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Edited Transcript of EFII earnings conference call or presentation 30-Jan-19 10:00pm GMT

Q4 2018 Electronics for Imaging Inc Earnings Call

FOSTER CITY Feb 6, 2019 (Thomson StreetEvents) -- Edited Transcript of Electronics for Imaging Inc earnings conference call or presentation Wednesday, January 30, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* JoAnn Horne

Market Street Partners, LLC - Co-Founder and Partner

* Marc D. Olin

Electronics for Imaging, Inc. - CFO

* William D. Muir

Electronics for Imaging, Inc. - CEO, President & Director

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Conference Call Participants

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* Aaron Christopher Rakers

Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst

* Ananda Prosad Baruah

Loop Capital Markets LLC, Research Division - MD

* Brian Paul Drab

William Blair & Company L.L.C., Research Division - Partner & Analyst

* James Andrew Ricchiuti

Needham & Company, LLC, Research Division - Senior Analyst

* Kathryn Lynn Huberty

Morgan Stanley, Research Division - MD and Research Analyst

* Michael Anthony Cadiz

Citigroup Inc, Research Division - Research Analyst

* Nikolay Todorov

Longbow Research LLC - Analyst

* Roderick B. Hall

Goldman Sachs Group Inc., Research Division - MD

* Shannon Siemsen Cross

Cross Research LLC - Co-Founder, Principal & Analyst

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Presentation

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Operator [1]

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Good afternoon. My name is Jessie, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Electronics for Imaging Q4 and Full Year 2018 Earnings Call. (Operator Instructions) Thank you.

JoAnn Horne, Investor Relations for EFI, you may begin your conference.

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JoAnn Horne, Market Street Partners, LLC - Co-Founder and Partner [2]

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Thank you, Jessie, and thank you, everyone, for joining us this afternoon to review EFI's fourth quarter 2018 operating results and the outlook for Q1 2019.

Bill Muir, EFI's CEO; and Marc Olin, CFO, will lead the discussion. Following management's prepared remarks, we'll take your questions.

Before Bill begins his comments, let me review the safe harbor statement. During the call today, we'll be making forward-looking statements, which are statements other than statements of historical facts and statements in the future tense, including, but not limited to, statements regarding our strategy; plans; expectations regarding revenue growth; introduction of new products; product portfolio; productivity; future opportunities for our customers and for our products as well as market trends, product innovations, new market opportunities and acquisition strategies as well as estimates in our projections of revenue, operating profit, growth, EPS, gross margin, cash flow, market share, operating expenses, tax rate, working capital; and any statements or assumptions underlying any of the foregoing.

Forward-looking statements are subject to risks and uncertainties that could cause our results to differ materially or cause materially adverse effects on our results. Please refer to discussion of risk factors in our SEC filings.

We do not undertake to update in light of any new information or future results. Statements we make today are made as of the date of this call and are subject to revision until the company will have on file its Form 10-K for the year ended December 31, 2018.

In addition, reference will be made to non-GAAP financial measures. Information regarding a reconciliation of non-GAAP to GAAP measures can be found in the press release that was issued this afternoon on our website in the IR section at www.efi.com. Please note that slides corresponding to the information reviewed on today's call are also available on the Investor Relations website.

And with that, I'll turn the call over to Bill.

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William D. Muir, Electronics for Imaging, Inc. - CEO, President & Director [3]

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Thank you for joining us this afternoon to review our fourth quarter results and discuss our outlook for Q1 in 2019. I'm especially pleased to share with you the initial steps we're taking to upgrade EFI's execution and improve the consistency of our financial results.

Final Q4 results were in line with the preliminary numbers we shared on January 15, though the cash generation was actually slightly stronger.

Cash from operations for the full year exceeded our goal of 100% of non-GAAP net income. Despite the disappointing revenue results, the strong cash generation was a highlight of the quarter, thanks to the hard work of the team. Mark will review details of the Q4 results.

I would like to use my comments to discuss my long-term plan to once again make EFI's industry-leading innovation and products the story. I had shared from the beginning that it was EFI's technology that brought me to the company. My confidence and my excitement about the innovation and the opportunity ahead has only grown over the past few months.

I'd like to start with Connect, our user conference last week. Spending time with these incredibly enthused customers crystallized for me the critical role EFI plays in their success, while listening to them discuss how the EFI ecosystem drives their business was very enlightening. Our success this quarter with our Midmarket Software (sic) [Print] Suite, which integrates with our Display Graphics systems, reflects how our customers value the ecosystem.

The same could be said about the next-generation Fiery for Display Graphics, the Fiery proServer, which we introduced at Connect. Our DFEs are an important differentiator, and I heard over and over that the integration of our products is one reason our customers truly value EFI.

Over 4 days, I had more than 50 meetings with customers, which confirmed for me that the strategy we're developing over the past few months is the right one to deliver the execution our customers deserve.

To that end, with my 100th day at EFI now under my belt, I had begun rolling out a series of initiatives to drive value for our customers and EFI. Many of these are multi-quarter initiatives, but we're off to a solid start.

First, we kicked off thorough supply chain review exercises across 2 areas of the businesses. Both exercises identified mid-single-digit percentage savings opportunities that will provide capital to reinvest in the business and improve our margin profile.

We're also close to completing a search for a senior operations executive who will lead the robustness, speed and cost effectiveness of our supply chain and operations.

A second initiative is focused on product development cadence. We've completed 2 thorough value stream mapping exercises in our R&D process, both of which were specifically targeted at Display Graphics developments. Our review has uncovered the opportunity for substantial waste elimination, which will be realized through a combination of standardization and adoption of a more robust stage gate process. Additionally, we'll implement more timely interim stage gates with a focus on minimally viable products.

In addition, I'm very pleased that we just onboarded a senior executive to head our Display Graphics business unit. We expect this new leader to prioritize product initiatives and resource allocation decisions, which will be invaluable in helping to avoid the delayed product cycle cadence that has impacted our Display Graphics business.

Another necessary initiative is to progress our go-to-market approach. Our historical approach has served us very well through the years and is a large part of EFI's success to date. Yet, as our customers evolve and the industry consolidates, we must meet customers at points that now create value for them. We are focused on developing our consultative enterprise sales approach as well as building deeper domain expertise in markets poised for growth. I view this opportunity as additive to where EFI is today and not a radical realignment of our sales process. In short, by adding expertise, we can better serve customers of larger scale and organizational complexity.

This will be a longer-term process. We're in the early steps of working with a third party to evaluate our current approach. I will share more details around this topic at our Investor Day in May.

The obvious question is how these steps translate to our financial results. And to be clear, this is not a fast fix. I firmly believe we are on the right path, but to rethink our internal operations and approach is only part of the answer. The back-end-loaded nature of our sales was a contributor to the disappointing Q4 results. As such, this quarter, we have instituted a more rigorous financial review process as well as taken some steps to modify incentive plans.

The good news is the sales force is onboard with this plan. It will probably take a few quarters for these changes to have a measurable impact. We're committed to improving productivity and strengthening margins and capital generation. While this will impact our near-term results, we believe it will help to rebuild backlog, smooth our results and normalize our activity throughout the quarter. Our first quarter guidance reflects this plan.

We have also reduced our outlook to reflect conservativism (sic) [conservatism] following the difficult Q4 when we experienced lower close rates. To be clear, the business today looks very similar to this time last year, and without the strategic decision to change the quarter linearity, our outlook would be in line with the first quarter of 2018.

We're optimistic that Q1 is a low point in this transition year, due in part to our outlook for Nozomi and to a much lesser extent BOLT. My excitement about the Nozomi opportunity has only grown after visiting a number of the customer installations. Listening to our partners discuss how Nozomi is beginning to change their businesses and the way digital expands the jobs they can take on from customers highlights where we can take this business.

You will see our announcement later today that CSI purchased 3 printers throughout last year. For competitive reasons, we couldn't announce the transactions until now, but they were in our 2018 results and are not included in our 2019 outlook.

We're very excited that we're seeing multiple orders from a single customer as proof of the value that Nozomi can bring. We have another multiple unit order from a current customer that we expect to share in the very near future.

I am equally excited about BOLT, which was introduced last quarter at an event attended by 200-plus customers instead of the 100 expected. With this unique approach marrying digital with some high-end analog technology and its unmatched speed and color quality, BOLT brings something really special to the textile industry. We expect to record the initial BOLT revenues in the next few months and expect sales will ramp slowly through the year.

With our confidence in $120 million of revenue from Nozomi along with an initial contribution from BOLT and our outlook for the Fiery business and the rest of the EFI business, we're confident we will achieve both revenue and EPS growth for full year 2019.

My goal, once we begin to realize the benefits of the plans I just sketched out, is to exit 2019 as a much more nimble, efficient organization. There is a great deal of work ahead, but I'm pleased with the engagement from the entire EFI team to take the necessary steps to improve our operations.

We will go into deeper detail on many of these topics at our Investor Day in New York in May. I look forward to seeing many of you there.

And with that, I'll turn the call over to Marc.

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [4]

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Thank you, Bill. We delivered revenue of $257 million in Q4, in line with the preliminary results we announced on January 15. Results were lower than our original expectations due to weakness in Industrial Inkjet equipment and Productivity Software license sales towards the end of the quarter. The weakness we saw was present across all of our Inkjet segments.

The highlight of the quarter was the significant year-over-year improvement in cash flow, allowing us to exceed our full year cash flow target.

Fiery delivered revenue of just over $60 million as expected, and we also saw a recovery in our ink volume as we corrected the supply issue discussed in Q3.

Productivity Software had a Q4 revenue decline of 6% year-over-year, primarily due to weakness throughout the Americas. Our Industrial Inkjet sales declined 5% year-over-year with lower printer sales, primarily in the Americas and Asia Pacific. Industrial Inkjet gross margin was lower sequentially, but up year-over-year due to improved margins for Nozomi and our other Inkjet printers, thanks to some initial success with our efficiency initiatives.

Total recurring revenue was $84 million, up 4% year-over-year and representing 33% of total revenue. Non-GAAP earnings per share were $0.46, down 12% year-over-year and lower than our expectations, given the weakness in revenue.

Currency negatively impacted this quarter's revenue by about $4 million and reduced EPS by about $0.01 when factoring currency at the levels of Q4 '17.

Now let me explain in more detail the revenue by business segment and region. The Industrial Inkjet segment generated Q4 revenue of $154 million, which was equal to 60% of total EFI revenue. This would have represented a 3% decline year-over-year had currency remained where it was in Q4 '17. As we mentioned during our earlier call, we saw greater-than-expected weakness in Display Graphics and our more mature hybrid products beyond just the high-end hybrid weakness that we experienced in Q3. This was felt primarily in the Americas.

While we sold out of our h3, h5 products, as we expected, we are not yet at full capacity on the h5s since it was the first quarter we shipped that product.

Our Building Materials and textile businesses were weak in Asia Pacific, with both experiencing double-digit percentage declines in China specifically. Our intention going forward is to no longer give ink volume data, since we are reporting ink revenue in our 10-Q and we will hit a full year of data with the 10-K. But given the ink shortfall in Q3 due to supply constraints, we wanted to provide a final update.

In the quarter, ink volume returned to double-digit growth levels, which we believe primarily reflects ink shipments returning to normalized levels combined with some catch-up from the orders we were not able to fill in Q3.

Productivity Software delivered Q4 revenue of $42.4 million, representing 17% of total EFI revenue in the quarter. This would have represented a decline of 5% had currency remained where it was in Q4 '17. As we mentioned on our prior call, we saw weakness late in the quarter, with many deals pushed out of Q4 due to concerns by customers about making significant capital commitments.

The Fiery segment delivered revenue of $60.5 million, down 1% year-over-year, representing 23% of total revenue. Product mix drove the gross margin up from the prior year. Fiery channel inventory remains in the targeted range.

In the Americas, revenue totaled $129 million, down 4% year-over-year, caused primarily by a decline across our Industrial Inkjet and Productivity Software business units.

EMEA was down slightly by 1% year-over-year with revenue of $94 million and would have shown an increase had currency remained where it was in Q4 '17.

APAC was down 13% year-over-year mainly due to lower Industrial Inkjet sales in China and the rest of the Asia-Pacific region as previously mentioned.

Looking to the March quarter for 2019, as Bill discussed, we are implementing a strategic initiative to address linearity, which we expect will result in improved margins and DSOs. Because of this, we anticipate that while Nozomi will grow, the rest of our direct businesses will decline. We expect Industrial Inkjet to decline high single to low double digit. Based on a very difficult comp with Q1 of last year when Productivity Software grew 25%, we expect a decline of mid- to high single digit for that segment.

We expect Fiery to be about flat with last year in what is the seasonally slowest quarter of the year, but expect we will average approximately $60 million per quarter for the full year, continuing the trend we've seen since the start of last year. All of that results in revenue guidance of $215 million to $225 million for Q1.

The strategic shift we mentioned will take some time to positively impact our performance. And therefore, we expect to see continued pressure in Q2 on revenue. As a result, we will see a modestly higher percentage of our revenue in the back half of the year compared to typical years, such as 2016 and 2017.

As Bill stated already, we do expect to see growth in both revenue and EPS for the full year with the benefit of Nozomi and BOLT and the changes taking place throughout the rest of the business.

Moving to gross margin, where I'd like to remind you all that further commentary is on the non-GAAP basis unless otherwise noted. Fourth quarter gross margin was 49.2%, up 130 basis points year-over-year and above our expectations due to better-than-expected margins in Industrial Inkjet and Fiery.

Industrial Inkjet gross margin of 34%, up 100 basis points year-over-year, but down 60 basis points sequentially due to product mix. Fiery gross margin was 71.9% with growth of 280 basis points year-over-year due to product mix.

In the Productivity Software segment, gross margin was down 120 basis points year-over-year to 71.8% due to weak license sales in the quarter.

For the first quarter of 2019, we expect overall gross margins to improve to 50% to 52%, thanks in part to the initiatives mentioned above on revenue. We expect Industrial Inkjet to improve to 35% to 36%, Software to be in the low 70s and Fiery to be around 71%.

Turning to operating expenses. For the fourth quarter, operating expenses were $100.5 million, up 2% year-over-year and comprising 39% of revenue, an increase of 230 basis points from the year ago period as a result of higher compensation-related expenses in Q4 '18 year-over-year.

R&D expenses were $36.7 million, representing 14.3% of revenue, up from 13.9% a year ago. Sales and marketing expenses were $43.9 million, representing 17.1% of revenue, up from 16.1% a year ago. G&A expenses were $20 million, representing 7.8% of revenue, up from 6.8% a year ago.

As we have discussed, we've been shifting OpEx within the company from products such as Fiery and ceramics to our rapidly growing Nozomi and textile product lines, while continuing to invest in other Inkjet and software product lines that deliver consistent growth.

Higher gross margin from Fiery and Industrial Inkjet, but lower year-over-year revenue combined with investment in R&D spend for our new packaging textile products resulted in an operating income of $25.9 million, down year-over-year, with an operating margin of 10.1%.

Other income and expense had a net loss of $1 million, driven primarily by costs of our convertible bonds. Our constant non-GAAP tax rate remained at 19%, and we expect it to remain at that level into 2019.

Looking to the first quarter of 2019, we expect non-GAAP earnings per share of $0.20 to $0.27.

As reminder, our Q1 outlook assumes our January foreign exchange rates stayed flat for the balance of the quarter. It also includes approximately $0.02 per share quarterly impact from the convertible bond interest payment.

Now turning to the balance sheet. Total cash, cash equivalents and short-term investments amounted to $411 million compared to $294 million at the end of last quarter. Cash flow from operations was $33 million or 162% of the non-GAAP net income for the quarter, for a robust year-over-year increase and exceeding our expectations for the quarter.

Cash generation in the quarter was positively impacted by improved balance sheet metrics year-over-year. For the full year, cash from operations ended up at 101% of our non-GAAP net income. This significant turnaround in cash generation for the company was thanks to the hard work of many people throughout our organization, and I'd like to thank them for their efforts in getting us over our target level despite the challenging Q4 revenue results.

For 2019, we expect to again target 90% of our non-GAAP net income and cash from operations with one qualification that about $60 million of the money we will repay of our $345 million convertible bond that matures in September is required to be classified as cash from operations, as it represents the option value portion of the bond. We'll exclude this amount from our ratio calculation going forward.

Net accounts receivable was $242 million, down $3 million year-over-year, but up 1% sequentially. DSOs were 87 days, up 3 days versus Q4 of last year.

Our net inventory balance was $134 million, up $13 million sequentially and up $9 million from Q4 last year, primarily due to unsold inventory of Industrial Inkjet printers in the quarter. This drove inventory turns to 3.9, down 0.4 turns sequentially and down 0.5 turns year-over-year.

Stock-based compensation this quarter was $14.8 million due primarily to the grants of our annual long-term performance-based restricted stock units during the quarter, which are tied to our next 3 years' results. This quarter, we returned $59 million to shareholders as part of our $150 million buyback program, which was put in place in January 1, 2016; and $125 million buyback program, which was started in Q3 '17. This completes the execution of these buyback programs, which we had committed to spend before the end of 2018 when they were created. Total diluted share count went down sequentially to 44.5 million shares.

In summary, while it was a difficult Q4 for us, there were a number of important milestones reached during the year. Our Nozomi launch, while generating a little less than we expected for the full year at $66 million in revenue, exceeded our target when we started the year and was the biggest product launch in the history of the company. We were able to build a significant business within a year of the launch of the product and have established EFI as the clear leader in the industry with the highest market share. I'm extremely proud of the many hours of hard work from teams across all of EFI that supported this launch and drove our success.

We mentioned during our earlier call that during Q4, one of our Nozomi opportunities was delayed, as the customer was not prepared to move forward. Bill mentioned in his comments that we hope to have this signed very soon. I'm happy to say that we just received the order from this customer, which was actually our first Nozomi client (inaudible) that ordered 2 additional Nozomi units, which will be placed in 2 new facilities. We see this as a great endorsement of the value of Nozomi to the industry. This order was factored into our Q1 guidance.

Continuing with my review of 2018. Our Productivity Software and textile businesses both had record years, with Productivity Software delivering 7% revenue growth. Fiery also met our expectations for the year, achieving the plan we laid out at our Investor Day in November of 2017. As Bill stated in his remarks, we're at the start of a next chapter of EFI. We have a lot of work to do, but the underlying strength of our company, our products, our people and our customers are as strong as they've ever been. And while it will take a little time, I'm confident we can return to the revenue and profit growth we've achieved in the many years of our history.

As always, we'd like to conclude by thanking our customers, employees and shareholders for their continued confidence in EFI.

We'll now be happy to answer questions.

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JoAnn Horne, Market Street Partners, LLC - Co-Founder and Partner [5]

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Operator, we'll take questions now. (Operator Instructions)

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Shannon Cross with Cross Research.

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Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [2]

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Bill, can you talk a bit about the strategy you have in terms of looking at supply chain and looking at go-to-market? How specifically you're running that and how many people you have on them? I don't know, just if you can kind of give us an idea of how you're doing that and then also how that can go on at the same time as running the business, which obviously you have to do. So do you have like a separate team doing it, or what's the strategy?

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William D. Muir, Electronics for Imaging, Inc. - CEO, President & Director [3]

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Sure. Shannon, nice to speak to you again. So a couple of different things. When I started the supply chain side of things, I would say we have an opportunity to look at our business, and I use this phrase a lot, a bit more horizontally than we do today. Today, I think we are looking a bit siloed, and there's an opportunity for us to aggregate -- spend a bit more effectively across the organization. Some of the efforts I outlined are being run by individuals that we have in the supply chain organization today. Just maybe through a different lens of looking at the business, a different expectation for how maybe we should engage with the supply chain and maybe a broader mandate to leverage spend across the company. In this area, we've also used third-party resources to more quickly get at opportunities that we think might be quick wins. And then I think as I mentioned in my prepared remarks, there are some things that we're doing to finalize kind of staffing that would be incremental to that in order to bring what I would consider to be greater depth and experience set from a supply chain expertise. So I think we're hitting that on a couple of different vectors: internal resources with a bit of a different mandate, third-party resources that are helping us accelerate some quick wins. And then at the same time, we'll be augmenting our resource base with some experienced leaders. And I think most likely, 1 or 2 areas folks that I have good experience working with previously. So that's the supply chain piece of things. The sales piece, again, I'm trying to be clear in my commentary about this being an additive exercise to what it is we're doing today, and it's one of the top initiatives that we have across the company. We are leveraging third-party resources to help us, if you will, kind of whiteboard our organization, how our customers' organizations have evolved over time, what we might need to do to evolve our organization. I would tell you that a substantial amount of the focus for me here is how do we continue to build deep domain expertise in markets such as packaging and textile, we think that are poised to really grow. And then at the same time, this basket of customers that are larger in scale and more complex, how do we approach those differently. And I think you'll see us, over the next couple of quarters, add resources to really augment both of those. So I would say, today, we're in a bit more of discovery phase. We're a bit more in kind of work and trying to understand our organization, how to best map it, and in parallel, looking to augment that with external resources.

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Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [4]

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Okay. That was helpful. And I'm just curious, since you've had a few weeks since -- you guys in the middle of December and then everything sort of went south. And do you have any thoughts about what happened now, now that people -- the salespeople have come back and gone back to those customers? I mean, clearly, some of the deals -- I think Nozomi, the one that was just signed. But just in general, have you gotten any more clarity in terms of why people didn't sign at the end of the year? And then do they anticipate, say, in the next 6 months that you actually will close those, even if it's not in first quarter?

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William D. Muir, Electronics for Imaging, Inc. - CEO, President & Director [5]

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Yes, so thanks for the question. I figure that would be kind of top of mind for lots of folks. Yes, one of the great things about last week is we get the opportunity to spend a few days at Connect. We probably touched somewhere between 40%, 50% of the company's revenue stream with a number of customers that are present there. And I think what I heard from a number of customers fairly consistently is just a bit of trepidation, a bit of concern about where the economy is, a bit of concern as to what the next couple of months might look like. And if I go to the first part of your question, so what happened in kind of last 2 weeks of December, I think we've tried to kind of reiterate our experience that from when we spoke 2 weeks ago to today, we entered Q4 with a really robust pipeline, we were tracking well ahead of plan and in the last 2 weeks really, really dried out. And we saw that across a couple of different areas of the business. I think that's consistent with commentary we heard last week, and we've heard so far from customers, just a bit more trepidation in terms of how they're feeling about the near-term environment. The Hinojosa news, which is about as real time as you can get, is good reassurance for us. But I think we've factored in a level of conservativism (sic) [conservatism] relative to kind of the macroeconomic environment in what we experienced in December in terms of how we're thinking about the beginning part of the calendar year.

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Operator [6]

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Your next question comes from Kathryn Huberty with Morgan Stanley.

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Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [7]

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Can I ask a follow-up to your answer to Shannon's question. I guess, it would be helpful to put context around the weaker 1Q guidance. Is that conservatism? Because you're hearing from customers that they're going to be a bit more cautious towards CapEx. Or is that purposely assuming lower close rates and intending to close fewer deals so that you can keep a pipeline going into future quarters and drive that linearity? If you can just sort of untangle those 2 dynamics. And then I'll ask my follow-up. Maybe, Marc, you can comment on this. What are you -- like if you take the pipeline today, what would typical conversion have been in the past? And what are you assuming in guidance around conversion, just so that we can understand how much you might be able to clean up the linearity issue in the first quarter versus this taking a couple of quarters to get right?

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William D. Muir, Electronics for Imaging, Inc. - CEO, President & Director [8]

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Yes, that's an awesome question. Thank you for that. I'm sure that's again kind of top of mind for lots of folks. So here's how we think about this, and there's probably no perfect [order] to give you an exact formula. But I think we started with this quarter in a bit on the aftereffects of kind of December. We started with a much more rigorous financial review of what's in the pipeline, of what deals legitimately have a good shot of closing this quarter. I think we started with kind of a more detailed deeper review of every stage in the buying process, where were we, capital expenditure readiness by the customer, et cetera, to get to a starting point. In addition to that, as we go through this quarter, we're instituting a more rigorous financial review in terms of deals that would get approved. And Katy, to your point, that will impact our close rates. We're looking to do so in a thoughtful way as we look to drive margin expansion, as we look to drive better and more predictable capital generation. So that will drive a level of reduction in our close rate. And then finally, we couldn't get to the point we're in today without a level of factoring in the macroeconomic environment and what our close rates were in Q4. I would tell you that the close rate assumptions we have made for Q1 are more conservative than the close rates that we experienced in Q4. I'll let Marc add a little bit more color to that in a second. With that backdrop, we've kind of factored that into our guidance for Q1, on top of which we'll also be more rigorous in terms of our deal approval process as we look to drive margin expansion and better capital.

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Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [9]

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And Marc, just in your response, maybe you can comment what was typical linearity in the past for an average quarter, right, in terms of percentage of revenue in the last month? And where would you intend to get the model in the future with this change?

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William D. Muir, Electronics for Imaging, Inc. - CEO, President & Director [10]

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Yes, let me -- I just want to make one final comment, which I think was either in my prepared remarks or mine and Marc's. I do think this won't manifest so fully just in one quarter. I think we'll see a bit of transition as we go through Q2 as well. And then we think we'll see a bigger uptick in terms of growth in the back half of the year. With that, I will hand it back over to Marc.

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [11]

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Yes. So Katy, I think if we first start to look at what is typical linearity, so typical linearity historically has been for Q4, for example, what we saw, which was that over half of the quarter's new sales, and so -- that's printer sales, obviously, not ink. But -- and that's license sales on software, not maintenance. But those types of things that are based upon deals being closed, you get over half of those deals are closed in the last 2 weeks of the quarter, and that was typical. And that's what we were expecting heading into those last 2 weeks of December. And again, we were ahead of plan going -- entering those last 2 weeks and the pipeline was more robust than it was the prior year, entering those last 2 weeks for what was remaining to close. So everything pointed to very positive indications. But it obviously didn't turn out that way. So I think we'd have liked to -- we're not going to end the concept of a back-end-loaded quarter when it comes to selling capital equipment or software that's -- not enterprise software, but significantly priced software. It's still going to be somewhat back-end-loaded. We're trying to smooth that out, though, and get it more pushed towards the front. How much of that we're going to get to do? I don't know. But I'd say, our primary goal for this is also to mitigate the DSOs and improve margins that have to basically to let deals close more on the customers' time line of when they need the product, not when we need to close the deal. And that's kind of a more natural close date, if you will, for what the customer -- when the customer would like to make the purchase. And so that we believe will lead to less lumpiness in the quarter.

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Operator [12]

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Your next question comes from Rod Hall with Goldman Sachs.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [13]

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I guess, I want to come back to this linearity effort. My understanding in this kind of business is people tend to push deals to the end of the quarter, because they understand the dynamics of quarterly reporting. So they use that leverage to get better pricing. And I guess, what I'm wondering is in order to get them to close earlier, you're going to have to give any sort of economic incentive to them. Or how exactly do you implement this less linear sort of a quarter? And I have a follow-up.

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [14]

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So I think, Rod, you're exactly right. The customers have been trained, and it's been getting, let's say, worse over the last few years about their understanding of that. So I think that's why we're saying it's going to try to -- it's going to take a couple of quarters before we let this filter through the system. But the idea is not that we're going to try to offer a lower pricing or more extended terms earlier in the quarter. I think the point is that we're just -- there are certainly a decent quantity of deals that close each quarter even at the end that don't require those supplemental incentives to the clients. And so the idea is to try to control the depth of that discounting and control the extent of the extended payment terms that we offer to the clients. And if it pushes to the next quarter, we'll let it push to the next quarter. We don't want to lose the deal to a competitor, but by the same token, we don't want to provide a greater-than-necessary incentive to get somebody to close in one quarter versus waiting another month or the next quarter. And so I think that's the methodology. And that's why you see a significant impact in Q1, with the revenue guidance where it is, because we're prepared to allow those deals to slip and move forward. And we're not sure whether it's going to take 1 quarter or 2 quarters until we start to see that momentum picking up and the deals closing on a more normal cadence.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [15]

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Okay. I appreciate that. And then just as a follow-up, I wonder, given that's the case, what do you think the margin impact of this is going to be over time?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [16]

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We're not prepared to put a stake in the ground. I mean, you can see already with what we gave in Q1, that we're expecting margins to start to trend higher already on the gross margin side just by examining deals that were done in the prior quarters and figuring out, okay, if we eliminate things that fall below this certain threshold, what's that going to do in terms of our gross margins. But over the long term, I think it's too soon to say. We need to see kind of again what a naturalized level of discounting and payment terms will be without having to provide the extra incentives to move deals upwards, so.

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Operator [17]

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Your next question comes from Ananda Baruah with Loop Capital.

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Ananda Prosad Baruah, Loop Capital Markets LLC, Research Division - MD [18]

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So just coming out of last week, do you feel like you're yet able to -- well, I guess, how if you -- it sounds like your customers, Bill and Marc, are still sort of tentative. So in that context, how would you handicap your ability to kind of develop confidence in revenue run rate right now, guidance notwithstanding? How would you context that if you're not able to -- like if you don't feel authentically that you can -- if -- did you feel like sort of great about the run rate now as you like to? When do you think -- at what point in the quarter do you sort of develop that? And then I just have a quick follow-up. I'll slip it in. Are there any supply chain initiatives, that you think would hit sooner rather than later that could provide a little bit more op income lift first half of the year?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [19]

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Yes. So I think we can -- I'll speak to the supply chain initiatives. I don't see any of those as being Q1 benefits. I think they're going to take some time to put in place, and we wouldn't really start to see that until the back half of the year. And heading into primarily in 2020 is when we'll start to see the real benefits of that. Again, we're talking about trying to unify purchasing across different continents and find common suppliers and leverage scale, and those things don't happen overnight. And we have to get the team in place, as Bill was talking about, that we have some people in mind. But we've got to get those people onboard. In terms of when we would gain confidence in the pipeline conversions and so on, that I think -- as Bill mentioned, we've done our numbers for Q1 based upon a lower close rate than we had in either Q4 or Q1 of last year to reflect this change in behavior that we're putting forth in our approach. But even with that, it's still going to be close to 50% of the deals that are going to close in that last 2 weeks of the quarter. I mean, that's just the nature of the beast. We're just trying to keep that to not be 50% and try to start bringing it downwards. So it's still going to be a decent-sized percentage. And so we're still not going to have that visibility until the very end of the quarter.

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Ananda Prosad Baruah, Loop Capital Markets LLC, Research Division - MD [20]

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And Marc, would you also -- just to sort of -- I think it was Bill's comments that you guys have been more rigorous with the pipeline review. Would that means that sort of there's some degree of greater confidence, philosophically, that should be in the pipeline that you're now applying the lower close rates to? So in theory, while you're still going to get 50% last 2 weeks of the quarter and customer is still cautious, this should be -- philosophically, this should be a bit more firmer of a revenue guide than may be typical?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [21]

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Yes, I think that's -- we definitely -- when developing the $215 million to $225 million that was, as Bill mentioned, based upon a more conservative set of assumptions around close rates than we typically had. We were guiding like -- using the same assumptions on close rates that we've done historically, we would have been guiding to flat with last year.

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Operator [22]

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Your next question comes from Jim Suva with Citigroup.

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Michael Anthony Cadiz, Citigroup Inc, Research Division - Research Analyst [23]

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This is Michael Cadiz for Jim. Apologies for that. So my question is more general on the competitive landscape and industry health, because with that question, I'm trying to understand is what we saw in late 4Q and thus far in this quarter indicative of behavior in the medium to long term? Or essentially, is the transition from analog to digital, is it a -- is a risk to it somehow? Will it be delayed or protracted? I'm trying to see if -- it's just a dip followed by a trajectory to the same endpoint? Or is the line shifted completely because of this?

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William D. Muir, Electronics for Imaging, Inc. - CEO, President & Director [24]

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Michael, this is Bill, I'll kick off. I don't know that -- you started off on the competitive side. I don't know that we've seen anything that has really shifted in terms of the competitive landscape. And I don't know if the question is more from a standpoint of either an inhibitor or a [governor] on the analog to digital transformation. Again, I don't know that we've seen anything whatsoever that is slowing that. I look at data points like Nozomi and some of the news coming in, with customers like Hinojosa, as continued desire by the marketplace to enable that digital transformation. We're hopeful, albeit at a lower level and lower rate. We're hopeful of seeing the same in BOLT as we launch that product out in the marketplace. But there is nothing that I'm seeing in meeting with customers that would indicate a slowdown in that analog to digital transformation, nor is there anything that I would put in the category of a substantial change in competitive landscape.

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Operator [25]

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Your next question comes from Jim Ricchiuti with Needham & Company.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [26]

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Just a couple of questions on the new products. I'm just wondering how we should think about that -- the Nozomi revenue guidance that you've given for the year. Should we assume some of that, given the close rates that you're striving for that, that's going to be more skewed toward the second half of the year?

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William D. Muir, Electronics for Imaging, Inc. - CEO, President & Director [27]

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So I think maybe to help from a modeling standpoint, if you start with the $120 million assumption for the year and you look at kind of the revenue linearity Q1, Q2, Q3, obviously Q4 being a bit of a step back, I think fair to look at and say year-over-year growth, that would imply a level of acceleration as we go through the year. So I offer that up and hope that's helpful from a modeling standpoint. So yes, there will be more of a back-end-load. I think again, if you look at the first 3 quarters of the year and kind of model that from a year-over-year growth standpoint and then maybe bit more growth in Q4, that would be helpful and reflective of the business.

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [28]

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Go ahead, Jim. Sorry.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [29]

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No, no, I didn't mean to cut you off, Marc. Please.

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [30]

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So I was just going to say that I'm not sure if that was clear before, but we are expecting Nozomi revenue growth all 4 quarters of this year. So while -- again, I would expect that the largest portion of the growth will be towards the end of the year. We are seeing, as we mentioned, some of the carryover from last year, with 1 of the 2 customers that had put a pause on Q4 committing, which was Hinojosa, in Q1. And we're hopeful that the other one will also commit before the end of this quarter. Beyond that, as Bill mentioned, the BOLT is also an important product for us for this year. That's going to be in beta for some time. We've got to get the first one shipped this quarter, but that's going to be in beta for 3 to 6 months. And so by definition, that revenue is definitely going to be in the back half of the year. And one of the things we wanted to share on the call today relating to BOLT is that people have been asking us about what that's going to sell for. We expect the average selling price for BOLT to be between $2.5 million and $3 million.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [31]

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Okay, that's helpful. And just my follow-up question is -- you see, I'm excited about BOLT and it's great. You also saw some slowing in the Reggiani business, the existing Reggiani business that you have. And it sounds like one of your competitors has also called that out in their conference call. And I'm just wondering what are you seeing in terms of the market trends in the textile printing business, putting aside the excitement around BOLT?

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William D. Muir, Electronics for Imaging, Inc. - CEO, President & Director [32]

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Yes, so I would say the challenge has been in some of the developing countries in their general investment profiles. So China, some of the other developing Asian countries have really slowed down some spending, and so that ripples into the textile world. Certainly, Reggiani still grew last year -- for the year as we expected them to grow for the year. But I think they -- there's an outsized hit on the textile business, because there is more business in the -- in some of the developing countries. But BOLT is a step change for us certainly for that business at that type of ASP. Our -- most of our printers sell for an average of about $0.5 million apiece. So going to a $2.5 million to $3 million printer is a significant change for us. And while we're not going to sell that many in 2019, it's still a big change and a big opportunity for us to accelerate the textile world.

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Operator [33]

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Your next question comes from Aaron Rakers with Wells Fargo.

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Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [34]

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I do have a follow-up as well. I just want to go back to the earlier comment on just kind of the setup as we work through some of this kind of change in linearity. And given some of the product news that you had talked about, if I look back over the past, let's call it, 3 years, you've grown in 2Q sequentially about 7% on average. You just made a comment that you expect the growth to accelerate through the course of '19. So I'm curious, should we assume that normal seasonality into 2Q is a fair point of reference to consider? Do you think it could be below seasonality, given some of these things you're working through? And I'm just -- do you think you actually can get back to year-over-year revenue growth in the back half of the calendar year?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [35]

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Yes. So first, in terms of the sequential behavior from Q1 to Q2, I do think that should be -- to behave normally. Obviously, we're at a lower number for Q1 with the $215 million to $225 million versus last year. But I think the sequential behavior should still be about the same. But the sequential behavior from Q2 into the back half of the year with the BOLT launch and starting to recognize revenue, that's -- and plus the, let's say, starting to get some of the benefit of the change in selling approach, that should give us more pipeline to the back half of the year, more backlog to the back half of the year, we do expect the back half to make up a greater-than-normal percentage of the total revenue for the full year. And so I would say, sequentially from Q2 to Q3, it will be abnormal from -- versus prior years but from Q1 to Q2 should be typical.

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Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [36]

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And is your view -- sorry to push you, but is your view that you get to a return of year-over-year growth in the back half of the calendar year?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [37]

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Yes. So in the back half of the calendar year and actually for the full year, I don't know if you -- that was in Bill's statement, but we do still expect, despite the slow start to the year, that for the full year we can get to year-over-year revenue growth and year-over-year EPS growth because of the strength of the back half of the year. So both Q3 and Q4, we would expect to show growth and certainly for the full year.

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Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [38]

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Okay, that's helpful. And then as a real quick follow-up, you talked in the initial comments about your display business and you talked about the h5 platforms. You shipped out of those and you're ramping manufacturing facility. How much revenue did you actually not capture, because you just don't have the manufacturing capacity setup? And when does that -- when do you feel like you're fully in a position to capture all the business from a capacity perspective?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [39]

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So I don't think we missed that much in Q4 from not being ramped up fully, because there was -- we were in an early adopter state. So it's not like the sales reps in Q4 were actively pushing the h5 as aggressively as they would if we had demo units and reference clients setup. We commercialized the product basically at the end of the quarter, allowed us to recognize the initial units that were shipped. But we intentionally always limit the amounts that we can make. It's not that we couldn't make more. We chose not to make more of the h5, because it was just commercialized late in the quarter and that was the plan from the beginning. So this quarter, we'll ramp up more of the h5, and I'd say we'd be at full production capacity for h5 by Q2. For the h3, the initial model, that's at full production capacity this quarter in terms of being able to make whatever we think the market demand for that would be.

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Operator [40]

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Your next question comes from Brian Drab with William Blair.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [41]

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I just have a couple of small questions at this point. Did you say that you have consultants onboard there that are helping? I think you used the term whiteboard things. And if so, when do they come onboard and how long will they be around, and what kind of expense should we see?

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William D. Muir, Electronics for Imaging, Inc. - CEO, President & Director [42]

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Brian, it's Bill. So folks are -- third-party consultants are helping us on some of the go-to-market efforts, probably been on board here for, I don't know, 4, 6, 8 weeks or so, somewhere in that time horizon. I would not think about it as an overly material line item as you're thinking about our expenses. And hopefully, there's enough of the things and some of the other stuff we're doing that would offset any, I [wouldn't] frame, as reasonably nominal increase there. How long are they going to be onboard? I don't know the answer to that. I would say that what we're trying to do to augment what historically has been a very, very good well-positioned sales force. As we look to build deeper domain expertise, as we look to become a bit more consultative in our approach, I don't view that as a 90-day effort or maybe even 120-, 150-day effort. I think there's some things from an ongoing education training standpoint, tool development to allow us to be better from a sales enablement standpoint that will take us some time. And I tend to think about that as really, really worthwhile investment to make sure that we're positioning ourselves in a way that really adds value for customers. So I would think about that as being some time, but I wouldn't think about that as a line item that if I were remodeling I'd be overly concerned about it.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [43]

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Okay. All right. And then just on the margins for Nozomi and also then BOLT, if you could, what's the current outlook for both of those machines in terms of maybe however you'd like to talk about it, EBIT margin relative to the Industrial Inkjet segment may be, and when you hit segment average EBIT margin for each of those machines?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [44]

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Yes. So I'd rather not go into too much detail on the EBIT margin profile, instead speak about the gross margin profile for those, because there's different investments we make that we may be doing in terms of future technologies that would bleed into those things. But in terms of gross margin, Nozomi is still below the average Inkjet gross margin, but it's getting closer to our target margin, even though the ink is still a very small portion of the total there. So I do believe it will -- as the ink becomes a more significant portion of the total Nozomi revenue, that we have an opportunity for Nozomi to be a little higher than the average gross margin in the rest of our portfolio. In terms of BOLT, it's too early. We haven't even shipped the first one yet. So we need to get more experience with it to go through the beta process and see what we need to do to the machines to get it fully commercialized with the client.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [45]

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Does the Nozomi gross margin get to the segment average in 2020 or 2019?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [46]

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I would say that we have -- it's probably towards the end of the year, probably by Q4, I would say, we have an opportunity to get it to the segment margin. The ink won't be at the ratio by then. But I think because of the very good work that they're doing on the equipment side, that's going to allow us to get to that segment margin before the ink is there. But it won't be at that for the full year, I wouldn't think. And heading into 2020, hopefully, we can -- 2020, we can get it at or above the segment margin for the full year.

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Operator [47]

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Your next question comes from the line of Nick Todorov from Longbow.

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Nikolay Todorov, Longbow Research LLC - Analyst [48]

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I want to go back to the question on achieving full year growth in sales and EPS. So I'm trying to bridge. So from one standpoint, you're saying that customer tepidness and spending is there and you guys are more conservative in closing rates. Kind of assuming that the first half is going to be down. In order to get to full year growth, that kind of implies some really strong seasonality in the second half, close to 15%, 20% growth second half versus first half. Just trying to understand what gives you confidence that, that tepidness is going to disappear and the pipeline is going to be there? I understand you have some new projects coming up in that. But do you guys assume that closing rates are going to improve in the second half of '19?

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William D. Muir, Electronics for Imaging, Inc. - CEO, President & Director [49]

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Yes, I'll start off and ask Marc to add color. So what gives us confidence? I guess, I may bucket that in 3 to 4 areas, kind of given the current macroeconomic environment. First, I’d start with Nozomi, given the growth expectation we have for that business, coming off a good 2018, for a level of a substantial growth in 2019 as well. So I think that if you think about the Nozomi contribution as a percentage of our business, that gives us confidence. If you think about BOLT and the contribution, although again, reasonably muted in '19, I think the incremental BOLT contribution, which is obviously not in any of our '18 numbers, that gives us the level of confidence. We've talked about the Fiery business averaging $60 million a quarter of revenue every quarter kind of on average, right, for the year. So I think from a foundational standpoint, that gives us a level of confidence. And although -- I guess, we haven't talked about the Productivity Software business. As we think about the outlook for that business and we think about historical ranges that we provided in terms of organic growth of 3% to 6%, we feel good about that being towards the lower end of those ranges. So if I think about all those, a couple of those being additive to our 2018 run rate and then still factor in maybe some headwinds in some other areas of the business, I think it's a summation of all that, that gives us a level of confidence that we'll achieve year-over-year growth.

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [50]

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And I would just add to that, that we are -- we will have a compare against a unusually weak Q4 for 2018 and the combination of the BOLT being available in Q4 of '19, plus we mentioned before our high end of Display Graphics launch we expect to have in the back half of '19, we'll have our -- the existing h3 and h5 at full speed in the back half of '19, which it wasn't in the back of '18. And obviously, we expect Nozomi to continue to ramp. So all of those factors give us the confidence in being still able to look at enough growth in the back half to get us to growth for the full year.

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Nikolay Todorov, Longbow Research LLC - Analyst [51]

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Okay. That makes sense. And just as a follow-up, can you guys talk about Nozomi capacity plans for 2019 to the extent you can? Do you see the need to expand capacity beyond the 10 units production per quarter? And I'm sure -- I'm not sure if you guys are 10 or you can achieve a little bit more than that with the current capacity?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [52]

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So we can do -- to clarify again for everybody, our current team can produce 10 per quarter. If we have demand for more than 10, we can produce many more than that in the existing facility by just adding another shift. That's basically just running 1 8-hour shift a day, we could go to 2 8-hour shifts if needed and double that capacity without changing the footprint. So we're not concerned about capacity constraints right now.

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Operator [53]

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And this is all the time we have for questions. I will turn the call back over to Bill Muir for some closing remarks.

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William D. Muir, Electronics for Imaging, Inc. - CEO, President & Director [54]

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Folks, I just want to say thank you. Thank you for your interest in our company. Thanks for the thoughtful questions today. Marc and I sit here incredibly excited about the opportunity we have in '19 and beyond. There's some hard work in front of us. I think we have good line of sight as to what that hard work is. And more importantly, I think we have good line of sight to the extent that we execute as we should to the value that we can create for our customers, and by extension, for the company. So we're looking forward to updating you on our progress as we go through the year. And again, thanks for your interest.

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Operator [55]

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