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Zebra Technologies Corporation (NASDAQ:ZBRA)

Q1 2011 Earnings Call

May 4, 2011 10:00 am ET

Executives

Doug Fox – VP, IR

Anders Gustafsson – CEO

Mike Smiley – CFO

Mike Terzich – SVP, Global Sales and Marketing

Analysts

Brian Drab – William Blair & Company

Paul Coster – JPMorgan

Greg Halter – Great Lakes Review

Ajit Pai – Stifel Nicolaus

Chris Quilty – Raymond James & Associates

Andrew Abrams – Avian Securities

Anthony Kure – KeyBanc

Keith Housum – NorthCoast Research

Operator

Good morning, and welcome to the Zebra Technologies 2011 first quarter earnings release conference call. Joining us from Zebra Technologies are Anders Gustafsson, CEO; Mike Smiley, CFO; Mike Terzich, Senior Vice President, Global Sales and Marketing; and Doug Fox, Vice President, Investor Relations.

All lines will be in a listen-only mode until after today’s presentation. Instructions will be given at that time in order to ask a question. At the request of Zebra Technologies, this conference call is being recorded. Should anyone have any objections, please disconnect at this time.

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

Doug Fox

Thank you. Good morning everyone. Thank you for joining us today. Certain statements made on this call will relate to future events or circumstances and therefore will be forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995.

Words such as expect, believe and anticipate are a few examples of words identifying a forward-looking statement. Forward-looking information is subject to various risks and uncertainties which could significantly affect expected results. Risk factors were noted in the news release issued this morning and are also described in Zebra’s 10-K for the year ended December 31st, 2010, 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. Today, Zebra reported outstanding financial results for the first quarter of 2011. We delivered 12% sales growth to a record $237 million, 26% growth in earnings from continuing operations to $0.54 per share also a record, and GAAP EPS to $1.10 including the gain on the sale of Navis.

We achieved significant year-over-year increases in gross margin, drove further improvements in operating leverage, and accelerated our buyback program with the repurchase of 1.1 million shares. Excellent execution in many areas of the business enabled us to achieve these record results and has positioned Zebra for further success in creating greater value for our shareholders.

Sales increased in all geographic regions as a result of a continued solid established brand position, as well as investments in additional sales resources in emerging markets in the past year. As supply chain organizations lowered product acquisition costs, building on our successful transition to outsourcing. Our increasingly productive engineering organization is accelerating the pace of new product introductions in a streamlined, more efficient product development model.

Our scale and numerous competitive advantages continue to benefit Zebra, as we enhance our ability to serve our customers’ demand for greater visibility, operational efficiency, and customer satisfaction. I would now like to provide an overview of the highlights for the quarter.

All geographies contributed to our sales growth for the quarter, with a rich product mix that included healthy sales of high performance and mid-range printers and aftermarket parts. Strong international sales were bolstered by the investments we made in geographic expansion. Sales grew 25% for the first quarter in those countries and regions where we added Zebra sales personnel over the past year, including more than 60% growth in China.

Asia-Pacific continues to be a substantial source of strength for Zebra. For the quarter, sales in the region increased 41%. In addition to China, we had excellent sales growth in India, another country where we have made recent investments. We also had growth in South Korea where we see a strong recovery in manufacturing. Zebra’s channel partners shipped mobile, high-performance and mid-range printers to support applications in warehouse management, fixed asset management, and sales force automation.

In EMEA, strong channel demand led to 12% growth in the region, with notable sales into postal and retail applications with desktop kiosk and card printers. Nearly all sub regions contributed to growth in the territory, which has a solid pipeline of business going into the second quarter. Latin America experienced somewhat slower growth for the quarter, but our expectation for the region remains very positive. For the quarter, we had strong growth in supplies as manufacturing in Mexico continued to recover, the breadth of depth of our product line provided us a clear competitive advantage as evidenced by a reseller who was able to meet a major retail customer’s printing needs with a bundle solutions of desktop and card printers.

Finally, in North America, we were pleased with our revenue growth and with a range of customer applications served, with revenue up a healthy 8% from a year ago and up 5% from the fourth quarter. The broad range of our product portfolio including tabletop mobile and desktop supported applications in retail, healthcare, manufacturing and government. Business activity continues to remain robust as we increased our engagement with customers at a higher more strategic level.

Activity in passive RFID remains strong. During the quarter, we secured a new relationship with a major U.S. apparel manufacturer for Zebra RFID printers encoders who recognized the value of our proprietary on-page and dynamic encoding capabilities. In addition to retail where we are involved in various promising pilot programs, RFID continues to attract attention in industrial manufacturing, aerospace and other verticals. Customers in these industries place high value in the technology where regular maintenance and controlled chain of custody are important.

We also made excellent progress in Location Solutions or LS. Following the successful sale of Navis, we have integrated the LS organization into the corporation. We moved all high-volume LS hardware primarily active RFID tags to Jabil, our contract manufacturer for Zebra printers. At the same time, we exceeded our sales goals with a combination of the continued rollout of solutions established customers and strategic wins with new customers.

In one case, we added an automotive manufacturer in Europe to do a relationship with a large system integrator. Overall, we remain upbeat about our progress with LS in the long-term prospects for the solutions we offer in this space. The first quarter was also notable for moving the company forward in other important areas. First, we completed another milestone in the implementation of our ERP system, then we successfully went live with important system modules, including order-to-cash in EMEA. Second, we took a major step forward in product innovation.

In April, we introduced two new products specifically designed for capturing more business in China. These include a new mobile receipt printer with the features and price point targeted at an important segment of this market and an innovative desktop printer with extra-large ribbon capacity. These products, in addition to others that are close to launch were developed to meet current and evolving market needs, leveraging our talented engineers located at our China Design Center opened last year.

The positive response to these products from our Chinese channel partners has been even stronger than anticipated. In addition to these two China-oriented products, we also launched another card printer for the global markets, the ZXP Series 3. This desktop printer delivers superior image quality, smart card capabilities and high performance for using a wide variety of personal identification applications, all in a small footprint.

In our card group, we also introduced a new ultra-high frequency RFID card which sets new levels of performance in access control, personnel tracking, and long-range ID applications. The UHF Gen2 RFID card incorporates a patent pending antenna design that is specifically optimized for UHF card applications to provide far greater read range, added memory and more reliability.

We also just completed testing and are about to launch the next generation of our popular QL series of wireless mobile printers. With several hardware, firmware and design upgrades, the new QL mobile printer sets new levels of performance for our customers. During the past two years, we have undertaken a systematic approach to improve the productivity of our new product development process and drive even higher levels of innovation. The first phase focused on rationalization our product line, while the second phase established new platforms. We are now with the third phase of this process which concentrates on developing a common architecture across all printer families. In reaching this point, we are now more efficient in our product development process enabling us to dedicate more resources to creating new innovative products.

Our first quarter results demonstrate Zebra’s capacity for growth in sales, profit and shareholder value creation. Zebra is well positioned in an attractive industry. Our current suite of products and solutions ensures that we will continue to be the clear innovation leader and solidly position to benefit from strong trends toward smarter operations and supply chain. We are able to build on our multiple competitive advantages including superior product performance and global presence to stay ahead of our customers’ needs for higher levels of visibility into their critical assets, people and transactions, both today and into the future.

I would now like to turn the call over to our CFO, Mike Smiley, to provide a detailed review of first quarter results and guidance for the second quarter of 2011. After Mike’s remarks, I will return for some brief closing comments.

Mike Smiley

Thank you, Anders. Let me highlight some of the key components of Zebra’s results for the first quarter. My comments will principally focus on year-over-year changes in the performance of Zebra’s continuing operations. As a result, we adjusted the first quarter of 2010 to the Navis sale. First, sales exceeded our guidance range on growth and all geographic regions in nearly all major product lines. Second, the increase in gross margin resulted from higher volumes, savings and raw materials and lower freight costs. And third, the business continued to demonstrate strong operating leverage with an increase in operating margin.

Let’s take a look at sales. For the quarter, sales were up 12% from $212 million last year to a record $237 million. Foreign exchange had no material impact on sales growth from a year ago. By region, Asia-Pacific sales were up 41% on broad strength across the region. We had robust sales at high-performance printers in the region, as manufacturing continued its recovery and had effective vertical penetration to retail, healthcare and government.

In EMEA, nearly all sub regions contributed to the territory’s 12% sales growth, as strong channel demand was supplemented by some large sales into retail and postal applications. Latin America sales were up 3% for the quarter and North American sales were up 8% from a year ago. The rebound in sales to retail customers accompanied sales into a broad range of verticals and healthy run rate business through distributors.

By product category, hardware sales increased 14% on growth in all major printer product lines in aftermarket parts. Supply sales advanced 10%. Consolidated gross margin increased 4.5 percentage points to 50.6%. As I mentioned earlier, increased volume and material savings contributed positively to the year-over-year improvement. Lower freight costs also positively affected profitability as we shipped relatively more products by ocean versus more costly airfreight.

Operating expenses up 17% from a year ago largely reflect higher employee-related compensation, payroll and benefits cost in part related to our geographic expansion and other growth initiatives. The expense includes $1.9 million in exit restructuring and integration costs related to the integration of Location Solutions into Zebra as a whole.

This performance led to a 35% improvement in operating income and operating margin of 18.7% for the quarter, up from 15.5% for the first quarter of 2010. Adding back $5.9 million in depreciation and amortization to the $44.4 million in operating income totaled $50.3 million of cash earnings or 21.1% of sales, up from 19.2% last year. The income tax rate for the first quarter was 32%. For the remaining three quarters of the year, we expect effective income tax rate to fall to 29.5% based on the impact of growing business and low tax rate jurisdictions.

GAAP EPS from continuing operations came in at a record $0.54 per share on 55.8 million average shares outstanding. At the end of the first quarter, we had 54.7 million shares outstanding. For the first quarter, we further accelerated our stock buyback program, with a repurchase of 1.1 million shares of Zebra stock. The average price of the first quarter purchases was $37.79 per share. For the past four quarters, we bought back 3.7 million shares returning $123 million to shareholders. Days sales outstanding improved to 40 days from 48 days for the fourth quarter of 2010.

Inventory turns were 4.0 times, down from 4.6 as inventories increased by $7.5 million for the fourth quarter. The increase in inventories included a greater number of printers on the water, which helped us to reduce freight costs. Free cash flow is slightly negative for the first quarter largely from changes in working capital, the payment of bonuses, higher accounts receivable and inventory and a reduction in accounts payable. We still ended the quarter with $375 million in cash and investments, including the $189 million received from the sale of Navis at the end of the quarter. We are confident of maintaining strong positive free cash flow for the year.

Now, let’s look at our second quarter forecast. We are forecasting 2011 second quarter sales growth of 9.5% to 14% to $240 million to $250 million. Earnings from continuing operations are expected to grow 42% to 61% to $0.54 per share up to $0.61 per share, including $0.01 per share for restructuring charges related to the consolidation of Location Solutions into Zebra. Our forecast assumes consolidated gross margin in the range of 49% to 50%. GAAP operating expenses are forecasted between $76 million and $79 million. The tax rate would be 29.5%, which we expect for the rest of 2011. This forecast includes some anticipated higher expenses to address developments arising from the tragic Japan disaster.

We are well positioned, however, to maintain a continuous supply of products as indicated by our second quarter guidance. That concludes my formal remarks, and thank you for your attention. Now, here is Anders for some concluding comments.

Anders Gustafsson

Thank you, Mike. Zebra’s first quarter performance demonstrates the strength and benefits that result from our industry leadership, strong execution and focused strategy. It further illustrates how we can leverage our competitive advantages to deliver value for our customers and shareholders. These advantages continue to position us to benefit from attractive global trends for tagging high-value assets and increased visibility into the supply chain. Now, with a sharper focus on core printing and RFID products as well as real-time Location Solutions, Zebra will build on its multiple competitive advantages to drive further growth and value in channels, products and markets by focusing on three key areas.

First, driving growth in the core business; second, promoting an ongoing commitment to innovation and superior product development; and third, expanding our international business. As in the first quarter, we will continue to use our brand strength and global presence to cultivate relationships with a broader range of channel partners. Stronger alliances with system integrators and independent software vendors will enhance our strategic focus on enterprise customers where we can offer the entire portfolio of Zebra products and solutions.

At the same time, we will maintain an ongoing commitment to superior product development. Zebra’s unrelenting attention to innovation is rooted in the products and solutions that can be applied across many industries to maximize Zebra’s long-term growth opportunities.

Today, Zebra invests more dollars in the development of thermal printers than any other company. With a significantly improved new product development cadence, we are becoming more efficient in the deployment of these resources. Kiosk, mobile and card printers offer above-average growth prospects in particular within our broad printer portfolio.

Products and solutions based on passive and active RFID technology offer exciting longer-term opportunities for profitable growth. Finally, Zebra will continue to build on its global leadership with further investments and sales resources in high-growth emerging territories. This proven low-risk high return activity gives Zebra a greater presence in key regions where developing market economies and local web creation support attractive business opportunities.

In 2010, we added approximately 40 sales representatives in developing regions and the results are evident. This year, we will add to this number with further investments in China, India and Russia, as well as other countries in Southeast Asia. Ultimately, our ability to sustain the pace of investment for the long-term benefits of our shareholders rests with Zebra’s financial strength. With this important flexibility in how we run the business, we continue to maintain a disciplined approach to delivering solid risk-adjusted returns.

In addition to funding internal growth, share buybacks continue to be an attractive use of excess cash. This concludes our prepared remarks, and I thank you for your attention this morning. I would now like to turn the call over to Doug for Q&A.

Doug Fox

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

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Brian Drab with William Blair.

Brian Drab – William Blair & Company

Good morning. Congratulations on a great quarter.

Anders Gustafsson

Thank you.

Brian Drab – William Blair & Company

First question just on the lower-than-expected R&D expense, at least lower than I expected. Is that $21.7 million of the run rate that we can expect something in the low 20s? Is that what we should expect going forward? And did that decline have to do with R&D spending that was associated with Navis?

Mike Smiley

Yes, that would be, I think Navis may have affected your numbers, and I think that we will see a little bit of an uptick in this quarter, because we are looking to qualify some parts and do some certification to make sure that we have sufficient components and products to meet customer needs to address the Japanese disaster. So, it will be up a little bit in the second quarter.

Brian Drab – William Blair & Company

Okay. Great. And then just one other quick one, on the decline in the raw material costs and freight costs, unlike what we are seeing with a lot of other companies right now given rising commodities, can you talk a little bit more about dynamic that's affecting your costs?

Mike Smiley

Sure. I think first of all, remember the first quarter of last year, we were dealing with the fact that demand for our products greatly outstripped our expectations, and so to address that, we put a lot of product airfreight, which the relative cost to move product airfreight versus ocean is tremendously different. So, when you look year-over-year, you are talking about a quarter that had a great deal of airfreight. This quarter, you can see our inventory went up. As inventory goes up, part of that is becoming it’s sitting on the ocean and we have the ability in a more calm fashion, move product from Point A to Point B, which reduce our freight costs meaningfully.

The other thing is that we have – I think that what we are seeing or what we saw in our raw material costs is continuing to benefit our outsourcing as we move to Southeast Asia. It takes a little bit of time to sort of see that full value of that cost reduction flow through the system. And so, the combination of parts cost reduction and freight, and then the last thing is, is that volume goes up, our fixed costs gets allocated over more units. So, the increase in our volume also benefited our gross margin. So, all of those things are played well into our results for the quarter.

Brian Drab – William Blair & Company

Okay. Thank you very much.

Mike Smiley

Yes.

Operator

Your next question comes from the line of Paul Coster with JPMorgan.

Paul Coster – JPMorgan

Yes, thank you very much. Mike, I wonder if you could explain a little bit better, not better, but a bit more detail, perhaps on what the net effects of exiting Navis is in terms of the overhead costs that you were left with? And is there a process that you have to go through before you kind of normalize the business and shed costs associated with what was left from that business, or is it instantly sort of normalized?

Mike Smiley

Yes, I think that we do have with the Location Solutions business, we have at this point, I think I don’t see a great change between Q1 and Q2 for surely overhead reduction as a result, but we will longer term as we start – there is an aspect of the business where we need to migrate some of the supporting systems on to the greater Zebra systems, the same system. As that happens, that will allow us to reduce our overhead overtime, but that’s not something in the next two quarters or so.

Lastly, I will tell you that one thing that you will see is in this quarter, the numbers that we have, we did move, as we pointed out, we did move the high volume products from Location Solutions from sort of to Jabil. And that’s going to improve our margins slightly. Again, that’s reflected in the forecast that we gave you for Q2.

Paul Coster – JPMorgan

I was looking at the operating margins for this business pre-ZES and you're regularly in the 20% range. Is that what your aspiration here, or can you provide some sort of medium-term outlook for your operating model?

Mike Smiley

We give a quarter out. So, I think we are going to stick to that, but I mean, as you do your model, I think you will see that as volumes pick up, our overhead doesn’t have to grow as dramatically. So, we expect that as our business grows, our profitability will be enhanced.

Paul Coster – JPMorgan

Okay. My last question is, the average selling price of your product declines modestly year-on-year in this first quarter on high volumes. And yet the narrative sounded like there was a little bit of a mix shift towards higher-end machines. What's the story there? Can you just sort of clarify a little bit why the ASPs came down?

Mike Smiley

Actually, when we looked at the sales year-over-year, we didn’t’ really – within certain regions, we had growth, like for example, we had great growth in high end in Asia-Pac which is a big high end market for us, but when you look across the globe, you look at products, actually year-over-year product mix wasn’t a major factor in our gross margin. I will tell you, when we look at our gross margin though, we were pleased with the mix, but we were also pleased with the mix a year ago.

Mike Terzich

Hi Paul, this is Mike Terzich. Let me just add a little bit of color to what Mike is saying. We have a very broad range of products and over the course of time, what has taken place is proportionately more of our unit sales have went to the mid-range desktop and mobile products versus some of the traditional high-end products, which were the origin of Zebra, if you will. When you get into the Asian marketplace, we have seen, as Mike indicated, we have seen quite a bit of strength in our high-end product sales, the support manufacturing in the region. Within a family such as an Xi family, we have multiple models and the difference that we see is that in the Asian market, they tend to use products that are at the lower end of a family range. So, we have AUP stability model-to-model. So, we don’t see degradation in AUP, but what we have is proportionately more Asian customers buying the lower end of the high end of the range, which in essence puts a little bit of pressure on the macro AUP number that you are seeing.

Paul Coster – JPMorgan

What does that do to your gross margins? Is that good or bad when the shift takes place in a region?

Mike Terzich

You know what, when you look at the strength of that product line from a gross margin perspective, inherently the gross margin on a percentage basis is almost equivalent product-to-product in that range. So, it really doesn’t put any pressure on that margin.

Paul Coster – JPMorgan

Thank you very much.

Operator

Your next question comes from the line of Greg Halter with Great Lakes Review.

Greg Halter – Great Lakes Review

Yes, good morning guys.

Anders Gustafsson

Good morning.

Greg Halter – Great Lakes Review

Relative to the restatement, will you be providing a pro forma balance sheet by quarter?

Mike Smiley

No.

Greg Halter – Great Lakes Review

Okay. The reason I ask, is I was trying to look at the inventories and payables. I think those changed on a basis given the sale.

Mike Smiley

Yes, we can, if you want to, we could talk to you a little bit offline about some of the direction there. But we don’t plan on disclosing more than we have right now.

Greg Halter – Great Lakes Review

Okay. And in the quarter, how much did ScanSource represent of your sales and what was the year-over-year growth in that business?

Anders Gustafsson

ScanSource increased 19%.

Greg Halter – Great Lakes Review

19%?

Anders Gustafsson

19%. For North America.

Mike Smiley

Greg, that’s just the revenue increase, but as a percentage of our overall business, I think we are going to have to get you that number.

Greg Halter – Great Lakes Review

Okay. So, the growth was 19%?

Mike Smiley

In North America.

Greg Halter – Great Lakes Review

Okay. Thank you.

Operator

Your next question comes from the line of Ajit Pai with Stifel Nicolaus.

Ajit Pai – Stifel Nicolaus

Yes, good morning.

Mike Smiley

Good morning.

Ajit Pai – Stifel Nicolaus

Couple of quick questions. I think the first is just looking at the margin structure, I think you have had a couple of folks ask about it already. But now that you have Navis off and you are looking at significantly larger scale from the company than you had maybe about five or six years ago, do we see an operating margin that should get back sort of into the mid-20s over the next two to three years based on your current operating model with the sort of outsourcing you have envisaged, as well as the product mix that you foresee for the next two, three years?

Anders Gustafsson

We are going to stay with our formal guidance around just the one quarter out. With that being said, we do expect that we will continue to drive greater revenue and we are working hard to make sure that we maintain a nice operating leverage in our earnings model. So, as we go forward, our plan is to make sure we continue to improve our financial results.

Ajit Pai – Stifel Nicolaus

Okay. The second one is just looking at the cash on your balance sheet, and you talked about liking share buybacks, but what about acquisitions? I know that you are trying to put together the other business, the enterprise service group that now after you have gotten rid of Navis has increased your flexibility, but I'm wondering it's still a focus to make acquisitions.

Anders Gustafsson

Yes, our position on acquisition has been changed over the last several quarters. We continue to look at opportunities, but nothing as yet that we have seen has yet met our hurdles. And first and foremost, any acquisition we look at has to have a strong strategic fit. It has to either enable or accelerate our strategy. And the second one is that compare that to any other investment opportunity we have on a risk-adjusted basis. So, we continue to look and be interested in finding the right opportunities, but we want to be very disciplined to make sure we do good ones.

Ajit Pai – Stifel Nicolaus

And the last question would be just looking at RFID, you mentioned it a couple of times, and some new products that you have over there and wins over there, could you give us some color as to what you see happening in that market and when do you think it starts becoming far more material as an opportunity?

Anders Gustafsson

Yes, we continue to be encouraged by what we see in the market. Activity is picking up, the demand is still strongest in the retail space. It’s moving down into smaller, more specialty retailers now. The application continues to be focused on apparel tagging. So, looking for increased inventory – better inventory management than better visibility into the supply chain. But we are also seeing other verticals starting to show more activity, more life.

Aerospace will be one, government hospitality, so it’s getting to be more broad-based also. And our customers are looking for the value propositions around lowest total cost of ownership. So, it’s not just a printer, but it includes supplies and other things. So, our value proposition around on pitch encoding and faster throughput works very well.

Ajit Pai – Stifel Nicolaus

Got it. Thank you.

Mike Smiley

Ajit, before you go, just to get back, I don’t think this was your question, but there was a question about how much of our revenue came from ScanSource. So, year ago, that was 18.3% and for this quarter, it was 19.6% of our total revenues. Next question?

Operator

Your next question comes from the line of Chris Quilty with Raymond James.

Chris Quilty – Raymond James & Associates

Good morning gentlemen. A follow-up from last quarter, you guys saw some unexpected softness in the fourth quarter in your North American retail business. Is it fair to assume that, that business saw a bit of a rebound here in Q1?

Anders Gustafsson

Yes, we were pleased with the performance of North America. Revenues were up 8% year-over-year. Retail specifically was much stronger on a global basis, was much stronger, but it also had a rebound in North America and was now a very healthy vertical for us there. What we saw in North America I think was, there was more – some of the retailers were not as aggressive in ramping the investments after the 2009 recession. We started to come online and do more investments. So, we saw a broader cross-section of retailer be active. But I would say, the quarter was characterized by a very strong run rate business, with a healthy but not necessarily a remarkable large deal activity.

Chris Quilty – Raymond James & Associates

Okay. And sort of a follow up to that, the discussion you just had on RFID and strength in retail, can you remind us, I think the biggest application there is some of the item level tagging, what sort of role you play both in the mobile printers or fixed printers, as well as the consumable part of that food chain?

Anders Gustafsson

So, we play a big role in the printing side. We have mobile printers that are in store, in the shop floor or in the back office, but we also track the supply chain further or upstream you can say. So, we also work with a number of garment manufacturers at source and tag garments at source. So, that might be in Asia or in the U.S. or elsewhere. So, we try to make sure that we have a strong position around for printing across the entire garment supply chain.

Today, we are not involved in smart label supplies. So, there was one business we exited in 2008 when we felt the economics around that business wasn’t particularly attractive.

Chris Quilty – Raymond James & Associates

Is there any change in thought on now that the industry is picking up?

Anders Gustafsson

It’s relatively straightforward for us to go back to become a converter for that, but we haven’t perceived that to be a particular sweet spot for us to enter. We discuss it on a regular basis, but so far, we felt that, that has not been the best area for us to invest more in.

Chris Quilty – Raymond James & Associates

Okay. And it looks like you're running out of authorization on the buyback. Is there any discussion about refreshing that at the board level?

Anders Gustafsson

So, we have our next Board meeting in two weeks. And that might be a topic for discussion there.

Chris Quilty – Raymond James & Associates

Okay. Thank you gentlemen.

Anders Gustafsson

Thank you.

Operator

(Operator Instructions) Your next question comes from the line of Andrew Abrams with Avian Securities.

Andrew Abrams – Avian Securities

Congratulations.

Anders Gustafsson

Thank you.

Andrew Abrams – Avian Securities

Just trying to understand a little bit about the way Navis, eliminating Navis, worked. Service margins, at least as far as I can see, jumped pretty substantially in the quarter and product margins down slightly, but almost negligible. Should we look at the service margins going forward staying in that rough area now that Navis is out, or was there something else that might have contributed to that at the same time?

Mike Smiley

Yes, I think that the results for the quarter are pretty much indicative for what you see going forward. There is not going to be a huge change from there.

Andrew Abrams – Avian Securities

Got you, okay. Just on one other question in terms of, what you saw in the run rate business, or actually maybe across the board, but on the run rate business, POS – ScanSource mentioned POS as an area that was a little slower for them. And I am not sure whether it was slower or whether they actually walked away from some of that business. Have you seen any kind of indication that, that has changed for you guys from quarter-to-quarter?

Anders Gustafsson

We didn’t really see much of a change. I will let ScanSource talk for their business, but for us, we felt we had a strong run rate business across POS or retail in general, and retail, we did well in market share in that area. We won our fair share of deals. So, for us, it was a normal quarter with retail coming back more strongly, particularly in North America.

Mike Terzich

This is Mike. Let me just add a little point to that. Yes, the ScanSource comment was reflective of POS in North America. To Anders’ point, our retail business was really strong across all four geographies, a nice bounce back up in North America. Our run rate business in Q1, a lot of it was driven from good old fashioned manufacturing which came back online to a great degree. And this is where our traditional product lines have been installed and that was also very helpful to the North America number.

Andrew Abrams – Avian Securities

Got it, thanks very much.

Operator

Your next question comes from the line of Anthony Kure with KeyBanc.

Anthony Kure – KeyBanc

Hi, good morning, gentlemen. Thanks for taking my questions. Just wanted to go back and look at the gross margins between the two hardware or tangible products, and then services and software. In your press release, you gave the 2010 gross margins, those exclude Navis, correct?

Anders Gustafsson

Yes.

Anthony Kure – KeyBanc

Okay. And I guess just looking why gross margins for services was 42% in the first quarter, well below what it was for the first three quarters of last year. Is that trying to get a better understanding why that moved down so much, and then obviously, you did much better on the product side. So, maybe just additional color there.

Mike Smiley

I don’t think we have anything of distinction. The only thing I would tell you is when we sell, when we carve out Navis, we carve out the business of Navis. There was a product line we talked about which was the maritime key, which is not a business by itself, it’s a product line. So, for the first quarter, we carry that business with us in the regular financial results, not down in discontinued operations. So, there is a little bit of that, that’s going to make it different. But we don’t have any big themes and services that would be driving our results of consequence.

Anthony Kure – KeyBanc

Okay. And then, just to confirm, I think you said that this is the first quarter sort of the gross margin profile between those two product types going forward, is that correct?

Mike Smiley

Yes.

Anthony Kure – KeyBanc

Okay. And then, the biggest delta on the gross margin out-performance during the first quarter. You mentioned a couple of things, freight, and raw materials and volume. Just wanted to get a feel for what was the biggest driver. Would that have been volume that had been the biggest driver of the improvement?

Mike Smiley

The biggest driver was first of all, the cost reductions for us. And by the way, when I say cost reduction, that is like that would be not only material, but it’s also the fact that we had, our overhead was better applied went up. That will be the largest component followed by freight.

Anthony Kure – KeyBanc

Okay. And then I think you used to comment on percentage of sales from new products. Would you happen to have that handy during the quarter?

Anders Gustafsson

No, we really stopped doing that. It is year-and-a-half ago now, so I think last quarter, I slipped and I gave but we don’t actually have it here today. We usually don’t calculate it the same way anymore.

Anthony Kure – KeyBanc

Okay. And then last question is just on China. With Asia getting to be a bigger piece of sales, about 14% of sales, how big is China as a piece of that? I know you probably don't want to bust out the exact numbers, but is it half of that, or just how big would China be?

Anders Gustafsson

When we talk about China, we call it Greater China. That’s China, Hong Kong and Taiwan. So, China is obviously the vast majority of that business.

Anthony Kure – KeyBanc

Okay. Great. Thank you guys.

Operator

(Operator instructions) Your next question comes from the line of Keith Housum with NorthCoast Research.

Keith Housum – NorthCoast Research

Good morning, gentlemen. Thanks for taking my phone call. Coming back to gross margins, not to beat a dead horse any further, but one more question on the breakout, or the benefit from quarter-over-quarter. You guys mentioned freight as being one of those primary drivers. With the gas prices or oil prices, being higher in the past few months, if we assume that they stay higher over the next year or so, will that have any impact on the gross margins, or where they stand now they pretty much would be watered down just based on volume?

Mike Smiley

Our forecast takes into consideration current freight, our expectation for current freight costs which would be fuel. Certainly, I think that there is a possibility over the long run for us to freight cost that we paying don’t fully absorb the fuel costs, that might, you know, third and fourth quarters have some impact. But I wouldn’t call it a major trend in our profitability. I think that the biggest piece, the biggest factor for us is how much of the freight, how much of the product that we put on the ocean versus air. Now, I will tell you, as we get into the year, and as we address some of the Japanese disaster and whether we have to sort of move products a little bit, if possible, we may have a little bit more freight cost at the back end of the year, but that’s it.

Anders Gustafsson

For us, as Mike said, the biggest issue is whether we have airfreight or sea freight. The second piece tends to be more of the capacity in the market, more so than I think oil prices. So, plenty of capacity that has a big impact on the freight charges than the oil price does. But oil will always be a indicator, too, but it tends to have a relatively modest impact.

Keith Housum – NorthCoast Research

Okay, great. Appreciate it, thank you. Quickly, one follow-up, I apologize if I missed this before. But the increase in general and administrative quarter-over-quarter, was there a one-time item in there, or is that more of an expected level I see going forward?

Mike Smiley

There were some, for year-over-year, there is some things like medical was a little bit higher, little bit more 401(k) that kind of stuff. There wasn’t really any big themes per se in our G&A.

Keith Housum – NorthCoast Research

Okay, thank you very much and congratulations on a great quarter.

Mike Smiley

Thank you.

Operator

Thank you. That was our final question. I would now like to turn the floor back over to management for any closing remarks.

Doug Fox

Okay. Thank you very much and thank you for joining us today and for your support in Zebra. Just as a reminder, our next conference call will be on Thursday, August 4th, currently scheduled before 10 AM Central Time. Thank you very much and have a good day.

Operator

Thank you. This concludes today’s conference call. You may now disconnect.

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