Paul Curlander – CEO
John Gamble – EVP & CFO
John Morgan – Director IR
Richard Gardner – Citigroup
Ben Reitzes - Barclays Capital
Bill Shope - Credit Suisse
Tony Sacconaghi - Sanford Bernstein
Kathryn Huberty - Morgan Stanley
Shannon Cross - Cross Research
Mark Moskowitz - JPMorgan
Lexmark International, Inc. (LXK) Q4 2009 Earnings Call February 2, 2010 8:30 AM ET
Good morning and welcome to the Lexmark International fourth quarter 2009 earnings conference call. (Operator's Instructions) I would now like to call the call over to John Morgan, Lexmark's Director of Investor Relations.
Good morning and thank you for joining us. Chairman and CEO Paul Curlander and EVP and CFO John Gamble are with me this morning. After their prepared remarks we'll open the call for your question as time permits.
We ask that you please limit yourself to one question and one follow-up, if needed, so that 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.
I would also like to mention our participation in the Goldman Sachs Technology and Internet Conference 2010 on February 24 in San Francisco. Please visit our investor relations website to obtain more information regarding our upcoming events.
As a reminder, any of today's remarks that are not statements of historical fact are forward-looking statements that 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 statement.
With that I'll turn it over to Paul.
Thank you John, our fourth quarter financial results were significantly better than anticipated reflecting strong sequential improvement in customer demand for our hardware and supplies. For the quarter both divisions exceeded expectations and geographically all regions improved sequentially in revenue and profit.
During the quarter we also continued to improve the fundamentals of the business through the implementation of our restructuring and expense reduction efforts totaling over $200 million in expense savings in 2009 and through a strong sequential increase in our cash flow.
Revenue for the fourth quarter was $1.073 billion, up 12% sequentially and down just 1% year to year, a significant improvement from the year-to-year performance in the first three quarters of 2009. Hardware revenue in the fourth quarter 2009 was up 17% sequentially and better than expected.
Hardware revenue was about flat year to year which is also a significant improvement from the year-to-year performance in the first three quarters of 2009. Supplies revenue in the fourth quarter was up 11% sequentially and was better than expected as both laser and inkjet supplies exceeded expectations.
Supplies revenue declined just 1% year to year, again a significant improvement from the year-to-year performance in the first three quarters of 2009. Now this 1% year to year supplies decline reflects year-to-year growth in laser supplies slightly offset by an ongoing but improved decline in inkjet supplies.
Overall supplies channel inventory was up slightly sequentially but the increase was much less than what we saw in the fourth quarter of 2008. Earnings per share in the quarter were $0.76. Excluding restructuring related charges, earnings per share in the fourth quarter were $1.16, a 55% increase year to year.
In the fourth quarter net cash provided by operating activities was $257 million, a 74% increase sequentially from the third quarter of 2009 and almost five times the fourth quarter 2008 result. Now let’s talk about our two divisions, in our printing solutions and services division, or PSSD, fourth quarter 2009 revenue was $748 million, up 14% sequentially and up 4% year to year, with the year to year growth in both PSSD hardware and supplies revenue.
PSSD operating income excluding restructuring was $164 million, up 68% sequentially and up 77% year to year. Now PSSD laser units for the quarter were up sequentially along with a strong sequential increase in hardware revenue.
Year to year laser units were down 16% but laser hardware revenue was up 6% year to year due to the improved mix of product. Now despite the year-to-year laser unit decline in the fourth quarter we continue to have good year-to-year growth in our color laser units and strong year-to-year growth in our laser MFPs with both categories benefiting from our new product introductions over the last 15 months.
For the second straight quarter our laser hardware sales have been supply constrained primarily due to the unexpected demand level compounded shortages and increased lead times. Now during the quarter we had strong growth in our enterprise management services business and continued to close new enterprise deals and help our customers such as Rexel, Rodea, and Kingfisher in Europe, to lower their costs and improve their document based processes.
According to IDC data for the first three quarters of 2009 we have continued to gain market share in our branded workgroup laser sales and according to our internal analysis for 2009 Lexmark continued to be number one in the US printer market in laser product awards received with more than three times the awards of any other vendor.
Let’s talk about our imaging solutions division or ISD, in the fourth quarter ISD revenue was $325 million, up 7% sequentially and down 11% year to year, an improvement in year-to-year hardware and supplies revenue performance from the third quarter of 2009.
ISD operating income excluding restructuring was $38 million, up 12% sequentially and up 25% year to year. ISD units for the quarter were down 34% year to year but with good sequential growth in ISD hardware revenue. Now despite our overall year-to-year inkjet unit decline in the fourth quarter we continued to improve our high-end mix and continued to have strong year-to-year growth in the retail sell out of our professional series products helped by the expansion of our shelf space in US office superstores in 2009.
According to IDC data for the first three quarters of 2009 we gained market share in our branded inkjet sales in the above $100 segment in the US and Europe and according to our internal assessment for 2009 Lexmark inkjet products received 28% of the US industry inkjet awards. Now this is a significant increase from 2008 making us number two in inkjet product awards received for 2009 and is a strong recognition of the evolution and improvement in our inkjet products over the last two years as we have shifted our focus to serving SMB customers.
Now looking back on 2009 despite a 14% year-to-year revenue decline we believe that Lexmark has performed better than the overall output market. For the year our operating income excluding restructuring related charges was down only 3% reflecting a positive impact of our cumulative restructuring and other expense actions totaling over $200 million of expense reduction in 2009.
In addition we are encouraged by the improved customer demand we saw during the second half of 2009 and ongoing improvements that we are driving in the fundamentals of our business including the significant refresh and upgrades in our laser and inkjet product line over the last 15 months, the share gain in our key focus segments of workgroup laser and business inkjet, the strong sequential improvements over the last three quarters in our cash generation, and despite our expense reductions we continue to invest significantly in our core print technology and product development and are driving a strong pipeline of future Lexmark products.
Now as we look into the first quarter of 2010 we expect revenue to be up slightly year-to-year. We expect GAAP earnings per share to be in the range of $0.64 to $0.74. Earnings per share excluding restructuring related charges are expected to be in the range of $0.80 to $0.90.
Now while it could be a long recovery for the overall printer market to return to its prior levels, we do believe that we are making Lexmark into a leaner and stronger competitor, improving our product, solutions and services offerings and our competitive position. We also continue to maintain a strong financial position with a solid balance sheet and with over $1.1 billion in cash and current marketable securities.
I’ll now turn it over to John Gamble, for his more detailed comments on our financials.
Thank you Paul, and good morning. Consistent with previous calls I'll first discuss our results of the fourth quarter of 2009 relative to the prior year, then relative to the third quarter of 2009. Next I’ll indicate our full year results. I'll then discuss selected changes on the balance sheet and certain items of cash flow. Finally, I'll finish with more detail regarding our guidance for the first quarter of 2010.
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 $1.07 billion, up 12% sequentially and down slightly compared to last year. The currency impact on Lexmark revenue in 4Q09 versus 3Q09 was positive approximately 2% and the currency impact on Lexmark revenue for 4Q09 versus 4Q08 was positive approximately 6%.
Our revenue exceeded the expectations we discussed at the October earnings call driven by stronger than expected supplies and hardware revenue. Full year 2009 revenue was $3.9 billion, down 14% compared to 2008. The currency impact on Lexmark revenue in 2009 versus 2008 was negative approximately 3%.
Geographically for the fourth quarter, revenue grew sequentially versus 3Q09 in all geographic regions. US revenue of $444 million declined slightly year to year. Europe revenue of $408 million declined about 5% year to year. The revenue for the remaining geographies increased 9% versus a year ago.
Geographically for the full year of 2009 revenue in the US was $1.672 billion and declined approximately 10%. Europe revenue of $1.454 billion declined about 17% and the remaining geographies declined about 18%. During the quarter we saw strengthening performance in all regions.
In 2009 Dell represented about 12% of revenue. In 2008 Dell represented 13% of revenue. In both 2008 and 2009 Dell was the only customer that represented over 10% of revenue. Supplies revenue declined 1% versus 4Q08, approximately 11 percentage points better than the year on year decline in 3Q09.
In 4Q09 PSSD supplies revenue was up versus 4Q08 with this growth more than offset by declines in ISD supplies. The sequential improvement in year on year performance was due to significant improvements in channel sell out revenue primarily in PSSD. In 4Q09 we saw channel inventory increase slightly but much less than the increase we saw in 4Q08.
Excluding these channel inventory effects we would have seen supplies growth in 4Q09. Sequentially supplies revenue grew 11% with growth in both PSSD and ISD. For the full year supplies revenue declined 12%. Hardware revenue was up 17% sequentially from 3Q09 and about flat from the same quarter in 2008.
Sequentially the hardware revenue improvement was driven by growth in both PSSD and ISD hardware revenue. Year to year the hardware revenue growth in laser was mostly offset by the decline in inkjet revenue. For the full year hardware revenue declined 22% year to year driven by declines in both divisions.
PSSD revenue for the quarter was $748 million, an increase of 14% from 3Q09 and a 4% increase year to year. The improvement versus 4Q08 was in both supplies and hardware revenue. Full year 2009 PSSD revenue of $2.6 billion declined 12% compared to 2008. The reduction was due to the 19% reduction in hardware revenue as well as a decline in supplies revenue.
PSSD hardware revenue improved 18% sequentially and 6% versus 4Q08. The sequential improvement was driven by positive mix towards workgroup devices and MFPs and higher unit volume. The year on year improvement was driven by positive price mix as sales shifted toward color lasers and MFPs.
PSSD laser hardware units increased 8% sequentially but declined 16% versus the prior year. The sequential increase was driven by good growth in workgroup devices and MFPs. The year on year decline was driven by a reduction in low-end mono laser placements.
During 4Q09 component shortages limited our ability to fulfill demand and as such we focused available capacity on workgroup and color devices and MFPs. In 4Q09 we saw year on year growth in both MFPs and color devices. On a full year basis PSSD hardware revenue declined 19% and units 21% versus 2008.
PSSD laser hardware average unit revenue was up 27% year to year in the fourth quarter driven primarily by positive product mix shift toward workgroup devices and MFPs. Full year 2009 PSSD laser AUR was up 4% compared to 2008. ISD revenue for the quarter was $325 million up 7% sequentially and down 11% from the same quarter in 2008.
The sequential improvement was driven by growth in both supplies and hardware revenue. The year on year decline of 11% was an improvement from the 3Q09 year-to-year decline of 18%. Full year ISD revenue declined 19% versus 2008. ISD hardware revenue was up sequentially 14% and down 14% versus 4Q08.
The sequential increase was driven by a favorable product mix toward higher end devices. The year on year decline was driven primarily by lower unit volume and negative net price FX partially offset by a significant improvement in mix toward higher end devices.
Full year ISD hardware revenue declined 28% versus 2008 as lower unit volume and negative net price FX were again partially offset by improved mix. ISD hardware units were relatively flat sequentially and declined 34% year to year in the fourth quarter. ISD hardware shipments of $4.2 million for full year 2009 declined 36% year to year.
ISD hardware AUR in the quarter was up 30% versus the prior year reflecting the shift in mix toward higher end products as we launched our new inkjet product line. Full year 2009 ISD hardware AUR was up 13% compared to 2008. Gross profit margin for 4Q was 35.7%. Excluding restructuring related charges of approximately $13 million gross profit margin would have been 36.9% up 650 basis points versus the prior year and up 300 basis points sequentially.
The 650 basis point fourth quarter increase versus last year was principally due to a 590 basis point increase in product margins in both hardware and supplies. Sequentially the 300 basis point improvement was principally due to a 380 basis point increase in product margin again in both hardware and supplies.
This was partially offset by a negative product mix driven by a higher relative percentage of hardware versus supplies. Gross profit margin for the year was 33.8%. Excluding restructuring related charges of approximately $51 million gross profit margin for 2009 would have been 35.1% up 30 basis points from 2008.
The 30 basis point increase was due to 240 basis points of favorable product mix reflecting a lower relative percentage of hardware versus supplies. This was partially offset by 210 basis points reduction in product margins driven by hardware. Operating expense for the quarter was $293 million with restructuring related expense of approximately $32 million.
Excluding this impact operating expense was $261 million a reduction of $22 million versus 4Q08. R&D was $93 million and SG&A was $167 million in 4Q09, a reduction of $12 million and $10 million versus 4Q08 respectively. Sequentially operating expense excluding restructuring related expenses increased by $11 million versus 3Q09.
SG&A was up $9 million sequentially and R&D approximately $2 million. The increase was principally due to higher bonus accruals reflecting the improved performance in 4Q09 and negative currency impact. For the full year of 2009 operating expense was $1.094 billion with restructuring related expenses of $90 million.
Excluding this impact operating expense was $1.004 billion down $203 million or 17% from 2008. SG&A declined about $155 million and R&D decreased approximately $48 million. The operating expense to revenue ratio excluding restructuring related expenses was 24.3% in 4Q and 25.9% for the year.
Operating income in 4Q was $90 million. Excluding total restructuring and related costs and expenses operating income was $136 million up $89 million from 4Q08 and up $61 million sequentially from 3Q09. The increase in 4Q operating income versus both 4Q08 and 3Q09 was primarily in the PSSD business segment while I’ll discuss more fully in a moment.
Full year 2009 operating income was $216 million. Excluding total restructuring and related costs and expenses of approximately $141 million, operating income was $357 million down $13 million compared to 2008. Excluding restructuring related activities PSSD operating income in 4Q09 of $164 million increased $71 million versus last year and increased $67 million sequentially.
PSSD 4Q09 improvement in operating income versus 4Q08 reflects higher gross margins in hardware and supplies, as well as lower operating expenses. Hardware and supplies margin improvements were driven by both improved net price FX and cost improvements from our restructuring and other actions.
Sequentially the operating income increase was primarily due to the higher supplies gross margins reflecting increased supplies revenue and related cost improvements. Hardware margins also improved primarily reflecting improved hardware mix. Full year 2009 PSSD operating income of $444 million declined $78 million compared to 2008.
The decline in full year 2009 PSSD operating income was primarily driven by the weak demand for supplies in the first three quarters of 2009 and the impact of currency on both hardware and supplies over the same period. Partially offsetting these impacts were cost and expense reductions from our restructuring and other cost reduction initiatives.
Again excluding restructuring related expenses ISD operating income in 4Q09 of $38 million was up $8 million versus last year and up $4 million sequentially. Full year 2009 ISD operating income of $159 million was down $6 million compared to 2008. The 4Q09 year-to-year increase was driven by lower hardware volume as well as significant cost and expense reductions across the business partially offset by lower supplies revenue.
The 4Q09 sequential increase in ISD operating income was driven by higher supplies revenue and cost reductions and improved hardware mix. The slight decrease in full year 2009 ISD operating income reflects the negative impact of lower supplies volume and the negative impact of aggressive hardware pricing and net currency impacts partially offset by lower hardware volume and expense reductions.
Other segment consisting primarily of cost related to centralized supply chain, IT and other operating expenses primarily G&A, were $67 million in 4Q09 excluding restructuring related activities, a $10 million reduction from 4Q08 and a $10 million increase from 3Q09. The reduction versus 4Q08 is a continuation of the impact of our cost and expense reduction efforts.
The increase versus 3Q09 primarily reflects the higher bonus accruals reflecting the improved performance in 4Q09 and the negative currency impact that I referenced earlier. Operating income margin in 4Q was 8.4%. Excluding the restructuring related expenses operating income margin was 12.6% an increase of 830 basis points from the fourth quarter of 2008 and an increase of 480 basis points sequentially.
Full year 2009 operating income margin was 5.6%. Excluding restructuring related expenses 2009 operating income margin was 9.2% up 100 basis points versus 2008. Concerning financing and non-operating costs in the fourth quarter of 2009 the net interest and other was an expense of $8 million up from an expense of $5 million in the fourth quarter of 2008 primarily driven by lower interest income.
Sequentially net interest and other was down $3 million. Full year 2009 interest and other was an expense of $29.1 million compared to expense of $1.3 million in 2008 due primarily to lower interest income and the interest on our $650 million debt issued in 2Q08. Our effective tax rate for 2009 was 22%. This was higher than the 18% we had estimated in October and the 17% ongoing tax rate we incurred in 2008 principally reflecting two factors.
The percent of 2009 earnings and high tax jurisdictions like the US increased versus our expectation and 2008. Also as our earnings before tax increased significantly versus our expectations the impact on the tax rate of fixed dollar tax dollar tax credits like the R&E tax credit is lower increasing our tax rate versus our expectation.
In 4Q09 the tax rate was 27.3% as we had to accrue at a higher rate in 4Q09 to bring the full year tax rate to 22%. Net earnings for the quarter were $60 million. Excluding the $32 million after-tax costs from restructuring related activities net earnings in 4Q09 were $92 million. In 4Q08 net earnings were $18 million or $60 million excluding after-tax restructuring related expenses.
GAAP earnings per share for the quarter were $0.76. Excluding the restructuring related activities EPS would have been $1.16 per share. This compares to 4Q08 GAAP earnings per share of $0.23 or $0.75 excluding restructuring related activities. GAAP earnings per share for the full year were $1.86.
Excluding restructuring related activities, EPS would have been $3.26 per share. This compares to full year 2008 GAAP earnings per share of $2.69 or $3.55 excluding restructuring related activities. In 4Q09 revenue and net income performance was significantly stronger than the guidance we provided in October.
In terms of revenue sequential supplies growth of 11% reflecting improved end user demand drove the significant majority of the improvement versus our guidance. PSSD hardware revenue up 18% sequentially also outperformed. In terms of operating income performance the primary factor was increased supplies revenue. Improved product gross margins reflecting both improved net price FX and cost performance were also contributing factors.
Now moving to the balance sheet and cash flow items, cash flow from operations for 4Q09 was extremely strong at $257 million reflecting our stronger earnings and good working capital performance. In 4Q09 earnings and working capital performance all improved versus 3Q09. Since the end of September accounts receivable decreased $20 million, inventory increased $14 million, accounts payable increased $29 million, and accrued liabilities increased $45 million.
In the quarter restructuring related cash outflows were $16 million, pension contributions were $4 million, and fourth quarter capital spending was $45 million. Depreciation in the quarter was $56 million and includes $11 million of restructuring related accelerated depreciation. Free cash flow in the quarter was $214 million.
Cash flow from operations for 2009 was $402 million down $80 million compared to 2008. Despite being down from 2008 we believe 2009 cash flow performance was strong as it included unusual payments of over $100 million including a large pension contribution of $92 million and settlement of copyright claims in Germany for a payment of $40 million.
In 2009 we also continued to improve our working capital performance as receivables and inventory days continued to improve and payables days remained strong. Since December 31, 2008 accounts receivable decreased $2 million, inventory decreased $81 million, accounts payable decreased $47 million and accrued liabilities decreased $13 million.
In 2009 restructuring related cash outflows were $59 million, 2009 capital spending was $242 million, depreciation in the year was $214 million, and includes $42 million of restructuring related accelerated depreciation. Free cash flow for 2009 was $162 million. Cash and marketable securities at the end of 4Q09 was $1.13 billion up $224 million since September.
Total long-term debt at the end of 4Q09 was $650 million with maturities on the debt in 2013 and 2018. At quarter end we had $491 million of share repurchase authority outstanding, no shares were repurchased in 4Q09. Now let me move to restructuring, for the restructuring plans announced in January, April, and October 2009 we continue to expect the overall program parameters to be approximately the same as discussed last quarter.
In 4Q09 total pre-tax restructuring and related costs and expenses were $46 million. In 4Q09 restructuring cash outflow was $16 million and savings from our 2007, 2008, and 2009 restructuring actions were $39 million. In 1Q10 restructuring and related costs and expenses due to the restructuring actions were expected to be approximately $17 million.
Savings in 1Q10 from the 2007, 2008, and 2009 restructurings are expected to be about $55 million. More details regarding the restructuring plans we have announced is available on the supplemental slide deck. Now for my forward-looking comments concerning 1Q10, we expect first quarter revenue to be up slightly year over year.
Supplies revenue is expected to be about flat versus 1Q09 with growth in PSSD offset by declines in ISD. We expect modest revenue growth in the PSSD business segment year on year. GAAP EPS is expected to be $0.64 to $0.74 in 1Q10. GAAP ESP includes expected restructuring charges of $0.16 per share. Non-GAAP EPS excluding restructuring and related costs and expenses is expected to be $0.80 to $0.90.
GAAP ESP in the first quarter of 2009 were $0.75 per share which includes restructuring charges of $0.14 per share. Non-GAAP EPS in 1Q09 were $0.89 per share. All of the comparisons that follow exclude the impact of restructuring. In the first quarter we expect gross profit margin percentage to be down versus the 36.9% we achieved in 4Q09.
Operating expenses expected to be down compared with the $261 million incurred in 4Q09. Operating income margin in the first quarter is expected to be below the 12.6% achieved in the fourth quarter of 2009. For 1Q10 we expect our effective tax rate to be 24% before any discrete items. This reflects the fact that the R&E tax credit has expired as of January 1, 2010 and has not yet been extended.
For the full year of 2010 we expect our effective tax rate to be 22%, assuming that the R&E tax credit will be reestablished in 2010. The guidance provided for 1Q10 is based on foreign exchange rates as of 12/31/09. Based on these rates the foreign exchange impact to revenue in 1Q10 versus 1Q09 would be approximately positive 6% and versus 4Q09 would be approximately negative 1%.
Given the volatile economic situation we’ve seen over the last five quarters, we thought that we would provide some commentary around the assumptions we are making for 2010. These thoughts reflect our current perspective only and may not be updated as we move forward.
While we have seen modest improvement in the overall market in 4Q09 we also believe that the economic downturn may not yet be over. Lexmark is executing 2010 assuming the overall output market revenue will be down slightly year-to-year and setting the appropriate associated cost and expense actions.
In 2010 we expect our PSSD revenue to grow in line with or faster than the broader laser market due to our strong product line and strong solutions and services initiatives. We expect our ISD revenue to grow less than the broader inkjet market as we concentrate on the sale of higher end devices and continue to reduce the sales of low-end inkjet units.
While our operating income margin has been somewhat volatile over the last two years we’ve operated at about 8% in 2008 and 9% in 2009. We expect 2010 operating margins to be about the same as 2009 with upside pressure driven by the numerous restructuring actions we’ve taken and favorable divisional revenue mix but countered downward by increasing hardware versus supplies revenue mix and the continuing aggressive pricing environment.
In terms of specific line items in the income statement and cash flow statements in 2010 we expect operating expense will decline 3% to 5% from 2009 levels reflecting the benefit of our restructuring initiatives. Combined net interest income and expense net and other income and expense will be consistent with 2009.
The remaining restructuring and related charges to be incurred on our already announced programs is approximately $65 million of which accelerated depreciation is approximately $21 million. Full year capital spending will be approximately equal to depreciation excluding accelerated depreciation at $185 million.
Pension funding in 2010 will be approximately $20 million of which about $7 million will be in 1Q10. We expect working capital performance to be stable to slightly improving as measured in days versus the levels achieved in 2009. The comments around 2010 are based on foreign exchange rates as of 12/31/09.
We will now open the floor for your questions.
(Operator Instructions) Your first question comes from the line of Richard Gardner – Citigroup
Richard Gardner – Citigroup
It may be early but I was hoping that you could at least give us some qualitative commentary on the markets reception to the new inkjet products and specifically what your experience has been with ink usage per device so far, how is that trending versus ink usage on your prior products.
Relative to the new products, reception has been very strong. We’ve won a lot of awards. We continue to see awards rolling in. What’s very interesting to us is that we track very closely customer satisfaction doing surveys with customers after the first 30 days. Customer satisfaction of the new products is up significantly from prior generations and is very encouraging.
Now relative to sales, sales are still ramping so it’s a little early to make comments on that but certainly we saw sales ramp through the fourth quarter. In terms of usage, again, I think it’s a little early. From what we’ve seen so far usage is certainly up from the prior generation significantly as we would have expected but its still a little bit too early for us to draw a conclusion on exactly where that’s going to settle out as people are currently just using products they bought and do not really see a lot of reorders just yet.
Richard Gardner – Citigroup
And then the supply constraints that you mentioned during your prepared remarks could you talk about the impact of those in the quarter and when you expect those to be alleviated.
The supply constraints we talked about were primarily in the laser business and the origin of those really is a couple of factors. One is in the second half you may recall we had, we significantly exceeded expectation in the third quarter as well as now in the fourth quarter. Demand has been increasing for us and we think this is a reflection of certainly some modest improvement in the market but also primarily a reflection of the strong product line that we’ve announced over the last 15 months in lasers, particularly in color and laser MFPs.
So we’ve been having trouble catching the demand because every month our view on it has been increasing. The other thing that’s happened here though is that the overall technology industry has picked up over the second half so broader than just printers and there’s constraints in the industry on components, there’s been increases in lead times out pretty significantly, out to almost 20 weeks on some key components and so that’s been an issue for us.
Obviously we’ve been chasing demand, we’re very focused on trying to catch that up and make sure that we’re setting our expectations appropriately as we go forward in time. But clearly its going to be some time in the first half of 2010 before we get to where we’d like to be. Again some of that depends on how demand moves as we go through the first half.
Your next question comes from the line of Ben Reitzes - Barclays Capital
Ben Reitzes - Barclays Capital
I wanted to just kind of clarify some of your 2010 assumptions, when you run the numbers on flattish revenue even down you get pretty flat EPS year over year of around $3.25 or so, if you could just go into that a little bit more in terms of your 2010 guidance, that’s pretty uncharacteristic for you to even give out all these things. What are you seeing that makes you more confident in your business that you can do that, just a little bit more on that. And is that math pretty much right, are you looking at those kind of numbers of $3.25.
Well a couple of things, first in terms of guidance we really haven’t given guidance, what we tried to do was give you some set of assumptions around what we’re thinking in our business. And the reason that we did it, and you’re right we haven’t done much of this in the past, the reason we did it is really the last five quarters have been very volatile with the economic situation and what’s been going on in the market.
And we just thought that the way the market had dropped and the way that we now have in the second half have done simply better than expectations that it might be helpful to the investors to just get some sense of the assumption set that we’re looking at for 2010.
As always we give guidance only one quarter ahead and that can be challenging from time to time to be able to do that. And so we just tried to give assumptions looking out into 2010. The first key assumption is really around the market. And I call this an assumption because we don’t know what the market is going to be like in 2010, nobody knows what its going to be like.
We set an assumption in terms of market revenue that it would be down slightly year to year and the reason we think that is a couple, one is that if we, results in the fourth quarter are continuing to come in and as we look across the competitors who have already announced we see revenue ranging from up slightly to down 11% and if you look across all that, it probably averages in the high single-digit decline. As we look at 2010 we would expect the market to improve from that, some of that’s just in terms of lapping easier year-to-year compares.
But we’re not sure how much that will improve so we kind of say well its in high single-digits, probably in the fourth quarter, we’re thinking 2010, well let’s say slightly down year to year. And that’s kind of where we’re coming from. We’re also looking to be a little conservative in our assumption set relative to market because I would tell you that we would prefer to prepare for the worst case relative to expense and cost and we’re very focused on even in a down market having a good year.
That’s what we’re trying to do. If the market turns out to be better than that, then possibly we’ll have a great year but that’s our focus. Now as we take a look at our revenue I think we tried to make sure people understand how we’re seeing our revenue certainly in the fourth quarter and I think it will include 2010 as well, that on the laser side we see ourselves as the market modestly improves with the strength we have and that we’ve gained with our product set in our solutions and services we see ourselves performing certainly at least with the market but we really think potentially outperforming the market.
On the inkjet side as we transition to focus on the high end we see ourselves performing under the market because we’re going to continue to move away from some of the low end devices that we’ve been selling through 2009. So we’ve kind of give that guidance, there’s upward pressure, there’s downward pressure on that and we’ve given a market statement but we haven’t given revenue range for 2010.
On the margin side what we’ve indicated is we look at 2009, we did about 9% in terms of operating margin, again upwards and downward pressures on that and as to how that will balance its always difficult to call but we tried to give some indications what are the things that are pushing us upward and the things that are pushing us down. In terms of pushing us up clearly we’ve done a significant amount of restructuring and the cumulative impact of that restructuring is very significant and I’m not sure people always appreciate the magnitude of what we’ve done and you certainly can see it in the fourth quarter results.
And so we’ve got more savings clearly coming in 2010. That’s pushing us up. The second thing is to the extent that we expect to do better in PSSD than ISD, PSSD above market, IDS below market, that’s going to be a favorable divisional mix which we would think would help our operating margin. Countering that we see a couple of things. First to the extent that we’ve very focused on hardware we see an increasing hardware versus supplies mix that’s going to be a negative from margin perspective.
And then the other thing is I think from a pricing perspective and I’m not saying an unusual level of pricing but I’m saying that pricing in our market is always been somewhat aggressive and so we’ve put some of that into the expectation there as well. So these are kind of the factors that are going on. Obviously in terms of your math if the revenue is flat and the margin is flat, then yes, the earnings per share would probably come out the same point. But again we haven’t tried to project exactly where the revenue would be but rather give you the assumption sets underneath what we think is going to happen in 2010 and we’ll certainly see how it unfolds as we go through the year. Very dependent on the market.
Your next question comes from the line of Bill Shope - Credit Suisse
Bill Shope - Credit Suisse
I know its still early with regards to the new inkjets, can you give us some color on the types of customers that are buying the new products and is this what’s in your originally targeted business segment. I guess lastly are you seeing that most of these customers are indeed laser converts.
Well I think we’ve seen a couple of things, and its always difficult to answer, what we’re seeing is a range. So clearly we’re seeing some business customers and we’re seeing an increase in our business customers. We’re also seeing high usage individuals as well. So our focus is to continue to push more towards the business customers to the extent we get a high usage individual we’re okay with that too as long as we have the usage type of thing.
So that’s kind of where we had expected to go. I think relative to are we seeing converts or not, I would say its always hard to comment on somebody’s specific transaction, did they consider laser and did they buy this versus laser, I think its clear to say that if you look in the market business inkjet grew in 2009.
Laser declined in 2009. If you look at low-end laser, color and mono laser, that declined in 2009. So for us as we indicated we’re having strong, continue to have strong, year-to-year sell out in our professional series. So its clear to us that business inkjet which is targeted in general over $200 and in many cases over $300, is doing much better in the market right now then low end laser which is sitting $200 to $500.
So our expectation as we’ve talked in the past is that inkjet is an increasingly important technology in the business market. We do think its going to compete with laser, certainly sub $500, possibly even sub $1000 and we think its an important technology for us to have as we focus on our business customers going forward.
Your next question comes from the line of Tony Sacconaghi - Sanford Bernstein
Tony Sacconaghi - Sanford Bernstein
Your operating margins were at high end of where you’ve been historically, I was wondering if you could comment on what impact currency may have had on margins in the quarter and just so we can think about whether that benefited abnormally and also on the margin side, can you maybe comment on supplies margins versus history, I know you did a lot of supplies factory consolidation, you’ve had a lot of cost cutting. Are your supplies margins qualitatively a lot better than history.
What we saw in the quarter is that supplies margins were up sequentially, up year to year. Primarily what we saw there was a couple of things, the volume increase that we saw which was unexpected for us, helped us on cost because we put a lot more velocity through the burden that we have in the supply chain.
Second thing we saw was as I say beyond just the cost, also from a, I’ll call it a price FX standpoint we did see some help there and pricing is a combination of things but we’ve taken price actions as you know over the last 12 months and some of that certainly is coming through on a year to year basis.
But the other thing is that as the currency has moved around the world, we’re also perhaps arriving a little higher than what we normally would in terms of harmonization of currency around the world so I think that also was a little bit of a help to us in the quarter. And the other point you made, yes we’ve done a lot of restructuring relative to supplies and long-term we do believe that’s going to help us.
But certainly as we look between 3Q and 4Q that was not a significant difference factor I don’t think just between the quarters. Year to year, yes, between the quarters I don't think so much.
In terms of currency what we gave earlier was about a 2% benefit in the fourth quarter versus the third about 6% benefit in the fourth quarter versus 4Q08 and revenue, and to the extent that that was certainly a benefit but the factors that Paul referenced were also very significant benefit and again in terms of restructuring we’ve taken a lot of fixed costs out over the past year and I think as revenues, as you start to see volume come back as it did then you start to see the flow through of the improved margin from those activities.
The other point to make on that is to the extent that we arrive a little high in harmonization around the world that’s not necessarily sustainable, [inaudible] come out at some point in time.
Tony Sacconaghi - Sanford Bernstein
And then you had mentioned that your supplies channel inventory increased fractionally sequentially in the quarter I think going in you had expected it to be flat maybe slightly down, can you comment on where you think supplies channel inventory in the inkjet and on the laser side stands now relative to history and how you’re thinking about that for 2010.
I think that we went up overall versus where our expectation was in inventory we were below that as we take a look but if we look at the specific place where we went up sequentially it was on the inkjet side not on the laser side. We think overall our channel inventory looks pretty good. We’re not expecting significant movements sequentially but sometimes it easy to get surprised on what the channel might do.
And it is possible that on the inkjet side where we went up sequentially we could see some of that come out. We’re not expecting to see much there but if it is possible. So I would say overall the channel inventory looks about right to us and again even with the slight increase on a year to year basis its much less than what we saw in the fourth quarter of 2008 as we’re going through the start of the economic crisis.
Your next question comes from the line of Kathryn Huberty - Morgan Stanley
Kathryn Huberty - Morgan Stanley
Good quarter, just a question on restructuring the savings are clearly showing up in the OpEx line over the past few quarters but a good portion of the restructuring charges over the past few years related to consolidating facilities and yet CapEx increased in both 2008 and 2009, so can you explain why that is and whether we should expect CapEx to normalize at lower levels in the future as you run and maintain fewer manufacturing sites.
In terms of CapEx for next year, we expect it to be about $185 million so kind of consistent with normal depreciation we’ll say which would be in about that range. The reason it was higher in 2009 was a couple of factors, first 2009 is when we launched our new inkjet product line and that required a little bit of capital. In 2009 also we were completing the investments we were making in our offshore R&D insured service centers. And that was a significant investment that we completed in 2009 and then also we’ve been investing in a new ERP. So those three large ongoing projects were executed and two of them actually completed in 2009, the ERP should complete in 2010.
But net net we expect that to kind of bubble in CapEx should be behind us and we would expect CapEx to be about $185 million next year.
Kathryn Huberty - Morgan Stanley
And as earnings normalize and you save some money on the CapEx line would you expect to reinvest that in the form of buybacks.
So in terms of excess cash flow and excess cash available so I think as we’ve said before the first priority obviously would be any strategic investments we would make and obviously we continue to think about those and then beyond that our position is really no different than its been before, we do consider repurchases with any excess available US cash.
The bulk of our cash balance does continue however to remain overseas.
Your next question comes from the line of Shannon Cross - Cross Research
Shannon Cross - Cross Research
In terms of the AUR growth which was clearly very strong during the quarter especially on the laser side can you talk a little bit about sort of what we should think on a more sustainable level, once your component shortages have alleviated, how are you looking at the mix shift up in terms of products.
We don’t really give forward-looking AUR guidance, what I can say is that our focus in both laser and inkjet is on the higher end. So we’re focused in laser on moving the workgroup much more focused there than low end so I would expect over time to see our mix shift continue to improve. I would also say that on the inkjet side we’re very focused on moving to the high end and moving away from sales in the low end.
So we’ve going to continue to see a mix shift there as well. So I would expect to see continued year-to-year pressure up on AURs on a year-to-year basis. But as I say, I apologize, we don’t give forward-looking guidance on that.
We did mention it in our prepared remarks, in the fourth quarter during the component shortages we did try to focus our available capacity on the high end so that was something that was certainly true.
So that helped laser in the fourth quarter perhaps a little unusually but I still believe the mix would have been up regardless of that.
Shannon Cross - Cross Research
And then last year in fourth quarter you gave 2008 foreign currency exposure and it was very helpful just in terms of trying to determine the contribution currency had to your operating income line, can you maybe give us some more color on is there any changes relative to the break down that you gave last year for 2009 and how we should think about foreign currency from the standpoint of operating income.
I think the way we’ll handle that probably is again what we’ll do is we’ll update the, in the slide deck that we post to the website, we’ll update that chart so that it includes the most recent data and I believe its already been updated to include the most recent data so it should be in there now.
Your final question comes from the line of Mark Moskowitz - JPMorgan
Mark Moskowitz - JPMorgan
Real quick question here on the supplies improvements in general, can you give us a sense in terms of how much of the supplies growth was attributed to products introduced in the last 12 months in terms of seeing the initial replenishment on those products versus maybe some customers coming back and doing some pantry restocking on older assets.
That’s a difficult question, certainly we know the products where the supplies ordering came in and I would tell you it’s a mix clearly always on the older products as well as the more recent products but certainly the more recent products we certainly saw some healthy reordering relative to that.
In terms of, and you’re asking a very good question, in terms of what you see out there is pantry restocking versus actual consumption of toner and ink this is a difficult thing and as we look back on 2009 we clearly think that there was more of the bleed off of pantry stock than was obvious as we went through the year, be it either in the second tier of supplies channel, distribution or in enterprise or in homes in terms of people just keeping supplies around.
And that could be a factor that played in here. We also though do think because we can see some of this in our large enterprise accounts where we have management services we do see some usage starting to come up. So clearly in terms of pre economic crisis levels, we’re not back to that. But we do see some positive trends there and certainly that increased usage I think perhaps in addition to some of the pantry stocking and replenishing of some of the second tier have been factors here in the third and fourth quarter as we’ve seen an over expectation relative to supplies revenue.
But again we do think that there is some modest improvement in the market going on here as well. So we’re hopeful of that as we look forward.
There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.
In closing I’d just like to briefly recap what we’ve discussed today, better than expected customer demand resulted in strong sequential growth for Lexmark exceeding our expectations for both revenue and profit in the quarter.
Both divisions exceeded expectations and geographically all regions improved sequentially in revenue and profit. Overall revenue was down just 1% year to year a significant improvement from the year-to-year performance in the first three quarters of 2009. Our year-to-year performance in ISD improved in the fourth quarter and our laser business returned to year-to-year growth with growth in both laser hardware and laser supplies in the quarter.
Overall looking back at 2009 we are encouraged by the improved customer demand for our products during the second half of 2009 and the ongoing improvements that we are driving in the fundamentals of our business including the significant refresh and upgrades in our laser and inkjet product line over the last 15 months, the share gain in our key focus segments of workgroup laser and business inkjet, the ongoing cost and expense reductions totaling over $200 million of expense reductions in 2009, the strong sequential improvement over the last three quarters in our cash generation, and despite our expense reductions we continued to invest significantly in our core print technology and product development and are driving a strong pipeline of future Lexmark products.
While it could be a long recovery for the overall printer market to return to its prior levels we do believe that we are making Lexmark into a leaner and stronger competitor, improving our product solutions and services offerings and our competitive position.
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