Zebra Technologies Corporation Q3 2008 Earnings Call Transcript

| About: Zebra Technologies (ZBRA)

Zebra Technologies Corporation (NASDAQ:ZBRA)

Q3 2008 Earnings Call Transcript

October 29, 2008, 11:00 am ET

Executives

Doug Fox – VP, IR

Anders Gustafsson – CEO

Mike Smiley – CFO and Treasurer

Analysts

Reik Read – Robert Baird

Ajit Pai – Thomas Weisel Partners

Greg Halter – Great Lakes Review

Chris Quilty – Raymond James & Associates

Anthony Kure – KeyBanc

Timothy Robinson – Boyne Advisors

Karey Kelley [ph] – Iron Works Capital

Operator

Good morning and welcome to the Zebra Technologies third quarter earnings release conference call. Joining us from Zebra Technologies are Anders Gustafsson CEO; Mike Smiley CFO; and Doug Fox, Vice President, Investor Relations.

(Operator instructions)

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

Doug Fox

Thank you. 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 forwardlooking statements within the meaning of the Securities Litigation Reform Act of 1995. Words such as expect, believe, and anticipate are a few examples of words identifying a forward-looking statement. Forward-looking information is subject to various risks and uncertainties which could significantly affect expected results. Risk factors were noted in the news release issued this morning and are also described in Zebra’s 10-K for the year ended December 31, 2007, which is on file with the SEC.

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

Anders Gustafsson

Thank you, Doug, and good morning everyone. Thank you for joining us. Today, Zebra reported solid third quarter results. We executed well delivering sales growth, profitability, and cash flow. We further positioned Zebra for success over the long-term by extending our industry leadership with customer solutions that deliver hard ROI, which is particularly important in these tough economic times. Given the unprecedented environments in which we and many companies are now operating, we are adapting our 2009 strategy to keep Zebra nimble in ever changing business conditions.

Early in the quarter, we recognized the potential impact of economic uncertainties and quickly moved to reduce our annual operating expenses by more than $10 million. Our actions included refocusing our resources in the Enterprise Solutions Group to high priority opportunities, streamlining the management of our Specialty Printing Group's sales organization, and eliminating many contractors.

In addition, we remain very frugal in our discretionary spending given the current environment. At the same time, we continue to build on the strength that enables us to serve more of our customer’s needs and deliver value for our shareholders. Zebra is in a solid position to extend our leadership in all economic conditions. In good times, our customers buy Zebra Solutions to expand their business. In tough times, our customers continue to buy our solutions to generate operational efficiencies. It is worth repeating the reasons for Zebra’s enduring ability to extend its industry leadership.

First, Zebra serves more of our customers’ needs with the broadest range of products, technologies and solutions in our industry. With the largest installed base in the industry, we have an increasing need of our space of customers across geographies and industries. More than 90% of Fortune 500 companies use Zebra products and solutions. Our global go-to-market channels deliver these solutions to help our customers improve their business performance and competitive position.

Second, Zebra operates a model of high profitability and substantial cash flow generation. Year-to-date, we have achieved a gross margin of 49.5%, a GAAP operating margin of 15.7%, and an EBITDAR margin of 20.9%. These results compare favorably to the performance of our peers and technology companies in general.

We generated free cash flow before acquisitions of $67 million. Between our current cash balances and cash flow generating capabilities, we are able to internally fund all of our currently anticipated business grants. In other words, we can invest in new products to meet more customer needs and extend our leadership even in the current economic environment. We are equally focused on profitability. That’s why we’re reducing our operating expenses, both in the short term and over the longer term, with projects like our new ERP system and outsourcing of manufacturing. These programs will have long-term enduring benefits.

Third, Zebra’s financial condition is strong. At the end of the third quarter, we had no debt and $247 million in cash and investments. This equates to almost $4 per share. In addition, we have $100 million untapped credit line with a consortium of highly rated global banking institutions. This financial strength gives our customers the confidence that Zebra can be their valued long-term business partner. Our financial strength further provides our shareholders the comfort that Zebra can continue to create shareholder value in good times and bad. And finally, it gives us the ability to invest in Zebra by buying back our shares. For all of these reasons, we’re in good position to extend our leadership.

I’d now like to review some Q3 highlights for you. Our Specialty Printing Group grew as a direct result of our business diversity. As Mike will explain, North America operations performed to expectations while European sales continued to be impacted by economic conditions. We had all-time sales records in Asia Pacific and Latin America. Our performance was reinforced by the investments we’ve made to build stronger channels to better serve our customers.

Specifically, in the past year, we’ve increased the number of Zebra resellers in China by more than 200. Earlier this month, we opened a new distribution facility in Singapore. This operation is part of our global expansion strategy to serve our resellers in the region and our global supply chain transformation. It will also provide income tax benefits as more products go through it. In Latin America, we put in place a more substantial infrastructure leading to stronger sales, most notably in Brazil.

The breadth of our solutions also grow performance. Sales of mobile work force solutions were particularly strong as customers looked to make their field personnel more productive in light of higher fuel prices and tougher business conditions. As an example, one of our customers is using our RW 420 mobile printer and a new Route Palette accessory to speed deliveries of food and beverages, which improves efficiency.

We also have multiple pilots underway for Zebra mobile, desktop and kiosk printers. These pilots are being driven by our customer’s desire to invest in upgrading their existing Zebra solutions with newer technology, deploy new solutions to improve business performance, and consolidate their printer needs around a suite of Zebra products.

Investments in Zebra solutions typically deliver a return in as little as six months. Results like these help drive customer demand even during a difficult economic environment. Our card business delivered a record quarter. This success was due to the actions we discussed with you earlier in the year. As promised, we consolidated the card printer sales, marketing and supply chain organizations into the Bar Code business unit.

These actions resulted in adding 30 new card resellers through our Partners First Channel Program and leveraging an expanded global sales force to reach more opportunities. Our goals for the Specialty Printing Group include focusing on growth in key vertical markets, driving growth in BRIC countries, and improving operational efficiency with such projects as outsourcing and ERP implementation. We are optimistic about the future for our Specialty Printing Group and look forward to continuing to extend our leadership in this market.

Let me now provide an update on our Enterprise Solutions Group where we continue to extend our leadership through more diversified solutions step and customer base. Let me remind you again of the rationale behind these acquisitions in order to provide an understanding of the significant value they bring to our company. Again, ESG currently makes up only 10% of Zebra’s total sales, yet it also enables Zebra to provide its customers the broadest set of asset tracking solutions available from any company today.

Zebra’s Enterprise Solutions Group extends the breadth of our products and solutions, expands our deep expertise in attracting vertical markets, and enhances our technology portfolio so we can meet more of our customer’s needs. Essentially, Zebra Enterprise Solutions Group enables the company to realize its vision of helping customers improve their business performance through a host of innovative solutions that identify, track, and manage assets, transactions and people.

As you are well aware, our 2008 priority for ESG has been to integrate four companies into one business unit. So far, we have made significant progress to position the organization for profitable growth and deliver more robust solutions to targeted customers. These actions include implementing a global business strategy, establishing common integrated organizations for strategy, product management and services, and integrating our sales teams along targeted verticals.

We’re excited about ESG’s long-term prospects and continue to execute on our growth strategy which includes penetrating deeper into existing vertical markets with a broader suite of solutions, moving into adjacent markets, developing programs that leverage system integrators in other channel partners, and expanding internationally. We’ve made good progress and we continue to execute on initiatives to achieve profitability. Make no mistake, this is a top priority for us.

Given the current business environment, we can only expect the timeline to reach profitability to be longer than originally anticipated. Since mid-August, I have been even more involved in the Enterprise Solutions Business. I have met with multiple customers throughout the world to discuss how well we are supporting their needs and how we can best address their requirements in the future.

For example, I attended the opening of the Euromax Marine Terminal in Rotterdam last month. Our terminal operating system makes Euromax one of the most advanced and automated container handling facilities in the world.

We’ve also diversified our sales across customers and verticals. Examples include the first sale of our operating system into a rail terminal in Australia. This is an important milestone in our strategy to expand into adjacent markets. A second example is the first sale of the combined suite of products from both our Enterprise Solutions and Specialty Printing Groups to a single customer. This channel driven sale to a large US government agency highlights the value of Zebra’s capability to deliver an expanding array of asset tracking solutions. And finally, a growing number of installations of our Material Flow Replenishment solution.

Last month, I visited a large equipment processing plant in the US where our customer has implemented the Zebra real-time location system and Material Flow solutions and they have achieved an inventory reduction from $14 million down to $1 million.

In summary, we are a leader in an attractive industry in a globalized economy. And today, we have a broader and more powerful solution sets. Each day, we see how our customers rely on our products and solutions to gain efficiencies, lower cost, and increase competitiveness. Our commitment to our customers is matched by our commitment to our shareholders. To ensure we will grow profitability over the long-term, we will continue to control our operating expenses through this challenging time to manage our margins and ensure shareholder returns. We realize this is a challenging environment and we will continue to assess our programs to ensure we are investing wisely, focusing on growth and profitability.

I would now like to turn the call over to our CFO, Mike Smiley, to provide a detailed review of third quarter results and guidance for the fourth quarter of 2008. After Mike’s remarks, I’ll return for some closing comments on our outlook.

Mike Smiley

Thank you, Anders. There are three key points to keep in mind while we go through third quarter results. They are; first, North America, Latin America, and Asia Pacific geographic territories performed at or above expectations. Sales were principally affected by the continued weakness in EMEA. There is no material year-over-year net impact from foreign exchange. Two, we had four nondiscretionary one-time items that had a $0.03 combined positive impact on EPS. And three, operating expenses include the effect of more than $10 million in annual cost reductions.

So let’s start with sales which increased 12.4% with organic growth of 5.2%. Specialty Printing Group sales increased 3.5%. Enterprise Solutions Group contributed $25.6 million to third quarter sales with continued contributions from terminal operating system installations and real-time location system deployments. For the quarter, ESG delivered $1.7 million in services related to lost purchase accounting revenue.

Under the accounting rules, we’re delivering the services which we’re obligated from the Navis acquisition but do not book the revenue against them. We have about $3 million left to deliver.

Let’s take a look at sales by product line now. Hardware sales increased 6.6% to $175.7 million from last year and represented 72% of total sales. We saw particular strength in mid-range mobile and card printers. The percentage of printer sales from new printers was a solid 20%.

The pipeline for scheduled product introductions makes us optimistic that we’ll see continued strength in this number. New products were introduced and are designed with features and benefits that open new opportunities for Zebra. In addition, we are continuing to add to our suite of offer that makes Zebra printers easier to integrate and use on enterprise networks, a clear benefit to our reseller partners and customers.

We shipped 242,000 printers in the third quarter, averaging at price of $596 was up from $585 a year ago but down from last quarter because of FX and product mix. Record supply sales of $45.5 million were up 9.1% and comprise 18.7% of total sales. The percentage of revenue from services and software held steady at 10.8%. International sales were up 18.8%, with Latin America up 27.3% and Asia Pacific increasing 25.2% to a new record. EMEA increased 15.1%.

Continuing the spotty body weakness we discussed during the last conference call, EMEA sales declined about 3% net of FX in Enterprise Solutions Group acquisitions. Out of our nine sub-regions, France, Germany, the Middle East, Africa, India, and Eastern Europe saw the greatest strength, countered by weakness in the UK, Italy, and the Benelux countries.

Third quarter sales in North America were up 5.5% of $110.9 million. Here again, the diversity of our customer base in verticals has been paying off. In retail, we saw healthy refreshment replacement connector business. Sales to customers in small package delivery were also strong this quarter as well as mobility solutions in several verticals to help customers improve performance in their field operations.

Consolidated gross margin was 48.3%, up slightly from 48.2% a year ago. Specialty Printing Group gross margin declined to 47.4% from 48.4% principally from some temporary production problems that arose in label manufacturing as we transferred lines for new facility in Atlanta. These problems have begun to abate this quarter with the installation of new equipment in the Atlanta location. Gross margin of 55.9% for the Enterprise Solutions Group was up from 40.2% a year ago on favorable shifts and revenue mix from the acquisitions.

Let’s take a look at operating expenses. First, our activities to reduce operating expenses cover several areas of the company in both business groups. Specifically, we found savings in areas of overlap in Enterprise Solutions Group through the integration process and consolidated sales management in the Specialty Printing Group.

Some one-time items also hit the quarter. First, we booked a $5.3 million settlement on the claim we had on the WhereNet escrow. In addition to lowering operating expenses, it reduced our cash burden in the quarter by $2.6 million since the settlement is considered a reduction in the purchase price for tax purposes and is not taxable.

Next, we also recorded a $1.1 million gain on the sale/leaseback of our facility in Camarillo, California, as we adjust our business to an outsourcing model for printers. Profitability of the business remained high. For the three-month period, EBITDAR margin was 22.3%, which is comparable to the 22.4% margin last year. Specialty Printing Group EBITDAR margin was a solid 27%.

Expenses for 123R totaled $3.8 million versus $4.8 million last year. Exit costs amounted to $2.6 million, relating primarily to our outsourcing activities. In addition, we incurred $1.7 million integration expenses, primarily related to severance as we merged duplicate functions to optimize resources across the Enterprise Solutions Group.

Investment income is another area with two one-time items. One, a write-down of $4.4 million for the impairment of our investment in Fannie Mae auction rate preferred securities. And two, a $2.9 million write-off of a long-term investment that the company entered into in 2002.

On the impairment, many of you may recall, that beginning a year ago, we began to reduce risks in our investment portfolio. These actions included exiting a small amount of hedge fund investments we have as well as selling auction rate securities. We were able to liquidate a substantial portion of them but not all. The impairment charge incurred in conjunction with Fannie Mae going into conservatorship in the third quarter.

Other than Fannie Mae preferreds, which were written down by 93%, we hold $7.7 million in other auction rate securities. We are comfortable with the value of these securities, 97% of which are AA rated or better municipal government and government agency securities.

Excluding one-time charges, investment portfolio had an annualized return of 3.7%. Diluted earnings per share came in at $0.40 on 54.7 million average shares. Exit costs and integrations expenses reduced diluted earnings by $0.04. We ended the quarter with 63.3 million shares outstanding. We had a $7.1 million sequential decline in net receivables and brought down day sales outstanding from 55 days at the end of the second quarter to 54 days. The increase in inventories was primarily due to the transition of printer manufacturing to Jabil. We ended the quarter with $247 million in cash and investments.

During the quarter, we used the entire 3 million share authorization with the repurchase of 1.9 million shares of Zebra common stock. As we announced today, the Board gave authorization to buy up to an additional 5 million shares of Zebra stock. This year, so far, we have used $107 million for stock buybacks. Over the past two years, we’ve reduced the number of shares outstanding by nearly 8 million.

Our fourth quarter guidance is appropriately conservative given current conditions, FX rates, our deal pipeline and channel activity. For the quarter, we are forecasting sales of $225 million to $241 million, with Specialty Printing Group sales of $203 million to $215 million and Enterprise Solutions Group sales of $22 million to $26 million. This forecast incorporates an average US dollar/Euro exchange rate of 1.28, which is a huge swing from the average 1.46 for both 3Q ’08 and the December 2007 quarter.

Hedging activity will have an immaterial impact on quarterly results. The weakening of the Euro against the dollar is expected to affect sales by 2.5% compared with 3Q ’08 results, which flows through to the bottom line. Without this impact, EPS would be $0.05 higher. Earnings are expected in the range of $0.30 or $0.38 per share. Our forecast assumes gross margin in the range of 46% to 48%, and GAAP operating expenses of $76 million to $80 million. We’re estimating exit cost and integration expenses to total $2.8 million. The income tax will be 34.5%.

That concludes my formal remarks. Thank you for your attention. Now, here’s Anders for some concluding comments.

Anders Gustafsson

Thank you, Mike. We will continue to use our financial strength to expand our global leadership by building our business across customers, geographies and solutions. This diversity across multiple dimensions gives Zebra resilience during challenging times. We will prudently manage our business and adapt to changing market conditions. Programs are underway to review the products in our portfolio to ensure they meet both our customers’ needs and our profitability requirement.

For example, we will stop producing photo printers, a business we began four years ago. This product generates revenue but little profit. And since this is an OEM product for a single customer, our exit will have no impact on our channel. We continue to make steady progress on our ERP implementation. To date, we are on plan and within budget. In fact, we just reached a major milestone as we begin implementing Phase II of this project. We are taking a low-risk approach to this multi-year project, which will lower costs by streamlining business processes and deliver multiple benefits to the company and our customers.

Our outsourcing project is also on target to deliver $25 million to $30 million in cost savings in 2010. As of today, we’ve moved 40% of our production capacity to Jabil, who are delivering the same high quality as our customers have come to expect from Zebra. These numbers will rise significantly over the next several quarters. In the near-term, we will focus on high return activities that are right for our business and our customers.

Looking ahead into 2009, we will continue to invest in activities that deliver sustainable returns including geographic expansion, which continues to be a core area of investment and growth, driving double-digits growth year-over-year for the last several quarters. We expect to place more resources in the BRIC countries of Brazil, Russia, India and China, plus Eastern Europe and Turkey.

We will also invest in new product development and innovation, introducing new products to meet more customer needs. Most recently, we previewed our new Re-transfer card printer which we will be introducing early next year. Initial reports from our customers tell us that they are excited about this new level of performance that this product will deliver.

Because Zebra has a strong focus on our customers and improving their business performance, I am confident that our strategy will pay off. Zebra has the financial strength, industry leadership and fiscal discipline to navigate through these challenging times. Prudent investments in geographic expansion and new product development will enable Zebra to extend its leadership and build value for our shareholders over the long term.

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

Question-and-Answer Session

Operator

Thank you. (Operator instructions) I’d like to hand it back to Mr. Fox for some comments.

Doug Fox

Thank you. Just to keep the Q&A moving along, we’d like to – we’d appreciate it if you keep your questions to one question and one follow-up. If you have additional questions, feel free to get back in the queue. So with that, let’s open it up for some Q&A.

Operator

Our first question comes from the line of Reik Read with Robert Baird. Please proceed with your question.

Reik Read – Robert Baird

It’s always very confusing. Good morning. Could you, guys, maybe – Mike, as part of your comments, you talked a little bit about some of the markets, but maybe you could expand on and talk about just maybe the retail, the industrial segment, the transportation logistics, what you’re seeing from a macro perspective, and then how Zebra might be able to fit into those markets in the next, say, several quarters with the introductions of new solutions or new products or new customers or new channels. Anything along those lines would be real helpful.

Anders Gustafsson

I’ll take that first. This is Anders. We talked about weakness in the retail segment for the last four quarters on our calls and we’ve been also talking about the weakness in Europe since Q2. Now, I think the investments we made over the last several years to diversify the business have made us a lot more robust as we can offset weakness in any one segment with strength in others.

Now, specifically to the retail segment, I think we have been able to offset some of the weakness we’ve seen with the largest US retailers by penetrating deeper into that vertical and also expanding more internationally. More recently, we’ve also introduced our kiosk printers into retail and there we basically doubled the revenues from kiosk printers in the retail. So, we are certainly still seeing weakness in that sector but we have been able to offset some of that.

Healthcare was a good vertical for us in the past quarter with strong growth. Also, our mobile workforce vertical did well for us. The manufacturing sector met the expectation, but wasn’t pretty weak, but also did not really exhibit any strength.

Reik Read – Robert Baird

Okay. And then, on the ESG side of things with respect to the integration, can you expand a little bit, Anders, on your comments to talk about how you are trying to bring reseller system integrators into the fold and what is the status of the sales force? I mean, do you have a unified sales force now?

Anders Gustafsson

Yes, I think we have – we made good progress on integration, particularly here in the third quarter. I’ll go through the integration a bit more. Specifically, we have a three phased approach. Now, the first phase is really to do the infrastructural and the organizational integration and that was really integrate four companies into one business unit, and we’ve come a long way by now. I think we have largely done actually at the end of Q3. We now have the common organization for strategy, for product management, for our services organization, and we’ve aligned our sales organization along our targeted verticals. When we get the ERP system implemented, we will able to see some further integration of our shared services and supply chain organizations also.

The second phase of the integration is going to be, or is – that’s really what we’re in the middle of right now. That is to integrate more of the ESG’s product portfolio into the various vertical markets they were serving. And we’ve – some examples of how we’ve made progress here or how our customers are responding to this, I mentioned in my prepared remarks that we had a first order for really a combined solution from both ESG and from SPGs. There was an order to a large US government agency that included WhereNet (inaudible) products as well as passive RFID printers. And we have also largely completed the road map in the development for integrating WhereNet and our internal solutions in order to start offering system solutions.

The third phase in the integration is to rebuild stronger ESG channel capabilities where we can leverage the SPG channel partners more fully, and that’s something we already had on the agenda for 2009.

Reik Read – Robert Baird

Great. Thank you.

Operator

Our next question comes from the line of Ajit Pai with Thomas Weisel Partners. Please proceed with your question.

Ajit Pai – Thomas Weisel Partners

Good morning.

Anders Gustafsson

Good morning.

Ajit Pai – Thomas Weisel Partners

Couple of quick questions. I think the first is just looking at the operating expense structure and profitability of the Enterprise Solution Group, I take it that the vast improvement in the operating profitability is primarily due to the two one-times, the WhereNet as well as some other one-times?

Mike Smiley

Yes. You got your hands on it.

Ajit Pai – Thomas Weisel Partners

Right. So, then, when you’re looking at that 30% negative operating margin, that’s about 6% right now, so on an overall basis, you’re actually looking at a business model that is still very dependent on scaling. You’re not looking at any cost cutting to get any margin improvement as far as the ESG group goes, right? It’s still an invest and growth kind of mode rather than a reach profitability mode anytime soon, is that a fair assumption?

Mike Smiley

Yes, I think. Look, let me just put it this way. I think one of the things, it's part of the integration process that Anders was talking about. As we put these organizations together, we want to make sure we’re focused on the right things and we don’t have people doing – more than one person doing the same thing, so that’s part of the integration, but we’re still investing for the growth and that’s what we’re doing.

Ajit Pai – Thomas Weisel Partners

Right. And would you say that the – in terms of the integration, the vast majority of the cost and streamlining and position mapping of the integration is behind us, or do you think there’s still some potential over there for redundancies to be eliminated?

Anders Gustafsson

We will continue to make prudent investments in product development for the long term and look at how we can make the organization as efficient as we possibly can. We have – but it’s fair to say that the real driver for profitability will be growth and scale. I think we’ve made good progress over the last several quarters in establishing ourselves with our customers proving the value proposition for these things. We did implement a pretty substantial cost reduction in the third quarter. And for us getting ESG to profitability is an absolute top priority. There’s no question about it. But with the current economic conditions, it makes it a little harder to predict.

Ajit Pai – Thomas Weisel Partners

Right. Looking forward, can you still expect the expenses on a sequential basis? I know year-over-year, because of the acquisition, it's a little difficult to model, but can you still expect the expenses even accounting for the WhereNet one-time, et cetera, including that to keep rising over the next several quarters or do we expect them to stay sort of flat?

Mike Smiley

We are expecting to hold them flat.

Ajit Pai – Thomas Weisel Partners

Okay. So you expect the expenses to be held back and the revenues to keep rising?

Doug Fox

Hey Ajit.

Ajit Pai – Thomas Weisel Partners

Yes?

Doug Fox

One question, one follow up.

Ajit Pai – Thomas Weisel Partners

Okay. This is primarily with one issue. The other one is just the card printers, you’ve talked about the synergies that you expected with the rest of your channel and the fact that you are using two completely different models for distributing that, and I think about two or three quarters ago, you said there was an initiative to ensure that you get better synergies across that. Could you give us some RFID [ph] on how that’s working right now?

Anders Gustafsson

In my prepared remarks, I talked about the card having had its best quarter ever. And that was really as a direct result of the activities we did in the beginning of the year by consolidating the sales and marketing organizations of our card business into our Specialty Printing Groups, and also on integrating the supply chain. So now, we have – we’ve been able to incorporate the card group into our Partners First channel program and that helps us add 30 new resellers to our card business. And also, we were able to then leverage a much larger global sales force to get better reach and see more opportunities.

Ajit Pai – Thomas Weisel Partners

So I guess it’s still quite early in the process, there's still tremendous growth left over there?

Anders Gustafsson

We are coming out with a new printer next year, a new Re-transfer printer which we’re very excited about and we hope that should – we expect that to generate good business.

Ajit Pai – Thomas Weisel Partners

Okay. Thank you.

Anders Gustafsson

Okay, next question.

Operator

Our next question comes from the line of Greg Halter with Great Lakes Review. Please proceed with your question.

Greg Halter – Great Lakes Review

Yes. Good morning guys.

Anders Gustafsson

Good morning.

Greg Halter – Great Lakes Review

Of the cash and investments that you currently hold, I wonder if you could break that down for us between strictly cash and money market funds or treasuries and everything else or however else you want to break it out just so we can get a better feeling on what’s there.

Mike Smiley

First of all, I think I mentioned that, this is Mike, that 97% of our investments are AA rated or above. Besides the Fannie Mae security which we wrote down, there’s really nothing below A. We have, I would say, is I’m looking across this probably about two-thirds of our investments, a little more than two-thirds of our municipal bonds, and then the rest are agencies and government backlogs. Actually, I misstated it here. No, that’s right. About two-thirds of our investments are municipal bonds.

Greg Halter – Great Lakes Review

Okay. And secondarily, I think on the last call, you’d talked about China with some impact from the Olympics and so forth. In the quarter, how did China do on a growth basis?

Anders Gustafsson

China did very well for us actually. We probably saw a little less effect of the Olympics than we expected. Greater China is now our third largest revenue-generating country. In the third quarter, it was the third largest generating country.

Greg Halter – Great Lakes Review

Okay, great thanks.

Operator

Our next question comes from the line of Chris Quilty with Raymond James and Associates. Please proceed with your question.

Chris Quilty – Raymond James & Associates

Good morning gentlemen. I was hoping that you might be able to give us a little bit more direction with regard to the anticipated revenue breakdown just specifically for Q4 between ESG and SPG?

Mike Smiley

Well, I think if we go back to the call, we quoted that the SPG would have between – let me just pull my notes out here. I may have missed it. Yes, I’m sorry about it. So, no – so SPG, we said was between $203 million and $215 million and the Enterprise Solutions Group was between $22 million and $26 million. So in total, we’re saying $225 million to $241 million.

Chris Quilty – Raymond James & Associates

Okay. And the key driver when you look at the Enterprise Solutions Group is still Navis, or are you expecting to see some year-over-year growth in the WhereNet business?

Anders Gustafsson

So, Navis will continue to be the largest single unit, but WhereNet had nice growth in Q3.

Chris Quilty – Raymond James & Associates

Okay, and is that primarily because the pickup in the port terminal business relative to the traditional exposure to automotive?

Anders Gustafsson

No, this was primarily driven by our real-time location systems and a new software package that we developed that we call Material Flow Replenishment Solution that goes into the automotive side. But we have been exposed also to some of the vagrancies of the automotive industry now, where four of our high confidence deals were for factories that actually are getting shut down. So, we are redirecting a lot of our marketing activities for this solution into more industrial manufacturing and government opportunities.

Chris Quilty – Raymond James & Associates

So, as you describe that part, it sounds like the old conbond [ph] system that you used to have, does that mean this is basically an upgrade to what existed and you’re getting upgrade business, or these are establishing new customers?

Anders Gustafsson

Both, so it’s an expanded solution from what we’ve had before with much graded intelligence and wherein our customers are able to drive the efficiency of their supply chain much further back into their suppliers, and it eliminates stock-outs and reduces inventory. So it’s both an upgrade from what we’ve had and it gives us ability to go into a lot of new customers.

Chris Quilty – Raymond James & Associates

Right. And you spearhead the [ph] capital and I’ll stick to my one question and circle back.

Operator

Our next question comes from the line of Anthony Kure with KeyBanc. Please proceed with your question.

Anthony Kure – KeyBanc

Good morning. I was just trying to get some color on the mechanics surrounding the claim against escrow, that $5.3 million offset to operating expenses. It sounds like there was an escrow account setup. I’m looking at your K from 2007 along – associated with the WhereNet purchase, which makes sense. So, when this was established, was it – how was it treated on the operating income line above the line and relative to how it’s treated now, could you just give me some color on that?

Mike Smiley

The way this thing works is, because it was settled after the one-year window of the acquisition, and that goes through your P&L. And so at this point, if it was sitting in the – effectively in the balance sheet, and now that this has been recognized, the purchase has to flow through the P&L, which is what’s reflected in our income statement interestingly enough. So basically, from a tax standpoint though, those proceeds are treated as return on investments, so it doesn’t get taxed to permanent tax difference.

Anthony Kure – KeyBanc

Okay, and then it looks like the escrow count was $13.6 million. Are there – is the balance still left to be collected or is that factored into your revenue guidance? I’m sorry, how does that work, the remainder?

Anders Gustafsson

We have now reached the final settlement with the WhereNet shareholders.

Anthony Kure – KeyBanc

Okay, so no more impact from something like this.

Anders Gustafsson

No more.

Anthony Kure – KeyBanc

Okay, thank you.

Operator

Our next question comes from the line of Timothy Robinson with Boyne Advisors. Please proceed with your question.

Timothy Robinson – Boyne Advisors

Good morning. Thanks for taking my call. I had a quick housekeeping question then a follow-up. First of all, what is the balance of the inventory obsolescence reserve at the end of the quarter?

Anders Gustafsson

Inventory obsolescence.

Mike Smiley

I don’t have that number with me. I can get back to you, if that’s okay?

Timothy Robinson – Boyne Advisors

Okay, yes. I could just follow-up that after the call.

Mike Smiley

Okay.

Timothy Robinson – Boyne Advisors

Okay. And lastly, I was just trying to get some more color into the increase in the receivables year-over-year. What is the average ESG segment DSO versus SPG segment DSO? And lastly, have you named a permanent replacement for the head of that segment yet?

Mike Smiley

The DSO for our ESG business is longer, so one of the things you’ll notice as you look at our business year-over-year is that our receivables days is longer than it was, let’s say, a year ago. Part of that's because of the type of customers that the new business brings relative to the kind of the business that we have on the Specialty Printing Group. So part of that increase is a big increase from the acquisitions that's happened.

Timothy Robinson – Boyne Advisors

Okay, is there a ballpark number there, is it 90 days, 70 days versus 60 days, or just –?

Mike Smiley

It’s more in the 100 days right now for ESG.

Timothy Robinson – Boyne Advisors

Okay, okay. Great, and the legacy business is about 50 to 60, I believe, correct?

Mike Smiley

Yes, between 50 and 60 in that ballpark.

Timothy Robinson – Boyne Advisors

Okay, great. And have you named a permanent replacement for the head of that segment yet?

Anders Gustafsson

No, we started a search in the beginning of August and we are in the middle of that now, and our expectation is that we will name somebody by the end of this year.

Timothy Robinson – Boyne Advisors

Okay, great. Thank you very much for taking my calls.

Operator

Our next question comes from the line of Karey Kelley [ph] with Iron Works Capital. Please proceed with your question.

Karey Kelley – Iron Works Capital

Hi, guys. I guess this is a bit of a follow-up on the inventory question. It's picked up a bit here at least more than I expected. Can you explain a little bit what’s behind the increase in inventories and maybe what you might be expecting that to be going forward? And then I have a follow-up on your CapEx, have your expectations changed at all given the current macro environment? Thanks.

Anders Gustafsson

So, the reason the inventories has gone up is because of our outsourcing program. So, as we are moving more of our production lines to China, we are still manufacturing the same products in the US as we ramp them up in China, so that means that we will have some extra inventory or part inventory. And then as part of the outsourcing to Jabil, we will have a more finished goods inventory in containerships coming back to the US, so the entire difference is really made up of the transition to Jabil in our outsourcing. We would expect that it will continue to be at elevated levels through the first quarter. And after that, we would expect it to come back down to our normal, what we have seen as normal historic levels.

Karey Kelley – Iron Works Capital

Okay. Given though that you have, I guess, more product shipping in these containers, does that alone won’t cost your inventory to stay high? It would bring it back into normal level.

Anders Gustafsson

So what happens is that we have – we take possession of the products when it’s finished from Jabil for the most part. We wouldn’t have as much parts inventory at that point but we will have a more finished goods inventory there.

Karey Kelley – Iron Works Capital

Okay, great. Thanks. And then on the CapEx?

Anders Gustafsson

What was the question on CapEx?

Karey Kelley – Iron Works Capital

I guess my follow-up was – given the lower revenue expectations in the macro environment that we’re (inaudible), has that caused a change in what your CapEx numbers are?

Anders Gustafsson

Our CapEx requirements are generally very low.

Mike Smiley

For this year, you’re seeing the CapEx for the ERP in our –

Anders Gustafsson

Yes, there is a higher CapEx this year and that will go on to – at a lower rate, but it still continues to be investment in our ERP program for next year.

Karey Kelley – Iron Works Capital

Okay. Thank you.

Operator

Our next question is a follow-up question from the line of Chris Quilty with Raymond James & Associates. Please proceed with your question.

Chris Quilty – Raymond James & Associates

Thanks gentlemen. A bit of nebulous question here and I know the indirect channel may not give you tremendous insight into the actual integrators and resellers, but can you give us a sense of where your end customers stand in terms of the financial crisis and how they’re dealing with it and whether major projects or small projects are being put on hold due to the current economic conditions?

Anders Gustafsson

From the perspective of where the end customer stands, it’s obviously lots of different customers and I think – I'll answer it by – in two ways. I think, first, the feedback we have from our channel partners particularly from the US has been that they are seeing some softness but not a material soft offer or softness. But they’re obviously more cautious about the outlook, which is reflected in our guidance for the fourth quarter. We feel good about our position in that we are leader in the industry and that our solutions really enable our customers to generate very quick ROIs and reduce their OpEx. So we should be somewhat less exposed to the vagrancies of the economy from that perspective.

Chris Quilty – Raymond James & Associates

Okay. And specifically on the retail channel, have you gotten any feedback on obviously the strong impact that the retailers have seen that there’s going to be a big slowdown?

Anders Gustafsson

We haven’t seen – no, we’ve been – actually, our retailers' business for Q4 looks to be in line with our expectation in North America.

Chris Quilty – Raymond James & Associates

Okay.

Anders Gustafsson

We’ve seen some strengthening by some of the larger ones in this quarter.

Chris Quilty – Raymond James & Associates

Very good. Thank you.

Operator

Our next question is a follow-up question from the line of Reik Read with Robert W. Baird. Please proceed with your question.

Reik Read – Robert Baird

Anders, I think you talked a little bit about this as part of your remarks but maybe expand the big balance sheet that you guys have is going to be a large benefit if we go into a protracted global recession? How do you use that balance sheet to take advantage and gain over your competitors?

Anders Gustafsson

We’re trying to balance, obviously, the requirement for short term – managing our margins in the short-term with also our long-term profitability – long-term growth objectives. We see benefit to us in that we have the ability to continue to invest in attractive opportunities to grow or to innovate and develop new products and also in our sales channels and new products. And when it comes to gross [ph] or the uses of cash from a perspective of where to invest, we see that Zebra is at this stage, really one of the most attractive investment opportunities out there. So we intend to continue to acquire our shares in the markets as we have for the last 12 months.

Reik Read – Robert Baird

Okay. And then can you just talk a little bit about the RFID space and the planned level of investment there? I mean, I know that you have – if I separate ESG out as more of the active side, what’s happening on the passive side?

Anders Gustafsson

The passive RFID has been up slightly this year.

Reik Read – Robert Baird

Can you talk a little bit about, I mean just given where that market is, what’s the planned level of investment?

Anders Gustafsson

We have a leading position in that market. We have, we believe, at least the same level of market shares or higher as we have in our traditional printer side, and we will continue to make sure that we nurture that and maintain that. The overall investment level for next year, we’re still working through our 2009 plan, so it’s a little too early to say exactly what it would look like.

Reik Read – Robert Baird

Okay. Thank you.

Operator

Our next question comes from the line of Timothy Robinson which is a follow-up question. Please proceed with your question.

Timothy Robinson – Boyne Advisors

Hi guys. Thank you for taking me on again. I just had a follow up on the ESG segment collection period. You said that right now they’re longer than 100 days. Do you have an internal goal for where you would like to see? Is it close to that or is it with the integration, is this substantially higher than you expect it to be? Just give a little bit more color there?

Mike Smiley

Well, it’s about 100 days and the point is that we will have longer days on that, but we expect that they will improve over time. We are continuing to focus on those. I think that’s part of the activities I would say in the integration side as to follow up on improving on those collections. So, we expect those to improve but they won’t be to the levels that we have on the SPG side in the long run.

Timothy Robinson – Boyne Advisors

Okay. Great. Thank you very much.

Operator

There are no further questions in the queue at this time. I’d like to hand it back over to management.

Anders Gustafsson

Okay. Well, thank you very much.

Doug Fox

Thank you very much for calling in and for your questions. And obviously if you have any follow-ons, we will be around for the next – here in the office today and for the rest of the week. Our next call is scheduled for February 17 and we will report on our Q4 results. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time.

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