Electronics For Imaging, Inc. (EFII) CEO Discusses Q2 2013 Results - Earnings Call Transcript

Jul.18.13 | About: Electronics for (EFII)

Electronics for Imaging, Inc. (NASDAQ:EFII)

Q2 2013 Earnings Call

July 18, 2013 5:00 PM ET

Executives

JoAnn Horne – IR, Market Street Partners

Guy Gecht – President and CEO

Vincent Pilette - CFO

Analysts

Shannon Cross - Cross Research

Ananda Baruah - Brean Capital

Keith Bachman - Bank of Montreal

Matthew Kempler - Sidoti & Company

Morris Ajzenman - Griffin Securities

Jim Suva - Citi

Operator

At this time, I would like to welcome everyone to EFI's Second Quarter 2013 Earnings Conference Call. (Operator Instructions) Ms. JoAnn Horne, Investor Relations for EFI, you may begin your conference.

JoAnn Horne

Thank you, operator, and thank you everyone for joining us today. I have here with me Guy Gecht, Chief Executive Officer and President; and Vincent Pilette, our Chief Financial Officer. Before we get started, let me review the Safe Harbor statement. During the call, we'll be making forward –looking statements that are statements other than statements of historical facts, including but not limited to statements regarding our strategy, growth expectations, product innovations, new market opportunities, acquisition strategy, expectations regarding our future relocation from the Foster City campus to our new headquarters and related costs, as well as estimates and/or projections of revenue, operating profit growth, EPS, gross margins, market share, operating expenses, tax rate, working capital and any statements or assumptions underlying any of the foregoing.

Forward-looking statements are statements of risks and uncertainties that could cause our results to differ materially or cause a materially adverse effect on our results. Please refer to the risk factors discussed in our SEC filings and the press release. We do not undertake to update in light of any new information or future events.

In addition, reference will be made to non-GAAP financial measures. Information regarding the reconciliation of the non-GAAP and GAAP measures can be found in the press release that was issued this afternoon on our website at the IR section at www.efi.com. There are also slides available there that correspond to today's comments.

I'll now turn the call over to Guy Gecht. Guy?

Guy Gecht

Thank you, JoAnn, and welcome, everybody, to our call. We are very pleased that the momentum from Q1 accelerated in our June quarter resulting in a solid 10% top line growth and a fantastic all time record quarter for EFI. Our focused strategy, solid execution and operating efficiency combined with our unique ability to offer an end-to-end suite of products that allow print professionals to enter new growth markets, win new business, and reduce the total cost of operations led to our 14th consecutive quarter of revenue and EPS growth. We again posted growth in all three segments with total revenue of $180 million and delivered $0.38 EPS, up 27% year-over-year.

An important factor in our success this quarter was the various trade shows EFI attended, allowing us to showcase our innovative product portfolio around the globe. Trade shows are a great opportunity for customers to easily compare our products to the competition, a comparison that we welcome.

For example, at the FESPA London 2013, screen and digital printing trade show, we had our most successful exhibition to-date. We completed a record number of equipment sales deals during the show, with attendants acquiring a wide form of printers leading by Fiery digital front end systems. This year, FESPA was also one of the best yet in terms of software sales with several companies purchasing new ERP systems from EFI, proving the value of our ecosystem.

As Layth Karagholi, Managing Director of Total Display who made a pair of purchases at FESPA said, as we were looking at into a new investment, it was at EFI that we found the best combination of versatility of applications, print quality and production speed. EFI Pace software offers the versatility we were looking for. It links seamlessly with the printer to offer good reporting, CRM and automated work flow. We can get Pace to tell us what we need it to tell us.

Or, as PLS CEO, Olivier Philippot, who purchased a VUTEk LED printer at the show stated, when we started to look for a new machine and learned that EFI VUTEk can give us much higher print quality than our current machine at a higher production speed and with the environmental benefit as well, thanks to LED cool-cure technology, we knew we did not have to look any further to expand our customer service offering and grow our business in the years to come.

At FESPA London, we emphasized the complete end-to-end solution we offer from web to print and MIS workflow to digital front ends and the world's leading industrial inkjet printing portfolio. The activity at FESPA along with the ISA Sign show in the U.S. early in the quarter, as well as successful shows in China and Australia, reinforced our product leadership and positions – and position us for strong Q3.

Before turning to our business segment, a few words on the different regions. The Americas were exceptionally strong for us, growing 22% in Q2 driven by both the initial roll-out of the new VUTEk HS100, Cretaprint expansion into Latin American and a strong Fiery quarter in this region. Asia, excluding Japan, grew 10% year-over-year. The 3% overall decline in Europe this quarter was less pronounced and once again it was only our inkjet segment that declined in this region while Fiery and Productivity Software both grew. In Europe, the same two factors impacted results. The tough environment for capital equipment and the continued migration of tile manufacturing to the emerging markets, which we discussed in the past.

Now turning to results for business segments. We delivered 10% revenue growth in Industrial Inkjet driven primarily by the new VUTEk HS100 Pro and the continued strength of the VUTEk GS architecture, as well as the Cretaprint P3 platform. The new VUTEk HS100 Pro, which enables users to deliver unprecedented levels of speed and quality, has now been commercialized. And as one early adopter has accurately described it, it is a game changer.

And while many of this quarter's numbers are good, my personal favorite is our 26% increase in UV ink volume, indicating the solid end demand for our customers and further validating our five-year focusing on growth areas in our industry. With strong sales activity and a high number of leads coming from the trade shows throughout the second quarter, we expect Q3 growth in the 7% to 10% range for the Industrial Inkjet segment.

We are again very pleased with the outperformance of the Fiery segment in Q2, which grew 9% and is our second consecutive growth quarter. As we mentioned in our last call, we were excited by the new product introductions from our Fiery Partner. Similar to Q1, this quarter we benefited from a strong demand for the Fiery on the Canon and Xerox engines introduced in the past six to nine months, as well as the new Ricoh engine launched in the back end of the quarter.

The new Fiery FS100 platform continues to differentiate us in the marketplace against lower cost, lower productivity alternatives. We believe that we are also seeing some modest improvement in market share. Looking at the current quarter, we expect very strong Fiery growth of 15% to 18% versus the flat results in Q3 last year.

Productivity Software delivered solid growth of 11% year-over-year. We continue to see good pipeline conversion with a relatively high mix of subscription based transactions. The pipeline remains strong and there continues to be a high level of interest in productivity tools. Digital imaging businesses around the globe are continuing to make it a priority to streamline their print operations and drive efficiencies in the business. Keeping in mind the less predictable timing of closing large deals and higher subscription mix, for the third quarter, we look for 10% to 15% growth in Productivity Software.

As we look ahead to Q3 we have again entered the quarter with a solid momentum despite the normal summer seasonality. Our sales pipeline is robust and we continue to innovate and introduce new products that make our customers more competitive. With that in mind, we expect revenue growth of 11% to 14% or $170 million to $175 million and EPS growth of 18% to 25% growth or $0.33 to $0.35 per share.

Now I will turn the call over to Vincent to provide additional details on the financial results for the quarter.

Vincent Pilette

Thank you, Guy, and good afternoon, everyone. In Q2 we delivered another strong quarter with record revenue of $180 million, up 10% year-over-year. We expanded our operating profit margin to 13% of revenue compared to 12% a year ago and we delivered non-GAAP earnings per share of $0.38, up 27% year-over-year. We improved our working capital metrics and produced $19 million cash from operations compared to $8 million a year ago. We could not be more pleased by these results.

Let me expand into more detail starting with revenue by business segment and region. Our Q2 record revenue driven by strong organic growth demonstrates that we continue to successfully execute against our strategy and that our innovative products are well received by our customers across all of our business segments.

The Industrial Inkjet segment generated a record quarter with revenue of $88 million, up 10% year-over-year, and contributing 49% of total EFI revenue. Demand for industrial digital printers was robust across our portfolio, and UV ink volume grew 26% year-over-year.

Fiery revenue exceeded our expectations with $64 million in revenue, up 9% year-over-year, and contributing 35% of total revenue. Fiery growth, once again, was driven by new products recently introduced by our partners while maintaining channel inventory within our normal operating range.

The Productivity Software segment delivered revenue of $28.5 million, up 11% year-over-year, and contributing 16% of total revenue. Similar to last quarter, software subscriptions and services revenue grew strongly year-over-year. Total recurring revenue was a record $48 million, up 12% year-over-year, representing 27% of EFI total revenue.

By geography, we saw particularly strong demand for our products in the Americas. Revenue in the Americas amounted to $101 million, up 22% year-over-year, a continuation of the strong demand we saw in Q1, especially for Fiery and Industrial Inkjet. Europe continues to operate in a challenging environment. Total revenue in the EMEA was $50 million, down 3% year-over-year, with the decline partially driven by the continued shift of the ceramic tile industry towards emerging markets in Asia and Latin America. Excluding Cretaprint, Europe grew 4% year-over-year. In Asia, revenue grew 1% year-over-year impacted by the decline in Japan. Excluding Japan, Asia grew 10% year-over-year.

Looking forward to Q3 2013, despite the normal summer seasonality, we expect revenue growth of approximately 11% to 14% year-over-year, or $170 million to $175 million. This outlook is based on 7% to 10% year-over-year growth for Industrial Inkjet, approximately 15% to 18% year-over-year growth for Fiery, and 10% to 15% year-over-year growth for Productivity Software.

Moving on to gross margin, non-GAAP gross margin for the second quarter was 54.6%, down 30 basis points year-over-year and 40 basis points sequentially driven mainly by revenue mix. Non-GAAP Industrial Inkjet gross margin was 40% in Q2 2013, right at our business model target. The benefit of higher ink revenue as a percentage of total inkjet revenue was offset by pricing pressure in Cretaprint as we accelerate our growth in emerging markets.

Non-GAAP Fiery gross margin was 67.4%, flat year-over-year and up 40 basis points sequentially. In the Productivity Software segment, non-GAAP gross margin amounted to 71%, down 90 basis points year-over-year and quarter-over-quarter driven by a higher mix of subscription and services revenue. Going into Q3, we expect overall gross margin to be flat to slightly up compared to a year ago and flat to slightly down on a sequential basis driven by revenue mix.

Turning to operating expenses. In line with our expectations, Q2 non-GAAP operating expenses amounted to $75 million, up 7% year-over-year driven as expected by a busy trade show quarter as well as higher variable compensation related to our strong performance. In Q2, we continued to gain OpEx efficiencies with non-GAAP OpEx representing 41.6% of revenue, a decrease from 42.9% of revenue a year ago.

Non-GAAP R&D expenses were $30.4 million, representing 16.9% of revenue compared to 17.7% a year ago. Non-GAAP sales and marketing expenses were $33.6 million, representing 18.6% of revenue, down from 19.1% a year ago. And non-GAAP G&A expenses were $11 million, representing 6.1% of revenue equal to last year.

For Q3, non-GAAP operating expenses will be slightly down sequentially with lower trade show marketing expenses. We believe leverage remains in our model as we drive towards the bottom of our long-term target range of OpEx at 40% to 44% of revenue on an annual basis.

As a result of solid revenue growth and operating leverage, we delivered, in Q2 2013, non-GAAP operating profit of $23.4 million, up 19% year-over-year generating an operating profit margin of 13%, up 100 basis points year-over-year. Non-GAAP other income and expense was a net gain of $0.2 million with immaterial impact from currency.

On the tax front, we booked a non-GAAP tax rate of 22.5%, in line with last year's tax rate of 22.6%. Changes in either the geographic mix or product mix of worldwide sales may have an impact on the tax rate in future quarters.

Our strong operational performance enabled us to deliver non-GAAP EPS of $0.38 this quarter compared to $0.30 a year ago, a 27% growth year-over-year. For Q3 2013, we expect non-GAAP EPS of approximately $0.33 to $0.35 or about 18% to 25% year-over-year growth, assuming today's foreign exchange rates.

Turning to the balance sheet. Total cash, cash equivalents and short-term investments amounted to $354 million compared to $381 million at the end of Q1. We generated $19 million cash from operating activities compared to $8 million a year ago and invested in key areas such as the purchase of our new headquarters, the share buyback program, the acquisition of GamSys and the year one earn-out payment related to Cretaprint.

Continued realignment of our working capital framework compared to last year helped us generate another strong cash flow from operations. Accounts receivable was $129 million in Q2 2013, up 4% year-over-year on a 10% revenue increase. DSO amounted to 65.2 days in Q2, down 3.9 days from the prior year. Our net inventory balance was $63 million, up 3% year-over-year with inventory turns improving to 5.2 compared to 4.8 a year ago.

Total working capital amounted to 56.5 days, down 8.2 days year-over-year. And as a result, we generated $19 million cash from operations. Excluding tax expenses related to our headquarter building sale, we generated $47 million cash from operations year-to-date, which is about one-time operating profit. While we expect Q3 to be traditionally a low cash flow quarter, for the full year, we're on track to deliver close to our model of cash from operations equaling approximately one time operating profit.

In Q2 we spent $22 million to buy our new headquarters building and signed a lease for incremental space. As we mentioned last quarter, we expect to spend a similar amount in construction costs before we move in October with a vast majority of that cash outlay occurring in Q3. Beginning around September 2013, we expect to incur operating expenses related to our new headquarters with an approximate impact of $0.01 per share on a quarterly basis at full run rate.

Over a year ago, we acquired Cretaprint for $51 million, with $31 million cash upfront and $21 million earn-out over two years. During Q2 2013, we paid the year one earn-out and a purchase price adjustment totaling $10 million.

On the common stock buyback front, we repurchased $5 million worth of shares this quarter as part of the $100 million buyback program, bringing the total purchased to $33 million since we announced the program. Our total diluted weighted average share count for Q2 2013 was 48.3 million shares with a sequential increase primarily due to the share price appreciation this year.

To summarize, our unique portfolio of innovative products and consistent execution have led to a record first half in 2013 with revenue growth of 9%, operating profit growth of 21%, and cash from operations as about one time operating profit. We are delighted to serve our customers while delivering value to our shareholders and we are on track for a record revenue year.

This concludes my comments and now we will be happy to answer any questions.

JoAnn Horne

Operator, we'll take questions now.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Shannon Cross. Your line is open.

Shannon Cross - Cross Research

Thank you very much. Good afternoon.

Guy Gecht

Hi, Shannon.

Shannon Cross - Cross Research

Can we talk about the Fiery business first? Obviously, it was stronger than expected this quarter and your guidance is strong. I know it's easy comp, but if you could talk about some of the underlying drivers and any thoughts on inventory or how things are positioned going into the third quarter?

Guy Gecht

Okay. So I'll start with inventory. Based on what we know, our partners carry inventory within the normal range that we expect them, no big change there. As far as the drivers for the growth, clearly, as we always indicate, new engines from them drive a lot of replacement in the channel. We saw Canon launching a good product for us in our sweet spot at the end of the year. Last year, in February, Xerox launched a great product, J75. And then at the end of this, in June, we had a launch with Ricoh and they started to take products from us. So, of course, that helped.

I think that investment in innovation in the last year, 18 months also helping. We came with a very strong architect FS100 and customers like it and what they see is that if I continue to invest and stay committed to this and the ROI I think at the same time compared to the alternatives that's coming from our partners that are lower cost but lower productivity in our mind and don't have as much feature-rich, the ROI is much stronger and favorable with Fiery. And the last thing is the connectivity between the Fiery to now we have about 25,000 and growing sites that's using our Productivity Software mainly on MIS. The connectivity is definitely advantage that other people don't have.

Shannon Cross - Cross Research

And when we…

Guy Gecht

So all of that…

Shannon Cross - Cross Research

Okay. Go ahead.

Guy Gecht

Sorry.

Shannon Cross - Cross Research

I know you don't give guidance sort of on a quarterly basis and beyond, but when we think about the strength sort of through year-end and beyond, I mean, do you feel comfortable with the pipeline that you're seeing from your partners in terms of launches in the next few quarters?

Guy Gecht

Yeah. As I said last time, the good news is that it seems like it's not one big bang. It's every quarter we have something and that definitely we see that launch continue in the next few quarters.

Shannon Cross - Cross Research

Okay. Great. Can you talk a bit about the ink sales up 26% year-over-year? Where are the – what's driving that? Is it – I guess, where is the demand coming from? And just feedback from your customers, because clearly ink sales have been quite strong for quite a while.

Guy Gecht

Yeah. As I mentioned, that's my favorite number that showed me that [indiscernible]. We sold to customers a lot, actually customers are growing faster than EFI, which is always good to see in our segment. I think, first of all, there's a lot of spend in the auto form advertisements and printing on all sort of materials and all sort of sizes, 3D type of large, small materials. So we definitely see that there continue to be growth there.

There's also migration in that segment from screen printing, which is analog based to digital printing. And I like to believe that our customers using our products in general in the category that we sell it to a higher productivity, higher quality to gain share against people that don't have EFI products. And so all of those three combined helping.

I can give you an example. For the first item, the LED based system that we started to ship over a year ago, we now ship more than 100 machines based on LED. When I compared the ink consumption of those machines to the same exact same GS that doesn't have the LED option, the ink volume for customers that have LED is over 50% larger on average and that tell us that they're using the innovation of LED to drive more applications, not just saving money, not just being more environmental friendly, all important, also to drive more applications.

So I think all of that together is getting very healthy business to our customers and they continue to buy printers as their business expand and buying more printers mean we're going to get more ink in the future.

Shannon Cross - Cross Research

Great. And then just one final question. Given all the cash you have and clearly the success of Cretaprint, what are your thoughts on acquisitions? And I know Vincent doesn't want the cash burn a hole in his pocket, but how are you thinking about the pipeline?

Guy Gecht

I hope that we demonstrate that the cash doesn't burn a hole in the pocket. We're very disciplined about M&A, but M&A is definitely in our strategy and I can tell you for certain that there will be more acquisition. I can be less certain on the timing and obviously the name of the targets.

But we're looking at couple of type of targets. One is we continue to look at small software companies that we add to our base and helping us to grow Productivity Software globally. Remember, still most of our sales are in North America, we're growing nicely in Europe. We can grow it beyond that. So that definitely we see more companies in that category. And we actually have done one of that GamSys a couple of months ago help us to expand in the middle of Europe.

And on the inkjet side there are quite a few acquisitions that expand and support the Industrial Inkjet segment. We're not done with who we're going to – which acquisition we're going to do, but we're very disciplined about it. We take our time with Cretaprint. We spend a lot of time learning the space. We spent about seven months negotiating and doing due diligence with the company. I like this discipline.

There is no reason for us to be honest to move faster. There's not that many buyers. And at the same time I'm very pleased with our organic growth. So it's not like I have to – we got to have an acquisition now to help with any type of shortfalls. So [indiscernible], we definitely focused us on the M&As and our future pipeline is very good.

Shannon Cross - Cross Research

Great. Thank you very much.

Guy Gecht

Thanks, Shannon.

Operator

Your next question comes from the line of Ananda Baruah for Brean Capital. Your line is open.

Guy Gecht

Hi, Ananda.

Ananda Baruah - Brean Capital

Hey – awesome. Thanks. Hey. Congrats on a solid quarter.

Guy Gecht

Thank you.

Ananda Baruah - Brean Capital

You're welcome. Hey. Just real quick on the revenue forecast. And if I'm calibrating my model correctly to your segment guidance, it appears that you're guiding kind of each segment down sequentially. And I just was wondering given the momentum in the Fiery product cycles sort of, obviously, sort of inkjet your products are tracking well as you mentioned and you're coming off of the trade shows and software seemingly actually [indiscernible]. What's the – I guess, what's the thinking behind the down sequential in the September quarter, which could sometimes does have positive seasonality with the product cycles or the trade show kind of orders [indiscernible]?

Vincent Pilette

Hey, Ananda. This is Vincent. In term of quarter seasonality, you know Q1 and Q3 are the weak quarter, Q2 and Q4 are the strong quarter. We are fortunate actually to finish here Q2 on a very strong momentum. But we also want to be prudent and cautious when we forecast, right? We forecast it to 11% to 14% growth year-over-year and you have the growth by the different segments that are pretty solid.

We definitely considered Europe as one of the environment that maybe is more stable than a little bit, but it's still in a weak environment. And we definitely wanted to take that into consideration. And then as you know July and August lots of people are on vacation and we just apply that normal cautiousness, if you want, in our forecasts.

Ananda Baruah - Brean Capital

Okay. Got it. Yeah, I guess, Europe did. I mean, Europe last year was tough for everybody and you felt that a little bit too. I guess, I can see the prudence there. That's useful. Thanks, Vincent. I appreciate that. Can you just talk a little bit more about the Creta price aggression to place units that you guys referenced, and what are the dynamics around that and how broad is that taking place?

Vincent Pilette

Yeah. So, Ananda, as you know, we've mentioned many times that the ceramic tile industry is moving from western world into emerging markets where the big growth is. EFI definitely is investing a lot in the emerging markets and we've seen very strong growth for us in countries like China, Mexico, Brazil, Turkey. I mean, we have a lot of activities going on there.

Cretaprint is still in the market. That's really low penetration from a digital perspective. With fast adoption, a lot of moving pieces. So we definitely see a market that's less mature and some pricing pressure and obviously you want to sustain the growth.

Overall, as we said, we managed the business at around 40% gross margin. If we go over, in the overall gross margin, we're normally going to reinvest in price to accelerate the penetration of those printers into those countries or those markets. And that's what we've seen so far and we've been fortunate to be able to manage good profitability and overall growth despite the pricing pressure. And then the last point I want to mention, since we acquired Cretaprint, we did a lot of work on the cost structure to take costs out of the printer or the product and we continue to do that leveraging our scale.

Ananda Baruah - Brean Capital

And I guess with inkjet margins at 39%, definitely – I mean, that's 40%-ish, no doubt. And at the same time, it's the lowest you've had in a while.

Vincent Pilette

So, Ananda, just correction. Industrial Inkjet gross margin was 40% this quarter.

Ananda Baruah - Brean Capital

I got it. Okay. Apologies.

Vincent Pilette

That's okay.

Ananda Baruah - Brean Capital

Okay. Thanks. And then just on the controller share gain comment, is that coming against Kodak or is that coming against the OEMs?

Guy Gecht

This is an area really difficult to measure, but we have multiple indications that we're actually gaining share in some areas, as I said, modest gain share. I think it's across the board. There's still some pockets with Kodak that obviously we're going after, but also our partners with, again more lower cost, lower productivity, I think this is where everybody push as hard as they can to get customer sales and pay less attention of what they're selling. And we're very focused on controller and the other party is really focused on moving engines. So the focus, the innovation, the execution, the field support is paying dividends.

Ananda Baruah - Brean Capital

And the partnership makes more sense that way?

Guy Gecht

Yeah. I agree. There's no conflict. First of all, our partners make a lot of profit on Fiery, because they are profitable sell for them. And, obviously, the bigger picture they sell an engine with a customer has a great ROI and we do anonymous survey on every part of EFI. The Fiery satisfaction rate with customers is the highest in the industry, it is the highest at EFI. People really like it, it's a great product for them. So our partners know that if they want to keep a customer happy, they keep selling the Fiery.

Ananda Baruah - Brean Capital

They make more margin selling an EFI product as opposed to their own product?

Guy Gecht

Dollar wise, yes. Percentage wise, it depends, what they allocate to the margin. But at the end of the day, the controller is a small piece of the equation. What they want is to place the engine then get of course the click charge, which is the most lucrative part of it and the controller. It doesn't matter. They just need the customer to be happy and to bring a lot of jobs to the digital part of the shop.

Ananda Baruah - Brean Capital

Got it. Thanks. And I guess just this last one thing. I know that's a lot of question. Just on – another one on cash usage. What's the thinking around timing to announce now we're sort of six months through the year and you kind of talked about $100 million share repurchase this year. When should we expect you guys to sort of talk about cash usage away from M&A, longer term, buyback, dividend, things like that whatever it is you're considering?

Vincent Pilette

Yeah. Yeah, Ananda. So I think Guy mentioned already we're already very active on the M&A front looking at due diligence and opportunities with specific targets. When it comes to the buyback, we bought $5 million this quarter.

When we open the $100 million program last September, one of the objective was to offset the dilution of the new headquarter building. At that time we estimated the impact on the P&L to be about $0.08 to $0.09 on an annual basis. That was a foolish assumption.

We're fortunate to be able to negotiate a very good deal for EFI and reduce that impact to $0.04. So today the objective number one of the buyback, which is offsetting the dilution impact of the headquarter, has been fully met and more.

When we implemented the buyback, we had the strategy of supporting the stock and we've been very fortunate to have very few days that the stock needing support since then. And so we'll continue to drive the buyback program to offset dilutions and maybe more and would continue on the same path.

Ananda Baruah - Brean Capital

Awesome. Thanks a lot, guys.

Guy Gecht

Thanks, Ananda.

Operator

Your next question comes from the line of Keith Bachman from the Bank of Montreal. Your line is open.

Keith Bachman - BMO Capital Markets

Hi, guys. A couple also on Cretaprint. Is Cretaprint growing on a year-over-year basis?

Guy Gecht

Cretaprint?

Vincent Pilette

Yes.

Keith Bachman - BMO Capital Markets

Yeah.

Guy Gecht

Absolutely.

Vincent Pilette

Yes.

Keith Bachman - BMO Capital Markets

Okay. I was a little confused when – I thought you said in Europe there were some issues there…

Vincent Pilette

Yeah…

Keith Bachman - BMO Capital Markets

With Cretaprint, but…

Vincent Pilette

No. Absolutely, Keith. So if you're asking us if Cretaprint in Europe specifically is growing on a year-over-year basis, the answer is no…

Keith Bachman - BMO Capital Markets

Yeah. No.

Vincent Pilette

Globally it is and there is this rapid shift from western world to emerging markets.

Keith Bachman - BMO Capital Markets

Okay. And then is there – can you give us the update on Cretaprint on the usage of own ink, so to speak, rather than third-party ink?

Guy Gecht

Sure. So you know we continue to sell Cretaprint, very pleased with the business. The growth in units is double-digit and strong, Keith, and the growth in revenue year-to-date is good and we're expecting a very good Q3 with Cretaprint. So it's all great indication. What we're missing is where the real money is, is that the ink.

And we knew it coming in because we started with a small acquisition in Spain, but that we'll need to work on this. We continue to work on that. We're making very good progress. I said before it's not a 2013 event, or not meaningful event in 2013, but it's certainly something that is a big upside and something we're very focused on.

Keith Bachman - BMO Capital Markets

So is it a 2014 event?

Guy Gecht

I'll be disappointed if we're going to sit here in 2013 and we still don't have an ink solution

Keith Bachman - BMO Capital Markets

Okay. And then an update on labeling rather. What's – any kind of metrics that we could use to think about that business, either your growth rate, growth rate of the industry activities, percent of your inkjet revenue? Any kind of metrics that you can give us an update on the labeling side of the business?

Guy Gecht

Sure. So I would say, well, VUTEk really has a fantastic quarter, Cretaprint had a fantastic quarter, especially in bookings. And in labeling what we're seeing, the good news is the customers we have in installed base. There's a huge growth in ink. They're getting more and more jobs. The growth rate of ink actually is higher than our average 26%, I'll give you that.

But at the same time the penetration of digital is still very, very small. So we're not too disappointed. We didn't build too much on this for 2013. We know at some point inkjet technology is going to get to the inflection point. It will be good enough for people to start to switch from analog. We're not there yet.

Keith Bachman - BMO Capital Markets

Okay. And then my final one is also to follow on Ananda. You bought $5 million stock and you have a high-class problem because you have share creep now with your stock price. Why not be a little more aggressive about at least trying to keep shares down, at least to deflate the stock price so to speak? But $5 million doesn't seem like a lot when you have $19 million of free cash flow.

Vincent Pilette

Absolutely, Keith. Overall, definitely, you know, offsetting the dilution of the building was one objective. Offsetting the natural dilution of share price increase was another one. Obviously, on the core-by-core basis, it's very difficult you know that we have a plan in place that enabled the company to buy despite wherever we are in the quarter. And you have to decide, it was quite fair enough, and in advance, you can't change them every day. So that's part also of what you see on a long-term basis definitely will work on offsetting the dilution.

Keith Bachman - BMO Capital Markets

Okay. That's it from me, guys. Thanks.

Guy Gecht

Thanks, Keith.

Operator

Your next question comes from the line of Matthew Kempler from Sidoti & Company. Your line is open.

Matthew Kempler - Sidoti & Company

Thank you. Thank you. First, I wanted to follow up on the labeling segment. You spoke about how you feel the inflection point is still approaching. From your view, what pieces still need to fall in place to hit that inflection point?

Guy Gecht

So if I look at other segments, for example, the design and graphics where VUTEk is doing really well, the two things that really caused people to move the model to digital are one, inkjet got really close to the quality and speed of analog. We're not there yet in labels as far as quality for sure, not in speed from an inkjet perspective. The second thing is, as far as the customer demand for short run, the ability to do versioning and personalization, there's of course there is demand. It's not strong enough to cause the manufacturers, the people that actually print labels, to go and buy despite the gap in technology to go and buy label machine.

Now, it's all a matter of time. People want short run. We see the people that get into this actually benefiting. As I mentioned, sales customer, the ink consumption growth is very nice. They're growing the digital business. But it's still not there and it's tough to predict what will be good enough quality on digital and inkjet that a lot of people are going to say, okay, now it's time to turn to digital.

Matthew Kempler - Sidoti & Company

Okay. And then following up on ceramic tile and Fiery, the Pro server product that you have, I'm curious how beta trials were turning out in the quarter and what launch plans look like for that product?

Guy Gecht

We had beta trials in the quarter. The feedback was very good. Customers are not only seeing the benefit from a workflow getting better quality trials, they also can save actually a little bit of ink by being more efficient in how they get to the design they want.

And so the feedback was very good. At the same time we discovered few features and functionality that is specific to ceramic that wasn't in the Fiery and we believe needed before we'll do a worldwide deployment. So we said, okay, let's spend few more weeks, so maybe a month or two to catch up what we're missing and then we roll it worldwide.

So while we're very happy where we are, it's a differentiator. When we show it in trade shows, people know it's a very important feature, everybody likes it. It's something that EFI is the only company in ceramic that's able to bring to the market. We took – as far as commercialization and actual revenue, we took a little bit of a pause just to close the gap on functionality.

Matthew Kempler - Sidoti & Company

Okay. And then the last question from me. You mentioned the strong trade show activity we saw in the second quarter over sales and leads. And I'm wondering would you characterize this at all as different from what you saw last year this time? And if so, is there anything that's influencing that?

Guy Gecht

I think it's just that it seems like things are accelerating. It feel like customers understand the growth opportunity. Look, if we sell 26% more ink volume, a lot of people out there will notice that you can do great – can get a great business by entering into this. So we're seeing people that were in different part of prints now getting into this grand format, auto form advertisement, sign and graphics, things that you think can help.

And so with that certainly we're seeing a lot more people looking at that and making buying decisions. And the number of fleets is definitely a lot higher than the growth in revenue, which is a very good thing. That means we should have something to work on the next few quarters to convert. And look, it's obviously everybody knows there's not a lot of growth areas in print. So when something grows that fast, a lot of people paying attention and getting into it. So that's definitely I would – I saw acceleration in interest, not just in sales.

Matthew Kempler - Sidoti & Company

Okay. Thank you.

Operator

The next question comes from the line of Morris Ajzenman. Your line is open.

Morris Ajzenman - Griffin Securities

Hi, guys.

Guy Gecht

Hey, Morris.

Morris Ajzenman - Griffin Securities

Hey. A question on Productivity Software. Up 11% this quarter and gross margins down 90 basis points. I think that's both sequentially and year-over-year. And then you attributed that to a higher mix of I think you said subscription service-based revenues. Is that correct?

Vincent Pilette

Yeah. That's correct, Morris. There's been now two quarters that we see a trend. You know we've had very strong bookings, but within those bookings the portion of subscription and services revenue was higher. We continue to believe in margin expansion in this business as we continue to scale the top line. But if the trend of subscription and services continues, maybe the scale up would be at a different pace than if we do all term perpetual licensing.

Morris Ajzenman - Griffin Securities

What percent of revenues in Productivity Software currently is subscription service-based?

Vincent Pilette

We don't break that out at this point in time.

Morris Ajzenman - Griffin Securities

Okay. All right. I guess – but has that increased as a percent of revenues in the last few quarters or last year or was it just this quarter it was particularly --?

Vincent Pilette

No. It has been a trend that we've seen more recently, obviously, it became more mature, but I would say the last two quarters the trend was already there.

Morris Ajzenman - Griffin Securities

Okay. And that trend should – I mean, I guess, there's nothing wrong with that growing, but it just impacts margins overall, but will that trend continue to – percent of revenues of the division grow?

Vincent Pilette

It may moderately impact the margin in the short-term. Obviously, in the long term, it's all good, because it builds a lot more recurring revenue, recurring revenue growth. The stability of the overall P&L improved. And I think all those things are very good things.

Guy Gecht

Morris, we give customers a choice. Frankly, we prefer that they would go subscription. We like to see an equivalent revenue continue to grow a good 12% this quarter. We're very pleased with that. So it's not something that we're fighting against. I think it's very positive. But of course the other side of subscription, we don't get to recognize all the revenue up front.

Morris Ajzenman - Griffin Securities

All right. Now, I mean, clearly, I mean, profitability is profitability. There's no question about you want to see that growth impact the margins near-term, but overall it helps the growth of the business. Aside from that, I think you had guided into this quarter, I could be incorrect, but I think you guided to 15% revenue growth for Productivity Software. It came in at 11%. I mean, again, 11% nothing sneeze out, but anything particular? Is it just a timing issue? I mean, anything where – because that was the only thing that came in a little light versus your guidance, if I'm correct on recollecting your guidance for the quarter?

Guy Gecht

Vincent would like to take a look at how we guided. I can tell you that we had more subscriptions than we expected, and which is again, I view it as a very good thing. When I look at the booking number, which we're not publishing, our booking was very strong. We booked way – the growth is way higher than the 11% of revenue. So that, of course, works well for the future, but the nature of it is you don't see it in the first quarter.

Vincent Pilette

And just for clarification, Morris, just to make sure we're on the same page with regard to the numbers. Going into Q2, we guided software at about 10%, not 15% as you mentioned. And in that forecast, obviously, we had factored the Q1 trend that we saw, which is the increase in subscription and services. I would say, software, came 1 percentage point over our estimate. I would say within our estimate we're very pleased by that growth and we'll monitor very closely to see what customers do in term of choosing perpetual license versus subscription business.

Morris Ajzenman - Griffin Securities

And, Guy, you mentioned bookings; you don't break out that number, do you?

Guy Gecht

No. We don't give out booking numbers. But I will tell you that bookings in software was very strong, way higher than the 11%. We're very pleased with the booking. By the way, we pay sales people based on that. So it's something you'd see it in the OpEx and commissions and so on. But a lot of the booking with subscription are things that we cannot recognize this quarter. Again, very good problem to have because the quarter turned out to be very good. We didn't need all of that. And we have this recurring revenue for the future.

Morris Ajzenman - Griffin Securities

Great. Okay. Thank you. One last question and I'll get back in queue here. On the inkjet side, I think like you said you have 10% this quarter. Can you give us just sort of handle on where you think the industry is growing? Right now, I presume it's lesser than the 10% rate. Any sort of ballpark figure you want to throw out on where you think the industry, i.e., your competition's growing right now?

Guy Gecht

It's definitely it's really tough to tell. HP don't give their growth or lack of – whatever they do in our segment. Private companies don't give their growth rates. So it's really difficult numbers to compare. Normally, we work with consultants or the analysts there. We will do this year the same way and we'll figure out what was the last 12 months growth. I'm pretty sure it was be below our growth, but I think we feel like we're definitely dominating a lot of markets with better ROI and value propositions.

Morris Ajzenman - Griffin Securities

Thank you.

Guy Gecht

Thanks, Morris.

Operator

[Operator Instructions] Your next question comes from the line of Jim Suva from Citi. Your line is open.

Guy Gecht

Hi, Jim.

Jim Suva - Citi

Hi. Thank you and congratulations to you and your team there at EFI for good results once again.

Guy Gecht

Thank you.

Jim Suva - Citi

A lot of the details and good questions have been asked. So if I can take a shot at asking a question kind of bigger picture, when you sit back as executives of your company, what are the various end markets or regions that looking forward, I'm not talking kind of Q2, I'm talking more of Q3 for next year that you find extremely enticing. I mean, there's got to be some that are kind of worrying you that you have on the worry chart that are walking down. Actually, ones that maybe you're walking down, what are you looking at for there? Are you looking at like industrial production numbers, are you looking at employment numbers, or what kind of bigger picture numbers should you be looking at just a few things quite to get potentially better or continue to be a bit of a hindrance?

Guy Gecht

Yeah. You know, we watch of course the headlines, spend on advertisement, especially spend on advance commercial, does change, again, impact of your bigger professionally Fiery numbers. Spend on – in new construction obviously could impact our Cretaprint sales although we're seeing shift to digital print. So even if the number of files will go down, there's still lot of growth from digital – from analog process to digital process that we can benefit for years to come. So the headlines sometimes are scary, but I'll tell you I looked at this quarter as obviously tons of metrics that we look at. We have a full team management report every morning that we get. This quarter was so good for so many ways.

I mean, we looked at a lot of indications. I mean, we'll definitely tell you the ink is definitely a very good leading indication. It seems like people are turning to the segments that we positioned ourselves in. So it feels like the strategy really is working. We thought that area's going to grow and we can grow faster than the segment by our innovating and our executing the competition, and that's exactly what we're seeing happening.

Jim Suva - Citi

Great. And then if I could just follow up a little bit, inkjet business is kind of the landscape has been changing for quite some time, but more recently we've seen some changes by Xerox and Kodak and some of the other players. Can you talk about inkjet over on the hardware and on the ink side? Are you seeing more aggressive pricing, pretty rational pricing or just how that landscape is kind of shaking out.

Guy Gecht

Do you mean from M&A or from customer purchases?

Jim Suva - Citi

Well, kind of an M&A that's in – through the customers.

Guy Gecht

No.

Jim Suva - Citi

Is the M&A have an impact on purchases?

Guy Gecht

You mean M&A of buying companies acquisition or customers buying equipment?

Jim Suva - Citi

Kind of both. I mean, how that all is kind of shaking out to dilutive results and any changes in pricing and pressure or is it still pretty favorable?

Guy Gecht

So I'll start – M&A's easy. We don't see Kodak and Xerox in any of the deals. I only remember one time that, in the last few years, that they were in the same deal. They focus on a different category than we're focusing, and so that does no – and I don't see any different pricing and valuation and we benefit from the fact there's not a lot of buyers. A lot of people play defensive in printing today and not looking at M&A and printing. So it's helping us.

From a pricing perspective, I think we're paying good valuation. We get a very quick return on that. As far as the prices what customers try to play against and go and get the best prices, we are in almost every category we're not the low price leader. We don't intend to charge above average, but we tend to bring people a much better ROI. And all the time, we established a reputation as such. If you pay upfront [indiscernible] but the return is much faster. And so I think that that's – this is the strategy that's working for us. We'll continue to emphasize the value. And as long as the customer need this value, that will continue to work for us.

Jim Suva - Citi

Great. And congratulations to you and your team there at EFI again.

Guy Gecht

Thank you very much.

Vincent Pilette

Thank you.

Operator

There are no further questions in the queue. I'll turn the call back over to Mr. Gecht for closing remarks.

Guy Gecht

Thank you. Thank you, everyone, for joining us today. We are delighted with the results we shared with you today, and we committed to continue to work hard and execute in the coming quarters. We like to extend a big thank you to our employees that delivered those with us, to our customers who are very loyal and our very supportive shareholders. We will be looking forward to sharing some more good news with you in the future. Thanks.

JoAnn Horne

Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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