Zebra Technologies Q1 2009 Earnings Call Transcript

| About: Zebra Technologies (ZBRA)

Zebra Technologies Corp. (NASDAQ:ZBRA)

Q1 2009 Earnings Conference Call

May 05, 2009 11:30 AM ET


Douglas A. Fox, CFA - Vice President, 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


Paul Coster - J.P.Morgan Securities, Inc.

Reik Read - Robert W. Baird

Brian Drab - William Blair & Company


Good morning and welcome to the Zebra Technologies' 2009 First Quarter Earnings Release Conference Call.

Joining us from Zebra Technologies are Anders Gustafsson, CEO, Mike Smiley, CFO, Mike Terzich, Senior Vice President and Global Sales and Marketing, SPS, and Douglas 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 questions. 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. Douglas Fox of Zebra Technologies. Sir, you may begin.

Douglas A. Fox, CFA

Good morning. Thank you for joining us today. Certain statements made 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, 2008, which is on file with the SEC.

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

Anders Gustafsson

Thank you, Dough, and good morning, everyone. I appreciate you joining us today. Here in the room with me are Mike Smiley, our CFO, and Mike Terzich, our SVP of Global Sales and Marketing for our Specialty Printing Group.

Today Zebra reported first quarter EPS well within our guidance range, but fell slightly short on sales. The environment during the first quarter was particularly challenging due to reduced capital spending, inventory reductions and project deferrals by our customers.

Our team however, did a remarkable job, managing the business prudently by executing well on the areas within our control. We continue to focus on increasing operating efficiencies, further aligning our expenses to match reduced sales levels, and managing inventories and receivables effectively.

In addition, our long-term projects, including transforming our supply chain through outsourcing, manufacturing and implementing our new ERP system, are progressing as planned.

Sales activities, as driven by our Specialty Printing Group, demonstrated some pick up in the first weeks of February, but was softer than anticipated in the second half of March. On a regional basis, we experienced weaker than expected sales in Asia-Pacific and Latin America.

We also saw greater softness in North America, as distributors moved aggressively to reduce inventory levels in the face of weak demand.

Business in EMEA met our internal expectations. As our outlook for the second quarter suggests, however, we could be seeing early signs of stabilization. As expected, our targeted verticals in healthcare and government performed relatively well.

We had some nice wins in the retail sector in Asia-Pacific and North America, and activity with coastal organizations improved in EMEA.

As we expected, the substantial decline in sales to customers in manufacturing, impacted product mix, gross margin and average unit prices, which we expect to rebound as business conditions improve.

In the face of current economic headwinds, we continued to align our sales activity towards the most promising and durable markets, including the government healthcare and mobile work force verticals.

On the expense side, we began to more fully realize the benefits of our actions taken in the second half of 2008, and early 2009, to align costs, with business activity.

For the quarter, we reduced operating expenses by 14% from a year ago. The entire team can be credited for doing an excellent job, controlling discretionary spending during this challenging period.

In addition, we made structural changes to our operations, including streamlining our sales and marketing functions, initiated in the fourth quarter of 2008. We continued to streamline and integrate sales and marketing to create a model with better coverage and resource alignment with our growth goals for 2009.

These efforts are beginning to improve execution, flexibility and responsiveness. These actions made an immediate contribution and will give Zebra added earnings leverage when market conditions improve.

Operationally, our surprising transformation remains on track to realize costs savings of 25 to $30 million, or 2.5 to 3 percentage points in gross margin improvement in 2010.

In our Q3 2008 call, we discussed that we had moved approximately 40% of our production capacity to Jabil.

At the end of the first quarter that number had increased to 59%.

Approximately 40% of first quarter printer sales were the products sourced from Jabil.

Likewise, our ERP implementation continues on schedule and within budget, with the latest module successfully launched as recently as yesterday.

Both of these multi-year projects would help Zebra deliver better customer service and greater operation efficiency.

We also remained focused on our disciplined capital allocation strategy to deliver the highest risk adjusted returns on our investments to build enduring shareholder value.

Our highest priority continues to be maintaining financial strength and flexibility, to navigate effectively through this challenging environment.

In Q1, we viewed repurchasing our shares as the highest risk adjusted return alternative. At the end of the first quarter, we had $189 million in cash and investments with no debt. For the quarter, we used $29 million to buyback 1.7 million shares. Since the beginning of 2008, we've deployed $186 million to buyback 7.7 million shares.

During our previous conference call, we discussed the urgency for the Enterprise Solutions division to generate an appropriate level of return.

For the first quarter, Enterprise Solutions performed within guidance, and I am pleased to report that the actions we took to lower the cost structure and improve operation efficiency, led to an adjusted EBITDA breakeven.

We remain confident. We have laid the ground work for Enterprise Solutions to be roughly EBITDA breakeven for 2009.

While we realize this is only a step towards our ultimate goal for Enterprise Solutions, it is an important financial milestone that demonstrates real progress and underscores our commitment to unlock the full value of these operations.

In addition, we remain on course with our faced strategy to fully integrate Enterprise Solutions into our global operations.

In 2008, we focused on integrating and streamlining the acquired operations with each other and gaining stocks compliance.

This year our energies are focused on solution integration, cross selling and channel development.

The Enterprise Solution's team is committed to realizing our vision for these businesses, by leveraging our assets to drive higher sales and market leadership. And I'm pleased with their progress. The success with Enterprise Solutions is critical to our global competitive positioning, as it enhances the value of our core business. It makes Zebra a more important strategic business partner through industry leading asset tracking and management technologies, high value software products, and a comprehensive solution set.

The Enterprise Solutions division is well-aligned with Zebra's core value propositions to our customers, and provides a deep expertise into targeted industry.

In addition, it gives us access to high level decision makers in the world's largest enterprises.

I am pleased to report, we made good progress in achieving the milestones we provided last quarter to cross sell and bundle our solutions within the division.

During the quarter, we formally signed five new channel partners, including three current Specialty Printing resellers.

We have nearly 20 more integrators who have applied or are in various stages of evaluation. This level of interest gives us confidence in meeting our goal of signing 20 for the year.

We deployed five systems in cross selling situations out of this year's goal of 25. We continue to cross sell the solutions across industries and into adjacent markets, such as the ultra wideband solutions that we typically sell into manufacturing.

In this quarter, we sold ultra wideband into government and aerospace and defense. This demonstrates the combined sales team's ability to up sell current customers, and cross sell into new markets.

And we installed 12 solutions out of this year's goal of 50, with customers around the world. The installations were in industrial manufacturing, maritime and aviation in EMEA, the United States and Latin America.

These achievements are all the more impressive given the difficult market environment in general, and the continued pressure on the automotive industry in particular, coupled with push outs of IT projects in other segments.

Even with these challenges, our customers continue to see value in these solutions this business offers.

Zebra has aggressively taken steps to maintain financial strength, align expenses with sales, and position the company through improving returns and earnings leverage, when market conditions improve.

While disappointed with the level of sales driven by current industry conditions, I am very pleased with Zebra continues to execute in this environment. We remain well-positioned to extend global leadership in a fundamentally attractive industry.

Our solutions, incorporating a broad range of established and emerging technologies, enable our customers to deploy their critical assets smarter to improve business performance.

We continue to build on our clear brand leadership, product breadth, financial strength, and global presence to move up the value chain and become a more strategic business partner.

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

Michael C. Smiley

Thank you, Anders. Let me highlight the key financial year-over-year drivers for the quarter.

Sales were down comparably in dollar terms across all geographic regions.

Gross margin was affected by lower sales volume, the expected shift in product mix, and changes in foreign exchange rates.

Operating expenses fell, with the biggest declines occurring in sales and marketing, and ammonization of intangibles.

The income tax rate of 32% was affected by non-taxable interest income, which is a larger percentage of pre-tax income than in prior periods. We expected 32% rate to be effective for the full year of 2009.

Foreign exchange had a negative impact on operating income of approximately $2 million.

Let's take a look at sales. For the quarter, sales were down 22% from a year ago, and 17% from the fourth quarter.

Sales in Specialty Printing Group were down 24%, with a slowdown in large deal activity, reduction of inventories with distributors, and general push outs and delays. Even with the slowdown, we are comfortable that we maintained or extended our global leadership position.

Enterprise Solutions sales increased to 1%, as we had entered the quarter with a good backlog. Booking activity in Enterprise Solutions remained healthy in the quarter.

Let's take a look at sales by product lines. The breadth of the sales decline occurred in hardware, which was down 30% to a 126 million from last year, and represented 55% of total sales.

As Anders commented, we had greater weakness in our high-end and middle range printer lines, from the extreme slowdown in manufacturing across the globe.

This mix change with relative better sales performance from desktop and mobile printers put greater downward pressure on gross margins than we expected. We view this decline as temporary, and expect margins to rebound as product mix benefits from improvements in the economy.

The percentage of printer sales from new printers came in at 7%, while printer sales introduced over the last 18 months have been ramping nicely, our very popular ZM400 and 600 models fell off the back end of the calculation.

We expect this number to move up, as we introduce new printers, and printer such as our HC100 wristband, G-series Desktop and kiosk printers gained further traction.

We shipped 199,000 printers in first quarter. Average unit price of $517 was down from $614 a year ago, largely because of product mix and foreign exchange. Pricing within product families remained stable year-over-year.

The price of 38 million provided a moderating effect down 9%, and comprised 20% of total sales.

Service and software revenues increased 3% and accounted for 13% of total sales. By region, we had comparable sales declines between 20 and 30%. Adjusting for FX, EMEA sales declined about 15%.

Foreign exchange and other hedges reduced consolidated sales by 6.7 million or 3%.

Consolidated gross margin was 44.6%, compared with 49.9% a year ago.

Again, the big story here was the mix in volume. Specialty Printing Group gross margins declined from 49.8% to 43.1%, including 0.7 percentage points from foreign exchange changes or $4.3 million.

Gross margin for Enterprise Solutions Group increased to 55.6% from 51%, with a benefit of from a more profitable services business, in which we aligned resources with the current level of activity.

We are very pleased with our overall control of operating expenses. First quarter total operating expenses were down 12 million or 14.3% from the prior year. Of this decline 2 million was due to changes in foreign exchange rates.

The bigger changes in operating expenses occurred in areas of business development, prototypes and tooling and other discretionary spending.

Amortization decreased 1.9 million, result of impairment charges taken in the fourth quarter.

For the quarter, the investment portfolio had annualized return of 3.1%. On an absolute basis, investment income was down principally because our deployment of cash to buy back stock.

The income tax rate for the quarter was 32%, down from our historical 34.5%. The difference was driven by non-taxable interest income, which was the higher percentage of pre-tax income than in prior periods. We expect 32% rate to be effective for the full year.

Net income came in at $0.16 per diluted share on 50.3 million average shares outstanding.

Exit restructuring and integration costs reduced earnings per share by $0.02 per share.

We ended the quarter with 59.4 million shares outstanding. And our receivables were down $15.5 million. Days outstanding were 65 days compared with 63 days because of the timing of sales.

Inventory levels were inline with our expectations and moved up only slightly during this period of transition to outsourcing.

Inventory reserves likewise remained flat with fourth quarter levels. And we ended the quarter with a $189 million in cash and investments.

Cash flow was affected by some big reductions in liabilities. We had 24 million in the accrued liabilities, including declines in accrued payroll and bonuses, and the settlement on foreign exchange balance sheet hedges.

Income taxes payable declined by $8 million and accounts payable were down by 6.5 million. We use this high use of cash to be principally timing related.

During the quarter, we maintained progress on the share buyback program.

For the period, we bought back 1.7 million shares at an average price of $17.30. We now have 3.7 million shares remaining authorized for repurchase.

Let me turn a moment to capital allocation. From all companies, Zebra has five potential -- like all companies, Zebra has five potential uses for its excess resources to built shareholder value, to invest in general projects, reduce debt, pay dividends, make acquisitions or buy back stock.

Given the current business environment, the highest priority is to maintain sufficient liquidity and balance sheet strength, to ensure we can support our business objectives under any economics scenario.

Beyond investing and important internal projects, share repurchases remain as our highest returning investment alternative on a risk adjusted basis.

In addition, our focus continues to be on increasing returns on Enterprise Solutions, before we make any more acquisitions in this area.

Now, let's look at our second quarter forecast. We are forecasting sales of 186 to $200 million. This forecast consists of expectations for Zebra's Specialty Printing Group sales in the range of 158 million to $180 million, Enterprise Solutions sales between 18 and $20 million.

The forecast incorporates an average U.S. dollar-euro exchange rate of 1.3 compared with 1.56 a year ago.

GAAP earnings are expected in the range of 12 to $0.20 per share.

Our forecast assumes gross profit margin in the range of 44.3 to 45.6%, given the impact of FX, product mix and lower volumes.

We expect GAAP operating expenses at 72 to $74 million.

We're estimating exit restructuring integration expenses to have a $0.04 per share impact on EPS. The income tax rate will be 32%. That concludes my formal remarks.

Now, here's Anders for some concluding comments.

Anders Gustafsson

Thank you, Mike. Going forward, we continue to manage our business prudently with the balance between preserving near term profitability and pursuing long-term opportunities, to ensure we position Zebra for accelerating earning growth when business conditions improve.

The effectiveness of our expense controls on current financial results is evident. At the same time, we are using our financial strength and flexibility, industry leadership and focus on the customer to drive greater success, increase shareholder value by directing our resources to areas that have the highest risk adjusted returns.

To date, our largest investments have been in Zebra itself, with stock buybacks leading the way, followed by our high value outsourcing in ERP projects.

In addition, we continue to invest in new products and solutions to serve more customer needs and further enhance our global competitive position.

The printer products we introduced last year are steadily gaining traction. In the middle of the year, we will begin shipping our new retransfer card printer, which gives us greater access to RFID Smart Card applications.

We also have new tabletop desktop and kiosk printers under development for release later this year.

In these turbulent times, when many companies are cutting back to survive, we've used our financial strength to bolster our competitive position by making selective additions of seasoned industry reference.

These suggestions include, experienced sales representatives for mobile solutions, an area of great opportunity for Zebra, and new leadership in sales management and engineering. We are also taking advantage of opportunities the global economic crisis is presenting, by focusing more marketing efforts to gain share in areas where weaker competitors are having trouble meeting customer requests.

Our Zebra employees have done an excellent job under difficult circumstances to maintain global leadership by capturing more available opportunities through meeting customer needs.

Let me close by saying that Zebra will be a more nimble and formidable company, as we come out of this global recession. Zebra is in strong position in a great industry that serves critical customer needs. I am confident that we're using our resources prudently to create lasting shareholder value. This concludes our prepared remarks. And we would now be happy to take your questions.

Question-and-Answer Session


Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Our first question comes from Paul Coster with J.P.Morgan. Please proceed with your question.

Paul Coster - J.P.Morgan Securities, Inc.

Yes. First of all, the OpEx is going up sequentially, notwithstanding the tough top-line at the moment. Can you just talk about where you're increasing your OpEx and why?

Anders Gustafsson

OpEx for the fourth quarter was 85...

Michael Smiley


Anders Gustafsson

Oh, the guidance. Why is the guidance going up? I'm sorry. Guidance is going up for a couple of reasons. I think, first of all, in the first quarter we had -- a lot of our discretionary spend was slightly below. We put a lot of pressure on that. We are expecting that that level may have to ramp up just a little bit from the first quarter. It's a primary driver for that.

We're seeing that -- we're comfortable with the guidance that we're getting, but we're not seeing a big increase. Again, the first quarter was we thought -- we put a lot of pressure in trying to keep that number down.

Paul Coster - J.P.Morgan Securities, Inc.

Yeah, I can see it is not very much. I am just curious though whether I can fly back to your comment about global leadership Mike. You said that you feel like you're gaining somehow. Is that because you're spending more than others in SG&A? Can you just sort of talk about the competitive landscape and what you're doing to capitalize from this weakness amongst your competitors?

Anders Gustafsson

Yeah we... this is Anders. We are trying to very carefully balance our short-term profit requirements with the long-term opportunities to position Zebra for growth and creating shareholder value.

We have taken opportunities to strengthen our team by hiring some very strong people in our sales organization, sales management and engineering. So, we want to make sure we take advantage of the market as it is.

We are also continuing to develop a lot of new products, and we see some of the expenses that come from molding and other tooling for new products. And we continue to do lot of marketing in order to stimulate end user demand to make sure that our brand name is out there and continues to extend its leadership.

Paul Coster - J.P.Morgan Securities, Inc.

If you were able to pinpoint the weaknesses amongst your competitors, which geographies and which product there is that they're starting to fall behind you?

Anders Gustafsson

I don't think we want go into anything specific with our competitors. We have a lot of different competitors and it varies by region and product line. So, we take them all seriously. And everybody is fighting hard at this.

Paul Coster - J.P.Morgan Securities, Inc.

Okay. Last question, Anders, you did mention the word stabilization. Can you just give us a little bit of color around what are you seeing that might be sort of more constructive out there at the moment?

Anders Gustafsson

Yeah. First, the environment continues to be very tough. We are not saying that this has become a benign environment. It's still tough. But, we do see from early signs of stabilization we believe. And with the increased proposal activity, and I think our pipeline is little less volatile. And... but, this stability is still limited. But, some signs of stabilization.

Paul Coster - J.P.Morgan Securities, Inc.

Great. Thank you very much.


Our next question comes from Reik Read with Robert W. Baird. Please proceed with your question.

Reik Read - Robert W. Baird

Hey. Good morning. If I could go back to the operating expense hit for a second. It looked like most of the reductions that you saw from an OpEx standpoint, it really came out of the sales and marketing area.

Can you address why that is given the importance of that area, and why not more of a focus maybe on administration, and talk about those actions? And Mike to your point, can you talk about how much of the actions you've taken is sustainable, and then what needs to be back build?

Michael Terzich

Hey Reik, this is Mike Terzich. I will take your question.

On the sales and marketing side, we commented in the prepared remarks about streamlining some of that activity. It's principally focused in two areas. We've taken a look at the business across the globe. And we're pretty well diversified across a variety of markets and applications spaces. And we've been moving some investment from some areas that have softer performance and a softer outlook into areas of the business that we're seeing some growth and opportunity.

So, in an overly simplified manner, we're pulling back on some investment in the manufacturing sector, and we're redirecting investment into areas such as direct store delivery, retail and healthcare.

And secondly, on the marketing side what we've done is we've consolidated some operations. And prior to the start of the year, we had investments, duplicative investments across the business, including both the SPS and the Enterprise Solutions business.

We've consolidated some investments. We've reduced the number of PR firms as an example. And it's giving us a little bit more control over the spend. We're getting more productive use out of that spend.

Michael Smiley

And Reik, going back to your question on G&A, by the way, the first... our G&A tends to be a little lumpy in respect of the benefit. The first quarter tends to be a little bit higher. And that tends to level off. So, we would expect the second quarter for G&A to be a little bit down from we're in the first quarter.

Anders Gustafsson

And also, the Enterprise Solutions Group, we've talked earlier about our efforts to reduce the breakeven point. And you see some of that in here also at the reduction in sales and marketing and other areas is part contributed by the Enterprise Solutions Group.

Reik Read - Robert W. Baird

And I guess I've heard what you guys have said is that at least with respect to the SG&A, with respect to the sales and marketing area, a lot of those changes are permanent, the streamlining, ought to create that continued efficiency?

Michael Terzich

Yes. Most of it are structural changes. But obviously, some of the marketing spend we can pull up and down based on activity. And certainly, a piece of the stuff are commissions. So, as revenue goes up, the commissions will go up, those kinds of things.

Reik Read - Robert W. Baird

Right, okay. Okay, great. And then, just on the ESG side, Anders maybe you could spend a little bit of time just given automotive is the key market, and there's been all these changes within the greater automotive space. Can you talk a lot -- can you talk about their -- they may want this stuff, but their real ability to implement it, what's the status there?

Anders Gustafsson

Yeah I think that our customers continue to see good opportunities with the solutions from ESG.

Our -- the vision we've laid out being able to help our customers to improve their business processes, by identifying, tracking and managing different types of assets is, I think, a very appropriate and good strategy and direction.

They do seek good return on investments for the price that they put in. But, it's clear that in many segments the ROI expectations have been pulled in. So, if you were to go back to, say 18 months, I think most projects below 18 to 24 months would get funded.

Today, I think very, very few projects get funded with a pay back of more than 12 months. And many of them are looking at it's more like nine months I think to get pay back.

But, in for ESG, there are certainly some market segments that are more cash strapped all so predictably, in the automotive side. And then, the ROI is secondary consideration. They first look into just preserve cash.

Reik Read - Robert W. Baird

And so, is that situation with automotive -- is it the ROIs maybe reasonable in some cases. But, you're seeing business continue to get delayed, because they simply don't have the cash at this point?

Anders Gustafsson

Yeah I think that they -- one is that they are looking preserve cash. And two, they are also looking to reduce the number of plans (ph) they have. And they haven't necessarily all been able to determine which ones. So, they are waiting for some of the -- some more clarity I guess, is to what their overall strategy is going to be.

Reik Read - Robert W. Baird

So, are they...

Anders Gustafsson

But, we're working very hard to make sure that we diversify our business though. We've talked about how we are trying to make sure we expand more into the industrial manufacturing and government side. And we're building up our channel capabilities to help us penetrate those segments better.

And I think we've good proof points that that's working. Although, we wish that we'd ran quicker.

Reik Read - Robert W. Baird

Okay. And then just also on the marine market. Can you just talk about one, the status of that market, and how it's performing?

And then, two, there's always been this opportunity to sell hardware on top of the Navis platform, and how is that going?

Anders Gustafsson

First, I think our bookings activity into the maritime segment has been quite healthy. And our cross selling opportunities have been pretty good also. And we've been able to introduce more our prevail fleet management solution into number of ports. We've been able to sell our WhereNet solutions into number of ports again.

But it's also fair to say that the ports are a cash flow business. They make a very substantial upfront investment. And then they use the cash flow to pay down that debt. And when they get into a situation like now, they do focus a lot on managing their cash, which makes it a little harder to get implementation to go as fast as we'd like.

Reik Read - Robert W. Baird

Okay, thank you.


Our next question comes from Brian Drab with William Blair. Please proceed with your question.

Brian Drab - William Blair & Company

Good morning.

Anders Gustafsson

Good morning.

Brian Drab - William Blair & Company

First question is regarding your use of the channel, given the current environment. Can you talk a little bit about your thoughts regarding using the channel more or less given the current situation?

Anders Gustafsson

I think we have two parts to that question. First, our Specialty Printing Group is a various channel centric organization.

We do sell through two-tier distribution. And that's been among -- that's worked very well for us to create great reach at a relatively modest investments. And we are very much committed to that model.

On the Zebra Enterprise Solutions side, we believe that we have opportunities there to make some products more channel ready, and then hooks on a limited number of channel partners, who have greater software and integration expertise, to provide an extension to our own sales force. And really penetrate particularly, industrial manufacturing and governments segments.

Brian Drab - William Blair & Company

Okay. And then, regarding your distributors, you mentioned you've seen inventory reductions in the first quarter. Of course, and do you expect to see that going forward, or do you think that's mainly behind us at this point?

Anders Gustafsson

We saw a sales out trend from our North American global distributors starting to decline in the late December of last year, and continued into this year. And our distributors are -- they didn't have excess inventory before. But, when sales out declines, they do reduce their inventory to just keep their -- the inventory turns stable.

I think we've seen the vast majority of those corrections. We expect it to be some lighter say in Q2. But, it's pretty stable.

Brian Drab - William Blair & Company

Okay. Thank you.

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