Zebra Technologies Corp. Q4 2009 Earnings Call Transcript

 |  About: Zebra Technologies Corporation (ZBRA)
by: SA Transcripts


Good morning and welcome to the Zebra Technologies 2009 Fourth Quarter Earnings Release Conference Call. Joining us from Zebra Technologies are Anders Gustafsson, CEO, Mike Smiley, CFO, Mike Terzich, Senior Vice President, Global Sales and Marketing, SPS, and Doug Fox, Vice President, Investor Relations. (Operators Instructions).

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

Douglas Fox

Thank you. Good morning and 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 31st, 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, Doug, and good morning to you all. Here in the room with me are Mike Smiley, our CFO, and Mike Terzich, our SVP of Global Sales and Marketing for the Specialty Printing Group.

Today we are pleased to report fourth quarter results that were well ahead of our expectations as well as a favorable first quarter outlook, surging customer demand in all geographies and across several verticals and product lines, drove an 11% sequential improvement in sales to $222 million.

A renewed sense of confidence among our customers generated the sales growth as signs of an improving global economy coupled with thawing capital budgets led to an increase in customers investing in new projects.

Equally encouraging, we experienced expectational earnings leverage with 72% sequential growth in operating income and 58% growth in GAAP EPS from ongoing expense control and our aggressive share buyback program.

This improvement is a direct reflection of our decision to move early and swiftly when we saw the environment deteriorating as well as our disciplined approach to position Zebra as a leaner, stronger company.

The order search much of it in the late quarter stress tested our supply chain. Our supply chain however responded with agility to this rapid rise in business activity, but with the added cost of $6 million in temporarily higher expedited freight charges that were necessary to fulfill customer orders.

I am extremely pleased with how our extended supply chain responded this quarter to enable us to take care of our customers needs. Our supply chain transformation, which is now substantially complete, is delivering its intended benefits. In addition, we are offering more applications with an extended and refreshed product line.

We have continued to invest in product development and geographic expansion activities that are vital to extending Zebra’s global leadership and build value for all zebra shareholders.

Let me briefly cover some of the highlights for the quarter in our specialty printing and enterprise solution segments. In specialty printing or SPG, sales increased by more than $22 million or 12% from the third quarter.

All areas of the business, geographies, channels, product lines and verticals contributed to the growth. All four geographic regions were up from the third quarter and three of that four had increased sales from last year.

Our EMEA region had particularly good performance with consolidated sales for the region up $14 million or 21% from the third quarter. The sales improvement was broad based with a robust run rate business, a pick up in sales to large enterprise customers and some inventory restocking by distributors.

Better sales of high performance and mid-range tabletop printers contributed to an improved product mix as customers in manufacturing refreshed production lines in response to more favorable business conditions.

In addition, customers in retail, healthcare and government implemented mobile card kiosk and other Zebra solutions to improve business processes and become more competitive.

New products also helped us serve customers better. During the quarter, we began shipping our first retransfer card printer, which has enabled us to deliver photo quality imaging for more security and government opportunities.

Channel partners and endusers tell us they are impressed with the combination of speed, print quality and value in this product. We’ve set a new standard in on-demand card printing.

Sales of our new Xi4 high performance printers also introduced in the fourth quarter are keeping Zebra as a supplier of choice for mission critical printing solutions.

During the quarter, we also began shipping updated 2-inch plus models of our leading light duty desktop printers, as well as innovative new IQ color labels. This breakthrough product enables customers to print spot color on predetermined areas of a label using any Zebra thermal label printer to enhance readability, increase business efficiency and improve safety. All of these products are examples of how Zebra is driving greater innovation to set them apart from the competition.

Let me now turn for a moment to Zebra Enterprise Solutions. Like SPG, the budget log jams in the verticals most served by ZES Maritime and Auto began to see some easing during the fourth quarter and the pipeline of ZES improved.

The ZES team did an outstanding job this past year. In 2009 we substantially improved financial performance generating cash earnings or adjusted EBITDAR break even from a $7 million cash earnings loss for 2008 on lower revenues.

In addition, I am pleased to report that we met all of our stated financial and operating goals for this business unit. We achieved cash earnings break even for 2009 as a whole, we signed 25 new channel partners against our goal of 20. We achieved our goal of 25 cross sales into adjacent markets which met our goal of 25 for the year and we achieved 57 go lives with customers around the world in 2009 against our goal of 50.

These results, which were by no means easy, demonstrate that ZES solutions deliver real value for our customers. We are also demonstrating our commitments to executing on the strategy we outlined in early 2009.

Our ZES team deserves much credit for these achievements in a very harsh business environment.

Finally, for overall Zebra, we continued to generate strong cash flows, bought back stock and ended the year with solid cash balances. Over the past three years, we have returned more than $330 million to shareholders through stock buyback.

The financial strength that has enabled us to buy Zebra stock at attractive prices during challenging times has also given us the ability to extend Zebra's global leadership through building stronger relationships with more channel partners, staying committed to product development and extending global reach, all activities that will serve Zebra, its shareholders and customers well long into the future.

In conclusion, 2009 began as a very challenging year. Recognizing the downturn early, we started in the third quarter of 2008 to trim and shape Zebra for improving performance as business conditions strengthened.

Zebra has been quick to move from defense to offense as well. We worked hard during the year to complete the outsourcing program and supply chain transformation for printers on time. We have also made progress on our new ERP implementation, which remains on track.

At the same time, we remain committed to a program of developing a new generation of distinctly superior products and solutions that would continue to set Zebra apart from the competition. Our results in the second half of 2009 are an early demonstration of the success of our actions. We captured more opportunities as customers around the world continued to standardize on Zebra as a strategic partner in asset tracking and supply chain management.

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 2010. After Mike's remarks I will return for some brief closing comments and our outlook and some details on our growth and profit initiatives.

Michael Smiley

Thank you, Anders. Because it's most relevant let me focus on some of the important sequential drivers for the quarter.

First, all four geographic regions experienced sales growth. Second, for gross margin, improved product mix along with an incremental 80 basis point contribution from out sourcing and favorable movements in foreign exchange were offset by higher inbound freight costs to meet customer demand.

Third, operating expenses were well within our guidance range. Sales were up 11% from the third quarter. Foreign exchange and other hedges had a favorable impact of $2 million on the sequential change.

Sales were down 4% from a year ago with a $7 million favorable impact from foreign exchange. Sales in the Specialty Printing Group were down 3% from a year ago but up 12% from the third quarter.

All regions experienced a pickup in their channel run rate business and large enterprise deals. Business in EMEA was up the sharpest increasing $14 million or 21% over the third quarter.

Leading the way from a growth perspective, were the U.K, Central Europe and Spain. We had notably strong sales of card printers as well as supplies fueled by the continued uptick in our HC100 Wristband Printer supplies.

This increase in HC100 Wristband Printer supplies demand is due primarily from the U.K health advisories, on hospital patient identification. EMEA also had larger sales in retail, postal and government.

In North America, sales were up 3% from the third quarter. The sequential increase was due to a continued pickup in enterprise sales and an improved run rate business to supply customers through channels and also for inventory builds with distributors.

From a year ago North America sales were down 13% because of certain large deals that shipped in the fourth quarter of 2008.

Let's take a look at sales by product line. Hardware, which was most affected during the downturn, experienced a 19% sales growth from the third quarter. Product mix improved with a greater percentage of high margin, high performance and mid range printer shift as manufacturing customers refreshed product lines.

After market sales of higher margin printheads also contributed to the better product mix. The percentage of printer sales from new printer products also move upward to 13.2% of printer sales, with shipments of our retransferred card printer Xi4 high performance printers and updated Plus desktop printers. This percentage is up from 7.3% for the third quarter.

Supply sales were down 10% from the third quarter mainly because of a large order that shipped in the prior quarter. During the second half of 2009 we also called some of our low margin supplies business to help improve the profitability of these operations.

Consolidated gross margin of 45.6% was comparable to the third quarter’s margin and down from last year’s 47.7%. Stripping away the temporary items we are increasingly confident that gross margin can and will return to historical levels in the high 40s with variance driven by FX.

Major factors affecting fourth quarter gross margin are: One, out sourcing contributed an additional 80 basis points. With a one percentage point improvement generated in the third quarter, we are on target to meet expectations in achieving the full 2.5 to 3 percentage points in higher profitability from out sourcing.

We expect to get the remaining portion by the middle of the year as we shut down the rest of our printer assembly operations in the U.S and move the remaining supply of parts from vendors in the U.S to Asia.

Two, the improved product mix had about a 1 percentage point favorable impact. And three, freight charges were approximately $6 million greater than normal and reduced gross margin by approximately 3 percentage points. We expect freight cost to remain at higher than normal levels in the first quarter as demand for printers, particularly high-end and midrange printers remains elevated, and as our volumes ramp at our sub-suppliers.

We expect more normal shipping patterns and freight charges beginning in the second quarter. Operating expense of $75.2 million were down $1.3 million from the third quarter. The most significant changes include decreases in employee benefits offset by increases in commissions, travel and entertainment and marketing costs.

Operating expenses declined $10.4 million from a year ago, excluding the $158 million in asset impairment charges incurred in fourth quarter of 2008. For ZES, the addition to certain reserves and some increased operating expenses resulted in negative cash earnings of $1.5 million for the fourth quarter even as we achieved our goal of reaching cash flow earning breakevens for the year.

Investment income of $695,000 was down from $813,000 for the third quarter and $1.3 million for the fourth quarter of 2008. Lower short term interest rates, and lower cash balances in part because of cash use for stock buybacks have been the primary reasons for the decline.

Net income excluding $0.03 per share in exit restructuring and integration costs came in at $0.33 per share on 58.8 million average shares outstanding. The income tax rate of 35.1% versus the year's normalized tax rate of 32% reflects some one-time year-end adjustments to our tax calculation, and reduced our earnings by another $0.02 per share.

During the fourth quarter, we used $16 million to buyback 594,000 shares, a pick up from our 327,000 shares acquired in third quarter. The average price of our fourth quarter purchases was $26.68.

For the year, we bought back 3.2 million shares for $65 million. Approximately 2.2 million shares remained authorized for repurchase at year-end. December 31, we had 58.3 million shares outstanding.

The day sales outstanding declined to 62 days from 66 days. We are very pleased to have weathered this recession without meaningful write-offs. Inventory turns increased from 51 times for the third quarter to 6.1 times for the fourth.

We ended up the fourth quarter with $247 million in cash and investments up from $222 million at the end of the third quarter. Quarterly free cash flow totaled $37 million to bring the annual total to $80 million or 10% of revenues.

Now let’s look at our first quarter forecast, a period where we normally see a seasonal decline from fourth quarter sales, we are forecasting sales of $217 million to $230 million. This forecast consists of expectations for SPG sales in the range of $198 million to $210 million and ZES sales between $19 million and $20 million.

Our forecast assumes gross profit margin in the range of 45.5% to 46.5% reflecting continued cost reductions and some improvement in freight cost offset by a less favorable foreign exchange rate.

We expect GAAP operating expenses of $77 million to $80 million, which includes a reinstatement of certain employee benefits and other incentive accruals as well as investments in our growth initiatives.

GAAP earnings are expected to be in the range of $0.25 to $0.32 per share. We are estimating exit and restructuring expenses to have a $0.02 per share impacts on EPS and the income tax rate will be 32%.

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

Anders Gustafsson

Thank you Mike. As our fourth quarter results and the first quarter outlook demonstrates, the aggressive actions we took during the downturn have positioned Zebra for improving financial performance and greater shareholder value creation.

We took advantage of our financial strength and tremendous cash flow generating capabilities to improve capital returns and extend global leadership in an industry with very attractive global trends.

I am confident that we are now well positioned to capture even more business opportunities as global economic conditions improve. Going forward, we are focused on four strategic imperatives.

First, we will continue to expand our core business by aggressively taking share through alliances with global partners and independent software vendors. Second, we will further penetrate near adjacencies where we can win by accelerating expansion in developing countries and driving innovation in product development in terms of performance, features and integration.

Third, we will continue to build lean, world-class operations through the expansion of our outsourcing initiatives, improved distribution and other IC initiatives. And finally, by building on our history of high performance teamwork, collaboration and people development, we are already making progress on these initiatives.

In North America, we streamlined sales and marketing processes to simplify the organization and build stronger customer relationships in the region as we expand our core. Specifically, we eliminated inefficiencies within our teams to improve parity, reduced territory sizes to increase customer contact and increased resources dedicated to channel partners.

At the same time, we recognized the success we have had over the years through the geographic expansion. We are now building on that tradition by committing more resources in key territories we have identified as having the highest potential for profitable growth. In Asia Pacific, Latin America and EMEA, we plan to add as many as 40 sales and sales related people in 2010.

Our plans call for establishing a presence in as many as five new cities in Asia as well as greater representation in Turkey and Middle East. And lastly in Brazil, we plan to add employees and establish a presence in one new city.

Adding new sales professionals supported by enhanced country specific marketing is a proven high return, low risk activity that will begin to generate channel support and more business later this year.

Likewise, we are confident that our plan to develop printers specifically focused on meeting regional requirements would result in higher sales internationally. In ZES, we entered 2010 with improving momentum in pipeline activity. Specifically, we're seeing renewed interest in auto related solutions to improve inventory management and in defense applications we are tracking assets and people.

Further growth opportunities are also developing internationally. Much like in SPG, our ZES customers increasingly understand the business advantages of working with a single dedicated strategic partner such as Zebra for their location solutions for supply chain logistics in operations.

We are devoting modestly more resources in ZES to areas showing the greatest traction. These initiatives include launching a new partner program along with new products explicitly designed for channel sales.

The incremental amount of additional resources we're committing to ZES is good business. They offer high returns in very promising growth areas.

While the additional expenditures may result in slightly negative cash earnings for ZES for the first quarter, they will produce a larger payoff with higher sales growth and improved profitability as we move through the year. Throughout our planning for 2010, we have focussed on generating the highest risk adjusted returns on our investments.

As in 2009, this principle will continue to guide us as we evaluate the potential for further capital deployments as the year progresses, whether in additional share buybacks, strategic acquisitions or further geographic expansion and product development.

Zebra’s future is bright. We completed 2009 on a favorable note and entered 2010 with positive momentum. Our success has been and continues to be the result of our more than 2000 employees around the world dedicated to meeting our customer’s needs.

By taking advantage of our financial strength during the downturn, we are now well positioned to win more businesses as global economic conditions improve. Our focus on our four strategic imperatives will guide us in 2010 and beyond.

We worked hard during 2009 to reduce costs and optimize resource deployment. Phase one of our out sourcing initiative is now virtually complete and generating the intended benefits. In addition, we strengthened channel relationships, introduce new innovative products and have begun to extend our geographic reach further. All of these initiatives have a lasting positive impact on building shareholder value.

Zebra is unique in the breadth of asset tracking and supply chain solutions that we can provide to our customers. Increasingly, our customers are turning to Zebra as a strategic partner to help them improve their business processes.

Zebra’s solutions are increasingly necessary elements in our customers operations. We look forward to reporting on our progress as the year continues. 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. (Operators Instructions) Your first question comes from Reik Read - Robert W. Baird.

Reik Read - Robert W. Baird

Just start on the gross margins for the first quarter, how much freight impact will, above normal will still exist in the first quarter and can you also talk about are you having to pay any higher component prices for raw materials right now?

Mike Smiley

We’ll see As we said, we spent about $6 million above normal paying capacity, we’ll probably see an improvement of maybe $3 million or so in the first quarter better than it was in the fourth quarter. But that still will be in an elevated level from what we think we’ll see in the long run.

And on component prices, we have seen greater than expected savings on our material costs and component costs as we move to China and that trend continues to hold.

Reik Read - Robert W. Baird

But you are not seeing anything short-term with component availability?

Mike Smiley

No, we have not seen any issues on pricing in the short-term or based on allocations or anything like that. Actually this is an area where I think our scale is quite beneficial to us and we are the largest player in our space and that gives us more pool with our sub suppliers.

Reik Read - Robert W. Baird

Okay. And then, Mike, again on your comments on gross margin in the first quarter, the FX impact, is that just directly from European currencies or is there anything else embedded in there?

Mike Smiley

It's European, all European.

Reik Read - Robert W. Baird

And then just with respect to, Mike, your comments on getting more improvement by midyear, can you just help us understand all of the puts and takes that are in there? I guess the way I would have thought about it is that you've largely completed that transition to Jabil, the remaining facilities would be shut down -- and it seems like that would happen in pretty short order. Is there a delay in there or are there other initiatives or what causes the comments for midyear?

Michael Smiley

There’s a couple of things. First of all, although we have 99% of our printers are manufactured in China, we still have less than 1% that are still being manufactured here because they’re perhaps new lines or something that are coming up. And that’s going to take us the first part of the year to sort of completely ramp down and then to pull ourselves out of those operations.

The other piece is although we've moved a substantial number of sub suppliers from the U.S. to Asia, there’s still more to be done. So those two things are sort of making us – so it's more like a midyear when we'll see hitting that target.

Reik Read - Robert W. Baird

And I'm sorry, so you said those were newer products such as – you’re more comfortable making them here until you get kind of stable?

Michael Smiley

Just for the time being, it's not long run thing.

Reik Read - Robert W. Baird

And then could you also talk about – the ASPs were down 4%, which is pretty normal for this quarter but you guys had talked about pricing and mix being stable or mix even getting improved a little bit. Is there an offset there in terms of incremental price pressure or what would account for that?

Michael Smiley

This quarter we didn't see any particular price pressure, since we were I think – most of the players in the industry, somewhat challenged on the supply chain side, we certainly weren't leading with price. We saw very stable pricing within our product families and we saw an improved mix. So we were pleased with the pricing environment we had.


Your next question comes from Brian Drab - William Blair & Company.

Brian Drab - William Blair & Company

Just wanted to begin by focusing on Europe. Great sequential growth there, 22% by my calculation. I was wondering if you could just drill in a little bit deeper into what you saw in Europe in the period and across the different countries within Europe?

Anders Gustafsson

Europe was strong, generally across the entire geography. We saw particular strength in Spain and the U.K and Eastern Europe and also some in the Middle East. In the U.K, we talked a bit about the healthcare sector being particularly strong. One thing that we didn’t see so much in Europe was a return of larger deals.

So, I think that’s something we still have coming.

Brian Drab - William Blair & Company

And, were government incentives in the U.K something that led your growth in that region?

Anders Gustafsson

The government was a good contributor but it didn’t stand out as a phenomenal success.

Brian Drab - William Blair & Company

Next question, about product mix. I know the product mix is improving, shifting sequentially toward some of the higher margin equipment. Where does that mix stand now compared to where you hope it would be ultimately, or where it was at the peak?

Anders Gustafsson

So, this is two questions, I guess. How does it stand compared to the peak and how does it stand compared to the middle of last year. So, it’s substantially higher than it was in middle of last year, but it is still somewhat lower than the peak, and I think, peak going back to 2006 timeframes. And part of that is that we have seen some other product and it's growing faster, so like mobile and desktop and kiosk have had higher growth rates than our tabletop product lines.


Your next question comes from Paul Coster - J.P. Morgan.

Paul Coster - J.P. Morgan

I just like to kind of go little bit further into, what you're seeing at the moment, whether there's any underlying trends? It sounds like everything pops up a bit, but you’ve got in the pipeline some big deals. Perhaps you can just sort of give us a sense on why those take a bit longer to come to market. And also what's behind mobile desktop and kiosk, so the mix shift towards those segments, what kind of drivers are happening in retail or other segments that might account for that growth?

Anders Gustafsson

The large deal, did you speak particularly to Europe or was that more generally?

Paul Coster - J.P. Morgan

Well, you just mentioned that you will see large deals soon and you didn't see them in this quarter, why are they little bit later on in the cycle?

Anders Gustafsson

I was specifically talking to Europe at that point. We did see larger deal flows in North America, Latin America and Asia Pacific. So there was more specific to Europe that we didn't see it, and we expect that we will continue to see a decent flow of larger deals. And I think that was driven by basically the underlying economy strengthening, giving our customers more confidence, so that a lot of projects that had proven good ROIs had been say frozen for sometime, as they were, our customers were more focused on managing the capital or the cash flows and as they gain some more confidence they start letting those flow through.

With respect to mobile desktop and kiosk, I think that there is good trends for each of those products to have higher growth rates and kiosk side particularly, there is a huge trend towards self service. You go to the airport, you go to hotels, you go to your local supermarket, there is lot of kiosk type of applications and that’s a obviously a much smaller market segment today. It is one that’s growing faster. And similarly with mobile there is a I think big trend globally around having more un-tethered workers.

So mobile workforce and other applications like that is a big secular trend that we’re trying make sure we tap into and desktop just has a much broader set of applications. You can go into my local cobbler to almost any type of logistics and transportation company fits in, lots of different type of environments. So there is a good underlying growth drivers for each of those products.

Paul Coster - J.P. Morgan

Mike, can you just comment a little bit on the tax rate and capital investments in 2010?

Michael Smiley

Yes, we are going to see 32% for 2010. We spent around 24, $25 million in CapEx in 2009, we expect that to go down maybe about $5 million in 2010 as the spending levels for some of the ERP implementation and out sourcing goes down.

Paul Coster - J.P. Morgan

Anders, the operating expenses are a little bit higher I think perhaps than we expected anyway in the first quarter, but it sounds like you’ve already answered the reason for that, that was the building up of the sales force in new geographies, is that correct?

Anders Gustafsson

There were specifically two components to that. One is that as we entered a New Year, some of the cost containment actions we had taken started to come back. So we are now accruing for match, having our 401(NYSE:K) match is back. We are accruing for target bonus and also in the beginning of the year you have more benefits, so people who do 401(K) payments, there is taxes and other things that come with that.

That’s the majority of it. And then the remaining part is, a modest, more investments in our some of our growth initiatives that we have high confidence will payoff well.


Our next question is coming from Chuck Murphy - Sidoti & Company, LLC.

Chuck Murphy - Sidoti & Company

Just want to come back to the gross margin for a second, just to make sure I am clear. In terms of the higher freight cost, I mean is it a matter of you guys needing kind of rush delivery, what exactly about freight was different this time round?

Mike Smiley

As we had to ramp up our supply chain, it takes, as I mentioned there are some long lead time item components in a printer and that puts some, they extended our delivery times from beyond what we would normally see as our traditional times.

In order to make sure that we could really serve our customers and not lose market share and protect our reputation, we did air freight more printers through the quarter. Also, this was exasperated by a surge in the tabletop side, the big printers, they are much more heavy and they cost a lot more.

Chuck Murphy - Sidoti & Company

My other question was just, for ZES, I mean down a little bit sequentially for the fourth quarter kind of flattish in the first quarter. And what are you thoughts for the reminder of 2010? I realize, it’s just early but will it see much of a ramp for the reminder of the year?

Michael Smiley

Fundamentally to start with, the applications and the solutions that ZES offers its customers have very high ROIs, very high returns for their customers. And I think we made great progress during the year by hitting all our metrics, all our targets.

So I think we've positioned ourselves now for modest incremental investment to really take advantage of some growth opportunities that we see. And we felt that really building up a stronger channel competency, which very much leverages the core competency we have in SPG, is a good area for this.

And we've also come up with some products that are specifically designed for the channel. So we feel good about where we’re in this respect. We think that as the year progresses, these investments will drive higher revenue growth and improve profitability throughout the year.

Chuck Murphy - Sidoti & Company, LLC

In terms of quoting activity or just general customer interest I mean have you seen that improve for Enterprise Solutions recently?

Anders Gustafsson

Pipeline activity for both the maritime side and the automotive, industry manufacturing side was increasing in the fourth quarter.


Your next question comes from Jay Meier - Feltl & Company.

Jay Meier - Feltl & Company

My question is really about the new retransfer printers. I'm curious if you could give some color around that market and how big of a revenue stream do you think that could be, maybe what’s your goal in terms of percentages going forward?

Anders Gustafsson

Yeah, we generally don't give individual product line revenue forecasts, but the retransfer market is a meaningful sized market within the card market. And for us it’s a new market segment that we did not print in before.

So we – and we believe that we can get an attractive share of that market, the feedback we've had from all our channel partners and end users who've seen the product had been very impressed the color acuity and the speed we can print at.

Now this is more of a project related printer, so it’s not one that has kind of the normal run-rate business through distribution. This is more into larger security or other types of deals. We've been very encouraged by the reception this product has had and it performs well for us in the fourth quarter, it met its expectation.

Mike, any comments from you?

Michael Smiley

Jay, a couple of things. One, the market for this product is in the identification card and also in the driver's license side of the business also because of the image quality, the photo quality capability of retransfer. We feel that we could really lever some of our retail, our legacy retail customer base and extend it into some loyalty card application.

And then lastly it gives us some potential opportunities to extend into some new market spaces. In some of the financial services sector where we traditionally haven’t played and as more and more movement those towards a decentralization and an instant issuance of some cards, we think that ultimately we can extend ourselves into some new space.

Jay Meier - Feltl & Company

And do you think that your competitive advantage there is on price or in yields or the quality of the system?

Anders Gustafsson

It's really all of the above. We believe we have a superior imaging processor, so the photo quality is superior. The speed of print is superior and we are able to offer this at a competitive price. We're not leading with price per se, but we're not the first to the market. So we recognize that we need to have a very attractive package.


(Operator Instructions). Your next question comes from Anthony Kure – KeyBanc Capital Markets.

Anthony Kure – KeyBanc Capital Markets

Michael, could you just mention again the one-time impacts to the fourth quarter for the ESG profitability, what was that again?

Michael Smith

It was a combination of some additional expense and some reserves that we took in the quarter; they weren't huge.

Anthony Kure – KeyBanc Capital Markets

You said it was about a $1.5 million impact or so?

Michael Smith

Well, the cash earnings loss for the quarter was minus 1.5.

Anthony Kure – KeyBanc Capital Markets

So if we back that out, is it fair to say, I mean with the GAAP operating losses $5.4 million or so, if we backout those type of expenses recurring in the first quarter, what's sort of the expectation that’s factored into your guidance for – I assume it’s a loss for the first quarter, is that correct?

Michael Smith


Anthony Kure - KeyBanc Capital Markets

What would be the, I mean range of that, are we looking at about a similar level of loss, or a little bit better? Am I right in thinking that it should improve from the loss of the fourth quarter?

Michael Smith

I got to tell you it's a small business and so there's all those little lumpiness here and there, so it's hard to really guide tightly, but I would say the first quarter is going to feel like the fourth quarter.

Anthony Kure - KeyBanc Capital Markets

What is the FX assumption for the first quarter guidance for the total company?

Michael Smith

Right now, the exchange rate is around 1.36, 1.37, so our forecast bakes into -- obviously in the first month it was running a little bit higher. So we're taking into consideration January actual rates and then sort of the current spot rate going forward.

Anthony Kure - KeyBanc Capital Markets.

Okay, And then just finally the cash has been building up through 2009 and just looking increasingly, are you looking increasingly at any acquisitions or do you think the share buyback is probably the best use of the risk adjusted cash usage at this point?

Michael Smith

We will continue to look at all options that we have available for capital deployment. But as we’ve reiterated over the last couple of years, like it is now, we are very much focussed on making sure we deploy our capital to the highest risk adjusted return opportunities.

We do perceive that there might be acquisitions out there, but we've always looked at those, although we said that for ZES, we are not considering anything there until we’ve been able to prove that business model going forward.

But also we have lots of good internal organic investment opportunities that we want to pursue. And buyback is something that -- we bought back $65 million worth of shares in 2009, which was really a tough year for the industry. We expect that we will continue to buyback shares.

Anthony Kure - KeyBanc Capital Markets.

Okay. I’m sorry one more question, just housekeeping, did you mention the gross margins for ESG in the fourth quarter or if not, can you?

Michael Smith

No, we just give company wide gross margins.


Your next question comes from Greg Halter - Great Lakes Review.

Greg Halter - Great Lakes Review

Wanted to delve into the investment portfolio a little bit further in terms of the composition, in terms of what it’s invested in and the location I guess by geography of the funds?

Anders Gustafsson

They’re in the U.S. and it’s very high grade government municipal backed securities. It’s a very short duration. It’s all very, very stable short duration securities.

Greg Halter - Great Lakes Review

And you don’t have any of the auction rates or any of other crazy stuff?

Anders Gustafsson

We have a small amount, but we have already taken the effect of those through our balance sheet, so that’s reflected in the value there.

Greg Halter - Great Lakes Review

What was ScanSource in terms of a customer in the quarter and then for the full year?

Anders Gustafsson

It’s been 16%, but it goes up and down a little bit, but it hasn’t been a big change in the quarter.

Greg Halter - Great Lakes Review

And Anders, I believe you were speaking about go lives and so forth. I think you had a goal to reach 20 new channel partners in 2009. I don’t know if you mentioned that or not in your prepared remarks?

Anders Gustafsson

Yeah, I mentioned, we have three operating metrics. One was reaching the goal of 20 channels partners, we actually achieved 25. We had another goal which was to have 25 cross sales and is obviously taking our product and bundling with other products or taking them into a new vertical market and we were able to achieve that, we ended up right on the money at 25.

And then we have said we were going towards 50 go lives for major projects and for that we achieved 57. So I think that’s great, a great progress for us, and I was actually surprised to see how close we came to each of those ones and I think that indicates we set pretty good targets.

Greg Halter - Great Lakes Review

Wanted to give you the chance to offer up any goals you may have for 2010, in each of those three areas?

Anders Gustafsson

We figured that we wouldn’t set any public goals like that now. We obviously have lots of goals internally to how to drive the business. But so we feel that we are now in a position to build on the strength we had in 2009. We have highlighted some of the areas that we’re focusing on with channel and some new products. And we feel good about all the activities and all the progress we made in 2009.


Your next question comes from Reik Read - Robert Baird.

Reik Read - Robert Baird

Could you just go back to Europe and the healthcare program that you're seeing in the U.K with wristbands? It sounds you're calling it out because it's meaningful, is that’s something that’s sustainable or are there other follow-on programs that maybe kicking in as well?

Anders Gustafsson

In the U.K, the NHS, the National Health Service have issued a recommendation for all their hospitals to use more patient ID technology. So we've seen for the last year material improvement or strengthening of our business to NHS hospitals. Now we’re working with others in that space to make sure we can replicate that into other countries and make that a much more of a movement across the entire European continent as well as rest of the world.

Reik Read - Robert Baird

Just in the retail vertical, can you guys make some comments there in terms of are you seeing the market begin to improve, and I guess I ask market versus also how you're doing because it seems the last couple of quarters, you have gained incremental customers and so you have tended to outpace the market. Can you give us a sense as to what’s happening there?

Michael Terzich

This is Michael Terzich, I'll take that. Yes, we have. We've seen an improvement in our retail performance; specifically, parts of Europe actually performed well; the U.K historically has been a strong retail market.

So we did see some recovery in the fourth quarter in the UK retail marketplace. And domestically in the United States retail has finished the year very strongly for us and I think what's important here is the tier two retail channel for us specifically, so if you get beyond the tip of the pyramid so to speak, you get down to the next level of retail.

Everybody is looking to increase some of that efficiency productivity within the store, this goes back to Andrews comment, this is where kiosk is starting to have an impact for us in multiple retailers and through our mobile solution. So we fell pretty good as we go into 2010, that outlook is improving.

Reik Read – Robert Baird

The operating expense guidance, Mike, that you gave, can you repeat it and tell us if the charges are included in that or not?

Michael Smiley

That would be, that would include – so the numbers that we gave were including restructuring in there. So that would be in there.


Thank you. There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

Douglas Fox

Thank you everybody for joining us today. Just to let you know, our next call is on May 4th for the first quarter earnings announcement, and we will certainly be around to answer any of your question offline.

So thank you very much, have a good day.


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

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