Electronics for Imaging Inc Q2 2008 Earnings Call Transcript

Electronics for Imaging Inc (EFII)

Q2 2008 Earnings Call

July 29, 2008 5:00 pm ET

Executive

Guy Gecht - CEO

John Ritchie - CFO

Analyst

Ananda Baruah - Banc of America

Jay Vleeschhouwer - Merrill Lynch

Shannon Cross - Cross Research

Matt Troy - Citigroup

Keith Bachmann - Banc of America

James McIlree - Collins Stewart

Presentation

Operator

Good afternoon. My name is Jeanatta and I'll your conference operator today. At this time, I would like to welcome everyone for the Second Quarter 2008 Earnings Call. All lines have been place 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 statements. 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 involve a number of risks and uncertainties. Actual results could differ materially as a result of many factors including variation of 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 risks in new investments and business strategies, litigation related activities, particular investments 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 the review of the financial statements. For your convenience, the company has posted slides on the website on the IR section 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. I am speaking to you today from our ninth annual Connect user conference, the industry's largest user conference. We find this event a terrific opportunity to help customers find new ways to maximize their revenues and profits as wells as a solid sales opportunity for introducing new customers to our Inkjet and Fiery products.

Turning to the quarter, we're pleased that we met expectations for the second quarter of 2008, despite a very challenging environment. While we were anticipating a difficult economy when we provided our outlook conditions deteriorated further during the quarter.

Despite this, we were still able to achieve results inline with our top and bottomline expectations. In fact, our Fiery business slightly exceeded our forecast, while our Inkjet business came in inline with our outlook.

On a percentage basis, our software business was the most impacted by the economic environment as delayed deals resulted in this. However, we believe our announcement earlier today to acquire Pace Systems will grow our reach for MIS solutions while allowing us to rationalize our product lineup and streamline our cost structure in this segment of our business. I will explain more on this acquisition in a minute.

On the subject of cost control, as we have promised in past, we are closely monitoring our cost structure to ensure we are making best use of our resources while closely matching our investment with the areas, where we see the greatest goal potential.

As such we will be taking additional costs cutting actions, which will help both our long-term profitability and allow us for increased investment in our Inkjet business for the short-term. I will review this plan in more detail shortly, but first I want to expand on the sales cycles we experienced in the prior quarter.

There is no question, the challenging environment is impacting our ability to close deals. In our direct business, we're seeing increasing demand for our products. In fact, we believe our pipeline has never been as robust for our inkjet and software products, but similar to the trend, we began to see in Q1 the issue is getting transaction closed.

There's no requiring more signatures to get approved and funding is becoming more difficult. Our Inkjet results in Q1 show this was a U.S. led slowdown, but in Q2, we also saw softness in parts of Europe. Our growing emerging markets business has helped our results.

This economic reality is also impacting our Fiery business, where we are revisiting the trends from the last slowdown, where we saw customers trading down to a lower end machine in a response to an environment. In fact, the total number of Fiery units sold in Q2 2008 closely matched the Q2 2007, but the majority of those sales were for lower end and better devices.

The strong performance of our embedded products has been possible due largely to our efforts in making our embedded Fiery more competitive versus an OEM internally developed controllers. And while this mix shift impacted our revenues our strategic shift to design license solutions at the lower end enable us to largely maintain our Fiery gross margins.

We also believe that the ongoing benefit from some of the operating initiatives implemented in our Fiery business over the past few quarters are helping our results during this weaker period. Increased visibility into our OEM inventory levels is assisting us in our planning process, while greater information regarding selling versus sell through it is helping us target our promotional spending.

We look for these programs and a solid management team in place to help guard the business, although, we are back in search mode for the new General Manager of the Fiery business as our current GM has decided to leave for rare opportunity with Cisco running a $6 billion business for them.

Despite the good progress in the Fiery business, we do feel it's prudent to reduce our costs structure to proactively respond to industry conditions. And we are planning on further costs reduction in this business. We will also be reducing headcount by 40 employees in our APPS division as the first step in integration of Pace Systems. This will allow us to optimize our cost structure, while accelerating product development.

We'll continue to use the ongoing savings from the Fiery business in APPS to invest in what we are more convinced than ever before a great growth opportunity in our Inkjet business. Another solid quarter of ink revenues confirmed that the VUTEk units place of seeing increased utilization.

Demand for our Inkjet products remained very high. As I mentioned earlier, our sales pipeline is robust. Our challenge is to overcome the economic headwind and convert customers' interest into orders. As anticipated, we met our internal objective for initial sales of the Jetrion 4,000 this quarter This product is being well-received.

We are also very excited about the announcement we made at drupa, concerning the VUTEk DS Series digital screen printer. This new category of high speed digital flatbed printer provide the advantage of UV technology and digital economics of speed, previously unattained for this market, increasing from current highest speed of 1,750 square feet an hour to 6000 square feet an hour.

The initial interest in this product has been very encouraging from both existing and new customers. This is only one of the few significant products we will be introducing in 2009, which will substantially expand future addressable market.

Early indications regarding the positioning and demand for this product is very encouraging. And we believe they will substantially increase total company revenue and profitability.

A few more words on drupa. Overall, it was a very positive show from our perspective beyond the first public showing of our VUTEk DS. Our next generation Fiery software got a very strong reviews from many large digital printers and our new Jetrion 4,000 got a solid interest from distributors around the world.

In drupa, that was sometimes labeled "Inkjet drupa," while others called it "Workflow drupa." We felt that we are certainly an innovation leader in both categories with a very attractive opportunity to be one of the leaders in the major transformation of the printing industry.

Turning to software. While the result was slightly below our expectation due to delayed deals, our pipeline of deals is stronger than ever before. The addition of Pace System will help expand our MIS products reach especially in the digital commercial print, COD and print for Pace segments, which are the prime markets for our Fiery controllers and for the majority of our VUTEk products. As such, the acquisition provides both a major overhaul of our MIS lineup as well as increased differentiation for our two largest businesses.

With the acquisition of Pace, we will move two of our platforms Logic and PSI to maintenance mode, while we'll allow for an increased profitability in our APPS business and on an EPS accretion of approximately $0.01 in Q4 and at least $0.03 to $0.05 in 2009. The opportunity is far larger in terms of growth rate profitability and market reach in the longer term.

We see many of the economic plans in Q2 carrying over to Q3. However, we continue to benefit from the successful diversification of our revenue streams, which allow us to focus increased revenues and profitability for Q3, despite the current challenges.

As for our outlook for Q3, we expect revenue EPS and operating margins to increase leading us to anticipate revenue of $145 million to $150 million, and non-GAAP earnings per share of $023 to $027.

Now, let me turn the call back to John to review the Q2 financial results in more detail and to discuss some of the important changes to our future financial related to the retirement of the convertible debt this past quarter.

John Ritchie

Thanks, Guy. I'll now go over the detailed financial results for the second quarter of '08. Second quarter revenues were $143.8 million, up 53% sequentially, and down 115% on a year-over-year basis. Non-GAAP net income for Q2 of '08 was $0.21 per share, up sequentially 5% from $0.20 in Q1, and down from $0.33 in Q2 of '07.

For Q2 on a GAAP basis, we were approximately breakeven compared to net income of $9.6 million or $0.15 per share in the second quarter of '07, and up from a net loss of $5.2 million, or $0.08 per share in the first quarter of '08.

In calculating both our GAAP and non-GAAP EPS, we included the 91 million shares related to our convertible debt, when inclusion of these shares is dilutive to the EPS calculation. For Q2, the 91 million shares is removed from our non-GAAP EPS calculations as of the date of the bond redemption. With the bond redeemed, our share count will fall significantly in Q3.

For the third quarter we are estimating a share count of approximately 54 million shares for EPS purposes. This estimate excludes any buyback activity that may take place in the third quarter. A reconciliation between our GAAP and our non-GAAP results is posted on the Investor Relations portion of our website.

Now, before I go through the quarter in more detail, I want to highlight some key milestones. Our non-OEM sales were 56% of total revenues. Our recurring revenues were over 18% of total, similar to last quarter, but on a higher revenue base; recurring revenues primarily consist of inks and software maintenance contracts.

We expect that the recently announced Pace acquisition will increase our total recurring revenues. We set another company record for quarterly ink revenues and UV ink volume. We believe that our Inkjet customers continue to see healthy print volumes as evidenced by our robust ink sales.

And that the strength in our ink business is a strong indicator that our customers are making short-term tradeoff decisions. They are increasing printer utilization by running multiple shifts and putting up capital expenditures, which we attribute to the weak economic environment.

We generated $14.3 million in cash in the quarter, excluding the effect of the share repurchase program and the debt redemption.

Turning to revenue by geography. In the Americas, we saw a small decline in revenue when compared to the prior quarter. America's revenues represented 50% of the total revenue down from 52% in the first quarter of 2008. Our European revenues were 38% of total revenues, up from 35% in Q1 of 08.

In Europe, we saw sequential improvements in Inkjet and the Fiery revenues. Revenue in Japan represented 8.8% of total revenues, slightly up from the prior quarter. And in that market, we saw an increase in Fiery revenues as well.

And finally, the rest of the world revenues were 3% in Q2 roughly flat when compared to Q1 of '08.

Now moving on to our product line. Fiery revenues $72.7 million, up 5.7% from Q1 '08, and down on a year-over-year basis 21%. Fiery revenues were 50% of total revenues for the quarter, roughly flat with the prior quarter. The sequential increase was attributable to our strength in embedded product offset by a decline in standalone print server revenues.

For the third quarter, we expect the Fiery business to come in between Q1s level of $68 million and Q2s level of $72 million in revenues. For the second quarter, our inkjet products contributed 40.3%, or $58 million, compared to 39.1% of revenue, or $53.4 million in the first quarter of 2008, a sequential increase of 8.6% driven by European demand.

Year-over-year revenues were up 5.8% in total. The increase was driven by a higher ink revenues offset by weakness in the U.S. markets and other signs of softness in Europe. The higher ink revenues had the positive impact on total gross margins for the Inkjet product line. For Q3, we expect to see year-over-year growth in the 6% to 10% range.

During the quarter the APPS business and Software business category contributed 95% of total revenues, or a $13.7 million, down 83% sequentially, and down 14.8% in year-over-year basis. The sequential revenue decline was driven by lower than expected closure rates. For Q3, we expect revenues to be up slightly off of the more normalized Q1 levels including a partial quarters benefit of approximately $1 million related to the Pace acquisition.

Non-GAAP gross margins for the quarter were 57.3%, up 10 basis points from 57.2% in the first quarter of 2008, and down from 59.2% in the second quarter of '07 The sequential improvements in gross margins was driven by the positive impact we received from higher ink revenues.

We expect to see a continued revenue mix shift in favor of Inkjet products with their respective lower margins and we still expect to hold margins roughly inline with where they were in Q2.

Non-GAAP expenses excluding the amortization of acquisition-related costs, stock-based compensation charges, severance and restructuring charges, and stock option reviews were up $3.7 million, or 5.3% to $72.5 million in the second quarter, compared to $68.8 million in the first quarter of 2008.

R&D expenses were $32.4 million, down $200,000, or 0.7% from Q1. In the second quarter, R&D expenses represented 22.5% of revenue, down from 23.9% in Q1. The decrease in R&D was driven by lower overall spending in Fiery, partially offset by increased Inkjet R&D spend.

Sales and marketing costs were $30.1 million, up $3.3 million, compared to $26.9 million in the first quarter of 2008. As anticipated, the increase in Q2 was driven by seasonally high trade show activity including the once every four year trade show drupa.

Sales and marketing spend has also been negatively impacted by the weak U.S. dollar. Sales and marketing expenses represented 20.9% of revenue for the second quarter of '08, compared to 19.7% from the first quarter of the year.

G&A costs were $10 million, up $600,000 driven by an increase in IP-related litigation costs. For the second quarter, G&A expenses represented 6.9% of revenue, compared to 6.8% in the first quarter of the year.

Now, looking forward to overall Q3 spending levels, we expect spending in the range of $70 million in Q3, down $2.5 million compared to Q2 and flat when compared to Q3 of '07. And looking at the year-over-year compare, the weak dollar negatively impacted our expenses by over $1 million.

As discussed in the past, the decrease in total OpEx from Q2 levels is driven by a reduction in the high trade show activity, which we see normally in Q2.

Now, let me review some of the additional strategy around our costs structure activities, which will allow for a continued investment in our Inkjet business. The acquisition of Pace will allow us to reduce the costs structure within our PMIS business. These cost reduction activities began immediately following the announcement of the acquisition.

We are consolidating our ink production operation. We plan on producing all our ink in one world class facility. We are pursuing additional costs cutting activities within our controller group. Costs related to these specific activities will result in a non-GAAP charge in Q3 and Q4 of a total of about $3 million to $5 million.

Separately, we expect the Pace acquisitions to add at least $0.03 to $0.05 for '09 results. Non-GAAP operating margins were 7% up from Q1 levels and down from 13.9% recorded in the year ago period. We expect to see sequential improvement in operating margins and income in Q3.

Other income of $5.6 million was $900,000 lower than the prior quarter driven by significantly lower cash balances, offset by gains related to the liquidation of securities in preparation of the redemption of our convertible debt.

We expect other income will decrease significantly to approximately $1.6 million to $1.8 million for the third quarter, a decline of approximately $4 million on a sequential basis primarily driven by the reduced cash balances and the redemption of our bond.

Turning to our tax rate. For Q2, it was 23%. The sequential decline from Q1 had an immaterial impact on our EPS. We are currently estimating a non-GAAP tax rate of 22% for Q3. Our non-GAAP tax rate anticipates the renewal of the R&D tax credit in 2008.

Moving on to headcount. At the end of Q2, full time headcount was 1,939 even with Q1 levels.

Moving on to the balance sheet. We ended the fourth quarter with approximately $2,38.4 million in cash and cash equivalents, compared to $477.4 million in the last quarter, a decrease of approximately $239 million driven again by the retirement of our convertible debt offering of $13.3 stock buyback purchased in the quarter offset by cash generation of $14.3 million in cash in the quarter.

We limited our Q2 buyback activity due to the pending acquisition. We currently have approximately $56 million remaining in our current stock buyback authorization.

Net inventory for the quarter was $44.9 million, an increase of $4 million compared to Q1 of '08s ending balance of $40.9 million. Q2 inventory turns at 6x remain constant with Q1 '08. Accounts receivable, AR decreased to $90.3 million compared to $97.1 million at the end of Q1 '08. The decrease in AR was driven by slightly improved sales linearity and improvements in our collection processes. Overall, DSOs decreased eight days to 57 days compared to 65 days in the prior quarter.

Now going back over to our outlook for the third quarter, we currently expect revenues in the range of $145 million to $150 million. We expect non-GAAP earnings per share of $0.23 to $0.27. We expect GAAP results of $0.01 to $0.05. And keep in mind, the sequential increase in EPS includes a significant fall off in other income from $5.6 million to approximately $1.6 million to $1.8 million.

Now, with that, we will be happy to turn it over to questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Ananda Baruah with Banc of America.

Ananda Baruah - Banc of America

Hi, guys. Thanks for taking the question. Can you hear me?

John Ritchie

Yes. How are you doing Ananda?

Ananda Baruah - Banc of America

I am doing great. Thanks. Just a couple of things, if I could. I guess the first one is given that the controller business is a little bit better than we were anticipating and they are maybe not a whole lot better, but a little bit better. I probably was expecting a little bit more operating leverage from that business. Am I right in that line of thinking? Or was there something else going on there maybe some spending that maybe would have offset some of that incremental leverage?

John Ritchie

Well, I think what you saw in our Q2 results was a kind of significant move up. You won't see the leverage when we have the high trade show activity, Ananda. For Q2, it makes it hard to get significant leverage off the results.

Ananda Baruah - Banc of America

Got it. Okay, understood. And then, guys, if you could just quickly, I think you did it last quarter and did you part of it sort of in your prepared remarks, but just maybe walk through the deals and how each part of the business did in each deal? Just fill in the blanks there.

Guy Gecht.

Yes. In general, I think the U.S. was continued to be the most challenging environment for our OEM partners. You have heard probably from all of them by now. For Inkjet business as well as our software business that is very concentrated in North America. Europe was better, but we saw pockets of issues in Europe, and in the emerging markets, it was pretty good in all fronts, obviously, very little software business. But both the Inkjet and Fiery were pretty good again on a lower basis.

If you look at just one comment just geographically the acquisition of Pace, although it's not in our numbers will allow us to take the software business beyond the North America. One of the things we were struggling with is the legacy software didn't allow us to make the modifications to take it to the international market without the significant investment in professional services support and product changes.

And Pace is a much more modern application platform based on Java, based on open source in some way running an appliance. And we feel that overtime it will increase our penetration into international markets including Europe.

Ananda Baruah - Banc of America

And Guy, just to make sure that I understand correctly. It sounds like you're saying that the controllers and Inkjet, which I believe were solid last quarter, in the March quarter, have both weak and incremental in Europe, is that correct?

Guy Gecht

But we were happy with the controller results in Europe. I would not say it's weakening. I think the European arms of major OEMs have continued to do well, certainly, in the drupa quarter, but the VUTEk sales we saw certainly in areas of market was not as strong as it was in Q1. Overall, still we grow the business, but it wasn't as strong as it was in Q1.

Ananda Baruah - Banc of America

And then just last one for me and then I'll turn it over. I guess just along the same vein, it sounded like, I mean the best I could tell you guys had pretty good deal construction coming out of the drupa on the Inkjet side of things. And I think some of these orders probably are getting written won't be recognized sort of into Q3, as well.

So is there anyway to separate, I guess what the underlying secular environment is in Europe on the Inkjet side from maybe some of the deals that got written purely because drupa fell in the second quarter?

Guy Gecht

I'll tell you, like other companies, we can certainly say that we overachieved on our plan for drupa. We are very satisfied with drupa. When you look at that, it's tough to say which of those deals would have get done anyway without drupa, because customers were clearly in the market to buy.

One of the problems we have that some of the advance leads we got from drupa, people that came said we're ready to sign here is the [peel] that we'll go forward if we can get financing. We couldn't get financing. Could not get financing, could not get signatures, some of them got cold feet as things progressed into the quarter. We certainly felt we are going to have a stronger Inkjet business coming out of drupa, because we had a very high level of interest and very good funds coming out this and we still have.

And finally just the closure rate is not as good as we like to see it. And I think it's really all about the economy and people reading all the bad news and not really anything different on the competitive landscape won't be seen before. I think the light at the end of tunnel of the economy is that we're seeing that customers are actually utilizing the machines in a very high rate.

The ink business was very strong. And so, that means that our customers are still getting a lot of jobs and they are running their machines. But we heard from more than one customer that they rather ran the machines another shift to half a shift to few more hours versus now investing in another machine and getting financing and going through this.

Ananda Baruah - Banc of America

Were your ink results inline with your expectations?

John Ritchie

I think it is fair to say that our ink results beat our expectations. That's ultimately what gives us confidence that the end markets are still extremely healthy, the end markets defined as our printers getting print jobs.

Ananda Baruah - Banc of America

Got it. Thanks a lot guys.

John Ritchie

Thank you.

Operator

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

Jay Vleeschhouwer - Merrill Lynch

Thanks. Good afternoon. Guy, you mentioned a number of times that your pipeline was looking good in a number of respects. How would you correlate that to the various specific vertical markets that matter to you, such as graphic cards, commercial print, packaging and alike. Could you be a little bit more detailed in terms of where you see the pipeline still holding up or improving in any specific areas?

Secondly, with respect to the controller outlook beyond Q3, over the next six to nine months there are at least a handful of new engines coming, some announced with drupa like the Xerox 700 the Ricoh 90 is coming and so forth. How do you think about this next wave of engines coming to market as drivers for new cycle in the controller market versus earlier such introduction cycles?

Guy Gecht

I don't know if there is much differences between the segments. Maybe the cold feet is more commercial print, graphic card and maybe the CLD and print for pay have more robust kind of a plan and firm budget. But I think it is about the same and the pipeline is very, very strong for all of that. There is a lot of interest. We feel very good about the offerings.

I alluded to the strong roadmap on the Inkjet next year. We show one out of few new devices new platforms and drupa, the feedback was fantastic. A lot of people want to stay in touch and be ready to be one of the few installs for the DS.

And then, the ink revenues, its all show us that there is pretty good opportunities out there in front. What was not good or not as good as we expected it to be, is the closure rate. I think that as I mentioned, you see people hesitating, you see people making a decision to push things for a few months, saying, you know what, we're not going to buy this quarter. We're going run the equipment another few more hours. You see people have issues getting financing.

And frankly, we talked to a few sales guys here that in connect that told us a few of those customers actually gave up, they are not going to seek financing for a few more months until it will be easier to get financing. So, we are certainly seeing that slowing down the pipeline, but we feel very good. The pipeline was never stronger on both year's second quarter. I can tell you that.

Backing with the controller market, certainly we have a lot of good engines coming to the market. The 700 particularly was very good for us. We had higher than we anticipated shares. There are three different controllers offer in that engine and out of gate, we have very high attach rate better than we expected.

We felt very good about that being a sweet spot, but I think Xerox talked about the fact that they had higher demand than they anticipated I think a lot of their customers were very interested in that versus maybe other engines. And they did not have the supply or the quantity from manufacturing perspective to satisfy there. And I think to a large degree, all they sold so far was Europe, which obviously did well with the quantity they got.

So I think Xerox is working on this. You probably know as much as I know. They are going to recover over time. The demand for the 700 looks very, very good. Ricoh is not yet officially in the market. They will be a few months with this engine. We'll have 100% connectivity to Fiery.

Definitely, we expect to see good revenue this quarter in Q3. They are very aggressive about it. It's difficult to predict to be honest. They have some very good channels like they bought [Banca] in Europe and in the U.S. they are going to have IKON. But it's tough to call out where it's going to go. But I think its going to go fairly well.

And obviously, Ricoh is spending more engines down the order. I am not going to say six to nine months, but certainly it's not the only engine they are going to bring to this. And we love to be, at least for now, be exclusive provider of Ricoh.

Cannon still a good traction of 6,000, obviously growing they said from last year, again, on a smaller base, but the good news is it seems like they are making good progress. Konica continued to be okay on the 650. So, again, when we look at [this year], despite the fact that the Fiery revenue is substantially down from last year, which was a very high quarter, the number of units was about the same. We are certainly seeing a make shift to embedded, which we saw the last time when the economy slowed down.

Jay Vleeschhouwer - Merrill Lynch

Guy, you mentioned that over the next year including the digital screen, you'll be expanding your portfolio of printers and you talked about consolidating ink production, which is something you actually talked about already not that long after you bought VUTEk. The question is what does that mean in terms of net production capacity for either printer run rate capacity or for your net ink capacity? Will you have more than you will have started with before you did this consolidation?

Guy Gecht

Okay, absolutely. I mean we talked openly about doing that consolidating both the operations of VUTEk and Jetrion. We said that we need to get to a critical level, where it will make sense financially and it got to this critical level and were moving forward with this. There is obviously some saving involved.

About our capacity, our capacity is going to be to very good. We are going to be able to scale it to lot more than that. We clearly are very pleased with the ink level. We are modeling it in different level growth. Going forward, we will not be constrained by capacity.

Jay Vleeschhouwer - Merrill Lynch

All right. And then, lastly back on the controller business, just to clarify. So the ASP was solely a function of mix the fact that revenues were down almost $20 million year-over-year, but units were about flat, is this solely a function of mix? You did not see in any given segment, particularly, on the Fiery side, any degradation of pricing?

Guy Gecht

Yes, just mix.

Jay Vleeschhouwer - Merrill Lynch

Okay, thank you.

Guy Gecht

Thanks, Jay.

Operator

Thank you. Your next question from the line of Shannon Cross with Cross Research.

Shannon Cross - Cross Research

Question has to do with linearity in the quarter. Just if you can give us any idea of how, sort of, you saw the slowness build? Or if it was sort of there to some extent from the beginning of the quarter on? And then, if you could just provide any more specifics on exactly where in Europe you are seeing the weakness. And if there are pockets of strength, how should we think about Europe? And then, I am also curious as to what you are seeing in terms of emerging market strength and the level of demand that you're still seeing out of some of those geographies? Thanks.

John Ritchie

Hi, Shannon. It's John here. So I'll start off with the linearity question. There was actually improved linearity in the quarter. If you remember Q1, we had the IFA Trade Show, which took place in the last week of the quarter. So, the Inkjet business saw improved linearity. It wasn't tremendous. It saw improved linearity of vis-à-vis the prior quarter.

The controller business, so far this year, it has been a fairly linear business Q1 and Q2. So it's making big difference we are going to see in the Inkjet business. Our software business is very backend loaded, as I think most software businesses are.

Shannon Cross - Cross Research

Okay, I am sorry?

John Ritchie

Go ahead.

Shannon Cross - Cross Research

And then, can you talk a bit about from an acquisition standpoint, just how we should think about going forward, maybe, over the year or so, your appetite for acquisitions. Any more color you can give us on, sort of, your thoughts on cash and cash generation, just so we can get an idea of sort of capital structure, et cetera, maybe not from just a quarter ahead but from the more longer-term standpoint?

Guy Gecht

I will take the first part on acquisitions. I mean we view this kind of relatively small deal. We view it as a lower risk tack in, no need to integrate new customers using same sales force, but helping us to offer higher value products, expand the infrastructure we have like we do to [C pay]. And then, certainly, in their case cut some costs internally and something that we would like to do going forward.

So right now, things can change. We don't look at anything significant anything bigger than that. We'll look at something in that level or maybe smaller that is packed in and using what we have, going forward. As far as the balance sheet…

John Ritchie

Sure. So as far as cash generation goes, so on a kind of full year basis, the way the characteristics of the business were, cash generation should be somewhere between pretax and taxable income. The only big variable you'll see on the balance sheet that could negatively impact cash balance is an extending of AR and that will occur slowly over time, as the Inkjet business grows faster than the Controller business. So, again, over a year period of time, we are somewhere between pretax and taxable income.

Shannon Cross - Cross Research

Okay. And then, just going quickly back to the end of my first question. Just in terms of Europe, can you provide any specific areas that are stronger or emerging markets?

John Ritchie

In terms of where we are seeing parts of Europe that are weaker, we're seeing the U.K. is sort of weaker, Spain is a little weaker. The rest of Europe seems to be kind of holding up. I read a couple of negative things about it. But right now, we are seeing the rest of Europe kind of adds it with weakness in Spain and the U.K. The rest of world markets Middle East Africa is doing very well for us, the Far East is doing very well for us and we continue to see robust demand for the product in those markets.

Guy Gecht

We also had a good quarter in Latin America and we are seeing good demand though.

Shannon Cross - Cross Research

Okay. And then, just a final question with regard to the real estate. I am sorry if I missed this, but did you provide any update on real estate?

John Ritchie

No. we didn't and thanks for bringing it up. So we had the JLL announcement that you all saw a while back. As of today, JLL is going through the diligence and the marketing part of the project. I can't give you much more flavor than that. Other than as we make progress we'll keep you guys updated.

Shannon Cross - Cross Research

Okay, thank you.

Guy Gecht

Thanks, Shannon.

Operator

Your next question comes from the line of Matt Troy with Citigroup.

Matt Troy - Citigroup

Guy, you said something earlier in the call. I want to make sure it was something we've been aware of or whether it was a new announcement today. You said there was a departure of a General Manager in the Fiery business?

Guy Gecht

Yes. So if you remember, we introduced Judy Lin about 10 months ago and I think we made a good choice by selecting her. But Cisco agreed with us and tapped her to run their Enterprise Switch Business, which is I think over $6 billion business, then, we're back in search mode.

The team is in a lot better shape than was nine months ago. Judy did a good job putting hiring a couple of key guys and realigning the team. Team is doing extremely well in execution quality and getting stuff to the market. And I think we're going to take our time and find the right head of this business.

Matt Troy - Citigroup

Okay. I think we were aware of the Judy news. I wanted to make sure it wasn't someone in addition to Judy. Could you just help me in terms of your thought process in filling that role? Obviously, you went externally for Judy, I was wondering is that the bias of where you are leaning? I mean the Fiery is obviously a crucible of activity as you look to restructure and streamline the organization. I am just wondering, what your one, two or three key items are in terms of criteria in searching for a replacement? And what kind of timetable are you working on?

Guy Gecht

So yeah, the timetable is when we find a very good candidate. The person that planned the business is key to continue to do everything, and we'll be working on. And what are those things? A, get overtime more output with less costs, and this is a business where you need to continue to give the OEMs changes per the engine changes. As there are more engines coming, they want quality, they added more finishers, it's more work. There is a lot of work there, but we need to do it at lower cost.

And actually, we were very successful this year lowering substantially the cost, but as a company we went and invested a lot of it back in the Inkjet business. So I want somebody to continue to do that continue to shift some work to our office in Bangalore. But at the time, capture growth opportunity, especially at the level below us, we're seeing good markets now with the embedded business. There is a lot more action in the high end of the office. There are more engines coming.

Our OEMs actually would like to work with us on activities there, because they have been challenged by their lower end and people have the single functional device and they like to have differentiation, which we can provide. So there is clear opportunity there. So while doing that continuing to improve the profitability, weathering the storm, continues execution, this is the type of people we are looking for.

Now, of course, we have great candidates internally, but I want to see the candidate level that we have externally. I was very pleased with the caliber of people last time when we looked for Judy. There were twenty people I personally interviewed and they were very, very high caliber. Some of them found very strong positions at other companies in the tech industry. I'll continue to do that. And we'll certainly will hire when we find the right person.

Matt Troy - Citigroup

Okay. And to the extent that you mentioned, I think we've heard this from various hardware players that customers are trading down. I was just interested in that particular trend in the VUTEk business, we all know commercial printers are cyclically sensitive. They are strapped for cash even in the best of times and no surprise that VUTEk would fall victim to a cyclical downturn.

I'm just wondering though in times like these, printers generally try and lean on their suppliers balance sheets. Are you seeing printers try to extract any more value in the negotiations either through favorable leasing terms or trade terms?

And to the extent they are trading down, is there a risk that they could be happy with instead of a high end top-of-the-line $300,000 VUTEk device that they buy now $150, $200 device and are comfortable and the market moves down when we nose out of this downturn?

Guy Gecht

We looked at that and actually, we are very pleased to see that these are actually out build that are tracked quite nicely. I think people see the opportunity to get a stronger allied. I mean our customers are sometimes paying for the device faster than the yield. So from their perspective quality speed reliability is very important and if they get the right machine they can cover the cost pretty quickly.

When we looked at the deals, we thought are going to have in the quarter. And again, around drupa, we thought we can have a much stronger VUTEk quarter. They did not really disappear to cut to lower end devices. It's not disappeared to -- I mean, of course, you always win some and lose some, but more than the unusual amount win loss.

It's a lot of people, they decided to wait and some of them tried to get financing and didn't like the answer from the banks, either didn't get an answer from the banks and decided to wait. It's a tough market to get financing today. And yes, in some cases we get better sales. I don't think that we have done dramatically different than what we did before, but we helped people that were really on the fence and we felt it's a low risk to do that.

John Ritchie

And Matt, one other thing to keep in mind, we're not just selling the printers to the customer; our customers are selling high quality output to their customers. And in order to maintain that same high quality output, it's hard for them to step down in the quality of machine. When their customers are used to the output they get from VUTEk devices.

Matt Troy - Citigroup

Right. But it wasn't necessary talking about quality, it was more quantity as in like the throughput. Obviously, a less robust device costs less and perhaps a printer thinks he can get by with adopting a machine that can operate five days instead of six or 12 hours a day, instead of 18, but I understand your point.

The last question I had was just revisiting kind of the long-term business model, certainly in times like this you see the trading down pieces in VUTEk. You talked about potentially a mixed shift towards more embedded on the controller side. You historically, said and targeted that when this model self-optimizes, an operating margin of 20% would be attainable.

I know in kind of the voice and guidance of conservatism, my modeling is about half that for the next two or three year, something closer to 10% or 11%. But I was wondering if you take a longer term view and things do nose up on the economy, is this a model that you think long-term could generate a 20% operating margin? Or is it time to rethink or revisit that assumption, and say its something closer to the mid-to-high teens? Thanks.

John Ritchie

So at this point, notwithstanding the economy. We don't want to throw in the towel in terms of what we think a long-term potential of business is. We still think 18% to 20% is definitely an achievable goal. Now, there is lot of things going in our favor.

We've got the DS product, which I think you guys all saw the ASPs that were suggesting on that and we're starting to see some real momentum build in the ink business. Again, these things will take time to occur. But over the long haul, we think those are all things that indicate that 18% to 20% is very achievable.

Matt Troy - Citigroup

Okay, great. Thank you, guys.

John Ritchie

Thank you.

Guy Gecht

Thanks, Matt.

Operator

Your next question from the line of Carol Sabbagha of Lehman Brothers.

Unidentified Analyst

[Ann Sigmon] on for Carol. First question just wanted to ask about the Inkjet pricing environment and I think in the first quarter you said that it was about a 200 basis point negative impact. Just wondering if you could update us there? How it compares in the U.S. versus Europe? And also I think last quarter you said that solvent was weaker than UV. Thanks.

Guy Gecht

No significant difference from Q1. But as I noted actually year-over-year, ASPs are nicely up, which is good in all regions. More outside of the U.S., which I think is just deflation of the economy and actually the ink prices is holding up pretty nicely.

We had a more solvent than prior quarter, this quarter, because drupa, I think a lot of solvent customers came out and looked whether we have available. And despite the fact we don't have any new models they like what we have. We've a very solid model in solvent. So we got a little bit of that.

But, overall, I think, it's again, we see very competitive market, but as John said people pay very quickly on those devices They get customers to pay them for this. And so, from their perspective, they know they have a lower cost options instead of buying VUTEk, but then the return is going to be much longer and you are not going to get the same level of customers as you got before.

Unidentified Analyst

Okay. Thank you. And just one other one, if you were to monetize the real estate assets, I know you haven't updated on that, yet. But have you given any details about your plans with the cash what you would do with it? And that's all. Thank you.

John Ritchie

No. We haven't given any specificity in terms of how much cash we think that we would be able to raise in real estates. And at this point, what we would like to do and we need some level of Board approval on this, because we only have the current authorization outstanding. There is an opportunity to put that cash into a buyback.

Guy Gecht

And Ann, I mean we all see the other income is going down for us for many other companies. Our share price is very far from where we would like it to be. And we don't have any large acquisitions. I think you can connect to those on their real estate per se.

Unidentified Analyst

Thank you.

Operator

Your next question from the line of Keith Bachmann with Banc of America, Montreal.

Keith Bachmann - Banc of America

Montreal. I have a couple of questions, if I could. John, did you say that you anticipate the Inkjet business being 7% to 10% growth in revenues here over the next quarter?

John Ritchie

Yes, 6% to 10% year-over-year.

Keith Bachmann - Banc of America

Yes. So, my first question is to Guy, then. You just did about a 6% Inkjet business. My assumption is you got a little bit of a tailwind from drupa in terms of excitement around deals, yet the credit environment is bad and perhaps deteriorating. You said Europe is slowing. Why wouldn't your Inkjet business continue to slow over the next couple of quarters? Because it sounds like you're expecting it to improve, certainly, over the next quarter, relative to the quarter you just did. If you could just help me understand that?

Guy Gecht

Clearly, I mean when you say, slowing, I don't think that we are seeing slowing compared to Q2. I think that factoring in the U.K. and Spain slowing factoring other difficulty in the U.S. There is still a tremendous amount of interest in the product. I look at the ink revenue, I know there is utilization. If we sell less unit than we hoped but we overachieved compared to our plan on the ink that is telling you utilization is going up.

So talking to customers, I know what they are going to buy. Some people didn't buy in Q2 that are buying in Q3, and some of the people, we hope are going to buy in Q3 are probably going to move too. But when we look at the funnel and we look at where we are, we feel pretty good about maintaining the same level of growth year-over-year. So last year Q3 was better than Q2, and I think this year its going to be the same way.

Keith Bachmann - Banc of America

Yes. I was referring to year-over-year growth rates, Guy, that's sort of added within that. You're anticipating acceleration and I guess my reaction is I am not sure why anything would accelerate given the description that you provided in your prepared remarks?

Guy Gecht

Yes, I understand. We said 6% last quarter. We are saying 6 to 10. Again, the funnel is there's a lot more units that's close to the finish line. We think some of the people that couldn't get financing are going to get it. Based on again where we are today and what we are seeing in the funnel, we think it's going to be an incremental improvement on a year-over-year basis.

Keith Bachmann - Banc of America

Okay. Fair enough. On the controller side of the business, my second question, you indicated that there is a bit of an issue on mix down in terms of people are going for lower functionality for improved pricing, a, why would that improve? And then, b, Guy, if you could also comment on how you think the Xerox business is? And the reference point there is, obviously, when we were in drupa, Xerox indicated they were trying to more internally source their controller business at the expense of, frankly, you guys, if you could just comment on that? Thanks.

Guy Gecht

I want to go back to your prior question. John added to you correctly that Jetrion is certainly going to add to the Inkjet business. Now, we are going to have a full quarter of about 4,000. We have pretty good pipeline for that. So, you need to take that into account for the sequential improvement.

Keith Bachmann - Banc of America

Okay. Fair enough.

Guy Gecht

Secondly, yeah, I heard about the comment from Xerox. They are showing up to work to sell engines. For them, if the customer prefers Fiery that is clear, it's a secondary or much smaller question than winning an engine against an Indigo or Kodak, or the other competitors, okay?

And at the end of the day, the salesperson gets the same comp whether they sale Fiery or DocuSP. And frankly, most of the Fiery that are sold to people that ask for the Fiery. So, an end user will tell you, if you like to have a Fiery, the 700. I am yet to meet a Xerox salesperson that will try to say, hey, we actually want you to buy another, let's try to give you something else instead of what you want. They want to sell. They want their customer to be happy and then move on.

Now, clearly, they want a DocuSP to be the best highest performance front-end in the industry, of course. I mean everybody wants their products to be that. We've been dealing with DocuSP since 2000. When they first show it up for sale, its not a new news for us. Of course, they continue to develop that I don't think they are moving -- based on what I can tell, I don't see they are moving any budget to DocuSP. If anything, I think its under the same budget constraints everybody has.

Many customers loved the Fiery. Remember that many customers see the advantage of Fiery in front of not just Xerox device but other devices. So for them, its a very good way to manage them systematic in the same way, consistent way many devices for many players, same way to do color management across the board. They don't want to be locked to proprietary workflow color management.

So, clearly what's driving us is customer loyalty for Fiery. But, again, I don't see Xerox doing any action different than what was done in last few years that's going to change the market share. We believe that if we do our job right, we are going to still going to have a good market share with Xerox. And I think the 700 will prove that.

Keith Bachmann - Banc of America

Okay. Let me just get two more, if I could. John, any quantification on how much the 4,000 may add? Just call it the back half of the year, can you give us any quantification on $5 million, $10 million, $3 million? Any numeric quantification on, you think range of potential?

John Ritchie

Keith, just I think all we can say it's embedded in what I think the guidance we gave you commenting on before, but we are not going to give product line revenue numbers.

Keith Bachmann - Banc of America

Okay. Last one then is, on your PPA you've been on a multi-year endeavor to try to better coordinate the very software applications over a common platform. Does the acquisition of Pace help or hinder that particular effort? And that's it for me. Thanks.

Guy Gecht

Great question. I think I know we work, I don't think we told people the new platform that will break the market organically that will start to consolidate the platforms we got from the acquisition of Printcafe without jeopardizing the work the customers are doing. And as we got closer to the finish line, it was clear to us that going with an acquisition of ePace will, a, reduce the risk because its proven platform that went to 5,000 customers; b, its going to be a lot more attractive from a profit perspective, we don't need to invest to bring new platform without revenue to the market. We can bring something with revenue to the market.

And the first thing we are doing as part of the utilization is actually terminating the new platform that never got to the market That's going to go away and then we are moving Logic and PSI to maintenance mode and essentially, we'll not develop any new functionality beyond the sale for those customers and we'll try our best to allow people to move to ePace. So, certainly, that will dramatically structure differently the restructure the APPS business. No question about it.

Now, the longer term, the Pace platform is a much easier platform to develop because its based on a modern architecture. Things we bought from Printcafe are 30 years kind of forward platform. So it will allow us to go internationally. It will allow us do better system for VUTEk customers. They are asking for it and allow us support digital printers better and allow us to work with Fiery better.

And these areas of the mid-market, its where most our Fiery and VUTEk are being sold. It's the majority of the printing industry. So it'd certainly going to allow us to develop them to roll our reach, but in the shorter term it will make our APPS business a lot more rationale as far as product line-up.

Keith Bachmann - Banc of America

Thank you.

Guy Gecht

Thanks, Kieth.

JoAnn Horne

Operator, are there any further questions?

Operator

Your next question comes from the line of James McIlree from Collins Stewart.

James McIlree - Collins Stewart

Thanks. John, what would the tax rate be if you assumed the R&D tax credit was not reinstated? And if the 22% include any catch-up for prior quarters or is that just like a Q3 going forward number?

John Ritchie

That's a Q3 going forward number. The R&D tax credit is probably good for two points.

James McIlree - Collins Stewart

Okay, great. And could you tell me again what the share count you expect for Q3 is and if that does or does not include buybacks?

John Ritchie

The share count would be $54 million excluding any buyback activity in Q3.

James McIlree - Collins Stewart

Okay, great. Thank you.

John Ritchie

And just to be clear, we expect buyback activity in Q3.

James McIlree - Collins Stewart

Right. All right. Thank you.

Guy Gecht

Thanks.

Operator

We do have a follow-up question from the line of Ananda Baruah from Banc of America.

Ananda Baruah - Banc of America

Thanks guys for taking my follow-up. Just a quick question on the Controller business. I know the hope was to show sequential growth as you move through the year here. I also realized that you guys did a little bit better this quarter than you probably anticipated.

But just given your guidance is kind of 60 to 72, just how much of that might be a bit of conservatism versus sort of the forces that sounds like prep, kind of, incrementally into the market this quarter. The shift more towards embedded. We have sort of incremental softening in Europe. And we've all seen what Xerox and Cannon have reported. Is there anyway to clear some of those away and help us understand, sort of, how they impact the guidance for the third quarter?

Guy Gecht

I think all the forces I mentioned before during the Q&A and the opening remarks, and again, its a good product to add for Xerox. But if they had enough supply of 700, we will have a much more upbeat outlook or more up beat outlook for the Fiery business. We are clearly very happy with this engine and with the demand.

Ananda Baruah - Banc of America

And Guy, I know a lot of the new products that you're going to be in the position to take advantage of that are coming to market in the second half of the year really aren't coming to market in North America until September-October timeframe. As you know, you are sort of left with some of the incremental softness, is it really the fourth quarter where you might be in a better position to see some uptick in some of these new products?

Guy Gecht

I talked about the 700. As far as Ricoh, we will have significant revenue this quarter, because they have started to take units and going to start to install that it to the end of quarter and early next quarter. So I can't say that that's true for Ricoh. But, clearly, the OEMs will continue to push hard on new engines. But there's nothing in the engines that we talked about really should change your thoughts about the short-term environment. It's really the trends I was talking about the mixed shift embedded, the economy, the supply situation on 700 and so on.

Ananda Baruah - Banc of America

And sorry, if I missed it, but do you comment on where channel mixed controller or channel inventories are ended this quarter relative to entering the quarter?

Guy Gecht

Yes, I think it's fine in most of the cases. And again, when it's not fine, I think we have a good environment and I think its embedded in our forecast.

Ananda Baruah - Banc of America

Again, just my last one I promise. Given there has been a bit of a shift towards embedded controllers, is there any difference in embedded controller inventory levels relative to standalone controller inventory levels?

Guy Gecht

I would say that in general there's no difference. I think embedded tend to be more inventory exposure because people ordering it for a while and take some, of course, with the supply chain of the design licensing. They need a longer supply chain. They are ordering some chips from us. And then, they build it in their own factory. So maybe embedded normally has a higher level of inventory. Certainly, when there is good demand and they want to make sure there is supply/demand. Again, nothing out of the unusual and whatever we have with inventory, it's built in our focus.

Ananda Baruah - Banc of America

Okay. Thank you.

John Ritchie

Thank you.

Guy Gecht

Thanks.

Operator

At this time, we have no further questions. Mr. Gecht, do you have any closing remarks?

Guy Gecht

Yes, thank you. So, as always, we appreciate the confidence and support of our employees, partners, customers and shareholders. Especially, we want to thank the newest employees from our Pace System, our latest acquisition. We thank you for all for the time today and we look forward to speaking with you very soon. Thanks a lot.

Operator

Thank you for joining today's conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!