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Edited Transcript of EFII earnings conference call or presentation 30-Jul-18 9:00pm GMT

Q2 2018 Electronics for Imaging Inc Earnings Call

FOSTER CITY Oct 5, 2018 (Thomson StreetEvents) -- Edited Transcript of Electronics for Imaging Inc earnings conference call or presentation Monday, July 30, 2018 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Guy Gecht

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

* JoAnn Horne

Market Street Partners, LLC - Co-Founder and Partner

* Marc D. Olin

Electronics for Imaging, Inc. - CFO

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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

* Jim Suva

Citigroup Inc, Research Division - Director

* Joseph Eric Wolf

Barclays Bank PLC, Research Division - MD & Head of Equity Research

* Joseph Helmut Wittine

Longbow Research LLC - Research Analyst

* Kathryn Lynn Huberty

Morgan Stanley, Research Division - MD and Research Analyst

* 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 Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Electronics for Imaging Second Quarter 2018 Earnings Conference Call. (Operator Instructions)

Ms. 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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Thanks, Rob, and thanks, everyone, for joining us this morning -- this afternoon to discuss EFI's second quarter 2018 operating results. Guy Gecht, EFI's Chief Executive Officer; and Marc Olin, Chief Financial Officer, will lead the discussion. Following management's prepared remarks, we'll be happy to take your questions.

First of all, I'll 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; demand for our products as well as market trends; product innovations; new market opportunities and acquisition strategy; 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; any future CEO transition announced today; 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 the 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-Q for the period ended June 30, 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 conference call are also available on the Investor Relations website.

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

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Guy Gecht, Electronics for Imaging, Inc. - CEO, President & Director [3]

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Thank you, JoAnn, and thank you all for joining us today. We are pleased with the second quarter results and the execution of the EFI team as we continue delivering on our mission to accelerate the digital transformation of industries around the globe with colorful images really matter. We made very good progress on both top and bottom lines and in fact, had foreign currency rates remained stable during the quarter, we would have achieved the higher end of both the revenue and EPS guidance. Our balance sheet metrics also improved due to the -- to our focused effort, with cash generation significantly ahead of our target, even as we build inventories to support Nozomi and the new McKinley platform for display graphics. Nozomi, again, executed to plan in the quarter and based upon our progress to date, we are increasing our outlook to full year revenue from Nozomi. More on that in a minute.

I don't think I need to remind anyone how challenging last year was for EFI. So to see us regaining momentum across the board is very encouraging. Of course, we are disappointed with the FX impact, but with little control on currency, we continue to focus on executing on our strategy, which we can control. As expected, Fiery seems to have turned the corner. We had predicted that Q1 was a trough and we anticipated a sequential increase in revenue in the second quarter. Revenues were $63 million, even a bit higher than we expected. With good uptake for new products launches, we continue to expect Q3 Fiery revenues would be approximately $60 million.

The direct businesses delivered 10% revenue growth. Productivity Software reported a solid quarter in line with our expectations, despite the overachievement in Q1. We expect to maintain this momentum given our healthy pipeline and continued progress, especially in the new growth areas of packaging and fashion.

Industrial Inkjet, again, posted double-digit growth even with the negative FX impact. In our textile business, we saw good initial demand for the Reggiani COLORS, which is our first 12-color Inkjet printer. We remain on track to launch our first single-pass system for textile, code name Bolt at the end of this year. That system will be the first in the promised line of Nozomi derivatives where we are leveraging the investment, proprietary technology and EFI expertise in developing game-changing, single-pass platforms to create systems for new segments of our targeted markets. As expected, display graphic results were largely flat in anticipation of the commercialization of the H3, which is the first of many products based on the new McKinley platform, which will be finalized and produced at the newly build innovation center in Manchester in New Hampshire. We feel confident that with the products coming from the McKinley platform, we are in a very good position to start recovering market share in display graphics.

Building materials was only disappointing product line, where we continue to evaluate focused way to reenergize the start of the business. We are reallocating spend and talent toward packaging, which we can do quite quickly since both businesses are based in our Castellón Center in Spain. The more time we devote to the packaging market, the more excited we get about the size of the opportunity and a positive market dynamic. There's no question that the industry needs and wants digital transformation. Corrugated is the first vertical we are attacking. But we have already started to allocate some development resources to Nozomi derivative, targeting another large packaging segment beyond the $9 billion corrugated packaging market opportunity.

Now for more details on Nozomi. While some of our clients do not want us to mention their name, I can say that in the second quarter, we sold initial units to some of the world's largest global corrugated [system] firms such as Smurfit Kappa, Europe's leading corrugated packaging company and this installation is progressing well. Also in Q2, we sold the first unit to the Thai Container Group, one of the largest packaging providers in Southeast Asia. Most of these companies have dozens or even hundreds of sites, and the first Nozomi is just to get their initial experience with this platform. We are pleased we met our target to ship 5 units in Q2 and are on track to ship 7 units in the third quarter, increasing to 8 in Q4. While the size of the sales pipeline continues to expand, it is our ability to produce, deploy and support Nozomi that is increasing our confidence in delivering the $60 million in 2018 revenue we have projections -- projected since last year. And we are -- we now believe we will see an additional $5 million in revenue from Nozomi in Q4. Even as we drive Nozomi, we are equally focused on improving the entire company financial metrics and we are beginning to see the results. We are very encouraged by the generation of $31 million in cash from operations in Q2, along with improvement in other balance sheet metrics. Our goal is to continue balancing the self-funding of innovation to capture the huge opportunity in packaging, while improving efficiency across the company to deliver increased margins.

Before I hand the call to Marc, I do want to take a minute to discuss my personal news today, and the process of selecting the individual who will be leading the next chapter of growth and execution at EFI. After leading this special company for almost 19 years, through multiple transformations, it is probably not surprising that I have been contemplating stepping down for some time. And I've kept the board aware of where I am on this topic. While I never gave any timeline, it has become increasingly clear to me that the time for change is getting closer. And if it wasn't for the events of last summer, I would have likely made this transition sooner. But with EFI needing to regroup, recover and go back to historic level of execution, I felt that the time was not right to make the announcement we are making today.

After the progress we have made since the beginning of this year, especially in Nozomi and building our innovation pipeline. I felt that now was the time to announce my transition and push forward with the search. We have already identified some excellent external and internal candidates with the help of the A-Team at Spencer Stuart. But we, the board, are committed to optimize the search to find the best possible successor and not for a speedy completion. I have assured the board that I will stay as long as needed and be very focused on running the company and furthering EFI's progress until the new CEO is named. And it goes without saying that I will help the new CEO in any way they will want me to above and beyond my duty and role as a board member. To be clear, this is never an easy decision. But after close to 2 decades as CEO and with the long-term strategy in place, including the unparalleled opportunity to digitally transform vast market, such as packaging and textile, I believe it is the right time to step down. It will be good for me, and EFI will truly benefit from new, fresh energy and thinking at the top.

With that, I'll turn the call over to Marc to review the second quarter results in detail and to discuss our Q3 outlook. Marc?

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

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Thank you, Guy. And let me say, I've greatly enjoy working with you for -- with many different roles I've had over the last 15 years. Your leadership in transforming EFI has put us in a great place and I'm very excited to continue helping EFI be a success for many years in the future.

I am pleased to announce record Q2 revenue results of $261 million. While at the lower end of our outlook due to FX volatility during the quarter after we gave guidance, without that volatility, our results would have been at the high end of our guidance range on both revenue and EPS. The quarter included strong growth for Industrial Inkjet and Productivity Software, solid recurring revenue growth, the strongest Q2 cash flows and software to Inkjet have been part of EFI. It improved financial metrics together with shipping 5 Nozomi presses. We were very pleased to see our overall Industrial Inkjet sales up 10% year-over-year with strong growth in printer sales not only from Nozomi, but a number of our other product lines as well. Industrial Inkjet gross margin, as expected, was higher sequentially, but was lower year-over-year due to the expected impact of the Nozomi ramp-up and a lower percentage of ink versus equipment than we saw in Q2 of last year. Productivity Software also had record Q2 revenue with growth of 7% year-over-year within our expectations for the quarter. Fiery had a decline of 5% year-over-year, but those results were better than we expected and delivered sequential revenue improvement as well. Total recurring revenue was $85 million, up 2% year-over-year and representing 33% of total revenue.

Non-GAAP earnings per share were $0.50, down 7% year-over-year and within our guidance range. As I mentioned previously, currency changes that occurred during Q2 were especially significant. Had currency remained where it was when we gave guidance, our revenue would have been $265 million and our non-GAAP earnings per share would have been $0.54, flat with last year despite the year-over-year Fiery revenue decline.

Now let me explain in more detail the revenue by business segment & region. The Industrial Inkjet segment generated record Q2 revenue of $156.4 million, which was equal to 60% of total EFI revenue. This would have represented 13% growth year-over-year had currency remained where it was when we gave our guidance. Digital ink volume once again returned to double-digit sequential growth in the quarter, driven by strong textile ink demand and a recovery from low ceramic ink volume in Q1. Productivity Software delivered record Q2 revenue of $41.7 million, driven by strong growth from our corrugated software segment and representing 16% of total EFI revenue in the quarter. Productivity Software revenue growth would have been 8% had currency remained where it was when we gave guidance. The Fiery segment delivered revenue of $63 million, down 5% year-over-year and representing 24% of total revenue, but grew sequentially by 17% compared to the first quarter. Product mix drove gross margin up from the prior year and showed a sequential improvement over Q1 '18. Fiery channel inventory remains in the targeted range.

In the Americas, revenue totaled $122 million, up 7% year-over-year caused primarily by double-digit growth in Industrial Inkjet, which was offset slightly by reduced Fiery and Productivity Software sales. EMEA was down 7% year-over-year with revenue of $94 million, driven by lower Industrial Inkjet and Fiery sales and despite Productivity Software having double-digit growth in the region. APAC was up 42% year-over-year, driven primarily by strong growth in Industrial Inkjet, including our recently announced Nozomi sale in the region.

Looking to the September quarter for 2018, we expect Inkjet to maintain its strong momentum and grow mid-teens, Productivity Software to grow high single digits and Fiery revenue to decline to around $60 million as we've been expecting, resulting in total revenue guidance of $260 million to $265 million. We expect to ship 7 Nozomi units in the quarter and 8 in Q4 '18. And based on what we now expect to achieve in Q4, we are raising our Nozomi target for the full year 2018 to $65 million.

Moving to gross margin, where I'd like to remind you that all further commentary is on a non-GAAP basis, unless otherwise noted. Second quarter gross margin was 49.7%, down 210 basis points year-over-year. Industrial Inkjet gross margin was 35.1%, down 200 basis points year-over-year, but up 10 basis points sequentially. Fiery gross margin was 72.2%, with strong growth of 220 basis points per year -- year-over-year due to product mix. In the Productivity Software segment, gross margin was down 460 basis points year-over-year to 70.1% due to product mix in the quarter. For the third quarter of 2018, we expect overall gross margins to be 47% to 49% as we have a larger portion of our revenue driven by Industrial Inkjet, including Nozomi, which while delivering positive gross margins and improving each quarter, is still scaling to get to normalized Inkjet margin levels. The larger Nozomi mix combined with the launch of our H3 platform in the quarter for our display graphics segment will have lower margins as well as the first quarter or 2 as it scales. And this will reduce our Inkjet gross margin slightly in the quarter to a range of between 33% and 35%. We expect software gross margin to continue in the low 70s and Fiery to be around 70%.

Turning to operating expenses. For the second quarter, operating expenses were $99.8 million, up 4% year-over-year and comprising 38% of revenue, a decrease of 50 basis points from the year-ago period. R&D expenses were $37.6 million, representing 14.4% of revenue, down from 14.8% a year ago. Sales & marketing expenses were $43.5 million, representing 16.7% of revenue, down from 17% a year ago. G&A expenses were $18.7 million, representing 7.2% of revenue, up from 6.9% a year ago, primarily due to the increased investment in our accounting team we announced last year. As we discussed during our Investor Day, we have 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.

Lower gross margin from decreased Fiery revenue, combined with investment in R&D spend for our new packaging and textile products, resulted in an operating income of $29.8 million, down year-over-year with an operating margin of 11.4%. As Nozomi continues to scale and Fiery recovers, we expect that our operating margins will continue to recover from the low point of Q1 this year. Other income and expense had a net loss of $1.9 million driven primarily by a significant foreign exchange impact. Our constant non-GAAP tax rate remained at 19% and we expect this level to continue through 2018, even with the changes from tax reform.

Looking to the third quarter of 2018, we expect non-GAAP earnings per share of $0.47 to $0.53. As a reminder, our Q3 outlook assumes our July foreign exchange rates stay 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 $314 million compared to $304 million at the end of last quarter. Cash flow from operations was $31 million or 137% of the non-GAAP net income from the quarter, a robust year-over-year increase and exceeding our expectations for the quarter. Cash generation in the quarter was positively impacted by higher collections and reduced inventory year-over-year. We previously said we believed it would take until the end of the year to get back to 90% of non-GAAP net income in cash from operations, but we were able to accomplish that for the first half of 2018, thanks to the strong efforts of our team.

In Q3, we expect a seasonally lower level of cash generated due to the buildup of inventory for Q4, our highest sales quarter of the year. This is further impacted by our plans to manufacture 10 Nozomis in Q4 and have 2 left over exiting the year, so we are prepared for the demand we expect in Q1 2019. Net accounts receivable was $243 million, down $8 million, representing our largest sequential decline since Q1 2013, thanks to strong collection efforts, despite the continued back-end loaded nature of the quarter. DSOs were 85 days, down 2 days versus Q2 of last year. While we will continue to do work to reduce DSOs in the direct business, with the growth of the Inkjet business and increased international sales, we expect DSOs will remain around this level going forward. We believe the $31 million in cash from operations generated this quarter is a key indication of the health of the business at current DSO levels.

Our net inventory balance was $118 million, down $6 million sequentially and down $3 million from Q2 of last year, due primarily to managing our direct business inventory and selling out all the Nozomis we built in the quarter. This drove inventory turns to 4.5, up 0.6 turns both year-over-year and sequentially. Stock-based compensation this quarter was $12 million, a bit higher than usual as we granted our annual 2008 performance grants during the quarter, which are tied to our 2018 results.

This quarter, we returned $11 million to shareholders as part of our $150 million buyback program, which was put in place on January 1, 2016, and the newly authorized $125 million buyback program starting Q3 of '17. This leaves approximately $81 million available in our buyback program. This was a lower amount than we would have preferred as we could not do any open-market buyback during the quarter due to a number of factors. As we are now working with bankers to understand our options for our convertible bond that matures in September 2019, we do not expect to do open market purchases until we have determined our course of action. Once this is resolved, we expect to resume doing open-market buyback as we feel the current stock price significantly undervalues the company. Total diluted share count decreased sequentially to 45 million shares.

As always, we'd like to conclude by thanking our customers, employees and shareholders for their continued confidence in EFI. We are very pleased with our Q2 2018 results and are very excited about the significant opportunities in front of us for the remainder of 2018 and beyond.

We will 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, please?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Shannon Cross from Cross Research.

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

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Guy, first -- end of an era, I don't want to make it too much. But I remember I think I've been working with you guys since 2001, which, thank god, neither one of us have gotten any older during that period of time.

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Guy Gecht, Electronics for Imaging, Inc. - CEO, President & Director [3]

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Exactly. You look the same. I got the little -- the more gray hairs, but, yes.

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

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Oh, yes, I've -- it's a good thing about being female as we can honestly paint our hair without any issues. But anyway we will, obviously, miss you when you finally do move on.

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Guy Gecht, Electronics for Imaging, Inc. - CEO, President & Director [5]

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Thank you very much, Shannon. Very kind of you.

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Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [6]

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So just to ask some questions about the quarter, though. Can you talk a bit more about what you said on Nozomi and utilizing the technology in new areas? I got textiles, I wasn't sure if there was display graphics in there as well, but sort of how do you anticipate the rollout of Nozomi technology across your product lineup and how much of a new addressable market might it open up?

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Guy Gecht, Electronics for Imaging, Inc. - CEO, President & Director [7]

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Yes, so I'll tell you more in a high level versus giving more details because the competition is listening, too. But we're very pleased with what we accomplished with Nozomi with the technical and know-how and the reliability of machines from the beginning, was able to work many hours all the way to 24 hours day-by-day with some of our customers. There are -- we're going to leverage a lot of this technology and platform for our targeted markets. We're not going to get into new markets because there's plenty of opportunity in targets markets, but obviously textile is one of them and we talked about the project. We first today tell you, the code name is Bolt. It should be done by the end of the year. We're expecting -- not expecting revenue this year, but should be done by the end of the year based on our current schedule. And then, there will be follow-up in corrugated. We think the corrugated market is such a big market that the lineup is very important. And in other parts of market of packaging -- and I don't want to get to which parts -- there are also multibillion-dollar opportunities, something we are working on to bring this derivative of this platform to the market and capture on those opportunities. That's in the next few years, not necessarily anything next year.

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Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [8]

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Okay, thanks. And then, Marc, just a question and sort of a follow-up and this one. The sustainability of cash flows, how should we think about what drove the cash flow improvement? Specifically what measures you put in place to improve your cash conversion cycle this quarter and if that's sustainable? And then, can you talk a bit more about why you didn't buy back stock? What were the number of factors there?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [9]

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Yes, so we can't really comment on the factors as to why we didn't buy stock. There were just items in play that prohibited us from doing that. So that's -- we can't comment on things that we haven't disclosed publicly. So -- but in any case, to the other items, around the working capital, we basically started instituting much greater discipline across the organization in terms of inventory, forecasting and inventory management down at our individual product lines and started pushing out on vendors as well to match terms with vendors that we have to give to our customers. So we have some synergy there. We were able to make some progress with our Nozomi vendors, which we said initially, we were not -- we were having some challenges with at the start of the year. So I think it's really just blocking and tackling throughout the groups that was able -- that accomplish that. And you can see kind of it wasn't just one specific factor in the balance sheet metrics that caused the cash from operations improvement. It was better collections, better inventory across the company, better inventory management, I should say, payables increased sequentially as well so that's the vendor management. So it was a combination of all those really helped drive the cash improvement. Now as we mentioned, Q3 is going to be more challenging because of this -- not only the fact that we're making the 7 Nozomis, that we're scaling up the Nozomi production in Q3. Some of that stuff has started to come in already, but the fact that we're targeting to manufacture 10 for Q4 means that we're going to have to start ordering a number of those parts, and those machines are going to be in process at the end of the quarter.

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Operator [10]

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Your next question comes from the line of 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 [11]

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Congratulations, Guy. Kind of sticking to the Nozomi topic. I know that you've raised your expectation for the full year on a revenue basis. I think just the math looks like the system shipment number at roughly 24 system shipping for the full year is the same. So I'm curious, I know we're kind of splitting hairs here a little bit on $65 million of revenue, but what's driving the increased confidence to raise the full year revenue number? Is it just higher ink consumption that you're seeing in the initial deployments here or is there something else that you're now factoring into the expectations in the back half?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [12]

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Yes, so no, it's actually -- it's from the -- machine selling prices have been averaging higher than we were originally anticipating. In fact, the number of printers that we've sold have been over $4 million at this point in time, because people have been leaning more towards the fully configured printers. They're getting them with the 7 colors plus white. While we haven't yet commercialized the white, we're still on track to do that later this quarter. And while we won't see that much revenue from white ink this quarter, it still sets us up well going forward. They're buying just more -- really more of the fully optioned machine with everything built into it, which raises the average selling price above what we were expecting.

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Operator [13]

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And your next question comes from the line of Jim Suva from Citigroup.

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Jim Suva, Citigroup Inc, Research Division - Director [14]

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Definitely have to say that it would be very much missed to see Guy stepping down here. So thank you so much for the many years of service.

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Guy Gecht, Electronics for Imaging, Inc. - CEO, President & Director [15]

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Thank you, Jim.

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Jim Suva, Citigroup Inc, Research Division - Director [16]

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A quick question, I don't know if it's for Guy or for Marc, but can you talk a little bit about, first of all, Fiery. I think your guidance was for about $60 million and it came in this quarter, I think, a little bit better than expected, but your guidance for about $60 million again for Q3. What calls Fiery to be better than expected this reported quarter? And is $60 million the new run rate or is there something that could actually keep it higher?

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Guy Gecht, Electronics for Imaging, Inc. - CEO, President & Director [17]

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So, Jim, there are multiple factors that cause the Fiery to come a little higher. Obviously, when we give the guidance, we don't have all the information and all the orders that we're getting throughout the quarters from our partners. And so it wasn't -- cannot be precise. Obviously, we're happy that it came above, especially after the cycle down we had. There's some good success with the new Xerox mid-range system that we have. Ricoh launched a new product and started with a higher level of orders. And so we have some other things that materialized through the quarter that we didn't know about or were not sure about, let's put it this way, when we were on the call 3 months ago. As far as the run rate, we assume it's going to have around $60 million. It's -- obviously, we will try to push it further up and change the mix and work with our partners to have higher touch rate and hopefully at some point, we can go back to Asia Pacific, but definitely not in the short term. So right now our assumption is -- run rate is around $60 million. It has been -- we've been saying that, I think, since the Q4 of last year.

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Jim Suva, Citigroup Inc, Research Division - Director [18]

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And then, my last question is, I've been on the sell side for a very long time, so I understand there's lots of items in play that could prevent stock buyback. I know you're probably forbidden from giving much details around that, but can you talk about have all those items been removed? Was it multiple items? Was it one item? And any thoughts around that?

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

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So there were multiple items that were in play. we did say -- or I did mention in my statement that after we've resolved our review with the bankers on our options for the -- for our convertible debt for next year that we expect to be able to resume buyback, assuming nothing else emerges in the interim. But right now, that's the last remaining item for us to be able to resume doing the buyback.

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Jim Suva, Citigroup Inc, Research Division - Director [20]

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Okay, and my last question. Channel inventory of, a, your products or, b, consumables or, b, -- I'm sorry, ink or b or c or Fiery. Any comments around channel inventories? Are they normal, above, below of the 3 different buckets?

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

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Yes, so the only channel inventory that we really have out there is for Fiery -- with our Fiery partners. Nothing else is really inventoried with channels. And the Fiery-channel inventory is in our normal inventory range. So no real news there.

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Operator [22]

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Your next question comes from the line of Ananda Baruah from Loop Capital.

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Ananda Prosad Baruah, Loop Capital Markets LLC, Research Division - MD [23]

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First off, Guy, very sad, man. We'll definitely miss you, but look if you're happy and if you're pleased, then we're happy for you.

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Guy Gecht, Electronics for Imaging, Inc. - CEO, President & Director [24]

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Thank you very much, Ananda. As I said, I'm -- of course, it's bittersweet for me, but I think for EFI, it's a good time and a new leader I think will actually be a good positive thing for the company. And remember, I'm a shareholder and I'll stay as a board member, so I'm definitely going to stay connected and involved and looking forward to see much bigger success in the coming years.

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Ananda Prosad Baruah, Loop Capital Markets LLC, Research Division - MD [25]

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So we can still give you a hard time is what you're saying?

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Guy Gecht, Electronics for Imaging, Inc. - CEO, President & Director [26]

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Yes, exactly. As always.

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Ananda Prosad Baruah, Loop Capital Markets LLC, Research Division - MD [27]

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Okay, okay, well, you helped build a really cool company. It's been very successful over the years. So thank you for doing that, we could be a part of that. Yes, I guess, if I could just focus sort of on Nozomi a little bit, can you -- how would you have us understand the pipeline at this point in whatever context you think is most helpful for us? I know you sort of tease out a little amount of information in some of the conferences through the quarter, but that how would you have us think about how the pipeline has been growing in a way that'd be useful for us? And then, just could you talk a little bit about onboarding support staff to help your customer kind of get the printers implemented. I know that has been -- I don't want to call it a bottleneck, but has been sort of a resource that you've been pushing on, given the interest in Nozomi. How would you characterize support staff onboarding at this point as well? And then I have a follow-up.

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Guy Gecht, Electronics for Imaging, Inc. - CEO, President & Director [28]

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Sure. So, yes, couple of quarters ago, I mentioned that the pipeline reached, I think, I said over 150 leads, which is a very high number. And then I immediately decided to not give an update on the exact number. But I can tell you, it has been growing ever since. And the number right now is very strong and can -- with normal conversion rate, we will sell all the Nozomi we can make in the next couple of years, but we're assuming a slower conversion rate, but still going to be pretty good. So we have a lot of interest and that's not even including multiple units from some of the people that bought the first unit and definitely capable as I mentioned. Some of our customers have 100 locations around the world. And so the opportunities -- they're happy and successful making money is tremendous. As far as the support, it's a very good topic and this is something we kind of working really, really hard to staff it. Even when we move people, let's say, from Cretaprint support to Nozomi, they need to learn a lot. And Nozomi in the first few months, after we deployed the first unit, was a moving target. We continued to upgrade it, make it more stable, more reliable, better system. It's now a lot more stable. There's very few upgrades right now that need to happen to the new units. But we keep hiring people or moving people to this and train them. And obviously, with every installation, we want to make sure it's working well. Customers keep telling us that once their customers getting addicted to the color gamut and to the ability to change things very fast, it's difficult to take them back. So once it's working, has to work really well. So we paid a lot of attention to this and we're ramping up. And I think we have the right plan here, which allow us to feel little more confident about going to 7 units and then 8 units in Q4.

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Ananda Prosad Baruah, Loop Capital Markets LLC, Research Division - MD [29]

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You feel like the support staff onboarding, is it tight, but manageable? Or you are where you want to be kind of with your unit cadence right now? Or is it just straight-out [about that]?

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Guy Gecht, Electronics for Imaging, Inc. - CEO, President & Director [30]

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No, no, I think it's not a trivial challenge. We were in Spain last week, we spent hours on how to make sure that we're doing the right thing, hiring the right people, training the right people, deploying it with the right deployment, setting customer's expectation, making sure if there's a hiccup after the first few weeks, we're addressing as soon as possible. It definitely was a learning experience, but we're getting better and better based on what I can see. And I think we have a good plan in place to continue to get better. We, obviously, don't view the endgame as 7 units a quarter or 8 units a quarter. We like to sell more there is demand. We'd like to be able to deploy more, so that's a lot of deployments. When you think about 8 units we're going to sell in Q4, we got to make sure they commission early next year. So again, we can always do better. It is -- it wasn't without hiccups. It is challenging. I'm glad -- I feel good about where we're going with this.

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Operator [31]

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Your next question comes from the line of Katy Huberty from Morgan Stanley.

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Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [32]

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Guy, congratulations and good luck with the transition. Just a couple of questions from me. On Industrial Inkjet, if you back out the 5 Nozomi shipments, making an assumption around ASP, the rest of Industrial Inkjet growth slowed. Is that -- do you view that as just a temporary slowdown ahead of some of the new products that come out in the back half of the year and if that's the case, which quarter should be assume an acceleration in revenue growth ex Nozomi in Industrial Inkjet? Then I have a follow-up.

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [33]

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Yes. So first, as it -- while, of course, we haven't given the breakdowns of the different segments I will say that we did see decline in ceramics activity in the quarter. As I mentioned, ceramics was a little slower than we had anticipated. So there was some downward pressure there. On the display graphics side, I do think that there is, as we've spoken about in the past, as customers are waiting for some of the new platforms to launch, that the H3 platform that's supposed to launch in Q3, we'll see some limited impact from that in Q3 as we always try to ramp up slowly when we're launching a new product. And that it'll pick up steam in Q4 and beyond as more of the new platform gets out and we start ramping up production.

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Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [34]

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Okay. And you provided, Marc, some helpful color around the cash conversion cycle. On DSOs, specifically, have you been able to leverage any third parties to either get receivables off the balance sheet or to use third parties for financing on some of those large direct deals? And if not, do you think you can do more of that in the future?

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

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Yes, so we did -- we have talked about that in the past. I mentioned that we are trying to find some third parties to take some of our leasing deals that we have with customers on our balance sheet to be able to sell those. We have not done any of that yet. But we are still pursuing that and that could certainly help. Our leasing receivables did go down about $1.5 million, sequentially. So we didn't do a tremendous amount of new leases in the quarter and we just had our normal paydowns on the existing leases with customers, so that brought it down a little bit quarter-over-quarter. But we're certainly always looking for nice third-party sources for -- to push our customers too to get financing and we are continuing to investigate options there as well as selling some of our existing leases on our balance sheet that we have today. Since -- we're collecting interest on them, so they're very marketable without really costing us anything to take out, except collecting interest in the future.

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Operator [36]

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Your next question comes from the line of Jim Ricchiuti from Needham & Company.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [37]

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You may have received these questions, I joined the call a little bit late. But have you said how many multiple unit Nozomi customers you have?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [38]

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We did not speak to that. For competitive reasons, again, we're not discussing it. The only thing we've said to date is that Aurora, when they did their initial buy, they bought 2 of them from us. And we've said that there have been other multi-Nozomi purchases, but we have not given any details beyond that.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [39]

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Okay. And with respect to ink consumption, if we put aside one of the early customers, which may have been a bit of an anomaly customer in Ireland, what can you say about ink consumption based on what you're seeing with the installed base, admittedly, a small number as of now?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [40]

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Yes. So I think it's one of the things we've spoken about over the last few months has been that it's taking -- it takes about 6 months after the customer deploys the -- gets Nozomi installed, for them to really ramp up their ink volume because most of the customers are really waiting to go sell the Nozomi until it's fully operational in their facility and at that point, they work with their sales reps to start going -- presenting it to their customers. And so we're seeing about that 6-month lag before the ink starts to ramp up from the end customers or from our customers based on their end-customer demand. That being said, the -- we're still comfortable in the $0.5 million to $1 million range that we've given in the past for where we think the ink consumption is going to end up. And it's going to vary from customer to customer based upon how many shifts they run and what type of product they're producing.

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Operator [41]

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Your next question comes from the line of Joseph Wolf from Barclays.

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Joseph Eric Wolf, Barclays Bank PLC, Research Division - MD & Head of Equity Research [42]

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A quick one, again, on Nozomi. I just -- given the sensitivity, given -- with the second half unit counts of 15, can you just give us a little bit of a hint towards the geographic mix of that given you've sold to all the regions at this point? Just in terms of where the largest interest is right now?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [43]

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I would say, we're still seeing the strongest interest in the U.S. but -- and EMEA is second. I think that we're trying to also -- we're looking to expand our geographic presence beyond just U.S. and the countries we've been -- we're in today in Europe. So I think we want to get some presence in other areas of the globe that we're still not in yet. So we're going to try to get some initial clients set up in those areas. Again, it's -- we do have -- as Guy mentioned, the pipeline is very robust, so we're still trying to figure out kind of which deals to prioritize, which will get us the best future impact in terms of helping to drive market demand.

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Joseph Eric Wolf, Barclays Bank PLC, Research Division - MD & Head of Equity Research [44]

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And then, you did point to weakness in the ceramics business, but there was also a contract announcement in July, which looked like a fairly large order. Is that a one-off with an existing customer and we shouldn't get too excited? Or is there some sort of a turning point even in the ceramics business towards -- in the back half of the year?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [45]

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Yes, that was a one-off deal in China, a very nice deal that we signed there for a multi-printer purchase. But again, I -- because of the degree of penetration in the ceramics business, we're at 70% to 80% digital already. Without a significant change in technology, which we are still working on and trying to come up with some things that can be game-changers there, we don't see real acceleration possible in the ceramic equipment side of the business.

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Operator [46]

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Your next question comes from the line of Brian Drab from William Blair.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [47]

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Congratulations, Guy.

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Guy Gecht, Electronics for Imaging, Inc. - CEO, President & Director [48]

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Thank you very much, Brian.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [49]

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I just wanted to ask about a different segment, if we can talk about software for a second. But the software business is hard to model and my -- I think, our original expectation said it should be a high single-digit growth business and it's been on the decline really now for 3 quarters, 4 quarters and the margins also are under pressure, it seems, from mid-70s going back a year or 2 to 70% now. So what are your expectations over the next -- well, you choose the period -- and have they changed for this business?

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

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Well, I think actually, Brian, we're very pleased with how software has been performing this year. Remember, it was up 25% year-over-year in Q1. It was up 6.5% this quarter. So both at or above our expectations. We gave guidance for high single digit in Q3. So I think we're still feeling very good about what we've been talking about for that. I think we had some challenges last year for a couple of quarters, but I think it's back to performing the way we expect it to. In terms of the gross margin pressure that you mentioned, that's really a function of the fact that the -- we've been seeing the strongest growth in our software targeted at the corrugated segment and the software that we sell to the corrugated segment has some hardware components that are sold with it that are designed to monitor the performance of the equipment at the plant. And so the gross margin profile for those sales that we make there are a bit lower and that's what has brought the margin down a little bit from the levels it was at last year. But we're definitely pleased with where that business has been trending this year and certainly expect it to perform at the levels that we've guided in the past at that high single-digit level or beyond.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [51]

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Okay. I'm just looking at trending and I know FX plays a small role here too. But $45 million in the fourth quarter to $44 million to $42 million in the second to $40 million in the third, and that's why I asked the question, but I'm going to follow up more with you on that later and just...

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

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Yes, it is a very seasonal business, Brian. So I should -- I guess I should have pointed that out. But Q4 is always the largest quarter of the year by far and so...

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [53]

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I understand. I'll follow up with you more later. Even if you go first, second and third quarter, I'll just -- want to ask the question. But on Nozomi, can you give us any updated thoughts since it seems like it's going a little bit better than expected, what your plans are? Target is for hitting EBIT margin in line with the Industrial Inkjet segment or in line with the corporate average? When could you -- you pick the target -- when could you reach a target like that?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [54]

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So the key -- I'll -- instead of telling you a date, I'll give you a milestone for that. So the key for Nozomi getting to corporate inkjet gross margin levels are -- is really when Nozomi gets to the 1/3 ink, 2/3 equipment ratio that the rest of the Inkjet segment is at. And how fast that happens, of course, is a function of how fast the equipment grows. So if the equipment continues to accelerate, then obviously it's going to push off that time frame a little bit further into the future. So at a certain extent, it's -- the longer it takes, the better it is because it means that we're selling the equipment a lot faster than you would normally anticipate with -- versus our other segments.

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Operator [55]

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Your next question comes from the line of Joe Wittine from Longbow Research.

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Joseph Helmut Wittine, Longbow Research LLC - Research Analyst [56]

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First one on Nozomi. Marc, is there anything you can tell us about how you're thinking about your production capacity? On "a normalized basis" even if you're not willing to talk specifics, do you envision increasing your capacity on an ongoing basis throughout '19 or could you reach kind of a steady state or an appropriate level sooner?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [57]

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So we don't know kind of where the top end is for how Nozomi is going to progress. One thing, you can conclude from what we've said about Q4, we're going to be able to make 10 units in Q4. Now that's not going to a second shift. That's really just by leveraging some of the extra capacity at our Spanish facility because we've ramped down some of the ceramic activity. And so kind of -- so 10 per quarter is really kind of the new -- I'd say, the new normal, if you will, in terms of what the facility can manufacture, given their capacity there. In terms of whether we ramp up past that next year, that's really a function of whether the demand, well, let's say, the demand is there -- whether that closing by the sales team continues to ramp up and accelerate from the levels we've seen.

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Joseph Helmut Wittine, Longbow Research LLC - Research Analyst [58]

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Great. And then, in your GAAP reconciliation, there's an $11 million, I think it's a charge for -- or change, excuse me, in fair value consideration. I think that's reversing an Internet liability. Is that right? And if so, what acquisitions does it relate to?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [59]

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That's correct, Joe. And good catch for looking at the GAAP details already from the press release. But that actually deals with the Optitex earn-out where the second earn-out period expired at the end of Q2, and they did not hit the threshold that was required to pay that earn-out amount. As we mentioned when we did that acquisition, the earn-out was based on very aggressive targets for fairly high multiple of where the revenue was when we did the acquisition. And they were not able to hit that threshold for the second earn-out period, which caused the -- their earn-out accrual to be reversed. The -- it's -- Optitex is still a growing business for us. We're still very excited about its prospects for the future and its tie-in to the Reggiani product line, but we ended up not having to pay that $11 million that you noted.

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Operator [60]

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Your next question comes from the line of Ananda Baruah from Loop Capital.

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Ananda Prosad Baruah, Loop Capital Markets LLC, Research Division - MD [61]

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Just, Marc, going back to the Nozomi operating margin question, can you just update us on how we should now think about -- how you'd like us to think about Nozomi kind of growing that margin positive and how we should, in whatever context, think about that progression through the year -- whether it's positive or not -- that margin?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [62]

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Yes, sure. So we still -- we guided in the past that we expected Nozomi to be breakeven on an operating margin basis starting in Q3 and we're still on track for that for Q3. And then, moving to positive operating margins after that, but obviously, going to positive does not mean it's going to be at the corporate level overnight. But we have seen positive improvement in gross margin every quarter since we launched Nozomi and we expect that gross margin improvement to continue for a number of quarters into the future. And obviously, as Nozomi scales, we'll get better leverage with OpEx within that segment and we'll start to throw off some improved operating margin there.

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Operator [63]

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(Operator Instructions) Your next question comes from the line of Jim Suva from Citigroup.

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Jim Suva, Citigroup Inc, Research Division - Director [64]

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A quick follow-up for you on the ceramics. You've mentioned some softness. The overall economy, whether it be commercial real estate, renovations or even residential home building, has been quite strong. The softness there, is it related to the penetration rate? I think you'd mentioned that you've now hit about 70% to 80%. I think we should expect that to kind of even move run rate going forward. Or is there something unique to it? It just seems like the overall economy would support pretty strong ceramic [terms]?

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Marc D. Olin, Electronics for Imaging, Inc. - CFO [65]

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Yes, no. As you point out correctly, Jim, the building industry is quite strong right now. The overall economy is quite strong. But the penetration rate is almost 80% there in terms of digital in the ceramics business. So while there are -- there is an -- occasionally a new factory built here or there, there's still a lot of capacity in China for producing that, most of what we sell in ceramic equipment into Asia right now. And so again, unless there is a real replacement cycle of the equipment that's out there already, because you're already at close to 80%, there's just not that much room. They can just utilize the equipment they have to do more production, add extra shifts, things of that sort. And so we did see some recovery in our ink volumes on the ceramic side from what was a low point in Q1 and we're expecting to start to see the ink to ramp up again now and that's really our best opportunity to take advantage of the -- let's say, the health of the volumes in the industry. But from an equipment standpoint, we do think it's going to take some new technology to really drive a refresh cycle.

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Operator [66]

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And there are no further questions at this time. I'll turn the call back over to our presenters for some closing remarks.

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Guy Gecht, Electronics for Imaging, Inc. - CEO, President & Director [67]

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Thank you very much, everyone, for joining us today. I'm probably going to be on the next earning calls, but if not, I want to thank all the shareholders, the analysts that spend a lot of energy in following EFI and our journey and I know that this company is going to produce great results for all of us, and I want to thank the -- also the employees. They did a great job. In the last 34 quarters, we grew 33x, not a simple achievement. So thank you all for everything. I look forward to talking to many of you soon and continue to stay a big fan of this special company. Thank you very much.

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Operator [68]

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