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Zebra Technologies Corp. (NASDAQ:ZBRA)

Q2 2009 Earnings Call

August 04, 2009 10:00 am ET

Executives

Douglas A. Fox, CFA - Vice President, Investor Relations and Treasurer

Anders Gustafsson - Chief Executive officer

Michael C. Smiley - Chief Financial Officer

Michael H. Terzich, Senior Vice President, Global Sales and Marketing, Specialty Printer Solutions

Analysts

Brian Drab - William Blair & Company

Chris Quilty - Raymond James

Reik Read - Robert W. Baird

Mark Strauss - JP Morgan

Mark Tulvale - Spectrum

Anthony Kure - Keybanc Capital Markets

Ed Young - Thomas Weisel

Richard Davis - Richard W. Davis

Greg Halter - Great Lakes Review

Presentation

Operator

Good morning and welcome to Zebra Technologies 2009 Second 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's Instructions) At this time I would like to introduce Mr. Doug Fox of Zebra Technologies. Sir, you may begin.

Douglas A. Fox, CFA

Thank you and good morning. Thank you for joining us today. Ceratin statements made on this call will relate to future events or circumstances and therefore will be forward looking statements within the meaning of the Securities Litigation Reform Act of 1995. Words such as expect, believe, and anticipate, are a few examples of words identifying a forward looking statement. Forward looking information is subject to various risks and uncertainties which could significantly affect expected results. Risk factors were noted in the news release issued this morning and are also described in Zebra's 10-K for the year ended December 31st, 2008, which is on file with the SEC.

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

Anders Gustafsson

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

Today we reported second quarter sales of $188 million and EPS excluding exit and restructuring costs of $0.19, both within our guidance range. We delivered solid performance by maintaining effective control over operating expenses, working capital, and sales execution. Although the business climate remains challenged, we began to see signs of stabilization during the quarter. Larger deal activity resumed and pipeline levels and conversation rates also improved. We are well positioned to benefit from this environment both in the near and long term.

Our global industry leadership across multiple dimensions gives us the ability to gain share and capture ample possible growth opportunities as we position Zebra for significant earnings leverage when business conditions improve.

Overall I was pleased with how Zebra employees continued to prudently operate the business by executing well in the areas within our control. We continued to reduce operating expenses. We also did a great job managing inventories and receivables that allowed us to deliver strong free cash flow.

Zebra Enterprise Solutions, also known as ZES, achieved adjusted EBTR or cash earnings break even for the second consecutive quarter and we continue to expect ZES to achieve cash earnings break even for the full year.

In addition, our manufacturing outsourcing and ERP project are progressing on target and within budget and we expect to achieve the operational efficiencies and cost savings outlined earlier. In the Americas we saw a return of some large deal activity, a sign that customers are willing to commit to projects that have rapid quantifiable paybacks. Latin America and Asia Pacific had positive sequential growth, but Europe remained more challenged. In addition, distributors around the world continued to tighten inventories, particularly in Asia, and our run-rate business remained weaker than this time last year.

We ended the quarter, however, with an improving backlog which gives us increased confidence that the business environment is stabilizing. We had a healthy diversity of wins in key verticals including retail, health care, direct store delivery, and logistics. We're pleased with the increasing demand for our HC100 Wristband Printer, which continues to gain traction for improving patient safety in hospitals and other healthcare venues.

In addition, we had some rewarding wins in retail including further deployments of kiosk printers. We've also won a strategically important piece of business for our rugged RW series of mobile printers, with a major food distributor this quarter.

As we noted in the first quarter, the global slowdown in manufacturing resulted in a proportionately greater decline in sales of high performance and midrange printers. This changing product mix continued to put pressure on gross margins. There is nothing permanent, however, about the gross margin reduction. We remain confident that gross margins can and will return to historical levels as mix and volume return and the benefits of outsourcing kick in.

While we protected key investments that drive long-term sales and profitable growth, we continued to pursue further expense reductions to align costs with business activity. In the second quarter, operating expenses declined 24% from a year ago and an additional 3% from the first quarter. We will continue to look at ways to adjust our cost structure to drive long-term structural changes in the business and reallocate resources and activities with the highest risk-adjusted returns.

Operationally, our supply chain transformation remains on track to realize 2.5-3 percentage points in gross margin improvement in 2010. In our Q1 call we discussed as we had moved 59% of our printer production to Jabil. As of today, that number has increased to 90%.

Over the next two quarters we will be ramping down our US manufacturing infrastructure before the full financial benefits of the project are realized. We have already begun to realize some operational benefits of our ERP implementation which continues on schedule and within budget.

During the first half of 2009 we implemented modules for payroll, human resources, procurement and payables, and portions of our general ledger. Both the outsourcing and ERP projects will help Zebra deliver better customer service and greater operational efficiency.

Turning to Zebra Enterprise Solutions, I am pleased to report we continued to make good progress in achieving the milestones that we provided earlier this year. For the second quarter we had a strong sequential increase in sales into industrial manufacturing and government, the result a more concentrated effort to diversity our base of industrial customers beyond the automotive sector.

Again, we are on track to achieve our stated goals for ZES. During the second quarter we had 18 major goal (inaudible) with customers around the world, bringing our year-to-date number to 30 against our goal of 50. We signed five new channel partners in Q2 which brings our total to eight, against our goal of 20. For the quarter, more than 35% of bookings in the automotive and the industrial manufacturing sector were partner generated deals. Integrators remain highly interested in participating in our channel program and we are confident in meeting our goal of signing 20 for the year. Lastly, we had four new cross sales interjacent markets, bringing our total for the year to 11, on schedule to achieve this year's goal of 25. These are all encouraging results and we are confident we will meet our goals for the year.

We also remain focused on our disciplined capital allocation strategy to deliver the highest risk-adjusted returns on our investments to build enduring shareholder value. Our highest priority continues to be maintaining financial strength and flexibility to navigate effectively through this challenging environment.

We also continue to repurchase shares as our stock remained attractive on a risk-adjusted basis. During the second quarter we used $13 million to buyback 600,000 shares. Since the beginning of 2008 we've deployed $200 million to buy back 8.3 million shares, or 12.5% of our shares outstanding.

In conclusion, at this halfway point in 2009 we are encouraged by the signs of stability within the current business environment. Customers are once again willing to engage in discussions about the larger distance improvement projects that offer rapid quantifiable paybacks, however, we are mindful of the ongoing challenging business conditions and will maintain our aggressive approach to sustain financial strength, align expenses with sales, and position the company for improving returns and earnings leverage when market conditions improve.

Looking beyond this quarter we see long-term prospects with Zebra as excellent. Significant opportunities exist to extend our global leadership in specialty printing and other asset tracking technologies that offer real business improvement benefits. With the industry's leading brand, strongest channels, broadest product line, and global presence, we have continued to invest prudently through this downturn to position Zebra for accelerating sales and improving profitability.

These investments are focused on expanding our product line, building even stronger channels, and extend Zebra's already considerable global reach into key markets. All of these objectives will help us continue to move up the value chain and become a more strategic business partner, as well as improve our overall competitive position.

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

Michael C. Smiley

Thank you, Anders. Let me highlight the key financial year-over-year drivers for the quarter. The story is much the same as for the first quarter. Sales were down comparably on a percentage basis in all regions against peak sales in the second quarter of 2008. Gross margin was affected by mix and volume which affected overhead absorption. Operating expenses decreased in line with the sales decline, with the biggest reductions in sales and marketing and amortization of intangibles. We did a great job managing working capital with sequential declines in inventories.

Let's take a look at sales. For the quarter, sales were down 26% from peak sales a year ago, and down 3% from the first quarter. Sales in Specialty Printer Group were down 27% from a year ago, but down only 2% from the prior quarter.

As Anders mentioned, large-deal activity began to return in North America, with notable business in mobile workforce solutions, healthcare, and government. Even with the slowdown we are comfortable we maintained or extended or global leadership position.

Enterprise Solution Sales of $20 million were at the high end of our guidance range.

Let's take a look at sales by product line. The brunt of the sales decline occurred in hardware which was down 33% to $125 million from last year, and represented 67% of total sales. Sequentially, hard sales were off less than 1%. On a unit basis, printers shipped declined 14% from a year ago, but were up 3% from the first quarter. Supply sales of $36 million were down 19% and comprised 19% of total sales, which is up from 17% of total sales a year ago.

Service and software revenue continued to increase to the percentage of sales, reaching 14% for the second quarter, up from 11% last year. By region we had comparable sales decline between 25% and 30%.

One exchange had an unfavorable impact on sales of $3.4 million or 1.3% from a year ago, with an average year-over-year rate of 1.38 for the quarter versus 1.56 last year.

As Anders commented, we had greater weakness in our higher priced, high end, and midrange printer lines, from the extreme slowdown in manufacturing across the globe. This mix change with relatively better sales performance from desktops and mobile printers, along with the greater proportion of supply sales, put downward pressure on growth margins.

Consolidated growth profit margin of 43.6% was down from a peak of 50.3% a year ago and 44.6% in the first quarter. The effective mix and lower volumes which negatively affected overhead absorption, primarily drove lower growth margins in the quarter.

For the quarter, Specialty Printing Group gross margin came in at 41.6%, down from 40.5% a year ago and 40.1% for the first quarter. We view this decline as temporary and expects margins to rebound as volumes increase, product mix improves, and outsourcing is completed.

ZES margin however, had a healthy increase, moving from 49.1% a year ago and 55.6% for the first quarter to 60% in the current period. Better margins on services and improved mix of business helped to further push up profitability of this segment.

We maintained excellent control over operating expenses. Second quarter total operating expenses were down $21 million or 24% from last year. They were down an additional $2.3 million or 3% from the first quarter.

Year-over-year, the biggest changes in operating expenses occurred in the areas of payroll and other employee-related expenses from the cost actions we have taken over the past year. The decline includes reduction payroll costs as employees are encouraged to start the summer by taking Fridays off in May as vacation, the cost of which was previously accrued. Lower costs for business development, legal fees, travel and entertainment, and (inaudible) expenses, also contributed to the downward move on operating expenses from a year ago.

Amortization decreased $2.1 million, a result of impairment charges taken in the fourth quarter. For the quarter, the investment portfolio had an annualized return of 4.5%, year-over-year, investment income was down principally because of lower interest rates, and cash balances from the buyback of Zebra stock.

Net income, excluding $0.04 per share in exit and restructuring costs came in at $0.19 per diluted share on 59.4 million average shares outstanding. Stock buybacks continued to push down the number of shares of Zebra's stock outstanding. During the second quarter we bought back 600,000 shares of Zebra stock at an average price of $18.04. The volume we purchased was down from previous periods largely because of the tighter cash flow we experienced in the first quarter. We now have 3.1 million shares remaining authorized for repurchase. We ended the quarter with 59.1 million shares outstanding.

Net receivables were up slightly from the first quarter due to the timing of shipments and collections. Still, the day sales outstanding were a comfortable 67 days compared with 65 days for the first quarter. Inventories declined 8 million from the first quarter with turns increasing from 4.2 to 4.4 times.

Finally, we ended the quarter with $207 million in cash investments, up from $189 million at the end of the first quarter. It was also a very good cash generating quarter for Zebra. Free cash flow amounted to $28 million. In addition to affective control over working capital, capital expenditures total approximately $6 million, which is down from previous quarters and closer to a more normalized rate now that we are largely half the elevated expenditures for our ERP and outsourcing projects.

Let me turn for a moment to capital allocation. Like all companies, Zebra has five potential uses for its excess resources to build shareholder value; invest in internal projects, reduce debt, pay dividends, make acquisitions, or buyback stock.

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

At this juncture, share repurchases remain as our highest returning investment alternative on a risk-adjusted basis. In addition, our focus continues to be on increasing returns of ZES before we have any more acquisitions in this area.

Now let's look at our third quarter forecast. We're forecasting sales of $186-$198 million. This forecast consists of expectations for Zebra Specialty Printing Group Sales in the range of $168-$178 million, and Zebra Enterprise Solutions sales between $18-$20 million. The forecast reflects a seasonally slow third quarter, particularly in Europe, and incorporates an average US dollar euro exchange rate of 1.4 compared with 1.38 in the second quarter.

Our forecast assumes gross profit margin in the range of 44.3% to 46%, reflecting a portion of the benefit of outsourcing and modest improvement in product mix. We expect GAAP operating expenses at $71-$74 million. This is up slightly from Q2 as we do not expect to see as much of a benefit from employees taking vacation like we experienced in the second quarter.

GAAP earnings are expected in the range of $0.14-$0.21 per share. We're estimating exit restructuring and integration expenses to have a $0.03 per share impact on EPS. The income tax rate will be 32%.

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

Anders Gustafsson

Thank you, Mike. In challenging times it's even more important for companies to understand their growth opportunities and the pathways for increasing shareholder value. During this downturn we have increased our dialogue with end users and channel partners and we have reconfirmed the soundness of our business strategy. We are even more confident in the opportunities for profitable growth in specialty printing and we are making the right moves to drive future success of Zebra Technologies.

In this turbulent environment, customers are consolidating their relationships with companies that can meet more of their needs. We are well positioned today and we will become stronger by selectively investing in areas that will enable us to gain share and build on our industry leading customer base as business recovers.

Geographic expansion continues to be a top priority. Asia is one region which we have an opportunity to penetrate more fully over the next 12-18 months. We have added more than a dozen sales and marketing employees to the region over the past year and we intend to add more. We continue to invest in growth through expansion of our channel-centric model to facilitate the placement of Zebra products with more customers around the world. We are focusing on growing our global base of value-added resellers, and on building relationships with large system integrators and independent software vendors or ISVs, which are a natural extension of our channel model. This group of partners will have Zebra move further up the value chain with large enterprise customers, penetrate existing targeted verticals more deeply, and enable entering the new areas of opportunity more quickly and efficiently.

Ultimately, strengthening our channels will help us serve our current base of customers more effectively as well as expand the number of customers we serve. Zebra consistently ranks among the highest in the industry in terms of customer satisfaction and loyalty as measured by net promoter scores. This loyalty has led to a high level of repeat business.

Broader channels help Zebra serve an increasingly diverse range of customers from value users of thermal printing to those who place a premium on innovation, software, and connectivity to attract assets in a smarter way.

With signs of stabilization in a still challenging business climate, we will continue to balance two key priorities, preserving year-round profitability while pursuing long-term opportunities. Our results demonstrate the effectiveness of our actions.

We are using our financial strength and flexibility, industry leadership, and focus on the customer, to drive greater success and create shareholder value by directing our resources to areas that have the highest risk-adjusted returns.

Our Zebra employees continue to do an excellent job maintaining global leadership capturing more available opportunities through meeting customer needs.

This concludes our prepared remarks. We would now be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator's Instructions) Our first question is from the line of Brian Drab with William Blair & Company. Please state your question.

Brian Drab - William Blair & Company

Good morning, guys. First question is just around market share gains or potential market share gains that you think you might be seeing globally. Can you talk about a little more in detail within specific geographies and end markets or product lines where you might be gaining some share?

Anders Gustafsson

I think overall we believe that we are holding or extending our share in product lines across the world. One area that we put more emphasis on has been the mobile workforce . We believe that we have been doing quite well there for the last well. Healthcare, we believe, is a market that we believe we are also doing well in today and growing. And I would say government is another market for us that we believe we're doing quite well in.

Brian Drab - William Blair & Company

Okay, great. And within specific geographies, and particular geographies you think you're doing better than any others in?

Michael H. Terzich

Brian, this is Mike Terzich. Specific to geography, the mobile workforce opportunities have been prominent for us in North America and in Latin America. Healthcare has been very solid both in North America and in Europe and the government has been also concentrated in North America and Europe, government inclusive of some of the postal opportunities in Europe and through the Armed Forces, Department of Defense, in the United States.

Brian Drab - William Blair & Company

Okay, great. And one more question. The end of the first quarter the sense that you gave us I believe was that inventory reductions that your distributors had pretty much played out and you didn't think you'd feel the effects of that to any great extent in the second quarter. What effect did inventory reduction of the distributors have on your sales in the second quarter?

Anders Gustafsson

There was some impact of inventory reductions in the second quarter. I think sales out of some of our distributors on a worldwide basis continued to reduce a bit, but they also increased the inventory turn targets they have. So we believe that at this stage the inventory reductions are really behind us and at this point we should see a nice flow through of orders as they receive them.

Brian Drab - William Blair & Company

Okay, great. Thank you.

Operator

Thank you. Our next question is from the line of Chris Quilty With Raymond James. Please state your question.

Chris Quilty - Raymond James

Good morning, gentlemen. I was hoping that you could help us quantify a little bit better the sort of accumulated cost savings we should be seeing by next year in two areas, one on the manufacturing side I know you had talked about incrementally picking up $20 million or more once the US-based manufacturing is shut down. That's the first one. And the second would be the ERP spending, when that will tail off and what the incremental pickup might be for next year.

Michael C. Smiley

First of all, on the gross margin I think we mentioned that from second quarter to our third quarter forecast we're seeing a little bit of the benefit of the outsourcing and the improvement of that gross margin. We expect, if you look at from Q2 to what we're going to see in 2010, the figure we've given you before still remains intact. Again, as volumes increase the savings will increase, as volumes decline, savings go down, but at this level we're sort of in the ballpark of what we've been telling you all along.

As far as the ERP spending, I think if you look at our capital expenditures, you can see that for the quarter they were down. I think a lot of the heavy cash flow already went through, a lot of it through 2008, and we expect the current levels roughly to be sort of where we see ourselves going forward. Again, 2008 had both the ERP implementation and some CapEx associated with the outsourcing.

Again, in 2009, and we're not quantifying this, but in 2009 we are in some respects carrying two sets of ERPs because we're not sure if switching one off and turning one on all at the same time — we're trying to take something that's a little bit less risky. So as a result, going through our (inaudible) we have software costs and maintenance on legacy systems as well as new systems.

And so at the end of 2011 we'll sort of see ourselves through most of the ERP implementation.

Chris Quilty - Raymond James

Okay. And have you quantified any tax-cost savings from the off shoring, not that the administration might not take those away, but —

Michael C. Smiley

Well, the 32% rate is meant to reflect sort of the potential tax benefits of outsourcing for this year. We haven't really computed — you bring up a very good point, it's difficult to know how the administration is going to affect our tax benefits in 2010 and going forward, so at this point we're not really giving a figure out for that.

Chris Quilty - Raymond James

Okay, thank you.

Operator

Our next question is from the line of Reik Read with Robert Baird. Please state your question.

Reik Read - Robert W. Baird

Hey, good morning. Anders, in your comments you had mentioned that the pipeline is building, and just could you clarify that a little bit? I had always looked at the printing business as more of a turns business with minimal pipeline and maybe in the Enterprise Solutions Group there's more of a pipeline, but could you just clarify what you mean there?

Anders Gustafsson

Yeah. The number of activities and deals that we see in our pipeline has been increasing, so that gives us some better confidence about the outlook. We're also seeing better conversion rates of deals — deals that actually end up in our pipeline have a higher proportion of getting closed. And third I would say as we entered the third quarter we actually had the healthiest backlog that we have seen in the last year.

Reik Read - Robert W. Baird

And when you talk about a backlog in pipeline, are these deals that your sales force is going out and earning and they may be fulfilled through the channel in some quick fashion?

Anders Gustafsson

Yeah. These are deals that we and/or our channels are working on. So we are aware of a number of deals that our channel works on that we aren't necessarily involved in directly ourselves, but we're also helping doing a high-touch model with our sales channel partners to ensure that they get as much benefit as they can from our resources.

Reik Read - Robert W. Baird

Okay. And then with respect to your guidance, can you talk a little bit about what your assumptions are for hitting the 186 number versus the 198, i.e. the low and the high of the range?

Michael C. Smiley

So we're in the third quarter which is a little bit — I think given what Anders was saying about the pipeline and seeing that we felt good, I think the hard part about predicting the forecast is we're going into what is, in Europe, a holiday season. So we're trying to balance on one hand knowing that we have a holiday season — sort of like going around the moon on Apollo 13 on the backside of the moon so we're trying to balance the fact that we don't know exactly how the holiday will affect us, but we're also sort of seeing right now things are looking attractive and so that's how we try to balance that range.

Reik Read - Robert W. Baird

And you mean attract in Europe as well as North America.

Michael H. Terzich

Right. That's what it means. We felt pretty comfortable with July, but we recognize that typically, August is the month of European holiday and with the broader economic situation still prevalent, we're just not certain how that holiday season is going to play out, but we like the way July looks and we feel pretty comfortable with the range.

Reik Read - Robert W. Baird

Okay. And then, Mike, since we have you on the phone, could you maybe give us just a little bit of an update on some of the key vertical markets, manufacturing, transportation, logistics, and retail, and what you're just generally seeing in the marketplace?

Michael H. Terzich

Well, I thin — and Anders' earlier comment with certainty — the extended manufacturing supply chain, including the transportation sector, has been the most challenging market that we're seeing and that' son a global basis not only in less, but also in just about every one of the export dependent international markets as well.

Where we have seen opportunities, including the pipeline comment that Anders made earlier, is in a couple markets, particularly in what we call mobile workforce which is a lot in the direct store delivery space as an example, where the efficiency of our solutions, even in tougher economic environments — there is quite a bit of interest right now for the folks that are delivering goods and services in the field to streamline printing solutions. So that's created some opportunity.

Healthcare has been very good and continues to be pretty robust for us globally. For that matter we're really positioned there with the partners and the solutions we have and the retail space is a bit hit or miss right now . And what I mean by that is you look at the high-branded goods retailers and their business obviously is soft. They feed off of same-store sales as a key effort for IT solutions appointments — the box retailers, the discount retailers, that business has been good and so we're seeing some interest in some of the larger project appointments that serve that space. So it's really a mixed bag.

Reik Read - Robert W. Baird

And just real quickly, two followups on what you just said, one on the retail side of things. You guys have been talking about trying to diversify that retail space for awhile, to what extent is that helping to offset some of the more general weakness? And then on the healthcare front, if you look at the stimulus spending — and I know that that's going to a lot of different places, but there's $23 billion that are floating out there for IT in healthcare — how much of that can you guys capture?

Michael H. Terzich

As far as the diversification strategy, that is working well. We actually look at that from two dimensions. The first dimension is diversification of selling a broader range of solutions into our existing retail customers and then the second dimension is adding retail customers. And I can tell you in the second quarter, that serves us well on both marks.

For example, we've introduced some kiosk printing solutions into some of our traditional retail customers and that was meaningful relative to the contribution in the second quarter, and we've added some new retail accounts as well both here in the United States and in the international markets.

On the healthcare front I think it's what you said — I think there is some surge in bringing AIDC technology into the healthcare space. We've been well positioned there for a number of years and we had a number of large hospital-related patient safety applications that we closed in the second quarter and the pipeline for the third quarter looks as robust.

Reik Read - Robert W. Baird

Okay, great. Thank you, guys.

Operator

Our next question is from the line of Paul Coster with JPMorgan. Please state your question.

Mark Strauss - JP Morgan

Hi, it's actually Mark Strauss on behalf of Paul. Apologies if we missed this earlier, but can you just remind us how far along we are in the outsourcing initiative?

Anders Gustafsson

The outsourcing we have now moved 90% of our prediction capacity to Jabil in China. So the focus now is to obviously complete the last 10%, but over the next two quarters we will ramp down remaining capacity we have in the US.

So if you remember, our strategy was to start up the line in China, ramp it and prove that we had a supply chain working properly and was being robust, and basically run our North American or Chinese product lines in parallel for about six weeks. And 90% is up, we're starting to really focus on ramping down the benefits or the product lines in the US.

We've also now started in July really to be able to reduce our headcount within the supply chain organization where well over 200 people have actually been leaving the organization now, many of them indirect employees, so obviously more the expensive part. So that's a difficult part of outsourcing, but that's also one that's going to help us drive the benefits in the third quarter here now, and we're still confident with the guidance we've given earlier about 2.5-3 percentage points of gross margin improvement in 2010.

Mark Strauss - JP Morgan

Got it, thanks. And then can you just tell us how the maintenance revenue has been churning as a function of customers delaying their new printer orders?

Anders Gustafsson

So the aftermarket revenues?

Mark Strauss - JP Morgan

Right.

Anders Gustafsson

Yeah, aftermarket revenues have been holding up much better than new product sales as customers have been repairing older printers, they have been buying new spare or replacement print heads and other things like that.

Mark Strauss - JP Morgan

Okay, thank you very much.

Operator

Our next question is from the line of Mark Tulvale (ph) with Spectrum.

Mark Tulvale - Spectrum

Good morning. I'm wondering if you could give us a little insight into the progress of the Enterprise Solutions business, and could you address, as part of that, the question of whether your jeopardizing any of your channeled relations by this project?

Anders Gustafsson

So first, progress on the business, one of the big objectives for this year was to make sure we got the ZES to cash earnings break even and we've now done that two quarters in a row and we expect that we will continue to achieve that for the full year. We laid out three different priorities or three different objectives. One was to feed 50 new large go lives for ZES and we are now at 30 for the half year point. We had said we wanted to sign up 20 new channel partners and we're now at 8 for that, and the majority of those are traditional Zebra SPG partners.

And the last (inaudible) that we were looking to add more cross sales between new verticals or new products into existing customers and we've now done 11 of those out of a goal of 25. So I think we're tracking quite nicely on the objectives we set out. We feel quite good about that, but this is a tough environment, obviously for Zebra as a whole and for ZES. Automotive was the largest single market for the (inaudible) position that we did and container traffic is down the first time, I think, in the history of the container, so it's not like those industries have been spared. But I think we've been dealing with that quite well.

With respect to the second part of your question, whether or not any of our traditional SPG partners will be concerned about ZES. I don't believe so. I think that we are working closely with a number of them to enable them to become also resellers for our ZES organization and for the most part our traditional partners don't have contacts or relationships or even capabilities to say to market terminal operating systems into marine main terminal operators.

So I think that we have a good situation with our current SPG partners and many of them are working with us to become partners for ZES also.

Mark Tulvale - Spectrum

Thanks, Anders.

Operator

Our next question is from the line of Anthony Kure with Keybanc Capital Markets. Please state your question.

Anthony Kure - Keybanc Capital Markets

Good morning. I just wanted to touch on the mix headwind's facing with the smaller printers. Could you just give me an indication of what kind of historic mix you may have experienced in the higher margin days for these types of printers? Was it the larger printers more than 50% of unit sales or less than 50% — I'm just trying to gauge the magnitude of which are being impacted here.

Anders Gustafsson

For the last five or six years the mix of our high-end tabletop printer lines have been around 30% of our printer revenues and that has come down a bit to 25% here now and I think really largely driven by manufacturing being down very substantially around the world. If you look at many markets where we have strong position like in Asia, there's very much export oriented and exports have gone down substantially so manufacturing lines are not being utilized to the same extent they were.

But we believe that we have a very strong market share in that area and we are holding our share, if not gaining share, and we have a number of new products in the pipeline at the high end that we believe will help stimulate demand over the next many months. So in the fall we're coming out with our new XiIIII printer which is a new high-end high performance printer for us. We also have a retransfer printer in the car business and earlier next year we come out to the high performance and security performance printer for our car business also.

We're doing a number of things to make sure that we have a very healthy and vibrant product portfolio that will help stimulate demand in that space also.

Anthony Kure - Keybanc Capital Markets

Okay and then I think you mentioned when the historic mix continues or returns to normal you get to historic margins. When you say historic — I want to quantify or get an idea on what historic timeframe we're talking about. Are we talking about historic operating margins, and in that light would that be sort of the low 20s? is that what you're referring to by historic margins?

Michael C. Smiley

We're talking about gross margins, and I think that historically we've been sort of in the 47%-48% range and I think that's sort of what we're talking about right now.

Anthony Kure - Keybanc Capital Markets

Okay. And then last question, I didn't catch the full comment on the impact of the employees taking the day off and the impact of accrual. Could you just, Mike, go through that portion of your comments again?

Michael C. Smiley

Well we're not disclosing exactly how much that is, but I'm going to tell you it's a meaningful part of the difference from quarter to quarter.

Anthony Kure - Keybanc Capital Markets

Of which piece, of the G&A?

Michael C. Smiley

Yes.

Anthony Kure - Keybanc Capital Markets

Alright, thank you.

Operator

Our next question is from the line of Ajan Pai (ph), Thomas Weisel.

Ed Young - Thomas Weisel

Good morning. This is Ed Young standing in for Ajan Pai. First, a couple of questions regarding Enterprise Solution Group. I believe this is the first (inaudible) for the segment on a year-over-year basis, and can you give us some color on end-market conditions? Given your pipeline, do you see improvement in the segment in the coming quarters?

Anders Gustafsson

Yes. (Inaudible) this is the first year-over-year decline for ZES. So from that perspective ZES has done well by hanging in there for as long as it has. Obviously the markets ZES are operating in are tough and exposed to the economic downturn, no less than the economy as a whole with automotive and shipping volume being to (inaudible). That being said, I believe we are well placed in a number of attractive markets here and we do expect that we will be able to hold and expand our share, and we are focusing very much on being able to expand, partially in the industrial manufacturing area and governments, though leveraging channel partners which will be a more cost effective way for us to go to market.

Ed Young - Thomas Weisel

Okay. And also on the same segment, you mentioned that the segment actually achieved cash breakeven and given the cost reductions and restructuring that you have implemented so far, what is the sales breakeven level for the segment now? Is this going to be roughly $20 million per quarter, or are you aiming for even lower volumes?

Anders Gustafsson

It's roughly $20 million per quarter and we think that's a good target for us to have at this stage.

Ed Young - Thomas Weisel

Okay, great. One final question, you mentioned mix shift and lower sales volumes were the main drivers for lower gross margin this quarter, but do you see any increase in pricing pressure in the end market given the current economic environment?

Michael C. Smiley

Well I think we talk about the fact that historically when we see large deals we'll see a number of competitors that will chase those deals and so quarter to quarter there will always be a little pricing up and down. We don't see anything terribly abnormal about this quarter's results in regards to pricing, but we will see again as big deals pop up it will attract a lot of competitors and the pricing will be more competitive.

Anders Gustafsson

Just one more point on that, when you look at our press release you can see AUPs have declined. That's really driven by mix shift, not by actual price decline within the product assemblies. So pricing within product assemblies is very, very stable. The only area we receive some extra modest price pressure is on larger deals where competition is somewhat tougher.

Ed Young - Thomas Weisel

Thank you.

Operator

Our next question is from the line of Richard Davis with Richard W. Davis. Please state your question.

Richard Davis - Richard W. Davis

Yeah, along the lines of the enterprise area, it looks as though there's a terrific improvement in either gross margin or operating costs, looking at the numbers, could you give us some color on that?

Anders Gustafsson

Yeah. There's a meaningful improvement in both gross margin and operating costs. We have worked very hard for the last year to really get our cost structure in place to enable us to operate at the cash earnings breakeven point. The gross margin we have worked really hard to improve the services gross margin. That's one big component of this. The other is that we have a more healthy mix in this quarter and we also expect that to be the case for next quarter. And then we have been driving some very substantial structural changes to the organization which has reduced the operating expense by several million dollars per quarter.

Richard Davis - Richard W. Davis

I see. Thank you.

Operator

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

Greg Halter - Great Lakes Review

Yes, thank you. Good morning. I didn't hear the figure for new product introductions as a percentage of sales and wonder what that is? And, Anders, I think you've discussed a couple of the new ones, but what your prospects are there going forward?

Anders Gustafsson

Yes, new product revenues for the quarter was 7.5% so in line with the prior quarter and we have a s I said, a number of new attractive products coming out in the second half of 2009 and into 2010 that should help to give that a nice boost.

Greg Halter - Great Lakes Review

Okay. And what percentage of your sales now is Scansource accounting for?

Anders Gustafsson

I have to look that up here.

Michael C. Smiley

It hasn't changed meaningfully from last quarter.

Greg Halter - Great Lakes Review

Still around 15%?

Anders Gustafsson

Yeah.

Greg Halter - Great Lakes Review

Okay. Have there been any changes in the investment portfolio composition?

Anders Gustafsson

No, not at all.

Greg Halter - Great Lakes Review

Okay. And I know, Mike, you touched on the receivables and so forth, but just wondered if you could expand on your thought as to the quality that you're seeing there and if you have any issues in terms of collectability and so forth.

Michael C. Smiley

This has been — and I'll sort of and another point. Our working capital over the last couple of quarters, we've been very pleasantly, not surprised, but we're pleased with where things are. So the receivables, we haven't had any meaningful customer inability to pay or anything like that. The quality of our receivables we feel are very good. I'd say the other piece we probably haven't amplified much in is that actually for our inventories to have moved in the direction that they did, given we're in the middle of outsourcing, I think our operations team has done a very good job of trying to manage that. I think at the beginning of the quarter I would've told you that I expected inventory to increase a little bit and actually for it to decline in the middle of what we're going through, we felt good about that.

Greg Halter - Great Lakes Review

Okay, that's good. And again regarding the backlog, you had made some comments about that, but is there any directional figures that you could provide if it's up 10 or 20 or 50% year over year?

Anders Gustafsson

I think we'd be comfortable to just reiterate what we said earlier that it's the healthiest we've had in the last 12 months.

Greg Halter - Great Lakes Review

Okay, I thought I'd give you a chance (laughter).

Operator

(Operator's Instructions) Our next question is from the line of Reik Read of Robert W. Baird. Please state your question.

Reik Read - Robert W. Baird

Just with respect to the ZES business, the automotive segment or the automotive industry is showing some signs of stability and obviously there's a lot of cash being infused by governments around the world to stabilize that. Does that suggest that there may be some returning opportunity, or is that something that's just going to stay dormant for awhile?

Anders Gustafsson

We believe that there are opportunities to do more in automotive. We actually had an increase in automotive and industrial manufacturing orders quarter over quarter. So the second quarter was up from the first quarter. We have a very strong position in automotive and I think that we are certainly well placed to be able to capture additional budgets that the automotive manufacturers may invest in.

And as the automotive manufacturers are starting to get out of bankruptcy for some and improve their financials in other areas, we would expect that they would continue to really drive hard to improve the efficiencies of their operations and our products have a very quick payback and it's very well respected by the users within the automotive community. So we are expecting to see improvements in that side of the placement.

Reik Read - Robert W. Baird

Anders, at this point are you having those discussions with them or is it still kind of a wait and see given everything that they've gone through?

Anders Gustafsson

No I mean it's obviously a lot of different manufacturers out there and some of them are more active in discussion than others, but we had a number of new automotive wins in the second quarter.

Reik Read - Robert W. Baird

Okay. And then just one followup on the specialty printing group. The operating margin, if I factor out the one-time items declined by about 100 basis point sequentially, the revenue was down modestly — less than 2%. What would have driven that decline given all the positive things that you had going on?

Anders Gustafsson

It was reserves.

Michael C. Smiley

I mean obviously we walked through the gross margins quarter over quarter. We talked about the fact that we have the vacation benefit, but we didn't really have any huge changes in our OpEx quarter to quarter besides the items that we've talked about.

Reik Read - Robert W. Baird

Okay, thanks.

Operator

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

Douglas A. Fox, CFA

This is Doug. First of all, thank you all for attending our conference call today. Just put on your calendar our next quarterly conference call will be on Wednesday, November 4th — third quarter conference call. Also if any of you want to followup, Mike Smiley and I will be around to answer your questions all day today. Thank you very much.

Operator

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

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