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Electronics for Imaging (NASDAQ:EFII)

Morgan Stanley Technology, Media & Telecom Conference

February 29, 2012 05:10 PM ET

Unidentified Company Representative

So EFI is a technology company positioned on the print vertical or the vertical of printing. Printing is a $1 trillion industry, many different activities within that industry and overall the vertical is growing at GDP type of business, some area are fancy growing trying, some are growing and where there is transformational forces, the transformation of printing activities from analog to digital is driving growth within industry and EFI is uniquely positioned on those gross segments of the print industry. The force is that we addresses are three fold with our current portfolio is the movement from long run book and wide type of printing, ink to personalize digital high quality color type of printing.

The second one is, the movement from analog activity in the industrial world from display graphics all the way to printing on ceramics of different materials moving from analog to digital and I'll come back on that and the third activity is the need for professional printers to automate a business processes to become more efficient. So we organize the company along those three lines. We have industrial inkjet segments about 45% of our revenue growing 16% in the last quarter growing double now for many, many quarters and really driving the transformation of analog industrial activities into digital printing activity. Gross margin around 40% there and a mix of printer revenue and ink revenue in that segment.

The second segment we have is the software segment and ERP for print professional or mailing the business processes of those print professional to about 15% of our revenue, gross margin venture 70% and growing. The gross rate of the fairly phenomenal as print professional starts to adopt bigger sized software or more sophisticated software to become more efficient. We grew 41% last year with guided Q1 in the same range and continue to grow at that type of gross rate.

And then the third segment is the fiery segment which is really a print server addressing the print activities that are moving towards short run high quality type of print activities. And then EFI is a unique competitive advantage of being able to provide products from acquisition of content all the way to production and creating an ecosystem of hardware ink services and software right around to move from analog printing into a digitized process of printing and that's what we're working about.

Unidentified Analyst

And maybe you can just talk about a little bit the competitive landscape and just mention like who you're competing with, who are the big players in those various areas that you are operating in.

Unidentified Company Representative

Yes, so as an ecosystem, print server production engine, ink services and software, there is no competition that can reproduce that. So we are very unique from that aspect. In every one of the segment be it print server, the fiery segment or the software, the apps business or the inkjet, we have a different competitive landscape. If you talk about Fiery between servers, we have about 50% market share in the high end point server. The other competition is clear that Kodak bought a few years ago, they have bought 15% market share and then about 30-35% is kind of pre-server embedded into a big multifunction point.

So our position there is really about building more and more subtle valuation that's in server and drive software options that have endorsed factor in that server. Turning to the inkjet segment, there the competition is a bit more open, the three main competitors are ESI, HP and Doors, Doors is a private company in Europe. About 20 to 25% market share for each player and then there are other players, (inaudible) is another one but a smaller market share. I think the penetration into the digital world is really where we're focusing on really trying to move from analog to digital and therefore the analog world is what we're trying to replace at this point in time.

And then finally in the approximately business, in the software business, ERP tailored for activities of printing. We are very unique. It’s a very fragmented market, commercial printers or production printers and have a lot of homegrown type of software and or local vendor. EFI is the number one market share in the US, everything else is very fragmented and small vendors. The smaller or the number two vendor in that category would be less than $10 million.

Unidentified Analyst

The skeptics would say paper demand is down 23-25% in the US over the last few years. Why should we invest in a printing company? How would you address that issue?

Unidentified Company Representative

So I think you're right. Pages are coming down and commodity printing type of page you have, emails printing etcetera is going down but there are activities of printing that will never disappear. Printing a label on a bowl, printing on a ceramic, having a need for people who will always have printing as a professional activity and need of software to move their business into the 21st century. All of that will continue to grow. So while overall printing maybe secular decline you've heard it from HP. The activity that are more industrially focused or high end type of printing activity will not go away and continue to grow quite fast.

Now most of the printing companies have the chance that they need to offset legacy revenue stream and printing as you say on pages and they need to offset that with the gross segments that transformed these activities within the print vertical. EFI is the unique position of not being the printing company but being a technology company with a portfolio entirely focused on those core segments and there is no legacy revenue stream offset if you want and we position on those core segments.

Unidentified Analyst

Let's just move on to sort of the cyclicality of your business. In the past your company has been viewed as a cyclical company and you transitioned it more into a company that's based on a large proportion of recurring revenue maybe you can talk a little bit more about the cyclical versus recurring part of the revenue stream.

Unidentified Company Representative

So in the past or the history of EFI having developed that first print server to manage a multi-function printer in the network environment right and that's the Fiery brand and that's the biggest revenue stream. It is one to one sales with the purchase of a multi-function readers from one of our OEM partners like (inaudible) and those sales are a bit more cyclical and aligned to a GDP type of movement. Over the last decade EFI really started to diversify its revenue stream and build around the vision of that ecosystem. Having a print server to really control the engine, the brain of the engine, adding to that industrial digital production engine, building the ink as a revenue stream, a recurring revenue stream, wrapping around services and software all in that solution which enable not only to diversify the revenue stream but as you mentioned, building some weight in the business model. We finished 2011 with $123 million of recurring revenue stream; it's been growing at double digits and definitely enable us if you want to move away from the original cyclicality that the fiery business had when it was a standalone business.

Let's just focus quickly about your M&A. You've been extremely inquisitive in 2011. I think you've done five acquisitions and most recently you bought a company called Cretaprint in Spain. You told about the rationale buying so many companies, what were they and what's so special about Cretaprint?

Unidentified Company Representative

So, as you mentioned we bought five companies in the last 12 months. The M&A strategy as an overall umbrella of trying to continue to build on the ecosystem vision if you want which transformed the company with a print server, a print software and industrial inkjet production. We see that we are fully transformed from there but within each segment we have opportunity to accelerate the organic growth that has been double digit for how many quarters with some tuck-in acquisitions. Tuck-in within one of our segments credits are some of the characteristics we look at when we look at opportunities. We've seen the accelerating on act or the funnel growing as we became more and more efficient and having more and more proof that the ecosystem is driving on growth.

In the software businesses as I mentioned it’s a very fragmented market. There is no software of scale but ESI and being able to buy some of those companies mainly internationally to grow up between outside of the US applying those customer and selling our ERP has been a great strategy for us. We want to reproduce what Oracle did in its own overall enterprise ERP segments due that for the print industry and we've been on that part if you are not for the last 12 to 18 months and we'll continue to do so.

We’re also looking at opportunities within the other segments with existing server or the inkjet segment. We brought (inaudible) in Canada mid-July and that was to really build some mobile printing capabilities into our print server and enables fiery if you want to continue to opt for more functionality and continue to grow in that area. And then as you mentioned, in January we bought Cretaprint and Cretaprint is a Spanish company that produces digital inkjet printer for the ceramic market that produces ceramic tile and that is changing to this from printing on probably an analog way into digital way. So we've seen into the display graphics, five to ten years ago, what we are pushing now debilitating markets, we have seen the same transformation happening in the printing activities on tile if you want.

So for us it’s a great opportunity to provide our knowledge and build around that printers as they try to sell their printer be the ones that printer are an ecosystem of ink sort of software and services to one and continue to accelerate our growth in that area.

Unidentified Analyst

And right now it's just limited to ceramic tiles but I guess that you could potentially take it to other non-paper.

Unidentified Company Representative

So what we call our industrial segment today is mainly display graphics that are other form of advertising, right. Its paper but it's not pages. So it's everything that's out of home, natural for marketing and the second revenue stream is the labeling market and this is adding if you want a third addressable market where and there is activity and that are happening from a printing perspective that will never go away and or would never become digital and then creating value by roughing around that ecosystem of driving digital printing operations.

Unidentified Analyst

You mentioned the software business, I mean this is about 14% of your overall mix but it grew over 40% in 2011 and can you talk a little bit more about the strategy of the app software business and what do you think you can achieve?

Unidentified Company Representative

So by itself, the software segment is being growing as we mentioned last year 41%. It's still relatively small in size, we move from $58 million of revenue in 2010 to 81 in 2011. The addressable market is about $900 million. It's growing at 4 to 6% and there is no vendor upside really addressing that market, very fragmented, home grown spreadsheet and or local vendors. Our strategy is to continue to build on that ERP functionality that we develop and acquire install base or customer base if you want outside of the US in that ERP system is about 70%market share in the US. Everything else outside of the US is very fragmented and we want to reproduce the same.

The M&A strategy is taking acquisition as described, it's interesting because we accelerated our organic gross rates. As we became more and more visible if you want for small commercial printers within our organic funnel growing pretty fast and we have double digit organic growth now for many, many quarters and we plan to continue that. That's for the segment by itself. There is no other supplemental size doing the same thing so we have a unique position.

And the second biggest value is when you run the software around the overall process of industrial digital printing, you create stickiness with the customer environment and basically become a much more strategic partner to that commercial printer that is changing his or her business processes to adjust to that digital part.

Unidentified Analyst

And then finally on the topline, 60% of your sales is in the US. Maybe you can a little bit about your strategy of expanding outside the US and then also if you can touch a little bit on the more concurrent issue in Europe, growth was very strong in the last year and I think the CEO guy mentioned that there is some delayed decision making recently, maybe you can give us a little bit of a more recent update on what's going on in Europe though; US total market and then Europe.

Unidentified Company Representative

So we've been very US centric 60% of our revenue, 30% of our revenue is coming from Europe, 10% from Asia. Definitely part of our strategy I mentioned when I look M&A but part of our strategy is to grow internationally. Europe first and then emerging market. Through acquisition or increasing coverage, we've seen Europe growing roughly or approximately 20% in 2011 and you continue to see that. Cretaprint, our Spanish acquisition is located some revenue in Europe, most of the revenue from emerging markets. Emerging market are becoming very important to us. We feel the need for quality printing rising in those countries and we'll definitely to continue to drive that as a focus for the country. So good opportunity for us.

When it comes to the macro level environment, I think we're not immune to the overall issue that we've seen and heard from many companies. Growth in Europe was 2% in Q4 so lower than the overall year but still much better than other companies where you've seen other companies declining in Europe during the same quarter.

And I think we have a unique position because we still have a small footprint because we have a small uniqueness like in the software business or with our ecosystems, we still have opportunities if you want to gain share, was it gaining share against our direct competition or gain share against the analog world where even in the slowing down environment, commercial printers need to automate more their business process to squeeze more cust out and drive more profits.

Unidentified Analyst

And just to margin quickly so we don't have a lot of time. Gross margins were up 300 basis points last year and a lot of it came from the inkjet business. I guess it may have been supplies driven and maybe you can talk a little bit about what's driven margin growth and what's your long term vision for where gross margin can be for your company like a year.

Unidentified Company Representative

Yes, so last year we delivered gross margin of about 66%, roughly up 250 million points. On a year-over-year basis, lots of debts coming from the inkjet segment having mentioned. In the inkjet segment, we have a target model, if you want a business model to run that segment at around 40% gross margin, 2010 with around 33%, on a full year basis moving that around 38% finishing at 40.4%. A lot of that improvement is coming from supply chain components and quality improvements. 40% was our target, is our target for that inkjet segment and then we've arrived there. As we continue to grow the topline double digit, I think we'll begin to run the business at around 40% and we inject any excess in margin into expanding the ink store printers which will all be good in the long run with more ink revenue.

When it comes to the overall long term model I think we can talk about the operating profit margin, we finished the year at around 11.7% operating profit margin. We last November raised our targets for the long term haul to have an OP target of 12 to 15% and obviously we work hard to get to the 15%. It's coming from mix and rate improvement on the gross margin but also levering our OpEx as we work more on the ecosystem and leverage all of our investments across all of our segments setting the operating system.

Unidentified Analyst

And back to OpEx. I mean you've reduced your R&D I think significantly over the last few years as a percent of sales. Is that something that we should worry about in terms of long term competitive positioning there.

Unidentified Company Representative

So the short answer is no. So we've reduced the OpEx as a percent of revenue in dollars and we continue to increase it. Internally we are working on two things, one is driving efficiency in the environment leveraging ourselves to activities across all of our segment, leveraging international footprint like for software development and that will continue to help having leverage into the overall operating government. At the same time we're reinvesting those savings or most of those savings into innovations. Innovation is when technology company but for us as well is really the blood or the core criteria for the future growth. We came up with 16 product in inkjet through 2011, it will continue at the same rate innovating on technology on how to curtail ink, new application moving from paper to textile and those kind of things. And so you continue to see if you won R&D dollars growing or it would be at a lower rate than revenue as we continue to leverage the overall operations.

Unidentified Analyst

And then just one final question and then we will take the questions. Can you talk a little bit your capital allocation? More M&A potentially dividend buyback, how do you, what's your plan for the next few years?

Unidentified Company Representative

So, before allocating capital we've been refocusing on maximizing the cash generation. We've worked on more efficient manufacturing operations and better yet, so through last year. We grew cash from operation 62% on a year-over-year basis and now about delivering cash about one time operating profit. So we feel pretty good about the improvement there which gives us a lot of higher power when you came through capital allocation.

When it comes to how we use our cash, the primary driver to this M&A, we look at the company that we can acquire, whether it’s the inkjet segment, the price segment or the software which is the most repeatable M&A strategy if you want. We look at the valuation and it's obvious that it's accretive and brings value almost immediately to the shareholders, so term of returning ROI on the cash, M&A are number one choice and are acquisitive behavior in 2011, you will continue see that moving forward.

The second one is opportunistic share buyback. The board authorized 60 million, two times 30 million program in 2011, we've bought back 40 million and we'll continue to buy back on an opportunistic basis. And then when there is no M&A for certain core and or buyback opportunity, I think the board is also comfortable with small cash accumulation being it the third option.

Unidentified Analyst

A couple of questions. Are there any aspects or any assets within the Eastman Kodak part of interest to you?

Unidentified Company Representative

So we compete with Eastman Kodak on the print server mainly. We have a little bit of software workflow as well and at this point in time we've been gaining share on the Fiery segment, growing 13% last year when the market didn’t grow at that space and we'll continue to do that. We've doubled down based on what happened recently on competing and selling aggressively and we saw one point in time there is an asset that comes from sales and at that point in time we would be proud of assessing that. So it's mainly the main server.

Unidentified Analyst

– sale though, so I guess my question is having noted that all out variety of things from packaging to printer, are they interesting to you or are they –

Unidentified Company Representative

So there is certainly some interest but at this point in time we don't know what would be for sales and what would be the process etcetera.

Unidentified Analyst

And on this software side, can you just walk me through this profile that business is it, you're making all the ERP analogies, so is it traditional software professional license and maintenance or have you built in more of a subscription model to it.

Unidentified Company Representative

It’s a traditional software model that has all of the above that we mentioned. Today about 60% is maintenance and services revenue about 40% is license. On the license the majority is perpetual license. We will also offer term license and a task model. So we will host the software as well.

Unidentified Analyst

Just one last question. The growth rate on the medium term organic growth rate for the inkjet business, what did you say that was?

Unidentified Company Representative

10% to 15%.

Okay, good. Thank you.

Unidentified Analyst

Thank you very much.

Question-and-Answer Session

[No Q&A session for this event]

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