A Look at Lexmark's Q3 Results

Lexmark reported its Q3 2016 results this morning. The focus in the news was that overall the company increased profits by 40% YOY, to $49M from $35M last year. Our main focus in DIR is the Lexmark Enterprise Software (ES) division, which over the past few years rolled up several companies covered by us, including, Kofax, Perceptive, Brainware, and ReadSoft.

The Kofax acquisition, which practically doubled the size of Lexmark ES, was completed in Q2 2015, so Q3 2015 represented Lexmark ES' first full quarter including Kofax results. Lexmark ES Q3 2015 revenue was reported at $165M with operating margins increasing to 19% - a positive trend. Of course, these results were released just three days after Lexmark had announced that is was "exploring strategic alternatives to enhance shareholder value." So, a lot has happened between then and now, including, in April, Lexmark agreeing to be acquired by a consortium of Chinese investors led by Apex Technology and PAG Asia Capital.

As Apex's primary business is the manufacture of ink cartridge chips, there have been questions about its use for Lexmark ES, and rumors have been flying that Lexmark ES would be sold in its entirety or piecemeal prior to the Apex acquisition closing, which is supposed to happen before the end of this year. In the meantime, Lexmark ES struggled through a rough first quarter before rebounding somewhat in Q2.  For Q3 Lexmark has reported revenue of $157M or about a 5% YOY decrease. Not great numbers, but considering all the FUD in the market surrounding who is going to own Lexmark ES going forward, not terrible. We didn't get any other numbers, like profitability related to Lexmark ES, as Lexmark corporate is keeping reporting to a minimum, and "will not conduct quarterly conference calls while the [acquisition] is pending."

To us the Q3 numbers indicated that Lexmark ES is still a very viable business, albeit with a run rate closer to $600M than the $700M that was originally projected when Kofax was acquired. ES has a large install base, along with plenty of maintenance revenue, as well as a stack of technology that it continues to invest in. So, what's it worth? Probably not the $1.89B we were speculating on in the wake of Open Text's acquisition of EMC's Enterprise Content Division (ECD). That was based on the projected $700M run rate.

Let's scale back that run rate to a more realistic $640M. Applying the same multiple of 2.7x revenue that Open Text paid for ECD, that puts a price for Lexmark ES closer to $1.73B, which still wouldn't be a bad price, considering Apex and PAG are paying $3.6B for the entirety of Lexmark, which is about equal to the revenue that the entirety of Lexmark reported for 2015. So, if they were to get even $1.5B for Lexmark ES, they would still be getting an approximately $3B hardware entity for close to $2B, which seems like a great deal. That said, Apex and PAG may be willing to go even lower on Lexmark ES, depending on what they value that hardware business at.

The bottom line is that Lexmark ES, even with its recent growth struggles, could be had at a relative bargain it seems. The question is, of course, who would buy it? Open Text is presumably out of the picture after the ECD acquisition, but you never know. Hyland owner Thoma Bravo has been rumored to be in play, but at their recent conference Hyland executives gave us no indication that was under consideration. Xerox wanted to buy Kofax before Lexmark did, and Xerox has stated they are on the ECM acquisition trail, but if the $1B price that Lexmark paid topped their original bid, would they be inclined to pay more for something larger, or would Apex and PAG be willing to break off Kofax separately for Xerox and sell it to them at their original bid? Or could Lexmark ES execs like Reynolds Bish and Carl Mergele cobble together enough financial backing for a private equity bid?

We still expect something to happen with Lexmark ES before the Apex/PAG acquisition closes. That would give us a little over two months. Stay tuned!

Lexmark Apparently for Sale

Today, Lexmark announced that its Board of Directors has "authorized the exploration of strategic alternatives to enhance shareholder value." After the announcement was made, Lexmark's stock rose more than 6% (as of this posting), lifting the company's market cap to $2.1B. This is not that great of a valuation for a company that bills itself as a "$3.7B global technology company that includes a $1.5B Higher Value Solutions business comprised of Enterprise Software (ES) and Managed Print Services (MPS)."

That Enterprise Software business, of course, includes Perceptive, Kofax, ReadSoft, Brainware, and some other ECM-focused companies that have been rolled up since 2010. Most recently, Lexmark acquired Kofax for $1B in a somewhat surprising deal. It followed up by appointing Kofax CEO Reynolds Bish as president of Lexmark ES, which has about a $700M annual run rate.

Unfortunately, investors were less than thrilled with the guidance Lexmark presented for its overall business in conjunction with its Q2 earnings report, which dropped the company's valuation by 20% on a single day in July. Although the stock has bounced back slightly over the past few weeks (including today), it is still trading at more than 25% below its July peak.

Lexmark has made a concerted effort to shift its business from hardware-centric to a software and services focus, stressing its growing ES and MPS revenue. Unfortunately, it appears that investors are still valuing the company based on its declining hardware and supplies revenue. Stated Jean-Paul Montupet, lead director of the Lexmark Board of Directors, in relation to this, "We are extremely proud of what the Lexmark management team and employees have accomplished in the transformation of Lexmark. While the Board is encouraged by the company's future prospects, the Board does not believe Lexmark's current share price fully reflects the intrinsic value created by the company, and the Board has concluded it is appropriate to explore strategic alternatives as the next step to unlock this value."

What specifically those strategic alternatives are is not mentioned, but speculation is that the company could be sold either to a private equity company or another high-tech company. HP, which had long been discussed as a possible landing point for Kofax and has a partnership history with Lexmark, is one possible buyer. However, to me, a private equity buyout at this point would seem to make more sense. After all, less than six months ago, Lexmark paid $1B to pick up Kofax, so selling the whole company to someone else for anything close to its current market valuation would seem unlikely. After all, Kofax was a $300M-plus company and Lexmark is a $3B-plus company. The math just doesn't make good sense.

What makes more sense is to take the company private, which would conceivably enable those who agree with Lexmark's management's transformative vision to stay on board as investors. The company would then be able to work on really affecting the changes it wants to without the worry of meeting quarterly numbers - which are going to be very hard to meet as the formerly hardware-driven company de-emphasizes hardware. When the transformation is complete, and Lexmark is operating as primarily a software and services business, it can then go public again, conceivably with a more favorable valuation.

At least that's the way I see it shaking out.

Your thoughts?

Aggressive Cost Cutting in Store for Lexmark Enterprise Software

Lexmark reported its Q2 2015 earnings today. Overall, Lexmark reported $891M in non-GAAP revenue and $139M in earnings. Apparently, Wall Street traders were not impressed with these numbers along with lowered earnings forecasts, as Lexmark shares were down more than 20% in early trading. I don't pretend the understand the complete dynamics of Lexmark's business, but I do follow its Enterprise Software division fairly closely, and this was the first quarter it reported that includes any revenue and income from Lexmark's Kofax acquisition, which closed on May 21.

For Q2, Lexmark reported $150M in total Enterprise Software revenue, with margins of 20%. On the surface, this looks great, considering that Lexmark's Enterprise Software margins for 2014 were around 5%. But, if you look closely, the Kofax Q2 operating margins are listed at 42.6%, which has something to do with the timing of the acquisition. Apparently, some Kofax operating expenses in areas like IT, finance, HR, facilities, and legal and corporate staffing were charged to "All Other," instead of Enterprise Software.

"The software segment benefited from the timing of the Kofax closing which coincided with the most profitable portion of what is traditionally Kofax’s strongest quarter," explained David Reeder, VP and CFO, of Lexmark in an analyst call. "Kofax added $48 million of revenue and $20 million of operating income to second quarter results." (Quotes are from the Seeking Alpha transcript of the analyst call.)

When you take Kofax out, Enterprise Software reported operating margins of 9.8%, which is not great, but is an improvement over what we've seen historically from the Enterprise Software group. And, of course, we all know that Lexmark has set a goal of exiting 2016 with 25% operating margins for Enterprise Software. So, how does it get there?

In conjunction with today's quarterly financials report, Lexmark announced plans to eliminate about 500 positions. "We are announcing a restructuring action today, the vast majority of which reflects the cost synergies targeted for the ReadSoft and Kofax integrations," announced Chairman and CEO Paul Rooke. "In total, we’re eliminating about 500 positions worldwide, primarily across the G&A, marketing, and development organizations with about one-third of the impacted positions being shifted to lower cost countries, and we expect to complete these actions by the end of 2016. Financially, these actions are expected to generate annualized savings of about $65 million in 2017, the vast majority of which will benefit the Enterprise Software segment."

Basically, it sounds like Lexmark is expecting to save more than $33M in operating expenses annually in Enterprise Software - as well as grow the division due to "revenue synergies." When you do all the math, this should work out to 15% operating margins for 2015 and 25% by the time 2016 ends.

Obviously, there are going to be some challenges growing Enterprise Software while simultaneously reducing headcount, but Lexmark at least has a vision to try and executive on. I feel badly that it sounds like many people in our industry are going to lose their jobs as part of this vision, but as document imaging and ECM gets subsumed into more general IT and larger organizations, this type of evolution is inevitable.

Now, I'm not saying Lexmark is guaranteed to succeed at what it has set out to do, specifically in terms of margins and more broadly in terms of transforming from a hardware player to establishing itself as a leader in the ECM space. But, I will say it's definitely worth watching - and I'm sure most of its competitors are. Lexmark is clearly betting big here. We should know the results of those bets in another couple years at the latest.

A Dialogue with Xamcor's Paul Carman on Lexmark-Kofax Deal

The following is a correspondence between Ralph Gammon, the editor of the Document Imaging Report, and Paul Carman, President and CEO of Xamcor, discussing what this deal means to the companies involved, as well as the industry as a whole.

Ralph Gammon of DIR: So, no surprise that an MFP vendor has announced plans to acquire Kofax. What is surprising is that it was Lexmark, instead of Xerox.

Paul Carman of Xamcor: I agree. Of course, it’s no surprise that Lexmark made another software acquisition , as they have been very active in building their software capabilities. However, Kofax does come as a bit of a surprise. With Brainware, an earlier acquisition, and then ReadSoft closing some months ago, the capture space didn’t seem to be the next logical area of opportunity.

To read the rest, please click through to the Xamcor site. 

Part II of the interview, in which we discuss if there is any merit to a shareholder rights-focused law firm filing a complaint against Kofax for not maximizing shareholder value.

Toshiba's Forward Thinking

In my last newsletter, there's a story on Toshiba America Business Solutions (TABS) launching a new business unit - Toshiba Managed Business Services (TMBS). No surprise here that an MFP vendor is trying to expand further into services. After all, we've written about Ricoh, Canon, Xerox, and HP all trying to do the same thing. With paper volumes declining, hardware just isn't enough to pay the bills anymore.

What's interesting about TMBS, however, is the range of its focus. It is targeting four main areas within the enterprise market:

• Managed Print Services
• Document security, workflow/capture
• Barcode systems
• Digital signage and kiosks 

Now we all know what MPS is, but here's what Chris Applegate, Director, Enterprise Services, TMBS, had to say about his organization's focus on MPS. “The MPS space has become overcrowded. You’ve got MFP vendors, big box office equipment providers, VARs, and even large technology distributors playing there. And their value propositions all sound alike.

“Basically, they tell the same story. They provide a baseline assessment and an analysis. They then help customers right size their fleets by doing things like replacing inefficient desktop printers with workgroup models. And they provide software to manage that new fleet of printers.

“We believe that creating a lower cost per printed page is only a foundation for managed services. The true value is in reducing print. The paperless office is a myth, but running an office with less paper can be a reality today. We help customers choose when paper is the best solution."

The focus on digital signage and kiosks is designed to offer an alternative solution to printing. In a world where more and more formerly printed materials is now being read on tablets, this makes a lot of sense. I always tell people that a number of years back at a Xerox Tech Expo I saw a lot of "digital paper" solutions previewed that I think foreshadowed today's tablets. I think even better "viewing" technology is on the way.

Healthy Coopetition
The other forward thinking strategy employed by TMBS is its vendor-agnostic approach. Included in TMBS software portfolio is Lexmark's Perceptive software suite, as well as some HP security software. Yes, both HP and Lexmark make MFPs that conceivably compete with Toshiba. This is the second time I have heard TABS commit to this vendor-neutral approach. The first was two years ago, when they launched a professional services group - and they said that it was not about the hardware anymore. I can't say for sure whether this is lip service or reality, but it certainly makes sense. Integrators selling scan-focused document imaging solutions realized it was not about the hardware brand several years ago.

Capture + MPS on the Horizon

There is certainly a lot of interest in introducing document capture and management applications into managed print services contracts. One of the most active discussions I've ever seen on LinkedIn, for example, has focused on the question of will "the next big move for MPS providers will be document capture / workflow?". The discussion takes place within "The Document Imaging Group"  and has more than 60 comments since being started a year-and-a-half ago - the last one coming just a couple days ago.

So, scanning is definitely a hot topic among those in the MPS market, but how much of it is really being sold with MPS implementations today? DIR recently sat in on a briefing about a number of MPS infrastructure players getting together to deliver a solution providing end-user information to resellers to help them improve their MPS deployments. Unfortunately, from our standpoint, the whole discussion focused on print.

We followed up with a question to Doug Johnson, senior VP of MPS for Supplies Network, a St. Louis-based organization which services some 6,000 North American resellers, providing them with products like toner, paper, IT supplies, and data storage media. Supplies Network also has a hosted MPS offering, which was discussed in the briefing. We were introduced to them through DocSolid, which offers an MFP capture platform designed for cloud environments.

Johnson told us, "To date, scanning (and particularly solutions around the scan function--content repurposing, further document workflow, storage, archival, retrieval, etc.) has largely been ignored in the MPS engagements between resellers and end users. We believe it is due to a lack of solutions that are integrated across the scanning value chain. An efforts like the one we recently discussed [on printing], eliminating white space across scanning solutions to create a seamless end-to-end solution, is needed."

 

So, while there clearly is plenty of interest in scanning in the MPS world, it seems the logistical pieces have not been put in place to really unleash it. This is not surprising, considering that printing is still the lead dog for MFP vendors and dealers, and they are still figuring out how to properly deploy it in MPS environments.

We also did a teleconference last week about a re-org at Xerox that discussed MPS, but was almost entirely focused on printing.  Here's two interesting quotes that came out of that teleconference, which may explain some of the interest in printing: "Retail printing is $700 billion market," and "direct mail is growing exponentially." (The figure I found showed that the market for direct mail is actually predicted to shrink slightly over the next five years, but it's still worth well over $10 billion annually, so I guess when you compare it to the document capture software market size of under $3 billion [per Harvey Spencer Associates], you can see why the MPS focus remains on print.)

But - remember, the document capture market is growing in double-digits and someday will catch a declining printing market (if indeed it is declining), which explains all the interest in document scanning amongst, apparently forward-thinking people in the MPS market.

Former IKON Exec Out as Head of Ricoh U.S.

Here's a great article discussing the departure of Jeff Hickling from Ricoh, U.S. Hickling was the president and COO of IKON when it was acquired by Ricoh in 2008. He was named president and CEO of Ricoh U.S. in 2010. I haven't found any confirmation of his resignation, but the link I have listed seems like a reliable source.

The article discusses some of the problems Ricoh has had with the IKON acquisition. While it certainly was a great way to punch Canon in the stomach, it seems it also peeved quite a few of Ricoh's dealers. I can't say I had the opportunity to interact with too many dealers at the recent Ricoh event I was at, as press and analysts were mainly given briefings prior to the dealers arriving en masse. But the linked article says something about Ricoh's percentage of sales through dealers dropping from 70% to 20%, which can't be good.

Yes, IKON has brought a great increase in direct sales, certainly, but I personally heard multiple times about some of the conflicts it created with Ricoh Business Solutions, which managed a lot of direct business before the acquisition. This conflict is also discussed.

The article doesn't indicate who would be in line to replace Hickling, but it will be interested to see what kind of background they have.

Coincidentally? Ed McLaughlin, who had been president of Sharp Imaging and Information Company of America (SIICA) since 2003, resigned last month.

Wonder how much of this all has to do with copier vendors' attempted transition away from boxes and toward more services-oriented business spearheaded by MPS.

Ricoh Launches MDS Tour

At last week's Convergence conference for its dealer channel, Ricoh spent a good bit of time discussing its new initiatives in the area of managed document services. MDS is clearly an area of focus for the Japanese MFP manufacturer, and it recently announced a $300 million investment in its MDS architecture. We'll have more on this in next week's premium issue.

Today, Ricoh announced "a multi-city U.S. tour designed to show companies how to improve their bottom line through effective information and document management. The events will discuss the challenges companies face in meeting their cost reduction, productivity and sustainability goals as well as showcase Ricoh’s Managed Document Services (MDS) approach."

The tour starts next week, on Thursday, June 9, in Chicago, and has about a dozen stops scheduled through March of next year. For more info, go to http://www.ricohandu.com/.

Nuance Buys Equitrac

As you probably saw, yesterday, Boston-area recognition specialist Nuance agreed to acquire print management ISV Equitrac. Kind of a cool deal on several fronts. First off, eCopy, which was acquired by Nuance in 2009 has a long-time partnership with Equitrac. The Equitrac Connector for tracking scanning for billing purposes in law firms, has traditionally been the most used of eCopy's third-party integrations. So, there is a natural connection there.

Robert Weideman, the GM of Nuance Document Imaging, who did most of the talking during the analyst conference discussing the deal, talked about the strength of both companies' desktop technologies. Of course, Nuance has its PaperPort, PDF, and OCR desktop apps that are either market leader or in the case of PDF, second. I'm not as familiar with Equitrac, but assume they have some sort of desktop print management application. And that's where it really starts to get interesting.

I came across an IDC report on Equitrac from 2006 and it said something about Equitrac expanding outside of  the cost-billback market and into the area of helping customers realize savings through print management. If that is indeed the case, the puts Equitrac's technology squarely in emerging managed print services (MPS) space, an area Nuance really wants to play in as well.  

I'll admit, it's kind of hard for me to think of the current offerings of Equitrac and Nuance as being a complete MPS offering, but I also had an interesting conversation earlier this week with  Doug Johnson of cloud-based MPS pioneer  Supplies Network. Basically, he brought up that only a relatively small percentage of organizations who say they are offering MPS are really delivering an advanced MPS solution. Most people are just offering pieces of MPS and calling it MPS. From that perspective, Nuance now certainly has two pretty important pieces. 

Michael Rich, president and CEO of Equitrac, who was also on the conference call, said something along the lines of  "Both Equitrac and Nuance have a  very substantial,  large install base of global clients. Those companies are looking for solutions in area of MPS. We have many opportunities to build on that strong base, and we already have a very broad value proposition that covers a lot of what customers want to do."


I think that makes sense and immediately entrenches Nuance as player in the MPS market.

DocSolid Signs Distribution Agreement with Supplies Network

DocSolid, an ISV promoting a universal document capture platform for managed print services implementations, recently announced a partnership with Supplies Network, which will be offering DocSolid's
Airmail2 platform to its MPS partners. Supplies Network bills itself as "the largest privately-owned wholesaler of IT consumables in the U.S. and an early innovator in MPS."

DocSolid was founded by document imaging industry veteran Steve Irons, a former reseller who also launched another ISV ImageTag. AirMail2 employs some of the same bar-code recognition concepts as ImageTag, but the eventual destination for scanned documents is a cloud-based computing environment, which currently manages e-mailing but will be made available for integration with other cloud-based applications.

Looking to take advantage of the MPS wave, Irons told us that instead of building a distribution channel for his software this time around, he was going to try to leverage one that already exists. He views capture as a natural extension of MPS with a cost of fractions of a cent per print - which is what the MPS charges are based on. More on this in an upcoming premium issue.

PBMS Partners With EMC Captiva

Pitney Bowes Management Services (PBMS) has signed a deal to utilize EMC's Captiva software for both its on-premise and hosted document capture solutions. PBMS is the $1.2 billion outsourcing arm of Pitney Bowes, Inc. It focuses on mailroom and document services for large, Global 1000 organizations.

Last year, we did an article (go to page 7) on PBMS's partnership with Omtool to increase its breadth of on-premise capture offerings. At the time, PBMS, which certainly does a lot of work around outgoing mail was focused on expanding its presence in records management and document processing. The partnership with EMC appears to be another move in that direction.

Xerox Acquires ISV/SI

Last week Xerox acquired DocuShare systems integrator WaterWare Internet Services. Water Ware, which is based in Northern California, near the Palo Alto Xerox office where DocuShare is developed, will do professional services and software development related to implementations of Xerox DocuShare implementations. They were doing this on their own previously, but now will do it in conjunction with the Xerox sales team.

WaterWare has already developed some software applications around  DocuShare, including at least a couple that include some document capture functionality. We did a story last year on one of WaterWare's implementations at an L.A.-area hospital. WaterWare is named after founder Mark Waters who is now Xerox's DocuShare Solutions manager. We'll have more on this in our next premium issue.

The acqusition of an ISV/SI like WaterWare is another indication of MFP vendors' desire to move more deeply into software and services. I'm not sure that this fufills my beginning of the year prediction that an MFP vendor will buy a capture ISV, but on a small scale, this is certainly an example of that.