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Lexmark International (NYSE:LXK) released its Q4 earnings on January 28, and the company posted yet another quarter of strong results as its managed printer services (MPS) and Perceptive software businesses delivered growth. The street responded positively to the results, and the stock price rose by over 9%. The revenues and earnings per share exceeded guidance range. While the revenues rose by 4% to $ 1 billion. Additionally, the company delivered adjusted earnings per share of $1.18, topping the Wall Street expectation by 9 cents. For the full year 2013, revenues declined by 4% to $3.67 billion. However, operating income and net income grew, reflecting a shift in focus from the low margin hardware business to high margin software services.

Lexmark's Perceptive software division continued to post healthy growth as revenues grew by 70% to $72 million. In Q4, the company acquired PACSGEAR to bolster its Perceptive division. Additionally, imaging solutions and services (ISS) revenues grew by 1% to $939 million, buoyed by growth in laser hardware and supplies. Within the ISS division, Managed Print Services (MPS) revenue grew by 22% year over year to $208 million, non-MPS revenue grew marginally by 4% to $631 million, and inkjet revenue declined by 32% to $100 million.

Outlook For 2014 And Beyond

For Q1 FY14, the company expects revenues to decline by 3% to 5% year over year, and earnings per share to be in $0.80 to $0.90 range. Lexmark guided that its revenues in FY 2014 will decline by 3% to 5%, while EPS will be flat in the $3.80 to $4.00 range. Furthermore, in long term, the company plans to grow its revenues at or above market, and maintain operating income margin in 11% to 13% range.

MPS and Perceptive Lifts Revenues

According to IDC, the worldwide hardcopy peripherals market grew by 2.6% in the third quarter of 2013. [1] Furthermore, most of the growth in this industry came from increasing sales of laser printers and MPS services. This is impacting hardware sales and pushing Lexmark to focus on high end laser printers and MPS.

According to research firms such as Gartner and IDC, Lexmark is a leader in the MPS business. [2] Companies are increasingly adopting Managed Printing Solutions to cut costs and simplify printer management. As a result, MPS contracts for the company have increased over the past 24 months and offset the decline in non-MPS revenues of the ISS division. While MPS revenues grew by 22% to $208 million in Q4, it grew by 16% to $722 million in 2013. We believe that MPS, integrated with Perceptive's solutions will deliver value to Lexmark's growing client base. We expect MPS to become the biggest driver of revenue for the ISS division going forward.

Perceptive software makes up 9% of Lexmark's estimated value. Revenues from this division grew by 48% to $224 million in 2013. As Lexmark continues to build Perceptive's product portfolio through inorganic means, we expect this trend to continue in the future. We also anticipate growth in software licensing revenue, which will drive revenue growth at Lexmark. Moreover, the seamless integration of Perceptive's array of solutions with MPS will bolster revenue for the company.

Margins Improve Due To Revenue Growth In High Margin Businesses

Lexmark has been restructuring its business in light of the emerging trends in the printer hardware industry. Lexmark is exiting from the low margin inkjet printer business and increasing its focus on laser printers, high margin MPS and the process management vertical (Perceptive software). Additionally, as Lexmark plans to become an end-to-end solution provider, Perceptive Software is becoming an increasingly important division for Lexmark.

The change in revenue mix, principally due to an improved mix of high-margin license and subscriptions revenue, resulted in a 550 basis point improvement in gross profit margins to 41.4% during the quarter. Furthermore, ISS gross margins increased by 45o basis points to 40.4%, while Perceptive Software's gross margins improved by 640 basis points to 73.4% during the quarter. [3] We expect this trend to continue in the future and the growth in high margin revenues to contribute to the increase in EBITDA margins going ahead.

We are in the process of updating our model. At present we have a $38 Trefis price estimate for Lexmark, which is in line with its current market price.

Disclosure: No positions.

Source: Lexmark Earnings: Revenues Beat Expectation As Margins Rise

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