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Zebra Technologies Corp. (NASDAQ:ZBRA)

Q2 2007 Earnings Call

July 25, 2007 10:00 am ET

Executives

Charles Whitchurch - CFO

Ed Kaplan - CEO

Mike Terzich - SVP, Global Sales and Marketing, Specialty Printer Solutions

Analysts

Jeff Rosenberg - William Blair & Company

Chris Quilty - Raymond James

Reik Read - Robert W. Baird

Ajit Pai - Thomas Weisel Partners

David Sterman - Jessup & Lamont

Greg Halter - Great Lakes Review

Andrew Matorin - Bear Stearns

Andrew Abrams - Avian Securities

Jeremy Grant - Stanford Group

Scott Scher - Clovis Capital

Unidentified Analyst

Presentation

Operator

Good morning and welcome to the Zebra Technologies' Second Quarter Earnings Release Conference Call. Joining us from Zebra Technologies are Mr. Charles Whitchurch, CFO and Mr. Ed Kaplan, CEO, of Zebra Technologies. 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 tape recorded. Should anyone have any objections, please disconnect at this time. At this time, I would like to introduce Mr. Charles Whitchurch, CFO of Zebra Technologies. Sir, you may begin.

Charles Whitchurch

Thank you. Good morning. Thank you for joining us today. Certain statements we will make 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. In particular, any statements we make regarding our financial forecast for the 2007 third quarter and expectations about trends in the company's business will be forward-looking statements.

The forward-looking statements involve risks, uncertainties, and other factors that could cause Zebra's actual results to differ materially from those expressed or implied by such forward-looking statements. Additional information concerning such factors is available on the press release issued today by Zebra as well as Zebra's filings with the Securities and Exchange Commission. In particular, we direct your attention to the company's Form 10-K for the year ended December 31st, 2006. Now I'll turn the call over to Ed Kaplan for some brief opening remarks.

Ed Kaplan

Thanks, Randy, and good morning everyone. Zebra met its second-quarter sales and earnings guidance on the strength of its international sales. We encountered softness in North America from unexpected order deferrals very late in the quarter and some inventory adjustment in distribution. While these events brought our numbers down for the quarter, Zebra won more business with national accounts and channel partners and extended global reach.

Now, at the halfway point to the year, Zebra has made great progress in positioning the company for further growth and success. Our activity to deliver solutions that help our customers identify, locate and track valued assets in high-growth vertical markets are working. Global expansion continues to yield strong, positive results. WhereNet is making an important contribution to the future of the company. All of these things taken together paint a picture of optimism for Zebra. Our confidence remains high and our strategy is to build stockholder value as we enter the second half of the year and look beyond 2008.

In the second quarter, record sales were achieved in each of Zebra's international regions and secondly, we continue to reduce manufacturing variances, reduce receivables, and generate strong free cash flow. Those activities that led to strong growth in the first quarter in North America sustained business in the second. Fundamentally, North America remains healthy.

First, distributor sales of Zebra products increased better than 15%, as our Refresh Partners First Channel program pushed Zebra further ahead with valued reseller partners. Second, national account management continued to work a robust business pipeline and diversify our key base beyond retail, including growing activity in route accounting, health care, and government. These actions will ultimately help reduce the volatility associated with large deal business. We also saw a significant up tick in sales and small package delivery.

Following on our first-quarter success, we extended deeper in to establish top tier accounts with additional solutions. We also generated first-time bookings with new accounts, all as part of our effort focused on driving large deal business. A number of these deals incorporate wireless mobile printers, including Zebra's recently introduced lightweight MZ printer. Sales of the MZ have ramped nicely since being introduced at the end of last year.

Looking at the third quarter, we already received bookings for some of the deferred second-quarter business. In EMEA, robust sales in emerging areas such as Eastern Europe and Italy offset temporarily, moderating sales in the UK and Germany. During the quarter, we closed a number of notable deals, which gave us a high backlog going into the second half of the year. These deals include solutions in the retail, postal, industrial, and leisure verticals.

During the quarter, we relocated our offices in Poland to make room for a warehouse facility and label conversion operations that came on line in early July. We added a new EMEA supplies director to give greater leadership and focus in this area of opportunity. We also placed additional sales roles in India and Spain to strengthen our positions in these growth regions. The outlook for EMEA is favorable as we enter the second half of the year.

Sales in Latin America rebounded nicely following a soft start earlier in the year. We had solid performance across all of the printer lines, with particularly strong growth in mobile printers supporting several wins in route accounting. Without doubt, Asia-Pacific stood out as the important contributor to this quarter's sales growth. Leadership put in place a year ago has received growth, revived growth and positioned the region for further success. China is once again delivering the results we expected since boosting our investment in the country a few years ago. Part of our pursuit of new business is now a sharper focus on securing large deals in the region.

During the second quarter, several recent wins included new deals in postal and agriculture. For the second half of the year, we will be maintaining our investment activities in the region with the launch of our Partners First Channel Program in South Asia and China, strengthening sales support and replicating elements of the China model in other parts of the region to support additional growth. One of our businesses that has received less attention lately from investors has been RFID. I am pleased that activity has picked up notably in business improvement applications. Not driven by compliance labeling mandates, companies are beginning to adopt RFID solutions based on hard ROI numbers.

Zebra is now involved in several of these projects. Shortly after the end of the quarter, Zebra was chosen by a large global technology hardware company and its contract manufacturer to provide printer ink coders for its production lines. We're very excited about this development, which we won in a competitive bake-off. It demonstrates the quality of Zebra's RFID products and building momentum for the use of RFID technology.

While disappointed with the order delays, the underlying business activity makes us optimistic about an improving growth trend. Clearly, Zebra is benefiting from those activities that are enabling us to deliver world-class printing and automatic identification solutions. Our investments in building global reach, product breadth and worldwide channels continue to build a more formidable company. We look forward with confidence for continued growth in the second half of the year.

Now, here's Randy to give a detailed view of second-quarter results and the guidance for the third quarter of 2007.

Charles Whitchurch

Thanks, Ed, and good morning, everyone. Second-quarter sales were just short of $209 million and up 11.5% and were at the lower end of our forecasted range. I might comment here at this point that our forecast was for $214 million, which is, our actual results was $5 million short and the entire difference here really came in very late in the quarter with the order deferrals and the inventory adjustment in some of our distribution accounts that Ed referred to earlier in our comments. So in the absence of what happened in the last couple of weeks of the quarter, we're going to be spot on with our forecast.

Hardware sales were double-digit, increasing 12.6%. We have particularly strong sales in our midrange printer line. New products accounted for 7.8% of second-quarter printer sales and this excludes any contribution from the addition of WhereNet and Swecoin products. Following five quarters of 10% plus growth, supply sales increased 2.2%, largely because of early quarter weakness in North America in the manufacturing and retail verticals. June showed some significant improvement and we had an improved backlog going into the third quarter, which makes us cautiously optimistic for the balance of the year.

In sharp contrast to the previous two quarters, North America was our weakest geography this quarter, up only 7.9%. Adding to Ed's comments, we did receive some orders from those deferred pieces of business already in the first few weeks of the third quarter. We want to remain cautious, however, on the timing of the balance of these deferred orders. Sales in EMEA, with $4.6 million of foreign exchange gains, were up by 9.9% to a new record of $76.2 million. On a constant currency basis, EMEA growth was 3.6%.

Softer sales occurred in the UK and Germany, which are the territory's two largest sub-regions, and we regard this weakness, however, as more of a hiccup based more on the timing of business, which strengthened as the quarter progressed. The EMEA region enters the third quarter with very strong momentum. Sales in Asia-Pacific and Latin America returned to very solid growth profiles. Latin America was up by 16.3%. Asia-Pacific was clearly the bright spot and was ahead by 38.7% in the quarter. We're seeing very positive results from the management changes made about a year ago, particularly in China, which had record sales for the quarter. Total international sales for the company were 52.9% of total sales and were up 14.9% over last year.

Consolidated gross margin for the quarter was 47.6% and in line with guidance. As expected, the negative effects of product mix masked excellent progress in reducing manufacturing variances from the peak in the fourth quarter of 2006. Operating expenses of $65.4 million were somewhat below forecast and included $5.8 million in charges for the amortization of intangibles and FAS 123R expenses compared with $2.7 million a year ago. Excluding these charges, operating margin was 18.9% versus 16.3% on a GAAP basis.

First-quarter investment income was $5.7 million with return on beginning balances of 5.1%. Net income computes to $0.37 a share. We generated $40 million in free cash flow. Receivables were down $12.3 million for the quarter with DSO falling to 54 days from 59.9 days. Inventories were flat and our cash position at the end of the quarter was $492 million.

We expect third-quarter sales to be between 208 and $220 million. Earnings should be in the range of $0.34 to $0.40 a share and this forecast assumes a gross margin between 47% and 48%. We expect operating expenses to be in the range of 66 to $68 million. This forecast includes approximately $3 million in FAS 123R expenses and $2.7 million in intangibles amortization. The effective tax rate for the second quarter will be 34.5%.

This concludes my formal remarks, and thank you for your attention. I will return the call to Ed for some closing comments.

Ed Kaplan

Thanks, Randy. Over the years, Zebra has delivered exceptional growth in stockholder value. We first focused on printers and their specifications, building a reputation for durability and reliability that has created the strongest global brand in our industry. Over time, we have systematically added products and technologies that help people solve real problems in identifying, locating and tracking assets and people.

Today, our leadership extends across a broad product range. This greater portfolio is enabling Zebra to drive solutions deeper and wider across the enterprise and through the supply chain. These solutions, which incorporate industry-leading bar code and receipt printers, application specific media, photo ID printing, digital photo printing, and passive RFID make us increasingly valuable to our customer base.

WhereNet extends the solution set further. Active RFID and real-time locating systems are important components to Zebra's future. These additions give Zebra even greater capability and more tools for us to build stronger customer relationships. It distinguishes Zebra further from its competitors. In this way, we're clearly building greater value in Zebra for all of our stockholders. While still early in the integration process, we're already seeing customer interest in exploring the full suite of Zebra's specialty printing and automatic identification solutions

During the second quarter, we extended our reach into new applications with introduction of new products incorporating GPS location and Wi-Fi communication capabilities. GPS is particularly important in tracking motorized equipment. Wi-Fi adds flexibility to how WhereNet tags are used. We look to the second half of 2007 and beyond with optimism. Our Channel and Strategic Account Programs are delivering the results, as we use our broader technology and product base to serve a wider range of vertical market applications. Our global reach on these capabilities, as does the strength of our channel.

Thank you for your attention. We would now be happy to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Jeff Rosenberg.

Jeff Rosenberg - William Blair & Company

Good morning. Randy, I wanted to ask about gross margin expectations, keeping the gross margin guidance range the same as it was in Q2. Can you compare that to your prior comments that you expected to see gross margin begin to make some further progress in the second half and specifically I'm thinking about the benefits of foreign exchange and okay, so go ahead.

Charles Whitchurch

Well, first of all, we're likely to get less of a comparative benefit on foreign exchange in this coming quarter than we have in past quarters. The differential between what we expect next quarter and last year is smaller, okay so it's going to be a smaller increase from foreign exchange. We are going to continue to improve our manufacturing variance performance. We've made really good progress on that early in the year. This quarter, in fact, manufacturing variances were 1.2% of sales. A year ago, they were 2.2% of sales. And they peaked in the fourth quarter of last year at 3.3% of sales. So you're going to see, by the fourth quarter, you're going to see some really substantial differences resulting from variances.

Now, all other things being equal, that would drop immediately to gross margin. But of course, all other things are not equal, and what we are indeed seeing as we are getting a half-point drag on gross margin from WhereNet, that it just operates it's currently a lower gross margin business. Now we expect that to improve over time, but there's no immediate forecast for that to happen in the upcoming quarter. And the other issue you've got working is product mix, and that's just one thing we try to be very conservative on, is inherently difficult to predict. The net of it all is the gross margins, we expect to improve sequentially on our internal forecast very slightly, but it's still within the range of guidance that we've provided to you.

Jeff Rosenberg - William Blair & Company

So longer-term, as you look at your, from where you are today, just under 19% excluding the non-cash things, you want to get that up a couple hundred basis points I think over time. I mean how much of that comes from gross margin?

Charles Whitchurch

Oh, yeah, the operating margin.

Jeff Rosenberg - William Blair & Company

Yeah.

Charles Whitchurch

Yeah. A portion of that is going to come from gross margin. We talked about some manufacturing cost reduction initiatives that we're embarking on, and we expect to see those begin to take effect hopefully starting later on this year and certainly in 2008.

Jeff Rosenberg - William Blair & Company

Okay. The follow-up I wanted to ask you was the comment you made about bookings for some of the deferred business already occurring in the third quarter. I guess what I'm semantics maybe, but I would have thought you already had bookings and they got deferred, and so now you're saying you're getting booking. Can you clarify a little bit of exactly what's happened in the third quarter in terms of -- are you shipping this stuff already or what?

Charles Whitchurch

Let's be clear in here. We fell short of our internal forecast by $5 million. If we hit the internal forecast, everybody would be happy right now. I mean you guys would be happy and we would be happy because you're happy. The reality is, as you take that $5 million, you can explain the entire amount of $5 million by some late quarter order deferrals from some major retail accounts in the US that occurred literally in the second half of June. And some inventory adjustments at one of our distributor accounts. Not ScanSource, okay. And the reality is, some of those order deferrals that we talked about have been booked in the third quarter and the balance, we're just being very cautious about at this point, when those will be booked.

Mike Terzich

Jeff, this is Mike Terzich. Let me just add a point to that, to Randy's comment. I think we were pretty solid for 11 of the 13 weeks and the deferrals did occur late in the quarter. We were more conservative in looking at those deferrals in third quarter, primarily for two reasons. There were a couple of large pieces of business with some large retailers that have previously come out in the market and indicated that they've had soft business results.

We've learned over the course of time for a long time that oftentimes translates into technology deployment, number one. And number two, we realize that the window for the deployment of the technology really is the third quarter because they get into the holiday season and they do not take on the risk of deploying new technology in the fourth quarter of the year. So that explains a little bit of the reason, why you don't see the uptick in the guidance in Q3 over Q2 even though some of the business was deferred.

Jeff Rosenberg - William Blair & Company

Okay. Thanks for that.

Operator

Your next question comes from Chris Quilty with Raymond James.

Chris Quilty - Raymond James

Good morning, gentlemen.

Ed Kaplan

Good morning.

Chris Quilty - Raymond James

Question for you, Randy, can you help us break down the North American market, if you were to strip out the WhereNet acquisition, what we're looking at for the organic growth?

Charles Whitchurch

No, we're going to decline to do that. We've said early on, when we did the WhereNet acquisition that we were not going to be providing updates. And in essence, that would provide an update on what the situation is with WhereNet. I will only say that the expectations for growth in North America would have been entirely fulfilled had we not had these late quarter order deferrals.

Chris Quilty - Raymond James

Okay. But if we look at on the other side, it's probably also fair to assume that some of the strength in the service and software also does reflect WhereNet.

Charles Whitchurch

Yes, it does.

Chris Quilty - Raymond James

Okay.

Charles Whitchurch

Yeah, that's exactly right. It's a different product mix right now. They have a much stronger component of service and software within their product mix than the core Zebra does. We have traditionally operated with something on the order. I think the numbers were something like 80% of sales were hardware related. That's down to 75% now, and that's because of the addition of WhereNet.

Chris Quilty - Raymond James

Okay. And can you just give us, whether it's you, Randy, or Ed, your general sense on the retail market. We had a big boom of activity going back to 2004, 2005 timeframe and it's been kind of muddling along for the last couple of years here. Is there a definitive trend you see in the market or any particular drivers for capital upgrade or point-of-sale equipment upgrade?

Ed Kaplan

Actually, I think I'd defer that question to Mike.

Mike Terzich

All right, Chris. It's been a, retail has been it's been tough going for the last several quarters. And where we benefited in the previous quarters as you've got two dimensions to retail? You've got new store deployments and refresh and then you have new technology sales to other retailers. And the business has been pretty solid in the Refresh and the additional store deployments, and it's been tough sledding in the new business side of the retail sector.

As you know, retail is very sensitive to their financial position and the state of the overall economy, and it swings, the technology deployments kind of swing pretty wildly with how they feel their business is progressing. And we see it on two dimensions.

We see it in order deferrals and I think Randy mentioned earlier in the call, when we look at our consumables business, we do a lot of label business through the retail sector of our business. So we expect that in the third quarter that is going to improve because you've got back-to-school promotions going on throughout retail. So we do feel that, that will improve, but a lot of the new technology deployments, it's kind of hit or miss.

Charles Whitchurch

Another point to make, and I kind of, on our overall sales result -- one of the comments that was mentioned I think in Ed's part of the prepared remarks was that, sales out from distribution were strong during the quarter. And we use that internally as a proxy for the overall health of the market. Our overall assessment is that the market in North America is still pretty good.

We did have these late quarter issues, which caused some distortion I think in our quarterly results, but the market, overall, I think, is reasonably healthy. And again, the sales being, I think the number we quoted was 15% of sales out in different distribution, and that's a pretty good number. And we're kind of expecting that our results will overall reflect that, given if you can strip out the impact of these large orders, and the inventory of swings within the channel.

Chris Quilty - Raymond James

Okay, and if I can, just a final question, Randy. You've commented that WhereNet played a role in the gross margin and product mix issue, but is really the larger question here on product mix just the fact that you are going faster in markets like Asia-Pacific, where customers are just going to want a lower value, lower margin product?

Charles Whitchurch

I think strategically, that's always been an issue with us. We've had over time, as you know, a very substantial shift in our product sales from high-end to low-end printers. And the simple fact is, I think certain markets, certain parts of the world, there is a preference for those kinds of products.

That being said, over time, we've had shown a good ability to keep our gross margins at very healthy levels despite this product mix shift. And we've done a variety of things with reducing product costs, and we continue to work on that angle very hard in order to keep the margins at the level that they've historically been. So yeah, this is no new -- this is nothing new. We've had this trend going on for our entire life as a public company.

Chris Quilty - Raymond James

Okay, great. Thank you, gentlemen.

Operator

Your next question comes from Reik Read with Robert W. Baird.

Reik Read - Robert W. Baird

Hey, good morning. I just want to go back to the comments Mike was giving us with respect to the new store in Refresh, that business has been good. Were you referring, Mike, to that is particularly sensitive to the financial position? Or is that the new technology component or both? And then also with that, can you just talk about why the deferrals, why you think the deferrals maybe occurred and how they are coming back as a result of that.

Mike Terzich

Okay. I'll be happy to do that. Now the two sides of the business, let me make sure this is clear. We have very large installed bases of products throughout the retail chain and the Refresh of that technology, when you look at a lot of the mobile printing in retail, it has a life in the field of about three to four years because it gets, quite frankly, it just gets really beat up by the user community.

So, they have to replace that. That generally tends to be smoother over the economic cycles because they can't go without it. The challenge lies on the other side of retail, which is new business, new stores, new customers, if you will, and first deployments of the technology because by and large, there's good portions of retail that are still very under-penetrated with the technology. So that should give you a little bit more clarity on the retail space in general.

Now, the deferrals basically, what winds up happening here is the deferrals wind up coming from both camps, right? You have new business. You have some refreshes. They are typically driven by the financial performance of the retailers. In some cases, they are basically pushing stuff from Q2 to Q3. In other cases, they are pushing it to Q3 but not giving us, at this point, a firm commitment as to when we're going to deploy that. And in most of the cases that occurred in Q2, we actually have built the product.

So the product is sitting, waiting to go. And we've received some orders early in the quarter, which makes us feel better. But there are a couple of large pieces that were deferred that we haven't seen yet.

Reik Read - Robert W. Baird

Okay. That's very helpful. And then just with respect to the inventory adjustment that you talked about, I guess two questions. Is one, what precipitates that? Is that the distributor? Is that you guys? What's in the marketplace there? And then secondly, is that complete?

Mike Terzich

I'll take that as well, Reik. In the distribution channel, there are three metrics that we watch very carefully, okay. And it's basically the inventory position of the distributors, the sales out, as Randy indicated, as well as our share position. And all the indices in the quarter were very positive. We tend to watch the inventory position of the distributors as much as they do, and we carefully manage that process. So there were some adjustments that were made at the end of the quarter and we put ourselves in a better position as a consequence. And I would say that where we want to be with the inventory position of the distributors.

Reik Read - Robert W. Baird

So there is no more actions that you would have to take is what you're suggesting, that actions completed?

Mike Terzich

Correct.

Reik Read - Robert W. Baird

Okay, great. Thank you so much.

Operator

Your next question comes from Ajit Pai with Thomas Weisel Partners.

Ajit Pai - Thomas Weisel Partners

Yeah. Good morning.

Ed Kaplan

Good morning.

Ajit Pai - Thomas Weisel Partners

A couple of quick questions. The first is, just looking at the cash balance that you have right now, could you prioritize what the uses of that cash would be, relative to further acquisitions with the pipeline there, as well as your share buyback, are you planning to use it?

Charles Whitchurch

Well, this is the same message we've given in prior quarters. This is the principal focus for our use of the cash is on acquiring companies to grow the company and secondarily for share buyback. And right now, the focus is entirely on acquisitions and we have a very active pipeline of opportunities. And right now, there is no formal authorization from the Board for share buyback at this point.

Ajit Pai - Thomas Weisel Partners

Okay. The second question is just related to some of the recent acquisitions that you made, and also RFID has been a business you've been investing in for a while. And we've had seen a slowdown that I think Ed's commentary suggested is turning to an acceleration over there.

Could you give us some color as to what the impact on the operating margins of some of these new investments is going to be over the next, two to maybe eight quarters? As it grows as a percentage of your business, do you expect them to have a negative impact on the operating margins or an improvement?

Charles Whitchurch

Well, I'm going to decline to comment on that point at this time.

Ajit Pai - Thomas Weisel Partners

Okay, thank you.

Operator

Your next question comes from David Sterman with Jessup & Lamont.

David Sterman - Jessup & Lamont

Good morning. I've got most of my questions answered. Might be there was some intermittent cutting out of the call. So just a couple numbers I missed. What was the European sales growth pre currency adjustment?

Charles Whitchurch

9.9%.

David Sterman - Jessup & Lamont

Okay. And you said that's south. Did I hear you right, 53% of sales now are from international?

Charles Whitchurch

Yeah, that's right.

David Sterman - Jessup & Lamont

Okay. If we could spend a little time on the North American market, and I understand there's timing issues associated with some order deferrals and other issues on the plate. But just wondering if you could give us a little look at what you're seeing in terms of end markets '07, '08 here in North America relative to either certain end markets maturing or the competitive environment.

Because I guess that's the hard part to track on a quarter-to-quarter basis and I'm trying to see a broader trend -- how a broader trend shakes out. So I'm wondering if you can just talk about North America, what you're seeing in the next few quarters.

Mike Terzich

David, this is Mike Terzich. By and large, I think I'm going to go back to what Randy said earlier. When we look at the health of the business, North America is pretty broadly distributed across multiple vertical markets. And by and large, that is pretty healthy. We had very solid double-digit growth on sales out basis through distribution.

That's always a good indicator for us for the health of the business. As you may know, we've been very steep and long, our history is very steep and long in a lot of the manufacturing supply chain sector, transportation and logistics. And those pieces of the business are pretty solid. And it's a combination of the high-touch selling effort that we've adopted to go after what I call the top of the pyramid accounts across multiple vertical markets.

We're focused on about 300 accounts across multiple vertical markets. This is large deal business. We're penetrating some new accounts. We have got a, our pipelines are growing, so the indications are that this is more a bump in the road for us in the second quarter than a harbinger of things to come.

David Sterman - Jessup & Lamont

Okay great. And then just shifting gears quickly over to the RTLS base, I know that since the acquisition of WhereNet it sounds like you guys are participating in a range of pilot programs. But as we saw with passive RFID, there was a lot of pilot activity that didn't necessarily translate into full-scale deployments. And I'm wondering if you can characterize the dynamics in the RTLS market and are you seeing pilots that are setting the stage for larger deployments or more just pilots that people feeling out the technology for now?

Ed Kaplan

I would say that we're very optimistic about the conversion of the programs that we're involved with into real orders. The difficult part of this always is what the exact timeline.

David Sterman - Jessup & Lamont

And I guess nothing you can share with us, it sounds like your visibility is not strong in terms of some conversion into a full-scale business.

Ed Kaplan

I'm just not motivated to go ahead and share with you the details of each of the accounts and circumstances.

David Sterman - Jessup & Lamont

Okay. I guess the final question on WhereNet, can you at least share with us relative to the time you made the acquisition, which I guess is now a little while back, where -- how the industry has evolved in your view positively or negatively, how would you characterize the evolution up till now?

Charles Whitchurch

Yeah, I think it's a little too early to characterize any changes in our view on that. I think, as Ed said, I think we continue to be very positive about the sector. I think one of the things that is uniquely different about the active RFID business, then the passives RFID supply chain business is that there are clearly demonstrable returns on investment from the deployment of the technology. This is well beyond the stage that the passive RFID is at, where they are still struggling to demonstrate a return on investment in many of the supply chain applications. The applications that we're involved in now are very strong, have very strong ROIs.

David Sterman - Jessup & Lamont

And then, just as a final question on WhereNet. When do you think we might start to be able to see a breakout and a meteor discussion from the revenue perspective or backlog perspective with WhereNet?

Charles Whitchurch

I wouldn't be able to give you any sense on timing of that right now. At some point I probably be some, but not in the immediate future. That's for sure.

David Sterman - Jessup & Lamont

Okay. All right. Thank you very much.

Operator

You have a follow up question from Reik Read with Robert W. Baird.

Reik Read - Robert W. Baird

Just a follow-up on the top 300 accounts that Mike talked about as kind of the national accounts that you are working with and you guys have been developing solutions for that. Can you characterize for us where that process is in terms of level of penetration? I know you are talking about getting some success there, but can you talk about where you are in terms of penetrating those accounts?

Ed Kaplan

Okay. This is part and parcel, Reik, of our high-touch sales strategy that I think we've talked about over the last couple of calls. And it is intended to put Zebra in a position, where we are just taking more control over demand generation. The primary purpose of this is to still flow that business through the channel, and it's across most of the vertical markets that we've been focusing on historically as a company.

And the nucleus of it obviously started from that retail space. So we have been engaged across all of the verticals. I couldn't tell you today how deep within each of the 300 we have been. But the effort is underway and we're working hand-in-hand with a variety of channel partners across these spaces, some of which fulfill that business, by the way, through distribution, which is reflected in the sales out numbers that Randy was talking about earlier.

Reik Read - Robert W. Baird

Okay. That's great. And then just one more question on WhereNet. With respect to, within the last I don’t know its two or three months now that the WhereNet technology was adopted by one of the ISO standards, to what extent is that helping things out? And to what extent are you able to identify some incremental sales opportunities given that Zebra probably brings something to WhereNet in terms of opportunity?

Ed Kaplan

I think standards are generally a good thing and recognition by high-profile agencies are a positive for Zebra. I don't know that we can go ahead and look at our pipeline and evaluate where standards have had an impact and where they haven't had an impact. The thing for us with this technology is that it's, while it's been around for a long time. It's suitability to create real value for corporations, is really a relatively new thing. And so we are mostly in an education process in terms of communicating to various vertical markets, the benefits that they can get from the technology. So that's really our strategy at this point.

Reik Read - Robert W. Baird

Okay. Great, thank you.

Operator

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

Greg Halter - Great Lakes Review

Good morning. There's been discussion about moving some of your manufacturing to lower cost areas at some point. I just wondered if you've made any more progress in that thought process.

Charles Whitchurch

We are continuing to work on that. As I said, we have had, over the years, a very systematic program to reduce manufacturing costs and maintain our gross margin, and that effort continues. We're moving along in the process. And I can't report anything more on that program at this particular point.

Greg Halter - Great Lakes Review

Okay. One last one. It's our understanding that WhereNet had some net operating loss carry forwards that may impact your tax rate at some point. And just wonder if you could give us a status on that situation.

Charles Whitchurch

No. Not at this point.

Greg Halter - Great Lakes Review

Okay. Thank you.

Operator

Your next question comes from Andrew Matorin with Bear Stearns.

Andrew Matorin - Bear Stearns

Hi thanks. With respect to WhereNet and the Swecoin acquisitions, can you just give us a little more insight as to whether, how it's tracking relative to your expectations heading into the deals, any color you can provide there?

Ed Kaplan

The only thing I would say about WhereNet in terms of tracking, is that this is a business that gets large orders. Since the basic business is relatively small, there's lumpiness in the orders and [technical difficulty]. I'm sorry. Do we have a connection problem?

Andrew Matorin - Bear Stearns

I think you broke out there for a moment.

Ed Kaplan

Okay. Can you hear me now?

Andrew Matorin - Bear Stearns

Yes.

Ed Kaplan

Okay, good. What I was talking about was that WhereNet's business is a very lumpy business. It's a small base, and so consequently, predictability of revenues on a month by month or a quarter by quarter basis tends to be difficult because of that nature of their business. We've been very pleased with a variety of customers that have expressed interest in our technology and specifically, the breadth of technology that Zebra is offering.

So by virtue of being in the RTLS space, it has a positive impact on other parts of our business. As it relates to the kiosk business, what we've discovered here is that our reach, Zebra's general reach on a global basis from a company that had a very modest size and very limited reach, is paying off for us. So our pipeline has been improved as a result of that acquisition and we would expect conversion of that into real business as the year rolls on.

Andrew Matorin - Bear Stearns

And with respect to that, you had mentioned that WhereNet was a drag on gross margins. Could you comment a little bit about Swecoin and its gross margin profile?

Charles Whitchurch

No. That gets into the area of individual product lines and we're not going to make any comments about that. Although, I will say that the way we look at Swecoin is as another product line within our specialty printing group rather than as a separate entity now. So it's entirely rolled in. It's just another product line like mobile and high-end printers and things like that.

Andrew Matorin - Bear Stearns

Okay. Just with respect to foreign exchange, you had made a comment that you expect to see less of a benefit this quarter than in Q2. What is the expectations embedded in your guidance for foreign exchange?

Charles Whitchurch

The expectation is for a EURO exchange rate of $1.34.

Andrew Matorin - Bear Stearns

Okay. Very good. And then, can you provide us with any update on the CEO search and where things stand there?

Ed Kaplan

We're actively working on it, but I don't have anything else to share with you at this point in time.

Andrew Matorin - Bear Stearns

Okay. Thank you very much.

Operator

Your next question comes from Andrew Abrams with Avian Securities.

Andrew Abrams - Avian Securities

Guys, I wonder if you could just talk a little bit about new products and new product development and the percentage of new products that show up in the sales numbers. You've been running, if I remember correctly, at the 10 or a little below the 10 level, and expectations were that things would start to pick up. Is there something on the horizon that you can point to for the next two or three quarters that are going to increment that new product percentage as we go forward, excluding any acquisitions that you might make?

Mike Terzich

Andrew, this is Mike Terzich. I'll answer that. And the answer is yes, we have some planned releases of products in the third, fourth quarter, and first quarter of 2008, that will lift our performance in that particular segment.

Andrew Abrams - Avian Securities

And would you expect the numbers to increment above where they've been for the last two or three quarters or are we just talking about kind of in that range?

Mike Terzich

No. I would expect that it will increment above and you have to recognize, too, that there's, because we sell through channel, it's typically about a two to three-quarter ramp-up for those products to get fully indoctrinated throughout our distribution network. But by and large, it will increment up for a significant product.

Andrew Abrams - Avian Securities

In the deferrals that you guys got from the retail sector, was there a particular segment of the retail sector where this tended to come from or are these customers just broad-based retailers?

Mike Terzich

I would say just it's broad-based.

Andrew Abrams - Avian Securities

Great, thank you.

Operator

Your next question comes from [Amos] Jeremy Grant with Stanford Group.

Jeremy Grant - Stanford Group

Good morning. Jeremy Grant with Stanford. I want to ask a little bit more about G&A in the quarter. It was, I guess, on the high side where you've been historically the last few quarters as a percentage of revenue. Is there any color you can shed on that?

Charles Whitchurch

Yeah, there is. Overall G&A expenses were up about 26% on reported numbers, good portion of that came from acquisition-related growth. In fact, if you factor in the impact of foreign exchange, I might remind you that everybody talks about the benefit of foreign exchange on the revenue side, which is the impact of the euro. But we've sterling denominated operating expenses, and when the pound is trading near $2 that kind of hurts and a portion of the operating expense increase was the result of that.

Overall, when you factor in foreign exchange, the increase in the intangibles, and 123R expenses, and the acquired expenses from acquisitions we've done over the last year, 16 points almost 27 points of growth in operating expenses came from those factors. The core business, Zebra year ago, the operating expenses were up 11%. While that is higher than the sales growth rate, the numbers that are reported are a little bit distorted from the factors, I mentioned above.

Jeremy Grant - Stanford Group

Okay. Going forward, are you able to give guidance as to whether that, I think it's around 9.5% of revenue is what we should expect?

Charles Whitchurch

Well, when you get on a comp basis, obviously the growth, a truly comparable basis, the growth in the OpEx is going to moderate. It's obviously something we have to be very mindful of going forward. Our expectation is when we're planning out the business is to grow the operating expenses less than the sales growth rate. And that hasn't worked this last quarter for sure, and that clearly didn't help us. But the truth is that the operating expenses are within the budget we set for the quarter. The problem is the sales didn't reach the number that we had anticipated for this particular quarter. They tend to be a little more volatile, as we've already talked about extensively.

Jeremy Grant - Stanford Group

Sure. Just talking a bit, you mentioned manufacturing variances and the cost of that going down and how that impacts the gross margin profile a little bit. Most of the variances, what you seen the reduction as the hangover from the [RoHS regs] fades away or are there other factors?

Charles Whitchurch

Yeah, that is. That's exactly what it is.

Jeremy Grant - Stanford Group

Okay.

Charles Whitchurch

That was a conversion that was, a lot of companies have been reporting that they have had increased expenses, as a result of the RoHS conversion and we're no different from that. And we're squeezing that out of the system overtime and we're going to make further progress on it this quarter.

Jeremy Grant - Stanford Group

Okay. And in terms of long-term, I know you said before, looking to obviously bring the gross margin profile back above 50%, guidance for next quarter obviously is much closer to what we've seen in the last two quarters. What has to happen over the long-term say next two to eight quarters to get back above that 50% profile again?

Charles Whitchurch

Well, I think we've to make further progress on the manufacturing variance front, and then, make some progress on reducing the, what I would characterize as the standard cost of the product, the core cost of the products we make. And we've programs in place to make sure that happen.

Jeremy Grant - Stanford Group

Okay.

Charles Whitchurch

So, we will migrate up, all other things being equal, the all other things mean product mix and foreign exchange. We will see an improvement in margin overtime, gross margin.

Jeremy Grant - Stanford Group

Right. And my final question was, did you guys provide average sales price for prints or number of printer sold?

Charles Whitchurch

Actually, we didn't provide that. I suppose the next question is what was it, right?

Jeremy Grant - Stanford Group

Yeah that would be my follow-up.

Charles Whitchurch

Well, why don't you holdout I'll start to give you some numbers here and see if I can dig that out for you and you can go on to another question and I'll come back. We will follow up on that, okay?

Jeremy Grant - Stanford Group

Sure. Only other question I had was you mentioned backlog, I think was up. Do you guys give a backlog number?

Charles Whitchurch

No, we don't.

Jeremy Grant - Stanford Group

Okay. I'm done then.

Charles Whitchurch

Okay.

Operator

Your next question comes from Scott Scher with Clovis Capital.

Scott Scher - Clovis Capital

A quick question. Ed, can you comment on when you think the business will get back to a level that's sort of more consistently predictable?

Ed Kaplan

You like predictability?

Scott Scher - Clovis Capital

Well, it just saves us a lot of gray hair, but I don't think it's the most important thing. I think look, I think last year people were open to understanding the RoHS issues. I think you came into this year with quite a bit of enthusiasm that things were going to get better. You made an acquisition. You seem optimistic every conference call.

And I think it's been six quarters of okay, when is this company going to get back to predictability? You've got a fantastic 20-year history of being able to be predictable at certain points of time. And I was curious, if you have some thoughts as to what's preventing you from being predictable. Is it management? Is it forecasting in this world is getting more difficult? Do you feel like you're doing a good job, but it's just too impossible to forecast this business anymore? I'm just curious what your thoughts are on that issue?

Ed Kaplan

We should have a beer and look at each other's checkpoints. We could have a hell of conversation.

Scott Scher - Clovis Capital

I love beer. That's not a problem.

Ed Kaplan

Okay. Next time you're in the neighborhood.

Charles Whitchurch

He'll be here tomorrow.

Ed Kaplan

Doug said you'll be here tomorrow. Okay. The, when of more stability, and fewer surprises is something that I don't think, I can directly comment on. But I would definitely tell you that the company is going through a series of transitions, and some of those transitions, the fallout from them have not been a surprise. And others, there have been a surprise. And if I reflect back over the course of the last 2.5 years, when we had the sharp decline in gross margin, couple years ago, that was strongly affected by change in currency and simultaneous change in mix of the products that we sold. And that knocked us for a loop and really caused us great pain in terms of adjustment.

The second event of note, which has already come up in this conversation, while we planned very far in advance relative to RoHs, and we didn't disappoint our customers in terms of delivering RoHS compatible products. It had a very, very penetrating and deep impact on the manufacturing operations of this business, and particularly things like inventory levels, and on-time delivery and variances were all going in the wrong direction; and from the middle of last year on, we faced that. We've now gone ahead and here in early '07, done an acquisition; that acquisition is a different kind of business than Zebra's core business.

It's a business that as you saw from some of the financial metrics that Randy was talking about, start moving some of our metrics in different directions. So, we've a business here that currently has a lower gross margin. It goes ahead and affects the overall gross margin of the business. We have a company that has a large component of software and services, much different than Zebra's historical business, and it has a base of business very large order business that is all sold on a direct basis, which gives us a different profile than the traditional bar-code and card business, which is really predominantly channel business versus direct business.

So, it's those drivers that are creating I'm not sure what you would call it, the instability, in the business, and so there's adjustments to those circumstances that are going on. Now, I think that the first two that I mentioned, we've adjusted to reasonably well, and things are improving in that regard. Relative to the WhereNet acquisition, and how it's going to affect the company going forward, we're working on that, and I'm very optimistic about how that is going to affect the growth of the top line and the bottom line of the business, as we go forward.

But there is some turbulence, as we do that. So, while I don't think, I gave you an answer directly to your question of when, I think even perhaps, maybe have a little better context for what it is we're facing.

Scott Scher - Clovis Capital

Thank you.

Charles Whitchurch

Okay, I'm going to have to interrupt at this point and give you one additional question, and I'm also going to respond to a question earlier about units. So, we shipped in the quarter 226,000 plus units, and the AUP was $573. So, one more question, and I will let you guys go on to your next conference call.

Operator

Your next question comes from (inaudible).

Unidentified Analyst

A couple of quick questions. One is I'm just trying to reconcile a couple of statements from the conference call. On the one hand, you guys talked about unexpected order of deferrals very late in the quarter impacting the revenue line a little bit. And later, I think you talked about how June showed some significant improvement, and you guys had improving backlog going into Q3. So I'm kind of confused on what the view actually look like in June. Was it order deferrals late in the quarter or...?

Charles Whitchurch

The comment about the strengthening of the business had to do with Europe. Europe had some weakness that they felt early in the quarter. And their business strengthened throughout the quarter, and they, the region of Europe went into the third quarter with a really positive outlook on their business. Overall in North America, on the other hand, we had very late in the quarter, some very specific order deferrals and inventory adjustments, which had an impact of $5 million on the top line. We can just specifically identify that.

Unidentified Analyst

Got you

Charles Whitchurch

Exclusive of that, my point was, we would have been very much on the forecast that we had provided to you.

Unidentified Analyst

Okay. And then two more quickies. So then if backlog being improved going to Q3, is that specifically referring to Europe or --?

Charles Whitchurch

That specifically referred to our European business. They feel very, mind you that the European business tends to be because of the vacation and the holiday schedule in Europe, tends to be their softest quarter of the year.

Unidentified Analyst

Got you.

Charles Whitchurch

But they go into their third quarter feeling pretty good about things. So, that made us feel pretty good, right? So, we had, go ahead.

Unidentified Analyst

That's encouraging to hear. And one last question. The impact of working capital on operating cash flow in Q3, any sort of insights that you can give or do you think working capital should be positive or in addition to --?

Charles Whitchurch

I think, working capital is going to be, over the next several quarters, will be neutral.

Unidentified Analyst

Neutral, okay. All right, thanks you guys.

Charles Whitchurch

That's going to have to end the call for today. I want to remind you that the next call is scheduled for I believe Monday, October 22nd, and we look forward to talking to you about third-quarter results at that time. Thanks very much for your participation today.

Operator

Thank you for participating in today's Zebra Technologies' second-quarter earnings release conference call. This call will be available for replay beginning at 2 O'clock PM Eastern Standard Time today through 11:59 PM Eastern Standard Time on Wednesday, August 8, 2007. The conference ID number for the replay is 1049754. Again and the conference ID number for the replay is 1049754. The number to dial for the replay is 706-645-9291. Again, the number to dial for the replay is 706-645-9291.

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