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Electronics for Imaging, Inc. (NASDAQ:EFII)

Barclays Capital Global Technology, Media and Telecommunications Conference

May 23, 2012 02:20 pm ET

Executives

Vincent Pilette – Chief Financial Officer

Analysts

Vincent Pilette

Good afternoon. I’m Vincent Pilette, the Chief Financial Officer of EFI and I’ll quickly run through a few slides, sharing with you both the results we obtained and the product offering we provide to the print industry; and then maybe I will go for a few questions.

A quick brief on the Q1 results that we posted here. We delivered a record March quarter in Q1 2012 - $160 million, growing 14%. And that was our ninth consecutive quarter of double digit growth year-over-year which I think everybody will agree for the print industry is pretty remarkable. We’ve posted record revenue for a lot of our new businesses: that would be the inkjet, the industrial inkjet business; the software business; and then also very strong double-digit growth for our recurring business made of maintenance software revenue and the ink revenue stream.

Over 60% of our business is now direct sales which is a far contrast to a few years ago when it was 100% indirect sales. We’ve delivered very good expansion internationally with more than 50% of the revenue being outside the US, and the US being the first market that (inaudible) in the 1990’s and early 2000’s. And then we’ve delivered $20 million non-GAAP EBITDA, 18% year-over-year. And we guided the tenth quarter of double-digit year-over-year growth, 15% revenue growth for next quarter and twice that for the bottom line – 30% year-over-year growth for non-GAAP EPS.

So our primary mission is really to lead the transformation of analog printing into digital automated color printing. If you look at the print industry it’s a $1.3 trillion industry. Lots of people understand that industry as being in [secular] decline and while maybe that’s true overall there are different departments and market segments that are fast growing and that’s what EFI is focusing on. We’ve developed a unique ecosystem of hardware, software and ink to address that transformation of analog into digital printing, and doing so we transformed our business model from being indirect sales transactional-focused into direct sales or a mix of indirect or direct sales; and a good mix of business models from hardware, software, transactional and non-transactional – focusing really on selling that solution.

We are focusing on favorable market trends within the print industry. If you look at the digital industrial printing, it’s growing steadily. That’s where the iPad or computers or the technology solution will not take over printing – printing on labels, printing for billboards, printing on ceramic where the electronic version will not replace the activity of printing. Marketing professionals have been focusing more on more on the personalized message, driving the variable, data management and really addressing their message to local target audiences.

Color printing jobs have been growing while color/black & white printing in the office has been declining. Professional production color printing jobs have been increasing year-over-year for many quarters now and the jobs are becoming shorter, a faster turnaround time requiring digital and advanced technologies in order to continue to be competitive in that market. And finally, print professionals have looked at more automated solutions to build on the long-term vision of almost a lights-out print manufacturing processes software to automate their print manufacturing processes.

We manage the company in three segments. Industrial inkjet is the first one – about 45% of our revenue stream, really focusing on display graphic driven by the art of form advertising, focusing on labeling and packaging; focusing on now ceramic inkjet printing, and then building UV ink, digital ink for those solutions. We’re the number one worldwide manufacturer for UV digital ink.

The second segment is the product driven software. It’s an ERP solution focusing on automating the business operations within print manufacturing. We provide ERP systems and [work to print] software solutions. And then the third segment is the Fiery branded segment, the digital frontend appliances loaded with software applications to enable color management, different variable data management, increasing the productivity across a printing floor and enabling also mobile printing.

We’ve been able to deliver very strong growth over the last two and a half years focusing on the selected market segments that have growth potential as the print industry transforms. We were able to, as I mentioned, post the ninth consecutive quarter of double digit growth and we’re going for the tenth quarter, and in Q4 of last year we posted our record quarter, the all-time record; and Q1 was a record March quarter. We’ve done that by diversifying the revenue stream and also increasing the direct sales businesses like software and inkjet, businesses that carry recurring revenue streams and building up on that momentum.

And finally, we’ve seen some good operational growth. Our customers are definitely winning with our solutions. We’ve been growing our ink volume 41% the last quarter and we have two and a half years of [whole ink] growth of more than 20% year-over-year for UV ink volume, showing that commercial printers who have migrated toward the industrial inkjet segment and focusing on the digital solutions are gaining very strong momentum.

Lots of people are asking how is that possible in the print industry, and you know, primarily we’ve been very focused on selecting the segments that we are addressing. We’re really focusing on this industrial printing, production printing where professionals have to migrate from analog into digital, and that’s driven by the [auto form] advertising and with the opportunity in labeling and packaging. Other opportunities are in automating the processes, creating online [transfers] – basically using technology and innovative technologies to constantly make money in an overall industry that may be in [secular] decline.

Equally important is where we’re not focused: printing at home, what we call casual printing; printing in the office where the tablet will replace the print volume. We’re not focused on publishing books or newspapers, and we don’t have any negative revenue stream coming from the offset of screen printing in the analog world.

Our total addressable market based on our current portfolio is roughly $4 billion growing at about 8% [KEGR] in different categories: printers, industrial printers for the industrial inkjet printing area; in ink, and then following that in software and the digital front are growing at a different growth rate. We’ve been expanding our addressable market by supporting a very accelerated acquisition strategy. We’ve closed the last two acquisitions this year: Cretaprint in Spain, expanding the inkjet addressable market into the ceramic tile manufacturers, and then the last acquisition we’ve done in April was a Software MIS for Printing in Latin America, becoming the #1 market share in Latin America for software for printing.

As I mentioned, one of our differentiators is the ecosystem we have built. Looking at the printer, the digital industrial printer loaded with technology innovation in which we built in the digital frontend, the Fiery branded first product of EFI to better manage the workflow of the printer and the overall job of printing digitally in the industrial production environment. Our ink is proprietary and grows across our printer install base in all segments.

And then our MIS wraps around the printer solution to automate all business processes from job scaling to job costing, inventory management, physically helping print professionals to manage all business processes around the job of printing. And then we have the overall subscription and maintenance mode to sell the solution. So we’ve delivered with this solution a clear ROI, built what we call a smart factory or a lights-out printing process, and the main differentiator for us is the software already loaded into Fiery and then supported by an overall ERP.

We’ve transformed the company. Ten years ago it was 100% Fiery transactional business, a digital frontend in front of high-end production printers, and we’ve moved that now to a very diverse business and a set of businesses. The last record revenue was in Q2 2007. At the time we had a very strong economy. Today in this new record we have to prove a clear ROI and building around the ecosystem has been our strategy. We had one dominant revenue stream in the Fiery; today we have a very balanced revenue. Fiery, which was 60% or 65% of our revenue a year and a half ago is now down to 38% and we’ve done that by growing the inkjet revenue stream and developing our software strategy.

We’ve moved from purely transactional to a lot more sustainability into our business model, building now on our very direct sales force touching the end user, the commercial printers or the industrial printers; and moved from focusing on innovation, spending about 20% of revenue on R&D into innovation but also customer intimacy through the direct sales force, and have acquired also a lot of discipline delivering on our promises for now many years.

Let me tell you a bit about each segment. In industrial inkjet we’ve delivered revenue of about $240 million through 2011, growing 16% in 2011, 30% in ’10. Q1 of this year we grew 47% - the mix of organic growth was in double digit and the acquisition of Cretaprint addressing the ceramic manufacturing process. When you look at the penetration rates in each of those market segments from a digital printing perspective we still have a lot of opportunity.

Display graphic, which is the biggest piece of our revenue stream in this segment is about 25% to 30% (inaudible) and color digital is growing pretty steadily using our equipment and ink. Label – it’s a pretty big market in terms of output, $50 billion. It’s only 2% digital from a production perspective and offering opportunities as digital prices become equal to [flexing] prices on analog presses. And for each one of those printers who provide their own manufacturing, as I’ve mentioned have had many quarters of double digit revenue growth.

We’ve expanded that segment with adding a third one which is ceramic tile producing; about a little bit less than 10% penetration from a digital perspective but very compelling ROI. These are solutions that are lowering production costs but are enabling also to have new applications, so enabling tile manufacturers to charge a premium when using a digital inkjet solution – being able to replicate woods, marbles or other solutions that are very, very close to the real solution.

It was important for us or accretive for us because we could expand our current knowledge in inkjet and digital print production with our ecosystem and extend that to this new market that had been analog for many decades and had not been touched by new technologies. It offers significant upside. We were a print manufacturer and we’re able now to develop ink and software, and over time wrap that into a solution specifically for tile manufacturing. And then we usually offer R&D and supply chain synergy as part of that deal.

The second segment, about 15% of our revenue is the software segment. It’s professional ERP for print manufacturers, and we also offer print solutions, our software modules enabling commercial printers to use the internet in their business activities. In 2010 it was a $58 million revenue stream. In Q1 ’12 we posted $24 million, annualized almost $100 million so a very fast growth rate, and in that gross margin expansion as we scale the software business.

It’s interesting to see how commercial printers, while the industry consolidates, need to use the internet to survive. They have now multiple production floors and need the ERP to manage capacity across multiple floors; or some extreme cases, when they go out of business they now don’t just go bankrupt – they use the internet to keep their name and capture content, and outsource the job of printing to bigger commercial printers. So the web-to-print solution has been fast growing within that portfolio as commercial printers start to use the internet in a creative way.

In the US about 75% of the top 400 commercial printers are using our ERP, and for us it’s a competitive advantage being able to pool the inkjet solutions with Fiery-led solutions into their environment. In the rest of the world the market is very fragmented; the number two competitor is less than $10 million in revenue, and our strategy has been to consolidate that market through acquisition. I mentioned metrics that (inaudible) to become the number one player in Latin America.

And the final segment, the digital front and the Fiery branded appliances grew 24% in 2010, 13% in ’11, down in Q1 ’12 due to product cycles and a specific one item in 2011. The gross margin is pretty stable at 67.5%. That’s our legacy product. It provides us a solid foundation, provides a commercial printer the ability to increase the productivity of each engine that is being sold by our OEM partners – Xerox, Konica, Minolta, Rico, Cannon. And we are the dominant player in the high-end digital frontend for those engines with about 50% market share. While it’s not the high growth rate for us it provides very strong operating profit and cash flow as well as software expertise that we can then utilize in our printing inkjet business and in the software business segment.

So the focus on those market segments has enabled us to deliver very strong growth as I mentioned, the growth driven by the inkjet and software segment with a focus on international operations and building on solutions that create recurring revenue streams. With that we had guided two years ago of gross margin expansion in the range of 54% to 56% which we achieved at the end of last year and have reset the gross margin target based on our business model to 55% to 57%. In Q1 ’12 55% has been reset with the Cretaprint acquisition.

Then along with this growth margin expansion we’re leveraging our OPEX across our business models: one sales force across all three segments, leveraging our supply chain across all inkjet product lines or R&D operations across all software activities. This will enable us to continue to grow operating profit which we guided at the top of our range at 15%.

We’ve been focusing on working capital, generating cash from operations on the last twelve months’ basis of $71 million, up 62% on a year-over-year basis. And we’re using our cash primarily for M&A activity, and we do opportunistic buyback and then when the opportunity is not there we just accumulate cash which the Board is fine with.

Our long-term model: we believe over the next three years we can grow about 10%, driven by inkjet 10% to 15%, software annual growth rate of 10% to 20% in an organic matter; and on top of that we’ll add our rollup (inaudible) acquisition strategy; and then the Fiery business is about GDP+. That enables us to expand our gross margin target from 54% to 56% to 55% to 57% and leveraging our OPEX to grow 12% to 15% gross operating profit margin. And while we do that we also diversify away from Fiery by growing inkjet and software with Fiery becoming less than 40% of our mix over time and about 45% of our gross margin.

So overall we’ve been gaining market share in this $4 billion total addressable market that for us has been growing at about 8% [KEGR]. We’ve had selling momentum for the last many, many quarters, growing the top line but also expanding our operating profit margin. We are coming up with a lot of innovation. At the end of last year, our 2011 second half we came up with six new inkjet printers and we continue to innovate in this market where technology is the only way for commercial printers to continue to squeeze more profit and [gain] business. We’ve built resilience into the business model as I mentioned and demonstrated operational excellence.

So with that let me stop here and see if there is any question.

Question-and-Answer Session

Analyst

Does anybody have a question? Vincent, what’s your most economically sensitive area right now? And given that we’re kind of heading into some tough times in Europe and potentially even Asia, how do you offset that?

Vincent Pilette

Yeah, so a couple of things. One is on the Far East side, we know that it’s linked to the product innovation from our partners, print manufacturers – Xerox, Rico, Konica, Minolta, Cannon. They renewed the first half of 2012 ahead of the [Drupa] which is a big trade show for the print industry wouldn’t be soft. So the Fiery business being soft in the first half was part of our concern. Fiery will continue to grow past [Drupa] which is in the second half of ’12 and first half of ’13, and we’ve been very focused on making sure we have growth opportunities in the other two segments to offset that which we demonstrated in Q1.

In terms of Europe, it’s interesting. We’ve been growing in Europe 19% last year although growth has slowed down starting in Q1 of last year at 26%, finishing at 2% at the end of ’11. We’re worried about Europe. We have about 30% of our revenue stream coming from Europe, but Q1 was a 24% growth rate for us and we’ve been gaining share. Some of that is through acquisition. We’ve acquired Cretaprint. In an industry that’s in transformation with a big economic downturn, it’s in transformation of going from analog to digital and seeing that analog is not an option anymore for those tile manufacturers since they can charge premiums and lower the costs which is very [good] for competition.

So the momentum if you want of going from analog to digital printing in the key areas we’ve been focusing on has enabled us to offset some of that volatility or uncertainty in Europe. And then the last point is software has been growing pretty steadily, and I would argue that in tough times you sell even better software as it enables the commercial printers to automate their business processes and know what their labor costs.

Analyst

So I mean Fiery is the one that would be the most economically volatile, and back when I used to cover you that was like most of the company and you’ve changed it and smoothed it out a lot. The margin profile though in the Fiery division as maybe imaging might be facing some secular challenges, is that sustainable on the Fiery side?

Vincent Pilette

Yeah, when you look at Fiery there were two external providers of high-end controllers – [Creo] from Kodak and Fiery. [Creo] has not been [invested in] at the same pace and Kodak has some changes that you guys know, and that has offered us an opportunity to gain share in that higher end of the market. And while obviously price is always important, price point has not been the most important driver – functionality and functions loaded on the Fiery has been more substantive in the discussions with our partners.

Analyst

Is there any ramp, you know, Xerox had a new product at (Inaudible). Is there anything significant that came out of [Drupa] that could be actually a second half driver for the company?

Vincent Pilette

Most of the innovations announced inside [Drupa] will be over the next twelve months, what we see as probably a very strong Q4.

Analyst

On the inkjet side, too?

Vincent Pilette

Inkjet for us is slightly different because we don’t depend on partners and their rate of innovation. It’s solely depending on us. We’ve been guiding the inkjet segment just for this quarter at over 30% and we see a strong momentum in that segment really driven by the secular trend of moving from analog to digital for industrial inkjet printing.

Analyst

Any other questions? Is the threat of third party manufacturers of the UV ink, is that completely gone?

Vincent Pilette

We have saturated that at well over 90%. Those machines are very sensitive and as soon as we see that there is a third party ink being used we don’t service the machines. Those are big CAPEX items, about $0.5 million, and therefore the commercial printer really has only incentives to protect that investment.

Analyst

Got it. And what do you think, I mean you mentioned tablets a little bit. There’s a view, it’s my view that tablets obviously create a challenge for printing – it’s probably a lot of other people’s view as well. And how do you kind of deal with that and offset that? It seems like you’re growing anyway because of your digital signage and some of your propositions going into offset are secularly safe anyway, but I was just wondering if you thought that was a potential threat.

Vincent Pilette

No, actually we see that as an opportunity. We do recognize the tablet will drive secular decline in printing but that’s more in office printing and casual printing; printing at home for a picture or printing in the office for emails or things like that. Fiery, which is really the main product we’re talking about is not really in the office; it’s in the professional production environment. Less than 2% is coming from the office, and when it’s coming from the office it’s a specific department focused on printing.

At the end of last year we came up with a new Fiery that can be loaded on the network to enable mobile printing, and while people are more mobile they still need from time to time to print on the web. By plugging in a Fiery solution into the network corporate IT can enable all of the printers on that network to be accessible in a mobile way from whatever mobile device that you have based on your authorization profile and so forth. For us it’s actually an opportunity to get more revenue as opposed to having to offset a negative revenue stream like HP and others have had.

Analyst

Well we are out of time but Vincent, thank you very much for being here. We’ll have a breakout in Liberty 5 and thank you again.

Vincent Pilette

Great, thanks for inviting me.

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