electronics for imaging, inc. q2 2009 earnings call transcript
Electronics for Imaging, Inc. (NASDAQ:EFII) Q2 2009 Earnings Call July 29, 2009 5:00 PM ETExecutivesJoAnn Horne - Investor Relations - Market Street PartnersGuy Gecht - Chief Executive OfficerJohn Ritchie - Chief Financial OfficerAnalystsShannon Cross - Cross ResearchRichard Gardner - CitigroupKeith Bachman – Bank of MontrealAnanda Baruah – Brean MurrayOperatorGood afternoon, my name is Christy, and I'll be your conference operator today. At this time I'd like to welcome everyone to the EFI second quarter 2009 earnings conference call. All lines have been placed on mute to storage prevent any background noise.
After the speakers' remarks there'll be a question-and-answer session. (Operator Instructions).I'll now turn the call over to JoAnn Horne, Investor Relations for EFI.JoAnn HorneGood afternoon everyone. I have with me here today Guy Gecht, EFI's CEO and John Ritchie, our CFO.
Before we begin the prepared remarks, let me review the Safe Harbor statement. Please note that during the call and during the question-and-answer session that follows the company will be making many forward-looking statements, each of which involves a number of risks and uncertainties. Statements other than statements that are historical facts including words such as anticipate, believe, estimate, expect, consider, and plan and statements in future tense are forward-looking statements.
Statements that could be deemed forward-looking statements include but are not necessarily limited to, statements regarding opportunities for the inkjet segment, our planned industry-leading new products, and statements and assumptions underlying any of the foregoing. Past performance is not necessarily indicative of future results. Forward-looking statements are subject to certain risks and uncertainties that could cause our actual future results to differ materially or cause a material adverse impact on our results.
For further information please refer to the risk factors discussed in EFI's SEC filings; including but not limited to the Annual Report on Form 10-K as amended, the quarterly report on Form 10-Q, the Form 8-K filed with the SEC today, and the attached press releases.The company recommends that you read these documents in conjunction with the review of our financial statements. For your convenience, the company has posted slides on the website on the IR section at www.
efi.
com to give you an overview of much of the information the company will cover today. We undertake no obligation to update any forward-looking statements or information discussed today.In addition, references will be made to non-GAAP financial measures.
Our earnings release provides a reconciliation between GAAP and non-GAAP measures. These non-GAAP measures are not in accordance with or as an alternative for GAAP and may be materially different from non-GAAP measures, including serially titled non-GAAP measures used by other companies. The presentation of this additional information should not be considered in isolation from, as a substitute for, or superior to net income or earnings per diluted share prepared in accordance with GAAP.
Non-GAAP financial measures have limitations in that they do not reflect certain items that may have material impact upon our reported financial results.I'll now like to turn the call over to our Chief Executive Officer, Guy Gecht.Guy GechtGood afternoon everyone. While this quarter's results reflect the impact power of continued weak global demand and the challenges in our industry, the primary issue behind the sequential quarterly decline relates to the delay in shipping a key new product.
In Q2, we hadn't expected a sequential decline in our Fiery business, which we sought to offset with a significant rebound in our inkjet segments. The inkjet segment showed its first sequential growth in almost a year, and while we're pleased with the 13.6% sequential growth, we are disappointed with the delayed broad commercial availability of our new VUTEk GS 3200 product, a 3.
2 meter wide hybrid UV printer.
This delay led to results that were below the prior quarter. I will expand on our inkjet business and the new inkjet product lineup in a minute. As would be expected, the mix shift to inkjet revenues significantly impacted our gross margins.
While we saw a 90 basis point sequential improvements in inkjet gross margins, this level of gross margins is still significantly below the full potential of the business, as the operations are running far below capacity. In Q2, we also incurred expenses of approximately $0.01 per share related to the completion of streamlining of our ink production, including our UV ink factory consolidation and outsourcing solvent ink manufacturing to Nazdar.
We expect inkjet gross margin improvements as volumes recover, and we see the impact of power the restructuring efforts. On a geographical basis, we still believe that in the US, our business has stabilized at a new albeit low level, and we are encouraged that the uptick may point to a broader industry recovery. While we are seeing improvement in Asia and Latin America, we remain concerned about market conditions in Europe, where in addition to a tough environment, our customers continue to encounter difficulties in obtaining financing.
To offset the weakness in sales, we over-achieved on our own cost-saving goals, reducing operating expenses by roughly 22% compared to the same period last year, despite integrating two acquisitions over the past twelve months. In addition to cutting operating expense, we also cut expenses above the gross margin line, but this saving is more than offset by the substantial drop in volume from last year level.We cut our costs strategically in order to continue investing in growth areas, as storage you can see from the record number of new inkjet printers we are bringing to market in the next several months.
Looking forward, we will maintain a stringent focus on costs and seek to keep operating expenses sequentially flat in the current quarter despite upward pressure from increased tradeshow activity. Now let's look deeper at each of our business segments, starting with the inkjet category. As I mentioned, we are pleased to see sequential revenue increase, ink revenue increase, and segment gross margin improvement.
All are the first positive changes in a negative trend line since Q2 of last year. These positive trends have occurred in front of highly anticipated new product introductions. We are particularly encouraged that these positive signs have been achieved while the economy is still weak and financing is difficult.
We also believe that the 16.
5% sequential rebound in ink revenues is an indication that our customers are beginning to benefit from their customers increased spending on out of home advertising, especially campaigns that involve digitally printed short hand productions. We remain very excited about the six new inkjet products we plan to bring to market in the next several months. All indications are that these products will be very well received even during tough economic times.
Bringing this number of new products to market is a big undertaking at any time, and especially challenging when power our budgets are very tight and customers' criteria for spending is very high. I will expand more on the new products, but let's first focus on the VUTEk GS 3200 delay. We delayed the broad based commercial shipment of this product as we are committed to meeting the highest expectations of the market for this hybrid category production printer.
After a solid introduction at the ISA show in April and European show in May, where it was enthusiastically reviewed by the media, customers, and industry experts, we saw strong initial orders and intended to ship in late June; however, the complex nature of this state of the art technology which prints at about 2.5 times faster than our current top of the line UV based printer, and includes a large array of possible print configurations in revolutionary inkjet heads, led us to delay commercial shipments for some final calibrations. This printer which listed at roughly $600,000 is a big financial commitment for our customer base.
We already have units operational at customer sites, and we plan to gradually increase this number. However, we will only deploy it broadly and recognize revenue when we feel that the product is ready to substantially meet the customer's highest expectations. It is difficult to predict when this printer will be finalized for broad shipment and revenue recognition.
While we are hoping it is a matter of few weeks, at this point we will not take the risk of providing a specific date. Lastly on the new VUTEk lineup, as we are leveraging the technology and platform of the GS to launch the GSR, our first 5-meter wall to wall UV printer, we anticipate that the GSR will be commercially available in Q4. As we have discussed in the past, a key element of our inkjet strategy is to increase the addressable market for our product portfolio with a lineup that offers lower costs, lower speed, and high quality output.
The Rastek product line is aimed at that segment of the market. We are currently shipping our first product in that category, the Rastek 700, and expect to launch two new products the Rastek 650 and the Rastek 660 over the next several months. We are excited about the new lineup which will bring our UV printer entry point price to about $70,000 significantly below our lowest VUTEk lineup which starts today at roughly $180,000, allowing us to address a new market segment.
As with any new technology development project, the commercial availability of these two new printers is also subject to scheduling. The performance of our third line of UV inkjet printers, Jetrion, which targets the label market continues to be strong even in the current environment. Jetrion again posted better than 50% year over year growth, as more label printers are increasingly recognizing the value in converting from analog to digital printing.
We are planning to expand the Jetrion product line later this year as we further leverage our investment in this fast growing industry. Turning to the Fiery business, the results of the segment were largely in line with our expectations due to the anticipated tightening of inventory levels by our OEM partners. However, we ere disappointed by the lack of recovery in the sales of production engines by our OEMs, and the ongoing shift toward lower-end engines.
We do expect that as in the past when the economy recovers we will see a pickup in production space. In the near term, these trends have a double impact on EFI, as we often don't have the solution at the low end.The combination of the lower sales through, the downward mix shift, and the current quarter being seasonally low for our OEMs lead us to expect that the Fiery business will be roughly at the same level this quarter.
From an engine roadmap perspective, we are excited about the recently announced new Canon engine lineup. We closely collaborated with Canon for two years in developing this new platform and are very enthusiastic about the opportunity this will provide. While we expect minimal revenue from this lineup in the current quarter, we do anticipate meaningful revenue in the fourth quarter.
We are also closely collaborating with Xerox, Rico, and Konica Minolta on new engines. The current launch will be our last major production introduction in 2009 since budget cuts and technology challenges pushed out a few of our OEM engines to 2010. The pushouts limits our revenue recovery for the Fiery business in the short term, but will make 2010 a busy year on the new OEM engine introductions front.
Lastly, our app business was impacted by the longer sales cycle and delayed deals that have characterized this economic cycle. Revenues were down 1.6% year over year with North America growing 7% and Europe declining 35%. We expect apps to be roughly flat quarter over quarter in Q3 with the completion of large deals currently in our pipeline representing an upside.
To briefly summarize the results this quarter, in a very tough environment we saw a return to growth in our inkjet business without yet the benefit of the new product lineup. Despite our focus on cost cutting this past year, we have maintained our commitment to aggressively expand our inkjet product line with innovative, state-of-the-art offerings. Looking at the September quarter, the most significant wildcard is the inkjet segment revenue driven by our new product shipments.
If we record revenue for all new products scheduled for introduction this quarter, we will see a solid sequential growth in our inkjet business.The normal visibility inherent in our Fiery and apps businesses gives us greater confidence in our outlook for Q3 revenue for both businesses at roughly the same level of Q2. We intend to hold expenses fairly flat quarter over quarter with gross margins depending largely on product mix.
Looking forward, our excitement about the inkjet opportunity has not wavered, and while we are very focused on executing in the short term and getting back to profitability as soon as we can, we don't want to lose sight of our overall strategy, the transformation of the company, the lower cost base for the future, our lower share count, and the significant opportunities ahead for all segments of our business. As we bring our 6 new inkjet printers to the market, EFI will have in our view the most competitive UV product lineup in both wide format and labels. As we place small printers with customers, our growing ink supply revenue will continue to grow.
We expect to see some significant benefit on this new lineup without any economic improvements and of course even more significant benefit if we start to see demand in marketing spend come back to past deal levels. Of course any improvement in our industry should also bode well for our Fiery business which is set to have a busy year with product introductions in 2010.Now I will turn the call over to John for further financial details on the quarter, and then we will be happy to answer your questions.
John RitchieI'll now go over the detailed financial results for the second quarter of 2009. Revenues came in at $90.1 million, down 6% sequentially and down 37% on a year-over-year basis. The non-GAAP net loss for the quarter was $0.
12 per share, down from $0.
08 in the first quarter of the year and down from $0.22 in the prior year's quarter. The GAAP net loss for the quarter was $0.27, down from net income of $0.52 in the first quarter of '09 and down from breakeven in the second quarter of '08.
I will not be going through a reconciliation between our GAAP and non-GAAP results as this information is posted on the Investor Relations portion of our website.Before I go through the quarter in detail, I want to highlight some key data points from the quarter. Our non-OEM sales were 59% of total revenues, a record for non-OEM sales.
Our recurring revenues were 29% of total, another record. As a reminder, our recurring revenues primarily consist of inks related to our inkjet businesses and software maintenance contracts.The inkjet business itself recorded revenues of $36.
5 million in the second quarter, representing an almost 14% sequential increase. Each product line in this category including VUTEk, Jetrion, and Rastek experienced double digit revenue growth on a sequential basis. Within the inkjet category itself, we've seen significant sequential improvements with our ink revenues, with those revenues growing 16% sequentially.
Our UV ink revenues reversed a two-quarter slide and grew 20% on a sequential basis and 2% on a year over year basis. Solvent ink revenues saw a 10% increase on a sequential basis.During the quarter, we also completed the consolidation of our UV ink facilities.
The transition costs with this consolidation cost approximately $0.01 out of our $0.12 loss. One of the benefits we saw as part of this consolidation was the substantial decline in our inventory levels of ink during the quarter. We also completed the outsourcing of our ink solvent production to Nazdar.
This is a significant step in helping us variabilize our cost structure. We continue to aggressively manager operating expenses as we navigate through these touch economic times. Our non-GAAP operating expenses of $56.7 million were down 4.4% sequentially and 21.7% on a year-over-year basis. This is the lowest absolute spending level the company has experienced since the second quarter of 2005.
This was accomplished through a company wide reduction in force, reduced T&E expenses, lower compensation expenses, and lower spending on all other discretionary items. Moving now onto revenue by geographies, revenues in the Americas were down across most product lines 7% on a sequential basis and 27% on a year over year basis. The significant year over year declines occurred in the Fiery product line, down 38%, and the inkjet business, down 25%.
Our apps business grew 7% on a year over year basis. EMEA revenues saw a broad based decline spread across most of our product lines. For the second consecutive quarter, the global economic slowdown continued to impact our EMEA revenues more severely than the North American region.
Although this sequential decline was a modest 3% from already low levels in Q1, the year over year decline was almost 50%.Japanese revenues were down 35% on a sequential basic and 50% on a year over year basis. These declines were driven by a falloff in our Fiery business, and finally for the rest of the world, sales were up 89% sequentially and down 25% on a year over year basis, albeit off of a small base.
The improvement in our rest of world category was almost completely driven by improvements in our inkjet business.Now moving on to our results by our product lines, as expected, our Fiery revenues came in on plan at about $40.2 million, down 18% from Q1 of '09 and down 44% on a year over year basis.
Fiery revenues were 45% of total company revenues for the quarter, down from 51% in the prior quarter. Fiery revenues declined across nearly all product lines within the Fiery product category. For Q3, we expect revenue results similar to Q2 levels, reversing a 3-year trend of a seasonal quarter over quarter decline for this business.
For the second quarter, our inkjet products contributed 40% of revenue, or $36.5 million, compared to 33% of revenue or $32.1 million in the first quarter of 2008, a sequential increase of 14%.
Year over year revenues were down 37% in total, primarily driven by lower volumes of VUTEk printers partially offset by significant increases in Jetrion and Rastek printer placements. Overall, ink revenues increased 16%. As we mentioned before, we believe ink volumes are a key indicator of the demand our customers are seeing. We believe this positive trend supports our comment from the Q1 call that the first quarter will mark a trough for the inkjet business.
For the third quarter, our inkjet results will be dependent upon the timing of our recognizing of the GS product revenue.Moving on to the apps category, the apps product line contributed 15% of our total revenues, or $13.4 million, down 1.6% on a year over year basis and down 10% sequentially.
The revenue shortfall relative to our initial expectations related to significant softness in Europe. For Q3, we expect the results to be roughly in line with the Q2 revenue level. Moving onto gross margins, gross margins for the second quarter were 52.
2%, down from 55.
3% in the first quarter of '09 and down from 57.3% in Q2 of '08. The decline in gross margins was driven by a mix shift towards lower margin in our inkjet products and one-time costs related to the transition of our ink consolidation plant strategy. In Q3, we expect inkjet margins to be flat to up based on the timing of the launch of the GS products.
Overall, we expect that the total gross margin for Q3 to be slightly down as a result of potential mix shift towards our inkjet product line.Turning to expenses, R&D expenses $26.2 million, down $1.8 million or 6.5% from the first quarter and down 6.2 million or 19.2% on the year-over-year basis. The decrease in R&D was driven by lower compensation expense and lower discretionary spending. In the second quarter, R&D expenses represented 29% of revenue, relatively flat with Q1 spending levels.
Sales and marketing costs were $24.
2 million, up $700,000 or 3% when compared to $23.5 million in the first quarter of 2009, and down $5.9 million or almost 20% on a year-over-year basis.
The sequential increase in sales and marketing spending was driven primarily by seasonal trade show activity, partially offset by lower variable compensation expense and headcount reductions. For the second quarter, sales and marketing expenses represented 26.9% of revenue, compared to 24.4% in the first quarter of '09.Moving onto G&A costs, they came in at $6.
4 million, or down $1.
5 million or 19.
3% from the first quarter of '09 spending levels and down $3.6 million or 36% on a year-over-year basis. The lower G&A spending levels were primarily attributable to lower bad debt expense, significant declines in legal spending, and a decrease in compensation associated with a reduction in force.
For the second quarter, G&A expenses represented 7% of revenue, compared to 8.2% of revenue in the first quarter of 2009. Our total non GAAP expenses, excluding the impact of recurring amortization of acquisition related intangibles, stock-based compensation expense, non-recurring charges and gains such as restructuring costs, asset impairment charges, and the gain on the sale of land and building, and the tax-related effect of these adjustments were down $2.
6 million or 4.
4% to a total of $56.
7 million in the second quarter compared to $59.4 million in first quarter of '09 and down 21.7% from $72.5 million in the second quarter of '08.As we've discussed in previous conference calls, we have taken decisive actions focused on lowering our overall cost structure on a more permanent basis, such as facility closures and headcount reductions.
In addition, we've instituted a number of temporary measures to respond more immediately to the economic downturn such as travel restrictions, freezes on pay, limited bonuses and limited hiring. We expect Q3 non-GAAP spending levels to remain approximately flat with Q2 spending levels. As Q3 is also a busy tradeshow quarter, we expect offset the incremental tradeshow costs with additional cost reductions.
On a year over year basis, we expect Q3 spending to be down approximately 18%.Our Q2 operating margins were negative 10.7%, a decline from the negative 6.4% in the prior quarter and down from the 7% operating margins we experienced in the year ago period.
Other income came in at $2 million and was $2.5 million higher than the prior quarter, primarily driven by foreign exchange gains and about $1 million in interest income. Rounding out the P&L, for Q2 our tax rate came in at 20% compared to 35% in Q1 of '09, driven by lower levels of profitability in low tax jurisdictions.
At our current levels of profitability, small changes in either geographic mix or product mix in our worldwide sales may have a significant impact on our tax rate in the future quarters.The change in our tax rate from 35% to 20% in the quarter cost us approximately $0.02 of earnings in the quarter, largely offsetting any of the benefit that we saw from our FX gains.
Moving onto headcount, at the end of Q2 full-time headcount was 1830 employees, down 83 employees from the first quarter. Our headcount is down approximately 10% from levels that we saw at the beginning of the year.Turning to the balance sheet, we ended the second quarter with $278.
9 million in cash, cash equivalents and short term investments, a decrease of about $8.5 million compared with the $287.4 million in the prior quarter. Our net cash used for operations was approximately $5 million, when adjusting with the balance of the cash consumed for restructuring activities.Our net inventory balance was $42.9 million at the end of the quarter, a decrease of $3.
3 million compared to Q1 level.
The lower inventory levels are primarily driven by our steps to reduce finished goods inventory related to printer shipments and also saw the benefit of our ink consolidation and outsourcing programs.Account receivable increased to $69.5 million compared to $68.6 million at the end of the first quarter. Overall, DSOs increased as expected to 70 days from 64 days in the prior quarter.
This was primarily driven by the expected mix shift towards our inkjet product lines which typically have longer payment terms as well as sales linearity within the quarter. As we've previously mentioned, we are also offering selected customers extended credit terms which also impact our DSOs. The DSOs for the third quarter will be dependent upon the timing of the shipment of our GS product line.
Now with that complete, I'll open up the call for questions.JoAnn HorneOperator, we'll take questions now please.Question-and-Answer SessionOperator(Operator Instructions).
Your first question comes from Shannon Cross with Cross Research.Shannon Cross - Cross ResearchWith the sequential improvement, and we all look sequentially now because we don't want to look year over year, and that's not just for your company, but my question is with ink what exactly do you think is driving the increased demand for ink? Any verticals, anything we can point to say this is sustainable? I'm curious as to what your customers as saying?Guy Gecht If you look at the revenue, Shannon, first of all we see that UV is growing sequentially, and solvent is shrinking sequentially, and it's part of what we've always said. Our focus was always on solvents. Since we got into UV, we never spent any energy on new products in solvents.
In that regard, we see a continued shift, and of course the UV was up more than the overall segment. When we look at globally on a sequential basis, North America grew better than overall, but Europe also grew sequentially which was a very good sign. From a segment of the business, we're seeing across the board just better spending with our customers which means that in the retail space and point of purchase, people are spending a little bit more.
I also would like to think that since normally VUTEk represents the highest quality and highest speed and not necessarily the lowest cost, I think our customers are finding that when there is a smaller pie, maybe it's an easier to compete on some of the smaller pie because they provide better turnaround time and better quality than our competitor's customers. Hopefully, that will explain, but in general, I think people are spending more. There is more marketing money, not at the level of last year, but more than at the level of Q1, and the good news is that in July we're seeing a continuation of that.
So far this quarter, the ink continued to improve, and overall anything that causes our customers to utilize the printer more and to get more money and more profit, at some point in the future, it will turn into more printer sales for us.Shannon Cross - Cross ResearchI had a question for John on funding for this equipment. You put in place that program. I am curious as to what you're hearing from customers in terms of their availability to funding, if you've looked into any potential impact from CIT.
Theoretically you're too far removed maybe on the controller side to have much insight, but anything you've heard from the OEMs as well on what they're hearing.John Ritchie I can tell you specifically the experience we're seeing. In the US, there is more funding available.
It's still not a great environment, but the environment has improved since the beginning of the year. In Europe, I think the easiest way to describe Europe is think of the US 7 to 8 months ago, it is very challenging to get financing in Europe for our customers. We have customers that have solid businesses, and we looked at these customers and we decided to extend terms ourselves.
Now, we're not getting into multiyear terms like the leasing firms, but we're doing what we can in terms of using the balance sheet to help get deals closed. On the CIT, we've worked with CIT in the past. They weren't particularly active with us over the past year.
I think the decline there has been going on for a while. They are more active in Asia, and they're still writing leases in Asia. They're still writing leases for us in Asia.
Shannon Cross - Cross ResearchOn cash flow, I think there was a use of about $5 million this quarter on an operating basis, but how should we think about cash flow going forward? Anything coming up in the near term in terms of year over year or sequential things we should take into account, and do you feel pretty comfortable that over time you'll obviously return to a cash positive situation?John Ritchie I want to answer that last question first. Absolutely, we're confident we'll return to a cash positive situation. Our primary focus right now is moving the needle on cash generation, and we think the quickest way to move the needle on cash generation is to get these new products out and drive revenue growth.
Now moving forward, we expect that if we were to lose money in the next quarter that our cash loss will be less than our operating income loss, must like what you just saw in the first quarter, but we're absolutely focused on getting back to a cash flow positive business.OperatorYour next question comes from the line of Richard Gardner – Citigroup.Richard Gardner - CitigroupYou talked about 16.
5% sequential growth in ink revenue in the quarter. I think you told us last quarter that ink was down 18% year over year. Can you give us the year over year growth rate for ink in Q2?Guy Gecht I think it was mid teens.
John is going to look up that question.
Richard Gardner - CitigroupI was hoping you could give us some help on the percentage of COGS that's fixed versus variable, and what I'm trying to get at is whether there is going to be a big hit to the gross margins as you bring down inventory levels in the future quarters.John Ritchie The short answer to that is no, there shouldn't be. The component in terms of the quality of inventory right now is moving up.
From our inventory, we've taken out some of our ink inventory levels, and percentage of our current inventory levels that relate to new higher margin products has actually improved, so we should see margin expansion as opposed to margin contraction as we work down on inventory.Guy GechtThe biggest driver of margins in the inkjet segment is the volume. Last year, it was 33-1/2 if I remember the number correctly, and the biggest driver was volume, and of course our hope is that as volume picks up, we are going to see obviously improvement in gross margins as we will have more printers to share the fixed costs over.
Richard Gardner – CitigroupJohn, by the end of the year, where would you like days of inventory to be on the balance sheet?John RitchieI look at it in terms of inventory turns as opposed to days. You get to the same answer. I think we should be able to improve it by at least one turn between now and the end of the year.Richard Gardner – CitigroupAnd the ink decline?John RitchieI don't have the information right in front of me.
Rich, if I get it during the call, I'll pipe in with the answer.OperatorThe next question comes from the line of Keith Bachman with Bank of Montreal.Keith Bachman – Bank of MontrealI wanted to follow on from Rich's question if I could on the first one.
John you mentioned the sequential growth of ink this quarter. What do you think ink growth does in the September quarter sequentially?John RitchieWe are going to give you a non-answer answer. We are not giving specific guidance for the quarter, but we would expect to see some level of sequential improvement.
It could be up to what we saw in the current quarter, but I don't think we are in a position to get much more specific than that.Keith Bachman – Bank of MontrealWhat's your sense on the drivers of that? Many of the other sectors that we are involved with have seen some inventory restocking versus usage, and let's say it is up sequentially, do you have a sense about if you look at your customers covered so to speak, any kind of comments or color on usage versus inventory restocking if it is up sequentially? John RitchieWe believe the sequential increase that we experienced in the second quarter was through increased asset utilization or increased printer utilization by our customers. There is a very short cycle time between their order placement to us and their actual print job.
Keep in mind, our customers are relatively small businesses and they are cash flow centric, so they try to tie the ink purchase as close as they can to the production of the actual print job.Keith Bachman – Bank of MontrealSo mostly demand is what you're saying.John RitchieBut circling back on the question that was unanswered, the year over year decline was 15.
3%.
Keith Bachman – Bank of MontrealMy second question is on the equipment that you are placing now on the inkjet side, any sense on new customers versus existing? Is it materially different from what it has been, and I have one followup from that.Guy GechtI would say that when the business was much more healthy and growing, we saw a lot of new customers. In printing, there is a good margin to be made in digital, printing of wide format, and I think we see a lot less of that.
People that are not in the business are getting in. Obviously the pie for those customers is also smaller, and so a lot of sales is go to existing customers. We hope that as things improve, we're going to start to see again expansion of the number of customers clearly.
I would say that if I look at the pipeline of customers for the new GS product, unfortunately we didn't see any revenue, although we shipped some units last quarter up to today, I think most of them if not all of them are existing businesses in this wide format. For example, next week, we have the Connect User conference, and we're showing the GS to selected the customers, and we already have 30 businesses, 60 customers, 60 people from 30 businesses coming to see, but they all are existing businesses in our space for that specific demo for us, so the only exception to this case is that we are expanding the total addressable market with Rastek, so now that we will have $70,000 going all the way to $150,000 on Rastek. With the printers we are going to bring to the market under that brand, we will appeal to completely a new type of customers.
People that have different requirements, a lot smaller runs, smaller space, still very high expectations as far as quality, and that obviously will expand.Keith Bachman – Bank of MontrealMy related question is as you bring these new products to market, how does that expand the product family in terms of price points and/or does it drive new customers or do you think you're selling to your existing customer base?Guy GechtFirst of all as I mentioned the GS product is listed at $600,000. That's a very high number compared to historically where we were, but something that prints 2.
5 times better and it's a fantastic printer. We feel very comfortable where we are compared to other competitors in that. We have a pipeline of customers. That certainly is a very good news from an ASP perspective, and again Rastek will see people that buy the printer at $70,000.
The Rastek, of course, is a very different printer, and the economics are very different. With the Rastek, you pay a lot more for ink, more than 2X. It will definitely expand the availability.
Today, if we're kind of $180,000 to $400,000, we'll be $70,000 to $600,000 in several months, which is a much larger installed base. As the economy is depressed, I'm not expecting too many people that are not in out-of-home advertisement to get into this because there is a lot involved in getting into this space, and while the pie is smaller, mainly it's going to be existing customers, but as things start to come back and start to improve there's a lot more analog printing that need to move to digital in this space, I certainly expect to see some customers that never been in this type of category to get into this and start to use our products as well as competitor products.OperatorThe next question comes from the line of Ananda Baruah from Brean Murray.
Ananda Baruah – Brean MurrayI wanted to just touch base on the controller business. I know that you had made comments last quarter that you thought maybe this quarter could be somewhat of a bottom. It sounds like you're expecting flat revenues in the September quarter as well or flattish revenue in controllers, but I also heard some comments that you may kind of categorize controllers where almost you led me to believe that it was surprisingly weak this quarter, so I just want to get a clarification on that number one, and number two, if you saw any meaningful shift in trends within the controller business, that would be great too.
Guy Gecht To be honest with you, and if you asked me few months ago if I'm expecting the controllers to be up sequentially Q3, I would have said yes given the fact that in Q2 we knew the OEMs are going to clean up their inventory, and I would say without naming names, three out of four did a pretty good job in cleaning up the level of inventory. There is one more that needs to do it in this quarter, so that to some degree, I would agree. I'd categorize that as disappointing being flat, but the other thing you need factor is that still this is equipment only, so there is no recurring revenue due.
Our sweet spot is this area.
In our OEMs, color is being hit the most. Our OEMs are seeing a mix shift downward, and in some cases actually getting us out of the deal because if somebody buys a printer where the Fiery is either too expensive or not even offered because we never developed a Fiery for that low level of printer, we're not getting involved, we're not getting any percentage of the sale, and lastly I think the very significant Canon announcement of lineup which they will shift to market in Q4 is not really helping this quarter. As I said, there is no meaningful revenue this quarter, but we'll be meaningful in Q4.
Part of what I said just to make sure the story is complete is that we were counting on a few engines for this year, and not surprisingly as we saw in other downturns, I think that shifted to 2010, budgets got cut, technology was challenging, but 2010 is shaping up to be a pretty busy year for new engine introductions, so we're hopeful that whatever economy improvement we'll see will benefit our Fiery business.Ananda Baruah – Brean MurrayJust to follow on to that, I think you guys mentioned last quarter there was a $10.3 million number as an inventory number for remaining work-down.
You mentioned 3 or 4 OEMs have cleaned up the inventory situation. Can you give us a sense for that means revenue wise?Guy Gecht On the last earnings release, we said that the Fiery number came at $49 million for Q1, and there is an $8 to $9 million over-desired inventory level that OEMs are determined to clean and to get back to the desired inventory level in Q2, and that's why we are saying that the fact we came at 40 is about in line with our expectations, and so overall, the numbers that we are seeing after the quarter end and the last week or so from the OEMs is pointing to at least 3 of 4 did a pretty significant job in reducing their inventory, and the remaining fourth I think will do it this quarter, so I think that from that perspective, we are more or less down on that front.Ananda Baruah – Brean MurrayThe weakness in Europe not withstanding, it sounds like you guys are positioning your comments around September expectations to say that the June-September quarter might be the bottoming period from a revenue perspective despite some I guess still if you can call them secular areas of softness.
Is that a correct interpretation?John Ritchie I think in terms of when we think our business has bottomed, we thought the inkjet business bottomed in the first quarter. We think facts have proven that correct. We think the controller business bottomed in the second quarter.
The debate is when do we start seeing a recovery off of that, so we think we have already hit the bottom. What can help the current quarter is the GS product, but we're going to stay away because we are not going to give a specific launch date on that. We're going to stay away specific guidance for the third quarter, but I think the key takeaway from us is that the inkjet business is definitely on a rebound.
Utilization rates are up, ink consumption is up, and we think that is comforting. It proves that we are spending the R&D dollars in the right space because we think that's what will drive revenue growth in the future. We're going to be a little reticent to give you an exact data as to when that revenue growth will come and how the impact will be with the launch of these new products, but the market is there.
OperatorOur last question comes from the line of Shannon Cross with Cross Research.Shannon Cross – Cross ResearchI was thinking about how you look at R&D and you're thinking about where you are putting your dollars these days, and with some of the push-outs of some of the development by your partners on the controller side, just how are you making the decisions on what controllers to support or what engines to support, and are you shifting dollars back to some of the Jetrion and some of the other business units? I'm just curious as to how you're looking at it and how you're positioning your expenditures on the R&D side for 2010 and beyond.Guy GechtFirst of all, you're correct in the assumption that while we cut across the board, we went very strategically and looked at every category and every project and every partner to see how much if at all we are going to spend of that, and if you remember three months ago on our conference call, we said that top of the line inkjet product, the GS, we felt that that's something that we can postpone for now and not go in to the market until the market will improve because the level of customers that will buy this level is not that high.
We were encouraged with the feedback and the results, and we are still are offering the GS at substantially below $1 million price tag, so definitely looking at which product we're spending. I would say in the inkjet, we do have a lot of products. We feel that all of them will have very positive effect on our business when they launch and over the long term, and obviously every machine we sell, we will continue to generate very good gross margin ink over years to come as we are seeing, that's pretty helpful.
As far as on the controller business, over the last couple of years we did a lot of work to make sure we only working on things that generate profit in relatively short term, so for example, I'm now only talking about four OEMs. If you remember couple of years ago we had a lot more. We had other names that were not one of the market leaders, so we definitely cut on that.
We're cutting more on customization as well. We only do the OEM customizations that we think are essential for the differentiation and we lever it. We are much more efficient in development, and another thing is we've shifted a lot more resources not just in our Fiery business across the board to our office in India, so while the numbers are down in North American employees, there is a bigger mix shift with a lot of the jobs are now in our India office.
That helped definitely on the saving in OpEx, and that's a permanent change. There are a lot of very brilliant minds obviously outside of India, mainly in US and also Europe that we don't think we're going to move their jobs; they are the best in the industry, but clearly a lot of the software development could be moved to India, and we've executed on that.Shannon Cross – Cross ResearchLast question I had is just on cash.
It's a good thing to have, and you obviously have a lot it and you are precluded from share repurchase with the ASR that you have in place for a while, but any thoughts other than it's a nice thing to have in terms of deployment of it in 2010, your thoughts on ongoing share repurchase going forward, and things like that.Guy GechtSo you answered the part on the buyback. Obviously, our goal one is to make sure we are consuming anymore of this cash and actually adding to it from operations.
We're super focused on that, and then beyond that, our business development guys continue to meet with companies, we continue to look at that, but we didn't feel that valuations are at the level to justify the current market conditions. We feel that we have enough on our plate, at least for the short term that if we executed on we will see benefit from, but maybe in the future, we'll move better on acquisitions as maybe prices will reflect reality. Maybe reality will become a lot better, so we continue to look at that.
The board will continue to discuss buyback as that becomes available again, and we will continue to focus on growing this cash balance.OperatorWe have a followup question from the line of Keith Bachman from Bank of Montreal.Keith Bachman – Bank of MontrealJohn, just wondering if there is any way to bound what do you think the ink jet product category could do in the September quarter? There is some variability with high-end product, but is there a way to bound what the variability is associated with how that plays out in the September quarter?John RitchieUnfortunately, Keith, we're not going to be able to answer that specifically.
There is so much of the quarter dependent upon the launch of the GS product.Guy GechtKeith, just to make sure that we are clear. I said it, but maybe not specifically enough, but we are shipping the GS.
We shipped a few, people are using it.
We'll ship more and more.
The question will be when is it going to be broadly available and when do we feel that we can recognize revenue for this.Keith Bachman – Bank of MontrealBut even just isolating that product, is that a $2 million swing factor or any kind of isolation of that variability?John RitchieWe're just not comfortable going down that path Keith.Guy GechtThere are too many valuables right now to give a precise answer to that.
OperatorWe have no further questions in the queue.Guy GechtAs always, we appreciate the loyalty and support of our shareholders, customers, and employees, and we are working very hard to get the new inkjet product lineup to the market, and we look forward to giving
After the speakers' remarks there'll be a question-and-answer session. (Operator Instructions).I'll now turn the call over to JoAnn Horne, Investor Relations for EFI.JoAnn HorneGood afternoon everyone. I have with me here today Guy Gecht, EFI's CEO and John Ritchie, our CFO.
Before we begin the prepared remarks, let me review the Safe Harbor statement. Please note that during the call and during the question-and-answer session that follows the company will be making many forward-looking statements, each of which involves a number of risks and uncertainties. Statements other than statements that are historical facts including words such as anticipate, believe, estimate, expect, consider, and plan and statements in future tense are forward-looking statements.
Statements that could be deemed forward-looking statements include but are not necessarily limited to, statements regarding opportunities for the inkjet segment, our planned industry-leading new products, and statements and assumptions underlying any of the foregoing. Past performance is not necessarily indicative of future results. Forward-looking statements are subject to certain risks and uncertainties that could cause our actual future results to differ materially or cause a material adverse impact on our results.
For further information please refer to the risk factors discussed in EFI's SEC filings; including but not limited to the Annual Report on Form 10-K as amended, the quarterly report on Form 10-Q, the Form 8-K filed with the SEC today, and the attached press releases.The company recommends that you read these documents in conjunction with the review of our financial statements. For your convenience, the company has posted slides on the website on the IR section at www.
efi.
com to give you an overview of much of the information the company will cover today. We undertake no obligation to update any forward-looking statements or information discussed today.In addition, references will be made to non-GAAP financial measures.
Our earnings release provides a reconciliation between GAAP and non-GAAP measures. These non-GAAP measures are not in accordance with or as an alternative for GAAP and may be materially different from non-GAAP measures, including serially titled non-GAAP measures used by other companies. The presentation of this additional information should not be considered in isolation from, as a substitute for, or superior to net income or earnings per diluted share prepared in accordance with GAAP.
Non-GAAP financial measures have limitations in that they do not reflect certain items that may have material impact upon our reported financial results.I'll now like to turn the call over to our Chief Executive Officer, Guy Gecht.Guy GechtGood afternoon everyone. While this quarter's results reflect the impact power of continued weak global demand and the challenges in our industry, the primary issue behind the sequential quarterly decline relates to the delay in shipping a key new product.
In Q2, we hadn't expected a sequential decline in our Fiery business, which we sought to offset with a significant rebound in our inkjet segments. The inkjet segment showed its first sequential growth in almost a year, and while we're pleased with the 13.6% sequential growth, we are disappointed with the delayed broad commercial availability of our new VUTEk GS 3200 product, a 3.
2 meter wide hybrid UV printer.
This delay led to results that were below the prior quarter. I will expand on our inkjet business and the new inkjet product lineup in a minute. As would be expected, the mix shift to inkjet revenues significantly impacted our gross margins.
While we saw a 90 basis point sequential improvements in inkjet gross margins, this level of gross margins is still significantly below the full potential of the business, as the operations are running far below capacity. In Q2, we also incurred expenses of approximately $0.01 per share related to the completion of streamlining of our ink production, including our UV ink factory consolidation and outsourcing solvent ink manufacturing to Nazdar.
We expect inkjet gross margin improvements as volumes recover, and we see the impact of power the restructuring efforts. On a geographical basis, we still believe that in the US, our business has stabilized at a new albeit low level, and we are encouraged that the uptick may point to a broader industry recovery. While we are seeing improvement in Asia and Latin America, we remain concerned about market conditions in Europe, where in addition to a tough environment, our customers continue to encounter difficulties in obtaining financing.
To offset the weakness in sales, we over-achieved on our own cost-saving goals, reducing operating expenses by roughly 22% compared to the same period last year, despite integrating two acquisitions over the past twelve months. In addition to cutting operating expense, we also cut expenses above the gross margin line, but this saving is more than offset by the substantial drop in volume from last year level.We cut our costs strategically in order to continue investing in growth areas, as storage you can see from the record number of new inkjet printers we are bringing to market in the next several months.
Looking forward, we will maintain a stringent focus on costs and seek to keep operating expenses sequentially flat in the current quarter despite upward pressure from increased tradeshow activity. Now let's look deeper at each of our business segments, starting with the inkjet category. As I mentioned, we are pleased to see sequential revenue increase, ink revenue increase, and segment gross margin improvement.
All are the first positive changes in a negative trend line since Q2 of last year. These positive trends have occurred in front of highly anticipated new product introductions. We are particularly encouraged that these positive signs have been achieved while the economy is still weak and financing is difficult.
We also believe that the 16.
5% sequential rebound in ink revenues is an indication that our customers are beginning to benefit from their customers increased spending on out of home advertising, especially campaigns that involve digitally printed short hand productions. We remain very excited about the six new inkjet products we plan to bring to market in the next several months. All indications are that these products will be very well received even during tough economic times.
Bringing this number of new products to market is a big undertaking at any time, and especially challenging when power our budgets are very tight and customers' criteria for spending is very high. I will expand more on the new products, but let's first focus on the VUTEk GS 3200 delay. We delayed the broad based commercial shipment of this product as we are committed to meeting the highest expectations of the market for this hybrid category production printer.
After a solid introduction at the ISA show in April and European show in May, where it was enthusiastically reviewed by the media, customers, and industry experts, we saw strong initial orders and intended to ship in late June; however, the complex nature of this state of the art technology which prints at about 2.5 times faster than our current top of the line UV based printer, and includes a large array of possible print configurations in revolutionary inkjet heads, led us to delay commercial shipments for some final calibrations. This printer which listed at roughly $600,000 is a big financial commitment for our customer base.
We already have units operational at customer sites, and we plan to gradually increase this number. However, we will only deploy it broadly and recognize revenue when we feel that the product is ready to substantially meet the customer's highest expectations. It is difficult to predict when this printer will be finalized for broad shipment and revenue recognition.
While we are hoping it is a matter of few weeks, at this point we will not take the risk of providing a specific date. Lastly on the new VUTEk lineup, as we are leveraging the technology and platform of the GS to launch the GSR, our first 5-meter wall to wall UV printer, we anticipate that the GSR will be commercially available in Q4. As we have discussed in the past, a key element of our inkjet strategy is to increase the addressable market for our product portfolio with a lineup that offers lower costs, lower speed, and high quality output.
The Rastek product line is aimed at that segment of the market. We are currently shipping our first product in that category, the Rastek 700, and expect to launch two new products the Rastek 650 and the Rastek 660 over the next several months. We are excited about the new lineup which will bring our UV printer entry point price to about $70,000 significantly below our lowest VUTEk lineup which starts today at roughly $180,000, allowing us to address a new market segment.
As with any new technology development project, the commercial availability of these two new printers is also subject to scheduling. The performance of our third line of UV inkjet printers, Jetrion, which targets the label market continues to be strong even in the current environment. Jetrion again posted better than 50% year over year growth, as more label printers are increasingly recognizing the value in converting from analog to digital printing.
We are planning to expand the Jetrion product line later this year as we further leverage our investment in this fast growing industry. Turning to the Fiery business, the results of the segment were largely in line with our expectations due to the anticipated tightening of inventory levels by our OEM partners. However, we ere disappointed by the lack of recovery in the sales of production engines by our OEMs, and the ongoing shift toward lower-end engines.
We do expect that as in the past when the economy recovers we will see a pickup in production space. In the near term, these trends have a double impact on EFI, as we often don't have the solution at the low end.The combination of the lower sales through, the downward mix shift, and the current quarter being seasonally low for our OEMs lead us to expect that the Fiery business will be roughly at the same level this quarter.
From an engine roadmap perspective, we are excited about the recently announced new Canon engine lineup. We closely collaborated with Canon for two years in developing this new platform and are very enthusiastic about the opportunity this will provide. While we expect minimal revenue from this lineup in the current quarter, we do anticipate meaningful revenue in the fourth quarter.
We are also closely collaborating with Xerox, Rico, and Konica Minolta on new engines. The current launch will be our last major production introduction in 2009 since budget cuts and technology challenges pushed out a few of our OEM engines to 2010. The pushouts limits our revenue recovery for the Fiery business in the short term, but will make 2010 a busy year on the new OEM engine introductions front.
Lastly, our app business was impacted by the longer sales cycle and delayed deals that have characterized this economic cycle. Revenues were down 1.6% year over year with North America growing 7% and Europe declining 35%. We expect apps to be roughly flat quarter over quarter in Q3 with the completion of large deals currently in our pipeline representing an upside.
To briefly summarize the results this quarter, in a very tough environment we saw a return to growth in our inkjet business without yet the benefit of the new product lineup. Despite our focus on cost cutting this past year, we have maintained our commitment to aggressively expand our inkjet product line with innovative, state-of-the-art offerings. Looking at the September quarter, the most significant wildcard is the inkjet segment revenue driven by our new product shipments.
If we record revenue for all new products scheduled for introduction this quarter, we will see a solid sequential growth in our inkjet business.The normal visibility inherent in our Fiery and apps businesses gives us greater confidence in our outlook for Q3 revenue for both businesses at roughly the same level of Q2. We intend to hold expenses fairly flat quarter over quarter with gross margins depending largely on product mix.
Looking forward, our excitement about the inkjet opportunity has not wavered, and while we are very focused on executing in the short term and getting back to profitability as soon as we can, we don't want to lose sight of our overall strategy, the transformation of the company, the lower cost base for the future, our lower share count, and the significant opportunities ahead for all segments of our business. As we bring our 6 new inkjet printers to the market, EFI will have in our view the most competitive UV product lineup in both wide format and labels. As we place small printers with customers, our growing ink supply revenue will continue to grow.
We expect to see some significant benefit on this new lineup without any economic improvements and of course even more significant benefit if we start to see demand in marketing spend come back to past deal levels. Of course any improvement in our industry should also bode well for our Fiery business which is set to have a busy year with product introductions in 2010.Now I will turn the call over to John for further financial details on the quarter, and then we will be happy to answer your questions.
John RitchieI'll now go over the detailed financial results for the second quarter of 2009. Revenues came in at $90.1 million, down 6% sequentially and down 37% on a year-over-year basis. The non-GAAP net loss for the quarter was $0.
12 per share, down from $0.
08 in the first quarter of the year and down from $0.22 in the prior year's quarter. The GAAP net loss for the quarter was $0.27, down from net income of $0.52 in the first quarter of '09 and down from breakeven in the second quarter of '08.
I will not be going through a reconciliation between our GAAP and non-GAAP results as this information is posted on the Investor Relations portion of our website.Before I go through the quarter in detail, I want to highlight some key data points from the quarter. Our non-OEM sales were 59% of total revenues, a record for non-OEM sales.
Our recurring revenues were 29% of total, another record. As a reminder, our recurring revenues primarily consist of inks related to our inkjet businesses and software maintenance contracts.The inkjet business itself recorded revenues of $36.
5 million in the second quarter, representing an almost 14% sequential increase. Each product line in this category including VUTEk, Jetrion, and Rastek experienced double digit revenue growth on a sequential basis. Within the inkjet category itself, we've seen significant sequential improvements with our ink revenues, with those revenues growing 16% sequentially.
Our UV ink revenues reversed a two-quarter slide and grew 20% on a sequential basis and 2% on a year over year basis. Solvent ink revenues saw a 10% increase on a sequential basis.During the quarter, we also completed the consolidation of our UV ink facilities.
The transition costs with this consolidation cost approximately $0.01 out of our $0.12 loss. One of the benefits we saw as part of this consolidation was the substantial decline in our inventory levels of ink during the quarter. We also completed the outsourcing of our ink solvent production to Nazdar.
This is a significant step in helping us variabilize our cost structure. We continue to aggressively manager operating expenses as we navigate through these touch economic times. Our non-GAAP operating expenses of $56.7 million were down 4.4% sequentially and 21.7% on a year-over-year basis. This is the lowest absolute spending level the company has experienced since the second quarter of 2005.
This was accomplished through a company wide reduction in force, reduced T&E expenses, lower compensation expenses, and lower spending on all other discretionary items. Moving now onto revenue by geographies, revenues in the Americas were down across most product lines 7% on a sequential basis and 27% on a year over year basis. The significant year over year declines occurred in the Fiery product line, down 38%, and the inkjet business, down 25%.
Our apps business grew 7% on a year over year basis. EMEA revenues saw a broad based decline spread across most of our product lines. For the second consecutive quarter, the global economic slowdown continued to impact our EMEA revenues more severely than the North American region.
Although this sequential decline was a modest 3% from already low levels in Q1, the year over year decline was almost 50%.Japanese revenues were down 35% on a sequential basic and 50% on a year over year basis. These declines were driven by a falloff in our Fiery business, and finally for the rest of the world, sales were up 89% sequentially and down 25% on a year over year basis, albeit off of a small base.
The improvement in our rest of world category was almost completely driven by improvements in our inkjet business.Now moving on to our results by our product lines, as expected, our Fiery revenues came in on plan at about $40.2 million, down 18% from Q1 of '09 and down 44% on a year over year basis.
Fiery revenues were 45% of total company revenues for the quarter, down from 51% in the prior quarter. Fiery revenues declined across nearly all product lines within the Fiery product category. For Q3, we expect revenue results similar to Q2 levels, reversing a 3-year trend of a seasonal quarter over quarter decline for this business.
For the second quarter, our inkjet products contributed 40% of revenue, or $36.5 million, compared to 33% of revenue or $32.1 million in the first quarter of 2008, a sequential increase of 14%.
Year over year revenues were down 37% in total, primarily driven by lower volumes of VUTEk printers partially offset by significant increases in Jetrion and Rastek printer placements. Overall, ink revenues increased 16%. As we mentioned before, we believe ink volumes are a key indicator of the demand our customers are seeing. We believe this positive trend supports our comment from the Q1 call that the first quarter will mark a trough for the inkjet business.
For the third quarter, our inkjet results will be dependent upon the timing of our recognizing of the GS product revenue.Moving on to the apps category, the apps product line contributed 15% of our total revenues, or $13.4 million, down 1.6% on a year over year basis and down 10% sequentially.
The revenue shortfall relative to our initial expectations related to significant softness in Europe. For Q3, we expect the results to be roughly in line with the Q2 revenue level. Moving onto gross margins, gross margins for the second quarter were 52.
2%, down from 55.
3% in the first quarter of '09 and down from 57.3% in Q2 of '08. The decline in gross margins was driven by a mix shift towards lower margin in our inkjet products and one-time costs related to the transition of our ink consolidation plant strategy. In Q3, we expect inkjet margins to be flat to up based on the timing of the launch of the GS products.
Overall, we expect that the total gross margin for Q3 to be slightly down as a result of potential mix shift towards our inkjet product line.Turning to expenses, R&D expenses $26.2 million, down $1.8 million or 6.5% from the first quarter and down 6.2 million or 19.2% on the year-over-year basis. The decrease in R&D was driven by lower compensation expense and lower discretionary spending. In the second quarter, R&D expenses represented 29% of revenue, relatively flat with Q1 spending levels.
Sales and marketing costs were $24.
2 million, up $700,000 or 3% when compared to $23.5 million in the first quarter of 2009, and down $5.9 million or almost 20% on a year-over-year basis.
The sequential increase in sales and marketing spending was driven primarily by seasonal trade show activity, partially offset by lower variable compensation expense and headcount reductions. For the second quarter, sales and marketing expenses represented 26.9% of revenue, compared to 24.4% in the first quarter of '09.Moving onto G&A costs, they came in at $6.
4 million, or down $1.
5 million or 19.
3% from the first quarter of '09 spending levels and down $3.6 million or 36% on a year-over-year basis. The lower G&A spending levels were primarily attributable to lower bad debt expense, significant declines in legal spending, and a decrease in compensation associated with a reduction in force.
For the second quarter, G&A expenses represented 7% of revenue, compared to 8.2% of revenue in the first quarter of 2009. Our total non GAAP expenses, excluding the impact of recurring amortization of acquisition related intangibles, stock-based compensation expense, non-recurring charges and gains such as restructuring costs, asset impairment charges, and the gain on the sale of land and building, and the tax-related effect of these adjustments were down $2.
6 million or 4.
4% to a total of $56.
7 million in the second quarter compared to $59.4 million in first quarter of '09 and down 21.7% from $72.5 million in the second quarter of '08.As we've discussed in previous conference calls, we have taken decisive actions focused on lowering our overall cost structure on a more permanent basis, such as facility closures and headcount reductions.
In addition, we've instituted a number of temporary measures to respond more immediately to the economic downturn such as travel restrictions, freezes on pay, limited bonuses and limited hiring. We expect Q3 non-GAAP spending levels to remain approximately flat with Q2 spending levels. As Q3 is also a busy tradeshow quarter, we expect offset the incremental tradeshow costs with additional cost reductions.
On a year over year basis, we expect Q3 spending to be down approximately 18%.Our Q2 operating margins were negative 10.7%, a decline from the negative 6.4% in the prior quarter and down from the 7% operating margins we experienced in the year ago period.
Other income came in at $2 million and was $2.5 million higher than the prior quarter, primarily driven by foreign exchange gains and about $1 million in interest income. Rounding out the P&L, for Q2 our tax rate came in at 20% compared to 35% in Q1 of '09, driven by lower levels of profitability in low tax jurisdictions.
At our current levels of profitability, small changes in either geographic mix or product mix in our worldwide sales may have a significant impact on our tax rate in the future quarters.The change in our tax rate from 35% to 20% in the quarter cost us approximately $0.02 of earnings in the quarter, largely offsetting any of the benefit that we saw from our FX gains.
Moving onto headcount, at the end of Q2 full-time headcount was 1830 employees, down 83 employees from the first quarter. Our headcount is down approximately 10% from levels that we saw at the beginning of the year.Turning to the balance sheet, we ended the second quarter with $278.
9 million in cash, cash equivalents and short term investments, a decrease of about $8.5 million compared with the $287.4 million in the prior quarter. Our net cash used for operations was approximately $5 million, when adjusting with the balance of the cash consumed for restructuring activities.Our net inventory balance was $42.9 million at the end of the quarter, a decrease of $3.
3 million compared to Q1 level.
The lower inventory levels are primarily driven by our steps to reduce finished goods inventory related to printer shipments and also saw the benefit of our ink consolidation and outsourcing programs.Account receivable increased to $69.5 million compared to $68.6 million at the end of the first quarter. Overall, DSOs increased as expected to 70 days from 64 days in the prior quarter.
This was primarily driven by the expected mix shift towards our inkjet product lines which typically have longer payment terms as well as sales linearity within the quarter. As we've previously mentioned, we are also offering selected customers extended credit terms which also impact our DSOs. The DSOs for the third quarter will be dependent upon the timing of the shipment of our GS product line.
Now with that complete, I'll open up the call for questions.JoAnn HorneOperator, we'll take questions now please.Question-and-Answer SessionOperator(Operator Instructions).
Your first question comes from Shannon Cross with Cross Research.Shannon Cross - Cross ResearchWith the sequential improvement, and we all look sequentially now because we don't want to look year over year, and that's not just for your company, but my question is with ink what exactly do you think is driving the increased demand for ink? Any verticals, anything we can point to say this is sustainable? I'm curious as to what your customers as saying?Guy Gecht If you look at the revenue, Shannon, first of all we see that UV is growing sequentially, and solvent is shrinking sequentially, and it's part of what we've always said. Our focus was always on solvents. Since we got into UV, we never spent any energy on new products in solvents.
In that regard, we see a continued shift, and of course the UV was up more than the overall segment. When we look at globally on a sequential basis, North America grew better than overall, but Europe also grew sequentially which was a very good sign. From a segment of the business, we're seeing across the board just better spending with our customers which means that in the retail space and point of purchase, people are spending a little bit more.
I also would like to think that since normally VUTEk represents the highest quality and highest speed and not necessarily the lowest cost, I think our customers are finding that when there is a smaller pie, maybe it's an easier to compete on some of the smaller pie because they provide better turnaround time and better quality than our competitor's customers. Hopefully, that will explain, but in general, I think people are spending more. There is more marketing money, not at the level of last year, but more than at the level of Q1, and the good news is that in July we're seeing a continuation of that.
So far this quarter, the ink continued to improve, and overall anything that causes our customers to utilize the printer more and to get more money and more profit, at some point in the future, it will turn into more printer sales for us.Shannon Cross - Cross ResearchI had a question for John on funding for this equipment. You put in place that program. I am curious as to what you're hearing from customers in terms of their availability to funding, if you've looked into any potential impact from CIT.
Theoretically you're too far removed maybe on the controller side to have much insight, but anything you've heard from the OEMs as well on what they're hearing.John Ritchie I can tell you specifically the experience we're seeing. In the US, there is more funding available.
It's still not a great environment, but the environment has improved since the beginning of the year. In Europe, I think the easiest way to describe Europe is think of the US 7 to 8 months ago, it is very challenging to get financing in Europe for our customers. We have customers that have solid businesses, and we looked at these customers and we decided to extend terms ourselves.
Now, we're not getting into multiyear terms like the leasing firms, but we're doing what we can in terms of using the balance sheet to help get deals closed. On the CIT, we've worked with CIT in the past. They weren't particularly active with us over the past year.
I think the decline there has been going on for a while. They are more active in Asia, and they're still writing leases in Asia. They're still writing leases for us in Asia.
Shannon Cross - Cross ResearchOn cash flow, I think there was a use of about $5 million this quarter on an operating basis, but how should we think about cash flow going forward? Anything coming up in the near term in terms of year over year or sequential things we should take into account, and do you feel pretty comfortable that over time you'll obviously return to a cash positive situation?John Ritchie I want to answer that last question first. Absolutely, we're confident we'll return to a cash positive situation. Our primary focus right now is moving the needle on cash generation, and we think the quickest way to move the needle on cash generation is to get these new products out and drive revenue growth.
Now moving forward, we expect that if we were to lose money in the next quarter that our cash loss will be less than our operating income loss, must like what you just saw in the first quarter, but we're absolutely focused on getting back to a cash flow positive business.OperatorYour next question comes from the line of Richard Gardner – Citigroup.Richard Gardner - CitigroupYou talked about 16.
5% sequential growth in ink revenue in the quarter. I think you told us last quarter that ink was down 18% year over year. Can you give us the year over year growth rate for ink in Q2?Guy Gecht I think it was mid teens.
John is going to look up that question.
Richard Gardner - CitigroupI was hoping you could give us some help on the percentage of COGS that's fixed versus variable, and what I'm trying to get at is whether there is going to be a big hit to the gross margins as you bring down inventory levels in the future quarters.John Ritchie The short answer to that is no, there shouldn't be. The component in terms of the quality of inventory right now is moving up.
From our inventory, we've taken out some of our ink inventory levels, and percentage of our current inventory levels that relate to new higher margin products has actually improved, so we should see margin expansion as opposed to margin contraction as we work down on inventory.Guy GechtThe biggest driver of margins in the inkjet segment is the volume. Last year, it was 33-1/2 if I remember the number correctly, and the biggest driver was volume, and of course our hope is that as volume picks up, we are going to see obviously improvement in gross margins as we will have more printers to share the fixed costs over.
Richard Gardner – CitigroupJohn, by the end of the year, where would you like days of inventory to be on the balance sheet?John RitchieI look at it in terms of inventory turns as opposed to days. You get to the same answer. I think we should be able to improve it by at least one turn between now and the end of the year.Richard Gardner – CitigroupAnd the ink decline?John RitchieI don't have the information right in front of me.
Rich, if I get it during the call, I'll pipe in with the answer.OperatorThe next question comes from the line of Keith Bachman with Bank of Montreal.Keith Bachman – Bank of MontrealI wanted to follow on from Rich's question if I could on the first one.
John you mentioned the sequential growth of ink this quarter. What do you think ink growth does in the September quarter sequentially?John RitchieWe are going to give you a non-answer answer. We are not giving specific guidance for the quarter, but we would expect to see some level of sequential improvement.
It could be up to what we saw in the current quarter, but I don't think we are in a position to get much more specific than that.Keith Bachman – Bank of MontrealWhat's your sense on the drivers of that? Many of the other sectors that we are involved with have seen some inventory restocking versus usage, and let's say it is up sequentially, do you have a sense about if you look at your customers covered so to speak, any kind of comments or color on usage versus inventory restocking if it is up sequentially? John RitchieWe believe the sequential increase that we experienced in the second quarter was through increased asset utilization or increased printer utilization by our customers. There is a very short cycle time between their order placement to us and their actual print job.
Keep in mind, our customers are relatively small businesses and they are cash flow centric, so they try to tie the ink purchase as close as they can to the production of the actual print job.Keith Bachman – Bank of MontrealSo mostly demand is what you're saying.John RitchieBut circling back on the question that was unanswered, the year over year decline was 15.
3%.
Keith Bachman – Bank of MontrealMy second question is on the equipment that you are placing now on the inkjet side, any sense on new customers versus existing? Is it materially different from what it has been, and I have one followup from that.Guy GechtI would say that when the business was much more healthy and growing, we saw a lot of new customers. In printing, there is a good margin to be made in digital, printing of wide format, and I think we see a lot less of that.
People that are not in the business are getting in. Obviously the pie for those customers is also smaller, and so a lot of sales is go to existing customers. We hope that as things improve, we're going to start to see again expansion of the number of customers clearly.
I would say that if I look at the pipeline of customers for the new GS product, unfortunately we didn't see any revenue, although we shipped some units last quarter up to today, I think most of them if not all of them are existing businesses in this wide format. For example, next week, we have the Connect User conference, and we're showing the GS to selected the customers, and we already have 30 businesses, 60 customers, 60 people from 30 businesses coming to see, but they all are existing businesses in our space for that specific demo for us, so the only exception to this case is that we are expanding the total addressable market with Rastek, so now that we will have $70,000 going all the way to $150,000 on Rastek. With the printers we are going to bring to the market under that brand, we will appeal to completely a new type of customers.
People that have different requirements, a lot smaller runs, smaller space, still very high expectations as far as quality, and that obviously will expand.Keith Bachman – Bank of MontrealMy related question is as you bring these new products to market, how does that expand the product family in terms of price points and/or does it drive new customers or do you think you're selling to your existing customer base?Guy GechtFirst of all as I mentioned the GS product is listed at $600,000. That's a very high number compared to historically where we were, but something that prints 2.
5 times better and it's a fantastic printer. We feel very comfortable where we are compared to other competitors in that. We have a pipeline of customers. That certainly is a very good news from an ASP perspective, and again Rastek will see people that buy the printer at $70,000.
The Rastek, of course, is a very different printer, and the economics are very different. With the Rastek, you pay a lot more for ink, more than 2X. It will definitely expand the availability.
Today, if we're kind of $180,000 to $400,000, we'll be $70,000 to $600,000 in several months, which is a much larger installed base. As the economy is depressed, I'm not expecting too many people that are not in out-of-home advertisement to get into this because there is a lot involved in getting into this space, and while the pie is smaller, mainly it's going to be existing customers, but as things start to come back and start to improve there's a lot more analog printing that need to move to digital in this space, I certainly expect to see some customers that never been in this type of category to get into this and start to use our products as well as competitor products.OperatorThe next question comes from the line of Ananda Baruah from Brean Murray.
Ananda Baruah – Brean MurrayI wanted to just touch base on the controller business. I know that you had made comments last quarter that you thought maybe this quarter could be somewhat of a bottom. It sounds like you're expecting flat revenues in the September quarter as well or flattish revenue in controllers, but I also heard some comments that you may kind of categorize controllers where almost you led me to believe that it was surprisingly weak this quarter, so I just want to get a clarification on that number one, and number two, if you saw any meaningful shift in trends within the controller business, that would be great too.
Guy Gecht To be honest with you, and if you asked me few months ago if I'm expecting the controllers to be up sequentially Q3, I would have said yes given the fact that in Q2 we knew the OEMs are going to clean up their inventory, and I would say without naming names, three out of four did a pretty good job in cleaning up the level of inventory. There is one more that needs to do it in this quarter, so that to some degree, I would agree. I'd categorize that as disappointing being flat, but the other thing you need factor is that still this is equipment only, so there is no recurring revenue due.
Our sweet spot is this area.
In our OEMs, color is being hit the most. Our OEMs are seeing a mix shift downward, and in some cases actually getting us out of the deal because if somebody buys a printer where the Fiery is either too expensive or not even offered because we never developed a Fiery for that low level of printer, we're not getting involved, we're not getting any percentage of the sale, and lastly I think the very significant Canon announcement of lineup which they will shift to market in Q4 is not really helping this quarter. As I said, there is no meaningful revenue this quarter, but we'll be meaningful in Q4.
Part of what I said just to make sure the story is complete is that we were counting on a few engines for this year, and not surprisingly as we saw in other downturns, I think that shifted to 2010, budgets got cut, technology was challenging, but 2010 is shaping up to be a pretty busy year for new engine introductions, so we're hopeful that whatever economy improvement we'll see will benefit our Fiery business.Ananda Baruah – Brean MurrayJust to follow on to that, I think you guys mentioned last quarter there was a $10.3 million number as an inventory number for remaining work-down.
You mentioned 3 or 4 OEMs have cleaned up the inventory situation. Can you give us a sense for that means revenue wise?Guy Gecht On the last earnings release, we said that the Fiery number came at $49 million for Q1, and there is an $8 to $9 million over-desired inventory level that OEMs are determined to clean and to get back to the desired inventory level in Q2, and that's why we are saying that the fact we came at 40 is about in line with our expectations, and so overall, the numbers that we are seeing after the quarter end and the last week or so from the OEMs is pointing to at least 3 of 4 did a pretty significant job in reducing their inventory, and the remaining fourth I think will do it this quarter, so I think that from that perspective, we are more or less down on that front.Ananda Baruah – Brean MurrayThe weakness in Europe not withstanding, it sounds like you guys are positioning your comments around September expectations to say that the June-September quarter might be the bottoming period from a revenue perspective despite some I guess still if you can call them secular areas of softness.
Is that a correct interpretation?John Ritchie I think in terms of when we think our business has bottomed, we thought the inkjet business bottomed in the first quarter. We think facts have proven that correct. We think the controller business bottomed in the second quarter.
The debate is when do we start seeing a recovery off of that, so we think we have already hit the bottom. What can help the current quarter is the GS product, but we're going to stay away because we are not going to give a specific launch date on that. We're going to stay away specific guidance for the third quarter, but I think the key takeaway from us is that the inkjet business is definitely on a rebound.
Utilization rates are up, ink consumption is up, and we think that is comforting. It proves that we are spending the R&D dollars in the right space because we think that's what will drive revenue growth in the future. We're going to be a little reticent to give you an exact data as to when that revenue growth will come and how the impact will be with the launch of these new products, but the market is there.
OperatorOur last question comes from the line of Shannon Cross with Cross Research.Shannon Cross – Cross ResearchI was thinking about how you look at R&D and you're thinking about where you are putting your dollars these days, and with some of the push-outs of some of the development by your partners on the controller side, just how are you making the decisions on what controllers to support or what engines to support, and are you shifting dollars back to some of the Jetrion and some of the other business units? I'm just curious as to how you're looking at it and how you're positioning your expenditures on the R&D side for 2010 and beyond.Guy GechtFirst of all, you're correct in the assumption that while we cut across the board, we went very strategically and looked at every category and every project and every partner to see how much if at all we are going to spend of that, and if you remember three months ago on our conference call, we said that top of the line inkjet product, the GS, we felt that that's something that we can postpone for now and not go in to the market until the market will improve because the level of customers that will buy this level is not that high.
We were encouraged with the feedback and the results, and we are still are offering the GS at substantially below $1 million price tag, so definitely looking at which product we're spending. I would say in the inkjet, we do have a lot of products. We feel that all of them will have very positive effect on our business when they launch and over the long term, and obviously every machine we sell, we will continue to generate very good gross margin ink over years to come as we are seeing, that's pretty helpful.
As far as on the controller business, over the last couple of years we did a lot of work to make sure we only working on things that generate profit in relatively short term, so for example, I'm now only talking about four OEMs. If you remember couple of years ago we had a lot more. We had other names that were not one of the market leaders, so we definitely cut on that.
We're cutting more on customization as well. We only do the OEM customizations that we think are essential for the differentiation and we lever it. We are much more efficient in development, and another thing is we've shifted a lot more resources not just in our Fiery business across the board to our office in India, so while the numbers are down in North American employees, there is a bigger mix shift with a lot of the jobs are now in our India office.
That helped definitely on the saving in OpEx, and that's a permanent change. There are a lot of very brilliant minds obviously outside of India, mainly in US and also Europe that we don't think we're going to move their jobs; they are the best in the industry, but clearly a lot of the software development could be moved to India, and we've executed on that.Shannon Cross – Cross ResearchLast question I had is just on cash.
It's a good thing to have, and you obviously have a lot it and you are precluded from share repurchase with the ASR that you have in place for a while, but any thoughts other than it's a nice thing to have in terms of deployment of it in 2010, your thoughts on ongoing share repurchase going forward, and things like that.Guy GechtSo you answered the part on the buyback. Obviously, our goal one is to make sure we are consuming anymore of this cash and actually adding to it from operations.
We're super focused on that, and then beyond that, our business development guys continue to meet with companies, we continue to look at that, but we didn't feel that valuations are at the level to justify the current market conditions. We feel that we have enough on our plate, at least for the short term that if we executed on we will see benefit from, but maybe in the future, we'll move better on acquisitions as maybe prices will reflect reality. Maybe reality will become a lot better, so we continue to look at that.
The board will continue to discuss buyback as that becomes available again, and we will continue to focus on growing this cash balance.OperatorWe have a followup question from the line of Keith Bachman from Bank of Montreal.Keith Bachman – Bank of MontrealJohn, just wondering if there is any way to bound what do you think the ink jet product category could do in the September quarter? There is some variability with high-end product, but is there a way to bound what the variability is associated with how that plays out in the September quarter?John RitchieUnfortunately, Keith, we're not going to be able to answer that specifically.
There is so much of the quarter dependent upon the launch of the GS product.Guy GechtKeith, just to make sure that we are clear. I said it, but maybe not specifically enough, but we are shipping the GS.
We shipped a few, people are using it.
We'll ship more and more.
The question will be when is it going to be broadly available and when do we feel that we can recognize revenue for this.Keith Bachman – Bank of MontrealBut even just isolating that product, is that a $2 million swing factor or any kind of isolation of that variability?John RitchieWe're just not comfortable going down that path Keith.Guy GechtThere are too many valuables right now to give a precise answer to that.
OperatorWe have no further questions in the queue.Guy GechtAs always, we appreciate the loyalty and support of our shareholders, customers, and employees, and we are working very hard to get the new inkjet product lineup to the market, and we look forward to giving
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