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Executives

Charles Whitchurch - CFO

Anders Gustafsson - CEO

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

Analysts

Jeff Rosenberg - William Blair

Chris Quilty – Raymond James

Reik Read - Robert W. Baird

Ajit Pai - Thomas Weisel Partners

Greg Halter - Great Lakes Review

Presentations

Zebra Technologies Corp. (ZBRA) Q4 2007 Earnings Call February 25, 2008 11:00 AM ET

Operator

Good morning, and welcome to the Zebra Technologies fourth quarter earnings release conference call. Joining us from Zebra Technologies are Mr. Charles Whitchurch, CFO, and Mr. Anders Gustafsson, CEO, of Zebra Technologies.

All lines will be in listen-only mode until after today's presentation. Instructions will be given at that time in order to ask questions. 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

Good morning, thank you for joining us today to discuss Zebra's fourth quarter financial results. Certain statements we'll 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. Words such as expect, believe, anticipate are few examples of the words identifying the 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 we issued this morning, and are also described in Zebra's 10-K for the year ended December 31st, 2006, 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, Randy, and good morning, everyone. I've asked Mike Terzich to join Randy and me on the call today. Mike leads global sales and marketing for our Specialty Printing Solutions business unit.

We had a solid finish to an important year of change for Zebra with record sales and record EPS for our fourth quarter of 2007. Sales for the period reflect the increasing impact of our vertical market focus, the account activities and ongoing international expansion. We achieved another quarter of gross margin improvement and our activities towards similar efficient product development process began to yield results.

During the fourth quarter, we completed the Navis acquisition and began integrating its operations with WhereNet and proveo to form our new enterprise solutions business unit. This past quarter positions Zebra well in several high growth segments. It gives us leading positions in effective verticals. And enables us to deliver a broader range of solutions that help our customers identify, track and manage; assets, transactions and people through the supply chain and across the enterprise.

We also laid the foundation for a global supply chain to support sales in high growth regions and lower product costs. This move to outsource final assembly of our printer products will enhance Zebra's to a competitive position in our core specialty printing solutions business. Overall, the change that began in 2007, and has continued in 2008, positions Zebra for improving growth and financial performance in 2008 and beyond.

Let me cover some of the highlights in our fourth quarter results. Our EMEA region concluded an excellent year with a strong finish. Sales growth for the quarter was particularly robust in the UK and the Middle East; with sales to customers in retail, postal and law enforcements. Eastern Europe is now benefiting from the label conversion and distribution facilities opened in Poland in the latter half of 2007. The region maintained good momentum going into this year.

Similarly, sales in Latin America maintained solid performance across nearly all printer product lines with especially strong sales to customers in Mexico and Brazil. Throughout the year, Latin America has been a leader in the adoption of mobile workforce solutions. The fourth quarter was reinforced by several wins in route accounting.

Asia Pacific performed as expected in a year that ended well above expectations. Growth for Greater China continued in the quarter, the result of a more focused execution oriented sales and marketing organization. In addition, the sharper focus on pursuing larger opportunities resulted in a number of wins in manufacturing and government based projects.

Asia is positioned for a solid start in Q1 with a nice backlog of business going into the quarter. We continued to gain traction in our vertical market activities with several large wins from mobile workforce, retail, and other verticals in North America. Our focus on key accounts secured several direct store delivery wins, which incorporate Zebra mobile printers.

We also did a good job in retail by diversifying our customer base and increasing the number of applications we sell into this important vertical. These applications include the sale of the first large scale rollout of self service kiosk. We were also pleased with our efforts in healthcare. Sales into this attractive vertical with a focus on patient safety increased 35% for the year.

Finally let me spend a moment on our acquisitions. Both WhereNet and proveo had solid bookings in the quarter and contributed modestly to sales. Wins during the quarter include a WhereNet installation with a major container shipping company and proveo won its third installation at the UK airport. These companies went into 2008 with good business momentum.

Overall for the quarter we made considerable progress in securing higher sales growth and greater profitability for Zebra. Record sales and earnings demonstrate the ongoing strength of our core specialty printing solutions businesses. The Navis acquisition and formation of the Zebra Enterprise Solutions business group positions us to deliver a broader range of enterprise solution to customers in targeted verticals.

Zebra now has a unique set of capabilities and scale to deliver a broader range of solutions that help our customers identify, track and manage; valued assets, transactions and people.

Now I'll turn it back to Randy to provide a detailed review of fourth quarter results and guidance for the first quarter of 2008.

Charles Whitchurch

Thank you, Anders. First, an overview. The fourth quarter was a strong period for Zebra, and our outlook for the first quarter of this year is equally positive. Sales were at record levels, gross margin expanded and earnings exceeded the top end of our guidance to a record $0.45 a share.

New printer products accelerated the 16.5% of total printer sales, sequentially up from 5.1% last quarter. Our core business growth was solid and bookings continued strong throughout the quarter. Sales growth clearly benefited from our acquisitions of WhereNet, proveo and Navis which was completed on December 14th and from foreign exchange.

We also completed a Board authorized share buyback, continuing our commitment to strategically redeploy cash and boost stockholder returns. On the downside operating expenses were above guidance. Now let's look at some of the details.

Sales in the fourth quarter were $233.6 million, a record, increasing 11.3% over an unusually strong fourth quarter of 2006. For the full year, sales were $868.3 million, also a record, and 14.3% ahead of last year.

Excluding acquired growth, Zebras' core printer and supplies business increased 3.5% over an unusually strong 4Q '06, and was up 2.9% sequentially, which in this case I believe is a better indication of the real strength of our core business.

For the full year, our core business growth was 9.7%. We believe this exceeds overall industry growth. Acquired companies had sales of $35.2 million for the full year, significantly short of our initial expectations, and due largely we believe to weakness in the automotive sector.

Fourth quarter revenue contribution from acquired companies was $16.3 million. This number includes two weeks of financial results from Navis. For the quarter, foreign exchange contributed $8.1 million to consolidated sales as the Euro strengthened 12.4% over the last year. For the full year, exchange rate movements contributed $23.3 million to sales.

Hardware sales were $177.4 million, an increase of 8.8% over the last year and comprised 76% of total sales. Supply sales were $41.6 million, up 7.8% and 17.8% of total sales.

Service and software sales were $14.2 million. This was an increase of a 103%, and shows the emerging impact of our acquired companies on Zebra's revenue profile. These sales represented 6% of total sales in the quarter, a figure that will increase substantially over the next several periods.

Next quarter or this quarter, we'll be reporting our results on a segmented basis, with the results of our acquired companies combined under a single segment Zebra Enterprise Solutions.

Geographically, we have very strong results from our international regions, combined they are up 19.5%, with exceptionally strong results in EMEA, up 26.1% and $93.9 million, aided of course by the strength of the Euro.

Sales in Latin America increased 11.5% to $16.1 million, although Asia-Pacific sales decreased 3.7% in the quarter, this was against the very strong comparison. For the full year, Asia-Pacific sales increased an impressive 17.1% versus 12.1% for Latin America and 21% for EMEA. Full year international growth was 19.1% compared 9.6% in North America.

Fourth quarter sales in North America were $108.1 million, an increase of 3.1% over last year, but against a very tough comparison. Sequential growth was 2.9%, a very solid result and more representative of the genuine progress we are making in our vertical market programs.

A key indicator of our business in North America is sales out from distribution partners. This statistic remained consistently strong throughout the quarter, as did our rate of incoming orders.

Gross profit margin increased both comparatively and sequentially to 48.5%, the highest in two years. Gross margin was favorably affected by foreign exchange, but these gains were largely offset by inventory reserve adjustments and warranty charges. Our program to eliminate loss related manufacturing variances is now essentially complete, as we begin to accelerate our program to outsource production.

Over the course of 2008, we expect $10 million of incremental outsourcing expenses to his gross margin, with another $8 million to $9 million affecting operating expenses. As I cited earlier, operating expense growth was an area of disappointment in the quarter. Our reported increase of 5.2% to $76 million is modest, but last year's spending was boosted by a large one-time charge.

Navis was clearly not in the quarterly guidance and accounted for $1.4 million of the miss. In addition we moved forward with some changes in our organization, which resulted in unforecasted severance expenses.

The balance of the miss was attributed simply to timing of expense recognition, and frankly a forecast error on expenses related to our outsourcing project and 123 R stock option expense.

Investment income was an unusually high, $8.5 million. During the quarter, we began liquidating our fund of fund investments, which caused approximately $4.2 million of accumulated profits previously carried on the balance sheet to move on to our P&L this quarter. The balance of the income is attributable to our core investment portfolio.

Comment here about our investments. We are invested in three categories of investment-grade assets, municipal securities, government agencies, and the small amount of corporate bonds with the majority being AAA rated. The minimum underlying credit of our municipal bonds is A minus. As a result, we have not and do not expect to be affected by the current turmoil in the credit markets. Earnings per share came in above guidance at $0.45, a record, on 67.9 million diluted average shares outstanding.

Couple of brief comments on the balance sheet. First, as you might expect, cash is down, both as a result of the Navis acquisition, as well as share repurchase activity during the quarter. During the quarter, we've repurchased 1.8 million shares for a total cash outlay of approximately $63 million. You'll also note that goodwill and intangibles are up, both the direct result of the Navis acquisition.

One final comment on the balance sheet. DSO increased to 59 days reflecting again the impact of Navis, whose customer base has longer payment cycles than the traditional Zebra customer. Cash and investments at year end totaled $281 million.

Our guidance for the first quarter calls for sales in the range of $238 million to $255 million and earnings of between $0.36 and $0.44 a share. Our forecast assumes gross profit margin in the range of 47% to 49%, and GAAP operating expenses of $78 million to $84 million.

It is important to note that these numbers reflect the impact of purchase accounting rules that do not allow us to recognize approximately $4.8 million of Navis deferred revenue. In addition, we will be incurring approximately $4.7 million of incremental expenses directly related to our outsourcing projects in the first quarter.

In combination, these factors impact earnings by $0.09 a share. For the full year, the purchase accounting impact on revenues from Navis will be between $8 million and $9 million. It should be fully reflected by the end of the third quarter and affect earnings by approximately $0.07 to $0.08. The incremental expense of the outsourcing project for the full year is expected to be approximately $18 million, split between cost of goods sold and operating expense. The impact on earnings will be approximately $0.18 a share.

Despite the reports of impending recession in the US, our business remains robust. Order rates continue to be strong, but we are obviously sensitive to all the recession talk, and we are closely monitoring our customer base for signs of weakness. We continue to be optimistic about the quarter and the full year.

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

Anders Gustafsson

Thank you, Randy. Zebra's performance in 2007 was the result of investments made over the years to extend our global presence, build stronger channels, and serve customers in targeted vertical markets better, with innovative and reliable products.

During the year, we initiated new activities to extend our leadership in specialty printing solutions even further. We have also invested in attractive businesses that are our natural adjacencies to our core business. These business offer higher growth potential and will enable us to serve customers better with a broader range of technologies and solutions to identify, track and manage valued assets.

In 2008, we will build on this activities to accelerate growth and increase profitability.

Within specialty printing, we will maintain our global expansion activities. Globalization of world economies, increased focus on supply chain efficiency, and greater concern over safety and security, continue to support high growth around the world for bar-coding and other automated identification solutions.

Our plans for supporting these global expansion efforts include a deeper penetration of targeted vertical markets. Our success in healthcare, by focusing strategically on solutions for specific applications is an excellent model for further expansion into retail mobile workforce and government, as well as manufacturing, and transportation and logistics.

Much of this focus will be accomplished with a mission to increase Zebra's involvement with the customer. Our drive towards greater customer intimacy will help us deliver new solutions that truly meets their further printing and identification needs. Our focus going forward will also be on cost control and margin expansion.

Earlier this month we announced an initiative to move final assembly of Zebra printers to a third party electronics manufacturer in China. We calculated the upfront cost for this program at $24 million to $26 million, with about $18 million to be incurred in 2008. Financial benefits are expected to begin accruing in 2009, with a full impact, currently projected at $25 million to $30 million hitting in 2010.

We are also well aware of the needs to manage operating expenses, particularly in the face of a potential economic slowdown. Capturing synergies across our business will be another activity we will be undertaking this year to unlock value within Zebra. Some of the opportunities we are finding to save cost and drive growth include consolidating printer manufacturing into a single supply chain emerging card and bar code sales in emerging organizations, and consolidating our Warwick label conversion facility with our newly opened operation in Avena.

Acquisition integration is also top priority for Zebra in 2008. During the year, we will combine the data acquisition technologies and solutions that WhereNet and proveo brought to Zebra, with Navis' enterprise systems. The combination of these elements give Zebra a unique end-to-end solutions that maximizes our customer's visibility over their supply chain. We are truly excited about bringing these businesses under one roof and believe they were an excellent investment for Zebra. The first stages of reconsolidation in to Zebra in 2008 has gone well.

Let me conclude with a comment on capital efficiency. As Randy mentioned, we bought back 3 million shares of Zebra stock in 2007. Today we announced that the Board has authorized the purchase of an additional 3 million shares. We believe acquiring the Zebra stock is a vote of confidence in Zebra's future and a good use for the excess cash that we generate. Going forward we intend to be more deliberate in our buybacks, mindful of cash needs for acquisitions and other corporate activities.

Thank you for your attention. We appreciate your time and interest in Zebra. And before we open the call for questions I want to remind you about Zebra's upcoming Analyst Day, which will be held in New York city this Friday. Please check our website for details and registration.

And we would now be happy to answer any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Jeff Rosenberg of William Blair.

Jeff Rosenberg - William Blair

Good morning.

Charles Whitchurch

Good morning.

Anders Gustafsson

Good morning.

Jeff Rosenberg - William Blair

Randy, could you breakdown for us on the $4.7 million for outsourcing expenses, how is that split this quarter between cost of good sold and operating expenses?

Charles Whitchurch

Later in the call, I can. I don't have that handy right with me now Jeff, why don't you just contact me later. Normally for the full year it is $10 million of COGS and $8 million of OpEx, so you can proportionalize the first quarter roughly along the same lines or maybe pretty close.

Jeff Rosenberg - William Blair

Okay, and just in terms of looking at the acquired growth, can you give us how much acquired growth we should assume or hold in Navis, in the first quarter and or I think, remind us what that would have been in the first quarter.

Charles Whitchurch

I’m not going to segment the guidance at this point Jeff. I think I'd like to make a comment at the analyst day.

Jeff Rosenberg - William Blair

Okay, but just in terms of how we think about those the seasonality, if you will in those $60 million that we’ve talked before granular, can you give any sort of help, I’d like to understands what the core business is doing, quarter-on-quarter in Q1?

Charles Whitchurch

Quarter-on-quarter in Q1, you can, okay. You can anticipate that the core business will do somewhat in the range of $213 million to $225 million with the balance coming from the acquisitions, the Enterprise Solutions group.

Jeff Rosenberg - William Blair

Okay, alright.

Charles Whitchurch

But that as far as, I’m going to go. Any more information you have to get from us out at Analyst Day.

Jeff Rosenberg - William Blair

All right, well, I’ll be there. And then last question I'll ask you is just for some color on the strength in the acquired revenue in Q4 versus throughout the course of the year. I assume that that wasn’t too much of that due to proveo. So it sounds like a pretty positive lump of revenue in WhereNet maybe some color there in terms of what happened there?

Charles Whitchurch

We had a good increase in activity in the Enterprise Solutions group in the fourth quarter. We mentioned in our comments that overall for the year, we were disappointed in the revenue results from WhereNet in particular, and this is largely attributable we believe to some weakness in the automotive sector, which caused some order deferrals. So, again, in the fourth quarter the results were actually pretty positive. So, we’re going into the year with some momentum and we are pretty encouraged about the direction of the business right now.

Jeff Rosenberg - William Blair

And can you give us a little bit of just how much of that we should consider to be lumpiness in big orders that come through versus, visibility into that really sustaining?

Charles Whitchurch

I really rather not provide any more color at this point.

Jeff Rosenberg - William Blair

Okay, alright thanks.

Operator

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

Chris Quilty – Raymond James

Good morning gentlemen.

Anders Gustafsson

Good morning.

Charles Whitchurch

Good morning.

Chris Quilty - Raymond James

Just wanted to clear up an item Randy, on the guidance here and the forward treatment of deferred revenues. Well it's sort of a new item, so if you can give us your philosophy?

Charles Whitchurch

Yeah, with software companies, if you would say it's one of the weird things about purchase accounting rules. There is a certain amount of deferred revenue that was on the books of Navis when we bought it, and we Zebra, as the acquirer are unable to recognize that revenue. We are only able to recognize a very small portion of it actually and it's particularly a key when you acquire a software company, because the fulfillment cost of the revenue is very small, and the fulfillment margin on this revenue is very small. So, we only get to recognize a very small portion of the deferred revenue that they've got on their books and the impact of that is -- for the total year at Navis, we estimated between $8 million and $9 million, and because it’s a software company, most of that lost revenue converts into lost operating profits to the tune of $0.08 to $0.09 a share. I mean it's really significant. We will be through this, mostly in the first two quarters and I am pretty assured that we're going to be completely fueled by the end of the third quarter. So in each of the first two quarters, our GAAP revenue from Navis will not reflect the real reality of their business. That's just a fact.

Chris Quilty – Raymond James

Fair enough.

Charles Whitchurch

I think acquisition of software companies just has this weird result and we are just going to have to live with it and that's it.

Chris Quilty – Raymond James

Okay. But you do on a cash basis recognize the deferred revenue?

Charles Whitchurch

Yeah.

Chris Quilty – Raymond James

Okay, so I mean, I guess the point I am getting to is midpoint of your guidance is $0.40, you've got the charge for restructuring, which is 4.5; let's call it $0.05. If you reported $0.45, it would be in line with what the guidance was. The deferred revenue is something that's going to be picked up in a forward quarter and shouldn't be something that would be backed out of what we had modeled.

Charles Whitchurch

Let's talk about this offline, but yeah, it should be because we're not getting credit for this revenue and consequently, we're not getting credit for the profit on the revenue.

Chris Quilty – Raymond James

Okay, fair enough.

Charles Whitchurch

So in the first quarter that's going to have a negative impact on our results of $0.04, if we were able recognize that deferred revenue, our earnings would have been $0.04 higher but we can't and those are just the rules, we have to live with it.

Chris Quilty – Raymond James

Okay. With regard to geographical sales, I know you don’t give a breakout on the acquired revenues, but is it fair to assume then if we backed out the acquired revenues, North America probably would have looked negative on a strong year ago comp?

Charles Whitchurch

That’s right.

Chris Quilty – Raymond James

Okay. And I think you and.

Anders Gustafsson

Excuse me slightly positive, right. Very slightly positive or very basically even flat.

Chris Quilty – Raymond James

Okay. And you indicated that the Q4 over Q3 is a better indicator, but Q4 is always up over Q3. So just in general...

Charles Whitchurch

Not to the extent that fourth quarter was last year. I mean, we had just a huge surge in the fourth quarter of last year which was quite unusual on a sequential basis, even for Zebra. We are typically, that is typically the strongest quarter of the year for us, but it's not that strong.

Chris Quilty – Raymond James

Okay.

Charles Whitchurch

As it was last year. I think we went from $208 million to $217 million. I mean, it is just a …

Anders Gustafsson

187 to 209.

Charles Whitchurch

187 to 209, that’s right.

Chris Quilty – Raymond James

Alright. But just in general, the outlook for the North American business. Is there anything about either that you are hearing from the channel or from large orders in the pipeline that would give you any kind of confidence about how North America is going to pan out the year ahead?

Mike Terzich

Hey. Chris. This is Mike Terzich. I will take that. The couple of things that I thought were very interesting in the way the year finished. And a lot has been discussed relative to retail outlook, which is a big portion of our business in North America. And the composition of our business has changed for the positive. And what I mean by that is we have been less dependent now on a go forward basis with some of the big box retail business that we had seen in the past. And so we have built a nice diversity to our retail business, which really helped as we exited the year.

From an outlook standpoint, I think we mentioned in the prepared remarks that sales from our distribution channel is a very healthy proxy for the state of our business, and that number continues to impress us. It's been very solid and we don't see a letup on the rate of bookings that we are seeing from that portion of the business. But we actually feel that we exited the year in better health in North America than we've seen over the last fourth quarters.

Anders Gustafsson

I guess add to that we can say also that our manufacturing sector has been performing well in the US, partly, in think, pulled by the weakness in the US dollar.

Chris Quilty – Raymond James

Great, okay. Thank you gentlemen.

Operator

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

Reik Read - Robert W Baird

Hey, good morning. Just to follow up on that, I mean it just seems like a lot of the strength that you guys are seeing right now is in that core business and in some respects the end market looks so, so neither good nor bad. But can you guys pinpoint little bit more in terms of what's driving that, is it a couple of specific verticals that are seeing some strength? Is it the diversification that you are talking about in retail? Is it new products? Any color you can provide there would be helpful?

Anders Gustafsson

I guess the first point would be, I think we see the base business is being quite strong at the moment and there is lot's of trends I think in the industry that will give us some level of confidence that that would continue for sometime. There is, all the supply chains are getting much longer and more complex and more focused on cost reduction, supply chain agility and so forth, drives a lot more investments into supply chain. And I think that that is something we expect that we will be well paced to take advantage of also.

We have seen I think in the U.S. certainly a pretty robust base business, our vertical market activities are working out quite well for us so far. I think that several of them are growing quite nicely. I think I mentioned in my opening remarks that healthcare was up 35% and also I think there is still a lot of growth coming from the international markets. So overall I think our core business is doing quite well and we feel it is being quite robust and we believe we are taking share.

Reik Read - Robert W Baird

For a long time, we have all been discussing healthcare in these conference calls. Is there something that you guys are seeing different that's causing that market to really move forward?

Mike Terzich

Right, this is Mike. I would say the difference now is we have been at it as you know for, I think your point long time we have been making investments in this space on a real deliberate basis for about 40 years. And we are finally seeing a point where at the patient safety level, choices are being made to invest in technology that can deliver the efficiency that the hospitals would like to see in the patient safety improvement that the hospitals would like to see. And for the first time we are seeing those investments are taking on equal weight as some of the other technology investments that hospitals typically made. So we see it's reflected in the pipeline of opportunities that we built, we have been working with the largest hospital management information system integrators that there are in the marketplace, and the pipeline has improved considerably and we exited the year with some strong business results for the company.

Reik Read - Robert W Baird

Okay. And then just going back to the WhereNet side, I think Randy as part of your comments you've mentioned auto was weak, I take it from what you're saying in terms of how you finished the year that auto started to strengthen. Is that something you continue to see as you get into '08? And then also can you guys comment on transportation logistics and how that verticals doing with WhereNet?

Anders Gustafsson

The automotive business is still kind of so, so right now for WhereNet. I would say that I did mention that we had nice acceleration in combined sales from both WhereNet and proveo in the fourth quarter and was actually quite significantly the strongest quarter of the year for those two companies. And Mike do you want to comment on the transportation or make any comments on transportation logistics vertical?

Mike Terzich

Our transport and logistics vertical across the whole of the business has been very strong and primarily due to some larger postal opportunities, some transportation opportunities that we've won internationally, so it's doing well.

Reik Read - Robert W Baird

Is that postal in Europe have to do with the deregulation?

Mike Terzich

Some of them.

Reik Read - Robert W Baird

Okay. And then just last question on expenses, with respect to the things that you're doing in terms of solution selling, putting Navis and WhereNet together, those are causing expenses to kind of come up. Can you talk a little bit about, if you look at couple of quarters out, how should we see that, given the guidance that you've given us today? How should we see those expenses? Will they stay relatively flat, or will they start to come down as we get later on in the year?

Charles Whitchurch

I wouldn't, I’m not going to forecast anything more than the first quarter right now, other than to say that clearly operating expense management and control is a very high priority for us in the first quarter. We did this in our guidance in the fourth quarter; due to combination of things that would have not being forecasted and quite frankly some forecast errors.

So, we really dug into what was going on in the spend rates, in particular in the core business, and reached a the conclusion that core spend rate, if you adjust for some of the things like the severance cost, and some timing issues that were clearly onetime in nature, it basically, okay. We are monitoring it, we are expecting to finish the quarter within the guidance we’ve provided you, and we are being very sensitive to making spending commitments by hiring a lot of people because of all those talk about the potential weakness in the economy, which although we have not seen anything in our business is obviously going to be something we’re going to be watching very carefully in the year. So we’re going to make sure we get the revenue result before we release the spending.

Reik Read - Robert W Baird

Okay. Guys, thanks very much.

Operator

Our next question comes from Alit Pai with Thomas Weisel Partners.

Ajit Pai - Thomas Weisel Partners

Hello, good morning.

Charles Whitchurch

Good morning.

Anders Gustafsson

Good morning.

Ajit Pai - Thomas Weisel Partners

A couple of quick questions, I think the first is about your Asian business, and I see that it was down sequentially. Can you give me some color, as to what’s going on over there, one just in terms of the seasonality of demand, but more importantly when you are setting up the China business and the what is your strategy in terms of being able to price in that market, that could be your conditional pricing strategy in that market, and could you give us some color, as to what the competitive dynamics you are facing over there are, as well?

Charles Whitchurch

That was a lot of questions in one I think. I guess first, the Asian business was down a little bit on an annual comparison, but the growth year-over-year was very robust in Asia, and China has been one of our fastest growing countries in the past year, and is now our third largest revenue generating country worldwide for us. And I think we are making good progress from that perspective, we also signed up, I think it was 50% additional new partners in greater China region in 2007 to make sure that our reach got much better.

The competitive environment in Asia. I would say, it's a little different frontier in that we do find, face some more local competitors. They tend to be very much at the low-end, but our business for most of our product lines are unaffected, but we certainly holding on our own and we believe gaining some in those areas in Asia as well.

And I think that will also go for the pricing environment that we see on the mid-to-high end of our product range, we're holding our prices quite well.

Ajit Pai - Thomas Weisel Partners

So when you shift part of your production to China, is that going to be able to -- unlike the margins that you are seeing right now is it comparable to your corporate average across the world, or is it actually lower when you're selling in Asia. And shifting production there, does part of that to actually help with the margins over there?

Charles Whitchurch

The intent of moving our manufacturing to Asia, is not to really give it back as price concessions, it is really to make sure we improve our gross margin and as times goes, I mean there is always some price erosion in the market. I hope to hold onto most of that ourselves. And not really looking at this as a way of enabling us to be more aggressive on price in Asia.

Ajit Pai - Thomas Weisel Partners

Got it. And then you talked about 18 months to 24 months for that transition to be complete. In the meantime, when do you think you'll see the biggest sort of savings? Is it going to start beginning like in early 2009 and accelerate as we go through the end of the year? At what point will these sorts of redundancy in expense where you have the infrastructure in the US and in China starts showing the most drastic fall?

Charles Whitchurch

I think in general, we're going to start to see some benefits beginning in 2009, but I think for further detail on that, it will be best to attend the analyst conference.

Ajit Pai - Thomas Weisel Partners

Got it.

Charles Whitchurch

We will have more -- we will have presentation by our operations people and they will provide a little more color to the outsourcing strategy.

Ajit Pai - Thomas Weisel Partners

Okay. And then just in terms of the Latin American trends you talked about, I think you specifically mentioned Mexico, and you mentioned Brazil. So historically, Mexico has been tied a lot into what's happening in the US economy. So was the trend you are seeing in Mexico much more to do with local retailers that are selling into the Mexican economy, or is it to do with the lot of folks that are producing for the US? And then in Brazil, like the level of penetration and strength you have been seeing, how long do you think it is going to continue?

Mike Terzich

Ajit, this is Mike, I will answer that. The business in Mexico is similar to some of the business that we are seeing Asia. That business tends to be influenced by some large deal opportunities, and we see a little bit of lumpiness in our business. So I think when we go on a go forward basis when we are drawing comparisons, quarterly and sequentially, in both of those regions, oftentimes the quarter result is influenced by some large deal opportunity and we have been making that a specific point of focus, both in Asia, in China and in Latin America as well.

And so in Mexico, the strength that we saw in the quarter was that we won several large pieces of business. And that business was across the manufacturing sector and the retail sector and also in the government sector owing to some security applications. So our focus has been entirely on continuing to drive large deal opportunities. We don’t really have any insight as to, at the core level, I think the business has been fine, it's been steady, it's been pretty solid and we are supplementing it with some large win opportunities.

As far as the outlook, I would say Brazil is similar. We have been concentrating on extending ourselves vertically in lot of the mobility applications, and the retail applications are very attractive in the Brazil marketplace as well, and we don't see anything in the foreseeable future that is changing our view at this point.

Ajit Pai - Thomas Weisel Partners

Got it, and then just in terms of operating margins I think this fourth quarter was probably the lowest margins on the operating side that you have delivered in many years. Looking out into the next three quarter's I think you're going to have redundant expenses and redundant cost structure for at least the next two to three quarter's before the savings start kicking in. Would it be fair to assume that even given the challenging environment as long as you have growth on the top line even if it is very modest that the operating margins will sort broaden in the first half of '08?

Charles Whitchurch

Well, our objective is to improve operating margins. Let me just leave it at that. The expectation is that operating margins over time will expand as both as a result of the benefits that will begin to happen, accrue to us as a result of the outsourcing activity but also integrating to be more successful on the integration our acquisitions and frankly working on improving internal processes helped in some degree by technology.

Ajit Pai - Thomas Weisel Partners

But the timing of that would you say that it would be…

Charles Whitchurch

I am not saying, I am saying we should see some improvement in operating margins in 2008.

Ajit Pai - Thomas Weisel Partners

Okay, thank you so much.

Charles Whitchurch

Well thank you.

Operator

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

Greg Halter - Great Lakes Review

Good afternoon guys.

Charles Whitchurch

Good morning.

Greg Halter - Great Lakes Review

Good morning I guess it still is. Lot of questions asked already. One regarding your capital spending level for '08, do you see any sort of big increase into the current year given the acquisition?

Charles Whitchurch

Not at this point, no.

Greg Halter - Great Lakes Review

And any figure that you may throw out there as a range for what you expect really?

Charles Whitchurch

No.

Greg Halter - Great Lakes Review

Okay. And wonder if you could provide an update on how things are moving in the passive RFID side?

Charles Whitchurch

Yeah on the passive side, we met our growth objectives for 2007. The outlook we have is for further and more of you know for the consistent growth 2008. We see more closed-loop pilots applications where we have solid return on investment in pretty short paybacks and we've also seen some more growth with Wal-Mart, using the Sam's Club operation there, and also the METRO group in Europe. But I think we would also say that we don't expect kind of the times driven market to really be the driver for growth. We see a lot of opportunities now in the active RFID side and also in more of the close loop applications where it's easier to get a very solid return on investment.

Greg Halter - Great Lakes Review

Okay. And would you happen to have the figure for what ScanSource representative sales in either quarter or year or both?

Charles Whitchurch

Let me get back to you on that. I agree it was 16% in the quarter.

Greg Halter - Great Lakes Review

Okay. Thank you very much.

Operator

Our next question is a follow up from Chris Quilty with Raymond James.

Chris Quilty - Raymond James.

Randy, just a quick question for you. Did you give a feedback on the supplies business, and a little bit of a slowdown there that's often at times a leading indicator on the printer side of the business?

Mike Terzich

Hey, Chris this is Michael. Let me answer that. I think Randy mentioned that in the prepared statements that we actually saw some sequentially improvements in the supplies business. We measure supplies sales as a good proxy indicator for the health of our business actually the fourth quarter across the whole of the business, supplies growth was very solid, near double-digit growth on a consolidated basis between the SPS business and the current business.

So that was probably the best quarter performance we've seen over the last couple of quarters. Now wrapped in that number, we tend to put other things like aftermarket products and some other parts of our solution offering and, so that maybe a bit misleading but the health of the supplies business was actually very good, and it was nice to see because it's been a little bit softer associated with some of the large retail rollouts that we had previously won.

Chris Quilty - Raymond James.

And pricing trends there are seeing relatively static?

Mike Terzich

Pretty much, pretty much, I think pricing for us has been very stable and I think there is a lot of conversations on just our regular, what's our AUP, what's the environment like and I will tell you that very isolated issues of pricing, but by and large Anders' earlier point we've seen improvement in a lot of our AUPs across all of the product families and supplies is no different.

Chris Quilty - Raymond James.

Okay, great. And final question on the restructuring activities, fair to assume that almost all of those cost benefits, I think you said about $25 million to $30 million by '10 are going to accrue in cost of goods sold and benefit gross margins?

Mike Terzich

Actually, the incremental cost of the project, they're going to be split between -- the benefits will accrue in gross margin, the cost will be split between gross margin and operating expenses. Most of the benefits are gross margin, but there are some in manufacturing overhead and other things that come below, but it's by far the most is in gross margin.

Chris Quilty - Raymond James.

But at this point even with the downsizing of the operations there in Illinois, have you plugged into that any facility closings and removing overhead and those of sort of items?

Mike Terzich

Yeah, in the out years we have, yeah.

Chris Quilty - Raymond James.

Okay. And actually I think you’ve mentioned the consolidation of the barcode printer and ID card printer?

Anders Gustafsson

Yeah, what we have done is that first we consolidated the supply chains for our barcode and the card printing businesses as we now outsource. We've got to have one organization that we are deal with the outsourcing partners and get all the efficiencies and benefits of that. So, that was one of them.

We also decided to consolidate our sales and marketing activities for barcode and card as we deal with many of the same customers and we have as many of the same issues in particular as we start looking to extend and grow the card business into a more emerging markets. We already have resources from some of the barcode printing side there, but not necessarily from cards. So, we have a better chance of leveraging some of the investments we have already done there to ramp revenue without any commensurate increase in expense.

Chris Quilty - Raymond James.

Okay. So do you end up losing [Camero]?

Anders Gustafsson

Camero, it will not going away.

Chris Quilty - Raymond James.

Okay, great. Alright, thanks again guys.

Anders Gustafsson

Thank you.

Operator

Our next question comes from Jeff Rosenberg with William Blair.

Jeff Rosenberg - William Blair

Hi. I want to ask gross margin follow-up. You said 47% to 49% in Q1, right. I guess, I'm trying to understand, maybe this is all related to outsourcing, but with folding in a software business incrementally (inaudible) gross margin and then you had some of the higher expenses from the reserves and warranties, why wouldn't gross margin to be moving up in Q1?

Charles Whitchurch

We are not moving up because we are incurring some incremental cost relating to outsourcing.

Anders Gustafsson

Those are going to affect gross margin. We've analyzed the same both from the sales mix and cost perspective and this is where we come in. From the software perspective, there's two things there, one is the purchase accounting issue that Randy talked about there we will differ some $4 million, or not recognize $4 million. The other part is that the Navis business or the ES, enterprise solutions business has a large component of services. So, that obviously has costs associated with it also.

Jeff Rosenberg - William Blair

I mean should we be thinking excluding the outsourcing issues that would be improvement in gross margin maybe not getting down in the quarter, but just in general, gross margin should be trending up, as we move past these three items?

Charles Whitchurch

Yes.

Anders Gustafsson

Yes. I think it's the answer.

Jeff Rosenberg - William Blair

Okay, and then the other follow-up on the FQ was -- Randy what sort of interest rate are you assuming on you cash as you come up with your forecast?

Charles Whitchurch

4%.

Jeff Rosenberg - William Blair

I am sorry, what was that again?

Charles Whitchurch

4%

Jeff Rosenberg - William Blair

4%. Okay, thank you.

Operator

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

Reik Read - Robert W. Baird

Just as a quick follow up on retail, the market has been pretty weak in the bar coding space in the last couple of years. Is some of the improvement that you're seeing just in that market maybe coming back and coming up on the priority list, or is it new customers or is it both? Any color you can give would be great?

Charles Whitchurch

I think this is an example where our vertical market activities have worked quite well for us, in that we have been able to penetrate much deeper into the verticals. So, we're less dependent on some of the very large retail organizations and we've also been able to introduce a number of new applications, so in that respect we're dealing with lot more customer. We had much broader customer base and been able to replicate a lot of successes we've had in some applications across a much wider base in all of the accounts. So, the overall market for us was up slightly in 2007, but some of the larger accounts were down a little bit more.

Reik Read - Robert W. Baird

Okay. And so you think about new accounts and new applications is really driving the growth right now and the market might help you a little bit, but not much?

Charles Whitchurch

Yes. I think that’s correct.

Reik Read - Robert W. Baird

Okay. Great. Thank you.

Operator

(Operator Instructions). Okay. There is no further questions. I will turn the call back to the managers.

Charles Whitchurch

Okay. In that case, if we don’t have any more calls, we will end today's session, but again, I would like to invite you and encourage you to come, visit and attend our analyst day in New York next on Friday.

Anders Gustafsson

And one last comment, our next conference call is currently scheduled for April 23rd at 10 o’clock and we look forward to reporting great results for the first quarter. Thank you for your participation today.

Operator

Ladies and gentlemen. This concludes today's teleconference. Thank you for your participation.

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