Electronics For Imaging, Inc. Q3 2009 Earnings Call Transcript

Electronics For Imaging, Inc. (EFII)

Q3 2009 Earnings Call

October 28, 2009 5:00 pm ET

Executives

Guy Gecht - Chief Executive Officer, Director

John Ritchie - Chief Financial Officer

JoAnn Horne - Investor Relations Market Street Partners

Analysts

Shannon Cross - Cross Research

Ananda Baruah - Brean Murray Carret & Co.

Keith Bachman - BMO Capital Markets

Richard Gardner - Citigroup

Presentation

Operator

Good evening ladies and gentlemen my name is Tracy and I will be your conference operator today. At this time I would like to welcome everyone to the EFI Third Quarter 2009 Earnings Conference Call. (Operator Instructions). Thank you. Miss Horne, you may begin your conference.

JoAnn Horne

Thank you, operator, and good afternoon everyone. I have with me here today Guy Gecht, EFI's CEO and John Ritchie, our CFO. Before we begin the prepared remarks let me review the Safe Harbor statement.

Please note that during the call and during the question-and-answer session that follows the Company will be making many forward-looking statements, each of which involves a number of risks and uncertainties. Statements other than statements that are historical facts including words such as anticipate, believe, estimate, expect, consider, and plan and statements in future tense are forward-looking statements.

Statements that could be deemed forward-looking statements include, but are not necessarily limited to, statements regarding opportunities for the Inkjet segment, our planned industry leading new products, return to profitability, continued growth in the future, and any statements and assumptions underlying any of the foregoing. Past performance is not necessarily indicative of future results.

Forward-looking statements are subject to certain risks and uncertainties that could cause our actual future results to differ materially or cause a material adverse impact on our results. For further information please refer to the risk factors discussed the advised SEC filings, including but not limited to the annual report on Form 10-K as amended, the quarterly reports on Form 10-Q, Form 8-K filed with the SEC today and the attached press release. The company recommends that you read these documents in conjunction with the review of our financial statements.

For your convenience the company has posted slides on the website on the IR section at www.efi.com giving an overview of much of the information the company will cover today. We undertake no obligation to update any forward-looking statements or information discussed today.

In addition, reference will be made to non-GAAP financial measures. Our earnings release provides a reconciliation to our GAAP and non-GAAP measures. These non-GAAP measures are not in accordance with, or as an alternative for, GAAP and may be materially different from other non-GAAP measures including similarly titled non-GAAP measures used by other companies. The presentation of this additional information should not be considered in isolation from, and a substitute or superior to net income or earnings per diluted share prepared in accordance with GAAP.

Non-GAAP financial measures have limitations and they do not reflect certain items that may have material adverse impact upon our reported financial results.

I will now like to turn the call over to our Chief Executive Officer, Guy Gecht. Guy?

Guy Gecht

Thank you, JoAnne. Good afternoon everyone and thank you for joining our call today. We are pleased with our results for the first quarter as we managed to return to sequential revenue growth across all three of our product lines despite the continued challenging operating environment and we are particularly encouraged by the 22% quarter-over-quarter growth in our Inkjet segment leavened by four new products introductions in the quarter including a state of the art VUTEk® GS3200 platform.

We also saw continued growth in our ink business indicating increased utilization rates within our install base. Our controller business exhibited modest sequential growth benefiting from normalized inventory levels and our OPs business provided healthy sequential growth.

We believe our growth is due to exciting new products driving demand as opposed to any significant economic recovery. We believe that our industry is still impacted by weak demand for new equipment and the difficulties for customers to obtain financing. We view the meaningful sequential improvement in our business and the growth trajectory as validation of our belief that the most effective way to overcome the impact of the economy on our industry is by launching best in class in products across our lines of business. We are managing to continue to innovate in a rapid way while achieving substantial cost reductions across the board including gin R&D.

However, despite the sequential improvement our results are still far from where they need to be. We will continue to take the steps necessary to expedite restoring shareholder value, starting with [inaudible] profitability which we expect in the current quarter.

Turning to our different segments, in the Inkjet segments our growth was largely driven by the strong demand for the new VUTEk® GS3200. The product is now shipping and with a list price of $600,000.00 it has significant impact on our sequential results. With speeds of up to 2,200 square feet per hour and photo realistic quality the GS3200 expands the reach of super wide printing into new industries and applications. It also allows customers to develop creative high value applications for their customers when improving their own bottom line.

We are also excited about the Jetrion 4830, our new product targeted to the labor markets which began shipping late in the quarter. The Jetrion 4830 brings roughly twice the weight of our existing Jetrion 4000 printer and allows for double the productivity when printing labels up to 4”. We have also added the capability of specialized wide printing which has significantly increased the market opportunity for the device. We launched the Jetrion 4830 last month at Label Expo where EFI won the 2009 Label Industry Global Award for New Innovation.

Our final two new inkjet products that began shipping during the quarter are in our Rastek line up, the Rastek H650 and the T660. We acquired Rastek in a strategic step to expand our addressable market by offering a lower price point wide formatting inkjet product. The strong reception to these products is helping us to quickly expand our distribution channels to cover this lower priced market and we look for these two products to be important contributors to future growth.

Once again, ink revenues were up sequentially, but still down 11% overall. UV volumes matched our record volume levels from Q308. As anticipated the growth of UV ink is offsetting the decline in our legacy solvent ink business. Between the ink revenue and the [inaudible] revenue roughly 27% of our revenue this quarter was liquid in nature. As you know a cornerstone in transforming EFI is to migrate a substantial amount of our business to recurring models.

This continued improvement in our revenue and the strengthening in both our printer equipment volume and the ink business led to increased inkjet gross margins in the quarter. We expect the inkjet segments revenue and margins to continue to improve during the coming quarter fueled by our new UV printers in the market that is definitely showing a strong preference to UV technology. This benefits EFI, as our UV product portfolio is in our view the strongest in the industry.

We experienced a modest improvement in our Fiery business this quarter, but the operating environment continues to be difficult resulting in 38% over the rate of decline. We saw slightly improved results in our Fiery business due to more normalized OEM inventory levels which should help match sell in and sell through in the coming quarters. We continue to see a shift to lower end products which as we have discussed in the past is a common result in a slow economy. We are optimistic that as the economic environment improves we will see customers start to again choose more sophisticated products with our Fiery technology maintains greater attach rate.

In addition, we look for the new Fiery for the new Canon line up to begin shipping in volume in the fourth quarter which should benefit our results. This is the last scheduled major OEM product introduction in 2009 and while we do not anticipate any meaningful pick up in production until the economy recovers, right now it appears that 2010 will be a busy year for OEM new product introductions. Naturally the state of the economy over the next few months will impact the volume of sales of this new entrance.

Turning to the OPs business, we are pleased with the results. It was down 8% year-over-year and up 8% sequentially which was boosted by the signing of 130 large deal in the quarter. We are encouraged by the strong pipeline we have in place, although large deals are still hard to close. This business continued to benefit from the strong recurring nature of maintenance and support revenue.

Lastly, as you will have read in our press release out today we have decided to accelerate the return of cash to our shareholders. Our board of directors has approved the repurchase of up to $70 million worth of shares of EFI common stock through the use of modified Dutch action tender also. This amount represents the balance of the after tax cash proceeds generated by the sale of our excess real estate and would complete our current $100 million buy back authorization. We believe repurchasing our shares is an attractive and prudent use of the Company’s strong cash position and would create value for our shareholders.

In summary, despite the significant sequential improvement in our business we are clearly far from where we want to be in terms of revenue and profitability. Our strategy of using innovative new products across the board to overcome the impact of the slowness in our industry and customers delayed buying decisions is working. Our work to improve margins and execution is far from done, but we are benefiting and will continue to benefit from a lean cost structure. We anticipate returning to profitability in the coming quarter.

Now I will turn the call over to John so he can review our financial results in greater detail.

John Ritchie

Thanks, Guy. Before I go through the detailed financial review I wanted to remind everybody that on the IR portion of our website we have posted our GAAP results, our reconciliation between our GAAP and our non-GAAP results, and the geographical break down of our revenues. As such I will not be covering those topics today.

Now moving on to the quarter, revenues came in at $100.9 million, up 12% sequentially and down 30% on a year-over-year basis. Our non-GAAP loss for the quarter was $0.05, an improvement over the $0.12 loss in Q2 and down from income of $0.20 in the year-over-year period.

Before I go through the quarter in detail I want to highlight some key take aways. As Guy mentioned our recurring revenues were 27% of total setting a new high water mark for recurring revenue dollars. As a reminder, our recurring revenues primarily consist of inks related to our inkjet business and software maintenance contracts.

Fiery revenue for Q3 was up 4.5% from Q2 of ’09, our first sequential increase since Q4 of ’08. This increase breaks a seasonal trend of third quarter declines in the Fiery business.

In the quarter we introduced four new inkjet products including our VUTEk® GS3200, the Jetrion 4830 and the two Rastek products Guy mentioned. These products drove the 22% increase sequentially that we had in the inkjet business.

Our UV ink volumes matched our peak levels from Q3 of ’08 and lastly our cost containment efforts continue to be successful with non-GAAP operating expenses of $57.3 million largely flat sequentially and down 17.5% on a year-over-year basis. We have held costs relatively flat despite increases in variable expenses related to higher revenue levels.

Now moving on to the product line results, the Fiery revenues, as I mentioned, were $42 million up 4.5% from Q2 and down 38% on a year-over-year basis. Fiery revenues were 42% of total revenues for the quarter, down from 45% in the prior quarter. This sequential increase in Fiery revenues was driven by continued strength at the low end. For the fourth quarter we expect Fiery revenues show further sequential improvements.

Moving on to inkjet, the inkjet product line contributed 44% of revenue, or $44.3 million compared to 40% of revenue, or $36.5 million in the second quarter of ’09, a sequential increase of 22%. The introduction of several new inkjet products led by our VUTEk® GS3200 drove the quarter-over-quarter revenue growth.

Year-over-year revenues were down 27% primarily driven by lower printer volumes. The inkjet business also benefited from continued improvement in our UV ink volumes. As we have mentioned before, we believe ink volumes are a key indicator of the demand our end user customers are seeing.

For the fourth quarter we expect sequential growth in the inkjet business to continue benefiting from the recently introduced new product line up.

During the third quarter the applications business contributed 14% of our total revenue or $14.5 million up 8% sequentially driven by closing a large transaction during the quarter. On a year-over-year basis revenue was down 8% and for the fourth quarter we expect revenues to be roughly in line with the results we saw in Q3.

Moving on to margins, non-GAAP margins for the quarter were 52%, down 20 basis points from the second quarter of ’09 and down from 57.1% in Q3 of ’08. At a high level the gross margins results were driven by a mix shift from Fiery revenues towards lower margin inkjet revenues.

On a product line basis we saw a continuation of margin expansion within the inkjet business that was driven by increases in ink and printer production volumes. We also saw gross margin improvements in our applications business driven by the large deal that we previously mentioned.

Overall for the fourth quarter we expect flat to improved gross margins.

Moving on to expenses, our non-GAAP expenses, which exclude the impact of the amortization of acquisition related intangibles, stock based compensation expense, non-recurring charges and gains, and the related tax effect of those adjustments were up $600,000.00, or roughly 1% to $57.3 million in the third quarter, compared to $56.7 million in the second quarter of ’09 and down 17.5% from almost $70 million in Q3 of ’08.

During the quarter our cost containment efforts allowed us to off set the expense pressure associated from higher revenue levels.

Moving on to the line items of the P&L, R&D expenses were $25.3 million, down $800,000.00 or 3.2% from the second quarter and down 5$5.4 million, or almost 18%, on a year-over-year basis. The decrease in R&D expense was driven by lower compensation of benefit expenses. In the third quarter R&D expenses represented 25.1% of revenue, compared to 29% in the second quarter of ’09. As we move forward we continue to focus on keeping a tight control on the R&D expenses.

Sales and marketing costs were $24.7 million up $0.5 million, or 2% when compared to the $24.2 million in the second quarter of ’09 and down over $4 million or 14.3% from the year-over-year period. The sequential increase in sales and marketing spend was primarily driven by seasonal trade show activity, which typically peaks in the third quarter, and higher variable compensation expenses.

For the third quarter sales and marketing expenses represented 24.5% of revenues, compared to 26.9% in the second quarter of ’09.

G&A costs were $7.3 million, up $1 million or 15% from the second quarter and down $2.6 million, or 26% on a year-over-year basis. The higher G&A spend was primarily attributable to an increase in legal spends as well as the costs associated with our fair value stock option exchange tender offer which was completed in the quarter.

For the third quarter G&A expenses represented 7.2% of revenue, compared with 7% in the second quarter of ’09.

We continue to focus on tight cost control and this focus is helping us improve profitability as we return to sequential revenue growth.

While most of the cost cuts we implemented in 2009 were permanent in nature, we do not anticipate reversing the temporary measures until we have returned to historical levels of profitability.

Overall for the fourth quarter we expect non-GAAP spending levels to remain approximately flat with the levels we saw in Q3. On a year-over-year basis this would result in a decline of about 16%.

Our non-GAAP margins were negative 4.8% for the quarter, an improvement over the -10.7% from the prior quarter and down from the 9.1% operating margins we saw in the prior year ago period.

Other income of $1.2 million was $800,000.00 lighter than the prior quarter primarily driven by a drop in foreign exchange gains.

Rounding out the P&L, our tax rate for Q3 was 29%, compared to 20% in Q2 of ’09. This was driven by lower levels of profitability in low tax jurisdictions reflective of the weak environment that we are seeing in Europe.

At our current levels of profitability small changes in either geographic mix or product mix on our worldwide sales will have a significant impact on our tax rate in future quarters.

Moving on to headcount, at the end of the quarter full time headcount was 1,813 employees down 25 from the prior quarter. Our head count is now down over 10% or over 200 positions from the beginning of the year. We continue to focus on a lean workforce as the primary means to maintain costs.

Turning to the balance sheet, we ended the quarter with $270.1 million in cash, cash equivalents, and short-term investments, a decrease of $8.8 million when compared to the $278.9 million we reported on June 30^th. Of this $8.8 million reduction in cash $2 million was related to the cash costs of restructuring efforts. We expect to be cash flow neutral to positive in the fourth quarter.

Our net inventory balances were $43.5 million at the end of the quarter, an increase of $600,000 from Q2 levels. The higher inventory levels are primarily driven by higher finished goods inventory due to the ramping up of production of the newly introduced GS3200. Despite the higher inventory levels our turns improved in the quarter by 0.6 times. With the broad roll out of new products we look forward to improved inventory levels and increased turns in the fourth quarter.

Accounts receivable increased to $79.5 million compared to $69.5 million at the end of the prior quarter. Overall DSOs increased two days to 72 days compared to 70 in the prior quarter. This was primarily attributable to revenue linearity and a mix shift towards our inkjet business.

Moving on to some of the equity activity we had during the quarter, during the quarter we completed our $30 million accelerated share repurchase program which was part of the previously announced $100 million authorization. As part of this program we repurchased approximately 2.9 million shares at an average share price of $10.56. In addition, during the quarter we completed our employee fair value option exchange program. As part of this program we cancelled 2.8 million options which won’t be available for reissuance and issued 300,000 restricted stock units, cutting our option overhang levels by about 50%.

Lastly, as Guy mentioned, today the Board of Directors has approved the repurchase of $70 million of shares through a modified Dutch option tender offer. This approval utilizes the balance of the previously authorized $100 million share repurchase program. The decision to immediately deploy the remaining balance of our $100 million share repurchase program completes our goal of returning the cash to our shareholders that was generated from the sale of our excess real estate. We expect that we will commence this tender offer during the fourth quarter at which time we will announce, amongst other things, the price range of the tender offer.

With that we are happy to turn it over for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Shannon Cross from Cross Research.

Shannon Cross - Cross Research

Can you talk a little bit more about what you are hearing from your partners on the Fiery side? Their thoughts on inventory, their thoughts on demand and then what you are hearing in your direct business from customers on the inkjet side just in terms of how they are thinking about 2010 budgets, if anybody is talking about that yet?

Guy Gecht

Starting with our partners I think you saw they issued their thoughts in the press release. We talked to all of them. I was in Japan last week and met with the Japanese partners. They are pretty conservative as far as how quickly they think things will improve. They understand the new products can help and I think they are focusing on getting new products to the market next year. They think like us on the inkjet refinancing they are all concerned about that as a lot of the buyers in the professional market at least are small to mid size companies that do not necessarily have a strong balance sheet who can easily obtain financing and that is certainly a concern for all of us. I think that they are going to wait and see, they would like to get new [inaudible] the pipeline is pretty full, so from their perspective they are fairly happy, but nobody is expecting a sharp turn as far as demand.

Our Fiery outlook, by the way, the fact that we saying that Fiery will increase quarter-on-quarter a lot of it has to do with the new Canon line up and the fact that the inventories are pretty tight right now. They are working on the inventory, some faster than others, more distant than others, but all of them are at inventory levels that they think they are comfortable with, at least when it comes to Fiery.

Talking about the inkjet side, customers are seeing better business, I would say in general. I did not talk to a single customer that said that things are getting worse. They are either not getting worse or getting better. We can certainly see that improvement in the ink demand, so people are starting to spend more money on advertisements. It is still tough for them to make a buying decision about new equipment while they see the business recover they are certainly enough capacity and the people that would like to buy new equipment many of them are still facing difficult times obtaining financing and again the situation is worse in Europe than it is in North America, though again it is not a slam dunk in North America to get financing.

What moves people is new products, new capabilities, appear to be more competitive and the ability to do more printing applications and we clearly saw that with the new products and that is our plan going forward. We see good demand for the new products and I think it is going to help us have another sequential growth in Q4 on the inkjet side.

Shannon Cross - Cross Research

Okay great and then we were glad to see the tender offer announcement. Can you talk a little bit about what discussions you have had with Blum where that relationship stand and any of your thoughts around that that would be helpful.

Guy Gecht

I think everybody saw the letter we got from Blum Capital. Let me just say that we have tremendous respect for them and we always have very constructive discussions with them on what is best for the shareholders. Blum, like other long-term shareholders, are really focused on long-term shareholder value and we certainly thank them for that. You can see from our announcement today that kind of in the Board sense the management and Board respect and agree with the position that the profit from the real estate transaction should be returned to the shareholders.

I think we got various opinions from other shareholders that they support that, but people are also having different opinions on the best way to return cash to the shareholder. So while the management and Board we agree with Blum on the merits of returning the forfeit from the sales of the real estate to the shareholders, we might defer with them on the best way to accomplish that. We think buy back is the best way. We strongly believe that that is the right way of returning cash to the shareholders and we know that many of our shareholders agree with that being the preferred method.

Again to summarize, we respect them, we agree with part of what they say. We picked a different method to return the cash to the shareholders and we feel pretty good about that.

Shannon Cross - Cross Research

Great thank you.

Operator

Your next question comes from Ananda Baruah with Brean Murray Carret & Co.

Ananda Baruah - Brean Murray Carret & Co.

Drawing down on revenue a little bit, on both sides of the business you guys are looking for a sequential up tick and I know there is on both sides, you know controllers and inkjet, there is some product cycle built into both sides of that. I am just wondering to what extent can you guys kind of parcel out how much of the sequential up tick that you kind of saw in the September quarter, maybe cumulatively in the September quarter and December quarter from each of those businesses is going to be product cycle related versus maybe a little bit pick up in just secular demand. I know you are not going to give guidance for the March quarter, but based on the commentary that you gave to Shannon’s question about how customers are thinking and maybe what you are feeling generally, what kind of follow through into next year away from the product cycles might we expect to feel?

Guy Gecht

Well it is tough to decide which portion of the upside came from the economy maybe improving in some areas of the world versus new products we believe most of what we have seen in Q3 and what we see going into this quarter is related to exciting, industry leading products on all fronts. So, we believe that that can continue as we believed in the beginning of the year that we decided to bring innovation to the market that will continue to help us recover our revenue and recover our possibilities.

Clearly as the economy continues to improve and who knows at what rate and condition it will be that will continue to help all of us and that relates also to not just the spending and advertisement, but also the financing environment that slowed us down.

As far as going forward, we are working under the assumption that we need to take matters into our own hands and we need to work hard on innovative products. We need to take share. We need to drive recurring revenue. We are very happy with the record percentage of recurring revenue this quarter. We will push all of that. Maybe the economy will come back faster, new products will be more successful than anticipated, but right now we will focus on what we can do to improve our financials.

Ananda Baruah - Brean Murray Carret & Co.

On the gross margin I don’t know if my counts are right, but I kind of have maybe a 200 basis point improvement in the inkjet margins just for that line. But, you exceeded my estimates on revenues and the ink seems like you got a little bit better. So, at least in my model there is a lot of the upside potential to the numbers, going intermediate term, whatever that means, is in the margin expansion potential of the inkjet business. I might have expected the gross margins to be a little better on the inkjet business than they were, if you had told me that you were going to put this kind of upside up on the revenue side, so could you maybe just talk about how we would expect the margin to expand in that business as we move forward?

John Ritchie

There are a couple of things impacting the margins. Directionally you are correct in terms of the improvement that we saw in the third quarter. The inkjet business will see improvements. It is a volume gain. As volume picks up we will see margin improvement, but keep in mind we are also probably the most aggressive we have been in terms of taking trade ins of our old product and remarking those in different markets, which also that might put a little bit of pressure on margins, but that pressure won’t offset the benefits that we see just from a pure increase in volumes. The UV ink volume is getting back to Q3 ’08 levels and that is very helpful and the printer volumes’ picking up with the new products also helps out.

Ananda Baruah - Brean Murray Carret & Co.

Is there any way you guys would provide what the sequential increase in supplies revenue was?

John Ritchie

Do you mean the sequential increase in the recurring revenues?

Ananda Baruah - Brean Murray Carret & Co.

Just in ink revenue.

John Ritchie

Our ink revenues on a sequential basis were up about 5%.

Ananda Baruah - Brean Murray Carret & Co.

What was it up last quarter?

John Ritchie

Last quarter it was up 16% on a sequential basis.

Ananda Baruah - Brean Murray Carret & Co.

Do you have any thinking around what you will do with the excess cash if all of the shares aren’t tendered?

John Ritchie

Let’s cross that bridge when we get to it. Our plan is to execute on what we said we were going to execute to. Let’s see how that plays out before we talk about the next step.

Ananda Baruah - Brean Murray Carret & Co.

Guy, in your commentary about you could choose one method versus another method to return the cash to shareholders and you chose buy back. Is it safe to assume that you guys feel the business model is stabilized and you are sort of there now because if the business model is still at risk then the buy back is not going to be that beneficial over the longer term. I would like your thoughts on that. Is there anything to read into that as far as, is this a signal that you really, really feel that the business model is stable now and that you will get the value out of the buy back?

Guy Gecht

As we got the $300 million from the real estate proceeding, so we estimate that to be the number. We acted on $30 million earlier and now we are acting on a lot more, so clearly we feel better about doing it now. We are strong believers in the Company opportunities going forward in the future, so we can’t really time the economy, but we certainly believe it is a good thing to buy the shares right now and help attrition down the orders that forfeit [inaudible].

Ananda Baruah - Brean Murray Carret & Co.

What is the ending share count John from this quarter?

John Ritchie

It is 49.4 million. So just to be clear by the time we get through this process I wouldn’t be making much in the way of share count adjustments in the fourth quarter.

Ananda Baruah - Brean Murray Carret & Co.

So 49.4 that was the average diluted, that was also the ending?

John Ritchie

The actual share count, I think, was 49.1 and the diluted was 49.4.

Ananda Baruah - Brean Murray Carret & Co.

Okay thanks a lot.

Operator

Your next question comes from Keith Bachman from BMO Capital Markets.

Keith Bachman - BMO Capital Markets

You mentioned the software deal that you had one large deal. What was the size of that deal?

Guy Gecht

For competitive reasons I will not give it to you, but it was significant to the point that I thought I should highlight that. We have large deals every quarter where we are trying to close. Since the beginning of the year it was tough to close large deals. That was a significant one that we managed to close finally. It was in the works for many months.

Keith Bachman - BMO Capital Markets

Okay, but it will be flattish, you said, to up a little bit on the software for the December quarter sequentially?

John Ritchie

It will be roughly flat in the fourth quarter.

Keith Bachman - BMO Capital Markets

Then John, in the ink side you had gross margins that were 42, 43 when you are running at even $53 million of revenue, so if we get into a position in 2010 will you be above 40% gross margins if you get above $50 million in revenues?

John Ritchie

I am going to answer that in a round about way. We don’t see why we can’t get back to those types of gross margins on our historical revenue rates. So, that is a long way of saying yes, if we get north of $50 million that doesn’t seem like an unreasonable goal.

Keith Bachman - BMO Capital Markets

Okay, because historically you have grown, even if I go back to 2007 you have had some quarters where you grew 20% sequentially in the December quarter. I guess in this environment that is a lot to ask?

John Ritchie

I think we would agree with that assumption that is a lot to ask.

Keith Bachman - BMO Capital Markets

All right and then going back to the share count issue, you said something that confused me and I was hoping you could elaborate on it. I understand your ending share count was 49.1 and then you said something to the effect that you shouldn’t assume much change in the December quarter. Perhaps I misunderstood, but if you are doing a $70 million tender over the next two quarters why wouldn’t your share count go down by 6 million shares?

John Ritchie

Our expectation is we would likely rap up the tender. We don’t know the final outcome. We don’t know the number of shares that will be tendered, but that will wrap up towards the end of the current quarter and that was my only point. My concern was that people were going to do the math and take millions out of the fourth quarter share count and we don’t want them doing that at all.

Keith Bachman - BMO Capital Markets

All right, I think that gets me where I need to go. Thank you.

Operator

Your next question comes from Richard Gardner from Citigroup.

Richard Gardner - Citigroup

You talked over the last couple quarters about OEM partners’ new engines being delayed this year. I was wondering if you could either quantitatively or qualitatively give us some sense of the magnitude of the deferrals that you have seen in 2009 and what you think that means for 2010 versus a typical year for the controller business. Maybe one way to go about it would be to give us some sense of how many new controller products, new engines, typically come out in a year and what you think next year is going to look like relative to that.

Guy Gecht

I want to be careful since we trimmed down on how many OEM we focus on and we are down to mainly four large players. I don’t want to give their plans and their competitive situation, but let’s just say that entering we had plans to do more Fiery for new engines than just the Canon, that is a very significant one by the way, that is launching as we speak this quarter. I think the big launch got picked to next year and next year seems to be fairly busy on the Canon side. Obviously those engines were shipped for the full year versus a couple of months and we have engines that got pushed from 2010 to 2011, but we pushed from 2009 to 2010 it is busier than ‘09. I can’t give you the exact numbers, but it is busier than ’09, probably busier than ‘08.

Obviously the economy is going to impact the success in how many engines are going to be upgraded, but we are certainly happy with our OEM plans to launch those engines and as I mentioned based on last weeks visit to Japan I think what we are expecting at this point is looking like it is going to come through as scheduled. You can always have surprises, but I think the plan is fairly busy for next year on all fronts.

Richard Gardner - Citigroup

Okay and then you have also talked about negative mix in controllers for the last couple quarters and you have talked about how big of a negative impact that can have on revenue and margin per unit. Can you give us a sense of first of all what the mix in controllers did in the third quarter versus the second quarter, if there was any material change? Then secondly what is your level of confidence that the mix will shift back up in a better economic environment or is this more of a secular issue that you are facing?

Guy Gecht

We saw a downward mix shift where many customers just bought a lower cost version to what they will typically buy. The Fiery ASPs normally attract the ASPs of the print engines, so if somebody buys instead of a $50,000.00 engine they buy a $25,000.00 engine the Fiery ASP will track that reduction and we actually saw that happening still in the third quarter more embedded than before, it was a mix. In some cases the downward shift brings the customer in to buy an engine where the Fiery added value of speed, and quality, and work flow is not as significant as it is in other engines and those are the type of engines where our tax rate is lower than the more solid robust engines and in some cases the customer ended up buying an engine where there is no Fiery offered because it doesn’t make sense to either us or the OEM to offer that. So, that has clearly impacted us during ’09.

We saw a similar behavior back at the 2002 time period, 2003, where the economy was slowing down and people bought lower end engines. At that time when the economy started to pick up the mix shift changed back. I cannot tell you today that I know that it will happen again. We will continue to make efforts to benefit more from a lower end engine on both profit and volume, but it’s tough to predict at what point, if at all, it will come back to the level it was historically.

I think that we are certainly expecting it will be better than today, but we don’t know to what level.

Richard Gardner - Citigroup

Okay great and then could you give us an update on the calibrations that you are doing on the GS3200. When are all the features of that product going to be available to customers? Maybe also give us a sense of when the three other wide formatting jet products that you talked about for the back half are going to be in the market place.

Guy Gecht

The product meets customer expectations, the generating production, the volume, and all that. Of course over time we will continue to improve every product we have including the product you mentioned. The other products we launched in Q3 were the two Rastek the T660, the H650 and the new Jetrion 8.3” wide. There are a couple of more that we will be announced that we will be bringing to the market in the next few months. Not necessarily this quarter, but in the next few months. One if our first 5-meter UV based printer and there is good interest in that product. We will bring that to the market in the next few months. The other product is a newer version of the GS3200. Again those products were announced, but they are not shipping yet.

Operator

Your next question comes from Shannon Cross from Cross.

Shannon Cross - Cross Research

I was just curious, as you think about expenses going into next year how much of the expenses that you have cut this year are ones that will sort of be recurring and you have improved productivity and you can continue to see the benefits? Also, how many of them are really cut backs on travel and other areas where you perhaps need to start spending again? Also, if you could remind me what you did with your 401K I am just trying to get an idea of where things may go.

John Ritchie

In rough terms when you look at the ’08 over ’09 expense reductions it is in the $50 million range. The vast majority of that was permanent cuts primarily through headcount reductions, facility closures; those will stay out of the P&L. In terms of the snap back effect you will get of the temporary cuts those will not come back until we get back to a significantly better profit picture, so getting back to kind of historical EPS levels. To kind of scale that, that will be EPS levels that are outside of single digits. I am not sure if that gives you enough color.

Shannon Cross - Cross Research

Yes, that was helpful. Then with regards to cash, clearly you are going to have your hands full with the tender offer for a while, but how are you thinking about cash on a longer-term basis? What are you thinking about in terms of acquisitions and again, maybe we are getting a little ahead of ourselves here, but it seems to me things are getting a little better. So, how are you sort of viewing that and then I am not sure if you addressed the 401K.

John Ritchie

On the 401K we had stopped our 401K match and that would be one of the items that will come back once we get back to reasonable levels of profitability. We are also focused on, like Guy talked about, the use of cash, but right now we are focused on getting back to being cash generative. We expect to be cash neutral to cash generative in the fourth quarter. Longer term we expect to get back to kind of a cash accumulation position.

I will let Guy talk to the environment in terms of potential acquisitions.

Guy Gecht

We continue to look at acquisitions, mainly small to mid size that can accelerate our growth and profitability in all sides of the business. There is definitely more activity on the inkjet related acquisitions that we look at. We are very conservative about that. We believe that we don’t have to make any acquisition to restore revenue both in the short and the long term; however, if we find the right acquisition we would like to act on it and we like to keep enough cash so that we are able to act on one or more than one in the future.

John Ritchie

To be clear, the $70 million that we expect to spend on this touch tender still leaves us with what we think is enough cash to fund any potential acquisition.

Shannon Cross - Cross Research

Great, thank you.

Operator

Your next question comes from Ananda Baruah from Brean Murray Carret & Co.

Ananda Baruah - Brean Murray Carret & Co.

Getting back to the inkjet gross margin, can you directionally give us what the most important components are to get gross margin appreciation? Is it the hardware covering the fixed costs or is it the ink, or are they roughly equal?

John Ritchie

Printer volume would be first and foremost.

Ananda Baruah - Brean Murray Carret & Co.

You mean the actual selling of the hardware?

John Ritchie

Yes.

Ananda Baruah - Brean Murray Carret & Co.

Okay. Would that drive like 75% of the appreciation?

John Ritchie

Let’s just say it would be over 50%.

Guy Gecht

Let’s put it this way, it was the major factor going down, driving down the gross margins. It would be the major factor driving up the gross margins.

Ananda Baruah - Brean Murray Carret & Co.

Thanks, that is helpful. I appreciate that. Guy, just another angle at the mix shift question, just in talking to some of the OEMs as we have gone through this slow down about the whole push for doing less is more and what we actually saw going into that last year and kind of through last year was a building out of more robust call them mid-production types of devices. That wouldn’t be the first time in hardware that you saw those types of moves in servers and storage like previously. Do you think there is a secular trend that had already started that maybe has some extra stickiness to it just because of the nature of economically what we have gone through?

Guy Gecht

There is excess stickiness to what?

Ananda Baruah - Brean Murray Carret & Co.

I guess to a greater degree using mid production types of machines or like production types of machines and maybe they are not moving up to the higher end of production, they are moving away from things like iGen and things like that. I know that is not the majority of your business, but I guess the flavor would be kind of, as more lower end of production machines become more robust, so maybe it is not even their reticence to not go back up, but maybe it is sort of the OEMs decision to keep pushing more functionality down.

Guy Gecht

Right and I think that that is something that certainly we welcome, because we do really well on those mid productions as far as share. It also makes the production color engine available to more than just the large print shops in commercial print to small print for pay, to corporate printing guru departments where EFI is very strong and the ability to have consistent color flow and work management would be the type of engines we provide is extremely important. So, this is actually a good thing for us. We are seeing the OEMs investing in this mid range to entry point productions. They see the potential of selling to a lot more customers than the few that can afford the iGen or the Indigo, things like that. At the same time, of course, there is still great potential there.

From our perspective because we are not getting benefit from the volume of pages, there are rather a lot more people buy entry point production than there are fewer people buying big engines.

Ananda Baruah - Brean Murray Carret & Co.

Okay great. Thanks a lot.

Operator

Your last question comes from Keith Bachman from BMO Capital Markets.

Keith Bachman - BMO Capital Markets

John, I wanted to ask you about the cash cycle. In ’08 you were running it anywhere from a mid-50 and then you kind of got caught at the end of the year to a 70 number. What are the pre-conditions to bringing that cash cycle down? Is it just revenues, or is there some kind of static amount of revenues that you could bring that down to improve the cash flow metrics?

John Ritchie

You are talking about the cash cycle from?

Keith Bachman - BMO Capital Markets

I am talking about the days perspective.

John Ritchie

So your DSOs less days payable?

Keith Bachman - BMO Capital Markets

Yes, DSOs plus inventory less payables. You can talk about any one of them, but we tend to think about the aggregation of those three just to improve your cash flow metrics. So for instance your DSOs have been running up 70 days where they had been mid-50s to low-60s.

John Ritchie

So the mix drives DSOs. So, the DSOs for the controller business are considerably lower than the DSOs for the inkjet business, so that is the primary driver. Then as we headed into ’09, I think we talked about this a couple of calls ago, we moved to using the balance sheet to a certain extent to fund some of our higher quality customers who were looking for bridge financing. Now we expect that pressure to ease if the economy gets better, which should allow us to bring down the DSOs.

Keith Bachman - BMO Capital Markets

What about the inventory levels?

John Ritchie

Inventory levels, from where they are at today, they should contract. If you look at what inventory levels we needed to run, and think of the inventory levels as 90% plus being related to inkjet, we have run that business with much better terms than we have had earlier this year; so you have seen sequential improvements and turns, and you saw a sequential improvement in Q3. You will see another sequential improvement maybe to the tune of about ½ a turn. One of the comments we made on the Q2 call is we were expecting one full turns worth of benefits by the end of the year; we think we will get to that goal. As we move through ’10 we should see improvements in the turns there as well.

Keith Bachman - BMO Capital Markets

Okay and your comment was you anticipate having cash flow from operations neutral to slightly positive in Q4, right?

John Ritchie

Correct.

Keith Bachman - BMO Capital Markets

Did you say what your cash flow from operations was this quarter?

John Ritchie

No, we didn’t give that specific number. All we talked about this quarter was the burn from how much of the burn in cash related to restructuring activities which should tail. We said we burned a total of 8.8 and 2 of that was from restructuring activities.

Keith Bachman - BMO Capital Markets

Okay thank you.

Guy Gecht

Thank you everybody. As always we appreciate the loyalty and support of our shareholders, customers, and employees. Thank you for listening to us this afternoon. We are looking forward to talking to you at the next opportunity.

Operator

Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation. (Operator Instructions).

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