as an example - we pretty much deal in U.S. dollars and as that currency shifts what happens is that the local currency pricing goes up dramatically very quickly. When that happens it disrupts our business on both hardware and supplies. And we saw impact from this in Asia-Pacific and we saw impact from this in Latin America that was very, very significant.

Even, I think, as we move into the first quarter we're looking to see does some of that disruption start to settle down, but of course we continue to take some pricing actions that are still fairly significant. So this was kind of a big factor.

The other factor that we saw in some of the emerging geographies was a real impact from channel credit availability. So the other thing that happened there in addition to the fundamental end user demand slowing down because of the rapid increase in pricing, we also saw our channel partners shrinking inventory. Now that's a little counter to what we talked about before about the buy aheads that we saw because of supplies, but in certain countries and in certain geographies, we did see a negative impact from shrinkage of channel inventories and that's kind of what you saw in the non-U.S., non-European results.

Benjamin Bollin - Cleveland Research Company

When you look at that channel inventory you did discuss on the supplies and the buy ahead, could you give us some idea on either the number of weeks of supply out there, how much inventory you think is in the channel and where you think that should be?

Paul J. Curlander

Well, I mean, I think that the buy ahead was significant. Just to kind of calibrate it, it was not quite - certainly it was not as big as the negative currency impact in the quarter, but it was still significant. In terms of where the channel is overall, I think you may recall that we had talked about in the third quarter that we had seen some channel build in that quarter. So what we're really looking for to come out of the channel is the increase that we saw in the fourth quarter and the increase that we saw in the third quarter because we didn't get that shrinkage that we had anticipated in the third quarter.

So that's kind of roughly what we see.

Operator

Your next question comes from Matt Whitaker - FTN Midwest Research.

Matt Whitaker - FTN Midwest Research

I was wondering if you could comment on any changes in the competitive environment, particularly in inkjet. We're well aware of Hewlett-Packard and Brother in the past year has come on, but I was wondering if you were perhaps seeing any new competitors in the battle for shelf space?

Paul J. Curlander

Well, I think in terms of battle for shelf space it's still pretty much the same competitors that we've seen before. I think that as we go forward in time our focus is try to improve our shelf space, and obviously we're very focused on evolving our product line and making that happen, particularly in areas like the office superstores. But that's the focus that we have as we go forward in time.

Matt Whitaker - FTN Midwest Research

And I was wondering with the demise of Circuit City if you had any plans to find a replacement channel or replacement retail partner, again, particularly in Consumer inkjet?

Paul J. Curlander

Yes, I mean, clearly the bankruptcy of Circuit City and their liquidation is disappointing from our perspective. Just to kind of calibrate it for you, if you look at our 2008 revenue with Circuit City, it's equivalent to about 2% of our 2008 Consumer segment revenue. If you look at the hardware revenue that we did with Circuit City, it's equivalent to about 1% of our 2008 Consumer segment revenue. And on supplies, you know, we still hope to get the supplies because the customers are still using the products and we're working on arranging other channels for customers to secure those supplies.

So we think that impact is in the 1% to 2% range and hopefully closer to 1%. You know, it really is we would like to strengthen our position in both Consumer electronics and office superstores, and so that is a focus that we have as we go forward in time.

Operator

Your next question comes from Jeff Embersits - Shareholder Value Management.

Jeff Embersits - Shareholder Value Management

I was wondering if you could talk a little bit about the aging of the installed base and how you're able to track that in Consumer versus Business and forecast the supplies revenues. And given the economic melee, how has that impacted your visibility into the installed base?

Paul J. Curlander

Well, I think that the economic situation hasn't really changed our vision into the installed base. I mean, overall what we do is we estimate the installed base. We don't know for certain because the reality is it's very hard to differentiate between someone discontinuing usage or just using less versus other aspects that may go on like loss of loyalty with remanufacturing.

But we have extensive models that we utilize in both our laser and inkjet business. We update these models every month with the actuals that we see. We get reporting out of our channel on channel inventories, so we're able to track that. And we track very extensively by SKU what we expect to see and what the history is we're seeing on usage as we go month by month in terms of not only sell in but also the sell out.

So overall we're typically fairly accurate. You know, in a given quarter this thing can move around a little bit, but overall we're fairly accurate and what we did see in the fourth quarter was we saw less than expected end user demand.

And it's hard to know what all the implications of that might be. Some of it may just be economic times where people are trying to print less. Some of it very possibly is due to the disruption of the significant price increases we took during the quarter, which may have caused people who may have had some inventory, particularly on the Business side, to just not buy for a quarter and utilize some of their internal inventory.

So some of that we'll see as we go forward in time, but I would say that certainly in this difficult economic situation we are seeing some weakness in end user demand, certainly in Consumer and some also in Business.

Jeff Embersits - Shareholder Value Management

Given some of the awards and things mentioned in the press release and earlier in the call, which segments do you think you've done particularly well in or might be able to point out to actual share gains, even if it's a shrinking market from a macro perspective?

Paul J. Curlander

Well, we feel like we've done well this year. Certainly, our Laser MFPs on a year-to-year basis, as we talked about in the fourth quarter, we did very well in our color lasers. As you look at these awards, really the focus that we're bringing to it is that we've made a lot of investments in laser R&D, particularly around color, particularly around laser MFPs.

And this is why I highlighted the Editor's Choice Award and the Better Buys for Business 2008 Innovative Product of the year. This is on workgroup color laser, our new workgroup color laser that we announced in October, so that's very significant to us because we think we're underrepresented in the color market. And so as a result of the investments we've made, we're trying to bring that technology out at a world class level and being able to get these awards on our new products we think is very significant.

Overall, as you look at lasers for the year, certainly in the fourth quarter, I believe we declined less than the market overall, and I would say overall we feel like we're at least holding share and possibly gaining share in some segments.

Operator

Your next question comes from Shannon Cross - Cross Research.

Shannon Cross - Cross Research

On Dell, you've usually provided what percent of revenue they were for the full year. I think it was 14% last year. Can you provide it for this year as well?

John W. Gamble Jr.

It was 13%.

Operator

Your next question comes from Richard Gardner - Citigroup.

Richard Gardner - Citigroup

I just had one follow up to the previous question. I'm just wondering, John, why near-term smoothing would not be a desirable thing in terms of hedging?

And then secondarily, you mentioned that 50% of your laser supplies revenue is contractual. I was wondering if you have provisions in those contracts that allow you to adjust pricing on supplies or hardware based on foreign exchange movements and, if not, what's the rationale there?

John W. Gamble Jr.

In terms of foreign exchange, specifically what we try to do is take a look at the underlying causes of the exposure and we try to address those as opposed to trying to address them in the foreign currency markets. But in terms of smoothing, we think you're going to be smoothing positively or negatively over time and all we're doing is just incurring an expense for really no long-term benefit. So at this point in time, we don't see a reason to begin hedging. We do hedge transactional exposures, but not cash flow exposures.

Paul J. Curlander

Let me talk to the contracts. The reality is that in our enterprise business - and enterprise is a significant piece of our laser business - the bulk of that is special bid, it's negotiated contracts with customers. A lot of our business around the world is done with governments. I can tell you one thing that's very, very difficult if not impossible is governments will only deal in their local currency. They will not take any risk relative to movement of their currency versus someone else. So to the extent you do business with governments, you cannot get any type of sharing.

And in some geographies and certainly on commercial accounts, we do attempt to do that and we have that in some of our contracts, but many of our large customers, this is a competitive situation. To the extent the competition may be willing to take that risk, you end up with that risk in the contract that you sign.

So it's a difficult thing when you're dealing with large international companies to actually execute that; government, it's essentially impossible.

Operator

Your last question comes from Benjamin Bollin - Cleveland Research Company.

Benjamin Bollin - Cleveland Research Company

I just want to get detail. You guys have reported laser and inkjet revenue for the year, laser and supplies revenue and then other. I was hoping you could provide those figures. And then also, I'm just trying to get your thoughts on why you don't break out the hardware and supplies revenue each quarter?

John W. Gamble Jr.

I think all the numbers you're requesting are in the supplemental slide deck, so actually probably the easiest way to get them is to just pull them right off the supplemental slide deck, which is on our website.

And what was your last question again? I'm sorry.

I think we do each quarter indicate the movements in revenue and that's the disclosure policy we have. Beyond that, I don't really have a comment.

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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