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Executives

Douglas A. Fox, CFA - Director, Investor Relations and Treasurer

Anders Gustafsson - Chief Executive Officer

Michael C. Smiley - Chief Financial Officer and Treasurer

Michael H. Terzich - Senior Vice President, Global Sales and Marketing, Specialty Printer Solutions

Analysts

Charles Murphy - Sidoti & Company, LLC

Paul Coster - JPMorgan Securities, Inc.

Brian Drab - William Blair & Company

Reik Read - Robert W. Baird

Chris Quilty - Raymond James & Associates

Andrew Abrams - Avian Securities

Ajit Pai - Thomas Weisel Partners, LLC

Anthony Kure - KeyBanc Capital Markets

Greg Halter - Great Lakes Review

Timothy Robertson - Boyne Advisors

Zebra Technologies Corporation (ZBRA) Q4 2008 Earnings Call February 17, 2009 11:00 AM ET

Operator

Good morning and welcome to the Zebra Technologies 2008 Fourth Quarter Earnings Release Conference Call.

Joining us from Zebra Technologies are Anders Gustafsson, Chief Executive Officer; Mike Smiley, Chief Financial Officer; Mike Terzich, Senior Vice President, Global Sales and Marketing, SPS; and Doug Fox, Vice President, Investor Relations.

All lines will be in a listen-only mode until after today's presentation. Instructions will be given at that time in order to ask the question. At the request of Zebra Technologies, this conference call is being recorded. Should anyone have any objections, please disconnect at this time.

At this time, I would like to introduce Mr. Doug Fox of Zebra Technologies. Sir, you may begin.

Douglas A. Fox, CFA

Thank you and good morning. Thank you for joining us today.

Certain statements we make on this call will relate to future events or circumstances and therefore will be forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995. Words such as expect, believe, and anticipate are a few examples of words identifying a forward-looking statement.

Forward-looking information is subject to various risks and uncertainties, which could significantly affect expected results. Risk factors were noted in the news release issued this morning and are also described in Zebra's 10-K for the year ended December 31, 2007, which is on file with the SEC.

Now, let me turn the call over to Anders Gustafsson for some opening remarks.

Anders Gustafsson

Thank you Doug, and good morning everyone. Thank you for joining us.

Here in the room with me is Mike Smiley, our CFO; and Mike Terzich, our SVP of Global Sales and Marketing for our Specialty Printing Group.

Today, Zebra reported strong fourth quarter results. Our sales were $233 million, well within our forecasted range demonstrating solid performance in today's challenging business environment.

Zebra also reduced operating cost and improved control over working capital. Our financial strength and flexibility continue to play a significant role in our ability to react decisively to changes in the business environment. This further solidifies our position as an industry leader.

As of December 31st, we had $225 million in cash and investments with no debt, and we generated $99 million in free cash flow for the year. Difficult economic conditions impacted most companies in the quarter, Zebra included. As you saw in our press release, we took $157 million in total impairment charges during the quarter. The majority of these charges are related to weakness in the markets served by WhereNet, which has been particularly hard hit over the last six months.

Charges also include right balance in the value of prepaid RFID licenses and other intellectual property. Our operating results were relatively strong due in large part to increased business diversity. Some of our targeted verticals including healthcare and government performed well while others such as manufacturing experienced a global slowdown.

In response to changing business conditions, we adapted our sales and marketing strategies to ensure we remain successful at further penetrating effective segments and gaining market share. We continued to leverage our strong cash flow by making prudent investments in our business and returning excess cash to shareholders through our share repurchase program.

During the quarter, we repurchased 2.6 million shares. For the year, we deployed $158 million in stock buybacks to reduce the number of shares outstanding by $6 million or about 8%.

During 2008, we continued to strike the appropriate balance between preserving near term profitability and positioning feedback for long term growth and continued market leadership. On the cost side, during the second half of 2008, we took several actions to lower annual operating expenses by approximately $20 million on a run rate basis.

During this time, we reduced headcount by over 120. Additionally, we reduced discretionary spend in areas that just travel and entertainment and marketing activities. We will continue to focus on executing our manufacturing outsourcing program, which will reduce our manufacturing costs by 25 to $30 million in 2010 compared to our cost structure associated with in-house manufacturing.

We will also complete our multi-year investment in a new ERP system, which remains on budget and on track. This will help us improve our customer service levels, and improve organizational efficiencies. We have taken steps in 2009 to further reduce operating expense by $25 million from current levels, including an $8 million reduction in amortization expense.

This reduction will be partially offset by $10 million in higher IT costs associated with the ERP implementation and approved bonus accrual, netting to a $15 million reduction in annual operating expense in 2009.

These actions demonstrate our commitment to reduce costs and realize increased efficiencies across our business, which is important in this environment. We will continue, however, to invest in opportunities to improve our competitive positioning. We have identified and are focused on activities that would deliver the highest risk adjusted returns.

These include, first: continuing to develop important new products that help customers to reduce their operating costs by improving supply chain visibility, customer service, and security.

Second: enhancing our channel partner programs. We are proud that Zebra was recently named one of the best channel vendors in a survey of 1,600 bars in Business Solutions magazine.

Third: targeting customers in healthcare and government in our Specialty Printing Group.

Fourth: deepening our strongest customer relationships in our Enterprise Solutions Group by cross-selling and targeting adjacent industries, where our solutions make good business sense.

And finally, buying back our own shares, because at this time, we clearly view share repurchases as the best risk adjusted investment alternative.

I'd now like to review some fourth quarter highlights. Our Zebra Specialty Printing Group or SPG performed well during Q4. Our results benefited from increased business diversity across partners, customers, geographies, and solutions.

Highlights include our North America region had its best performance of the year in Q4. We increased our volume of large deals to key accounts and small package delivery, government, and retail; and our installed base generated strong sales of aftermarket parts, supplies and follow-on business.

Mobile, desktop, and kiosk printers performed well in the fourth quarter as customers continued to implement solutions to improve employee and operational efficiency. During the quarter, we extended product leadership with the introduction of our P4P printer, the world's first RFID enabled mobile terminal transfer printer.

We also expanded our mobile printer product line with the introduction of the EM 220 for easy economical receipt printing as well as a new kiosk print station for easy integration of Zebra printers into self service locations.

We were also pleased with the performance of our card products. The consolidation of our card and barcode businesses in 2008 has delivered stronger channel relationships. Our Zebra Partners first program now includes close to 100 new CTS channel partners worldwide.

Our stronger product line and our global channel makes us optimistic about future growth record. The depth and breadth of our SPG product line also helped us penetrate vertical markets more closely, more deeply.

For the year, healthcare was up 21% in North America. Our HC100 Direct Thermal Wristband printer continued to gain traction in this attractive space.

During the quarter, we helped hospitals increase patient safety with the introduction of a new, more comfortable wristband as well as internationally compliant labels for blood banks.

We further benefited from a diverse retail customer base this quarter. We saw our larger customers increase invest to improve in store productivity and reduce costs.

Let me now provide an update on Zebra Enterprise Solutions Group or ESG. ESG's financial performance for 2008 has not met our expectations, and we've realized it as whole and short term euros as well. We also recognized that the impairment charge we took this quarter reinforces the urgency we must bring to generate the appropriate level of return from this business.

That said, ESG did end the fourth quarter with the highest level of total bookings for the year and a solid backlog. We made good progress this quarter and strongly believe that our integration efforts and our plans position us well to unlock the full value of this segment.

We are pleased to start the year with the new General Manager for ESG. Bill Walsh comes to Zebra with more 20 years of leadership experience in high growth enterprise solutions companies.

He brings extensive integration experience and the right combination of skills and business development, technology in international markets to maximize the success of this business.

We continue to give the value proposition of ESG and at synergies with our core SPG business as compelling. ESG makes Zebra the more important strategic business partner through industry leading asset tracking and management technologies, high value software products, and the comprehensive solution sets.

ESG is well aligned with Zebra's core brand attributes, and provides deep expertise into attractive industries. In addition it gives us access to high level decision makers in the world's largest enterprises.

Recent successes during the quarter provide evidence of our progress in realizing these important synergies. These include in Q4 working with the long standing SPG partner, we sold our WhereNet Material Flow and Replenishment solutions to a major truck manufacture.

We also sold WhereNet and proveo solutions into an important existing Navis customer. We sold the Navis system into a non-marine worldwide distributor, which is using the software at yard and distribution center management at six regional hubs in North America.

And we won several aviations deals in Middle East effectively doubling our global install base in aviation. In addition, as we communicated last year, we have been executing on a comprehensive three phase strategy to fully integrate ESG.

During the fourth quarter, we achieved the following milestones. We completed the heavy lifting stage of our strategy simplifying and streamlining our infrastructure and back office support functions. We completed the year with full stocks compliance including ESG.

Second, we aligned our sales teams along vertical markets to sell the entire suite of ESG solutions and last, but not least, we lowered ESG's cost structure by $10 million per quarter. As a result, ESG should be able to breakeven on earnings before interest, taxes, depreciation and amortization and other non-recurring items at approximately $23 million in quarterly sales.

This is an important first step towards making ESG a meaningful contributor to our profitability. With the appropriate foundation in placed, we are now focused on integrating ESG's product portfolio and leveraging these products to create broader solutions in the industries we serve.

In addition, we are accelerating the development of partner programs and creating tighter alignment with our SPG segments. The ESG team has committed to leveraging our assets to drive higher sales and market leadership.

Let me share with you several important milestones we expect to achieve in 2009. First, signing out 20 new channel partners in 2009, of which 25% will be combined SPG partners. Second, deploying 25 systems, where we cross sell multi platforms such as proveo into maritime and Navis into AIMT.

And third, installing at least 50 solutions with customers around the world. This includes upgrades as it indicates the significant investment for our customers June, the top year.

Giving these goals and the actions taken to reduce ESG's breakeven we have laid the ground work for ESG to be roughly EBITDA breakeven for 2009 given current market conditions.

I am confident that Bill and his team will leverage ESG's unique position of strength as the only consolidated and well capitalized company in this space. This unique position gives our customers confidence that they have a partner capable of serving their needs well into the future.

In summary, Zebra remains well positioned to extend its industry leadership. The breadth of our solutions improve our customers, business performance by enabling them to deploy their assets smarter. Our clear brand leadership, diverse revenue base, and comprehensive go-to-market channels enables us to extend industry leadership and build stronger customer relationships.

Our financials strength and global presence give customers and partners the confidence that Zebra will be there to meet their needs well into the future. And our knowledgeable and dedicated employees give me the confidence that Zebra will continue to succeed.

As we leverage our leadership position in compelling value proposition to customers, we remain committed to enhancing the value of our shareholders investments in Zebra. We continue to strike the appropriate balance between preserving near-term profitability and positioning Zebra for long-term growth and continued industry leadership. By adapting to changing business conditions, Zebra will maximize return for investors.

I'd now like to turn the call over to our CFO, Mike Smiley, to provide a detailed review of fourth quarter results and guidance for the first quarter of 2009. After Mike's remarks, I'll return for some closing comments on our outlook.

Michael C. Smiley

Thank you, Anders.

Before I go through the numbers, let me highlight the key financial drivers for the quarter. We maintained strong cash flow in operating earnings. Sales performance came from strength in key account sales to large customers in North America and from our acquired businesses in ESG. Gross margin was predominantly affected by changes in foreign exchange rates and product mix.

Additional SG&A expenditures from the ESG acquisitions were offset by cost reductions in the second half of 2008, and we recorded $157 million in non-cash impairment charge.

Let's turn to sales first. For the quarter, sales were comfortable with the year ago declining only 0.4%. On an organic basis, sales were down 2.8% with sale from our Specialty Printer Group down a modest 3.1%. Our Enterprise Solutions Group contributed 5.7 million to fourth quarter sales driven by recent acquisitions.

For the quarter, ESG provided 1.2 million in services related to loss purchase accounting revenue. On the accounting rules, we are delivering the services for which we are obligated from the Navis acquisition, we do not book revenue against them. We have about 2.6 million left to deliver.

Let's take a look at sales by product line. Hardware sales declined 7.8% to 163.5 million from last year, and represents 70.3% of total sales. We experienced continued strength in mobile printers for ongoing deployments by large retail customers brings to our solutions.

Desktop printers sales also held up relatively well with shipments to small package delivery customers. We have weakness in our high end and mid range lines, which put some downward pressure on gross margins, reflecting the weakness in global manufacturing. We expect this trend to continue to Q1. The percentage of per year sales for new printers was held up well at 19%.

We shipped a record 249,900 printers in the fourth quarter. Average unit price of $538 was down from $600 a year ago because of foreign exchange and product mix. Supply sales of 40.9 million, were up almost 1.7% and comprise 17.6% of total sales. Service and software revenue increased 85.3% to offset the declines in hardware and supply sales. These higher margin pieces of our business accounted for 11.2% of total sales.

In North America, sales grew 3.6% to $112 million. Diversity of our business across verticals and customers clearly benefited us during the quarter. North America SPG has strongest quarter of the year with key accounts, which offset lower demand in the channel.

In addition to shipments to retail in small package delivery, we also experienced strong sales into healthcare, government, and mobile workforce.

Going forward, we see further opportunities in these sectors. The strengthened diversity of Zebra's product line is enabling us to win more business especially in this difficult operating environment. International sales were up 3.9% for the quarter.

Sales to customers in Latin America were up 15.7% and Asia Pacific was up 26.3% accounted by a 12.3% decline in the EMEA sales.

Excluding the effect of foreign exchange and sales by the Enterprise Solutions Group, EMEA sales declined about 11%. The harder hit sub-region continued to be the U.K. Still, within this environment, Zebra continued to win important new businesses and targeted verticals.

During the quarter, we closed three deals in coastal plus others in healthcare and retail. Consolidated gross profit was 47.7% compared with 48.5% a year ago. Specialty Printing Group gross margin declined to 46.2 from 48.5 on significant strengthening of the dollar against the euro.

On a year-over-year basis, the dollar decreased 9.1% in value versus the euro, which resulted in a $6.4 million negative impact on our gross profit. The shift in product mix particularly with lower sales of tabletop printers also impacted our profitability.

The change is partially offset by growth in higher margin aftermarket sales. Gross margin for Enterprise Solution Group was 61.5% was up from 48.7% a year ago.

During the quarter, we benefited from true profitability for services. In addition, our reversal of the contract losses are partially offset by an inventory adjustment at a $1.8 million favorable impact and gross margin for the quarter.

Looking to the first quarter of 2009 and beyond, we expect the normalized gross margin for the ESG business in the range of 58% to 62%.

Let's now turn to operating expenses; fourth quarter SG&A was down 5 million from the prior year. This change includes an additional 4 million for ESG's acquisition, late in 2007 offset by cost reductions of 9 million, primarily in the second half of the year in 2008.

R&D increased 5 million from the prior year. R&D increased 5 million from the prior year. This increase primarily came from R&D associated with the ESG acquisition. Amortization also increased 1.4 million, again due to ESG. As Anders mentioned, the annual operating expense came down roughly 20 million on a run rate basis in the second half of 2008.

Most of these reductions came in the form of wages, G&A, marketing and professional fees. In total, headcount was reduced by 120 in the second half of 2008 or in the third quarter and 80 rate in the fourth quarter.

The third quarter reductions were primarily associated with services and impact cost of goods sold. The fourth quarter includes $158 million in non-cash asset impairment charge, which resulted from the testing we did respond to current business conditions. A significant majority of the charges relates to ESG's legacy WhereNet business, which is affected meaningfully by declines in the automotive sector.

Simply put, the value of the intangible assets on our books didn't match the current or expected business in this area. The charges relative to write downs, the patents, and other intellectual property including prepaid RFID licenses associated with the SPG business. The impairment charge will result in a reduction and amortization of approximately $8 million in 2009.

For the quarter the investment portfolio had an annualized return of 3.8%. On an absolute basis, investment income was down because of our deployment of cash to buyback stock. The net loss per share came in at $1.88 or on 62.6 million average shares.

The impairment charges had a $2.20 per share impact. Asset class integration expenses reduced EPS by $0.08 per share. We ended the quarter and the year with 60.9 million shares outstanding and 8% for the number of shares that were outstanding at the end of 2007.

We did a good job managing working capital during the quarter. Net receivables from $19.3 million to $152.7 million, the lowest level of the year. Days outstanding were a comfortable 60 days. Inventories moved down by $6 million and we ended the quarter with 225 million cash in investments.

During the quarter, we made significant progress on the 5 million share buyback authorization. For the period, we bought back 2.6 million shares at an average price of just over $19 per share.

As Anders mentioned, we used $157 million to repurchase 6 million shares in 2008. We also announced today that the Board authorized the purchase of another 3 million shares of common stock.

Before I talk about our expectations for Q1, I want to spend a few minute discussing our capital allocation policy and strategy going forward. In the near term, our highest priority is to maintain sufficient liquidity and balance sheet strength to make sure we can support our business objectives under any economic scenario. In doing so, we maintain a longer term view of our businesses as we continue to pursue activities to extend industry leadership and build shareholder value.

That said, because of the current consistency of our cash flow and low capital requirements, we can also continue to buyback our stock at attractive prices. Today, share repurchases standards are highest return investment alternative on a risk adjusted basis.

In addition, given the current market environment, we will not make more acquisitions for the ESG business before we have demonstrated the ability to generate adequate returns with the assets we have in place today.

Over the long-term, we intend to move to a balanced capital allocation model. Based on our analysis, the future resource requirements and investment alternatives, we will use approximately 25% of our cash to cash flow to fund working capital and capital expenditure needs.

We expect this remaining 75% cash flow equally between returning cash to shareholders through share repurchases and other investments that provides the highest risk adjusted return.

This capital allocation matches closely with we how we've invested cash over the last five years. With no respect to follow this allocation policy precisely every year as our decision, we did pay them our current business conditions in available investment alternatives. However, we believe our policy serves as long-term aspiration of frame work for how we intend on deploying our capital.

For the first quarter, we expect to continue buyback shares similar to our activities in 2008. We'll be more aggressive at lower valuations.

Now let's look at our first quarter forecast. For 2009, we are taking cost actions such as salary freezes and decreasing our 401K plan match, which will meaningfully affect our 2009 earnings. For the first quarter, we are forecasting sales of 195 to $210 million.

In this environment, we are taking appropriately conservative approach with our guidance based on trends we see with channel partners, key accounts, and enterprise customers.

This forecast consist of expectation for Zebra Specialty Printing Group sales in the range of 175 million to 188 million and the Enterprise Solution Group sales between 20 million and $22 million.

The forecast incorporates an average U.S. dollar, euro exchange rate of 1.3 compared with 1.51 a year ago, which has a negative impact on operating income of $8 million or $0.08 per share. Hedging activity will have an immaterial impact on first quarter results.

GAAP earnings are expected in the range of $0.11 to $0.20 per share. Our forecast assumes gross profit margin in the range of 44.5% to 46% based on the impact of foreign exchange, product mix and lower volumes.

GAAP operating expenses are forecasted at 76 to $79 million and reflects the $2 million of lower amortization expense, our estimating extra costs and integration expenses to total $3 million and the income tax rate will be approximately 34.5%.

That concludes my formal remarks. Thank you for your attention and now here's Anders for some concluding comments.

Anders Gustafsson

Thank you, Mike.

While the uncertainty in the global economy presents a challenging outlook for 2009, we have addressed areas within our control to preserve profitability and extend our industry leadership over the long-term.

In 2008, we took a number key actions to prepare Zebra with a current business downturn. These include, first: taking costs out of the organization and prioritizing those projects with the most immediate and highest returns in investments.

Second: streamlining marketing functions to drive efficiency and a stronger global brand. Third: canceling products that didn't meet our profitability targets. Fourth: reducing SKUs to improve efficiency and profitability. And fifth: funding our outsourcing and ERP initiatives to the lower costs enhanced business execution and improve customer service.

During the challenging economic times all companies continue to look for ways improve their business processes. And Zebra's product solutions help them do that. The diversity of our business across partners, customers, products, and geographies positions Zebra to pursue a broad range of prospects. Programs are underway to direct resources to the most promising opportunities.

Card, mobile, and kiosk printers and healthcare, government, and retail verticals standout as among the most attractive. Our investments in new products continue to extend the range of customer needs we can satisfy. New software tools also enhance the value propositions of Zebra products by making them easier to integrate use and manage.

As Mike discussed, we are increasingly focused on detouring our resources in those areas that have the highest risk adjusted returns. Our first priority is to maintain cash reserves, to remain nimble in today's challenging operating environment.

Given our financial strength, in the near term, we will continue buying back our shares at attractive prices. In fact, the Board gave authorization to buy up to an additional three million shares of Zebra stock. To reinforce this further, we are introducing ROIC as a component in our 2009 executive incentive plan.

We have made significant progress in sizing ESG that are currently available and perceivable opportunities. We entered 2009 with a much lower cost structure and breakeven point. We have continued confidence in the long-term outlook for this business. Our balanced approach to managing our business was not only to ensure, we navigate the correct environment. But we'll also position Zebra for enhanced earnings leverage when market conditions improve.

Zebra is well positioned in the current environment. Our financial strength and flexibility, industry leadership and focus on the customer. All represent elements that will help drive success in the creation of shareholder value.

Thank you for listening. We will now be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question is coming from the line of Chuck Murphy of Sidoti & Company. Please go ahead for your question sir.

Charles Murphy - Sidoti & Company, LLC

Good morning, guys.

Michael Smiley

Good morning.

Anders Gustafsson

Good morning.

Charles Murphy - Sidoti & Company, LLC

Just wanted to touch on what you were saying at the end there. Mike, you said OpEx should be 76 to 79 million?

Michael Smiley

Yes.

Charles Murphy - Sidoti & Company, LLC

And can you just give us a breakout for your sales guidance for the first quarter between SPG and ESG?

Michael Smiley

Sure. We have... for SPG, we said 175 to basically $188 million and ESG is probably between 20 and $22 million.

Charles Murphy - Sidoti & Company, LLC

Okay, great. Thank you.

Michael Smiley

Yup.

Anders Gustafsson

Thank you.

Operator

Our next question is coming from line of Paul Coster of JPMorgan. Please go ahead with your question.

Paul Coster - JPMorgan Securities, Inc.

Thank you. Good morning. You said that the booking were strong in the Enterprise Solutions Group. Can you give us some kind of breakdown of the backlog whether it by geography or by industry vertical?

Anders Gustafsson

We had a good bookings performance in Q4. We had orders from a number of new customers ranging from people in China, Manila, Pakistan, Middle East, particularly for the aviation business, and Africa along with U.S. and Europe. Our backlog at this stage is commensurate with what we saw going into 2008 from a planned perspective.

Paul Coster - JPMorgan Securities, Inc.

And, so just on that the industry verticals?

Anders Gustafsson

I'm sorry. One more time?

Paul Coster - JPMorgan Securities, Inc.

What industry verticals are for yielding that strong backlog for you in the ESG?

Anders Gustafsson

So, aviation is one that has done very well in Q4 for us as a specific growth market. Maritime is still our largest significant market, and also had good bookings in the fourth quarter.

Paul Coster - JPMorgan Securities, Inc.

Okay. And my last question is: as the year progresses and you get closer to the outsourcing, how should we think about inventory and gross margins as you go through the transition at year-end?

Anders Gustafsson

We've done a lot of transition so far, but we still have very significant amount to do in 2009. And so what happens is you'll end up with two lines; one in the U.S and then one at Jabil running at the same time, and then you shutdown the U.S. line. So, there will a build up of inventory under raw material side as we transition the inventory from the U.S over to China.

So, I'd expect to build an inventory in 2009 for a bit. And as far as gross margins go, we would expect that you'll see the improvement more meaningful in the fourth quarter than from the first quarter. And as I mentioned, just I'd like to highlight one of the big points in our margin that's affecting us is the fact that we have a meaningful shift in product mix from the high-end products to more lower-end products. And then again, because our volume is lower than we in prior years, prior quarters, that volumes also affects our margin in the first quarter.

Paul Coster - JPMorgan Securities, Inc.

Great. Thank you.

Operator

Our next question is from the line of Brian Drab with William Blair. Please go ahead with your question.

Brian Drab - William Blair & Company

Good morning.

Michael Smiley

Good morning.

Anders Gustafsson

Good morning.

Brian Drab - William Blair & Company

First question on ESG, would you be willing to breakup the portion of the impairment charge that was attributable to the ESG, so we can get idea of what actual operating... run rate operating expenses were in the quarter there?

Anders Gustafsson

Yes. Roughly of the $157 million, roughly $15 million is related to SPG and the rest is related to ESG.

Brian Drab - William Blair & Company

Okay, great. And just one other question. You said if I heard correctly that currently hedging in the first quarter will have an immaterial effect. And that's correct, right?

Anders Gustafsson

The hedges that we have are basically close to the spot rate and we're assuming...

Brian Drab - William Blair & Company

Yeah, okay. And then looking forward to the rest of 2009 given where your hedges are at and the current exchange rate that you expect that you'd have an immaterial effect for the balance of the year. How should we forecast that?

Anders Gustafsson

We are not really giving guidance beyond this quarter.

Brian Drab - William Blair & Company

Yeah. Okay, all right. Thank you very much.

Operator

Thank you. Our next question is from the line of Reik Read of Robert Baird. Please go ahead with your question.

Reik Read - Robert W. Baird

Hey, good morning. I was wondering if you guys could just give us a comment on the direct business, which seem to hold up pretty well for you guys, and you mentioned a number of markets retail transportation logistics. There are our fairly weak end markets right now. Is that something that as you consider your guidance and you're looking at the year that you that think that that will still hold up reasonably well or will we see that add back a little bit.

Michael Terzich

Reik. This is Mike Terzich. I'll take that question. You're absolutely correct. In the fourth quarter, the direct business performed very well, and that's essentially a North America concentrated business. And it was in the retail and transportation space. What we are seeing is in the retail space with discount retail there has been some rollouts of some store refresh programs that we took advantage of in the fourth quarter. And the transportation sector was along similar lines, some product refresh.

As far as the course of the balance of '09 and how that's going to play out, the broader retail business as know has been under some pressure. And but they are working off a very thin margins. And so we expect that some other productivity initiatives that they are still looking to advance are still going to play out. But net-net retail we are expecting as a whole retail will be soft as part of our '09 plan.

Reik Read - Robert W. Baird

Okay, great. And then just Mike, going back to the Jabil side of things; with the duplicate lines, when does that, I guess the question is when does that kind of seize? And as you get to the end of the year, can you give us a sense of how much of that overall program has been completed in rough percentage terms?

Michael Smiley

Yes. We expect that, as we said, we are really pleased build to... that at the end of 2009, we'll have the sub-transition; we are on track with that. And so at this point, we're not giving any more guidance in that, but we are on track with what we said by end of 2009 those lines will be transferred over.

Reik Read - Robert W. Baird

And so really what you'd expect at the end of year that that duplicate line would shutdown?

Michael Smiley

Absolute, yes. So by the end of the year we'll be all on, one line out in China.

Reik Read - Robert W. Baird

Okay. And I mean, but is that going to be kind of... to your comment that the fourth quarter ought to be better. Is that reflective of a number of lines, slowly shutting down in a staggered format or how does that...

Michael Smiley

Fortunately, we're not just like moving all at one time. There will be a transition. I will tell you a lot of it sort of in the second, third quarter type timeframe. So you'll see the fourth quarter, if you would ask me just generally the fourth quarter margin will reflect more of the benefit of outsourcing than the third quarter.

Reik Read - Robert W. Baird

Okay, great. Thank you.

Michael Smiley

Yeah.

Operator

Thank you. Our next question is from the line of Chris Quilty of Raymond James. Please go ahead with your questions.

Chris Quilty - Raymond James & Associates

Do I have you?

Michael Smiley

Yep, okay. Good.

Chris Quilty - Raymond James & Associates

Just checking the line there. Just a follow-up, I think, Mike, you mentioned the $50 million of the goodwill and tangible write-down was attributed to SPG, which acquisition was that? Was that the Swecoin or going way back to the Atlantic?

Michael Smiley

That was primarily to passive by the licenses, we had prepaid.

Chris Quilty - Raymond James & Associates

Okay. So nothing acquisition...

Chris Quilty - Raymond James & Associates

No acquisition.

Anders Gustafsson

No, no.

Chris Quilty - Raymond James & Associates

Okay. And the ESG; did I catch the number that were $5.7 million of acquisitions, acquisition related revenue in the quarter?

Unidentified Analyst

That's additional, that's incremental. And when we look at the year-over-year change in revenue, part of that increase, $5.7 is due to the ESG from year-over-year.

Chris Quilty - Raymond James & Associates

Got you.

Unidentified Analyst

Revenue was 22.1.

Chris Quilty - Raymond James & Associates

Right. But Navis was picked up very late in the quarter, and that's a business that had been running around $15 million a quarter 14, 15 million, and you picked up sensibly another million or two from Multispectral. So fair to assume you are seeing order of magnitude 50, 60% down even in the Navis business?

Michael Smiley

No Navis came in at 14th of December, I guess; it was 2007. The Navis business has held up very well so far. The weakness we've seen has been really focused on the automotive and to some degree, the industrial manufacturing market.

Chris Quilty - Raymond James & Associates

Okay. And shift over the Jabil and the outsourcing, do you have an update? I mean I think your fourth quarter charges for restructuring were much bigger than you had projected. You had originally talked about 24 to $26 million for the entire implementation of this strategy should we expect that number is now going to move up?

Michael Smiley

When we talked about the asset costs, we had not envisioned as Anders said, we've done some second half cost reductions, which is more to the restructuring, which was not really part of what we call the manufacturing switch over. So, those layoffs are primarily difference between the number that we've quoted in the past in our actual results. We had... like severance and stuff that we had to pay to effect some of those cost reductions.

Chris Quilty - Raymond James & Associates

Okay. But other than that the cost or your own plan for what you had expected for the exit costs?

Michael Smiley

Yeah, we are.

Chris Quilty - Raymond James & Associates

Okay. Those were three follow-up that I'll campaign as my one question.

Unidentified Analyst

Okay. Thank you.

Operator

Our next question comes from the line of Andrew Abrams of Avian Securities. Please go ahead with your question.

Andrew Abrams - Avian Securities

I wonder if you could talk about the channel a little bit. Did you increase penetration or decrease penetration into the channel during the last quarter or so. And the results that came out of that channel I'm assuming were a little weaker than they were in the previous quarter given the strength in your direct business in North America. Maybe you could characterize that for us.

Anders Gustafsson

Yeah. I think we had very strong broad based performance in the first 11 weeks really over 10, 11 weeks of December. And I think we continue to make good strides with our channels. I believe we are continuing to extend our leaderships in that area.

We saw some full opportunity... as I said at the end of the quarter, the more sales out from some of the largest distributors. But that we don't see as an ongoing thing that was where the correction put from their sales out prospective in the short-term.

And Mike you can maybe add some more color.

Michael Smiley

Okay. Andrew your question is a bit complicated in the broadest sense we saw further penetration in growth through the channel, this is across all geographies. Now within North America to Andrew's point the strength that we saw in the fourth quarter was our direct sales versus our true channel business.

But in the international markets, we continue to advance our growth. It's all principally through our channel business. So growth in the international markets comes through channel. And I think we mentioned in the prepared comments, we essentially doubled the number of channel partners we have in our card business. So, all indications are that our channel business is continuing to progress and we are continuing to take share.

Andrew Abrams - Avian Securities

Thank you.

Operator

Our next question in from the line Ajit Pai of Thomas Weisel Partners. Please go ahead with your question.

Ajit Pai - Thomas Weisel Partners, LLC

Good morning.

Anders Gustafsson

Good morning Ajit.

Ajit Pai - Thomas Weisel Partners, LLC

Couple of quick question I think the first one is just looking at the gross margins that you saw in your Enterprise Group, the ESG Group. It was at a record level. And I think you did attributed to like mix of business and service margins, but would love to understand what the backlog for that business looks like in terms of mix?

And on the same question, I think, you've talked about a record backlog in that business, but you also talk about the fact that business is going to be on a year-over-year basis down for the first time going into the first quarter. So, could you give us some color as to what the tenure of that backlog is? About, when you expect that backlog to shift to actually shift and we recognize as revenue?

Michael Smiley

Okay. As you just talking about the ESG gross margin, I just want to make sure you highlight the fact that I said that, in the quarter, we benefited from roughly $1.8 million of contract, a loss provision adjustment offset by some inventory.

So, in Q4, I would say 61.5 benefited from some one time items. Needless to say though, we've had some significant improvement in our services margin business that's helped us dramatically. And we've been able to do that again through the cost reductions we did in the second half, and some of the head count that services business services business.

Anders Gustafsson

And what we said was that our bookings in Q4 was at the highest level for all of 2008. And that our backlog going into 2009 was commensurate with the backlog we had going into 2008, so going to 2009 was commensurate with the backlog we had going into 2008 from a planned perspective.

We are not quite prepared to break that into the different components of it. But, when we get the contract, usually it takes us between six and 12 months to realize the revenue for that depending what with segments. So, if it's on in marine, it's more like a year. If it's more in the say, automotive and industrial manufacturing side, that tends to be more like a six month contract, six month to realize the revenue.

Ajit Pai - Thomas Weisel Partners, LLC

Got it. And then the second question or the follow-up question would be, just looking at the number of store closers that you have seen right now in the U.S. and potentially also in Europe at some point into immediate future, are you seeing any kind of sort competition from the secondary market, any equipment, Zebra equipment, subsiding the secondary market as folks shut down stores or is that not the case?

Michael Terzich

Ajit, this is Mike. No, we are not seeing that, and principally a lot of the store applications are mobility based products and solutions. And those products tend to get pretty beat up in the marketplace. And usually when a door shuts sound, those products to get retired with it.

Ajit Pai - Thomas Weisel Partners, LLC

Got it. Thank you.

Anders Gustafsson

Thank you.

Operator

Our next question is from the line of Anthony Kure with KeyBanc. Please go ahead with your question.

Anthony Kure - KeyBanc Capital Markets

Good morning. Just a couple of questions in relation to the international markets. I think on the third quarter you said China, during the third quarter was the third biggest country revenue wise. Just wondering what you are seeing out of China, what you saw in the China in the fourth quarter.

Anders Gustafsson

Our China business in the fourth quarter was still very good, was clearly the leading region, sub-region in Asia from a growth perspective. We did see a slowdown towards the end of the quarter, consistent with some other things we've seen, principally because they are serving a big portion of the western demand for export and western demand in the United States and Europe is slowdown.

Anthony Kure - KeyBanc Capital Markets

Okay. And then as far as the fourth quarter, the 7.8 or so total costs, how much of that was, if you could breakdown, related simply to the outsourcing?

Michael Smiley

I'm sorry, 7.8 million of COGS?

Anthony Kure - KeyBanc Capital Markets

No, the 7.8 million called out, which was the asset restructuring integration expenses?

Michael Smiley

And how much of that was what?

Anthony Kure - KeyBanc Capital Markets

How much of that was the actual outsourcing program?

Michael Smiley

Yeah, I've got there, hold on a second. Of that amount, 7.8 roughly, 3.4 million was asset associated with the outsourcing.

Anthony Kure - KeyBanc Capital Markets

Okay, great. Thank you.

Unidentified Analyst

Thank you.

Operator

Our next question is from the line of Greg Halter [Great Lakes Review]. Please go ahead for are question sir.

Greg Halter - Great Lakes Review

Yes, good morning. I have a question for you about the cash and investments of where that is invested currently in terms of investments, and then where in terms of geography?

Anders Gustafsson

They are all in the U.S. And it's primarily... it's almost entirely government-backed, municipal-backed type securities, highly rated. So, we're feeling really good about the availability of those funds and what they're invested in.

Greg Halter - Great Lakes Review

Okay. And you provided I think a 3.8% annualized rate of return on the investments?

Michael Smiley

Yes, for Q4.

Greg Halter - Great Lakes Review

For Q4, all right. If I do the math on the 1.3 million that you realized and divided it in the 3.8, I get $136 million of investments. And obviously, you have more than that. I just wonder if you could maybe walk me through the apparent discrepancy there.

Michael Smiley

Yeah. Well, I think the part that that you've got in the math, you've got to look at... a lot of them are annuities, so the tax... look at the tax impact we've turned started back into that.

Greg Halter - Great Lakes Review

Okay. And one other quick one, if could: can you comment on your receivables quality currently?

Anders Gustafsson

Certainly, I think at the end of the quarter, I was very pleased with where we came in with the receivables. We saw some meaningful collections from the ESG side of the business were at 60 days; and basically the SPG business held flat with their DSOs, and ESG improved. ESG was continuing to focus on. But that was where we saw the meaningful improvement in the fourth quarter. I got to tell you though, we are going into a difficult market. So Mike and I'd spend a lot of quality time together making sure we're making the right decisions on customers and credit. So that's where we're.

Greg Halter - Great Lakes Review

Okay. Thank you.

Operator

Thank you. Our next question is a follow-up from the line of Paul Coster with JPMorgan. Please go ahead with your question.

Paul Coster - JPMorgan Securities, Inc.

Yeah. I've just got one follow-up on the gross margin and the transition to outsourced operations. And clearly, you said something really clever here. Because surely as you wind down your operation in North America, isn't your absorption rate going to decline? Or am I simply misunderstanding the way in which you are going to do this transition. Obviously, I am worried that the domestic product gross margin, sort of it's weighed down by lower absorption rates for the final period?

Anders Gustafsson

Could you help me re-say what you are looking for, so I can answer your question as well?

Paul Coster - JPMorgan Securities, Inc.

So you are going wind down operations, internal operations and then you are going to move to the outsourced operations over the course of this year. As you wind down your operations, in-house operations then your absorption rate on your firm and your production lines will pull.

Anders Gustafsson

Yes.

Paul Coster - JPMorgan Securities, Inc.

So gross margins will be weighing down. But you are saying that that won't happen. So why is that you are able to avoid that transition risk?

Anders Gustafsson

Well, the point is that one of the challenges with the transition is as you move these lines over, the objective is then to reduce the cost associated with those lines to be in transition. So that you end up with not carrying too much capacity. So that's one of the challenges that the SPG group is to time the transition from one group to the other and so you're right. In the middle of the transition, you are not running optimally. But we expect at the end of fourth quarter that we'll be close to that. And our gross margins that we're talking about is not so much the capacity of the volume in the two lines.

It's just that when you look at Q4 to Q1, there is a meaningful decline in revenue. We look at that revenue decline that is having some impact on our margins.

Paul Coster - JPMorgan Securities, Inc.

Okay. Got it. Thank you.

Anders Gustafsson

Thank you.

Operator

Thank you. Our next question is from the line of Reik Read of Robert Baird. Please go ahead with your question.

Reik Read - Robert W. Baird

I just want to follow-up again on retail and transportation logistics. You guys had been doing quite a bit of diversification within the retail market. Is that something that even though with the weak environment do you think that that will help you out on a relative basis more than transportation logistics?

Michael Smiley

Reik, this is Mike. Yes, the retail space, I mean the diversification of our business has been on two fronts. One, globally retail has become more important in the international markets, in it's contribution at the whole and that has certainly worked well for us.

We saw a good retail success in the fourth quarter. We expect that to continue and then second, we've diversified from the big back discount retail into specialty retail. I think the challenge in the marketplace right now is specialty retail. This is usually the higher margin, higher goods retailers are struggling. But we've been offsetting that with good growth in the discount retail, including by our definition retailers into grocery and some of these other sub-verticals, which we've seen some success in.

Anders Gustafsson

If you remember back, our Q2 call of 2008, we actually said that we benefited that point from small customers and also international. And in Q4 it was more North America and larger customers. So I think the diversification is working for us very well.

Reik Read - Robert W. Baird

Okay. And just one follow-up on the ESG, Mike, I think as part of your comment that you said you've got, roughly 2.5 million of burn through remaining of the purchase accounting. When do you expect that to be finally completed?

Michael Smiley

We are not very good at guessing that. I think we've been running at probably 1 million or 2 a quarter, so you can just extrapolate we're not really, I'm not really certain.

Reik Read - Robert W. Baird

Okay. Fair now enough. Thank you.

Anders Gustafsson

Thanks.

Operator

Our next question is from the line of Timothy Robertson of Boyne Advisors. Please go ahead with your question sir.

Timothy Robertson - Boyne Advisors

Good morning guys. Thanks for taking my call.

Anders Gustafsson

Sure.

Timothy Robertson - Boyne Advisors

Just back to the receivables question, what was the collection dates for the EGS segment this quarter?

Anders Gustafsson

The collection date to the EGS's segment was improved from basically at the beginning of the... end of last year was north of 180 days, now stand at 125 days.

Timothy Robertson - Boyne Advisors

Okay. Great. And could you give me a breakdown of the inventory balance between raw materials with finished goods and deferred contract costs?

Michael Smiley

Yeah. Roughly half of it is raw materials the other half is finished goods and there is a little bit of work in process in deferred costs long-term contracts.

Timothy Robertson - Boyne Advisors

Okay. And what was the plus reserve at year end?

Michael Smiley

7.2 million.

Timothy Robertson - Boyne Advisors

7.2 million?

Michael Smiley

Yeah.

Timothy Robertson - Boyne Advisors

Okay. Do you expect any additional onetime items to be flowing through gross margin in Q1?

Michael Smiley

Do I expect it? If I expect it, I would have included it in our forecast.

Timothy Robertson - Boyne Advisors

Okay.

Michael Smiley

I don't know of anything at this point.

Timothy Robertson - Boyne Advisors

Okay, great. Thank you very much.

Michael Smiley

Yeah.

Timothy Robertson - Boyne Advisors

Okay.

Anders Gustafsson

Thanks.

Operator

Our next question is a follow-up from the line of Greg Halter with Great Lakes Review. Please go ahead with your question sir.

Greg Halter - Great Lakes Review

Yes. Thank you for letting me back. The current in the release about the year-end share count at 60.86 million, I presume versus the average for the quarter that would have meant that you bought quite a bit of share later in the quarter to bring you down to the year end figure?

Anders Gustafsson

I don't know. We obviously became lot more active after the second quarter after the third quarter earnings call, and that sort of happens sort of the way through. So you're right, it was pride more back end loaded than front end loaded.

Greg Halter - Great Lakes Review

Okay, I'm just trying to get a gauge on the share count, and looks like the 60.86 is about it, because it does not appear there is much in the way of option dilution currently.

Anders Gustafsson

No, no there is not.

Greg Halter - Great Lakes Review

Okay. Thank you.

Operator

Our next question is a follow-up from the line of Chuck Murphy of Sidoti & Company. Please go ahead with your question.

Charles Murphy - Sidoti & Company, LLC

Hey guys. Could you just talk about the linearity of your orders for the past three or four months? I mean was January lower than December and February lower than January?

Anders Gustafsson

So, in Q4 we saw very strong broad based bookings through October, November, and first part of December. And we saw weakening in the last two to three weeks of the fourth quarter. That's part of our guidance as we go into Q1. I think we've seen in the first quarter a lot of companies doing things like we are doing absolutely delayed their actual budgeting process. So, lot of the business units haven't seen their capital budgets yet. So you don't have necessarily the capital budgets to a spend. So our January was a bit weaker than we had expected, but that's also then baked into our forecast. And we expect that those budgets will now be finalized and people will be able to get their budgets to spend.

Charles Murphy - Sidoti & Company, LLC

Okay. I guess as it stands now, I mean would you feel like it's more likely than not that June is at least flat if not a little better than the March quarter?

Anders Gustafsson

I think we'll stay with it, Q1 the guidance here, I think that we... going into Q2 gets to be a little further field in this environment.

Michael Smiley

There has been a lot of debate with a lot of companies about whether they give next quarter guidance at all, and it's a tough market now. So we feel good to be able to give you the guidance that we are, but we don't want to go beyond that.

Charles Murphy - Sidoti & Company, LLC

Okay, sounds good. Thanks.

Operator

Thank you. Our final question will be coming from the line of Chris Quilty; it's a follow up. And he's from Raymond James & Associates. Pleas go ahead with your question.

Chris Quilty - Raymond James & Associates

Thanks guys. I just want to quantify with regards to the restructuring efforts. The numbers you had mentioned previously about cost savings for this year. Those are all based upon restructuring charges that are already being accrued. And those are sort of annualized rates?

Anders Gustafsson

Yeah, I don't think there is much more going on, most of it's already been accrued.

Chris Quilty - Raymond James & Associates

Okay. And I was trying to go back during the discussion here in back through all the numbers of the strict exit charges and what not. But maybe you can just to make it easy for me, beyond the amount you stated for the first quarter and exit restructuring charges, what are you assuming as well for the balance of the year in remaining charges?

Anders Gustafsson

We're not going beyond the quarter, but we've got basically $3.1 million in the first quarter for exit and ESG integration costs, and that's what we have right now.

Chris Quilty - Raymond James & Associates

Okay. But if I add up what you previously charged through 2008, and again I couldn't quite back out between the exit and the restructuring side, it doesn't look like there is all that much left through the balance of the year or am I running the numbers wrong?

Anders Gustafsson

I think you're in the right ballpark here.

Chris Quilty - Raymond James & Associates

Okay. I just wanted to make sure.

Anders Gustafsson

Yeah.

Chris Quilty - Raymond James & Associates

Thank you.

Operator

Thank you. I'd like to turn the floor back over to management for closing comments.

Douglas Fox, CFA

This is Dough. Just want to say thank you. Our hour is up. Mike Smiley and I will be around the rest of the day if you have further follow-up questions.

Also I just want to let you know that our first quarter conference call will be held on May 5th. So we look forward to taking with you at that time. Thank you very much.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Zebra Technologies Q4 2008 Earnings Call Transcript
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