Zebra Technologies' CEO Discusses Q4 2013 Results - Earnings Call Transcript

Feb.19.14 | About: Zebra Technologies (ZBRA)

Zebra Technologies Corp. (NASDAQ:ZBRA)

Q4 2013 Earnings Conference Call

February 19, 2014 11:00 AM ET

Executives

Anders Gustafsson - CEO

Mike Smiley - CFO

Mike Terzich - SVP of Global Sales and Marketing

Doug Fox - VP of IR

Analysts

Ryan Treff - William Blair and Company

Keith Housum - North Coast Research

Michael Kim - Imperial Capital

Jason Rogers - Great Lakes Review

Operator

Good morning and welcome to the Zebra Technologies 2013 Fourth Quarter Earnings Release Conference Call. Joining us from Zebra Technologies, are Anders Gustafsson, CEO; Mike Smiley, CFO; Mike Terzich, Senior Vice President of Global Sales and Marketing; and Doug Fox, Vice President of 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 your question. At the request of Zebra Technologies, this conference call is being recorded. Should anyone have any objections, please disconnect at this time.

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

Doug Fox

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 we issued this morning and are also described in Zebra’s latest 10-K 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 everyone. Zebra achieved record financial results for the fourth quarter of 2013 on strong sales and earnings growth. For the quarter earnings, increased to 20% to a record $0.82 per share, including acquisition, exit and restructuring costs that reduced earnings by $0.09 per share. Quarter sales increased to 12% over the fourth quarter of 2012 to a record $284 million. Growth was broad based across virtually all dimensions of our core business. Supported by this performance I am proud to report that Zebra surpassed $1 billion in annual sales for the first time in the company’s history.

For the quarter, sales increased in three out of our four geographic regions with North America and Europe setting new records. Run rate activity through distribution partners across all regions remained firm and large deal business improved. Sales in all product categories, hardware, supplies, service and software grew more than 10% year-over-year with sales of all printer lines increasing as well. Fourth quarter growth was virtually all organic with the Hart Systems acquisition in mid-December contributing less than $400,000 to sales.

Even though some areas of weakness remain most notably in parts of Southern Europe and Latin America Zebra’s broad success reflects continued improvement in business conditions in many of our verticals and geographies. The record volume supported solid gross margins, operating income growth and free cash flow. Our results demonstrate the effective execution of our proven strategies that have enabled us to first penetrate the targeted industries such as retail and healthcare more deeply with solutions that offer a compelling value proposition. Second, expand into new market. Third, intensify innovation around product and processes. Fourth, maximize operational effectiveness. And lastly, inspire our people and culture.

Investments and the steadfast focus on execution of these strategies have further enhanced the diversity of our business across geographies, solutions and customers. They will continue to strengthen our core business while persisting us with initiatives that align Zebra with prevailing technology trends such as the Internet of things Big Data and cloud computing.

In North America, sales increased 16% fueled by strong run rate business and an improvement in large enterprise deals, in part from refresh cycles. In addition to retail and transportation and the logistics, healthcare remained a solid contributor to growth with momentum continuing within our wrist band product lines. Our patient identification solutions improve hospital efficiency, patient safety and enable electronic health record systems. Supply had an excellent quarter in the region with sales increasing more than 15%.

Thus far in 2014, Zebra’s strong core value proposition has led to further opportunities in North America. In addition, the acquisition of Hart Systems and the formation of our retail solutions group to deliver a broader range of solutions to our retail customers add to our optimism for continued growth in the region. In EMEA positive trends continued during the quarter with growth in nine out of 13 sub-regions and ongoing challenged business environment in part of Southern Europe partially offset solid growth in the UK, Benelux and Spain.

Large deal activity improved along with the strengthening run rate business. During the quarter we shipped mobile and RFID printers to retail customers, card printers for a variety of personal ID applications and a broad range of supplies. For the first quarter of 2014, we have a firm pipeline of business including orders that will be fulfilled for postal applications in Italy and rail applications in Hungary among other deals. In Latin America economic and political challenges and the shipment of a large deal last year restricted growth in the region. Card printer shipments remained strong as I refreshed product line continues to gain popularity for using applications such as drivers’ licenses, student IDs and bank credit cards. Strength in Mexico from a rebounding manufacturing sector partially offset sales declines in Brazil and other South American countries.

In Asia Pacific, sales increased 29% and exceeded $40 million for the second consecutive quarter, return of manufacturing in the region led to higher shipments to customers in China, India and South Korea. Broad improvement across Asia Pacific also included sales to customers and retail and healthcare. Shipments of card products continued to gain momentum as well. Also in Asia Pacific the power of Zebra’s brand helped to drive strong growth in supplies, the growth is a direct result of our investments in regional supplies of product managers and highlight how our customers value the quality and consistency of our supplies for their mission critical labeling applications.

Overall Zebra’s record fourth quarter results demonstrate the strong global demand for our products and solutions. Companies worldwide rely on Zebra printers’ supplies and other products to identify track and manage their assets better, across their supply chains. Ongoing competitive forces continued to drive our customers to invest in core bar-coding solutions. In addition to emerging technologies, such as passive and active RFID, to improve business execution and deliver better customer service.

Zebra is leveraging its competitive advantages including scale installed base and global go-to-market channels to help more customers achieve their goals. Our success is extending our leadership in a fundamentally attractive industry. We’re confident in our ability to continue to diversify our business across multiple dimensions to drive further growth and enhance shareholder value.

Now our CFO, Mike Smiley would provide a detail review of fourth quarter results and guidance for the first quarter of 2014. After Mike’s remarks I will return for some brief closing comments.

Mike Smiley

Thank you Anders. Let me highlight some of the key components to Zebra’s fourth quarter results. First, sales increased broadly across all dimensions to Zebra core business. Our system was not a material contributor to performance in the quarter. Second gross margin improved primarily from the increase in volume, and third operating expenses included higher marketing professional services and employee compensation costs.

Now let’s take a look at sales. For the quarter sales increased 12.4% from $253 million last year to a record $284.5 million. The high pace of business was sustained through the entire quarter; foreign exchange had a positive impact on sales $2 million net of hedges. Sales for North America increased 16% from a year ago with strong growth in hardware, supply service and software. Within North America desktop, mobile and kiosk printers were top performers.

In EMEA, sales increased 6.4% also to a new record; nine out of 13 sub-regions had year-over-year growth. The region had strong growth in RFID, mobile, kiosk and card printers as well as supplies. Latin America sales declined 3.5% against record sales a year ago, higher shipments to the customers in Mexico, Argentina and Colombia partially offset declines in Brazil, Chile and Peru.

In Asia Pacific, sales increased 29% with growth in nearly every sub-region. Table top printers supported customer expansions and manufacturing, in addition we had strong shipments of desktop, mobile and card printers to customers in retail, healthcare and government as our marketing activities further diversify our business in the region.

We’re very pleased with the success of our desktop printers; they are designed to meet the needs of customers in developing regions. Underscoring diversity as Zebra’s business by product category, sales of hardware increased 12% and supplies advanced 13%, services revenue grew 19% primarily for investments we made to expand the number of repair facilities around the world and the greater emphasis on sales and marketing.

Software revenue was up 72% on small base, for the fourth quarter gross margin was 49.6% up from 49.2% a year ago. As I mentioned higher volume was the primary reason for the improvement, hedges favorable currency movements increased fourth quarter gross profit by $1.7 million. Sales and marketing engineering and administrative expenses increased 9.4% from a year ago. The growth is primarily related to higher marketing professional services and employee compensation costs.

Total operating expenses which were up 14% over a year ago included $3.3 million in acquisition costs as you pick up the pace of M&A activity. Part of the quarter’s expenses related to the completed Hart acquisition. Exit and restructuring cost totaled $2.4 million for the quarter. The expense primarily relates to actions we’re taking to re-direct more location solutions resources to sports and other motion management opportunities.

Quarterly operating income of $49.1 million plus depreciation and amortization of $8.8 million totaled $57.9 million of cash earnings or $1.14 of cash EPS on a pretax basis. The effective income tax rate for the third quarter was 17.3%; rate reflects the impact of a greater proportion of our income that is generated in regions with lower tax rates plus some one-time benefits from certain tax filings. Earnings totaled $0.80 per share including a reduction of $0.09 per share for acquisition expenses and exit and restructuring cost and 50.7 million average shares outstanding. At the end of the fourth quarter, we had 50.3 million shares outstanding. For the fourth quarter, inventories increased $14.4 million from the third quarter to further improve customer service levels and reduce spread (Ph) cost. Net receivables are up $1.3 million from the third quarter.

Quarterly inventory turns held stay from the third quarter at five times. Day’s sales outstanding declined from 61 days to 56 days. During the quarter we generated $51 million in free cash flow. This amount brought full year free cash flow to $175 million. We deployed approximately $100 million for the quarter with $95 million for the Hart acquisition and $5 million for the buyback of 88,100 shares of Zebra stock at a weighted average price of $52.70 per share. For the full year, we returned $63 million to Zebra shareholders in the form of stock buybacks. We ended the period with $416 million of cash investments with approximately 50% held in foreign accounts, all of which are invested in U.S. dollar denominated securities.

Now let’s look at our 2014 first quarter forecast. We are forecasting first quarter sales in the range of $276 million to $286 million. The forecast contemplates continued organic growth plus the revenue contribution from Hart Systems. In 2013, Hart had annual revenues of approximately $21 million; about half of its revenues occurred in the first quarter with the other half spreads somewhat evenly across the subsequent periods. Because of large effect Hart has in the first quarter revenues, we expect a typical sequential increase in Zebra’s consolidated second quarter sales to be more muted on a go-forward basis. Expected sequential growth in core printer and supply sales will be offset by seasonal reduction in Hart’s revenues. Hart will be immediately accretive to Zebra’s earnings.

First quarter earnings are expected in the range of $0.77 to $0.87 per share. Our forecast assumes a consolidated gross margin in the range of 49.5% to 50.5% which impart is benefited by higher gross margins associated with Hart. Operating expenses for the first quarter are forecast between $88 million and $90 million impart due to the usual increase in first quarter benefit cost and Hart operating expenses. The forecast also assumes an effective income tax rate of 19.5%. That concludes my formal remarks. Thank you for your attention. Now here is Anders Gustafsson concluding comments.

Anders Gustafsson

Thank you, Mike. Zebra’s record fourth quarter results underscore the global strength of the Zebra brand and the value of the diversity of our business. The underlying drive of companies to gain greater visibility into their extended value chains continues to create abundant opportunities for us. Looking ahead Zebra is well positioned for further success by leveraging our considerable competitive advantages and focusing on those activities that extend our leadership over the long-term. Our core business continues to hold multiple avenues for growth and high returns from further vertical and geographic expansion. Greater business diversification offers considerable opportunities particularly with customers in retail, healthcare and government.

To achieve this goal we are building on our industry leading channel partner network by adding new partners to reach customers in more geographic regions and emerging technology areas. We are also optimistic about further growth by increasing our annuity attach rate in services, software and supplies to complement our leading industry position in thermal printers. In retail, Hart has given us greater critical mass for delivering a broader suite of solutions that address vital customer needs in a rapidly changing business environment. Our high value portfolio now includes software and hardware solutions for inventory management and pricing, mobile point of sale and a broad set of applications for personalized customer engagement to deliver unique customer insights and efficient retail operations.

It enables us to sell more deeply across a wider range of customers. Product innovation continues at the brisk pace at Zebra. In 2013, we introduced 17 printer related products. In the fourth quarter we introduced the ZD500R RFID desktop printer. Its high performance and cloud connectivity in a compact package are attracting attention from new customers in retail and healthcare. For 2014, we are scheduled to release other RFID printers in addition to exciting new products in other categories. In the fourth quarter, we launched Zatar, an open cloud based services platform to connect and control devices including Zebra printers. Since its launch in October, we announced a partnership with the RFID middleware provider.

We also demonstrated Zatar at the NOF Show and how it enables retailers to build IB and applications to identify customers and deliver customized in-store marketing programs. Finally, we are optimistic about the growing opportunities for our location solutions business. Active RFID is capturing greater attention as customers see the benefits of managing things in motion. During the fourth quarter the pipeline of orders grew for yard management and other industrial solutions.

We also entered into a pilot with a large airplane manufacturer to improve worker health and safety as well as engaged with a regional Hospital for improving care in cardiac centers. We are optimistic about the future for our Zebra MotionWorks and other LS solutions. All of these initiatives are helping to build an even stronger Zebra that is well-positioned to take advantage of the internet of things Big Data and other important technology trends. They differentiate us further from our competition and will generate greater software and service content through our offerings over time.

As we pursue our growth goals we will continue to strive for greater operational excellence to improve efficiency, optimize costs, and deliver better customer service. At the same time we will invest our resources in those activities that will deliver the highest returns with a long-term benefit of our shareholders.

Thank you for your attention today. I would now like to turn the call back to Doug for Q&A

Doug Fox

Thank you Anders. Before we open the call to your questions, let me ask that you limit yourself to one question and one follow up. In addition Mike and I will be available after the call for any further discussions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions) Our first question is from Ryan Treff from William Blair; please go ahead.

Ryan Treff - William Blair and Company

So one question and one follow and I’ll stick to that. You mentioned in North America the refresh cycle, and could you talk a little bit more about that, and is that going to be primarily a fourth quarter phenomena and how will that impact 2014?

Anders Gustafsson

I’ll start and then I will ask Mike Terzich to also give some color on that. In North America in fourth quarter it was really very broad based search in the business. And that gives us a lot of confidence for how we enter 2014. We feel that our strategies are working and we do expect a very strong continuation of the run rate business, there was really a run rate business quarter in Q4. But we did see a return of large deals in retail P&L and healthcare to a more natural levels, I guess more normal levels. But we are also seeing a higher level of refresh. And we expect that to continue for some time but it’s a more definitive period for that. Normally we will say we have good visibility for one or maybe two quarters and we feel good about certainly the first quarter as you see it here and we expect that we’ll have a good year, the comps in the first-half are much easier certainly than the comps that we would have in the second half. Mike?

Mike Terzich

Ryan, just a couple of added points here; I do think that in North America particularly on previous calls we talked about some of the challenges with some of the retail, the broader retail markets sweating the assets and kind of holding onto a more aged equipment if you will, so we started to see some relief from that in the context of the fourth quarter. A lot of that business was actually at the Tier 2 and Tier 3 retail, account based so it was reflected in the strong run rate business that we saw through the distribution channel as Anders noted. And yes historically it’s kind of hard to predict where it all lands but our visibility is always a quarter or two maxed out, and as things look as today we are seeing that search continuing into the first quarter.

Ryan Treff - William Blair and Company

And maybe one quick question, probably for Mike Smiley, on Hart, can you talk a little bit about the gross margins, operating margins at Hart, if you are able to and what IV very far off the market, I guess that may be Hart could be $0.04 to $0.05 accretive in the first quarter of 2014?

Mike Smiley

I think the way we’ll describe it is, the gross margins are higher in that business as you would expect to be more of a soft versus service. A portion of that business we would also say the margins are - net whole of business are little bit higher than the corporate average and so I think you can triangulate knowing that roughly half of that revenue that we will get in the year will come in the first quarter and historically that business has had mid-teens growth rate. So if you triangulate I think income of with the answer you’re looking for.

Operator

Our next question is from Keith Housum from North Coast Research; please go ahead.

Keith Housum - North Coast Research

If I look at the supplies and the software and services segments obviously there is going to be some great drivers of growth for a year, is there a level of that recurrence that you see on a regular basis from this or every quarter you actually each with your [indiscernible] here?

Anders Gustafsson

It is a little bit of both I guess. We have supply tend to be a more of an ongoing attach. We try to pursue customers that have more of ongoing need versus individual project-based business. So, there is a high level of stability to our supplies business and I think our supplies strategies have worked really well over the last couple of years. We’ve increased our supplies revenues very consistently for two to three years now, and I think with our channel partners our end users customer they know we want their supplies business also that we’re not just looking for the printers but we really want their supplies business. And we’ve stepped by again when it comes to providing good quality product and short lead-time for deliveries and be competitive in how we how quote.

Mike Terzich

Keith, this is Mike Terzich. Let me just add a point or two to Anders’ comments. We’ve talked previously on the call about where we tend to focus our supplies business which is in the higher value specialty solutions space. We tend to stay away the commodity paper business. The commodity paper business is more in line to you comment which is, it’s kind of fly-by-night business, it’s a hit-or-miss business. We tend to be streakier no pun intended in the space we play because we’re more engineered into the longer solution that our customers are looking for.

Keith Housum - North Coast Research

Okay so if I think about this little bit further, we should expect to see like a getting out sale because this business is at least as you’ve said a higher catch rate.

Mike Terzich

It is and I think for us I think it’s been - it’s certainly we try to - we look at it like an annuity business where certainly very interested in expanding in that business and we have international opportunities to get closer to that customer base. But generally we hold onto the business for longer periods of time, we get into less pricing events off cycle events and we like where we’re positioned today.

Keith Housum - North Coast Research

Okay, can you elaborate on your comments and you have agent supplies manager. I’ve previously thought you guys are in too much in supplies business in Asia.

Mike Terzich

It’s been a very interesting story. I think Anders’ comments earlier about the power of the Zebra brand on supplies is a very relative on in Asia because of the heavier manufacturing base that we have that’s again a profile of a higher quality supply play for us. And what we’ve been doing as we’ve added some people to carve out some strategies there and we’ve been effective at actually producing supplies in both believe it or from the United States moving them in container load and selling them effectively to end users in Asia.

Operator

And our next question is from Michael Kim from Imperial Capital.

Michael Kim - Imperial Capital

Just turning to gross margins and you’ve talked a little bit about the increase in scale but are you also seeing a shift in the mix especially towards the higher performance products with maybe uptick in manufacturing?

Mike Terzich

Good question. When you look at this year-over-year mix and it has not been a big player year-over-year, it’s really driven by volume and I would say management of our cost structure in that area. So I think we year-over-year it’s not really so much of a mix issue benefiting our gross margins.

Anders Gustafsson

We had more in middle of 2013 a period where we had weaker mix but then we would consider the Q4 to be more of a normal mix for us.

Michael Kim - Imperial Capital

Got it. And then just as a follow-up on a high level question you with, it looks like to be an expansion and potential sales opportunities, how are you guys think about balancing near-term growth versus perhaps the ramping investments in sales and marketing and really expanding your ability to capture more deal?

Anders Gustafsson

So we’ve balanced that very carefully. We spent a lot of time trying to figure out what are the top priorities for us and how do we make sure we’ve resourced those priorities appropriately but we’ve also spent a lot of time figuring out, how do we now drive efficiencies or stop doing other things to free up investment capacity to make the necessary investments in the biggest growth areas. So we’re trying to make sure we can really get the most impact for our investment dollar possible.

Operator

(Operator Instructions) And we have a question from Jason Rogers from Great Lakes Review.

Jason Rogers - Great Lakes Review

What is the estimate for CapEx for 2014?

Anders Gustafsson

We don’t give that out but I would say if you look at our CAGR (Ph) we’ve historically been about 20ish or so like that and I think that’s sort of consistent going forward. Our business doesn’t drive a lot of need for CapEx since primarily driven out of sort of IT and some of our manufacturing, but it’s pretty well.

Jason Rogers - Great Lakes Review

Okay, and the looking at the RFID business, is that still less than 5% of the corporate total and what areas in that whole area do you think hold the greatest potential for 2014.

Anders Gustafsson

Yes, RFID is still a small part of our business, it is less than 5%, but we’ve seen I think 2013 was a good year for RFID overall. Passive RFID on the printing side saw a lot of interest from retailers primarily in North America and in Europe as well as in the extended retail supply chains, so all the way back to government manufacturers in Asia. And we participated nicely in many of the larger deals in 2013 and we expect that passive RFID will continue to be a nice growth area for us, although from a smaller base. Then on the active RFID side, we had a strong position in industrial manufacturing applications for some time, we’re seeing, shifting little bit of our focus to, instead of tracking just location, we’re now tracking motion, so we can actually keep track of things that are moving in a different way and that expands our opportunity to more sports verticals but also we’ve seen great wins from this with, we talked about in the script a large airplane manufacturer for a health and safety application and also in healthcare to track people moving in hospitals.

Operator

And we do have a question from Michael Kim from Imperial Capital.

Michael Kim - Imperial Capital

Just a quick follow-up question on channel inventory levels and if your sense is relative to kind of what we saw maybe a year or two ago, that’s at normalized levels or with the expansion sales that maybe it’s been down a little bit relative to historical norms.

Anders Gustafsson

A good question, I think we look over year over year, we look at our channel inventory is actually down about 5% from the beginning of the year, do you recall in the first quarter we mentioned that some of our sales decline was because of sales that needed to hit larger levels of inventory beginning of the year, and we see them at, I’d say we’re at good levels and as I think we talked about before we’ve done a lot of work with the distributors and such to make sure that those inventory levels are really appropriate for level of business that they’re seeing today.

Michael Kim - Imperial Capital

Okay, great and then just one other follow with the Latin America is sort of a little bit of an outlier geographically, is it your sense that that area should stabilize or is Brazil maybe one of your larger country markets and any color you can provide on regional changes in that business.

Anders Gustafsson

We expect Latin America to improve in 2014, for us Mexico is the largest country and there’s been a peaking of steadiness for us, Brazil has been a bit more choppy, we had some great quarters and some not so great quarters with Brazil and then we have other countries like Venezuela and Argentina have historically been good countries for Zebra, but there’s more variability I think to the outlook and the results for Latin America, based on political and macroeconomic situations, but our position competitively in Latin America I think is very strong and we have a very good team and we don’t believe we lost share in any way, on the contrary, we believe we actually gained share even though the market was or our revenues were down some.

Michael Kim - Imperial Capital

Great, thank you very much.

Operator

And we have a follow up question from Keith Housum from North Coast Research, please go ahead.

Keith Housum - North Coast Research

Thanks guys for the follow up questions here. Early in the year you guys announced the restructuring your result (Ph) of supply chain over in China, is all those benefits come through in the gross margins already or should we expect any more benefit it FY14.

Anders Gustafsson

Scratching our head a little bit, I don’t recall that we announced a large restructuring, did we?

Mike Terzich

We did, but effectively the value of that restructuring is pretty much our margins right now so I wouldn’t have going forward we’re not really projecting any big change year over year because of the restructuring in our margins, in other words we’ve already realized the benefit of that.

Keith Housum - North Coast Research

Okay, fair enough, that’s I was looking for, and then you guys have mentioned in your press release this morning, expansion to new geographical markets, perhaps if you could expand a little bit there, I guess what markets you’re looking at there and how much of your sales base in the fourth quarter came from I guess any of those efforts.

Anders Gustafsson

So the expansion we’re thinking about now for entering new geographic areas is much more modest say than the programs we had in 2010 when we put real effort and real investments into some of the larger markets, so now it’s more infused in other markets, Southeast Asia will be one of those markets we believe still has lots of opportunities for us, Africa is turning out to be a stronger one, but that’s small investments to help drive that, we still continue to grow in China so that’s a big market for us and we see India coming back in a pretty good way. Overall though I would say the investments are much more modest than what we did a couple of years back.

Operator

And we have no further questions, I will now turn the call back over to Doug Fox for closing comments.

Doug Fox

Once again everybody thank you for joining us today. Just want to let you know that our next regularly scheduled conference call for our first quarter earnings will take place on May 6. Until then have a very good day. Thank you.

Operator

Thank you ladies and gentlemen, this concludes today's conference. Thank you for participating, you may now disconnect.

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Zebra Technologies Corporation (ZBRA): Q4 EPS of $0.82 beats by $0.04. Revenue of $284.53M (+12.4% Y/Y) beats by $16.5M.