Imaging Industry Operating Income - How Soft Really?

The newest update of the Imaging Industry Margin Index Report from the Woodford Group spotlights a once unflappable industry finally experiencing the full impact of a turbulent economy. Although the results of the imaging industry trends are dramatically lower this quarter, the downturn is not surprising given the overall state of the economy.   

Industry revenues took a major dive, but were surprisingly not the lowest on record. However, industry margins, taken together, were definitely the lowest ever, and yet some companies still managed to perform well. It’s a challenge to interpret these results, particularly on a macro level, as there are several overlapping factors and influences to take into consideration.

The first and most obvious of these is the belt-tightening that most companies experience in the face of a serious economic downturn. Both at channel and end user levels, restriction on purchasing is strictly enforced, as is tighter inventory control. Secondly, many imaging industry firms are opportunistically restructuring, which affects their bottom lines. The final and perhaps most significant influence on the imaging industry is the shift in usage patterns, specifically a reduction in overall print volumes. This is difficult to quantify because it is overshadowed by the other gating influences. Although all three radically affect revenue and margin, the third influence will likely have the most lasting impact on the industry as a whole.

On an individual company level, the IIMI report identifies some interesting developments, most notably with Ricoh who, for the first time, came in second on the revenue scale. By sustaining only a minimal sequential drop in a volatile economy, Ricoh was able to overtake competitors who traditionally have been strong industry performers, but who have suffered more drastic reductions in revenue. Ricoh has worked to build a broader business which addresses more attractive customer segments, a strategy which is clearly successful and profitable for them.

Other key players experienced shifts in both directions as well, illustrating just how diverse and dynamic the imaging industry remains. Despite ongoing internal costs for restructuring and external market pressures, the ever-resilient imaging industry continues to offer attractive and stable returns, especially as the economy begins to improve and new business opportunities emerge.

The twenty-first consecutive report in the quarterly series, the latest IIMI report provides the most recent data and analysis, highlighting key trends within the imaging industry as a whole, as well as individual strengths and weaknesses of 12 key industry players. Since 2004, the Woodford Group together with their partner, the Photizo Group, has tracked key revenue and profitability metrics of these companies, which represent more than 90 percent of the distributed imaging industry. The Imaging Industry Margin Index Report is available immediately. To purchase a copy as an individual report or as part of a quarterly subscription package, please contact the Woodford Group at www.woodford-group.com or call 1-845-987-6201.

Xerox - Timing the Transition

This is a great opportunity for Xerox and Ursula Burns, though maybe not necessarily in that order.  Ms. Burns is certainly competent and well prepared, but given the current economic situation and imaging industry flux, there is nothing that can be taken for granted.  It remains to be seen whether she can continue the positive trajectory established for Xerox under the stewardship of Anne Mulcahy.  The succession was widely expected, but nonetheless remarkable.  Yet notwithstanding the human interest side of the story, the key point will be to deliver positive results, and the handover of the CEO job seems to be well timed to allow this.  

Xerox has put together an impressive collection of technologies and offerings across the entire spectrum of the imaging market:  desktop, departmental and centralized products and applications, from major accounts served by an established and highly competent direct sales force to small business customers served by a growing network of well supported channel partners, hardware, software, services, consulting, geographic reach, . . .  From the supply side, things look very positive. Except for the economy, this is a great company to inherit.  Yet with just limited improvement in that realm, prospects for Xerox will be looking up.

Anne Mulcahy could certainly have stayed on, but handing over now is a wise move.  The current economic situation knocks down expectations, so there is plenty of upside.  There will be a number of key management and strategic decisions coming up and Ms. Burns is ideally prepared and positioned to take these over quickly and seamlessly.  As an added advantage, the momentum of the company and (soon?) the economy will contribute to an outlook for success.

While this seems to be a good move undertaken at a good time, the only concern we need to mention is that Ms. Burns may have too much of a hardware product focus at a time when visions, strategies and service-oriented products need to be at the forefront.  She may in fact have all the necessary skills, but was not addressing these topics due to her current responsibilities and task-sharing arrangement with Ms. Mulcahy.  We will soon see whether she will grow into these new key areas quickly and effectively.

VPRT - Putting the Pieces Together

If you bought any given stock last November, where would you hope to be today with that investment?  Most answers will be in the category of minimizing losses, or in some optimistic scenarios possibly treading water around the same level as when you bought in. So a company whose stock price in the same period has more than tripled rightly deserves giving some attention to the strategies which have delivered stable and positive results which have in turn supported the stock price in historically difficult times.

Vistaprint has at least three approaches which conspire for this success:

1) Focus on small and medium businesses: while a lot of companies see their future addressing the high end of the market, Vistaprint is unashamed about preferring clients in the SMB space, attracting and retaining millions of customers with small budgets and low average orders (just a touch over $30). Big wins with key accounts make the news, but they can also break your margins and such deals are difficult to repeat. If you establish a broad customer base and address them relentlessly with new offers and ideas (see following points), the business might be less spectacular but the results can be comparable - or even superior.

2) Master the art of web-based marketing: although nominally a web-to-print company like many others, Vistaprint demonstrates exceptional talent in developing, packaging, promoting and delivering products which are ideally suited for the medium of internet sales and support. You have to find, touch and attract a lot of prospects, as otherwise your business model, like many internet business concepts, is a load of hot air. But Vistaprint avoids the "bubble trap" by ensuring that there is substance as well as regular and highly relevant customer touches. Both the methods and the deliverables are ideally suited for web-based business, and the implementation is exemplary.

3) Support hard copy and electronic platforms equally: the core concept at Vistaprint appears to be hard copy print job submission and fulfillment. But Vistaprint defines their sweet spot as everything that makes sense for small business marketing and studiously avoids limitations based on HCO - hard copy only.  They use their platform to offer other services such as internet and e-mail services. Not only are these additional and attractive revenue streams that can be extracted from the same customer base, but the cost of customer acquisition declines rapidly as they leverage existing communications, processes and customer relationships.

This last point is somehow astounding. At the most basic level, nothing they offer is genuinely new. But their knack for selecting components that belong together (especially from their chosen target group's perspective) is unique. Much larger companies in the imaging industry are evidently blinded to such opportunities by their focus on the hard copy (read: print supplies) business.  This is indeed lucrative, but the extreme focus of efforts and expertise cause many companies to neglect key opportunities and allow others like Vistaprint to gain momentum.

Another observation, which is a corollary (but hardly less amazing), is that all components of the Vistaprint package are there for almost anybody to grab and go, but the Vistaprint selection, timing and execution is superb. They are doing a fantastic job of anticipating and leveraging opportunities, and the head start they have now established will be difficult to overcome. The product could always become a commodity, but it appears that they will achieve and maintain an advantage through their unique and prescient attention to providing key tools to improve their customers' business.  Even in tough times, that basic message and strategy is a formula for success, and the market has been rewarding that approach for Vistaprint.

Lexmark - Stabilization or Decline?

The recent Lexmark earnings call signaled some gradual but significant shifts in the market and in their own position in the industry. On the positive side (if you can call it that), the announced results did not precipitate any drastic market reactions. Also positive was a somewhat more satisfactory operating income number ($74.6M), the best result since the middle of last year.

But while the operating result was positive and better than the last two quarters, it was well below the average historic result, which had been typically well in the range of the three-digit millions.  Also, their quarterly revenue ($944.1M) dipped below $1B for the first time in over 20 quarters.

Lexmark management defended the results as positive and healthy. Viewed as a product of the strategic shift away from unprofitable consumer business, that is correct in a limited sense. But the idea of that strategy was to compensate with healthy mid-range and corporate installations, and that hope has not come to pass.

The imaging industry is indeed healthy and can be enormously profitable, but only if you capture and maintain installations and drive ongoing output volumes.  But with hardware sales declining 30%, you will not maintain your MIF (machines in field), and even improving print volumes will not deliver the level of revenue and margins required to drive future business. This development is certainly not (yet) a death spiral, but it is a serious warning sign.

One also has to wonder about certain cost allotments. Lexmark has only two main business divisions, the laser ("Printing Solutions and Services") and inkjet ("Imaging Solutions") product groups. We can debate the sense or nonsense of these naming conventions in another space. In a somewhat murky accounting exercise, the operating incomes for both divisions were reported as strong positives: $93M for PS&SD and $52M for ISD. But that total is then reduced by $71M for "other" operations. Since these "other" activities account for an amount greater than one of the major business divisions, it seems like it might have been better to allot those costs directly to the respective operating areas. But depending on how those activities/costs are are parsed out, these might limit (or even eliminate) that division's positive result.

Analysts are also learning to track these key drivers, especially print volume developments. Many of the questions addressed different aspects of that issue: inventory buildup in danger of going chronic, increased threats from third party supplies, reasons for weak supplies demand, cost implications from underutilized production facilities.  These analysts know that this is what drives the future business, and they obviously feel the softness that Lexmark is now exposed to.

Invitation to Say . . . What?

Lexmark held an investor / analyst day at the New York Stock Exchange recently and took the opportunity to say . . . nothing special. Considering the cost and effort of bringing this key audience together, and considering the exceptional circumstances in the economy and in the imaging industry, it was nearly breathtaking how little substantial or new was shared.

Any outlook for future revenue or earnings was studiously avoided, maybe for good reason. Xerox recently revised their Q1 outlook downward and was immediately rewarded with a stern round of agency downgrades and a thrashing in the stock market (although the stock price has since recovered). Such a severe reaction may not have expected , and Lexmark management, who previously may or may not have been prepared to make a similar statement, refused to be drawn on the topic. 

Other statements? More cost cutting and restructuring, but that announcement is not necessarily newsworthy these days. The amount ($75M) is substantial, but one pointed question about how much of that actually benefits the bottom line remained unanswered. 

Some statements were vague or even contradictory: core investments will include R&D, but no focus was provided for which product or business area will benefit, and overall R&D spending will be reduced. Even portfolio-challenged Kodak provided more guidance on where their core investments will be targeted, but they also ignited a discussion by revealing their direction. So maybe again Lexmark thought better of providing too much (any?) detail.

Other topics highlighted:

• The divisions have been renamed - old news, confusing terminology.
• Pullback from unprofitable product lines and regions - old news.
• New products - always welcome, but these are all improvements in the current space.
• Reliance on internally developed technology - commendable but severely limiting.
• "Print less, save more" - a remarkable statement for a printing company.

One statement that did stand out was the clear demarcation to the world of copiers/MFPs, with the newest model positioned as the "copier killer." The presentation included tape on the floor depicting the size and service access areas of the competing products, obviously stressing how monstrous the competing products are. So while other companies are expanding their approaches and product portfolios to embrace all corners of the customer organizations, Lexmark has clearly stated that this is not an area of interest for them. Especially with a renewed focus on managed print services and a declared focus on high-volume and high-value installations, it is notable that an entire category of relevant products will not be pursued.

Several pointed questions surrounding the future of the inkjet business were also artfully dodged, leaving the audience with no clear outlook. Margins are at an unacceptable level but will improve, installations are dropping but will stabilize, higher volumes will improve results but no expected usage patterns were provided. And (again) the statement that inkjet will now successfully enter the business market. But the questions of how, why and why now were also left open.

So maybe the event and accompanying statements made sense for the hosts. But many of the guests were left wondering what the real message was.

You Never Know . . .

Today's headlines regarding Xerox:

"Xerox slashes earnings target on weak economy"

"S&P revises Xerox outlook to negative on lowered guidance"

"Xerox shares down 7% in early trading"

On the one side, this development should come as no surprise. Poor results will be punished, by ratings agencies and by the market.  On the other side (and this could sound a bit bizarre), is there a hint of a "return to normalcy" in these headlines?  

It was not that long ago that reduced or negative earnings hardly raised an eyebrow in the market. And now this reaction - why this time so severe?  You never know  . . . But the aberration was then, not now.

The market sensitivity to this announcement may catch Xerox management unprepared, as they might have expected a more casual overall response. They may have assumed a higher tolerance for further negative news, but obviously such developments were not baked into the current expectations. 

This was most definitely not the case, so what is the issue? The markets will not be so forgiving, maybe because there is proof that some individual companies can indeed perform well through the difficult times.  Or there is a stronger expectation that the leading companies in key sectors should now be able to deliver more acceptable results after market and internal adjustments.

So if the "market of expectations" has bottomed out, the results will have to follow a more positive curve, or those companies will suffer the consequences more severely than they have recently. The first quarter will be a key indicator for the future direction of the market.