Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Electronics For Imaging, Inc. (NASDAQ:EFII)

Morgan Stanley Technology, Media & Telecom Conference Call

February 26, 2013 4:55 pm ET

Executives

Vincent Pilette – Chief Financial Officer

Analysts

Scott Schmitz – Morgan Stanley & Co. LLC

Scott Schmitz – Morgan Stanley & Co. LLC

Okay, I’ll go ahead and get started here. For those of you don’t know, my name is Scott Schmitz, part of Morgan Stanley’s Hardware Research Team. And I am pleased to be joined by Vincent Pilette, the CFO of EFI. Vincent thanks for taking your time today.

Vincent Pilette

Thanks Scott.

Scott Schmitz – Morgan Stanley & Co. LLC

So maybe for those less familiar, may be we can just start with just a brief overview of the company. I am not sure how well it’s know, but just give us a brief run down of your three major segments and then we’ll dive into some more details.

Vincent Pilette

Yeah, so we’re not well-known enough. Many people associate EFI to the overall print industry, $1 trillion industry that’s facing some secular decline pressures and that’s what we’re not. We are focusing on specific niche markets within the print industry that is really looking to grow segments where there is a secular shift from analog printing into the digital world. And that majority of the addressable market that we serve today is still using printing activities in production/industrial space in the analog fashion. We are not commodity printing, we’re not printing in the office. We are entirely focused on print professionals for the industrial space.

We manage our company is three segments; the first segment is the industrial inkjet, about 50% of our revenue. We have a software business that automates the business processes around the digital printing activity that’s about 15% of our revenue. Then we have controller business, the Fiery business for the production space and industrial space and that’s about 35% of our revenue.

We’ve been posting double digit gross rate on the top line for the last three years and in that fashion we definitely have no money for the vertical markets we sell.

Scott Schmitz – Morgan Stanley & Co. LLC

Thanks, great. So maybe you can give us a few more stats on how large your addressable market is, how fast it is growing and then maybe more specifically can you distinguish between your installed based growth and then what’s the growth rate is on the recurring revenue side of the supply side?

Vincent Pilette

Yeah. So, overall at this point in time, we size our addressable market with the current products in our portfolio at around $4 billion, growing at the CAGR of about 7% to 8%. We have three different segment reserve and then an overall ecosystem we provide to customers. In the industrial graphic space, we serve display graphics, the out-of-home advertising, billboards etcetera. We serve the label printers, people printing on labels, direct packaging printing. And then we serve the ceramic tile industry, which is vastly unallocated today. And really thinking on ceramic tiles for the construction business.

In each one of those segments, we have an under penetration to lay off digital printing activities in the vast majority of analog, display geographies to about 40% to 45% digital, labels less than 2% digital, ceramic tiles 10% digital and firstly adopting a digital solution.

So in that industrial inkjet segment, we positioned a long-term gross really. That’s around 10% to 15% with the overall market growing at different pace for each one of the sub segment, but most of the goals coming from the shift from analog to digital.

In the software business, where we really automate the business process for print professionals and the industry that’s really behind versus the enterprise today in term some of tech adoptions. We have a market growth opportunity of 10% to 20% different two sub segments, the web to print software it, enabling the print professionals use Internet and online activities to manage multiple plans and acquire and then the MIS module software business was a lower growth, but automating all of the manufacturing process of the printing activities.

And then – so those are high growth segments. And then we have the controller, the Fiery brands called also the digital front-end addressing entirely high end production color printing, personalized printing which is growing more along the GDP line around 4%.

Scott Schmitz – Morgan Stanley & Co. LLC

Okay, that's great, that's helpful. Maybe you can move on to, I think at the recent Connect Conference that you talked about, windows of opportunity and looking for the next growth areas. So can you talk a little bit about your acquisition strategy? How you identify segments? What your valuation parameters are and just kind of your overview of that?

Vincent Pilette

Yeah, so we’ll start with a very clear strategy. So we manage the company in the segments I’ve mentioned. But really then bring everything together as a solution in the ecosystem enabling an industrial process where there is an activity of pointing to move into the digital space. Moving the business processes in the digital space with our software, moving the activity of printing in a digital way and controlling everything through the Fiery.

That's a well understood ecosystem that will continue organically to refine, build integration, building a life out processes where there is no more laborer intervening that process. Then we look at opportunities to apply that ecosystem in different industrial spaces, the last one we penetrated is the ceramic tile manufacturing process. In January 2012, we built Cretaprint. We are the provider of Cretaprint in building a digital inkjet printer for this ceramic tile manufacturing space, mainly analog to this, and first growing from a digital perspective.

And what we are doing organically is building the EFI echo system around the industry enabling the ceramic tile manufacturing to move on-demand digitally personalized content printing. So rather than going to Home Depot and look at your Ceramic tiles and choosing amongst multiple inventory that you have, which type you want, you would be able in the future to go, you have a kiosk glossary, load your picture, decide which color you want to have on your tile base and how you want to decorate your home, which kind of texture you want we produce woods or stones and directly send that to the manufacturer using the ERP system and they are manufactured on demand in that ceramic tiles.

So really shortening the supply chain or the value chain of the that industry. We’re constantly looking at new opportunities to build on that overall strategy.

Scott Schmitz -– Morgan Stanley & Co. LLC

How many market are there, I mean the ceramic tiles and then the near island really…

Vincent Pilette

But there was a display graphics, there is labeled that we still refining the technology to manage the analog reliability and quality level if you want, behind the label, as well you have the packaging industry on demand, direct to packaging, printing, fitting of the big brown box from Amazon’s well impersonalized, put it in big volume, they could pull your profile automatically from many different places and print it on that box directly that comes to you, that could be a new venture.

So continuously pushing the technology in the packaging space would be different. One think where we spent efforts on, you talked about we spend effort on – you told about ceramic tiles and then you can let go your imagination and look at many other activities where there is a printing activity from an industrial space that’s probably mainly analog today. You can think about textile for example, your tie, personalizing tie. There was many other activities that we could move into and then for obvious reasons we’re leaving to that.

Scott Schmitz -– Morgan Stanley & Co. LLC

Can you balance it on the 3D printing market, is that a market that you think set’s your criteria type of...

Vincent Pilette

Yes so, let’s me use my – hire up here fine, there is no kind of the word printing, there was no real conversions or overlap with EFI, that was a very different sector, outside there is no technology leverage outside of jetting something, there is nothing, there is no color management or controls, nothing that really overlaps with EFI.

As a personal investor, I would be very careful. I think it’s still a very highly speculated space that they have positioned in manufacturing. The current valuation of that really needs to be supported by the proof that they can extend to many other adjacent market opportunities. And that has not panned out yet. Now, whether which we don’t ask, we are meant to be seen then. As an investor I am sure you will have a better site than me.

Scott Schmitz – Morgan Stanley & Co. LLC

Okay. So just maybe finishing up the kind of acquisition discussion here and relating to your R&D, how much of your future product development is done internally for your own R&D dollars versus going out and acquiring and then how do you make that decision?

Vincent Pilette

Stopping short of seeing 100%, close to 100% is organic development. Let me explain. The M&A strategy is two fold for us. One is in the software space. Our software business is facing a very fragmented market, about $900 million size from the market opportunity, we are about $100 million size now, just crossed $100 million in 2012 and we are the biggest vendor in that market, the close competitors are less than $10 million.

Our acquisition strategy there is been to develop the fragmented market, establishing new beachheads in every other countries and sell our portfolio into the customer acquired, putting the technology acquired in many more. So it’s not technology acquisition, it’s customer or market acquisition if you want. And therefore the R&D is driven to zero very quickly. We support the maintenance revenue stream acquired from the company as we have set our portfolio. So that’s number one.

Out of the last eight acquisitions we have done, seven are in that category. The second strategy in M&A is to expand the addressable market taking the EFI ecosystem I described earlier and applying that to new industries and Cretaprint, the one we've done in January 2010.

Now Cretaprint is now the biggest piece of our R&D, but if you take Cretaprint we then apply a lot of our value add to Cretaprint which is knowhow in inkjet technologies, knowhow in software, knowhow in controllers. All of that is using our organic capabilities if you want to build the ecosystem and that's why that’s close to 100%.

Scott Schmitz – Morgan Stanley & Co. LLC

Okay, I think mentioned some of the competitive dynamics, so maybe we can transition into talking about where you compete against, in the likes of HP and then just on the software side, who are your main competitors and what really differentiates you?

Vincent Pilette

Yeah, so, different dynamics, we’re kind of a unique company in term of the portfolio that is put together and integrated and the way we serve our customer. There is no one-to-one competitive side to this EFI level. Also I am sure many in our verticals would like to reproduce. When it comes to the controller, the digital front-end Fiery, I think we have established a leading brand in the production and color management environment. CREO from KODAK has about 15% of that market. We own about 50% of that production market and the rest is coming from our OEM with different size or range of controllers.

When it comes to software, I mentioned closest compare is sub skill software vendors that has locally developed products and have not maintained it up to the current, I think that to for the 21 century. Really the biggest competitive dynamics there is to convince the print professionals to upgrade from home grown tools or locally developed software into robust professional standardized ERP.

And the next wave, when that will be complete, we need to convince them to move from owned perpetual license into cloud based environment which we already provide from an architectural perspective with small proportion of our portfolio today.

That’s for the software environment. When it comes to industrial inkjet, that’s where the environment is the most open from a normal competitive dynamic. HP for at the industrial inkjet, the rest for ceramic tiles and display graphic, (inaudible) some of those competitors. Our unique value proposition again is to rub the digital printer in that segment with ink and services but also electronics like Fiery that nobody else can provide with the same level of reliance and then provide an ERP to optimize the whole solutions. So we compete really using our software as a differentiator.

Scott Schmitz – Morgan Stanley & Co. LLC

So if we look at the mix of your business, I mean Fiery is down to about third of revenue, it should help your top line growth, but there is different margins dynamics within the business segments. So can you talk about the mix as we go forward? What type of out of the margin profile evolve with an exchanges?

Vincent Pilette

As we first recap on the top line organically, EFI a long-term model can go at about 10% organic growth. It’s really driven by the organic growth, what we call the direct business. It’s the business that we sell direct to customers. I think industrial inkjet and software and then there is the Fiery business, the one that sold through the major print manufacturers, that’s more GDP plus type of gross along a cyclical curve. So it was up 23% in 2010 to 16% in 2011, it was down 15% in 2011, it was down 15% in 2010. So there was no new product in the production area.

In 2013, we’re very excited because Fiery now is facing a lot of new products in the production area from say (inaudible). So we have a very good position from a revenue gross moving forward perspective. At the 10% organic growth, we believe that our business model can generate about 12% to 15% operating profit margin from a bottom-line margins perspective.

In 2010 it was around 7%, in ’11 we generate a little bit over 11%, in ‘12 a little over 12% operating profit margin. And we’ll continue to move up continue to move up towards the 15% in the long range model. And that's made really mainly of OpEx leverage due to business mixture.

Industrial inkjet carries a lot’s of OpEx than a softer business or even a Fiery business that has a lots of software intensifying activities. And then depending on way prior than these curves, we’ll have our gross margin ranging from 55% to 57%. It was close to 55% in 2012 and Fiery was down 12%.

Scott Schmitz – Morgan Stanley & Co. LLC

Can you help me understand the software business a little bit better, so when I looked at competitive or comparable maybe not comparable but just a traditional software business, I think generally gross margins, a 80% to 90^ plus. So what's different software in your industry that 70 million or in that range.

So gross margin is really driven by two things. One is scale and other its business, revenue mix. So let’s go to scale first, we have multiple curves of growth in the software business, but if you look back at our data, we are generating 2010, 50 million revenue for 15% gross margin which of course notable. In 2011 we generated a $81 million at about 70% gross margin and this 2012 $100 million at 72% gross margin. If we do a regression analysis on this, it’s about an incremental point of margin per $10 million of revenue and you will continue to see something similar along that linear line as we continue to scale up our software business. Obviously we’re the biggest vendor in that market. We are 100 million on a 900 million market, so we have room to grow and double in size you will see margin expanding as a result.

Then comes the mixed impact, there are three things; there is a maintenance; there is services and there is license. I guess license have good 95% gross margin we have the same matrix, maintenance its well above 80% to 85% gross margin. We have the same thing and services deployment is a bit less. Everything is at benchmark from our perspective, but we have more services revenue than a traditional software business because we serve paint professionals that don’t have IT shops that have the capacity to deploy your all of the software’s. So along with our software we also sell services engagement to deploy that software bringing print professionals into the next wave of technology.

Scott Schmitz – Morgan Stanley & Co. LLC

I looked at you first quarter guidance, also prior to be flat sequentially which is better than normal seasonality. Can you just talk a little bit more about the drivers behind that guidance, is it inventory replenishment, pent-up demand or what are seeing from a (inaudible)?

Vincent Pilette

So I have mentioned that, today Fiery were 98% in the production high end color space, it was not the case 10 years ago when we also served et cetera but not today. The cyclical revenue still there in terms of aligning the prior revenue with the new production engine introduced by our print manufacturers. We have done a lot of work working with them to get very good visibility on the sales through on the end user demand and the lining of inventory along with those three manufacturers lowering the inventory in the channel. We finished Q4 of 2012 with a very low point in dollars in term of inventory channels very lean, and we’ll continue to manage it that way.

But what really drives the better than expected revenue for Fiery, in terms of guidance is driven by the new product cycle. 2012, no new products. Fiery was down 15%. 2010 and 2011 it was up 12% and 13%. So now, we’re moving into a new wave of new products. Canon introducing the (inaudible) in Q1 and all of our major OEM’s has announced new products in the production space for 2010.

Scott Schmitz – Morgan Stanley & Co. LLC

Okay. I just have one more questions and then we’ll open up to the audience if they have any questions. Sort of thinking about those, but if you just look at your cash strategy, you sold your headquarters maybe you can talk about that, the reason behind that. How you’re moving into the new facility, the cash impact and then what’s beyond that bigger impacts or using for your cash M&A returning to shareholders, buybacks and things like that.

Vincent Pilette

So in term of cash, the first priority is the business is different improve working capital. Before the acquisition of Kodak, we’ve been improving every year working capital generating cash from one person at about one time operating profit as a metrics for our business model. 2012 was a transition year, we acquired credit being lot more inkjet, sales internationally and Fiery went down 15%. It constrained a little bit cash, but we keep the long-term model of cash generation from an operation perspective at about one time operating profit. When we review with the board frequently, the usage of cash, we really have three priorities, and overall it’s really about putting the cash to support the growth as a priority to return cash to shareholders and then look at other windows. The first one obviously is to invest into the business.

We are using cash to develop better quality, put more demo machines out there et cetera and support in moderate way from a capital injection perspective, the business course. The second one is to support the M&A strategy. We have very high hidden rate in term of delivering results above and beyond the acquisition model.

From a result perspective, if in general, nine acquisitions out of 10 is failure and one is a smashing success, roughly have to reverse and that’s because a lot of acquisitions are maintenance modes acquisition strategy that well known and we just need to operate them and then the one that we took a risk on Cretaprint is actually a very strong success for us.

So very good success there and whether it’s from an investor perspective or from the Board, very supportive of continuing acquisition strategy. We have done about one in a quarter and we have no commitment in term of space, but you will continue to see us being acquisitive.

And then the third support of the growth using our cash is doing buyback and as you know the Board approved a $100 million buyback program in September and we are supporting the stock as to return the laying back stocks.

Scott Schmitz – Morgan Stanley & Co. LLC

Okay, great. Any questions from the audience?

Question-and-Answer Session

Unidentified Analyst

Hey, thanks. So my question is around the inkjet business model, there has been obviously a lot of talk for many years of this analog to digital transition and the growth rates you talked about it sounds like maybe that’s accelerating a little bit. But do you think in the future in order to continue to gain more and more digital business, you need to go out and acquire vertical products specific applications in order to do that or is there an inflection point that’s somewhere down the road where a lot of these very specific product in the industries would kind of I don’t know maybe slowly see what the competitors are doing, so they kind of help you on that path.

Vincent Pilette

Yeah, so long-term for us in industrial inkjet segment, we have an aggregated growth rate of about 10% to 15% that’s into our aggregated business. When you got the digital penetration it’s a different stage for the different submarket we serve. The curve looks something like proceeds flattish and you develop the technology trying to make it as par with analog et cetera. Then there is a break-through and it becomes an exponential curve, doctors and everybody wants to rush in and you have more linear growth where you have some side base reduction then it still don’t.

In display graphic we surpassed that exponential little more in the liner phase of no more adoption, either from analog or replacement of the old digital technology by the new digital technology. Kodak Prints ceramic tile manufacturing is right in the middle of that exponential adoption phase. Label it’s early technology refining still figuring out how to crack the code and get that exponential phase. And then behind that if you crack the code on label, you have all of the packaging opportunities. So I think the opportunities that seem gigantic before we can talk about a slowdown of an overall aggregated gross rate, also display graphic needs to slow down. We still have many other sub verticals, I can use that word to address before you see any overall meaningful slowdown.

And then the last point I want to make is if the top line sales are down, we’re going to sell less printers and ink will become a bigger proportion of the mix and you’re going to have a gross marring inflections point. Today we’re managing the business at around 40% with a much higher mix of printer revenue versus ink because we are in the old face of analog digital. I think you have many more years to go.

Scott Schmitz – Morgan Stanley & Co. LLC

Any other questions from the audience? May be we can just hit on a little bit more of the macro impact, it should have maybe started there. But yeah, what do you think from a macro does it slow down your demand or elongating sales cycle, any kind of the macro?

Vincent Pilette

So I am going to give you a convince, we’re not immune to macro level headwinds. However if ESI, Fiery was 100% of ESI revenue is a really 100% transactional fees about 10 years ago. We’ve done lot of work to diversify the portfolio build with resilience in the business model and understand our business level to navigate through moderate micro headwinds. If we take 2012, Q2 and Q3 were our toughest quarters. We had the volatility currency – macro level volatility in Europe, really because the sales cycles to get a lot longer. When you have the software value ads, when you have 26% of your revenue being recurring revenue like we do. When you’re managing the business with very lean inventory. When you have flexibility to extend on those DSO, or from the economic value of the total view, you could discount a printer, but increase the ink price and keep the same economic value. That gives you a lot of levers to navigate through that micro headwinds. The good news is that I feel I believe it’s more my personal opinion that the overall sentiments for expanding in 2013 is better than what I have seen in 2012.

Scott Schmitz – Morgan Stanley & Co. LLC

How does that vary by geographies, is there any – you mentioned Europe. I mean can you talk about…

Vincent Pilette

Independent. At the end of Q4 it was more of the US for the slowdown. It was tough to compare because in 2011 Q4, it was the U.S. which was really going strong. Q3 was the toughest quarter from us in Europe, by Q4 we saw a pick up of pace, growing Europe by 6% year-over-year, not extraordinary, but better than the decline we had seen in Q3 and people understanding that, maybe some of that volatilities, they are too large, but they could finance around it funding options to continue to drive it.

When you look at the best indicator for us is the ink consumption. We now have three years of UV ink volume growth over 20% and that means that despite whatever happens at the macro level, all customers that use our printer are using and growing the usage of those printers and so we are pretty pleased by that.

Scott Schmitz – Morgan Stanley & Co. LLC

Okay, great. We got time for maybe one more question from the audience. So anyone, your last chance? Okay, maybe I’ll just finish on with this one. We talked a lot about acquisitions, when do you divested business by work. How do you realize that this segment is no longer an area of interest for you guys and what have you exited in the past?

Vincent Pilette

Yeah, core competence of EFI innovation. As a second skill set was really customer intimacy, getting in touch through the acquisition we have done in mid 2000 and that really end user understanding the customer and then through the down turn 2008 to recession 2009 recession the team really improved operations. Put a lot of rigor in place. They have 11 daily reports on how the business is doing along the world.

We have monthly review of the business cadence and quarterly review of strategic discussions with each one of us in segments; GMs and the Corporation.

Through those quarterly reviews, we will be both acquisition opportunistic from that business development team brings in and all the GM. As well as the products in our portfolio that are not delivering on what we had expected. And so sometimes, we stop the development on some products or we put some products as I mentioned in software maintenance mode, then put products in legacy mode and just sustain the current install base, but do not develop or sell it anymore. It seems to have been at the 5% for the last few years. We did not formally divest the business. Also they have done that before and we look at constantly, that’s where we stopped supporting some products. So it’s looking on both hand of the product portfolio.

Scott Schmitz – Morgan Stanley & Co. LLC

Okay, unfortunately we’re out of time, but Vincent, thanks very much.

Vincent Pilette

Sure, absolutely, thanks guys.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Electronics For Imaging's CEO Presents at Morgan Stanley Technology, Media & Telecom Conference (Transcript)
This Transcript
All Transcripts