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Zebra Technologies Corporation (NASDAQ:ZBRA)

40th Annual J.P. Morgan Global Technology, Media and Telecom Conference

May 15, 2012 2:10 PM ET

Executives

Paul Coster – JP Morgan

Anders Gustafsson – CEO

Paul Coster

All right, so good afternoon everyone. My name is Paul Coster, I’m the Senior Analyst covering applied and emerging technologies here at JP Morgan. And this is the 40th Annual TMT Conference. It feels like I’ve been at all 40 of them, that can’t be right, can it? Anyway, I’m very happy to have and discuss with the CEO of Zebra Technologies here this afternoon, thanks for joining us Anders.

Anders Gustafsson

Thank you.

Paul Coster

All the way from Chicago, right?

Anders Gustafsson

All the way from Chicago.

Paul Coster

Okay. I hope you’ve got one-on-one sessions. I think what I’ll do is I’ll assume that you know, some folks in the audience aren’t necessarily familiar with the story. So, let’s start off by talking about what it is that Zebra does.

Anders Gustafsson

And most of you probably have heard of us as a leader in bar-coding and RIFD. And we think about what it is we actually do for our customers, we tend to talk about how we help our customers increase visibility into their operations. So, we do that basically by providing a digital voice to the most important asset. And that voice can be in the form of a barcode, passive RFID or active RFID tags or different types of sensor technology.

But that voice basically enabled the assets to talk with their software applications to provide more real-time information to their software application about what’s going on in their operations and that can be a supply chain that can be a retail facility that can be a healthcare facility, so almost any type of operation. And that information ultimately enables our customers to make smarter and more, timely business decisions.

Paul Coster

All right. So, the first quarter is at the way. And to my expectations guidance was little bit soft though. And we saw a little bit of a dip in gross margins moving forward. What’s happening in the near term here?

Anders Gustafsson

I think gross margin was flat quarter-over-quarter. And I think we guided it to be consistent with that. But first quarter was on an absolute basis, growth was not quite this robust as we have seen over the last couple of years. In 2010, we had 21% growth, 2011 we had 10% and we had 3% in the first quarter. But I think in a relative basis, we did quite well in the first quarter, I’m quite confident we extended leadership in the industry and our market share gains.

So, we were by far the leader in our space, our market share is probably about four times that of our nearest competitor according to VDC, that is the preeminent independent market research firm in our area. We had growth in all four geographic regions so, US grew, Asia-Pac, Latin America but also Europe which was probably more of a – more unusual. So, I think we had a solid first quarter considering the economic environment we saw.

Paul Coster

Okay. Now I apologize, so you had 49% gross margins, you’re looking for similar gross margins in the next quarter, all right, got it. Now, what’s interesting here though is that in aggregate you’re growing at low single digits. But at the Analyst Day event which you held only a few months ago right, though, you talked about re-acceleration into the high single digits. What gives you confidence that this is going to happen?

Anders Gustafsson

Yeah. So, again, go back to 2010, ’11, we had 21% and 10% growth. So, I think we – at our Investor Day, talked about a longer term growth view for the next say three or four years, while being able to generate 8% to 10% revenue growth. And we base that on – again, first on market, expected market growth of 6% to 7%, again that comes from independent market research. And we felt that we ought to be able to grow a couple of percentage points faster than the market.

And if you look at the last few years, I’m confident we’ve grown at least that according to VDC again, I think our market share has increased by about 2 percentage points per year over last several years. So, we feel we are well positioned in our industry and we think it’s an exciting industry with a lot of growth opportunity. So, we felt that that will be a reasonable growth target through a cycle.

Paul Coster

Right, got it. So, meaning that they can peak higher than that later?

Anders Gustafsson

It can peak higher this year obviously 3% is less than that. But say in 2010 and 2011, both of those years were either higher or at the top end of that range.

Paul Coster

So, this year you would describe as being as cyclically slower year?

Anders Gustafsson

We don’t necessarily give guidance for the year. We only give quarter-over-quarter but obviously 3% in the first quarter and we guided for something less than 6% to 8% growth in the second quarter. So, it’s – it wouldn’t be unreasonable to assume that this is going to be somewhat slower this year. And I think to a large degree, it’s driven by Europe where we’ve had very healthy growth. Last year we grew by 10% in Europe, in Q1 we were growing. But that was I think more of an anomaly.

We’ve seen a bifurcation of the business in Europe. Some of our Southern European countries are doing – are struggling to be frank. Italy is a fairly decent sized business for us and that’s been hurt quite a bit. But on the other hand, Germany, some of the other Northern European countries, Russia, Turkey, they’ve all done very well. So, we’ve seen kind of some countries do really well in Europe and some countries are struggling.

Paul Coster

Okay. You called out in the last quarter that the strength that you saw in the supplies in card printers in particular.

Anders Gustafsson

Yeah.

Paul Coster

What would you think was behind that?

Anders Gustafsson

On the card side, we’ve invested meaningfully over the last three years I would say, to refresh our card product line. And we’ve come out with several new card products over the last couple of years. And we’ve refreshed our card channel programs. And we recruit a lot of new channel partners. So, for the last year plus we’ve seen nice growth in our card business and the card was particularly strong in the first quarter. So, we feel we’re well positioned in that industry today with a nice reinvigorated portfolio of products.

And on the supply side, we’ve continued to gain share. I think we’ve executed well in that space. We have been able to gain some good new customers, and we’re focusing on and part of that market segment that is a bit more specialized. So, we’re also seeing better margins than most people in the supplies business.

Paul Coster

You saw strength double digit growth in Latin America. And what was behind that, was it the – just getting the sales force out there or was that something about the region that’s working?

Anders Gustafsson

In supplies?

Paul Coster

Well, no, not it supplies, just generally I think the region was up 11% versus single digit in all other geographies. So, is there something that – is there something in Latin America you want to call out? For that matter, last year much of the emphasis was on China.

Anders Gustafsson

Yeah. China in our first quarter, China grew, if my memory serves me right, 13%. Latin America had, you know, we’ve been very strong in Latin America for quite some time. We’ve made substantial investments in Brazil. But Mexico and the rest of Brazil has been, good markets for us for a long time. And we expect that Latin America will continue to be – to grow faster than the average for the company. And Brazil and Mexico will be the two largest parts of our Latin America business.

Paul Coster

Is it and just some – simply the end market demand or is it some of execution?

Anders Gustafsson

I think it’s both. I think end market demand was – the end markets in Latin America were stronger than we saw in many other parts of the world. But I also believe that we continued to gain share there. We have invested in strengthening our resources particularly in Brazil but also across Latin America. And I think that’s paying dividends.

Paul Coster

How important is RFID to the story now?

Anders Gustafsson

RFID is a growing part of our business. And it’s still a small part of the overall business but it’s growing faster than the average part of the business. And we’ve seen nice growth particularly in North America over the last couple of years from – with retail being the vertical market that’s adopted at the most. So, in-store inventory control is now a well established application which is driving a good size of our demand. But it’s also finding new homes in manufacturing and other parts of the business. So, we believe RFID will continue to be a faster growing part of our portfolio and one that we see as very important for our, in, as far as our innovation and brand leadership position.

Paul Coster

Is there an associated sale of a printer when an RFID printer goes in, meaning that that there is generally a sort of broader upgrade to the processes and practices with the customer?

Anders Gustafsson

Yes. Most often when one of our customers put in, implement the RFID application, it is a broader and larger project than just a printer. But for us that means, that was – the printer is an important part of it of enabling that application overall. But also for us the RFID, that means not only passive but active RFID. And we have won a number of new attractive opportunities for real-time location solutions. So, we have active RFID in – in the second quarter, I think we talked about an application with (inaudible) where we’ve used IBM as a system integrator. So, we’re very strong in automotive particularly there.

Paul Coster

Well, that actually brings me to the question of industry verticals. Are there any industry verticals that are standing out at the moment in terms of registering, talk about another weakness?

Anders Gustafsson

I don’t think either one – any one stands out for being weak starting with that. I think in manufacturing which is our largest vertical market, it’s about 50% of our total revenues. We’ve actually seen a nice resurgence in manufacturing in North America. Our North America business has done quite well over the last three quarters. And the – say the extended automotive supply chain has been a driver for that. Other verticals that are doing well for us globally has been healthcare, that’s probably our fastest growing vertical market over the last several years.

We have value propositions that both address the need for – to provide more cost effective care but also for patient safety. Another fast growing market has been government in many areas as government also need to adopt a lot of the same technologies as industry has done to become more effective than effective. We’ve seen value for us in those areas also.

Paul Coster

You’re quite an interesting company from the sort of lead indicator to space because you touch many industry verticals globally. And lead time on sales is not very good at all, so partnership business in large part. So, what I mean inferring from you is that business is okay at the moment. There are couple of soft patches in Southern Europe. But otherwise things are quite good, getting better perhaps?

Anders Gustafsson

So, if you look at our Q1 results and what we said there. There were some – the environment is not as robust or strong as it was same time last year. But the comps are also tougher. But I think we from the Zebra perspective, we said two things. One, we are whatever the economic environment is we are quite confident and certainly committed to growing faster than the market to continue to extend our lead in the industry.

And I would say also that irrespective of the economic environment, we’re fortunate that our application, they work in good times and in more challenging times. In good times our customers are expanding factories, expanding retail facilities, healthcare facilities, which obviously drives business for us. In more challenging times, our customers tend to trade OpEx for CapEx. And I think that’s been an important driver for our business in the more established markets, certainly North America and Western Europe over the last few years, where companies are invested more and more in technology to enable them to gain greater efficiencies.

Paul Coster

So, the stock I think is sort of generally looked as – not the most exciting stock in the world. But then from a technology perspective there are certain elements to this story which is really fascinating and that is, and I think you called out on your Analyst Day. Then which is that, suddenly the world – has ubiquitous connectivity.

Anders Gustafsson

Yeah.

Paul Coster

And wherever there is an IP address, you can basically plug in a device that can then monitor assets and people and that’s where you fit in, you’re over there.

Anders Gustafsson

Yeah. I mean, I think that – I’m probably slightly biased. But I think there is a terribly exciting story. I think that people who feel that we are not exciting haven’t really looked hard at Zebra.

Paul Coster

That is my point. I’m kind of, sort of tease-out here a really big idea which is internet of things, right?

Anders Gustafsson

Yeah. So, I think that for us we are associated, we are I think we’ll benefit from a lot of the larger mega-trends that are budding say in the industry. One, is that ubiquitous internet connectivity. So, anytime you have a connected device you can learn something more about what goes on in your operations. And that device can be certainly bar-coding but it can also be passive-active RFID sensors and things that can back all that information.

That feed still roll big data discussion. And lots of information or lots of investments are going into kind of the big data trends. But today that tends to be more in a difficult software that are analyzing, if you want to learn something about next year’s Christmas season most companies then are looking at last year’s Christmas season’s database of information. What we can do is provide much more real time data by what goes on in your operations.

So, from a retail perspective the mention of RFID having in-store inventory control, customers that have implemented their attempt to generally improve their inventory accuracy from about 65% by mainly going out and counting the goods on store shelf to well over 95%. And now you can see much more real-time, what you actually have on your shelves. So, if you’re running low on something you can more quickly reorder it if you’re – if you have plenty of inventory, no need to reorder.

You can move stuff from the back office to the store shelves. And you’re much more likely – the customer is much more likely to be able to buy the good, they come in to actually purchase. And you can keep less inventory so you get better revenues, less inventory and for retailers, they tend to translate into very much sort after cash flow. And that we can do in much more real-time. So, it helps feed, I think the kind of the big data trend, the ubiquitous connectivity piece of always knowing what’s happening.

So, we’re very much associated and benefiting from large secular trends. And I’ll say another trend which I think is probably overlooked a bit is the growing wealth of or the creation of the middle class in emerging markets. We tend to enter emerging markets through manufacturing so we take China as an example, we entered China 10, 15 years back.

Largely following European or North American customers in manufacturing but today China has created a much stronger, wealthier middle-class. They now want to have better retail facilities, better health care. The government want to provide better transportation so you have now ticketing and stuff. So, we are now selling our entire portfolio of products in China. So, including retail solutions, healthcare solutions, ticketing. So, we lead with manufacturing but as most of these emerging markets or less developed economies are becoming more and more industrialized, the middle-class gross and that posted a lot of business for us.

Paul Coster

Nearly two years ago you said that to watch out for 2011 would be an interesting year because you would have a record number of new products in the market, I think it was ’12. What’s the product innovation played into like in 2012 and 2013?

Anders Gustafsson

Yeah, we’ve invested significantly in both improving processes and how we approach product development to enable us to increase the cadence on new product development. So, historically we’ve released four, five, six new products per year. But we need to do something similar so I think that that’s kind of the new normal level for us. And we’ve done that by both plat-forming to sort of what – so we can reuse so much more of the electronic platforms and the software probably about 70%. And so that means, shorter development times high quality products when they come out.

And we can then use the resource that we have to develop more value added function or features. And so, I think for us that has been a big improvement in how many new product we get out, the level of innovation they have. So, I think that’s an important part of the growth we’ve seen and how we’ve been able to extend our lead in the industry.

Paul Coster

Mostly I think three of the products were specifically designed for emerging markets and that was China. What about this year?

Anders Gustafsson

So, those three products we launched last year in China, we specifically designed them for China. That was the first time in the history of the company that we designed a new product, not for North America. You know, we tended to design for North America and then sell them worldwide. This time we looked at the market segment in China specifically where we were underrepresented. And we just signed them to be competitive in that segment.

This year we’re now taking those products into a number of other emerging markets, so we’re launching them in Brazil and some Latin American countries and in India some other markets in Asia this quarter.

Paul Coster

And without compromising on gross margins?

Anders Gustafsson

So, these, it’s something we often hear from investors that if we’re competing in China, that must mean that our margins there are much lower. You know, we have – we actually sell larger proportion of our high-end printers in China. So, we have very good margins from those. We have a very disciplined pricing and channel programs across the world, because we know we are very channel-centric organization.

If we were to sell at a much lower price points in one market, those channel partners will quickly buy up little more than one and start distributing those products into other markets. They will find their way into the US or other places. So, we’re very, very sensitive to how we set that pricing and work that. So, specifically but these products that we launched for emerging markets they are slightly lower to gross margin in that average but much less so than most investors think.

Question-and-Answer Session

Paul Coster

Are there any questions in the audience, I got two more by the way. But yes sir, please.

Unidentified Analyst

Can you turn around on the retail vertical in RFID? Excuse me. You’ve done well in the retail vertical on RFID. I guess I would say it’s been underwhelming in other verticals. What’s been there and you might take exception with (inaudible). But what’s been the sort of barrier to gaining traction for RFID. I mean, if I go ways RFID was going to be the second coming and it just hasn’t really gained traction. So, comments on them?

Anders Gustafsson

Yeah, so RFID, I would say RFID as a technology has probably been underwhelming in other industries. I don’t think that Zebra’s performance and our verticals necessarily has been underwhelming compared to RFID. I think we’ve certainly done as well as an industry I think. Retail has become the – actually retail and government was the two, largest verticals from the beginning. The RFID had I guess a four star, it got over-hyped in 2004.

It was very much a compliance mandate where some of the large retailers and government said, if you want to send it to me, if you want to deliver to me, you have to have a RFID tag on or something. The value strictly went to the one point in the value chain say, versus being value for everybody. Now it’s much more of a close loop type of application where the people who are making the investment get the value. And it’s much more driven by business value than compliance.

So I think this is a more robust way for the technologies to gain traction and grow. Outside of retail, let’s say for us active RFID has been very successful in particularly automotive and industrial manufacturing to track assemblies or chassis on an assembly line or inventory replenishments or electronic compound systems, tracking sub-assemblies through a large type of plant. There is a whole raft of applications we have for active RFID in that.

But also active RFID we track I think we talked about it in our – some of our earnings calls. We track students in university, where the university get reimbursed from the government for each student trained. We track cows. The way cows move has to do with – you can tell when they’re about to calf or you can do it differently on the health to make sure that’s productive and milk production is good. We’re tracking police officers in subway stations. So, there is a very broad range of application. But the core I would say for us has been passive RFID in retail and also manufacturing. And active RFID particularly in the industrial manufacturing.

Paul Coster

Yes sir.

Unidentified Analyst

I was going to ask you about, you’ve been pretty aggressive in buying your stock over the last five years. You’ve made acquisitions right around when you started. But the industry – there is one competitor particularly has been struggling. But maybe talk a little bit about your thoughts around the balance sheet and cash and how you think about M&A versus buyback your own stock and whether you think about acquiring within your core business or whether you might look for growth areas outside your core business?

Anders Gustafsson

Sure, yeah. So, first, when we look at the investment opportunities, we look at investing in the areas where we can have the highest risk adjusted return. So far, we have prioritized organic growth opportunities so we have invested you know quite substantially in accelerating growth in the emerging markets and further penetrating new applications or vertical markets in our more established areas and in innovation.

After that, in over the last few years we’ve prioritized buying back our own shares. We felt that when we looked at acquisition opportunities, we were the most attractive opportunity we could find. We’ve acquired about 20 million shares over the last three years, so that’s about a third of our outstanding share capital I think.

We still continue to think that our shares are an attractive investment opportunity. We are more, we’ve always said we wanted to be price sensitive. So, we tend to step in and be more aggressive when there is a dip in the share price and we tend to hold off a bit or be less aggressive when the share price is on a strong upward trajectory.

We’ve done analysis to look at how well we would have done if we’d bought back steady over every quarter at the average price per quarter versus the way we’ve done it. And by – our strategy would be more price sensitive and even opportunistic has actually turned out to be very productive for us.

When it comes to acquisition, we say the same thing, first, it has to be an attractive opportunity on a risk adjusted basis. It has – the other hurdle would be – it has to enable or accelerate our strategy. So, we’re not looking to build a new business there, we’re looking to really have something that reinforces our current business or that leverages our current business to gain strength. And then of course has to meet our financial hurdles and so forth.

We will be more comfortable putting more capital to work if it is close to our core. If it is something you’ll be more – further away from our core it would go, the less money we will probably put to work. We will probably then make smaller investments to learn about the technology about that market space first.

Unidentified Analyst

What are the five pillars of execution?

Anders Gustafsson

So, we laid out the – we call it the five-pillar strategy, five pillars, five core areas for our growth strategy. The first one we talked about is how we can further penetrate new vertical markets or new applications in our more established markets in North America and Western Europe. The second is how we can accelerate growth in emerging markets. The third has been about how we can motivate our – created, motivated and excited and engaged the employee work force. The fourth one has been about how we can out-innovate our competition. And the fifth one is around how we can gain maximum efficiencies in our operations.

Paul Coster

Well done.

Anders Gustafsson

You thought, it would stump (ph) me.

Paul Coster

Yeah, that’s very good. I think unless there is, any more questions, at this point, we’ll wrap the session. Thank you very much. And we really appreciate it and thank you for making this working out here.

Anders Gustafsson

Thank you. Thank you for coming.

Paul Coster

Thanks.

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