August 29, 2002 -- Creo could use a good financial deal right now. As Mr. Tribute noted in his article yesterday, Creo’s stock price reached an all-time low on the day of this announcement. Certainly shareholders will have questions about this transaction and request a full explanation once the deal closes. All spending is questioned these days, but the challenges Creo has had with their Printcafe investment and Scitex "merger" must still be fresh on shareholders’ minds. And then there is State Street’s recent industry study reporting that Creo is losing share in the United States to Fuji, Heidelberg, Screen, and Presstek in the metal CTP systems market. The Price Everyone we talked to including competitors of Creo, say the acquisition was a smart move. ScenicSoft’s popular Preps product has 20,000 seats installed around the world (at least 20% in Creo workflows) and estimated annual revenue of under $10 million. It is believed that Creo has been attracted to ScenicSoft for a long time as a way for Creo to increase its recurring revenue stream and beef up its own products. Creo shareholders should be pleased. Indeed, many were surprised at the low price ($9.5 million) Creo will pay. Upon closing, Creo outlays $3.2 million at the closing, absorbs $2.3 million in liabilities and the rest, $4 million, is not due until one year after the closing. Even there, the $4 million is represented as promissory notes. Creo can convert these notes into common shares at an average of Creo’s closing stock price for the ten days prior to the one-year anniversary of the closing. The reason for the low acquisition price may lie in ScenicSoft’s current financial status. It is believed that sales for most of ScenicSoft’s products have been down over the last two years as a result of the economy. This transaction is subject to several conditions, including the expiration or waiver of certain notification periods between ScenicSoft and third parties and customers. In terms of the price paid, if Creo valued the OEM agreements over all other values or assets (technology; expertise, R&D) we feel, that Creo would have made part of the payment conditional on the continuation of OEM contracts, which a spokesperson for Creo told us it did not. It should be noted that Creo is working to shore up confidence within the dealer channel and with partners, but it is important to consider OEM sales as it relates to the price paid. One important financial synergy is that sales to Creo generated about 18% of ScenicSoft’s annual revenue in 2001 making Creo their largest client. In effect, ScenicSoft will be acquired by one of its biggest customers. (For the first half of 2002, software sales to Agfa were greater than sales to Creo.) On the economic front, Creo could reduce the size of the staff at ScenicSoft. ScenicSoft reduced staff in 2001 and earlier this year, the company released 22% of its staff. The company now has 72 employees, with about 30 employees in research and development. From a strategic standpoint, Creo could reduce ScenicSoft’s administrative/customer service employment further. The company could move only the R&D staff to Canada absorbing customer service and administrative functions into Creo’s current operations. In most cases, it is less expensive to employ skilled technology workers in Canada. No plans have been made here and Creo says they value greatly the expertise that ScenicSoft’s employees could bring to Creo. Again, we note this option as it relates to the pricing of this deal only. Creo should be able to recover its investment quickly. In fact, within the first year of operations, a Creo spokesperson told us that the acquisition is expected to contribute positively to adjusted earnings per share. The company has negotiated favorable payment terms and an excellent price. Even if circumstances evolve to where Creo only sells ScenicSoft products to Creo customers, it is still a good bargain for Creo’s shareholders. Again, circumstances should not evolve to where Creo only sells products to its customers, but our point is that the price paid is still a good value even if it was to happen somehow. As for ScenicSoft’s shareholders, the privately held company is mostly owned by founder and President, Erik Smith. In the press release announcing the acquisition, Creo said it had entered into a merger voting agreement with shareholders of ScenicSoft who represent over 67% of the outstanding preferred and common stock. In order to have majority ownership in the state of Washington for the purposes of the acquisition, Creo needs 67% of the outstanding shares in each category of common and preferred stock. A spokesperson for Creo told us that they have signed an agreement, “primarily with Erik Smith, to ensure Creo receives this required support.” It is unclear who owns the rest of ScenicSoft’s stock and if they supported the acquisition. Regarding Erik Smith’s role after the acquisition, a Creo spokesperson says that he has agreed to assist with the transition process in an advisory role for up to a year. Creo’s Competitors: Cautiously Optimistic Mr. Tribute described some of the possible conflicts that could arise as a result of Creo’s ownership of the ScenicSoft products. Overall, people we spoke to from the major equipment manufacturers are cautiously optimistic about Creo’s plans. One senior executive said the reason their company consummated a deal with ScenicSoft was because of their independence. "Erik Smith (President of ScenicSoft) proclaimed their independence proudly. We were comfortable working with them because we had no fear that something like this would happen." He said his company is already in talks with Creo and expects a satisfactory arrangement. A concern from several of the printers we spoke with, is that Creo might take the ScenicSoft products and make them proprietary to their own workflow. One executive said, "Unfortunately in a down market, there is a tendency for manufacturers to make their products proprietary to survive." A source at Creo called this analysis "insane" as a strategy for the ScenicSoft products, especially considering the acquisition’s financial goal of generating relevant recurring revenue. Regardless of how deals between Creo and companies like Agfa or Fuji are negotiated, manufacturers will move to ensure their workflows operate openly with many kinds of imposition software. Collectively, vendors downplay the "keystone" role of the ScenicSoft products in terms of affecting the ultimate performance of their own products. John Zarwan of State Street Consultants thinks that vendors will obviously reevaluate their agreements, but "I see no particular reason other partners should be left out in the cold. That's not to say it won't happen, just that it doesn't necessarily follow." Specifically, Susan Wittner, Director of Marketing for Agfa Graphic Systems said that ScenicSoft has been, for many years, a strong partner for Agfa. “Apogee and Preps are working seamlessly together to the benefit of many users, thanks to an open and good relationship with the ScenicSoft people. We are committed to open systems and standards. Creo and ScenicSoft management have expressed their continued interest in our partnership and we expect Creo to be committed to offer and support ScenicSoft products as open solutions. We will continue to work with them and most importantly, we will continue to keep our customers informed.” In terms of ApogeeX, Agfa has been moving to make it more open. Ms. Wittner continues, “Because the openness of systems has always been very important to us, with the announcement of ApogeeX earlier this year, we will offer customers even more flexibility and choice for imposition by unbundling Preps. This same openness applies for other market segments like packaging, where ApogeeX will work seamlessly with ScenicSoft Pandora and other open solutions." For Creo’s part, they appear committed to doing what is right for all ScenicSoft customers. As stated earlier, there are product enhancement advantages for Creo in this deal. Most importantly, though, is the less cyclical revenue stream which it needs for the future. Too Early to Tell: In fairness, it is too early to know how all of this will unfold as the deal has not closed. At this point, Creo has no choice but to reassure shareholders and the industry by using phrases such as "no immediate plans.” Creo must carefully calculate revenue projections, staffing plans, channel use and integration strategies. And much of this depends on how customers and OEM partners react in the next few months. Current Creo customers and shareholders should be happy; they got a great deal. ScenicSoft’s partners and customers who don’t work with Creo systems could be happy if they get a great deal. Time will tell. Click here to search for Creo in the industry's largest archive. Click here to search for ScenicSoft in the industry's largest archive. We would like to thank Molly Joss and Gail Nickel-Kailing for their help with this series. Molly Joss, Contributing Editor to WhatTheyThink.com, is also a freelance writer and book author. She can be reached at [email protected] Contributing columnist, Gail Kailing, is principal consultant at Business Strategies Etc.and can be reached at [email protected]. - - - ScenicSoft’s Competitors: Proudly Independent Imposition companies such as Dynagram and Ultimate are likely to gain market share from any disruption, especially since the imposition market is gaining ground with smaller printers. The two companies have less market share, but are already using their independence as a primary reason for companies to choose their products. Both have supplied statements to us and we have placed them below. (They have been edited for length.) David Watson, president of Ultimate sent WhatTheyThink.com the following statement: "As the inventors of digital imposition, we are now the largest independent supplier of imposition technology. We look forward to serving OEMs, dealers and end-users that want alternatives to the closed systems of the major manufacturers." "Ultimate has the longest history of supplying OEM imposition solutions in a variety of flavors that are designed for different markets from the most demanding professional printing organizations to versions for on-demand printing, small printers and for scatter proofing to a variety of devices. Ultimate also has a long history of serving a global distribution channel with imposition software in eight different languages. "Ultimate has built years of experience with end users into solutions designed to serve their needs, not the needs of selling a particular piece of hardware. Any objective look at the various imposition solutions in the market would show that the software from the independent companies that have focused on this market have more utility and greater functionality than the offerings that are built by companies as components of a workflow system to sell heavy iron. The general trend in the computing industry is to have specialist companies in software and hardware. "The large companies are trying to recapture the old days of CEPS systems, remember those? They tried to tie the user to one manufacturer of scanners, workstations typesetters and film plotters. Are we not better off with what happened to these behemoths? The prepress business needs what happened with desktop publishing, a revolution away from proprietary expensive systems and the creation of sleek products by sleek companies." And Dynagram sent us the following: "While ScenicSoft has cemented its role as a prepress software provider for Creo, Dynagram remains an independent provider of a wide range of imposition solutions. This means that Dynagram establishes partnerships with manufacturers, it does not compete against them. "The after-effects of this type of consolidation in the industry cannot be ignored. Dynagram firmly believes that the industry needs to have independent software providers. What will other manufacturers do now that (ScenicSoft’s) prepress software has been purchased by a competitor? They will be on the market for other prepress solutions. "Moreover, what will the clients of these manufacturers do now that their prepress software belongs to a manufacturer that they do not endorse? They may very well pull away from ScenicSoft’s software and turn to other, independent software providers. "Dynagram as well as other independent software providers stand to benefit from the acquisition." Creo and ScenicSoft – A look at the money Gail Nickel-Kailing Creo Cash and Cash Equivalents At the end of their fiscal third quarter, June 30, 2002, Creo had $130.6 million in working capital, $62.9 million in cash and cash equivalents and $19.3 million in short-term debt as compared to $120.0 million working capital, $33.3 million in cash and cash equivalents, and $17.3 million in short term debt at the end of the previous quarter, March 31, 2002. The increase in working capital and cash was attributed to the $11.8 million loan repayment received from Printcafe, timing effects on payments from accounts payable, and operational improvements in collections of accounts receivable in the third quarter. (Translation: Printcafe paid up; timing benefits from customer prepayments, tax refunds and changes in accrued liabilities; and improved collection efforts accelerated payment by Creo customers.) Creo and Printcafe - Repayment In June 2002, at the completion of its Initial Public Offering, Printcafe repaid $11.8 million (one half) of money loaned by Creo in January 2002, approximately $1.4 million in interest, and $3.7 in prepayment fees. Creo then reinvested the prepayment fee in Printcafe Software common shares, giving them an aggregate equity interest of just over 30%. The remaining $11.8 million balance will be repaid by January 2004 and bears a 4% annual interest rate. Creo and Scenicsoft – Terms The proposed terms under which Creo Acquisition, Inc. (a wholly-owned subsidiary of Creo) will merge with ScenicSoft, are: - The Creo subsidiary will assume approximately $2.3 million of ScenicSoft’s liabilities – the equivalent of about 12% of Creo’s short-term debt of $19.3 million shown in the June 30, 2002, balance sheet. - Of the remaining $7.2 million to be paid to common share, preferred share, and options holders of ScenicSoft at the closing of the transaction, $3.2 million is cash and the remaining $4.0 million will be represented by unsecured, non-interest bearing, convertible promissory notes. These notes are payable by Creo one year after the close of the transaction. Note: Creo has the option to convert these promissory notes into common shares at an average closing price of Creo common shares for the ten days prior to the one-year anniversary of the closing of the transaction. That could either be more or less than the current price of Creo common stock of about $7.35 per share. So, for example, if the price for Creo common stock reaches $11.00 this time next year, Creo would need 1/3 fewer shares to complete the transaction. The End Result Creo acquired a company that is both an OEM partner and supplier with revenues of under $10 million, a strong customer base and a number of products aligned with Creo’s Networked Graphic Production initiative for essentially $3.2 million cash, an as-yet-undetermined number of common shares totaling $4 million (Again, Creo could pay with cash or stock), and a small liability of $2.3 million that can certainly be leveraged to the company’s benefit. Buying a partner and supplier to whom you pay a considerable amount of money for products you resell has both positive and negative affects. For example, of ScenicSoft’s $10 million in revenue, Creo contributed almost $2 million. With the acquisition, Creo will no longer have to pay $2 million for products it resells, but it also has acquired a company whose revenues in that segment next year could be at least 20% less as a result.