UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 000-18805

ELECTRONICS FOR IMAGING, INC.

303 Velocity Way, Foster City, CA 94404
(Address of principal executive offices, including zip code)

(650) 357 - 3500
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x  No  o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes  x   No  o

The number of shares of Common Stock outstanding as of October 31, 2004 was 53,783,315.

ELECTRONICS FOR IMAGING, INC.

INDEX

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PART I            FINANCIAL INFORMATION

Electronics for Imaging, Inc.

See accompanying notes to condensed consolidated financial statements.

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Electronics for Imaging, Inc.

See accompanying notes to condensed consolidated financial statements.

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Electronics for Imaging, Inc.

See accompanying notes to condensed consolidated financial statements.

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Electronics for Imaging, Inc.

1. Basis of Presentation

The unaudited interim condensed consolidated financial statements of Electronics for Imaging, Inc., a Delaware corporation (the “Company”), as of and for the interim period ended September 30, 2004, have been prepared on the same basis as the audited consolidated financial statements as of and for the year ended December 31, 2003, contained in the Company’s Annual Report to Stockholders on Form 10-K. The December 31, 2003 Consolidated Balance Sheet was derived from audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. In the opinion of management, the unaudited interim condensed consolidated financial statements of the Company include all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the financial position of the Company and the results of its operations and cash flows, in accordance with accounting principles generally accepted in the United States of America. The interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements referred to above and the notes thereto. Certain prior year balances have been reclassified to conform with the current year presentation.

Amounts within the financial statements and footnote disclosures have been recorded in thousands except for per share data.

The preparation of the interim condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the interim condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.

The interim results of the Company are subject to fluctuation. As a result, the Company believes the results of operations for the interim period ended September 30, 2004 are not necessarily indicative of the results to be expected for any other interim period or the full year.

2. New Accounting Pronouncements

EITF 04-08

The Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB) reached a consensus on Issue No. 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings per Share” at its September 29-30, 2004 meeting. The effective date has not been finalized but is expected to be for reporting periods ending after December 15, 2004. Under EITF Issue No. 04-8, net earnings and diluted shares outstanding, used for earnings per share calculations, would be retroactively restated using the if-converted method of accounting to reflect the contingent issuance of 9,084 shares under our outstanding 1.50% Convertible Senior Debentures which were issued in June 2003. Fully diluted earnings per share would have been approximately $0.48 for the year ended December 31, 2003 and $0.62 for the nine months ended September 30, 2004 as compared to $0.48 and $0.67 as reported for the same periods, respectively.

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3. Accounting for Derivative Instruments and Hedging

Statement of Financial Accounting Standard (“SFAS”) No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities — Deferral of the Effective Date of FASB Statement No. 133, and SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, an Amendment of SFAS No. 133 requires companies to reflect the fair value of all derivative instruments, including those embedded in other contracts, as assets or liabilities in an entity’s balance sheet. The Company determined that its only derivative is an embedded derivative in its 1.50% Senior Convertible Debentures, which was determined to have an insignificant value.

4. Stock-based Employee Compensation

As permitted under SFAS No. 123 Accounting for Stock-Based Compensation, as amended, the Company has elected to use the intrinsic value method as set forth in Accounting Principles Board Opinion No. 25 Accounting for Stock Issued to Employees. Accordingly, no stock-based compensation costs related to stock options have been recorded in the income statement. The Company has determined pro forma net earnings and net earnings per share information as if the fair value method described in SFAS 123 had been applied to its employee stock-based compensation and had been recognized as compensation expense.

5. Comprehensive Income

The Company’s comprehensive income, which includes net income, market valuation adjustments and currency translation adjustments, is as follows:

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6. Earnings Per Share

The following table represents unaudited disclosures of basic and diluted earnings per share for the periods presented below:

Anti-dilutive weighted average shares of common stock of 3,264 and 4,881 as of September 30, 2004 and 2003, respectively, have been excluded from the effect of dilutive securities because the options’ exercise prices were greater than the average market price of the common stock for the periods then ended. The convertible debentures issued June 4, 2003 are considered contingently convertible securities and were excluded from the earnings per share calculations for all periods presented. The debentures represent 9,084 potential shares of common stock issuable upon conversion. See Note 2 for further discussion regarding the contingently convertible securities and potential dilution.

7. Acquisitions

2003 Acquisitions

Best GmbH

In January 2003 the Company acquired Best GmbH, a German-based software company that provides proofing products for worldwide print and publishing markets, for approximately $9,585 in cash. The acquisition was accounted for as a purchase business combination and accordingly, the purchase price has been allocated to the tangible and identifiable intangible assets acquired and liabilities assumed on the basis of their fair values on the date of acquisition. The following table summarizes the allocation of the purchase price to assets acquired and liabilities assumed:

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The amounts allocated to intangible assets are being amortized using the straight-line method over their respective estimated useful lives; developed technology has a five-year life and all other acquired intangibles have a ten-year life.

The acquisition complements the Company’s strengths in graphic arts and workflow software, adding a range of pre-print, pre-press and remote proofing solutions for inkjet printers to its product portfolio.

Printcafe Software, Inc.

In October 2003 the Company acquired Printcafe Software, Inc. (“Printcafe”) for total consideration of approximately $33,401, paid in cash and common stock of the Company. Approximately 12,877 shares of Printcafe common stock were issued and outstanding on that date, of which approximately 8,813 shares of Printcafe common stock were redeemed for $22,916 and approximately 1,927 shares of Printcafe common stock were exchanged for approximately 202 shares of the Company’s common stock, valued at $5,011. The remaining 2,126 shares of stock were acquired by the Company for $5,529 earlier in 2003. The Company applied the equity method of accounting for its investment in Printcafe and accordingly recorded a charge of $1,562 based upon its share of Printcafe’s losses for the pre-acquisition period. The Company incurred $941 of capitalized transaction-related costs including legal fees, accounting fees and other consulting fees and assumed stock options with a fair value of $566. The Company assumed liabilities in excess of assets on the date of acquisition of $14,906. The acquisition was accounted for as a purchase business combination and accordingly, the purchase price has been allocated to the tangible and identifiable intangible assets acquired and liabilities assumed on the basis of their estimated fair values on the date of acquisition as follows:

The amounts allocated to intangible assets are being amortized using the straight-line method over their respective estimated useful lives; developed technology has a four-year life and all other acquired intangibles, including customer relationships, have a five-year life.

With the addition of the Printcafe suite of products, the Company can now offer a full range of products for the commercial print market. Printcafe’s market position in print supply chain management will allow the Company to offer both printers and their customers powerful end-to-end solutions to maximize their efficiency and profitability. By increasing its sales to distributors and end-users with the Printcafe direct sales force, the Company also lessened its revenue dependency on its traditional customer base.

T/R Systems, Inc.

In November 2003 the Company acquired T/R Systems, Inc., for approximately $20,021 in cash. The acquisition was accounted for as a purchase business combination and accordingly, the purchase price has been allocated to the tangible and identifiable intangible assets acquired and liabilities assumed on the basis of their estimated fair values on the date of acquisition. The following table summarizes the allocation of the purchase price to assets acquired and liabilities assumed:

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The amounts allocated to intangible assets are being amortized using the straight-line method over their respective estimated useful lives; developed technology has a three-year life, customer relationships have a four-year life and the remaining acquired intangibles have a five- to seven-year life.

T/R Systems’s Micropress engine enhanced our black-and-white server offerings. T/R also provided us access to a web-based document submission program.

2004 Acquisitions

Automated Dispatch Systems Inc.

In February 2004 the Company acquired Automated Dispatch Systems, Inc. (“ADS”), for approximately $11,811 in cash. The acquisition was accounted for as a purchase business combination and accordingly, the purchase price has been allocated to the tangible and identifiable intangible assets acquired and liabilities assumed on the basis of their estimated fair values on the date of acquisition. The following table summarizes the allocation of the purchase price to assets acquired and liabilities assumed:

The amounts allocated to intangible assets are being amortized using the straight-line method over their respective estimated useful lives; developed technology has a three-year life, customer relationships have a four-year life and the remaining acquired intangibles have a five-year life.

With the addition of ADS’s technology, the Company hopes to further develop relationships with equipment distributors, such as Ikon and Danka. The automated equipment maintenance systems from ADS also offers excellent synergies with the Company’s product portfolio for the office equipment channel.

Valuation Methodology

Intangible assets acquired consist of developed technology, patents, trademarks and trade names and customer relationships. The amount allocated to the purchased in-process research and development (“IPR&D”) was determined using established valuation techniques and was expensed upon acquisition because technological feasibility had not been established and no future alternative uses existed. The value of this IPR&D was determined by estimating the costs to develop the purchased IPR&D into a commercially viable product, estimating the resulting net cash flows from the sale of the products resulting from the completion of the IPR&D and discounting the net cash flows back to their present value at rates ranging from 25% to 30%. The percentage of completion for in-process projects acquired ranged from 10% to 90%. Schedules were based on management’s estimate of tasks completed and the tasks to be completed to bring the project to technical and commercial feasibility. IPR&D was included in operating expenses as part of other acquisition-related charges. There have been no significant changes to management’s original estimates.

Pro forma Information

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The unaudited pro forma information set forth below represents the revenues, net income and earnings per share of the Company and its 2003 and 2004 acquisitions as if the acquisitions were effective as of the beginning of the periods presented and includes certain pro forma adjustments, including the adjustment of amortization expense to reflect purchase price allocations, interest income to reflect net cash used for the purchase and the related income tax effects of these adjustments. All acquisitions are included in the Company’s financial statements from the date of acquisition.

The unaudited pro forma information is not intended to represent or be indicative of the consolidated results of operations of EFI that would have been reported had the acquisitions been completed as of the beginning of the periods presented and should not be taken as representative of the future consolidated results of operations or financial condition of EFI.

2004 Divestiture

In February 2004 the Company sold certain assets related to its Unimobile business for cash of $5,259, including $1,052 of cash held in escrow for up to eighteen months after the sale. The Company recognized a gain on sale of $2,994 after accounting for the intangible and tangible assets of $1,808 and related liabilities of $588.

8. Balance Sheet Components

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9. Goodwill and Other Identified Intangible Assets

As required under SFAS 142, Goodwill and Other Intangible Assets, the Company performed its annual review as of July 1, 2004 and determined that no impairments needed to be recorded against the goodwill account at that time. The acquisition of ADS and additional purchase price adjustments associated with prior year acquisitions increased goodwill by $9,379 for the first nine months of 2004.

Aggregate amortization expense for amortizable intangible assets was $3,520 and $10,515 for the three and nine months ended September 30, 2004, respectively and $1,330 and $3,988 for the three and nine months ended September 30, 2003, respectively. As of September 30, 2004 future estimated amortization expense related to amortizable intangible assets is estimated to be:

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10. Long-term Debt

On June 4, 2003 the Company sold $240,000 of its 1.50% convertible senior debentures due in 2023 (the “Debentures”) in a private placement. The Debentures have been registered with the Securities and Exchange Commission under the Securities Act of 1933 pursuant to a registration statement declared effective in January 2004. The Debentures are unsecured senior obligations of the Company, paying interest semi-annually in arrears at an annual rate of 1.50%. Additional interest at a rate of 0.35% per annum will be paid if the average market price of the debentures for the five trading days ending on the third trading day immediately preceding the first day of the relevant six-month period equals 120% or more of the principal amount of the debentures, beginning in the sixth year after issuance. The Debentures are convertible before maturity into 9,084 shares of EFI common stock at a conversion price of approximately $26.42 per share of common stock but only upon the stock trading at or above $31.70 per share for 20 consecutive trading days during the last 30 consecutive trading days of the preceding fiscal quarter, or upon the occurrence of certain other specified events. None of the events that would cause the Debentures to be convertible have occurred at this time. The Company may redeem the Debentures at its option, on or after June 1, 2008 at a redemption price equal to par plus accrued interest, if any. In addition, holders of the Debentures may require the Company to repurchase all or some of the Debentures on June 1, 2008, 2013 and 2018 at a price equal to 100% of the principal amount plus accrued interest, including contingent interest, if any. The Company will pay the repurchase price for any debentures repurchased on June 1, 2008 in cash, but may choose to pay the repurchase price in cash, common stock of the Company, or any combination thereof in 2013 and 2018. Additionally, a holder may require the Company to repurchase all or a portion of that holder’s debentures if a fundamental change, as defined in the indenture, occurs prior to June 1, 2008 at 100% of their principal amount, plus any accrued and unpaid interest, including contingent interest, if any. The Company may choose to pay the repurchase price in cash, common stock of the Company, or any combination thereof.

Maturities of long-term debt are approximately $24 per year for the next five years.

11. Income Taxes

During the third quarter of 2004, the tax provision reflects the one time effect of the resolution of the Internal Revenue Service (IRS) examination of the Company’s federal income tax returns filed for the years 1999 through 2001. As a result of the settlement reached with the IRS for these years, the Company was required to remit $0.6 million in tax deficiencies and related interest and utilized $6.4 million in credit carry forwards available to offset income taxes payable in future periods.

In addition and as a result of such settlement, the Company has reversed previously accrued taxes of approximately $7.8 million related to the foreign sales corporation and research and development tax credit matters as such tax liabilities are no longer required.

Also, during the third quarter of 2004, the Company has evaluated the business objectives and financial requirements of its domestic and international operations and determined that it intends to permanently reinvest $29.0 million of unremitted earnings of certain foreign subsidiaries reported for the periods through 2003. Therefore, the tax provision also reflects a benefit of $11.1 million from the reversal of the previously recorded deferred tax liability associated with those earnings.

The net impact of these events for the three months ended September 30, 2004 is a net income tax benefit of $18.9 million. The effective tax rate was a benefit of 357% and a provision of 27% for the three-month periods ended September 30, 2004 and 2003, respectively. Excluding the net income tax benefit of $18.9 million, the Company’s effective tax rate for the three months ended September 30, 2004 was a benefit of 54%.

The effective tax rate was a benefit of 52.5% and a provision of 27% for the nine-month periods ended September 30, 2004 and 2003, respectively. Excluding the net income tax benefit of $18.9 million, the Company’s effective tax rate for the nine months ended September 30, 2004 was a provision of 25%.

For the 2004 year, the rate was negatively impacted due to the in-process research and development write-off related to the ADS acquisition, the expiration of the United States research and development credit on June 30, 2004, and decreased investments in tax-exempt securities. In each period, the Company benefited from tax-exempt interest income, research and development credits, and benefits from foreign sales in achieving a consolidated effective tax rate lower than that prescribed by the respective Federal and State taxing authorities.

On October 4, 2004, the Working Families Tax Relief Act was signed renewing the federal tax laws regarding the research and development credit. In accordance with FASB 109, “Accounting for Income Taxes,” the benefit of this reinstatement will be reflected in the Company’s fourth quarter tax provision.

12. Commitments and Contingencies

Off-Balance Sheet Financing - Synthetic Lease Arrangement

The Company is a party to two synthetic leases (the “301 Lease” and the “303 Lease”, together “Leases”) covering its Foster City facilities located at 301 and 303 Velocity Way, Foster City, California. Both Leases expire in July 2014. The Company may, at its option, purchase the facilities during or at the end of the term of the leases for the amount expended by the lessor to purchase the facilities ($56,850 for the 303 Lease and $31,730 for the 301 Lease). The Company has guaranteed to the lessor a residual value associated with the buildings equal to 82% of their funding of the respective Leases. Under the financial covenants, the Company must maintain a minimum net worth and a minimum tangible net worth as of the end of each quarter. There is an additional covenant regarding mergers. The Company is in compliance with all of the covenants at the time of this filing. The Company is liable to the lessor for the financed amount of the buildings if it defaults on its covenants.

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The Company has assessed its exposure in relation to the first loss guarantees under the Leases and believes that there is no deficiency to the guaranteed value at September 30, 2004. If there is a decline in value, the Company will record a loss associated with the residual value guarantee. The funds pledged under the Leases ($56,850 for the 303 Lease and $31,730 for the 301 Lease at September 30, 2004) are in LIBOR-based interest bearing accounts and are restricted as to withdrawal at all times. In conjunction with the Leases, the Company has entered into separate ground leases with the lessor for approximately 30 years.

The Company is treated as the owner of these buildings for federal income tax purposes.

As part of the amended financing arrangement for the 301 Lease, the Company was required to complete a valuation of the building located at 301 Velocity Way. Under the original financing agreement, upon termination of the original lease the Company guaranteed the lessor an 82% residual value in the building which cost $43,080. The recent valuation has provided a value of approximately $31,730, and the Company paid $11,350 to the lessor and recorded a one-time loss associated with the original lease in the third quarter of 2004. In addition, the Company was required to write off $852 of capitalized lease costs associated with the original lease.

Effective July 1, 2003, the Company has applied the accounting and disclosure rules set forth in Interpretation No. 46 Consolidation of Variable Interest Entities, as revised (“FIN 46R”) for variable interest entities (“VIEs”). The Company has evaluated its synthetic lease agreements to determine if the arrangements qualify as variable interest entities under FIN 46R. The Company determined that the synthetic lease agreements do qualify as VIEs; however, because the Company is not the primary beneficiary under FIN 46R it is not required to consolidate the VIEs in the financial statements.

Purchase Commitments

The Company sub-contracts with other companies to manufacture its products. During the normal course of business the sub-contractors procure components based upon orders placed by the Company. If the Company cancels all or part of the order, it may still be liable to the sub-contractors for the cost of the components purchased by the sub-contractors for placement in its products. The Company periodically reviews the potential liability and the adequacy of the related reserve. The Company’s consolidated financial position and results of operations could be negatively impacted if the Company were required to compensate the sub-contract manufacturers for amounts in excess of the related reserve.

Product Warranties

Financial Accounting Standards Board Interpretation No 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN 45”) requires that upon issuance of a guarantee, the guarantor must disclose and recognize a liability for the fair value of the obligation it assumes under that guarantee. The Company’s products are generally accompanied by a 12-month warranty, which covers both parts and labor. The Company accrues for warranty costs as part of its cost of sales based on associated material product costs and technical support labor costs. The warranty provision is based upon historical experience by product, configuration and geographic region.

Changes in the warranty reserves for the nine months ended September 30, 2004 and 2003 were as follows:

Legal Proceedings

Over the past several years, Mr. Jan R. Coyle, an individual living in Nevada, has repeatedly demanded that the Company buy technology allegedly invented by his company, Kolbet Labs. In December 2001, Mr. Coyle threatened to sue the Company and its customers for allegedly infringing his soon to be issued patent and for allegedly misappropriating his alleged trade secrets. The Company believes Mr. Coyle’s claims are baseless and completely

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without merit. Therefore, on December 11, 2001, the Company filed a declaratory relief action in the United States District Court for the Northern District of California, asking the Court to declare that the Company and its customers have not breached any nondisclosure agreement with Mr. Coyle or Kolbet Labs, nor has it infringed any alleged patent claims or misappropriated any alleged trade secrets belonging to Mr. Coyle or Kolbet Labs through its sale of Fiery, Splash or EDOX print controllers. The Company also sought an injunction enjoining both Mr. Coyle and Kolbet Labs from bringing or threatening to bring a lawsuit against the Company, its suppliers, vendors, customers and users of its products for breach of contract and misappropriation of trade secrets. On March 26, 2002, the Northern District of California Court dismissed the Company’s complaint citing the Court’s lack of jurisdiction over Mr. Coyle. The Company appealed the Court’s dismissal to the Court of Appeals for the Federal Circuit in Washington D.C., who reversed the dismissal of our case and remanded it back to the Northern District of California Court. Mr. Coyle and Kolbet Labs subsequently moved to dismiss our complaint under the Declaratory Judgment Act. The Court granted dismissal on February 17, 2004. On February 17, 2004, the Company filed a second declaratory relief action in the Northern District of California against Mr. Coyle and Kolbet Labs. The Company appealed that ruling to the Court of Appeals for the Federal Circuit in Washington, D.C., which heard oral arguments on October 4, 2004. Their decision is pending. The Company is pursuing both of its cases against Mr. Coyle and Kolbet Labs.

On February 26, 2002, Mr. Coyle’s company, J&L Electronics, filed a complaint against the Company in the United States District Court for the District of Nevada alleging patent infringement, breach of non-disclosure agreements, misappropriation of trade secrets, violations of federal antitrust law and related causes of action. The Company denied all of the allegations and management believed this lawsuit to be without merit. On March 28, 2003, the Federal District Judge dismissed the complaint for lack of jurisdiction over the Company. J&L Electronics appealed the dismissal to the Court of Appeals for the Federal Circuit. On February 9, 2004, the Court of Appeals for the Federal Circuit affirmed the dismissal of J&L Electronics’ complaint. J&L appealed to the U.S. Supreme Court who denied his petition on January 12, 2004. Although Mr. Coyle lost both of his appeals, he caused J&L Electronics to initiate yet another legal action, this time in Arizona.

On May 3, 2004, J&L Electronics, filed a complaint against the Company in the United States District Court for the District of Arizona alleging patent infringement, breach of non-disclosure agreements, misappropriation of trade secrets, violations of federal antitrust law and related causes of action. The Company has moved to have that legal action dismissed or transferred to California. The Company believes that the patent is invalid and the lawsuit is without merit and intends to defend itself accordingly.

On June 25, 2003, a securities class action complaint was filed against Printcafe Software, Inc., now a wholly owned subsidiary of the Company and certain of Printcafe’s officers in the United States District Court for the Western District of Pennsylvania. The complaint alleges that the defendants violated Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 due to allegedly false and misleading statements in connection with Printcafe’s initial public offering and subsequent press releases. The Company acquired Printcafe in October 2003. On June 28, 2004, an amended complaint was filed in the action adding additional Printcafe directors as defendants. The Company believes that the lawsuit is without merit and intends to defend itself accordingly.

Because of the uncertainties related to both the amount and range of loss on the pending litigation matters, the Company is unable to make a reasonable estimate of the liability that could result from an unfavorable outcome. Pending or future litigation could be costly, could cause the diversion of management’s attention and could upon resolution, have a material adverse effect on the business, results of operations financial condition and cash flow.

In addition, the Company is involved from time to time in litigation relating to claims arising in the normal course of its business.

Indemnifications

In the normal course of business, we provide indemnifications of varying scope to customers against claims of intellectual property infringement or other possible claims made by third parties arising from the use of our products. Historically, costs related to these indemnification provisions have not been significant and we are unable to estimate the maximum potential impact of these indemnification provisions on our future results of operations.

As permitted under Delaware law, we have agreements whereby we indemnify our executive officers and directors for certain events or occurrences while the officer or director is, or was serving, at our request in such capacity. The indemnification period covers all pertinent events and occurrences during the officer’s or director’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have director and officer insurance coverage that limits our exposure and enables us to

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recover a portion of any future amounts paid. We believe the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal.

The following discussion and analysis should be read in conjunction with our financial statements and the related notes thereto contained elsewhere in this Quarterly Report on Form 10-Q. Except for the historical information contained herein, the discussion in this Quarterly Report on Form 10-Q contains certain forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, beliefs, expectations, forecasts and intentions. The cautionary statements made in this document should be read as applicable to all related forward-looking statements wherever they appear in this document. Our actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include those discussed below in “Factors that Could Adversely Affect Performance,” as well as those discussed elsewhere herein. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to update any forward- looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates that affect the amounts reported. Please see the discussion of critical accounting policies in our Annual Report on Form 10-K for the year ended December 31, 2003.

Results of Operations

The following tables set forth items in our condensed consolidated statements of income as a percentage of total revenue for the three-month and nine-month periods ended September 30, 2004 and 2003 and the percentage change from 2004 over 2003. These operating results are not necessarily indicative of our results for any future period.

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Revenue

We classify our revenue into three major categories, Servers, Embedded Products and Professional Printing Applications, along with a Miscellaneous category for other sources of revenue. The first category, “Servers”, is made up of stand-alone servers, which connect digital copiers with computer networks. This category includes the Fiery, Splash, Edox, and MicroPress color and black and white server products. The second category, “Embedded Products”, consists of embedded desktop controllers, bundled solutions and design-licensed solutions primarily for the office market. The third category, “Professional Printing Applications”, consists of software technology centered on printing workflow, print management information systems, proofing and web submission and job tracking tools. Miscellaneous revenue consists of spares, and the enterprise solutions suite of products consisting of scanning solutions, field dispatching solutions and mobile printing solutions.

Our revenues were relatively flat at $97.6 million in the third quarter of 2004, compared to $97.3 million in the third quarter of 2003, with a 37% decrease in unit volume between the two periods. For the nine-month period ended September 30, 2004, revenues were $313.4 million, a 15% increase over the same period in 2003, while the unit volume decreased by 21%. Sales of our higher-margin stand-alone servers and professional printing applications accounted for a significant portion of revenue for both the three-month and nine- month period comparisons, while the decrease in volume was primarily driven by reduced sales of our lower-margin embedded products and the divestiture of eBeam.

The following is a breakdown of categories of revenue, both in terms of absolute dollars and as a percentage (%) of total revenue. Also shown is volume as a percentage (%) of total units shipped by product category.

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Revenue

Volume

For the three-month period ended September 30, 2004, the Servers category made up 44% of total revenue, a 9% increase over the same period in 2003. For the same period comparison, the volume of servers shipped increased 2%. The Servers category made up 45% of total revenue and 25% of total unit volume for the nine-month period ended September 30, 2004 and it made up 43% of total revenue and approximately 17% of total unit volume for the nine-month period ended September 30, 2003. For both the three-month and nine-month period comparisons, the increase in revenue and increase in unit volume in this category was due in part to the launch of a new series of Fiery servers in the fourth quarter of 2003 and to sales of our Micropress server product, a product of T/R Systems, a company we acquired in November 2003.

For the three-month period ended September 30, 2004, the Embedded Products category made up 31% of total revenue, a 34% decrease over the same period in 2003. The Embedded Products category made up 31% of total revenue and 74% of total unit volume for the nine-month period ended September 30, 2004. It made up approximately 41% of total revenue and 77% of total unit volume for the same period a year ago. The decrease in both comparisons is the result of a shift in demand to lower-cost products in the office and a delay in new product introductions. Since our share of the lower-cost products segment of this market is relatively small, the shift in demand to lower cost products from the higher-cost engines has resulted in slower sales of our products in this category. A significant percentage of our embedded product revenue is attributable to EFI’s design-licensed solutions, which have a lower average selling price but higher gross margin than our other embedded products. Although the amount of design license solutions as a percentage of the total revenue in the Embedded Products category is growing, decreased demand in the embedded board products has put additional pressure on the top-line results in this category.

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For the three-months ended September 30, 2004 and 2003, the Professional Printing Applications category made up 17% and 4% of total revenue, respectively. For the nine-months ended September 30, 2004 and 2003, the Professional Printing Applications category made up 16% and 4% of total revenue, respectively. The majority of the increase in this category for both comparisons came from the print management information system products acquired through the Printcafe transaction in addition to substantial growth in the other software products such as our graphic arts package and color profiler. We recorded an approximate 32% revenue growth for the three months ended September 30, 2004 compared to the same period in 2003 when the pre-acquisition revenues from the acquired companies are added to our revenues in the prior year. The organic growth in this category can be attributed to stability in the former Printcafe operations, which has resulted in increased sales as well as growth in software offerings sold as upgrade options with our servers. Because this category consists of software sales, we do not have any associated unit volumes.

The Miscellaneous category has remained flat at 8% of total revenue in the three-month period ended September 30, 2003 and 2004 while volumes in this category decreased from 2% of total volume to 1% of total volume for the same period comparison. The Miscellaneous category has decreased from 12% of total revenue in the nine-month period ended September 30, 2003 to 8% of total revenue in the nine-month period ended September 30, 2004 while volumes in this category decreased from 6% of total volume to 1% of total volume for the same period comparison. The decrease in revenue is mostly attributable to reduced sales of spare components, the divestiture of the eBeam product line and the sale of the Unimobile assets, partially offset with the revenue from ADS which was acquired in February 2004. The decrease in volume is due to the divestiture of the eBeam product line, which in the first 9 months of 2003 accounted for 91% of the volumes in this category.

To the extent our major product categories do not grow over time in absolute terms, or if we are not able to meet demand for higher unit volumes, it could have a material adverse effect on our operating results. There can be no assurance that any new controller products that we introduce in the future will be qualified by all or any of our OEM customers; or that such products, or any of our other products, will successfully compete, be accepted by the market, or otherwise effectively replace the volume of revenue and/or income from our older products. Market acceptance of our software products, products acquired through acquisitions and other newly introduced, internally developed products cannot be assured.

We also believe that in addition to the factors described above, price reductions for all of our products will affect revenues in the future. We have previously and will likely in the future reduce prices for our products. Depending upon the price-elasticity of demand for our products, the pricing and quality of competitive products, and other economic and competitive conditions, such price reductions may have an adverse impact on our revenues and profits. While we have managed to improve gross margins in the past through the utilization of fewer contract manufacturers, obtaining favorable component pricing from our suppliers and through an increase in higher gross margin software sales and design license sales, this trend may not continue. If we are not able to compensate for lower gross margins resulting from price reductions with increased sales volumes, our results of operations could be adversely affected. In addition, our revenue in the future may depend more upon sales of products with relatively lower gross margins such as embedded controllers or sales of our design-licensed solutions, which have lower per unit sales prices, but higher gross margins. If we are not able to compensate for such lower gross margins, or lower per unit revenues with an increased volume of sales of such products, our results of operations may be adversely affected.

Revenue and volume by geographic area for the three-month and nine-month periods ended September 30, 2004 and 2003 were as follows:

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The Americas region increased 30% to $173.3 million in sales during the first nine months of 2004 from approximately $133.7 million in the first nine months of 2003, largely attributable to sales of the newly acquired products from Printcafe and ADS, as well as increases in the server category. Revenues in the Japan region increased 9% to $44.2 million during the first nine months of 2004 from $40.6 million in the first nine months of 2003. A significant portion of this increase can be attributed to greater demand for design-licensed color solutions, which are sold to OEM customers in Japan, for incorporation into their products, which are then shipped from Japan to other countries. The Rest-of-World region, which includes the Asia Pacific but excludes Japan, showed a decrease of 8% for the nine months ended September 30, 2004 largely due to design license products being shipped to Japan rather than directly into the region. A decrease in embedded products revenue partially offset by increases in the server and professional printing application revenue fueled an overall moderate decrease in Europe.

Shipments to some of our OEM customers are made to centralized purchasing and manufacturing locations, which in turn sell through to other locations, making it difficult to obtain accurate geographical shipment data. Accordingly, we believe that export sales of our products into each region may differ from what is reported. We expect that export sales will continue to represent a significant portion of our total revenue.

Substantially all of our revenue for the last three years was attributable to sales of products through our OEM customers and independent distributor channels. During 2004, we have continued to work on both increasing the number of OEM customers and expanding the size of existing relationships with OEM customers. For the nine months ended September 30, 2004 and 2003, three customers — Canon, Konica Minolta, and Xerox — provided more than 10% of our revenue individually and approximately 65% of our revenue in aggregate for 2004 and 71% of revenue in aggregate for 2003. No assurance can be given that our relationships with these and other significant OEM customers will continue or that we will be successful in increasing the number of our OEM customers or the size of our existing OEM relationships. Several of our OEM customers have reduced or discontinued their purchases from us at various times in the past and any customer could do so in the future. Such reductions or discontinuations have in the past and could in the future have a significant negative impact on our consolidated financial position and results of operations.

In addition to our server and embedded products sold through our OEM’s, we have diversified into new markets and distribution channels with our Professional Printing Applications. This category has grown to 17% of our revenue in the third quarter of 2004. We have no significant customers in this category, other than our OEM’s who have purchased products from this category as well as from our other categories.

We continue to develop new products and technologies for each of our product lines and intend to continue to introduce new generations of server and controller products and other new product lines with current and new OEM customers, distribution partners, and end-users throughout the remainder of 2004 and beyond. No assurance can be given that the introduction or market acceptance of current or future products will be successful.

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Gross Margins

For the quarter ended September 30, 2004 our gross margin was 65% compared to approximately 61% for the same period a year ago. For the nine months ended September 30, 2004 our gross margin was 65% compared to approximately 60% for the same period a year ago. The improvement in both comparisons came from increased sales of design-licensed solutions and an increase in software sales both of which traditionally have higher gross margins than our other products. We believe that gross margin will continue to be impacted by a variety of factors. These factors include the market prices that can be achieved on our current and future products, the availability and pricing of key components (including DRAM, Processors, and Postscript interpreter software), third party manufacturing costs, product, channel, and geographic mix, the success of our product transitions and new products, the pace of migration to a design-licensed business model for embedded products, competition with third parties and our OEM customers, and general economic conditions in the United States and abroad. Consequently, we anticipate gross margins will fluctuate from period to period.

Operating Expenses

Operating expenses as a percentage of revenue amounted to approximately 73% and 46% for the three-month periods ended September 30, 2004 and 2003, respectively and 61% and 50% for the nine-month periods ended September 30, 2004 and 2003, respectively. Operating expenses increased by 58% in the three-month period ended September 30, 2004 compared to the three-month period ended September 30, 2003, and increased 38% in the nine months ended September 30, 2004 compared to the same period in 2003. Approximately 55% of the increase quarter over quarter and 28% of the increase year over year is attributable to real estate-related charges. The addition of Printcafe and T/R Systems in late 2003 and ADS in mid-February 2004 contributed the majority of the remaining increase in operating expenses, while increased employee costs, negative impacts of exchange rate variances, and increased legal, auditing and tax-consulting expenses including costs related to compliance with the Sarbanes-Oxley Act of 2002 were also a factor.

We anticipate that operating expenses may increase in future periods both in absolute dollars and as a percentage of revenue as investments are made in new business areas and direct and channel relationships in our sales organization.

The components of operating expenses are detailed below.

		Research and Development
		Expenses for research and development consist primarily of personnel expenses and, to a lesser extent, consulting, depreciation, and costs of prototype materials. Research and development expenses were 29% and 24% of revenue for the third quarter of 2004 and 2003, respectively. For the nine months ended September 30, 2004 and 2003, research and development expenses were 27% and 26% of revenue, respectively.
		In absolute dollars, research and development increased by approximately $4.7 million in the third quarter of 2004 from the third quarter of 2003. Research and development expenses related to our recent acquisitions partially offset by the reduction in costs from the eBeam and Unimobile divestitures contributed the majority of the increase for the quarter ending September 30, 2004. The remaining increase consisted of increased payroll costs from merit increases and increased headcount, partly offset by lower consulting expenses and prototype expenses.
		Research and development expenses increased by approximately $13.5 million year over year for the nine months ended September 30, 2004. Research and development expenses related to our recent acquisitions partially offset by the reduction in costs from the eBeam and Unimobile divestitures accounted for the majority of the increase for the nine months ending September 30, 2004. The remaining increase consisted primarily of increased payroll costs from merit increases, and additional employees, partially offset by lower prototype expenses.
		We believe that the development of new products and the enhancement of existing products are essential to our continued success, and intend to continue to devote substantial resources to research and new product development efforts. Accordingly, we expect that our research and development expenses may increase in absolute dollars and also as a percentage of revenue in future periods.

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		Sales and Marketing
		Sales and marketing expenses include personnel expenses, costs of trade shows, marketing programs, and promotional materials, sales commissions, travel and entertainment expenses, depreciation, and costs associated with sales offices in the United States, Europe, Asia, and other locations around the world. Sales and marketing expenses for the three-month period ended September 30, 2004 were approximately $18.0 million or 18% of revenue compared to approximately $14.7 million or 15% of revenue for the three months ended September 30, 2003. The increase in absolute dollars was approximately $3.3 million for the quarter. Additional costs for acquired companies were partially offset by a decrease in expenses from the spin-off of the Unimobile group accounted for the majority of the increase, while increased tradeshow expenses added most of the balance. In addition, sales and marketing expenses, particularly those incurred in Europe, where we have a significant presence, were negatively impacted by the weakening US dollar, increasing expenses from year to year slightly. While the costs in the local currency outside the United States have generally remained constant, during the third quarter of 2004 the translated US dollar costs have increased.
		Sales and marketing expenses for the nine-month period ended September 30, 2004 were approximately $57.0 million or 18% of revenue compared to approximately $44.7 million or 16% of revenue for the nine months ended September 30, 2003. The majority of the increase in absolute dollars of approximately $12.3 million is comprised of costs related to the operations of the acquired companies, offset by a decrease in expenses due to the divestiture of eBeam and Unimobile groups. Expenses for tradeshows increased as well, adversely impacting the nine-month comparison. In addition, sales and marketing expenses, particularly those incurred in Europe, where we have a significant presence, were negatively impacted by the weakening US dollar, increasing expenses slightly from year to year. While the costs in the local currency outside the United States have generally remained constant, during 2004 the translated US dollar costs have increased.
		We expect that our sales and marketing expenses may increase in absolute dollars as we continue to actively promote our products, introduce new products and services, and continue to build our sales and marketing organization, particularly in Europe and Asia Pacific, and as we grow our software solutions and other new product lines which require greater sales and marketing support from us. We also expect that if the US dollar remains volatile against the euro or other currencies, sales and marketing expenses reported in US dollars could fluctuate.
		General and Administrative
		General and administrative expenses consist primarily of personnel expenses and, to a lesser extent, depreciation and facility costs, professional fees, and other costs associated with public companies. General and administrative expenses were approximately $7.2 million or 7% of revenue for the quarter ended September 30, 2004, compared to approximately $5.5 million or 6% of revenue for the quarter ended September 30, 2003. The increase in absolute dollars of approximately $1.7 million primarily came from costs related to the acquired organizations and increased legal, auditing and tax-consulting expenses including costs related to compliance with the Sarbanes-Oxley Act of 2002. We expect that general and administrative costs will increase both as a percentage of revenue and in absolute dollars in the fourth quarter of 2004 due to additional costs that will be incurred for compliance with the Sarbanes-Oxley Act. We also expect that if the US dollar remains volatile against the euro or other currencies, general and administrative expenses reported in US dollars could fluctuate.
		General and administrative expenses were approximately $20.6 million or 7% of revenue for the nine months ended September 30, 2004, compared to approximately $15.5 million or 6% of revenue for the nine months ended September 30, 2003. The increase in absolute dollars of approximately $5.1 million primarily came from costs related to the acquired organizations, increased employee salary and bonus expense, and increased legal, auditing, and tax-consulting expenses including costs related to compliance with the Sarbanes-Oxley Act of 2002. We expect that general and administrative costs will increase both as a percentage of revenue and in absolute dollars in the fourth quarter of 2004 due to additional costs that will be incurred for compliance with the Sarbanes-Oxley Act. We also expect that if the US dollar remains volatile against the euro or other currencies, general and administrative expenses reported in US dollars could fluctuate.

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		Real Estate Related Charges
		We completed a valuation of the building located at 301 Velocity Way as part of the amended financing arrangement signed in September 2004 for that building. Under the original lease of $43.1 million, we guaranteed the lessor an 82% residual value in the building upon the termination of the original lease. The recent valuation provided a value of approximately $31.7 million for the building, and we paid $11.4 million to the lessor and recorded a one-time loss associated with the original lease in September 2004. In addition, during the quarter ended September 30, 2004, we wrote off $0.9 million of capitalized lease costs associated with the original lease and $2.1 million of capitalized costs associated with other development activity within our Foster City campus.
		Amortization of Identified Intangibles and other Acquisition-related Expense
		Amortization of identified intangibles and other acquisition-related expense for the three months ended September 30, 2004 was approximately $3.5 million compared to approximately $1.3 million for the three months ended September 30, 2003. Amortization of identified intangibles was approximately $11.5 million and approximately $5.2 million for the nine months ended September 30, 2004 and 2003, respectively. The increase was attributable to the amortization of identified intangibles related to the acquisitions made in late 2003 and early 2004. In-process research and development was $1.0 million for the first half of 2004 for the ADS acquisition and approximately $1.2 million for the first half of 2003 for the Best acquisition. Additional information on the intangibles and the related amortization can be found in Note 9 of the Condensed Consolidated Financial Statements.

Interest and Other Income, net

		Interest and Other Income, Net
		Interest income is derived mainly from our short-term investments, net of investment fees. For the three months ended September 30, 2004 interest and other income was approximately $3.4 million, while for the three months ended September 30, 2003 it was approximately $3.1 million. For the nine months ended September 30, 2004 interest and other income was approximately $9.3 million, while for the nine months ended September 30, 2003 it was approximately $8.7 million. The increases were driven by higher interest rates.
		Interest Expense
		Interest expense for the first nine months of 2004 includes the interest expense and debt amortization costs of approximately $4.4 million related to our 1.50% senior convertible debt issued in June 2003. We had approximately $1.6 million in interest expense for the first nine months of 2003, which included approximately 4 months of interest expense and debt amortization costs for the convertible debt.
		Gain on Sale of Assets
		We recognized approximately $3.0 million in the nine months ended September 30, 2004 from the sale of assets related to Unimobile.
		Litigation Settlement Income
		The litigation settlement income of approximately $1.6 million in 2003 consisted of settlements received from litigation protection our intellectual property, net of related legal expenses. We have received $58 thousand in additional settlements in 2004, net of related legal expenses. We expect to receive additional amounts in the future, but are unable to estimate the total at this time.

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Income Taxes

During the third quarter of 2004, the tax provision reflects the one time effect of the resolution of the Internal Revenue Service (IRS) examination of our federal income tax returns filed for the years 1999 through 2001. As a result of the settlement reached with the IRS for these years, we were required to remit $0.6 million in tax deficiencies and related interest and we utilized $6.4 million in credit carry forwards available to offset income taxes payable in future periods.

In addition and as a result of such settlement, we have reversed previously accrued taxes of approximately $7.8 million related to the foreign sales corporation and research and development tax credit matters as such tax liabilities are no longer required.

Also, during the third quarter of 2004, we have evaluated the business objectives and financial requirements of our domestic and international operations and determined that we intend to permanently reinvest $29.0 million of unremitted earnings of certain foreign subsidiaries reported for the periods through 2003. Therefore, the tax provision also reflects a benefit of $11.1 million from the reversal of the previously recorded deferred tax liability associated with those earnings.

The net impact of these events for the three months ended September 30, 2004 is a net income tax benefit of $18.9 million. The effective tax rate was a benefit of 357% and a provision of 27% for the three-month periods ended September 30, 2004 and 2003, respectively. Excluding the net income tax benefit of $18.9 million, our effective tax rate for the three months ended September 30, 2004 was a benefit of 54%.

The effective tax rate was a benefit of 52.5% and a provision of 27% for the nine-month periods ended September 30, 2004 and 2003, respectively. Excluding the net income tax benefit of $18.9 million, our effective tax rate for the nine months ended September 30, 2004 was a provision of 25%.

For the 2004 year, the rate was negatively impacted due to the in-process research and development write-off related to the ADS acquisition, the expiration of the United States research and development credit on June 30, 2004, and decreased investments in tax-exempt securities. In each period, we benefited from tax-exempt interest income, research and development credits, and benefits from foreign sales in achieving a consolidated effective tax rate lower than that prescribed by the respective Federal and State taxing authorities.

On October 4, 2004, the Working Families Tax Relief Act was signed renewing the federal tax laws regarding the research and development credit. In accordance with FASB 109, “Accounting for Income Taxes,” the benefit of this reinstatement will be reflected in our fourth quarter tax provision.

Liquidity and Capital Resources

Cash, cash equivalents and short-term investments increased by $25.2 million to $649.3 million as of September 30, 2004, from $624.1 million as of December 31, 2003. Working capital decreased by $44.8 million to $620.4 million as of September 30, 2004, down from $665.2 million as of December 31, 2003. We invest cash in excess of our operating needs in short-term investments.

Net cash provided by operating activities was $46.6 million for the nine-month period ended September 30, 2004. Net income of $37.2 million during 2004 was increased by $18.0 million for non-cash charges of depreciation and amortization, the write-off of in-process research and development cost, bad-debt expense, deferred compensation and gains from the sale of assets offset by losses from the retirement of assets and decreased by $12.7 million for adjustments to deferred income taxes related to an the settlement of a tax audit issue. Changes in current assets and liabilities increased cash by $4.1 million, with decreases in cash resulting from accounts receivable and income taxes payable, offset with increases in cash from, inventories, other current assets and accounts payable. Accounts payable balances increased at the end of the period as we were aggressively managing our cash balances. Inventory balances were down as we decreased our finished goods inventory and consumed raw materials that were purchased over the last several quarters. The change in income taxes payable of $2.5 million includes payments of $1.4 million, current provision of $13.8 million and adjustments related to the settlement of the IRS audit of $12.7 million.

Sales in excess of purchases of short-term investments were $11.6 million for the nine-month period ended September 30, 2004, to provide funds for our common stock repurchase program and acquisitions. In connection with the synthetic leases for our Foster City campus buildings we reduced funds held in restricted investments for an

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increase in cash of $24.1 million. In February 2004, we acquired ADS for approximately $11.6 million, net of cash received in the transaction. In March 2004, we sold assets from our Unimobile group and received $4.1 million in proceeds. Our capital expenditures generally consist of investments in computer equipment and furniture for use in our operations. We purchased approximately $4.4 million of equipment during the nine-month period ended September 30, 2004, net of retirements.

Net cash used by financing activities of $30.0 million in the nine-month period ended September 30, 2004, was the result of $25.7 million from the exercises of common stock options and the issuance of stock under our Employee Stock Purchase Plan, less $55.6 million used for the repurchase of shares of our common stock. During 2003 and 2004 our Board of Directors authorized an aggregate of $150.0 million for the repurchase of our common stock, of which $98.9 million remains available.

Inventory

Our inventory consists primarily of memory subsystems, processors and ASICs, which are sold to third-party contract manufacturers responsible for manufacturing our products. Should we decide to purchase components and do our own manufacturing, or should it become necessary for us to purchase and sell components other than the processors, ASICs or memory subsystems for our contract manufacturers, inventory balances and potentially fixed assets would increase significantly, thereby reducing our available cash resources. Further, the inventory we carry could become obsolete thereby negatively impacting our consolidated financial position and results of operations. We also rely on several sole-source suppliers for certain key components and could experience a significant negative impact on our consolidated financial position and results of operations if such supplies were reduced or not available.