Lexmark International Management Discusses Q4 2013 Results - Earnings Call Transcript

Jan. 28, 2014 11:40 AM ETLexmark International, Inc. (LXK)
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Lexmark International (NYSE:LXK) Q4 2013 Earnings Call January 28, 2014 8:30 AM ET


John Morgan

Paul A. Rooke - Chairman, Chief Executive Officer and Chairman of Executive Committee

John W. Gamble - Chief Financial Officer, Principal Accounting Officer and Executive Vice President


Jim Suva - Citigroup Inc, Research Division

A.M. Sacconaghi - Sanford C. Bernstein & Co., LLC., Research Division

Brian G. Alexander - Raymond James & Associates, Inc., Research Division

Shannon S. Cross - Cross Research LLC

Benjamin A. Reitzes - Barclays Capital, Research Division

Kulbinder Garcha - Crédit Suisse AG, Research Division

Ananda Baruah - Brean Capital LLC, Research Division

Kathryn L. Huberty - Morgan Stanley, Research Division

Benjamin James Bollin - Cleveland Research Company


Thank you for standing by, and welcome to the Lexmark International Fourth Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded on Tuesday, January 28, 2014. I would now like to turn the call over to John Morgan, Lexmark's Director of Investor Relations. Please go ahead, John.

John Morgan

Good morning, and thank you for joining us. Chairman and CEO, Paul Rooke; and EVP and CFO, John Gamble, are with me this morning. After their prepared remarks, we'll open the call for your questions as time permits.

Our fourth quarter earnings release and earnings presentation were posted to our Investor Relations website located at investor.lexmark.com earlier this morning. As with our prior calls, we will be referring to specific slide numbers from this earnings presentation deck, again, this morning.

Also note that we will be referring to non-GAAP measures during today's presentation unless otherwise noted. Pursuant to the requirements of Regulation G, the company has provided reconciliations of GAAP to non-GAAP measures and a discussion of management's use of non-GAAP measures in the Reconciliations section of the earnings presentation slides.

I want to call your attention to a few new items in the slide deck, which we hope you'll find useful. In the Supplemental section of the deck, we have added deferred revenue -- I'm sorry, deferred software revenue trends. This can be found on Slide 33. We have also included details on the pension accounting methodology change, showing GAAP and non-GAAP results at a segment level, under both the prior method and new method. Refer to Slides 41 through 44 in the GAAP to Non-GAAP Reconciliations sections of the deck.

Lexmark anticipates that the record date of its first quarter 2014 dividend will be March 3, with an anticipated payment date of March 14. Please note that future quarterly dividend payments are subject to board approval. We have also included our anticipated dividend schedule for 2014 and 2015 in the Supplemental section of the earnings presentation.

Following the conclusion of this conference call, a complete replay will be made available on our IR website. As a reminder, any of today's remarks that are not statements of historical fact are forward-looking statements and involve certain risks and uncertainties that are disclosed in the Safe Harbor section of our earnings releases and SEC filings. Actual results may differ materially from such statements and Lexmark undertakes no obligation to update any forward-looking statements.

With that, I'll turn it over to Paul.

Paul A. Rooke

Well, thank you, John, and good morning to everyone. As John said, we'll be using a presentation slide deck, and we'll refer to the slide numbers as we go to keep everyone on the same page. So let's begin.

Starting with Slide 4. It was a strong quarter for Lexmark, delivering overall revenue and earnings growth. Revenue, excluding Inkjet Exit, grew 11% for the quarter and 4% for the year. Gross profit, operating income and earnings per share all grew for the quarter and the year, driven by year-to-year gross profit margin improvement, solid operating expense management and lower outstanding shares from our ongoing share repurchases. Free cash flow was also very strong for the quarter and the year.

Now in the fourth quarter, we continued our progress in creating a higher value portfolio for Lexmark, driving strong double-digit revenue growth and record revenue for both high-value areas of Managed Print Services and Perceptive Software.

We also delivered record Laser Supplies revenue with the growth of 8% in the fourth quarter and 2% for the year. We continued working to increase our profitability, and we remain committed to our long-term operating margin assumption of 11% to 13%.

We delivered strong year-to-year improvement in Perceptive Software's profitability for the quarter and the year, and we expect continued Perceptive Software operating margin expansion in 2014 and beyond.

We delivered annual savings of $85 million in 2013 from the restructuring action we announced in 2012, and expect to deliver $110 million in annual savings in 2014, increasing to $140 million in 2015.

Finally, we continue to maintain our capital allocation discipline to deliver shareholder value. Our focus is squarely on the needs of business customers as we build and grow our solutions business through our organic expansion and acquisitions, where we have grown our strategic software capabilities significantly in both breadth and depth since 2010, having announced 5 more acquisitions in 2013.

We remain committed to returning greater than 50% of our free cash flow to shareholders through dividends and share repurchases on average, having returned $157 million in 2013 and more than $675 million since July of 2011.

Now on Slide 5, you can see the fourth quarter financial highlights. Revenue for the fourth quarter was $1.01 billion, up 4% year-to-year. Excluding Inkjet Exit revenue, revenue grew 11% year-to-year, driven by record Perceptive Software revenue with total growth at 70% and strong organic growth of 15%, record Managed Print Services revenue with strong growth of 22% and record laser supplies revenue with growth of 8%.

With the strong revenue growth from our high-value areas, we more than offset the headwinds of a continued weak economic environment and the planned ongoing decline from the Inkjet Exit, resulting in the 4% overall revenue growth for the fourth quarter.

We also delivered strong operating income improvement in the fourth quarter, up $31 million year-to-year, and an operating margin of 11.1% for the fourth quarter. Now this was driven by strong growth in the high-value segments with a solid gross profit margin, along with good cost and expense management.

Operating expense was up sequentially and year-to-year for the fourth quarter, driven primarily by increased software investments from our recent acquisitions to drive future growth and increased compensation expense from the improved results.

In addition, operating expense in the fourth quarter reflects an increased legal accrual in the amount of $13 million. This was partially offset by expense reductions in ISS, including benefits of the previously announced actions to improve our cost and expense structure in 2013 and beyond. As a result, operating income was up significantly year-to-year, reflecting ISS and Perceptive Software improvements of $41 million and $9 million, respectively.

Now as I mentioned, Perceptive Software, again, delivered significant year-to-year improvement in profitability this quarter, up $9 million, driven by the 2 factors we've been focused on. First, we delivered solid Perceptive Software growth year-to-year, including good license revenue growth. This increased license revenue contributed to a year-to-year gross profit margin increase. Second, with the actions we started to take last year, we've been able to reduce Perceptive Software's organic cost and expense growth without negatively impacting revenue growth. And for the full year 2014, we expect to achieve double-digit software revenue growth and remain committed to delivering a positive and expanded software operating income margin.

Finally, for the fourth quarter, earnings per share were $1.18, up significantly year-to-year, and we generated strong free cash flow of $164 million.

Now moving to Slide 6. You can see how the composition of our revenue continues to shift as we evolve to an imaging and software solutions company. On the left, you'll see the 3 sections we've been reporting. The Inkjet Exit section, the gray part, is the revenue comprised of the past Consumer & Business Inkjet segments that we've exited. Inkjet Exit revenue is expected to decline over time at a rate of over 40% year-to-year as the trailing supplies revenue from the installed base naturally decreases.

Now the Imaging Solutions section, the purple part, is comprised of both MPS and non-MPS revenue. The MPS part is our Enterprise Managed Print Services revenue and the non-MPS portion includes revenue that flows through our partners, some of which flows through our transactional partners and some of which flows through copier dealers that are managing fleets of our devices as a service. And then the third section, the blue part, is the Perceptive Software revenue.

Now combining the Imaging Solutions and Perceptive Software revenue, the purple and the blue sections together, this represented 90% of our total fourth quarter revenue and will continue to grow as a percentage of our total revenue as the Inkjet Exit revenue declines over time. And for the fourth quarter, Imaging Solutions and Perceptive Software revenue on a combined basis grew 11%, driven by strong double-digit growth in both MPS and Perceptive Software revenue.

Now combining the MPS and the Perceptive Software revenue, only the bottom 2 sections, representing higher value add, longer-term solutions relationships with customers, this combined software and services business grew 32% in the fourth quarter.

I would note that MPS and software markets are growing and our growth is well in excess of the market, indicating our value propositions and our ability to execute them is resonating with our customers. Additionally, we expect that as our software revenue grows and the margins expand here, this will be a significant driver of future profitability.

Now on Slide 7, you can see how our recent actions fit into the larger strategy we're driving, the driver strategy of becoming an end-to-end solutions provider. We've been making a number of key investments over time.

First, we continue to invest in Smart MFP and Managed Print Service solutions, including a global, enterprise-focused sales force, along with best-in-class global infrastructure and systems to support our MPS customers. Second, we've been aggressively investing in software solutions through acquisitions from our initial acquisition of Perceptive Software in June 2010 to our most recent acquisition of PACSGEAR last quarter. And finally, we completed the exit of the Inkjet business with the sale last year. These actions have all been taken with the end in mind of becoming a world-class end-to-end solutions provider.

Now on Slide 8, here's a brief summary as -- this is a reminder of where we're headed strategically, our unique value proposition and what we're doing to accelerate our growth and transition into becoming a world-class end-to-end solutions provider.

So starting at the top. We're rapidly becoming a broader provider of unstructured information solutions, focused on helping customers capture and connect their unstructured information to their core systems and applications, building on our core strength of output management technology.

We've quickly added a broad portfolio of content and process management technologies that together comprise the key technologies to solve our customers' unstructured information challenges. We now have the ability to help our customers capture, manage and access a broad range of unstructured content, documents, images, video, audio, across a broad range of industry segments.

Now moving to the lower left block. We went through a unique customer value proposition that combines technology ownership, deeper industry experience and superior customer intimacy. Together, these enable us to listen more closely and act more responsibly with industry-specific solutions through our customers' unstructured information challenges.

Finally, in the lower right box, we're accelerating our growth with the synergies we're creating between the Imaging Solutions and Perceptive Software units. The Imaging Solutions unit is leveraging its global large account presence, MPS leadership, industry expertise and global infrastructure to open doors and grow our Perceptive Software Solutions more quickly, deepening Lexmark's overall penetration into these accounts. And these are general accounts that have been with Lexmark for a number of years and have come to trust us to deliver productivity gains and savings for them, and they're counting on us to bring them additional productivity gains and savings.

So similarly, Perceptive Software is expanding software capabilities and industry presence in health care, higher education, back office operations. It's further differentiating and growing our Managed Print solutions quicker, also deepening our penetration in these accounts.

Now as proof of these synergies, we're winning software solution deals and ISS accounts across a range of industry segments. In fact, for 2013, we won over 40 new capture, content and process software deals across a range of ISS retail, manufacturing, banking and insurance, government, health care and education accounts and our sales funnel continues to strengthen.

We're also beginning to see the reverse happen as well, where ISS is capturing MPS deals in Perceptive Software and health care accounts. In fact, our MPS and Perceptive Software revenues each grew double digits again this quarter, well in excess of market growth rates and on a combined basis, grew 32%. As we expand our solutions offerings and build more customer references, we expect these synergies to continue to grow.

Moving to Slide 9. Our award-winning A4 laser technology is a key component of our unique value proposition. You can see our unit share position in the high-usage, large workgroup segment for A4 or letter-sized format lasers. These large workgroup A4 laser devices are increasingly displacing the larger A3 or 11 x 17 format copiers due to their smaller size, lower cost and improved functionality.

According to IDC, for the last 4 quarters ending third quarter of '13, Lexmark continued to hold its position in this large workgroup A4 laser segment. This is important since these are higher-usage devices which drive Supplies revenue.

And in Slide 10, Lexmark continues to be recognized as a leader in our key focus areas of output management and content and process management. Recently, Gartner again recognized us as a Managed Print Services leader, and IDC recognized us as a smart MFP leader. These MPS and MFP accolades showcase our leadership position, driven by our world-class Smart MFPs, the seamless integration with Perceptive Software's growing array of solutions and the world-class MPS capabilities we've built and refined over the past 15 years.

As proof of this leadership position, within the last 24 months, we've competed for and won 23 new management services contracts with companies listed on either the Global 500 or Fortune 500, which represent incremental business to Lexmark.

In addition, as we continue to bring savings and value to our customers, our renewal rate for our Managed Print Services customers was 100% in 2013, and our overall Managed Print Services revenue set another record and grew again by double digits in the fourth quarter. We continue to believe this is a clear indicator that our value proposition resonates strongly and continues to be differentiating with these large discriminating customers.

We also continue to gain accolades in the content and process management space. The synergies Lexmark is bringing to accelerate Perceptive Software's R&D and sales capabilities through our organic investments and acquisition is certainly contributing to this. And as we've stated before, Perceptive Software's content management, combined with VNA or vendor neutral archiving solutions from the Acuo acquisition and connectivity solutions from PACSGEAR, are contributing to our growing recognition as a health care content software leader. And as proof of this leadership position, our overall software revenue set another record and grew again by double digits in the fourth quarter.

So as I reflect back on 2013, we've taken a lot of key actions to accelerate our progress. We've sharpened our solutions focus with the sale of our Inkjet technology in addition of 5 new acquisitions. Internally, we've integrated our solutions and marketing teams to accelerate new solutions discovery and development, as well as our solutions selling efforts, and we'll soon complete our transition to single instance, global IT systems that will help integrate and accelerate solutions development and sales initiatives across the company.

We've also invested in our hardware, software services platforms to strengthen our solutions of value proposition. And our health care proposition, for example, has been strengthened considerably this year with the addition of the Acuo and PACSGEAR acquisitions to our core content and process capabilities, broadening our ability to capture and manage a broad spectrum of unstructured health care content, documents, video, audio, enabling clinicians to now view a complete patient electronic medical record.

We've also accelerated the development of a powerful new software platform, integrating all of the capabilities we've assembled today and capable of operating on-premise, in the cloud or both. And we're seeing the results of these actions externally. Our Software business is growing rapidly and improving its profitability, making good progress towards our goal of $500 million of annual software revenue by 2016 with software industry-like margins.

Our MPS business is growing faster than the market with industry-leading customer retention rates. And combined, our software and MPS revenues are expected to exceed $1 billion in 2014. We're also now recognized as a leader by Gartner in the key hardware segments of MPS and Smart MFPs, as well as the software segment of enterprise content management.

And while we're pleased with this progress, we have more to do. The Lexmark team remains focused on our customers and our execution of the strategy, and we're excited about leveraging our new capabilities to grow our current customers and win new ones.

Now just as a reminder, on Slide 11, Lexmark's overall capital allocation framework is to return more than 50% of free cash flow to shareholders on average through quarterly dividends and share repurchases while pursuing acquisitions and organic growth that support the strengthening and growth of the company.

In the fourth quarter, Lexmark paid a dividend of $0.30 per share, totaling $19 million, our ninth consecutive quarterly dividend payment, and repurchased $20 million of stock. Since mid-2011, Lexmark has returned more than $675 million to shareholders through quarterly dividends and share repurchases. And for the first quarter, we are planning to continue share repurchases and paying a quarterly dividend.

On Slide 12, you can see our longer-term revenue growth assumptions. Earlier, I discussed how we're creating synergies between the Imaging Solutions unit and the Perceptive Software unit to grow each faster. Based on these synergies, we expect to grow the Imaging Solutions revenue greater than or equal to the market, leveraging the differentiation obtained through Perceptive Software Solutions portfolio, along with the industry growth trends towards MPS and workflow solutions.

Similarly, we except to grow Perceptive Software revenue greater than the market, leveraging the expanded reach through Lexmark's worldwide large account presence and relationships and continued investment in software development, marketing and sales.

And while the Inkjet Exit is currently a large headwind, it is a declining headwind, and we expect it to be less than $100 million annually by 2015. Therefore, as we grow Imaging Solutions and Perceptive Software together against the declining Inkjet headwind, the underlying revenue growth will emerge.

So moving to Slide 13. You can see our revenue guidance for full year 2014. It reflects a similar overall 3% to 5% decline, driven by similar segment dynamics.

For the Inkjet Exit revenue portion, the gray part, we're continuing to assume an accelerated decline of over 40% and expect this portion to be about 6% of total revenue for the year.

For the strategic Imaging and Software Solutions revenue portion, the purple and blue parts together, we're assuming this to be up slightly, driven by combined MPS and Perceptive Software growth of about 15%, with MPS being less than 15% and Perceptive Software being greater than 15%.

And like 2013, we're focused in 2014 on revenue and profit growth from the strategic imaging and software segments of our business, particularly MPS and Perceptive Software. And while this growth will be dampened by the remaining Inkjet Exit headwind in 2014, this headwind will decline over time. What's important is the underlying business we're building for the future once the Inkjet headwind has gone.

So looking ahead, on Slide 14, you can see our first quarter full year 2014 and long-term outlooks. For the first quarter, outlooks for revenue will be down 3% to 5% year-to-year. Excluding Inkjet, we expect revenue to grow slightly for the first quarter. We expect earnings per share for the first quarter to be in the range of $0.80 to $0.90 per share.

For the full year 2014, our outlook is for overall revenue to be down 3% to 5% year-to-year, with revenue excluding Inkjet Exit to be up slightly. We expect earnings per share for the full year to be in the range of $3.80 to $4 per share. Long-term, our outlook is to grow revenue at or above the market with an operating margin in the range of 11% to 13%.

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

John W. Gamble

Thank you, Paul, and good morning. As John indicated earlier, the discussion that follows is on a non-GAAP basis and reflects non-GAAP adjustments unless otherwise noted.

As shown on Slide 16, 4Q '13 EPS of $1.18 was above our guidance range and substantially above 4Q '12. For our press release issued on January 7, 2014, we disclosed 2 events impacting 4Q '13 that were not included in our guidance that combine to negatively impact our results by $0.05 per share. The change in pension accounting methodology possibly impacted 4Q '13 EPS by $0.08 and calendar year 2013 EPS by $0.32. A legal accrual regarding California wage and our practices negatively impacted 4Q '13 and calendar year '13 by $0.13 per share.

Operationally, our performance versus our expectations in 4Q '12 was very strong. Total revenue grew 4%, well above expectations. ISS performance was extremely strong, with 1% overall revenue growth, driven by 8% growth in laser.

We also saw improved product margins. Operating margin of 21% in ISS was well above expectation than last year. Perceptive Software revenue grew 70% with organic revenue growth of 15%. Perceptive was profitable for the third quarter in a row and substantially improved profitability versus 4Q '12.

Below operating income, the effective tax rate of 27.4% was below our guidance rate of 30%, reflecting discrete tax items and substantially below 4Q '12. EPS also benefited versus 4Q '12 from ongoing share repurchases.

As mentioned earlier, the change in pension accounting reduced 2013 and 2012 cost and expenses versus the prior method by $0.32 per share and $0.27 per share, respectively. In 2014, the benefit from the pension accounting change versus the prior method is expected to be somewhat less at about $0.20 per share. All historical periods referenced in this presentation have been recast for the accounting change.

Turning to Slide 17. For calendar year 2013, our financial performance was very strong versus 2012 and the guidance we provided in January 2013 for a revenue decline of 8% to 10% and EPS of $3.90 to $4.10. Revenue in 2013 declined 3% year-to-year. Excluding Inkjet, revenue grew 4% with Laser revenue up 1% and Perceptive Software up 48% for the year. EPS of $4.19 was up 11% from 2012.

Operationally, both ISS and Perceptive Software showed improved income year-to-year. ISS delivered higher operating income, up $7 million, despite the decline in Inkjet Exit revenue. This was driven by cost and expense reductions executed in 2012 and 2013 and growth in ISS supplies, software and service. Perceptive Software had a slight operating loss of $2 million, an improvement of $23 million versus 2012. We expect continued substantial improvement in Perceptive Software operating income in 2014.

2013 EPS did include the net $0.19 per share benefit related to the net impact of the pension accounting change and legal accrual that I referenced earlier. Below operating income, a lower effective tax rate in 2013, primarily reflecting discrete tax items and lower shares outstanding, also drove improved EPS. Free cash flow in 4Q '13 and for calendar year 2013 of $164 million and $308 million were also extremely strong, up 63% and 23%, respectively.

Skipping ahead to Slide 19. In 4Q 2013, we had growth across all strategic revenue categories. We saw a revenue and unit growth across laser large and small workgroup hardware and revenue growth in both laser supplies and Perceptive Software. Large workgroup hardware had over 25% growth in color and about 15% growth in MFP units. Small workgroup hardware had over 10% growth in MFP units.

Laser Supplies revenue grew 8%, driven by continued strong MPS growth. In absolute terms, laser supplies channel inventories grew slightly in the quarter versus our expectation of flat. Laser supplies channel movements had a minimal impact on year-to-year revenue growth. As we look forward, we, again, expect supplies channel inventory to remain relatively flat sequentially in 1Q '14.

Geographically, in 4Q '13, excluding Inkjet Exit revenue, the U.S. grew 4%, EMEA grew 25% and all other grew 3% year-to-year. The U.S. growth is driven by Perceptive Software as weaker federal spending continues to offset strong MPS growth and ISS. EMEA growth reflects strong ISS performance, driven by MPS growth, as well as growth in Perceptive Software.

Moving to Slide 20. In calendar year 2013, large workgroup hardware revenue was flat, with 3% growth in overall units. Large workgroup represented 83% of total hardware revenue in 2013. Large workgroup MFP units grew almost 15% and color units almost 20% in 2013.

Laser Supplies revenue grew 2% in 2013, again, reflecting strong MPS growth. Laser supplies channel inventory movements had a minimal impact on year-to-year revenue growth. In absolute terms, we estimate the laser supplies channel inventory increased during 2013 to support our page growth and buying ahead of announced price increases.

Geographically, in 2013, excluding Inkjet Exit revenue, the U.S. grew 2%, EMEA grew 10% and all other declined 2%. The U.S. growth reflects growth in Perceptive Software, partially offset by declines in ISS due to weak spending in the federal government. EMEA grew, reflecting strength in all revenue segments.

In 4Q and full year 2013, the impact of currency movements on revenue were negligible. As shown on Slide 21, gross profit margin expanded in both 4Q '13 and calendar year 2013, reflecting our continued improvement in product mix toward more software and laser supplies. In 4Q '13, gross profit margin increased 520 basis points year-to-year and 40 basis points sequentially.

The increase year-to-year was driven by 300 basis points of positive product mix, reflecting relatively less inkjet hardware and more software and laser supplies, and 220 basis points of positive product margins, principally in laser hardware. The increase sequentially was driven by 190 basis points of positive product margins, principally laser hardware, partially offset by 150 basis points of negative mix, principally less supplies relative to hardware.

In calendar year 2013, gross profit margin increased 160 basis points year-to-year, driven by 290 basis points of positive product mix, reflecting relatively less Inkjet hardware and more software and laser supplies, partially offset by 130 basis points of negative product margins. Perceptive Software's gross margins improved year-to-year for both 4Q '13 and calendar year 2013, principally due to an improved mix of high margin license and subscriptions revenue.

Turning to Slide 22. Operating expense increased year-to-year in 4Q '13 and calendar year 2013. Factors increasing operating expense in both periods were principally the same: In all operating units, increased employee variable compensation expenses, including sales commissions, driven by strong financial performance in 4Q '13 and the calendar year; in all other, the legal accrual referenced earlier; and at Perceptive Software, the impact of acquisitions completed in 2013; and the increased employee variable compensation, including commissions and legal accrual combined represented almost 90% of the increase in year-to-year operating expense.

For calendar year 2013, operating expense was down at ISS as the sale of Inkjet technology and related development resources in late 2012, as well as the impact of further expense actions, resulted in a reduction in ISS operating expense.

As shown on Slide 23, 4Q '13 and calendar year 2013 operating income both improved year-to-year, up $31 million and $2 million, respectively. For both periods, increased operating income at both ISS and Perceptive Software were partially offset by higher all other cost and expense.

ISS segment 4Q '13 operating income increased $41 million year-to-year, reflecting improved laser profitability, driven by growth in laser supplies due to continued strong MPS growth and reduced operating expenses. Calendar year 2013 ISS operating income was up slightly as improved laser profitability, principally reflecting lower operating expenses, were offset by reductions from Inkjet Exit.

Perceptive Software operating income was positive in 4Q '13 for the third consecutive quarter. Perceptive Software continues to deliver above-market revenue growth and improved gross margins, while the actions taken in 2Q '13 and 3Q '13 have reduced cost and expense growth. Calendar year 2013 Perceptive Software operating income improved $23 million and was slightly below breakeven.

All other cost and expenses increased year-to-year in both 4Q '13 and calendar year 2013. These cost and expense increases principally reflect the legal accrual reference at the beginning of my presentation, increases in variable and equity compensation, reflecting the strong 4Q '13 and calendar year '13 results, and FX losses, principally transaction losses in Argentina and Brazil and other emerging market countries. These cost and expense increases more than offset reductions implemented as part of the August 2012 restructuring program.

Turning to Slide 24. Net income and earnings per share increased year-to-year for both 4Q 2013 and calendar year 2013. The increases in both periods reflect improved operating income, lower shares outstanding from ongoing share repurchases and a lower tax rate.

Turning to Slide 25. Cash from operations and free cash flow in 4Q were very strong, $205 million and $164 million, respectively. Strong 4Q performance included excellent receivables performance, driven by shipments occurring earlier in the quarter and collection process improvements and outstanding inventory management.

Full year free cash flow of $308 million, representing 115% of non-GAAP net income, was better than our expectation. We maintain a strong liquidity position with $1,055,000,000 of cash, along with other significant sources of liquidity. U.S. cash at 12/31/13 was $40 million. Cash conversion days were exceptional with a net 7-day improvement year-to-year. Receivables days improved sequentially, driven by revenue, timing and strong collections, especially in EMEA.

The sequential decrease in inventory days was driven by strong ISS revenue and very good inventory management. Payables days decreased sequentially, driven by reduced year-end purchasing activity as we closed our major product facilities for the holiday season.

The 4Q cash conversion days were exceptional. However, we do not believe we can maintain this level of performance in 1Q '14. We expect cash conversion to remain very good in 1Q '14, but to likely move toward more typical levels. Both receivables and inventory in 4Q '13 were helped by the holiday season as customers ordered and took delivery of product earlier in the quarter, allowing for improved receivables collections and better inventory management.

Although this occurs each year in the fourth quarter, this year was exceptional. The expected negative working capital impact in 1Q '14, as well as large annual payments for employee incentive compensation, the anticipated payment of the legal matter discussed earlier and other items is expected to result in our free cash flow being negative in 1Q '14.

Slide 26 provides a summary of the historical and expected cost and savings from our August 2012 restructuring program. We continue to take actions to improve our cost structure and offset the lost income from declining Inkjet Exit revenue. As a result, our program cost and savings from the August 2012 restructuring programs have increased. We now expect restructuring actions for this program to be $200 million, up from the previously indicated $170 million. We also expect the savings in 2014 to be $110 million and the annual ongoing savings in 2015 and beyond to increase by $35 million to $140 million.

As part of the change in pension accounting, we now exclude pension mark-to-market, as well as acquisition divestiture-related and restructuring-related amounts from non-GAAP net income. Pages 48 and 49 of the earnings slide deck provide a detailed bridge of GAAP to non-GAAP for 2013 versus 2012 and 4Q '13 versus 4Q '12. There was a substantial pension mark-to-market gain in 2013 and loss in 2012, which drove a significant portion of the difference in GAAP net income between 2013 and 2012.

Please turn to Slide 27 for my forward-looking comments for 1Q 2014. We expect first quarter 2013 revenue to decline 3% to 5% year-to-year. This guidance reflects a sequential revenue decrease of 15% to 16%, which implies a larger-than-normal sequential decline for the laser portion of the ISS business due to the exceptionally strong fourth quarter. This outlook reflects a decline in Inkjet Exit revenue of approximately 45% year-to-year, with an impact to total revenue of approximately negative 6 percentage points.

Laser plus Perceptive Software revenue is expected to show continued growth. We expect continued strong growth in MPS. Perceptive Software is expected to have strong revenue growth and be profitable in 1Q '14. GAAP EPS in 1Q 2014 is expected to be $0.31 to $0.41 per share. GAAP EPS in 1Q 2013 was $0.62, which included the benefit of a low tax rate, driven in part by the recognition of the 2012 U.S. R&D credit benefit in 1Q '13. In 1Q 2014, non-GAAP adjustments made up of restructuring expense and acquisition-related items were expected to yield a net cost of $0.49 per share. This includes restructuring cost of $0.19 per share and an estimated $0.30 per share from acquisition and divestiture-related cost and expense.

Non-GAAP EPS is expected to be $0.80 to $0.90 per share. Non-GAAP EPS in 1Q 2013 was $0.95, which included a U.S. R&D tax credit benefit of approximately $0.09 per share, which I will describe more fully in a moment. In 1Q '14, we expect gross profit margin percentage to be up year-to-year, operating expense dollars to increase slightly year-to-year, and operating income margin percentage is expected to increase year-to-year. We expect the effective tax rate for calendar year '14 to be 29%, slightly below the ongoing rate we had in 2013, reflecting expected improved performance and income outside the U.S. and Perceptive Software. This rate assumes the U.S. R&D tax credit will be passed in 2014. If the U.S. R&D tax credit does not pass, our 2014 tax rate will be approximately 31.5%. The increase in the 2014 tax rate from the 26.4% effective rate in 2013 primarily reflects positive discrete items incurred in 2013 such as the 2012 U.S. R&E tax credit that was reflected in 2013 results due to the delay in its passage. The effective tax rate for 1Q '14 is assumed to be 31.5% as we cannot assume in our tax accrual the passage of the U.S. R&E tax credit until it occurs. 1Q 2014 free cash flow is expected to be negative as discussed earlier.

On Slide 28, we provide key bridge items from our 1Q 2013 non-GAAP EPS of $0.95 to the midpoint of our 1Q 2014 guidance range. Operationally, we expect similar operating income performance to 1Q '13 as improvements in laser profitability and at Perceptive Software offset the negative impact of declines in Inkjet Exit revenue and income. Items below operating income are driving the reduction in EPS year-to-year.

The higher effective tax rate in 1Q '14 more than explains the decrease in EPS. Our 1Q '13 effective tax rate was low as it reflected both the 2012 U.S. R&E tax credit, which was passed retroactively in January 2013, and the pro rata share of the 2013 U.S. R&E tax credit. We do expect a small benefit to EPS from our ongoing share repurchases. Our expectations for the 2014 calendar year are shown on Slide 29. We expect revenue to decline 3% to 5% versus 2013. Inkjet revenue is expected to decline over 40% from the $405 million we had in 2013. This results in an approximately negative 5 percentage point impact on year-to-year total revenue in 2014. Overall, for 2014, inkjet revenue should be about 6% of total revenue. Total laser plus Perceptive Software revenue is expected to be flat to up 2% in 2014. Combined MPS and Perceptive Software revenue is expected to exceed $1 billion, growing over 15% with MPS growing less than 15% and Perceptive Software greater than 15%. Non-GAAP EPS is expected to be $3.80 to $4 per share, reflecting operating margins at the low end of our 11% to 13% target. I'll discuss EPS in more detail on our next slide.

As shown on Slide 30, the midpoint of our EPS expectation for 2014 of $3.90 is down approximately $0.30 or 7% from 2013. This decline reflects 2 main factors: below operating income, about negative $0.10 per share from the net negative impact of unexpected increase in our tax rate, partially offset by our ongoing share repurchase activity; operationally, negative about $0.20 per share, as growth and improvements in Laser and Perceptive Software offset substantial majority of the lost gross margin from the decline in inkjet supplies; specifically, in Laser, product margin improvements and OpEx reductions from the broader cost and expense reduction program discussed earlier; in Perceptive Software, both revenue growth and expanding operating margins, as we hold the growth in operating expenses substantially below the growth in revenue and gross margin; and in all other, cost and expense reductions across all groups. Of the total operating income improvements from these 3 items, Laser is expected to deliver over half the improvement, Perceptive Software about a quarter and all other, under a quarter.

Gross profit margin is expected to continue to increase in 2014. Also, operating expense dollars are expected to decrease slightly in 2014. For calendar year 2014, free cash flow will be negatively impacted by the approximately $51 million of restructuring payments. Despite this, we expect free cash flow to be at the low end of our target range of 90% to 100% of non-GAAP net income.

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

Question-and-Answer Session


[Operator Instructions] Your first question is coming from the line of Jim Suva of Citi.

Jim Suva - Citigroup Inc, Research Division

Kind of I have a big strategy question for you and then I have a follow-up financial question for you. First, on the big strategy question, can you kind of help us better understand Lexmark's go-to-market strategy and where you're seeing the most success? And maybe, what I mean by that is it certain end markets or segments or business size or geographic regions? Because it appears, looking at the data, that you're actually outgrowing Lexmark and HP -- I'm sorry, outgrowing Xerox and HP, who are larger companies, so I'm just kind of wondering about your strategy that you're going to market. Then on the financial question, if you can let us know, for your EPS outlook of $3.80 to $4, you're very clear in Q1 that it excludes the tax credit being reenacted. Am I correct that the $3.80 to $4 includes that? And then for the stock buyback, I assume you're assuming another kind of 50% of cash flow to shareholders both for dividends in the stock buyback for 2014?

Paul A. Rooke

Okay. Yes, Jim, let me take the first part, and then John will take the second part. On the go-to-market strategy, as you can see in our strategic segments there of MPS, particularly, Perceptive Software, we're very focused on the enterprise segment, not excluding the small and medium business, but a lot of our growth is coming from enterprise, large account types of customers where our MPS proposition is just -- it's resonating from its global infrastructure ability to execute this across very complex, multi-country fleets of devices. And so all the things that we built over the last 15 years in terms of our fleet management software, our skills, our processes and things are just our ability to execute there, we believe, is second to none. And then later on, the additional Perceptive Software capabilities now that we're building to get us into the more content process, that combined with MPS, is really starting to resonate now with these large enterprise customers, particularly in segments within the enterprise space like healthcare. We're now, as we talked about the Acuo and PACSGEAR, I mean, the healthcare proposition is really accelerating for us. But outside of healthcare, some of these back-office processes, where we're capturing documents, unstructured documents, invoice processing, those type of things are resonating. Geographically, our business is largely North America, Europe, and so it's working there. Latin America also has been very strong for us in MPS historically and continues to be. AP is a bit underdeveloped Asia for us, but we're working to extend that strategy into Asia as we speak to grow that piece of it. So I'd say it's enterprise with particular strength in targeted segments like healthcare, and then geographically, they're our core geographies with growth now coming as we look ahead into Asia.

John W. Gamble

And to the finance questions, yes, the tax rate for the 2014 outlook was 29%, and that did include the assumption that the U.S. R&E credit would pass. If it doesn't pass, our tax rate would be about 31.5%. And then yes, we have assumed that we'll continue our capital return philosophy and return over 50% of cash flow to shareholders in 2014.


Your next question comes from Toni Sacconaghi of Sanford Bernstein.

A.M. Sacconaghi - Sanford C. Bernstein & Co., LLC., Research Division

I was wondering if you could just comment on the dynamics in the marketplace around laser. Year-over-year, laser hardware was up 7.5%. In the previous 6 quarters, it had been down year-over-year. And so maybe you can describe whether there was a change in the overall market or whether this was very strong competitive share gains or whether you just had a bunch of large deals kind of all connect this quarter. But for a business that's increasingly supposed to be stable because of the Managed Print business, such a dramatic change in year-over-year growth as well as dramatic sequential growth, it feels a little bit inconsistent with that. So if you could help define that, and I have a follow-up, please.

Paul A. Rooke

Yes. So Tony, we did see, as you say, good growth here in the fourth quarter in our Laser business, particularly, even in the Hardware segment there, we saw growth in our large workgroup, as well as small workgroup. And in the large workgroup, I would characterize it as a -- we had growth in MFPs, in color and so on, but a lot of that is driven by our MPS growth. We saw 22% in the quarter. And even the back half of '13, saw good strong growth in MPS. I mean, it averaged out 16% for the year. It was a little lighter in the first half, much stronger in the second half, as many of these large deals wins that we had earlier in the year started rolling out in the second half, and that gave us acceleration into the fourth quarter. As we look more steady-state, we don't expect 22% MPS growth going forward. But certainly, the market is growing maybe 8-ish, 8%, and so we expect to grow faster than that. And as you saw in our projections, the 15% MPS in Perceptive with MPS, a little less than 15%, but still north of, say, the market at 8%. So we think that's probably more sustainable, not the 22%, but that's what's driving a lot of that hardware growth. In SMB, we had a better performance in the small workgroup, particularly in Europe. Our MFPs grew, and we just had better execution. We're also coming off some of the retail exit compares. So that gave us a little bit of easier compare there, but nonetheless, we had good execution in our small workgroup as well.

A.M. Sacconaghi - Sanford C. Bernstein & Co., LLC., Research Division

Okay. I mean, maybe you could just clarify. So there was no dramatic change in your pipeline or backlog for your laser business or no really uniquely large deals? That was what I was trying to understand. And then, my follow-up question is similar but on the supply side. So I think you were guiding for laser supplies to be flat year-over-year. They were up about 8% year-over-year. You did mention that channel inventory grew, which you did not expect in the quarter. How much of the 8% delta or above forecast that you realized in laser supplies was due to a build in channel inventory? And how much was due to just more fundamental overage, please? So if you could follow up on the first and that one, I'd appreciate it.

Paul A. Rooke

Yes. So on the pipeline, yes, these MPS deals, they take time, anywhere from, I don't know, 1 year, 1.5 years to work through. So most of what we saw here in the second half and in the fourth quarter were deals that we won earlier in the year rolling out. So it wasn't an abrupt change in that. Like you say, it's more of these things kind of roll out over time. Now having said that, our MPS activity continues to be very good, and particularly in times like these, our MPS proposition resonates as companies continue to look to optimize this infrastructure, lower their cost and so forth. So we're seeing good activity in our MPS, but we had a particular surge here this fourth quarter from deals that we won earlier in the year. But we expect it to be -- continue to be strong as we go into 2014. I'll let John talk about our supplies there.

John W. Gamble

So in terms of laser supplies channel inventory, Toni, the increase was a little over a point in terms of growth, but the increase had occurred in period. Now year-on-year, as we said, since there was some increase in 4Q '12, there really wasn't much of effect. But if you just looked at the absolute increase in this quarter, it was just over a point.


Your next question comes from Brian Alexander of Raymond James.

Brian G. Alexander - Raymond James & Associates, Inc., Research Division

John, your long-term operating margin target of 11% to 13% that you reiterated this morning, despite the added benefit of the change in accounting for mark-to-market and then also the additional restructuring actions that you announced, can you confirm that these 2 changes would theoretically help your operating margins by over 100 basis points? And can you talk about what's changed in the core business that keeps the overall margin target intact despite these benefits?

John W. Gamble

Sure. So we indicated that the pension accounting benefit, the change in method, if you look at say '14, the benefit would be about -- would be smaller, on the order of $20 million. So net-net, the benefit of that is less than a point, probably on our ongoing or our forward-looking operating margin. But going on -- since we've been operating slightly below 11%, all the actions we've taken are getting us to the bottom end of the range, and as we move forward, we'll continue to look at that range. But we still think 11% to 13% is a good range for us to execute in. As inkjet supplies revenue declines and becomes a much smaller headwind, then we'll see that -- the real margin the business can throw up on an ongoing basis and then, obviously, we'll reevaluate at that time.

Brian G. Alexander - Raymond James & Associates, Inc., Research Division

Okay. And maybe I didn't hear correctly, but did you say that you expected to fill at least half of the inkjet profit void from the Laser business and roughly 1/4 of that from Perceptive? If I heard that correctly, my math would suggest that's at least $80 million in incremental profits that you would expect to come from the Laser business over the next few years, and that's kind of like a 15% to 20% increase in laser profits over that timeframe. So I know I threw a lot of numbers at you, but I'm just curious kind of if you can just talk about what your expectation is for laser profit growth if that statement was correct and what gives you confidence in getting there?

John W. Gamble

So what we said was that there was about -- there was net negative $0.20 impact operationally in 2014 versus 2013. And obviously, the big negative, as you indicated, is the decline in inkjet supplies. And then what we indicated is that 3 major factors, and I won't go through them again, will help us offset operationally the decline in inkjet supplies, getting us back to a negative impact of $0.20 per share. And that, yes, half of the positive effects are laser. So in terms of your absolute numbers, I can't really confirm those, but the net effect, we said, would be a negative $0.20 -- would be about a negative $0.20 in 2014 versus 2013 operationally, and -- but we are expecting very nice improvement in laser profitability there. They continue to perform well in terms of laser supplies performance. We continue do very well in MPS, and they continue to improve their cost structure. So we have every reason to believe we're going to see improved performance in terms of profitability out of the laser business, but the net effect is what we talked about earlier.


Your next question is coming from the line of Shannon Cross of Cross Research.

Shannon S. Cross - Cross Research LLC

I wanted to talk a little bit about inkjet. It was better than I think we anticipated this quarter in terms of the runoffs and better relative than the full year. So when you say 45%, I think it was decline next year. How is that sort of going to trend through the year? What confidence do you have in that number? Because obviously, where there's upside, then it helps support earnings too. So I'm just trying to figure out what sort of drove the movement back to $100 million this quarter and how we should think about it going forward.

Paul A. Rooke

So Shannon, it's a bit hard to predict. We're exiting a segment here. So we've outlooked greater than 40%, and we'll see. It was a little -- it was less than that obviously here in '13. We had a little better performance in the fourth quarter. We did take a price action effective January 1 of this year. So we had a little bit of -- a little stronger momentum there at the end of the year than normal. But overall, it's -- we think, particularly, as the base gets smaller and the increments, the declines may perhaps stay the same year-to-year, then you get these bigger percentages, so we'll see. It's -- if we do a little better, less decline, then our results will be a little better in '14. If it ends up being 45%, then you had it so...

Shannon S. Cross - Cross Research LLC

Okay. And then I'm curious on restructuring. You restructured for several years, and as Brian just was talking about and you're expecting some substantial improvement in laser, which, perhaps, lower prior incremental restructuring. So how do you think about your restructuring programs? It's obviously a significant amount of hit to your GAAP earnings versus non-GAAP, and other companies, like Xerox, just incorporate them within their ongoing results as sort of a cost of doing business. So can you talk about potential for incremental restructuring? Do you think you have your cost structure in place now in the laser side? Do you think you actually start to expand at some point? How are you sort of thinking about the printing in MPS side of the business?

John W. Gamble

Well, the comments I made in terms of significantly improved profitability reflect the restructuring actions that we've already announced, right? So in order to achieve the improved laser profitability I referenced, we don't need incremental restructuring actions. We just need to execute the things we've already announced. But on an ongoing basis, we're going to continue to tweak our cost structure to try to continue to make it better. The actions we took reflect the fact that we think there were opportunities to improve our efficiency and also quite honestly because we have a declining inkjet revenue stream and we wanted to make sure that we did everything we could to offset that decline in income. But principally speaking, the significant actions needed to restructure the printing business, which were heavily related to inkjet, are behind us, right? We've done the facilities closures. We've sold the remaining inkjet technology and facilities. So what's left is really what's core to the business, and I think, going forward, what we're talking about is just adjustments and tweaking.


Your next question is coming from the line of Ben Reitzes of Barclays.

Benjamin A. Reitzes - Barclays Capital, Research Division

I just want to talk a little bit more about Page 30 in your slides, the bridge, from 2013 to 2014. It looks like the pension benefit from the restated basis is a $0.15 hit year-over-year. So that's most of the negative $0.20, but you were able to improve your operations by $0.02 last year, and the laser growth is looking pretty good, the Supplies and Perceptive, obviously, could see better profitability. I just was hoping you could talk a little bit more about that bridge and dive into more detail. I understand there's a $0.15 hit there from that pension benefit that you got in 2014, but that $0.20 hit seems a bit dramatic when you look at the other positives, and just help us bridge a little bit better there.

John W. Gamble

Well, Ben, I think what we've done is we try to provide a relatively realistic view of what we think we can achieve going forward, right? The decline in inkjet revenue is, as you said it, 45% is relatively substantial next year. So we're taking some fairly substantial actions to offset the loss profit from that, and we think the net is about negative $0.20 per share. Is our goal to offset it? Sure, absolutely. That's our goal, but at this point in time, we think the more reasonable forecast is for us to say that there'll be probably a negative $0.20 movement there. 2014 -- 2013, we agree it was a good year, but this was kind of where we think we can get to this year -- in '14, I'm sorry.

Benjamin A. Reitzes - Barclays Capital, Research Division

Okay. But that's assuming that $110 million of restructuring savings is going to the bottom line, but you sounds like $0.26, and you still get negative $0.20.

John W. Gamble

Well, no, those savings, right, were net -- those are the savings that we're executing versus the time in which the restructuring was taken, right? So that's certainly the case, but yes, so we're reducing our expenses $110 million from the levels that we announced when we did the restructurings in 2012. So that's a multi-year reduction, and yes, that's part of what's necessary to offset the decline in the overall inkjet business, which as you know, was substantially larger in 2012 than it was in 2013 and 2014 so...

Benjamin A. Reitzes - Barclays Capital, Research Division

Right, so you get a $35 million benefit year-over-year there, but it's still going to result in the decline of $0.20, okay. All right, I just wanted to clarify that.


Your next question is coming from the line of Kulbinder Garcha of Credit Suisse.

Kulbinder Garcha - Crédit Suisse AG, Research Division

I just want to go back to the previous one, just to be very clear, the pension benefit last year in 2013 was $0.32, and this year, you're assuming, it's $0.20, and there's no litigation impact in 2014. Is that correct?

John W. Gamble

That's correct.

Kulbinder Garcha - Crédit Suisse AG, Research Division

Okay, good. And then basically, just going forward on the MPS under Perceptive growth that you guys talked about of about 15% this year, can you speak about what supports that? Is that the current backlog, the -- how the orders or how the pipeline is building? Can you speak about that, let's give us some color there? And how much of it is due to acquisitions?

Paul A. Rooke

So first of all, we don't assume acquisitions in our forward guidance there, but back to the 15%, so we've said Perceptive will grow a bit faster than 15%, MPS a little less than that. If you look at the -- first of all, just the market growth rates for MPS, like I said, they're kind of 8-ish, 8%, 8% to 10%. The software segments, similar range. We think on the MPS side, while we've been exceeding those considerably here as we talked earlier a lot in the second half because of strength in some of the large deals, we think that will maybe settle back down, but still, we're seeing good activity. We're having good success in winning these large deals so we expect that momentum to continue because what we're seeing is that our ability to execute our leadership position now, validated externally, is getting us in more deals and considered for more deals, and our ability to execute now is, particularly with the software synergies that we're bringing there, is enabling us to win more than our fair share. So that's supporting our MPS growth. On the Perceptive side, we're investing heavily in the Perceptive Software both organically, as well as for the acquisitions, and that's building some very compelling propositions in segments like we talked earlier in healthcare and beyond, and that's helped in enabling us again to get into more deals and win more than our fair share of them. We do have some -- we've given the additional visibility in our deferred software revenue there in one of the slides, as you can kind of see the backlog, if you will, of revenue there to give you some feel for that. But we see good activity in the software business, and we think that strength will continue. We've been growing organically in that range, and we expect that to continue.


Your next question is coming from the line of Ananda Baruah of Brean Capital.

Ananda Baruah - Brean Capital LLC, Research Division

I guess, just sort of a follow-up on the last -- on that one regarding Perceptive, can you talk a little bit about some of the cross-selling efforts that have come together and that you see coming together between the traditional business and Perceptive? And I guess, if you want to talk to management services in that regard as well, but just trying to get a sense of where you are with the cross-selling efforts and where you actually need to get to be able to achieve the Perceptive goals longer term. I think you said in the past that the ability of the traditional salesforce to actually sell Perceptive is key. I guess, I'd just like a clarification on that. If you could talk to some of that, and then I have a follow-up.

Paul A. Rooke

Yes, Ananda, you're right on, I mean, the -- we're spending a lot of time on our ISS salesforce in training and so forth to get them up to speed with the increasing and broadening array of software capabilities that we have. But it's a very natural discussion in many of our existing accounts, particularly MPS accounts, where we are a trusted adviser to take that MPS proposition and extend it a little further into the document workflow with some of the captured technologies that we now have as a very natural adjacency, a very natural discussion for our ISS reps. And so as they open more doors in these ISS accounts, whether it be in retail, manufacturing, banking, insurance, and so forth, working in conjunction with their Perceptive counterparts, that's a big initiative for us, and we expect to see the fruits from that. In reverse, we have some of the more Perceptive legacy accounts, if you will, particularly in healthcare and education, that we think we're beginning to see some doors open there in terms of bringing the MPS proposition into some of those software accounts. So it's working both ways, obviously, due to the size of our ISS salesforce. There'll be more of that way in terms of ISS bringing Perceptive into their accounts than the other way, but that is a key focus for us, and very active within our company.

Ananda Baruah - Brean Capital LLC, Research Division

Got it. That's very useful. And I guess, just to that end, would we not expect to see the organic revenue growth accelerate over time as the cross-selling efforts pick up? And then I just want to get a sense of what you guys see as the inquisitive landscape as you look for the next year or 2 years?

Paul A. Rooke

Yes, we'll see. I mean, our expectation is to grow faster than the market. We think with the propositions strengthening, we're investing to strengthen our differentiation versus our competitors, plus the expanded reach from the ISS salesforce. Those things combined should support growing in excess of the market rate. Relative to acquisitions, I mean, it's still a key part of our strategy and focus so we continue to look at opportunities there. And so we'll -- as we do them, we'll announce them, but it is an active part of our strategy going forward.


Your next question is coming from the line of Katy Huberty of Morgan Stanley.

Kathryn L. Huberty - Morgan Stanley, Research Division

Just 2 quick questions. First, how sustainable do you view the recovery in Europe over the last couple of quarters? And then secondly, the $140 million of cost savings starting in 2015, is that from $105 million a quarter ago? Where is the incremental savings coming from?

Paul A. Rooke

Yes, so Katy, Europe, we had a good performance there out of Europe. I think as we look at the markets headed into '14 and beyond, there's still a good bit of uncertainty out there. So we're expecting kind of more of the same in terms of sluggishness. I think we're just now -- we executed better in Europe. They're very focused, whether it'll be at those -- the levels we saw in the fourth quarter, we'll see. But they executed their MPS deals like we saw. As well, in North America, they're in a number of large deals, have won a number of large deals that they were rolling out here in the second half, and so we expect to see good MPS strength in Europe, and so we do expect that to continue. Fourth quarter was just exceptionally strong, therefore, I'll let John talk to the cost savings question.

John W. Gamble

Yes, the $140 million is versus the $105 million we've previously indicated, so it's a $35 million increase, and it's really expense reductions across kind of the gamut of the company. It's -- again, it's just improving our overall cost structure to ensure that we can deliver the level of profitability we've committed to. So it's touching most of the organizations across the company.


Our final question will be coming from the line of Ben Bollin of Cleveland Research.

Benjamin James Bollin - Cleveland Research Company

A couple of parts here, but first on Perceptive, could you comment on the margin profile of this business over time? If I recall, you've talked about some other players in the industry, and you expect to get to those type of margins. When does it scale and how do you get there? The second part, relating to MPS and Perceptive, could you comment, is there any percentage of your total revenue that does not reoccur once customers renew those deals? And then a brief follow-up.

Paul A. Rooke

Yes. So Ben, as we've said, we are driving Perceptive to an expanded margin, more software industry-like. And then with the big action we took, really starting after a period of investment ahead of revenue, we decided to slow the growth of their cost and expense. So it's still increasing, but at a much lower rate than where the revenue is. So that will naturally create margin expansion over time. So as we track to our goals in 2016, we expect that to steadily move towards kind of mid-20s, if you will, industry-like margins. Let's see, your question on the MPS and Perceptive is -- your question is related to renewing those contacts or the things that don't occur again, is that your question?

Benjamin James Bollin - Cleveland Research Company

Correct. Is there any portion of that revenue, which is essentially a start-up cost and when those customers do renew, you don't get to recognize that again? Are there any start-up costs or any portion of that revenue which does not reoccur when they renew?

Paul A. Rooke

Yes. I would say, I mean, there's always some refresh of an installed base, depending on the age of the contract. These things range from 3 to 5 years, so if it's -- if the equipment is aging, so there could be some of those costs that come back in, in terms of refreshing the install base. If they're able to continue that existing equipment, then there'll be less of that, obviously. But -- and in some of these deals, it's not only a refresh, but an expansion within the accounts. As we get into the accounts, we find opportunities to get into other areas, which is a good thing, expanding our presence in those accounts, but I think it largely depends on kind of the stage at which the hardware is at, at that point in time.

Benjamin James Bollin - Cleveland Research Company

And then a follow-up, just looking at supplies, the price actions that you've talked about, can you talk about how you feel the aggregate increase in supplies will impact total revenues in '14? Is there -- are you increasing prices 3%, 5%, 8%? How are you thinking about kind of aggregate pricing actions?

Paul A. Rooke

Yes, it's our -- about 70% of our basis is under contract, so any price actions we take, take time to actually appear, but we look at it regularly. We look at currency movements, so forth, and make decisions about when and how much to adjust our prices. So it's an ongoing thing we look at. But it's -- given the nature of our business and the amount that's really under these large MPS and other types of contracts, it's not something that you would see immediately like in 2014.


Thank you. With that, I would like to turn it back over to Paul Rooke, Lexmark's Chairman and CEO, for closing remarks. Please go ahead, Paul.

Paul A. Rooke

So in closing, it was a strong fourth quarter. Operationally, we delivered total revenue growth of 11%, excluding the inkjet exit revenue. We achieved it by delivering record MPS, record Perceptive Software and record supplies revenue. We also delivered earnings per share growth, continue to improve Perceptive Software's profitability year-to-year, and generated strong free cash flow.

So we remain confident in our strategy. We believe the investments we're making in our high usage hardware and high-value software technologies to bring new and differentiated solutions and services to market will drive long-term growth in our business, sustain margins and drive long-term value for Lexmark and our shareholders.

With that, I'll turn it back over to the operator to close out the call.


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

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