During the past few years, companies have sought to cut all non-essential expenses. Office equipment was among the many items that saw a sharp slowdown in demand. But like all other hard goods, copiers and the like tend to wear out over time. So as the economy moves into recovery mode, a replacement cycle can't be too far off.

This cycle should play right into the hands of Electronics for Imaging (Nasdaq: EFII), which provides the printer engines that go into high-end machines offered by companies like Canon (NYSE: CAJ), Xerox (NYSE: XRX) and Epson. These companies are starting to see a nice turnaround in demand that is in turn fueling a turnaround for EFI.

It's fair to wonder why those esteemed firms wouldn't simply develop their own printer engines. The answer lies in EFII's massive R&D spending, which has enabled the company to stay on the leading edge of printer capabilities. EFII knows that those customers are great at selling, and it prefers to keep it simple by focusing on product advancements that help to maintain its cutting edge reputation.

EFII routinely spends more than $100 million on annual R&D -- and that accounted for nearly 25% of sales last year. The payoff: EFII is rolling out a range of new products in both its inkjet division (42% of sales) and Fiery printing engines division (47% of sales). Fiery is the brand name for EFII's state-of-the-art printer systems.

EFII was duly humbled by the recent downturn after many years of profitable growth. But if history is any guide, a solid rebound could be in the offing. Back in 2002, the company saw sales fall from $518 million to $350 million. As the economy rebounded in the ensuing decade, sales steadily rebounded to $621 million by 2007. But they fell back again in 2008, and quite sharply in 2009, all the way down to $401 million.

Yet a snapshot of recent trends indicates that we're entering another rebound phase. Quarterly sales, which fell to the $90 to $95 million range in the first two quarters of 2009, recently moved back north of $100 million -- to $114 million in the most recent quarter. And even though sales are likely to be soft in the seasonally weak March quarter, they should still be handily above year-earlier levels. EFII looks set to post solid double-digit quarterly sales gains in 2010, even as many companies remain capital-constrained. As credit opens up for small and medium-sized businesses down the road, EFII looks set for additional double-digit sales gains in 2011 as well.

EFII has been using the downturn to its advantage by buying back massive chunks of stock and sharply reducing expenses. The company had 68 million shares outstanding in 2007, but has since removed 20 million shares from the market. Moreover, operating expenses fell by more than $200 million in 2009. If the share count had remained static, EFII would likely earn around $0.50 a share in 2011 (assuming sales grow +15% this year and +10% in 2011). The reduced share count would propel that figure to around $0.70.

The other appeal for investors is the likely floor in place for the stock's price. Shares trade for right around book value and a little more than two times cash. The shares would likely find support in the $10 range, even if sales growth proves slow to materialize. As noted above, first quarter results might appear weak on a sequential basis. Yet management is likely to note on the conference call that sales trends for the seasonally important second and third quarters are extending the promising trend seen in the December quarter. A bullish outlook from management could be the catalyst to send shares higher. With modest downside, and potentially impressive upside toward the $20 mark, the risk/reward on EFII looks quite appealing.

-- David Sterman

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