Ed Lane, chief executive and publisher of The Lane Report, sat down with Lexmark CEO Paul Rooke for a candid interview last month. Here is the transcript of the interview, in which Rooke discusses Lexmark’s plans to expand in software and managed print services, and become a broader solutions provider.
Paul Rooke, chairman and CEO of Lexmark International Inc., has been with the Lexington-based company since its inception in 1991. After holding various management positions, Rooke was named president of Lexmark’s printing solutions and services division in 1999. In 2007, he was selected as president of the company’s imaging solutions division, where he was responsible for meeting the needs of Lexmark customers worldwide for inkjet printers, all-in-one products and related supplies and support, including development, manufacturing, marketing and sales. In 2010, he was named president and CEO of the company. Rooke holds a bachelor’s degree in mechanical engineering from the University of Michigan and a master’s degree in business administration from the University of Kentucky. He serves on the boards of several nonprofit organizations, including the University of Kentucky College of Business Advisory Board, the Business-Higher Education Forum and the Bluegrass Economic Advancement Movement (BEAM).
Ed Lane: Lexmark sells its products in more than 170 countries and had revenues of $3.8 billion in 2012. Fiscal year 2012 (ending Dec. 31, 2012) was a bumpy road. Our interview will touch on a number of the macroeconomic factors that caused Lexmark’s stock price to decline 38 percent the past year to $23 per share on March 1, 2013, and on Lexmark’s plans for future growth. In August of last year, Lexmark announced it was exiting the inkjet printer category. What were the key business factors related to this decision?
Paul Rooke: That was certainly a tough decision. Lexmark is a company in transition; we’re undergoing a transformation from a hardware-centric to a solutions-centric company. Lexmark, over the last two or three years, has been divesting certain pieces of its business while investing in others. Lexmark actually started exiting its consumer inkjet business in late 2007.
The Lexmark brand was known because its inkjet printers were in many retail outlets for years. We moved inkjet technology upstream to become more of a business inkjet – a higher performance and value product. Lexmark’s inkjet printers were targeted to small and medium businesses through retail channels like Office Depot and OfficeMax, but Lexmark couldn’t generate enough business to sustain inkjet development. We decided it wasn’t going to be a long-term profitable model and decided to pull the plug and exit the remaining inkjet business. Lexmark is completely out of inkjet now, but it is making many investments in software businesses in order to become a solutions provider.
Inkjet is still a viable technology, which Lexmark still has. But Lexmark also has and it is heavily investing in laser technology, which is a very viable and competitive color technology even against inkjet.
EL: In mid-2012, Lexmark announced staff reductions of 1,700 employees worldwide; 550 were based in Lexington.
PR: Lexmark has essentially completed this reduction, except there is still a large manufacturing site in the Philippines that makes inkjet cartridges; by the end of 2015, we’ll ramp that operation down as that install base for inkjet winds down.
EL: Will the reductions in operational costs increase Lexmark’s profitability?
PR: The 1,700 people we talked about come out over time, and they start to generate savings. There are also savings beyond the personnel reduction because our engineers will not be spending dollars to create inkjet prototypes. So both labor and material savings contribute to reduced operational costs.
EL: Lexmark’s R&D investments increased from 8.1 percent of sales in 2007 to 10 percent in 2012. In what general business areas will Lexmark focus in the future?
PR: Lexmark is a technology company at its core, so the percent of revenue that it spends on R&D will remain in those ranges. Lexmark will keep spending on hardware technology, but you will see more investment in software products.
EL: Is the demand for copies declining?
PR: In the last several years, businesses have been looking for ways to cut costs and expenses. Reduced printing is one of those opportunities. Lexmark’s managed print services is targeted at helping companies optimize and reduce their printing expense. Printing is still an important medium for communication.
EL: At year-end, Lexmark increased its dividend to $1.20 per share – an approximate 5 percent return on its current stock price. Does the current dividend reflect Lexmark’s policy to return 50 percent of its free cash to shareholders?
PR: A little over a year ago, Lexmark described for investors its capital allocation framework, which was to return greater than 50 percent of Lexmark’s free-cash flow to investors or to reinvest in the business through acquisitions. For example, one of the first things Lexmark did was establish a dividend, but we are also returning capital through share purchases. Management feels very confident this is not a high-risk return of capital. We’ve done it for six quarters. We’re early in the world of issuing dividends, but Lexmark expects to be very consistent with its dividend and share purchase policies.
EL: How does the repurchase of stock benefit shareholders?
PR: It’s just another form of returning capital. Some investors prefer to receive a dividend check and others prefer stock repurchases that increase their share of ownership (percentage of outstanding shares) in the company. Some shareholders may elect to sell off some of their stock while maintaining their ownership share of the company. Some investment entities prefer dividends, others prefer share purchases, and some say they don’t care – just return cash.
The big part of communicating its capital allocation strategy was so Lexmark could be consistent with its approach of returning free cash, and investors would know so they could make their own decisions on whether or not to invest in Lexmark.
EL: Lexmark is expanding in software and managed print services. What is your outlook for these two business categories?
PR: It’s really all about Lexmark being a broader solutions provider. In addition to hardware, we’re adding software and services so Lexmark can offer a broader array of products to create solutions for customers. Management services and software are two areas of acquisition interest. Lexmark has acquired six software companies over the last couple of years. These companies are rapidly adding to Lexmark’s capabilities by bringing deeper industry expertise. Beyond the software, managed print services have grown rapidly. In fact, for 11 years straight, Lexmark has been a leader in that category.
In managed print services, Lexmark manages the total fleet – copiers, printers, multi-function devices, whatever. During the early days of Lexmark, we focused on competing by going deeper as opposed to wider against broad-based competitors like Hewlett-Packard. A very important focus for Lexmark is to be more knowledgeable and a thought leader, whether it be in retail, manufacturing, banking or insurance.
EL: Perceptive Software is a Lexmark company that specializes in electronic storage and retrieval of data. How is this division helping boost Lexmark’s revenues?
PR: Perceptive Software was our first software acquisition in mid-2010. Since then, we’ve added five other software companies that we’ve tucked underneath Perceptive Software. The combined entities ended 2012 at $162 million, so the Perceptive Software division has gone from $0 to $162 million in sales in just about two years. We’re very excited because Perceptive Software is giving Lexmark the capability to do more with our customers than we’ve ever been able to do before.
ACUO is our most recent acquisition and is a medical software. Lexmark started in healthcare with Perceptive Software. Perceptive manages documents beyond the information and electronic medical records (EMRs) that are in every hospital’s core system. Perceptive manages all medical documents (e.g. physician notes or information about a patient) and connects it to the core system.
With ACUO, Lexmark can bring in all the medical images that are scanned in a hospital and connect them with the core documents and EMRs to give a single, patient-wide view. That’s a powerful thing in the hospital system.
EL: Somebody has to go out and sell product. How does Lexmark manage its marketing effort?
PR: With a lot of these solutions, Lexmark has a direct sales force calling on the largest Fortune 1000 class accounts. In the medical market, we’re calling on the largest hospital systems in the world. Our sales executives are highly trained, very sophisticated, and they communicate directly in selling our proposition.
EL: What other general business categories might be of interest to Lexmark as future candidates for acquisition?
PR: Lexmark has its future strategy mapped out, which is to be a solutions provider in various vertical industries.
Lexmark identifies the things it has and the things it wants as well as gaps in technologies, industry presence or expertise. We look at natural adjacencies – services that are near our core. That strategy is leading Lexmark from printing to content and process management.
Each of these last six acquisitions has fit very neatly within various adjacencies and expands Lexmark beyond its printing core. We not only acquired sales people who have knowledge in a particular industry, but also gained very good R&D, software and service skills. Lexmark evaluates the people as much as the technology that it is acquiring.
EL: Lexmark’s fourth quarter 2012 GAAP (generally accepted accounting principles) net earnings were $6 million compared to 2011 net earnings for September of $69 million. How much did restructuring costs impact earnings?
PR: Lexmark’s earnings took a slide for the fourth quarter. We carefully evaluate non-GAAP earnings because many restructuring costs are one-time charges. Let me characterize. In 2012, Lexmark’s operating margin dipped to about 10 percent. Our goal is to be operating in an 11 to 13 percent range. We’ve targeted to operate in that range in 2013, albeit at the lower end of the range. A lot of the improved margin will come from further growth in these strategic areas plus some of the savings from restructuring.
EL: How is Lexmark helping to boost education in Kentucky?
PR: As a part of the whole community initiative coming from a technology company, Lexmark is very focused on the advancement of STEM (Science, Technology, Engineering and Math) in our school systems. In response, at its 20th anniversary a few years ago, Lexmark decided to make a major set of gifts. One was an investment with the University of Kentucky to renovate the old (Fayette public) library on the north side (of Lexington) into a STEM center to help teachers. It’s the UK and Lexmark Center for Innovations in Math and Science Education on Bryan Station Road. The center brings in high school teachers from all over Kentucky to help them learn how to teach science and math better.
We’re also doing an educational program with middle and high schools; every month Lexmark recognizes an outstanding science or math teacher in the Central Kentucky area. We walk into the classroom and surprise a teacher with a $1,000 check every month. It’s obviously rewarding to teachers, but more importantly the program helps create future scientists.
EL: According to Lexmark’s lawsuit filed on Feb. 12, 2013, Lexmark was the low bidder on the Commonwealth of Kentucky’s request for proposal for statewide managed-print services, but the state awarded the contract to Xerox Corp. What is the status of this litigation?
PR: First of all, large managed-print services deals are a key strategic piece of what Lexmark does. Lexmark is recognized as a leader in the managed print services for multibillion-dollar multinational companies around the world. Of course, when Lexmark had the opportunity to bid on services for the state of Kentucky, we thought we could provide superior services. Lexmark’s bid was quite competitive. The next closest bid was 50 percent higher in cost than Lexmark’s, which is a large difference, but Lexmark was not awarded the bid. We felt the low bid shouldn’t go uncontested, especially with a significant difference in cost – I think it was about $7.5 million over the life of the contract. Lexmark felt it should use the normal legal appeals process. Given that Lexmark is a world-class leader in managed print services, was the low bidder and was not being awarded the contract, it didn’t add up to us. That is why Lexmark filed the lawsuit. We’ll see what happens.
EL: How well has Commerce Lexington served Lexmark International during the years it has operated in Kentucky?
PR: I work with Bob Quick at Commerce Lexington. The chamber has been very supportive of Lexmark, and in fact when we went through the restructuring here in the back half of 2012, Commerce Lexington was one of the very first folks to reach out to see how they could help transition our people. Lexmark has a very positive view of Commerce Lexington and the role it serves in our community.
EL: How would you rate Lexington as Lexmark’s global headquarters?
PR: Our company has been in Lexington as IBM from the ’50s and as Lexmark for over 20 years (since 1991) when we were acquired from IBM. Lexmark has a long relationship in Lexington and is very happy with the business environment and the quality of our community. In any part of Lexington, you will find Lexmarkers out there serving in a number of community volunteer areas. Our employees take pride in their interaction with the community. Lexmark has a big responsibility to serve and give back to our community. As a location for international headquarters, Lexington is a smaller community, but it is very family oriented with a lot of diversity. Lexmark has been able to recruit employees to the area. There are a lot of advantages. Sometimes it may be a bit hard to get to and from Lexington, but we’ve gotten used to it and we find ways.
EL: What about the quality of the workforce? Do you find that beneficial?
PR: Lexmark recruits a large number of its employees from the universities here in Kentucky, but it also recruits from outside Kentucky. As an international company, Lexmark is hiring not only in Lexington but all over the world. Lexmark has been able to attract very good talent into Lexington. I think people would be amazed at the types of professional talent and expertise that we have inside Lexmark’s walls here in Lexington.
EL: With advanced manufacturing technology, is there a possibility that some of Lexmark’s hardware and toner products can again be economically manufactured in Kentucky?
PR: As Lexmark moves from being a hardware-centric company to a software solutions-centric company, we are shifting the mix of our production and services. Having said that, a majority of Lexmark’s hardware product is manufactured in Asia, and supplies components are manufactured regionally around the world. Being focused on broader solutions – beyond hardware – to encompass software and services, Lexmark is bringing a different set of skills into Lexington.
A lot of folks in Lexington may not appreciate the significant changes going on within the walls of Lexmark. People probably still think of Lexmark as the manufacturer of printers. We’ve moved well beyond that, particularly in the last two to three years, to a much broader range of solutions. Lexmark is a company in transition.
EL: Is any new construction planned?
PR: As Lexmark is undergoing its transformation in Lexington and divests its inkjet business, it is investing in its corporate headquarters. One of those investments is a daycare center for our employees. It’s quite exciting for them. A lot of employees spend long hours here because we’re international and we receive phone calls in the mornings and evenings. With employees trying to manage busy lives with families, we felt having a daycare center on site would be a wonderful addition to make childcare more convenient. We’ve also added a wellness center to help people with colds or flus so they can quickly get taken care of and manage their busy lives. So we’re excited about the new bricks-and-mortar on the Lexington site.
EL: It’s lonely at the top, and you’ve recently made some tough decisions. What advice would you give to others to help them deal with stress?
PR: The first thing is to surround yourself with good people. I’ve got wonderful fellow Lexmarkers here who help me with a lot of those decisions. In the end, somebody has to make the final decision. I have a wonderful family that I spend time with. I’ve got a new grandson and twins on the way, so my family is rapidly expanding. Between my family and my faith – I’m very active in my church – I do a lot of things that keep me grounded and balanced beyond just Lexmark 24/7.