Electronics for Imaging, Inc. Q1 2008 Earnings Call Transcript

Electronics for Imaging, Inc.(EFII)

Q1 2008 Earnings Call

April 23, 2008 5:00 pm ET

Executives

JoAnn Horne - IR

Guy Gecht - CEO

John Ritchie - CFO

Analysts

Matt Troy - Citigroup

Austin Bernard - Cross Research

Woojin Ho - Merrill Lynch

Ananda Baruah - Banc of America Securities

Jim McIlree - Collins Stewart

Presentation

Operator

Good evening. At this time, I would like to welcome everyone to the EFI first quarter 2008 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you. Ms. Horne, you may begin your conference.

JoAnn Horne

Thank you, operator. And good afternoon, everyone. This is JoAnn Horne, Investor Relations for EFI. 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 forward-looking statements, each of which involves a number of risks and uncertainties.

Actual results could differ materially as a result of many factors including variation in customer order patterns, the timing of new product introductions, market acceptance of new products, the company's ability to attract and retain key customers, intense competition in the marketplace, integration issues surrounding acquisitions, unforeseen risk in new investments and business strategies, litigation related activities, particular adjustments or restatements deemed necessary by the company, and the company's ability to service its debt, and other risks outlined in the company's SEC report and the company's earnings press release filed with the SEC today.

The company recommends that you read these documents in conjunction with your review of the financial statement. For your convenience, the company has posted slides on the website on the Investor Relations section of the website at www.efi.com, giving you an overview of much of the information the company will cover today.

Now I'd like to turn the call over to our Chief Executive Officer, Guy Gecht. Guy?

Guy Gecht

Thank you, JoAnn. Good afternoon, everyone. We believe we made progress in many of the objectives laid out last quarter, allowing us to achieve results at higher end of the both, our top line and EPS range despite operating in a more difficult market than when provided that [originally]. While we don't count on any improvement in the economic environment in the short-term, we are focusing a sequential revenue growth for both the Fiery and Inkjet business in Q2.

But before we move to our June quarter outlook, let me first discuss each of the businesses and how the current environment impacts them. Our Fiery revenue was $68 million coming in above our expectations which is another indication that portion of the Q4 sharp decline in this business was due to inventory correction by our OEMs during Q4. We also previewed some of the other achievement to the launch of the new entry-level production server, the Fiery 480, with KM and Canon. Despite the out performance of Fiery in Q1, the large enterprise market remains challenging as the slowing economy is having an impact of the segment.

All of our OEMs are experiencing delay in buying decisions, especially in North America. We also believe the industry is moving toward carrying lower inventory overall, so we do not expect any significant channel field as a result of new engines introductions in the near term. As promised, we took steps during the quarter to increase visibility into our OEM inventory level and sell-through. For example, we have begun to consolidate and track monthly sell-through rates versus inventory for each individual SKU.

This information will create more accurate forecast and will help us determine requirements for promotional programs. While the Inkjet business did not meet our aggressive growth rate, we believe that 11% the overall growth is still a strong result in light of the economically sensitive nature of this business. There is no question that the slowing economy has negatively impacted this market in the US, while outside North America we saw greater than 20% year-over-year growth. In the US, we saw numerous examples of deals being pushed out as customers become more cautious with their capital equipment budget.

In some cases, we were more aggressive in pricing to close transactions which negatively impacted gross margins. We are planning to continue being aggressive with prices in the Inkjet business when needed, but we are taking steps to offset some of this gross margin peer pressure. While we are entering Q2 with robust pipeline of sales opportunities that match our long-term growth targets for the business, our recent experience in the long sales cycle and difficulty in closing deals due to the challenging environment is tempering out short-term growth expectations.

As such, we are projecting year-over-year growth of 6% to 10% or about 10% sequential growth for the June quarter. Our Jetrion labeled printer beta program progresses tracking to our plan with very positive feedback from our early users which collectively printed 600,000 linear feet since the beginning of the year. We are planning to show the 4000 at a Drupa trade show and expect to record initial product revenues late in the quarter.

Our APPS business was up 14% from the same quarter last year, a remarkable accomplishment considering that most of our revenue in this segment is from North America. We see the combination of this business environment and tough competitors leading to flat sequential results. All of our businesses will have a strong presence in Drupa, the industry's largest trade show which will take place at the end of May.

EFI will be there in full force demonstrating current and future technologies in color management, digital workflow and industry leading inkjet technologies. While our company isn't the size of some of the industry giants, we will show some of the most exciting new technologies at Drupa and many leading end customers are expected to visit us both as they look to EFI for the most demanding high quality digital printing technology.

As promised, we reduced our cost structure especially in the Fiery and the APPS businesses helping us achieve our stated goal of about $68 million in operating expenses, while still investing in the Inkjet business. As we have discussed in the past, the second quarter is an important time for trade shows which are the prime sales channel for Inkjet business. We traditionally see an increase in sales and marketing in Q2 due to trade shows. This year we'll have an additional cost associated with Drupa which occurs every four years.

If you remove the $2 million impact of Drupa, our spending this quarter will be about $3 million to $3.5 million below last year's level. As we have stated in the past, we will closely monitor both our Inkjet and total company revenue growth and we'll slow our spend in the Inkjet business if the revenue growth does not meet our objectives. As a point of reference, we increased our head count in the Inkjet business by about 30% during 2007, while in light of current market conditions we have kept head count in Inkjet flat in Q1 and plan only a very few critical hires during Q2.

Following up on our commitment last quarter, we have executed on our share buyback plan. This quarter we bought about 2 million shares and currently we have 69 million remaining on our authorization. In the last six months, we have bought back about 5 million shares or 9% of our outstanding shares for a total of $100 million. Further reducing our share count, we have also made a definitive decision to call our outstanding convertible bond which will reduce our share count by an additional 9.1 million when completed.

Let me discuss one more topic before I turn to the Q2 outlook. We told you before that we are in the process of adding new board members. Today we are excited to announce the addition of Dr. Richard Kashnow and Tom Georgens to our Board of Directors. Richard Kashnow has a long list of accomplishments including having served for many years in a senior position within GE, being the CEO and Chairman of Raychem, a $1.8 billion company, and numerous board memberships in the past.

Tom Georgens is a rising executive in the storage industry and was recently appointed as the President and COO of NetApp, a $3 billion company, who like EFI deals with hardware and software products which are sold direct via channels and to OEMs. We are excited about the experience that Dick and Tom will bring to the board. At the same time, Chris Paisley has decided not to stand for re-election to the EFI Board of Directors at the company next annual meeting of stockholders.

We would like to thank Chris and express our gratitude for his four years of significant contribution to our company as a Board Member and as the Chair of our Audit Committee, including his tremendous effort, working countless hours to oversee the company's restatement process last year. With the addition of Kashnow and Georgens and the Paisley departure, EFI's Board of Directors will consist of seven members, five of which are independent.

Now turning to the Q2 outlook. Despite the challenging economy, we anticipate a modest sequential increase in the Fiery business and about 10% sequential growth in the Inkjet business leading to revenues in the range of $141 million to $147 million. As I discussed earlier, we are seeing pricing pressure in the Inkjet business which we don't believe will lessen in Q2. The price situation along with a tougher spending environment will put continued pressure on margins leading to a slight increase in operating margins, but falling short of the 10% operating margin target for Q2 we discussed last quarter. On a per share basis, we look for earnings in the $0.20 to $0.24.

I just want to end by reiterating our commitment to increasing shareholder value. We took many steps this quarter including the share buyback, cost cutting, calling the bond and the Board additions that I just reviewed. Our focus on increasing shareholder value, we will keep you updated as we make additional progress as we know we are far from done in this process.

Now we'll turn over the call to John.

John Ritchie

Thanks, Guy. I'll now go over the detailed financial results for our first quarter. First quarter revenues came in at $136.6 million, down 7.6% on a year-over-year basis and down 10.1% sequentially.

Non-GAAP net income for Q1 of '08 was $11.8 million or $0.20 per share, down 39.7% from $19.6 million or $0.30 in Q1 of '07 and down 18.3% from $14.4 million or $0.23 in Q4 of '07. For Q1 we had a GAAP net loss of $5.4 million or a loss of $0.10 per share compared to net income of $2.1 million or $0.04 in the first quarter of '07, and down from net income of $7.7 million or $0.12 per share in the fourth quarter of '07.

As a reminder, in the calculation of both our GAAP and non-GAAP EPS calculation, we include the 9.1 million shares related to our convertible debt, when the inclusion of these shares is dilutive to the EPS calculation. For Q2, the 9.1 million shares will be removed from the EPS calculation as of our announced bond redemption date. This will reduce the weighted average shares used for the EPS calculation. We are currently estimating a share count of 61.5 million for the non-GAAP diluted share count for the second quarter.

The differences between our GAAP and non-GAAP earnings for the quarter reflect the following items: A $7.2 million charge related to the amortization of fuel-related intangibles; a $9.9 million charge related to stock-based compensation; a $5.5 million charge related to our severance and restructuring actions taken in Q1; a $1.1 million charge associated with the review of our past option granting practices; and lastly a $6.5 million tax credit related to the tax effective in non-GAAP adjustment.

Before I go through the quarter in detail, I wanted to highlight some key milestones for the quarter. Our non-OEM sales were 57% of total revenues. Our recurring revenues set an all-time high at 18% of total revenues. Recurring revenues primarily consist of [ink's related] or Inkjet business and software maintenance contracts. We set another company record for UV-ink volume growth.

We added $6.5 million in cash to the balance sheet excluding the effect of the share repurchase program. We added this cash during what is typically our weakest cash flow quarter, which was compounded by the cash impact of our restructuring charges. We also saw a sequential increase in our Fiery business and what is typically a seasonally a weak quarter.

Now turning to revenue, by geography, in the Americas we saw stronger than expected results for Fiery offset by greater than expected Q1 seasonal weakness in our Inkjet business. The Americas represented 52% of total revenues, up from 51% in the fourth quarter of '07. Our European revenues were 35% of total, down from 36% in Q4 of '07. European revenues were 32% when compared to the period in Q1 of '07.

In Europe, we experienced stronger than expected results for Fiery although we anticipated sequentially seasonal decline for Inkjet, year-over-year we still saw robust growth in this area. Japan represented 9% of revenue, down from 10% in the prior quarter. Sequentially, we saw a decline in Fiery revenues in Japan. Finally, the rest of world revenues were 4% in Q1, roughly flat with Q4 '07.

Before moving on to revenue by product line, I want to remind everybody of our previously announced reclassification of revenues. Effective this quarter we will include our Fiery option sales in our Fiery revenue category. Previously this revenue was included in our APPS product category. As Fiery software options are directly tied to the Fiery business, we feel this provides a better view of how the Fiery business is progressing.

For your reference, we have provided three years of historical data on the Investor Relations portion of our Website to reflect this change. Sequentially, the first quarter Fiery revenues were $68.3 million, up 2% from Q4 of 2007, and down year-over-year 21%. Fiery revenues were 50% of total revenues for the fourth quarter compared to 44% in the prior quarter. For the second quarter, we expect the Fiery business to see a small sequential increase off of the much better than expected Q1 level.

For the first quarter, our Inkjet products contributed 39.1% of revenue, or $53.4 million compared to 45.6% of revenue or $69.3 million in the fourth quarter of '07, a sequential decrease of 22.9% driven by normal seasonality and a challenging economic climate in the US. Year-over-year revenues were up 11% in total. During the quarter, we saw pricing pressure which negatively impacted gross margins with the VUTEk product line. For Q2, we expect to see year-over-year growth in the 6% to 10% range and about 10% sequentially.

During the first quarter, the APPS category contributed 10.9% of total revenue or $14.9 million, down 5.7% sequentially from Q4 '07 levels and in line with our expectations. The sequential revenue decline was driven by normal seasonality in the APPS business. For Q2, we expect revenues to be even compared to Q1 despite a challenging economic environment. Non-GAAP gross margins for the first quarter were 57.2% up 130 basis points from 55.9% in the fourth quarter of '07 and down from 60.2% in Q1 of '07. Despite the pressure on our Ink margins we're pleased with the sequential increase in gross margins overall.

In Q2 we expect to see a revenue mix shift to lower margin Inkjet products yet we believe we will be able to hold margins level or see a slight improvement compared to Q1 levels due to cost containment initiatives above the gross margin line. Our non-GAAP expenses, including the amortization of acquisition related costs, stock-based compensation charges, severance and restructuring charges, and the option review costs were down $3.2 million or 4.4% to $68.8 million in the first quarter compared to $72 million in the fourth quarter of '07.

R&D expenses were $32.6 million, up $300,000 or 1% from the fourth quarter. In the first quarter, R&D expenses represented 23.9% of revenue, up from 21.2% in Q4. The increase in R&D was driven by changing the method of certain corporate allocations which were primarily facility related. These costs were partially offset with lower headcount costs.

In the first quarter of 2008, sales and marketing expenses were $26.9 million, down $2.9 million from $29.8 million, when compared to the fourth quarter of '07. The decrease was related to lower compensation costs, driven by headcount reductions and lower T&E spending. In addition, sales and marketing saw some benefit from the change of method of allocated costs.

Sales and marketing expenses represented 19.7% of revenue for the first quarter of '08, roughly flat with the fourth quarter of '07. G&A costs were $9.3 million, down 6.4% or $600,000 from the fourth quarter of '07. For the first quarter, G&A expenses represented 6.8% of revenue compared with 6.6% in the fourth quarter of '07. The decrease in G&A expenses were driven by lower headcount costs.

Now looking forward to Q2 spending levels. We expect spending of approximately $72 million in Q2, up approximately $3 million compared to Q1 and down to $1 million when compared to Q2 of '07. As we discussed before the increase in Q2 is driven by seasonally high trade show activity including the once every four year trade show Drupa, held in Düsseldorf, Germany. When compared to Q2 2007, our spending, net of the Drupa expenses, is expected to be down approximately $3 million.

Non-GAAP operating margins were 6.9%, down from 8.6% in Q4 of '07, and down from 13.3% recorded in the year ago period. We expect a sequential improvement in gross margins in Q2, however, we do not expect to reach our previous goal of 10%. The shortfall in the gross margin target is primarily driven by pressure on VUTEk gross margins combined with a reduced revenue outlook.

Other income of $6.1 million was $100,000 higher than the prior quarter driven by the liquidation of securities and preparation of the redemption of our convertible debt as well as some FX gain. We expect other income to come in below $5 million for Q2. We expected decline will be driven by the maturation of longer term, higher yielding instruments that will be invested in short-term duration investments in preparation of our bond redemption, as well as overall reduced cash balances related to the redemption of the bond. And lastly a significantly lower interest rate environment.

Turning to our tax rate, we are currently estimating a non-GAAP tax rate of 24% to 25%. Our non-GAAP rate anticipates the renewal of the R&D tax credit in 2008. Moving to head count, at the end of Q1 full-time head count was 1,938 employees.

Moving on to the balance sheet, we ended the fourth quarter with approximately $477 million in cash and cash equivalents and short-term investments compared with $500 million on December 31, a decrease of approximately $23 million. This was driven by $29 million spent in conjunction with our previously announced stock buyback program offset by $6 million of cash generation.

Inventory levels of $40.9 million were about $1 million higher from Q4. We expect inventory levels to be even when you compare Q1 to Q2. They accounts receivable balance decreased from $97 million, from $102 million in the first quarter. DSOs increased to 65.4 days from 61.7 days in the first quarter. The extension of DSOs was driven by a more back end loaded quarter, specifically within our Inkjet product line.

A significant trade show, ISA, was held in the last week of March. As we have mentioned before, trade show activity is the primary source of lead generation for the Inkjet business. Due to the timing of the trade show, customers delayed purchasing decisions until very late in the quarter.

Now turning to our Q2 outlook, we expect revenues in the range of $141 million to $147 million. We expect non-GAAP earnings of $0.20 to $0.24 per share. We expect GAAP results from between break even and $0.04 per share.

Finally, as discussed in our press release and mentioned by Guy we'll be calling our convertible debt in early June. This will materially reduce the share count used in our non-GAAP EPS calculation. Q2 share account will see a partial benefit of this as the bonds will be called mid-quarter. Given this we are estimating a share count in the range of 61.5 million shares. For Q3 and quarters beyond we'll see the full benefit of the reduced share count for the entire quarterly period.

With that I will now turn it over to questions.

JoAnn Horne

Operator, we'll go to questions, please.

Question-and-Answer Session

Operator

(Operator Instructions). We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Matt Troy of Citigroup.

Matt Troy - Citigroup

Good evening. Couple of questions. On the wide format side, John, we were up there in, was it March? The fact that it came in where it did, I think certainly should come as no surprise given the economy but I'm interested in your comments about pricing pressure. I would think you would see demand deferrals, maybe some trading down, but can you put some context around that, specifically how do we get comfortable that it is not HP getting more aggressive on wide format. Certainly they've been making a little bit more noise. How should we think about the pipeline going forward? If we look back, I think it was 2001 in that recession, growth in the wide format business actually got a lot worse than the positive 11% you guys put in this quarter. What is the bear case scenario for Inkjet if we stay down here in kind of a down 1%, 2%, 3% economy?

Guy Gecht

Hey, Matt. This is Guy.

Matt Troy - Citigroup

Hi, Guy.

Guy Gecht

So I'll start from the -- kind of the middle question. It's nothing here we believe is any material different to the competitive situation. Of course, we're not the only one aggressive. Other people are also aggressive. But we view our position very strongly. We believe that growing 11% in this economy is positive. Not as positive as we think it should be or would like to see it, but it certainly reflects the demand and what people think about our lineup. The pipeline, both when we talked to you in January and today, is actually very strong. People sit on decisions. Sometimes they have difficulties getting a loan. Sometimes they just wait, they do a second shift. They wait for their older books to be more robust before they pull the trigger. And in some cases unless they have a really good prize in front of me, I don't think I'm going to pull the trigger, I'm going to wait. We're not doing it all the time but in some cases we felt that's the right thing to do to get somebody over to our side now and start to print and generate the ink revenue.

And again, we're not the only one doing it. As long as the economy is tough I think the pricing pressure will be there. As I said, we're going to take some steps and put margins things that are in our control, but overall we think the pipeline is pretty good. We're happy. Just a closure rate is really slow and below what it should be and that is deferring the decisions to the future when some of the customers feel more comfortable about their business.

Matt Troy - Citigroup

And the last time we were in a recession, I know it was before you bought the company, but if you look at some of the private equity books on VUTEk then, then this business go negative in the last recession?

John Ritchie

Yeah, actually, Matt it's John here. I don't think it went negative. To be honest with you, we're giving one quarter's guidance for the time because that is as far as we can see in the crystal ball. If the economy gets worse, yeah, we'll be impacted by it, but we don't want to kind of pontificate on that at this point.

Matt Troy - Citigroup

Okay. Okay. Yeah, it came in in line. So I'm not trying to say there is no surprise there. I'm just trying to get a sense of could there be additional downward pressure? That is a tough question to answer in this environment. Second question, just on terms of sell-through trends of the installs you are landing now. Could you just give us a sense of UV over solvent, is it a 60/40 relationship in terms of hardware placements? Is it higher than that? Just trying to get a sense of business mix on sell-through.

John Ritchie

Our sell-through is pretty consistent with the prior quarter. You're in the ballpark in your percentage, it's predominantly UV-based. We didn't really see much of a mix shift on that. I will say that we saw more pricing pressure on the solvent devices than we saw on the UV devices, which I think speaks well for how our UV products are seen in the market.

Matt Troy - Citigroup

Okay. And then, John, one thing I think you had alluded to and then talked to at the analysts meeting was the potential to monetize the headquarter real estate or at least examine strategic alternatives, not to put words in your mouth, examine strategic alternatives. Any update there? Is that still a focus and anything you can tell us about that?

Guy Gecht

Matt, as I said, there is certainly a strong focus on continuing to improve shareholder value. It is premature to update on the real estate. But we meant what we say, we will look at all of these options including this option.

John Ritchie

Absolutely no defocus whatsoever, it is still one of our number one priorities

Matt Troy - Citigroup

Okay. And if it is then put back on the convert, is it safe to say you scale back the share repurchases until that's done, or can you dual track?

John Ritchie

So we have an authorization with $70 million left on it and we have the put -- the bond coming back to us the call, the weaker the balance sheet can more than withstand both.

Matt Troy - Citigroup

Okay. Great, thank you.

Operator

Your next question comes from the line of Shannon Cross from Cross Research.

Austin Bernard - Cross Research

Hi, yes, this is Austin Bernard in for Shannon. Real briefly could you talk on how comfortable you are with the ability to forecast the control business going forward? I'm just taking a look at how you performed this year, this quarter. Numbers did come in well, but far beyond what we were expecting.

Guy Gecht

So I think we're building a better visibility into the OEMs and they're even totally level sell-through. Where I think it's difficult of course, as this is an environment where they also have less than perfect visibility because of -- they don't know which deals is going to happen, what's going to be delayed and what's going to happen in the second quarter. We said I think, we're going to be slightly below the Q4 level. I think we came few millions below the Q4 level, which was a positive surprise. We like to make sure that we continue to monitor and improve our forecast ability, but I think we're getting much better at that in the controller business. And it moves there from the end user -- obviously, is a disadvantage when you try to focus. In the VUTEk case, we are in the deals, we're talking to the end user, we can get a better sense of where they are or [this is in the OEM selling to an OEM].

Austin Bernard - Cross Research

That answers my second question. Thank you very much.

Operator

Your next question comes from the line of Jay Vleeschhouwer of Merrill Lynch.

Woojin Ho - Merrill Lynch

Hi, this is Woojin Ho for Jay Vleeschhouwer. Real quickly would you remind us of what the revenue mix of the VUTEk business, US and non-US?

John Ritchie

So, the non-US is over 50%. The US is about 40% to 45% in any given quarter.

Woojin Ho - Merrill Lynch

So given how strong Europe has been in terms of imaging spending over the past year and obviously we see that with the VUTEk growth in the first quarter, in the near term how sustainable do you believe the VUTEk growth can be in Europe? And have you seen any pricing, similar pricing pressure in the European business as well?

John Ritchie

Overall we are seeing the pricing pressure, but I would say that baked into the guidance range we gave for the Inkjet business, we're taking what we think is a realistic view of the economies in the different regions that we work in. So we're not -- you know, we're not expecting the US to measurably improve in any way. We're aware of what's going on in Europe and the other geographies that we work with them.

Woojin Ho - Merrill Lynch

Got it. And, Guy, you had indicated that your OEMs are tightly managing inventories, as well. Now, in the long run is that better for the controller business at all in terms of your visibility with the tight inventory levels that your OEMs are carrying?

Guy Gecht

Absolutely, I think lower inventory mean a better match between sales in to sales through. And that is what we want to see. And they need to continue to track inventory to their sell-through, so if they have a slowness or jump in sales they want to track this. Overall that is a positive from our perspective.

Woojin Ho - Merrill Lynch

Okay. And lastly one more on the controller business. Has there been any further share loss or gains in the controllers to one or both of Creo or DocuSP?

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Guy Gecht

So, I think the positive part is that we talked about steps that we didn't execute very well last year in getting the new 480 to the market in the M3 production. We launched it last year with Xerox and IKON and we launched at the beginning of this year with KM and Canon and I think we're seeing good traction. I believe we're gaining share in the area as well. We had competition especially in the Konica Minolta channel where cite last time, we said we have issues there. Xerox mentioned on their call they are doing well on 260 on the 7000 and 8000. I think we're working very well with them on those kind of ventures and feel good on where we are in this quarter.

Woojin Ho - Merrill Lynch

Thank you.

Operator

Your next question comes from the line of Ananda Baruah of Banc of America.

Ananda Baruah - Banc of America Securities

Hi, guys. Thanks for the call, I appreciate it.

John Ritchie

Hi, Ananda.

Ananda Baruah - Banc of America Securities

Just going back to the controllers, can you maybe just touch this a little bit on where specifically the upside came from? Was it just a matter of conservatism going into the quarter? Maybe you can talk about some of the verticals that did better? It looks like it's was strong to the upside, or a little better than expected across geos, but if you could dig into some of the verticals?

John Ritchie

Ananda, absolutely going into the quarter, coming off our Q4 results, we took what we thought was a fairly conservative view of it, of that business. Europe did well on the controller -- in the controller space. Saw weakness in the US and we saw weakness in Japan from a geography standpoint. In terms of specific end markets, I'll hand that question over to Guy.

Guy Gecht

As I said, 480 did very well. I think we did pretty well with all of OEMs. I think they also reported good quarter I think which is very well with that, we did well with Canon, we did well with IKON.

Ananda Baruah - Banc of America Securities

Any sense for which verticals may have held up better than others?

Guy Gecht

Tough to say. I think the government is doing pretty well for everybody. Everything else is tough but again, better than what we expected.

Ananda Baruah - Banc of America Securities

Okay. And then channel inventories, obviously you've commented they've come down. Are they kind of where they need to be given where the growth is right now?

John Ritchie

I think the channel inventories are definitely coming down. There is variations in geographies and there is variations with different product lines, but in general we think they are at the levels they need to be at. And as we mentioned before, our preference is that the industry manage to these levels because any time sell-in is more reflective of sell-through, we have a better indication of the health of the business.

Ananda Baruah - Banc of America Securities

Is it -- I mean, I mean is there anyway you can kind of tell sort of given with the business has done in the last couple of quarters? I mean, should we expect -- I mean, I know you can't give forward-looking guidance obviously, but given what you're seeing in the marketplace is it reasonable or is it likely that we can get back to some kind of seasonality at some point in the second half of the year?

John Ritchie

We're trying very carefully to stay away from any second half guidance, but we do expect -- which is part of our traditional seasonality, we do expect a seasonally up quarter for Q2, which is standard for us in that business. So to the extent that we're willing to give guidance it is following regular seasonal patterns.

Ananda Baruah - Banc of America Securities

Got it, and the last one for me, thanks. Your guidance, sort of consistent with your remarks coming off of the December quarter call, you're guiding margins up sequentially for the June quarter. But it looks like -- I mean the mix of the business has changed a little bit, so controller is a little bit better, Inkjet is a little bit worse. So could you just talk about your ability to -- what you're doing to sort of manage, I guess, if anything, to the revenue mix shift to support the margins?

John Ritchie

First of all as we head into Q2 there will be an overall mix shift towards Inkjet. So the -- an overall mix shift towards Inkjet coming off the current quarter, we think we can do specific things above the gross margin line absorbing some of the pricing pressure we see that will still allow us to show flat to up gross margins. Now, we're not going to get to the details of the specific actions, but we're confident. We've been looking at that, obviously, since the tail end of Q1, I mean working diligently towards that goal and we think we're making progress and will continue to do so.

Ananda Baruah - Banc of America Securities

Okay. Great, thanks guys.

Guy Gecht

Thanks.

Operator

Your next question comes from the line of Jim McIlree.

Jim McIlree - Collins Stewart

Thanks, good evening.

John Ritchie

Hi, Jim.

Jim McIlree - Collins Stewart

Did the headcount reductions have a full impact in the quarter or is there a still a lit bit of that to take place in the subsequent quarters?

John Ritchie

So the headcount we got little over a half of our quarters worth the benefit for the headcount reduction. There is a little bit, but not a material amount of incremental headcount reduction -- or benefit to see in out quarters. The majority of the headcount reduction took effect mid-quarter with very little to follow.

Jim McIlree - Collins Stewart

Okay. I'm hearing you say two things though, if you did it mid-quarter wouldn't there be some further OpEx reductions, ex-Drupa?

John Ritchie

Yes. When you're doing a full quarter to full quarter comparison, you're correct.

Jim McIlree - Collins Stewart

Okay, great. And can you quantify that, how much that might be on a quarterly basis?

John Ritchie

I think when we did our compares, we we're in the kind of $3-niche million range.

Jim McIlree - Collins Stewart

3 per quarter?

John Ritchie

Actually you were saying -- but keep in mind it will be continuing some investment in our Inkjet business.

Jim McIlree - Collins Stewart

Okay.

John Ritchie

So, if you're to take it on a standalone event that's roughly what it would equate to. But that will erode a little bit as we continue some lower level investment in Inkjet.

Jim McIlree - Collins Stewart

Okay. And the option review charge, I was a little bit surprised to see that. When is that going to be done?

John Ritchie

I think on our last call we mentioned that we expect that this would be the close to the last quarter. If there are any other incremental charges they will be very small from this point forward.

Jim McIlree - Collins Stewart

Okay. And just lastly the option expense, can you help me understand why it went up so much this quarter?

John Ritchie

Yes, we had a late December grant in a company-wide grant, and a grant in the current quarter which was -- we also restarted our employee stock purchase program. That had a significant impact, as well.

Guy Gecht

So we didn't do any grants since we started the investigation of the options, and there was a bill little bit of catch-up, something at the end of December, beginning of the year.

Jim McIlree - Collins Stewart

Okay. Alright. Great. Thank you.

Guy Gecht

Thank you.

John Ritchie

Thank you.

Operator

(Operator Instructions). You have a follow-up question from Ananda Baruah of Banc of America.

Ananda Baruah - Banc of America Securities

Hey, thanks, guys. If I can just circle back for a second on the pricing pressure comments that you made. Is this market -- is there a sort of pricing, because that's the pricing in Inkjet across the board that you're seeing. So is it market price aggression or is it more driven by you guys to drive units? I did hear you make comments about seeing other folks out there pricing aggressively.

John Ritchie

I'll answer part of it and hand it off to Guy. The pricing pressure we're seeing we think is not reflective of our competitive situation in the market. We are still the number one player in ultra-wide format UV printing. That dynamic hasn't changed at all. We see pricing pressure in the solvent area, but I think the overarching drive in terms of what's causing the pricing pressure is just the general economy.

Ananda Baruah - Banc of America Securities

Got it. So it's -- I mean, so it's a collective lowering of price from all of your competitors?

Guy Gecht

Yeah, I think some of the customers need the machine, they will go and buy it, they can afford it. They get a lot of business. There is no issue. Some of the guys will work a second shift, a third shift and only if there is some appealing opportunity in front of them they will move and buy a system. In some cases, we made the decision to give them a little bit more discount than we usually do to get them to get going, especially not on the high-end UV, more on the low-end UV and solvent. As John said, we decided to move forward with more aggressive prices.

Ananda Baruah - Banc of America Securities

Okay. I get your point. And then, thank you, that's helpful. And then just -- I mean on the controllers, are you seeing any actions from your OEMs, yet? I mean away from what's going on in the pricing on the Inkjet is there any attempt from your OEMs to maybe put a little pressure on you from a pricing perspective incremental kind of due to what is going on in the economy?

Guy Gecht

Our controller prices are long-term prices. We negotiate normally prior to an engine launch based on historic prices. I would not say -- we're not seeing anything unusual or any prices pressure at all. If anything I would say that they buy the products from us in dollars, so to the point that they sell it outside of the US they are actually probably more profitable than our product at this point.

Ananda Baruah - Banc of America Securities

Okay. Thanks a lot.

Guy Gecht

Thanks.

John Ritchie

Thank you.

Operator

There are no further questions.

Guy Gecht

Well, I'd like to thank everybody that joined us today. I thank our shareholders and our customers, and of course our employees that work hard to help us deliver those results. And I'm looking forward to talking to you guys, soon.

Operator

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

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