Electronics For Imaging, Inc. (NASDAQ:EFII)
Citi 8th Annual Small/Mid Cap Conference Call
November 16, 2011 11:05 a.m. ET
Marc Olin - Senior Vice President and General Manager of Advanced Professional Printing Software
With equipment, we do it with software. But we do it in what we feel is a unique way in helping to facilitate a number of the megatrends that are taking place within the printing industry today of shift from analog processes to digital processes. This can be analog printing to digital printing and analog manufacturing management to digital manufacturing management. And so the question I get when I talk to people aren’t familiar with EFI is, I am an investor, why should I get into software or equipment that’s associated to the printing industry.
Because you see various things about the printing industry that normally raise this concerns in people. You see, well, book stores are closing, the post office which is the primary delivery vehicle for printed material, it just announced today actually a $5.5 billion loss in their 2011 fiscal year, newspapers going away from print editions. You know when was the last time anybody used the phone directory. Millions and millions of phone directories printed before. So clearly the industry is under a lot of pressure
But what this also means is that the industry is transforming. Because there’s various parts of the printing industry that are actually very healthy and growing very quickly. And it’s this transformation that’s taking place that provides the significant opportunity for a company like EFI to be able to facilitate that transformation and really drive the change within the printing industry. Because with significant change comes significant opportunity.
Some of the examples of this. Restoration Hardware, a retailer, does a tremendous amount of business online. They just published their largest catalog in their history 560 pages. I don’t know if any of you have seen that before, but it’s like a inch and half thick. Because they saw the value in printed material to their clients. Studies have shown that internet use actually drives increases in magazine readership and vice versa, magazine readership is driving people to associated internet websites.
Outdoor advertising is one of the fastest growing means of advertising media, second only to the internet as a forum of advertising media and its growth. And you don’t typically think of that as printing, but those huge billboards and signs and all of the stuff that’s wrapped on the side of a building, that’s actually printed material. Printed in many cases using equipment supplied by EFI, as we are the leading provider of the wide format ink-jet devices that print the type of building wraps that you see on the screen here.
And lastly, even a company like Staples, you think of them, they are a office supply company. Well, one of their fastest growing businesses inside of Staples is their copy and print business. In 1600 stores now they have set up copy and print centers, that’s a platform that didn’t even exist ten years ago. And they are taking advantage of the ability to turn around documents very quickly, efficiently and with high quality color. In fact the document that you have there, the book on the table, I actually submitted online using our web technology. Staples is one of our customers and they use our website to set up an internet store front for all of their copy and print submission.
So I submitted that through the website, configured it, told it how I wanted the thing finished with the clear cover and the plastic bag, and how many copies I wanted printed. Within an hour I went down the street a mile, picked up those Staples -- the copies from there, brought them back. That’s the type of thing that ten years ago would not have been possible to do in an hour. That would have involved the trip there, discussion. The technology that we provide is key to helping facilitate that opportunity for a company like Staples and allow them to grow in this part of the industry.
Overall, the printing and packaging industry is a huge industry. It’s a trillion dollars worldwide. The business of printing and packaging. And that’s to the companies that provide those printing and packaging services that we are selling our technology. And it’s this technology and what we see as our ability to help these companies transform their businesses that has led to seven consecutive quarters of double digit growth for our business.
And EFI’s business is divided into these three sectors. What we call, Fiery, Inkjet and our application software which is the group I run. We will talk about them in some more depth later but you can see in Q3, 14% growth overall for the business as a whole. 9% for Fiery, 15% for inkjet and 36% for APPS. And it’s because again of our ability to help printing companies transform that we have been able to facilitate this growth. Looking at it on annual basis, the results also are even more dramatic. 19% through the first three quarters of this year, year-over-year growth. And within the business units you can see 18% for Fiery, all three business units up by double-digit growth levels.
And so what are the things within the industry actually changing, that are helping to drive the demand for our products. So the nature of the type of work that the printer are doing is changing. It’s becoming an on-demand world, everybody wants their stuff, tomorrow or today or within an hour. Just like last night I wanted my books produced within one hour. So I get them back here before the store closed and have them on the table for you this morning. And again that type of turnaround was not possible in the industry. In the past print jobs took a week, from the time you conceived them to the time you could get them delivered.
With our technology we are able to drive down to be able to accommodate the shorter run length, faster turnaround requirements, requirements for nice color in the presentations, and requirement for variable content, which is also a significant trend in the industry. Whereas before, if someone was producing some marketing material, they produced 10 million copies if they are trying to do a big national campaign. Today what's happening is marketers are getting much more selective about how they target their end customers. And so they want each piece individually targeted and printed with the name of the person that’s going to what we call variable data. That’s another trend that drives adoption of digital printing and drives adoption of our technology.
Out-of-home advertising, as I mentioned before, is growing steadily. The demand for both high quality and what we call UV based outdoor printing is a significant trend within the industry, because UV printing can be done with minimal environmental impact. In the past printing was done with solvent based inks emit VOCs, causes a lot of environmental concern. We have helped pioneer UV digital printing technology for outdoor advertising and now are a leader in the space.
We are also involved now in packaging opportunities. We are one of the first companies to come out with a UV inkjet based label printer. And this again is just scratching the surface of the opportunity here as 98% of the labels today are printed on an analog basis. But our UV Jetrion printer is a significant opportunity for the future as that transformation starts to take place in packaging the way it’s taken place in commercial print.
So let’s go into a little more depth about each of the different market segments. I mentioned before our Fiery segment. That is the part of the business that’s been with EFI the longest. It’s a digital front end for print engines. It’s basically what ensures that the color that you see in the printed output is an accurate representation of what you want it to look like. That the print engine can process it quickly, efficiently and accurately. And so the technology we have in Fiery is attached and sold by most of the leading printer and copier manufacturers you know of in the world. Xerox, Konica Minolta, Ricoh, Canon, all sell Fiery digital front ends in front their copiers and printers. It is the leading product in this space. We sold over $2 million of these since this product has been in existence.
And as you can see, over the first three quarters we are up 17% from last year. Full year in 2010 was a 24% increase over 2009. So it’s a steady growing product. It generates significantly higher gross margin then you think of in an equipment based type of sale, because Fiery’s intellect property is mostly software based not equipment based. Even though it’s a digital front end that’s sitting in front of a copier and printer.
Next we go to the inkjet space. So we are hitting two primary market segments here. The display graphics space which is about $125 billion market, and the labels and packaging space, which is a $50 billion dollar market. Now these are the -- those are the values of the printed output of the printers that we are selling into. But the key to understand about these markets is that they are still largely analog based markets. So most of the display graphics today show 75% of the graphics that are printed, are printed on screen presses or offset presses that are production processes. And as the industry starts transforming to use digital which is -- it has been accelerating again 25% in digital today, and that’s been increasing rapidly. As that acceleration continues and people switch from analog to digital, it drives demand for our digital presses.
On the packaging and label side, you see again we are just scratching the surface today. Most of the labels today are printed by a flexographic printing, again an analog process. Our digital printer is the leading ink-jet printer in this space. But still just a very small piece of the overall market. You can see however that as with Fiery, double-digit growth for the inkjet business, both for the full year 2010 and year-to-date for 2011.
And don’t want to forget to mention, we are today, the number one manufacturer of UV curable ink in this space as well. And so that is providing a significant pool of recurring revenue from the clients that we sell these printers to. But they got to come back and continue to buy the ink from us to run these presses. Next is the software space, which is the group that I run. So we do two different types of software products. The first is business management software. We are in a fact a SAP or the Oracle of the printing industry. Because printing is a custom manufacturing business. It has a unique set of requirements that standard ERP packages can't meet. As a result we have been able to take our, build the product and build a dominant market share in the printing industry. Starting primarily in North America and now we have been expanding to Asia Pacific and Europe.
And So you can see that we have been able to grow significantly, already meeting what our full year revenue number was in 2010 through just the first three quarters in 2011. And we have done this through a combination of double digit organic growth as well as a number of roll-up acquisitions where we purchase products, put them into maintenance mode and switch the customers to our current platform. The gross margins, we have also been able to consistently continue to improve. We are up over 70% gross margin now as of Q3, year-to-date it’s 69.6% and we expect to be able to continue to push those gross margins forward.
The second type of solution we offer are the print e-commerce solutions. The things that allow me to do what I was talking about earlier, that allows Staples to set up a website and be able to receive printed products that they can produce. And the reason why Staples can't just use their normal e-commerce website, they are the second largest print -- business based e-commerce on the internet across all market segments. The reason why they couldn’t build their own print based solution is because it’s fundamentally different. You can’t just put up a catalog of products to purchase when it comes to printing. You also have to allow submission of the content that you want to print. I have to be able to submit my PDF file to them and then I have to be able to configure the different options I wanted as far as how that document was going to be produced.
And so our websites allow that process, allow validation of the content, allow configuration of the output and allow real time pricing, so that I can see what amount extra it costs for me to put a clear plastic cover on that presentation instead of just printing it without a cover. So we bring our products to market through a combination of different sales forces. As I mentioned before, our Fierys are sold through our OEM partners. Those OEMs both have direct sales forces and they have a number of dealers, but in total we have about 10,000 people out there through the OEMs and their dealers that are selling Fiery. We have a direct sales force that sells our inkjet products and our software products in the U.S., Europe and Asia Pacific.
And we sell through trade shows as well. We have our own user conferences actually held every year in Vegas, at the (inaudible). And we typically attract between 1000 and 1500 customers that pay to come to our -- they pay us about $1000 each to come to our conference every year, so that they can learn more about our products, take classes, see our lab. And it’s a significant driver of the unique value proposition inside of EFI. So looking at where these sales people are selling, the addressable market. I mentioned before that the printing and packaging industry as a whole is a $1 trillion market. So we are of course not selling printing we are selling software and equipment to segments of the printing industry. And so our addressable market is about $3.5 billion that we are selling into today. Again, just scratching the surface on lot of these different segments today even within the segments that we serve, so we feel we have significant room to grow faster than the growth rates in each of these different market segments.
Today we are the leading provider in a lot of the segments that we work within. Certainly with the Fiery, as I mentioned before, it’s actually over 2 million I believe now, installations there. The print MIS which is again the business I run, over 12,000 installations worldwide there. The UV ink, as I mentioned we are the largest provider of UV ink in the world and we have over 3600 of these super-wide formats, these giant inkjet presses that we sell. Those presses, for reference, range from two meters wide up to five meters wide. So 15 feet wide, a single piece of equipment that’s printing off of a roll of paper. So these things can print massive display graphics and outdoor graphics.
So what are the things that are going to drive accelerated growth in our business? One of the unique things that we offer inside of EFI that no other company in the world offers, is the end to end workflow. There are other companies that sell competitive software, there are other companies that sell competitive equipment. But there is no company that has both the software and equipment together, to be able to provide an integrated workflow at a printing company, that allows them to automate the process from the time that the content is submitted by the customer for production through the time that printed product is delivered out the back door. And that’s why our software products, our software installations for example, give us the competitive advantage when we are going to sell our Fiery products and our ink-jet products because we connect better from our software to our inkjet our Fiery products and that helps drive decreased cost at the printing companies that we sell to. So that power of integration, that power of connectivity that’s illustrated on this slide, is something that is unique to EFI and it’s given us a great advantage out in the marketplace for our products.
On the software side. I mentioned before we are growing through a combination of organic growth and roll-up acquisitions that we have been doing around the world. In the U.S. today we have over 60% market share for new systems that are sold. Now there is still a huge amount of development that takes place internally inside of printing companies to do their own developments of ERP and there are still a lot of legacy installations out there where customers are just paying maintenance, continuing to use the same product, where we are helping to bring them over. Transform them from those systems that they might have had for 5, 10, 15 years, and put in a complete new package. But we are the dominant player in North America today.
We are growing rapidly in Europe, through a combination of building our platform, building a sales force, doing some rollups over there as well. And over the last five years, we have internationalized all of our core products. So we are now able to sell our products focused at every segment of the printing industry throughout Europe and Asia Pacific. And that’s helping to drive the growth. So today we are on a run rate to get to about $80 million for the full year. Up from $58 million last year. And we believe that over the long term this software business can be a $150 million business inside of EFI by itself with gross margins in the low 70% range.
We have done the first couple of acquisitions this year. Certainly looking to do additional acquisitions. These are small companies but it gives us a great ability to be able to convert customers, build on installed base, build our recurring revenue. Because as you will see later on, the recurring revenue and our software business is close to 50%. And so that combination of maintenance revenue that we get from the existing clients from -- combined with SaaS agreements that we have for our web to print products, where we actually host them like with Staple, to long term services contracts with our clients, allows us to build a stable base of recurring revenue.
On the inkjet side, it’s all about the product introductions and driving additional ink volume with the existing client base. We have a number of really exciting product introductions we have come out with this year that we feel are really going to help drive growth in this business. The Rastek line is our lower end line, it’s an introductory level product, that we just introduced, that gives commercial printers an easy way to dip their feet in the outdoor graphic space without spending hundreds of thousands of dollars on a product. We have a new textile signage printer that’s leveraging our current state of the art 3250 technology for UV printing. The GS5000 which is our 5 meter high speed graphics device. We have a roll-to-roll version of that and we partnered with 3M on certified ink, that’s matched to the 3M substrate that you can print on, so we can drive value for our customers there. And one of the most exciting things that we have is this last product down on the bottom that I will get to.
Next, which is our LED bases UV printer. And rather than using very hot UV bulbs to cure the ink, this uses a cold curing process with LED bulbs. And so it uses much less energy, it’s much more efficient in terms of the type of substrate that can be used to print on. So rather than having to print on heavy substrate because you are exposing it to a lot of heat, and that can cause the substrate to get damaged, with these cold curing LED technology, you can print on very thin materials. So that cuts down on the shipping cost, cuts down on the material cost, cuts down on the energy cost. It’s a huge win. We are the first to come out with this LED curing. Our primary competitor in this space, right before we announced it, said that they didn’t see LED as a buyable for five years in to the future. And we have proven it. We are shipping it, starting this quarter.
On the Fiery side, it’s really about innovation within the servers, of driving faster performance, more flexibility, better color fidelity, and we do that through a combination of software but also ASICs that we put inside of the servers to drives faster performance within the Fiery. Also in this area, we have introduced mobile printing. We have a product called PrintMe that allows mobile printing from BlackBerrys, iPads and any other type of mobile device without having a print driver installed. So there is a website that you can email a document to, called printme.com. Just email to the website and it’s available then in a cloud to be able to download at any PrintMe location. And if you go the website you can find the thousands of different PrintMe locations that are located around the country. Where you can pick up that output and then print it locally.
So some of the financial metrics, and you look at our breakdown between the U.S., Europe and Asia Pacific, you can see Asia Pacific and Europe are growing more rapidly. We are going to try and recreate the market share that we have in the U.S. in those regions as well. We think we have had some good success with that year-over-year. You see, because of the faster growth within our software group that’s becoming a larger portion of our revenue year-to-date. And I mentioned before the recurring revenue, for EFI as a whole we are at about 24% recurring revenue now. Generated from both the ink that we have contracts with our clients as well as our maintenance and SaaS agreements on the software side.
So that’s something that also is up 12%, I believe over last year in Q3. So seeing some good progress on the recurring revenue. And as the inkjet and software become larger portions of our revenue, we will expect that to continue to grow. Looking at the P&L trends. For full year 2010, we had $0.59 EPS, you can see year-to-date we have already exceeded that. Our EPS is up quarter-over-quarter I Q3 from $0.22 to $0.25. If we didn’t have the currency effect that we had, a positive currency effect in Q3 of last year and a negative currency effect in Q3 of this year, that actually would have been a $0.09 increase in EPS year-over-year in Q3. And for the full year, we have given guidance on our conference call, and that’s available on the EFI website, but we certainly expect to be up significantly from 2010 and again I would ask to reference our earnings call transcript on the EFI website for the details about the Q4 and full year estimates for EPS and revenue.
One of the other interesting things about EFI is that we have significant amounts of cash on our balance sheet, about $200 million of cash on the balance sheet today, and we have generated so far this year about $43 million of cash. As you can see we have a consistent record of generating cash with every year except for 2009 and so accommodation of cash that you see there plus AR and our building which we own in Foster City, California, gives us the total asset value of about $720 million. And so that amounts to about $4.25 just on the cash alone, about $4.25 of cash value out of our stock price which is about $14.5 right now. The building’s worth another significant amount as well. Obviously we don’t have an exact amount for that but a dollar or more in stock value also.
We have been using the cash on our balance sheet to drive down the number of outstanding shares as well to do the smaller acquisitions. And the board is committed to continuing to use the cash to drive down that share count and also to do smaller acquisitions. We are not going to do any transformative acquisitions or any dividends, so those are going to be the primary users of cash from the company. And so from a long term financial model standpoint, we are looking at a 10% long term growth as our primary target there with gross margin in the 55% to 57% range. OpEx in 40% to 44% and 12% to 15% operating margin. We raised those targets during our investor day a couple of weeks ago in New York. So those are all raises as you see on the right hand side of the slide here, from where our prior long term guidance was. And from a revenue mix standpoint, less than -- out target is to get Fiery down to less than 40% and the inkjet and software business over 60%, and our gross margin to be about 45% from the Fiery and about 55% from the software and inkjet.
So our priority is for 2011. Obviously, we are almost done with the year, but continue growing top line faster than the industry. We have been doing that consistently for a long time. We want to continue that trend. Focus on our operational execution so we can drive mover EPS to bottom line and continue to optimize our capital structure. And so all of this we believe makes EFI a very unique and interesting opportunity. Again, huge change happening in the printing industry, we have an ability to be at the forefront of that change and the enabler of that change. And as $1 trillion dollar industry transforms, they are going to spend a lot of money accomplishing that transformation. And we believe we are in the right spot with the fastest growing places in the industry to take advantage of that.
We have a lot of products in the pipeline that we continue to work on that continue to drive on the software side, the inkjet side and the Fiery side. And we believe that we are uniquely positioned to be able to take advantage of these trends. So, thank you, and we still have a few minutes left here for any questions.
You talked about getting to the growth targets, what's organic and what's acquisition driven?
So we haven’t really done any significant acquisitions outside of our software group. And we don’t give detailed breakdowns. I can't say that our software business, organic growth is still over 10%, so it’s double digit organic growth as well as the inorganic growth that’s driving as well. So we expect that to continue, that the organic growth can continue to be over 10% and that will continue to build our customer base, build that recurring revenue. And that also gives us a pool of clients that we can convert to our existing platforms and help build market presence in these area around the world where we don’t have a significant presence today. Anyone else?
Kind of following on that. When you acquire in the software -- the small software acquisitions. What's the retention rate and kind of the conversion rate and walk us through the kind of revenue ramp after those acquisition.
Yeah. So that’s the interesting thing. We have about a 95% retention rate for our maintenance clients on the software side. These acquisitions we have done. The most recent two, which were the first ones we have done with this maintenance mode strategy. It’s really too early to tell. I wouldn’t want to make a -- because we have lost virtually no clients after making these announcements, so I am sure we are going to lose some over the next few years and we will see higher than the 5% attrition rate we have for our core products. But to date, we really haven’t had any attrition at all from the clients that we have acquired. One more.
Can you talk a little bit about the competitive dynamics? I mean on the higher end I believe you are up against Kodak more and then with some of the Rastek, you are simply going down against traditionally kind of the HP, Canon world, right?
Yeah. So in the Fiery space we are competing against two primary classes of competitors. Kodak, that has -- that also makes the controller that’s attached to multiple different devices. We have larger market share then them in virtually every market that we serve. We also compete against the OEMs own controllers. They make their own, typically not as fast, do not have as many features as our Fiery products. And again, in most cases where we have a Fiery and there is an OEM controller, we have been able to maintain a higher market share, and in many cases increase our market share over the last few years. In the inkjet space we are competing primarily with HP in the Rastek area and even with VUTEk, HP has an offering in there as well, as a number of other companies like Agfa and Durst and so on that we compete in this space.
In the software business, it’s really a bunch of tiny companies that we primarily compete against. These are companies, $2 million to $10 million in annual revenue, there is just a ton of them out there. And so that’s the primary companies. We occasionally run into an SAP or an Oracle when we go into the multi-billion dollar printing company, but even there, other than in the financial accounting capability, we are able to beat them for the manufacturing management.
And then on the inkjet side, the differentiation you have over an HP or...?
So, you know the differentiation there is all about the innovation on the individual printers. It’s speed, it’s quality and flexibility of the printers. So you really need to look printer by printer. But one of the unique things that EFI has, again that HP doesn’t, is this ability to have the end-to-end workflow. The software platform that the printers can sit on top of. And so only if you have a VUTEk printer can you get real time feedback from the printer about how much ink is consumer on each job you print. And so you can truly understand the profitability of the job that’s not possible with other companies.
On the inkjet division again. Would it be fair to think of that as kind of a razor and blade model? Is the reason for the focus on the UV ink manufacturing that that’s where all the profit is?
There is -- we cannot -- you cannot sell the printers without making a profit on the printers as well. But certainly that recurring revenue, there’s higher margins on the ink than on the printers. And so, yes, you sell the printers at a lower margin than the inks so you can drive that recurring revenue from the ink base. That’s correct.
We are out for time for questions. Thank you very much.