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Lexmark’s Q4 financial results hold more despair but a degree of hope

Issue #0804/1 – Still heading downwards on a slippery slope, Lexmark’s latest financial results show exactly why the company’s strategy needed modifying, suggesting that further action is needed and that there may be some way to go before anyone sees an overall upturn, despite record results in some areas.

Quarter 4 of 2007 saw yet another reduction in revenue for Lexmark, 4% overall, with some high points but more low points than high. The quarter was effectively the worst of the year, as evidenced by the full year revenue reduction of only 3%. All other segment results showed a similar trend. For instance: business segment revenue for the year grew by 5% but Q4 growth was only 4%; and, consumer revenues fell 12% over the whole year but by 15% in Q4.

As the low-point of the report, consumer inkjet hardware sales continue to slump. The decline was 18% from 2006 to 2007 and totals more than 34% over two years. Given a further four years at the current rate of decline and Lexmark would have no customers for its inkjet devices!

Not all inkjet devices are suffering in this way though. High-end All-in-One machines – i.e., those that are of interest to business users – have seen a growth in unit sales of 12%. For this segment on its own, this is a very healthy growth.

Again, low-end single-function laser printers are in decline while sales of laser multi-function devices grow.

Revenue by Business Category

Lexmark – Q4, 2007 vs Q4, 2006

Quite clearly, this indicates that buyers are disenchanted with the cheap Lexmark hardware that the company has foisted onto its customers over the past decade. Just as important, results over the past year or so have shown that supplies sales have been suffering a severe downturn despite increasing hardware sales, indicating that owners are not using the hardware they have acquired – almost certainly because the supplies are too expensive, making the printers too costly to run even though they were dirt cheap to buy.

Thankfully, it looks as though Lexmark may finally have recognised this fact and, also, that buyers are more likely to be attracted to quality hardware at the right price rather than any hardware at the lowest price.

Again, this is evidenced by the booming business segment. A record $800m revenue was posted for Q4 – an increase of 4% over Q4 of 2006 – based on healthy sales of laser supplies even though sales of those low-end machines were in serious decline. Total laser hardware unit sales fell by 5% but the focus on removing cheap machines from the equation meant that average unit sale price rose by 2% as customers bought higher-end machines.

This means more money for fewer sales and – more significantly – sales into business environments where page volumes are higher, thus driving supplies sales and contributing towards a 3% increase in revenue from supplies.

By contrast, the consumer segment is effectively dying on its feet with Q4 revenues amounting to only a fraction over $500m, representing a huge decline of 15%, based on a decline in unit sales as high as 40%.

As indicated, it is the low-end units that are disappearing, with the higher value, business-oriented models attempting to take up the slack. Indeed, average unit sales price on inkjet units rose by an impressive 12%, indicating that the company’s shifting strategy to focus on higher value sales into higher print volume environments is paying dividends.

Geographically, there are major differences in performance as well. Although Europe is a major market for Lexmark, bringing in 36% of the global revenue, Q4 saw an unhealthy 7% revenue decline while the revenue decline in the Americas and the rest of the world was only 3%.

Whereas the Q4 result from Europe is much worse than the result for the whole year, a revenue decline of just 1%, in the Americas the whole year decline was 5%, showing that there was a slight improvement towards the end of the year.

In its statement, Lexmark claims that, “Overall our financial position remains strong, and in 2007 we continued to generate strong cash flow from the on-going sales of our aftermarket supplies.”

Following some disastrous results over the past couple of years, notably involving supplies revenue that has been reluctant to grow even in an environment of hardware unit growth, Lexmark’s primary message to investors is that it is to focus on capturing supplies in high page-growth segments of the market – and capturing them profitably.

This is certainly the only route to survival. In the past year or so Lexmark has, at least, gone from a position of negative supplies revenue growth on positive hardware unit growth to one of modestly positive supplies revenue growth on negative hardware unit growth, thus putting the company in a much stronger position for revenue growth in the future.

Now the company has to achieve hardware unit growth based on its new target markets. This is primarily the business market with “higher page-generating workgroup class lasers”, together with “geographic regions, product segments, and customers that generate higher page usage” in the inkjet market.

This retargeting of its inkjet market comes in the face of inkjet hardware sales that are not meeting expectations. However, Lexmark finally seems to have discovered that not pricing the hardware quite so aggressively, and finding ways to reduce operating costs, is having some benefit on product margins as well as average unit selling prices.

What we should certainly expect to see is a decrease in the volume of unit sales while this transition occurs.

So, Lexmark needs not just to focus on business customers and higher volume printing environments but probably needs to cull its product line and cut out the dead wood at the bottom end of the market.

Xerox pulled out of the consumer inkjet market completely in 2001 at a time of dire distress. For the company, it was the best decision it could have made because it allowed resources to be focused on business areas with real revenue potential rather than on product development and production of products that could never command high revenues on the aftermarket.

For too long, Lexmark has put too much emphasis on the bottom end of the market, aiming to sell as many units as possible at as low a price as possible. Cheap low-end products with poor build quality over the years have decimated Lexmark’s standing in the market.

Could the latest round of financial results be a sign that buyers are becoming more discerning and canny in their purchase decisions, with a lower emphasis on the ‘ultimate low cost purchase’?

If this is the case, Lexmark has to act very rapidly to stop the rot in the hope that existing customers can be persuaded to continue buying Lexmark, preferably higher up the range, and potential new customers will be attracted by the right hardware at the right price with the right value proposition.

There would seem to be two keys to the success of this strategy.

Firstly, Lexmark must re-establish itself as a serious business contender, capturing pages not customers. Ten high volume large businesses are worth a hundred low-volume small businesses or a thousand homes.

Secondly, the products have to be able to sell themselves on the basis of quality and value. There needs to be clear differentiation between members of the product line-up and between different classifications of the same products.

Looking at the inkjet line-up in particular, there are far too many products with far too little differentiation. In addition, Lexmark’s new ‘Professional Series’ or ‘Business Editions’ do not display enough marketing differentiation from the standard inkjet range.

Wireless capability seems to be working well for Lexmark. There are few products on the market with this feature but it is a major attraction for small businesses and home offices where wireless networking can be very attractive because of the ease with which a network can be established without the need for unsightly cabling and expensive installation.

For Lexmark, 60% of its revenue comes from the business environment and this is where the true potential lies. This is emphasised by the reported Operating Income (GAAP) for Q4. Whereas there was a 6% growth in the business segment, there was a 26% decline in consumer segment. The situation was even worse for the full year – although Operating Income in the business sector showed growth of 2%, in the consumer sector the decline was a disastrous -62%.

Not to put too fine a point on it, Lexmark must fight hard for the business segment, separating out consumer inkjet, as a segment, from business inkjet as a separate segment. If Lexmark is to survive at all, it has to focus on what it is apparently good at, shed its consumer business and turn away from the low-end, non-business consumer – i.e. drop all the cheap products and focus on value.

If Lexmark is not prepared to do this, the best solution would probably be to sell the whole inkjet business to Dell, Lexmark’s major inkjet OEM customer, and focus on the laser market alone.

However, to tackle high-volume corporate customers head on and truly capture pages, Lexmark will need strong print management skills.

Looking to the future, Lexmark indicates that it is still expecting revenue to reduce in the coming months and continues to take restructuring costs and expenses as a charge in the accounts. This is inevitable until the new product strategy reaches maturity. Then Lexmark will be able to build for the long-term on a solid foundation.

As an early stage in the product shake-up, Lexmark introduced several new products in January. These comprise the new range of ‘Professional Series’ (US) or ‘Business Edition’ (Europe) inkjet All-in-Ones and a new ‘high-performance’ colour laser All-in-One. These will be the focus of next week’s TCPglobal.

Lexmark Business Club

In addition, Lexmark Europe has taken the business initiative a step further and launched a ‘Business Club’, which buyers of Business Edition products can register for – again, please see the following article for more detail.

So far, financial markets seem to have responded positively to the new product range and the possible brighter prospects for Lexmark. The company’s share price has risen by about 35% in less than 2 weeks following a 12-month slide from December 2006 that wiped around 62% off the value of the company.

It is unbelievable that Lexmark has taken this long to realise the errors of its ways. The company has been largely responsible for the scale of the price erosion across the printer industry, and therefore a degree of the pain that the industry has experienced, over the last decade or so.