Irvine Firm Seeks Imprint on Copier Industry : Technology: Gradco supplies copy machine accessories to major Japanese manufacturers. Yet analysts say it has not lived up to its potential.
Keith B. Stewart, an articulate man with a graying beard and a stern demeanor, has built a company that looks on the surface like a classic entrepreneurial success. In little more than 10 years, his Irvine-based Gradco Systems Inc. has grown from a lowly distributor of mechanical paper feeders to a $100-million company that claims a virtual monopoly on certain copy machine accessories.
And with the growing proliferation of copiers, computer printers and fax machines, a company specializing in paper sorters and feeders would seem to have a great future, especially when it can boast, as Gradco does, of broad patents and strong relationships with major Japanese electronics companies.
But Gradco has never quite lived up to Wall Street’s expectations. Stock was initially offered to the public in 1983 at $18 a share, and it now languishes around $9. A proposed management-led buyout announced by Stewart last fall--which drove the stock to $19--never materialized, apparently because the Japanese financiers who were backing the deal grew skittish. And last month, Gradco announced an unexpected quarterly loss and a sharp decline in revenue.
While Stewart maintains that these setbacks are temporary, others are not so sure. Gradco recently lost a key contract to supply sorters to Xerox Corp., and analysts suggest that other copier companies may find ways to design around Gradco’s patents. Analysts have also raised questions about Stewart’s management style, and both Gradco and Stewart are facing several unrelated lawsuits alleging various forms of fraud.
Stewart, a controversial figure described by associates as everything from an “excellent manager” to “autocratic, charming and ruthless,” says the lawsuits are all groundless. And he maintains that the poor quarterly results were an aberration that will be emphatically corrected in the coming year. “Demand for our products is greater than ever,” Stewart said in an interview. “We have contracts with every major copier manufacturer going forward.”
Indeed, some securities analysts still believe that Gradco has a lot of potential. A recent report from the Los Angeles brokerage firm Bateman Eichler, Hill Richards states that the company has a “bright long-term future” and predicts that either a buyout or simply good operating performance will drive the stock at least to the $12 level and possibly much higher. New York-based Plenum Publishing Corp. now owns about 8% of Gradco’s shares and has said it might pursue a takeover, though most analysts discount that possibility and say a Japanese takeover is more likely.
Stewart has taken the offensive in countering the recent troubles and is putting the finishing touches on a complex restructuring of Gradco that will shift the core operations to Japan. A management buyout, he said, still remains a possibility, as does a takeover by another firm or a public offering of the beefed-up Japanese subsidiary.
Restructuring
The restructuring plan calls for Gradco’s Japanese subsidiary to assume operational responsibility for all copier products, which account for some 70% of Gradco’s revenue and include the patented “moving bin” sorter that has long been the core of Gradco’s business.
The remaining operating entity in the United States will be called Gradco Printer Products and will be headed by a new president currently being recruited from outside the company. Gradco Systems in Irvine will effectively become a holding company for the operating entities, carrying out some basic research and development as well as corporate finance and acquisition functions.
The Japanese unit will be headed by Mark Takeuchi, whose track record includes a long stint at C. Itoh & Co., and Gradco Japan will establish its own subsidiary in the United States under the name Gradco Systems America. Ikegami Tsushinki Ltd. of Japan and Sindo-Ricoh & Co. of South Korea will take small equity stakes in the Japanese company and will be responsible for all engineering and manufacturing of Gradco’s copier and printer products, respectively.
The equity stakes, whose exact proportions have not been determined, constitute a “pre-distribution” of shares that would speed up any future public offering of the Japanese subsidiary.
Stewart said equity or joint venture partners will also be sought for the U.S.-based printer business, and a new distribution network for those products will either be developed internally or acquired. The fate of Gradco’s 100-employee Santa Ana manufacturing facility has not been determined, but it might be closed.
“On the surface, the printer and copier markets look very much the same,” Stewart said in explaining the reorganization. “But the more you look at them, they are totally different markets with products sold through entirely different channels, and they take different sets of skills and experience.” The new manufacturing arrangements will yield substantial cost reductions, he added.
Stewart hopes that the new structure will enable Gradco to build the printer-products side of the business to 50% of revenue and reduce the company’s heavy dependence on copying machine sorters. The moving-bin sorter, which consists of a column of as many as 20 paper bins that move up and down to catch the copies as they emerge from the machine, is the technology of choice for small office copiers known as “convenience copiers.”
Contract Loss
Gradco has attributed its recent problems--a quarterly loss of $1.5 million on revenue of $20.5 million, contrasted with a profit of $1.4 million and revenue of $30.4 million a year ago--to the loss of a major contract, product delays on the part of the copier manufacturers and problems in getting some of its printer products out the door. Stewart confirmed that the lost contract was with Xerox Corp., one of the company’s oldest and biggest customers.
Xerox still does business with Gradco, and Stewart notes that Fuji Xerox of Japan remains a major customer. But the fact that Xerox is increasingly using its own sorter technology points to a potentially broader problem for Gradco. Much of Wall Street’s enthusiasm for the stock over the past five years grew out of the perception that Gradco had a virtual monopoly in its niche, and that is becoming less and less the case.
“There are ways to get around the patents,” said Robert Sostilio, who follows copiers for the market research firm Dataquest. If copier manufacturers can develop their own technology, they can make their own sorters and not rely on products or licenses from Gradco. Nicholas Pantazis, an analyst with the New York stock research firm Monness Crespi & Hardt, added: “Gradco has had the most effective technology, but not the only technology.”
A former Gradco executive, who asked not to be identified, said the company had done “a very poor job of taking advantage of its place in the market,” remaining far too dependent on moving-bin sorters. Gradco’s effort to penetrate the printer-feeder business through the acquisition of Ziyad Inc. in 1986 for $24.5 million has had mixed results, and Gradco’s newest market--sorters for fax machines that would route incoming documents to personalized mailboxes --is unlikely to develop for some years.
The dent in Gradco’s image that became visible last year was especially ill-timed for the firm, coming just as Stewart was trying to put together a management buyout. After a run-up in the stock price, Stewart disclosed last September that he was pursuing a buyout and had retained the Lodestar Group as financial advisers. But on Dec. 1, after several days of rumors, Stewart revealed that the financing had fallen through.
Stewart said Ysuda Trust Co. and Yamaichi Securities were both part of the proposed buyout, though he would not confirm reports that the buyout consisted of a novel plan to take the company private and then re-float it on the Japanese stock exchange. This would have enabled Gradco to take advantage of the fact that share prices in Japan are far higher for the same level of earnings than they are in the United States, and it made sense for the company because so many of its major customers are in Japan.
The Gradco deal was still being put together when the failure of the United Airlines leveraged buyout cast a pall over all such transactions, Stewart said, though he conceded that the earnings problems also may have contributed to the collapse of the deal. Stewart owns 12% of Gradco’s shares and indirectly controls another 11%.
Jane Gilday of Gruntal & Co. in New York and several other analysts said the buyout discussions diverted the attention of Stewart and other Gradco executives from the day-to-day operations of the business, contributing to the poor results. Stewart rejects the criticism. “It’s just not that time-consuming a process,” he said, and added that the bad results were due to factors beyond his--or anyone else’s--control.
Upside Potential
Some outside observers agree that Gradco’s difficulties are nothing out of the ordinary. Elliot Steinberg, a San Francisco investment manager who helped advise the wealthy Pritzker family when it bought a 6% stake in Gradco, said the problems were similar to those experienced by many small companies. “They’ve just fallen behind in their game plan,” Steinberg said. “But they should make up for it this year.”
Frank K. Moore, a former Gradco director who owns an Orange County copier outlet, said he believes that the company has scraped bottom and “the upside potential is excellent.” Gradco, he said, has “gone through some struggles,” but is now in “better shape than ever.”
One securities analyst criticized the investment community for not looking more closely at the company and building up expectations that could not be met. Stewart echoed this notion, saying there had been a lot of speculation over the past several years. He attributed the financial community’s interest to the fact that his was a niche company with a strong market position whose business was easy to understand. But while the former price of $19 a share might have been based on takeover speculation, at $9 the stock is undervalued, he added.
Nevertheless, some Gradco watchers remain wary of the company, in part because of Stewart himself. A native of the United Kingdom who was raised in Rhodesia, Stewart--who lives in Laguna Beach and drives a Rolls Royce with “GRADCO” license plates--tends to evoke strong reactions from those who come in contact with him. While many associates praise him as a dynamic businessman with a tremendous amount of energy and excellent sales skills, others say he is autocratic, unable to delegate authority and disrespectful of those who disagree with him.
Peter Shea, who co-founded Gradco with Stewart as a simple collater distributor in 1972, describes Stewart as an excellent salesman who can be very charming but also can be quite ruthless. Shea, now the owner of Entrepreneur magazine, said he and Stewart no longer talk.
Analysts question Stewart’s management style. “It’s definitely a one-man show,” said Donna Hostetler, an analyst with Crowell Weedon & Co. in Los Angeles. “Whatever Stewart wants, he’ll get. I don’t think the company is run by the board of directors. When a company gets to a certain size, you have to start delegating, and I don’t think he’s done that.”
Gilday of Gruntal & Co., a one-time touter of Gradco stock when she was with McKinley Allsopp, added: “Steps have been taken that have failed, and the business has dropped off, so I don’t give him high marks.”
But Moore called Stewart “dynamic, intelligent and very creative in the way he does business,” though he said Stewart had in the past made some mistakes in choosing managerial talent. “He has given up the reins and it hasn’t worked out; he’s had to step back in.”
Lawsuits Filed
Two former employees have much harsher criticism for Stewart. In separate but related lawsuits filed in Connecticut, John C. Hamma and R. Clark Dubois, both former Gradco engineers, allege that they were co-inventors of the sorter technology and that Stewart fraudulently deprived them of royalty payments.
They charge that Stewart induced them to accept lump-sum payments in lieu of a percentage of sales by misrepresenting the status of Gradco’s efforts to license the technology to major copier manufacturers. Hamma also alleges that he was intimidated by Stewart and threatened with termination if he hired a lawyer, and Dubois claims that he was fired and locked out of his office for complaining.
Stewart said the claims are completely without merit. Gradco’s key technology, he said, was invented by Frederick J. Lawrence, who remains the company’s chief engineer.
Stewart also has been sued for $6 million by Alton Laguna Partners, owner of Gradco’s headquarters in the Irvine Spectrum. Alton Laguna alleges that Gradco backed out of a deal for an expansion of the office space after the partnership refused to enter a “usurious” loan agreement with an off-shore company affiliated with Stewart.
Stewart called the allegations “fictitious” and “a joke,” and said he had refused a recent offer to settle the case out of court. Robert Beauchamp, an attorney representing Alton Laguna, said his client offered to settle for $3 million. “We are not concerned about the strength of our case; we think it’s very strong,” Beauchamp said.
In the wake of the failed management buyout, Gradco also has been sued by several shareholders claiming breach of fiduciary duties.
Stewart has in the past suffered reversals in the courtroom. In 1986, an Orange County Superior Court judge ruled that Stewart had fraudulently persuaded his wife to accept a $750,000 divorce settlement in 1983 by concealing from her the true value of Gradco. Under the settlement, Connie Stewart agreed to give up any claim to 2.1 million Gradco shares that the Stewarts owned. A day after the agreement was signed, Gradco sent a letter to shareholders announcing its plans for a public stock offering, which eventually valued those shares at more than $37 million.
The case was subsequently settled out of court for an undisclosed sum.
No matter how many feathers he has ruffled, though, Stewart can still lay claim to building a successful company that competes in a part of industry where few American companies dare tread. Standing in the lobby of Gradco’s headquarters, Stewart gestures brusquely at row of plaques on the wall--quality awards from International Business Machines and several other companies. “Why does everyone look at the negative and never talk about that?” he grumbles.
Indeed, if Stewart’s latest plan succeeds, Wall Street may again be talking about Gradco as a great American entrepreneurial success.
