WHERE’S LEXMARK HEADED ?

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Where’s Lexmark headed?
 Lexmark executives cut their third-quarter earnings forecast by more than half earlier this month, stockholders abandoned the company in droves, dropping the share price more than 28 percent in one day.
On Tuesday, executives of the Lexington-based printer maker will release third-quarter earnings and provide guidance for the future, which analysts hope will reveal whether recent setbacks were an aberration or a sign of things to come.
Analysts identified several key areas to watch in the months ahead. They include:

• Consumer demand for Lexmark inkjet printers and supplies.
• Concerns that inkjets’ lifespans are shortening.
• Lexmark’s relationship with Dell, for whom it manufactures printers that are sold under Dell’s name.

Demanding times
In his Oct. 4 conference call with analysts, CEO Paul Curlander revised third-quarter earnings from a predicted range of 95 cents to $1.05 per share to 40 to 50 cents.
He said part of the company’s woes came from lower than anticipated sales of supplies, such as ink, and of Lexmark-branded printers, which were down year-to-year.
“Branded printers” are printers sold with the Lexmark logo, in contrast to printers Lexmark makes for companies such as Dell that are sold under the other company’s name.
Compounding the problems was a series of price cuts on printers, ranging from 7 percent to 30 percent, to stay competitive with the company’s rivals.
Though Curlander said printer sales increased late in the quarter, analysts said the price cuts will not be enough to boost the company’s waning market share. Lexmark held 13.9 percent of the U.S. market share of printers and multifunction printing devices in the first half of 2005, down from 16.2 percent in the first half of 2004, according to market analyst IDC.
Analysts said Lexmark’s image adds to the problem.
SG Cowen & Co. Managing Director Richard Chu said Lexmark has historically built its printer business around price instead of quality, though it has focused lately on more upscale products.
“All you have to do is walk into a store” he said. “I don’t think the typical consumer walks to the Lexmark product saying, ‘I’ve got to have this.’ If he’s looking for price, he may gravitate towards there.”
Hilliard Lyons Senior Technology Analyst Tom Carpenter said the problem is most noticeable at electronics retailers such as Best Buy.
“(Lexmark) tends to do fine in the Wal-Marts, the Meijers and the Targets,” he said, “but in the stores where … there’s a salesperson there and they have some influence with the purchase decision, it seems like it would pay off for the salespeople to have a favorable impression of Lexmark products. They have no one visiting them and going over the product and the features and explaining why it’s better than the competition.”
Lexmark officials would not comment about any of these issues before Tuesday’s announcement.
And while Lexmark aims to bump up its share of the market with the price drops, Chu said the cuts are indicative of a larger problem with the printer industry’s business model.
On a razor’s edge
Referred to as a razorblades model, printer companies, like razor manufacturers Gillette or Schick, charge little or nothing for their initial product — the razor or the printer — and then make their profit by charging higher prices for supplies for the initial product — blades, ink and toner.
But if sales of supplies dwindle, the model becomes broken, which Carpenter said has already happened.
Companies could once rely on consumers to buy multiple ink cartridges over the lifetime of a product, offsetting the losses on the sale of the low-price printer. But with printers — which typically are packaged with ink cartridges — even cheaper than before, consumers may be buying new models more frequently.
In the recent conference call, Curlander said the drop in supplies sales could very well be due to a shorter printer lifetime, but he said Lexmark had no firm data to support one theory over any other.
Chu said Dell’s practice of bundling some Lexmark-produced inkjet printers with PCs may have created a base of users that actually don’t use the printer.
In some cases, Dell has given away free inkjet printers with computer packages “to somebody who had no intention of buying a printer.”
Even though Lexmark’s installed base of customers grows larger, “in some cases (the printer) doesn’t do much printing or it never gets opened, so it doesn’t generate the required supplies,” Chu said.
Carpenter uses himself as an example.
“I’ve had my Dell/Lexmark printer for almost two years, and I have not replaced the toner cartridge,” he said of his home printer. “I would just go buy a new printer. … If you spend almost $30 on a replacement cartridge, why not go and buy a $40 or $50 printer?”
Chu said Lexmark’s potential could lie with laser printers, which sell for higher margins up front and also have highly profitable toner cartridges and supplies.
When combining inkjet and laser printer sales, Lexmark controlled just over 10 percent of the worldwide market share in the first quarter of 2005, according to IDC, compared with printer giant Hewlett-Packard’s 40 percent
“If you sell a corporate laser, whether it’s through Dell or by yourself, chances are pretty good it will pump away consumables predictably for a number of years,” Chu said. “That certainty is not there with consumer inkjets.”
With that prospect, he said Lexmark should consider shifting course.
“It may be blasphemous to contemplate this, but Lexmark should consider whether it should even have an inkjet business,” Chu said. “I doubt that they’ll agree with that.”

Dump Dell?
Carpenter, of Hilliard Lyons, advocated in a report to investors that Lexmark should fundamentally change its relationship with Dell, which accounted for more than 10 percent of the company’s revenues last year.
He went as far as to suggest it may want to sever ties.
“When Dell is offering your printer at lower prices with the Dell badge, which has a more trusted name, the value brand is being taken away from you,” Carpenter said.
At the very least, Carpenter said, Lexmark should change its pricing agreement with Dell. Though the terms of the agreement are not discussed by executives, Carpenter said Lexmark should receive more money from Dell for both the hardware and the first or second replacement cartridge to offset potential losses from users who don’t frequently print. Once printer owners have ordered more replacements, Lexmark can offer higher discounts to Dell.
However, the Dell relationship could be important to the long term, Chu said, should the PC maker begin selling more Lexmark laser printers.
But UBS analyst Ben Reitzes said in a recent report he believes Dell is purposely shifting its mix toward lasers produced by Samsung and Fuji Xerox.
Cross Research Managing Director Shannon Cross said there is also potential Dell may expand its partnership with Kodak, leaving Lexmark less and less important to the company.
Lexmark’s future
Curlander, during the conference call, said the same factors that troubled Lexmark’s third quarter may continue into the fourth.
In the short-term, analysts predict it will be difficult for Lexmark to turn around its market share dilemma.
“It’s not a one-quarter fix,” Carpenter said. “They’ve got to figure out what they stand for going forward or Dell is just going to keep taking share from everybody using their printers.”

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October 27, 2005 at 12:16 PM