Executives
John W. Gamble – Executive Vice President & Chief Financial Officer
Analysts
Mark Moskowitz – JPMorgan Chase & Co.
Lexmark International, Inc. (LXK) 40th Annual JPMorgan Global Technology, Media and Telecom Conference Call May 17, 2012 8:30 AM ET
Mark Moskowitz – JPMorgan Chase & Co.
Good morning, everyone, and welcome to Day three of the JPMorgan TMT conference, the 40th annual edition. So John Gamble today here is CFO of Lexmark and we’re pleased to have him with us. Appreciate it, John, for showing up.
John W. Gamble
Happy to be here.
Mark Moskowitz – JPMorgan Chase & Co.
Thank you, the interesting thing about Lexmark is that they are a printing company but they are keenly aware of some of the changing secular dynamics out in the marketplace and, as a result, have been doing some interesting stuff around diversification. So we hope to definitely talk about the software initiatives of the Company over the past year workflow management, what have you. So, my name is Mark Moskowitz. I’m going to start here with about 15 minutes or so of Q&A and then we will turn it over to the investor audience.
So in the interest of time let’s get started. John, maybe we could first touch on that first point I brought up earlier about the secular dynamics. Our recent JPMorgan CIO survey would suggest that printing is still scoring pretty low from a priority perspective for most CIOs. So, just trying to get a sense from your vantage point, what is Lexmark doing to try to overcome that secular shift that is going against you in terms of low priority stature and what are some of the drivers and initiatives?
John W. Gamble
Absolutely. So I just need to start with the Safe Harbor. So the contents of this presentation that are not statements of historical fact are forward-looking statements and involve risks and uncertainties that are discussed in the Safe Harbor section of our earnings releases and SEC filings. Actual results may differ materially from such statements.
Lexmark undertakes no obligations to update any forward-looking statements. This presentation contains non-GAAP financial measures unless otherwise noted. Lexmark has provided in the supplemental materials section of our slide deck GAAP to non-GAAP financial measures and a discussion of management’s use of non-GAAP financial measures.
Thanks. Yes. So, we certainly understand the secular trends, I think, in the market very, very well. If you look at the kind of long-term forecast for printing revenue in general, you probably are looking at something that’s kind of flattish to up slightly in the relative near term. Recently, it’s been negative.
In terms of positioning in the market right we’re positioned really in the business segment more in the Enterprise segment and more in the distributed space. So in terms of the general trends in the market we think that’s probably one of the better places to be situated.
Certainly, centralized printing is declining substantially and some of those pages are moving into distributed printing. And the consumer market appears to be under a lot of duress right now and that’s a market we pretty much exited.
But admittedly, even in the enterprise action and the business section, the dynamics aren’t for significant, long-term growth. Again, kind of it’s more of a flattish market. So we’re really focused on, and we’ve been very consistent in this, is trying to be extremely strong in managed services and extremely strong in extending managed services into solutions and software.
So, we’re really focused on being a solutions company that helps people improve their cost structure overall and we can do that in the Printing segment. It’s certainly the largest portion of our business today through managed services and providing technologies that allow companies to manage their fleets of printers more effectively, could take down their cost related to printing.
And you’re seeing very good growth in MPS in general, right. You are seeing the MPS market growing probably between 5% and 10% depending on, which survey you decide to read. And we’ve been growing substantially faster than that. This first quarter, we grew strong double-digits. Last year we grew over 20%. We grow over 20% the year before that.
And so, our performance in the MPS segment itself is very strong, but more importantly it’s the way we go to market. So over 70% of our hardware revenue is in that large workgroup category, which is really the Enterprise segment of the market and that percentage is growing and it’s being driven by our ability to deliver high-end services and solutions and it links in very well with where you started in some of your comments in terms of our focus on adding more and more technologies that allow us to deliver more and more software solutions.
We’ve done, we did three acquisitions last quarter and relatively small acquisitions but very important from a technology perspective. We acquired a company called Brainware, which has outstanding technology in terms of intelligent capture. And what that means is it’s for any document, any unstructured content which comes into the enterprise can be a scanned document, can be an email, can be an attachment, anything which comes in unstructured, it has what we think is leading edge technology in terms of the ability to pullout the content, to find the important information on the invoice, in the record and turn that into structured data, so that you can then process it effectively in your core systems.
And that’s a business that has been growing very; very well, but, very importantly, we think is beautifully synergistic with our management services business. As well as with Perceptive because it’s the front end to starting a lot of workflow processes. We acquired a company called ISYS, which they do search technology. They are – we’re not trying to go compete with Autonomy. What they do is search technology around documents and document-related items, and they offer federated and enterprise search.
So what we’re able to do now is we’re able to – if someone is working in a process and we’re providing the infrastructure to work in that process, we can help them understand what other information is available on that process. Not only within our own repositories, but across the enterprise. And we call it pre-treat, but to effectively provide the information to the customer before they have even asked for it. And then we extended our strength in higher education.
Because as you know Lexmark has long been strong by industry. So the other way we try to take it, we try to counter some of the trends in the industry in the overall printing market is by being very strong by vertical market. So we’re very strong in financial services. We’re very strong in insurance. We’re very strong in healthcare.
Growing strength in government and through the addition of Perceptive now and their teams, we’re very strong in higher education. And with the expanded growth of our MPS business and our capabilities there, we have expanded strength in back office.
We think what that’s allowed us to do is to be very applicable across all industries in terms of serving their back-office needs and we’ve had some very good validation of the strength of our business recently in terms of industry analysts.
We had Forrester yesterday come out and put us in the top of their Wave in terms of a leader in MPS. We had Gartner earlier in the year come out and put us in their Leader Quadrant in terms of MPS as well as smart MFPs. And IBC did the same as well. So we feel like the investments we are making have clearly improved our ability to deliver for our customers.
Mark Moskowitz – JPMorgan Chase & Co.
That was a great overview. Appreciate it. I have a few follow-on questions. One, in terms of MPS, how should investors think about the margin contribution? Is it additive; is it neutral to the overall business structure?
And then, the second question is, as you get the word out about MPS, have you had to maybe accelerate some of your OpEx expenditures around that business so maybe down the road you actually have some operating leverage improvements? It is a two-part question.
John W. Gamble
Sure. So, MPS is really just a large transaction for us and so larger transactions with larger entities. The margins are a little tighter than they would be just going directly through the channel, for example. But it isn’t any different than doing a very large hardware and supplies deal with a customer.
The margins tend to be very similar. The nice thing for us why we like it so much, obviously, is because we have visibility into the customers, so we can now provide them additional services. We can help them do analytics on their fleet and on what they print and how they print.
So we can start adding value-added services that will hopefully allow us to improve the margins and the whole share wallet in the customer as we can then help them do workflow and value-added services on top of the fleet. Plus also, since we are delivering the supplies, then we obviously have a very good understanding of what supplies are going into the fleet and we can be in a good position to make sure it’s Lexmark original supplies and hopefully maintain the margin that we expected to get in the account as opposed to having it potentially decline [if someone] wants to switch off of our supplies.
Mark Moskowitz – JPMorgan Chase & Co.
Good.
John W. Gamble
In terms of spending, we are definitely investing and extending our large account, our enterprise sales teams. But basically what we did is there we shifted, right. So as we’re no longer really in consumer and even the low end of our small workgroup devices are shifting higher and higher in the market, we are basically shifting out of retail hardware. So you are seeing less and less Lexmark hardware going through retail channels. So we have effectively reallocated those retail sales teams into the enterprise workgroup area.
Mark Moskowitz – JPMorgan Chase & Co.
And then earlier you mentioned about Lexmark’s strength in financial services, insurance, healthcare, to the pharmacies, I believe, and now education. Are those the areas that you are targeting first for MPS or are there other Greenfield opportunities beyond that that can maybe expand your vertical exposure overtime with MPS?
John W. Gamble
Our MPS, because of the way we’ve built our MPS capabilities, because we built everything, we deliver MPS services based on, based on technology as opposed to based on feet on the street, right? So we spent a lot of time growing our ability to service and to understand the performance of a fleet remotely.
We’ve built our global system that operates on a single instance where all assets managed under by Lexmark are all managed centrally. So we truly have very good consistent data on all alerts, all performance. And we think that allows us to provide the service less expensively than most of our competitors.
It also provides a common platform for us to add additional capabilities to those customers. So we think the platform we’ve built is applicable across industries. What we are trying to grow is our domain expertise and we are continuing to grow that. So we are adding domain expertise and new verticals.
But the good thing is a lot of the printing in many industries that don’t have distributed offices is really similar. Back-office is back-office and as we continue to get stronger and stronger in MPS in general, we think our back-office strength applies across all industries. And you are seeing that because we weren’t strong in brewing, but we want Anheuser-Busch.
And so things like that. And our global capabilities are extremely helpful because we want Anheuser-Busch in the U.S. We also happen to service them in Brazil. And they knew us in Brazil because we are so strong in Brazil and that helped us win here. We think it will help us within Europe.
So we think, probably surprising to some people, but we think our global delivery capability even though we are the smaller of the probably the three largest players in MPS in terms of the company, we think our global delivery capability is substantially better than anybody’s. And we win so many large deals because we deliver so well, so fast, so fast and so consistently, because our processes are common, our systems are completely common.
Mark Moskowitz – JPMorgan Chase & Co.
Okay. That was helpful. In terms of the global delivery opportunities though, I guess from what I am hearing from you, it sounds like U.S. so far has been where you have had the best penetration with MPS. Is that fair? And if so, how should we think about the opportunities particularly in Europe, just given the greater level of austerity measure risk there in that region? I think they would probably be more cost-conscious than any corporate sector.
John W. Gamble
We have a large presence. North America was our home, right, so I think we probably started quicker there in MPS, but we have a very large MPS footprint in EMEA. Some of our largest global customers are actually EMEA-headquartered companies. And we have an extremely strong MPS business in Latin America. We are number one in Brazil. We have the vast majority of the Brazilian financial services industry.
Lexmark provides the MPS services to those companies. We are very, very strong and expanding very rapidly in Brazil, growing in Mexico. Probably the region of the world where we have the weakest penetration is in Asia. We have a relatively strong business in Australia.
We haven’t been as successful in China, haven’t been as successful in India. Our penetration in China and, to a lesser extent, India has heavily been driven by the fact that as we win global customers as you know we won Cummings, for example, that was announced. Since they’re in China we’re in China. Wal-Mart stores, they’re in China, we’re in China.
But we are just now starting to grow our Chinese-based Company, MPS business and service business and it’s starting to happen. It’s slower, but we think the fact that we are so strong with multinationals, as they grow in China, it grows our footprint there, it grows our ability to deliver there. But it really is a global business for us.
In terms of your specific question on EMEA, we saw it in the U.S. in ‘09 when things got very weak. The number of the MPS bids actually went up and what happened was people broadened their view as to who they would bid. So we were able to participate in more opportunities sometimes and maybe we wouldn’t otherwise have had a chance to participate in. So we’ll see if that happens again in EMEA. I don’t know.
We do think, however, the fact that we are now in the Magic Quadrant basically with everybody that have a Magic Quadrant, but we’re in the upper right. We’re in the Leader’s Quadrant for the three major industry services, as well as [Q Serca], which is our major European service. We think that’s going to be very helpful in terms of us just getting even unsolicited, the ability to get unsolicited because many companies as you know, will bid everybody in the upper right.
Mark Moskowitz – JPMorgan Chase & Co.
And as far as these quadrants, was this just a function of the industry analyst finally kind of carving out parameters to measure this new space or emerging space at MPS? And that’s why you’re ranking now in the top quadrant, or is it something that is really Lexmark-specific where now you’ve assembled the right portfolio of assets and services to really be recognized by these analysts that the quadrants are already there and now you are finally entering the quadrants?
John W. Gamble
I think there’s long been a rating of MPS capabilities, but I don’t think that’s particularly new. I think some of the services have started to do, I think the Forrester Wave is a little bit new. But in general, I think what’s occurred over the past five years, and you follow this very well is five, six years ago we made major investments in color and color MFPs and those all came to fruition probably two years ago. So we have an extremely strong broad hardware line. So that certainly was a piece of it.
Our ability to deliver globally, we’ve invested in heavily for 10 years and I think it’s now become understood in the industry by industry analysts and also it’s long been understood by our customers that our global reach and our truly global common processes do differentiate us and our ability to deliver globally, consistently, rapidly and not only deliver in terms of installation and maintenance, but deliver data and deliver analytics.
But I think one of the big steps that occurred in the past couple of years is the real extension of our ability to provide software solutions that extend off the MFP. And the industry is clearly moving that way. It’s moving toward analytics, it’s moving toward the ability to manage and improve cost well beyond, which you can do in the device and in the printing environment.
And because of the investments we’ve made and our ability to really deliver solutions and high-value solutions we think that’s really pushed us, really catapulted us into the leader positions even though we are not quite as large obviously as some of the others players that are there.
Mark Moskowitz – JPMorgan Chase & Co.
Okay. Thank you. Earlier, you commented that recently the growth prospects have been somewhat negative for printing, but you do kind of expect longer term more of a flattish growth profile. What are some of the swing factors that investors should consider that can actually drive maybe potential upside or downside to that outlook?
John W. Gamble
When I quote flattish, I’m really just quoting industry analysts. I mean, as we take a look at the markets we understand that there certainly are dynamics in printing as we take a look at the other technologies, the other display technologies that just look around the room that are pervasive everywhere.
What occurred historically, as new technologies were generated to create content, the amount of content created would grow. The percentage of it that was printed would decline and then whether the net printed pages were affected up or down, what was a matter of those two dynamics. You saw when laptops occurred; I think you’re seeing it now. There certainly is a lot more content available. How much of it are people going to print?
Really hard to tell. But we understand long-term, the dynamics are certainly not that you’re going to see growth in printing, right. Long-term, it’s certainly not the case. What we’re trying to make sure we do is make sure that we are the very strongest player in terms of helping companies reduce the cost of their environment and make their environment as effective as possible.
And that’s really around managed services as well as the improvements we continue to make in the devices to make them lower cost and to deliver toner at much lower and lower cost. I think at much lower and lower cost. But again beyond that how do we help?
How do we help companies take that very powerful imaging device that they just happened to acquire and turn it into an important part of their workflow? So that they can generate, they can take unstructured information that probably in the past wasn’t useful in their environment, and they can turn it into structured information that becomes data that they can then provide analytics on. And those are the investments we’ve really been making in software. It is workflow, yes.
We have repositories and retention, yes. We’re very strong in healthcare, for example in providing repositories to major EMR deployments. But even more than that, the acquisitions we’ve made recently really help companies turn unstructured information into valuable structured information and which they can then execute analytics.
Mark Moskowitz – JPMorgan Chase & Co.
I want to dig deeper into the software piece in a second, but I have one more question. More around the printing business just in terms of page volume versus toner, laser sales. Just trying to get a sense from you, some of the work we have done suggests that we have seen some pantry replenishment here and there over the past year from a supplies perspective, but a lot of folks are saying that their page volumes are continuing to decrease. Are you starting to see that as well where page volumes are starting to decrease?
John W. Gamble
So the place we can do analytics is really and places where we’ve managed the environment around MPS and I think what we’re seeing is to date, right, kind of the pages per device if you try to narrow it down really aren’t, we haven’t seen significant changes in the trending.
The trending is, we’re not seeing big growth obviously, but we’re not seeing significant inflection points in terms of reduction either. And our expectation is that we, again, will over time see declines and we need to be able to manage to that. And we need to help our customers learn how to take pages out of their environment because they want to take costs out of their environment.
So again, we understand that our business proposition to our customers is to help them get pages out of their environment. And we’re working very hard to do that. So, when we say we’re not seeing anything change material, we’re not materially versus what we expected which is what we expect is that our job is to help them improve their processes, so they don’t need to print as much.
Now hopefully then, as they grow as a company, we pick up more locations for them, so we get an improved share of their wallet and then also we get an improved share of their wallet by providing them other services well beyond printing and that’s really where we’re headed. But we know like any service provider, if we don’t help them take our pages, help them reduce their cost, and they are going to bring in somebody else.
Mark Moskowitz – JPMorgan Chase & Co.
Okay. Great, thank you. Why don’t we shift gears now to the software initiatives? Big data continues to get a lot of attention, scores pretty high in terms of IT priorities when we do see our surveys will have you, but what we do hear is that folks are still more in the pilot stage versus implementation.
From your vantage point, what is kind of your view? How much of your business still is where folks are vetting or piloting or demoing your products maybe in their labs versus broad scale rollouts across their enterprise? And how should investors think about that tail, I guess?
John W. Gamble
Yes, so we are not really in data analytics, so we are not a competitor there. But what we do is a little bit what we talked about previously is what we can do to help people improve their ability to execute analytics on their own business is to take that huge volume of unstructured information they receive and the percentages of data inside the company, they are unstructured very widely, but they are all very, very high.
They are all well over 50% and we can, with the technology we have around intelligent capture, around search, we can help create structure and workflow, we can help create structure out of that unstructured information so that it becomes data so that as they choose to run analytics on it, they can, they actually have data on which they can run analytics.
And that is really a lot of the focus that we have. We understand that really what we are doing, what we help someone execute a workflow, yes; we are helping them process a payable or process a receivable or process a medical record or whatever. But effectively what we are doing is taking a lot of unstructured information and making it structured, so it can process in a core system.
And the faster we can do that, the better we can be at line item extraction on an invoice or line item extraction on an EOB, so that we can give that customer more data, well then, from there they will decide what is interesting to them. But if we can give them that data then that is more value to them and we hope to get paid for that.
Mark Moskowitz – JPMorgan Chase & Co.
Okay. And then as far as just the model impact, I know you have talked previously about running Perceptive at break-even. When should investors start to contemplate or prepare for margin accretion for the overall consolidated model and are we talking three years out, five years out, what is kind of the timing there?
John W. Gamble
So Perceptive is the Perceptive family with the companies we’ve acquired it’s becoming a still small, but relatively substantial software business. We would expect it to start being profitable next year. And we would expect over time that is going to have software margins consistent with a strong and growing software business.
Its gross margin profile is very consistent with what you would expect of a content management type company, and we have been investing as we’ve said well ahead of their current size, because of the benefits we see in terms of accelerating their growth, but also the benefits we see in terms of helping us win more and more MPS and services agreements on the print side.
So you know, in the first quarter they certainly had an $8 million loss and that was really around, they had very good growth at 41% almost 20% organically. We would expect them to grow faster and when the growth didn’t quite show up, and it was really around certain transactions just didn’t close in period. A couple of them have already closed this period.
We just expect, we didn’t slow the investment. We didn’t think it was prudent for us to do that. We wanted to deliver the solutions faster, because we see what it does for our services and printing business, as well as accelerating the growth of our software business, so we just kept going.
The goal as we’ve said for the rest of the year is they should operate around break-even. It could be a little negative in the quarter. It could be a little positive. But they should operate around break-even and that is really what we are trying to focus on having them do. And then as we get into next year, we are expecting to see positive contributions. Not at traditional software levels yet, but they will improve from there.
Mark Moskowitz – JPMorgan Chase & Co.
Okay. And then you mention some of the deals closed related to Perceptive. And the deal slippage that took place back in 1Q. What was the driver there? Was that Lexmark specific just in terms of your ability to fulfill the orders or was it something on the customer side?
John W. Gamble
That is just their software deals. As we’ve learned as we grow in the software business a lot seems to happen toward the end of periods and things just didn’t close on time, that’s all.
Mark Moskowitz – JPMorgan Chase & Co.
Okay.
John W. Gamble
We don’t think there was nothing specific. There was no delivery issue, because it’s generally delivery of licenses, so it was just really around timing of closure. A couple of one or two of the transitions we actually didn’t win, but in general, it was just a matter of timing.
Mark Moskowitz – JPMorgan Chase & Co
Okay, I have a bunch of questions still, but I want to give investors time, we got about 15 minutes, so why don’t we open up to the investor audience. We do ask that you wait for the microphone, just so the webcast listeners can hear. First question over there, Adams?
Question-and-Answer Session
Unidentified Analyst
Your mix of hardware and software, what is it I just saw a core legacy, but you group them together. So what is the mix today and then where you think that’s going to be if you look out three years?
John W. Gamble
Our Hardware and software?
Unidentified Analyst
Yes, services mix.
John W. Gamble
Sure, a hardware supply is the dominant portion of our revenue, it’s in the financial statement, it’s about 70%, right. Software is still relatively small, but growing very fast, right so the software business probably was about $30 million in the last quarter and should grow substantially from there and we’re expecting to grow well much faster than the rate of the market, which we think is 10% to 12%, 10% to 15%.
But our business model right, what it should drive is a higher percentage of supplies over time, right because we continue to move into situations where there are larger enterprises, there are managed environments, where the goal of the customer, as well as ourselves is to have fewer devices that are more efficient, not one device in the corner, which we think is wholly inefficient right.
But distributed devices around an environment to keep them fully utilized and efficient, which reduces the relative percentage of hardware in transactions and increases the relative percentage of supplies, so it helps our margins in general, helps the cost structure to the customer and so that’s basically the plan.
So you should continue to see that trend, the growing software percentage, growing supplies percentage probably somewhat less high percentage in hardware. The only time that wouldn’t give you cases for having tremendous hardware growth, that’s a good thing, right, but in general that’s probably not that entering.
Unidentified Analyst
All right, well folks ruminate, I’ll ask a few more questions, just coming back to software, can you talk a little more about the integration efforts underway with the three most recent acquisitions, I know there are small in scale, but just how should investors think about the integration, should we be done by say it, summer time or was it going to take a little longer than that?
John W. Gamble
Yeah, I’d say the technical integration’s back office systems, processes, et cetera should be completed by July and those are going well, but we can generally get them done in three to six months. And so we think that’s going very, very well. The marketing integration, it’ll take a little bit longer, but it’s occurring already.
And I think the joint marketing sales efforts are occurring, getting everything in terms of electronic marketing fully at the speed and all the content communized, we’ll take a little bit more time than that, but we think that’s moving along relatively well. Technical integration takes little longer the roadmaps will be built right. We’re absolutely committed to integrating the technology base of all the companies.
We’re not going to end up with a group of acquired companies where the technology base is already inconsistent. So we we’re building those roadmaps now and the investments. We’re planning the investments to make sure we end up with consistent common technology foundations that we can extend these products on and ensure they interrelate well. So that’s going well to us. So in general, probably as we hit summer time, we’ll call it call it steady and then we’ll move on from there.
Mark Moskowitz – JPMorgan Chase & Co
Great, question in the back, give the mike.
Unidentified Analyst
I am not sure, I understood margin effect of this MPS strategy, so I do understand you said now margins are tighter, but you get more dollars from your plans because you’re selling more services, the net effect of it to the extent you sent telling now, is it positive or negative.
So you’re getting more dollars from your clients because selling more services, but the margins are tighter in percentage terms. So if I look at dollar margins, or client, what is the net effect of these two things, lower percentage margins, higher top line sales?
John W. Gamble
In terms of dollars received into the entity, right.
Mark Moskowitz – JPMorgan Chase & Co.
Yeah.
John W. Gamble
Because MPS is growing much faster than the rest of the business in terms of dollars MPS is clearly positive, right.
Mark Moskowitz – JPMorgan Chase & Co.
I’m sorry.
John W. Gamble
In terms of percentage margins
Mark Moskowitz – JPMorgan Chase & Co.
Let me rephrase my question, just look at one client and forget about the growth. So previously you’re selling $100 to the client at 10% just picking numbers 10% margins now you’re selling $130 at 9% margins and if you do math and you’ll come to $2 numbers?
John W. Gamble
The dollar number of MPS is bigger.
Mark Moskowitz – JPMorgan Chase & Co.
Okay, that’s all I wanted to know. Thanks.
John W. Gamble
Yes.
Mark Moskowitz – JPMorgan Chase & Co.
Why don’t we shift gears to capital allocation strategy?
John W. Gamble
Sure.
Mark Moskowitz – JPMorgan Chase & Co.
Clearly in the past year, Lexmark has been a lot more expansive or holistic in their approach with both increased share buyback as well as initiation of the quarterly dividend resonated well with investors now let those two placeholders out there, should we think about M&A still be in more of the focal point for any incremental cash usage or can you just weigh in on that?
John W. Gamble
Absolutely, so what we indicated I think was about six months ago now that about 50%, just over 50% or over 50% of our cash will go back to shareholders. Your dividends and share buybacks we just made the dividend $1.20 a share, which if you do the math we said would be 90% to 100% of our non-GAAP net income number and we gave guidance for non-GAAP net income.
So it’s almost equally split now. If you’re just over 50% between dividends and share buybacks and we’re committed to continuing to execute on that basis. We want to make sure we give a fair return to shareholders who want to make sure that we are a very strong cash flow company; we want to make sure we return that to shareholders as best we can.
But yes the cash that isn’t return to shareholders the focus is acquisitions, we do think that continuing to grow the software and solutions business is critical to us as a company in the long term and also very beneficial to us in the existing MPS and enterprise business and printing. So we’re continuing to look for opportunities to extend and expand our solutions and software business kind of within the framework that we’ve been working so far.
Mark Moskowitz – JPMorgan Chase & Co.
Okay, great. I know we have spent most of the time talking more about longer term strategic opportunities, but I have to at least ask one more near-term question. It does seem to be there some sort of conflict or delta right now between what the company has provided in terms of full year kind of expectations versus what’s the street is looking for this, there seem to be a pretty big gap in terms of first half versus second half EPS. Can you just give us some parameters here in terms of why you feel?
John W. Gamble
Sure.
Mark Moskowitz – JPMorgan Chase & Co.
The company can deliver on the second half is it seems like the Street right now just not given you any credit for what you may believe is still achievable?
John W. Gamble
Yeah, absolutely. So as based on the guidance we gave for the second quarter and the guidance we gave for the full year obviously second half needs to be significantly stronger than the first half in the neighborhood of $0.60 plus, stronger in the second half than the first half and if you take a look at the reasons why it is kind of broken into three big pieces we actually there is a chart on this on our last earnings slide deck I forgot the page number but it is in there and effectively little less than a quarter of it is really non-operational stuff our tax rate we expect be lower in the second half because we expect the U.S. army or any credit that pass.
Our shares outstanding will be lower in the second half because we are continuing to buyback and that somewhat beneficial. Over half of it is really our ISS division and its two things, right; we announced the restructuring we announced its cost, right, we announced the restructuring late last year and that’s going to drive increased cost position cost restructuring and cost performance improvement in the second half relative to the first half as those restructuring are completed plus we had a negative effect of Thailand in the first half and what we should get some recovery of that cost through insurance in the second half.
So when they put a cost benefit, second half versus first half as well. And then the last little piece was around our large work group, we’re expecting continued improvement in our large workgroup. We’re expecting a continued improvement in our large workgroup sales and our large workgroup sales are accretive to our earnings and also drive supply.
So, we’re expecting improvement in large workgroup hardware and related services and that’s going to be beneficial to the ISS division and that’s over half. That’s the bulk of the relative improvement, second half versus first half. Then the last piece is really around perceptive. Perceptive, the losses they had in the first quarter and therefore we’ll have in the first half is not something we expect to run at generally.
We said we expected to be running about break-even. We’re not expecting to recover the losses that were occurred in the first quarter, but we are expecting to run in the neighborhood of break-even in the second half. So as that’s the case, you’ll see some improvement, second half to first half as well. So you add those three things up and we think that’s really the bulk of what drives the improvement in the second half versus the first half.
Mark Moskowitz – JPMorgan Chase & Co.
Thanks for that clarification. I appreciate it. Couple more minutes here if we have any questions in the audience. Okay. I had a question, more near-term focus again, just in terms of what is Lexmark’s view on the supplies overhang in the channel? I know that the top-line did benefit last quarter due to the pull forward of supplies, as a result of some [harmonization] due to currency.
It always seems in this industry that supplies overhang has taken a little longer than expected to fully kind of work their way through and be digested. So is this one-quarter event, is it two or three quarter event? And what’s your kind of thinking right now in terms of how investors should prepare for supplies?
John W. Gamble
Sure. We indicated in the first quarter that currency effect was about 2 points and basically that the increased supplies revenue in the period, a little bit more than offset the impact of currency. Our expectation is, as we’ve said in the call that we would expect to see that come out of our revenue, principally in the second quarter, but you are right. It is difficult to tell how the channel is going to absolutely react.
It is a difficult thing to predict. We do expect it to affect us in the second quarter. It could affect us a little bit in the third quarter as well. But our expectation is principally you’ll see it in the second quarter, and then probably there will be a little bit lag effect in the third or in the second half, but the bulk of it, hopefully in the first period.
Mark Moskowitz – JPMorgan Chase & Co.
Okay. And then, just my last question if you could. Clearly Lexmark has done some great things over the past five to six years in terms of restructuring the business model, tighten the focus more around the enterprise, changing your supply chain, really driving some nice optimization, but the biggest piece is just bringing down the legacy exposure. I think right now it’s around 6% or 7% of total revenues is due to legacy exposure. When should investors anticipate that number going to zero? When you’ve completely just gone ex-legacy?
John W. Gamble
Well, effectively what we’re down to now is we are talking about consumer supplies, because consumer hardware, we’re out of consumer hardware and that’s legacy. So we’re talking about consumer supplies and they have been declining in the neighborhood of 35% per year.
So that’s kind of what the tail is going to look like. I think, again, we have a chart in the slide deck, which shows the overhang that occurs over the next couple of years. But you’d probably think of it in the neighborhood of 35% reduction in that revenue per year. The good new is it’s becoming as a percentage of our total revenues. You just coded a relatively small percentage.
So in terms of the rest of the business, the core business, which has generally been growing relatively well and the software business, as those things perform and presume they continue to perform well then it should be much easier to offset that 35% reduction in the legacy business, but it’s probably going to fall somewhere between 30% and 40% a year, difficult to predict exactly how much, but it’s becoming relatively small and 30% to 40% to [46%] is not that big a number anymore. So we think we are getting to point where we should be able to manage that within the overall [percentage].
Mark Moskowitz – JPMorgan Chase & Co.
All right. We’re out of time. So thanks again, John Gamble, CFO of Lexmark.
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