Case Study

By: Zach Aldrich, Kacee Britton,

Kyrstie Ehm, & Nicholas Marra

April 16, 2015

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Table of Contents

Executive Summary: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Company Background: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Mission and Vision Statements: . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Vision Statement: . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Mission Statement: . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Imperatives and Objectives: . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Strategic Imperative: . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Financial Imperative: . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Strategic Objective: . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Financial Objective: . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Overall Financial Analysis: . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Asset Analysis: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Recommendations for Asset Analysis: . . . . . . . . . . . . . . . . . . . 16

Liability Analysis: . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Recommendations for Liability Analysis: . . . . . . . . . . . . . . . . . . 20

Equity Analysis: . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Recommendations for Equity Analysis: . . . . . . . . . . . . . . . . . . 25

Revenue Analysis: . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

Recommendations for Revenue Analysis: . . . . . . . . . . . . . . . . . . 29

Stock Price Analysis: . . . . . . . . . . . . . . . . . . . . . . . . . . 29

Conclusion: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

Remote Environment Analysis: . . . . . . . . . . . . . . . . . . . . . . . . . 31

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Economic: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

Technology: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

Legal: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

Industry Analysis: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

Define Industry: . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

Key Characteristics: . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

Market Size and Growth: . . . . . . . . . . . . . . . . . . . . . . 38

Geographic Scope: . . . . . . . . . . . . . . . . . . . . . . . . 38

Market Share by Key Players: . . . . . . . . . . . . . . . . . . . . 39

Technological Changes: . . . . . . . . . . . . . . . . . . . . . . 39

Cost Structure: . . . . . . . . . . . . . . . . . . . . . . . . . 39

Five Forces Framework: . . . . . . . . . . . . . . . . . . . . . . . . . 40

Buyer Power: . . . . . . . . . . . . . . . . . . . . . . . . . . 40

Supplier Power: . . . . . . . . . . . . . . . . . . . . . . . . . 41

New Entrants: . . . . . . . . . . . . . . . . . . . . . . . . . . 42

Threat of Substitutes: . . . . . . . . . . . . . . . . . . . . . . . 44

Degree of Rivalry: . . . . . . . . . . . . . . . . . . . . . . . . 45

Strategic Group Map Analysis: . . . . . . . . . . . . . . . . . . . . . . 46

Attractive Industry: . . . . . . . . . . . . . . . . . . . . . . . . . . . 48

Internal Analysis: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49

Imaging and Solutions Services: . . . . . . . . . . . . . . . . . . . . . . 49

Products: . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

Marketing and Distribution: . . . . . . . . . . . . . . . . . . . . . 51

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Competition: . . . . . . . . . . . . . . . . . . . . . . . . . . 51

Manufacturing and Materials: . . . . . . . . . . . . . . . . . . . . 52

Perceptive Software: . . . . . . . . . . . . . . . . . . . . . . . . . . 53

Solutions: . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54

Marketing and Distribution: . . . . . . . . . . . . . . . . . . . . 54

Competition: . . . . . . . . . . . . . . . . . . . . . . . . . . 55

Core Competencies: . . . . . . . . . . . . . . . . . . . . . . . . . . 55

Current Strategy Analysis: . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

Recommendations and Implementation: . . . . . . . . . . . . . . . . . . . . . . 58

Conclusion: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

Works Cited: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

Appendices: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

Global Environmental Factors: . . . . . . . . . . . . . . . . . . . . . . 63

Social Environmental Factors: . . . . . . . . . . . . . . . . . . . . . . 63

The Internet of Things: . . . . . . . . . . . . . . . . . . . . . . . . . 64

Inkjet Sale: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64

Lexmark Financial Statements: . . . . . . . . . . . . . . . . . . . . . . 65

Consolidated Statement of Financial Position: . . . . . . . . . . . . . 65

Consolidated Statement of Earnings: . . . . . . . . . . . . . . . . . 66

Consolidated Statements of Cash Flows: . . . . . . . . . . . . . . . 67

Ratio Calculations: . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

Value Chain Diagram: . . . . . . . . . . . . . . . . . . . . . . . . . 68

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Executive Summary:

Lexmark International, Inc. has received attention over the last four years due to their

ambitious acquisition strategy of several software and services-based companies. They have

started the transition from predominately hardware-based solutions to software and services-

based solutions, and they took the first step in selling off their inkjet technology in 2012 after

several years of noticing a decline in consumer print business.

Lexmark’s new strategy focus has been predominately on expanding their content and

process technology, industry expertise in healthcare, and geographic reach. This can be seen by

their most recent acquisition of Kofax Ltd., who specializes in content and process technology,

for $1 billion1 and several other acquisitions2. These acquisitions have increased restructuring-

related costs, and in analyzing Lexmark’s financials, there is an alarming trend in debt acquired

over the last four years.

Lexmark is currently positioning itself to compete in a competitive and growing Software

and Services Industry, and in order to compete with existing rivals, they need to ensure they can

serve the proper industries with their current solutions and services.

The right mix of software solutions coupled with industry expertise and global reach

places Lexmark in a competitive position with some of the largest players within the software

and services industry. Lexmark is well known for their stance on “creating customers for life”

and continues to pursue lifelong connections through understanding the customers and their

needs.

The following case study analyzes Lexmark’s financial position in addition to an analysis

of the software and services industry and the overall environment Lexmark operates in. The

1: This $1 billion in acquisition funds accounts for approximately half the acquisition cost over the last five

years. 2: See Acquisition Chart on p. 57 for a detailed look at all recent acquisitions.

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imperatives and objectives suggested will help Lexmark take a step back and focus on their

position within the Software and Services Industry.

Company Background:

Lexmark International, Inc. was founded in 1991 in Lexington, Kentucky when IBM

chose to downsize and sell its Information Products Division. IBM made a deal to sell Lexmark

(“Lex” represents “lexicon” and “mark” represents “marks on a paper”), its Information Products

Division, through the private investment group of Clayton, Dubillier, and Rice for approximately

$1.5 billion. The buyout was financed mostly through loans which left Lexmark, a newly

founded company, with $1 billion in debt. Martin Dubillier recognized that Lexmark was going

to need aggressive management to survive so he hired Marvin Mann, an IBM vice-president with

32 years of experience, to serve as Lexmark’s chairman, president, and CEO (“Lexmark

International, Inc. History” n.d.).

During Lexmark’s early years, approximately 70% of sales generated came from printers

and printer-related supplies. In this competitive landscape, Lexmark was able to generate $1.8

billion during its second year of operations and reduce its debt to $700 million. Lexmark

continued to push its inkjet printers, made its name in the laser printer market, and grew its

global presence (“Lexmark International, Inc. History” n.d.).

Today, Lexmark sells its products and services in over 170 countries and made

approximately $3.7 billion in revenue in 2014 (57% from international sales). The company has

switched its focus away from printers and hardware and into software and services. They have

acquired 13 software companies since 2010 which has allowed them to provide further solutions

for their clients. Lexmark competes in several software-related markets including managed print

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services, intelligent capture, healthcare content management, enterprise content management

(ECM), business process management (BPM), financial process automation, and enterprise

search. All of these solutions are “focused on helping Lexmark customers connect employees to

the most relevant information the moment they need it. (“Company Overview” n.d.)”

Mission and Vision Statements:

Lexmark has a “Vision and Values” page that lays out what concepts the company finds

to be most important. They do not have a mission statement and that is very important in order to

see what products and services the company provides as well as outline their purpose. Thompson

says a mission statement, “describes the enterprise’s present business and purpose - - who we

are, what we do, and why we are here”. (Thompson, p. 24)

Vision Statement:

“We, the employees, are Lexmark - a dynamic, global information technology

company. We have a vision: Customers For Life. To earn our customers' loyalty, we

must listen to them, anticipate their needs and act to create value in their eyes. We

want to be known for reliability, flexibility, responsiveness, innovative products and

services and exemplary citizenship. Growth, longevity and financial success will

naturally follow. We will make this happen in an enriching environment of trust,

cooperation and mutual respect.”

The statement describes the direction in which Lexmark is heading; this is important

when establishing a vision. The emphasis on customers and referring to them as customers for

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life shows that Lexmark is looking forward which is a great foundation. Another strong point is

the part where they state what they want to be known for. The statement: “growth, longevity and

financial success will naturally follow” shows that Lexmark is focusing on the things that will

make them a great company, letting the growth and success happen organically. Lexmark has

passion and a good sense of where they want to be moving forward.

There are two changes that should be made to the statement. The first one being: “We

want to be known for…” to “We will be known for…” This adds confidence and shows that

Lexmark will achieve the goals and objectives they have set, not just make an attempt. The

second change would be moving the first sentence from the vision statement to the mission

statement. The first sentence is stating who they are which would better fit in their mission.

After Lexmark’s vision statement they have different subsections for values, customer

commitment, employee satisfaction, corporate wealth, corporate citizenship, mutual respect,

integrity, long-term perspective, and excellence. There is a short paragraph describing each of

these, which is not needed. If Lexmark feels inclined to keep these values in their vision

statement, a simple list will do. This will remove most of the length, making it more attractive

and easier to understand. The reader will most likely disregard a page long vision statement. For

this reason, a short and concise statement is best.

As for adding a mission statement, this is important in order to show shareholders who

Lexmark is, what they do, and why they are here. The vision and mission are interrelated but

should be two statements of their own as each holds a different purpose.

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Mission statement:

“We, the employees, are Lexmark - a dynamic, global information technology

company. At Lexmark you will encounter a unique relationship as customers are our

purpose. We work to provide high quality products and personalized solutions to our

consumers.”

Overall, the vision, values, and mission (that was developed) describe Lexmark as a

company. These establish a sense of direction for the company. The statements are related as

they both focus on the customer as the foundation. The customer fits into the aspirations of the

business as well as drives the purpose behind how the company conducts its operations. Lexmark

really emphasizes the consumer in all aspects of the business; without customers there would be

no Lexmark. Also, customers are the source of innovation leading to new ideas, products, and

services.

Imperatives and Objectives:

Strategic Imperative:

1. How can Lexmark use its recent acquisitions to position itself in a way that

promotes competitive advantages relative to industry competition?

From 2010 to the first part of 2015 Lexmark has made 13 acquisitions. In these acquisitions

they have acquired companies with a variety of industry specialties ranging from but not limited

to Business Process Management, Cloud-enabled management software, automated business

process software, Healthcare connectivity, and Medical Imaging Exchange software. Each

specialty promotes a new aspect of the Software and Services Industry that Lexmark can engage

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in. As key rivals Xerox, Hewlett-Packard, and others actively engage in many of the same

acquisition activities, it is crucial that Lexmark leverage their diversified industry holdings in a

way that strengthens the company collectively.

Financial Imperative:

2. Will Lexmark be able to continue their current pace of acquisitions while still being

able to meet all current debt obligations?

Given the current industry “norm” of making acquisitions, Lexmark has been placed in a

slightly difficult spot due to their current market share size. Rivals such as Xerox and Hewlett-

Packard have much larger balance sheets in connection with their market share size. This gives

each company the potential of making acquisitions without being forced to rely on debt financing

to the same degree as Lexmark. Due to the smaller size of Lexmark, in order to engage in

acquisition activities at a competitive level, the company has had to use a variety of debt

financing activities such as Senior Note issuances and revolving lines of credit. With each new

acquisition the company increases its current debt load. At some point, given the company’s size,

they will no longer be able to continue acquisition activities at a rate consistent with their key

rivals.

Strategic Objective:

1. Lexmark will align current acquisitions in a way that allow synergies to be realized,

promoting a competitive advantage for the company as a whole.

The wide variety of acquisitions that the company has made throughout recent years give the

company both access and proficiencies in a variety of specialized areas of the Software and

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Services Industry. In many cases, the proficiencies that Lexmark acquired are related. For

example, at the end of 2014 the company acquired GNAX Healthcare which specializes in

medical imaging exchange software. This specialization was enhanced by the company’s 2015

acquisition of Claron Tech, Inc. which specializes in medical image viewing, distribution,

sharing, and collaboration software. Moving forward, it will be important that Lexmark combine

the capabilities of these two acquisitions in a way that creates a core competency in medical

imaging solutions. The company could then take this core competency, and with the support of

PACSGEAR, Inc., an acquisition in 2013, enhance the healthcare connectivity of its medical

imaging solutions software. The alignment of these three acquisitions would create a competitive

advantage for Lexmark as they work to position themselves appropriately relative to their key

rivals.

In additional to the synergies available in the company’s healthcare acquisitions, there are

numerous others that are active in the business process management field. These include Pallas

Athena (2011, specializing in BPM, DOM, and process mining and discovery software), ISYS

(2012, specializing in search solutions, and text mining), and Readsoft AB (2014, specializing in

automated business process software). Each of these companies are engaged in similar activities.

As outlined in the healthcare example above, it is vital that Lexmark align each of these

acquisitions in a way that allow them to combine specializations and create another core

competency for the company through the capitalization of strategic fits.

The two core competencies created above are necessary as the company manages the

wide range and variety of acquisitions they have made in recent years. Combining forces will

allow the company to better position its distinct segments within the Software and Services

Industry and capitalize on the associated competitive advantages the repositioning will create.

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Financial Objective:

2. The company will continue to make acquisitions that align with the current

company strategy and provide competitive advantages while giving special

consideration to the amount of debt used.

As the company works to position itself competitively relative to key rivals it is crucial that

they make acquisitions of companies with distinctive competencies in the Software and Services

Industry. The company has been successful in this strategy with more than 13 acquisitions since

2010. The problem that Lexmark currently faces is the methods with which they have financed

all of these acquisitions. Unlike some of their key rivals, Lexmark does not have a massive

balance sheet with large quantities of cash available for investment in acquisitions. Because of

this fact, the company has used varies forms of debt financing to complete their acquisition

activities.

Given the current strategy of the company is to reposition themselves within the Software

and Services Industry it is understandable that the amount of debt on the balance sheet has

increased. However, given the company does have to use debt financing in order to make their

acquisitions, the time has come that they look to evaluate how important a new acquisition is to

the company’s current strategy. For example, Lexmark has already made three acquisitions of

medical imaging software related companies. It is unlikely that, at this point in time, they will

need to make further acquisitions in the field of healthcare. That said, there may be other

companies that currently specialize in aspects of healthcare software that could further enhance

Lexmark’s healthcare position.

Therefore, as the company continues to execute on its repositioning strategy it needs to take

special consideration of further acquisitions. As it stands, the company has a debt load

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approaching two times its current equity position. For this reason, all further acquisitions need to

be both cost justified and help Lexmark realize its current repositioning strategy within the

Software and Services Industry.

Overall Financial Analysis:

Financially, Lexmark is in a tough position. In the past few years they have been making

numerous acquisitions as they shift into the Software and Services industry. In doing so they

have taken on a substantial amount of debt and therefore eclipsed their current optimal capital

structure. Additionally, top line revenues have not seen a steady increase as a result from these

high margin industry acquisitions. In the company’s most recent earnings call top management

forecasted negative total revenue growth for the year 2015. “We expect full year revenue to be

down 3% to 5% …” (Lexmark(b), p. 5). Much of this is caused by the negative impact on the

company’s decision to exit its inkjet manufacturing operations and headwind in foreign currency

exchange markets.

Asset Analysis:

At year end December 31, 2014, Lexmark recorded total assets of $3.633 billion. This is

up slightly from $3.616 billion and $3.525 billion in 2013 and 2012, respectively. Key

contributions to the year-to-year increase come from Goodwill3 and associated intangible assets.

The $76 million increase in 2013 was the result of four acquisitions4 while the $151.1 million

increase in 2014 was the result of two acquisitions5. It is important to note that all Goodwill

acquired during 2013 and 2014 was assigned to the Perceptive Software segment of the

3: The excess of the total value paid over the fair market value of the acquired assets.

4: AccessVia, Inc., Twistage, Inc., Saperion AG, and PACSGEAR, Inc.

5: Readsoft AB and GNAX Healthcare

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business. This designation indicates that the company is keen on keeping its computer hardware

services and software solutions services separate. Even so, the increase in Goodwill is expected

to continue in 2015 with the acquisitions of Claron Technology, Inc. and Kofax Ltd. These

increases are expected as Lexmark continues expansion efforts into the Software and Services

Industry.

A second positive influence on the company’s total assets comes from the steady increase

in Cash and Cash Equivalents; $309.3 million, $273.2 million, and $212.4 million in 2014, 2013,

and 2012, respectively. The increase in this quantity strengthens the company’s financial position

as they continue to engage in acquisition activities. With regards to Cash and Cash Equivalents

and Marketable Securities there is one area of concern. As of December 31, 2014, 93.75%6 was

held by foreign subsidiaries. If the company were to need these funds domestically they would

be subject to repatriation taxes amounting to approximately $306.425 million. The silver lining

of this concern is that two recent acquisitions, Readsoft AB and Saperion AG, where of

international origin, indicating the origin of a portion of total cash and cash equivalents as well

as the use of these international funds to acquire Kofax Ltd.

Despite the positive impacts on total assets, the company does report two line items with

a negative three year trend. These are Property, Plant, and Equipment and Inventories. The three

year decline in each relates directly to the company’s 2012 Restructuring Actions7. These actions

were announced in January and August of 2012. With the inkjet exit the company derecognized

$3.0 million in Inventories and $27.8 million in Property, Plant, and Equipment, net. As the

restructuring actions wind down the company forecasts a 40% year-to-year decline in inkjet

6: $933.9 million in Cash and Cash Equivalents and current Marketable Securities, $875.5 million held

internationally. 7: 2012 Restructuring Actions include exiting the development and manufacturing of the Company’s

remaining inkjet hardware, with reductions primarily in the areas of inkjet-related manufacturing, research

and development, supply chain, marketing and sales as well as support function. These actions are expected

to be completed by the end of 2015.

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related revenue. This current downward trend in Property, Plant, and Equipment and Inventories

is expected to stabilize as the company continues its shift into software and services.

As seen by the varied fluctuations in the company’s various asset accounts it is hard to

determine the effectiveness with which these assets can generate sales revenue. In order to

properly analyze the company’s assets the following ratios were calculated; Fixed Asset

Turnover Ratio8 and Total Asset Turnover Ratio9. Furthermore, each ratio will be compared to

two different industry averages, the Computer Hardware Industry10 and the Software and

Services Industry11. These industry averages will be used in all ratio analysis hereafter.

The first ratio, Fixed Asset Turnover Ratio, suggests that the company is nowhere close

in respect to the two industry averages. Specifically the ratio is 4.720, 4.515, and 4.493 for

Lexmark compared to 10.314, 10.365, and 11.239 for the Computer Hardware Industry and

12.422, 13.372, and 13.199 for the Software and Services Industry in 2014, 2013, and 2012,

respectively. The fact that the company’s ratio is only a third of the ratio for each industry

8: Fixed Asset Turnover Ratio - Measures the extent to which a firm is using existing property, plant, and equipment

to generate sales.

= Sales / Net Fixed Assets 9: Total Asset Turnover Ratio - This ratio indicates how effectively a firm uses its total resources to generate sales.

= Sales / Total Assets 10

: Computer Hardware Industry – Xerox, Hewlett-Packard, and Canon 11

: Business Support Services Industry – IBM, Pegasystems, Inc., and Open Text

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suggests that the company struggles to utilize its fixed assets. This struggle is likely due in part

to the current industry shift the company is undergoing. The fixed assets needed to operate in

each industry differ enough that the company has not yet reached a point where they are utilizing

all fixed assets optimally for each industry’s operations.

In opposition to the challenges created by fixed assets, the company shows strength in its

Total Asset Turnover Ratio in comparison to the two industries. Specifically the ratio is 1.021,

1.014, and 1.077 for Lexmark compared to 0.801, 0.769, and 0.773 for the Computer Hardware

Industry and 0.803, 0.747, and 0.736 for the Software and Services Industry in 2014, 2013, and

2012, respectively. A higher ratio indicates that the company is able to convert each dollar’s

worth of assets into more sales. In relation to each industry, Lexmark does a better job of

utilizing its total assets to generate sales revenue.

Recommendations for Asset Analysis:

As the company continues to make acquisitions, the total quantity of assets are going to

increase as can be seen in the Goodwill analysis earlier. The current problem is that the company

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does not appear to be reinvesting funds internally. A good way of evaluating this is by

comparing the company’s Capital Expenditures to its Depreciation Expense. Over the past three

years, Lexmark has reported $136.3 million, $167.4 million, and $162.2 million in Cap Ex and

$184.5 million, $189.3 million, and $229.6 million in Depreciation Expense in 2014, 2013, and

2012 respectively. The fact that depreciation expense is larger than Cap Ex each year indicates

that the company is not investing internally. Some of this discrepancy can be explained by the

inkjet exit and sale of associated assets. Even so, it may be time for the company to reallocate

some funds away from acquisitions and into internal investment projects geared toward covering

each year’s depreciation expenses and protecting its current assets.

Liability Analysis:

Over the last three years both current liabilities and total liabilities have risen. Accrued

liabilities have provided a portion of this increase. From 2013 to 2014 there was a $6.1 million

increase due primarily to a $33.8 million increase in deferred revenue. This increase is caused by

the company’s conscious decision to increase its subscription based offerings. For example, in

4Q14 the company signed a five year managed print services agreement with Alberta Health

Service in Alberta, Canada worth approximately $100 million in services. The initiative to

increase software subscription revenue translates directly into increased deferred revenue.

Additionally, the company experienced an $11.8 million increase due to its cash flow hedging

activities12. These increases were somewhat offset by a decrease of $28.1 million and $13.3

million in Compensation accruals13 and Marketing programs, respectively.

The company currently has two issuances of Senior Notes outstanding, 2020 Senior

12

: Cash flow hedges include foreign exchange options generally with twelve month expirations. As Lexmark has

acquired international companies and continues to expand operations internationally, the use of foreign exchange

options helps protect against the potentially negative impacts of changes in the exchange rate. 13

: Legal matter settlement amounting to $14.4 million in expenses.

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Notes and 2018 Senior Notes. Combined these notes amount to $699.7 million in debt liability

for the company. The 2020 Senior Notes raised $400.0 million. A portion was used to extinguish

the 2013 Senior Notes in the amount of $350.0 million. The remainder will be used to fund share

repurchases, fund dividends, finance acquisitions, finance capital expenditures, and investment in

subsidiaries. Additionally, at the start of 2014 the company amended its current multicurrency

revolving credit facility14. These two activities combined give the company a sizable amount of

available funds to continue its current acquisition plans. The creation of varied debt instruments

is a positive sign to investors that the company is committed to its current expansion objectives.

In order to understand the impacts of the debt that the company has undertaken the

following ratios will be used and compared to the Computer Hardware Industry and Software

and Services Industry; Current Ratio15, Debt Ratio16, and Debt-to-Equity Ratio17.

14

: Amended current $350 million 5-year senior, unsecured revolving credit facility. New agreement amounts to

$500 million maturing in 2019 with the ability to increase the limit to $650 million if certain conditions and

circumstances are met. 15

: Current Ratio - The amount of cash that each dollar of current assets must be converted into in order for the

company to satisfy the claims of short-term creditors exclusively from existing current assets.

= Current Assets / Current Liabilities 16

: Debt Ratio - Measures the proportion of a firm's total assets that is financed with creditor's funds.

= Total Debt / Total Assets 17

: Debt-to-Equity Ratio - Relates the amount of debt financing to the amount of equity financing.

= Total Debt / Total Equity

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First, in terms of the Current Ratio, Lexmark is performing adequately relative to both

industries. In the past two years it has produced a current ratio both above each industry average

and 1.0. This suggests that, if at a particular point in time the debt obligations of the company

came due, they would have the resources necessary to pay off their current liabilities.

The debt ratio provides an insight into the degree of debt leverage a company has taken

on and the potential risks the company faces from said debt. In any case it would be concerning

to see a debt ratio above 100%. Fortunately, Lexmark is not to that point. They reported a debt

ratio of 65.2%, 62.2% and 63.6% in 2014, 2013, and 2012 respectively. In comparison to the

industry averages this is several times higher18. Currently this is not an area of concern though.

The debt that has been taken on by the company has been used to acquire certain companies that

not only result in a larger asset balance for Lexmark but also allows the company to entire new

markets.

.

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: Computer Hardware Industry: 34.4% in 2014, 34.1% in 2013, and 33.5% in 2012

Software and Services Industry: 22.7% in 2014, 17.6% in 2013, and 17.4% in 2012

20

This debt increase can be seen further in the company’s debt-to-equity ratio. Given

Lexmark has been aggressive in growing the company it is expected that their debt-to-equity

ratio will be relatively high. In comparison, Lexmark far exceeds the two industry averages.

Specifically the ratio is 187.6%, 164.3%, and 175.1% for Lexmark compared to 99.8%, 93.5%,

and 111.3% for the Computer Hardware Industry and 141.6%, 72.2%, and 75.6% for the

Software and Services Industry in 2014, 2013, and 2012, respectively. The year-to-year increase

for Lexmark and the Software and Services industry is indicative of the current shift to software

solutions by numerous companies.

Recommendations for Liability Analysis:

At first glance it does appear concerning that the company has such a large degree of debt

on its balance sheet. However, the level of debt makes sense with regard to the current expansion

activities of the company. In order to finance acquisitions Lexmark has chosen to taken on debt

through Senior Note issuances and Revolving credit agreements. In that regard, their large

portion of debt is justified. However, based on their current financial position their debt-to-equity

ratio (Financial Leverage) is above the optimal capital structure19 of 139.85% calculated using

19: Optimal Capital Structure Calculation: Ka = [ E / (B + E) ] ( ke) + [ B / (B + E) ] ( ki )

Ke = 18.26% ki = 6.27% E = $1,263.2 million B = $699.7 million

21

the weighted cost of capital method. It may prove beneficial for the company in the coming

months and couple of years to consolidate some of their debt and decrease their financial

leverage to a point that falls closer in line with their optimal capital structure as previously noted

in the financial objectives.

Equity Analysis:

Total Stockholder’s Equity has fluctuated over the last three years; $1,263.3 million,

$1,368.3 million, and $1,281.5 million, in 2014, 2013, and 2012, respectively. There are a couple

components of stockholder’s equity that do not fluctuate but rather show the same trend over the

last three years. Those components are Treasury Stock and Accumulated Other Comprehensive

Loss. Treasury stock has risen as a result of the share repurchase activities20 of the company. In

2013 the company repurchased 2.7 million shares worth approximately $82 million. In 2014, 1.9

million shares worth $80 million were repurchased. These are the latest repurchases in a series

dating back to 1996. Since that time the company has repurchased 112.2 million shares worth

$4.76 billion. Additionally, over time the company has retired treasury stock21 and reclassified it

as authorized but unissued shares of Class A Common Stock.

Accumulated other comprehensive loss has seen a negative trend in the last three years.

From 2013 to 2014 the amount of loss rose 160%. This large increase was due to a $71.2 million

adjustment in foreign currency traslation22 which was offset somewhat by the $15.9 million

20

: One of the company’s objectives is to return 50% of free cash flows to investors. The company has chosen to

use share repurchases as a leading component of their objective. This action not only benefits shareholders but

also the company because, as the number of shares outstanding decreases, the respective Earnings per Share and

Dividend per Share calculations improve due to a decrease in the calculations denominator. 21

: Retirement of 44.0 million, 16.0 million, and 16.0 million shares of treasury stock in 2005, 2006, and 2008,

respectively. 22

: Currency Translation – 11% decrease in Brazilian Real, 12% decrease in Mexican Peso, 12% decrease in

Euro, and 18% decrease in Swedish Krona.

22

impact of the company’s cash flow hedging activities. As the company continues to expand

internationally, the potential for negative foreign currency translation adjustments increases.

Now, in order to compare Lexmark’s Stockholder’s Equity to that of the two industry

averages the following ratios were computed; Payout Ratio23, Dividend Yield24, Return to

Stockholder’s Equity25, Market-to-Book Value26, and Equity Multiplier27. When looking at the

payout ratio it is easy to see that Lexmark is far above the two industry averages. This indicates

that they are paying a greater portion of dividends compared to earnings. In 2014 it is interesting

to note that the Payout ratio is above 1.0. This would suggest that the company paid more

dividends per share than earnings per share for the year. This was possible in part because of the

$400.0 million Senior Note Issuance in 2014. As noted earlier, a portion of those proceeds would

be used to pay dividends. Next, similar to the payout ratio, the company’s dividend yield exceeds

the averages of both industries. It has also remained relatively stable at just over 3% since 2012.

In many cases, it is important for the company to show strong dividend yields because Investors

focused on dividend income look to this ratio when making decisions. They may feel more

comfortable investing in a company that shows stable dividend returns.

In comparison to both industries, Lexmark has struggled with their Return to

Stockholder’s Equity. Specifically the ratio is 6.26%, 19.13%, and 8.40% for Lexmark compared

to 14.01%, 14.02%, and -10.7% for the Computer Hardware Industry and 51.92%, 43.3%, and

23: Payout Ratio - Indicates the percentage of a firm's earnings that are paid out as dividends to its common

shareholders.

= Dividends per Share / Earnings per Share 24

: Dividend Yield - Measures how much cash flow investors are receiving for each dollar invested in the

company.

= Expected Dividend per Share / Stock Price 25

: Return on Stockholder’s Equity - Measures the rate of return that the firm earns on stockholders' equity.

= Net Profit Margin x Total Asset Turnover x Equity Multiplier 26

: Market-to-Book Ratio - Used to determine the value of a company by comparing its book value to market

value.

= Market Price per Share / Book Value per Share 27

: Equity Multiplier - Is a measure of a company's financial leverage. Key in analysis of Return on Stockholders'

Equity.

= Total Assets / Stockholder’s Equity

23

36.67% for the Software and Services Industry in 2014, 2013, and 2012, respectively. The

degree of variance between Lexmark and the industry averages is due in large part to the

difference in Net Profit Margin for each. From 2012 to 2014 the company reported Net Profit

Margins far below the industry average. This has been caused by a decrease in net earnings

relative to sales due to an increase in operating expenses. The increased operating expenses are

likely caused by the current industry transition the company is going through. Therefore, the

lagging returns to stockholder’s equity are currently justifiable given the company’s activities.

24

Since 2012, the company’s Market-to-Book ratio has moved in line with the Computer

Hardware Industry average. Each fluctuates slightly year-to-year but remains between 1.0 and

2.0. Alternatively, the Software and Services Industry reports a ratio of 6.64, 5.39, and 8.50 in

2012, 2013, and 2014, respectively. It is slightly concerning that Lexmark has not seen a steady

rise in there Market-to-Book ratio in light of all their recent acquisitions in the Software and

Services Industry. This would suggest that, given the current level of equity and shares

outstanding in the company, the market does not feel the acquisitions are providing increased

value at a rate that is comparable to companies already in the Software and Services Industry.

Finally, as mentioned earlier, the degree of financial leverage that the company is

engaged in is well above the level that provides the lowest weighted cost of capital. This would

suggest, as recommended, that Lexmark should look to decrease its debt load to some degree.

When comparing the Equity Multiplier to each industry average it is interesting to find that

Lexmark is currently the lower of the three since 2012. Specifically the ratio is 2.75, 2.64, and

2.86 for Lexmark compared to 3.01, 2.74, and 2.83 for the Computer Hardware Industry and

3.42, 3.16, and 4.76 for the Software and Services Industry in 2014, 2013, and 2012,

25

respectively. This is a positive sign for Lexmark given they have completed 13 acquisitions from

2010 to 2015. It shows they have been able to use additional sources of funding such as free cash

flows and cash and cash equivalents rather than relying primarily on debt financing.

Recommendations for Equity Analysis:

Moving forward, Lexmark needs to work on two areas in order to improve their current

equity position. First, Net Profit Margins over the last three years have had a negative impact on

the return on stockholder’s equity. The company should look to reduce operating expenses by

aligning the value chain activities of its recent acquisitions to promote increased earnings.

Second, the degree of cash flow hedging is not adequate enough to offset the negative impacts

the company has been experiencing with foreign currency translation. As the company continues

to expand internationally there is a need to reduce the company’s exposure to exchange rate risk.

26

Revenue Analysis:

While there is no trend in Total Revenue year-to-year it is important to note the current

trends in the company’s revenue segments. Product Revenue makes up 86.3%, 88.7%, and

90.8% of Total Revenue in 2014, 2013, and 2012, respectively. The proportion makeup alone

shows that the company’s revenue streams are moving away from products and into services.

This is supported by the fact that over the last three years, Product Revenue has been declining

from 2012 to 2014 while Services Revenue has increased over the same period. These trends

align closely with the shift into the Software and Services Industry as seen by the inkjet exit and

acquisition of software solutions based companies.

At this time, the small degree of volatility in Total Revenue is not overly concerning

given the company’s industry switch. However, the increase in Operating Expenses year-to-year

are having a negative impact on Net Earnings. As the company makes acquisitions it is

understandable that Operating Expenses are going to rise. The issue is that they are not rising

proportionately with Total Revenue and thereby causing a decrease in Net Earnings. In order to

properly examine these concerns the following ratios were calculated; Gross Profit Margin28, Net

Profit Margin29, and Return on Investment30.

Gross profit margin for the last three years has remained relatively close to the Computer

Hardware Industry average, in both cases ranging from 35% to 40%. However, in the Software

and Services Industry the average is slightly greater than 60% each year. After four years of

28: Gross Profit Margin - Measures the relative profitability of a firm's sales after the cost of sales has been

deducted.

= (Sales – Cost of Sales) / Sales 29

: Net Profit Margin - Measures how profitable a company's sales are after all expenses, including taxes and

interest, have been deducted.

= Earnings After Taxes (EAT) / Sales 30

: Return on Investment - Measures a firm's net income in relation to the total asset investment.

= Earnings After Taxes (EAT) / Total Assets

27

acquisitions in the Software and Services Industry it is odd that Lexmark has not been able to

increase its gross profit margin to a level somewhat in between the averages of each industry.

This would suggest that the company is not currently experiencing the revenue gains from the

Software and Services Industry in enough magnitude to offset hardware and supplies revenue.

Net profit margin shows nearly the same result. Each year Lexmark is lagging behind

both industry averages. Specifically the net profit margin is 2.13%, 7.24%, and 2.83% for

Lexmark compared to 7.33%, 7.83%, and 2.79% for the Computer Hardware Industry and

28

11.94%, 21.89%, and 10.54% for the Business Support Services Industry in 2014, 2013, and

2012, respectively. The major increase for Lexmark in 2013 was caused by the positive impact

on net earnings of the $100.0 million inkjet sale. From this margin calculation it is clear why

Lexmark is making the shift into the Software and Services Industry. The net profit margin on

sales is drastically higher. Given that, it is concerning that the company has not yet seen a

positive impact on profit margins as a result of their numerous acquisitions.

Return on investment for Lexmark again tells a similar story. In comparison to each

industry average, the company is behind. In 2013 the company’s ROI was 7.24%; relatively

competitive with each industry average. When the proceeds from the inkjet sale are removed the

actual ROI falls to 5.2%. This adjusted ROI falls back in line with Lexmark’s relative

performance in 2012 and 2014. Given the current activities of the company, there are not any

major expectations of a large ROI. The continuous acquisitions are causing total assets to

increase. At this point, there has not been a relative increase in net income to match the increase

in total assets.

29

Recommendations for Revenue Analysis:

It is clear that Lexmark is currently struggling to generate revenues as can be seen in their

Gross Profit Margin and Net Profit Margin. A concerted effort needs to be made to reduce the

current costs of revenue and operating expenses associated with net income. To do this, the

company will need to take special consideration of realizing potential synergies with each

acquisition. These synergies will help the company begin to operate in a manner that will

generate revenues in line with companies currently competing in the Software and Services

Industry. Additionally, the company needs to find ways to increase its ROI primarily through

increased income associated with the assets it currently has on its balance sheet rather than

continuing to add to those assets.

Stock Price Analysis:

Over the last five years the company’s stock price has seen a 21.7% increase.

Alternatively, from August 2012 to present the stock has climbed 149.86%. The reason for this

dramatic difference is that when Lexmark announced the exit from the development and

manufacturing of inkjet technology in August, 2012 the stock plummeted to $17.33 per share, its

lowest level since the Great Recession. Now, since that time the company has completed four

acquisitions in 2012, four in 2013, two in 2014, and two in early 2015. The climb in the stock

price reflects investor’s approval of these acquisitions. This approval was again shown March

25th, 2015 when Lexmark announced the acquisition of Kofax Ltd. for $1 billion. When the

market opened that morning, the stock price jumped 10%.

30

Although the stock price growth is positive, investment firms such as Zacks currently

rank Lexmark as a Sell citing expected negative EPS growth and Revenue growth. (Quote

Overview, 2015) Analysts at Reuters have a similar outlook. Based on their analyst

recommendation, a majority rate Lexmark as Underperform while a smaller set give the rating of

Hold. (Reuters, 2015) Underperform is supported by the negative expected revenue growth for

2015 while the Hold rating is supported by the steady stream of acquisitions the company

making.

Conclusion:

From the financial analysis above there is one overarching area of concern that the

company needs to evaluate. It would appear that the company has become over-engaged in their

acquisition activities. This can be seen by the debt ratio which exceeds their optimal capital

structure for minimizing the weighted cost of capital. Even though the company has availability

to a large amount of debt financing it is time some of their investment activities shifted

internally. Given the company is showing depreciation expense that exceeds their capital

31

expenditure, it is clear that they are not meeting the current internal needs. Therefore, it is time

for the company to slow down its current acquisition trajectory and focus on improving operating

efficiencies between all subsidiaries.

Additionally, the company’s gross and net profit margins are substantially below both

industry averages. It is expected that, as the company expands into the Software and Services

Industry, the profit margins will climb. The challenge is, Lexmark has been acquiring companies

in this landscape for the past four years and these margins have not risen to their expected level.

This suggests that the company is not currently realizing the full potential of strategic fit between

all subsidiaries likely caused by the blinding focus of simply making acquisitions. Therefore, in

the coming months and couple of years it will be vital that Lexmark wind down the speed of

their acquisitions and begin focusing on properly aligning each subsidiaries within the

organization and promoting increased operating efficiencies.

Remote Environment Analysis:

Economic

There are many factors that fall under the economic environment that a company should

carefully evaluate. They change for every industry and company but there are several main

factors that the majority of companies need to analyze. These include the propensity of people to

spend on a specific product, inflation rates, trends in growth of gross national product and gross

domestic product, unemployment rates, the general availability of credit, and the level of

disposable income for the target market. For example, GDP is the market value of the goods and

services that an economy produces during a certain period. In general, when the economy is

growing there will be greater demand for a business’ products and services thus causing GDP to

32

rise. Of course, there are exceptions to this such as the demand for inferior goods during times of

economic struggle.

One thing that the Fed has done in an attempt to manufacture economic growth is

implementing monetary policies like Quantitative Easing I, II, and III. The Fed began pumping

money into the economy to pull the country out of the recession. These strategies increased the

money supply and decreased interest rates which would, in theory, increase inflation and reduce

the value of the dollar. GDP began to increase and companies started to see growth.

Unemployment rates began to decline and the overall economic environment began to change.

This is when Lexmark began acquiring companies to aid in their major industry transition.

Capitol was easy to find and lines of credit were issued at much lower rates. These economic

conditions encouraged Lexmark to spend money and they did just that, acquiring 13 companies

in four years.

In analyzing the current economic state, market expectations are forecasting a decline in

GDP in coming quarters. This is largely because the health and value of the Euro is declining and

therefore it makes the dollar more valuable. A more valuable dollar hurts net exports and in turn

has a negative effect on GDP. Specifically, net exports are affected negatively because as the

value of the dollar increases domestically produced goods become more expensive in

international markets. Consequently, goods and services produced in the U.S. become more

expensive for other countries to purchase.

The Euro decreasing in value is counteracting the Feds strategies of pumping money into

the economy and decreasing interest rates. With more dollars circulating, one would think that

the value of each dollar would decrease but because “value” is relative, the dollar is actually

increasing in value despite the increase in supply. This chain of events has a strong impact on

33

companies like Lexmark because the decrease in net exports naturally drives international sales

down.

An example of how remote environment analysis affects the way a company is operated

and the direction the company decides to go in is Lexmark’s recent acquisition. The industry that

Lexmark is in is going through a major transition period. Much of the industry, including

Lexmark, is moving from hardware and printing services to software and IT, which is shifting

their industry into software and services. Lexmark, along with other companies, are making this

transition mostly because of the declining growth in hardware services.

Their recent acquisition of Kofax Ltd. for $1 billion solidified and accelerated this

transition in the enterprise software business. Lexmark has made this transition because they

have analyzed the economic environment and recognize that the future of the industry is going in

that direction. Lexmark will double its software business serving corporations and other large

enterprises through the acquisition of Kofax Ltd. According to the stock prices, analysts and

investors seem to like this decision as Kofax Ltd. shares gained $3.43, more than 45%, to $10.93.

Lexmark rose $2.31, or close to 5.7%, to $43.10. IDC Market also named Lexmark as a leader in

smart multifunction products and managed print services three consecutive times. The moves

that top line management at Lexmark is making seem to be moving the already transitioning

company in the right direction. This acquisition is not only a major move into the software

industry but after further research it also brings another benefit to the table that will be touched

on later.

The health of the economy is a factor in almost every industry but how much it affects a

certain industry varies greatly based on the goods and services that are being sold. Software and

Services is right in the middle of the pack in terms of how drastic this affect is. For example, in

34

February 2000, the U.S. economy was booming and Lexmark’s stock reached an all-time high of

$121.63. In contrast to this, in July 2009, the economy was dealing with the recession and

Lexmark stocks sold at an all-time low of $14.43. This is a massive drop, but it is important to

remember that almost every company’s stock took huge hits and stock prices fell drastically

during that time.

Paper production as a global commodity is decreasing and that is a major part of

Lexmark’s transition from paper to software-based services. The world of paper printing is

slowly declining. According to Lexmark, “Based on industry information, Lexmark management

believes that the overall distributed printing market declined slightly in 2014. The distributed

printing industry is expected to experience flat to low single digit declining revenue overall over

the next few years” (Lexmark(a), p. 6) Paper production has been declining and will continue to

decline for the foreseeable future. There are a lot of reasons for this change, a lot of which is

technology based and will be touched on in the next section. Additionally, the world is trying to

become more energy efficient and the “Green Movement” is in full swing31.

The economy as a whole has a massive effect on any company and Lexmark is no

exception. The monetary and fiscal policies implemented to pull the country out of the recession

greatly altered Lexmark’s strategies. They saw an economy start to grow as the money supply

was being increased and saw capital that was easier to obtain at lower interest rates. Lexmark

began purchasing other companies to assist and accelerate their long-term plan in transitioning to

software and services. Analysts are now forecasting a few slow quarters and with Lexmark’s

high amount of debt and multitude of acquisitions it will be interesting to see how this affects

their strategy. A substantial decrease in spending is encouraged in preparation for the forecasted

31: See Social Environmental Forces (Appendix, p. 63)

35

economic struggles. With the near-future of the economy looking sub-par, Lexmark cannot

continue acquiring companies at this rate because they already have too much debt to manage.

Technological

Lexmark sold their inkjet technology in 2012 and by the end of 2015 will be completely

out of the inkjet division. Top management has analyzed the technological factors in their

environment analysis and saw that the future of their business was not in inkjet printers, amongst

other things. Lexmark has now fully committed to transitioning from hardware to software. Top

management at Lexmark saw this change coming years ago and started making large changes to

the company’s structure and direction in order to cope with the ever changing world of

technology. The major transition has been in full swing for years, as Lexmark has acquired

many software companies that have skills in the realm of software and services.

The sale of the inkjet technology did not mark the end of Lexmark’s print and imaging

division, but it is declining. Over the last three years, Product Revenue has been declining while

Services Revenue has increased over the same period, as noted in the financial analysis. These

trends align closely with the shift into the Software and Services Industry as seen by the inkjet

exit and acquisition of software solutions based companies. Lexmark knows that paper

production and the need for these printing and imaging solutions is still relevant but the demand

is decreasing. This was the beginning of a long transition period from print and imaging to

software and services and the recent addition of Kofax Ltd. is another step in that direction. With

this being said, Lexmark will continue to manufacture parts and supplies for inkjet and provide

customer service in this area.

36

Another part of the technological environment is the advances in cloud based storage

systems. This somewhat new technology is very popular in storing and organizing information

and what can be seen as an overlap in Lexmark’s products and services which is creating some

cannibalization of current sales. Because Lexmark is making the industry change, they are seeing

their software support services and specifically, things like cloud storage, cannibalize their print

and imaging sales. This is largely because consumers are storing documents, pictures, etc. in the

cloud as opposed to printing them. Although this is not ideal, Lexmark understands that they are

trying to transition from a product based market in paper and printing to a service based market

in software and services so this cannibalization is somewhat expected. Lexmark is also okay with

this overlap because it is temporary and they are moving from a declining industry to a new,

growing industry.

Legal

One thing that Lexmark is aware of and has to account for is the possibility of certain

countries (mostly in Europe) imposing fees on devices that enable the potential reproduction of

copyrighted content. Lexmark says that they have taken the necessary steps to address the risks

related to this issue. Depending on the outcome of European legislation, this could have a large

financial impact on Lexmark. This is something that is out of Lexmark’s control but it appears

that top management is doing what they need to in order to be prepared for the worst-case

scenario. If the legal system were to agree with the publishers and enforce this change, there

would be a fee for every page printed. This would add a substantial expense for Lexmark and

would undoubtedly decrease their profit margins.

37

The Kofax Ltd. acquisition touched on earlier also has some legal benefits for Lexmark.

Kofax Ltd. is based in Irvine, California but originated in Bermuda. This allows Lexmark to

deploy overseas cash without the large tax bill creating a substantial competitive advantage over

many tech companies that don’t have this luxury. This will increase margins for international

affairs and substantially decrease money spent on taxes.

Industry Analysis:

Define Industry

Lexmark’s recent acquisition of Kofax Ltd. solidifies that they are focusing their efforts

on the Software and Services Industry. This industry includes a vast array of companies,

offering a variety of products and services. These include personal computer operating systems,

office productivity suites, network security applications, processing services, information

technology consulting and outsourcing services, among others. In particular, this industry can be

broken down into two main components: software and services offered via perpetual license

agreements and another which combines software and services offered as custom-made solutions

to a vertical market’s reoccurring needs (Clark, p. 1). An important aspect of this industry to

note is how global it is with several of the key players being multinational. This industry has

been consolidating over the last few years due to how concentrated the software industry is with

a few dominate players holding a relatively high global market share. These large players have

been acquiring smaller, niche players to broaden their portfolios (Shields, p. 13). Many of these

companies offer niche products and services, therefore do not often compete with each other

directly. The industry also has a cost structure that is focused in marketing and R&D (Shields, p.

15).

38

Key Characteristics

Market Size and Growth

As stated earlier, the Software and Services Industry is a global industry, therefore the

global market analyzed will include North America, South America, Western Europe, Eastern

Europe, Middle East and Africa (MEA), and Asia-Pacific. This industry experienced moderate

to strong growth from 2010-2014 with a compounded annual growth rate of 6.2%. In particular,

the global software and services industry grew by 3.2% in 2014 reaching a value of $2,946.3

billion. Broken down further, IT services segment accounted for $1,318.1 billion, the Internet

Software and Services segment accounted for $1,309.5 billion, and the Software segment

accounted for $318.7 billion of the $2,946.3 billion in 2014. This growth is expected to

decelerate over the next several years, with an anticipated compounded annual growth rate of

4.9% from the years 2014-2019, driving the industry value to $3,748 billion by 2019 (“Global

Software & Services”, p. 7).

Geographic Scope

North America has been a very strong portion of the global software and services

industry with several key, multinational players (i.e. IBM, Hewlett-Packard, Microsoft, etc.). In

particular, the Americas (North and South) account for 34.8% of the global software and services

value. Asia-Pacific accounts for 31.4% of the global industry, trailed by Europe with 24.3%, and

finally MEA with 9.6% (“Global Software & Services”, p. 10).

39

Market Share by Key Players

To further break down this industry, key players need to be analyzed. IBM is currently

the leader in this industry generating a 2.9% share of the industry’s value, followed closely by

Microsoft (2.4%), Google Inc. (1.9%), Hewlett-Packard Company (1.9%), and other (90.8%).

This may seem alarming considering the majority of the industry’s value comes from “other,”

but the Software and Services Industry is full of small to medium-sized firms. In analyzing

Lexmark International Inc. in comparison to key players, it can be seen that they account for

approximately 0.13% of the global industry’s value32 (“Global Software & Services”, p. 11).

Technological Changes

Due to the rapid increases in data processing speeds, software applications and interfaces

can be developed and deployed, increasing the efficiency and productivity of nearly every

organization. Today, even small businesses depend on an assortment of software and services.

This being said, the demand for software and services is seen to be strong (Clark, p. 1).

Additionally, the “cloud” and “Internet of Things” projects are impacting the industry. The key

players are either buying or building technology to support their client’s cloud and “Internet of

Things” projects33 (Shields, p. 17).

Cost Structure

The primary expenditures of firms in the Software and Services Industry are accumulated

through marketing and R&D. In fact, the marketing expenditure often surpasses the R&D

expenditure with companies spending, on average, 15-25% of their revenues in sales and

32: Based off Lexmark’s 2014 Statement of Earnings

33: Appendix, p. 64

40

marketing activities. There is also support costs that include the costs associated with customer

support and help desks (Shields, p. 16).

Five Forces Framework

This section analyzes the five competitive pressures outlined by Michael Porter’s Five

Forces Framework. Attempting to understand the five competitive pressures (buyer power,

supplier power, new entrants, threat of substitutes, and degree of rivalry) and intensity of

competition within the Software and Services Industry will give an indication of profitability and

attractiveness of the industry both now and in the future (Thompson et al., p. 49).

Buyer Power

There are two major factors that play into whether buyers can exert competitive pressures

on industry members: (1) degree to which they have bargaining power and (2) level of price-

sensitivity. Buyers that have strong bargaining power can limit industry profitability by

demanding certain prices or additional services. When a buyer has price sensitivity it creates a

price ceiling for the industry because raising prices could cause additional revenue loss

(Thompson et al., p. 61).

The buyers within this industry differ in size, from smaller, individual customers to

multinational companies and government agencies. The smaller end of the market is more

fragmented, with the smaller, niche firms serving the needs of small businesses while also

targeting specific industries. The larger buyers help strengthen the buyer power because the loss

of business from one of these customers could have a detrimental impact on revenues, especially

for these smaller players that make up 90.8% of the industry’s value.

41

Next, contracts made between firms and buyers lead to potential switching costs for

buyers. Some IT service contracts can last up to several years although consulting contracts tend

to be shorter. In the data processing and outsourcing market segment long-term contracts are

common, meaning potential switching costs for buyers.

For larger customers, there tends to be a bidding war between the key players securing

greater buyer power. If there are several key players offering similar products and services, the

buyer has the power to start negotiating reduced prices, additional services and features, and

overall better payment terms. This can negatively impact industry revenues.

Finally, name recognition tends to be significant for customers, especially when it comes

to electronic data processing and outsourcing. Buyers need to ensure that the company can

provide a reliable service, which often leads them in the direction of the key players within the

industry. This therefore reduces their buying power considerably. Overall, there is a moderate

degree of buyer power within the Software and Services Industry (“Global Software & Services,

p. 14).

Supplier Power

When suppliers have abundant bargaining power they can negatively impact industry

profitability by charging industry members higher prices. The strength of their bargaining power

is derived from several factors: (1) whether the demand for the product is high and they have a

limited supply, (2) whether they provide an input that enhances the overall performance of the

industry’s product, (3) whether switching costs are high for industry members, (4) whether the

item supplied is a bulky fraction of the cost of the industry’s product, (5) whether industry

members are major customers of suppliers (Thompson et al., p. 58).

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A major input for the Software and Services Industry is staff with technical knowledge

and expertise. Industry players rely on these qualified employees and high rates of turnover can

impact the business and be costly. For example, the average salary for Software Engineers in the

U.S. is $75,000-$90,000 a year. This shows the importance of bargaining power because

suppliers are able to command higher salaries. Also, this would equate to a very high switching

cost for a company, with the employees viewed as suppliers of expertise.

Other inputs would include hardware components and are often purchased form sole

suppliers. These suppliers are often large companies offering differentiated products, resulting in

substantial supplier power. Even so, there are some companies, like IBM, that show some

backward integration in the value chain with their own hardware and software, which does

reduce their reliance on outside suppliers.

Overall, given one of the largest inputs for the Software and Services Industry is human

capital and hardware components are frequently purchased by large suppliers, the supplier power

in the industry is strong (“Global Software & Services”, p. 15).

New Entrants

New entrants to a market can bring several things with them, including production

capacity, the desire to secure their place in the market, and resources. The seriousness of the

competitive threat of their entry depends on two classifications: (1) expected reaction of

incumbent firms to new entry and (2) barriers to entry. Those players who have already been

established may launch defensive maneuvers to maintain their place in the market and make it

difficult for a new entrant to become profitable. Some of these maneuvers include price cuts,

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increased advertising, and new product features. A barrier to entry exists when it is difficult for

a new player to break into the market (Thompson et al., p. 54).

In this particular industry, entry on a smaller scale is attainable. In recent years, small

players have experienced growth due to government and commercialized institutions turning to

third parties for IT support. Also, buyers are currently seeking to cut costs, and data processing

and other business processes have increasingly been outsourced to specialists so they can focus

on core activities.

The market also has a dominate theme of mergers and acquisitions among public IT

software companies. An example would be the acquisition of Business Objects, an enterprise

software company specializing in business intelligence, by SAP or the acquisition of Taleo, a

database vendor that is known for “talent intelligence”, by Oracle. These smaller, niche players

are attractive to the key players in the industry looking to better their competencies.

Large companies in this particular market have significant economies of scale in

processing and can overall offer more services. Despite this, small companies can compete by

specializing in industries and offering customized services. Unfortunately, established

companies may be unwilling to trust these smaller, niche players. This offers the large market

players a leg up.

Because there are so many players in this market, entry into this industry will have a

more successful outcome by the expansion and diversification of existing products. In fact, this

trend has pushed software product companies to look to diversify from competition, turning

towards a more service-oriented product and solutions market.

Barriers to entry in this market include name recognition of large players who are more

likely to attract and retain a strong customer base. If a company wants to enter this industry, they

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must have considerable expertise. However, there are new business models that do not require

massive capital investment such as web based to free software models. It is relatively difficult for

these smaller players to compete with the Microsoft and Google’s of the industry, but they can

become a niche player and a go-to provider for their specific area.

Also, because the key players have a strong customer base already, it makes switching

costs high which creates challenges for start-ups. This coupled with a market that is constantly

changing and subject to technical advancements makes it difficult for newcomers. In order for a

company to be successful, they need to be able to anticipate such changes and regulations. For

example, data processing services for financial institutions are often tightly regulated which may

be unattractive for a new player. All of these pieces contribute to strong barriers to entry.

Overall, the Software and Services Industry has low capital investment with popularity in

niche markets. This is balanced by key players having significant economies of scale and name

recognition which keeps some new entrants at bay. A crowding out effect may take place in the

near future due to too many new entrants, but for now the likelihood of a new entrant into this

industry is moderate (“Global Software & Services”, p. 16).

Threat of Substitutes

Companies in any one industry face competitive pressure from companies in a closely-

related industry whenever a buyer views the products of the two different companies as

substitutes for one another. Whether the competitive pressure from the substitute products are

weak or strong depends on three basic factors: (1) whether substitutes are available and

agreeably priced, (2) whether a buyer views the substitute as comparable or better, and (3)

whether the costs a buyer incurs in switching is low or high (Thompson et al., p. 57-58).

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The leading alternative to many of the services offered in this industry group is to use in-

house staff to provide such services or work on tailored software. In previous economic

downfalls, many companies started to rely on their existing employees rather than third-party

service providers.

Even with a minor threat of substitutes, services offered by industry players provide

several key advantages to buyers. For example, important employees may be relieved from

performing these non-core processes, which in turn allows the company to concentrate on its

core activities. Also, business’ can become more flexible by not investing in the assets necessary

to perform software and related service activities and this can reduce response time to

environmental changes. Essentially, this allows those with the best knowledge to perform

specific activities. The downside to this comes in the loss of internal business process know-

how. Overall, given the occasional economic downturns while simultaneously balancing the

benefits of allowing a company to focus on core competencies, there is a low to medium threat of

substitutes in this industry (“Global Software & Services”, p. 18).

Degree of Rivalry

The degree of rivalry among competing sellers within an industry depends on several

factors such as when buyer demand is growing slowly, when it becomes less costly for buyers to

switch companies, when products become less differentiated, when there is excess supply, when

the number of competitors increase and they become more equal in size, and when exit barriers

are high and keep businesses from leaving (Thompson et al., p. 49-52).

The Software and Services Industry is split, even though there are large, multinational

players (IBM, Microsoft, Hewlett-Packard, Google, etc.) who hold approximately 9.8% of the

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market share. The key players are experiencing increasing pressure from diversification by other

smaller companies in the industry. This trend has caused large players to attempt diversifying

typically through acquiring smaller, niche companies to attract specific industries. By

diversifying and offering several products and services (i.e. printing products and services,

personal computers, IT infrastructure, software, services, etc.), companies can help ease the

pressures on themselves.

However, many of these large players offer very similar services and offerings, despite

diversification. This causes increasing pressure to battle with pricing and offerings. On a

positive note, the rivalry within this industry is alleviated by positive growth in this area in recent

years. Overall, this industry has a moderate to strong degree of rivalry, especially amongst the

key players (“Global Software & Services”, p. 19).

Strategic Group Map Analysis

The first strategic group map looks at the differentiation of solution offerings in

comparison to market share within the global software and services industry. In analyzing each

individual company’s revenue for the year 2014 in comparison to the $2,946.3 billion estimated

value for the industry in 2014, the results show that Hewlett-Packard (4% market share) and IBM

(3.2% market share) lead in market share and solution offering differentiation. Next, notice how

Xerox (0.7% market share) and EMC Corporation (0.83% market share) share relative market

share size and solution offering differentiation. Finally, Lexmark (0.13% market share) and

OpenText (0.06% market share) come in on the smallest end of the market share and product

differentiation scale. In analyzing this strategic group map, there seems to be a correlation with

the number of solution offerings and market share, although it is not perfect. The larger the

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solution offerings, the larger the market share is, generally speaking. It is important to note that

approximately 90% of industry value is made up of small to medium-sized firms which are why

the market share percentages seem so small.

The second strategic map focuses on the comparison of Operating Profit Margin (OPM)

and the number of industries served by each company. The OPM is the operating income over

the net sales, and it tells analysts approximately how much a company makes on each dollar of

sales. As expected, IBM leads with the highest OPM which is likely a result of scale economies.

Their pricing can be more competitive because they can afford to lower their pricing while being

able to cover expenses. Also, note that they have the highest industry representation.

Surprisingly, OpenText has an equivalent OPM (18%) to IBM even though it has a much smaller

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market share. This suggests that OpenText has significant pricing power. EMC Corporation

follows right behind with an OPM of 17% even though they have the smallest industry

representation. Perhaps their strategy to focus on fewer industries has given them a leg up, even

when placed next to Hewlett-Packard which has a much larger market share and greater industry

representation. Finally, Xerox, HP, and Lexmark all fall within similar industry representation

and OPM (6%, 6%, and 4% respectively). On the strategic group map, all three companies

overlap therefore their approximate location is marked by a red dot. Note that Lexmark has the

lowest OPM, but this is most likely due to their increased interest on the debt they have accrued

through their numerous acquisitions.

Attractive Industry

In analyzing the five forces, the Software and Services Industry seems to be an attractive

industry, especially for the key and niche players. Yes, there is a moderate level of competition,

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especially among the top players, but this industry is primarily marked with small to medium-

sized players. Being a niche player that specializes in a particular industry creates competitive

power and even makes a company “acquisition-worthy” to a large player. Next, there seems to

be low to moderate threats of substitution. The companies that specialize in software and

services allow other companies to focus on their core competencies instead of pulling their

attention and people away from the task at hand which tends to save time and money in the long

run. Even when there is an economic issue, companies tend to rely on these specialized IT and

software operations. Finally, there seems to be a low to moderate threat of new entrants due to

the large players holding a large amount of market share. Even so, the niche players continue to

succeed in their efforts. Overall, the Software and Services Industry is growing and is expected

to grow 27.2% by the year 2019 which is encouraging for currently positioned software

companies and start-ups (“Global Software & Services”, p. 12).

Internal Analysis:

Lexmark has two types of product lines that they provide to the market. The first market

they serve is Imaging Solutions and Service (ISS). The other product is content and process

management. They provide products as well as services.

Imaging Solutions and Service

The Imaging Solutions and Service segment of Lexmark works to continually provide

high-quality, technologically-advanced products and solutions at a competitive price. They

continue to work with large corporations, small to medium businesses and the public. This

segment of Lexmark works to differentiate itself from competitors to maintain a competitive

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advantage. With the ISS sector they do this by continually looking for issues within the industry.

By addressing these issues, they are able to help customers more efficiently than competitors.

Products

Lexmark offers a variety of monochrome and color laser printers, supplies, software

applications, and solutions to help businesses with their efficiency. “ISS laser products are core

building blocks for enabling information on demand” (Lexmark(a), p. 8). These are key products

for businesses because they can effectively capture documents as well as deliver quality printed

products. The businesses who utilize these products in combination with Lexmark’s other

services have to potential to dramatically improve their business productivity.

Their printers and products can print many sizes and varieties. Their printing products are

the monochrome laser, color laser, dot matrix products, as well as supplies and service parts for

their printers. The printers can print up to 70 pages per minute which is ideal for many larger

businesses. Lexmark no longer produces inkjet MFPs or AIOs but they still provide services and

supplies for consumers continuing to use this technology. “Lexmark management believes that

ISS is an industry leader with regard to the recovery, remanufacture, reuse, and recycling of used

laser supplies cartridges and service parts…” (Lexmark(a), p. 8).

When a business purchases an ISS product from Lexmark, they also receive the expertise

of the company’s employees. Lexmark has substantial customer service. Before a company

purchases products and/or services Lexmark will go through and assess their situation then make

recommendations on the products the particular company should purchase. Later on, customers

are able to see how these purchases have created a more efficient work environment. The

company works to cater to the specific needs of each business customer.

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Marketing and Distribution

Lexmark relies on marketing teams to create demand among businesses for their

products. As stated above, they are reaching out to large corporations, small and medium

businesses, as well as the public. The industries primarily focused on are financial services,

retail, manufacturing, education, government, and health care. ISS is able to reach an extensive

amount of industries because they are focused on customizing their services to meet the

consumer’s needs. With ISS, the business will be able to do a variety of things such as printing

electronic forms, handling media, intelligent capture duplex printing, and other document

workflow solutions. ISS delivers the products once purchased through a distributor and reseller

network. This network includes IT resellers, direct marketing resellers, and copier dealers.

The supplies for the inkjet products are available to the customer at multiple distribution

centers. For Lexmark (in 2014) most of their inkjet supplies were sold through authorized

company suppliers. Customers were not seeking out as many discount store chains, other

distributors, or online dealers. ISS has many alliances in which they also sell their products.

Competition

ISS is continually looking to expand and develop new products to keep up with

competition so they can be competitively priced. Competition in the market is very strong and

Lexmark, at times, struggles to keep up. The company is not able to compete with some of the

larger companies such as the market share leader of laser printing, Hewlett-Packard. The larger

companies have an advantage as they have greater financial, marketing, and technological

resources. Due to the resources larger companies have, they are able to offer lower prices.

Lexmark has a hard time keeping up with the pricing pressure. Other competitors they are

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watching out for include; Canon, Ricoh and Xerox, Brother, Konica Minolta, Kyocera, Okidata,

and Samsung.

Manufacturing and Materials

The ISS section of Lexmark operates manufacturing centers in Lexington, Kentucky,

Shenzhen, China, and Geneva, Switzerland. They also have company owned manufacturing sites

in Boulder, Colorado and Juarez, Mexico. Along with these locations they also have

customization centers in all major locations in which they are currently operating. When it comes

to manufacturing, ISS maintains direct control over many of its more complex processes that are

essential to the business model such as the manufacturing of toner and photoconductors.

Although they keep a lot of manufacturing processes in-house, some are outsourced to certain

partners with technical expertise. These partners have facilities located in China. They provide

ISS with almost all of its printer production capacity. ISS evaluates strategies and their success

so they can continually make adjustments as needed.

For the laser printer, specifically supplies and operations, take place in Boulder,

Colorado, Juarez, Mexico, Zary, Poland, and Shenzhen, China. Geneva, Switzerland is the

control center for these printer supplies. The cartridges are produced by a combination of in-

house and third-party manufacturers. Inkjet supplies are produced in Lapu-Lapu City,

Philippines and Juarez, Mexico. They are also manufactured by a combination of in-house and

third-party. The overall manufacturing control center for inkjet supplies is also in Geneva,

Switzerland.

There are many components throughout the manufacturing process. Some of the

components used throughout the process are semiconductors, electro-mechanical components

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and assemblies, and raw materials. Most of these are available from multiple suppliers, in which

ISS works to create unique supplier relationships. They develop a relationship with a preferred

supplier which, in many cases is the only way to ensure consistency and quality of products.

Some of their printer engines and finished products are sourced from OEMs. They work to

provide continuous supply so there is not a shortage of supplies when they are needed. When

more demand occurs than was projected, ISS can have some shortages in supply. They try to

compensate for this by air shipping, as needed, to make products available faster. In return this

can negatively affect their operations expenses. In a slower market ISS can decrease their

inventory as demand will be lower. To improve these processes ISS works to execute supplier

managed inventory agreements. This helps their supply chain move much more smoothly and

enhance the customer’s overall experience as well. This helps assure products are ready at the

time of purchase for the customer. There were a large amount of printers purchased under SMI

agreements in 2014.

Perceptive Software

Perceptive Software is the software and services side of Lexmark. This allows businesses

to manage their everyday processes and information more efficiently. In 2014 Perceptive

Software acquired two companies, giving them the ability to reach out and help more businesses

and industries. The two companies are ReadSoft and GNAX Health. This allows them to help

with more accounts payable services as well as healthcare. Overall, Perceptive Software offers

solutions to specific industries. There has been a noticeable increase in the amount of healthcare

solutions offered.

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Solutions

The specific industries that they offer solutions in are; healthcare, government, retail,

manufacturing, higher education, and financial services. They also work to provide services for

accounting, human resources, and contracts of these specific industries. Perceptive Capture and

Perceptive Search allow businesses to improve the functionality of accounts payable, accounts

receivable, order management/benefits processing, as well as transcript processing for higher

education. This allows them to extract data and integrate the information with existing business

processes and systems.

Marketing and Distribution

Like the ISS segment, Perceptive Software creates teams to promote and generate

demand for the products. They group marketing teams by industry sector focusing on three large

sections: healthcare, public, and commercial. The headquarters for Perceptive Software is in

Lenexa, Kansas. There are also other offices globally located in Denver, Colorado, Ashburn,

Virginia, Bloomington, Minnesota, Pleasanton, California, Berlin, Germany, and Helsingborg,

Sweden. There are some Perceptive Software employees located in various ISS office locations

as well.

Perceptive Software does allow third party programs to distribute the products as well as

OEM programs. When the customer purchases the software they can pay for the product up front

and then continue to pay for any ongoing charges or services they may want to add. Another

method of payment that customers can take advantage of is a subscription basis, where they pick

a specific period of time in which they will choose to make payments either quarterly or

annually. This is cheaper for the customer upfront and they can continue to focus on their own

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services and customers. Lastly, customers can choose to subscribe on a recurring basis which

takes place quarterly or annually.

Competition

Perceptive Software is a leading developer of content and process management products

and solutions. The company offers “Content in Context” which allows them to automate almost

any business process of a company. Again, they continually work to provide for the specific

business and industry needs to ensure their processes run as smooth as possible. The company is

a leading developer in an industry that is highly competitive. They compete with a large number

of ECM providers specializing in document management, web management, and document

imaging, workflow, and capture. For the Enterprise Content Management (ECM) competition, it

is a little larger with companies like EMC’s Documentum, OpenText, IBM’s FileNet. Business

Process Management (BPM) competitors include Appian, IBM, OpenText and Pegasystems.

Core Competencies

There are many core competencies that Lexmark possesses. One of which is that they are

a global company. This gives them an advantage over companies who are not globally located.

This allows them to operate in different markets with their products at a higher volume. They

also have many locations for customers to receive products and services since they are located in

various geographic locations based on their consumers. Lexmark also does a combination of

outsourcing and in-house manufacturing. They are not set on doing one or the other which

provides them with flexibility down the road. The alliances they have created with other

manufacturers and suppliers allow them to potentially outsource even more in the future, leading

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to possible decreased manufacturing costs and increased productivity. They remain competitive

with larger businesses that provide the same services because they offer a wide range of software

and solutions to a variety of segments including healthcare, government, retail, and many others.

Lexmark is able to maintain a vast amount of services and segments due to extensive R&D.

Evaluation of customer needs and wants is taken into consideration as well as developing new

products to remain competitive in the industry. Lexmark takes pride in looking into its customers

operations and basing their production on the consumer’s current needs.

Current Strategy Assessment:

Lexmark has a business model that is founded on investing in new technologies to

develop and sell printing and imaging as well as content and process management solutions.

This includes printers, multifunction devices and software-based solutions with the overall

objective being growth in their installed-based hardware devices and software licenses and

installations, which helps with recurrent printing supplies sales and software subscription and

services revenue. The profits that Lexmark derives from sales helps fund investments in new

product, solution, services and software technology, all of which allow Lexmark to maintain a

competitive edge.

Lexmark continues to broaden its MPS and content and process management software

solutions and anticipates that their revenue will become predominantly software and services-

based. Their expansion can be seen through their acquisitions of Perceptive Software, Pallas

Athena, Brainware, Isys, Nolij, Acuo, AccessVia, Twistage, Saperion, PACSGEAR, ReadSoft,

GNAX Health, Claron, and Kofax Ltd., all of which add to Lexmark’s technology strength and

provide content and process management solutions for key industries. These acquisitions solidify

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a core strategic component of Lexmark’s future as Lexmark transitions out of a predominantly

Hardware Services Industry focus and into the Software and Services Industry. This is also

solidified through Lexmark’s exit out of the development and manufacturing of their inkjet

technology which they sold to Funai in 2013.

Lexmark’s other segment, ISS, continues to focus attention on capturing supply and

service annuities that are produced by mononchrome and color laser printers and multifunction

(MFP) products. ISS has been focused on printing and document process solutions, therefore has

relied on original equipment manufacturer agreements to pursue further business opportunities

with alliance partners including Toshiba, Xerox, Cannon IV, Dell, and Hitachi. These partners

are considered reselling partners and typically sell add-on solutions that work with their clients

existing user interfaces and platforms.

They have initiatives that include expanding their line of workgroup, color and MFP

devices, strengthening industry solutions including enterprise content management, business

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process management, document object model, and intelligent data capture and search solutions.

All of which will help in growing the MPS business, and expanding the rate of joining in new

market opportunities.

Recommendations and Implementation:

Pulling on the strategic and financial imperatives outlined earlier there are two key

recommendations that Lexmark must consider in the near future. First, Lexmark is actively

working to reposition themselves within the Software and Services Industry through the

numerous acquisitions over the past four years. In order to ensure this repositioning is completed

effectively and efficiently it would serve the company well to split itself into two separate

operating entities. This split will allow each operating segment to better position themselves

within their designated operating industry.

Furthermore, this recommendation is supported by the news of Hewlett-Packard splitting

into Hewlett-Packard Enterprise, focused on software and services, and HP Inc., focused on

personal systems and printing markets. Given Lexmark is currently operating in two segments,

ISS and Perceptive Software, the recommendation of formally giving each segment its own

“company” so to speak, seems possible. By splitting, Lexmark as a whole would allow each

segment to operate in a fashion that is conducive to success and proper positioning within each

industry. Additionally, in nearly every case, the acquisitions the company has made over the

years have all been accounted for in the Perceptive Software segment. Therefore, as it stands, the

company is already aligned in a way that would make the split a relatively easy process to

complete.

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Implementation of this recommendation will either be difficult or simple depending on

how top management chooses to allocate resources and personnel. For example, given all of the

company’s recent acquisitions there are numerous overlaps in management and executive

positions. These overlaps should be the first places the company looks to for individuals who

would be good candidates to fill new executive positions created by the split. Outside of top

management there should not be a great deal of overlap in operations given each segment

competes in different industries and sells different products and services. If personnel can be

properly allocated the split into two new entities should run relatively smoothly.

The second recommendation moving forward is centered around the level of current debt

that the company is dealing with. As mentioned in the financial analysis section, Lexmark has a

current debt-to-equity ratio that exceeds it optimal capital structure. This issue has come about

from the flurry of acquisitions that have been made and the various debt instruments that have

been used for financing. If the company were currently able to see larger percentage increases in

their top line revenues and net profits then it would be arguable that the current debt load is

justified as the company works to shift into a new industry. This is currently not the case though.

The company is taking on more debt while not posting noticeable increases in revenues.

Therefore, based on the financial imperative it is likely time that the company should stop

its current steam of acquisitions. In some respects the rate of acquisitions can be seen as a “land

grab.” There are several large companies all fighting to take market share of the same industry.

To do these, these companies are acquiring large numbers of niche companies currently within

the industry in order to keep their competitors from gaining too large of a market share. The

challenge for Lexmark is that the competition has larger balance sheets and is able to continue

making acquisitions. In order to ensure the financial strength of the company it is time that

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Lexmark shift its focus into developing and integrating its current acquisitions in an effort to

improve the company’s revenues and income streams.

The challenge for implementation will come from the need for each acquired company

and its personnel to integrate with one another. It will take a great deal of leadership at both the

top tier and mid-level management to foster the changes in operations and cultures that may be

necessary to ensure each entity operates as a collective unit. From a financial standpoint the

implementation should be relatively simple. In many cases the funds that were previously being

reserved for future acquisitions will now be used to help train employees and streamline

operations between subsidiaries.

Conclusion:

Over the last decade, the Computer Hardware Industry has seen a large shift in consumer

preferences. These shifts have created large challenges for companies such as Lexmark. In an

age where physical printing is being substituted for cloud based data management and storage

and file sharing, Lexmark has been forced to realign its operations. This has caused Lexmark,

and may others, to expand into the Software and Services Industry.

Lexmark has taken large steps in recent years to keep up with the dramatically changing

business environment. The numerous acquisitions are a testament to the company’s commitment

to a new strategic plan despite the potential concerns regarding the financial implications. For

this reason, it will be imperative that the company focus on the available strategic fits between

subsidiaries as they continue to expand into new niche markets within the Software and Services

Industry.

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As the recommendations noted, it would be beneficial, in the next year or two, for

Lexmark to split its current operating segments. The split would promote further strategic fit

efficiencies and allow the company to be more competitive in a rapidly maturing international

technology industry.

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Works Cited:

Clark, Charles. "Industry Analysis: Computer Software and Services." Value Line. N.p., n.d.

Web. 06 Apr. 2015.

Funding Universe. "Lexmark International, Inc. History." N.p., n.d. Web. 11 Apr. 2015.

"Global Software & Services." Software & Services Industry Profile: Global (2014): 1-36.

Business Source Premier. Web. 5 Apr. 2015.

Lexmark(a). “10-k”. 3 Mar. 2015. Web. 19 Mar. 2015. < www.lexmark.com>.

Lexmark(b). “Q4 2014 Lexmark International Inc. Earnings Call – Final.” 27 Jan. 2015. Web. 21

Feb. 2015. <www.lexmark.com> .

Lexmark(c). "Company Overview." N.p., n.d. Web. 11 Apr. 2015.

“Quote Overview.” Zacks. 27 Mar. 2015. Web. 27 Mar. 2015.

<www.zacks.com/stock/quote/LXK>

Reuters. “Lexmark International Inc (LXK.N) Analysts. 27 Mar. 2015. Web. 27 Mar. 2015.

<www.reuters.com/finance/stocks/analyst?sybol=LXK.N>

Shields, Anne. "Must-know: An Overview of Enterprise Software." Market Realist: 1-23. 1 July

2014. Web. 06 Apr. 2015.

Thompson, Arthur A., Margaret A. Peteraf, John E. Gamble, and A. J. Strickland. "Evaluating a

Company's External Environment." Crafting and Executing Strategy: The Quest for

Competitive Advantage: Concepts and Readings. 19th ed. N.p.: n.p., n.d. N. pag. Print.

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Appendices:

Global Environmental Factors:

There are also many global factors that Lexmark must analyze and prepare for to

maximize global market share and profits. One thing that Lexmark is clearly aware of is the

money lost in currency exchange rates. In 2014 alone they lost $56.4 million in revenues due to

unfavorable exchange rates. These changes in exchange rates ranged from 11% to 18%. Every

year, due to Lexmark’s global presence, they lose millions from unfavorable exchange rates but

2014 marked a jump from $30.1 million to $56.4 million in losses.

As stated earlier, the acquisition of Kofax Ltd. has many positive aspects for Lexmark but

in terms of global affects it allows Lexmark to deploy overseas cash without the large tax bill.

Many competitors face these taxes when dealing with overseas transactions and now that

Lexmark doesn’t have that problem, it gives them another competitive advantage over such

companies

Social Environmental Factors:

Social issues affect Lexmark in the way that the world is moving away from paper

consumption and printing as a whole. Not only is technology moving in a different direction, so

are the social beliefs of many people. As stated earlier, the “Green Movement” is in full swing

and people are trying to make decisions with sustainability as a major factor. Paper consumption

causes deforestation amongst other detrimental issues on the environment and global awareness

of these consequences is at an all-time high.

Regardless of someone’s decisions on sustainability, people are not printing like they

used to. People are storing pictures and documents on computers and never printing out the

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physical document or picture. This is a social change that has occurred over the past 10-15 years

that greatly affected Lexmark’s paper division. This is one part of why Lexmark has made the

changes they’ve made.

The Internet of Things:

The “Internet of Things” is a network of physical objects that connects them to the

internet. It allows day-to-day objects to have an online presence, and collects data and

information for those objects. According to Gartner, the IOT is expected to grow to 26 billion

units by the year 2020. Leading software players are planning on increasing their IOT

capabilities. This is currently a threat to the software security industry. Experts believe that

current anti-spam, anti-virus and anti-malware infrastructures won’t be sufficient to protect their

companies from the new endpoints created by IOT.

Inkjet Sale:

In 2012, amidst the company’s announced restructuring actions, the inkjet-related

technology and assets were sold to Funai for $100 million under the Master Inkjet Sale

Agreement. As part of the total sale, Lexmark included one of its subsidiaries and certain

intellectual property, among various other assets. The sale had a 4% unfavorable impact on

revenue in 2014 (Lexmark(a), p.28) and a projected 6% unfavorable impact on revenue in 2015.

(Lexmark(b), p. 5)

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Lexmark International, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

For the years ended December 31, 2014, 2013, and 2012

(in Millions, Except Par Value)

2014 2013 2012

ASSETS

Current assets:

Cash and cash equivalents 309.3$ 273.2$ 212.4$

Marketable securities 624.6 781.5 693.4

Trade receivables, net of allowances of $22.2 in 2014 and $24.7 in 2013 421.6 452.3 523.6

Inventories 253.0 268.2 277.3

Prepaid expenses and other current assets 225.8 195.3 214.6

Total current assets 1,834.3 1,970.5 1,921.3

Property, plant and equipment, net 786.1 812.4 845.3

Marketable securities - 6.7 6.3

Goodwill 605.8 454.7 378.7

Intangibles, net 264.3 258.0 231.4

Other assets 142.6 114.6 142.3

Total assets 3,633.1$ 3,616.9$ 3,525.3$

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:

Current portion of long-term debt - - 350.0$

Accounts payable 532.8$ 474.7$ 512.6

Accrued liabilities 678.5 672.4 582.1

Total current liabilities 1,211.3 1,147.1 1,444.7

Long-term debt 699.7 699.6 299.6

Other liabilities 458.8 401.9 499.5

Total liabilities 2,369.8 2,248.6 2,243.8

Commitments and contingencies

Stockholders' equity:

Preferred stock, $.01 par value, 1.6 shares authorized; no shares issued and outstanding - - -

Common stock, $.01 par value:

Class A, 900.0 shares authorized; 61.3 and 62.0 outstanding in 2014 and 2013, respectively 1.0 1.0 1.0

Class B, 10.0 shares authorized; no shares issued and outstanding - - -

Capital in excess of par 956.2 915.8 900.6

Retained earnings 1,404.1 1,413.1 1,229.4

Treasury stock, net; at cost; 35.7 and 33.8 shares in 2014 and 2013, respectively (1,006.4) (926.4) (844.4)

Accumulated other comprehensive loss (91.6) (35.2) (5.1)

Total stockholders' equity 1,263.3 1,368.3 1,281.5

Total liabilities and stockholders' equity 3,633.1$ 3,616.9$ 3,525.3$

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Lexmark International, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF EARNINGS

For the years ended December 31, 2014, 2013, and 2012

(in Millions, Except Per Share Amounts)

2014 2013 2012

Revenue:

Product 3,203.9$ 3,242.3$ 3,447.5$

Service 506.6 425.3 350.1

Total Revenue 3,710.5 3,667.6 3,797.6

Cost of revenue:

Product 1,931.3 1,880.3 2,064.0

Service 360.1 321.9 284.0

Restructuring-related costs 9.3 21.5 47.8

Total Cost of revenue 2,300.7 2,223.7 2,395.8

Gross profit 1,409.8 1,443.9 1,401.8

Research and development 354.5 287.2 369.1

Selling, general and administrative 888.2 810.1 805.1

Gain on sale of inkjet-related technology and assets - (73.5) -

Restructuring and related charges 17.9 10.9 36.1

Operating Expense 1,260.6 1,034.7 1,210.3

Operating Income 149.2 409.2 191.5

Interest Expense(Income), net 31.6 33.0 29.6

Other Expense(Income), net 4.2 4.5 (0.5)

Loss on extringuishment of debt - 3.3 -

Earnings before income taxes 113.4 368.4 162.4

Provision for income taxes 34.3 106.6 54.8

Net Earnings 79.1$ 261.8$ 107.6$

Net earnings per share:

Basic 1.28$ 4.16$ 1.57$

Diluted 1.25$ 4.08$ 1.55$

Shares used in per share calculation:

Basic 62.0 63.0 68.6

Diluted 63.2 64.1 69.5

Cash dividends declared per share amount 1.38$ 1.20$ 1.15$

67

Lexmark International, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the years ended December 31, 2014, 2013, and 2012

(in Millions)

2014 2013 2012

Cash flows from operating activities:

Net earnings 79.1$ 261.8$ 107.6$

Adjustments to reconcile net earnings to net cash provided by operating activities:

Depreciation and amortization 259.4 249.6 275.8

Deferred taxes (17.9) 41.2 20.6

Stock-based compensation expense 27.6 26.7 23.3

Pension and other postretirement expense (income) 76.4 (87.9) 26.7

Gain on sale of inkjet-related technology and assets - (75.3) -

Other 2.5 1.7 10.5

Changes in assets and liabilities, net of acquisitions and divestiture:

Trade receivables 60.7 78.3 (57.2)

Inventories 15.3 7.3 58.2

Accounts payable 55.7 (38.3) 22.0

Accrued liabilities (34.7) 95.0 (72.5)

Other assets and liabilities (71.9) (55.3) 45.7

Pension and other postretirement contributions (29.2) (24.8) (39.4)

Net cash flows provided by operating activities 423.0 480.0 421.3

Cash flows from investing activities:

Purchase of property, plant and equipment (136.3) (167.4) (162.2)

Purchase of marketable securities (848.3) (878.8) (947.1)

Proceeds from sales of marketable securities 851.0 565.8 831.8

Proceeds from maturities of marketable securities 160.0 219.0 220.7

Purchase of businesses, net of cash acquired (83.2) (146.1) (245.4)

Proceeds from sale of inkjet-related technology and assets, net of cash transferred - 97.6 -

Other 0.8 0.5 (0.3)

Net cash flows used for investing activities (56.0) (309.4) (302.5)

Cash flows from financing activities:

Repayment of assumed debt (15.9) - (4.3)

Repayment of debt - (349.4) -

Purchase of shares from noncontrolling interests (154.9) - -

Proceeds from issuance of long-term debt, net of issuance costs of $3.3 - 396.7 -

Payment of cash dividend (85.3) (75.3) (78.6)

Purchase of treasury stock (80.0) (82.0) (190.0)

Proceeds from employee stock plans 11.0 0.4 5.8

Other 1.4 1.9 3.7

Net cash flows used for financing activities (323.7) (107.7) (263.4)

Effect of exchange rate changes on cash (7.2) (2.1) 0.9

Net change in cash and cash equivalents 36.1 60.8 (143.7)

Cash and cash equivalents - beginning of year 273.2 212.4 356.1

Cash and cash equivalents - end of year 309.3$ 273.2$ 212.4$

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Ratio Calculations:

Value Chain Diagram:

Asset Analysis

Fixed Asset Turnover Ratio 2014 2013 2012 2014 2013 2012 2014 2013 2012

Total Asset Turnover Ratio 4.720 4.515 4.493 8.960 8.944 8.458 6.840 6.729 6.475

Inventory Turnover Ratio 1.021 1.014 1.077 0.879 0.881 0.940 0.950 0.947 1.009

8.944 8.153 7.819 7.983 7.679 7.494 8.463 7.916 7.657

Liabilities

Current Ratio

Quick Ratio 1.514 1.718 1.330 1.457 1.604 1.449 1.486 1.661 1.389

Debt Ratio 1.305 1.484 1.138 1.344 1.477 1.344 1.324 1.481 1.241

Debt-to-Equity Ratio 65.2% 62.2% 63.6% 44.0% 39.9% 40.5% 54.6% 51.0% 52.1%

187.6% 164.3% 175.1% 164.6% 118.3% 125.4% 176.1% 141.3% 150.2%

Revenues

Gross Profit Margin

Net Profit Margin 37.99% 39.37% 36.91% 50.19% 50.18% 48.51% 44.09% 44.78% 42.71%

Return on Investment 2.13% 7.14% 2.83% 7.04% 14.52% 6.69% 4.59% 10.83% 4.76%

2.18% 7.24% 3.05% 5.19% 7.97% 5.59% 3.68% 7.60% 4.32%

Equity

Payout Ratio 107.8% 28.8% 73.2% 67.13% 21.99% 43.93% 87.47% 25.42% 58.59%

Dividend Yield 3.26% 5.31% 3.09% 2.29% 3.12% 1.89% 2.78% 4.22% 2.49%

Return on Stockholders Equity 6.26% 19.13% 8.40% 29.09% 31.22% 22.53% 17.68% 25.17% 15.46%

Market-to-book Ratio 2.077 1.041 1.995 5.293 3.216 4.319 3.685 2.128 3.157

Equity Multiplier 2.876 2.643 2.751 3.818 2.904 3.084 3.347 2.774 2.918

Lexmark Computer Hardware Industry Software and Services Industry