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Financial Results – Hardware and supplies sales down but positive signs for most companies

Issue #0906/1 – Financial results for the last quarter released by Hewlett-Packard this week underline the difficult times that the industry is facing during this current economic downturn. However, whereas immediate revenues are down and Lexmark’s troubles gather pace, there are clear positive signs within the industry.

It is always hardware sales that are hit hardest at a time when money is perceived to be in short supply. We are now experiencing: car sales that are down by as much as 60%; car manufacturers receiving massive loans just to survive; and banks also receiving billions, and being nationalised, due to toxic debts; and yet the hard copy industry is holding its own and has a business model to support survival even when sales of capital hardware (printers and MFPs) are hit in the way that car sales have been.

This is at least partly due to the fact that documents still need to be printed, meaning that printing supplies have to be replenished – providing the perfect annuity stream for the manufacturers. The very fact that printer manufacturers achieve anywhere between 50% and 70% of their revenue from supplies means that they have a high proportion of revenue effectively protected.

Hewlett-Packard

This is emphasised by the fact that Hewlett-Packard’s supplies revenue represented 68% of total revenue for the Imaging and Printing Group (IPG) in the last quarter, when it has been more typically in the low 60s over the last couple of years but as low as 56% as recently as 2005/6.

Pessimists will look at the results and see that IPG suffered an 18% decline in revenue for the last quarter in comparison with the same quarter of the previous year. However, this is the first quarter since the troubled times of 2001 that Hewlett-Packard has returned seriously negative year-on-year growth and only the second quarter that negative growth has been seen (the last quarter of FY2008 showed a 1% decline in revenue year-on-year).

Unit sales of printers and MFPs were hit hard in all categories, with a 33% overall decline. Within this figure, commercial hardware units (laser) were down 39% while consumer products were down 31% and MFPs only 10%. What this indicates is that large customers are taking strategic decisions where hardware has to be replaced and are moving towards multifunction devices for primary hard copy output, probably moving older, single-function hardware sideways to fulfil other needs instead of buying new hardware for those applications.

More worrying is the fact that revenue from supplies fell by 7%, perhaps linked to the sideways move of old hardware to lower-volume applications but perhaps also indicating that customers may either be recognising that printing less is one way to save money or, alternatively, experimenting with third-party supplies and remanufactured units. Xerox also noted a downturn in revenue from Post Sale activities, said to be driven by fewer channel purchases of supplies – implying that direct-supply (contract) sales have not suffered.

For Hewlett-Packard, this all has to be balanced against the phenomenal growth that the company has returned over the years. For instance, from its first quarter of FY2002 (end of calendar 2001) to Q1 of FY2008 (end of calendar 2007), IPG’s revenue grew by 43%. Therefore, the reduced revenue experienced for Q1 FY2009, may amount to an 18% drop year-on-year but still leaves revenue 17% higher than at the end of 2001.

Lexmark

Compare this to Lexmark, which has been in persistent decline since 2004, and we see that the position of Hewlett-Packard’s IPG is still strong. It is still more than five times the size of Lexmark (5.5x) and, as stated, this the first quarter that IPG has experienced serious negative growth, whereas Lexmark’s growth from 2001 to 2007 was a mere 14% and revenue now is 6% down on 2001 levels!

Quarterly Revenue

Hewlett-Packard (FYQ1), Lexmark & Xerox (FYQ4)


Note: $4bn has been added to Lexmark quarterly revenue to bring it to a level where the trend is more easily comparable on this chart with trends for Hewlett-Packard and Xerox revenue.

There is however, one particularly important point to note here. At the end of 2001 (HP Q1, FY2002; Lexmark Q4, FY2001), Hewlett-Packard suffered a 2.5% fall in revenue year-on-year at another time of global downturn, while Lexmark grew by 5.1%. It is often the larger companies in the printer industry that stand to suffer first and/or most at a time of trouble – hence the current 18% negative growth with Hewlett-Packard, while Lexmark, in dire financial straights, has suffered slightly less, at 17%, on top of its consistently falling revenues over the last four years.

Xerox

Xerox, another large player in the hard copy field, nearly went under in 2001 and has fought hard to recover. Since the end of 2002, Xerox experienced 15% growth through to this time last year (Q4, FY2007). While this year’s result’s show a significant 11% fall, Xerox is still 3% ahead of its position in 2002.

All three companies have worked hard to reduce operating costs, with varying results. Hewlett-Packard’s IPG lost 3% of its operating profit compared to last year but increased its operating profits as a share of revenue by three percentage points, to 18.5%. Lexmark on the other hand, returned an operating profit of $47m (non-GAAP), which was precisely wiped out by restructuring costs, resulting in a GAAP operating income of zero. This is after returning an operating income of $114m last year (8.7% of revenue – GAAP). Xerox struggled even more, with restructuring and other costs that more than wiped out its healthy operating profit of $382m to report an eventual loss of $6m (-1% of revenue).

Kyocera

Just bringing in a couple of other manufacturers, Kyocera’s Information Equipment Group suffered a 29% fall in revenue in the last quarter, with a severe 74% drop in operating profit (Kyocera’s dependence on hardware revenue is much higher than that of other manufacturers). But, operating profit still represented 5% of revenue even though it has fallen from 13% last year. In fact, Kyocera is just in the process of buying a larger stake in Germany’s Triumph-Adler, giving Kyocera overall control of the company (94%).

Oki’s Printer Division reported a relatively minimal fall in revenue of only 9.5% (but this is for the 9 months to the end of 2008, not the final quarter of the year). This resulted in a reduction in operating income of 8.8%.

Oki

In terms of hardware unit sales, all these companies have experienced a fall in demand overall – Hewlett-Packard’s by 33%, as we have seen – but, there have also been some high spots. For instance, Oki reported an increase in sales of mono LED printers and MFPs while Xerox reports growth in sales of colour MFPs (9%) and colour printers (5%). In fact, for the whole year, Xerox reports that unit sales have grown in all sectors, with sales of colour MFPs up 24% and colour printers up 12%. This contributed towards full year revenue growing by 4%.

Further encouragement comes from the fact that Hewlett-Packard saw a 25% increase in page volume on its Indigo colour production printers and Xerox reports continued strong growth in colour pages printed, amounting to 23% year-on-year and now representing 18% of total pages printed.

Geographically, the US has generally not suffered as badly as other regions even though it was in the US that the current economic turbulence began, through banking mismanagement of housing loans. In the US, Hewlett-Packard (as a whole) saw revenue growth of 15% while EMEA suffered a 3% revenue decline and Asia Pacific suffered an 11% revenue decline.

This is also supported by the fact that Xerox noted an economic slowdown occurring in developing markets. Bizarrely, Lexmark Europe revenue was down by only 9% against a 20% fall in US. However, other international revenues were again worst hit, with a revenue decline of 26%.

Hewlett-Packard has, quite rightly, summarised its recent results with the words, “We are very happy with performance considering the ‘very difficult’ economic environment”. Oki can certainly identify with that sentiment, as can Kyocera, as both have reported positive operating profit.

For Xerox, the results are more disappointing but the heavy penalty of the restructuring costs should pay dividends over the next year to place the company in a better place for renewed growth.

It is Lexmark that really cannot feel confident about the future, with falling hardware unit sales (-8% laser, -43% inkjet), falling supplies unit sales, falling revenues (-21% laser hardware, -43% inkjet hardware, -12% supplies, resulting in -17% overall) and zero operating profit. Furthermore, the company expects revenue to continue falling at about the same rate over the course of 2009, albeit with decreased planned operating expenses (10%).

One of Lexmark’s reactions to this kind of situation is to increase prices on its already overpriced supplies, which it is attempting to do as part of a global harmonisation program. However, this is not a quick fix. Lexmark says that 50% of its laser supplies are sold under contract, meaning that prices cannot be increased immediately.

The company is busy slashing operating cost to try and keep afloat – reducing fixed infrastructure, business support costs and headcount – prompting renewed speculation that Lexmark is being prepared for sale!?

If this is the case, the big question is, ‘who to’? Only Dell would benefit from owning Lexmark’s inkjet technology, whereas companies that currently do not own their laser technology could benefit. The field, however, is narrow – really only including Dell, Epson and Hewlett-Packard!

Ending on a note for hard copy users, because the cost of consumables represent the lions share of a user’s expenditure on hard copy (over 90% easily possible), they may very well be better stretching their capital budget to replace ageing printers, if they have a high CPP, with new models that have a proven low CPP. Research needs to be undertaken – calculations need to be performed and quotations obtained.

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